Issues currently affecting the sector include:
2012 - Demise of the squeezed middle?
For a number of years now industry commentators have been predicting the shakeout of the European aviation market and the rise of the big four / five. Given the economic headwinds facing Europe, combined with high oil prices, 2012 could be the year when we start to see this become a reality.
European debt crisis and implications for state owned airlines
The ongoing financial challenge for European nations, both within and outwith the Eurozone is well documented. The EU’s fiscal compact prescribes that member states should have debt to GDP ratios at a maximum of 60%. Those that do not will have to adjust at a prescribed rate. This places restrictions on short-term borrowing and longer-term debt reduction for those countries exceeding 60%, whilst also putting pressure on those countries whose current spending levels would drive their ratio towards 60%. These actions also raise levels of risk associated with Government debt and mean that running a large deficit is becoming an increasingly less viable option, particularly in a slower growth environment.
How can the industry convince governments there is an economic case for supporting growth?
The airline industry has come a long way from the Government owned national carriers of the past, supported by the public purse. The airline industry has matured with once local or regional markets opened to global competitive pressures. Emerging markets are supporting airlines and see aviation infrastructure as vital to achieve future economic growth. However, many Governments and regulatory bodies in mature markets are at the same time imposing restrictions and operational and tax burdens at a local level.
M&A continues but legislation needs to catch up
There were a number of high profile M&A transactions in the sector in 2011 including BA / Iberia, Flybe’s acquisition of Finncomm, Hainan’s acquisition of Turkish based ACT airlines, LAN / TAM, Air Berlin taking full control of Fly Niki and latterly IAG’s acquisition of BMI. This reflects the push for consolidation and drive for scale which remains the ultimate vehicle for top tier global carriers to:
However, considerable legal and regulatory barriers to full merger remain in place, including limits to foreign ownership, and ongoing government shareholding.
High fuel prices are here to stay. How does the industry respond?
Fuel now accounts for over 30% of the industry’s collective cost base and fuel price volatility is currently the key determinant of industry profitability.
The anniversary of oil at $100+ has passed and we have now had 14 consecutive months of oil trading above $100 per barrel. The average price for the period Feb’11 to Feb’12 was $113 with fluctuations between a high of $126 and a low of $100. With increasing tension in the Middle East region and tentative signs of recovery in the US economy there is further upward pressure likely on the oil price in 2012.
Is bio fuel still too expensive as an alternative?
Over the longer term the ongoing investment into biofuels needs to be considered. Best case industry estimates forecast 50-70% of jet fuel could be replaced by bio fuels by 2035 and even worst case estimates put biofuel use in aviation as high as 40% by 2035. Fuel price volatility, regulation of air traffic greenhouse gases through EU ETS and the IATA industry wide goal to reduce net carbon emissions by 50% by 2050, have prompted a number of biofuel trial flights in recent years. These have explored the use biofuel feedstock options including algae, jatropha and camelina.
Further cost base reduction is required - how much deeper can cuts be made?
The downturn in demand in 2009 and significant increases in fuel prices since then has been the catalyst for cost reduction programmes and restructuring activities across the sector aimed at tackling the non-fuel cost base. A lot of these programmes have been presented as transformational, with significant savings numbers being communicated to the market. However, digging deeper into the specific plans shows that some programmes are more tactical than transformational – high volume of low value initiatives and one-off cost cuts e.g. cutting marketing spend, reducing rates with existing suppliers and releasing provisions, as opposed to implementing longer term transformational change
Imperative for improved yields to offset continual cost pressure
The Indian market in 2011 delivered a salutary lesson in the perils of chasing volume. For the majority of 2011 Air India, the national carrier, pursued a volume-based strategy driven by aggressive yield discounting. This destroyed yields in the market in a period when oil prices were significantly increasing and the rupee was depreciating against the US$. The net result is that the market in India is forecast to deliver a loss of $2.5bn in 2011, in large part driven by a decline in yield.
EU-ETS - 2012 is year 1. Will there be a year 2?
The EU Emissions Trading System went live for all airlines with a flight departing or arriving within the EU from 1 January 2012. Payment for the first year of emissions is due on 30 April 2013.
There is lot of uncertainty surrounding the future of the scheme, with questions being asked more broadly than just in relation to the airline industry.
New Aircraft orders and their implications for older generation aircraft and residual values
Technological innovation and the increase in fuel prices have driven order books for new, fuel efficient aircraft to record highs. New aircraft programmes such as the A380, A350, A320 neo, B747-800, B787 and B737 MAX all offer the opportunity to replace ageing, less efficient aircraft with significantly more fuel efficient variants. The operating cost benefits of these aircraft are amplified as oil prices continue to rise.
Aircraft financing - More constrained and more expensiveThe record order books of Boeing and Airbus reflect a period of strong orders buoyed by both new aircraft types and strong growth in air travel demand in the high growth markets of Asia, South America and the Middle East. However, there are a number of headwinds in the aircraft finance markets which will make these orders more difficult to finance, and more expensive.