Investor/An insider's guide to the market: The mid-September decline in oil prices into the low $40s per barrel has proved to be merely a temporary lull in the ongoing trend of rising oil prices. This week, oil prices moved to the $50-per-barrel threshold.

Ongoing tension in the Middle East, the impact of Hurricane Ivan on output from the Gulf of Mexico and the threat of increasing unrest in Nigeria all played a part in the resumption of a rising oil price trend.

However, it is becoming increasingly apparent that underlying supply and demand is finely balanced and that, therefore, even small supply shocks can have a disproportionate impact on a nervous market.

Equity markets are taking this most recent assault on the $50-per-barrel oil price in their stride. Despite relinquishing some of the gains made during September, most equity indices are significantly higher than the levels of four weeks ago.

However, sectors such as transportation, where oil accounts for a high proportion of costs, have come under renewed pressure. The global airline industry is already on its knees and higher oil prices are playing their part. For Irish investors, only the low-cost airline sector - Ryanair and, to a lesser extent, easyJet - offer serious investment potential.

Up until it issued its first-ever profit warning at the beginning of this year, Ryanair had been one of the best-performing stocks on the Irish Stock Exchange. From a level of more than €2 in 1999, the shares traded as high as €8 in late 2002 and were still trading at just under €7 at end-2003.

Over this period, the rapid expansion of its low-cost network in Europe went hand-in-hand with rising profits and a rising share price.

Ryanair continues to expand but, since late 2003, profitability has come under pressure. The sheer scale of Ryanair's expansion over a relatively short period of time has put pressure on the group's overall profit margin.

This expansion is occurring at a time when there have been many new entrants into the low-cost sector. Although some have already gone bankrupt, the overall environment remains intensely competitive. This is putting pressure on Ryanair's revenue yields and, consequently, the airline issued a profit warning in January 2004, which led to a sharp fall in its share price and it is now trading at just over €4.

The airline is still highly profitable, with brokers forecasting trading profits in the region of €250 million this financial year. However, investment analysts have had to reduce profit expectations and there is also a much higher degree of uncertainty surrounding these forecasts.

Shareholders in Ryanair's main low-cost rival, easyJet, have had an even more turbulent time in recent years. In spring 2002, easyJet issued a profit warning that took its share price down from £5 (€7.35) to lows of under £2 a year later. The root cause of this profits slowdown was a too-rapid pace of expansion.

The company subsequently slowed its pace of expansion and managed to regain investor confidence through 2003. As a result, its share price recovered and traded as high as £3.50 in early 2004.

However, increased competition and rising oil prices forced the company to issue two profit warnings this year and, as a result, the shares are now languishing at a lowly £1.20.

The better relative performance of Ryanair's share price would seem to be fully justified by business fundamentals. Ryanair has a much lower cost base and has focused its expansion on Europe's secondary airports. Its strong bargaining position vis-à- vis these under-used facilities has enabled the company to negotiate very favourable long-term airport charges. In contrast, easyJet primarily uses major airports that involve significantly higher costs.

Ryanair's more robust business model is generating net operating profit margins of approximately 20 per cent in a difficult environment, whereas easyJet's profit margins have only occasionally exceeded 10 per cent.

Current share prices would seem to reflect these divergent operating ratios. It can be seen in the table that Ryanair trades on a prospective price/earnings ratio (PER) of 14.6 compared with easyJet's 7.9.

In the US, the pioneering low-cost carrier Southwest Airlines is on a much higher PER of 29.9. Ryanair has modelled itself on the very successful Southwest model and, on a long-term perspective, Ryanair has all the necessary attributes to mimic Southwest's American success in Europe.

Therefore, a strong investment case to buy Ryanair shares on a long-term view does stand up to scrutiny. However, Investor takes the view that the short-term headwinds of intense competition and high oil prices will negatively impact the sector for several more months.

Ryanair's announcement of more routes into Spain and easyJet's plans to open routes from Gatwick to Ireland are symptomatic of a dogfight in the low-cost sector.

The broader picture still is one where there are too many players, many of whom are undercapitalised, leading to excessive fare discounting on many routes.

This difficult business environment emphasises the high risks associated with investing in the sector. While there may be a strong temptation to purchase shares in the sector after such large share price declines this year, Investor takes the view that buying now is just too risky.

If tough trading through the winter months is combined with continued high oil prices, profitability would be squeezed even further and share prices would follow downwards. Therefore, there may well be an opportunity to invest at even lower share prices during the winter months.