In the February issue this column suggested that the record order intake of 2005 should not be seen as a precursor to a golden age for the aviation industry.
Recent events, despite the optimism of some airlines and the financial targets of others, give us no reason to change that view. Indeed they focus attention on where the industry has structural growth opportunities and where airlines are dependent more on the phase of the economic cycle for growth than any other factor.
At the risk of appearing rather dull, now is the time to ask whether or not so-called legacy carriers are capable of structural growth or are they in fact restricted to riding the economic cycle? The follow-up question is that if growth is only cyclical, how confident should we be that the expected benign global economic environment will in fact materialise?
Recent headlines have been dominated by stock market falls and concerns over the future path of the global economy. Although most medium- and long-term forecasts suggest a favourable economic environment and steady-state economic growth of some 3.5%, recent concerns highlight the fragility and stresses within the economic system and, in particular, the importance of continued US consumer spending. This is combined with concerns over commodity prices and inflation.
Some observers suggest that this reflects a long overdue rendezvous with reality. The counter view is that it is little more than a market correction.
In the past we have written of the importance of expectations in respect to aircraft ordering or economic policy. How the industry acts is fundamental. In this respect the fear (or expectation) of inflation will result in a reaction in advance of higher inflation materialising. In this particular case, after a prolonged period of downplaying the effects of higher oil prices on inflation and economic growth, it appears that history has inevitably repeated itself. This is despite the usual time lag of 18 months or so between the increase in the oil price and the effect on GDP and inflation being longer. There are some suggestions that oil may reach $100 a barrel – implying an increase in jet fuel prices of over 50% from current levels. In itself this would be devastating for the industry.
More realistically however it would have a more immediate and damaging effect on the wider economy and inevitably result not only in higher airline costs but also on stunting traffic growth.
Despite the benefits of an improved traffic mix over the past year or so, and of implicit or explicit fuel surcharges on overall yields, there appears to be little if any pricing power in the market. There is however a need to avoid yield illusion. Moreover, while fuel surcharges are being levied, they tend not to fully recover the additional costs of the fuel. Indeed British Airways expects its fuel bill to rise by a further £200 million ($377 million) this year but surcharge increases will only recover some £60 million. It is also worth remembering that the ability to add more fuel surcharges is likely to be limited almost irrespective of the fuel price.
If the economic cycle is faltering, an important question is who will grow and where? Development in any market can be broadly characterised as either cyclical growth related to a country’s economy or structural growth which is generally related to new opportunities resulting from economic development or improved market access.
For an individual company, growth can also arise by taking market share or through the introduction of new business models. Within this group are the low/no-frills carriers and also the Gulf-based airlines with models that seem to be re-fragmenting the market and changing the nature of the transfer traffic flows.
On page 42 we review the plans of the transatlantic carriers for this summer. They seem to suggest an upbeat perspective from these airlines – but make no mistake, there is still plenty of discounting in all classes. An added dimension in this market is the possibility of pre-emptive action as the prospect of some form of EU-US Open Skies agreement increases.
This would be good for consumers but not particularly good for revenue. By our estimates the North Atlantic market already appears close to maturity and although Open Skies will provide structural opportunities for new entrants, including business-only services operated by mainline airlines, the reality is that their gain will be another participant’s loss. ■
Source: Airline Business
