Economy May Limit Airlines' Ability to Cope With Rising Fuel Costs

Slowing growth has led analysts to question whether airlines are going to be able to continue to raise fares to offset higher oil prices.

The busy summer travel season is in full swing, and several U.S. airlines said this week that demand for seats on already crowded planes is still strong. But with planes at or near record capacity, fare hikes are among the few ways to cover rising costs.

Higher fares on the back of strong travel demand have given airlines pricing power in recent months, which fueled strong second-quarter results. But with the economy showing signs of slowing and travelers becoming hesitant to fly because of high prices and security concerns, the pricing power and accompanying profits could quickly evaporate.

"The problem that the airlines face is that, at some point,fares are capped" -- but fuel costs aren't, said Roger King, an analyst with CreditSights. He thinks airlines should have raised prices further in the peak summer traveling season in order to test consumer response.

While traffic is still on the rise, recent industry data show the growth rates are declining. Southwest Airlines Co. (LUV) , AMR Corp.'s American Airlines (AMR) and Continental Airlines Inc. (CAL) reported slower growth, or declines, in passenger revenue in July compared with June.

Southwest said it flew 2 percent more paying passengers in July, compared with a 9 percent increase in June. Continental estimated that July growth in the per-mile revenue it generates from each seat rose 9 to 10 percent for its mainline and regional network in July, but that was down from the 11 percent increase it had in June.

American said traffic, as measured by miles traveled by paying passengers, decreased 2.3 percent in July, which compares with a 7.8 percent rise in June.

"What's happening is traffic is starting to slow" because of higher fares and concerns about the events in the Middle East, said Richard Gritta, professor of finance and transportation at the University of Portland.

Weakening demand will make it more difficult for the carriers to raise prices. "It's getting harder to squeeze the bucks out," he said.

Airlines say that the slowing growth is just a reflection of the strength of the market a year ago.

"It's not raising eyebrows here," said Ed Stewart, a spokesman for Southwest. "Our bookings for the third quarter look very good."

U.S. airlines have been weakened in recent years by low-fare competition that makes it hard for carriers to raise ticket prices enough to cover costs. Chief among those costs is soaring fuel prices. At $2.23 a gallon, the cost of jet fuel is about 34 percent higher than a year ago.

In the last year, however, major carriers have initiated several lasting fare hikes that led to second-quarter profits. The latest round was last week, when most carriers raised domestic fares by $5 per leg.

But as summer vacations wind down, there have been some signs that airlines are willing to cut fares in order to stimulate demand. US Airways Group Inc. and Delta Air Lines Inc. on Thursday lowered fares on tickets between New York and Boston by as much as 54 percent.

Last week, discount airline JetBlue Airways Corp. (JBLU) announced discounts of between 18 and 34 percent on some seats.

But the discounts thus far have been more tempered than in past years, said Tim Sieber, general manager of airline and aviation consultancy The Boyd Group. "Nobody wants to go down as the guy that started the price war."