It was only a few months ago that the greatest threat to the financial performance of the airline industry was considered to be "the economy". But at the present time there are very few industry observers who would deny that now the threat is quite clearly fuel.

On the basis of its latest forecast, IATA predicts that the industry fuel bill for 2008 will be some $65 billion higher than it was in 2007. If we put this into context this is equivalent to ­almost 13% of global airline ­revenue. IATA estimates that the industry's fuel bill will increase from some $136 billion in 2007 to close to $200 billion in 2008. This could mean that operating losses could well reach $50 ­billion ­without any offsetting ­effects from higher fares or more overt fuel surcharges.

What is increasingly clear is that the industry overall is likely to move into loss in 2008, and if there is no improvement in the price of oil by 2009 losses could well be even worse next year.

To put this into perspective, operating losses in 2001 were just under $12 billion with a further $5 billion in 2002, but fuel only represented some 13% of operating expenses rather than the close to 40% it is expected to represent in the current year.

So what can be done? Is it just a question of gritting teeth and hanging on? Perhaps, but it is clear that for a number of airlines the consequences of this alone could be financially catastrophic. Although there tends to be a focus on the profitability of almost any industry, the real need for most businesses - and airlines are no different - is for cash.

In this respect the consequence of the higher fuel price is direct and will quite quickly have an impact on levels of airline debt. Although balance sheets are better than they were back in 2001/02, they are still not particularly strong. Fare increases, higher surcharges, and for some of the low-cost, no-frills airlines raising ancillary charges - which may have some success - may provide some relief from the full effects. However, as I have argued many times before, the rules of economics do apply to the airline industry and it is only possible to ­increase fares if there is relative excess demand.

Against a background in the USA where there are clear signs of a combination of economic slowdown and, for some, actual recession, pricing power from whatever source is likely to be non-existent. We shall watch the latest increases in ancillary charges to see if they result in a behavioural change and a revenue impact, although I believe that at least in the near-term they will provide a route for at least some additional revenue.

Limited Scope

The scope to reduce costs to offset the increase in the fuel price is limited. As a result, for all airlines there is likely to be a significant deviation in their expected cash flow, which will need decisions to be taken in a number of areas - not least in respect of the need for near-term capacity. For others the cash squeeze may mean that payments for pre-delivery aircraft become unaffordable, whether or not the airline believes the additional capacity is still needed.

Generalisations are of course dangerous and for some airlines this period of pain will represent an opportunity. However, at least for now the real questions should be: how far will profits fall, cash decline and debt increase? And how many of the orders for the 150-seat order book will not be delivered to the customer that places the order? Or indeed, how many of these orders will not be delivered at all?

Of course only time will tell, but one thing is clear. This downturn appears likely to be far more painful than any that have been experienced over the last quarter of a century or so.

Source: Airline Business