Airlines tremble at prospect of $100-a-barrel oil Beleaguered U.S. airlines seem to have slowly staggered to their feet since the terrorism and recession of earlier this decade. But credit agency Standard & Poor's has come up with a worrisome scenario that could knock them back down: $100-a-barrel oil. Last month, S&P issued a provocative report saying the steady rise in prices in the past three years and the fear of potential supply disruptions "has created an environment where a triple-digit oil price in the near term is not unimaginable." The world's tight refining capacity, coupled with political unrest or violent storms, could cause the price, $71.14 at the market close on Friday, to climb to triple digits. No one, not even S&P, has crawled out on a limb to predict that prices will go that high. And prices have been moderating for more than a week. Still, there are enough potential sources of disruption in the flow of oil and refined fuels that some on Wall Street and in corporate suites are contemplating what would happen to the domestic airline industry if the market price does reach $100 a barrel. The speculation comes just as the industry is coming off its best quarter in six years: a collective $1.4 billion profit after setting aside one-time bankruptcy reorganization costs at Northwest and Delta. What S&P sees at the $100-a-barrel level isn't pretty: Northwest and Delta airlines could be forced to liquidate; others could be pushed into Chapter 11 bankruptcy-court protection. Discount giant Southwest would likely see its remarkable profit streak halted. Industrywide, carriers would ground aircraft, cut service and lay off workers. Travelers could count on fewer choices, more travel hassles and higher fares. Philip Baggaley, S&P's chief transportation analyst, says airlines would be in the "awful position of desperately needing to raise fares" to cover fuel costs just as "individuals and corporations would be cutting back on non-essentials, like travel." Though oil prices have fallen since hitting a record $78.40 on July 14, they remain at historically high levels. The price of jet fuel, which has averaged about $2.20 a gallon in the past month, is almost 21/2 times the 90 cents that airlines paid in 2000. If oil goes to $100 a barrel, airlines could expect to pay $3 for a gallon of jet fuel. Analyst Ben Brockwell at energy tracker Oil Price Information Service calls the concern about $100 oil "hyperbole" driven by "pundits talking about some sort of worst-case scenario." Futures contracts — agreements made now for future delivery of oil — are costing buyers no more than $80 a barrel for any month through 2008. But a growing number of speculators find nothing far-fetched about $100 oil. Some investors are buying oil futures options that pay off only if the price of crude reaches $100 or higher. Adam Sieminski, energy analyst at Deutsche Bank in New York, issued a July 28 report ominously entitled "$100 Oil Has Lost Its Shock Value" in the futures options market. Sieminski said that among a rising number of daring options investors, "$125 is the new target for bullish trades." Their high-risk options pay off only if crude's market price gets that high. They are placing bold, high-risk bets, Brockwell says. "They're gambling that the Iranian standoff with the United Nations won't be resolved, that the cease-fire between Israel and Hezbollah won't hold, that production from BP's Prudhoe Bay (Alaska) fields will be completely shut down (or) that some other major world event will disrupt supply," he says. "I just don't see that kind of price in the markets." Frightening thought The very thought of $100 oil "makes me sick," says John Heimlich, chief economist at the Air Transport Association, the airlines' trade group. He says oil prices that high could push one or two of his group's big member airlines into bankruptcy, with the most endangered solvent carrier being Houston-based Continental. And, he says, it likely would keep Delta and Northwest in Chapter 11 much longer than anticipated because it would be almost impossible in such market conditions to find investors to provide financing needed to emerge. Both airlines currently expect to exit bankruptcy in 2007. Northwest officials declined to respond specifically to such suggestions. But in recent financial reports and news releases, Northwest officials have raised the possibility that the company may not be able to absorb escalating fuel costs. Betsy Talton, spokeswoman for Delta, says high fuel prices "do pose a risk to our plan" to emerge from bankruptcy in 2007. "For 2006, we've seen a nearly $600 million impact from higher fuel prices." Baggaley agrees that Continental is most at risk of entering bankruptcy protection if oil prices climb to three digits. Despite outperforming most other big carriers by several measures in the past couple of years, Continental has the smallest cash cushion. Continental spokesman David Messing declined to comment on that speculation. Prolonged oil prices above $100 a barrel could even run the USA's only perennially profitable carrier, Southwest, into the red on a full-year basis for the first time since 1972. The Dallas-based discounter's recent quarterly profits have been mostly the result of gains from its industry-leading fuel-hedging program. Southwest (LUV) has locked in fuel prices by contracting for future delivery at negotiated prices. Though it continues to be the best-hedged U.S. carrier, those hedges are eroding as oil prices climb and futures investors seek a premium for locking in a price for the airline. This year, Southwest has contracts guaranteeing that the price of 75% of expected fuel purchases will be based on crude prices no higher than $36 a barrel. Next year, that falls to 65% at $41 a barrel. Only 39% of its 2009 fuel needs are hedged, and at prices up to $44 a barrel. Southwest CEO Gary Kelly discounts the likelihood of $100 oil. "We don't think the fundamentals justify the current price, and certainly not something as high as $100. There's a lot of fear included in the market price right now." Still, Kelly acknowledges that "world events could occur that could push the market price much higher." That's why, he says, Southwest hedges in the first place. Little wiggle room In the past, global oil production capacity accommodated demand with plenty to spare. But today, with production running almost flat out, the world consumes 98% of the nearly 85 million barrels of crude produced each day. If rebels blow a hole in a Nigerian pipeline, Iran stops shipping oil to make a political point, or a hurricane knocks out U.S. refineries, the lost production can't be replaced quickly or easily. Larry Goldstein, president of PIRA Energy Group, a petroleum industry-funded think tank, says the prices of crude and refined products such as jet fuel react violently because of the lack of spare production capacity. When an event disrupts or threatens to disrupt production anywhere in the world, spigots elsewhere can't be opened wider. It "used to be that prices moved in response to supply disruptions by nickels and dimes," Goldstein says. "Today, without any cushions left, the price moves by dollars in response to disruptions and threats of disruptions." Still, some argue that oil is more likely to tumble below $40 a barrel in the next six months to a year than it is to rise to $100. Aaron Gellman, a professor at Northwestern University's Transportation Center, says prices are likely to fall. Oil-producing nations tend to raise production to keep prices low enough to discourage investment in alternative fuels, says Gellman. Also, he says, "We're finding new sources of oil all the time, and new technologies to re-exploit oil fields that have been let go." A major blow Any way you look at it, U.S. airlines would be overwhelmed by fuel prices approaching $3 a gallon, the jet fuel price that $100 oil would bring. According to the ATA, a 33% jump in crude prices, from $75 a barrel to $100, would increase the industry's fuel bill by $32.5 million a day. If $100 oil were to persist for a month, it would cost the airlines an extra $975 million. Over a year, the damage would total $11.7 billion. That's a staggering sum to an industry that collectively lost $42 billion in the five years ended in 2005, and assumes carriers would continue operating current schedules. For consumers, $100 oil likely would lead to higher fares in the long run. But as Heimlich notes, "It's one thing to raise fares; it's quite another for anyone to actually buy them." Fewer people would be willing to pay higher fares, because $100 oil would mean paying more to fill their cars, more for groceries delivered by truck, more for home energy — more for just about everything. And that would create a kind of vicious cycle for the airlines: fare increases driving away business, thereby increasing pressure to raise fares again. Undoubtedly, some people, particularly business people, would continue flying, says Dilip Ballal, director of the von Ohain Fuels and Combustion Center at the University of Dayton in Ohio. But their numbers would be reduced, and their travel and buying patterns would change as they become more price-sensitive. "People will still have to travel. They will just have to get used to paying more and traveling less." That's why Ballal and others are attempting to develop alternative fuels and new engine technologies. They want to reduce both the cost of aviation and aviation's draw on the world's finite supply of oil. Ballal and others are looking at ways to create synthetic jet fuels that can be used by themselves or in a mixture with conventional jet fuels. A Pentagon-sponsored project to produce a synthetic fuel for the U.S. military's aircraft is underway and eventually could lead to commercial use of such fuels. But no one expects relief from the research soon.