Americans are evidently enthusiastic about Rep. Nancy Pelosi’s efforts to raise the minimum wage and to relax the rules on buying drugs from foreign countries.

What they should be excited about is the new House speaker’s proposal to ban congressmen from accepting rides on corporate jets. Why? Because now our legislators will actually have to travel on commercial airlines and will be exposed to the horrors of flying America’s not so friendly skies.

Anyone trying to travel west for the holidays would likely suggest an overnight stay on the floor of O’Hare Airport as part of the initiation program for incoming congressmen. While snowstorms were blamed for the near collapse of the air travel system in December, the industry’s outdated air traffic control also contributed to the mess. December was not a fluke. In November, the American airline industry posted the worst monthly on-time record since 2000.

In the meantime, the number of suitcases lost in the ether is skyrocketing. In November alone, some 314,573 bags were lost, a 36% year-over-year jump.

Let’s not even get started on the domestic carriers’ disregard for food, pillows, and other amenities.

Notwithstanding the outward and visible signs of an industry in decline, the stocks have been on a tear. American Airlines (AMR $33), Continental (CAL $45), and US Airways (LCC $58) are all up better than 8% since the beginning of the year, while the S &P 500 is down slightly.

While much of the gain reflects Wall Street’s knee-jerk reaction to declining oil prices, there is also a rationale evolving for more significant improvement in the industry’s fortunes. The optimists are betting on consolidation, more fuel-efficient new airplanes, and the positive aftereffects of bankruptcy proceedings to yield sizable earnings and stock price gains going forward. Lower oil prices may be the icing on the cake.

Most longtime investors have traditionally regarded the airline stocks as trading vehicles, as opposed to “buy and hold” issues. This categorization stems from the industry’s seeming inability to maintain pricing and profitability, regardless of historically good demand growth.

Brian Nelson, who covers the sector for Morningstar, is among the majority who view the industry as providing a commodity service. “Yields, or prices, may have seen significant gains in 2005 and 2006, but it doesn’t seem likely the trend will continue,” Mr. Nelson says. “The industry was mired in overcapacity for years and will always have pricing pressure.”

Also, the industry’s profitability has long been hampered by heavy union wage and benefit demands, which ultimately helped put United (UAUA $47), Delta (DALRQ. PK $1.29), and Northwest (NWACQ. PK $4.36), among others, into bankruptcy.

After the 2001 terrorist attacks, the industry perforce became more cautious about expansion. New plane orders plummeted, while the downturn in travel triggered a financial crisis that sparked significant consolidation. At present, reorganized US Airways is attempting to merge with Delta as it emerges from bankruptcy, and bankrupt Northwest is considered a likely target as well. Mr. Nelson estimates that the combination of Delta and US Airways, and resulting fleet reductions, could cut industry capacity by 2%.

An economist for Fred Alger Investment Management, Zachary Karabel, is skeptical about the consolidation benefit, calling the proposed merger a seeming “act of desperation.” He notes the two carriers have very different systems and will be difficult to integrate.

Mr. Karabel is also doubtful that the industry will ever be able to rise above commodity status. However, he agrees that the carriers that have gone through bankruptcy have been able to shed pension and other benefits responsibilities, thus significantly reducing expenses. Just last week Delta defaulted on pensions covering its pilots amounting to $920 million, tossing those obligations to the ever ready Pension Benefit Guaranty Corporation. United and US Airways arranged for a similar unloading as they reorganized.

As the industry rationalizes, it is getting a lift from a lull in fuel cost increases. Oil prices are trading lower, and though the weakness may be only temporary, it offers relief to fuel-guzzling airlines.

In 2005, fuel costs for the airline industry amounted to 22% of operating expenses, up from 16% in 2004; the 2006 total is estimated at 26%. Jet fuel prices soared from $29/bbl in 2002to $71/bbl in 2005. That’s a hefty headwind. While the industry attempted to hedge some of the increase, the cost of this practice also rose, lessening the benefits.

Even if energy prices resume their upward march, a new generation of airplanes coming onstream is more fuel efficient, and will produce savings which should fall directly to the bottom line. Boeing’s much heralded Dreamliner 787, made of carbon and titanium, is the gold standard here; it is touted to run on 20% less fuel and also to fly faster.

So, there is a good case to be made for a multiyear profit expansion from the airlines, and the stocks of late have reflected that possibility. Valuations in the sector will also be limited by the industry’s vulnerability to higher fuel prices, over which the companies have little control, and by the ever present possibility of another terrorist attack. Last August, when the British uncovered a possible plot against certain trans-Atlantic flights, the stocks immediately nosedived. Though they quickly recovered as the arrests were made, it served as a reminder of this all-too-real vulnerability.

Wall Street analysts are still cautious about the industry’s outlook, which is a good thing. Estimates are all over the place. There especially appears to be little enthusiasm for the riskier issues such as Delta (DALRQ. PK $1.30)), which is still in bankruptcy proceedings. Of course, if oil prices remain steady or drop, it may be the most leveraged companies that perform the best.

For American Airlines, for instance, estimates for 2007 range from $2.66 to $6.60, and there is a sizable short position in the stock, also a good contrarian sign. Continental has seen its stock price double in the past year; estimates of 2007 earnings range from $4.20 to $7.10. Similarly, estimates for United (UAUA $46) range from $2.75 to $6.35.

Overall, these are stocks which will rise and fall on the outlook for oil prices, but which have sufficient secular improvements ahead that the bottoms and tops may be higher over the next couple of years. Given all the uncertainties, investors are advised to keep those seat belts fastened.

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