Turbulent Times Ahead

It is a measure of just how fast the global economy is deteriorating that some of the assumptions upon which the Boyd Group based its aviation forecasts already appear to belong to a different era – just two months after they were published.

The independent outlook was originally produced in October and released at an industry conference in Aspen, Colorado. But in these volatile times even the most educated of predications can soon become outdated.

For example, the global economy has deteriorated markedly in the past few months as the crisis in the financial system has intensified. Furthermore, Boyd's forecasts were formulated at a time when the oil price was hovering above $100 a barrel. In July it had reached $147 a barrel while mid-December values were around $42.

Indeed, in the introduction to its forecasts, Boyd says: "No airplane flying was designed with the concept of $50 oil in mind, let alone $100." It adds: "Fuel costs have eliminated many formerly viable mission applications. Maybe forever."

How the world has changed. At the same time that oil was slumping to just above $40, Merrill Lynch said the global downturn could prove so severe that fuel demand would plummet in 2009, forcing crude oil down to a miserly $25 a barrel.

Downward spiral

While falling fuel costs are undoubtedly positive for the aerospace industry, the economic outlook is now far worse than it was in early October. Traffic volumes were already slowing when Boyd made its forecasts but not to the levels being witnessed just two months later. In October the global economy was undoubtedly facing a slowdown but by December it became much more apparent that nearly all major developed economies were sinking into severe recessions.

Nick Cunningham, an analyst at Evolution Securities in London, said "the net benefit to traffic of falling oil prices will be negligible initially because most airlines have hedged positions. The benefits won't be felt until around a year from now, provided the oil price remains relatively low."

He adds: "Furthermore, the macroeconomic background has deteriorated dramatically and that will have a very big effect. As a rule of thumb, traffic grows by around double the pace of GDP growth. So, if the GDP of the developed economies declines, and it looks like the US, Japan, the UK and probably Continental Europe are going to see negative GDP growth in 2009 and possibly for some of 2010, aggregate global traffic volumes will decline."

Cunningham also says that traffic volumes are likely to come under pressure even in the emerging economies of the world, such as China, where GDP growth is likely to be much lower than was expected just a few months ago. "At the moment, traffic has recovered on domestic routes in the country but international traffic with China is contracting. And, of course, India's volumes have fallen off a cliff.

"While I do not expect to see anything like double-digit declines in traffic next year, we will see low to mid single-digit declines – an outcome which far outdoes the worst previous year, which was 2002."

Falling traffic will have a knock-on effect of very low orders for aircraft going forward. "Indeed, the past few months have already been a desert as far as orders are concerned and I think that this trend will continue for several years," says Cunningham. It then becomes quite likely then that the fleet forecasts outlined by Boyd in October are likely to prove overly optimistic.

Build rates have already fallen for 2009 and there is not much scope to reduce them further since the aircraft are already on the production line. However, Cunningham anticipates that there will be a sharp drop in build rates in 2010 and this slump will continue in 2011 and 2012. Indeed, he forecasts that civil-aircraft build rates will halve between late 2009 and 2012 in a cycle seen many times before.

"This will be the sixth recession of the jet age and volumes have declined by between 38% and 73% during every previous recession," he says.

In Europe, the cut in production will come as a particular shock especially for Airbus which has grown through the last three recessions. But, as Cunningham says, Airbus, "now accounts for half the market and is going to get hit hard."

Historic figures for the aftermarket don't hold up much better. It fell by around 15% in terms of maintenance, repair and overhaul (MRO) in 2002, equal to ten times the fall that took place in terms of traffic, says Cunningham.

He thinks, therefore, that there will be, "a substantial double-digit decline in MRO activity in 2009, followed by an anaemic recovery."

Financial woes

It will clearly be very difficult to finance the purchase of new aircraft given the economic downturn. "Like any other big-ticket item, it is going to be very difficult to arrange finance to buy new aircraft. Most of the purchases in 2009 are already financed but there is a massive question over financing in 2010," says Cunningham.

Boyd also forecast sales through to 2018 by type of aircraft. It says that that until 2018 the category most in demand will be 126-180 seaters where an additional 4,486 units will be required. But once again, this projection was made before the global economic slump. Cunningham says that it is often assumed wide-bodied aircraft and business jets are more resilient than narrow-bodied aircraft during a downturn but in the depths of the last cycle, sales of all three fell by around 40%.

"This time around, I suspect that wide bodies and narrow bodies will be affected equally badly. I think that the only reason that wide bodies have been more resilient in the past is that the sector is a less mature market. Narrow bodies were launched in the late 1950s and wide bodies didn't come along until the late 1960s and early 1970s."

He adds: "The global financial crisis seems to be affecting international trade in particular and international flying appears to be as weak as demand for domestic services, especially in developing markets. I don't think there is any reason to believe that wide bodies will be particularly resilient this time around."

This recession is going to have a particularly big impact on the corporate sector and therefore also on business jets. Cunningham says that the bubble of shared ownership which brought in new players to this sector will see them readily disappear in the coming months. If international meetings are vital even top management will move to using scheduled flights.

It should be remembered that economic prosperity peaks and troughs – recessions are nothing new. But for those in the aviation industry the next few months will be hard and it is a case of the fittest, the leanest and the most agile that will come through this test stronger.