High Oil Prices, Natural Disasters, Political Unrest Take Their
Toll
The International Air Transport Association (IATA) has further
downgraded its 2011 airline industry profit forecast to $4 billion.
This would be a 54% fall compared with the $8.6 billion profit
forecast in March and a 78% drop compared with the $18 billion net
profit (revised from $16 billion) recorded in 2010. On expected
revenues of $598 billion, a $4 billion profit equates to a 0.7%
margin.
“Natural disasters in Japan, unrest in the Middle East and
North Africa, plus the sharp rise in oil prices have slashed
industry profit expectations to $4 billion this year. That we are
making any money at all in a year with this combination of
unprecedented shocks is a result of a very fragile balance. The
efficiency gains of the last decade and the strengthening global
economic environment are balancing the high price of fuel. But with
a dismal 0.7% margin, there is little buffer left against further
shocks,” said Giovanni Bisignani, IATA’s Director
General and CEO.
The cost of fuel is the main cause of reduced profitability. The
average oil price for 2011 is now expected to be $110 per barrel
(Brent), a 15% increase over the previous forecast of $96 per
barrel. For each dollar increase in the average annual oil price,
airlines face an additional $1.6 billion in costs. With estimates
that 50% of the industry’s fuel requirement is hedged at 2010
price levels, the industry 2011 fuel bill will rise by $10 billion
to $176 billion. Fuel is now estimated to comprise 30% of airline
costs—more than double the 13% of 2001.
“We have built enormous efficiencies over the last decade.
In 2001, we needed oil below $25 per barrel to be profitable.
Today, we are looking at a small profit with oil at $110 per
barrel” said Bisignani.
This fuel price spike is substantially different from the one
that occurred in 2008. First, while oil inventories are low, there
is substantial spare OPEC and refinery capacity, which was not the
case three years ago. Second, the monetary expansion that fuelled a
surge in financial investments in commodities is ending, which will
remove a major upward pressure on fuel prices. Nonetheless,
volatility in the fuel prices remains one of the industry’s
major challenges.
Despite high energy prices, world trade and corporate earnings
continued to improve. As a result, global GDP projections
increased by 0.1 percentage points to 3.2%, which is supporting
continued growth in demand for air transport. However, growth rates
for both cargo and passenger markets have been revised downward
because of higher fuel costs. Passenger demand is now expected to
grow 4.4% over the year, a full 1.2 percentage points below the
5.6% previously forecast in March. Similarly, cargo demand is
expected to increase 5.5% and not 6.1% as predicted earlier.
The number of price-sensitive leisure travelers has fallen
3–4% over the past five months, as travel costs were forced
higher by fuel prices and, in Europe, by new passenger taxes. Less
price-sensitive premium travel demand has been more robust in the
face of rising prices and continues to be driven by growing world
trade and business investment. Premium passenger growth has dipped
from the 9% of 2010, but is expected to be close to the historical
trend this year at a 5–6% rate.
Overall capacity (combined passenger and cargo) is expected to
expand 5.8%, which is above the 4.7% anticipated increase in
demand. The gap between capacity and demand growth has widened to
1.1 percentage points from 0.3 percentage points in the previous
forecast. Due to schedule commitments and fixed costs, capacity
adjustments are expected to continue lagging behind the fall in
demand, driving load factors down. By April, passenger load factors
were hovering around 77%. This is more than a full percentage point
below the 78.4% achieved for international traffic in 2010.
Aircraft utilization is also falling. This decline in asset
utilization, represented by lower load factors and average hours
flown per aircraft, is the most significant downward pressure on
airline profitability.
Robust economic conditions have given airlines some scope to
partially recover higher fuel prices. This is reflected in an
increased yield growth forecast of 3% for passenger traffic (double
the previously forecast 1.5%) and 4% for cargo (up from the
previously forecast 1.9%). The problem is that higher travel costs
are now weakening price-sensitive demand and airlines are not
expected to be able to offset higher costs with increased
revenues.
The key risk to this outlook is a weakening of global economic
growth. High energy prices will certainly have a slowing impact on
economic growth. However, the impact will be mitigated by two
factors. First, while high oil prices previously triggered
recessions, today’s economies (which generate a unit of GDP
using just half the energy required in the mid-1970s) are less
sensitive. Second, the corporate sector is cash-rich, business
confidence is high, and world trade continues to expand at around
9% annually. The International Monetary Fund and others have raised
global growth projections, which would indicate a recovery in
demand growth to the historical 5.6% level for the second half of
2011. IATA’s forecast for continued, albeit lower, airline
profits despite $110 a barrel oil prices, is dependant on a strong
economy to generate sufficient revenues to partially offset higher
fuel costs.
Asia-Pacific carriers are expected to earn $2.1
billion—the most profitable of all regions. Even so, this is
dramatically down from the $10 billion profit that the region
achieved in 2010. Airlines in this region are more exposed than
others to cargo markets and fuel price fluctuations. Asia-Pacific
airlines carry 40% of all air freight volumes, while low labor
costs and relatively low hedging means fuel accounts for a bigger
proportion of total costs. In addition, the Japanese earthquake and
tsunami are expected to dent the region’s prospects for the
remainder of the year. However, this will be more than offset by
robust growth in both China and India. The continued dynamism of
these economies means that Asia-Pacific is the only region where
demand increases (6.4%) are expected to outpace capacity growth
(5.9%).
North American carriers will see the $4.1 billion profit of 2010
fall to $1.2 billion. The region’s carriers are being hit on
the cost side by rising fuel prices, exacerbated by an older, less
fuel-efficient aircraft fleet. The region is also taking a hit on
the demand side with 12% of international revenues linked to the
Japan market. This is being offset somewhat by a stronger than
expected US economy and stronger inbound demand and exports fueled
by the weak US dollar. Careful capacity management is expected to
see an overall demand increase of 4% balanced by an equal increase
in capacity.
European carriers will deliver a $500 million profit, down from
$1.9 billion in 2010. The sovereign debt crisis is dampening demand
from the peripheral European economies. Core economies are
benefiting from strong exports, but new and increased taxation of
passengers is damaging price-sensitive demand. Much of the profit
forecast for this year is expected to be generated on more buoyant
long-haul markets. A capacity increase of 4.8% is expected to
outstrip demand growth of 3.9%.
Middle East carriers will deliver a $100 million profit, down
from $900 million in 2010. Political unrest in parts of the region
is hurting demand. The major airlines in the region are expected to
continue to win market share on long-haul markets, flying
passengers via Middle Eastern hubs. However, high fuel costs
will weaken demand from key passenger segments and asset
utilization will be under downward pressure. Capacity growth of
15.5% is expected to outstrip demand expansion of 14.6%.
Latin American carriers will be the only region to deliver a
third consecutive year of profits. The regional economies continue
to show good growth, and trade links with the United States and
Asia in particular are boosting traffic. Innovative business models
and consolidation have combined to generate reasonable profits from
these growing markets. But a $100 million profit is down
considerably on the $900 million profit of 2010. Capacity growth of
6.9% will outstrip the 6% increase growth in demand.
African carriers are forecast to be the only region to post a
loss, $100 million, in 2011. Political unrest across Northern
Africa is dampening demand, particularly in Egypt and Tunisia,
which have proportionately large tourism industries. Economies and
air transport demand in many African countries have grown strongly
but the local industry has struggled to turn this into profitable
growth, hampered by poor infrastructure and restrictive government
regulation. To compound the problem, capacity growth of 7.4% will
outstrip demand growth of 6.5%.