Also see "Reaching for the Skies" by ATA Vice President & Chief Economist John Heimlich
Is the industry back on solid footing?
Conditions are much improved, and the initial economic outlook for 2007 is the most promising in years. In addition to a healthy revenue environment, U.S. airlines are seeing the results of painstaking, ongoing cost reduction efforts and balance-sheet repair. However, debt levels remain high, leaving the airlines vulnerable to fuel spikes, recession, or exogenous shocks (e.g., terrorism, pandemics, natural disasters), not to mention ill-advised public policy decisions. The challenge airlines face is to achieve meaningful and sustainable profits, and to improve credit ratings to the point where they can weather normal economic turbulence while simultaneously investing in their future.
When did the U.S. airline industry last report an annual net profit?
In 2000, U.S. passenger and cargo airlines recorded a $2.5 billion net profit, reflecting a 1.9 percent margin. From 1997 to 1999, the industry enjoyed net margins of 4.3 percent to 4.7 percent. (Put in perspective, these rates, which were a deregulated (post-1978) airline industry “high-water mark,” compared unfavorably to the range of 5.4 percent to 6.7 percent enjoyed by the average U.S. business over the same three years.) Between 2001 and 2005, excluding extraordinary restructuring charges and gains, the industry posted $35 billion in cumulative net losses. For this and other financial information, see ATA’s historical table of financial results.
What is the earnings outlook for 2006 and 2007?
For U.S. passenger and cargo airlines, as of January 2007, ATA is projecting an aggregate net profit (excluding bankruptcy restructuring and/or reorganization charges) of $2 billion to $3 billion for 2006 and $4 billion for 2007 on operating revenues exceeding $150 billion. Again, it bears noting that consistently superior margins for the average U.S. business illustrate the pressures on airline balance sheets and the importance of vigilant cost control.
How would you compare the 2007 revenue environment to 2006?
Passenger revenue was relatively strong in 2006, but remained sharply below comparative historical levels. Passenger revenue since 2001 has dropped to 0.73 percent of U.S. gross domestic product (GDP) from the 1980-2000 average of 0.95 percent. In today’s economy, that translates to $32 billion in “missing” revenue. That structural decline in demand, along with stubbornly high fuel prices, is keeping the industry laser-focused on cost containment. Global economic growth has begun to slow, and barring any dramatic changes to the industry-operating environment, passenger and cargo revenue growth will decelerate in 2007.
Capacity, as measured in available seat miles (ASMs), is expected to rise 2.5 percent from 2006, in line with projected U.S. GDP growth of 2.5 percent to 3 percent. Airlines are working tirelessly to bring the breakeven load factor requirement down from the low-80s, where it has resided for the last few years. Meanwhile, they are investing in new seats, refurbished interiors and in-flight entertainment systems to generate additional revenue.
What is the 2007 fuel-price outlook? What are airlines doing to conserve fuel?
ATA projects the average price of crude oil to approximate $60 per barrel in 2007. Refined product markets will remain tight on rising world demand and limited U.S. refining capacity. ATA sees average jet fuel prices exceeding $1.80 per gallon in 2007, down slightly from 2006. Historically, fuel has accounted for 10 percent to 15 percent of the airline industry’s operating expenses, whereas today fuel contributes to 20 percent to 30 percent of operating expenses and has become the top cost (overtaking labor) for many carriers. As tracked in our Airline Cost Index, fuel costs have risen from close to one cent per ASM in early 2002 to more than three cents per ASM as of the second quarter of 2006.
For comprehensive information on fuel price trends and fuel efficiency improvements, see Energy Challenges Facing U.S. Airlines or ATA’s fuel efficiency page.
How do labor expenses factor in to the equation?
From August 2001 to October 2006, employment at traditional network airlines dropped by more than 170,000 – 38 percent of the pre-9/11 workforce. These losses were offset only modestly by job growth of about 15,500 at low-cost and regional airlines. (Additional information is available on ATA’s Labor page.) Labor restructuring has resulted in substantial gains in airline productivity and contributed enormously to the industry’s remarkable recovery. As tracked in our quarterly Airline Cost Index, labor costs have fallen from more than four cents per ASM in late 2001 to just below three cents per ASM as of the second quarter of 2006.
What are some other cost areas to watch?
Airlines continue to simplify their fleets and reduce the number of sub-fleet types. They have disposed of older airplanes to curb not only fuel and labor expenses but also maintenance costs and fuel-related emissions. This important trend is expected to continue in 2007. At key hubs, airlines continue to streamline schedules while simultaneously increasing their global presence both through their own flights and via expanded worldwide alliance arrangements. They also have closed obsolete facilities, shifted bookings to lower-cost distribution channels, expanded the deployment of self-service check-in kiosks at on- and off-airport locations, and improved Web site functionality to provide customers with more options and control of their travel experience. By necessity, the changes are numerous and ongoing.
Is government policy or intervention hindering the industry’s return to profitability?
While the airlines have done yeoman’s work in a remarkably difficult environment, there are limits to what they can do to help themselves. The government can alleviate the barriers to sustained airline profitability by lessening some of the operating inefficiencies it imposes upon the industry. In particular, restructuring the air traffic control (ATC) system, including both how it operates and is funded, is a critical first step.
Today, airlines constitute about two-thirds of FAA-controlled flights but pay more than 90 percent of the bill. In return, the airlines are stuck using a 1950s ground-based, radar-dependent navigation system with legacy facilities and processes. This results in unnecessary delays to airlines and their customers, which consume more fuel, crew time and other resources. Non-airline users of the ATC system are growing at a healthy clip and consume more and more system resources but do not pay in proportion to that growing use.
Airlines should pay for the costs they impose on the ATC system – but no more. Airlines and their customers should not be expected to subsidize the 17,000 business aircraft operating in the United States, which constitute the largest use of FAA-controlled airspace after airlines. If funding were tied to usage, FAA would have sufficient revenues to build and maintain a scalable system that worked for all and could accommodate the demanded level of civil aviation activity expected over the next two decades. Current FAA leadership is committed to turning things around, and has made important strides, but much work remains to be done in transitioning to an ATC system that meets future needs and determining how it is to be fairly funded.
What about security costs?
In addition to taxes and fees used to support the ATC system, airlines contribute more than $3 billion annually in special taxes/fees to the Department of Homeland Security (DHS) to ensure safe and secure travel in the U.S. transportation network. Every year since 2001, the airlines have been pressured to pay increasing amounts to fund national security that is, by all accounts the responsibility of the federal government. At the same time, unfunded security mandates are imposed with insufficient prioritization based on risk management or cost-benefit analysis. ATA endorsed the creation of DHS partly because it was an opportunity to improve homeland security while simultaneously eliminating inefficient governmental agency redundancies that had crept into the system over time. Yet, airlines continue to pay six separate DHS fees whose total has risen, not fallen. Moreover, ATA is disconcerted that DHS may have used some aviation funds for non-aviation purposes such as border patrol.
An effective public-private partnership in passenger- and cargo-related aviation issues should facilitate economic activity while maintaining safety and security. Remember, U.S. airlines operate in a global economy. A healthy U.S. airline industry, operating in an efficient commercial aviation system, is among the key ingredients of U.S. economic growth and competitiveness on the world stage. A March 2006 study by the Campbell-Hill Aviation Group found that commercial aviation ultimately drives 11.4 million U.S. jobs, or 8.8 percent of the nation’s employment. If aviation markets are allowed to work, other U.S. markets will also work better.
Are there any other major policy issues confronting the industry?
Yes – the prospect of emissions trading or other misguided schemes imposed upon the airlines. Airlines contribute approximately 8 percent of global economic activity but less than 3 percent of man-made greenhouse gas (GHG) emissions. Since airlines have a powerful economic incentive to reduce GHG emissions, which relate directly to fuel consumption (and expense), airlines have improved fuel efficiency more than 70 percent over the past 30 years, extending long before GHG emissions became an issue. Said differently, unlike many other industries, GHG emissions are not an “economic externality” for airlines; therefore, regulations designed to make airlines “internalize” the cost of GHG emissions are ineffective and unnecessary.
Legacy ATC systems and noise rules often force airlines to fly inefficient routes, creating easily avoidable GHG emissions. In fact, a modernized ATC system offering more efficient air navigation services could cut fuel use and greenhouse gas emissions 10 percent to 15 percent annually. In addition to the airlines’ continual pursuit of greater fuel efficiency, ATA is actively supporting the development of alternative fuels.
So one profitable year, let alone one quarter, is not enough?
Precisely. What the industry is seeking is sustained financial health. Achieving a normal rate of return will help airlines invest for the long term. Ultimately, financial stability in the airline industry is good not only for airlines and their customers, but also for the rest of the economy. U.S. airlines must remain competitive globally to continue to foster the nation’s economic growth.