Forecast 2010: Shuffle the Cards

ABOUT ALL THAT CAN BE SAID concerning the New Year is that it probably will be a better one for airlines than were 2009 or 2008. This won't be difficult, given that these were two of the worst years in what is the worst decade that commercial aviation has ever experienced. Yet the presence of some wild cards in the deck makes predicting too much upside a risky bet. Foremost among them is the strength of the nascent economic recovery, but excess capacity and weak yields have the potential to turn fortunes down as well.

"There is still a lot of volatility in the bigger landscape," Seabury Aerospace President Henri Courpron tells ATW, adding, "The global economy is growing again but it looks to us like it is going to be a slow recovery." In October, the IMF forecast 2010 world economic growth of 3% with expansion driven by the developing economies, which will experience GDP growth of almost 5%. Advanced economies, meanwhile, are projected to grow "sluggishly" throughout the year, up around 1.25% following a contraction of 3.5% in 2008.

"Unfortunately for the airline industry," comments IATA Chief Economist Brian Pearce, "many of our markets are in developed worlds [although this is] less so for freight." He believes 2010 "is going to be a story of stronger recovery in traffic growth but it's going to be a slow business getting back to profitability" owing to the fragile revenue environment. On the plus side, traffic growth for IATA airlines resumed last September (off the depressed September 2008 base) and a sampling of 76 carriers showed the group posted a combined third-quarter profit of $341 million compared to a loss of $3.8 billion by those same airlines in 2008.

In mid-December, IATA forecast that the airline industry will post a net loss of $5.6 billion in 2010, with all major regions spilling red ink (see tables and charts throughout). While depressing, this still represents a nearly 50% improvement over 2009, when losses are estimated at $11 billion, and 2008, the industry's worst-ever year on a global basis with losses of $16.8 billion (IATA made a downward revision to the 2008 result from a loss of $10.4 billion to a loss of $16.8 billion last September to reflect restatements and clarification of the accounting treatment of very large revaluations to goodwill and fuel hedges).

Oil On Troubled Waters

IATA's 2010 forecast assumes an average price for oil (Brent crude) of $75 a barrel, which is up from the 2009 average of $61.90 but still well below the 2008 average of $99 and the record high of $146 recorded in July of that year. Fuel began 2009 at less than $40 a barrel so the trend is upward, but Pearce believes, "We've not got the same sorts of conditions for the spike in oil prices that we had in 2008. The economy is recovering but there is a lot of spare capacity in OPEC and the expectation is that this is going to keep prices flat." He points out that "every dollar [up or down] is worth $1.5 billion on or off our costs."

Courpron says Seabury is advising its clients to assume that fuel "is going to be around $80 a barrel if not more. If we are wrong and it is $60, fantastic . . . [But] if you bet on $60 and you are at $80, you are dead." "We are still seeing very volatile oil prices. I just can't believe that story is going away . . . and the risk is to the upside," says William Swelbar of the International Center for Air Transportation at MIT.

Barring a nightmarish spike in oil prices, however, fortunes in 2010 will depend on what happens to yield and revenue. John Heimlich, chief economist for the Washington-based Air Transport Assn., remarks, "If I had $80 oil and spring 2008 revenue, I might be in pretty good shape, but with today's revenue climate and $80 a barrel, I'm not in good shape." No indeed: In November ATA reported that US passenger revenues fell 15% in October, marking the 12th consecutive month of year-over-year declines and the 11th month of falling yield, with 3% fewer passengers traveling on US airlines in the month compared to October 2008.

Propelled by double-digit declines in yield, world airline revenues are estimated by IATA to have dropped a staggering 14.9% last year to $456 billion, more than twice as bad as the 6.4% decrease that occurred between 2000 and 2001. Pearce expects a modest recovery this year built on 5.2% traffic (TKP) growth and flat yields, raising 2010 revenues to $478 billion. This is well below the $535 billion recorded in 2008, a level unlikely to be seen again before 2012. IATA estimates that worldwide passenger and freight traffic including non-IATA members sank 6.7% in 2009 on a 4.2% decline in capacity.

"2009 was an exceptional year in many ways," Pearce states. "We've never seen airfreight fall quite so far. It normally just goes flat in a recession. The collapse we saw was completely unprecedented (see related article, p. 31). And we also saw yields collapse as well; both passenger and freight yields were pretty much down 20% by the second quarter. In the middle of the year, we started to see that turn around because the other feature of 2009 was that airlines continued to cut capacity throughout the year."

Courpron estimates that globally, ASMs were down 2.5% last year. He expects that "there is more to come" in the way of capacity reductions over the winter: For full-year 2010 he predicts capacity will rise 1.5%-2% but this "basically assumes that North America, Europe and developed Asia remain flat and emerging markets are up 6%." He notes that US carriers have taken a lot of lift out already, but believes "Europe will have to adjust capacity significantly."

IATA foresees a 2.8% rise in ATKs this year but capacity discipline will be key to achieving this low figure. Indeed, the organization believes that "the biggest risk in the business environment ahead is the latent overcapacity [that is] overhanging yields." Pearce notes that airlines took delivery of around 100 new aircraft per month last year so that by October the fleet "was about 6% higher than in the first quarter." The only way carriers could shrink capacity was by reducing utilization, which was down around 6% last year, but this had the disadvantage of raising costs. They are scheduled to take around 1,300 new jets in 2010. "So we are either going to have to see a lot of aircraft retired or utilization rates stay down. It is going to be difficult to keep a lid on capacity, and [while] it might not be a problem in Asia or some of [the faster-growing] markets, I think it will be more so in the slow-growing developed markets."

European Questions

IATA is forecasting a 4.5% traffic (TKP) rise for all European airlines this year on a 2.8% increase in ATKs. Assn. of European Airlines Manager-Information David Henderson is less sanguine about AEA member carriers, a group that excludes the faster-growing and more profitable LCC segment. "As far as traffic is concerned, we have no idea. One imagines we will see some kind of plus but there is no real reason why . . . and even if we do, it won't mean a great deal" owing to the collapse in fares.

"Our yields are a disaster," Henderson says. "They were down 16% in the second quarter and . . . the third quarter. And this is really horrible. It's enough to offset any foreseeable traffic growth . . . Our main concern is that we are not going to get those pre-crisis yields back again."

AEA is estimating that its members had an operating loss of €2.9 billion in 2009, which is "50% worse than our worst-ever result," he says. IATA, meanwhile, expects that Europe's airlines in aggregate had an operating loss of $2.1 billion and a net loss of $3.5 billion. While AEA will not forecast a 2010 result, IATA predicts carriers there will lose $2.5 billionthe worst performance for any region.

Overhanging the outlook for this year are concerns over the Emissions Trading Scheme and the question of whether the European Commission will reinstate the airport slot waiver for the 2010 summer season, having let it lapse for winter 2009-10. AEA members also are concerned about rising charges from airports and air navigation services providers: "You can't put prices up when your customers are bleeding to death," Henderson remarks.

Another issue is fallout from a controversial study on pilot fatigue and flight times commissioned on behalf of EASA. "Some of the things contained in this report are so outlandish . . . It would seriously throw into question, for example, the ability of a European airline to fly nonstop to Los Angeles," he complains.

Reality Intrudes

US airlines entered 2009 fairly confident that the drastic capacity cuts undertaken in 2008, coupled with the collapse in fuel prices, would help them fly through the recession with minor turbulence. Alas it was not to be, as revenues plunged further and faster than any had thought possible, leading to another round of capacity cuts and layoffs across the industry. "Three quarters, $3 billion in losses, a quarter of probable losses yet to be reported," is how Heimlich characterizes the year, adding, "I suppose sadly that this will be an improvement from 2008, when depending on how you measure it we had anywhere from $9 billion to $24 billion in losses."

ATA will not issue a financial forecast for 2010, but Heimlich says that "there are tremendous challenges" with returning to profitability, citing among other things the fact that US unemployment is at its highest level since April 1983. US domestic ASMs were down an estimated 6.9% in 2009 versus 2008, the steepest drop since 1942 when the airline industry went to war (see Sidebar).

The 2008-09 period also marks just the second time in history that the US industry has shrunk in back-to-back years (the first was 2001-02). Turning to 2010, Heimlich notes that "most of the projections for 2010 are for flattish capacity . . . If you are likely to see something other than flat I would bet on reduction rather than increase for both domestic and international." Among the 10 biggest US passenger airlines, only two, AirTran and JetBlue, will operate more ASMs in the first quarter of this year than in the same period in 2008, according to schedule data.

Separately, IATA is forecasting that North American airlines, which include those in Canada, will lose $2 billion in 2010 but manage a $1.2 billion operating profit.

Spurred by Democratic majorities in both houses of Congress and the most pro-labor president in 30 years, US airline labor could flex its muscle in a number of key negotiations this year, Swelbar suggests, stating, "Labor negotiations and the National Mediation Board will be a big part of the news in the US in 2010." Last fall, NMB angered airline management and Republican leaders in Congress by voting by a 2-1 majority to change longstanding rules to make it easier for unions to win representation. Swelbar notes that all the major labor contracts at American Airlines and United Airlines are in negotiation and under federal mediation. "I could envision at least one strike--if not in early 2010 then early 2011," he states. He thinks an early indication will be how the board handles the contract dispute between Hawaiian Airlines and its pilots that currently is in mediation.

Can Asia Recover?

Airlines in Asia suffered almost as much as their European counterparts last year, with losses estimated by IATA at $3.4 billion. The Assn. of Asia Pacific Airlines--whose 17 members include many of the largest and best-known carriers in the region but none from mainland China--put their 2009 losses at $4.8 billion, deeper than the $4.3 billion AAPA members lost in 2008. For the year to Oct. 31, AAPA member carriers' international passenger numbers were down 8.2% year-over-year while cargo traffic slumped 16.5%, particularly troubling in a region where many airlines generate 30% or more of their revenue from airfreight. But signs of improvement are apparent: AAPA members' passengers carried reached 11.1 million in October, down just 3% year-over-year, while cargo traffic was 2.5% lower, the smallest drop of any month this year.

For 2010, IATA sees the region's airlines losing just $700 million as recovery takes root among the developing nations there. Yet deep problems remain for some, such as Japan Airlines, whose fate was undecided at this writing, as well as Air India. And unlike those in Europe and to a lesser extent the US, Asia/Pacific carriers remain unable to consolidate or to use their considerable clout on the world stage, a problem Singapore Airlines CEO Chew Choon Seng identified at the AAPA Assembly of Presidents in November. "Airlines in the EU and US are consolidating with greater synergies and economies of scale," he explained. "With a 60-year-old prohibition against cross-border mergers, how will airlines in the rest of the world, like us, compete?" (Note to readers: ATW will continue to examine the condition of Asia/Pacific Airlines in a special report next month).

While the government-owned Gulf-based airlines have taken a "Damn the torpedoes, full speed ahead" approach to the global recession (ATW, 11/09, p. 60), carriers of the Middle East lost an estimated $1.2 billion last year and will shed a further $300 million in 2010, according to IATA. The big question is whether the newly disclosed debt problems of Dubai will overhang the region or have any impact on its most successful airline, Emirates, this year.

Latin American carriers, meanwhile, appear to have overflown the swine flu crisis. Although traffic took a big hit last year (down 4.1%), the region's airlines achieved a breakeven result and are expected to resume growth in 2010.

Still, even perennially profitable Emirates experienced a 14% fall in revenue in its fiscal first half ended Sept. 30 and there is concern all over the world that fares will never return to pre-crisis levels: "If you look at the history of yields, particularly in real terms, yields tend to ratchet downwards and they might flatten out but they don't normally recover losses," Pearce states. So the problems of 2008 will linger long after memories of the credit crisis have blended into all the other crises of this Decennis Horribilis.