That IATA raised its fuel price expectations for the year by $12 per barrel, yet its industry profits forecast for 2011 remained virtually unchanged from three months ago shows key dynamics evolving on both the cost and revenue side for airlines.

For an industry still scarred by the oil price volatility of which of 2008 and 2009, the threat of escalating fuel costs was always one of the big obstacles to building on last year’s recovery during 2011. The creep in oil price has turned into a surge as unrest and political turmoil continues to spread across countries in North Africa and the Middle East. The price of Brent crude closed 2 March at $116, a sharp rise on the $90 level seen just three months ago.

Small wonder than that IATA in its latest forecast for 2011 has sharply raised its expectations for fuel this year. This has jumped from what IATA back in December conceded was probably a conservative estimate average price of $84 per barrel, to an average of $96 per barrel.

FUEL
$96
IATA has increased its expected oil price average for 2011 by $12 per barrel of crude oil

It is against this backdrop that IATA has scaled back its full-year profits forecast for 2011 from $9.1 billion to $8.6 billion. While this marks a further reduction on the $16 billion profit the industry made last year, it is a relatively small adjustment given that IATA estimates each dollar increase in the oil price adds $1.6 billion to the industry cost. Even allowing for hedging mitigating the impact of rising fuel prices, IATA still sees an addition $10 billion added to airline costs from fuel.

So why is there no pronounced fall in the profits forecast given the sharp rise in fuel costs? The answer lies in the improved economic environment. IATA had originally expected only fractional growth in yields during 2011. But off the back of improving economic growth, it now sees yields growing 1.5%.

"GDP forecasts in December were for 2.6% growth. That has risen to 3.1%. And so we have revised our growth forecasts upwards to 5.6% growth in the passenger business and 6.1% growth on the cargo side,” explains IATA chief executive Giovanni Bisignani.

YIELDS
1.5%
IATA has lifted from 0.5% its forecast on yield growth in 2011

Increased passenger demand also helps the revenue environment as it moves demand closer to likely supply this year. "We see a narrowing gap between demand and capacity. The capacity has remained the same, but the GDP is pushing business traffic in a more positive way,” says Bisignani. IATA predicts the gap between passenger demand and capacity will now be just 0.3 percentage points, from the near 1% gap it originally saw. “Tight supply and demand environment will give the airlines some pricing power,” says Bisiginani.

But while IATA still sees profits for this year, Bisignani does warn of possible risks ahead. “The oil price rise is based on political fears with the Middle East unrest. If the price rises to levels that stall economic growth, the impact will be severe,” he says. Secondly he points to the recent run of additional taxes on the sector. “This is a price sensitive business.  Adding taxes, which in some cases are 3-5% of the cost of a ticket on top of the rise in oil prices, is also a big risk.”

PROFIT
$8.6bn
IATA has trimmed its 2011 profit forecast from its earlier projection of $9.1 billion

While local unrest has hit demand in some markets, and contributed to the recent jump in fuel prices, overall IATA has actually increased its profits expectations for the Middle East as a whole - projecting a $700 million profit now instead of $400 million it previously forecast. "Political instability in the region is expected to take its toll in Egypt, Tunisia and Libya which combined account for about 20% of the region’s international passenger traffic. This is balanced by the Gulf area which benefits from economic activity related to high oil prices and whose hubs continue to win long-haul market share," it notes.

Of the regions, it is Asia where IATA scaled back its expectations the most. While it still expects Asia to be the most profitable region for airline, it has shaved nearly $1 billion off its previous profit forecast for Asia to $3.7 billion. "The key reason for the downgrade from December’s forecast is that the region is more exposed to higher fuel prices, due to relatively low hedging on average," it explains. Likewise it has also scaled back its expectations for Latin American carriers, and expects profits of around $300 million this year rather than the $700 million forecast three months ago.

It has left its forecast of North American airline profits of $3.2 billion unchanged, while slightly raising its forecast for European airline profits to $500 million.

Bisignani also notes the fragility of the industry, given the relatively limited buffer it has to absorb further shocks after a torrid last decade. While the industry has been able to recover quicker than expected from the financial hit of the economic crisis, he says: “The industry handled capacity and demand in a good way, but in order to survive the industry had to increase total debt levels by $30 billion. We now have an industry with around $210 billion debt.” This is set against estimated revenues of $594 billion for 2011. “When we see margins of 2.5% in 2010 and 1.4% this year, you understand the fragility of the industry,” he says.

For more on the impact of rising oil prices on the airline industry read our recent analysis here

Source: Airline Business