Mainline carrier mergers have led to shrinking or disappearing hubs. Rising fuel costs have sucked the profitability out of the 50-seat regional jet markets. The rapid increase in passenger count of the last 15 years is over. In short: The U.S. regional airline industry has to look outward for new opportunities to grow.

But the environment, while challenging, is not without opportunity. Changes in airline scope clauses mean shifts to larger regional jets (RJs)—just what regionals need as rising oil prices render 50-seaters uneconomical. And mainline carriers typically benefit from having multiple regional partners, so while there are fewer majors, there is still plenty of work to bid on. Some industry observers even suggest that the rapid decline in 50-seater demand could make those aircraft attractive once again at least for some, in much the same way that ValuJet built its fleet on the back of aging, unwanted McDonnell Douglas DC-9s.

In the bigger picture, there is little doubt that the era of rapid growth among U.S. regionals has paused, if not passed. Regional airlines carried 160.7 million passengers in 2011 (the latest full-year figure available), according to the Regional Airline Association (RAA). While nearly double the number carried in 2000, the total fell slightly from 2010, and was up just 5.3% from 2005, when the annual passenger count first topped 150 million.

Available seat miles underscore the trend. After jumping 123% from 2000's 42.8 billion to 2005's 95.6 billion, they grew just 5.1% through 2011, hitting 100.4 billion.

Now that growth through growing is off the table, regionals are, much like their mainline partners, emphasizing cost control. American Eagle parent AMR Corp. used the cloak of bankruptcy to help cut the regional arm's aircraft costs. AMR returned 18 Embraer ERJ 135s and cut a sale-and-leaseback deal on 21 more, with terms that end this year. It also slashed lease payments 49% on its 58-plane ERJ 140 fleet and cut leases on 68 of its 118 ERJ 145s by 34%.

The moves are part of AMR's plan to increase the size of its regional aircraft, including outsourced flying. A recent expansion of American Airlines's scope clause, which limits variables like aircraft size or the number of aircraft that partners can fly for the major carrier, made it possible for the carrier to boost its maximum RJ capacity to 76 seats from 50.

American is not alone. Similar expansions to the scope clauses of Delta Air Lines and American Airlines mean that regionals have significant opportunity to add larger RJs to their partner agreements. Demand is so great that American, fearing a rush on regional jet orders, pushed hard to complete a deal with Republic Airways Holdings earlier this year that adds 47 76-seat Embraer 175s as outsourced Eagle capacity.

“I believe that there is likely to be an unprecedented demand for large regional jets in 2014 and 2015 that could leave some mainline carriers with unsatisfied demands,” said Charles Schubert, American's vice president for network planning, in an April court filing.

Republic, which includes Republic Airlines, Chautauqua Airlines, Shuttle America Corp. and Lynx Airways, carried 20.1 million passengers in 2012, down 3.2% from 2011's 20.8 million.

Chief among Republic's 2012 accomplishments was changing Chautauqua's fortunes. Like many 50-seat regional operators, Chautauqua found itself flying at a loss due to rising maintenance costs on aging RJs coupled with reduced reimbursement rates from major partners. Republic cut some lease rates and landed new contracts for idle planes. The result should improve cash flow by $45 million per year for the next five years, allowing the carrier to get by until it can get out from under 50-seat flying.

“As long as we keep aircraft operating under Chautauqua, it should produce near break-even results,” says Tim Dooley, Republic's chief financial officer.

Despite consolidation among the majors, Republic executives are confident that, as its American deal showed, regionals will have significant opportunity to add work.

“In general, just about anything that helps our partners achieve stability and sustained profitability is in our own best interests,” says Bryan Bedford, Republic Airways Holdings CEO.

The specter of capacity cuts by the merged American/US Airways entity looms large, however, even as the combined carrier pledges to keep its total of 10 hubs.

An analysis from LeighFisher consultants shows that six years after American's 2001 merger with TWA, the combined carrier had eliminated capacity equivalent to TWA's entire fleet. St. Louis was hardest hit, losing nearly 70% of its seats, while San Jose lost more than 60%. The 2006 US Airways-America West combination cost Pittsburgh about 75% of its seats by 2010, while Las Vegas lost slightly more.

“When you shut down all these hubs, what was flying out of them?” asks Glenn Engel, senior airline analyst with Bank of America Merrill Lynch. “You can't shrink hubs. They lose their connectivity. With all of these mergers, you are seeing airlines pick the hubs they need.”

And shed the routes they don't—often at the expense of regional partners. “The growth in the fixed-fee business for regional carriers [that] occurred over the past decade has significantly diminished in recent times as major carriers have reduced capacity and as increased fuel prices have limited the cost efficiencies of small regional jets,” Republic Airways noted recently. “We believe as fixed-fee contracts come up for renewal, there will be competition for market share, which may lead to lower margins and higher risks for regional carriers.”

Republic's analysis has about 1,150 50-seat RJs and 600 larger RJs flying on behalf of U.S. majors. “It is our belief that over the next four to five years, we'll likely see about 600 of these small 50-seat regional jets replaced by about 300 additional large RJs,” Bedford says.

Bradford Rich, president of SkyWest Airlines, also sees bright skies. “We do think there are still hundreds-of-aircraft worth of opportunity out there.”

Engel, the Bank of America Merrill Lynch analyst, expects the majors to keep divvying up work among the regional players. “You want to diversify your flying because you want to play one RJ guy off another,” he says. “American had too much concentrated in one player,” its own subsidiary. “If you have everything in one basket, you lose leverage.”

As the largest regional airline operator in the U.S., SkyWest has deals with everyone. The SkyWest group, which includes carriers ExpressJet, Atlantic Southeast and SkyWest Airlines, flies for United, Delta, US Airways, American and Alaska Airlines. The group carried 58.8 million passengers in 2012, up 5.3% year-over-year. The group's annual operating margin rose 3.3 points to 4.4% in 2012. While an improvement, it is still the second-lowest figure in the last six years, and far off the 2006-07 days when operating margins were more than 10%.

SkyWest is not alone. “Cost pressures are rising on RJ operators as their growth has stalled,” says Engel. “Meanwhile, the price increases are limited. That is why margins are half of what they used to be.”

SkyWest had some extra help. The carrier's challenges incorporating ExpressJet—purchased in 2010—into its Atlantic Southeast Airlines subsidiary contributed to its financial challenges. A series of cost-cutting efforts, ranging from reducing maintenance expenses to eliminating customer service staff, helped the group swing a 2011 net loss of $27.3 million to a $51.2 million profit in 2012.

Meanwhile, the carrier has positioned itself for an anticipated boost in large regional jet demand. It is the U.S. launch customer for the MRJ90, Mitsubishi's new 90-seat regional jet, having a completed a 100-aircraft order last December. Deliveries are slated to start in 2017.

Delta has taken several innovative steps to hedge its bets against a large RJ capacity crunch, including agreeing to take on bankrupt Pinnacle Airlines as a subsidiary. Under a court-approved restructuring agreement, Pinnacle will dump its 140 Bombardier CRJ200s and take delivery of 40 CRJ900s by 2015, leaving the carrier operating 81 CRJ900s—all in Delta colors.

The deal gave Pinnacle much-needed financial support as its cash reserves were dwindling. For Delta, which recently withdrew from the regional subsidiary business by shuttering Comair, the agreement underscores the urgency to secure large RJ capacity. Pinnacle was slated to exit bankruptcy in early May.

Delta's Pinnacle venture is part of a larger plan to increase the size of its regional aircraft. Delta's revised pilot agreement caps 50-seat aircraft at 125, down from about 350, and allows Delta to fly 102 70-seaters and up to 223 76-seaters. In exchange for boosting 76-seaters, Delta is adding mainline capacity (and mainline pilot jobs) in the form of 88 former AirTran Boeing 717s. Delta also has 30 CRJ900 options, likely meaning more work for a regional partner.

Interestingly, the small RJ's mass-exodus has some airlines eyeing 50-seaters as a possible contrarian's pick for short-term lift. While the economics are tenuous at current market rates, a rock-bottom acquisition cost contrasted by a possible tightening in the large RJ market could change things quickly.

“You can . . . imagine an environment where everyone is trying to get large regional jets and as a result, large regional lift becomes expensive and 50-seat regional lift becomes inexpensive,” says Scott Kirby, US Airways president. “We're agnostic about whether we have 50-seaters or larger regional jets. It is all about the economics. Today, the economics of large regional jets are better, but five years from now, that might be different.”

While business is always top of the minds in airline boardrooms, the U.S. regional sector's biggest concern in 2013 may be regulatory. FAA is facing an August deadline to issue a final rule revamping pilot qualifications. The new regulation will require 1,500 flight hours and an air transport pilot (ATP) rating for all first officers, up from the 250 flight hours and commercial pilot rating currently needed.

FAA's draft rule includes some exceptions, such as military experience, that would lower the minimums. However, if the agency doesn't get the rule out by Aug. 1—it is already more than a year late—Congress has mandated that the 1,500-flight-hour requirement become law.

Rule or no rule, RAA says its members will be ready, but it is a costly process. American Eagle says it had nearly 1,600 pilots flying the line who fell short of FAA's proposed requirements when they were published in February 2012. Eagle's estimated cost to comply with the requirements: $2.2 million.