The term "crack spread" has turned into a curse for airlines.

The spread, which measures the additional cost of refining crude oil into the jet kerosene that fuels planes, ballooned after Hurricanes Katrina and Rita knocked out refineries around the Gulf Coast.

Airlines don't need any added pressure. They've already suffered almost two years of rising crude prices and an abundance of competition preventing individual carriers from lifting fares enough to offset fuel bills.

Even though crude oil prices have fallen almost 15% from record highs touched just after Katrina slammed into Louisiana and Mississippi, they remain high at above $60 a barrel. Plus, the crack spread for a barrel of fuel is painfully wide, at around $22, and it's been as high as $30 in recent days; the average from 1990 through 2004 was $5, notes Vaughn Cordle, an airline pilot and founder of AirlineForecasts, a consulting company based in Washington.

Third-quarter results from several airlines last week illustrate the impact from the double-punch of high crude prices and crack spreads. AMR's ( AMR) American Airlines, the world's largest carrier according to passenger traffic, paid $204 million more for fuel in the latest quarter than it would have had jet fuel stayed at the second-quarter average. Total operating expenses were $5.45 billion.

Meanwhile, fuel -- traditionally airlines' second-largest cost after labor -- became the biggest expense at Continental Airlines ( CAL) last quarter.

Airlines forecast that things will get worse during the fourth quarter because the full period will reflect post-hurricane crack spreads, while only one month of the third quarter did. Gerard Arpey, American Airlines' CEO, predicted last week that jet fuel prices will rise 24% in the fourth quarter from the third, costing the airline an additional $353 million.

Losing Big

All told, the surge in the crack spread, combined with high crude prices, will leave the 12 biggest U.S. airlines paying $9.6 billion more for all of 2005 than they did in 2004, Cordle estimates.

Full-year losses will be staggering.

Delta ( DALRQ) alone expects to lose $2.16 billion this year, excluding special items. Soaring fuel costs pushed Delta, the nation's third-largest airline, into bankruptcy protection last month. For the 12 largest airlines, Cordle expects 2005 losses to total $5.2 billion.

To get a sense of just how damaging petroleum costs have been to the sector, Cordle points out that if the 12 biggest airlines were to pay the same fuel costs in 2005 as they averaged from 1990 through 2000, they would have a pretax profit for the year of $12.7 billion.

Of course, had oil remained cheap, the airlines probably wouldn't have been able to wrangle the $10 billion worth of labor concessions they got in recent years, sometimes using the threat of bankruptcy or liquidation. But even excluding labor savings, the 12 largest airlines would have ended up with $2.7 billion of profit if fuel had remained at last decade's levels.

Alaska Air Group ( ALK), Continental, JetBlue Airways ( JBLU) and Southwest Airlines ( LUV) reported third-quarter profits last week. With the exception of Continental, they all benefited from hedging programs that use financial derivatives to cap the crude-oil price of some portion of their fuel needs.

Still, Continental and JetBlue said fuel costs will cause them to report fourth-quarter losses. And JetBlue, a young, low-cost carrier that's been profitable for 19 quarters in a row, said its fourth-quarter loss will be enough to wipe out its profits in the first three quarters of the year. That prompted Standard & Poor's to lower JetBlue's corporate credit rating to B-plus from BB-minus.

Fuel hedging had helped Alaska and Southwest weather tough times. However, the hedges only apply to crude oil and don't cover the added cost of a wider crack spread. There is no futures market for jet kerosene, but Southwest executives said last week they have added an additional layer of protection by hedging heating oil and gasoline. How effective those hedges will be remains to be seen, as the crack spread for jet fuel remains well above the additional cost of refining the two other products.

Tim Evans, senior energy analyst at IFR Markets, says Gulf Coast refineries should be back at full capacity by the end of the year, but it will probably take more time to rebuild a comfortable inventory of jet fuel.

Cordle expects the crack spread to decline next year to an average of $16 a barrel from a likely fourth-quarter average of $22 a barrel. Even that lower level -- when combined with a forecast for $62-a-barrel crude oil -- will punish the industry. The combination implies a per-gallon jet fuel price of $1.96 when fueling costs and taxes are included, above the $1.88 American paid in the third quarter when it lost $153 million, or 93 cents a share.

The airlines' fuel problem is concealing the industry's progress at reducing costs and increasing efficiency. American, for example, reduced unit costs, excluding fuel and special items, by 2.4% in the latest quarter from a year before.

The carrier has identified opportunities that could save $500 million next year and bolster revenue by $300 million. In St. Louis, it's experimenting with new ramp procedures designed to boost efficiency and reduce the amount of time airplanes are on the ground. If it's successful, American could expand the changes.

Hard to Own

Considering the industry's challenges, airlines are a tough sector for buy-and-hold investors. Ray Neidl, analyst at Calyon Securities, says he remains "cautious" about investing in the industry because of high fuel prices and the approach of the seasonally slower winter months. Also, Helane Becker, airline analyst at Benchmark, a New York-based brokerage, says she's currently no fan of investing in the major carriers.

That said, there may be short-term opportunities. Becker, whose firm doesn't offer investment banking, says one is in shares of Frontier Airlines ( FRNT), a smaller low-cost carrier flying out of Denver. The stock lost more than 28% of its value last Thursday after Southwest said it would begin flights next year from Frontier's home base.

Although investors were worried about the competitive threat from Southwest, which is expanding its capacity, Becker says the selloff was out of proportion to that threat.

She estimates Southwest, which has yet to disclose details of its Denver foray, will begin with 10 to 20 daily departures from the city. Although Southwest, known for low fares, might put some pressure on Frontier's competing routes, the latter makes 235 daily departures out of Denver, far more than Southwest is likely to start out with.

What's more, 10% of Frontier's capacity is on routes to and from Mexico, and Southwest doesn't fly outside the U.S. Some Frontier passengers may stick with it because it has frills that Southwest lacks, like satellite television on every seatback.

Neidl, whose firm does investment banking business with companies it covers, says a sharp decline in oil prices could spark a rally in shares of nonbankrupt carriers.

Delta, Northwest Airlines ( NWACQ) and United Airlines parent UAL ( UALAQ) are operating under Chapter 11 bankruptcy protection. Shares of Delta and Northwest will probably be worthless if and when they exit bankruptcy, while United already has said it will cancel existing shares in its planned exit early next year.

The market will get more third-quarter results this week -- Republic Airways ( RJET), AirTran ( AAI), Frontier, FLYi ( FLYI) and SkyWest ( SKYW).

Staff reporter Rob Lenihan contributed to this article.

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