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Leeham News and Analysis
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ISTAT 2016: Air transport market at cross-roads
By Bjorn Fehrm
September 29, 2016, ©. Leeham Co: We visited ISTAT (International Society of Transport Aircraft Trading) 2016 conference in Barcelona this week. The most interesting part of the conference was the economists panel with discussions between the economist: Brian Pierce, chief economist of IATA; Peter Morris, chief economist at Ascend; and Adam Pilarski, SVP and Head of Consulting, AVITAS.
The economists agreed that the air transport market is at a cross-roads, but not which route it will take.
Let’s start with the market facts presented by IATA’s Pierce:
Air travel surprisingly resilient
IATA and others have continuously been mistaken on the resilience of world air travel growth, Figure 1. The red line is actual air travel which can be compared to the IATA forecasts over the years.
Figure 1. IATA forecasted and actual air travel. Source: IATA.
Air travel growth stayed at 6% or better over the years despite the world economy growing slower than the economists predicted in recent years, Figure 2.
Figure 2. IMF forecasted and actual world economic growth. Source: IATA.
The question is why? Pierce showed that air travel has been stimulated by lower air fares, principally triggered by Low Cost Carriers, LCCs. These have also opened new destinations, Figure 3. The low fuel prices have augmented this trend.
Figure 3. Growth of city pairs and decline of air fares. Source: IATA.
The growth in air travel has not been evenly distributed. Figure 4 shows that the largest market, US, grew at 4%; China as second largest at 7%, while India grew at 20%. Russia is standing still and Brazil is contracting.
Figure 4. IATA travel market statistics of market size and growth. Source: IATA.
World economy slowing
The growth in air travel is seen against a world economy which is slowing down from a modest cycle, Figure 5. World trade is now at zero growth.
Figure 5. Global economic cycle indicators. Source: IATA.
There are many indicators that show that we are heading for problems, continues Pierce. To stimulate a sluggish economy, the central banks have been injecting money in the system, Figure 6.
Figure 6. Central banks inject money in a slow world economy. Source: IATA.
Other debts continue to grow, Figure 7. The result is a growth in asset prices which are now back above the level of the Global Financial Crisis, Figure 8.
Figure 7. Debt of non financial sector. Source: IATA.
Figure 8. Asset price development. Source: IATA.
Those are market signals which have been present at previous downturns in the world economy. Pierce also showed how wages and company profits now have the trends that have proceeded recessions, Figure 9.
Figure 9. Movement in wages and company profits precedes recessions. Source: IATA.
Economy at cross-roads
The economists could therefore agree that the world economy and thereby aviation markets are at a cross-roads, Figure 10.
Figure 10. World economy and therefore aviation market at cross-roads. Source: IATA.
They would not agree on which way the world economy will take, however. IATA’s Pierce and Ascend’s Morris tended towards the optimistic scenario, especially when it comes to air travel.
“Air travel consumption is not governed by the same laws as goods consumption,” Morris said. “When you have bought your fourth iPhone, your propensity to buy a fifth is limited. It is not the same with air travel. The growth comes from new layer of society having the disposable income to travel.”
“We witness that politics that are for open trade and cooperation gets replaced by ‘simple messages’ politics that blame foreigners for all evil and preach isolationism (e.g. Brexit’s “we want our country back”),” said Pilarski, who was for the pessimistic route. “I see less trade, less economic growth and weak governments that don’t dare to take the right actions,” he continued, “We shall also not be so naive as to think economic cycles have gone away; they have not.”
Pierce and Morris argued that in a downturn, the air travel and therefore commercial aircraft business will not be gravely affected. Airlines are acting more rational when it comes to capacity expansion, especially in the US market.
Once again Pilarski did not concur: “What says that the European, Middle East and Asian airlines have not all built their to/from Asia traffic growth on the same passengers?”
“politics that are for open trade and cooperation gets replaced by ‘simple messages’ politics that blame foreigners for all evil and preach isolationism (e.g. Brexit’s ‘we want our country back’) said Pilarski
Thats a bit strange as the EU is a highly protective trading block, which does limit outside immigration as well.
What had changed is that the UK had become back fro the GFC with a roar and most of the rest of the EU stagnated with high levels of unemployment. As well the immigration inflow in the UK had increased markedly due to better economic conditions. The UK has long had a much more open approach with immigration from its Commonwealth, which would shame the rest of Europe ( apart from France).
Its does seem that commentary over Brexit is a sort of bubble mentality, the economic aspect has been totally rubbished and as time goes by most of the rest of the predictions will be too. Especially the civil aircraft production, there was a common belief Airbus is some sort of EU only favourite son( they wish!)- so it was finis for UK after Brexit. Airbus has a global supply chain and it makes little difference for them., other factors being much more important
Here are the key points discussed by Pierce and Morris:
1- “Air travel growth stayed at 6% or better over the years despite the world economy growing slower than the economists predicted in recent years. The question is why?”
2- “World trade is now at zero growth.”
3- “There are many indicators that show that we are heading for problems.”
4- “The growth in air travel [correlates with] a world economy which is slowing down from a modest cycle.”
5- “Those [debt vs asset] are market signals which have been present at previous downturns in the world economy.”
6- “[Pierce and Morris] could therefore agree that the world economy and thereby aviation markets are at a cross-roads.”
This is a very interesting discussion, but something is missing. For we should be concerned by three things and only two are considered here:
1- World economy.
2- Air travel.
3- Aircraft orders.
As it has been demonstrated above there is an obvious correlation between the world economy and air travel. But it would be much more difficult to establish a correlation between the world economy, air travel and aircraft orders. Since 2008 we have been through the largest recession since 1929; it’s called the Great Recession for a reason. And it could be argued that we have not yet fully emerged from it. Yet, after 2008 the Big Two continued to gather one order after another, and their order books are full like never before. In the aftermath of 9/11 there was a much more immediate impact on aircraft orders. But post 2008 the only sector that was seriously impacted was business aviation. And this may have been triggered by President Obama shaming the CEOs of GM and Chrysler that had landed in Washington onboard their luxurious private jets to ask for corporate welfare assistance.
My view is that aircraft orders have their own individual cycles. And widebody cycles are not necessarily correlated with narrowbody cycles; I would say they are mostly independent from each other. But whatever individual cycle commercial aviation may find itself in at any given time, it can still be impacted by a major economic downturn. As I mentioned above we have actually witnessed just that post 9/11. But if the Great Recession had little impact on commercial aviation it can only mean that there might also be other forces at play. In fact the world economy and aircraft orders have their own independent cycles that can either 1- cancel each other (zero growth); 2- add to each other (negative growth); 3- have no impact on each other (positive growth). Number 2 is what we saw post 9/11. Number 3 is what we saw during the Great Recession. Number 1 is what I expect to see in the coming years.
Lets not forget fuel prices.
I was told I was wrong. Like most bubble momentum related aspects, they don’t turn on a dime but a fuel prices have stayed down the orders have dropped off despite low interest financing .
Im thinking its just a natural cycle, a falloff after one of the previous drop in plane orders.
9/11 was 15 or so years now, ( a good time to offload your high time workhorses) for many carriers they didnt order much then so dont need to replace them. We could see a similar drop off when we reach 15 years after the GFC ?
What we have witnessed since 2008 is this:
1. Low fuel prices.
2. Low interest rates.
3. Low economic growth.
4. High aircraft orders.
Low fuel prices don’t explain the high aircraft orders that we have seen in recent years. Same thing for low economic growth. In fact only low interest rates are favourable to high aircraft orders. That being said, low fuel prices will likely have a delayed positive effect on future aircraft acquisitions because airlines are now in a more favourable financial position. The US and EU are mature markets but the rest of the world should continue to make progress because the emerging economies have not yet reached their full potential. However, because of the looming world recession that growth is likely to slow down markedly. If commercial aviation was less impacted post 2008 it is probably because China was still going full steam at the time. And since most of the growth was coming from the Asian market we might see a marked decline in orders coming from that region. But the growth potential in terms of air travel remains underdeveloped in Asia and various other places on the globe. Since most airlines are healthier today I don’t expect negative growth, but only zero growth, in the coming years. By zero growth I mean that for the aircraft manufacturers the book to bill ratio will likely remain slightly below one for an extended period of time. My personal impression is that we are in for the long term because of the impact Brexit might have after Article 50 will have been triggered early next year. Markets in general don’t like uncertainty and Brexit means wall to wall uncertainty, and for an extended period of time. If we add to this some serious banking problems in Germany we have good reasons to believe that we may be about to go through some sort of global stagnation morass, that is almost no growth accompanied by little inflation. That is why I think the party is probably over for Airbus and Boeing.
If I were in charge of supply of anything in this industry I would be focusing on costs and cost alone. The degree of uncertainty relating to orders, world Economy etc etc means that the OEMs and first and second tier will have to accept a burn of the backlog and hope that there is an upturn before gaps start appearing. The saving grace is the vast size of that backlog. It is when we get substantial and multiple cancellations that the real concern arises.
Hi everybody, longtime reader of this great site here but first time poster so please bear with me if my thinking does not appeal to you. I’m not an economist but in marketing and sales so maybe my view is biased.
I think Normand Hamel is on to something with his view that aircraft sales have their own independent cycles. Look at the sales numbers of Airbus and Boeing each time after they offered a new or significantly improved model. B. got a sales bump after the 787 and 737Max were announced, A got a bump after the 320neo and the 350. Could it be that sales numbers relate more to efficiency gains than anything else?
Imagine this scenario; no growth of the world economy, no growth or even a decline of airtravel. Now OEM xy brings a new model to market, its 20% more efficent than the planes currently flying. Would it sell? I think so. Airtravel may be low but its still a market, the best offer wins, so airlines will need the new model to cut cost and be more competitive. What do you think?
I totally agree with you. I have been saying for sometime now that it is the aircraft that defines the market, not the other way around. You say you are in marketing, do you seriously think people need to get a new iPhone every year? Yet they do, for many of them find it is imperative to get the latest and greatest. Aviation is no different, except for scale. You ask the following question: OEM xy brings a new model to market, its 20% more efficent than the planes currently flying. Would it sell? My answer is yes if it’s Boeing or Airbus, but not Bombardier. Boeing and Airbus are well recognized brands. But who is that company with a hard to pronounce name? And what is a company with a military name doing in the commercial aircraft business? Ironically, it’s the only aircraft manufacturer that is not producing military aircraft. Why do I bring the case of BBD up? Because they offer exactly what you propose: a 20% more efficient plane. Imagine if the C Series was a six-abreast with the name Boeing on it. The backlog would be 3600 instead of 360. Marshall McLuhan famously said that the medium is the message. Well, I dare to say that the aircraft is the market.
Its not just the name. No one wants to be stuck with a plane order from a company that cant pay its bills.
The executive/business aircraft field is littered by some recent great designs that get built and then dropped.
Hawkers gone. The Horizon only did just under 75 produced, yest its older models based on the 125 made 1500 +
Learjet is going going…..
My favourites, the Piaggo Avanti ( turboprop) is finished as a commercial aircraft -despite being better than the Kingair series, and the Gulfstream 150 is no longer offered.
And yet mediocre products made by Cessna soldier on
“The OEMs and first and second tier will have to accept a burn of the backlog and hope that there is an upturn before gaps start appearing.”
It will be interesting to see what they will do with production rates. Until recently they wanted to bring them up to unprecedented levels, but I am afraid they may have to curtail their ambitions. Of course it’s too early to say if they will have to lower production, but if the current downturn is going to last for an extended period of time we have to expect a concomitant production slowdown. And this would allow some overstretched suppliers to catch their breath.