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Volcano threat leaves airline stocks in limbo

Growing fears of a volcanic eruption in Iceland left investors on edge Wednesday with airlines braced for potential disruption.

Bardarbunga is the second highest mountain on the island and a "swarm" of around 2,600 earthquakes has been felt in the region since Saturday morning. The Icelandic Met Office has raised the risk level to the aviation industry to orange—the fourth level on a five-level scale—but has added that there were no signs of magma moving to the surface. There are presently no signs of an eruption.

A warning sign blocks the road to Bardarbunga volcano, some 20 kilometres (12.5 miles) away, in the north-west region of the Vatnajokull glacier August 19, 2014. The threat of an eruption of Iceland's Bardarbunga volcano has increased, according to the Icelandic Meteorological Office, with 'intense seismic activity' and 'ongoing magma movement' reported at the site of the volcano.
Reuters
A warning sign blocks the road to Bardarbunga volcano, some 20 kilometres (12.5 miles) away, in the north-west region of the Vatnajokull glacier August 19, 2014. The threat of an eruption of Iceland's Bardarbunga volcano has increased, according to the Icelandic Meteorological Office, with 'intense seismic activity' and 'ongoing magma movement' reported at the site of the volcano.

However, the organization is closely monitoring the situation and said it was not ruling out the possibility of an explosive subglacial eruption, leading to "an outburst flood and ash emission." The country's Civil Protection Authority announced Wednesday it was evacuating the area north of the volcano as a safety measure.

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"Although this is an early warning and clearly a lot will depend on whether there is an eruption, wind patterns etc., investors will be concerned for trading and earnings," Robin Byde, a transport analyst at Cantor Fitzgerald, said in a morning note on Wednesday.

Loss in revenues

Transport stocks on the pan-European Euro Stoxx 600 Index pushed lower Wednesday, pushed by weak sentiment in the wider markets. Drifting ash clouds from volcanoes have the potential to disrupt flights, meaning cancellations and loss in revenues. Airlines, not to mention holidaymakers, will only be too aware of the problems posed in 2010 when Iceland's Eyjafjallajokull volcano shut down much of Europe's airspace for six days.

At the time, The International Air Transport Association estimated that the financial impact on airlines would be in excess of $200 million per day in lost revenues. It finally settled on a final figure of $1.8 billion in lost revenue and said that 10 million passengers and 100,000 flights were affected during the period. Within nine days of the eruption the European travel and leisure sector had lost 13 percent of its value, before facing an extremely volatile trading period for a further two months. Byde noted on Wednesday that European airline stocks have already seen some weakness in recent months and this would limit further falls if the ash clouds do materialize.

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And it's not only European airlines that could be affected. The volcano's location means that U.S. carriers flying trans-Atlantic routes could also be affected. Byde covers several international airlines and said that the eventual impact on earnings after the 2010 eruption was a "fairly modest" $80 million of operating profits across five airlines that year. Rorrie Mars, a U.S. transportation analyst at Atlantic Equities, said United Continental has the greatest exposure to these events as it generates 16 percent of its revenues from Atlantic flying. This is followed by Delta at 15 percent and American Airlines Group at 10 percent of revenue. Mars also said Delta's Atlantic traffic declined 5.5 percent year on year in the reporting period when the 2010 eruption happened, costing $5 million a day, which he added was a relatively small impact.

In the long term, the earnings power of the airlines would not diminish because these events do not necessarily change long term travel behavior, according to Mars.

"We would see any selloff in the stocks on the back of it as a buying opportunity. A temporary impact to revenue is certainly a possibility but analyzing the potential is very difficult as it depends on so many variables out of anyone's control," he told CNBC via email.

New technology?

The positives for investors are that airlines and governmental organizations could be more prepared this time. Eurocontrol, an air navigation safety group for the region, said this week that Europe has better mechanisms in place than it did in 2010.

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"Every year, volcanic ash exercises are conducted and we learn from them: the latest one was held in April this year. However, volcanic ash is still a hazard for aviation and does have the potential to cause disruption. Safety is, as ever, our primary concern," it said in a report on Monday

Meanwhile, U.K.-based airline easyJet has been busy trying to develop its own technology to enable it to fly through any ash clouds. In October, it completed the final stage of testing for its AVOID (Airborne Volcanic Object Identifier and Detector) volcanic ash technology, but the system has yet to be widely fitted into aircraft and is due for production in 2015.

—By CNBC's Matt Clinch

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