Could higher fuel prices actually help U.S. airlines?

Publicly, U.S. airlines are wringing their hands about rising fuel costs and using the continued spike in oil prices to justify each round of fare increases and new charges for former freebies like seat selection or checking a second bag. Many carriers claim consolidation is the only viable option to survive escalating operating costs. But privately, higher oil prices may be the cause of great jubilation in some airline board rooms. In the long run, some U.S. airlines could benefit substantially from a protracted fuel price crisis, and they may be some airlines you'd least expect.

In recent years, the big six network or legacy airlines have been the most vulnerable during adverse conditions in the airline industry, but that's no longer true in a world of $120+ per barrel oil. Most airlines, with the exception of Southwest which still has much of its fuel needs hedged this year, are affected by rising fuel costs. For a variety of reasons, low cost carriers (LCCs) are at greatest risk. Within the last few months, higher fuel costs have been a major factor in the liquidation of at least eight airlines (see accompanying chart on airline liquidation), most of which were LCCs. Frontier Airlines is also bankrupt and the current fuel crunch will likely claim more victims in the coming months.

Shrinking to profitability

I've always maintained that overcapacity in the airline industry was a myth, or a concept existing only in the minds of airline executives whose carriers couldn't compete effectively against lower cost rivals. Over the last three decades of deregulation, every time an airline cut capacity another airline was waiting to fill the void, effectively foiling the former airline's attempts to fly full with fewer seats and simultaneously raise airfares.

This repeating scenario assured the continued advance of LCCs across the USA and the slow demise of a host of legacy airlines, which have been whittled down to the big six of today. With oil prices rising, we find the big six in familiar posture, trying to shrink their way to profitability by eliminating unproductive flights and routes, grounding airplanes, or seeking consolidation to reduce overhead, cut capacity, or take another competitor out of the market. In the past, efforts by the big six to lower capacity proved futile, as other airlines would inevitably step in to eat the lunch at the table they abandoned.

But this time around something is very different. After so many bankruptcies, service reductions and other cost-cutting measures, operating costs between the big six and LCCs have narrowed substantially. As the playing field is leveled, fuel costs are affecting both groups equally. Everyone is struggling to survive and the fuel crisis has tipped the balance of power in favor of some big airlines for the first time in decades.

In this harsh environment, where jet fuel costs increased more than 70% in the past year and more than 200% in the past five years, every major U.S. airline is curbing expansion plans and scaling back operations. Most of the big six already cut domestic capacity by 5% in the last few months and are planning additional 5% to 10% cuts by year end, assuming oil prices remain at these levels. Even rapidly growing LCCs like Southwest and jetBlue have trimmed their expansion plans for the current year. For the first time in decades, as the big six contract, no airline is poised to replace those abandoned flights, routes and markets.

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