INTERVIEW: IATA confident air travel will ride economic turbulence despite high jet fuel costs

Global economic weakness is unlikely to derail the recovery in air travel demand to pre-COVID levels by 2024, but the threat of high jet fuel cracks through next year is a significant concern, according to Marie Owens Thomsen, the International Air Transport Association's chief economist.

While IATA sees passenger growth slowing sharply in 2023, it believes that as long as unemployment rates remain low or are falling, demand is likely to continue to grow and keep the recovery on track.

"At the current junction we do not perceive any significant risk of a reduction in demand for travel until unemployment rates start rising," Owens Thomsen said in an interview with S&P Global Commodity Insights.

While IATA sees demand returning to 2019 levels in the next couple of years, there are regional variations, with travel likely to recover to pre-COVID levels in the US in 2023 and in China in 2025.

Global weekly scheduled airline seat capacity added 200,000 more seats to reach 102.5 million for the week starting Aug. 8, according to aviation data company OAG, putting global capacity less than 14% below 2019 levels.

Owens Thomsen said Aug. 12 that the industry has had many experiences in the past with higher oil prices and these have not necessarily been devastating in terms of demand destruction or financial results, highlighting 2011-2014, when oil prices also hit triple digits and the airlines were profitable collectively.

"Managing costs and thinking creatively about how to generate revenue has been the hallmark of airlines during this period... War in Europe, high oil prices, high inflation overall, and lingering travel restrictions all ensured in 2022 that those skills at airlines will continue to be in great demand," Owens Thomsen said. The Dated Brent oil benchmark rose to close to $140/b in March on supply-side fears after Russia invaded Ukraine and which has since seen inflation in major economies spiral higher.

"These factors are likely to produce an inferior outcome compared to if the industry had not had to face those headwinds... but our industry today finds itself close to posting a positive financial result this year and likely will next year, which is a phenomenal performance," she said.

Demand destruction?

The top economist at the air travel body noted that under normal circumstances, airlines compete mainly on price, and demand is sensitive to price evolutions, but she pointed out that there is less evidence of such price sensitivity in this post-COVID travel boom.

"This rather unusual situation might fade into 2023 as inflation and higher interest rates might bite into disposable incomes more significantly next year... Moreover, precautionary savings accumulated during the COVID period might progressively become depleted and hence contribute to greater price sensitivity of demand going forward," Owens Thomsen explained.

The main concern from IATA is this very demand destruction -- economic weakness combined with persistently high jet fuel costs.

Owens Thomsen pointed to "the limited refinery capacity globally and the fact that jet fuel is not necessarily the priority at those refineries," and flagging that this "could well spell a higher crack spread for longer, and likely throughout 2023."

Platts assessed CIF Northwest Europe jet fuel cargoes at a premium of $60.50/mt over front-month ICE LSGO Aug. 8, down from $62/mt a week earlier, with FOB FARAG barges at a $50.25/mt premium, down from $60.50/mt, according to S&P Global data. Oil product refining margins spiked higher on strong demand and availability fears in recent months and despite some easing in July, cracks remain at elevated levels, especially for diesel.

Platts Analytics also notes international leisure travel continues to exhibit evidence of picking up and should continue for the remainder of the summer, along with a lagging pickup in business travel, adding that incremental uplift will come from a pick-up in Asian international travel in countries that have remained notably impaired, including China and Japan.

Structural challenges

Owens Thomsen also highlighted the structural challenge the industry faces stemming from the disjointed value chain.

"Airlines are price-takers upstream in the value chain where oligopolies reign (aircraft manufacturers, airports, etc.), and face global instantaneous price discovery regarding their perishable product (seats and cargo on planes)," the economist said, highlighting that the whole value chain would benefit if airlines were less squeezed in this sense.

While airlines have a choice to make between compressing their already thin margins or passing costs on to consumers, Owens Thomsen said the normal functioning of any industry is to aim to cover its costs and hopefully realize some profits that can be used for future investments.

"While any consolidation is subject to regulation, with over 5,000 airlines in the world, one can easily imagine that some consolidation would benefit the industry, notably in the context of the industrial concentration in the upstream value chain," she said.

Owens Thomsen also explained that as an indebted industry, higher inflation is actually helpful in terms of reducing the real value of that debt and its debt service costs.

"Interest rates are mostly still below the rate of inflation, meaning that the real interest rate is negative. This is a good time to carry debt. However, it is still necessary to earn enough cash to be able to amortize and service the debt in nominal terms. Hence it remains crucial for airlines to maintain a high degree of liquidity," she pointed out.

"Into this mix of challenges, we must also throw in the exchange rate risk," Owens Thomsen said. "An appreciating US dollar is not helpful for anybody with earnings and debt in a different currency. Exchange rate movements can exacerbate the oil price increase and cancel the inflationary benefits."