Boiled by Oil: For U.S. airlines, profits are falling even at a time of epic demand strength

It takes a long time to descend from a high mountain. But U.S. airline profitability is indeed descending, still strong relative to the global average but getting further away from its peak. During the springtime April-to-June quarter, the sector’s nine major publicly-traded airlines collectively earned a 13% operating margin, down from close to 18% in the same period a year earlier. Here’s an explanation of why exactly the decline occurred, and what’s behind other major trends and developments that transpired during the quarter.

So why the significant five-percentage-point drop? This year’s Q2, keep in mind, didn’t have the entire Easter holiday period, which helped last year’s Q2. But far more significantly, U.S. airlines were less profitable because of a 36% y/y mega-spike in fuel outlays. Some carriers had a bit of hedge protection. All added planes that increased their fleet’s fuel efficiency. Many raised fares. But the oil market’s vertiginous jump was simply too much to manage in such a short period of time. As a reminder, carriers were dealing with a 25% y/y increase in fuel costs during last year’s Q2, which followed a tremendous decline in early 2016. The question now: Will fuel costs rise a third straight year? Or might they start dropping again, or at least stabilize?

What about non-fuel costs? The biggest non-fuel cost item for U.S. carriers is labor, which increased 4% y/y last quarter. Many carriers already absorbed big increases from new contracts last year, as highlighted by the sector’s more dramatic Q2 2017 labor cost increase of 12%. Of course, JetBlue just finalized a new pilot deal last week. Spirit signed one earlier this year. And a few old contracts have yet to be recalibrated to current market conditions, including those covering Frontier’s pilots and Hawaiian’s flight attendants. What’s more, a new round of Big Three labor negotiations looms as current contracts become amendable—that’ll happen for United’s pilots in January. So the trend is still inflationary. As for other non-fuel costs, fleet renewal is a big containment tool, giving carriers lower unit costs via larger shells with more seats, and via technology that burns less fuel and demands less maintenance. (There are instances of downgauging and de-densification too, however, i.e., Delta’s move from B747s to A350s and Hawaiian’s lower-seat-count A330s.) U.S. airlines generally buy their planes at…

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