U.S. airlines in 2016 will again have a chance to capitalize on the low fuel prices that led to record profits in 2015. But in order for the major airlines to make the most of that opportunity, they’ll have to maintain capacity discipline in the face of surging growth from low-cost carriers.
“They would get beat bloody on Wall Street if they left capacity discipline behind,” said Bob Mann, president of R.W. Mann & Co.
The Big Three U.S. airlines, Delta, United and American, kept a tight lid on capacity in 2015, with growth rates through September of 4%, 2.6% and 1.3% respectively. Even so, by the end of the third quarter, plunging fuel costs and downward price pressure from low-cost carriers such as Spirit, JetBlue, Frontier and Allegiant had pushed ticket prices down 5.6% year-over-year.
Still, airlines prospered in 2015, fending off modest drops in income with massive savings in fuel expenses. Southwest, for example, reported record year-over-year net income for 10 consecutive quarters. Delta, meanwhile, recorded net income of $3.5 billion through September, up from $1.4 billion for the first nine months of 2014.
Analysts project that crude oil costs, which hovered at near $42 per barrel in early December, will stay low in 2016, driven largely by a continued worldwide supply glut. That bodes well for airlines both in the U.S. and around the world, especially as their hedging contracts on fuel expire.
“I think in the short term we’re going to see increased benefits for airlines as hedging unwinds,” said Barry Humphreys, a U.K.-based airline industry analyst. “It will be interesting to see whether the airlines compete away their extra profit or hang onto it.”
For now, there are signs that the U.S. Big Three will remain disciplined in 2016. Delta, for example, projects that it will expand capacity by no more than 2% in the coming year.
While slow growth would help maintain demand, it might not be enough to fend off increasing route competition from low-cost carriers, said airline industry blogger Judson Rollins. Spirit, for example, expanded its capacity 34% during the first three quarters of this year.
“I expect [industrywide] profits close to what they were last year but maybe a little lower because of increased domestic competition,” Rollins said.
So far, the major carriers are indicating they’ll take different approaches to competing with the discount airlines. American President Scott Kirby made waves in October when he announced that the airline would match prices with Spirit and other low-cost carriers. But Delta and United said they don’t plan to compete with the discount carriers dollar for dollar.
Still, Mann predicts that legacy airlines will be working on new ways in 2016 to counter the pressure being applied by their discount competitors.
“I think we’ll see a continuing move by the higher-cost network carriers to develop products and fare families to compete with the much faster-growing lost-cost carrier segment,” he said.
Competing for low-end customers, however, will be just one part of the mix for the larger U.S. carriers in 2016. In fact, says Mann, a bigger key to financial success is to outcompete rivals for high-end customers, including business travelers, by offering a better mix of upscale products.
Airlines, of course, have long been working to achieve such ends, and those efforts will peak in the coming 12 months. American, for example, said it will unveil details in 2016 on a selection of upscale packages for luxury passengers. Alaska Airlines, in December, announced that late next year it will begin offering a new upscale main cabin Premium Class.
Political battles continue
As U.S. airlines work in the coming year to maintain the profit momentum they enjoyed in 2015, political battles from this past year will spill over.
The question of whether air traffic control should be removed from the auspices of the FAA and turned over to a nonprofit corporation will likely continue to divide airlines over the coming months as an FAA reauthorization bill is debated.
House transportation committee Chairman Bill Shuster (R-Pa.), backed by the trade group Airlines for America (A4A), is expected to include such a proposal in the reauthorization bill he’ll file ahead of a March 31 deadline. But while A4A says that transforming air traffic control management would help speed development of the GPS-based NextGen technology, Delta says that the restructuring process itself would only sidetrack NextGen implementation. Delta left A4A in October, in part due to the disagreement over air traffic control.
Also carrying over into 2016 will be the dispute between the major U.S. airlines and their smaller competitors over whether Persian Gulf carriers should be sanctioned under Open Skies rules for allegedly receiving government subsidies.
But Rollins predicted that the efforts of American, Delta and United to have the U.S. block Emirates, Qatar and Etihad from launching new routes here will fizzle.
“I think it is already dead,” he said. “The Big Three U.S. airlines aren’t getting traction on the Hill."
Meanwhile, Mann said that a pilot shortage at Republic Airways, which operates regional Delta Connection, United Express and American Eagle flights, could come to the fore in 2016.
Republic, Mann said, had to cancel between 5% and 7% of its flights over the past year in a labor dispute with pilots. The parties reached an agreement in October. But now, Mann said, Republic will need to restructure its agreements with Delta, United and American to be able to hire the pilots it needs at the wages it agreed to.
“So it’s actually a watershed for the industry,” Mann said.
Senior editor Robert Silk covers the airline industry for Travel Weekly.