Disaster for Airlines: Oil Prices

May 14, 2008 — -- Go ahead and scoff -- but those backroom whispers about oil hitting $200 a barrel in a year or two are whispers no longer -- the idea is being shouted from the headlines. Don't believe me? Just type "$200 barrel oil" into Google, grab yourself a big cup of coffee, and watch 1.3 million references begin to pop up. Yes, oil at $200 a barrel is very likely heading our way, and if you don't believe me, ask the folks at Goldman Sachs who suggested just that.

Now, let's go back to last summer -- before the run-up in fuel prices began -- and I think you'll find most passengers, leisure and business alike, were OK with airline ticket prices; the cost of airfare was generally compatible with travelers' budgets. And it was working for the airlines, too: after years of clawing their way out of financial disaster, many carriers were finally showing signs of strength with profitable financial quarters.

But as I said, that was before the price of fuel went completely bonkers.

Now, Southwest Airlines CEO Gary Kelly says, "No airline can make money at $123 a barrel." A sobering message, considering his airline is the only large one that made any profit at all in the first quarter of this year. So, I wondered -- in this stumbling, lurching economy of ours -- what does air travel look like at $200 a barrel?

In a word, grim. I envision a combination of sharp fare jumps coupled with fewer airlines and fewer available seats, and, worst of all, maybe a return to government regulation (the word "bailout" comes to mind). Others are casting around, looking for new aviation "heroes" to rescue us from this mess (Howard Hughes, anyone?).

My prediction: it won't be pretty, it will be painful, but we can get through it. Let's take it from the top.

First of all, fuel now represents 40 percent of airline expenses; according to an industry analyst, a 3 percent daily rise in oil prices is enough to wipeout an entire year's profit. An entire year's.

Of course, this isn't really new: airlines have been folding (which fits in nicely with a 25-year-old prediction I unearthed recently, that claimed the airline industry would eventually be dominated by an oligopoly, where the few control it all).

And that includes controlling the prices: since January of last year, the airlines have increased prices 27 times. That's one way airlines fight for survival; the other is to cut capacity. That's happening now, too. Cities, like Pittsburgh, have lost significant service, and dozens of small cities are losing all their scheduled fall air service.

"Whoa," say some analysts, "how much capacity can be cut?" Good question, and in answer, some are saying maybe it's time to go back to the days before the Airline Deregulation Act of 1978 -- an intriguing and worrisome notion.

Most analysts say airline deregulation was successful, but not everyone liked it at first. I was recently perusing an unintentionally humorous article from the New York Times archives, dated 1982, in which the author bemoaned the loss of amenities in the deregulated airline world: "gone are the days when minimum-rate passengers were served prime steak and complimentary champagne." Perhaps even more shocking, the author wrote that some airlines "have been experimenting with penalties for passengers who cancel bargain tickets." We can laugh now, but they weren't laughing then.

The pros and cons of deregulation? The cons are easy: airlines feared losing protected routes and prices. Smaller cities were concerned about losing service. And unions worried about losing pay and losing jobs. Much of this has happened, but the main pro in the deregulation debate also happened.

Ticket prices went down.

For example, in 1977 you would pay $86 to fly from Philadelphia to Pittsburgh; in today's money, that's about $295. But you don't pay $295 today; last week I found a fare from Philly to Pittsburgh for just $112. Great, right? But wait a minute: how can an airline survive at that price? Forget oil prices reaching $200 a barrel -- how can an airline survive such prices at the current price of oil?

Well, as noted, many are not surviving; so, the airlines are desperately adding fees ($25 to check that second bag) and they're slapping fuel surcharges onto the prices of their tickets, which has meant an additional $130 above the base ticket price for hundreds of thousands of fares. And notice that the $130 fuel surcharge is currently higher than the price of a barrel of oil.

The economics of airlines at $200 oil are upside down (I sometimes have bizarre nightmares about passengers trying to avoid the extra bag check and fuel surcharges by squeezing a barrel of oil into an overhead bin).

Some say the airline industry is disappearing with oil at $120 a barrel. Can it come back? Can we make the industry work again? That is the question buzzing through the management offices at every airline.

But does re-regulation make sense? I don't think so. And it would be ironic if we went back to those days, especially since Europe and Russia have taken the plunge into the free market (with varying results), but if Goldman Sachs is correct -- and I believe they are -- oil will be a nasty part of the airline equation for years to come.

Now, I'm not saying Americans necessarily have a right to cheap airfare, but I do believe we should always have the right to the relatively cheapest airfare, and bargains can still be had. Savvy shoppers just have to dig deeper, and be more flexible about travel planning than ever before (some of the best deals around today require that you travel literally within a few days of your purchase).

Someone said not too long ago that what the airline industry really needs is the imagination and vision of new aviation heroes -- someone like Howard Hughes, perhaps, or Southwest's plain speaking Herb Kelleher, or maybe Virgin's Richard Branson -- now, there's a man with ideas.

Or maybe the situation is so dire that we need super-heroes -- unfortunately, Iron Man is busy with his new movie. In the meantime, though, I think we need to do the same thing for leisure travel that we're doing in all areas of our lives during these troubled economic times, and that's using every tool at our disposal to make the most intelligent purchases we possibly can.

This work is the opinion of the columnist and in no way reflects the opinion of ABC News.

Rick Seaney is one of the country's leading experts on airfare, giving interviews and analysis to news organizations, including ABC News, The New York Times, The Wall Street Journal, Reuters, The Associated Press and Bloomberg. His Web site FareCompare.com offers consumers free, new-generation software combined with expert insider tips to find the best airline ticket deal.