Industry Research

2009 Biz Travel Survey: Airlines See High Fuel Prices, Lower Demand

Posted on June 10, 2009 by LCT Staff - Also by this author - About the author

NEW YORK — U.S. airlines ended 2008 in a much smaller and less profitable industry than the one that they entered, dropping about 9% of capacity, watching seven smaller airlines liquidate, shedding nearly 28,000 full-time jobs, and approaching $20 billion in net losses.

The year began with mounting oil costs, which reached a crescendo of nearly $150 a barrel in July, then as fuel spiraled downward, the sustained recession sent demand along.

"Looking back at 2008, the environment was very challenging throughout the year," said Continental Airlines CEO Larry Kellner during the carrier's full-year earnings call this January. "Crude oil prices were extremely volatile, peaking as high as $147 per barrel in July, and then dropping to a low of $32 per barrel in December. Add in the revenue environment deteriorating as the economy weakened, and you have an operating backdrop that rivaled any we've seen in our industry for many years."

U.S. carriers spent 2008 recalibrating to combat fuel costs through efficiency gains, capacity cuts, headcount reductions, and ancillary revenue initiatives, which made them better prepared to weather the economic crisis. Yet the profit outlook for 2009 remains bleak.

"In effect, we've swapped the oil prices of 2008 for the travel demand crisis of 2009," American Airlines CEO Gerard Arpey told investors in a first-quarter earnings call in April. "We are also facing disruptions in the capital markets and, like the recession and resulting decline in travel demand, the tightening of the credit markets is a challenge, not only for American but for the entire industry and other industries as well."

Topping labor as the airlines' largest expense in 2008, fuel cost was the biggest driver of airline losses last year. Noting that every dollar increase in a barrel of fuel adds $448 million in expenses to carriers' bottom lines, the Air Transport Association noted the cost of fuel was between 30% and 40% of total operating expenses for most carriers last year — well above the historical range of 10% to 15%.

Airlines spent $15.9 billion more on fuel in 2008 compared with 2007, according to ATA chief economist John Heimlich.

"That incremental expense, which was the largest year-over-year expense we've ever had, was done on 5.3% less consumption," Heimlich said. "The price increase was that big that it offset a reduction of just over one billion gallons consumed. Some of that was done through efficiency, a lot through contraction."

Averaging nearly $100 a barrel in 2008, the volatility in fuel pricing spurred major carriers to hedge — which turned out to be a costly insurance policy for many.

"When the price of oil started to drop, that should have been good news," said former American Airlines CEO Don Carty, now chairman of Virgin America and Porter Airlines. "Two things happened to make it worse: One, which was not self-inflicted, was the falloff in demand. The second thing, which was self-inflicted, was the airlines saying, 'Aha! $100 barrel of oil, I've got to get some of this while the price is right.' Then, of course, it dropped."

To cope with the highest fuel costs in history, airlines last year slashed capacity, retired aircraft, and reduced headcount. By the fourth quarter, the U.S. industry had reduced domestic available seat miles by 9% from the fourth quarter of 2007. Carriers parked aircraft in the desert, reduced frequencies, traded larger aircraft for smaller planes on some routes and abandoned some markets altogether.

A General Services Administration report issued in April said 38 airports lost all commercial airline service in 2008, "roughly twice the number that lost all service for the same periods in 2006 and 2007." GAO also noted U.S. airlines last year reduced the number of active aircraft in their fleets by 18% "by eliminating mostly older, less fuel-efficient, and smaller — 50 or fewer seats — aircraft."

Domestic airlines last year maintained a degree of pricing power, and initiated a number of charges, fees and surcharges.

U.S. Bureau of Transportation Statistics data showed full-year 2008 domestic airfares grew by nearly 7%, compared with 2007. However, airlines' ability to increase pricing faded quickly as demand dived in the third quarter, and fares declined in the fourth quarter.

Source: Business Travel News

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