Airline Woes: It's Just Math

While most airlines have money in the bank, the industry still struggles with rising fuel costs and the lingering threat of recession

Hannah Johnston/Getty Images

by Justin Bachman

As crude oil tops $110 per barrel, a worried hum heard in the U.S. airline industry in recent months is now building into a shrill alarm. The latest alert came Mar. 12 when JPMorgan Chase (JPM) downgraded seven large U.S. airlines and suggested the "best-case" scenario for the industry is a $4 billion loss for the year. "And if demand trends mirror prior recessions, a $9 billion loss can't be ruled out," JPMorgan analyst Jamie Baker wrote.

That report came a day after a similar Credit Suisse (CS) warning and a notice from Standard & Poor's Ratings Services that it will review its ratings on 10 U.S. airlines, citing "cost pressures of rapidly increasing fuel prices and a weaker domestic economy."

That was about all investors needed to hear. Alaska Air Group (ALK) plunged 18%, to 18.36; American parent AMR (AMR) tumbled 13%, to 9.31; Delta (DAL) fell 16%, to 10.13; Northwest (NWA) dipped 16%, to 10.25; and US Airways Group (LCC) dropped 10%, to 9.02. All of those stocks set 52-week lows on Mar. 12. UAL's (UAUA) United dropped 10%, to 24.29, and Continental (CAL) was off 10%, to 20.46.

The selling came on a day when a barrel of West Texas Intermediate crude oil rose to a record of $110.20 on the New York Mercantile Exchange (NMX). Jet fuel has soared nearly 80% over the past year, from $1.85 per gallon a year ago to a record $3.21 on Mar. 11 on the spot New York Harbor exchange. That's far above the forecast of $2.50 to $3 per gallon most airlines had expected for the current quarter.

The only good news in all the gloom is that the airlines' balance sheets can withstand the current price, for a while. The two largest U.S. airlines, American and United, had $5 billion and $3.6 billion on hand, respectively, at the end of 2007. The bad news is they are heading into a period of likely malaise for the U.S. economy and reduced travel spending.

An Uncomplicated Equation

The immediate problem for all the airlines comes down to a simple equation they've been able to do very little about: a high and rising fixed cost—jet fuel—combined with weak sales that may soon drop. As Baker puts it: "The math is not complicated." Across the industry, he says, airlines are staring at a fuel bill that is $25 billion more than in 2002, the second year of the industry's last significant downturn. That swamps the $7 billion airlines squeezed out in labor costs during the wave of bankruptcy reorganizations that followed.

On Mar. 10, Northwest Chief Executive Doug Steenland said oil above $100 will cost the company $1.7 billion more than it had budgeted in 2008. "For us, this is a serious budget-breaker. Every $1 increase in fuel equates to $42 million per year in added costs," Steenland told employees on a Mar. 10 weekly telephone message. "If fuel remains where it is today, our increased fuel costs will again create a difficult financial challenge for the airline." Delta Chief Executive Richard Anderson also complained about high fuel prices this week at a conference in Washington, D.C. Both airlines have reportedly been talking about merging.