Fasten Your Seat Belts: Airlines Prep for Turbulent Second Quarter

Update: The merger of two U.S. airlines was announced Monday morning. They're forming the world's largest airline -- United Continental Holdings Inc. -- in a deal worth about $3 billion. The airline will be run by current Continental CEO Jeffery Smisek. United CEO Glenn Tilton will be chairman for up to two years. The combined airline will have revenue of about $29 billion. By merging, the companies expect to save $1 billion to $1.2 billion a year by 2013.

It seems like there's no such thing as "quiet time" for the airlines. A possible merger between Continental Airlines (CAL) and United Airlines (UAUA) is latest potentially landscape-changing event to crop up in the aviation industry. While insiders have been speculating about the tie-up for a couple of weeks, it had seemed to be in danger of falling through over a price disagreement. But on Friday, The Wall Street Journal -- citing anonymous sources -- reported that the deal could be announced as soon as Monday.

If the merger goes through, the result would be a global airline offering passengers more international flights, especially to Asia. But the deal could hit some headwinds as pilots, flight attendants and others try to sort out the details of their contracts.

The rumor is the the latest in a recent series of headlines about mergers, near-mergers and partnerships. It also represents only one of many issues the airline industry has had to deal with while gearing up for the second quarter, which begins the traditionally busy late-spring-and-summer travel season.

On the runway to the second quarter, aAirlines also have faced epic winter storms, which made life miserable for many air travelers; a new law that could impose economically-crippling fines on carriers who keep their passengers languishing on the tarmac; and week-long international flight disruptions caused by the Iceland volcano.

Airlines Tally Volcano Losses

Earlier this week, before the merger news, a Continental representative emailed to say the carrier's European operations had been "greatly impacted" by the volcanic ash plume. "We canceled approximately 400 flights due to the closed European airspace," she wrote. "We estimate the negative impact to our passenger revenue at approximately $24 million."

American Airlines had to cancel about 350 flights during the volcanic event, which had resulted in a loss of $15 million dollars so far, a spokeswoman said near the end of April. And Delta reported around 470 volcano-related flight cancellations that lost it around $20 million over four days.

Mac Clouse, professor of finance at the University of Denver's Daniels College of Business, says we should expect approximately several billion dollars in volcano-related losses from the U.S. airline industry this quarter. Industry analysts, he says, "will give [airlines] a bit of a break by calling this a one-time event. The problem is, that's only for analysis. It really did happen; it doesn't make the loss go away, it just gives you an excuse and maybe a pass for missing your numbers."

The EU, meanwhile, plans to supply up to $3.3 billion to help European aviation recover from losses incurred from the volcano, which left 100,000 flights canceled and 10 million passengers stranded across the continent.

Potential Fuel Cost Fluctuations

Fuel prices are another major variable for the air carriers. Fuel historically made up about 10% to 15% of a U.S. passenger airline's operating costs. But according to the Air Transport Association, airline fuel costs averaged more 35% of airline operating expenses by the third quarter of 2008. And while fuel prices are currently down from their historic highs, the airlines remain very sensitive to any fluctuation in fuel costs.

The latest wild card: newly-implemented Department of Transportation rules, which require U.S. domestic flights to let passengers off their aircraft and back into the terminal if their planes are delayed on the tarmac for three hours. While there are certain exceptions for security and safety reasons, U.S. airlines violating the rule now face fines of more than $27,000 per passenger. The "Airline Passengers' Bill of Rights" will help avoid repeats of recent, highly-publicized nightmares involving passengers interminably stuck on airport runways. But it might also mean more delays as airlines preemptively cancel flights at risk of violating the new rules.

All of these variables mean higher costs for the carriers, and inevitably for air passengers as well. "From the consumer standpoint, we're seeing airline tickets that might be $150 to $200 higher than they would have been for the same flights last summer," says Clouse, who believes new mega mergers would help keep the U.S. carriers functioning. "There may be less competition, so that may hurt consumers in the short run, but in long run I think it means these airlines can survive."

Hint of Clouds Over Bright Outlook

The future of U.S. airlines also depends on continued economic recovery, and especially on stable fuel costs. In a worst-case scenario, such as if oil prices again break through the $100-a-barrel mark, Clouse believes U.S. aviation could become the next "too big to fail" industry targeted for some form of government intervention.

A government bailout, he says, might come in the form of a financial-aid package, similar to the one the U.S. government passed after the 9/11 terrorist attacks.

Other, future measures, he says, might involve revisiting the ban on foreign carriers flying U.S. domestic routes, or perhaps reopening negotiations with between the airlines and their employees and vendors to map out better cost structures for the long run.

"If they can't survive even when we've allow them to reduce some competition, to consolidate some costs, then that suggests the industry needs a much bigger overhaul," Clouse says.