The case for wider and deeper

liberalisation of air transport

Brian Pearce
Chief Economist
This presentation is available online at: www.iata.org/economics
www.iata.org/economics

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The case for liberalisation
¸ Why air transport is similar to banking
¸ Bank credit facilitates trade and market transactions
¸ Air connectivity facilitates trade and globalisation

The case for liberalisation

¸ Why air transport is different to banking
¸ Risk of failing financial system largely from lack of
regulatory oversight
¸ Risk of failing air connectivity largely from restrictive
market access and ownership regulations

2
The case for liberalisation
¸ Best practice regulation is focused
on market failure
¸ Bank prudence
¸ Air transport safety and security

The case for liberalisation

¸ No clear market failures justify regulating
market access or airline capital and
ownership structures

3
 Other network industries
already have commercial freedoms
¸ Banking
¸ Electricity and gas
¸ Telecoms
¸ Media

Liberalisation has brought large

benefits to air travel consumers
Airline passenger yields deflated by consumer prices
18.0 25
US domestic (left scale) Intra-Europe (right scale)

16.0
20

14.0
Euro cents/RPK
US cents/RSM

-30% 15
12.0

10.0
-50% 10

8.0

5
6.0
Source: ICAO, AEA

4.0 0
1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006

4
 Employees have also benefited
from post-liberalisation expansion
7.0%
US since deregulation EU since deregulation
6.0%
Source: US GAO study
5.0%

4.0%
Annual % change

3.0%

2.0%

1.0%

0.0%

-1.0%

-2.0%

-3.0%

-4.0%
Passengers Number of pilots Pilot compensation Real yields

There have been large benefits

for the wider economy as well
Liberalisation of Thailand-Malaysia market
Estimated impact of MOUs to Bermuda 1 provisions 1996-2006

37% rise in traffic

4,300 jobs created
US$114m boost to GDP
Source: InterVISTAS study

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 Studies have shown consistent
wider economic benefits
Liberalisation of Australia-
New Zealand market
Estimated impact of Single Aviation Market
1996, Open Skies 2002

56% rise in traffic

20,600 jobs created
US$726m boost to GDP
Source: InterVISTAS study

Deeper liberalisation would bring

additional economic benefits
Liberalising the US-UK Bermuda II bilateral
Model-based forecast of impact

Open Skies only: +1-25% UK benefits

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

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 Studies suggest additional economic
benefits would be significant
US-EU Open Skies liberalisation
Model-based forecast of impact

Open Skies O&C liberalisation

only (incremental benefits)
Passengers: +26m +15-40m
Economic benefits: €6-12bn €4bn
Jobs: +70,000 +1,800-10,000
Source: Booz Allen Hamilton study

Further cost efficiencies possible

from deeper liberalisation
Network airlines vs lowest cost for within-Europe operations
4% average ROIC

0.5 1.2 Potential synergies/

10 Potential synergies/
scale economies
scale economies
2.2
8
€ cents per ASK

2.4
6
11.6 21% average
ROIC
1.1 21% average ROIC
4

2 4.1
Source: McKinsey, IATA
0
Network Labour Aircraft and Infra- Product, Seat Density Ryanair
Airlines Fuel structure Distribution, Adjustment
Overhead

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Deeper liberalisation may address
financial unsustainability of airlines
10.0 Cost of capital/ target ROIC

9.0

8.0
WACC
7.0
% invested capital

6.0

5.0
Airline industry ROIC
4.0

3.0

2.0

1.0
Source: IATA
0.0

1993 1995 1997 1999 2001 2003 2005 2007

The problem is not with

business models
Airline returns on invested capital (ROIC)

8 Average cost of capital/ target ROIC

7
% invested capital

0
Network LCCs Network LCCs Network LCCs
Airlines Airlines Airlines
Total US Europe
Source: McKinsey, IATA

8
 The problem is not geography

Airline returns on invested capital (ROIC)

8 Average cost of capital/ target ROIC

7
% invested capital

0
Total US Europe Asia

1996-2000 2001-2004 Cost of Capital

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)
Ratio of upturn to downturn ROIC (volatility)

25.0 4.0
ROIC, left scale
Volatility, right scale 3.5
20.0
3.0
% invested capital

2.5
15.0

2.0

10.0
1.5

1.0
5.0
0.5

0.0 0.0
es
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Source: McKinsey, IATA

Fr

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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)

2
+0.3 +0.2
0
Investor Return (US$billion)

-2
-1,1 -0.2
-4

-6

-8

-10 +0.4
+0.7 -0.01
-12 ~11
-14 -11,7
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Source: McKinsey, IATA
Fr

Now fallout from financial crisis

threatens to damage air transport
Asset prices
1800 230
US house prices
1600 (right scale) 210
Case-Schiller US house price index

World equity prices 190

1400 (left scale)
MSCI equity indices

170
1200
150
1000
130
800
US equity prices 110
(left scale)
600
90

400 70
Source: Haver

200 50
1992 1994 1996 1998 2000 2002 2004 2006 2008

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 Fuel prices have subsided - so have
foundations for air travel and freight
140
Source: Haver
150 Oil price
(right scale) 120

130 100
Confidence index

US$/barrel
80
110

60
90

40
US consumer
70
confidence 20
(left scale)

50 0
2003 2004 2005 2006 2007 2008

Traffic volumes have already

weakened very sharply
International passenger and freight tonne-kilometers
Source: IATA
12%
10% Passenger RPKs

8%
% change over year

6%
4%
2%
0%
-2%
-4% Air freight FTKs

-6%
-8%
-10%
M 6

M 7

M 8
6

8
Se 5

N 5

Se 6

N 6

Se 7

N 7

Se 8
08
Ja 5

M 6

Ja 6

M 7

Ja 7

M 8
0

0
0

-0

-0

-0
l-0

l-0

l-0

l-0
-0

-0

-0

-0

-0

-0
n-

n-

n-
p-

p-

p-

p-
ay

ay

ay
ar

ar

ar
ov

ov

ov
Ju

Ju

Ju

Ju

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 Causing the industry to shrink
and put economic benefits at risk
Scheduled ASK planned growth - all regions
Source: IATA SRS Analyser
10.0%

8.0%
% change over year

6.0%

4.0%

2.0%

0.0%

-2.0%
Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09

Losses expected to continue in 2009

10.0 10
8.2 8.5

5.6
5.0 5
3.7
Operating margin
% (LHS)

0.0 0
US$ billion
% sales

-0.5

-5.0 -4.1 -4.1 -5

-5.6 -5.2
Net losses
-7.5 US$bn (RHS)
-10.0 -10

-11.3
Source: ICAO, IATA
-13.0
-15.0 -15
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008F 2009F

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More airline bankruptcies likely
in months ahead
Airline bankruptcies and service cessations since 1978
Source: Air Transport Association, Morgan Stanley Research

Commercial freedom required

¸ Banking crisis accentuates fundamental
problems

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Commercial freedom required
¸ Liberalisation brings great benefit
to consumers and the wider economy

Commercial freedom required

¸ Low airline returns mean scarce capital
is not being used efficiently
¸ Consumer and wider economic benefits at risk
if airline performance unsustainable
¸ But this is not due to business models
¸ It is not due to geographical market
¸ It is only marginally due to the value chain

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Commercial freedom required
¸ Removing the barriers to restructuring airline
capital is key to long-term sustainability
¸ May avert widespread airline failures
¸ Will generate cost efficiencies improving returns
and reducing fares
¸ Can be achieved maintaining safety, security
and labour standards

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