Airlines go into crisis mode as fuel hits new high

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"In the struggle for survival, the fittest win out at the expense of their rivals because they succeed in adapting themselves best to their environment." With the price of a barrel of crude oil having reached a previously unthinkable $135 in the past couple of days, never has it been a more appropriate time to apply these timeless words from Charles Darwin to the airline industry.

Already we have seen the weakest airlines dying off at the first hurdle, and several carriers have now begun to desperately restructure their operations as they face the very real possibility that, far from declining, the price of oil could continue its upward march. In the words of Air France-KLM chairman Jean-Cyril Spinetta, speaking at the carrier's annual results conference on 22 May: "If oil prices remain as high as they have been over the last several days, it's clear that our industry is going to be profoundly transformed over the coming years.

"After this restructuring of the business, the strongest players will come out of it even stronger than they beforeThe companies that are going to get through this period will be the ones with healthy balance sheets, new fleets and reasonable costs."

Drastic measures were this week outlined by the world's largest carrier in terms of traffic, American Airlines, which will slash domestic capacity by 11-12% year-over-year in the fourth quarter and retire at least 75 mainline and regional aircraft. The carrier also announced that it would introduce a $15 fee for the first checked bag as part of a package of new fee increases aimed at boosting revenues.

On announcing these survival tactics, American chief executive Gerard Arpey neatly summed up the seriousness of the situation in which the industry finds itself: "The airline industry as it is constituted today was not built to withstand oil prices at $125 a barrel, and certainly not when record fuel expenses are coupled with a weak US economy." American's first-quarter fuel bill rose by 45%, with the carrier forking out $665 million more for fuel than it would have done had the price of oil remained the same as it was in the same quarter last year.

In Europe, Finnair issued a profit warning for 2008 as a result of record fuel prices and weakening demand. "Factors troubling the entire industry - rapidly rising oil prices and a sharp fall in passenger load factors - are also clearly weakening Finnair's profit-making capacity," said the carrier's chief executive Jukka Hienonen. "With the current outlook, we can assume that the operational result for January-June, and therefore the full year, will fall short of last year's levels."

As a coping mechanism, Finnair is "planning to reduce capacity, particularly in Europe", although it has not detailed how much capacity will be cut. Fellow Scandinavian airline company SAS Group also plans to cut capacity by 11 aircraft and slash 1,000 jobs this autumn as part of its "Profit 2008" programme, which it recently expanded in response to rapidly increasing fuel prices and increasing overcapacity. This programme, the company estimates, will "generate an earnings effect in 2008 of SKr1.1 billion [$186.1 million], including price adjustments, changes to the traffic programmes, additional efficiency enhancements of overheads and the discontinuation and postponement of certain planned activities".

And larger European carriers are also preparing to feel the pinch. British Airways, which unveiled a strong financial performance for the 12-month period ending 31 March 2008 and hit its long sought-after 10% operating margin, expects the coming financial year to be "challenging", and as a result is "reviewing our capacity, costs and network in the context of the economic pressures and high fuel prices". Based on oil at $120 a barrel, BA expects that its total fuel bill for this financial year will rise by £1 billion ($1.98 billion).

Irish budget carrier Ryanair has also said it will ground 20 aircraft this winter and describes the outlook for the coming fiscal year as "poor".

However, like an island in a sea of panic, Lufthansa chairman Wolfgang Mayrhuber optimistically predicts that the German carrier will at least match its record-breaking 2007 financial performance this year. Mayrhuber says Lufthansa can adapt quickly if it needs to and could withstand the grounding of aircraft because of its strong balance sheet. Echoing the sentiments of Air France-KLM's Spinetta, Mayrhuber says: "It is doable because of the strength of the balance sheet. We have the beauty of a smaller financial impact than most of our competitors."

The Centre for Asia Pacific Aviation describes the day (Thursday 22 May) that oil prices hit $135 a barrel as a "tipping point" for the industry: "As if investors and consumers had been holding their breath for as long as they could - then let them out with a collective rush, as they realised oil prices were not in fact going to fall back soon." CAPA adds that "airline boardrooms worldwide will now be forced to give serious consideration to capacity cuts, even where they are not yet in financial danger territory".

As the number of airline casualties continues to grow and as carriers restructure their operations to make sure they're not next, it is becoming increasingly apparent that those with the strongest balance sheets and the most fuel-efficient fleets will be the ones that survive as the industry reshapes to face what some expect to be the worst downturn in years.