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The case for wider and deeper liberalisation of air transport

Brian PearceChief Economist

This presentation is available online at: This presentation is available online at: www.iata.orgwww.iata.org/economics/economics

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The case for liberalisationWhy air transport is similar to banking

Bank credit facilitates trade and market transactionsAir connectivity facilitates trade and globalisation

The case for liberalisationWhy air transport is different to banking

Risk of failing financial system largely from lack of regulatory oversightRisk of failing air connectivity largely from restrictive market access and ownership regulations

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The case for liberalisationBest practice regulation is focused on market failure

Bank prudenceAir transport safety and security

The case for liberalisationNo clear market failures justify regulating market access or airline capital and ownership structures

4

Other network industriesalready have commercial freedoms

BankingElectricity and gasTelecomsMedia

Liberalisation has brought large benefits to air travel consumers

Airline passenger yields deflated by consumer prices

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006

US

cent

s/R

SM

0

5

10

15

20

25

Euro

cen

ts/R

PK

US domestic (left scale) Intra-Europe (right scale)

-50%

-30%

Source: ICAO, AEA

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Employees have also benefited from post-liberalisation expansion

Source: US GAO study

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

Passengers Number of pilots Pilot compensation Real yields

Ann

ual %

cha

nge

US since deregulation EU since deregulation

There have been large benefits for the wider economy as well

Liberalisation of Thailand-Malaysia marketEstimated impact of MOUs to Bermuda 1 provisions 1996-2006

37% rise in traffic

4,300 jobs created

US$114m boost to GDPSource: InterVISTAS study

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Studies have shown consistent wider economic benefits

Liberalisation of Australia-New Zealand marketEstimated impact of Single Aviation Market 1996, Open Skies 2002

56% rise in traffic

20,600 jobs created

US$726m boost to GDPSource: InterVISTAS study

Deeper liberalisation would bring additional economic benefits

Liberalising the US-UK Bermuda II bilateralModel-based forecast of impact

Open Skies only: +1-25% UK benefits

Open Skies + OAA: +9-34% UK benefitsSource: UK CAA study

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Studies suggest additional economic benefits would be significant

US-EU Open Skies liberalisationModel-based forecast of impact

Passengers:Economic benefits:Jobs:Source: Booz Allen Hamilton study

Open Skiesonly+26m€6-12bn+70,000

O&C liberalisation(incremental benefits)

+15-40m€4bn+1,800-10,000

Further cost efficiencies possible from deeper liberalisation

Potential synergies/ scale economies

4% average ROIC

21% average ROIC

Network airlines vs lowest cost for within-Europe operations

11.6

4.1

0.5 1.2

2.2

2.4

1.1

0

2

4

6

8

10

NetworkAirlines

Labour Aircraft andFuel

Infra-structure

Product,Distribution,

Overhead

Seat DensityAdjustment

Ryanair

€ce

nts

per A

SK

Potential synergies/ scale economies

21% average ROIC

Source: McKinsey, IATA

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Deeper liberalisation may address financial unsustainability of airlines

Cost of capital/ target ROIC

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

1993 1995 1997 1999 2001 2003 2005 2007

% in

vest

ed c

apita

l

Airline industry ROIC

WACC

Source: IATA

The problem is not with business models

Airline returns on invested capital (ROIC)

0

1

2

3

4

5

6

7

8

NetworkAirlines

LCCs NetworkAirlines

LCCs NetworkAirlines

LCCs

Total US Europe

% in

vest

ed c

apita

l

Average cost of capital/ target ROIC

Source: McKinsey, IATA

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The problem is not geography

0

1

2

3

4

5

6

7

8

Total US Europe Asia

1996-2000 2001-2004 Cost of Capital

% in

vest

ed c

apita

l

Airline returns on invested capital (ROIC)

Average cost of capital/ target ROIC

Source: McKinsey, IATA

There are serious problems in the air transport value chain

Returns to capital invested (ROIC) in the air transport value chain (1996-2004)

0.0

5.0

10.0

15.0

20.0

25.0

CRS

Lesso

rs

Freight F

orward

ers

Ground han

dling

Manufac

turers

Fuelling

Travel

Agents

Caterin

g

Mainten

ance

Airports

Airlines

% in

vest

ed c

apita

l

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Rat

io o

f upt

urn

to d

ownt

urn

RO

IC (v

olat

ility

)

ROIC, left scaleVolatility, right scale

Source: McKinsey, IATA

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But returns are unsustainably low for air transport as a whole

Annual investor returns (US$bn) in the air transport value chain (1996-2004)

-14

-12

-10

-8

-6

-4

-2

0

2

Manufac

turers

Lesso

rs

Airports

Service

s

Airlines

CRS

Travel

Agents

Freight F

orward

ers

Non-Acc

ounted

Total

Inve

stor

Ret

urn

(US$

billi

on)

+0.3 +0.2

-1,1 -0.2

-11,7

+0.7 -0.01 +0.4~11

Source: McKinsey, IATA

Now fallout from financial crisisthreatens to damage air transport

Asset prices

200

400

600

800

1000

1200

1400

1600

1800

1992 1994 1996 1998 2000 2002 2004 2006 2008

MSC

I equ

ity in

dice

s

50

70

90

110

130

150

170

190

210

230

Cas

e-Sc

hille

r US

hous

e pr

ice

inde

x

US house prices(right scale)

US equity prices(left scale)

World equity prices(left scale)

Source: Haver

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Fuel prices have subsided - so have foundations for air travel and freight

50

70

90

110

130

150

2003 2004 2005 2006 2007 2008

Con

fiden

ce in

dex

0

20

40

60

80

100

120

140

US$

/bar

rel

Oil price (right scale)

US consumer confidence (left scale)

Source: Haver

International passenger and freight tonne-kilometersSource: IATA

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

Jul-0

5

Sep-05

Nov-05

Jan-06

Mar-06

May-06

Jul-0

6

Sep-06

Nov-06

Jan-07

Mar-07

May-07

Jul-0

7

Sep-07

Nov-07

Jan-08

Mar-08

May-08

Jul-0

8

Sep-08

% c

hang

e ov

er y

ear

Air freight FTKs

Passenger RPKs

Traffic volumes have already weakened very sharply

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Causing the industry to shrinkand put economic benefits at risk

Scheduled ASK planned growth - all regions Source: IATA SRS Analyser

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09

% c

hang

e ov

er y

ear

Losses expected to continue in 2009

8.2 8.5

3.7

-13.0-11.3

-7.5-5.6

-4.1

-0.5

5.6

-5.2-4.1

-15.0

-10.0

-5.0

0.0

5.0

10.0

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008F 2009F

% s

ales

-15

-10

-5

0

5

10

US$

bill

ion

Net lossesUS$bn (RHS)

Operating margin% (LHS)

Source: ICAO, IATA

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More airline bankruptcies likely in months ahead

Source: Air Transport Association, Morgan Stanley ResearchAirline bankruptcies and service cessations since 1978

Commercial freedom requiredBanking crisis accentuates fundamental problems

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Commercial freedom requiredLiberalisation brings great benefit to consumers and the wider economy

Commercial freedom requiredLow airline returns mean scarce capital is not being used efficiently

Consumer and wider economic benefits at risk if airline performance unsustainableBut this is not due to business modelsIt is not due to geographical marketIt is only marginally due to the value chain

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Commercial freedom requiredRemoving the barriers to restructuring airline capital is key to long-term sustainability

May avert widespread airline failuresWill generate cost efficiencies improving returns and reducing faresCan be achieved maintaining safety, security and labour standards