Articles & speeches

A Perfect Storm?
Keynote address to the 21st Annual Canadian Airline Investment Conference
Toronto, June 2o, 2008
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And we should not forget that American Airlines is also interested in the right merger.

Of course, size does not guarantee survival. If this had been the case, Eastern Airlines and Pan Am would still be around today.

And there is no doubt that many mergers and acquisitions have not resulted in increased shareholder value – sometimes quite the opposite!

Nevertheless, there have been examples of successful mergers, for instance U.S. Airways. Iin Europe we can point to KLM/Air France, and to Lufthansa/Swiss, both of which have worked out rather well.

With the actual seat occupancy factor for most airlines in the high seventies and low eighties – and many U.S. airlines cutting back capacity – very little room for revenue improvements can be expected from carrying more people on each airplane.

This means that the price of fares in the U.S. will inevitable need to go up significantly, given that all other cost components have been thoroughly reviewed – and reduced – to the extent possible in the last few years.

Elsewhere, the many new aircraft deliveries and increased liberalization are likely to continue to put pressure on yields. The high cost of fuel, however, should encourage the airlines to park or scrap older airplanes, and reduce the excess capacity.

It is somewhat unfortunate that the delivery of the latest types of aircraft being produced by both the major manufacturers – Boeing and Airbus – have been delayed.

They represent a significant improvement in operating cost, and in particular fuel consumption.

Their deployment would have considerably helped airlines to reduce their operating costs.

The fuel consumption per passenger-kilometer achieved by the Airbus A380 represents a significant reduction, but unfortunately the production rate of this new airplane is much lower than originally anticipated, which will prevent deliveries from taking place as planned.

Additionally, the continuing delay, of probably some two years now, for the B787 will prevent airlines from achieving a much better operating cost, and force the continued use of much less efficient, older B767s and Airbus A300s.

The U.S. carriers will continue to face a rather difficult time, given that they have some of the oldest fleets around and, unfortunately, their weak balance sheets are likely to be further battered by the current financial and fuel crises which will severely restrict their ability to modernize their fleets rapidly.

This will also likely prevent the U.S. carriers from taking advantage to the same extent as their European counterparts, of the opportunities arising from the recently implemented U.S.-E.C. air bilateral, which will provide a great deal of flexibility and encourage new services to be launched across the Atlantic.

A vigorous implementation by several carriers of the new Freedoms offered by this bilateral could further stimulate the market, and could act as a counter balance to the current down trend in traffic.

It is well known that new market opportunities always stimulate the market in general and create new growth to the benefit of the economies at both ends of the route.

The main Canadian carriers, WestJet and Air Canada, benefit from relatively newer fleets than their American counterparts, and this should hopefully provide them with a cost advantage when competing trans-border with the American carriers.

Thus with the rather strong Canadian dollar and a more fuel-efficient fleet, the Canadian carriers should be in a position to take advantage of the current difficulties of their American competitors.

Invariably, airlines place large orders for new airplanes when the economy is good and traffic is growing, but unfortunately – and frequently – inevitably delivery of those airplanes takes place when the economy is weak and traffic is decreasing.

We could be facing a similar situation once again.

Over the past two years, an unprecedented number of new airplanes have been ordered, both Boeing and Airbus. Admittedly, many of these were ordered by the so-called “BRIC” economies – Brazil, Russia, India and China – where air traffic has been growing in double digits.

If the current economic crisis – still somewhat focused around North America and the international banks – begins to resolve itself by the end of this year, the airline crisis may equally show signs of resolving itself – barring the fact that a few more carriers will fail and/or consolidate their operation.

However, should the economy worldwide show further deterioration, we would be faced once again with substantial overcapacity over the next couple of years, with the associated dire consequences of price wars and further bankruptcies.

The financing needed to cover this big order of new aircraft is considerable, and one may wonder whether the financial markets are able to respond adequately to this challenge, given the traditional fragility of our industry.

To state the obvious, those airlines which have a solid balance sheet - and good cash flow – will have little difficulty in meeting their financing requirements.

Unfortunately, this is unlikely to be the case for majority of the airlines, which may result in a still greater percentage of airplanes being owned by the leasing companies.

The regional airlines on a worldwide basis will continue to grow, although possibly at a slower pace, but the high price of fuel will also have an impact on their viability.

The current fuel crisis is giving new life to turbo props, which had continued to be out of favor with some consumers who wrongly believed that these airplanes are older generation than the jets.

Bombardier’s Q400 has re-gained some popularity with the consumer, and there are even questions of developing a stretched version.

With the acknowledged inability of both Boeing and Airbus to begin work on an eventual replacement for the A 320 family and the B737 family, the Bombardier C series may find itself in the fortunate position of filling that gap.

Neither Boeing nor Airbus is likely to produce a new single aisle airplane much before 2020, and if the C-series can actually be produced and become operational by 2012-2014 – and assuming it is able to deliver a 15-10% improvement in operating costs, including fuel consumption – it may well become a very popular choice both for the regional carriers and the mainline airlines for the larger 100-135 seat market.

A good part of that cost improvement depends, of course, on the success of the engine being developed by Pratt & Whitney, and on Bombardier gaining from the experience of the two main manufacturers on the increased use of composites for the fuselage and for the wings of that airplane.

Far from having to worry uniquely about fuel cost, security, and air traffic congestion, the airlines still have to contend with their “carbon footprint” and the proposals in different parts of the world, in particular Europe, to charge to compensate for the CO2 being released by aviation.

Biofuels, some believe, may be one of the giant steps the industry needs to take to achieve a significant reduction in CO2 emissions.

Richard Branson is one such believer, and has said that he intends to build plants to produce an environmentally friendly aviation fuel.

His Virgin Fuels subsidiary has formed a partnership with Boeing, GE Aviation, and Virgin Atlantic, to demonstrate the feasibility.

From a practical point of view, this in my view is more for the sake of appearances – to show that something is being done – than for practical results.

Incidentally, scientists calculate that it would take six million square kilometers – an area the size of Europe – to produce enough biofuel to totally replace jet fuel using soybeans.

And recently, the current agricultural crisis has put the spotlight on the disadvantages of crop-generated biofuel, and is likely to force a review of that approach.

Last year at the World Air Transport Forum in Cannes, I suggested that algae were probably the most likely – and least damaging – source of biofuel.

Recent research has shown that algae would do the same job with only 35,000 square kilometers. Not only do they absorb great quantities of carbon dioxide during their lifetime, but they are also a source of energy-rich oil that can be turned into fuel.

I understand the U.S. industry is now focusing more of its attention in this direction.

Fuels, engines, and aircraft are all critical components of the air transport industry in its drive for sustainable development.

All offer good promises in the long term.

In the short term, there are great opportunities for significant reductions in CO2 emissions by streamlining air traffic management.

Three fairly well-defined projects could delivery real results

A Single Sky for Europe

An efficiently coordinated and integrated air traffic control operation for the Pearl River Delta in China

And implementation of the next generation air traffic system in the U.S.

The Single European Sky alone could deliver a 12 million ton reduction in CO2 a year.

But governments are dragging their feet. With strong political will, a Single European Sky could quickly become reality.

Well truly, ladies and gentlemen, this industry has never faced a shortage of challenges – and we are unlikely to experience a dull day any time soon.

But… are we facing a Perfect Storm? And is this likely to be the worst crisis since the great depression, as some have suggested?

Naturally, the U.S. domestic air traffic situation – and the soaring costs of fuel – are good reasons for the U.S. carriers, both legacy and low costs, to be pessimistic.

As for the other markets, in Europe, Asia, and the Middle East, the traffic forecasts remain relatively strong for this summer.

Whatever happens to the U.S. economy in the next few months will be watched very closely, and there will be a temptation to reduce capacity for the Fall as a precautionary measure.

Having survived – with scars to prove it – through four or five major aviation crises to date, I am not prepared to declare this one as the worst!

My first experience goes back to the 1970’s, when the price of oil increased from 2 to 3 USD per barrel to some 12 USD a barrel over a relatively short time.

This caused much pain and adjustment.

But for my money – and without any doubt what-so-ever – the worst crisis I have ever had to face was 9/11.

We came close to a complete collapse of the aviation system as the skies over North America remained silent for some five days, and the economy almost came to a halt.

I was the Head of IATA at the time, and fully engaged in the struggle to get the system re-instated – urging the re-opening of air traffic, implementing security measures, keeping some aviation insurance available, etc.

The intensity, depth, and duration of that 9/11 crisis will hopefully never be matched.

This is not to say that I am unconcerned by the current situation – far from it. It is serious, and the end is certainly not in sight – but I would be tempted to say, as Mark Twain once said coming out of Wagner symphony…

“Perhaps it’s not really as bad as it sounds”.

Thank you!

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