Aviation Economic Outlook

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It is said that the International Air Transport Association (IATA) expects a return to profitability for the global airline industry in 2023 as airlines continue to cut losses stemming from the effects of the COVID-19 pandemic to their business in 2022.
In 2023, airlines are expected to post a small net profit of $4.7 billion—a 0.6% net profit margin. It is the first profit since 2019 when industry net profits were $26.4 billion (3.1% net profit margin).
During IATA’s Global Media Day held in Geneva, Switzerland from December 7 to 8, Marie Owens Thomsen Chief Economist at IATA presented her Economic Outlook report to the assembly.
Marie who has spent most of her 30-year professional life in various Chief Economist roles for both investment banks and private banks, including HSBC in London, Merrill Lynch in Paris, and Indosuez in Geneva, caught up with Capital’s Groum Abate for an in-depth insight of her report and the airline industry’s future. Excerpts;

 

Capital: How is the inflation affecting the aviation sector?

Marie Owens: Well as most things in economics it has two effects at the same time. So inflation is a tax on savings or tax on any money that you already have. But it’s a subsidy on the money that you might want to borrow. Yeah, so it’s very favorable for anybody who holds debt because you will be paying back a lower real value, so that’s really good. Obviously it is favorable not only to our industry which is heavily indebted but it’s actually favorable for everybody because the world as a whole has never been so indebted. And this concerns sovereign states and corporates and households everybody holds more debt.
The trick is to not have a very high inflation rate that imperils your nominal earnings since you still have to earn the nominal money to be able to service your debt.
There’s a sweet spot somewhere and that obviously depends on the country but then, what we have of course in weaker countries and more vulnerable countries where the inflation rates are approaching runaway inflation rates and so on.
We run very serious risks of balance of payments crises. What tends to happen in emerging markets is that they are more dependent than the mature economies. So much of those imports perhaps need to be settled in dollars. If the country is not earning itself enough dollars it can literally run out of foreign exchange and this can create debt defaults and balance of payments crises and blocked funds which is an issue for our industry as well.
Today we have about 2 billion blocked funds in the world which when airlines have made sales to the local population and are unable to exchange those earnings into dollars and repatriate them.
This is really a very dangerous vicious circle. If a country enters in this situation it cannot honor its international financial undertakings and this then won’t allow airlines to repatriate their funds. Airlines cannot operate forever without being paid so this might reduce the service or lead to closure. As a result, the country loses connectivity, the ability to support its local economy and it just sort of spirals downwards. This is the greatest danger I think with the situation that we’re in at the moment, which is the damage to countries that were already vulnerable.
Most of the mature countries are not experiencing anything like these kinds of rates of inflation.

Capital: Regarding the blocked funds, Africa takes the lion’s share, why is that? How does that affect the global airline industry?

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Marie Owens: Yes, to be specific, a quarter of the world’s blocked funds today relate to Nigeria. One airline that I’m aware has said that they will no longer fly into Nigeria. This happened also in around 2015 vaguely with Venezuela.
Venezuela was unable to honor their international financial obligations and the airline industry actually had to write off 3.7 billion dollars of sales which were owed since the settlements of those sales were never received.
Now this is moving again apparently because things have evolved and now we need Venezuelan oil. So maybe Venezuela is actually going to pay back some of that money. If we just go on that example, three and a half billion dollars of blocked funds were never paid, yet to the airlines we are predicting a profit next year of 4.7 billion dollars.
These sums can be the difference between loss and profit for the whole airline industry if we are unfortunate. When we look at Venezuela’s traffic it also proves the point that I made earlier that this is really detrimental for the productivity of the country, and weakens the country’s structurally ability to honor those payments in the first place; this is why it’s such a vicious circle and this is how it can affect the global aviation industry

Capital: How is the insurance sector affected by the aviation industry or even vice versa?

Marie Owens: The main insurance issue today I would clearly argue is the 400 aero planes that are stuck in Russia. This is a very big insurance issue since the aggregate value of those assets is about 15 billion whereas the war insurance system was calibrated on a potential loss of 1.5 billion.
Insurances are thinking maybe something bad would happen in one specific airport or something and you lose a couple of planes. Nobody could really imagine that, you know 400 planes were being taken out of circulation. We clearly do not know yet how that will end.
We have seen movement in the insurance sector with some insurance companies saying there’s too much risk citing that they do want to be involved in covering these risks anymore. Some companies have withdrawn from the market arguably other companies will come because now the insurance premiums are much higher so the business looks interesting.
But one way or another will also impact airlines because we might pay higher insurance premium and we might also pay higher leasing fees as a result of this. So now many it’s mostly leasing companies who own the aero planes that are stuck in Russia and many of these leasing companies have filed large insurance claims and it will be years in the courts.
But I think insurance is definitely one of the bills where we can totally anticipate it to increase and given our slim margins, that is evident.

Capital: There has been a notable rise in infrastructure costs in relation to climate change. How is the aviation industry working to cope with these issues?

Marie Owens: Well first of all, it has to be said that energy intensity of flying has been decreasing steadily since the birth of aviation. The credit obviously goes to the aircraft manufacturers who have progressively been able to make more and more energy efficient aircraft. And we of course clearly expect that to continue but it’s a process that airlines cannot control. We just have to wait for them to come up with a new version of an aircraft.
And similarly on the fuel side, you know airlines are buying all the sustainable aviation fuel that’s available on the market but that’s only not even 1% of total jet fuel consumption. Clearly, we need the world around us to be able to produce more sustainable aviation fuel.
I find it really fun about airlines doing that for themselves. I think that will be just marvelous, yet if we could insource our own fuel production that would make us so much more independent and we could make our own sustainable aviation fuel but it costs basically 500 million USD per production site and airlines unfortunately do not have those types of balance sheets. This is why it remains a bit of an enticing thought, but clearly the conclusion is that airlines cannot do this as they need the help of both private and public investors in this space.
For example jet fuel is only 6% of refined output. It looks like it would be possible to replace this with another product without disturbing too much of the overall market and without preventing the old companies from deriving profits from their existing assets.
This would be one call out to the oil companies that would be really helpful if they could jump on the bandwagon and perhaps they need to be a bit incentivized by the governments. That’s pretty much what’s happening in the US but not Europe. We would like that to change in Europe and in the other countries.
We all know that these incentives were successful for solar and wind, solar and today the two are the cheapest energy in the universe cheaper than coal. Why can we not do the same for sustainable aviation fuel and allow our industry to fly sustainably and make the contribution to economic development? That ought to be extensively looked into.

Capital: The IATA – McKinsey study stated that even though airlines improved profitability in the years following the global financial crisis, profits incurred are not like that of their suppliers and infrastructure partners. Why is that?

Marie Owens: Well the blame is not necessarily on what we’re trying to do. We’re trying to analyze and understand clearly some of the changes that have been made. The responsibility for these is also the airlines. I would say maybe we have sort of reached the limit of what we can do in terms of outsourcing and there’s a risk that you can outsource yourself into oblivion. This is the risk that airlines are totally aware of and this needs to be mitigated perhaps more strongly. So, you know, at some point in aviation history, we outsourced the distribution to the global distribution network.
Today in a completely oligopolistic market situation whenever you have high degrees of market concentration you basically have an outsized pricing power of those companies versus their clients.
The distribution costs have been excessive and I think we can say unambiguously very much because of this outsized market pricing power that they have we could say the same about aircraft manufacturers.
We all understand how uniquely challenging it is to produce an aircraft and we are super impressed with what Boeing and Airbus is doing. But nevertheless the regulators have allowed those companies to buy smaller aircraft manufacturing operations and thereby increase the monopolistic pricing power of those two companies.
Also it is not easy to rectify but certainly doesn’t look right. Not to mention the oil companies of course, and pretty much everybody else in our upstream value chain. You know, airports are not global monopolies but they are local monopolies in most cases, same for the air with air traffic control and, and so on.
We sort of have a very disjointed value chain where the upstream has too much pricing power and the downstream doesn’t have enough pricing power. Because airlines are more like a utility as it is a high volume, low margin business and we have this hyper competitive environment with complete price transparency for the customers which is great for the customers as they obviously have benefited from low ticket prices. But I bet it’s a very unique market in that sense as a few other markets have that kind of instantaneous prices which give discovery on a global scale.
Financial markets you could argue can provide that but it is business to business and not business to consumer. Somehow, I think airlines need to think about horizontal and vertical integration of services as a spun off loyalty programs and may be some of those loyalty programmes need to be insourced.

Capital: In most cases cargo flight operators are profitable than the passenger flight operators. How and why is that?

Marie Owens: When the pandemic stopped all activities, it became a question of who has what kind of restrictions in place and what are we allowed to do, which sort of imposed upon our industry from the government.
This was predominantly the restrictions of course related to the moving of people and not goods. So cargo was a market segment that was pretty much unaffected by all of these travel restrictions.
The ingenuity of airlines such as passenger planes being transformed to be able to take cargo loads led to a lucrative crisis management which allowed the airlines to benefit from the market segment which was still allowed to operate.
And then the second market segment was less affected by travel restrictions and of course domestic and the international markets came last. That’s still the case and we have that order to date. In terms of recovery to 2019 levels that cargo is still the closest followed by domestic and then followed by international.

Capital: What’s the reason behind the lag for profitability in African and Middle Eastern Airlines than US and European airlines?

Marie Owens: Well, I think it’s partly related to how these restrictions have been implemented or not and to the size of the domestic market. If you are a country that had a large domestic market with few restrictions on domestic travel and plugged into global supply chains and therefore playing a lot of cargo; then you tended to do well and that is obviously in North America and to some extent Europe.
I think what I would say about Africa in general is that, if we go from the Chicago convention in 1944, when it was said that we want to have this global aviation market and in order to do so we need a level playing field; then I really think that Africa sort of stands out in terms of not being able to provide that level playing field.
Africa is a unique continent in that it trades more with other continents than with itself whilst all the other continents trade more with themselves which is their usual development, that proximity and connectivity matters.
Unfortunately in Africa even the proximity is not operating the way it should. I mean I don’t mean to pick on Africa because we can see different but similar patterns. In India for instance, the federal state has their own rules and this all impedes trade between the Indian states within the country.
What I would try to say is there have been many initiatives in Africa trying to get countries to work together and to remove some of these obstacles to trade and to connect in the region. I think there are a lot of people that have that desire to which I wish them success.