As Oil Prices Rise, Airlines Turn to Capacity Cuts

Fare hikes can only do so much

By Susan J. Aluise, Aviation, Auto & Transportation Writer

As oil prices go, so go airline stocks.

On Tuesday, airline shares rallied as the skid in oil prices fueled optimism that the sector will be better able to control costs and boost earnings.  Oil prices had dropped 7% in two days – fabulous news for fuel-hungry airlines.

On Wednesday, however, with oil catching another bid, the Dow Jones Airline Index had dropped 1.8%.

Apart from the give-and-take of daily oil prices, it actually turns out that airlines paid for — and used — less fuel in February than they did in January.

While some of that decline had to do with winter storms and flight cancellations, there’s a strategic component in the mix: capacity cuts.  Fuel costs for airlines are down largely because they’re flying less. Fare hikes are the typical way airlines offset higher fuel prices, but the market has shown resistance over airlines’ past three attempts to do so.  The fallback position is to reduce the number of flights and routes — or simply to cut seats by replacing larger planes with smaller, more fuel-efficient aircraft. 

And they’re doing precisely that.  Airlines scaled back capacity by as much as 3% in March, although the disaster in Japan affected airlines with Asia-Pacific routes like Delta Air Lines (NYSE:DAL) and United Continental (NYSE:UAL), which have pulled back on service for the near term. 

AMR Corp.’s (NYSE:AMR) American Airlines, which just landed a trans-Pacific partnership with Japan Airlines to serve the region, has vowed to keep up those commitments.  Still, the airline has cut capacity by about 1%.  Southwest (NYSE:LUV) is bucking the trend, having slightly boosted load factor in March.

Despite a moderation in oil prices and the reduction in capacity, serious headwinds remain for the U.S. airline industry.  And quarterly earnings reports due out in the next couple of weeks likely will reveal that fuel price-driven operating costs will hit airline profits hard.

Fuel prices as a share of operating costs could reach historic proportions of as much as 40%, the Air Transport Association said this week.  The group which represents believes those quarterly financials will show that the industry is on track to pay as much as $3 billion more on fuel than it did last year.  And that’s just about enough to skunk up the sector’s recovery for 2011.

Bottom Line: U.S. airlines received a two-day break in oil price hikes, but don’t count on it to last much past the release of their quarterly financials.  Oil prices may be settling down from their wild ride of over $112 a barrel, but airlines face pressure at prices as low as $90 and serious pain at $100. 

As of this writing, Susan J. Aluise did not hold a position in any of the shares mentioned here.

Article printed from InvestorPlace Media,

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