The COVID-19 pandemic has decimated air travel demand this year, causing airlines to dramatically slash their schedules. Despite these service cuts, small cities were able to retain vital air service, thanks to CARES Act rules requiring airlines that accepted payroll support to -- with very limited exceptions -- maintain service to all domestic destinations in their route networks.

Unfortunately, negotiations for a follow-up pandemic relief bill that might include additional airline payroll support have been progressing very slowly. For now, airlines are on their own. Meanwhile, the restrictions on service cuts expired at the end of September.

American Airlines (NASDAQ:AAL) responded by dropping about a dozen small cities from its route map last week. Now, management is warning that without additional aid, more cuts are likely.

An initial round of cuts

Back in August, American Airlines said that -- barring an extension of the payroll support program -- it would suspend service to 15 small cities in early October. It is the only airline serving nine of those markets: Del Rio, Texas; Dubuque, Iowa; Florence, South Carolina; Greenville, North Carolina; Joplin, Missouri; New Haven, Connecticut; Roswell, New Mexico; Stillwater, Oklahoma; and Williamsport, Pennsylvania.

Local communities eventually prevailed upon American to maintain its flights to Roswell and Stillwater -- at least for now. The airline has also been forced to continue service to Joplin and Sioux City, Iowa while it waits for permission from the U.S. Department of Transportation to exit those markets permanently.

An American Airlines plane parked on the tarmac

Image source: American Airlines.

However, American Airlines suspended service to the other 11 cities on Oct. 7. Furthermore, while it initially planned to return to those markets in November, it recently extended the service suspensions through Dec. 1 as part of a massive November schedule cut.

Given that air travel demand is improving at a snail's pace, there could be additional delays in restoring service to these markets. American could even choose to drop some permanently.

This is just the first step

In a recent CNBC interview, American Airlines CEO Doug Parker said that without additional federal aid, his company would have to drop additional small cities from its route map. This shouldn't be surprising. Two months ago, the full-service airline estimated that it would suspend flights to up to 30 small cities as soon as October.

Airlines (including American) have been trying to delay drastic moves like pulling out of cities entirely, believing that a payroll support extension could be coming soon. Actions like closing operations at an airport, furloughing pilots, and permanently retiring aircraft cannot be reversed quickly. In general, airlines want to maintain the flexibility to quickly ramp up service again when demand improves.

That said, American Airlines has the weakest balance sheet among major U.S. airlines, making it vital to conserve cash. It has already furloughed about 19,000 employees this month. The need to trim unprofitable flights could force American to temporarily or permanently exit additional small markets.

What seems temporary could become permanent

Most industry observers believe that air travel demand won't return to 2019 levels until 2023 or 2024. Business travel will be especially slow to recover. That could make it hard for American Airlines and its peers to restore service to small cities in the years ahead; business travelers tend to pay high fares that are critical to legacy carriers' profitability.

The longer such cities go without scheduled air service, the harder it will be to turn back the clock to 2019. On the demand side, extended periods with no air service could drive companies to relocate to larger cities with reliable air service, permanently crippling small-city demand. On the supply side, network airlines are shrinking their fleets of 50-seat regional jets, which they use to serve their smallest markets.

Congress' apparent inability to pass an airline payroll support extension despite bipartisan support for the program will weigh heavily on near-term earnings and cash flow for the sector. But it could also have long-term consequences for the U.S. economy, due to the airline industry's role as a key enabler of commerce.