Back to Air Transport IT Review - Issue 1, April 2009

Booms follow recessions

By Dr. Frankie O'Connell, Air Transport Department, Cranfield University, UK

The air transport industry is highly cyclical. The equation is simple - strong economic growth triggers rapid growth within the air transport industry and it has a multiplier effect of around 1.5 (i.e. economic growth of 4% represents traffic growth of around 6%).

However, an economic boom is usually followed by a down cycle as economies contract which directly impacts the airline industry as executives substitute business class for economy and the family holiday gets ranked as a low priority.

As the industry is bracing itself for a serious downturn in 2009, it must also prepare itself to accept a record number of new aircraft and make payments in a tight liquidity market. Many analysts predict that a large number of aircraft that are on order will be deferred or cancelled.

Linked economies

Historically recessions are geographical in nature as an underperforming US economy, for example, is counter-balanced by a booming Asian economy. However, in this round, the signs are alarming as a whole array of countries around the world (i.e. US, Canada, most of Europe, Japan, New Zealand and Hong Kong) are all in recession. This produces an adverse effect as today's global economies are all heavily interlinked, because a 1% slowdown in the US economy reduces China's growth by around 1.3%. It took only 6 months for the global economies to enter this recession.

Air Cargo through Hong Kong fell by 9.8% in October 2008 and by 19% in November and the 17 member airlines that compose the Association of Asia Pacific Airlines (AAPA)registered a drop of 11% in freight ton kilometres for October. Other issues such as fuel prices and terrorism continue to plague the industry and are factors which are outside of its control, but airlines are resilient and many have realigned their strategic plans in order to resolve these issues.

Credit crunch - a new phenomenon

However, the banking liquidity crisis is a new entity facing carriers, as credit lines have begun to freeze and banks have run out of money before airlines. As the credit crunch turned to crisis, the world watched as almost every large US investment firm was bailed out and liquidity started to contract at unprecedented levels. It was hard to find a bank that was not being nationalized or otherwise backed by the state.

The weakest environment ever encountered by airlines was in 2001, which had the double effect of 9/11 coupled with an economic slowdown. According to ICAO industry revenues have experienced annual decreases only twice since 1947: 2000-2001 and 2001-2002. Industry revenues peaked at $329 billion in 2000, bottomed at $306 billion in 2002 and surpassed the 2000 level by 2004. The six year expansion that began in 2003 saw revenues rise 66% through to 2008. This is due to the fact that traffic always recovers very quickly after a recession bottoms out. However, IATA forecasts that revenue will decline from an estimated US$ 530 billion in 2008 to around US$ 467 billion in 2009 with overall net losses of around US$ 4.7 billion.

Savings and investment

In 2008, fuel was the unpredictable element in the airlines cost structure as it sky rocketed to $147 in mid 2008, but within 6 months it had fallen back to around $35 - a fall of some 76%. It took 4 years for the price of oil to rise by the same amount. The peak price of oil was costing the industry about $287 billion per year in annual fuel costs. However at $35 per barrel, the industry's annual fuel costs have fallen to about $87 billion.

This is an enormous saving and it allows airlines to begin to invest in other areas of the business such as IT. Information technology is regarded by industry CIOs and internal IT departments as an important part of the equation, as they look for IT to make an impact on their businesses during the recession, such as decreasing costs, enabling more efficient ways of doing business and helping to generate further revenue.

Regional insights

Most of the world's airline traffic stems from the US, Europe and Asia. How is each region is doing? The US carriers are expected to make a loss of around $4 billion in 2008, primarily due to the high cost of purchasing fuel. However they are expected to outperform expectations, as they have realized $25 billion in annual fuel savings from the collapse of the price of oil, while their relentless drive to reduce capacity (by approximately 8-10%) will pack more passengers into each departing flight.

The strengthening dollar will also positively impact their financial performance. The total capacity cuts that were implemented by the US based airlines since 2001 has rolled back the industry to its 1998 size - a year where US based airlines made huge returns. However the extent and depth of the recession coupled with the need to replace its ageing fleet will continue to pressurise the profitability of the US airline industry.

The European carriers pursued a different approach than their transatlantic partners as many had fuel hedging strategies in place, which protected them from high oil prices in 2008. Meanwhile, the strengthening Euro also softened the impact from rising fuel prices as it is paid for in dollars. The 35 member carriers that form the Association of European Airlines (AEA) are expected to post pre-tax profits of around $380 million for 2008.

During the first 10 months of 2008, AEA scheduled capacity rose by just over 4%, out-running traffic growth of just 2.3%. However, 2009 is expected to be a tough year for the European carriers as many of the AEA members have: hedged fuel going into 2009 at high prices; are beginning to reduce capacity - Lufthansa, for example, has removed four A340-600s from its fleet and British Airways intends to fly 1% fewer ASKs (Available Seat Kilometres) this summer compared to 2008; the Euro is also weakening against the dollar which will impact their margins.

The British and Irish Governments are set to introduce an Air Travel Tax in 2009, which may diminish the demand for air travel and if this is deemed lucrative, then other European governments may also incorporate this in order to boost their exchequer receipts. In addition, low cost carriers in Europe are severely affecting the short-haul networks of the full service airlines as the low cost carriers had just 17% of the European market in 2003, but by 2008 that had increased to almost 43%. Presently around 60% of Spanish and British intra-European markets are composed of low cost airlines, which is an alarming statistic that is facing the network carriers.

Consequently, they are beginning to merge and form strategic partnerships as pairings such as Lufthansa/Brussels Airlines, Lufthansa/Austrian Airlines, Alitalia/Air France-KLM have recently taken place. Over the next few years there will be further consolidation within Europe and aviation experts all agree that there may only be 3-5 large European airlines existing into the future as the smaller carriers will feed traffic to the larger carriers at their hubs.

The Asia Pacific carriers are expected to make a net loss of around $500 million for 2008 and IATA predicts that these carriers will lose around $1.1 billion in 2009, with most of the losses stemming from India and China. India's carriers are all losing money with IATA predicting that these airlines could lose hundreds of millions for 2008. India's inadequate airport and navigational infrastructure is causing huge bottlenecks at its major airports as around 70% of its traffic grows through Mumbai, New Delhi and Kalcutta.

In addition the Indian market grew far too quickly as statistics show that passenger traffic increased by 40% in 2006 and by 30% the following year as low fares (that were unsustainable) were offered by multiple airlines stimulated demand and now India is undergoing a correction period. China's economic engine has slowed considerably and this has a considerable knock-on effect as freight is an important component of the business model of the Asia Pacific carriers.

Also, China's international passenger traffic fell by about 20% by late 2008. The government propped up the finances of China Southern and China Eastern in order to shore up the companies balance sheet. However the 17 member airlines that constitute the Association of Asia Pacific Airlines (AAPA) Carried 141.5 million international passengers in 2008, 1.8% fewer than the record levels achieved in 2007. International air cargo traffic for 2008, expressed in freight tonne kilometres (FTKs), suffered a more significant decline, 6.1% lower than the record set in the previous year.

Recovery and long-term growth

In spite of the dark clouds, there is a silver lining as fuel is expected to average around $55 for 2009, down from $100 in 2007. This reduction in fuel costs translates to around $75 billion savings for airlines. Again, these are savings that can be invested in areas like IT - where there may be opportunities to contribute to the bottom line. It is also important to remember not to stand still and to consider such investments to prepare for upcoming growth. Booms follow recessions and traffic will recover with IATA predicting a 4% growth by mid 2010. Worldwide, over the next two decades ICAO expects the number of flights worldwide to double, with passenger growth compounding at around 5% annually, whilst air cargo demand is forecast to grow at 6% over the same period.