The worst of the oil shock is probably over. That's the good news. The bad news for the airline industry is that high crude oil prices aren't going anywhere soon.

Even with crude oil's 10% retreat from its record high of more than $55 a barrel in October, industry observers expect jet fuel to remain a big problem because it hasn't fallen nearly enough for many carriers to avoid further heavy losses.

Oil's rise was a big factor behind last year's losses. Seven of the top eight U.S. carriers lost a combined $9.50 billion. The remaining airline among the eight,

Southwest

(LUV) - Get Report

earned $313 million.

Analysts still predict plenty of red ink this year. Even so, their estimates depend on crude oil moderating significantly from current levels of around $47 to $50 a barrel

For example, J.P. Morgan airline analyst Jamie Baker forecasts 2005 EPS losses of $1.95 at

AMR's

(AMR)

American Airlines

, $1.17 at

Continental

(CAL) - Get Report

, $7.20 at

Delta Air Lines

(DAL) - Get Report

and $5.15 at

Northwest

(NWAC)

. But those estimates -- which are better than the Wall Street consensus published by Thomson First Call -- depend on crude oil averaging $42 a barrel this year. (J.P. Morgan does and seeks to do business with companies covered in its research reports.)

With jet fuel constituting the second-largest operating expense for airlines after labor, the impact of oil price increases on airlines' income statements is large. American Airlines, the world's largest carrier, spent $1.11 billion more on jet fuel last year than in 2003, as its average cost for a gallon of jet fuel rose to $1.22 from 88 cents.

The problem for airlines has been that, unlike industries such as shipping, they have been unable to pass along higher fuel costs to customers in the form of surcharges or higher overall prices. The growth of low-cost carriers such as Southwest and

JetBlue Airways

(JBLU) - Get Report

has only increased the capacity of available seats, and in that environment, individual carriers are reluctant to raise fares out of fear that rivals will simply underprice them and increase market share. Yields, or average fares, remain under pressure.

"The key variables are yields and fuel, and it doesn't appear capacity is going to come out fast enough to make this industry viable," said Vaughn Cordle, chief analyst at Airlineforecasts LLC and a senior 777 captain at United Airlines. He noted that

US Airways

(UAIRQ)

, which is in Chapter 11 bankruptcy protection and had been struggling to avoid liquidation, gained more breathing room last month when the Federal Air Transportation Stabilization Board extended the airline's use of cash under a federally guaranteed loan. That put off the capacity reduction that could have resulted from a potential liquidation.

Cordle said Wall Street analysts may be using overly optimistic crude oil forecasts. He says Wall Street consensus forecasts for airline losses imply an average cost for a barrel of crude of $39 this year and $35 next year, even though futures contracts suggest much higher crude prices of $48 and $43, respectively, for those periods.

Changing the fuel variable has a big impact on estimates. Cordle estimates that if fuel were to average $45 a barrel this year, the net loss at 13 of the biggest U.S. airlines would total $5.08 billion, assuming carriers' current cost structures. If fuel were to average $48 a barrel instead, the total net loss would swell an additional $778 million. Cordle notes that both those forecasts are higher than the $3.52 billion tally of Thomson First Call estimates for the 13 airlines.

The chief economist at the Air Transport Association, an industry trade group, is offering a preliminary forecast for industry losses of $5 billion in 2005, according to a spokesman.

Airlines may have expected bigger declines as recently as late last year. In a November regulatory filing, Delta said its business plan is based on crude oil returning to an average of $40 a barrel this year and $35 a barrel next year. (So far this year, oil has settled as low as $45 a barrel.) If oil were to average $50 a barrel, Delta said, its liquidity needs would increase by $600 million this year and $900 million in 2006.

Even Southwest, which prides itself on its aggressive fuel-hedging program, hasn't been immune from high oil prices. The airline said its fourth-quarter earnings declined 15.2% because of higher energy costs.

Airlines say they're doing what they can to limit the damage. Southwest is close to outfitting all of its 737 jets with fuel-efficient winglets, said Laura Wright, the company's chief financial officer, at a J.P. Morgan investor conference Thursday. Continental has been putting winglets on its planes, too, and continues conservation efforts such as "tankering," in which it loads more fuel than necessary on planes leaving cities where jet fuel costs less, said Jeff Misner, its CFO, at the same conference.

Southwest's recent earnings outperformance vs. the industry has been partly due to fuel hedges it locked in before oil's spike last year, though the carrier's overall cost structure remains the envy of many rivals. Southwest has 85% of its fuel needs for this year hedged at a crude oil price of $26 a barrel. It also has 65% of next year's needs hedged at $32 a barrel and more than 45% of 2007's at $31 a barrel. Smaller hedges on a percentage basis stretch out through 2009.

Even so, Southwest expects its average jet fuel cost per gallon to be higher this quarter than the fourth quarter's 89 cents.

JetBlue also benefited last year from a significant hedging program, but it has hedged a smaller percentage of its 2005 needs -- 21% to 22% at $29.95 a barrel -- and has no hedges in place for 2006. John Owen, the company's CFO, said the airline is not inclined to take advantage of current hedging opportunities, which would allow it to lock in prices only in the mid-$40-a-barrel range. "We'll keep watching," he said at a Citigroup Smith Barney investment conference in Las Vegas Wednesday.

Larger airlines have used fuel hedges in the past but didn't have them in place to avoid last year's fuel price run-up. Early last year, cash-strapped Delta sold its fuel hedges to raise $83 million. Before the Sept. 11 terrorist attacks, American Airlines had a significant fuel-hedging program, with up to 50% of its needs hedged up to two years into the future, said Gerard Arpey, AMR's CEO, at Thursday's J.P. Morgan conference. But in the travel slump that followed the attacks, the airline's creditworthiness declined, making it hard to find counterparties for hedging trades, he said.

The airline is trying to go back to hedging and has hedged about 15% of its first-quarter needs in the low-$40-a-barrel range, Arpey said.

But some analysts argue investors shouldn't pick stocks just by looking at airlines' fuel security. Low-cost carriers are trading with high multiples.

J.P. Morgan's Baker has underweight ratings on low-cost carriers

AirTran

(AAI)

, JetBlue and Southwest, "as we believe these carriers are still largely priced for perfection despite deteriorating profits and narrowing cost advantage."