Airline profits came under heavy pressure during the second quarter as the gnawing return of high fuel costs came back to haunt the sector.

North American carriers saw their profits checked in the three months to June to roughly half the level of the same period last year. A sample of results for Asian carriers shows a collective operating loss for the period, though a return to profit at a net level. While in Europe revenues and profits grew strongly, though this was off the back of an ash-cloud distorted comparable period.

The fact that airlines had to fight to cling on to their profit gains illustrates the pressure that higher fuel prices bring and the uncertainty that continues to dog the near-term economic outlook.


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The recent story of strong premium demand has largely continued. It has been a robust economic performance that has thus far helped to at least partially offset the impact of high fuel prices.

In particular, confidence has remained high at a corporate level. So unlike 2008, when the soft economic environment made it difficult for airlines to recoup increased fuel costs through higher fares, strong demand for premium travel has helped airlines take the edge off the fuel spike. As chief executive of British Airways parent International Airlines Group, Willie Walsh, noted during a second quarter results call: "The main driver behind the growth in the premium cabins is what I would call genuine business travel."

That ability to recoup higher fuel costs though will get harder for airlines. "The comparisons over the second half will be more difficult," acknowledges IAG chief financial officer Enrique Dupuy. "The second half of last year was strong and in the next quarters we gradually unwound and used our fuel hedges, so if the market prices remain high, our fuel bill will grow." The group has so far been able to recover 50% of the additional fuel cost through revenue initiatives, but says this will be harder to achieve during the second half.


Among US carriers, volatile fuel prices continue to underpin any sustained confidence they have in predicting long-standing profitability. But a quiet assurance emerged during the second quarter that those airlines are far better positioned now to weather the unpredictability in energy expenses than they were when record fuel prices forced sustained business discipline.

Corresponding with second quarter profitability reported by Delta, United-Continental, US Airways, Alaska, JetBlue and Southwest reported tales of skyrocketing fuel bills over the same period last year. Delta saw a $1 billion rise in its fuel expenses, while United-Continental's fuel costs were $1.1 billion higher excluding hedges. US Airways estimated that its second quarter fuel bill would have been $400 million cheaper at 2010 fuel price levels. Alaska, JetBlue and Southwest - including AirTran numbers for the first time - all saw hefty hikes in their fuel bills.

American, which cited a more than $500 million jump in its fuel bill, was the laggard among the US major carriers. Profit eluded it as net losses rose to $286 million.

"The sharp increase in the price of fuel has clearly had a negative impact on the entire industry," notes JetBlue chief executive Dave Barger.

Anderson: the industry is probably three-fourths of the way there in terms of having a profile that will give it a return on capital

Yet despite the eye-popping rise in fuel expense, carriers have largely accepted triple-digit fuel prices per barrel as the new norm, and feel reasonably comfortable about their staying power at those price points.

Although US Airways is expecting fuel prices similar to 2008, carrier chief executive Doug Parker believes year-to-date the airline is achieving break-even results, declaring the carrier is, "obviously off to much a better start than we had for the full year 2008". Characterising that as a major improvement, Parker believes it reflects major systematic changes in the industry centred on consolidation that has fostered capacity discipline and management teams focused more on returns than market share.

Parker does acknowledge that collective US carrier industry profits are down from 2010, "and none of us are happy about that", But he adds: "Fuel has risen very quickly as of late, and it does take time to respond."

Parallel to rising fuel, US carriers also faced what US Airways president Scott Kirby described as "erratic behaviour in bookings", with weakening demand in June puzzling most carriers.

"Leisure demand unexpectedly and somewhat suddenly lost momentum at the end of June, pressuring industry revenues," says JetBlue chief financial officer Ed Barnes.

Kirby of US Airways attributes some of the demand volatility to a spate of negative headlines emerging throughout the year ranging from Middle East turmoil to sovereign debt worries and concern over a potential US debt default. "On the plus side," he states, "demand has remained strong, particularly when we don't have negative headlines."

Heading into the back-end of the northern hemisphere summer, revenue performance appeared to slowly start stabilising. US Airways recorded an 8% consolidated rise in unit revenues during July, besting the 7% it had forecast. United-Continental's consolidated and mainline 7.5-8.5% rise in July unit revenues also surpassed original estimates.

Delta expects to be "solidly profitable" in the third quarter, says president Ed Bastian, as "summer bookings and yield remained solid".

As all carriers navigate the new reality of a permanent high-cost fuel environment, Delta chief executive Richard Anderson observes "the industry is probably three-fourths of the way there in terms of having a profile that will give it a return on capital. Fuel prices are very high and that's going to put pressure on Delta." But he cites the carrier's determination to "continue to have free cashflow to put on our balance sheet", and reiterates its drive to constantly "figure out and continue to make progress in figuring out to how to have return for our shareholders".


But as if anyone needed a reminder of how fragile the airline industry's grip on profits for the year could be, it came with a crash in August. Whether the slump on global stock markets is a precursor to double-dip recession in the USA and parts of Europe or merely a market correction remains to be seen. But it underlines the continuing uncertainty and fragility of market conditions in parts of the world.

Central to market concerns are disappointing numbers out of the US, prompting fears it could slip back into recession and S&P to downgrade its credit rating, together with Eurozone leaders' inability thus far to quell fears of the debt crisis spreading.

The economic outlook and business confidence is key for the industry's profit hopes. IATA has already had to twice downgrade its industry profits forecast for this year to $4 billion - less than a quarter of the $18 billion profit enjoyed last year. In revising its forecast in June, IATA identified weakening global economic growth as the main risk.

If the revenue climate is hit, that would see more pressure on airlines to keep capacity under control to protect yields. As CTAIRA analyst Chris Tarry observes, this could mean airlines have to take "more capacity out, for longer".

But while revenues could come under pressure from a slowing economy, the flip side is it might also take some of the heat out of the oil price, and thus airline costs. Since the stock market slide, Brent Crude Oil has traded below $110 per barrel - a level seldom seen since March and that could mean at least some fuel cost respite is on the way.

Source: Airline Business