Aviation Outlook 2008: Address by the Centre's COO Derek Sadubin to Piper Alderman Aviation Function
Distinguished guests, ladies and gentlemen.
My thanks to Andrew and the team at Piper Alderman for inviting me to address you this evening.
The timing couldn’t be better as the Centre for Asia Pacific Aviation will tomorrow publish our Aviation Outlook report for 2008.
And what a year it is shaping to be.
After the benign conditions of 2006, Asia Pacific aviation entered an earnings sweet spot in 2007 that led, in many cases, to record airline profitability. Just about everyone made money last year and the hopes were high this time last year that 2008 would be even better – particularly for the long-suffering US airline industry.
But the storm clouds started to gather towards the end of last year, as fuel prices continued to climb and the fallout from the US subprime crisis started to emerge – and indeed continues to emerge. Very quickly it seems, the US has slid into recession and the rest of the world is looking on to see how bad it will get – and how much it will affect them.
For now, the Asian Development Bank (ADB) forecasts Asian economies will register solid growth in 2008, despite a slowdown in major industrial economies, surging food and fuel prices and the credit crisis in the US. The ADB forecasts developing Asian economies to expand at 7.6% in 2008 and 7.8% in 2009 after posting the highest level of growth in almost two decades in 2007 - averaging 8.7%. The IMF has been similarly upbeat on Asia’s economic prospects in its latest commentary.
But clearly, Asia Pacific aviation is entering a period of economic uncertainty.
The Association of Asia Pacific Airlines (AAPA) said yesterday that while demand has been reasonably solid at the start of 2008, there is a “growing sense of unease about the likely impact of slowing global economic growth, coupled with cripplingly high oil prices”.
So it is increasingly likely Asia Pacific aviation is in for a bumpy ride over the remainder of the year.
But this region has evolved to an airline industry structure that is potentially positioned better to cope with a sharp downturn. It is the first time that the Asia Pacific region will have faced adverse economic conditions with a full armoury of low cost/low fare airline options.
A decade ago, in the Asian Financial Crisis, the outcome was simple: people stopped flying and airlines lost money. This time around, things could be very different. We have a new aviation environment - with new, private airlines, mostly well-positioned to survive in difficult conditions.
The region’s major network airlines (but not all) have also restructured effectively to allow them to be competitive when times get tough.
If the IMF and ADB projections prove accurate, the industry’s pain should not be intense in 2008. However, as we move further into the year, there are clear signs of a significant imminent slowing in air travel. Load factors are starting to ease as fresh capacity enters the market. These suggest that the IMF and ADB may be overly optimistic.
In previous downturns, low cost/low fare airlines in the US have managed better than higher cost/higher yield competitors. Even in good economic times, LCCs have been taking a rising share of intra-Asian travel. This could accelerate under a turbulent economic environment. The Middle East airlines are also poised to play an accelerated role over the next couple of years. Dubai Airport overtook Singapore Changi in the first quarter of 2008, in terms of total passenger numbers. Traffic at the Middle Eastern hub is growing almost three times faster than at Changi.
On the issue of oil prices, if we had to put our money where our mouth is, we suggest that we are near the top. Oil prices should start to level out and then to slide, as economies soften and the US dollar stabilises.
But in reality, the main problem is not costs – but revenues; the threat of globally softening demand is expanding far beyond the slowing US market. That is where the concern really lies.
Turning to Asia Pacific liberalisation, as the first signs of economic turbulence affect the region’s airlines, with premium traffic showing softness, so the first test of government resolve to liberalise arises. Until now, the rash of new entrants has been allowed to expand in a time of economic growth where, simultaneously, established flag carriers have shown high profitability.
However, as economic conditions erode that profitability, many of the region’s still-influential flag carriers may seek to halt liberalisation moves. This will coincide with the lead-up to the first major liberalising stage of the ASEAN Multilateral Agreement (which removes restrictions on inter-capital city operations) at the end of the year.
2008 will therefore be a critical signpost to the future. On balance, the Centre believes that momentum for change has now become irresistible and liberalisation will move ahead in 2008.
On the issue of the Environment, the region is nowhere near having a coordinating voice with which to address the major issues in a coherent way. The result: the region’s airlines and governments will all act independently, and in effect make their individual responses largely reactively to the often heavy-handed unilateral decisions of the EU.
This is unfortunate. We have already seen the harmful and costly effects of regional incoherence when it came to responding to the far-reaching unilateral decisions taken by the EU on liquids and gels (LAGs) on board aircraft. As a result, 2008 and 2009 will spawn an array of different national and corporate responses to the global warming issue.
Turning to the Australian market, Qantas, Jetstar and Virgin Blue enjoyed the best-ever conditions in the second half of calendar 2007. But 2008 promises a much more exciting array of challenges for Australian airlines - which now includes a hungry Tiger Airways.
Shareholders in Australian airlines have enjoyed healthy dividends this year. But the flavour of the market is likely to be very different at this time next year.
High fuel costs, added capacity, a slowing market and rising competition will take a bite out of earnings in the previously highly profitable Australian domestic market in 2008 – particularly the second half.
Early evidence suggests the process of yield dilution is already occurring under the influence of new airline entry.
Overall, the strong outbound international travel market should help insulate Qantas from the increasing turbulence in the domestic market. But here again, that outbound demand depends on maintaining strong domestic economic conditions.
Meanwhile, Virgin Blue remains heavily exposed with its rising cost line. A change of ownership could bring about another shift in strategy. The standoff in the airline’s sale process must surely be resolved in 2008; otherwise, the impact of its share price slide will make Toll’s core business unwieldy. Here it is hard to see any other buyer than Virgin Group. The outcome might be in a compromise where a partial sell-down leaves Toll in a stable minority position – but there is no obviously wholly satisfactory outcome for Toll.
For Qantas Group, the extended – and still undetermined – delay in deliveries of the B787 have meant a serious rethink of the strategy for Jetstar’s international expansion. Relying on an untested and unflown aircraft type as the foundation for Jetstar’s international expansion was always going to be a relatively high-risk option. On this occasion, the gamble was apparently lost.
But the downside may not be extreme. Jetstar is already using the A330 as its international vehicle and Qantas will provide it with further aircraft to allow the expansion process to continue. This will however mean that Jetstar is not able to take advantage of the next generation features and cost effectiveness of the B787 in its early growth stages.
And Jetstar’s short haul international expansion – via north Australia into southeast Asia and from its Singapore and now Vietnamese hubs seems likely to proceed rapidly. The Jetstar brand should become firmly established in the region in 2008 as a result. However, there are costs involved in this expansion and, with parent Qantas under some pressure at home, the appetite for risk might be diminished, compared with recent years.
It’s the Centre’s view that if international conditions turn unfavourable, the Australian domestic market may become a target for an even larger expansion of domestic capacity, as Tiger looks to consolidate its newly established position.
The Centre's Asia Pacific Aviation Outlook 2008 report has been published and is now available for complimentary download by CAPA Members from the Members' Area. To purchase the report individually, please click here.