The survival of the commercial airline industry

Oil prices are beginning to moderate, which is bringing some financial relief to a domestic airline industry that has been ravaged over the past several months by high fuel prices. Many airlines had taken to implementing new fees, cutting routes, and reducing the size of their workforces in an attempt to offset the higher fuel costs, while other airlines have ceased operations altogether. But it appears that, for right now, the worst might be over:

Oil prices, which triggered the crisis in the first place, have fallen even faster over the last five weeks than they rose during the first half of this year. Since peaking above $147 a barrel on July 11, oil has fallen to $115. That's the fastest, most dramatic decline in history.

And though most carriers still can't turn a profit at existing jet fuel prices, they're getting close to the break-even point.

Another $10 to $15 drop in the price per barrel, which some oil experts now say is possible, will have most of them back in the black. Analysts at both Morgan Stanley and JPMorgan Chase even are suggesting that the haggard industry could be profitable in 2009.

Eh, let's not get too confident about 2009 just yet. While the current downturn in oil prices might be welcome relief, it could very well be nothing more than a temporary respite brought on by seasonal changes (such as reduced oil demand due to the end of the summer driving period) or recent fluctuations in the value of the dollar. The overall conditions that lend themselves to high oil prices - tight supplies, surging demand in China and India, instability in producer states like Iraq and Nigeria - remain.

Which brings up a question: if oil prices climb upward once again, which airlines are likely to survive, at least in the near term? A usatoday.com article analyzes the financials of the ten largest domestic carriers and classifies them into three categories: strongest, likely to survive, and struggling.

The "strongest" airline is Southwest. No surprise there; Southwest has posted a quarterly profit every cycle since 1991. No other airline can come close to making that claim.

American, Alaska, Continental, Delta and Northwest fall into the "likely to survive" category. The article says that the strengths of Houston-based Continental are its strong cash position for its size and good hubs in Houston and Newark, but that its weaknesses are its lack of equity in its own aircraft and its lack of a strong presence in major foreign destinations. All things considered, the hometown airline seems pretty healthy. Northwest and Delta, for their parts, plan to strengthen their position by merging into a single airline.

Then there are the four airlines in the "struggling" category: AirTran, JetBlue (which was the rising star of the domestic airline industry until the Valentine's Day Massacre eighteen months ago), United and US Airways. Denver-based Frontier, which is currently operating under bankruptcy protection, would likely fall into this category as well. If the current respite in high oil prices doesn't last, any or all of these airlines could collapse.

Of these four, I think United is probably the most likely to go under another wave of sustained high gas prices occur. The Chicago-based airline's 14.1% ratio of cash to revenue is the lowest of the ten carriers surveyed, and friction between labor and management (especially embattled CEO Glenn Tilton) could grind the airline to a halt if its financial situation deteriorates. The fact that they've decided to begin charging for meals on international flights reeks of desperation, and this story (via m1ek, who describes United as "an airline that needs to die, as soon as possible") certainly doesn't make me want to fly them anytime soon. Needless to say, I'm glad that Continental decided against merging with this struggling airline.

There comes a point, however, when oil prices become so high that no airline's business model is sustainable:

Despite recent fluctuations, a growing number of economists are bracing for oil to hit or surpass $200 per barrel in a few years, and most industry analysts agree with Douglas Runte, of RBS Greenwich Capital, who told The Wall Street Journal in June, "Many airline business models cease to work at $135-a-barrel oil prices." After all, most airlines barely figured out how to be profitable in a world of low fuel costs. Jeff Rubin, chief economist of Canadian investment bank CIBC World Markets, has predicted that gasoline will hit $7 per gallon by 2010, forcing some 10 million cars in the United States off the road. If that happens, he told me, "You're going to see an even bigger exit in the airline industry."

The long-term effects of sustained high oil prices would have a horrendous effect on commercial aviation, both at home and abroad. Air travel would revert to a means of transportation exclusively for the wealthy. Tens of millions of others who can afford to travel by air today would no longer be able to do so. The commercial airline industry would shrink dramatically and become a fraction of its current size as all but perhaps a couple of airlines cease operations. Millions of people working in civil aviation and affiliated industries worldwide would lose their jobs. The global tourism industry would also suffer as families are no longer able to fly to Cancun or Disney World for vacation. Services that we take for granted today, such as relatively inexpensive overnight shipping by air, would disappear. The overall effect on the worldwide economy would be enormous and devastating. What's more, while places like Europe and Japan have high-speed, electrified rail networks that could take the place of air travel for at least some percentage of trips, the United States, outside of the Acela Corridor, does not.

What's alarming is that, should $200/barrel oil become a long-term reality, there really isn't much that can be done to prevent this from occurring:

Is there a way to avoid this fate? I reached Richard Gilbert, one of the analysts warning of a potentially drastic decline in U.S. air travel over the next two decades, as he was returning from a meeting in Toronto with the U.S. Transportation Research Board, a government research body. I asked him what sort of response he gets when he discusses his book with industry insiders. "You see three arguments," Gilbert told me. "One is that ingenuity, American or otherwise, will overcome the problem in terms of oil prices. The second is that we'll wrestle it to the ground with technology. And the third type of response--and this one doesn't have a specific argument--is that this just can't happen."

It's always dangerous to bet against human ingenuity. But, while most of the technology needed to replace gas-guzzling cars with, say, plug-in hybrids either exists or sits just over the horizon, decarbonizing air travel is a much harder prospect, not least because of the massive amounts of energy needed to lift a large passenger plane in the air. The industry has already boosted the fuel efficiency of jets 70 percent in the last four decades, and is now left sanding down the rough spots--tinkering with ultralight materials, flying more slowly, or even charging passengers for extra bags. Propeller planes use less fuel than jets but are only really viable for some short-haul flights. Engine manufacturers say that more advanced technologies like fuel cells and carbon capture are still technically infeasible, while "blended wing" designs--planes shaped like stealth bombers to reduce drag--have barely left the drawing board. Improvements in air-traffic control will reduce both the length of flights and fuel-wasting delays, but may not be enough to surmount $200-per-barrel oil.

Virgin Airlines CEO Richard Branson has held out high hopes for jet biofuels, though spikes in food prices and massive deforestation have dimmed ethanol's star. Someday we may get solar-powered jets or hydrogen fuel cells, but, as the Intergovernmental Panel on Climate Change concluded in its landmark 1999 aviation study, "There would not appear to be any practical alternatives to kerosene-based fuels for commercial jet aircraft for the next several decades." The military may be one exception: The Pentagon, worried about peak oil scenarios, has pushed to fuel its Air Force with liquefied coal, which may keep fighter jets aloft, but would have horrifying climate consequences if used on a broad scale.

For now, however, recent adjustments made by the airlines, as well as the downward turn in oil prices, have created a rosier outlook for a commercial airline industry that until just a few weeks ago was facing gloomy prospects. Returning to the original article:

JPMorgan analysts Jamie Baker and Mark Streeter told investors in an Aug. 12 report that the "industry today is a significantly different one than that which gave us pause last March."

It's not just because jet fuel prices have fallen by more than $1 a gallon from their early summer peak, though that change by itself will save the industry more than $13 billion annually. The carriers' recent capacity cuts, decisions to ground old, fuel-inefficient planes and to boost revenue via higher fares, and the imposition of new and larger fees are likely to be long-lasting changes, Baker and Streeter wrote.

That means that instead of focusing on "the potential magnitude of the fuel-induced cash burn, capital and liquidity options, and who might disappear, and when," as Baker and Streeter did during the first half of this year, they now are "assessing who might first return to annual profitability, and when."

I'm certainly not looking forward to a world without the convenience of inexpensive air travel, so I'm rooting for the airlines to return to profitability (and for some of them to get their act together as well). But the commercial aviation industry is at the mercy of the very resource that fuels it; they have no alternative. Future surges in oil prices are likely, if not inevitable, and there will very probably come a point, someday, where the survival of the commercial aviation industry as it currently exists becomes uncertain. No amount of service cuts, layoffs, or fees on pillows, blankets and baggage will make a difference.