Will Katrina ground airlines for good?

By Mark Tatge and Phyllis Berman

updated 12:26 p.m. ET Sept. 2, 2005

CHICAGO - Add U.S. airlines to the casualty list in Hurricane Katrina's wake.

Expect more Chapter 11 bankruptcies followed by mergers among the industry's top players. Topping the list are two familiar names: Delta Air Lines and Northwest Airlines.

Skyrocketing jet fuel prices, which have already cost the airlines an additional $9 billion since 2003, will only accelerate industry consolidation if oil prices stay above $70 per barrel, as is widely expected. Jet fuel prices are running $2.32 per gallon on the East Coast. And while that may seem cheap compared with a gallon of gas, jet fuel prices have more than tripled since the mid-1990s.

Jet fuel now accounts for 27 percent to 30 percent of operating costs and exceeds labor costs at some airlines.

Flight cancellations and service disruptions related to the hurricane are going to cost the airlines revenue. And it couldn't come at a worse time -- just before Labor Day, marking the start of the seasonal traffic slowdown. As traffic tapers off, airlines will have less cash to pay those big fuel bills.

Watch for major airlines to press the U.S. government for emergency relief or an exemption from antitrust, so they can consolidate.

Delta, with its Atlanta hub and headquarters, is among the hardest hit, a bad situation only made worse by Katrina. Calyon Securities analyst Ray Neidl titled his Aug. 22 report, "The Grim Reaper Approaches," noting that avoiding bankruptcy was almost impossible.

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Now, the situation is at a breaking point. Not just for Delta, but for the entire industry. Katrina should reduce total refining output by 43 million barrels over the next two months, according to Lehman Brothers. That translates to about a 10 percent to 15 percent reduction in the supply of jet fuel. Oil prices, despite falling back slightly in the past day, are expected to stay above $70 per barrel until at least the end of the year.

Both Delta and Northwest have no hedges against exposure to rising fuel prices. AMR's American Airlines and Continental Airlines, although in better financial shape, have no hedges in place either. The only airline with significant hedging is Southwest Airlines, which holds hedges for 65 percent of its 2006 fuel needs -- most of it at $32 per barrel, according to Lehman Brothers.

The other problem the airlines face is aging fleets. While upstarts like JetBlue Airways have relatively young (five years or less), fuel-efficient fleets, and UAL's United, while in bankruptcy, has been dumping its gas guzzlers, American, Delta and Northwest must contend with older, less fuel-efficient aircraft.

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Even with recent retirements, Northwest has among the oldest fleets of the major airlines, averaging 18.2 years of age, with nearly one-fourth of its jets dating back to 1969 or before, according to 2004 year-end figures compiled by the Airline Monitor. American's workhorse is the reliable, but gas-guzzling, MD-80 series, which also make up nearly half of American's 710 jet mainline fleet. Delta's jets average 12.4 years, and AMR's average 12.1 years. UAL's average fleet age is now down to 10.2 years, followed by Southwest at 9.1 years and Continental at 7.9 years.

Higher fuel prices will put increased pressure on all of the airlines to pare expenses further or to consolidate operations. Fuel prices could also hinder attempts by UAL and U.S. Airways Group to emerge from bankruptcy.

UAL, which has lined up $3 billion in exit financing, has until Nov. 1 to file a plan stating how the airline plans to pay its debts and emerge from bankruptcy. The actual exit from bankruptcy probably won't occur until sometime early next year.

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