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Airline Industry Profit Estimate SlashedJune 6, 2011 By: George Dooley
High oil prices, natural disasters and political unrest have led to the International Air Transport Association (IATA) further downgrading its 2011 airline industry profit forecast to $4 billion. This would be a 54 decline compared with the $8.6 billion profit forecast in March and a 78 percent drop compared with the $18 billion net profit (revised from $16 billion) recorded in 2010, IATA reports. On expected revenues of $598 billion, a $4 billion profit equates to a 0.7 percent margin.
“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 $4 billion 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 percent margin, there is little buffer left against further shocks,” said Giovanni Bisignani, IATA’s Director General and CEO.
Fuel: The cost of fuel is the main cause of reduced profitability. The average oil price for 2011 is now expected to be $110 per barrel (Brent), a 15 percent increase over the previous forecast of $96 per barrel. For each dollar increase in the average annual oil price, airlines face an additional $1.6 billion in costs. With estimates that 50 percent of the industry’s fuel requirement is hedged at 2010 price levels, the industry 2011 fuel bill will rise by $10 billion to $176 billion. Fuel is now estimated to comprise 30 percent of airline costs—more than double the 13 percent 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.
This fuel price spike is substantially different from the one that occurred in 2008, IATA said. 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.
Demand: Despite high energy prices, world trade and corporate earnings continued to improve. As a result, global GDP projections increased by 0.1 percentage points to 3.2 percent, which is supporting continued growth in demand for air transport. However, growth rates for both cargo and passenger markets have been revised downward because of higher fuel costs. Passenger demand is now expected to grow 4.4 percent over the year, a full 1.2 percentage points below the 5.6 percent previously forecast in March.
The number of price-sensitive leisure travelers has fallen 3–4 percent over the past five months, as travel costs were forced higher by fuel prices and, in Europe, by new 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 percent of 2010, but is expected to be close to the historical trend this year at a 5–6 percent rate.
Capacity: Overall capacity (combined passenger and cargo) is expected to expand 5.8 percent, which is above the 4.7 percent 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 percent. This is more than a full percentage point below the 78.4 percent achieved for international traffic in 2010. Aircraft utilization is also falling. 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.
Yields: 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 percent for passenger traffic (double the previously forecast 1.5 percent) and 4 percent for cargo (up from the previously forecast 1.9 percent). 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.
Risks: 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 percent 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 percent 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.
North American carriers will see the $4.1 billion profit of 2010 fall to $1.2 billion, IATA says. 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 percent 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 fueled by the weak US dollar. Careful capacity management is expected to see an overall demand increase of 4 percent balanced by an equal increase in capacity.