Fuel-cost crisis drives drastic airline cuts

The soaring cost of fuel presents the U.S. airline industry with an unprecedented crisis, one that shatters its business model and forces staggering consequences.

The challenges could mean the that industry will be reduced by 25 percent, including one or more airlines going out of business.

To survive, the nation's big airlines are making drastic changes: grounding aircraft because they cannot afford to fly them, thus markedly reducing the number of flights and seats available to passengers; significantly raising ticket prices; and cutting thousands of jobs.

Continental Airlines Inc. said yesterday that it would retire 67 of its older and least-fuel-efficient planes through 2009, reduce capacity by 11 percent, and slash 3,000 jobs.

"The industry faces its worst crisis since 9/11," Continental said.

A day earlier, United Airlines said it would ground 70 planes from its 460-aircraft fleet. The company had announced it was taking 30 planes out of service to save money.

Other airlines are likely to make similar moves, adding to the disruption for would-be air travelers.

"The race is on to see if airlines can raise fares high enough to cover the fuel bills before they run out of cash," Roger King, an analyst with CreditSights of Norwalk, Conn., said in a research report.

This crisis is different from other times of upheaval for the airlines because their costs were not skyrocketing in the way jet-fuel prices have, climbing 85 percent over the last 12 months.

In the past, carriers were able to reduce their biggest expense, labor, mainly through layoffs or by forcing wage-and-benefit concessions under the threat of liquidation.

This time around, with the economy tanking and people feeling the pinch in their own pocketbooks, fewer passengers may fly, which will force even more cuts to match the lower travel demand, industry analysts say.

Airlines need to shrink from 20 percent to 25 percent of their capacity to earn a profit and survive, some analysts said.

As necessary as the big changes are for airlines, even those cuts may not save them all. Analysts say they believe that one or two, maybe several, carriers could file for bankruptcy next year.

"We think the market consistently underestimates the power of capacity reduction," Lehman Bros. Holdings Inc. analyst Gary Chase said yesterday in a research note. "We also believe the economics of capacity reduction are more compelling than at anytime in the last two decades."

US Airways Group Inc., the Philadelphia region's dominant carrier, said in April that it would cut capacity 2 percent to 4 percent in the second half of the year and also would replace older aircraft, letting leases run out on 28 planes - four Boeing 757s and 24 Boeing 737s. Those aircraft will be replaced with 14 Embraer 190s and five Airbus 321s.

Morningstar Inc. analyst Brian Nelson said US Airways must make more cuts because of its financial position, which, he said, is "among the least-attractive" of the big U.S. carriers.

US Airways spokesman Philip Gee said the nation's fifth-largest carrier was "pretty close" to its minimum fleet requirement, 332, under its labor contracts. "Because of our pilot contracts, we have to have so many planes," Gee said. "We couldn't get rid of 50 planes tomorrow."

US Airways has 357 planes in its fleet. However, 19 are Embraer 190s, which do not count against the 332 minimum, Gee said. "So, I guess technically we could go down to 313."

The cuts by Continental will not have much impact in Philadelphia, said James M. Tyrrell, city deputy aviation director. Continental operates six mainline and five regional jet flights a day to Cleveland and Houston.

The new realities for consumers of shrinking airlines will be higher fares, fewer flights, substitution of smaller regional jets for larger planes, and some dropped routes.

Besides higher ticket prices, airlines are adding extra fees for everything from checking bags to traveling with pets and sitting in an aisle seat.

Tom Parsons, chief executive officer of Bestfares.com, an online discount Web site based in Arlington, Texas, said fares already had shot up this year, especially on routes where only US Airways has nonstop flights, such as Philadelphia to Charleston, S.C.

In June 2007, a round-trip advance-purchase ticket was as little as $178 on the Charleston route, compared with $594 this summer, Parsons said. On other routes that are served by low-cost carriers, but where the older, legacy carriers have the only nonstop flights, fares may be more than 200 percent higher than last year, he said.

"We believe these airfare hikes on nonstop routes will stay in place until the end of August, due to high demand for summer travel," Parsons said.

Customers also will not get the same choices of flight times, and destinations will be more limited.

US Airways Express, for example, will operate three fewer flights a month to Ithaca, N.Y. Instead of 34 flights per month, by November, there will be 31, Philadelphia's Tyrrell said. AirTran plans to stop flying to Fort Lauderdale and Tampa from Philadelphia starting in November. United will cut in half its daily flights to Los Angeles, fall airline schedules show.

All service to Wilmington was eliminated when SkyBus folded in April, just a month after it started. Lancaster, as well as Hagerstown, Md., and Brookings, S.D., lost all air service last fall.

Smaller cities are "going to be hurt tremendously," Tyrrell said. The Philadelphia market is "so strong that we've been able to maintain almost all of our service."

"We very rarely lose a destination. We will lose frequency possibly, but never a destination altogether," he said.

All airlines are not suffering equally.

Southwest Airlines Co. is in the best shape to withstand the run-up in fuel prices and to benefit as the others cut back. Southwest was the only big carrier to report a first-quarter profit and was able to do it only because it had bought fuel-hedging contracts years ago that locked in lower prices. Southwest estimated in April that it would pay an average of $2.35 a gallon for jet fuel in the second quarter, compared with an average on the spot market last week of $3.86 a gallon.

Southwest has other advantages: a relatively new, fuel-efficient fleet of 737 jets, and a highly productive workforce that gets more miles flown each day out of each airplane than the other major airlines. Several other low-cost carriers, including AirTran Holdings Inc., JetBlue Airways Corp. and Spirit Airlines Inc., have operating costs similar to Southwest's.

Even the younger, low-cost airlines, which have grown more in recent years than the older carriers, are starting to cut back. AirTran says it plans to go from 20 percent capacity growth a year to zero growth this year.

The airlines' travails are helping Amtrak's passenger-rail system, although in many cases increases in ridership are more likely the result of higher gasoline prices. The volume of passengers taking Amtrak's short-distance and long-distance trains was up 11 percent from October through April, the first seven months of the federal fiscal year, the National Association of Railroad Passengers said.

Another winner: airline shareholders. News of hefty cuts in jobs and fleets sent airline stocks rallying yesterday in hope the industry was taking the steps to stabilize itself. But while stock prices rose, they were still pretty low.

Airlines have been through crises before - some survived and some folded.

But this crisis may be different. The cost of fuel this year already has forced the liquidation of ATA Airlines Inc.; Aloha Airgroup Inc.; SkyBus Airlines Inc.; two all-business-class carriers to Europe, MaxJet Airways Inc. and Eos; and two other commuter carriers.

Said Kevin P. Mitchell, chairman of the Radnor-based Business Travel Coalition: "The outlook for the airlines has never been darker."

Airline-industry job cuts so far this year are double the 2007 total.

Year Announced

layoffs

2000. . . 4,346

2001. . . 99,969*

2002. . . 51,467

2003. . . 57,295

2004. . . 31,659

2005. . . 44,098

2006. . . 8,208

2007. . . 10,748

2008 to date. . . 21,710

*A recession and the Sept. 11 terrorist attacks occurred in 2001.

SOURCE: Challenger, Gray & Christmas Inc.

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Business, Section C.