Oil Prices Pose Challenge to Airline Traffic (UAL, AMR, DAL, LUV)

Just as passenger and freight traffic have begun to improve for the world’s airlines, rising crude oil prices have thrown a monkey wrench into the airlines’ hopes of profitability in 2011. The International Air Transport Association (IATA) reports that January 2011 passenger traffic grew 8.2% year-over-year and freight traffic grew 9.1% in the same period.  The bad news, of course, is that unrest in North Africa and the Middle East has caused global oil prices to take off faster than expected.

The IATA notes that its forecast for 2011 airline profits was based on a price for Brent crude of $84/barrel, a level it passed about three months ago. The price for Brent crude currently exceeds $110/barrel. For every dollar above $84/barrel, the world’s airlines need to recover another $1.6 billion in costs.

The IATA has projected airline revenues of $598 billion and a profit margin of 1.6% for 2011. That works out to about $9.57 billion in profit, which means that profits go to zero at a price of about $93.50/barrel.

The implication is that US carriers like United Continental Holdings (NYSE: UAL), AMR Corp. (NYSE: AMR), Delta Air Lines Inc. (NYSE: DAL), and Southwest Airlines Co. (NYSE: LUV) will either have to raise fares or impose a fuel surcharge fee to prop up profits.

Airline industry research firm Advito estimates that current fuel surcharges on overseas business class tickets can add up to 6%-12% of the fare, and as much as 20%-30% of an economy class ticket.  Because the surcharge is not covered by corporate discount plans, the impact on corporate travel budgets is proportionally greater than the actual dollar amount.

Advito also noted that fares in 2011 would rise in a range of 6%-9%, higher than the firm’s earlier estimate of a fare increase in the range of 4%-7%. Interestingly, the research firm says that the rising prices won’t affect demand, oil prices above $100/barrel “could potentially lead to double-digit fare increases—and would almost certainly engender a significant drop-off in corporate travel demand.”

Both passenger and freight volumes are back above pre-recession peaks set in 2008. Compared with low points set in early 2009, passenger volume is up 18% and freight volume is up 39%, although freight volume is off -2% from the post-recession high set in May 2010.

Libyan oil shipments have reportedly restarted today, and that could cool crude prices a bit more, but it is very unlikely that crude prices will revert to $84/barrel anytime soon. The airlines face another round of higher costs that will once again put the squeeze profits.

Paul Ausick