31 AUGUST 2020
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In this exclusive paper which provides cause for some deep thinking, BTN’s regular contributor Chris Tarry has partnered with his “Five Aero” aviation consultancy team colleague, Rowland Hayler, to offer their perspectives on a number of key challenges facing the industry.
"The last six months have been tumultuous for the entire global air transport industry. Airlines and airports have taken unprecedented steps to cut costs and boost their liquidity through new funding arrangements. Nation states have responded in a variety of different ways. Germany, France and The Netherlands have reached deep into their pockets (€9.0bn, €7.0bn, €3.4bn respectively) to support their national carriers and in so doing, have raised interesting questions about the potential for market distortion. No doubt the well managed low-cost carriers (LCC), which up and until the onset of Covid-19 were also highly profitable with healthy balance sheets, will be making representations to the appropriate authorities, in the appropriate way, at the appropriate time.
For now, the shape and scale of the recovery is anyone’s guess and there is no shortage of guessing going on. One of the things that many commentators now appear to agree on, is that the recovery is likely to be long, discontinuous and asymmetric – i.e. painful. Whilst this presents the industry with numerous and indeed unprecedented challenges, it also provides an unique opportunity for the industry to re-imagine, re-calibrate, re-form and return in a more resilient and sustainable way for the future. Necessity is the mother of invention.
So, what are the key challenges for passengers, airlines, airports and national air traffic control providers (Air Navigation Service Providers)?
Let’s start with first principles. In simple terms, Air Transport is a highly integrated value chain that is driven by consumer (passenger “PAX”) spending. No PAX spend, no airline revenue, no flights operated, no means for air traffic control to recover their costs from airlines, no passengers at airports, no airport revenue.
In the new Covid-19 reality, most consumers will only spend on air travel if they’re confident that travelling will not
Whilst a range of health-related measures have been taken by airlines and airports to provide passenger confidence (e.g. social distancing, face masks, heightened cleaning and disinfecting regimes), it is clear that significantly more sophistication is required with regard to test, track and trace capabilities and inter-governmental policy alignment – and it was required yesterday.
Despite the best efforts of airlines to drive sales activity in an attempt to salvage something from this disastrous summer, given the current lockdown and quarantine uncertainties, passengers quite understandably appear to be increasingly booking their travel late. This raises its own logistical and forward planning challenges for airlines as well as having an impact on cash in advance of carriage and prices. How can they nimbly plan and respond in a cost efficient and profitable way when many of the historical patterns and norms that underpin their planning cycles are erratically being turned upside down?
Airport managements face significant challenges too and since they have little control over revenue, their only lever is to manage cost. Operational expenditure per passenger is likely to increase as airports are unable to reduce or avoid operating costs in line with the reduction in passenger numbers where there is an inevitable and negative outcome on cash generated – perhaps the only metric that really matters. Many airports have taken a sharp knife to their capital expenditure plans with non-essential programmes placed on hold.
A key concern for many airport managements, given their typically large infrastructure maintenance and development programmes, is how to service pre-existing and newly undertaken financing commitments. Heathrow’s recently published 1H2020 results reveal that since December 2019, net debt has increased by some £570m bringing the total to £14.9bn. Heathrow’s Cash Interest Paid for Q1/20 was £151m on £593m of Revenue. In Q2/20 with Revenue of £119m, Heathrow’s Cash Interest Paid costs had increased to £170m, equivalent to 142% of revenue generated. This is patently unsustainable.
European Air Traffic Control organisations (ANSPs) have similar challenges in terms of revenue loss and unrecovered costs. EU2019/317 sets out the rules and procedures for the ANSP performance and charging scheme and Eurocontrol’s Central Route Charges Office bills and collects route charges from airspace users to fund ANSP services, facilities, and future developments. The charge is calculated on a per flight basis using three elements (1) Distance (2) Aircraft Weight (3) Unit Rate of Charge. This is all well and good when airlines are flying, but Covid-19 has had a significant impact on air traffic volumes. Consequently, ANSP costs have not been fully recovered. In fact, we estimate the total cost recovery shortfall for 2020-2022 is likely to be in excess of €7bn, a sum that is equivalent to the total European ANSP costs for one year. The European Commission is currently exploring temporary derogations and revised union-wide performance targets are expected early Q2/21. It is doubtful this will be much comfort to airlines for unless the regulatory charging framework and mechanisms are changed, it’s highly likely that airlines will ultimately be required to cover the cost shortfall. The only question really is how long they will be given to pay it.
The last six months have been tumultuous for the entire global air transport industry. Whilst a number of airlines are engaged in the “restart phase” there are also a number who are still in effect dormant. The loss of much of the summer will make the winter exceptionally challenging.
We must remain hopeful, although that’s rarely a strategy for business success, nor in this case is “hanging on”, for what may be an even more bumpy ride over many months to come.
FIVE AERO - THE ANALYSIS
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