Aerospace industry is flying turbulent course

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There’s an old joke about two men in a dark tunnel. One says he spots a light at the end. The other replies: “Let’s hope it’s not a train coming our way.”

The warning could apply these days to the aviation industry, which, at the recent Dubai air show, sought to put an optimistic gloss on its prospects next year.

Senior EADS and Boeing executives claimed that they were finally seeing a flickering light at the end of the tunnel. They were confident that the market would eventually start recovering by the end of next year.

But the industry seems to be heading for even greater turbulence. If you believe veteran aviation expert Chris Tarry, the industry is facing fundamental change in its economics that will inevitably imply some pretty painful structural adjustments. In his latest contribution to the economic analyst series of international airline association IATA, Mr Tarry makes the obvious point that the aviation industry cannot escape the rules of economics even if it seems to have done everything it could in the past to do so.

The simple fact is that there are already too many planes in the sky and far too many new planes on the manufacturers’ order books.

In a rational world, airlines should be striving to balance supply and demand and achieve the necessary prices and revenues to cover their costs and make a reasonable return.

In other words, in a recession that inevitably reduces revenues but not necessarily airline costs – the cost of fuel, by the way, has been rising again – the rational thing would be to cut capacity by grounding aircraft as well as deferring and cancelling orders for new ones.

But Mr Tarry argues that, in a sector as competitive as the airline industry, carriers often indulge in apparent irrational economic behaviour to protect their volumes and market share with the hope of taking traffic from rivals or seeing them exit the market.

A majority of airlines also tend to hang on “for a bumpy ride” with the expectation that the cycle will eventually turn and they will be in a good position to take advantage of the recovery.

That too could be wishful thinking this time round given the fact that the industry is suffering from what increasingly appears to be a structural and not merely cyclical reduction in revenues.

IATA is forecasting a fall of some $80bn in industry revenues this year compared with 2008, and that industry revenues next year will still be about $60bn lower than in 2008.

So an adjustment is inevitable, all the more so since, in the current cycle, the industry as a whole will not be able to rely as it did last time on the low-cost airline sector coming to the rescue.

These airlines helped prop up the market for single-aisle 150-seater jets that have long been the cash cow of manufacturers – whether Airbus or Boeing.

But there are good reasons why the low-cost airlines will not be able to kick start a quick industry recovery this time. First, they tend to turn over their aircraft after seven to nine years, so an airline such as Ryanair will not require delivery of new single-aisle jets until 2013.

Second, there is a limit on how low-cost the low-cost airlines can go. This would imply even more favourable terms for new aircraft purchases. Third, the planes they will eventually be disposing of will still be relatively new and will inevitably put even greater pressure on prices in the second-hand market.

All this is bad news for manufacturers that have long relied on the single-aisle sector to provide the cash for developing their wide-body and jumbo aircraft programmes. Just like the airlines, they will soon realise that the real, painful adjustment of the aviation industry has yet to come.

Dubai cliffhanger

The entire aviation industry in the Middle East must be sitting on the edge of their collective seat to see how the financial crisis in Dubai unfolds – not least Airbus and its parent EADS, which are far more exposed in the region than is their US rival Boeing.

Any eventual impact of the crisis on Emirates, the government-owned national carrier and one of the industry’s recent big success stories, would have dire repercussions on the European manufacturer because of Emirates’ large outstanding orders for its A380 super-jumbo and other aircraft.

Emirates was one of the major launch customers of the A380 and has ordered 58 jumbos out of the current A380 order book totalling close to 200 aircraft.

If anything should happen to Emirates, it would be another severe blow to the manufacturer’s already troubled A380 programme.

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