Aviation
après le Déluge May/Jun 2024

By 2024, it expects the industry to achieve revenues 20% above pre-pandemic levels.

At the global level IATA forecasts that the industry may generate operating profit margins around the long term normal of 6% — with revenues in 2024 approaching the iconic US$1tn mark. Operating profits may reach $60bn (last achieved in 2015 and 2016) and net profits could touch $31bn (having lost $140bn at the operating level in the three years of the crisis, and $100bn at the net) — see graph. Not surprisingly 80% of these profits are estimated to be realised by airlines in North America and Europe (see graph). But, maybe surprisingly, even airlines in Africa are expected to make their first ever profit contribution.

At a global level, the margins are paltry, and as IATA consistently points out, the industry provides returns on investment well below the cost of capital. However, it is worth pointing out that there are a handful of carriers which generate investment-worthy returns (and more than the total industry profits), but a very long tail of under-performing and loss-making airlines.

IATA’s economic presentation, subtitled “Deep Change”, focuses on some negatives: climate change, the challenge of rising sea levels, the number of democratic (and some not so democratic) elections in 2024, geopolitical tensions in Ukraine, the Levant and South China Sea, and the unwillingness of the oil and gas industry to invest in the production of sustainable aviation fuel. It also highlights India’s achievement of exceeding China’s massive 1.4bn population: and India’s population will still grow, while China’s ages and shrinks.

But it does suggest that air traffic will reach an “all time high”. Referring to its own (internal?) forecast for long term traffic (supposedly published in Feb 2024), the group expects total industry passenger number to increase by an average 3.8% a year for the next twenty years. Growth in the relatively mature markets in North America and Europe it estimates at 2.3%-2.7% a year, But the Asia Pacific region is expected to generate a compound annual growth rate of over 5%: by 2043 the region will generate two thirds of the additional 4.1bn passengers expected (there were 4.5bn air passengers in 2019).

For those of us involved in forecasting, there is only one thing we can be sure of: our forecasts will be wrong.

The traditional view is that traffic growth in the industry has been generated from a real annual 2% reduction in unit costs arising from technological advances in aircraft and technological design (flying larger aircraft, faster and more efficiently) that translated into a 2% fall in real yields and combined with an average 3% economic growth (as a surrogate for increase in income) to generate a compound average annual increase of 6% in RPK. Traditionally, traffic in RPK is viewed as having grown at twice the rate of GDP. Particularly in the USA, there is a perception that commercial aviation revenues should “rightly” account for 0.8%-1.0% of total GDP. But mere observation is not proof of causality.

The Boeing long-term forecasts in their Commercial Market Outlook published in 2019 (see graph) proposed 20 year growth averaging 4.6% to reach 20tn RPK by 2038. A couple of years later, following the shock of the pandemic, their estimate of growth had fallen below 4% and the 20tn benchmark extended four years to 2042. If the softening of the S-curve is greater by one percentage point over the period, it could be that total demand falls 15% short of that. Such is the power of compound growth rates.

So to Toulouse — this year’s setting for the annual FEAMA meeting. For those of you who don’t know, this is a symposium (conducted under Chatham House rules — which means we can’t say who said what, or even whether we were there — bringing together the analysts who produce the industry forecasts. Much of the discussion centred round the long -term prospect of “market measures” (for which read taxes) that governments might impose to limit demand growth on the path to net zero; and increases in costs (for which read mandated increases in the uptake of sustainable aviation fuel) being a constraint on growth. Notably, consensus numbers suggested another notch down in annual growth forecasts.

In one session, entitled “The View from the Lessors”, and in a presentation delving into geopolitical considerations, we were introduced to a new acronym: the CRINK. Quoting an article by Pulitzer-winning Anne Applebaum, published in The Atlantic earlier this year, the speaker highlighted the danger to the world order presented by China, Russia, Iran and North Korea — all of which are subject to US sanctions and restriction — the billions of dollars they (may) have poured into propaganda designed to undermine western democracy, and their (possible) links with Donald Trump’s MAGA movement.

In addition to neutralising US power, the CRINKs’ goal is to “persuade their own people to stay out of politics, and above all to convince them that there is no democratic alternative: Our state may be corrupt, but everyone else is corrupt too. You may not like our leader, but the others are worse. You may not like our society, but at least we are strong. The democratic world is weak, degenerate, divided, dying.”

Needless to say, the speaker suggested that the second highest risk to the established world order, just behind a disaster scenario for Europe should Ukraine fall, would be Trump winning election for a second Presidential term.

There were a couple of charts in the public presentations which struck us as pertinent.

One of the major concerns in the post-pandemic airline era relates to business and corporate traffic. This segment of demand accounts for a minority of total traffic, but a majority of airline income — and has been viewed as particularly important in making long haul operations viable.

A presentation on the performance of business jet operations showed that there has been a meaningful shift in usage since the pandemic (see graph).

In the depths of the lockdowns in 2020, bizjet usage plummeted (as did all forms of transport). But it recovered quite quickly and from early 2021 there has been a step change: in the past two years the total number of business jet flights has jumped to a level 35% higher than seen in 2019.

The vast majority of business jet usage is in the USA, but there are meaningful levels of operations in Europe, Asia and the Middle East. The authors of the presentation highlighted a retrenchment in regional connectivity in both the US and Europe over the past four years, which may go some way to explaining such a sizeable shift.

In volume terms the data is insignificant. In revenue terms it may be relevant. Whether this trend shows a desire from rich corporate executives to avoid contamination with the great unwashed on commercial air services, reflects an increasing move to “onshoring” of supplies in markets poorly connected by scheduled services, or is a way of hiding from public scrutiny corporate ESG credentials, who knows?

Maybe this data raises more questions than answers it solves.

Oxford Economics separately presented a slide of air fares in W Europe (sourced presumably from IATA, with whom they have a close relationship) showing a real decline in fares of 18% between 2010 and 2019 — equivalent to the historic real 2% fall in yields. Their modelling suggests that air fares in Europe will be static in real terms to the end of the current decade, and rise by 40% in nominal terms.

There have been many econometric studies performed over the years on price elasticity in air transport as it relates to demand. Intuitively, the lower the price of a commodity or service deemed attractive, the higher the potential for an increase in the willingness to pay for it. So superficially a forecast for stagnant real pricing structures might remove opportunities for demand stimulation and stagnate growth.

The numbers Oxford Economics presented relate specifically to Europe where there are many (specifically European) government imposed directives to force the airline industry to decarbonise — from its ETS, to increased departure taxes, to prescribed mandates on the production of SAF. These costs will be passed on to the consumer — and Lufthansa has recently announced that it will be charging an environmental fee from 2025 of up to €72 per ticket (depending on length of haul) on all flights departing European airports.

But with the constant decline over the years in the real cost of flying, the proportion of a passenger’s total trip cost represented by the flight has fallen significantly. Maybe now “price elasticity” also has less of an influence.

In any case, the centre of aviation is moving inexorably eastwards. By 2024, IATA suggests that there will be nearly 10bn passengers a year, and half of them in the Asia Pacific region.