27 June 2008
By David Furlonger
The aviation industry is in crisis. Airlines all over the world are either collapsing, 
frantically cutting costs or seeking mergers. And the situation is no different in SA. Does this spell doom and gloom for travellers, and what about tourism?
The word "crash" is not a welcome one in the aviation industry. Like the term "good luck" in the theatre, it is considered something of a jinx. But it’s difficult to find a word that better sums up what is happening to the world’s airline companies.
After posting its first profit last year since the September 11 2001 terrorist attacks, the industry is once again in free fall. Dozens of airlines around the world have crashed in the past few months and more are expected to collapse. This week, United Airlines, one of the biggest carriers in the US, announced plans to axe about 950 pilots, or about 14%, over the next 18 months as it grounds 100 aircraft.
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WHAT IT MEANS |
Rising fares threaten long-haul tourismIndustry forecasts paint a dire picture for 2008, with losses ranging from a rose-tinted US$2,3bn to a popular guess of about $6bn to a crippling $8bn by year end.
Giovanni Bisignani, CEO of the International Air Transport Association (Iata) – which represents 230 airlines comprising 93% of scheduled international air traffic – says the aviation industry carried 2,3bn passengers in 2007, so "$3,5 trillion of business and 32m jobs depend on our success".
He pulls no punches when he states: "The situation is desperate and potentially more destructive than our recent crises – Sars (severe acute respiratory syndrome), terrorism and war – combined. Large parts of the industry are being reshaped. To keep this vital part of the global economy functioning, extraordinary change must involve governments, industry business partners and labour."
The main culprit is the price of aviation fuel. In 2002, the first full year after the 
September 2001 attacks, a barrel of oil cost $25 and the industry’s total fuel bill was $40bn. In 2007, when the industry made a turnaround profit of $5,6bn, the oil price averaged $73 and the bill was $136bn.
That it was able to make money in such circumstances owed much to changes in the industry’s cost structure during the intervening five years, says Bisignani. "Fuel efficiency improved 19%. Sales and marketing unit costs plunged 25%. Non fuel unit costs dropped 18%. And airlines rolled out e-ticketing to every corner of the planet."
But those savings have been wiped out by an oil price now teetering around $135/barrel. If this price holds for the next 12 months, says Bisignani, the increased fuel cost for 2008 will be a "staggering" $99bn more than the 2007 bill. In addition, for every extra dollar on a barrel of oil, industry costs rise another $1,6bn. The industry has set itself a target of further improving fuel efficiency by 25% before 2020.
SA airlines know exactly how painful the oil price issue can be, and admit it’s wreaking havoc on their budgets and bottom lines. There are concerns that rising airfares will deter long-haul foreign tourism. In SA, where tourism contributes more than 8% of GDP, that’s particularly bad news.
At this stage, no-one wants to even think about the potential impact on the 2010 soccer World Cup. Airports Company SA (Acsa) is twitchier than most – more than half of its five-year, R22bn capital expenditure programme – R13bn – is aimed at the World Cup. Acsa boss Monhla Hlahla says borrowings this year are expected to reach R12bn. The company has already committed to spending 90% of the R13bn.
SA airlines are already taking strain. SA Airways (SAA) CEO Khaya Ngqula says unexpected fuel price increases knocked nearly R1bn off the national carrier’s bottom line last year. And budget airline 1time, announcing its annual attributable profits of R28,5m recently, added a footnote: "The steep increase in the price of oil during the first quarter of 2008… will have a major negative impact on [2008] first-half earnings."
That’s putting it mildly. Not long ago, fuel accounted for no more than 30% of local airlines’ total costs. Nico Bezuidenhout, CEO of SAA’s budget-fare subsidiary Mango, says the figure is now close to 45%. "The oil price has risen 500% since 2002. That’s bound to hurt."
Adding to the pain is the weakening rand. Gidon Novick, CEO of British Airways’ Comair and its budget subsidiary kulula, says: "The crude oil crisis speaks for itself, but the rand-dollar exchange rate is equally important. Losing 15% against the dollar has had a significant impact. It’s very dramatic."
In the belief that the oil price cannot rise indefinitely, local airlines have shied away from 
hedge buying of oil. 1time CEO Glenn Orsmond sums up the general attitude: "Even when it hit $100, we all thought oil would drop."
SA domestic passengers have so far been spared the worst of cost-related fare increases because of robust competition among low-cost airlines. Market share is shifting towards these airlines to the extent that at least two are considering leasing new aircraft to meet demand. But increased capacity, while improving cost-per-passenger, does not protect these airlines from market reality.
Orsmond says 1time has raised ticket prices for a one-way domestic trip by R100, far less than the actual cost increase. Competition dictates that rivals must also limit any intended fare hikes.
Adding to the cost pressure is the fact that the domestic market is not growing, but simply shifting to where prices are cheapest. "The market is incredibly price-sensitive at the moment," concedes Bezuidenhout. Novick predicts steady decline in passenger numbers during the coming months.
John Morrison, CE of the Airlines Association of Southern Africa, was quoted at the weekend as saying: "It is going to be difficult for Southern African airlines to be profitable. They have two options: either absorb the costs themselves or hike fares. They can’t afford to absorb the costs, so fares will go up and they are going to have fewer passengers."
Outside the region, it’s already happening. Iata chief economist Brian Pearce says international business travel in March fell at the fastest rate in five years. Economic downturn in many parts of the world, combined with shrinking disposable income among consumers, is hitting everywhere. The biggest single contributor is the US credit crunch. In expectation of continued pressures, airlines are shedding capacity.
That’s not always easy. The oil crisis has hit so fast and hard that many airlines are preparing to take delivery of new aircraft booked while the industry was still in a bullish mood.
European aircraft manufacturer Airbus says orders peaked during 2007. Most of the new aircraft will be delivered between 2010 and 2012. No wonder commercial director John Leahy recently predicted a 50% decline this year in orders for new commercial aircraft.
Pearce estimates that the cost of carrying passengers has risen by 20% in the past year. "The combination of weak economies and surging oil prices means airline unit costs will rise sharply and cause yields, in real terms, to fall.
"This means the load factor at which the industry will break even will rise a further one or two percentage points on top of the four seen in the past 10 years. The chances of the industry achieving this increase in utilisation look slim."
Pearce adds that not only is traffic growth softening as a result of the economic downturn, but aircraft deliveries are scheduled to rise to a new peak, creating a significant risk of over capacity on some markets.
Though oil prices and economic recession are the biggest threats to the international aviation industry, they are not the only ones. Iata’s Bisignani is offended by the anti competitive attitude of airports companies around the world (are you listening, Acsa?).
Pressure from Iata achieved savings of $3,7bn in 2007 in various airline fees. "But like Sisyphus (the mythical Greek character who endlessly rolled a rock up a mountainside), we were forced back by airport cost increases of $1,5bn. Too many airports still live happy days, isolated from commercial discipline."
Bisignani has a particular barb for the UK Civil Aviation Authority (CAA) which he says deserves the "Worst Regulator Award" for 2007. "Look at Heathrow. Service levels are a national embarrassment but still the CAA increased charges by 50% over the past five years, and plans 86% for the next five. Could anyone in this room ask for a fare increase of 86%? Nobody. That only happens in Monopoly-land," he says.
"It’s time for governments to get serious about regulating monopolies that abuse their position. Effective regulation means delivering results on cost efficiency and good service; it’s not a licence to print money."
Then there’s passenger security, which Bisignani calls "an unco-ordinated mess". Since 9/11, airlines and their customers have paid over $30bn for security measures. "For this we get more frustration than value. Fear drives decisions. The infrastructure cannot cope. Governments are not co-operating. Nobody is taking leadership. Passengers are suffering because they face a maze of duplication, bureaucracy and hassle."
Bisignani recommends that governments focus on risk management, harmonise global standards, use technology and intelligence effectively and take responsibility for the bill.
Bisignani also has little time for the European parliament, whose "misguided and unilateral" emissions control regulations will cost the industry €6,4bn. If they ever come into being, the aviation industry has vowed to fight in the courts.
Not everything is gloomy, however. In 2007, airlines safely carried 2,3bn people and 44 Mt of cargo. The accident rate was equal to one every 1,3m flights.
There’s also good news in the industry’s crisis, particularly in the retrenching of pilots and the reduction in orders for new aircraft.
Says Bisignani: "An estimated 18 000 aircraft will be delivered over the next 10 years. To fly them we must train 19 000 pilots each year but current capacity is only 15 000. The downturn could help us gain ground."
But that’s in the future. The immediate priority for airlines is survival, pure and simple. All over the world, airlines are going out of business, frantically cutting costs or seeking mergers. In the US, particularly, there has been a softening towards traditional opposition to industry consolidation. Delta, United, Northwest, Continental and American have all held merger discussions in recent months.
Rival airlines in India, Japan and Europe have also discussed mergers. Bisignani says: "The fuel crisis means we must think more globally and act more quickly. Cross-border mergers are delivering shareholder value. Look at Air France-KLM or Lufthansa-Swiss."
Ultimately, he wants to see a situation where stifling bilateral airspace agreements and political compromises are abandoned. "Let’s rip up the 3 500 bilaterals and replace them with a clean sheet of paper without any reference to commercial regulation. Airlines would be free to innovate, compete, grow, disappear, and become financially healthy".
Tags: Air Transport Association, Airline Companies, Aviation Industry, Doom And Gloom, Furlonger, Global Economy, Industry Forecasts, International Air Traffic, International Air Transport, International Air Transport Association, Jinx, Punches, Sars, September 11 2001, September 11 2001 Terrorist Attacks, Severe Acute Respiratory Syndrome, Terrorism And War, United Airlines, What Is Happening To The World, Zh
