Record-high oil prices are threatening to ground millions of travelers who have grown accustomed to flying for fun and business during the past 30 years.
Air travel in the USA has grown at a rate five times faster than the population since 1978, when deregulation first allowed airlines to compete by setting their own prices and routes without government approval. Last year, 769 million passengers boarded U.S. airline flights.
But with today’s unprecedented jet fuel prices, airline executives and aviation analysts are warning that only extreme fare increases and dramatic cutbacks in flights will enable the industry to cover a 2008 jet fuel bill the airlines’ trade group projects will be 44% higher than last year’s.
By this time next year, there could be as many as 20% fewer seats available if carriers respond to oil prices well above $100 a barrel by cutting as many flights as securities analysts such as JPMorgan’s Jamie Baker are suggesting.
That would be like shutting down a carrier the size of American Airlines, (AMR) the world’s largest, which, with its regional carriers, operates 4,000 flights daily. That alone would sharply increase demand and prices for plane tickets.
There would be fewer daily flights in cities of all sizes, fuller planes throughout the day and much more inconvenience. There would be fewer non-stop flights and longer layovers between connecting flights. And travelers who have long avoided flights at 6 a.m. or 10 p.m. might well have no other choices.
Those kinds of changes in Americans’ traveling habits could be inevitable: Extraordinary jumps in fuel prices are being driven by surging demand in the fast-growing economies of China and India, instability in oil-rich Venezuela, Nigeria, Iraq and Iran, investor speculation and other factors.
“You can’t underestimate the spike in fuel prices and how it is fundamentally changing the industry,” says Delta Air Lines (DAL) CEO Richard Anderson, who estimates ticket prices would have to rise 15% to 20% just to cover fuel costs.
Consumers already are getting a glimpse of travel’s costlier future.
The website Travelocity reports that fares this summer to eight popular destinations — including Boston, New York, Chicago, South Florida, Denver and Los Angeles — are up by at least 18% since last summer.
A family of four would pay Delta Air Lines about $2,500 to fly from Cincinnati to Los Angeles this summer if they bought tickets now. If ticket prices rise another 20%, as Anderson suggests is needed, that family would pay about $3,000.
“Some leisure travelers are going to be priced out” of flights, says Tom Parsons, CEO of the travel website BestFares.com.
For many families, vacations by plane that have been within their financial reach could become an unaffordable luxury, Parsons and other travel specialists say.
For entrepreneurs and small businesses, the increasing cost of travel could prohibit them from making faraway sales calls to grow their business.
Smaller markets threatened
Small and midsize cities now served mainly or entirely by 50-seat regional jets could end up with far fewer flights each day, because at today’s fuel prices, even fully loaded small jets don’t bring in enough money to justify the same number of flights.
Small cities with fewer flights per day could have a harder time promoting themselves as good locations for conventions, new factories or corporate offices.
“Communities won’t lose air service entirely, but they will lose access to air service, because it will be more expensive,” aviation consultant Michael Boyd says.
The ripple effect of higher fares and air cargo rates could affect every part of the economy that depends on air service.
Resorts, hotels, cruise lines and convention destinations could suffer. Tourism, especially in states such as Florida, Nevada and Hawaii that depend on it heavily, could take a hit, damaging state economies and forcing cuts in government services.
High jet fuel prices helped prompt the April 14 merger deal between Delta and Northwest (NWA) airlines, whose marriage would produce the world’s biggest carrier.
Delta and Northwest have pledged not to close any of their seven airport hubs if federal regulators approve their deal, but both already are slashing unprofitable flights. More mergers are possible — United and US Airways are in talks — in a trend that could reduce competition among carriers.
“Travel patterns are going to change,” predicts Northwest CEO Doug Steenland.
Travelers likely will begin seeing big changes this fall as major airlines reduce service more aggressively by dropping routes, substituting smaller planes and reducing the number of daily flights on a route.
The airlines’ goal: Push up the average price paid for each remaining seat to generate the maximum revenue per gallon of fuel burned.
Delta, the USA’s third-biggest carrier, will get rid of up to 20 full-size jets and up to 70 small regional jets this year. It’s pulling out of several cities, including: Atlantic City; Islip, Long Island; Tupelo, Miss.; and Corpus Christi, Texas.
This month, JetBlue (JBLU) will halt service between New York and Tucson.
That route’s current flights — one a day each way — generally are 70% full. However, at current fares and fuel prices, the flights need to be 85% full for JetBlue to break even on them, according to airline data.
Chicago-based United Airlines, (UAUA) the nation’s second-biggest airline, will retire at least 30 of its oldest, least-fuel-efficient jets this year.
United lost $537 million in the first three months of this year, its biggest loss since emerging from bankruptcy reorganization in 2006.
American, Continental (CAL) and Northwest are planning smaller cuts. However, some industry leaders and analysts say none of the announced cuts go deep enough. Some predict more cuts are coming.
“I guarantee you that if oil prices remain at the same level … you’ll see even more reductions in capacity,” AirTran (AAI) CEO Bob Fornaro said last week.
More fare increases expected
Airlines have raised fares 10 times since the middle of December, and several are hinting at an 11th increase this week. More jumps in ticket prices are widely expected to follow.
Parsons says travelers on long-haul routes of more than 1,500 miles already are paying up to $260 more for a round-trip ticket than they did four months ago. The increases on some routes are even higher.
Consultant Richard Leck, founder of Bruin Consulting in Bedford, N.H., flies nearly every week from Boston or Manchester, N.H., through Chicago to San Francisco, where his client is based.
Since last fall, his airfare has jumped from $800 round trip to $1,500. That’s partly because United stopped service from Chicago to Oakland, which was cheaper to fly to than San Francisco International. United also switched to small jets at Manchester; seats sell out faster.
Last week, his ticket for a non-stop flight from Boston to San Francisco cost $2,400 round trip, partly because he changed his original ticket, incurring extra charges.
“I was stunned,” he says. “Everyone has their limits, both individuals and corporate clients.”
A USA TODAY/Gallup survey in April found that 45% of air travelers would be less likely to fly this summer if fares are higher.
Driven by fare increases, revenue for U.S. carriers rose about 10% in the first three months of this year, a healthy jump in normal times. But every major U.S. carrier except Southwest Airlines (LUV) posted losses in the quarter. The cost of fuel was up 50% or more.
Some carriers don’t have the financial cushion to withstand the cost pressures. Fuel prices have forced seven small U.S. carriers to shut down since Christmas. Frontier Airlines was forced to seek Chapter 11 bankruptcy court protection on April 11.
Even Southwest, which has reported 17 years of uninterrupted quarterly profits, lost money on flying last quarter.
It reported a $34 million profit only because of its sophisticated fuel-hedging program. Through aggressive trading in oil futures contracts, Southwest was able to knock $302 million off what it would have paid had it bought all its fuel at current market prices.
The carrier’s executives acknowledge that they can’t play that risk-laden game forever.
After holding the line against fare increases during the first three months of this year, Southwest raised fares twice during the first two weeks of April.
“The reality is that there’s no U.S. airline that has a sustainable business model if $117-a-barrel oil prices endure,” says Dave Emerson, head of Bain & Co.’s global airline consulting practice.
Expansion plans curbed
Southwest, which has been aggressively expanding at U.S. airports for 35 years, will not grow in the second half of this year.
Nor will Orlando-based discounter AirTran, which had been growing at double-digit annual rates since 2002.
Clamping down on potential business is not a choice airlines make easily. It’s one thing to sell a bunch of planes. Pulling out of a city also means shutting down ticket counters and gates, and laying off or moving employees.
“Once you make those decisions to get rid of those things, you can’t very easily or quickly bring them back,” Emerson says.
Such are the tough decisions airlines are making this year, while they still have billions of dollars in cash on hand.
By 2009, if the price of jet fuel doesn’t abate and airlines can’t raise prices enough, even carriers with big bank accounts could start running short of cash and find it difficult to borrow.
“There are going to be more airline failures in this environment, and they could be liquidations,” says Delta Chief Financial Officer Edward Bastian.
JPMorgan’s Baker likens the potential financial impact of soaring jet fuel prices to the economic blow airlines suffered after the Sept. 11, 2001, terrorist attacks.
Millions of passengers, out of fear, quit flying, sending the industry into a financial free fall. The government beefed up airport and plane security, and passengers eventually returned.
But today’s fuel price crisis threatens to be a much more enduring and difficult problem.
There are no simple fixes to the unprecedented jump in prices, up 60% in April over April 2007.
Oil industry analysts say it could be years before new oil supplies can be tapped, new refineries built or alternatives to petroleum-based fuel developed and produced in enough quantities to fuel the airlines, which launch 30,000 flights a day. A wide-body jet gulps 30,000 gallons or more at every fill-up.
Texas oil billionaire T. Boone Pickens, who thought last year’s run-up in oil prices would fade, has reversed course. BP Capital Management, Pickens’ energy-oriented hedge fund, is investing based on his belief that prices will rise to $125 a barrel soon, then move past $150.
This week, the head of OPEC, Algerian oil minister Chakib Khelil, told reporters that oil likely is headed to $200 a barrel and there’s nothing the cartel can do to stop it.
He said forces other than the amount of crude oil pumped out of the ground are driving up prices.
Oil prices closed at $113.46 a barrel Wednesday after peaking at just under $120 Monday.
Even if they were to drop an unlikely 30%, average prices would remain historically high. And there’s little chance they would fall much, because of the relentless demand from China, India and other fast-growing economies.
For decades, “Air travel has been one of the incredible bargains for U.S. consumers,” says Tom Horton, American Airlines’ chief financial officer.
“We’re now in a world where airfares are going to have to reflect the cost of the product.”