U.S. airlines have been able to offset rising oil prices through a combination of cost cutting and capacity restraint, which has led to fuller aircraft and enabled carriers to raise fares. In the third quarter, Delta Air Lines posted record revenues and Northwest Airlines had its best results in a decade. "We as an industry have been pretty darn successful at passing on higher crude prices," United Airlines CFO Jake Brace told investors this month.
But with crude prices nearing $100 a barrel, airlines are scrambling again. Brace says that if oil prices remain high and demand slows, United could be forced to ground up to 100 or more of its aircraft. "The third quarter may well turn out to have been a high point," says Standard & Poor's airline credit analyst Phillip Baggaley. (S&P, like Aviation Week & Space Technology, is a unit of The McGraw-Hill Companies.)
Southwest Airlines and Alaska Airlines are the only two U.S. carriers that hold long-term fuel hedges to protect against price spikes. "Most carriers have limited or no hedge positions beyond the first quarter of next year," notes Calyon Securities analyst Ray Neidl.
In Europe, airlines generally are better positioned to cope with $100 crude. The soaring value of the euro has helped offset some of the bite of rising oil prices, and many European carriers have robust fuel hedges in place. And European carriers derive a larger portion of their revenues from international routes, where there is less or no competition from low-cost carriers.
Even though oil prices moderated last week, analysts predict they will remain high over the long term. Julius Walker, an analyst at the Paris-based International Energy Agency (IEA), says supplies remain tight, with OPEC's spare capacity limited to just two million barrels a day. That means the oil cartel has little leverage to limit a future price spike caused by a geopolitical or weather crisis.
Meanwhile, thirst for oil continues to rise in China and India. Eduardo Lopez, IEA's senior demand analyst, says consumers in those nations have little incentive to limit fuel consumption because heavy government subsidies shield them from price spikes. He believes that if governments in China, India, the Middle East and Southeast Asia were to lower energy subsidies, global demand for oil could fall sharply, leading to an easing of prices.
A similar situation exists in Europe, where high energy taxes -- not government subsidies -- keep consumer behavior in check. Lopez says European consumers and businesses already pay high prices for fuel and are less likely to moderate their travel and purchasing behavior due to rising oil prices. While that's good for European airlines, it keeps pressure on energy demand.
A big concern is that high oil prices will push the U.S. economy into a recession. That would reduce demand for air travel, making it much more difficult to raise fares to offset higher fuel costs. U.S. demand for transport fuels already is slowing, says Lopez. That may just be a reaction to rising oil prices—or it could be related to the unfolding economic consequences of the subprime mortgage crisis.
John Heimlich, chief economist at the Air Transport Assn., says airlines are especially concerned that a weakening economy and higher energy costs will prompt corporations to slash travel budgets. If that happens, demand for lucrative business fares would drop.