US Airways breaks off merger talks with UAL Corp.  (Updated from MarketWatch at 10.50 AM EST)

The IATA, the airline industry’s trade association which has over 220 members, reported that carriers lost $1.7 billion due to the Iceland volcano eruption which shut airlines service in most of Europe for almost a week. The airlines are back in the skies above the region, but it will take days for them to empty airports of stranded passengers.

And volcanoes like the Eyjafjallajökull one in Iceland can erupt again.

Eyjafjallajökull is still active although it is not spewing tons of ash 30,00 feet into the air. That means that traffic could be disrupted again. Whether that will  happen again is tough to say.

Ironically, the fuel bill for the grounded airlines was cut by $110 million during the incident, just as higher fuel prices threaten airline profits as crude oil prices have run from $50 in last July to the current level of $84. US carrier AMR (NYSE: AMR) parent of American Airlines, said its loss of $505 million in the last quarter was largely due to rising jet fuel prices. The problem is not isolated to AMR and is bound to undermine earnings at all of the world’s carriers.

It appeared that the airline industry had dodged the effects of the recession with large losses but not bankruptcies of major global carriers. Passenger traffic plunged, but airlines cut routes and fired tens of thousands people. British Air let  more than 8,000 people go late last year as it was plagued by loses and a pension deficit of over $5 billion.

The marriages that carriers are planning now are largely to cut costs and not to save one of the two partners in a merger from bankruptcy. BA recently concluded a deal to merge with Iberia. United (NYSE: UAUA) is in talks with US Air (NYSE: LLC) and perhaps Continental (NYSE: CAL) as well.

But, airline mergers will probably take on a new urgency if crude stays well above $80 or runs up to $100 which Goldman Sachs and Morgan Stanley have as their 2011 price targets. The thirst for oil in China could hasten that run. And, if oil begins to spike higher carrier mergers will go back to being based on survival as much as they are on efficiency.

Douglas A. McIntyre

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