BA fears oil price rise may destroy its profit margins

British Airways has warned it would no longer be able to operate profitably if the price of oil continues to rise and that a sustained high price would lead to "fundamental changes in the industry".

The carrier sounded the warning at an investor day yesterday in which it predicted that its fuel bill would rise to £2.5bn this year, representing nearly a third of its entire cost base and £450m more than the previous year. Combined with the heavy spending on Heathrow's new Terminal Five, the soaring costs led the chief executive Willie Walsh to abandon his long-held target of achieving 10 per cent margins, predicting instead that it would see a margin of about 7 per cent for the 2009 financial year.

Shares in the carrier plunged to a new low on the news, falling 7 per cent to close down 20p at 245p, just as oil hit a new all-time high of $105.97. BA's finance director Keith Williams warned that it was reaching a level at which the carrier's profits could be obliterated altogether. "A question I am sometimes asked is how high fuel prices have to go before you lose your operating profit," he said. "That would be just under $120 per barrel next year. Long-run prices at those sorts of levels would result in pretty fundamental changes in the industry."

The inexorable rise of the oil price has mirrored the fall in BA shares over the past year. While the price of the black stuff has roughly doubled, BA has watched about half of its market value, about £2.8bn, evaporate. The company has managed to offset much of the rising cost through fuel surcharges foisted on to customers. Mr Williams said it recoups about two-thirds of its rising fuel bill through these fees, and hinted that more could be in the offing. In the past three years, the company has pushed through 12 increases, meaning that customers flying on its longest overseas routes now pay an average of £128 on top of the basic return ticket price. Mr Williams said the expected drop in profitability would be exacerbated by a slowdown in America. "We've started the down-cycle, particularly in the US," he said.

The gloomy outlook overshadowed what were otherwise decent projections for the company. Mr Walsh predicted that the company would increase turn-over by up to 4.5 per cent to £9.1bn next year. Long-haul premium traffic, the slice of customers that account for most of the carrier's profits, grew 11 per cent last February from the same time a year earlier (after taking an extra trading day this year into account), a trend Mr Walsh predicted would continue despite a "sharp slowdown in the US and the UK" and a less extreme deceleration in Asia and Europe.

Mr Walsh also reiterated his desire to lead airline consolidation, expressing his "admiration" for the successful tie-up between Air France and KLM. Iberia, the Spanish airline that he considered buying last year before pulling out, remains in his sights. Having declined to make a move at €3.60 (£2.76) per share, the stock has plummeted in the ensuing months. "Some people have accused me of lack of ambition," he said. "I look at the stock price now and say it was a bloody good decision."

Even so, he said that the Spanish carrier "remains attractive" and that he still covets rival Bmi for its significant presence at Heathrow. Peter Caldwell, an analyst at Barclays Wealth, summed up what seemed to be the view of most in the City. He said: "High oil prices and an uncertain volume outlook means the shares should be avoided, with lower oil and/or improving data being the main catalysts for a better share performance."