As Oil Prices Rise, Airlines Turn to Capacity Cuts

As oil prices go, so go airline stocks. On Tuesday, airline shares rallied as
the skid in oil prices fueled optimism that the sector will be better able to
control costs and boost earnings.  Oil prices had dropped 7% in two days –
fabulous news for fuel-hungry airlines. On Wednesday, however, with oil catching
another bid, the Dow Jones Airline Index had dropped 1.8%. Apart from the
give-and-take of daily oil prices, it actually turns out that airlines paid for
and used less fuel in February than they did in January. While some of that
decline had to do with winter storms and flight cancellations, there's a
strategic component in the mix: capacity cuts.  Fuel costs for airlines are
down largely because they're flying less. Fare hikes are the typical way
airlines offset higher fuel prices, but the market has shown resistance over
airlines' past three attempts to do so.  The fallback position is to reduce
the number of flights and routes or simply to cut seats by replacing larger
planes with smaller, more fuel-efficient aircraft.  And they're doing
precisely that.  Airlines scaled back capacity by as much as 3% in March,
although the disaster in Japan affected airlines with Asia-Pacific routes like
Delta Air Lines (NYSE: DAL ) and United Continental (NYSE: UAL ), which have
pulled back on service for the near term.  AMR Corp.s (NYSE: AMR ) American
Airlines, which just landed a trans-Pacific partnership with Japan Airlines to
serve the region, has vowed to keep up those commitments.  Still, the airline
has cut capacity by about 1%.  Southwest (NYSE: LUV ) is bucking the trend,
having slightly boosted load factor in March. Despite a moderation in oil prices
and the reduction in capacity, serious headwinds remain for the U.S. airline
industry.  And quarterly earnings reports due out in the next couple of weeks
likely will reveal that fuel price-driven operating costs will hit airline
profits hard. Fuel prices as a share of operating costs could reach historic
proportions of as much as 40%, the Air Transport Association said this week. 
The group which represents believes those quarterly financials will show that
the industry is on track to pay as much as $3 billion more on fuel than it did
last year.  And that's just about enough to skunk up the sector's recovery
for 2011. Bottom Line: U.S. airlines received a two-day break in oil price
hikes, but don't count on it to last much past the release of their quarterly
financials.  Oil prices may be settling down from their wild ride of over $112
a barrel, but airlines face pressure at prices as low as $90 and serious pain at
$100.  As of this writing, Susan J. Aluise did not hold a position in any of
the shares mentioned here.