At a Glance
- Despite slower momentum, the underlying drivers for a gradual acceleration in economic activity remain intact worldwide.
- North American airlines are set to once again have the highest net post-tax profits at US$ 18.1 billion, more than 60% of the worldwide result.
- Airlines are beginning to enact strategies to protect themselves from oil price surges, either through large-scale cost cutbacks or focus on market-share driven strategies.
- Maximization of the financial performance via higher profits and strong non-fuel cost discipline is key to long-term sustainability.
Although the long-term trend in oil prices is uncertain, oil markets are expected to remain relatively low in the near-term. Heading into 2017, the oil price forecast is generally not widely diverging in the US$ 40-60 per barrel range over the next two years despite the recent volatility.
Notwithstanding, longer-term projections reflect a broader divergence of opinions. Market reactions to the OPEC agreement to cut production by 1.2 million b/d starting in January 2017 and projected stronger economic growth are major contributors to expected rising oil prices forecast from current levels.
Relations between the USA under its current administration and Iran are likely to hold much sway over the direction in oil prices.
Capacity Growth Discipline
A two-year long slump in oil price has resulted in a hugely positive financial impact on the airline industry’s costs, but airlines must consider the importance of operational efficiency so profits can outlast the fuel cycle.
The lower price of oil tempts airlines into backsliding on their strategy of disciplined growth, as it reduces the pressure to cut costs and capacity. The likely result is profit-destroying expansion. Another important driver over which airlines have almost as little control as over the oil price are exchange rates: the U.S. dollar’s recent strengthening was not widely predicted, and has offset some of the upside from the reduction in oil prices.
Protecting Against Oil Price Surges
Competitive non-fuel costs are critical to long-term sustainability. The extent to which rising fuel cost affects profitability in the airline industry depends on the proportion of non-fuel cost in the total airline’s revenues. Lower non-fuel cost (as a percentage of passenger revenue) means that airlines have a greater room to profitably absorb a hike in oil prices.
After oil skyrocketed to US$ 145 per barrel in 2008, U.S. airlines undertook large scale cost cutbacks to try to cope with oil at whatever price it may be. On the other hand, some airlines in other regions – notably Europe and Emerging Asia – are still focused on a market-share driven strategy, as capacity discipline seems theoretical at best.
Profits may erode and gains may be wiped out if crude oil moves up again. While U.S. carriers are well positioned to operate in a higher price of oil environment, the European and Asian airline industry are failing to keep tabs on non-fuel costs. Although labor unit cost is increasing at a greater rate in the U.S. – as labor unions have demanded better working rules after years of wage austerity and massive layoffs – airlines in the country have greater room to deal with oil price increase.
Non-fuel Costs as % of Revenue – 2016Source: Airlines, Associations
Beyond the obvious near-term positive impact on balance sheets and cash flows, there is the ever-increasing threat of overcapacity. The glut of available seats has been impacting ticket prices, leading to significant fare discounting in certain parts of the world. This trend may be accelerated if there is a massive capacity inflow in the system. Discipline is the engine of the strong financial performance of North American carriers. Net post-tax profits will be the highest at US$ 18.1 billion in 2017, more than 60% of worldwide result. Sustainable profitability needs to be widespread. The profitability of non-North American airlines is respectable by historical standards but still modest.
Economic Performance of the Airline Industry - 2017F
Hedging Against Boom & Bust
In a high-volume, low-margin environment, it is obvious that a competitive cost structure remains strategically important for business sustainability. The airline industry is notoriously known for its boom and bust cycles, and unforgiving to airlines who are unable to adapt in time. The fluctuations in the market place put the carriers under severe pressure to sustain profitability and fleet optimization is critical in the vicissitudes of business cycles. Resilient profit growth can no longer be supported solely through cost reduction. Greater control in matching aircraft capacity to market demand results in a greater percentage of higher-fare passengers, increasing both yields and load factors.
Despite slower momentum,
the underlying drivers for a gradual
acceleration in economic activity
remain intact worldwide
• North American airlines are set
to once again have the highest net
post-tax profits at US$ 18.1 billion,
more than 60% of the worldwide
• Airlines are beginning to enact
strategies to protect themselves
from oil price surges, either through
large-scale cost cutbacks or focus
on market-share driven strategies.
• Maximization of the financial
performance via higher profits
and strong non-fuel cost discipline
is key to long-term sustainability.