travel
Aviation
Adopting the
brace position
Gulf airlines are bracing themselves for the impact of
persistently high oil prices and the threat of a new oil
shock to the industry’s recovery
by Martin Rivers
thegulf@tradearabia.net
T
he International Air
Transport Association
(IATA), the airline industry’s
main trade body, has never
been shy about talking up
the perils of an oil shock. Even in May
2005, when a barrel of Brent Crude set
you back just $50, IATA was calling
jet fuel “The Fifth Horseman of the
Apocalypse”.
But with Middle East unrest now
pushing oil prices to double that level,
the group’s latest warning has touched a
nerve with airline bosses. The last time
crude passed the $100 mark the world
was tumbling into its deepest recession
for decades, and few industries hit the
ground harder than civil aviation.
In 2009, as global financial markets
began pulling themselves back from
the abyss, air traffic was still falling
at its fastest rate since records began.
Cash-strapped holidaymakers were
opting for “staycations”, business travel-
lers were downgrading to economy and
stunted economic activity was choking
off demand for cargo. All told, the
industry lost $9.4 billion.
Today, with memories still fresh of the
30-plus carriers that went bankrupt,
IATA’s big fear is that a new oil shock
could trigger a return to the dark days
of 2009.
At first glance the data is alarming. For
every $1 added to the price of crude,
the industry’s annual fuel bill soars by
$1.6 billion. Most airlines use futures
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Av i at i o n
contracts to lock in prices for the year
ahead, but even after hedging IATA still
expects fuel costs to rise by $10 billion
in 2011. With a net profit margin of just
1.4 per cent, or $8.6 billion, further oil
volatility could easily send the industry
into the red.
Gulf airlines may seem well placed to
offset fuel prices, owing to their benign
tax environments and low employee
cost-base. But experts say their competi-
tive edge has been blunted since 2009.
Whereas the region’s airlines made
rapid expansion the cornerstone of their
business models – with Emirates alone
placing orders for 90 Airbus A380s –
rivals in Europe and America took the
opposite path. In order to weather the
downturn, most of the world’s lumber-
ing airlines became leaner outfits,
The conundrum for
drawing synergies from consolidation Gulf airlines, reliant
and deploying an arsenal of cost-cutting
measures. on year-on-year
British Airways exemplifies this transi-
tion better than most. In addition to
growth, is how to
its merger with Spain’s Iberia, the flag boost yields without
carrier introduced a wave of ancillary
charges, axing everything from free suffocating demand
meals to baggage allowances. Labour
costs were also cut, with pilots’ wages a balancing act on a very thin tight-rope
and cabin crew complements both of a 1.4 per cent margin,” IATA has
falling after the recession. warned. “It is a structural problem that
These industry-wide changes helped the industry has faced ... over the last
foster a buoyant recovery last year, four decades. There is very little buffer
when worldwide net profits came in for the industry to keep its balance as it
at $16 billion. But with their impact absorbs shocks.”
already factored into IATA’s forecast for Attempts to maintain equilibrium in
2011, pressure is building once again for the face of an oil shock will now
higher profit margins. hinge on tight yield management and
“This year the industry is performing a renewed focus on surcharges – both
April 2011 | the gulf
Av i at i o n
of which could be hard for Gulf carriers
to swallow.
Back in 2009, most of the world’s
airlines responded to faltering demand
by slashing their route networks, cutting
frequencies and grounding planes. At
the time, retrenchment of the sector’s
high overheads made perfect sense
given the dearth of passengers.
But when people started returning to
the skies, constrained capacity took on
a new appeal. By limiting seat availabil-
ity, airlines could prop up load factors
– a measure of how full their planes
were. Industry chiefs understood that
the narrower the gap between supply
and demand, the higher they could
push passenger yields (average fares
per mile travelled).
In short, the strategy was to fly fewer
planes, but fill them with higher-paying
passengers. And with oil now squeez-
the gulf | April 2011
Emirates hiked fares across all sectors in March
ing profit margins once again, evidence
of the same approach is emerging.
IATA last month downgraded its
capacity growth estimate for 2011 to
6 per cent – just a smidgen above
expected demand growth of 5.7 per
cent – which in turn tripled passenger
yield growth forecasts to 1.5 per cent.
Alongside impressive load factors of 78
per cent, this conservative management
aims to minimise the risk of operating
half-empty, loss-making flights.
US carriers were first off the mark,
largely because of their distaste for fuel
hedging. Domestic fares rose six times
between January and March, while
formerly-bullish talk of growth ground
to a halt. Elsewhere, the list of interna-
tional airlines upping fuel surcharges
grows weekly.
Even in the Middle East, where
capacity constraints are anathema to
travel
the region’s expansion plans, there are
signs of passengers being tapped for
extra revenue. Emirates hiked fares
across all sectors in March, followed
days later by Qatar Airways’ decision to
introduce a new fuel surcharge.
The conundrum for airlines – particu-
larly those in the Gulf, which are reliant
on year-on-year growth – is how to boost
yields without suffocating demand. It is
here that the issue of fuel prices comes
full circle, as the greatest threat to traffic
remains oil-driven stagflation.
Unlike everyday inflation caused by
economic growth, oil spikes have a
deflationary as well as inflationary
impact. Consumers have less money
in their pockets even as the cost of
goods and services starts to rise,
making it harder to justify discretionary
expenditure on travel. Without buoyant
demand, passenger yields fall by the
wayside and the industry's safety net
comes crashing down.
Saj Ahmad, an aviation analyst based
in London, says that the immediate
fears may be overdone. “It is still much
cheaper to fly today in real terms
than 25 years ago,” he notes. “While
the net effect will see some elastic-
ity in demand, overall it will not be a
long-term trendsetter.”
However, Ahmad cautions that the
outlook remains sobering: “The fact
is high oil prices are here to stay,
irrespective of geopolitical turmoil.
If that means going back to closed-
door protectionist policies that support
airlines, the aviation industry is likely
to say, ‘So be it’.”
Regardless of what happens to oil
prices, Middle Eastern economies are
rightly nervous about the impact of
recent events on civil aviation. EgyptAir
is expecting to lose 80 per cent of its
income this year due to the exodus
of leisure and business travellers. Any
contagion to the United Arab Emirates,
where 20 per cent of gross domestic
product (GDP) comes from aviation,
would be devastating.
The cancellation of Bahrain’s Formula
One Grand Prix is just one example
of tourism taking a direct hit. If such
incidents recur across the region,
passengers won’t need the excuse of
high fares to keep them away from the
Middle East. <
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