RIO DE JANEIRO, June 7 (Reuters) - The global airline industry nearly halved its 2026 profit forecast on Sunday, citing conflict in the Middle East that has driven up fuel costs, disrupted key air corridors and exposed the fragility of a sector operating on thin margins.

The International Air Transport Association, which represents more than 370 airlines accounting for about 85% of global air traffic, said in its annual report that it now expects the industry to post a combined net profit of $23 billion in 2026, well below a previous projection of about $41 billion and down from $45 billion in 2025.

The downgrade underscores airlines' exposure to geopolitical shocks and fuel volatility, even as passenger demand remains resilient, planes are flying fuller and revenues are set to rise to more than $1.1 trillion.

"There are two major factors: one is the significant increase in jet fuel prices, which has gone way higher than I think anybody would have expected, and then the disruption to the airlines in the Gulf region, so that combination has led us to reduce the forecast," IATA Director General Willie Walsh told Reuters at the group's annual meeting in Rio de Janeiro.

Walsh said he expects some smaller airlines to go bankrupt or be taken over by bigger carriers this year and next as higher fuel costs bite. U.S. low-cost carrier Spirit Airlines shut down last month, the first airline casualty of the Iran war.

Airlines are also expected to cut unprofitable routes to protect margins, while fares - which have surged since the start of the Iran war - are unlikely to fall soon, Walsh said.

"In an environment where demand remains pretty robust, but capacity comes down, that will likely lead to a situation where fares will remain elevated," Walsh said.

FUEL COST SHOCK WIPES OUT HIGHER REVENUES

The Middle East conflict, triggered by U.S. and Israeli airstrikes on Iran, has forced airlines to reroute flights around closed or restricted airspace, adding hours to some journeys, increasing fuel burn and straining already tight capacity.

At the same time, oil prices have surged on fears of supply disruption, pushing jet fuel prices sharply higher and widening refinery margins, leaving airlines facing a steep jump in their largest cost.

Gulf airlines such as Emirates, Qatar Airways and Etihad Airways face the greatest operational uncertainty after a near-complete shutdown of regional airspace at the start of the conflict.

Walsh said most regions should remain profitable, though at lower levels, while Middle East airlines are likely to slip into the red due to the conflict and weaker demand.

IATA expects airlines' fuel bill to surge to about $350 billion this year from roughly $252 billion in 2025, with fuel accounting for nearly a third of operating costs.

That is eroding profitability per passenger, with airlines now expected to earn about $4.50 per passenger, roughly half last year's level.

On the upside, IATA expects industry revenues to rise 9.4% to around $1.16 trillion this year, driven by steady travel demand, higher fares, and growing income from extras such as seat upgrades and onboard services.

Aircraft shortages are also squeezing the sector. Delivery delays at Boeing ( BA ) and Airbus are forcing airlines to keep older, less fuel-efficient planes in service for longer, raising maintenance bills and blunting efforts to improve margins, Walsh said.