Do Airlines Have A Viable Business Model?

Whenever someone comes up with a brilliant idea to start their own business, one of the first recommendations is that they write a business plan to see if their idea is feasible. Many businesses end up failing because their founders never took the time to do this exercise. Spending the time to create a business plan and take a realistic look at the cost involving with running your business allows you to see how difficult or how easy it will be to make your business successful. So has anyone taken a look at the airline industry lately to see if their business plans are viable?

Over the last few months we have seen several airlines file for bankruptcy and/or completely go out of business. Escalating oil prices that approached $150/barrel earlier this summer caused airline stock prices to fall to their lowest level in years. In fact, the high price of oil did more damage than even the terrorist attacks of 9/11 and the ensuing economic recession.

Fortunately for the airlines (and a lot of other businesses), oil prices have receded dramatically in recent weeks and now stand at $106. This has caused the airline sector to rally, but how long before oil prices go up again?

The International Air Transport Association said this week that slowing passenger-traffic growth and high fuel prices could cause the airline industry to lose $5.2 billion this year. The prospects aren’t much better for next year either as they estimate a $4.1 billion loss in 2009.

Billions of dollars in losses are nothing to ignore, but what is most frightening is that it could get much worse. Much of the losses this year have been caused by the higher fuel costs, as oil averaged $113 a barrel in the first six months of 2008. This was a 55% increase over the $73 a barrel paid last year.

With oil now at $106 a barrel, investors are once again flocking to airline stocks, but the fact is even though oil prices have retreated almost 30% off their high’s, airlines still cannot even break even at these prices. The International Air Transport Association estimates that oil prices need to average $95 barrel for the industry to break even.

The other side of the equation is the consumer who is becoming more reluctant to spend money on travel with the economy continuing to decline. This is being further augmented by the fact that airlines are forced to raise ticket prices to try and offset their higher operating costs. In June, US Airways President Scott Kirby stated that to break even his airline needed to get $650 to $700 per passenger. While business travelers wouldn’t blink at those prices, the average family of four would scarcely even consider paying $2,600 just to fly to their vacation destination. For many families, this just wouldn’t be an option as they simply couldn’t afford to pay that much just for airplane tickets.

With fuel costs representing roughly half of airlines operating costs, what happens if oil returns to the levels we saw in early summer? There seems to be plenty of potential catalysts to drive price higher once again. We remain in the middle of hurricane season with the potential for serious disruption in the Gulf of Mexico. Iran and Israel continue to trade verbal blows and many believe it is just a matter of time before some level of military action is taken. Escalating tensions between Russia and the U.S. led NATO coalition could interrupt Europe’s oil supply as they over a quarter of Europe’s oil.

These potential developments, along with many other not mentioned, seem to indicate that oil price will be rising again and maybe very soon. So if airlines can’t charge enough to make money at $106/barrel, how do investors expect them to perform at $150 or even $200/barrel? Consumers and even small-business travelers will not be able to afford to fly. So do airlines really have a viable business plan or are they simply gambling that oil prices will defy the odds to drop and stay at levels far below where they are currently.