IATA Warning: Rising Oil Prices Reducing Airline Profits

Primarily due to rising oil prices, the International Air Transport Association (IATA) reports a downgrade to its industry outlook for 2012. IATA expects airlines to turn a global profit of $3.0 billion in 2012 for a 0.5 percent margin. This $500 million downgrade from the December forecast is primarily driven by a rise in the expected average price of oil to $115 per barrel, up from the previously forecast $99.

Several factors prevented a more significant downgrade, IATA said: (1) the avoidance of a significant worsening of the Eurozone crisis, (2) improvement in the US economy, (3) cargo market stabilization and (4) slower than expected capacity expansion.

“2012 continues to be a challenging year for airlines. The risk of a worsening Eurozone crisis has been replaced by an equally toxic risk—rising oil prices. Already the damage is being felt with a downgrade in industry profits to $3.0 billion,’’ said Tony Tyler, IATA’s director general and CEO.

Airline performance is closely tied to global GDP growth. Historically, when GDP growth drops below 2.0 percent, the global airline industry returns a collective loss. “With GDP growth projections now at 2.0 percent and an anemic margin of 0.5 percent, it will not take much of a shock to push the industry into the red for 2012,” said Tyler.

IATA revised upwards its estimated profits for 2011 to $7.9 billion from the previously forecast $6.9 billion. This was primarily owing to the much better than expected performance of Chinese carriers.

Oil Price: The major driver of reduced profitability is rising oil prices. In December 2011, the consensus forecast for 2012 stood at $99/barrel for Brent crude. The average price year-to-date is approaching $120 and the consensus forecast for the year has been revised to $115 (from the $99 previously forecast). This will push fuel to 34 percent of average operating costs and see the overall industry fuel bill rise to $213 billion. Political tensions in the Gulf region increase the risk of significantly higher oil prices, the implications of which could put the industry into losses.

Asset Utilization: Overall capacity (passenger and cargo combined) is expected to grow by 3.2 percent in 2012 (based on announced schedules) which is behind the 3.6 percent expected expansion in demand. This is a reversal of the expectation in December of capacity expansion (3.1 percent) outstripping demand (2.9 percent). Both passenger load factors and aircraft utilization have returned to or above pre-recession levels. In January the passenger load factor stood at 76.6 percent, which is more than 2 percentage points higher than pre-recession levels. The average hours flown by passenger aircraft is also close to pre-recession peak utilization rates.

Passenger Demand: Passenger demand is expected to grow by 4.2 percent, which is 0.2 percentage points ahead of the December forecast. January premium traveler numbers were up 2.9 percent on previous year levels, while economy class travelers grew by 6.1 percent. This reflects stronger business and consumer confidence in the US and Asia-Pacific.

Yields: In December yields were forecast to be flat in 2012 for both passenger and cargo. Higher fuel costs, tighter capacity management in passenger markets and the stabilization of freight markets is now expected to drive a 2.0 percent yield improvement in 2012 for both passenger and cargo.

All regions will see reduced profitability in 2012 compared to 2011, IATA says, and Europe and Africa will see losses.

European carriers by far face the most difficult situation among the regions, IATA says. The outlook remains unchanged from December with the expectation of a $600 million net loss and an EBIT margin of 0.3 percent of revenues. While it appears that a major worsening of the Eurozone crisis has been averted, many European economies are in deep recession which will see continued weakness in both the cargo and passenger business IATA says. At the same time air travel is being hit by taxation and the cost of the EU ETS.

North American carriers are expected to deliver a profit of $900 million, down from the previously forecast $1.7 billion. The 2.0 percent EBIT margin shares top position with Asia-Pacific carriers. Higher fuel costs are responsible for the downgrade, but airlines in this region will see the smallest deterioration from last year’s performance among the major regions,

IATA notes that a number of commentators have pointed to a scenario where an escalation of the crisis in Iran could see the closure of the Strait of Hormuz cutting off vital supply links for oil. In this scenario, oil prices could spike at $150/barrel for Brent crude mid-year, for a full year average of $135. In such a scenario, global GDP growth would fall to 1.7 percent IATA  warns, plunging the entire industry towards losses of over $5 billion.

“While we have seen some improvements in economic prospects any further significant rise in the fuel price will almost certainly turn weak profits into losses,” said Tyler. “Airlines are buffeted by many forces beyond their control. Today’s forecast demonstrates just how quickly the operating environment can change. Four months ago the biggest worry was a European financial disaster; today it is rapidly rising oil prices. Nimbleness and operating efficiency are critical to maintaining competitiveness and managing through such dramatic shifts,” said Tyler.

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