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Europe Preview: Will Airlines Go Bust as Oil Soars?

Patrick Allen, |News Editor

British Airways CEO Willie Walsh told CNBC on Wednesday that with crude topping $130 a barrel, some of his smaller rivals risk going bust. American Airlines is cutting capacity, charging for baggage and retiring old planes as a way of countering record fuel costs. Ryanair’s CEO says he can still make money with jet fuel at these prices, but says the costs are really hurting the low-cost Irish carrier.

If any industry is going to be hit by the ongoing leap in oil prices, it is the airlines. In the US, the industry is clearly hurting; in Europe, the likes of Alitalia are on the brink of collapse. In the Middle East, the big players are lucky enough that they neither have to make money nor answer to a publicly listed board of directors. So when Air France-KLM reports on Thursday morning at 7:30 CET, it will be interesting to see how the world’s biggest airline by revenue views the prospects for what is likely to be a very difficult year.

Full-year profits are expected to come in a very respectable 26 percent higher, on the back of strong revenue growth that has outpaced higher costs. But as the wider market stares transfixed at Nymex contracts, the airline industry is working with a different number. The gain in jet fuel prices has been even more extrodinary than headline crude numbers: From $83 a barrel in May 2007, prices are now past $150 a barrel.

So what can Air France-KLM management say? CNBC Europe’s Stephane Pedrazzi will be talking to deputy CEO Pierre Henri Gourgeon on "Worldwide Exchange" at 10:45 CET and will be asking for three key answers: Can profits continue if oil prices keep rising? Does it make sense to start investing heavily in new, more fuel-efficient airplanes now? And will Air France-KLM take advantage of a weak market to expand through acquisition?

If I had to answer those three questions, I would answer "no," "sort of" and "not yet". Profit in the airline industry—if prices stay at these levels or higher—will become nonexistent. Buying new, fuel-efficient planes from Boeing and Airbus takes time, and while logical, wouldl take years to impact the fleet significantly. Air France-KLM is still trying to come to grips with its recent merger, and while the carrier is well-placed to buy rivals, it has already walked away from the loss-making Alitalia. And Washington is not yet ready to sanction a takeover of the likes of Delta , American Airlines, Continental or Northwest .

Lehman Brothers today downgraded the sector, saying prices are not yet compelling. If 2008 turns out as badly as I think it will, Air France-KLM could well pick up rivals a lot cheaper this time next year.