Skip to main content

The oddest things happen in the airline industry.

If contrarians are right, the very thing that dealt out so much punishment to the commercial carriers in 2005 -- high fuel prices -- might be about to turn into a major ally. On a call with analysts Tuesday,


( AAI) executives said industry capacity will decline in 2006, with high fuel prices likely to encourage that trend.

"If we stay in the high $60-a-barrel range, most of the companies have budgets that are much lower than that," AirTran President Robert Fornaro said. "They'll reach a point where they say, 'They're not going down, we need to act.' Last year, when fuel prices really spiked, that's when you saw capacity come out."

If oil goes to $65 or $68 a barrel, Fornaro said, "there's not a lot of carriers that are going to produce reasonable results. If you stay where we are at these prices, you'll see capacity coming out in the second half."

In a recent report, J.P. Morgan airline analyst Jamie Baker sounded the same theme. "Ultimately, industry adaptation is helped by higher crude, insofar as fares will continue moving higher, labor costs lower, and at some point even the most stubborn growth names may see the need to decelerate," Baker wrote.

Historically, the airline industry has been at war with itself, ordering airplanes whenever times are good. The orders take years to fill, and in a cyclical world that pretty much assures that the bad times become worse. That's when airlines take delivery of new airplanes, flooding weak markets with new capacity.

When capacity shrinks, carriers are generally able to raise ticket prices as passengers vie for fewer seats. That can help to offset increases in the cost of fuel and other operating expenses.

Recently, the trend has been for capacity to decline at most U.S. legacy carriers:







TheStreet Recommends




( NWACQ) and

US Airways




(CAL) - Get Caleres, Inc. Report

is the only exception, showing domestic growth in 2005.

According to Eclat Consulting in Reston, Va., overall domestic capacity at the six carriers declined by 2.9% during 2005. By contrast, domestic capacity rose 14.8% at four low-cost carriers:


(LUV) - Get Southwest Airlines Co. Report

, AirTran,


(JBLU) - Get JetBlue Airways Corporation Report



( FRNT). Overall domestic growth is slated to increase by half a percent this year.

"The industry is clearly divided into haves and have-nots," said Gary Harig, a senior vice president at Eclat, an aviation consulting firm. "Whenever people talk about capacity reductions, it's always the legacy carriers that are the subject of this discussion."

High costs continue to force legacy carriers to downsize, said AirTran CFO Stan Gadek. For some time, he said, legacy carriers have added capacity, believing that the marginal cost "was insignificant while also serving as a deterrent to low-cost airline growth. What they did not anticipate was the impact of higher fuel costs and the dilution of their own revenue base."

This year, Gadek said, forecasters project continued capacity declines, including double-digit reductions in AirTran markets, as Delta continues to downsize domestic flying during its bankruptcy.

Meanwhile, Southwest plans to add nearly three dozen jets this year and AirTran nearly two dozen. JetBlue is also expanding rapidly.

American Airlines, the world's largest carrier, is among those acting to reduce domestic capacity.

"We are much more focused right now on driving a very large asset base to profitability rather than to worry about market share," said CEO Gerard Arpey during a conference call last week. Domestic capacity at American is likely to drop about 4% this year.

Arpey questioned why some airlines continue to grow. "I am very concerned that an industry that is chronically destroying capital is continuing to pour investment into the business," he said at the time. "I'm scratching my head over that."