Is Delta-Northwest merger a route to global survival?

With their pilots union leaders locked in a weeks-long struggle over how to integrate their ranks, what is keeping executives at Delta Air Lines and Northwest Airlines from pulling the plug on merger plans?

Try $105-a-barrel oil for starters.

Oil's surge through the $100-a-barrel level, combined with a growing industry consensus that foreign carriers and low-fare domestic competitors are only getting stronger, is making the prospect of soldiering on alone less attractive.

Ben Hirst, a Northwest senior vice president, said in an interview late this week that carriers are favorably disposed toward mergers because of "the need for a strategy to counter this rapidly and totally uncontrollable increase in the price of oil."

He stressed that they also need to grow. "Underlying the widespread belief that consolidation in the industry is inevitable is the need for the network carriers to expand their [route] networks," which would make the surviving airlines better equipped to compete on an international basis, Hirst said.

Delta CEO Richard Anderson, shortly after crude oil reached $103 a barrel, told his employees a week ago that Delta's 2008 business plan was built on $90-a-barrel oil.

"That $90 a barrel will drive an increase of $1.3 billion in [fuel] costs compared to last year," Anderson said, noting that every $1 increase per barrel costs Delta $60 million in added fuel costs on an annual basis.

Northwest and Delta emerged from Chapter 11 last spring after shedding billions of dollars of annual operating costs and their managements said they had viable stand-alone business plans.

But Wall Street analysts are now questioning the ability of network carriers to prosper on their own in light of current oil prices, so they envision more efficient operations through mergers. Analysts and airline executives also argue that merged carriers would have route networks that would strengthen passenger yields as well as boost overall revenue.

If consolidation fails to unfold in the coming months, Northwest, Delta and some of their network peers will be smaller a year from now "given business models poorly positioned to withstand crude at $105 and a falloff in revenues," Credit Suisse analyst Daniel McKenzie said in a recent report.

McKenzie also favors big carrier mergers because the market share for low-cost carriers in the United States has grown from 15.4 percent in 2000 to 27 percent in 2007. As a result, low-cost carriers are setting prices on many routes, and Northwest and Delta have responded by shrinking their domestic capacity and focusing on international expansion.

Ray Neidl, an airline analyst from Calyon Securities, said that consolidation will occur through an "orderly process of planned mergers" or a "damaging bankruptcy process."

In a report, Neidl said that the big U.S. network airlines have been unable to make sufficient investments in new equipment as most of their foreign competitors have done.

"Foreign carriers, particularly in Europe, have been merging to form larger entities," Neidl wrote. "The industry is now truly global and this will also leave U.S. carriers at a competitive disadvantage unless they gain additional market bulk."

Investors are reflecting that pessimism about the airlines' prospects if they remain independent. Shares of Delta and Northwest are trading near the lows they hit early this year, before the merger negotiations touched off rallies in both stocks.

With the U.S. economy weakening, it's exceedingly difficult for network airlines to grow in the domestic market, said Randy Babbitt, an aviation consultant and former president of the Air Line Pilots Association.

That's why Delta, which has been expanding its business in Europe and Latin America, and Northwest, with a major presence in Asia, are compatible merger partners, Babbitt said in an interview.

"They can take advantage of a strong domestic network that is supported by a stronger international network. The combined entity will have a world-class international network," he said.

For the past few weeks, Delta and Northwest executives have been waiting for pilots to reach a seniority-integration deal before announcing a merger.

The U.S. Department of Justice must review any merger before it could be consummated, and about 10 months remain before a new president is sworn into office.

Opinions vary about how long it would take to evaluate a Delta-Northwest merger. But aviation consultant Dan Kasper said that if the new administration considers the merger proposal that it could be the summer of 2009 before new antitrust officials are in place.

While the two companies could propose a merger even if their pilots fail to reach a deal, that action would risk tremendous upheaval in the workforce by leaving pilot seniority integration to arbitration.

Also, Northwest prefers that a merger proposal be ironclad before an announcement, because it now holds special stock in Continental Airlines that allows it to block a Continental merger.

In a late February regulatory filing, Continental said Northwest's authority would be lifted under certain circumstances if it signs a "definitive agreement" that would result in a "change of control" at Northwest.

While there are many advocates for consolidation, some critics already are lining up to oppose a merger, including U.S. Rep. Jim Oberstar, D-Minn., the International Association of Machinists and Aerospace Workers and some rank-and-file Northwest employees who are angered that pilot needs have been the focus of the two managements.

Hirst said any merger that Northwest would enter would be one in which "a network is filled out and completed," so he argued that "each merger needs to be examined on its own merits, on its own facts."

Liz Fedor • 612-673-7709