Fuel above USD130 (plus refining margins). But pilot shortages critical too

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Last year was perhaps one of the few in history where the stars were aligned for the global airline business – a “sweet spot” that delivered almost decent returns for many companies. The world experienced a harmonious synchrony of economic conditions, where demand for travel was strong, oil prices were still well below USD100 a barrel, there was no pandemic of bird flu, nor major terrorist attack to undermine travel confidence and the conditions looked basically serene. This year offers a stark contrast.

There are many investors, Warren Buffet and George Soros among them, who would gladly go back in time and risk life imprisonment for shooting Orville and Wilbur Wright if they felt that would have prevented the flood of red ink that has trailed the airline industry over the following 104 years. For them, December 17, 1903 was not a great day.

Certainly the industry is not one that fills the basic requirements of a good investment. Its financial returns are classically well below those of any sound corporate investment: the variables that surround it are enormous, entirely unpredictable and frequently well outside the control of management; the complexity of the industry itself has to be seen to be believed, from operational to commercial; and the intense political and popular fascination with the industry only serves to distort sound business management.

So, when airlines today scream about high fuel input costs, this is in reality only the tip – albeit a big one - above the array of issues that form the base of the iceberg of airline challenges.

In fact, fuel costs may deliver the impetus for a widespread move to rationalise the industry. But, less obviously, the effects of an above average growth rate over the past five years are having an equally important impact on airlines’ bottom lines – indeed, even on their basic operations. Rapidly rising aircraft lease prices and the accompanying shortage of aircraft, along with skills shortages, had already made new entry near-impossible. And incumbents were suffering too.

Of the other issues, the best-publicised is the growing pilot shortage. Even if current traffic growth rates diminish, this promises not to be just a cost-push item, but more fundamentally, to restrain the growth itself.

Pilots unions would also suggest that shortages threaten to reduce safety margins, although there is no statistical evidence to that effect yet. (However, in a survey this month of 140 safety and other airline professionals by Ascend Worldwide, the biggest barrier to further improvements in safety, was a “shortage of experienced personnel” when ranked out of 10 potential threats – and 56% of respondents felt that “the level of airline safety will stay the same or worsen over the near to medium term”.)

IATA has forecast a need to train 19,000 pilots annually for the next couple of decades, to meet fleet expansion needs. New training schools are gradually being added, as the demand creates a commercial underpinning for third parties and the airlines themselves. But the Centre estimates there is still a shortfall of between 3-5,000 pilots – annually. In other words, until enough new facilities are fully functional, that number is accumulating each year.

The raw effects are being felt mostly at the smaller end of the market. Regional airlines, which tend to be the training ground for new pilots, but cannot offer the “glamour” of flying jets or of international flying, are seeing their flight crews passing through even faster than in the past. The problem is exacerbated as experienced instructors are taken out of circulation, courted by airlines to fly commercially. Across the world, airlines are faced with similar problems, whether they translate to higher costs or to pure shortages.

There are market-based solutions to this, as with most financial equations. Sooner or later, supply rises to meet the demand, as providers see a market opportunity. But the market for pilots is not evenly distributed across a level playing field. And responding to demand is not a matter of turning on a tap. Producing a suitably qualified captain ideally takes nearly a decade of experience – and every commercial aircraft needs a captain.

It may be that the emerging economic slowdown will help alleviate each of these constraints, oil costs, aircraft prices and skills shortages. But it will not happen evenly - and probably not in the regions where the shortages are most pressing. New entrants will spring up as conditions become more hospitable; and so the cycle continues.

Whether or not pilot shortages do translate into a safety issue, that threat alone should be enough to demand widespread industry action to provide better for the future. There are undoubtedly sufficient commercial imperatives to make collective approaches a good idea.

The present poaching “system” might satisfy short term needs. But in an industry which, for all its investment flaws, is a global benchmark in operational cooperation, a more creative and long term approach is essential.