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  • Forecasts 2006: Airlines - With costs falling,recovery will continue

Forecasts 2006: Airlines - With costs falling,recovery will continue

With demand for airline travel soaring around the world and US carriers finally addressing the high costs that have bedevilled them for years, the sector’s recovery will continue apace in 2006. Record airliner orders reflect an industry that is more confident and expansive than it has been for a long time.

But because of the high oil price, the global airline industry is beginning the new year in the red for the fifth year running, according to the International Air Transport Association, which says total losses since 2001 have risen to $42 billion. However, the recent dip in the fuel price means estimates for net losses in 2005 – at $6 billion – are less than IATA had been predicting.

Airlines made great strides in reducing their non-fuel costs during 2005, says the association, but when the industry goes into profit largely depends on the price of oil. If oil falls to $50 a barrel, airlines will break even, says IATA. The fact that airlines can edge into profit with oil at this price is testament to the much higher passenger numbers – what IATA calls “an exceptionally strong revenue environment” – and the efforts carriers have made to become more efficient: in 2003 the oil price at which the industry could break even was $22 a barrel.

The association estimates that the industry will lose $4.2 billion this year – based on a $53 barrel of oil – and will move $6.2 billion into the black in 2007, assuming oil falls to $50. However, it will be some time before airlines become an attractive investment proposition. Profits of $6 billion represent an operating margin of just 3%. This is still well below the “cost of capital” or the point at which shareholder value kicks in, says IATA.

IATA’s overall numbers mask a tale of two industries: while US airline losses got worse in 2005 (reaching a likely $10 billion once the sums are done), carriers in the rest of the world are making money. Europe’s airlines were expected to notch up $1.3 billion profits last year.

Cost control

Much of this may have to do with the different legal regimes in the USA and most of Europe. While several US majors, including Delta, Northwest, United and US Airways, have spent long periods in Chapter 11 bankruptcy protection since 9/11, most of the big European airlines were forced to take drastic and immediate remedies to get their costs under control. British Airways and Aer Lingus slashed – and in BA’s case are still slashing – the payroll; Air France and KLM, and Lufthansa and Swiss, joined forces. The expansion of EasyJet, Ryanair and others forced flag carriers to adopt aspects of their low-cost model, moving to on-line ticketing and cutting cabin service.

This year will see the consolidation trend continue in Europe, although further full-scale mergers involving majors – such as the long-rumoured BA-Iberia tie-up – are unlikely. The still-expanding low-cost sector could see a shake-out of some of the weaker players and struggling flag carriers such as Alitalia could finally give up the ghost despite the efforts of politicians to keep them alive.

In the USA, United should finally emerge from its nearly four-year Chapter 11 hibernation leaner and fitter, but do not expect much from Delta or Northwest until late in the year at least: both still have serious surgery to undertake. The breakneck growth of the big Middle East carriers will carry on, as Emirates, Etihad and Qatar take delivery of dozens of new aircraft and add a host of new routes. In China and India, an air travel revolution is taking place with hundreds of thousands of individuals flying for the first time each year. Elsewhere in Asia, ambitious carriers such as Singapore Airlines are rapidly adding capacity.

Environmental pressures on airlines are likely to intensify in 2006 and beyond, believes IATA, making additional taxes on airlines more likely and increasing opposition to new airport capacity. “It remains a challenge because demand is growing faster than aircraft are getting efficient,” says the association’s chief economist Brian Pearce. “It’s the price we pay for our success.”

MURDO MORRISON/EDITOR

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