When the price of a barrel of oil shot up to a record $147 in July, it looked like things could not get much worse for the airline industry. However, while oil prices have plummeted since the summer, the industry now faces an even bigger challenge: a lengthy and painful global recession which will cause overall traffic to drop by 3% in 2009, according to IATA.
"Recession is by far the biggest threat facing the airline industry," says IATA director general Giovanni Bisignani. "It is more concerning [than high oil prices] because this is the first truly global recession the airline industry has faced. Never before will we have seen revenues go down so dramatically."
IATA is predicting that airline revenues in 2009 will fall by $36 billion year-over-year to $500 billion. To put this into perspective, the last industry downturn saw revenues fall by just $1 billion year-over-year to $306 billion in 2002. Bisignani says 2009 will present airlines with "the most challenging revenue environment for 50 years".
Based on oil prices of $60 a barrel, IATA is predicting an industry net loss of $2.5 billion for 2009. This is half the $5 billion loss forecast for 2008, largely owing to an expected turnaround in North American carriers' fortunes from a net loss of $3.9 billion in 2008 to a slight profit of $300 million in 2009. However, other regions, particularly Europe and the Asia-Pacific, are expected to fare much worse in 2009 than they did the previous year.
The North American turnaround is partly due to the fact that US carriers were not as successful as some of their European and Asian counterparts at entering into hedging contracts when fuel was at its most expensive. While this hurt US carriers at the time, the upside was that they were able to take advantage of the lower spot price of oil much sooner than airlines in other regions that were still locked into paying a higher price for their fuel through their hedges.
Another reason for the turnaround is that US carriers have already taken significant steps to slash their capacity, which will help them to cope with falling traffic in 2009.
But things are not all rosy for US carriers, as they will face difficulty financing the aircraft desperately needed to renew their ageing fleets. "In the US there is a big need to replace the fleet - US carriers have got a very big financing need for new aircraft," says IATA chief economist Brian Pearce. "Because of the credit crunch it is getting increasingly difficult to finance new aircraft.
"The market will look to Ex-Im banks and manufacturers increasingly. The availability of credit with the banks withdrawing means a lack of capital looks to be a real issue, as well as the fact that airlines are parking aircraft." Pearce believes the result of this will be that "some orders and deliveries will be at least deferred and some cancelled".
IATA expects losses to amount to more than $1 billion in 2009 in both Europe and the Asia-Pacific, compared to respective losses of $100 million and $500 million the previous year. Losses in the Middle East and Latin America will double from $100 million to $200 million, while African carriers will see their losses remain flat at $300 million.
Overall traffic will drop by 3% in 2009, according to IATA, which had originally predicted it would grow by almost the same amount. Pearce also expects to see yields fall by 3% as competitive pressure intensifies. "We're seeing a very steep fall-off in business travel, which is highly sensitive to the cycle," he says.
Although over 30 airlines have recently failed and withdrawn from the market, Pearce points out that this represents just 1% of global capacity. "It's going to be a very challenging environment for airlines. Those that can control and reduce their costs will survive and maybe succeed.
"Labour and employment costs will have to shrink with the industry," he says, adding that foreign ownership and control regulations limit the airline industry's ability to shed excess capacity in a meaningful way. "In a more rational world where we could have cross-border consolidation, this would lead to a more orderly and sensible shrinkage of capacity."
Bisignani predicts the expected drop in revenues next year will be so sharp that it will take the airline industry "at least two years" to recover. "Normally I'm optimistic, but it's hard to find something that will support optimism. I will start to be more optimistic when freight numbers improve consistently - at that point we can say the worst is over. As soon as freight moves in the right direction, we can start being more optimistic."
Tim Jeans, managing director of UK carrier Monarch Airlines, also has a glum assessment of the coming year, although he does see a glimmer of hope in his home market. "The outlook for next year is not great - in fact it's grim. Economies are declining and nobody knows where the bottom of this recession will be," says Jeans.
"The only opportunity for optimism, in the UK at least, is that lots of capacity is coming out of the UK market. If capacity continues to fall, at least there will be some grounds for optimism that it won't be a bloodbath." Jeans is also hopeful that there will be "some resilience" in the leisure market and that "people will continue to use what disposable income they have to have a holiday".
But consumer demand and business travel in particular will be "the biggest wildcard for 2009", according to Mike Cox, managing director and head of corporate advisory at Seabury Group's New York office. "Everyone agrees this global recession is potentially bigger than any prior recessions," says Cox, adding that while "there will be some pockets of the world that may be exempted from this", it "appears to be global". This will result in worldwide capacity adjustments as the industry struggles to keep up with the drop in traffic.
Andrew Herdman, director general of the Association of Asia Pacific Airlines, predicts that capacity in his region will be flat at best over the coming year. "I think we will see negligible capacity growth [in 2009] and if market conditions continue to decline, you might see some cuts in capacity," says Herdman.
"At the moment the cargo market has shown the steepest decline and cargo capacity has been cut sharply, but load factors have stayed unchanged. On the passenger side, we have not been cutting capacity fast enough to match falling demand. That is forcing airlines to keep revisiting their capacity plans."
Herdman adds that "there is no escaping the fact we are facing a global slowdown", and says Asia will not be excluded from this. However, he notes that some domestic markets, such as Indonesia and China - after a difficult 2008 - might be quite strong in 2009.
IATA's Pearce says the "weakness of China has been a very important factor in precipitating the weakness we've seen", but agrees that there is likely to be "some growth of air travel in China, which will help to support travel in the region". However, while domestic markets in Asia are "rebounding", Pearce points out that "international travel is still declining sharply".
It is clear that the airline industry is going to have to tightly fasten its seatbelt and prepare for an extremely bumpy ride as we head into 2009. With a global recession that looks set to get much worse before it gets better, those carriers that haven't "done their homework", as Bisignani puts it, could find themselves in deep trouble.
Adds Pearce: "In this sort of environment it's very difficult to say who the winners are and who will be the losers, but it's clear that to survive in this environment, airlines will have to have low costs and robust balance sheets."