U.S. Airlines Report Smaller-Than-Expected Losses

Most carriers reported that fuel expenditures jumped 40–60% year-over-year (y/y). The price of jet fuel was up 85% y/y in June. Since the beginning of 2004, the price of fuel has increased 285%. During its brief period of profitability in 2006–07, the industry had done a good job of controlling costs, raising fares, and restraining expansion, but that was not enough to stay profitable in the face of high fuel bills.

Second-Quarter Earnings Reports
(Millions of dollars)

*Includes large items resulting from Northwest's emergence from bankruptcy

Airlines are looking at a variety of strategies in response. One has been to raise fares, which were up 18.7% y/y in June. Airfares are mainly demand-driven, however, and raising fares too high risks driving away fliers. A weak national economy also hurts demand. Consumers, whose wallets are already pinched by higher costs of living, may cancel vacations or choose alternate transportation. A slowdown in economic activity may also result in a decline in business travel. Thus far, evidence suggests demand has remained fairly resilient, although fare reductions to drum up demand have been somewhat more prevalent in recent weeks.

If demand concerns keep fares from climbing too sharply, revenue needs to be increased in other ways. Nearly every service associated with flying now comes with a fee, from baggage check to onboard drinks.

More dramatically, carriers are looking at supply-side solutions. Most have announced sharp capacity cuts for late 2008 and through 2009. Underperforming routes will be eliminated to keep flights as full as possible, with passengers willing to pay the most. Most domestic airlines plan their capacity to be around 10% y/y lower in the fourth quarter.

Cost-cutting measures are being implemented as well. Staff are being bought out, laid off, or furloughed. Less fuel-efficient aircraft, from smaller regional jets to old A300s, are getting grounded.

Smaller-than-expected losses were not the only good news in late July and early August, as oil prices fell too. The outlook now appears a bit more optimistic than it did earlier in the summer, but costs are still historically high. Airlines will have to be flexible and resilient to weather the storm.