North American airlines start reining in supply as oil prices bite

Washington DC
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North American carriers are turning back to the weapon that served them so well in their last battle against high oil prices, by pulling back planned capacity increases to safeguard recently restored profitability.

Major carriers Air Canada, American, Delta and United-Continental have all revised their capacity forecasts to combat oil prices hovering in the $100 per barrel range. Frontier Airlines and leisure carrier Allegiant have also opted to prune capacity to stave off an increasingly dim outlook for fuel costs.

Jet fuel prices in early March reached $3.20 per gallon and the Air Transport Association of America says if the $3 price sticks all year, US Airlines could face a $15 billion hike in their fuel bill to $54 billion.

"Oil is now fundamentally over $100, and that means that jet-A is going to stay over $3 a gallon," says consultancy Boyd Group International. "What that means is smaller units of airline capacity are seeing their economics dive into the red for a lot of mission applications - missions that just a year ago were contributory to the bottom line."

So carriers are digging tools out of their chest from three years ago when fuel made its historic run-up in 2008, and are taking a hatchet to their capacity plans.

Delta was the first out of the gate, slowing first quarter capacity to 3-5% growth from 5-7% and overall growth of 1% for 2011. This is down from year-end 2010 projections of 1-3% growth for this year. American has trimmed its consolidated supply for 2011 by 1% from previous guidance of 4.3% growth.

United-Continental expects to keep capacity flat overall this year compared with previous plans to grow ASMs by up to 2%. Air Canada's overall capacity is projected to grow up to 5.5%, one percentage point down from its guidance in February.

Allegiant now anticipates second its quarter capacity to be flat or cut 4%, while Frontier's reining in shows capacity now likely to be flat in the second quarter.

Allegiant chief financial officer Scott Sheldon during a recent investor presentation explained late in the fourth quarter the company took a "real bearish" view "as to where fuel was going to gotherefore we kind of took a knife to our capacity outlook in the first and second quarter in order to get the average fare up".

Southwest and JetBlue, which plan to increase capacity 5.7% and 6.8% respectively for 2011 (see chart), have not as yet revised their capacity plans.

CRT Capital analyst Michael Derchin does not see those carriers making meaningful cuts this year, "maybe just a little pruning". But if oil continues to spike, "I can see them and others being prudent and trying to keep demand and supply in balance".

PROFIT FORECAST HALVED

CRT believes US carriers will remain profitable in 2011 despite rising fuel costs, although it has nearly halved its profitability forecast to $3.3 billion - compared with a $4.1 billion profit in 2010.

It now expects only 2% overall capacity growth for US carriers, including a 1% cut in domestic capacity, and urges jittery investors anxious about seeing a repeat the demand sink of 2008-09 to calm down.

What is different now? CRT believes high oil prices are keeping inefficient aircraft parked and consolidation a la Delta-Northwest and United-Continental is keeping capacity in check. It also believe anti-trust immunity achieved by the three large global aircraft alliances, "turn former competitors into partners and permit profit sharing over selected routes. Capacity is constrained and price levels maintained by alliance partners."

Also key is demand for the moment remains steady despite rising fares. US aviation consultant Robert Mann says business demand has so far been strong enough to absorb fare increases, and demand in that category appears fairly inelastic.

But carriers like Allegiant and Spirit, more dependent on elastic demand driven by discretionary passengers could face headwinds, he says. For Allegiant it might just be a matter of missing some revenue guidance as aircraft ownership costs for its Boeing MD-80s remain low, and the wider travel group has other revenue streams.

Mann believes Spirit could ultimately have both a cost issue and top line revenue challenge if discretionary demand dries up. The carrier's aircraft ownership costs are higher on its Airbus A320 fleet and Spirit also concluded a pilot deal in 2010 providing a 10% raise for captains and 18% rise in first officer wages.

As legacy airlines seem poised to weather rising fuel prices, Mann says loads could emerge as a key issue. Even though leisure passengers represent 35% of revenue at those carriers, those customers account for "major volume" at legacy carriers, he explains. If higher oil prices ultimately curtail appetites for leisure travellers, majors could see their load factors fall.