IATA: High Oil Price Will Cut Airline Profits

The International Air Transport Association (IATA) downgraded its airline industry outlook for 2011 to $8.6 billion from the $9.1 billion it estimated in December 2010. This is a 46 percent fall in net profits compared to the $16 billion (revised from $15.1 billion) earned by the industry in 2010. On expected industry revenues of $594 billion, the $8.6 billion 2011 profit equates to a net profit margin of 1.4 percent, IATA says.

“Political unrest in the Middle East has sent oil over $100 per barrel. That is significantly higher than the $84 per barrel that was the assumption in December. At the same time the global economy is now forecast to grow by 3.1 percent this year—a full 0.5 percentage point better than predicted just three months ago. But stronger revenues will provide only a partial offset to higher costs. Profits will be cut in half compared to last year and margins are a pathetic 1.4 percent,” said Giovanni Bisignani, IATA’s Director General and CEO.

Fuel: IATA raised its 2011 average oil price assumption to $96 per barrel of Brent crude (up from $84 in December), in line with market forecasts. Including the impact of fuel hedging, which is roughly 50 percent of expected consumption, this will increase the industry fuel bill by $10 billion to a total of $166 billion. Compared to levels in 2010, oil prices are now expected to be 20 percent higher in 2011. Fuel is now estimated to represent 29 percent of total operating costs (up from 26 percent in 2010).

“Growing economies give airlines the opportunity to recover some of these added costs with additional revenues. For example, since early 2009, rising oil prices added 25 percent to unit costs while average fares (excluding surcharges) rose 20 percent. But in 2011 higher revenues are not expected to be sufficient to prevent the rise in oil prices from causing profits to shrink by 46 percent from 2010 levels.
Demand: An increase in global GDP forecasts to 3.1 percent (from 2.6 percent in December) bodes well for continuing strong demand for air transport. In line with this, IATA revised its passenger demand growth forecast to 5.6 percent (from 5.2 percent) and its cargo growth forecast to 6.1 percent (up from 5.5 percent). Overall, this will generate a 5.7 percent expansion in ton kilometers flown.

Capacity: Published airline schedules indicate a capacity increase of 6 percent, slightly lower than the 6.1 percent previously forecast. Of this, 5 percent will come from the 1,400 new aircraft being introduced to the fleet over 2011. The additional 1 percent is expected to come from the normalization of underutilized capacity in the twin-aisle fleet.

Yields: With capacity expected to increase by 6 percent in 2011 and demand by 5.7 percent, the gap is 0.3 percentage points. This has narrowed from the previously forecast gap which was 0.8 percentage points. While there has been some weakening in passenger load factors, as of January they remained near record levels at a seasonally adjusted 77.7 percent. Freight load factors are also high compared to previous cyclical peaks. These tightening supply and demand conditions give scope for yield improvements. Passenger yields are expected to grow by 1.5 percent (up from the previous forecast of 0.5 percent) and cargo yields by 1.9 percent (up from the previous forecast of no growth).

Premium Travel: Premium traffic is an important contributor of a network airline’s profitability, IATA said. Purchasing managers’ confidence is a leading indicator for business travel. In January, the JP Morgan/Markit Purchasing Managers Index hit a record high. Moreover, strong corporate reporting at the end of 2010 and expanding world trade will continue to drive business travel in 2011, albeit at a slower pace than we saw during the 2010 post-recession rebound.

Risks: Rising oil prices are always a challenge for airline profitability, IATA said. If they are accompanied by strong growing economies and world trade, airlines have some opportunity to command prices that can offset the rising fuel costs. If, however, rising energy prices stall global economic growth there is a strong downside risk to this forecast. With oil prices now being driven by speculation on geopolitical events in the Middle East rather than strengthening economic growth, this is a significant downside risk.

“This year the industry is performing a balancing act on a very thin tight-rope of a 1.4 percent margin. It is a structural problem that the industry has faced with an average margin of just 0.1 percent over the last four decades. There is very little buffer for the industry to keep its balance as it absorbs shocks. Today oil is the biggest risk. If its rise stalls the global economic expansion, the outlook will deteriorate very quickly,” said Bisignani

IATA also highlighted the risk of increasing taxation, particularly in price sensitive leisure markets. In 2010, the industry saw new and increased taxes in the range of 3-5 percent of ticket prices in the UK, Germany and Austria. Recently, Iceland, India and South Africa have joined with plans for additional taxation. “This is a price sensitive business. Aviation has the power to stimulate economies. But that ability is being compromised by adding taxes at a time when we are struggling to cope with high fuel prices just to maintain anemic margins,” said Bisignani.

North American carriers are expected to deliver $3.2 billion profit, unchanged from the previous forecast and down from the $4.7 billion profit made in 2010. Higher oil prices will damage profitability in 2011, but earlier cuts in capacity have led to much stronger conditions for yields than elsewhere. The US economy has also been stronger than expected, IATA said. Compared to IATA’s December forecast, better revenues in 2011 will offset higher fuel costs.

Visit www.IATA.org.

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