Airlines embrace oil decline, but no time to party

By Kyle Peterson and John Crawley - Analysis

CHICAGO/WASHINGTON (Reuters) - A 23 percent drop in oil prices since mid-July brightens the outlook for troubled airlines, but clouds remain thick over the industry, with little hope that carriers will scale back downsizing plans or repeal unpopular fees.

The U.S. airline industry has fallen on hard times, as rising fuel prices have far outpaced a series of fare hikes that began in 2006. Economic weakness, meanwhile, threatens to erode demand and rob carriers of the pricing power they reclaimed in the wake of a low-fare war with newer, leaner airlines.

But carriers are fighting back with massive reductions in capacity and staff. And some of the gloomy talk from airline experts has turned positive in the last month since crude oil retreated from a record high just above $147 a barrel to a three-month low of $112.87 on Tuesday.

"This represents both the most rapid and most significant expense savings ever realized for the airlines, standing well in excess of any historic precedent for demand weakness," JP Morgan analyst Jamie Baker said in a research note this week.

The brokerage said the fall of $1 per gallon of jet fuel leads to $13 billon of reduced annualized expense. JP Morgan issued a revision of its ratings on 12 North American airline stocks.

Based on a $3.30 per gallon price of jet fuel reached this week, JP Morgan believes the airline industry can be profitable in 2009, after racking up big losses in the first half of 2008.

"The industry today is a significantly different one than that which gave us pause last March, both in our equity and credit views," the brokerage said.

Share prices of AMR Corp (AMR.N), parent of American Airlines, more than doubled during oil's drop over the past month, while those of United Airlines parent UAL Corp (UAUA.O) tripled and Delta Air Lines (DAL.N) doubled.

Airline stocks shed some of their gains on Wednesday as oil bounced up to about $117 after government data showed supplies fell last week.

SLASHING CAPACITY

Airlines, including cargo carriers, project they will consume 18 billion gallons of fuel this year, roughly 8 percent less than in 2007. This includes planned year-end capacity cuts by passenger carriers, which remove the least efficient aircraft from service.

The major airlines are in the midst of revising their projected industry losses for 2008 to $7 billion to $10 billion from $10 billion to $13 billion, according to the Air Transport Association trade group.

The change accounts for the drop in fuel prices and the expectation that they will not go up again. Planned capacity cuts, higher fares and new fees for checked bags, pillows and soft drinks also resulted in the revised estimate.

AMR Corp (AMR.N), parent of American Airlines, said it would trim domestic capacity by up to 12 percent in the fourth quarter. UAL Corp (UAUA.O), parent of United Airlines, has said it would cut its fourth-quarter mainline capacity by up to 16.5 percent.

Other carriers planned comparable cuts and issued an avalanche of fees for items and services that previously were complimentary.