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Can Airlines Combat Rising Fuel Costs?

Despite lingering oversupply worries and a vacillating dollar, U.S. crude prices continue to hover around the $50 mark. Recent production disruptions in Libya, Canada and Nigeria helped crude prices to cross $50 per barrel for the first time in seven months on Thursday. However, they closed lower and continue to remain below this psychological level.

But the airline industry is facing trouble on this count. Several large carriers are planning to take steps in the immediate future to combat an assault on their top lines. Despite satisfactory performances during the quarter, investors are clamoring for more, which may translate into higher airfares.

PRASMs Under Pressure

The biggest headwind airlines are facing at this point is a key revenue metric – passenger revenue per available seat mile or PRASM. This is a measure of sales relative to the capacity of a carrier.

For instance, last month United Continental Holdings Inc. UAL reported first-quarter 2016 earnings (on an adjusted basis) of $1.23 per share, which beat the Zacks Consensus Estimate by 6 cents. Consolidated PRASM or unit revenue declined 7.4% year over year.

This was a direct outcome of falling fares, which in turn are a result of lower fuel costs. Over the last two years, carriers have saved billions of dollars due to falling fuel costs. But this phenomenon has also proved to be detrimental since it resulted in airlines adding more and more seats to accommodate higher demand from passengers.

Fare Hikes Likely

By last year, airfares had fallen to a record low. An average round trip around the U.S had reached a five-year low. Airfares are continuing to fall this year with even trips to European destinations becoming more and more affordable. And this is giving airlines enough cause for worry.

It is now clear that airlines have been adding seats at a faster rate than the demand at which it was growing.  Now, major carriers are preparing to raise fares. However, such changes are unlikely to happen in the near future. Fares are likely to remain low during a period when travel peaks.

Delta Air Lines, Inc. DAL has recently announced that it plans to cut growth at a faster rate this year. Delta expects passenger carrying capacity to increase by 2.5% as the fourth quarter approaches, compared to the end of last year. This is significantly lower than the 5.4% growth logged in the first quarter. United Continental has reduced planned growth for the current year by 0.5 percentage point. Meanwhile, American Airlines Group Inc. AAL has decided to cut planned international growth for 2016 from 6% to 2.5%. Similar announcements may be forthcoming from JetBlue Airways Corporation JBLU and Southwest Airlines Co. LUV.

In Conclusion

Air travelers have enjoyed a long period of low fares thanks to falling fuel prices. This situation is unlikely to change drastically in the near future. However, by the end of the year, they may have to pay higher prices in order to fly. In the interim period, they are likely to face the snaking queues at airports as they prepare to fly out for their vacations.

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SOUTHWEST AIR (LUV): Free Stock Analysis Report
JETBLUE AIRWAYS (JBLU): Free Stock Analysis Report
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UNITED CONT HLD (UAL): Free Stock Analysis Report
AMER AIRLINES (AAL): Free Stock Analysis Report
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