Accuracy Talks Straight #2 – Industry Insight
The aeronautics industry is feeling the heat
Senior Advisor – Aerospace & Defence,
Air transport is at the top of the list when it comes to sectors most heavily affected by the COVID-19 crisis. Behind it, the entire aeronautics industry is suffering, from manufacturers to equipment suppliers of all sizes. The shock is all the more brutal as annual growth stood on average at 5% over the past 40 years and was forecast to continue at over 4% a year for the decades to come.
In 2020, air traffic fell by 66% compared with 2019, and both the timing and the extent of its recovery remain uncertain. For domestic flights in large countries, recovery will depend on the speed and efficiency of vaccination efforts. It is already strong in the United States (traffic was only 31% lower in March 2021 than in March 2019) and China (+11% higher), but it remains weak in the European Union (63% lower). For international flights, recovery will depend on lockdowns linked to the emergence of new variants and the rate of vaccination in each country, not to mention the confidence that countries will have in each other’s efforts to contain the coronavirus. This recovery is currently very weak. In total, the level of traffic in 2021 will remain much lower than historical levels. At the end of April 2021, the IATA forecast world air traffic at 43% of the level in 2019 (compared with a forecast of 51% in December). Globally, a return to the 2019 level of activity will no doubt have to wait until mid-2022 for domestic flights and 2023, or even 2024, for long-haul flights. Only air freight has experienced continued growth, but it represents less than 10% of all air traffic.
Several factors lead us to consider that air traffic is not yet ready for a return to the long-lasting growth experienced in the decades before the crisis (5% a year from 1980 to 2019), and various arguments reinforce this vision:
– Passengers’ ecological concerns are becoming of prime importance – some will be more reluctant to travel and especially to travel far.
– Large groups have got through the COVID-19 crisis by completely stopping all business travel: short, medium and long haul.
It was an abrupt lesson, with radical conclusions favouring the strict limitation of such travel. As a result, these groups generated significant savings, as well as an improved ecological balance sheet, something monitored by the markets more and more closely. According to the leaders of major European groups surveyed at the end of 2020, business travel may permanently fall by 25% to 40% compared with 2019.
– These two factors are already enough to bring about a significant drop in traffic, but this drop will be compounded by a third factor, an immediate consequence of an airline’s economic model: first class and business class passengers are the major levers of profitability for a long-haul flight. If their traffic is reduced by 25% to 40%, airlines will have no other choice but to increase average prices significantly for all passenger classes.
The impact on prices of the change in behaviour should lead to a new economic balance: a reduction in business class volumes of 30% may lead to an average increase in ticket prices (business and economy) of 15%. With a price/volume elasticity of 0.9, an average fall in economy travel of 13.5% can be expected.
To sum this up, the forecast impact on passenger traffic could be as follows:
– A fall in business class and first class passenger numbers of 30%
– A fall in economy class passenger numbers of 13.5%
– An increase in average sales prices of 15%.
In our opinion, the sudden turbulence in the industry presents a unique opportunity for it to restructure; its untenable financial situation obliges it to do so. The air transport sector has taken out debt of over $250 billion since the beginning of the pandemic, and its total net debt should exceed its revenues during the course of 2021 or in early 2022. Today, the sector continues to lose tens of billions of dollars in cash each quarter, contributing to the rise in its debt levels.
The industry will be forced to overhaul its model significantly, especially given that this economic constraint doubles up as an ecological constraint that is just as fierce. Indeed, air travel is a substantial emitter of CO2, representing up to 2.5% of emissions globally and around 4% in the European Union. In addition, air travel suaffers another constraint that is specific to the sector, namely that CO2 represents only a fraction of its overall climatic impact. The most recent studies (July 2020) confirm that its emissions of nitric oxide (NO) at high altitudes contribute more to global warming than its emissions of CO2.
In total, air travel alone represents 5–6% of humanity’s impact on the climate. But it is not for lack of trying – the industry has been making substantial efforts. CO2 emissions per passenger kilometre have shrunk by 56% since 1990, one of the best performances of all industries. The total emitted tonnage of CO2 has nevertheless doubled over the same period because of the increase in traffic. Ryanair, the European low-cost leader, summarises the climatic impasse of air transport quite nicely: its aeroplanes are very recent, their occupancy at a maximum (average rate of 95%), but it is the company with the highest CO2 emissions in Europe after nine operators of coal power plants.
Technological progress will continue but, for aeroplanes as we know them, it will not be accelerating. As for truly new technologies (hydrogen, electricity), their time will undoubtedly come, but too late to play a significant role in meeting the object ives o f the Intergovernmental Panel on Climate Change (IPCC) in 2050, that is, limiting global warming to 1.5°C and net carbon emissions to zero.
In this context, the industry must reinvent itself, taking into account the following points:
– Growth in traffic will for a long time remain lower than the growth seen in previous decades.
– Progress in energy efficiency will continue but will not accelerate.
– This progress should be completed by credible and rapid climatic solutions (i.e. not offsetting), like clean fuel. Boeing and Airbus recently announced, in spring 2021, their desire to accelerate their use of green kerosene quickly and significantly. But the volumes will be insufficient to meet the objectives of the IPCC.
– The serious issue of high-altitude emissions – currently left out of the equation – will have to be dealt with.
– Owing to and considering the cost of decarbonisation solutions, the cost of air travel will inevitably increase by a significant margin.
– This increase will weigh heavily on the most price-sensitive traffic, tourism, whilst technology will clearly and permanently reduce “high contribution” traffic.
– Combined with a concerning debt situation, these factors will force a complete overhaul of the economic model of air transport.
Despite this severe assessment, we think that there are ways for the industry to react radically and constructively. We will present some of them soon.
1 Boeing and Airbus
2 International Air Transport Association (IATA)
3 Accuracy interviews with management of large groups
4 OECD, INSEE