Despite an expected rise in passenger demand, an industry group downgraded its fiscal outlook on the airlines Tuesday, citing rising oil prices.

The International Air Transport Association now expects airlines to make $3 billion in profits this year, down $500 million from its earlier view provided in December.

The downgrade reflects a rise in the expected average price of oil to $115 a barrel, up from a previous forecast of $99. The average price year-to-date is approaching $120.

Carriers are heavily dependent on the volatile price of fuel. The industry group says the rise in oil will push fuel to 34% of average operating costs, causing the overall industry fuel bill to rise to $213 billion.

“The risk of a worsening eurozone crisis has been replaced by an equally toxic risk—rising oil prices,” IATA chief executive Tony Tyler said in a statement.

By region, carriers in North America were the primary reasons for the downgrade, with the IATA reducing its view on their profit to $900 million from an earlier $1.7 billion.

IATA says the downgrade would have been worse had it not been for the easing of the eurozone crisis, an improvement in the U.S. economy, stability in the cargo market and slower-than-expected capacity expansion.

The group revised higher its view on passenger demand growth to 4.2%, which it says is a reflection of consumer confidence and stronger business travel.

Major airlines including Delta (NYSE:DAL) and United (NYSE:UAL) started to increase the number of more profitable routes offered to travelers earlier this year after a decline throughout 2011.

Capacity is projected to grow by 3.2% in 2012, behind the consensus of 3.6%, but load factor is two points above pre-recession levels.

Airline performance is closely tied to global GDP growth, with airlines usually reporting a collective loss when GDP growth drops below 2%. Now that GDP growth projections are at 2%, IATA said it will not “take much of a shock to push the industry into the red” this year.

On a happier note, the IATA revised upwards its estimated 2011 profits on the industry to $7.9 billion from $6.9 billion, led by better-than-expected performance by Chinese carriers.

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