Recorded at CAPA Live July

CAPA Chairman’s Update: Outlook 2021

As aviation and travel continues what can only be described as a period of darkness, the industry that emerges will look vastly different than it did before the COVID-19 outbreak. The implications are wide-ranging and highly disruptive. As a continuation of CAPA’s Masterclass Series, CAPA – Centre for Aviation’s Chairman Emeritus Peter Harbison delivers a global big picture overview of our industry and where it will be in 2021.


  • CAPA - Centre for Aviation, Chairman Emeritus, Peter Harbison

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Speaker 1:

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Speaker 2:

Welcome to this Bastil

le day version of CAPA alive. I've got to talk about where we're looking for the

next few months and possibly even years. I've been banging away for the last few months about how

somebody needs to do something to recognise the system's going to change. I'm

giving up on that line

because I think there isn't going to be any active change that it's really going to be a passive response to

a whole lot of things that are going to be happening, which aren't necessarily terribly good. But

whatever happens is going

to be different. So what I'm going to try and do today is look at the what I'm

calling the building blocks of the new airline system. Just so that we can go through some of the basics

and perhaps speculate a little bit on what is going to happen next. So

first of all, talking of basics, let's

have a look at the airline industry.

There's nothing particularly new here, but I think it's worth reminding ourselves of what we're

looking at and w

hat it has been and what the prospects are of it continuing along the same way. First of

all, it's a deeply cyclical industry. Which really means it's not cyclical, but there are just constant shocks

to it which set it back and cause bankruptcies, course a

ll new cycle of change. Airlines intrinsically are

value destroyers. They destroy more equity than is put into them almost. They have very high and fixed

variable costs, fixed and variable costs. The majority of the input costs are variable beyond control,

particularly fuel. And real yields have decreased roughly by one to 2% every year for decades now. The

industry really only grows because of the longterm decline in cost versus income. Asia might be a bit of

an exception to that because it's a sort of new

entrant market where whole major economies are

coming through a cycle of economic development, which has allowed them to travel.

But the same equation applies as income grows steeply. It'

s a commodity business. There's very

little ability to diversify or to differentiate product. Same aircraft, same airports, same pretty much

everything, except the way you treat people and that can vary quite a lot. Labour costs mostly unionised

or the lar

gest of costs. And because of the diverse nature of the airline industry, there are so many

different unions involved typically. Even with new tech, those costs are going to continue to rise. And

probably fundamental to the reason that the industry doesn't

work effectively internationally is that

rationalisation and all which is another word for merger quite often is prevented by international

ownership rules. And that really just makes a... Fundamentally undermines what potentially should be a

good system.

So looking at those basics, it's a deeply cyclical industry. This is the graphic display of the

net profit of airlines for the last 15 years.

And I should say, these are the good years in

most cases. So if you look at the right


hand side of

that graph, we're looking at for 2020 and 2021 something like $200 billion of new debt. That's on top

of... Sorry, new losses. That's on top of the debt that's being accrued as well during that period.

And I

say those were the good years. If you look back to 1970, going back to 50, 60 years, that is the level of

constancy, of stability in the airline industry. The maximum EBIT margin you see there back in the late

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nineties before we get to the so



good period I was just talking about, is around 6%. That's not a

decent margin. And there are many occasions where the EBIT is well below the line there. And as IATA

says, the world airline industry has generated an average annual post


tax profit net of de

bt servicing

costs of just 0.1% of revenues over the last 40 years.

That's the 40 years up to 2010. This is from an IATA vision report, vision 2050 put out in 2011. In

other words, the air

line industry has been able to pay its bills, renew its fleet and service its debts, but

there's been nothing left to pay its owners or shareholders for their risk


taking. This is what it used to be

like before we got into this massive hole that we're digg

ing ourselves out of now hopefully. Of the

leading groups in terms of revenue in US dollars, the top 10 are shown there. Five, six of those are US

airline groups. Top three of those are the big three in the states. There's a very good reason why they're


e top earners. And even so they're not that big in terms of major market companies. But the magic

ingredients they have is they're able to merge.

They're also able to go through chapter 11

and come out with a whole new debt profile. And

they're also working inside a protected domestic market. In other words, it's the ability to combine and

to have effectively limited competition, to some extent and oligopoly in the US. And it's those two


nditions that don't exist internationally generally for anybody else if we're looking at how to get a

sustainable system for the future. High fixed and variable costs, aircraft are very expensive. Payments

are typically in US dollars so they're subject to

currency fluctuations. Even if you hedge it's still going to

be a cost and it's not something that prevents those costs. And grounding aircraft at the moment of

course is very popular and even grounding an aircraft doesn't save as much as you would imagine


PART 1 OF 4 ENDS [00:08:04]

Speaker 2:

... doesn't save as much as you would imagine because even some direct operating costs are involved in

that. You're going to have maintenance, you'r

e going to continue with some crew to look after them.

There's ground rental and so forth. So it's a very expensive business, just having an aircraft on the

ground. And externally with the variable costs, oil prices, which ranged anywhere from 20 to 40% of

costs vary enormously. And I'll look at that in a moment. And even hedging oil prices, which is again,

something which is pretty typically done not by everybody. It can be very risky as a lot of carriers found

when they'd hedged for 2020 back in 2019 or 2

018. When they hedged for 2020 and they found that

they didn't use that fuel that they'd hedge for, you actually have to pay on the downside as well. So, it's

a really risky business.


is just to give an indication. This graph shows the major lessors who now account for more

than 50% of all the aircraft that are flying in the major international and domestic industry. The largest

of those, AerCap and GECAS, between them have 15, $16 bil

lion worth of aircraft on the ground and

going down. You can see there's a lot of aircraft, in other words, on the ground. That's just the grounded

part, which counted for probably in many cases about 30% of the total fleet. And that other 70% was

not full

y utilised.

But interestingly, so the blue bar in each of those cases is the value of the aircraft before the

beginning of 2020. And while typically aircraft are written down to the tune o

f about three to 5%, the

impairments over the last month or reductions in value compared with the difference between the base

value and the market value is probably more like 20%. Now that makes a massive difference in a whole

array of things that I might

go into at the moment, but it has repercussions all down the chain for asset

values, for debt obligations. And really does probably create one of the big problems that aren't talked

about very much at the moment, but we'll have to come to the fore in due c

ourse. This one shows the

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major airlines that have grounded aircraft of considerable value. These are almost all wide body aircraft

that we're talking about here. Hence, the fact that the majority are actually full service carriers and

therefore have much

more expensive metal, but there are one or two of the smaller carriers there too.

And then, the old enemy. This is a headline from CNBC just a couple of weeks ago. $100 oil is not

that ext

raordinary. And if we look at this graph back in 2012, it was well above that level. It was up at

$125. This is Brent Crude, which is actually quite a lot less than airlines are paying for the fuel that they

use. Today, it's hovering around $80. And OPEC i

s trying to push prices up as economies recover, if they

presumably will. Then demand for fuel, the airline industry has to compete with whole array of other

industries, including cars.


en it's probably not unreasonable to think $80 is where we're looking and possibly even a

$100 in a difficult situation. That creates massive problems for a lot of airlines. And unfortunately, in

many cases too for the lower cost carriers, that has a much

more important effect disproportionately

because their other costs are lower. So, it creates a bigger headwind for them. Time for a rethink. So as I

said at the beginning, there's been no attempt to remedy the situation, knowing these things that are


g down the track, knowing what the problems are going to be. Instead, governments have

essentially been propping up this faulty old system, this rickety old system that's been demonstrably



viable, non



So in these circumstances, what's going to happen? How can the incumbents adjust? And I'm

going to look now at some of the known knowns as Rumsfeld would have said. There are obviously

reasons for seeking to maintain the statu

s quo. So, what are they? Well, the first one is the easy one.

That's inertia. Just, well, there are lots of other things to do and it'll have to sort itself out. But there are

some innate and very valid reasons for wanting to protect, let's say a national

carrier to use very generic


It does have a big flow on to skilled jobs and unskilled jobs to the travel industry. It ensures

connectivity for a nation having a national carrier in

some cases more than others, particularly for island

countries for example. There are some countries maybe in Europe, which probably can't argue that

quite strongly because there are lots of alternative services if they don't operate their own airlines. Bu


that brings us to the last one of those points, and that's nationalism. Nationalism is always been a big

part of the airline industry. It's a matter of national pride as well as being an economic driver.

So some of the things we do know, the known knowns. Sustainability, what's going to happen?

Well, first of all, corporate buyers are going to be under major investor pressure to reduce their carbon

footprint from business travel. These ar

e important because, and I'm not going to talk a lot about

business travel, but I've drilled on that a lot before, but it does help to underwrite long haul services in a

big way. And then directly on the airlines, there's going to be much stronger popular

and political direct

pressure to reduce emissions. The airlines are actively trying to produce SAFs, which themselves are a

high cost. But also at this stage, a very tiny proportion of fuels used and really don't look to have a major

impact on reducing emi

ssions until probably 2030 and beyond.

So there's a lot more activity there, but it adds to cost because they cost more than regular fuel.

There are going to be carbon taxes, one form or a

nother. Whether they're global, whether they're

regional, whether they're national, there will be carbon taxes. I think that's... And they're going to be

generic probably, but they will apply to airlines in many cases. And then on the other cost side, it's


to require new, efficient aircraft for those airlines that don't have new aircraft. They're going to have to

invest because the pressures will be so strong to reduce their carbon footprint.

What do we anticipate? Well, lower average yields as I mentioned. As business travel reduces,

that's a difficult one for airlines. Higher costs because of the SAF usage and generic carbon taxes.

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Together, these damage long haul operations particul

arly because they account for around 40% of all

aviation emissions from the sustainability side and because they very much need business travellers to

operate effectively. What are we doing? What we do know about border restrictions? Well, of course,


's been very little intergovernmental coordination on reopening borders. A lot of confusing

passport messages. There's not terribly encouraging signs of interoperability either with the exists, the

various passports that are being produced. That will chang

e, but its change...

PART 2 OF 4 ENDS [00:16:04]

Speaker 2:

... with the various passports that are being produced. That will change, but it's changing very slowly.

Vaccination coverage is

still extremely limited in many countries and will stay that way probably for

years. Many countries are either going through new waves of infection or about to go through new

waves. And of course the new variants, the longer we don't have vaccination herd

immunity globally,

which will probably never occur, new variants are going to continue to emerge and challenge the health

defences. I just mentioned too that Asia Pacific has a much lower tolerance to illness and death than

Europe and North America, which

does have substantial implications for the reopening of those


So, what we anticipate, governmental coordination will improve, particularly in Europe and

North America, but it's un

likely to do so in other markets. Mutual, standardised, recognition of

vaccinations, passport recognition and proof thereof will slowly improve, but slowly is the key word.

Vaccination coverage won't be achieved in many countries until well into the end of

next year and

beyond. And that will very much limit market access because there won't be regular and even reopening

of different markets.

As I said, Asia will be much slower to operate mo

re openly, other than on perhaps bilateral basis

in some of the bilateral bubbles that we're seeing. Even that's a bit hopeful at the moment. Government

roles, what do we know about government roles? Well, first of all, they've invested very heavily in


porting their national airlines and aviation industries. Directly in many cases, sometimes generically

through job supports generally. But directly with either debt or equity or both in several cases, to the

tune of two or $300 billion globally. The other

thing in terms of government roles is they want key air

services restored. There's no doubt about that. It's important for connectivity. So what's likely to

happen? Well because of the new government roles, they're going to be more protective of their own

airlines' market position. That implies continued financial support, it implies restricting competition

from other airlines probably, that is foreign airlines, especially competing hub carriers, and also other

airlines maybe from that country, which don't

have that same level of government support.

And also government support for the key long haul trunk routes may be necessary. This is a big

move, but if yields are too low to support econom

ic operations, and border re


openings continue to be

sporadic, then governments will, I'm sure in bilateral cases, start to make some sorts of direct intrusion

into the market forces. What do we know about airline finances? Well, it's common knowledge. We

enter this next phase heavily indebted with reduced cash reserves, if any. Many airlines indebted to

government in one form or another. Many will continue to fly, and this is the risky one, many will

continue to fly, even if they are unprofitable. And this

is where the system starts to become very uneven

and unequal and unwieldy, in fact.

The US airlines, however, are in a strong position because they've had expensive government

support to

the tune of some $50 billion, but also because their market has reopened faster with

vaccinations and also a different attitude to the way the health issues have been addressed. What'll

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happen within aircraft finances, airline finances... well, there will

be failures. There's no doubt about it

this year. And possibly many as border re


opening becomes increasingly a challenge.

Mergers, they may be attempted, although government prop


up and m

arket exit are more

likely. One of the two, which is not an ideal situation. For lessors, new aircraft purchases will be

challenging for airlines because of their financial situation now, and that will undoubtedly enhance the

important role of lessors. And

it's already increased considerably during COVID. And some established

LCCs, which have demonstrably stronger economics and greater versatility, as well as decent cash

balances, could flourish. Again, higher fuel prices do start to challenge that model mo

re than others

though, as I mentioned.

What do we know about market recovery? US domestic market has recovered strongly, as has

China's and Russia's, although the US is surging ahead proba

bly, more strongly now. Strenuous attempts

are being made to reopen the very valuable North Atlantic market, US to Europe, and Canada to Europe.

Vaccination levels are higher in these regions than other parts of the world, so it should be possible to


der much more effective reopening.

Meanwhile though, what we do know is that other international markets do remain highly

uncertain. What do we anticipate? Well, the North Atlantic probabl

y will reopen faster than other large

international sectors, but on that, it's likely that beyond feed, which is what hub carriers rely on, six

freedom traffic, will not be there so strongly as previously. And that'll hurt operating economics for the


rk airlines. On the other side of that coin is that increased narrow


body operations will enhance

the potential for point




point operations across the North Atlantic, both by new entrants and by

established airlines with new narrow


body fleets, but also

because they will perhaps be in a stronger

position as they don't need to rely on that sixth freedom feed.

And then just quickly, I'm going to look through what's happening in the US as pe

rhaps as an

indicator, because they're the first to be coming out of this as the major market in the world. And to see

what pointers we can get from that. So flush with tens of billions of dollars in government aid and the

recovery and traffic, those US ai

rlines might give us a good indicator of what's coming down the road.

This is the big one, of course, most recently United order for 270 Boeing and Airbus aircraft, all of them



body. MAXs and Airbus 321 Neo's as well as refitting most of their narro



body fleet. So a great

reliance on narrow


body. And a 75% increase in premium seats as a result of that with a whole array of

associated features with it.

Over the next few years, United

plans to introduce more than 500 new narrow


body aircraft.

And you can see from that, the narrow


body ones there are the blue and the gold. And the green. Sorry,

not the green, the blue and the gold. And there's not a lot else in the near future coming up

. And in

2023, there'll be something like one new aircraft arriving every three days, one new narrow



arriving. That's important because its wide body fleet is very old with a median age of... the fleet overall

is a median age of 17 and a half years, t

he long haul sector, the


PART 3 OF 4 ENDS [00:24:04]

Speaker 2:

... median age of 17 and a half years, the long haul sector, the 76s and 75s are around about 25 years

old. So either they'r

e going to be replaced, you would hope, in terms of environmental sustainability, or

this accent is going to be reinforced much more towards moving to the narrow


body profile.

Like United,

Delta too has a very ageing wide


body fleet. Again, 75s, and 76s of 25 years and

thereabouts, median age. It's got too a large number of narrow


bodies coming through. And in that you

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can see everything other than the blue or the red is narrow


body aircraf

t, two twenties and three


But of course these are large airlines. Things can change too. They can also add considerable

numbers in the near future. But just as a quick summary of

where the major carriers are in that respect,

those median ages there, you see American has a major contrast there in terms of a median fleet age of

about just under 12 years, which is really less than two


thirds of the other carriers. It too has a large

order book of narrow


body aircraft. And I think we can see there that this very much is where the U.S. is


One lonely little circled aircraft for Airbus there in the first five month

s of 2021, which is the only



body that's been ordered in the first five months of this year, which is the latest data we've got.

Then of course, you can add to that the United aircraft that have just been ordered, which are all on the

left side of tha

t little lonely red wide


body. I'm just looking who's growing fastest. It's the narrow



operators, the Allegiants, the Spirits. They're the ones who are growing fast. Obviously their fleets are

considerably smaller, but that growth is accelerating, as

we can see from 2007 to 2019, it's going to

accelerate even further in the near future. And this continues a trend towards point




point operations,

which was already there before COVID hit. But I think we can anticipate that will emerge from this


s, with that growth line being even steeper. So in summary, what can we expect post COVID?

Well, first of all, it's going to be a long time before COVID is in the past.

There are new varia

nts, there are new waves, and then things like less than 2% of Africa is

vaccinated. And underneath all these lie a lot of tragedies, but it also from an airline point of view,

means unpredictable market access will continue for a long time. Unpredictabili

ty is the only additional

thing that airlines don't need, which will make life much more difficult for scheduling, for planning, for

every cost you can imagine. There will be greater government involvement, directly and indirectly,

investment and protectio

nism involved. Indebted airlines saddled with high cost pressures will leave the

market. That, to some extent, is inevitable. There will definitely be a greater role for lessors. They have

solid business models. They work, even though they're selling to ai

rlines, they have credit ratings and

they can buy aircraft.

There may well be a shift in the operating regimes as well, towards virtual airlines. We've

already seen this in the middle part

of this decade, this past decade rather, where Acme became quite a

popular move, basically just buying aircraft and then wet leasing them to full


service carriers.

One of the hopeful thin

gs, and I think one of the things that airlines are going to be pushed into,

is actually leveraging their brand because the only viable parts of an airline industry operation are the

parts that don't involve flying large, very expensive pieces of metal aro

und the sky. And we're seeing

increasingly a much greater reliance on looking at retail, but certainly on frequent flyer programmes as

well, and loyalty programmes. Just direct distribution is accelerating, partly helped by COVID, but it was

already there

as well.

There will be much greater pressure to reduce emissions, which is going to make the airlines life

much, much more difficult. And an operational thing, as I was talking about befor

e the rise and rise of

point to point, cost


effective efficient narrow


body service. The two key things I think there, which are

going to be really, really important, the greater government involvement and the role of lessors, which

will have to shift the

way the airline industry works, I think. It's not going to be obvious immediately, but

it will become very, very apparent as we move along.

And before I close, I just want to say one of th

e interesting trends is when we're looking at the

difficulty with business travel and the effect that that's having, where airlines will start to look for

someone who's going to pay premium prices, which is the premium leisure market they're hoping for,

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t also a much more cost conscious business market. So premium economy seems to be where people

are looking. And what you're seeing there is an extract from a story that we just put on our website

which highlights some of the data from our new in


flight dat

abase. If you want to find out some more

about that, just pop to the website and have a look.

And then finally, finally, one other thing coming down the road, we don't really know how


rtant this is going to be at this stage, but it does make an awful lot of sense. e


VTOL electric vertical

takeoff and landing companies being listed at the moment. They have a lot of strong backing. A couple

of U.S. carriers have already placed pre



But where they have the greatest potential is in those

very short markets, whether they operate from airports or not, whether they might even operate from

your back garden to wherever you're going. Any route under sort of a hundred kilometres or so is goi


to be very much open to e


VTOL aircraft. And they're talking about combined, which is overly optimistic.

Talking about something like 4,000 aircraft being reduced by the end of this decade. I think that's

probably overoptimistic, but undoubtedly these a

ircraft will start to make a difference in that very short

haul market. And with that, thank you. And hopefully I've produced some thought provoking and maybe

even helpful comments there. Thank you.

PART 4 OF 4 ENDS [00:31:52]

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