‘High oil prices, natural disasters, and political unrest’ have all combined to force the International Air Transport Association (IATA) to further downgrade its 2011 airline industry profit forecast to $4bn – a 54% fall on the $8.6bn profit forecast in March and a 78% drop compared with the $18bn net profit (revised from $16bn) recorded in 2010.
In a statement released today, IATA’s Director General and Ceo Giovanni Bisignani said: “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 $4bn 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,” he said.
OIL PRICE IS MAIN PROBLEM
IATA says it is the price of oil that is the main reason for reduced profitability. It says that 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, IATA adds that airlines face an additional $1.6bn in costs. It estimates that with 50% of the industry’s fuel requirement said to be hedged at 2010 price levels, the industry 2011 fuel bill will rise by $10bn to $176bn. 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.
IATA also maintains that this ‘fuel price spike’ is substantially different from the one that occurred in 2008, as it explained: “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.”
PASSENGER DEMAND MAY DROP
IATA adds that despite high energy prices, world trade and corporate earnings continue to improve and as a result, global GDP projections have increased by 0.1 percentage points to 3.2%.
But while IATA acknowledges that this is supporting continued growth in demand for air transport, growth rates for both cargo and passenger markets have been revised down 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 by 5.5% and not by 6.1% as predicted earlier.
The airline association says that the number of price-sensitive leisure travellers has fallen 3% to 4% over the past five months, as fuel costs have increased travel costs alongside new European 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% to 6% rate.
CAPACITY HIGHER THAN DEMAND
Meanwhile, IATA adds that overall capacity (combined passenger and cargo) is expected to expand by 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.
IATA says that 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.
IATA said: “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.
WEAKER ECONOMIC GROWTH RISK
“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 dependent on a strong economy to generate sufficient revenues to partially offset higher fuel costs.”
GLOBAL OUTLOOK BY REGION
IATA says that Asia Pacific carriers are expected to earn $2.1bn this year, as the most profitable of all regions, but this is still dramatically down from the $10bn profit that the region achieved in 2010.
IATA said: “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 labour 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%).”
IATA adds that North American carriers will see their $4.1bn profit of 2010 fall dramatically to around $1.2bn. It says that 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 fuelled 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 PRESSURED
By contrast, IATA predicts that European carriers will deliver a $500m profit this year, which is a big fall from the $1.9bn achieved in 2010. The association says that 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,” said IATA. “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%.”
An even more dramatic fall in profitability is predicted for Middle East carriers. IATA says these airlines will collectively deliver a $100m profit compared with $900m in 2010. It says: “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 CARRIERS FLOURISH
Latin American carriers are expected to be the only regional collective of airlines that will deliver a third consecutive year of profits. IATA notes that 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 $100m profit is down considerably on the $900m profit of 2010. Capacity growth of 6.9% will outstrip the 6% increase growth in demand.”
AFRICA SET FOR A $100M LOSS
Perhaps not surprisingly, IATA says that African carriers are expected to be the only regional collective to post a loss of $100m in 2011. It says 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%,” says IATA.