Major U.S. airlines have had a lot of good news to crow about lately.  As the economy recovers from a recession that took a devastating toll on the industry, ticket sales are rebounding, earnings are rising and passenger volume is up – particularly in the profitable business travel segment. 

So why have investors shedding airline shares the past two days like they were overcoats at a beach party?

The answer is soaring oil prices and the catalyst is the current state of turmoil in Libya.  After a long holiday weekend during which the news was flooded with accounts of chaos in Africa’s third-largest petroleum producing country, oil prices had surged to their highest prices in more than two years on Wednesday. 

And worse news: Tokyo-based investment bank Nomura Holdings said Wednesday that the loss of all oil production in Libya and neighboring Algeria (where there are also protests) could push oil prices as high as $220 a barrel.

All of the big airline stocks hit a two-day slide on Tuesday and Wednesday — United Continental (NYSE:UAL) was down another 6.8% on Wednesday, AMR Corp (NYSE:AMR), parent of American Airlines, lost 6.6%, Southwest Airlines (NYSE:LUV) slipped 1.6% and US Airways (NYSE:LCC) closed down 7.4% to end the day at $9.17. The Guggenheim Airline ETF (NYSE:FAA) closed down 2.2% after losing 5.3% on Tuesday.

The Amex Airline Index was off more than 3% on Wednesday to hit five-month lows.

Oil prices have a profound impact on airline earnings because fuel accounts for at least one-third of airlines’ total expenses.  Airline shares flew through some turbulence during the recent crisis in Egypt, but since that country doesn’t export oil, the stocks stabilized once fears of a Suez Canal shutdown abated.  

That’s not the case with Libya, which produces nearly 2% of the world’s oil and exports more than a million barrels a day.  And according to a Reuters report, the crisis in Libya already has reduced production by 300,000 to 400,000 barrels a day and a shutdown of all oil production activity is not out of the question.  Neither is the possibility that Libyan leader Col. Moammar Gaddafi, who has vowed to yield control of the country only over his dead body, will torch the oil wells rather than cede those assets to a succeeding regime.

All transportation companies face a threat from rising fuel prices and the pain threshold for airlines is particularly low.  To try to stay ahead of the curve, airlines have increased their fares at least four or five times since Thanksgiving alone; many also are increasing the amount and types of fees they charge passengers for baggage, food, itinerary changes and the like.

So far, fare and other fee increases haven’t had a major effect on load factors, which measure how much of an airline’s passenger carrying capacity is being used.  And the FAA’s annual forecast last week predicted an acceleration of passenger growth. But airline load factors will start to sink if oil prices exceed $100/barrel for any length of time, because at that level, it will be much harder to pass on increased costs to customers. 

The International Air Transport Association predicted earlier this month that airlines would be profitable in 2011, but at the Brent crude oil price of $84/barrel, industry profits would fall by 40%.  “For every dollar increase in the average price of a barrel of oil over the year, airlines face the difficult task of recovering an additional $1.6 billion in costs,” IATA Director General Giovanni Bisignani, said. On Wednesday, Brent oil prices rose into the $110-a-barrel range, and those levels are enough not only to disrupt airlines’ earnings, but also to derail the global economic recovery.

Bottom Line: investors can expect more jitters in the sector in the near term because if there is any sustained support for oil prices at $100 a barrel or above, airlines won’t be able to pass on the higher fuel costs to their customers. As a result, passenger load factors will fall through the cellar.  And there’s a double-whammy for airlines because triple-digit oil prices are very likely to stall the fragile economic recovery, sending all transportation shares into a tailspin. 

 Airlines do have the option of hedging, although that will become more expensive, too. While a brief spike in oil prices shouldn’t cause investors to grab their parachutes and bail out of airline stocks en masse, the headwinds of high oil prices pose a clear and present danger to airline earnings this year.

 At the time of publication, Susan J. Aluise did not hold a position in any of the stocks mentioned here.