Air Transport World

A new kind of normal: traffic responds to economic activity but a dismal US financial performance keeps the industry mired in red ink.(Passenger Forecast)(Industry Overview)

SAYING THAT THE AIRLINE industry's fortunes will improve somewhat in 2005 is overly optimistic for some carriers while being a bit too dark for others. Yet, on average that's what the year will bring ... unless.

"Unless" in this case is an ugly word that underlies everything about this forecast's promise of growth, a growth that is relatively normal in that it will be driven by world economic conditions--except for oil. However, a portion of that growth, varying widely by region, will be stimulated by low fares semi-independent of overall economic activity and difficult to predict outside of tracking the expansion of low-cost carriers' fleets. That stimulated growth, in turn, provokes an echo growth as network airlines respond with similar fares, adding more stimulation to the expansion bow wave.

This "new normal" for 2005 is much the same as what was experienced in 2004 except that this year starts with generally declining yields--some already at historic lows--and astronomical fuel prices. While there may be some hope for oil, there is little hope for yields. In some markets, particularly for US legacy carriers, either or both must improve to restore healthy financial returns.

And then there is that word "unless," which, after three consecutive years of nasty surprises for the airline industry, needs no elaboration.

In general, many will view 2005 as a recovery year. In fact, 2004 saw a number of airlines, particularly in the high-growth Asia/Pacific region, some in Europe and most LCCs and Regionals in North America, already well into their recovery. However, the best US legacy carriers can expect is to get breakeven in sight, while some large European airlines still not impacted fully by the blunt instrument of LCC fares will see improvements even though their economies are lagging.

In the North American market, with a huge domestic component that has been hammered by ever-declining yields and high fuel prices bought with dollars that have lost significant value over the past 18 months, the vast majority of the financial losses reside with six US Major carriers. Air Transport Assn. President and CEO James May says, "We are guessing [for 2004] about $6 billion in losses [for ATA members], and the overall increase for fuel ... is going to come in between $5 and $7 billion. It's almost an exact parallel."

The least-controllable economic element facing carriers is the price of oil. After being beaten soundly by an oil price market rising on emotional waves and a few disrupting events, airline executives, skeptical about their chances of a reprieve in 2005, largely have given up trying to forecast prices.

"[We look at that] with great frustration," says Doug Herring, American Airlines VP and comptroller. "We've given up trying to guess what is going to happen with fuel prices. We are simply using the forward curve, very volatile numbers, changing daily, thankfully coming down a little bit lately." A week after he said that, oil again hit $50 a barrel; a week later it was nudging $40.

"Oil price depends on political developments," says Adam Pilarski, senior VP at the Avitas consultancy. "Economic realities justify prices below $20 a barrel." But with an ongoing war in Iraq plus other destabilizers, "It looks like high oil prices are here to stay for the foreseeable future. Maybe not $50 a barrel, but in the $40s."

Robert Milton, Air Canada president and CEO, has a similar price view but for different reasons: "My hope is for numbers in the $30s, but I would be surprised if we got much further than the $40s. I'm not optimistic that this is a risk premium issue. I think it is a more fundamental refining capacity issue and demand issue."

The impact of the oil price hike has been worsened by the general lack of hedging, with most airlines either too poorly positioned to hedge or believing that oil was peaking when it hit the high $30s and refusing to lock in that level.

"The most powerful derivative products are unavailable to us given our balance sheets," Herring says. "There are very few people willing to take our credit. The things that are available to us are, first, very expensive, and second, we're not sure we want to be hedging when fuel is [so expensive]. …

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