Global Economics

Airlines in a Tailspin

As oil prices soar, some airlines are waiting for better times and hoping that rivals go bust first. Others are raising fares and slashing routes

The black cloud hanging over the airline industry became even darker yesterday as Air France and Qantas became the latest carriers to add to the chorus of gloom surrounding the industry.

The French national carrier indulged in a touch of understatement that could have been British when it said it expected the current year to be "challenging" with the global economy stuck in a deep rut and oil prices hitting fresh highs every day.

Downright awful would have been a better description as Europe's largest airline was forced to report a loss of €542m (£430m) for the three months ending 31 March, compared with a profit of €44m the previous year.

What is worse—from an industry perspective—is that Petercam analyst Thijs Berkelder pointed out that despite Air France's gloomy outlook, it is in rather better shape than most of its rivals. "They can keep a profit while others will dive into losses," he said, as the group said it expected operating profits to fall by nearly a third to €1bn in the coming year. Air France does, at least, have a young fleet of fuel-efficient aircraft and synergies it can extract from its merger with the Dutch carrier KLM to cushion it. Others lack these advantages.

To ram the point home the Australian carrier Qantas raised ticket prices for the second time in less than a month, while Japan Airlines, Asia's biggest carrier, said it would have to raise its fuel surcharge. It came just a day after American Airlines' announcement that it planned to slash capacity.

It's not hard to see the reason—oil prices smashed through the $135-a-barrel barrier yesterday, and even those with hedges in place will not be able to avoid the reality of $100-plus a barrel oil prices for ever. BA yesterday could only point to its release when it said profits would be hit by £18m for every $1 the oil price rises. That suggests that despite actively hedging, it is probably now losing money, and will continue to do so without taking further action.

So what can the industry do to adapt to the new reality? And has it really woken up to the challenge it faces? The Deutsche Bank analyst Chris Reid thinks not. In a recent note he castigated the industry for indulging in a "last plane standing strategy"—hoping that rivals will eventually go bust and they will be left sitting pretty when energy prices start to fall.

That won't be anytime soon if you listen to oil analysts. Tristone Capital, the energy specialist investment bank, for example, believes prices will be above $100 a barrel for the next two years at least. And if prices keep on rising, that view—still seen as relatively bullish—could actually prove to be conservative.

In his report, Mr Reid says: "Virtually all the airlines we cover have the same strategy to deal with a rising fuel cost base and downside risks to demand. They all plan to "wait out" the downturn such that either fuel prices will come back to acceptable levels or competitors, suffering more, will go bankrupt first." He argues that airlines will have to slash growth plans and costs and/or sharply increase fares.

So does Douglas McNeill, air analyst at Blue Oar Securities. He says: "There are various things they can do. We have seen American Airlines announce that it was going to make massive cuts as it seeks to winnow out those routes that are unprofitable. BA has indicated it will do something similar, while easyJet will be retiring some less fuel efficient aircraft."

Ryanair, says McNeill, has quietly increased prices, although it has always adamantly insisted that it will not impose fuel surcharges, but also, innovatively, has started offering its website as a vehicle for advertising, allowing people to promote their holiday villas, for example.

Other wheezes cooked up by various airlines include charging for things that were once a part of the ticket, such as food, baggage, priority booking, etc. These are not things the low-cost carriers can resort to, however, because most levy some sort of charge for these already.

Then, says Mr McNeill: "There is consolidation. But when you get down to it, they are all mitigation to what is a much more fundamental problem, which is the price of fuel."

He argues there are two real options: "To file for insolvency, and we will see an increasing amount of that after cashflow starts to fall when the seasonal pick-up from summer bookings come to an end. The other option is to put up prices and hope customers will wear it. This is something the network carriers with a high share of business traffic are already doing, but there is already some evidence that the low-cost carriers have reached the limit."

Ultimately, what these people are really saying is that airlines are going to have to completely reassess their business models to adapt to the new reality because high energy prices are most likely here to stay. And the upshot is that consumers are going to have to pay more for less, or simply not fly.

Much has been written about how the era of cheap food and fuel is coming to an end, with a tough decade to come. Those who still have cash to spend on holidays when those price rises have been absorbed are going to find that the era of cheap air travel has come to an end also.

Perhaps it is now time for the greens to start cheering. Because there aren't any smiles in aviation any longer.

Provided by The Independent—from London, for Independent minds

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