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Nov 09, 2012

Airlines struggle with energy turbulence

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News of airline carriers experiencing financial headwinds has been coming thick and fast of late. There are two main reasons for this: stalling global economic growth and the heavy burden of three-digit oil prices. The outlook for both of these drivers does not bode well for the medium-term future of the airline industry.

To understand the pressures facing airlines, we need only look back four years to the oil price super spike and the financial crisis of 2008, which, together, ushered in the first global recession since World War II. In 2008, at least 30 airlines crashed financially as spiralling fuel costs and weakening demand wiped out profits.

This year, it has been a case of déjà vu. A double-dip recession in the European Union, an anaemic so-called ‘recovery’ in the US and slowing growth in Asia have slackened demand for air travel. Meanwhile, Brent crude oil has been selling for over $100/bl since early 2011, except for just one brief dip below that psychological benchmark in June.

At these prices, fuel costs comprise 30% to 40% of average airline operating costs. Predictably, the International Air Transport Association (Iata) has warned that the global airline industry’s profits will shrink from $7-billion in 2011 to $3-billion this year, while Africa and Europe could post losses.

Short-haul flights suffer relatively more from higher oil prices, since average fuel efficiency – that is, fuel consumption per passenger kilometre – is substantially lower than for long-haul flights.

So, it is no wonder that South African airlines are taking strain. Low-cost carrier Velvet Sky went bankrupt earlier this year and 1time Airline recently filed for business rescue. Trying to compete with a State-subsidised, quasimonopolistic national carrier did not make their struggle for survival easier.

But South African Airways (SAA) and its offshoots are also taking financial strain – SAA posted a loss of R1.3-billion in the year to March. The adverse market conditions have contributed to the management problems at the national carriers – half SAA’s board of directors and the CEO recently resigned. SAA has received another controversial government lifeline in the form of a R5-billion loan guarantee – on top of the R15-billion received over the past decade – provided that the new management come up with a realistic business plan to return the airline to profitability.

But the economic outlook does not inspire confidence in the new management’s ability to do so. For one thing, if the worsening tensions in the Middle East – such as Syria’s descent into civil war and Israel’s threats to bomb Iran – boil over into a new regional conflagration, there is no telling how high the price of crude could spike.

Secondly, the eurozone debt crisis and the US’s equally large debt burden are anything but resolved, because unlimited ‘quantitative easing’ (read money printing) by the European Central Bank and the US Federal Reserve cannot by itself create the real economic growth that is necessary to avoid a debt implosion without superinflation. That requires structural reforms and – crucially – affordable energy supplies.

Iata recognises an oil price spike and the eurozone debt crisis as the two biggest risks facing the industry, and yet airline manufacturers seem to be blissfully unaware of these pressures. Last month, European manufacturer Airbus said it was anticipating orders for 28 000 new planes over the next 20 years and expected the total world passenger fleet to double in size. US rival Boeing is even more optimistic about future aircraft sales. But sales of superjumbo jets like the Boeing 747-8 and Airbus’s gargantuan A380 doubledecker plane, which offer more passenger seats per unit of jet fuel, are already flagging. And airlines are having difficulty filling seats in those they have already bought.

When it comes to peak oil, the managers of Airbus and Boeing – along with those of most airline carriers – have their heads in the clouds. World oil production is likely to slide off its seven-year plateau some time this decade, ushering in a new era of annually falling supply and rising prices. The air transport sector, which currently accounts for less than 10% of oil consumption, has to compete with other demand sectors like road transport, shipping and the petrochemicals industry.

Currently, the only substitutes for oil-based jet fuel are synthetic coal-to-liquids fuel made by Sasol and small amounts of biodiesel blended with conventional jet fuel. Significantly expanded production of these substitutes may be constrained by concerns about carbon emissions and the food/fuel trade-off respectively. Thus, the long-term future of aviation is highly uncertain.

Several decades hence, it is hard to imagine air travel on anything like today’s scale unless there is a radical breakthrough in energy technology. Perhaps, if the dreams of low-energy nuclear reaction pundits someday become real, then even the sky will not be a limit to human mobility. In the meantime, airlines are in for a bumpy ride.

Edited by: Martin Zhuwakinyu
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