Record oil prices test survival of U.S. airlines

By Mark McSherry - Analysis

NEW YORK (Reuters) - It took a $15 surcharge on a suitcase to finally drive home the message that major U.S. airlines are facing an economic crisis greater than the impact of the September 11 attacks.

Seven small airlines have filed for bankruptcy or stopped operating in the past five months and, if oil prices stay at current levels or go higher, some major airlines face the prospect of Chapter 11 protection, experts say.

"The airlines have been saying for some time they are in a crisis mode, but nobody cared -- until they slapped a surcharge on a suitcase," said Patrick Murphy, principal of aviation consulting firm Gerchick Murphy Associates.

Murphy said the crisis will lead to major cuts in services, thousands of job losses and much higher air fares.

American Airlines, owned by AMR Corp (AMR.N), said on Wednesday it will cut thousands of jobs and reduce capacity in a move to counter record fuel prices and a weak U.S. economy.

But it was the announcement by American, the world's largest airline by traffic, that it plans to charge $15 for many passengers' first checked bag that got the headlines.

This is an unprecedented move by a major U.S. airline and somehow it managed to illustrate the predicament of the network carriers better than any red ink.

AMR Corp chief executive Gerard Arpey said on Wednesday the airline industry as it is constituted today was simply not built to withstand oil prices at $125 a barrel. Crude oil futures hit a record $135 a barrel on Wednesday, more than double the price a year ago.

BIGGEST TEST SINCE 9/11

The September 11, 2001, hijack attacks accelerated a financial downturn for airlines that eventually led to four major carriers -- US Airways Group Inc (LCC.N), United Airlines, Northwest Airlines Corp NWA.N and Delta Air Lines Inc (DAL.N) -- going bankrupt between 2002 and 2005.

UAL Corp's (UAUA.O) United Airlines spent more than three years in Chapter 11, emerging in 2006, while Northwest and Delta stepped out of court protection last year. US Airways eventually merged with America West Airlines in 2005.

This time around, however, analysts said any airline that is forced to seek bankruptcy may find it harder to reemerge.

"It's hard to see how all of our major airlines can survive without bankruptcy and even then whether they can come out of bankruptcy," Murphy added.

Sky-high fuel prices and a weakening U.S. economy have stalled the airline industry's modest recovery from the 2001- 2006 downturn.

Goldman Sachs said last week it expects U.S. crude to average $141 a barrel in the second half of 2008 and earlier this month said oil could even shoot up to $200 within the next two years as part of a "super spike."

LAST MAN STANDING

To survive, analysts say major airlines have to cut costs, reduce services, lay off workers, increase fares and extra charges -- and raise capital.

Some carriers see mergers as the answer. Delta agreed last month to acquire Northwest, while United Airlines has been holding talks with US Airways recently.

But Ray Neidl, an analyst at Calyon Securities, said that, in the current environment, even mergers might not be enough.

"We do not believe the market will give a premium value to the pending merger in the current uncertain environment," Neidl wrote in a note to clients, on the Delta/Northwest deal.

"Mergers, which were supposed to make the industry more efficient, may not work in this environment since there is a large cash outlay upfront and high execution risk in this type of environment."

For most of the major airlines to survive the current crisis, many believe the industry simply needs fewer players and a drastic cut in capacity.

In an interview, Neidl painted a bleak scenario he called "last man standing."

"We have to get capacity out of the market to get ticket prices up to meet the higher fuel costs," he said. "The sooner we can get seats out of the system, the better it is going to be for everybody else."

HARD ROAD AHEAD

But that might not be easy, or quick.

"Unfortunately, airlines die very slow and as they are dying they are dragging down the other airlines with them," said Neidl.

JP Morgan analyst Jamie Baker said a "war of attrition" appears to be underway between the major carriers, where managements may engage in "value destructive behavior" as they try to simply outlast one another.

At current fuel prices, "legacy (airline) bankruptcies and/or merge-at-all-cost attempts are a question of when, not if," said Baker.

He estimates a collective loss of $7.2 billion for U.S. airlines this year and said the sector needs to shrink by about 20 percent to adjust for current fuel prices.

In a note to clients, Baker concluded: "Current fuel prices pose an earnings challenge to the industry that actually exceeds the economic impact of 9/11 in our view."

(Editing by Andre Grenon)