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How profitable will airlines be in 2014?

In December IATA outlined its forecast that airlines could post collective profits of $19.7 billion. Not only is that $3 billion higher than IATA thought just three months ago – and an improvement on the near $13 billion they will likely make in 2013 – it tops the previous highest industry profit of $19.2 billion in 2010.

While IATA is quick to issue the caveat that profit margins will not be as strong as 2010, it would still mark a fifth consecutive year of net profit – in stark contrast to the horrendous losses racked up in the previous decade. Also, all regions are seen as profitable in 2014.

“The average margin of the airline industry even in 2014 – which if we are correct will see the highest absolute profit ever – will be 2.6%,” says IATA director general Tony Tyler. “Many airlines will do better than this. And many others will under-perform.”

North American carriers are among those set to prosper the most. IATA expects these carriers to make a combined net profit of $8.3 billion, making it comfortably the most profitable region.

Airlines in the USA in particular have benefited from consolidation, both through mergers and joint business ventures on key markets like transatlantic routes. The majors – and indeed many of the established low-cost carriers – have improved aircraft utilisation and efficiencies as a result. The tight capacity discipline of recent years has continued, helping to lift passenger yields. Much of the attention in 2014 will now go on how American Airlines’ recently approved merger with US Airways – the final part of the US majors’ consolidation jigsaw – will contribute to the reshaped US market.

Asian carriers are the next most profitable, but are some way from the levels enjoyed a few years ago, as they grapple with a still-stagnant cargo market and falling yields. While that picture is mixed across the different markets, fares have struggled in some key areas like India, where the extra capacity has increased pressure in the short-term. IATA points to the impact on supply and demand in the region from the expected delivery of 710 aircraft next year.

For all the difficulties, European carrier profit projections – while still small – are on the up. The region has been aided by strong long-haul performances, but this again this differs widely across markets. Generally most of the strength has been linking northern European markets on North Atlantic routes.

The year is likely to see Europe’s network carriers retrenching from some markets as they continue to refocus short-haul business. This has already seen the likes of Air Berlin, Austrian and Iberia sharply cut capacity, and more reductions across other carriers are likely in 2014.

European network carriers' attempts to restructure will come under close scrutiny from regulators and unions alike. A number of restructuring moves are already being closely watched by the European Commission, to ensure there is no state aid through the back door. For some the challenge will be securing staff buy-in, as airlines seek a further round of productivity improvements to give them more chance of competing with low-cost rivals.

Indeed, many budget carriers are ready to pounce on any sign of weakness – made evident by the likes of EasyJet, Ryanair and Vueling all raising their game in Rome, even before Alitalia had detailed any of its expected cuts. However, low-cost carriers face their own challenges – not least Ryanair, which continues to take steps to make itself more appealing to higher paying passengers. Expect more freeing up of rigid rules around flying during 2014 from the now touchy-feely, tweeting, lowest-cost carrier of them all.

“The cash being generated by airlines is rather good under the circumstances,” says IATA chief economist Brian Pearce, citing high fuel costs and a relatively weak economic growth environment. “This puts the airlines in a good position to start improving their financials when the global economy starts turning around. We think we are now seeing the economic cycle turning upwards again. Unless we experience a shock, 2014 should be stronger than 2013.

“We had the Eurozone crisis – that seems to have eased. The banking crisis – in the USA they seem to have turned that around, and fears have eased a bit on oil prices,” says Pearce.

“Fuel prices have been in a flat range for the last three or four years. We expect to see some easing in fuel prices, because we have seen some changes [on the supply side],” he says, pointing to improved relations with Iran and the fresh supply of shale gas in the USA.

While passenger traffic is growing at historically typical rates – IATA sees passenger numbers increasing by 6% to 3.3 billion in 2014 – the air cargo market is still to recover. After two years of decline, air freight levels will rise by only 1% this year and 2% in 2014. This growth will be wiped out by falling freight yields.

“Cargo has been a very difficult market. How that business develops depends on seeing much stronger growth in international trade. Stronger economic growth should help that,” says Pearce. The issue is compounded for cargo operators because strong passenger demand is bringing with it additional belly freight capacity. “Despite efforts to reduce the freighter fleet, it has not been enough to bring the capacity in line with demand because of the growth in the passenger fleet."

“Getting that stronger international trade will help. We are seeing some signs of turnaround, some stronger volumes, so it’s heading in the right direction,” he adds. “But I don’t think it will get there in the next 12 months.”

Will the industry finally do something about the single most critical safety problem facing it – automation-related degradation of airline pilot skills?

A huge amount of study has been carried out to understand the modern pilot operational skills deficit that has led to a spate of loss of control in-flight (LOC-I) fatal accidents over the last 15 years. However, so far no regulator has modified training requirements to address the need to restore what were recently considered core pilot skills.

The skill deficiency is recognised as not only the result of the lack of physical and mental practice induced by dependence on automation, but also the industry’s failure to develop best-practice in the use of ever more sophisticated flightpath management devices, and prepare pilots to handle an associated proliferation of flight management system (FMS) modes.

In the last year, manufacturers such as Airbus have fundamentally reviewed the way they provide training to customer airlines’ pilots converting to their latest products, which is a positive development. IATA, ICAO and the Royal Aeronautical Society have set up committees that have defined the problem, but are to yet deliver a universally accepted solution.

However, in November 2013 the US Federal Aviation Administration published a significant and long-awaited study entitled “the operational use of flight path management systems”, which has the potential to provide the global leadership that will bring action in this critical area.

It is doubtful, however, that the industry will see any of the action or results in 2014, unless individual airlines decide voluntarily to act on the report’s findings, which is what the FAA makes clear it would like to see. The airlines that will act are those that are already safe and do not have serious accidents anyway, so their participation will have no short-term effect on statistics – it will instead signal the beginnings of a change in culture.

In the study, the FAA’s working group cited several factors expected to impact future operations:

• Growth in the number of aircraft operations,

• Continuing changes in the demographics of the aviation workforce, including pilots and engineers

• Evolution in the knowledge and skills needed by pilots and air traffic controllers

• An extremely low commercial aviation accident rate, particularly in mature aviation economies, that challenges the cost/benefit case for regulatory changes

• Future airspace operations that exploit new technology and operational concepts for navigation, communication, surveillance and air traffic management

It is also worth listing the FAA’s identified “vulnerability” areas. Although fatal accidents have been making them obvious for years, this is the first authoritative organisation to derive a list based on hard operational evidence. These, according to the FAA, are the vulnerabilities:

• Prevention, recognition and recovery from upset conditions, stalls or unusual attitudes

• Appropriate manual handling after transition from automated control

• Inadequate energy management

• Inappropriate control inputs for the situation

• Crew co-ordination, especially relating to aircraft control

• Definition, development and retention of such skills

That is a list of pretty basic skills, but they have been allowed to decay. Next year will see a growing cultural awareness that something needs to be done, but the corrective actions will lag the intention, even in the USA.