Tough times force airlines to scale back

Fly the shrinking skies of United – and most major American carriers. With fuel prices reaching record highs, a recession on the horizon, Wall Street battering their stocks, and the American dollar sinking to new lows, airlines are scaling back operations.

They're grounding planes, cutting domestic capacity, and eliminating jobs. American Airlines even plans to sell off its regional carrier, American Eagle.

They're all hoping to strengthen their frail bottom lines in the face of stiff economic headwinds. And for the flying public, all this retrenching will mean higher ticket prices, more fare restrictions, and decreased access to some smaller cities.

"The party's over, particularly for leisure travelers," says Robert Mann, an aviation analyst in Port Washington, N.Y. "The public has benefited from six years of remarkably low pricing which is going to come to an end."

Last week, some airlines hiked prices an average of $50 per round trip. Aviation analysts say with oil hitting $111 a barrel, that's just a start of a spiral that could lead to even higher prices in the near future. That's because of the relationship between price and demand. When ticket prices go up, fewer people usually choose to fly. And when fewer people fly, it costs more to operate the planes, and prices may go up yet again. So airlines are preparing for a double whammy.

"Economic growth is so weak that these price increases will immediately translate into a loss of customers," says Mr. Mann. "Combine that with weaker demand due higher energy costs and there's a very immediate need to cut capacity."

In a round of meetings with JP Morgan this week, airline executives lined up to announce one after another that they were doing just that.

Delta plans on eliminating 2,000 jobs, cutting back domestic flights by as much as 10 percent, and grounding 40 planes. United, too, is cutting domestic flights and plans to ground about 20 planes. American is also cutting domestic flights and some analysts expect it will announce plans to park some planes in the next few weeks.

The cuts may sound grim, but to some aviation analysts accustomed to the industry's historic boom and bust cycles there's actually some good news here.

"This is the first time that airlines have been able to adjust to what would otherwise be a major disaster," says Michael Boyd, an aviation analyst in Evergreen, Colo. "More important, it's the first time in history that airlines have found it necessary to reduce capacity in the face of strong demand."

The recent price hikes haven't yet translated into a drop in the number of people choosing to fly. But many experts contend it's only a matter of time. Right now, the price of the average ticket is still lower than it was in 2000, when oil was just $28 a barrel. Since then, the large network carriers have undergone a major restructuring, cutting costs and redrawing route structures to save money.

But with oil hitting $111 a barrel – double what it was a year ago – even the leanest airlines will have to hike prices more, say experts. "Over the past year, we've led several price increases as the cost of oil has increased," Beverly Goulet, American Airlines' treasurer, told the JP Morgan conference. "But the disconnect between the modest yield increases we've been able to achieve and the blows the industry is taking on fuel expenses is a big problem for us and our peers."

Five years ago, when American Airlines was working to avoid bankruptcy, it was paying 88 cents a gallon for jet fuel. Last year, the company paid $2.13 a gallon, according to Ms. Goulet. That translates into an additional $4 billion in added expenses.

This past January, it paid $2.64 a gallon. "The industry needs to find ways to cover the cost of this expensive input," says Goulet.

Many aviation experts believe airlines will cover some of those costs by hiking ticket prices. And that, along with the weakened economy, is expected to prompt many travelers to look for diversions closer to home. "When people have to start paying the real cost of [flying] ... there will be far fewer of them willing to take 'on a moment's notice' trips," says Mann.

Some analysts like Mr. Boyd say that even if fewer Americans fly, most airlines will weather these tough economic times better than they have in the past. That's because of actions they're taking now to cut capacity and the restructuring they've done in the past six years.

Nevertheless, some companies are expected to take a hit during this downturn, especially the small companies that lease small commuter jets, which are less fuel efficient, to the big airlines. "They used to be known as the regional airlines," says Boyd. "They're stuck with about 1,500 planes that don't really have much economic future."