Costly Fuel, Economic Woes Weigh Down U.S. Airlines

Merrill Lynch now predicts that the eight largest U.S. carriers will post combined losses of $1.5 billion this year, compared with a previous forecast for a collective profit of $1.7 billion. J.P. Morgan analyst Jamie Baker expects wider industry losses of between $4 billion and $9 billion this year, and a slump in travel demand starting in the second quarter. The airlines have hoarded big piles of cash, estimated at nearly $25 billion at the end of 2007. But while oil prices retreated yesterday, falling $4.94 to $104.48 a barrel on the New York Mercantile Exchange, they remain near all-time highs. And with jet-fuel prices around $132 a barrel, those cash piles could shrink fast, putting carriers in danger of breaching debt covenants with lenders. Bill Warlick, an airline-debt analyst at Fitch Ratings, said if aviation-fuel prices remain constant for the rest of the year, potentially $10 billion or more of the airlines' cash "could fly out the window." Mr. Warlick expects cash to get tighter this year if there isn't a pullback in fuel prices or an airline merger. If those stresses continue into 2009, he said some airlines could find themselves cash-strapped enough to file for Chapter 11 bankruptcy protection and some, potentially, could be forced to liquidate. For now, the situation isn't uniformly grim. Most of the major airlines were profitable in 2007 as a whole, though several slipped into the red in the fourth quarter because of higher fuel costs. Airlines were successful at pushing through fare increases last year and have negotiated several increases this year. Travel demand also remains strong, with carriers reporting that 75% or more of their domestic seats were filled in January. But Standard & Poor's Corp. recently predicted that "this trend will stall across the industry in the face of softer demand, likely first on domestic routes and then in international markets." It was a reduction in travel demand in early 2001 that presaged a severe downturn for the airlines. That plunge was exacerbated by the Sept. 11, 2001, terrorist attacks and a spike in fuel costs. Since 2001, four big airlines and many smaller ones have been through bankruptcy court and others reorganized under the threat of a bankruptcy filing. Collectively, the airlines laid off 170,000 workers -- or about 38% of their labor forces -- cut wages and benefits, and pared other expenses. That's left them with scant room to make further cost reductions, said John Heimlich, chief economist for the Air Transport Association trade group. "Unlike the last cash crunch, it's a lot harder to find things to cut this time." Carriers can either cut costs or increase revenue, he said, "and they're still trying to find the revenue angle." If oil had stayed at $50 a barrel, the industry would have been highly profitable. But the price of oil has more than doubled since 2004, and the difference between the cost of a barrel of crude and a barrel of jet fuel -- the so-called crack spread -- has widened dramatically as refiners have boosted their profit margins on aviation fuel, capitalizing on a lack of refining capacity by charging airlines more. So when crude-oil prices drop, airlines don't always see immediate relief. From 2002 to 2007, the jet-fuel crack spread rose to an average $18.59 a barrel from $3.61, and this week the spread topped $30 a barrel before narrowing some yesterday. Airlines continue to hedge some of their fuel needs, but at current prices hedging is extremely costly, and the carriers don't want to lock in historically high fuel costs in case prices fall.