War has impacted aviation recovery

The consequences of Russia’s war against Ukraine have spread far beyond that country’s borders. While the human costs have been unimaginably and unconscionably high, the economic fallout needs to be calculated as well. Increased fuel costs, airspace restrictions, reduced consumer confidence and a rising cost of living have all combined to set back the post-Covid air travel sector recovery.

“This is the last thing the industry needed,” says Thomas Conlon, associate professor of banking and finance at UCD. “It’s certainly going to postpone what airlines were hoping would be a full recovery. It’s creating a number of challenges and some of them relate to demand from customers. The inability to fly over Russian and Ukrainian airspace is also affecting them – 3 per cent of European flights are impacted by that.”

Those restrictions can have a very significant impact, according to Dr Marina Efthymiou, assistant professor in aviation management at DCU. “If you’re flying to Tokyo from Europe, it can add 1,400 nautical miles to the journey,” she points out. “Certain countries are more affected than others. Sweden, for example, had a lot of routes that flew through Russian airspace. Longer flights use more fuel, they take more time for customers, and create more environmental damage. It is a big problem.”

That disruption is magnified by oil price increases. “Fuel usually accounts for around 30 to 35 per cent of the operating costs of an airline,” says Efthymiou. “Oil had rose by 27 per cent in the first month of the crisis and by 14.3 per cent in the following month. Overall, there was a 126 per cent rise in the year up until then. Operating costs for airlines are significantly higher and those costs will be transferred to passengers at some point.”

Hedging

The blow has been softened by hedging in some cases.

“The picture becomes more complicated when some airlines hedge,” Efthymiou adds. “Ryanair is very good at reducing costs and that applies equally to fuel. They have hedged 80 per cent of their fuel requirements at $63 per barrel. That was a very good deal. They now have a competitive advantage over other airlines which haven’t hedged – until the second quarter of 2023 at least. Air France KLM have done the same at $90 per barrel for 53 per cent of their fuel. American Airlines and United haven’t hedged. They are disadvantaged relative to those who have. Smaller airlines are more affected by this, and it might lead to some going bankrupt.”

The financial pressures on the sector have also been exacerbated. “Funding is becoming more challenging,” says Conlon. “It is more difficult and more expensive now. Airlines run on very small margins, and some may run into liquidity problems. One thing we know is that airlines do go out of business from time to time.”

And this comes at a time when interest rates were rising anyway. “The lessors will look at that and say they are happy,” he notes. “Many of them have funded their businesses at historically low costs and there is no major shortage of capital at the moment. But they will have to go out for more at some point.”

The leasing business has been badly hit, nevertheless.

“It’s terrible,” says Efthymiou. “The Russians broke the deal and 513 aircraft worth $10 billion were impacted. Only 32 of them came back to the lessors. That’s a very small percentage. Aercap had 135 planes leased to Russian airlines and they managed to get 22 of them back. They were the most successful. Most of the planes will probably never come back. And if they do, we don’t know when. And Boeing and Airbus won’t be supplying spare parts for those planes and their value will keep falling because they won’t have maintenance records. It’s the first time something like this has happened. They broke the Cape Town Convention. The lessors are now submitting insurance claims. The impact on insurance companies will be huge.”

There are longer-term consequences as well. “Lessors will probably refuse to deal with Russia. Russia has lost its credibility,” she adds.

Conlon agrees. “Russia was one of the big emerging growth markets for the industry. It is difficult to see how lessors could lease to Russian airlines in future. Insurers may change the terms and conditions as well. The lessors may be forced to look elsewhere for growth.”