Fare Wars, Oil Prices Cause Major Concern For Carriers, Subcontractors

Faced with structural growth in air traffic, increased competition, price pressure, and the rise in oil prices, the airline industry is facing new challenges that are hurting carriers and subcontractors, according to a study by global trade credit insurer Euler Hermes. However, the effects are widely varied between aircraft manufacturers and the airlines themselves.
 
Economists and trade credit insurance experts from Euler Hermes – the world's leading provider of trade credit insurance and risk management information – studied the profitability outlook and claims experience for the various industry players. Euler Hermes has determined that the aircraft manufacturing sector seems to be the only portion of the airline industry that is experiencing success, with overflowing order backlogs. Meanwhile, the airlines – and, subsequently in a domino effect, the subcontractors working for the airlines – have been weakened.
 
Major airlines have been weakened by the increasing success of low cost carriers and rising oil prices. The major carriers have been under pressure, despite the strong upturn in air traffic since 2003 and a forecast rise over the next 20 years boosted by growth in Asia. Worldwide growth in the number of low cost airlines has especially hurt the large US carriers.

 
According to Euler Hermes, the low cost airlines have a more efficient cost structure and are more easily able to offer competitive rates while keeping sufficient profit margins. Discount carriers have increased their US market share from 4% at the beginning of 1990 to 12.5% in 2001 and 18% in 2003. Euler Hermes estimates that in 2005, the total market share for the low cost carriers will reach 25%, with a 40% market share expected by 2014. Meanwhile, fare prices have tumbled by nearly a third over the past 10 years.
 
"In the US, we have seen the discount carriers come on very strong in the past few years, both in price pressure and market share," said Lynne Borkowski, Euler Hermes ACI Risk Underwriting Vice President. "The major airlines, which were already shaken by the competition from their low cost rivals and high labor costs, are now faced with significantly higher oil prices. This has led several of the major carriers to seek bankruptcy protection and reorganization."
 
The increase in oil prices has been strong over the past three years: +20.4% in 2003, +38% in 2004, and +56% in 2005. Consequently, the airlines have seen their oil costs rise to nearly double the level from three years ago. In 2006, the average price of a barrel of oil will decrease to an estimated $48 in view of a global slowdown, resulting in slightly lower fuel bills. The impact is expected to provide a slower decrease in the price of jet fuel.
 
Aircraft manufacturers have protected their satisfactory profit margins due to better cost control. Despite a sharp fall in business between 2001 and 2004 – which is amplified for North American manufacturers by the euro/dollar exchange rate -– the main jet makers succeeded in maintaining satisfactory margins due to better cost control. Boeing has also helped its profitability through its military manufacturing commitments.
 
Having hit a low in 2003 with only 586 planes delivered, the two main manufacturers -– Airbus and Boeing –- should increase deliveries by 38% and 48% respectively between 2004 and 2007.
 
Equipment manufacturers also have good prospects, since they specialize in niche markets and are bolstered by a profitable maintenance business that cushions them from the shock of downturns in the general economy. Some have also chosen to expand operations via acquisitions, given that the market is still fragmented.

FMI: www.eulerhermes.com/usa