Recorded at CAPA Live December

CAPA Chairman’s Update: Outlook 2022

Speaker: CAPA - Centre for Aviation, Chairman Emeritus, Peter Harbison

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Peter Harbison:

Hello and welcome to CAPA Live for December 2021. What a year it's been. This will be our last presentation and our last session of CAPA Live for this year. And we don't really know if we'll be really live next year, hopefully we will be, but here we are. I want to address today something that's, really I think, incredibly significant for the future and will, as it suggests in the headline, be a remarkable transformation for the industry. It's going to be a very different world once we do start to travel internationally. In some ways it'll be almost imperceptible, but it will happen and will actually happen quite quickly.

But first, just a couple of words. We need to learn how to ride the rollercoaster. We haven't been very good at it so far and obviously learning the Greek alphabet is something we've all become accustomed to. But the rollercoaster, it's the bookings and actual travel. Every time something happens we're back into the downside, hopefully back into the upside again afterwards. But one thing here is that we aren't through this. We're nowhere near through it. And I think if anybody really believes that we are now, they should take another close look at what's happening. And to wish ourselves through it is not going to get... The hope is just not a plan, because there are going to be more of these Omicrons and I desperately would like to know what the next letter is in the Greek alphabet even if we skipped a couple.

But it's going to keep happening. So let's get prepared for it. And as the WHO has said on many occasions, until everybody's vaccinated, nobody is vaccinated. And as we're starting to learn now, we'll all need probably one or two or three more. With those that slide, it's actually of some concern that the bookings were actually dropping before Omnicron struck in Europe. And just some of the relatively small numbers there, but it was a significant week before, relative to 2019. And it does suggest that consumers have really become quite wary of journeying internationally. It's something that's always been in the background and increasingly as everyone gets burnt more and more times the reluctance to travel increases. It'll go away eventually. But in the short term, when airlines really do need the cash, it's going to be a real contributor to slow growth.

So going back to my main theme, what are the drivers of change? First of all, we're all pretty familiar with these, airlines can't afford to be buying aircraft, they're heavily indebted and loss making. And that number of 200 billion US dollars in additional debt that's been accumulated during COVID is a burden that's going to weigh heavily for some time to come. Recovery prospects are not great. As we're starting to see now, 2021 was not the recovery year that we hoped for, particularly internationally. If you've got a domestic market to operate in, then it is some comfort.

The second point is that it's become increasingly clear that lessors have a much better viable business model than the airlines do. Today they are more than half the world's airline fleet. And they can because they have decent credit ratings, they can be buying new aircraft. Airlines to the vast majority still jump on status. And interestingly with lessors, and I'll dwell on this a little bit more in the moment, they want easily transferable assets. They want ideally new narrow body, economy configured aircraft that can be really slotted from one airline to another at the end of a lease or whenever.

The third point here is that business travel reduction is going to reshape the way long haul operates. And I won't labour, that we've talked about it a lot of times, everybody's pretty well aware that business travel will be down, whether it's 20%, whether it's 50%, whether it's 2023, that it comes back. We don't know, but we do know that it's going to be significantly down and particularly for long haul operations. Even if companies do get back to travelling, there won't be so many people travelling. They won't be travelling so frequently, and that does have a very significant impact on long haul, wide body operations. And then in terms of the negatives, even though we are hopefully saving the world by doing it, environmental pressures, whatever they are mean added costs. Whether it's buying new lower emission aircraft or whether it's upsetting, whether it's buying carbon, whether it's just investing in the SARPs and everything that goes with it. And importantly, this goes back to some extent, to the previous point about business travel, long haul wide body services account for about 40% of airline emissions.

So going back to the first point, you probably the familiar face of Steve Hazing, he said on one of our Capital Lives early this year, airlines and again, it's not rocket science to know this, but in most cases, airlines are very much at the end of the borrowing capacity because they have leveraged just about everything they have. And Steve says, if the recovery takes a long time, they'll have to rely on outside sources and a bit of self-promotion aircraft, lessors are a far better shape in terms of capital allowing airline to use lessors as a crutch. And this is where the recovery prospects are dim.

I've shown this slide a few times and whether or not it's going to be correct for 2022, but these are the IR forecasts. And even the best one, which is within Europe, suggests a 25% reduction per 2019 for the full year of 2022 calendar. The worst standard of that the right hand side is within Asia, where we're talking about a 90% reduction and all of that, of course, due to water closures and uncertainty about opening, which in terms driven by new waves of COVID or lack of vaccination and just uncertainty in general, inability to communicate and coordinate.

So the lessor issue is, has become a really, really important one that very steep set of stairs shows how the ownership of aircraft worldwide has grown over the last 20, 30 years. Today it's actually above 50%. And as it notes there, in 2021, lessors were responsible for 65% of all new audits. So that number is going to continue to rise and given what the situation is with airlines being able to raise capital and place burdens on their balance sheets. It's unlikely that the airlines themselves will be buying aircraft. So the lessor pathway to heaven is going to continue to grow by the looks of it.

The lessor model business model is obviously much stronger. They have access to liquidity and this was actually some months ago that this was said, but just suggest that the best airline credit availability is three percentage points above what the leasing company like Air Lease Corp can do is really suggested taking the much easier course, even if it can afford to buy probably better off going with lessors. So it's going to be a slipper slope for quite some time to come. Now, this is where I get into some of the nitty gritty. There are two aspects, I'll let you in on the secret. There are two aspects I'm going to deal with here. One is the rapidly evolving trend towards narrow body aircraft. And the other one is, in some many ways that plays into the hands of the LCCs. And we've seen the recovery by the LCCs, particularly in domestic and within Europe markets has been much faster than in most cases than full service carriers.

And as a development new narrow body aircraft are going to take a much larger share of the world fleet. They're more fuel efficient, they have lower emissions. So they satisfy those two economy and decarbonization requirements. They're very versatile for network planning because they do have the ability to fly long range. So small aircraft typically, down to sort of 120, 150 seats with the [inaudible] but around about anywhere from 150 to 200 plus with the other aircraft, as well as being able to fly short haul and as a result of all that, so much smaller point to point city pairs than previously. As an example of that talking to Wizz Air a month or so ago, they noted that they had established 400 new city pair roots since COVID began last year.

And that really is an indication of what is possible with these aircraft. The next point is that lessors, are going to be dominating aircraft selection, not just being able to provide them, but of course, lessors have to buy them themselves. And when airlines can't afford to buy, they're probably going to be finding, there's lesser of a selection on the shopping centre shelves, because lessors do want to have, particularly in tough times, they want to have aircraft that are readily transferable between less seas, and that tends to be narrow bodies of a certain profile. And then we have this issue that consumer profiles are changing.

There's no doubt about that. Aside from being a little bit more reluctant to fly, it is predominantly a ledger market at the moment, including BFR clearly. But it's simple cheap point to point travel they're really looking for, they don't want to go to through airports if they can help it, certainly not intermediate airports anyway. And the fact that there is less demand for premium. Once we see business traveller numbers reduced and each of these factors has been accelerated by COVID in one way or another. And to go to the point I was making before, main drivers and the beneficiaries of this are the low cost carriers.

I'll stop. Sorry. I'll just close my slide show. Okay. Start again. So narrow body aircraft orders, point the way. Let's have a look at what's going on in that market. On the left is the number of aircraft in service. I'm going to go through each of the regions this way, showing the proportion of wide to narrow body aircraft in service. Well, as things stand, there are at 17% wide body jets and something like 56% narrow body aircraft in service. If we look at the orders that changes quite dramatically, that 17 goes to 16, but the 56% goes to 71% of narrow bodies on order. That in a market where the preeminent carriers are the big three, in terms of network operations, that does suggest some considerable reduction in, at least in growth, if not in actual side of the capability for network operations coming over Europe. And on the other side of that coin, a very large increase in narrow body aircraft operating within that market.

The middle east is obviously a very different market, a lot of wide body there. So 48% actually in service at the moment versus 40%. A number which has actually grown quite considerably over the last five years. But then again, when we look at orders, the 48% of wide body goes to 41% and narrow body goes up to 58%. These are significant changes in terms of pointing towards the horizon and in terms of which aircraft are going to be carrying and operating the largest number of RPKs. Asia Pacific is even more dramatic and already, it was a very large proportion of narrow bodies at 60%, but that's going to go to 79% if we look through the orders, it's not going to go to 79%, it's going to go in that direction because 79% of the new aircraft are going to be narrow bodies.

And we do have to put the caveat on that. That some of the aircraft orders in Asia are fairly extravagant, to put it that way and may turn down, particularly if the market, as I ought suggest, is not going to be very strong internationally. In fact, it's going to be very weak, internationally. Nonetheless, that's what the orders suggest at this stage. Latin America, even more dramatic going from seven to 48% to 1% versus 90%. So what we're looking at is very much a short haul market in Latin America. And a lot of very new narrow body aircraft coming through. US is a bit different, but again, still fairly significant in terms of the change, 15% to 47% in actually aircraft and service. And that 15% drops to 10% and over two thirds of the orders, narrow body. And I should say that when we'll see this in the moment, that's not necessarily all LCCs because of the very oligopolistic nature of the US market and when it comes to talking about full service carriers.

Another one very recently example, is what happened at the Dubai Air Show. Just last month, Airbus had 408 new orders, for commitments for Airbus aircraft. Only two of those 408 were for wide body passenger aircraft. There were two or three wide body freighters, which is another interesting direction for the future, although a relatively storm part of the market, but a very valuable one at the moment. But only two out of 408 new orders were for wide body aircraft and buying, fronting up with its maxes, had a much more modest outcome, but of the 98 new orders, they were almost entirely maxes. And most of their wide body orders were for freighters. And in turn, the vast majority of orders were from LCCs and lessors. So not a lot of activity from full service carriers there, except on the freight side perhaps. Now to bamboozle you further with numbers, at present, 42% of the world's aircraft are operated by full service carriers, but when it comes to orders, they only have one third of the orders and this applies both to wide and narrow bodies.

So it's probably in a lot of ways, even more strikingly the shift in direction towards LCCs. At the same time, LCCs at the moment operate only 18% of the aircraft, but they have one third of all the aircraft orders wide and narrow bodies. So the proportion of bodies are that much higher, and that's about the same proportion as full service carriers have on order. So again, that mammoth shift in direction. So needless to say, just looking at this from a different direction, the yellow bar here in each of these cases is narrow jet aircraft and the other ones, which aren't quite so visible on this, but are wide bodies, which is blue on the left of the yellow bar. And they're basically two we're looking at, as you can see Asia Pacific aircraft, narrow body aircraft are way ahead of the rest of the pack. The next largest is Europe with narrow bodies.

And that's talking about roughly 700, 750 aircraft on order compared with two and a half thousand in [inaudible] pack. Full service carriers while they're well behind in Asia Pacific, just a thousand. And we do see here the difference between north America and the rest of the world in that oligopolistic position that the large carriers hold means that there isn't that much scope at the moment for low cost carriers to operate. Although airlines groups like Frontier are starting to make some inroads into that. But again, all of this suggests two sides of the coin. And they'll come to that other side of the coin. First of all, full service carrier fleets are middle wage faster because full service carriers are not watering so many aircraft, or they're going to reduce in size and proportion. And that's one of the things in our discussion with Steve Hazing earlier this year, that he did suggest that's, it's very likely, particularly for those airlines who policy who don't have adequate funding.

The US airlines are probably better positioned in this case because they've been the recipients are much greater generosity than their government, and they've been able to generate some cash during the year because the domestic market has recovered. But on the other side, as the lawyer on the third hand, older aircraft, unfortunately do mean higher emissions and look where the worst offenders are. The US fleet average age of US fleet is over 18 years, whereas age of Asia Pacific and the middle east in particular, and much lower. Even Europe, which is what we call middle aged is again considerably lower than the US. So be some real changes there. If the airlines there to meet the needs of the global industry in reducing carbon emissions. And most the greatest likelihood is that some of those airlines are going to reduce size.

One of the interesting factors coming out of this too, is that with the changing profile of revenue yield within, in particular decline in premium travel, long haul LCC, always a debated issue, perhaps back in the mix, particularly in this region where long haul is often shorthand for something like eight to nine hours, perhaps where it can actually be relatively affected. And there are no less than 12 LCCs in this region, which have wide body aircraft as well. And their model perhaps is going to be much better, climatized to a market where premium travel is not as readily available.

And it needs to be stressed that probably the overriding, highly intrusive feature, which will be affecting management decisions right through the twenties and beyond, but particularly in the near term, is going to be the need to both, decarbonize and to show efforts to decarbonize. This is a highly controversial area, which is come very much to the fore as COVID has... For some reason, it's not always clear, but really has brought to the fore. Then Cop 26, I think, although I didn't really touch much on aviation did bring out a lot of the opposition to it, at least in the media. Airlines have been accused of brainwashing, probably in many cases legitimately, but from an airline point of view, it's really important to lay out what the plans are. It's not enough to say we're going to be carbon neutral by 2050, because really that doesn't mean much.

The CEO won't be around, the management team, won't be around. It's what happens in the next three to four to five years. And it's not going to be sufficient just to have vague assurances because you can bet your life. The opposition to flying will be considerable. We've already seen some airlines seriously and practically established 2030 goals for using sustainable aviation fuels. But for them, it's very clear, particularly what Willie Walsh's been saying. That it's going to need support. It's going to need support from governments. And we're also starting to see some considerable support from that other business model, the lessors, because they also have a very strong vested interest in that in ensuring that airlines continue to fly otherwise their business model goes out the window. But it's not easy to do. And it is unfortunately going to be very costly for many airlines, hopefully through that government support and leasing company and other companies support, particularly the fuel suppliers themselves will need to be very much an active part of that.

Even within the airline industry, there's no consensus on the role of offsets, how effective they are, do they change management behaviour and you may forward them anyway. And how effective are they? There's a distinct lack of credibility there that needs to be resolved. Much of this presentation's been about reducing fleet ages. And that obviously is a key one, but again, that does require substantial outlays. And it also does require a lot of old aircraft, which have probably been flying around longer even before COVID, had been flying around longer than they should have just in order to try to squeeze and profitability out of what was already becoming in 2019, a fairly difficult financial environment.

Network plans may change. And certainly they will with the emphasis on low cost aircraft. And then as we progress through this decade, there is increasingly a belief that some short haul electric aircraft will be able to operate on regional route, 2025 and beyond. But then the others, use of hydrogen and E-Tech generally are really going to be confined to 2030 onwards and probably therefore need a little bit more than some brainwashing.

So I've later this point previously, the airline industry has not been an economic one. It's consistently shredded equity. It's managed to repay its debts in most cases, which has allowed it to survive, but we're wasting a good crisis if we don't see the transformation need. And if the industry is to become something which is better than it used to be. But it looks as if that's going to be changed from the bottom up, because while everybody's just looking to the future and hoping, and hope it's the main strategy, there doesn't seem to be any real consensus and really making fundamental changes to the industry. Clearly narrow body aircraft and LCCs are going to be part of that bottom upwards movement. And I think it's quite clear that short to medium haul flying will recover first and that almost inevitably full service carrier long haul flying will diminish. But that perch may not be so solid if we try to strain it any further.

Okay. Well, that's all I have to say for 2021. It's been a tough year for all of us, I think, and well done for fighting your way through it. There are certainly some glimpses of hope for next year, as we get used to the idea of being vaccinated and also start to address the issues in somewhat more realistic way. I do wish you well for the festive season, have a great holiday and come back refreshed for 2022. Thanks for being with us this year. We hope you've enjoyed it. We hope you've a little bit, we hope you've kept in touch with what's been going on. Thanks. And to here's to 2022.

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