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Turmoil in Iraq could raise air travel costs unless loonie rises, says analyst

MONTREAL - Canadians face a better than 50-50 chance that the cost of air travel will go up this summer due to higher oil prices, which have risen amid political turmoil in Iraq, an airline industry analyst said Friday.

"It will depend on how long this situation in Iraq is going to last," said Robert Kokonis, president of airline consultancy firm AirTrav Inc.

It will also depend on whether the crisis escalates and causes further impact on Iraq's oil refining, storage and transmission infrastructure, Kokonis said.

He said airlines could raise fares and fuel surcharges for international flights, but he doubts Air Canada (TSX:AC.B) or WestJet (TSX:WJA) will introduce surcharges on domestic or routes to the United States unless oil prices rise a further seven or eight per cent.

The U.S. benchmark price for oil on Friday was about US$107.26 per barrel on the New York Mercantile Exchange, up 35 cents for the week.

Roger McKnight, an analyst with En-Pro International, said he expects prices could still rise four per cent in the next three weeks to a month.

"That bubble could burst right away if that thing gets settled down, or it could go higher," McKnight said in an interview.

McKnight said crude prices seem reflect whether militants seem to be stopped or moving further south to Iraq's oil fields.

He said Wall Street traders worry that the situation could get out of hand, threatening about 10 per cent of the supply by members of OPEC, which represents 12 oil producing countries including several of Iraq's neighbors.

"It has nothing to do with supply and demand in North America," McKnight said. "This is a problem 6,000 miles away that's affecting gasoline prices and it will affect distillate prices, which are jet fuel prices."

Fuel is one of the largest costs for airlines, accounting for about 30 per cent of their operating expenses.

Air Canada estimates that each dollar change in jet fuel affects operating earnings by $34 million a year and 12 cents per share in net earnings. For WestJet, the impact is $9 million a year or five cents per share. The impact on Transat AT (TSX:TRZ.B) is estimated at $3.7 million or about seven cents per share.

Kokonis estimates a four per cent increase in the fuel price would increase Air Canada's costs by $136 million and WestJet's by $36 million.

However, Kokonis said, a three-cent increase in the value of the Canadian dollar would largely offset the higher fuel bill. He said each each cent increase in the loonie provides a $48 million improvement in Air Canada's pre-tax profits, while WestJet's sensitivity is $10.7 million.

Kokonis said currency movements are "critical", with a robust rise in the dollar perhaps enough for airlines to lay off any kind of cost increases.

"These carriers hope the Canadian dollar will strengthen because that will help to mitigate the collateral damage from rising oil prices."

David Tyerman of Canaccord Genuity said that although fuel prices have been rising, they are not out of line with where they've been since the start of 2011.

Jet fuel was about US$3.02 per gallon on Friday, up the US$2.80 range in early June, down from the first-quarter average of US$3.055, Tyerman wrote in an email

"Fuel does not look like a significant problem so far, but if fuel prices spike, I would expect airline profits to be hit short-term, and prices to be raised to offset the higher costs," Tyerman wrote.

On the Toronto Stock Exchange, Air Canada's fell six cents Friday to close at $9.43, WestJet gained 20 cents at $25.35 while Transat gained five cents at $9.85.

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