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Airlines in Transition: Industry Pressures and Responses

Editor's note: This was originally published on RealMoney earlier this month. With the Delta-Northwest merger back in the news, it is being republished as a bonus for TheStreet.com readers.

Airline executives are popping champagne corks this week. They knew that a powerful direct hit by Gustav would have decimated the industry. Simply put, the financial position of many of the carriers is extremely tenuous, and oil prices above $140 or even $150 surely would have triggered faster cash burn rates and closed the doors to badly needed balance-sheet fixes.

Gustav showed more bark than bite, and the airlines are heaving a collective sigh. The stocks of the major carriers all rose more than 15% on Monday.

But investors are missing a key point: $140 oil is lethal for these carriers, but $100 oil is no panacea. At that level, most carriers would still bleed red ink. The carriers would need to see oil at $80 and the economy on the mend if they are to keep their planes full and profit margins in the black.

Although the airline sector has pushed through a range of price increases, oil prices have risen even faster. As a result, the five major carriers are on track to lose more than $3 billion in 2008.

The carriers have been slow to respond to the changing market, and actually added an aggregate 1% in new available seats this year, compared to a year ago. That net increase and the slowing market has led to many planes that are less than full, typically with about 79% of seats filled.

In years past, an occupancy rate above 70% ensured a profitable flight. Nowadays, with fuel oil priced far higher than in the past, that figure is closer to 85%.

To fill more seats, airlines have just begun a post-Labor Day process of taking many flights out of commission. The hope is that fewer planes (and seats) will lead to greater pricing power. But the industry has never hit 85% occupancy before, so it is unclear whether the capacity cuts will be enough to meet that figure, especially in the face of slowing demand.

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