OAG Travel News

Commercial aircraft manufacturing and the global airline industry are not businesses for the faint-hearted. The relentless rise in oil and other raw material costs over the past 12 months has taken them into uncharted territory. Equally unsettling is the broad economic outlook. As consumers face simultaneous inflationary pressures and uncertainty over their employment prospects, discretionary air travel will face serious head winds.

Uncertainty among corporate managers about the outlook, as well as the inconvenience of tighter security measures and a perceived decline in airline service standards, is also putting a squeeze on business travel - by far the most profitable segment of airline traffic.

The annual report of the Bank for International Settlements, the supervisory agency in Basel, Switzerland, that tracks international monetary flows, warned last month that "deflation in the world's largest economies is now a possibility." For parallels, it cited "the long recession beginning in 1873, the global downturn beginning in the late 1920s, the Japanese and Asian crises of the early and late 1990s."

Vaughn Cordle, chief executive of Airline Forecasts, an investment research firm based in Arlington, Virginia, is both a chartered financial analyst and a current, qualified Boeing 777 captain with a major airline, who knows both the industry's balance sheets and the view from the cockpit. Cordle says that, as consumer spending keeps dropping in the United States and other developed economies, business travel outlays - the most profitable by far for the airlines - could easily fall by $2 billion to $3 billion over the next 12 months. That, he said, adds up to a strong likelihood of further airline bankruptcies.

A survey published in mid-June by the Stanford Transportation Group, a consultancy in San Francisco, found that the number of U.S. domestic "premium" trips - First Class, Business Class and full-fare Economy/Coach tickets - has stalled at 41 million one-way flights per year. Premium trips now represent only 10 percent of total U.S. domestic airline travel, down from 20 percent in 2000. In the same period, the comparative volume of travel on private or corporate business aircraft has ballooned, to 41 percent of premium airline traffic from 16 percent eight years ago.

Effectively, 90 percent of public airline travel within the United States is on discounted fares.

In Europe, too, the trend has been to cheaper tickets, spurred by the proliferation of low-cost carriers in the European Union after the EU's full economic deregulation of the airline industry in April 1997.

That has left the carriers facing both cutthroat competition and soaring costs.

"Previous crises like SARS or Sept. 11 were shocks," Giovanni Bisignani, the director general of the International Air Transport Association, said in an interview, referring to the impact of the epidemic of severe acute respiratory syndrome in Asia in 2003 and the terrorist attacks on the United States in 2001. "Something happened, and the industry had to recover. The fuel crisis, however, has brought lasting change of unprecedented dimensions."

"If oil stays at current levels through 2008, we would have a fuel bill of $190 billion - 34 percent of airline costs and an increase of $53 billion in just one year," Bisignani said. "In 2002, the total fuel bill was $40 billion, only 13 percent of costs."

It is not only passenger traffic that has been hit. On July 2, the IATA released its global air traffic report through May, pointing to a significant slowdown in air cargo growth, to just 1.3 percent. Both Federal Express and UPS, widely seen as proxies for overall economic conditions, have recently announced significant downgrades in their traffic forecasts.

Yet, against that unpromising background, both Boeing and Airbus, the two dominant aircraft manufacturers, say that they see some bright spots in the industry - sometimes in surprising places.

"The real issue is fuel costs," said John Leahy, head of sales and customer services for Airbus and a 25-year veteran of the industry who has worked through four major boom-and-slump economic cycles.

"There is an urgent need to get rid of old aircraft," Leahy said. "The silver lining in this cloud is that, if fuel came down to $100 per barrel, at least the strong carriers could order new planes, so the recovery could be swift and sharp."

In the single-aisle sector of the market, where Airbus sells its A320 and Boeing its 737, "it is possible to get a 20 percent fuel improvement just by retiring old aircraft like the DC-9 and the MD-80 and replacing them with modern units," he said, referring to aging McDonnell Douglas models that first entered service, respectively, in the 1960s and 1980s.

Leahy also noted some bright regional sales prospects. For example, "the Gulf area is having its biggest boom in a long time," he said. "They need to recycle their petrodollars and several carriers there are very good Airbus customers."

In China, he said, the ending of subsidies on aviation fuel would slow traffic growth, "but it is still a strong market." India, in contrast, "has overcapacity problems. We are watching carefully for likely consolidation among airlines there."

Europe, he noted, had some of the strongest airlines globally. "There is a lot of euro and sterling revenue, while both fuel and aircraft are dollar-denominated, a growing advantage."

Across the Atlantic, Boeing tells a similar story.

"Many airlines are caught in the difficulty of balancing their costs and revenues as they deal with the unpredictable spikes in oil prices, said Scott Carson, executive vice president of Boeing and chief executive of its commercial airplanes unit. "Given this situation, airlines see the need to replace their older aircraft with newer, more efficient models, and we continue to see demand across our product line."

Randy Tinseth, vice president for marketing of Boeing Commercial Airplanes, added: "It is encouraging that U.S. airlines are acting fast to cut domestic capacity. Southwest Airlines and Air Tran have deferred deliveries of some orders, but American Airlines and Continental are continuing to take deliveries on schedule."

Boeing has an order book of 3,645 planes, worth $270 billion. Reflecting the shifting fortunes of carriers in the United States and abroad, only 11 percent of that backlog is for U.S. carriers, Tinseth said. Before the shock to U.S. airlines of the Sept. 11 terrorist attacks, their share was closer to 60 percent.

Richard Aboulafia, vice president of Teal Group, an aviation consultancy in Fairfax, Virginia, said Airbus had an order book of 3,655 aircraft, similar in number to Boeing's, but with a larger proportion of the less costly single-aisle A320 family, compared with Boeing's greater share of wide-bodied, twin-aisle, long-range models.

In Europe, Tinseth said, "strong carriers are able to afford fuel price hedges, the market is growing robustly, and many carriers have the advantage of earning large portions of their revenue in euros or sterling, while paying for aircraft and jet fuel in depreciating dollars."

In Asia, there is also strong growth as countries like China develop rapidly, with growing numbers of people able to afford air travel for the first time.

"The situation is better in China than in the United States," Tinseth said, speaking after a recent visit to China, "but fuel prices are also becoming a problem there."

The Middle East is also growing strongly on the back of oil and natural gas revenues. The region is leveraging its strategic location to develop nonstop long-distance routes - Emirates Airways of Dubai is preparing to start nonstop flights to Los Angeles and San Francisco this year, using the very long range Boeing 777-200LR.

Looking at Boeing's order book, which stretches into the next decade, Tinseth said, "What sticks out is diversity."

"Some 60 to 65 percent of the unit numbers are single aisle 737s, but they are only 30 to 35 percent of the dollar value," he said.

Despite the current market angst, Tinseth said, Boeing is raising its production rate cautiously, amid constant dialog with its customers to avoid sudden surprises. Boeing's deliveries in the first half of this year totaled 241 aircraft, of which 39 were long-haul 777s and a surprising 9 were 747s, 38 years after the earliest models entered service. Six more were 767s and the remaining 187 were the ubiquitous 737s, now in their third generation.

"When Boeing's global market forecast is published, it will show strength long term, after a near-term transition period," he said.

Just how painful that "near-term transition" may be should become clearer this week at the Farnborough air show, a classic venue for large order announcements.

In an analysis sending both sour and sweet signals to the aircraft makers, Steven Udvar-Hazy, chief executive of International Lease Finance Corp., said that he estimated that as much as 25 percent to 30 percent of the backlog at both Airbus and Boeing could be "soft" options, liable to be abandoned in a downturn - implying potential order losses of around 1,000 planes for each.

But Udvar-Hazy, a major client whose company leases aircraft to airlines around the world, also said ILFC may place orders for some 300 aircraft, either at the Farnborough show or in following months, to supply airlines whose corporate balance sheets cannot stretch to outright purchases.

The bad news for aircraft makers, Aboulafia of Teal said, is "capacity cuts - the resulting higher ticket prices and their effect on travel demand - reducing the size of the market," particularly in the United States.

"Historical elasticity has shown that if prices rise 10 percent, we lose 6 to 6.5 percent of demand. The most elastic group is at the bottom end of the market."

Still, he said: "The good news is that airlines want better, newer jets."

Source: http://www.iht.com by Daniel Solon