Fuel Costs Crushing Carriers

The growing cost of fuel continues to dampen domestic airlines' prospects for profitability this year, as one analyst likened the magnitude of fuel costs to the fallout from Sept. 11, 2001, and raised his voice in the growing chorus for drastic industry downsizing.

JP Morgan analyst Jamie Baker said plans for industry consolidation and the recent downfall of several smaller carriers would not take enough capacity out of the domestic system to yield profits in 2008. Major domestic carriers' first-quarter losses reported in recent weeks set the tone for the year.

Though many major carriers continue to scale back capacity growth for 2008 on top of downward demand projections established earlier this year, it likely is not enough, Baker said, as the fuel bill for the industry likely would exceed 2007's "by at least $15 billion," a figure he said "roughly approximates the operating impact the industry withstood as a result of the 9/11 terrorist attacks."

Unless current fuel prices abate, "the industry needs to downsize anywhere from 15 percent to 20 percent in order to recalibrate for profitability at current fuel prices," Baker said in a research note following the announcement of the Delta-Northwest merger agreement.

The growing cost of fuel already has proved fatal for several carriers, helping to sink Aloha, ATA and Skybus. Baker said the cessation of those carriers would take out about 1 percent of system capacity. "Every bit helps, though in this case not by much, in our view," he said.

Fuel costs also partially contributed to Frontier Airlines' Chapter 11 bankruptcy protection filing in April. Though Frontier said a policy change by its primary credit card processor to increase the share of customer receipts it would hold forced its hand into Chapter 11, Frontier president and CEO Sean Menke also cited "unprecedented and significant increases in the cost of jet fuel."

Baker predicted even more gloom and doom for an already gloomed and doomed industry, predicting others would follow Frontier's path. "Unless fuel prices rapidly retreat, it stands to reason that additional carrier bankruptcies cannot be ruled out. After all, no recession since the industry deregulated has failed to include the bankruptcy of at least one—more typically, several—carriers of size."

Some eyes have turned to American Airlines as a candidate, one of two legacy carriers that avoided a Chapter 11 filing in recent years.

Following AA's first-quarter earnings report, UBS analyst Kevin Crissey said the carrier "is seeing its annual costs rise at about $1 million per hour. That is what AMR has faced in fuel costs so far this year."

Baker said, "Our base case remains that AMR avoids a bankruptcy fate, but we simply cannot ignore the potential realities of current fuel and economic conditions in which the company may be forced to operate for a sustained period of time."