Last year it seemed that the airline industry had finally turned its back on the unseemly scrabble for market share and was preparing to enter the next recession a little more rationally than it did the last. It seems that the hope may have been premature.
The threat of recession which hung over the western economies a year ago has, at least for the time being dispersed, and apparently taken some of the restraint on capacity with it. Over the past three months the reins have been loosened on both sides of the Atlantic, with the major carriers raising seat capacity well ahead of traffic growth. And this potentially damaging momentum shows few signs of slowing over the summer.
The premier battleground of the North Atlantic is a case in point. A flood of new frequencies and seats is putting painful pressure on yields, and a number of the participants in the battle are already talking of a "blood bath".
The extent of the capacity growth is reflected in the monthly figures coming out of the Association of European Airlines (AEA), which show a massive 13% rise in available seat kilometres (ASKs) across the North Atlantic for April. And analysis of the planned flight schedules filed with OAG suggests that the increase is still running strong as we go into July.
The OAG data shows US airlines planning to add around 15% more capacity on the route this month, while the European carriers are poised to contribute a smaller, but still significant, 8.6% increase of their own. Admittedly there is a significant variation in plans for individual routes and carriers. Following last year's over-ambition, British Airways is poised to raise North Atlantic capacity by just 0.1%, while a burst of new frequencies from Continental puts it on course for a breakneck 20%. But overall, the evidence is that the market is on course for a double digit hike in seat ASKs.
It is not only the North Atlantic that is a problem area for Europe's majors. The slowing rate of economic growth in the region is taking its toll.
Although there were few shocks over the first three months of the year, the outlook became markedly worse for the European majors as the second quarter got under way with a significant worsening of yields. Financial markets had already been expecting yields to fall reasonably sharply this year, compared with a relatively healthy performance a year ago, but in some cases the actual figures have undershot even this downgraded expectation by as much as three percentage points. Profit warnings have started to become more evident.
The key to understanding how much further the pain may go, is to look at the widening gap between the underlying "natural" level of traffic growth in the market and the level of actual growth being "stimulated" at the expense of yields to fill excess capacity.
It is this balance that Airline Business and Commerzbank have set out to model, based on historic airline reporting, the predictive OAGschedule data and economic indicators.
As a rule of thumb, passenger traffic grows at between 2x and 2.5x GDP. On this basis the underlying rate of traffic growth this year for the AEA members is probably no more than 5.5% and for next year 6-7%.
In reality however this rule of thumb tends to overstate real growth. The relationship between traffic and GDP is asymmetric. Experience shows that even during a recession, traffic will typically continue to rise as airlines fill aircraft by stimulating demand.
The current state of these relationships in Europe makes it clear that yields have further to fall through this year. Many carriers have begun to accelerate cost reduction programmes, but their scope is limited in the face of a sudden drop in yields. Perhaps only a third of costs are directly within management control
Last year, the AEA estimates that its members made windfall gains worth close to $1 billion from the fall in fuel prices. That alone represents around half of their collective pre-tax profits. The fuel price now appears to have stabilised, although at a marginally higher rate. An outright hike could have dramatic impact on industry profits.
Even without such unpredictable dangers, the immediate prospect is that the European airline industry is facing a period of pain, which could last well into next year.
Source: Airline Business
