Airfares stay low, for better and for worse

Passengers benefit, but the industry is running on empty.

To fly or not to fly often depends on the price.

Despite a recent nudge upward in fares, ticket costs are still so low that a record number of Americans are opting to hop a flight for a quick business trip or a weekend getaway.

But a dispute is now brewing among analysts as to how long those low fares will last. The outcome will determine not just how much Americans pay for a flight, but the health of the nation's so-called network carriers – the backbone of the US aviation industry with their hub-and-spoke system.

For most of the past five years, the network carriers have been wallowing in red ink, and they're just now returning to profitability. If fares continue to rise, the sector can recover, say analysts. If they don't, it could mean more trouble ahead.

"What's at stake for travelers and for the country is the democratization of air travel that came about as a result of deregulation.... Almost anyone can basically afford to run down to Florida now," says Kevin Mitchell, chairman of the Business Travel Coalition in Radnor, Pa. "That could be jeopardized."

Last week, American Express's "Business Travel Monitor" – a leading aviation industry analysis – reported that the price of hopping a plane made a double-digit jump in the second quarter of this year. Fares were expected to continue to rise well into 2007.

The increased price of jet fuel, combined with a hike in the number of people flying on fewer available seats, had given airlines back their pricing power. That prompted some analysts to predict that Americans' heady days of cheap air travel would soon be a thing of the past.

But other factors have held sway: the recent fall in the price of oil, a slowing economy, and the low-cost carriers' ever-growing share of the marketplace. That combination has prompted some other aviation analysts to predict that instead of rising, airfares could go into a sudden free fall.

"We've got what looks like a perfect storm coming for prices to plummet, at least in the short term," says Mr. Mitchell.

The reason: As the price of jet fuel drops, low-cost carriers will be able to continue to offer lower fares, undercutting their rivals' ability to raise prices. The low-cost carriers' share of the market has already jumped from about 12 percent in 2001 to a projected 28 percent by the end of this year.

Mitchell says that "eye-popping" statistic could mean serious trouble for the nation's network carriers in the short term, and trouble for consumers in the long term.

"Our network carriers' balance sheets are still terrible, especially compared with the global competitors around the world," he says. "If fares drop further, we're probably in for a period of slow liquidation. To the extent that the system shrinks, and these airlines continue to fail, there will eventually be fewer seats available for the kind of rock-bottom prices we've been seeing for all of these years."

The ongoing threat of terrorism is another factor that could undermine the network carriers' ability to raise prices. The disruption of the plot to blow up as many as 10 airliners from Britain prompted US authorities to ban liquids and gels in carry-on bags, adding to an already-high-hassle factor at security checkpoints. The new rules prevented many people from making their overnight bag a carry-on item, which put a damper on some short-haul flights.

"This is still destabilizing and another reason why airlines can't raise prices. People are still nervous," says Richard Gritta, an aviation expert at the University of Portland in Oregon.

On Monday, the Transportation Security Administration announced that it will now allow some liquids and gels in carry-on baggage. But the agency was very specific, which some analysts say could add to travelers' confusion and frustration.

Other analysts think the changes will help the airlines, particularly in terms of business travelers who often take nothing but a carry-on bag. "We think we're going to see a return to short-distance flying. Before, some people didn't want to check their overnight bags [and opted not to fly]," says David Stempler, president of the Air Travelers Association in Washington.

Aviation analysts like Mitchell believe that in order for the overall US aviation industry to return to economic vitality, Congress needs to step in and formulate some kind of national aviation policy that will allow both the low-cost carriers and the network airlines to thrive in the same environment. In the past, the network carriers depended on the big premiums paid by business travelers to cover their costs, which are significantly higher than those of the low-cost carriers. But the business community has discovered not only the low-cost carriers, but also the cheap leisure fares available on the Internet. A study by AirlineForecasts found that in 2006, 50 percent fewer business people are paying the higher business fares than in 2001.

While the network carriers have made great strides in cutting labor costs and increasing efficiencies over the past five years, their costs are still high.

"Their costs are still way, way above the low-cost carriers, and the premium they can get for business travel has been evaporating," says Mitchell.

He and others contend the major network carriers, despite their problems, are still central to the health of the aviation industry, as well as the overall economy. They have the largest systems with international connections, which businesses still depend on. The challenge is to find a way for them to make money in this highly competitive market.

"The fact is that it's consumers who have pushed this industry along with deregulation to lower fares, and to survive in the long-term revenue climate, you've got to get your costs of production down," says John Heimlich, chief economist of the Air Transport Association, the lobbying arm of the major carriers.

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