Can Cheap Oil Fuel the Aerospace Sector?

February 3, 2009

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Due mainly to recently fallen oil prices, the U.S. aviation industry shows improved earnings potential. Yet with tumbling demand alongside it, cheap oil may not be enough to keep the industry flying.

The International Air Transport Association (IATA) recently released its forecast for 2009. Unsurprisingly, it's bleak. After posting a global airline industry loss of $5 billion in 2008, IATA predicts a $2.5 billion loss for the industry in 2009. Although totaling merely half of 2008 losses, it will be another tough year for the industry.

The reduction in losses is due to a shift in results of North American carriers that were hardest hit by high fuel prices because of very limited hedging earlier this year, the IATA says. Early domestic capacity reduction in response to the fuel crisis has given the region's carriers a head start in combating the recession-led fall in demand. This lack of hedging and the recent sharp drop in fuel prices is now providing relief for these airlines.

Last year, record-setting oil prices coupled with meager growth in passenger traffic battered North American carriers, the Associated Press reports. This year, they are expected to post a small profit of $300 million, which is less than 1 percent of their revenue.

North American carriers are the only ones expected to be in the black. The rest of the world's airlines are predicted to lose out this year. The IATA breaks it down thusly:

  • Europe — Predicted losses of $1 billion because of hedging that locked in high fuel prices in U.S. dollars. The situation is exacerbated by the weakening euro against the dollar.
  • Asia-Pacific — With 45 percent of the global cargo market stemming from this region, IATA anticipates losses of $1.1 billion due to the forecasted 5 percent drop in the global cargo market.
  • Middle East — Losses forecast to be $200 million as the region copes with lack of capacity, resulting in traffic slows.
  • Latin America — Suffering from the downturn in the U.S., the region is expected to see losses of $200 million.
  • Africa — The region is expected to continue to lose $300 million annually as it struggles to maintain market share.

Overall, even with oil averaging $60 per barrel and the restructuring efforts of airlines, carriers will still struggle because of commercial and cargo traffic drops. Air cargo traffic — which comprises 35 percent of the value of goods traded internationally — is expected to decline by 5 percent this year following a 1.5 percent slump last year. Prior to 2008, the last time cargo decreased was in 2001, when a 6 percent drop was recorded, the IATA says.

"Airlines are struggling to match capacity with fast-falling demand," the AP quoted IATA CEO and Director General Giovanni Bisignani as having said. "Until this comes into balance, even the sharp fall in fuel prices cannot save the industry from drowning in red ink."

Bisignani continued:

Airlines have done a remarkable job of restructuring themselves since 2001. Non-fuel unit costs are down 13 percent. Fuel efficiency has improved by 19 percent. And sales and marketing unit costs have come down by 13 percent. ...In 2008 (the IATA)'s fuel campaign helped airlines to save $5 billion, equal to 14.8 million tons of CO2. And our work with monopoly suppliers yielded saving of $2.8 billion. But the ferocity of the economic crisis has overshadowed these gains and airlines are struggling to match capacity with the expected 3 percent drop in passenger demand for 2009.

In response, airlines pared down scheduled flights, deferred aircraft deliveries or scaled back expansion plans. Air Transport Association (ATA) analysis of Innovata schedules showed the 10 largest U.S. carriers all cutting capacity in the first quarter of 2009. The cuts ranged from 3.3 percent to 22.1 percent.

As a result, airline employment has plummeted, ATA reports. The cutbacks also have trickled down to manufacturers who were forced to scale back production and lay off workers to deal with the falling demand and soaring inventories, Aviation Week says. In December, FedEx deferred delivery of Boeing 777 freighters for up to 17 months, Aviation Week adds. The Boeing Company (and Airbus SAS) will likely have to slow production rates this year to cope with delivery deferrals and order cancellations.

Boeing also recently announced that it would reduce its workforce by approximately 10,000 because of the global economic crisis, Agence France-Presse reports. The cuts will be made "through attrition, retirement and layoffs," Boeing's chief executive Jim McNerney said.

"Analysts fear deeper cuts will be needed in 2009," Aviation Week notes.

Aerospace and defense (A&D), at least in the U.S., seems to be the only aviation sector with a fighting chance against the economic crisis this year. This is due in large part to the 60 percent climb in defense spending during the Bush administration, which will total at least $612.5 billion in fiscal 2009, according to Deloitte's 2009 Industry Outlook: Aerospace & Defense.

Lockheed Martin, for instance, raised its sales forecast for 2009 to range between $44.70 billion and $45.70 billion. Despite a 5 percent sales dip in its aeronautics division, which shifted from making F-16 fighter jets to F-35 planes, the company reported sales growth last year, the AP says. Lockheed, the Pentagon's largest supplier, reported fourth quarter earnings of $823 million and earnings of $3.22 billion in total for 2008 (on sales of $42.73 billion). In 2007, it reported profits of $3.03 billion (on sales of $41.86 billion).

The rest of the A&D industry, in comparison, is expecting leaner, though not woeful, times ahead as the U.S. Department of Defense's budget is likely to flatten or decrease due to expected slowdowns of military action in Iraq and Afghanistan, Deloitte notes.

Still, the A&D sector is "better-positioned to weather an economic crisis than other industries," Deloitte adds. "Defense contractors have significantly improved their balance sheet strength with several years of debt reduction and stock buybacks. ...By focusing on product innovation, process improvements and new revenue opportunities, A&D companies will be well-positioned to take advantage of an economic turnaround."

As for the commercial sector of aviation, Bisignani outlined an industry action for 2009 that called for "industry partners to contribute to efficiency gains. And governments must stop crazy taxation, fix the infrastructure, give airlines normal commercial freedoms and effectively regulate monopoly suppliers."

"The industry remains sick," he says. "And it will take changes beyond the control of airlines to navigate back into profitable territory."


US$2.5 Billion Loss for 2009 for 2009 - Worst Revenue Environment in 50 Years International Air Transport Association, Dec. 9, 2008

Financial Forecast: Lengthy Recession is Now Main Challenge International Air Transport Association, December 2008

World's Airline Industry Lost $5 Billion Last Year The Associated Press, Jan. 29, 2009

Industry Review and Outlook Air Transport Association Office of Economics, Jan. 23, 2009

Breaking Even is Hard to Do, So Why Stop There? by John Heimlich Air Transport Association, Jan. 16, 2009

Opaque Outlook for Aerospace Industry in 2009 by Graham Warwick Aviation Week, Jan. 25, 2009

Boeing to Slash 10,000 Jobs this Year Agence France-Presse, Jan. 28, 2009

2009 Industry Outlook: Aerospace & Defense Deloitte LLP, Jan. 28, 2009

Lockheed Martin Lowers Outlook over Pension Costs by Stephen Manning The Associated Press, Jan. 22, 2009

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