Open To All Readers
By Judson Rollins
July 13, 2020, © Leeham News: As the world waits for the COVID-19 storm to abate, questions are growing over the duration of a demand downturn for airlines.
Many journalists and industry observers have been obsessively searching for “green shoots” indicating the beginning of a recovery, but much of this commentary misses the mark. For instance, much attention has been focused on capacity restoration in the US and China. However, little is known about the percentage of seats filled by Chinese carriers – and last week United Airlines told employees in an internal presentation that while US carrier capacity in July is back to 47% of 2019’s level, it believes industry traffic has only reached 28% and revenue just 19%.
Last month, investment research firm Bernstein published an analysis calling for narrowbody traffic to recover by 2023 and widebody traffic by 2025. This is consistent with most public forecasts from airlines, banks, and industry observers. The firm’s analysts said that single-aisle concentration in short-haul and domestic routes should see them returned to 2019 utilization sooner than twin-aisles due to reduced long-haul demand and lower demand in short-haul markets previously served by widebodies (e.g., in most of Asia).
LNA believes that 2024 is the earliest possible date for a return to 2019 global passenger traffic – and it could conceivably take until 2028. Many obstacles lie between the present situation and a full recovery: deployment of a successful vaccine (or vaccines), rollback of border restrictions, passenger confidence in the medical safety of air travel, and most importantly, restored willingness to pay by business and leisure travelers. Specific countries or regions – especially those with local vaccine production – may recover sooner, but a global recovery to pre-COVID traffic levels requires all these to happen at a global scale.
To be clear, LNA’s definition of “herd immunity” is that of the global medical community: population-level resistance to virus transmission that occurs because a large majority have been vaccinated or previously infected. This differs from an increasingly popular usage of the term in reference to the passive infection-oriented virus management approach taken by Sweden and other countries.
As widely reported, business investment has slowed significantly or even halted in most regions of the world as uncertainties abound across nearly every aspect of business operations. When it withdrew full-year earnings guidance in late April, paper products giant Kimberly-Clark cited “high levels of uncertainty [in] global business and economic activity, consumer and end-market demand, global supply chain operations, and volatility in foreign currency exchange rates and commodity costs.” When even a producer of toilet paper struggles with so many unknowns, it’s hard to imagine how other businesses can navigate the current environment.
Such a breadth of issues was not seen in previous downturns. All these unknowns make it difficult for any business to invest in people or infrastructure, which puts a hard brake on any economic recovery. Subsequent waves of COVID-19 cases will only increase these uncertainties.
A vast array of industries has already been affected by the current recession, as opposed to the global financial crisis of 2007-2009, where the downturn was highly concentrated in the financial sector and eventually radiated to others. During this period, GDP in developed economies fell by 3.3% according to the IMF. As of April 2020, the combined GDP of these countries had already fallen 6.1%.
Since 1900, the average US recession, or period of flat to negative GDP growth, has lasted 15 months. The longest was the Great Depression of 1929-33, which lasted 43 months. Global recessions are harder to define as developing-country GDP growth often remains positive even as developed countries see negative growth. In any scenario, however, it takes significantly longer than the technical end of a recession for full employment to be restored and economic output to return to its pre-recession trajectory.
The range of economic and medical uncertainties in the current crisis, combined with the breadth of industries affected, make it likely that the COVID-19 economic crisis will be of greater magnitude and duration than any since World War II. Whether it eclipses the Great Depression depends on how long economic activity is restricted by the pandemic. The social restrictions imposed by many governments to limit the spread of COVID-19, while necessary, will damage an ever-wider spectrum of companies and jobs. This in turn lowers consumer willingness to spend on anything other than essentials and reducing corporate willingness to invest in future growth. Both have obvious implications for airlines and their suppliers.
Although rapid testing, contact tracing, and improved therapeutics will reduce the need for social distancing and local/regional lockdowns, international air travel will continue to be impaired by border restrictions, passenger concerns about infection, the sheer unpleasantness of anti-viral precautions (mask use, pre-departure testing, etc), and the inconvenience and lost productivity of self-isolation or quarantine requirements on arrival. Rolling back these measures will require herd immunity to COVID-19, meaning most people must be exposed to the virus through infection or a vaccine.
The earliest possible approval for any vaccine is October of this year, for a candidate under development of the University of Oxford’s Jenner Institute. However, researchers at the institute and pharmaceutical partner AstraZeneca caution that such approval would be based on limited clinical data and would likely only allow vaccination of high-risk groups. If multiple trials prove effective, full approval would probably follow in early 2021.
The Johns Hopkins School of Public Health estimates at least 70 percent of the world’s population – or 5.6 billion people – must be exposed to the novel coronavirus in order to achieve herd immunity. No company currently in the race to produce a successful vaccine has committed to a production capacity of more than two billion doses per year, although a couple are planning to start producing doses this year even before safety and efficacy have been proven to the satisfaction of regulators.
Even with pre-approval production of successful vaccines, worldwide production and distribution will take at least 18-24 months from approval absent significant supply chain, regulatory, or geopolitical hurdles, such as individual countries hoarding doses. This means global herd immunity is unlikely to take hold until late 2022 at the earliest, even if highly developed countries like the US achieve it sooner.
The (justifiably) accelerated pace of vaccine trials also means we may not know how effective any approved vaccine is until after it has been in wide distribution for some time. It’s also unclear whether any vaccine will provide long-lasting immunity or whether subsequent “booster” doses will be required. Moreover, virus mutation may mean new COVID-19 strains aren’t captured in the first round of approved vaccines.
With these risks in mind, individual governments are unlikely to roll back border restrictions until large portions of their respective populations have been vaccinated and new COVID-19 cases stay near zero for an extended period. LNA believes bureaucratic caution will lead most countries to take an additional 6-12 months after herd immunity is achieved before reopening to most inbound non-resident passengers.
This means most cross-border travel will be restricted until sometime in 2023 in an optimistic scenario. Network carriers dependent on inbound non-resident traffic, such as Turkish Airlines, or those reliant on non-local connecting traffic, such as Emirates or Singapore Airlines, will be among the last to return to 2019 traffic levels.
Even for domestic or regional travel, passengers must feel safe from infection before they’ll fly again. Mask use is widely believed to reduce infection risk, and Airbus and Boeing are touting the effectiveness of the HEPA filters installed on their aircraft. However, many travelers won’t be convinced that the close confines of an aircraft cabin are safe until rapid and reliable pre-departure virus testing is available, or virus case loads are low at both their origin and destination. Airlines can expedite this by leveraging the presence of key influencers demonstrating renewed convenience and comfort of air travel.
Most authorities will prioritize vaccination of those who have the most public contact: health workers, police and safety personnel, retail and restaurant staff – and hopefully airline flight and cabin crews. Vaccinating those who interface with the public is an easy way to “break the infection chain” early the fight against COVID-19. At the same time, the development of forgery-resistant vaccination credentials will make it easier for vaccine recipients to receive permission to enter countries whose borders would otherwise remain closed to foreigners. In theory, frequent travelers could also be given priority in a country’s vaccination queue, although this may raise questions of social equality.
Most countries will see a fall in economic output during the pandemic in direct proportion to their dependence on external trade and tourism. This means countries with greater internal consumption of domestic production should recover sooner than trade-dependent countries. Accordingly, domestic travel in the US, EU, and China is likely to return sooner than in most other regions. On the other hand, any significant economic downturn in trade-dependent countries will not begin to reverse until cross-border traffic flows are restored.
Growing geopolitical tensions are a risk that shouldn’t be ignored, and COVID-19 may create an excuse for “politics by other means.” For instance, could the US and EU impose reciprocal visa requirements on supposedly medical grounds? What if China were to cut off travel to/from the US or Europe? These are hypothetical questions, but a return to previous traffic levels assumes no material changes in freedom of movement.
Getting business travelers back on airplanes will require renewed economic activity, in addition to the obvious safety requirements. This will be a top priority for airlines as business customers contribute an outsized proportion of revenue in many markets. The higher yields these passengers bring will help get airlines closer to profitability, giving them confidence to restore capacity on a larger scale.
However, business travel after the 9/11 attacks in America never returned to the same extent as business travelers permanently adapted to their short-term inability to fly. Improved video conferencing technologies like Zoom, Skype, and Google Meet make a similar structural shift all but inevitable as businesses learn how to operate in a COVID-impaired world where air travel is challenging and inconvenient.
Leisure travel requires customers with adequate disposable income and confidence that their income levels will be secure for the foreseeable future. Any economic downturn damages both. To be coaxed back into air travel, the leisure passenger must believe a given destination is within their travel budget – not just in terms of airfare but also accommodation and activities.
However, as long as travel demand remains depressed, supply will fall in other parts of the travel ecosystem, especially hotels (partly offset by alternative providers like Airbnb). Some will be converted to long-term residential accommodation (i.e., apartments) or other uses. This infrastructure takes longer to restore than airline capacity, and its scarcity will have an obvious effect on prices in the meantime. Higher accommodation cost means a higher overall cost of travel and limits airlines’ ability to stimulate demand, further slowing the restoration of passenger traffic.
While airlines are likely to lead the market with additional capacity before demand is fully proven – as is already the case in the US – this will be a trial-and-error process. Airlines that restore capacity too quickly will see their profitability dented as too many seats chase too few passengers and are likely to pull back if they don’t stimulate enough demand at high enough yields to break even.
As passenger demand increases and airlines restore capacity, more seats will be made available at lower fares as airlines work to stimulate demand. This will happen as a natural outgrowth of the restoration of business and consumer confidence – but prior availability of lower fares is required to get budget-conscious travelers back in the air. To the extent that business travel is permanently impaired, low-cost carriers will have opportunities to fill any gaps left by full-service carriers.
There will be a long tail of leisure travel destinations waiting for traffic to return to pre-COVID levels. Each country’s or region’s recovery will depend on its distance from key inbound markets, relative cost, and stringency of border restrictions. Inexpensive destinations within close reach such as Cancun or Ibiza will see a return to normalcy much sooner than far-flung and high-cost ones like Mauritius or New Zealand.
Airline traffic will return eventually, of course; history shows this to be inevitable. But the myriad factors at play – medical, regulatory, economic, and behavioral – are largely intertwined and will not be overcome at the same pace in all countries, or perhaps even across the developed world.
This analysis assumes no changes in the infectiousness of COVID-19. If the virus were to mutate into more infectious strains, or if vaccines do not deliver lasting immunity, then one would expect the timeline for airline recovery to be worse. Conversely, if subsequent strains prove to be less easily spread, the industry could see a return to pre-COVID traffic levels sooner.
All of this means previous demand downturns are unlikely to be reliable models for the duration or shape of a post-COVID recovery in air travel. It portends continued pressure on airlines, lessors, manufacturers, and suppliers for most of the decade.