Daily Memo: Interest, Currency, Oil—How Shifted Fundamentals Affect Airlines

As the global airline industry heads into 2023, the worst and most disruptive phase in its history appears to be over. 

Demand has returned substantially wherever travel restrictions designed to contain COVID-19 have been lifted. What the industry now faces feels more familiar: an astonishing level of uncertainty, big fluctuations, and seemingly longer-term shifts in economic factors well outside of its control, alongside increased operational challenges with airports, aircraft manufacturers, other suppliers and regulators.

Kerosene is now almost twice as expensive as IATA anticipated at the beginning of the year, the reason of course being Russia’s war against Ukraine and its fallout. Meanwhile, the U.S. dollar has appreciated significantly vis-à-vis the euro and many other currencies, changing the economics for airlines with large exposure to U.S. dollar debt and with a high share of revenues in other now-weaker currencies. After a long period at very low levels, interest rates have risen again, making debt more expensive to service. Inflation and the rise in labor costs appear to all but guarantee a structural increase in operating costs.

Looking back around 10 years ago helps put things into perspective. Then, the industry was emerging from the Great Recession and entered an unusually long upturn, which resulted in exceptionally high profits, particularly among U.S. legacy carriers. That this unprecedented surge took place was no coincidence. The airline industry benefited from economic fundamentals that played in its favor. Low interest rates allowed airlines and lessors to finance aircraft orders, some of which they would not have been able to afford with rates at normal levels.

Fuel costs were also low, with a relatively brief exception, giving room for carriers to accelerate demand for air travel through relatively low air fares. The weaker U.S. dollar helped airlines fund aircraft purchases, which are usually denominated in American currency. The more favorable exchange rate helped with many other costs, too, crucially fuel. Travel became more popular than ever as more and more people could afford it. Customers were willing to spend as travel replaced other “consumers goods” as a top priority. And, frankly, the 2010s were a decade of mostly talk—and not a lot of action—on tackling climate change. People simply traveled anyway.

As shown, almost all factors supporting growth back then are pointing in a different direction now. There are two exceptions. While inflation hits airlines’ costs and customer’s savings pots, it does reduce the real value of debt. And employment levels have almost never been as high as they are today in Europe and the U.S., making people comfortable to still spend money on flights.

Of course, inflation could recede, and fuel costs are likely to come down somewhat if and when the war in Ukraine ends.

At the same time, climate activists are now blocking runways at European airports on an almost weekly basis. And while that may be an extreme case of protests, the awareness that flying is not good for the environment has certainly risen compared to a decade ago. Flight shaming has emerged and with it regulatory action by some governments to limit flying. The Dutch government is leading the charge as it prepares to introduce a movement cap at Amsterdam Schiphol, one of Europe’s biggest hubs and the basis for KLM’s network model.

Policies like this are not going away and will make growth harder to achieve. The transition to a more sustainable industry will also not come for free, instead requiring large amounts of investment. Sustainable aviation fuel (SAF) alone is three to five times more expensive than Jet-A. Consumers will ultimately have to pay through higher fares.

It is probably too soon to tell just how difficult the latter part of the 2020s will become. But the golden times of the 2010s are long ago and far away, and they will not return.