From: Reuters
Published December 7, 2007 09:21 PM

CORRECTED: Southwest sees higher fares, mergers

By Chris Reiter

WASHINGTON (Reuters) - Southwest Airlines Co, the leading U.S. low-cost carrier, expects soaring fuel costs to lead to higher fares and possibly push rivals into mergers, its chief executive said on Wednesday.

"It feels like fares will need to continue to rise on an annual basis because costs are escalating rapidly," Gary Kelly said at the Reuters Aerospace and Defense Summit in Washington.

Oil prices, which hit record levels in recent weeks, are driving up the cost of jet fuel. Combined with a darkening outlook for the U.S. economy, the U.S. airline industry, which emerged from a five-year slump in 2006, may be heading for another rough patch.

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"There is a lot of peril that remains," Kelly said.

The recent run-up in oil "isn't a spike. We're at a new level. The industry hasn't adjusted to it yet. We haven't adjusted to it yet."

Higher fuel costs could help cripple the industry's hard-won turnaround, which has come through deep wage cuts and reduced fleets. But airlines remain vulnerable and may look to merge to survive.

"You will have a recession some time, and the impact on the airline industry will be dramatic," said Kelly. "All of that leads to consolidation, I think."

Southwest, one of the few U.S. carriers to consistently post profits, is adjusting to rising fuel, labor, and airport costs by looking to boost revenue, with new products like its Business Select fares, which come with faster boarding and a cocktail on board.

The new initiatives, which also may include on-board Internet and code share agreements with an international carrier, are expected to boost revenue by more than $1 billion by 2010, but they may not be enough on their own to keep from boosting fares, Kelly said.

Southwest is better positioned than its rivals because of its aggressive fuel hedges, which have locked in prices well below the current level.

Those hedges are likely to generate a gain of "a couple hundred million dollars" in the fourth quarter, Kelly said.

Still, even with this protection, Southwest expects its costs per available seat mile, or unit costs, to rise by 4 percent this year and by "mid-single digits" in 2008.

Despite plans to rein in growth in 2008, Southwest may expand capacity faster than the currently planned 4 percent to 5 percent rate.

"If our competitors start retreating, that may cause us to change our mind and accelerate our growth plan," Kelly said. "If the airline industry is shrinking, obviously that puts us in a great position to pick up additional passengers."

Wall Street has been concerned about Southwest's ability to offset its unwinding hedges -- the company loses a bunch of its protection after 2008.

The shares have fallen about 10 percent this year. Still, the stock has fared better than the overall sector. The Amex airline index is down about 30 percent.

On Wednesday afternoon, Southwest shares were down 13 cents at $13.67 on the New York Stock Exchange.

(Additional reporting by Kyle Peterson and John Crawley, Editing by Jeffrey Benkoe and Gerald E. McCormick)

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