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oil prices are down, so...what now?

Oil is at $114. Mr. Airline, would you like to meet Mr. Profit?  Aug 12, 2008

In a research report Monday, Morgan Stanley analyst William Greene predicted that if crude oil falls to $115 a barrel, the airline industry could be profitable. Well, oil settled today at $114.25, after hitting as low as $113.25 during the day.

Now, providing this pricing point proves durable, can the industry take advantage?

Airline analysts aren’t overly optimistic, fearing that the industry could reverse course from the very recent trend of cutting the number of flights and seats. As Greene hinted darkly, “falling oil prices introduce the risk of destructive competition as plans for capacity rationalization and revenue discipline fall victim to the seductive cost and market share benefits associated with capacity growth. Such actions would inevitably erode operating margins in an oil-driven up-cycle.”

Rising oil prices, of course, hurt the airline industry, but those stratospheric costs also provided a sort of cloud cover for the industry’s essential dysfunction. Intense competition, labor disputes, absentee parenthood from Washington regulators–all have combined to put the industry in a position that requires deeper thought. As one industry expert summed it up to me: “No leadership, no policy, no strategy, everyone blaming the other…all circling Foggy Bottom while the industry goes down the Potomac.”

Consider the issue of capacity. The agreement to combine Delta Air Lines and Northwest Airlines was motivated in part by the desire to achieve economies of scale. While some argue that capacity cuts are an overblown solution to the industry’s ills because they are temporary, many airline analysts have argued for months that deep capacity cuts–as much as 20% of the number of flights, in the opinion of analyst Ray Neidl–are the only way for the industry to reduce its costs and thus improve its bottom line.

Or take alliances. Airlines that have declined to merge have sought out alliances with rivals as a way to reap some competitive benefits and increase revenue by cross-selling tickets. Continental and United went that route; American Airlines is planning to tell U.S. lawmakers it should be allowed to form an alliance with British Airways and Iberia.

The falling price of oil is good news. But for an industry that has been grounded by losses as long as the airlines, it is no panacea.

Oil is at $114. Mr. Airline, would you like to meet Mr. Profit?

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