PILARSKI SAYS… Cycles in aviation: where are we right now?
Cycles in aviation: where are we right now?
Although there are differences of opinion about where we are in the cycle, most agree the peak is in sight, writes Adam Pilarski, Senior Vice President at Avitas
Everybody in our industry accepts that aviation is highly cyclical. There are many reasons for that. First, economies are cyclical and aviation is strongly tied to the economy. There are some cycle deniers who hope that this time realities changed and we finally achieved a recession-proof period, because new developments make history superfluous. The timing of a downturn is notoriously difficult to predict and historically has been often precipitated by external shocks or policy mistakes. However, as sure as night follows day (trust me, I am a doctor) a future recession will happen. The basis for economic cyclicality, for those who insist on knowing, is the so-called accelerator-multiplier effect related to the investment component of economic activity. The reason that aviation is more cyclical than other branches of the economy is that our industry can justifiably be characterized as luxury. Human needs to eat or for health care are deemed more critical than the joy of flying. Hence, our industry faces what economists know as an elastic demand curve. This means that as incomes go up by 1%, the number of passenger miles will rise by, say, 2%. The opposite happens on the way down because we stick more with eating than flying to exotic travel destinations. The same goes for business, where as our incomes go up, the value of our time rises and we are loath to waste it on getting to our destinations by slower means than air travel. While passengers are the backbone of aviation, many of our readers deal with the movement of assets that move passengers. The environment for aircraft is layered with a slew of additional relationships causing cycles. As traffic increases, airlines desire additional lift. New aircraft are not instantaneously available – hence, airlines place new orders. They also scrounge for capacity at lessors and bid up prices of existing aircraft. The time to produce a new aircraft, even assuming no backlog, is an added factor contributing to the intricate pattern of lags guiding the aviation cycle. As orders increase, they signal to manufacturers to raise production levels. As backlog increases, the lags between orders and deliveries lengthen. This relationship faces a different pattern on the way down. As airlines face much lower demand as a result of deep recession, they do not need added capacity and would rather reduce their fleets. The manufacturing process, though, cannot be stopped abruptly because of long-term supplier contracts and more units are introduced into a system that no longer wants them. The cycles faced by the different players in aviation are not the same and are subject to various lagged effects. Usually the economy falters first which causes traffic to decline, affecting demand for aircraft and airline profitability. Supply factors still continue expanding but after some time are affected and start declining. Aircraft values, which are highly variable by type, vintage and phase of production, have a cycle that lags the economic and airline cycle. Indeed, in May 2014 I wrote a column in this journal headlined “Rashomon and the aviation bubble debate” describing how out of kilter the perceptions of the financial and manufacturing communities were with respect to the phase of the aviation cycle each community believed we were in. During the May Euromoney Airfinance Conference in Miami I asked the participants to rate their subjective feeling regarding where we are in the cycle. The participants were asked to vote as to whether they believed we were at a low point (trough), rising, peak or falling past peak points in the cycle with regard to the economy, airline industry, manufacturing and value of aircraft. The almost 100 people voting very strongly supported the view that we were either rising towards or already had reached the peak. This view was supported by on average 85% of the participants. Substantially more believed that we were already at the peak. This was especially the case with manufacturing where 57% of the participants believed we had reached the peak. To collaborate this finding further, Boeing shared with me the results of voting of participants at their superb seminars for financiers conducted in New York, London and Tokyo. Their beliefs about values were similar to those voting in Miami. The share of participants believing values were either at their peak or two-thirds towards their peak was between 79% and 92%. Also, more than half in each city believed there was a possible oversupply coming in the next three years. Interestingly, the highest percent (London) of participants who believed a potential oversupply was on the horizon also believed that values were at their peak – a very appropriate causal relationship of value and demand/supply balance.