Increasing oil prices, low-budget competition and skilled labour shortages are sending the aviation industry into a state of flux.
By Leithen Francis
In case of turbulence
In the past couple of years the airline industry has experienced a boom period. Despite high oil prices, 2007 saw strong traffic growth of 5.9 per cent and even stronger revenue growth of 8.4 per cent. The International Air Transport Association (IATA) estimates airlines around the world posted a US$5.8 billion profit last year.
'A favourable economic environment and effective efficiency measures helped mitigate the impact of high fuel prices,' reveals the Geneva-based association, which represents the world's major airlines.
But some of the challenges the industry has managed to ride up until now are getting tougher in 2008. The average price of fuel this year is expected to be US$78 a barrel compared to US$73 in 2007, says IATA, adding that 'there will also be a broadening impact of the credit crunch'.
If a $5-a-barrel increase is hard to quantify, the bottom line is that revenue growth will slow to 4.7 per cent and traffic growth to 4 per cent. 'The peak of the business cycle is over,' IATA has declared.
North American carriers will see the largest fall in profitability, from US$2.7bn in 2007 to US$2.2bn in 2008, according to IATA. Asian carriers will also see a drop in profitability of around US$100 million, yet robust traffic growth to and within Asia is expected to partially insulate carriers from the impact of the crunch.
'The Middle East will remain stable at US$200m, supported by ambitious route expansion, while Latin America is the only region to see profitability improve by US$100m, to break even in 2008,' says IATA.
The problem of high oil prices has led some airline bosses, such as Singapore Airlines' CEO Chew Choon Seng, to quip they no longer work for the airline but for the oil companies.
Generally speaking, fuel has increased in price to the point where it represents about 35 per cent of an airline's total expenses. This is assuming the airline has a number of fuel-efficient aircraft. In the case of airlines that operate only old aircraft, the percentage can be higher. Air Philippines, for example, operates eight Boeing 737-200s that are around 25 years old. Airline president Edilberto Medina says fuel accounts for 50 per cent of Air Philippines' total expenses.
Some financially sound carriers have dealt with the challenge of rising fuel prices by buying new aircraft that are more fuel-efficient. Mandala Airlines, which is one of Indonesia's largest carriers, has replaced most of its ageing 737-200s with new Airbus A320s. It could afford to do this because last year the airline was bought outright by wealthy Indonesian logistics company Cardig International and cashed-up American private equity firm Indigo Partners. Mandala CEO Warwick Brady says a new A320 burns 30 per cent less fuel than a 737-200, even though the A320 is a bigger aircraft, with 180 seats compared to 120 on the 737-200.
Another example is Cathay Pacific Airways, which is phasing out its Airbus A340-600s in favour of Boeing 777-200LRs. The A340-600s that Cathay uses for non-stop lights to New York are still fairly new aircraft. But because the 777-200LR has only one engine on each wing, it is more fuel efficient. The push for greater fuel efficiency, occurring at the same time as last year's buoyant economy and the launch of new airlines, meant there was a huge surge in aircraft orders.
Last year Boeing booked a record 1413 net orders, an increase from its previous record of 1044 in 2006 and 1002 in 2005. The increase in demand for aircraft has also flowed through into the lease market. Jon O'Connell, senior VP of sales at AWAS, the world's third-largest aircraft leasing firm, says lease rates have increased, but that the percentage increase depends on the aircraft type. Surprisingly, says O'Connell, in terms of the percentage change, the demand for older aircraft such as Boeing 767-300s and Boeing 737-300s has increased more than newer air-craft. This is because in the wake of the 2001 US terrorist attacks these aircraft types experienced the sharpest falls in lease rates.
For example, the monthly lease on a Boeing 737-300 was US$90,000 to US$130,000 in 2002 but now the market rate is US$175,000 to US$200,000. 'We are not seeing any let-up in demand in the market at the moment,' says O'Connell. 'Availability is still very tight.'
There is such a huge backlog of orders that if an airline places an order now, it will usually take three years for the aircraft to be delivered. Even if an airline wants and can afford newer aircraft, it may have no choice but to operate old aircraft in the short term. Some major US carriers fall into this category.
Many of the US airlines were unable to order new aircraft a few years ago because they were in voluntary bankruptcy. Delta Air Lines, which exited Chapter 11 bankruptcy in April last year, still has Boeing MD-88s as the mainstay of its domestic fleet, even though some are nearly 20 years old. Northwest Airlines, which exited Chapter 11 bankruptcy in May 2007, has about 100 McDonnell Douglas DC-9s in service, most of which were built in the 70s and 80s. IATA says North American carriers will see the largest fall in profitability in 2008 because 35 per cent of the fleet is over 25 years old, so the impact of high fuel prices is greater than in other regions.
There are also other expenses, besides fuel, to bear in mind when operating older commercial aircraft. Conor McCarthy, the former Ryanair executive who is a co-founder and consultant to Malaysian low-cost carrier AirAsia, says older aircraft cost more to maintain. Sometimes a start-up company will opt to lease older aircraft because they can't afford new, and think old aircraft are good value. But they underestimate how much needs to be spent on a spare-parts inventory, and later learn that sourcing spare parts for an old aircraft type can be difficult, says McCarthy. If a carrier has to ground an aircraft because it has a technical problem and it takes two days to source a spare part then ultimately it costs the airline more.
Air Philippines' Medina says that about every five years it costs his airline US$300,000 to complete a heavy maintenance check and US$300,000 to do a lap joint check (a major airframe check) on a 737-200. He says it makes no sense to spend US$600,000 on such an old aircraft, which is why the airline will be grounding and disposing of the 737-200s when the aircraft fall due for a heavy maintenance check.
Besides fuel, another challenge airlines are facing is a shortage of skilled and qualified personnel, and this in turn has led to an increase in labour costs. Jeff Roberts is group president of innovation, civil training and services at international aviation training company CAE. He says analysts around the world have forecast the global shortage of pilots to be 15,000 to 20,000. Roberts says many analysts are suggesting it could take 10 to 15 years before the supply of pilots increases to levels high enough to meet demand.
'Even though a lot of infrastructure and training programs are being put in to address the shortfall in supply, there are still a lot of people to train,' he says.
The other problem is that there is not just a shortage of pilots but also a shortage of maintenance personnel and cabin crew, Roberts adds. The labour shortage is particularly acute in Asia, where airlines have been expanding the fastest. For example, a few years ago in India there were only two major carriers: Air India and Indian Airlines. But today there are several other big players such as Air Deccan, GoAir, Kingfisher Airlines and Jet Airways.
Commercial aviation is truly a global business; skilled pilots and other personnel can go wherever they earn the most money. The Indian government has tried to alleviate the problem by increasing the retirement age for pilots to from 61 to 65, and is quickly working to establish new training institutions for pilots and maintenance engineers. China's airline industry has also experienced tremendous growth. The Civil Aviation Administration of China (CAAC) estimated that from 2004 to 2010 the country would need to recruit 12,000 pilots.
Yet at that time China's state-run pilot training schools were producing only 850-900 pilots a year. To change the situation China has expanded the state-run training colleges, allowed the establishment of privately owned pilot training schools, and has sent recruits overseas for training. China's airlines are also making up for the shortfall by employing foreign pilots, further adding to costs.
Even countries such as Australia that have traditionally enjoyed a surplus of pilots, now have a shortage. Lim Kim Hai is chairman of Australia's largest independently owned regional carrier Regional Express (Rex). He says the company's annual attrition rate for pilots is 65 per cent. 'How can any organisation cope with this?' Lim asks rhetorically, adding that 'it doesn't look like the attrition rate will slow [considering the] massive orders for aircraft at Qantas Airways, Jetstar and Tiger Airways.' The lure of more money and the opportunity to fly larger air-craft is irresistible for many pilots. Lim says his airline has been forced to ground aircraft and suspend some flights because of the pilot shortage. Rex is establishing its own flying school, which will produce its first batch of qualified commercial pilots this year and is expected to produce 60 to 80 graduates per annum.
All these cost pressures are occurring at a time when consumers increasingly have an expectation that airfares should be cheap. This change in perceptions has largely been driven by the emergence of low cost carriers seeking to generate publicity and win market share by offering ridiculously low fares.
And the success of some overseas low-cost carriers such as Southwest Airlines in the US and Ryanair in Europe has spurred on some full-service carriers to establish low-cost carriers of their own. Low cost carriers generally have a lower cost base than many full-service carriers because they operate only one type of aircraft, don't offer free food and drink on board, operate on short-haul routes, and have fast turnaround times and high aircraft utilisation.
Yet even if an airline adopts the low-cost carrier business model, there is still no avoiding the bigger challenges.
Singapore-based Leithen Francis is the deputy Asia editor for weekly aviation magazine Flight International and online news service Air Transport Intelligence.
The airline industry's top five challenges to overcome in order to stay in the black:
Rising fuel prices.
Wage pressure.
Shortage of skilled and qualified personnel.
Higher purchase price and lease rates on aircraft.
Price competition from low-cost carriers and other airlines.
The pilot crisis: causes, effects and solutions
If you're planning to fly to the Snowies for a pre-season ski, you might be in for a nasty surprise and a long drive.
Compelled by the pilot shortage crisis, Regional Express Airlines (Rex) has suspended its flights between Sydney and Cooma, as well as its Melbourne / Griffith and Maryborough / Brisbane routes. And the situation is going to get worse, says Rex chief of staff Jim Davis, adding smaller airlines and emergency services will bear the brunt of the crisis.
A growing demand for Australian pilots is the primary reason behind the shortage. An increasing number of carri-ers within Australia and a booming industry in China and India has seen a scrabbling for staff. Aviation in the Asia-Pacific region is growing at such a rate that aircraft manufacturer Boeing predicts that 89 per cent of all new aircraft deliveries will be to the region over the next 20 years.
Within Australia, Rex estimates the industry will need an additional 1800 pilots over the next two years. But it is likely to train far less than half that number, and many of those will soon be poached by overseas companies.
Training for a commercial licence costs about $80,000, which is a major impediment to increasing recruitment, and will only be relieved if government includes this training in HECS.
In addition to these costs, many students are increasingly attracted to industries such as IT that have the promise of higher salaries.
Yet while local enrolment numbers have dropped, thousands of international students are being turned away, because there is also a shortage of flying instructors. A Future Pilot Task Force met for the first time in February to address the crisis.
Pilot shortages were put at the top of a list of key industry risk factors, acknowledging instructor numbers needed to increase by at least 15 per cent. 'What we have identified is that it is difficult to retain pilot instructors for a range of reasons, including the high demand in the job market for working pilots,' taskforce convenor and University of South Australia head of aviation Steven Phillips said.
