Surge in orders for fuel-efficient aircraft

by Surekha Galagoda

The economic growth was robust in the third quarter of last year even in the US and therefore we are looking for a growth slowdown rather than a recession, said Chief Economist of International Air Transport Association (IATA) Brian Pearce addressing the Global Media Day in Geneva, Switzerland recently.

He said that Central Bank surveys already show that banks are tightening their credit conditions. We have not yet reached the credit crunch that followed the dot com collapse but we are heading in that direction.

Now the US housing bubble has moved into a double dip with house prices falling at a rate of 5% a year and this was the root cause of the defaults in the sub prime mortgage market which is leading to the growing losses in the financial sector.

Pearce said that as a result of all this confidence is now falling for both consumers and businesses which will result in less leisure and business travel particularly in the USA.

Central banks are doing their best by injecting liquidity into the banking system and cutting down interest rates. But the high energy and food prices raised the inflation. He said that today most Central banks have inflation targets and this is restricting their ability to cut interest rates sharply to avoid a major growth slowdown. This increases the risks of a more severe growth slowdown.

Until recently financial markets were pointing at continued economic expansion and growth, with rising equity markets and bond yields. In the last month both are now pointing downwards and towards a weaker economic outlook.

He said that forecasts for the US economy in 2008 have slipped from 2.5% growth to 1.5%. There is more optimism over economic growth in the Asia-Pacific region and China in particular. Europe is also expected to emerge relatively unhurt from the US slowdown.

The robust growth in Asia and to a lesser extent Europe will provide some support for the airlines, but the US market represents 30% of the aviation market and so will cause a significant slowdown in overall traffic growth from 5.9% in 2007 to 4% in 2008. (International traffic is forecast to slow 7.3% to 5%).

The timing of the traffic slowdown is not good since aircraft deliveries have yet to peak, said Pearce. In the past cycles too airlines ordered when traffic was the strongest and took delivery just when the cycle was at its lowest.

According to him the growth slowdown is far from the recessions of 1991 and 2001. However, increasing deliveries and slowing traffic will combine to put downward pressure on the improvement in yields and load factors.

Pearce said that as a result of slowing traffic volumes and yields we expect a sharp slowdown in revenue growth in 2008. During 2007 airline revenue growth was 8.4% which helped to offset the sharp rise in fuel costs, permitting profitability to improve.

In 2008 IATA only expects a revenue growth of 4.7% providing a much lesser cushioning effect against the high fuel costs. He said that at the same time when the revenue outlook is weakening fuel prices hit record highs. Jet fuel at present costs more than $110 a barrel, compared to less than $40 a barrel four years ago.

He said that the weakness of the US dollar has been a double edged sword for the industry. It has provided some shelter for European (and Asian) airlines as the Euro cost of oil has risen 200% since 2003 compared with 300% in US$ terms.

However the weakness of the US dollar itself has been helping to drive oil prices higher as oil producers seek to restore the purchasing power of their oil revenues in domestic currency terms.

Pearce said that a fall in oil prices is forecast but that still leaves the 2008 average at US$ 78 billion. As a result IATA expects an even higher fuel bill for airlines in 2008, almost reaching $150 billion which represent a record 30% of operating costs.

The record fuel costs have led to a surge in orders for fuel efficient aircraft, partly to meet rising travel demand in emerging markets.

There is also a large part that is replacement demand to improve fuel efficiency and cut down operating costs. He said that during the 1990s when oil was $25 fuel efficiency improved by about 2% a year. Since the increase in prices fuel efficiency has been improving at more than 3% a year.

He said that there may be some short-term pause in travel demand in the US but the IATA annual survey shows that airlines are expecting demand from an additional 600-700 mln passengers in the next five years and the majority will be in the fast growing Asian markets such as India and China.

Pearce said that, however, even slow growing US and European markets will generate demand for 100-150 mln extra passengers a piece.

He said that a further challenge to growth and profitability is a growing shortage of key persons such as pilots and engineers. Shortage of skilled labour are widespread and a symptom of the recent economic boom that has reduced unemployment to low levels throughout the OECD.

As a result wages are rising as are the costs of many other inputs such as leased aircraft. This will make it harder to achieve non-fuel cost reductions that will be essential to further improve profitability. With revenue growth slowing as well the only option is to achieve further efficiencies.

The productivity of labour, fuel and aircraft use have all improved sharply. As a result non-fuel unit costs have been falling at an average rate of 1.5% over the past decade and faster recently, said Pearce.

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