From Recession
to Inflation June 2022

Every recession is recessionary in its own way. When the aviation industry experienced the largest by far collapse in demand in its history, we expected that the consequent surplus of aircraft, personnel and airport slots would cause the price of these inputs to fall sharply, maybe creating the conditions for radical restructuring. The opposite has happened, the industry is experiencing the highest cost inflation in decades.

Government support throughout the pandemic meant that there have been no airline collapses of real significance no Chapter 11-type restructurings (outside of Latin America and SE Asia), little reallocation of resources, and no significant new entrants (with the exception of long-planned Breeze and various reincarnations like Norwegian and ITA). The alternative — governments allowing their airline sectors to implode — was just unacceptable, but the industry has missed out on the benefits of creative destruction.

In North America and Europe, labour forces were largely protected throughout the pandemic through the CARES Act Payroll Support Program and other national furlough arrangements, which has left labour in an unexpectedly strong situation in the recovery, with airline employers facing shortages and bottlenecks. The pressure for substantial pay increases is intensifying, justified by general price inflation — in June consumer price inflation was running at an annual rate of over 9% in the US and the UK, around 7% in the Eurozone

The graph below takes a longer term look at US industry employment trends. Following the major restructuring of the major carriers through Chapter 11 and mergers, the employment total held fairly constant from 2009 through to 2014, but then started to grow markedly — by 50% from 2015 to 2019, during which period passengers enplaned grew by only 16%. According to A4A the 2022 employment total is now almost back to 2019 levels. Employment costs (wage plus benefits) rose by an average of 3.7% pa during 2009-21, but, when adjusted for US retail price inflation, the average annual increase in real terms was only 1.7%.

The current strength of pilot unions in the US is evident: United is in the processing of finalising a deal that will give pilots a 14%-plus pay rise over the next 18 months. This is expected to act as a benchmark for contract negotiations at other carriers.

Partly, the pilot situation is due to demographics as many pilots who joined the industry in the post-deregulation 1980s are now coming up to retirement (anecdotally, some may have delayed retirement to take advantage of the PSP). Partly, it may be due to the restraints placed on pilots moving from regional to mainline operation; since 2013 they have been required to complete 1,500 flying hours on regional carriers, twice the hours previously mandated.

Airline managements are in a difficult situation: they cannot afford to risk further operational disruption, missing out of the traffic rebound that has taken place domestically, and is gradually filtering through to the international and business traveller sectors. The legacy carrier balance sheets have been greatly weakening by the state-guaranteed debt taken on, but their liquidity positions are generally very high.

Across the Atlantic and at the other end of the aviation skill set, ground handling and security has been in particularly hard hit by labour shortages which airlines and airports are being forced to address by increasing wages (or fees paid to handling companies). The problem is that employees made redundant when furlough schemes ended have shifted to better pay and conditions in companies like, for example, Amazon. The shortages have been compounded by a lack of preparedness by government agencies in reinstating security clearance procedures. For example, in the UK security clearing for new airside staff has risen from three weeks pre-pandemic to three months.

This table complied by Wolfe Research gives an approximation of the total unit cost inflation facing airlines. It uses US data but the implications are global — unit costs in 2022 are at least 26% above pre-pandemic levels. In context, direct labour unit costs are expected to contribute 17% of the unit cost increase but 55% comes from fuel, an unavoidable consequence of the war in Ukraine.

Oil industry expectations are for a moderate softening in the price over the next year. The US Energy Information Administration forecasts that the crude oil price for WTI will decline from its 2022 peak of $110/barrel to $85 in 2023; unfortunately, the 95% confidence bounds range from $30 to $220, so don’t place much faith in that outlook.