Back in May, Michael Palumbo, then

Delta Air Lines'

(DAL) - Get Report

chief financial officer, cautioned that no commercial airline business model works when crude oil costs between $50 and $60 a barrel.

At the time, oil was trading around $49 a barrel, but executives feared it would rise again to the mid-$50 range.

Now that crude has established itself around $65, it raises the question of what's next for the beleaguered airline industry.

Something else has to give, say analysts. That something might be more bankruptcies, more fare hikes, or cost-cutting. However, each has its limits.

While some argue that bankruptcies would be beneficial because they would cull the weaker hands from a crowded industry,

UAL's

(UALAQ)

United Airlines

and

US Airways

(UAIRQ)

have shown that airlines can continue flying for a long time under Chapter 11, keeping capacity in the system.

Meanwhile, fare hikes will cause passenger demand to slacken. And most airlines have already made significant progress chopping expenses -- sometimes at great pain to workers -- so further cuts may be more difficult to come by.

"There are only so many times you can go to employees for lower wage rates," says Helane Becker, airline analyst at the Benchmark Co., a New York-based brokerage. "The industry has done a great job of cutting nonlabor costs ... I look at that and say, there needs to be a way to address the higher costs. If fares go up, that will address costs, but it will tamp down traffic."

So what has been described as an industry death spiral may continue.

There has been some positive news, as revenue has been rising on strong summer traffic and a series of fare increases by major carriers. Recently,

American Airlines

parent

AMR

(AMR)

hiked fares on international flights by $20 round trip, citing fuel costs.

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Even

Southwest Airlines

(LUV) - Get Report

, which lifts fares less frequently than rivals, has gotten into the act, boosting fares between $2 and $4 one way.

Still, those developments aren't enough to change the bleak long-term picture, according to some. "We remain encouraged by recent revenue trends and we believe the summer months will see very strong revenue comparisons (double-digit in August and September), but these revenue gains are not keeping pace with rising fuel costs," Lehman Brothers analyst Gary Chase wrote recently in a research note.

"We cannot analytically justify an assumption that the industry is at the beginnings of a long-term structural revenue recovery," added Chase, who lowered his 2005 and 2006 bottom-line estimates for most major carriers. Most of his estimates are well below the Wall Street consensuses.

Vaughn Cordle, who runs AirlineForecasts, a consulting company based in the Washington, D.C., area., also says Wall Street consensus estimates could be low-balling fuel costs.

With oil at $65, Cordle -- who is also a senior 777 captain at United -- predicts 13 major carriers would lose a combined $3.5 billion in 2006. Only Southwest and

JetBlue Airways

(JBLU) - Get Report

would be in the black, with Southwest benefiting from hedges capping 65% of next year's fuel needs at a crude equivalent of $32 a barrel.

Pricey Crude

If oil remains at lofty levels, it will obviously force more carriers into bankruptcy protection.

Independence Air

parent

FLYi

(FLYI)

is getting close, as its cash dwindles. And Delta is struggling to avoid a filing.

Analysts say FLYi would likely liquidate in bankruptcy, providing some relief to pricing on the East Coast, where it had been luring passengers with bargain-basement fares. Still, the benefit would be marginal, says Standard & Poor's airline equity analyst Jim Corridore, noting Independence's small size.

Given that many of Delta's assets are encumbered, the airline would have a tough time restructuring in bankruptcy, analysts agree. Yet Becker and Corridore don't think a liquidation is in the cards anytime soon. Delta's size -- it's No. 3 in the U.S. -- means it would probably be able to attract enough financing to take a stab at reorganization.

United's more than two-and-a-half-year run in Chapter 11 has shown that a carrier can keep flying for a long time in bankruptcy. Still, new bankruptcy rules going into effect Oct. 17 could speed up the Chapter 11 process if airlines file after that date.

The rules limit to 18 months the exclusivity period for bankrupt companies before other parties can file takeover plans.

The bottom line, however, is that big airline bankruptcies don't lead to liquidations that would remove weak players from the industry, along with all of their capacity.

That's unfortunate, say many analysts, because a capacity reduction resulting from a disappearing airline could improve pricing for the rest of the industry, at least for a while until other carriers stepped in to fill that lost capacity.

Rethink the Hubs

But Roger King, airline analyst at CreditSights, an independent New York research firm, offers a slightly different view. A liquidation is exactly what the industry needs, but not because it would reduce capacity. King maintains that overcapacity is not the real problem -- overhead is.

The exit of one large airline like Delta would eliminate that airline's fixed costs, which he contends are duplicative of other carriers. Competitors would eventually fill the void by boosting flights, but the industry's total overhead would have been reduced significantly.

"US Air has a hub in Philadelphia," he notes. "Continental has one in Newark. US Air has a hub in Charlotte, and Delta has one in Atlanta. All the overhead in Philadelphia and Charlotte is a waste of money to the entire industry. We have way too many hubs. If we got rid of an airline and you kept the planes going under other airlines, with the same costs of flying those planes, but more passengers per airline, you'd end up with a profitable system."

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But for an industry that thought US Airways would be out of the picture by now -- it was saved by its merger with

America West

(AWA)

-- hoping for a big airline to go away anytime soon may be overly optimistic.