AVIATION MELTDOWN
For the foreseeable future, fuel charges will be a ubiquitous topic. It is intermingled with and dependent on the most profound and formidable aspects of human society, such as religion, politics and business. Combine with this the current problems of the economic recession and the ‘credit crunch,’ and it is no surprise that oil is the topic inducing high blood pressure in businesspeople and investors all across the globe.

This has been a turbulent DECADE for the AIRLINE INDUSTRY

It started seven years ago with a terrorist attack which date needs no reference. The airlines, especially those in America suffered instantly and despite their best efforts, never completely regained customer confidence. The abundance of new security measures and the persistent media coverage that followed turned into a relentless reminder of the vulnerability of the aviation system. Since those events the world has changed dramatically and the business sector and commodities market have had to endure many dilemmas and instabilities. However, now, at the latter end of the decade, new problems have arisen and none is more salient than the price of oil.
Fuel prices are a constant source of dismay and no sector is as reliant on the black gold as the aviation industry. So when the market crashes and the price of oil rises from $50 to $143 in a year, the aviation market crashes too, and that’s exactly what has been happening throughout 2008. In the years leading up to the crash the airlines had been combating the fuel efficiency problem with relative vigour- the urgency of the carbon emissions problem being a prevalent factor- and had improved fuel efficiency by 19 percent between 2001 and 2008. In addition they had reduced non-fuel costs by 18 percent, but the industry still remained exposed and reported consecutive losses in six of the last seven years, formulating a debt of $190 billion. Moreover the global airline industry has now downgraded its forecast for the third time this year and is predicting an overall loss of £1.1 billion because of sustained high oil prices. The International Air Transport Association (IATA) also observed that if oil prices stayed at the current, extortionate price of $143 then this figure could worsen to over £3 billion.
Giovanni Bisignani, director general of IATA said at the annual conference in Turkey: “Oil skyrocketing above $130 per barrel has brought us into uncharted territory. Add in the weakening global economy and this is yet another perfect storm.” These conditions have put over a dozen airlines out of business this year already and only a select few will have the privilege of not reporting a loss on their balance sheet. After several years of misery, 2007 was the first year that the global aviation industry reported a collective profit, earning a respectable $5.6 billion. However, rising fuel costs have been driving the carriers into meltdown and a significant number have either applied for bankruptcy protection or entered administration.
One of the principle reasons for the decline happening so rapidly is that there has been a surge in demand for all the middle distillates of oil including diesel and heating oil. Since January 2008 crude oil prices have surged by 42.7 percent while jet fuel prices have moved 58.8 percent higher. This means that for every one dollar rise in the crude oil price, carriers face a rise of $1.6 billion in costs. So severe is the situation that Mr Bisignani reported at the annual conference that the situation was “desperate and potentially more destructive” than previous setbacks this decade such as the outbreak of Sars, the war in Iraq, economic slowdown and terrorism. He went on to say “This is an extraordinary crisis with the potential to reshape the industry with impacts throughout the global economy. Governments should scrap the system of 3,500 bilateral treaties that govern international aviation and prevent global consolidation.”

The homefront
The problems of high fuel charges are unsympathetic as each country suffers with their own difficulties. Britain is no exception and recently saw the demise of Silverjet, a British all-business class airline based at Luton Airport. Prior to the suspension of operations they were operating a service between the UK and Newark Liberty International Airport and Dubai International Airport. A statement was released from the CEO, which stated that Silverjet would cease operations and suspend all flights immediately, due to failing to secure essential funding. Thousands of passengers were left stranded or needing to find alternative operators with an estimate of 7,000 UK and 2,500 non-UK customers being affected. To add insult to injury, their charges will not be covered by the air travel industry’s insurance scheme. Silverjet specified that the only means of refund would be for the customer to contact their credit card company and travel agent to ascertain funds via their own insurance.
Ireland-based Kingplace, which was managed by Swiss management company Heritage, was making an offer to re-launch Silverjet on behalf of private clients. However, talks broke down in late July, highlighting problems with raising sufficient cash to satisfy the Civil Aviation Authority (CAA). It is understood that the regulator required Kingplace to show it could provide more than £25 million of funding to the airline over the next six months which they refused to commit to. Furthermore, Justin Bates, analyst at Daniel Stewart the investment bank group said it was unlikely that Silverjet’s shares would redeem themselves and that the difficulties the broker saw in the business model have been exacerbated by the “meteoric rise in the oil price.” He went on to comment that it, “costs more than £44,000 in fuel for a round trip to New York on a Silverjet B767, up from £28,600 at the time of the November 2007 fundraising.”
To make matters worse, the UK has contributed to its own plight with the shambolic opening of the £4.3 billion terminal five. Opening on 27 March 2008, it became immediately apparent that the operation was not running smoothly. After 10 days some 28,000 items of luggage failed to travel with their owner and over 500 flights were cancelled with the original schedule unable to resume until well into April. Mr Bisignani criticised the CAA and the British Airports Authority (BAA) for being a “national embarrassment” to Britain.
Despite forcing new investment, alienating their customers and the obvious humiliation, BA’s chief executive Willie Walsh said in a defiant act of self-righteousness, “We will take capacity out during the winter, so I think for the current year we’ll probably be looking at flat capacity versus last year. There is no question that airlines will have to increase their prices to offset some of the increase in the fuel cost that we are seeing.” As a result, at the annual IATA conference in Turkey, the CAA were dubbed the ‘worst regulator of the year’ after permitting BAA to increase landing charges by 86 percent over the next five years, despite the poor service which Mr Bisignani said could only ever have happened in ‘Monopolyland.’ Consequently the Competition Commission is investigating whether to break up BAA’s monopoly control of London’s major airports Heathrow, Gatwick and Stansted - and the government has also announced a review of the CAA’s regulation of UK airports. The biggest discrepancy for consumers is that these problems did not arise from the fuel issue, but poor organisation.

A bad state of affairs
It could be argued the worst hit country has been the United States. Its reduced demand for air-travel can be seen from consumer confidence levels which ominously highlight the lowest level of consumption since the 1950’s. This is largely due to the US legacy carriers’ financial restructuring, which has left them unable to afford new, more fuel – efficient planes. The two American airlines most hit by the crisis are Maxjet and EoS Airlines who were both specialised all-business, long-haul airline carriers who have been forced completely out of business. Maxjet had a fleet of five Boeing 767s equipped with 102 business seats and had flown 74,760 passengers in eleven months. The airline said it was in advance discussions on a financing round for working capital and growth in 2008, which it had hoped to close before the end of the year. A Maxjet spokesperson said the board has been forced to accept that the financing was “unlikely to succeed in a timely manner,” highlighting the rapidly increasing operating costs, competitive pressures, a decline in consumer spending and fuel price inflation as the reasons for the inevitable closure.
The second, EoS Airlines, began flying between London and New York in late 2005 but closed for business in late April 2008. Adam Komack, EoS chief lifestyle officer said just before the closure, “We must be very careful about opening new routes and acquiring new aircraft in this economic environment… we must maximise the use of the six aircraft and much depends on the success of Newark and Dubai” However the company could not survive in the current climate and fell into bankruptcy along with several other smaller US carriers including low cost short-haul carrier SkyBus, Aloha Airlines, ATA and Frontier airlines. US air carriers are reported to have a pre-tax loss of over £1 billion excluding special items in the first quarter. Inevitably it has been the recent start-up and periphery organisations that have proved most vulnerable.
Whilst the major airlines might not be deteriorating quite so rapidly, they are by no means immune to the current crisis. American Airlines, the largest aviation company in the US announced its intention to cut jobs, retire old planes and charge passengers $15 for their bags in an attempt to cut costs, an unprecedented move for any major airline. The group announced that in an obvious act of desperation it would reduce its US capacity by 85 jets resulting in a 12 percent cut in the fourth quarter, the biggest service cutback since September 11. Gereard Arpey, chief executive of the airline said; “The airline industry as it is constituted today was not built to withstand oil prices at $125 a barrel, and certainly not when record fuel expenses are coupled with a weak US economy.” Consequently shares in American Airlines have fallen dramatically, in the same month that Northwest announced they would retire some of their old planes and Delta announced plans to cut 2,000 jobs as they simultaneously cut domestic service by 5 percent and an 11 percent cut in overall capacity. The biggest cut this year by any major US airline is by United Airlines which plans to reduce its 460 strong fleet of aircraft by 100, 70 more than previously planned and cut 1,600 jobs, three percent of their total employee number.
In order to stem the loss, many American airlines have attempted to forge mergers, to effectively lean on each others’ assets to curb potential damage. United Airlines and American Airlines each tried to merge with Continental, however both deals fell through and in turn they tried to merge with each other, these negotiations again collapsed before a deal could be struck. The reason was highlighted as US Airway’s looming obligations to pay for new aircraft and elements of their labour contract which would mean pilots would be awarded a contracted pay-rise. With a despairing sense of incongruity, nearly all airlines are yet to find a merger, with CEOs Glenn Tilton and Doug Parker informing their employees that “It is simply unlikely that anything will happen in 2008 as our industry continues to struggle with how to function in a world with $130-a-barrel oil prices.” As it stands there has been only one successful merger to come out of the various attempts. This was an early agreement between Delta Airlines and Northwest Airlines, which caused reason to believe there would be a number of more lucrative negotiations.
Similarly, many other world airlines are not fairing any better. Italian airline Alitalia is burdened with a large fleet of old MD-80 short haul jets which are largely unhedged against the soaring oil price. The ailing operator is currently being kept in business by small state donations. In Spain, the smaller low-cost carriers are preparing for a shake-up including Vueling which started operations in July 2004 and reported a profit after just eighteen months. However the company started restructuring in 2007-2008 to enhance profitability as it started to lose money and feel the pressure of the fierce competition among European low-cost operators. Clickair, another low-cost airline based in Barcelona and founded in 2006 is predicting massive losses. Eastern European airlines SkyEurope and Wizz Air could also prove vulnerable to sharply rising fuel charges and distress signals are being sent out by Austrian Airlines and SAS Scandinavian Airlines. Oasis, the Hong Kong Airline which attempted to offer clients radically lower fares to long-haul routes between Hong Kong and Europe and North America also fell under the pressure of the elevated fuel charge and many more might collapse as recent jet kerosene costs are over $1,200 a tonne, and the ratio between fuel consumption and seat cost becomes crucial to survival.

Every cloud has a single lining
There is however some room for optimism over the high fuel prices, namely, when one company goes bust, another one prospers, and that’s exactly what many who have stronger balance sheets behind them are preparing for. The big conglomerations with low debt levels and big cash reserves have had the opportunity to hedge a large part of their fuel requirements for the next 12 months, whereas the exposed weaker airlines have been unable to afford such protective insurance. The carriers that have continued to invest in new aircraft and therefore have the most fuel-efficient fleets can benefit from the gaps left in the air-space by the liquidated services. The main opportunists will inevitably be RyanAir, EasyJet and Asia-Pacific’s low-cost leader AirAisia.
Air France-KLM ordered a fleet renewal programme which replaced its primitive four-engined Boeing 747-400 jumbo passenger jets and freighters with twin-engined Boeing 777s, which in effect resulted in a 25 percent drop in fuel consumption. Chief Executive Jean-Cyril Spinetta has said that hedging would only offer a temporary respite from higher fuel costs and only fleet renewal could bring long-term relief. It has also become apparent that the service networks to benefit further will be those with the strongest hubs, which can envelop customers from wider catchments and fill their long-haul services more easily. They have the flexibility within their network to move capacity from regions that have weak economies to prosperous ones. These include the big European three, Air France-KLM, Germany’s Lufthansa and British Airways as well as Asia-Pacific’s Singapore Airlines, Hong Kong’s Cathay Pacific, Australia’s Qantas and from the Middle East, Dubai-based Emirates.
The future of the aviation sector looks compromised for as long as the fuel crisis persists. The UK has set its own target of generating 15 percent of energy by renewable sources by 2020 and 50 percent by 2050. However with scenes of pandemonium already being played out across the globe it seems optimistic this simple target will solve any of the current problems. Analysts at Goldman Sachs have predicted the price will reach $150 per barrel this summer, whilst in Russia Gazprom have predicted the price will reach as high as $250 per barrel. Speculators were blamed for creating the ‘myth’ of the speculative bubble where there isn’t actually a real shortage, but now leading figures in the oil industry have come forward to denounce this ‘myth,’ such as Tony Hayward, BP’s Chief Executive who told delegates at the World Petroleum Congress, “This is a fundamental thing. Its not about speculation… investors is a better word than speculators. They are investing in the oil market because they believe the prices will go up.” If he is right, then Gazprom’s prediction might not seem so far away and those long-term solutions need to be adapted sooner than first thought.

CAUSES OF THE CRISIS

• Most of the oil is held by unstable countries. Nigeria alone has shut a fifth of its output since 2007 due to a succession of militant attacks. (325,000 fewer per day)
• A flood of cash from investors who want to move away from a sagging global equity market into commodities has arisen. Investors also want to hedge against inflation and the weak dollar by investing in oil.
• The level of increased production is not enough. The extra 200,000 barrels Saudi Arabia committed to producing was ‘unlikely to tame prices’ according to oil minister Ali Al-Naimi even though this took their level of production to as much as 9.7 million barrels per day.
• China and India are now demanding a large number of middle distillates due to an improvement in their economy.
• The Olympics are also rumoured to be putting pressure on the high level of oil supply needed for the Eastern part of the world.


Industrial Focus July/August 2008