Yearbook cargolux. 50 years Association of European Airlines

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1 Yearbook 2004 cargolux 50 years Association of European Airlines

2 Disclaimer Any views or opinions presented in this Yearbook are solely those of the AEA and do not necessarily represent those of individual member airlines.

3 . 50 years Association of European Airlines Avenue Louise 350 B Brussels Tel. +32 (0) Fax Web Dear reader of the AEA Yearbook, As you may see from the letterhead at the top of the page, 2004 has been a special year for the AEA. Last December, the world celebrated 100 years since the Wright Brothers first took to the air, which means that AEA has been around for half the lifetime of manned flight itself. In recent years, the graph of our market development has looked a bit like one of those pioneering flights, tossed up and down by turbulence rather than the smooth and steady climb that we have been used to. As usual, part of this Yearbook describes what happened to our market in This should have been a recovery year, following the steep downturn after 9/11 which persisted through much of Instead, we were hit with two exceptional traffic-suppressing events the Iraq War and the SARS outbreak. The result unforeseen at the beginning of the year was that the AEA airlines, collectively, would suffer a fifth consecutive annual loss. And so on to 2004, another year which dawned with hopes of a brighter outcome hopes which have taken a sharp knock with the skyrocketing price of jet fuel. Nevertheless, when we airlines are coping, on an individual basis, with such upheavals in the marketplace, at an industry level we badly need a stable and coherent regulatory platform on which to build our strategic planning. This is where AEA comes in is also a year of major change in the political landscape, as regards our main regulatory partner, the EU. On May 1 st it experienced its biggest-ever enlargement and it is not hard to imagine the importance of air transport in integrating those new markets is also seeing a new European Parliament, and a new Commission. These are the people who will oversee the ongoing involvement of the EU in external aviation affairs, security, environmental issues, safety regulation, consumer matters all key issues for the airlines as they strive to establish a more sustainable economic basis on which to grow and to thrive. I hope you will find all these undercurrents properly addressed in the following pages. This is not meant to be a catalogue of complaint. Our industry is dynamic and resilient and our customers remind us daily just how much they take for granted the availability of convenient and affordable air transport. Vagn Soerensen Chief Executive Officer of Austrian AEA Chairman 2004 Adria Airways, Aer Lingus, Air France, Air Malta, Alitalia, Austrian, bmi, British Airways, Cargolux, Croatia Airlines, CSA, Cyprus Airways, Finnair, Iberia, Icelandair, Jat Airways, KLM, LOT, Lufthansa, Luxair, Malev, Meridiana, Olympic Airlines, SAS, SN Brussels Airlines, Spanair, SWISS, TAP Air Portugal, Tarom, Turkish Airlines, Virgin Atlantic Airways.

4 50 YEARS OF SERVING EUROPEAN AIR TRANSPORT In 2004, the Association of European Airlines celebrates the 50 th anniversary of its foundation as a permanent body serving the European airline industry. AEA actually traces its history further, to 1952, when the Presidents of Air France, KLM, Sabena and Swissair formed a joint study group, shortly afterwards expanded with the addition of BEA (a forerunner of British Airways) and SAS. In February 1954, the Air Research Bureau was established on a permanent basis, in Brussels. The name was subsequently changed to the European Airlines Research Bureau and - i n AEA. Shortly after the ARB was established, the 1954 Strasbourg Conference on the Coordination of Transport in Europe led to the foundation of the European Civil Aviation Conference (ECAC) as an intergovernmental body. It recommended that participating states encourage air carriers to undertake cooperative studies aimed at promoting an orderly development of air transport in Europe. Evidently, the ARB was wellplaced to be the industry's representative in dialogue with ECAC. By the time the AEA name was adopted, membership had grown to 19. There were three standing committees: Research and Planning, Airline Industry Affairs, and Technical Affairs, which was formed when a pre-existing industry body (the 'Montparnasse Committee') was absorbed into AEA. Since then the AEA's structure has evolved to reflect the realities facing the industry. 'Industry Affairs' divided into Commercial and Aeropolitical (subsequently renamed Public Policy), in recognition of the growing involvement of the EU in air transport matters. This involvement was formalised in 1986 when air transport was confirmed as being subject to the single-market process. Social Affairs, Infrastructure and Environment have also gained their place within the AEA's structure. For most of AEA's history, membership was limited to IATA member airlines. This rule was relaxed in 1981 to allow Luxair to complete the (then) full set of EU flag-carriers. AEA has had in all 38 members: three (Balkan, Sabena, Swissair) have suffered corporate failures, two (BEA and BOAC) merged into British Airways, and two (British Caledonian and UTA) were taken-over by BA and Air France respectively. Apart from the six founder members, additions to membership have occurred as follows : 1950s - seven; 1960s - four; 1970s - four; 1980s - three; 1990s - seven; 2000s - seven. Evidently, there is as much demand for industry representation as at any other time in AEA's existence. For the Association to continue to serve its members into its second half-century, it will have to continue to adapt and transform itself, to be as dynamic as the industry it serves. 50 years Association of European Airlines ASSOCIATION OF EUROPEAN AIRLINES - i

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6 CONTENTS AEA Serving the industry for 50 years i SECTION I AEA AIRLINES IN 2003 I-1 At a Glance I-2 The Global Economic Environment I-4 Flying through Currency Upheavals I-6 Traffic Trends 2003 I-7 Operating Results 2003 I-9 SECTION II OUTLOOK FOR 2004 II-1 Looking Forward... II-2 Sustaining the Recovery II-3 Financial Outlook 2004 II-4 New Market Opportunities, in Europe and Globally II-5 SECTION III RESHAPING THE INDUSTRY III-1 Comparing Business Models Network and No-Frills Carriers III-2 No-Frills Carrier Developments III-4 No-Frills Carriers and the Charleroi Decision III-5 Mergers and Alliances Strengthening the Networks III-6 An End to Bilateralism? III-7 SECTION IV REGULATION TOO MUCH OR NOT ENOUGH? IV-1 Security in the Aftermath of 9/11 IV-2 Does Europe at last have its Single Sky? IV-4 Airports A Fair Deal for Airlines and Passengers IV-5 Compensating the Passenger IV-6 The Great Gaseous Emissions Debate IV-7 SECTION V SPOTLIGHT ON THE AEA V-1 AEA Highlights V-3 Who s Who at AEA V-5 AEA Fast Facts V-6 Airline Profiles & Review of 2003 V-7 SECTION VI KEY STATISTICS VI-1 Key Statistics - Total AEA VI-2 Key Statistics - By Carrier VI-4 What do we mean by? VI-9 ASSOCIATION OF EUROPEAN AIRLINES I-1

7 2003 AT A GLANCE MONTHLY TRAFFIC MONITOR The traffic trend line started the year in reverse gear, as demand faltered in anticipation of the Iraq War. The recovery from a relatively short-duration trough due to the war itself was hindered by the massive impact, particularly on the Far East, of the SARS phenomenon. 60% change in Revenue Passenger Kilometres 50 Total Europe North Atlantic 40 Far East / Australasia 30 Total Scheduled PASSENGER YIELDS - Total Europe Real Yields: adj. for exchange rate fluctuations and inflation 20 US per Revenue Passenger Kilometre % per annum Source: AEA AEA_YB_ Passenger yields tumbled, in real terms, by 10.7% in 2003, a far greater drop than at any other time in the long-run reduction in average prices. Several effects were in play, not least of which was the network carriers response to their no-frills competitors % CURRENCY EFFECTS: Strong Euro, Weak Dollar US dollars = 1 Euro Source: AEA AEA_YB_ Currency fluctuations, in the shape of a strong Euro vis-à-vis the US dollar, affected costs, revenues and market conditions. See chapter I-6 for an analysis of how currency variations have repercussions favourable and otherwise throughout the industry Annual average Euro appreciated by 20% against US dollar Source: OANDA AEA_YB_04003 I 2 ASSOCIATION OF EUROPEAN AIRLINES

8 -1.48 billion US$ Financial Loss (-1.42 bn) 5.9 bn US$ more Revenue Total Scheduled Revenue all services (5.3 bn) fewer Passengers Total Scheduled Passenger numbers CRISES IN PERSPECTIVE AEA traffic and revenue loss in six months following: Event Impact on RPK loss Revenue loss millions % USD millions September 11 North Atlantic SARS outbreak Far East Source: AEA AEA_YB_ % Passenger Traffic increase Total Scheduled Passenger Kms 1.8% increased Capacity Total Scheduled Seat Kms on offer 2003 over 2002 ASSOCIATION OF EUROPEAN AIRLINES I 3

9 THE GLOBAL ECONOMIC ENVIRONMENT In 2003, world economies generally maintained their slow climb back from the depths of 2001, with a growth of 2% for the OECD countries as a whole, and increases of 3% projected for 2004 and Quarterly figures for 2003 showed a still very sluggish growth situation in the early part of the year, with the geopolitical uncertainty surrounding Gulf War II, high oil prices and low consumer and business confidence. A significant upturn occurred in the third and fourth quarters, however. These were global figures, to which the European economies compared relatively poorly. With a 2003 growth of only 0.7%, the EU was the only main economic region to post poorer figures than in Within the EU, Germany, with zero growth, and France, with just +0.1%, were obvious constraints on the total. The UK economy was the most resilient among the bigger players, at plus 1.9% and is projected to continue above trend over the next two years. Economic growth in the US was a relatively healthy 2.9%, with further robust results projected. Japan, so long in the doldrums, also posted relatively favourable figures at plus 2.7%. The business house JP Morgan identifies a change in strategic thinking among the world s policy-makers aimed at promoting growth and economic welfare, rather than exclusively targeting price stability. In the longer term it sees a 60% probability of reflation stable growth and modestly-rising inflation. There is a 25% probability of high and volatile inflation and growth leading to tightened monetary policies, and a 15% risk of global deflation, with price declines and low growth. Beyond the major markets, recent conditions have been generally favourable perhaps the best period for emerging markets for a decade. China, Thailand and India are projected to have growth of 6% or better in 2004, with Latin American economies also buoyant. WORLD ECONOMIC GROWTH 8% growth in real GDP OECD EU Japan US Q1 Q2 Q3 Q Source: OECD AEA_YB_04002 I 4 ASSOCIATION OF EUROPEAN AIRLINES estimates

10 2002 GLOBAL CAPITAL FLOWS Russia is foreseen as emerging from years of stagnation with plus 5% or more, and similar figures expected for Turkey and Poland. Australia Mexico United Kingdom Spain Others Importers of Capital However, there are some caveats. The current recovery is essentially US-led and has been driven by household consumption, based on low interest rates. It has been referred to as a job-less recovery, as the market has grown on productivity gains and not through investment and associated gains in employment opportunities. Exporters of Capital United States Japan It has also been built on wide US fiscal and current account deficits, with the budget deficit at its highest level ever, and growing. Government spending is up with a strong military and security component but tax receipts have fallen due to the 2000/1 recession and tax cuts in 2001 and Business Investment lags Consumer Spending 16% change over previous year Others Source: IMF AEA_YB_04006 Germany China Switzerland Russia US Consumer Spending Source: OECD AEA_YB_ US Business Investment Given the fiscal deficit, a rise in interest rates is not impossible. This could halt the growing indebtedness of US consumers, but also stall economic growth There exists also a huge US trade imbalance, financed by foreign investment in the US which, according to the International Monetary Fund, absorbed more than 75% of world capital in The largest investors are those countries which are also the largest exporters to the US and they are thus fuelling both the American and their own growth. If those countries (in particular China) attempt to address the imbalance this creates in their own economies safeguarding against inflation, for example this could again jeopardise world growth. All in all, while the indicators are generally favourable, there remain serious questionmarks about the sustainability of the current model. ASSOCIATION OF EUROPEAN AIRLINES I 5

11 FLYING THROUGH CURRENCY UPHEAVALS All international airlines conduct their business in a cocktail of currencies, within which their own, and the US dollar, predominate. The Dollar is particularly important for a number of reasons. For many European airlines, the USA is among their largest external markets. In many other countries, fares and rates are fixed in US$. Elsewhere, currencies such as the Chinese Yuan are pegged to the dollar or for policy reasons are limited in their fluctuation from it, as in Japan. As well as revenues earned in such markets, airlines also have costs and local expenses, but far more importantly, fuel and lease contracts which are traditionally expressed in US$. In the last year for which figures are available 2002 about a quarter of total costs for the AEA carriers based in the Eurozone were dollar-denominated, and exceeded their dollar revenues, which amounted to 18% of total receipts. It is estimated that, in general, a 5% appreciation of the Euro against the dollar results in a 1% loss in revenue, purely due to exchange-rate effects. In 2003, the Euro experienced an unprecedented appreciation against the dollar, of 20%. The President of the European Central Bank described the currency movements as brutal for exporters. They undoubtedly depressed economic growth, one of the principal drivers of air traffic demand. On the cost side, the currency fluctuations mitigated the impact of increasing fuel costs. Throughout 2003, the European airlines were relatively protected against the fuel price hikes by the weakness of the dollar. Whereas the average price of jet fuel increased by 26% in dollar terms between 2002 and 2003, the increase was limited to 5% in Euro. In January 2004 the Rotterdam spot price for jet fuel stood at US$ 43 per barrel, a figure surpassed only in late 2000 and in early 2003 in the lead-up to the Iraq War. Since then the price has continued to escalate, and by May had surpassed $48/barrel, triggering a round of fuel surcharges by airlines, within AEA and worldwide. The Impact of the US dollar Exchange Rate extends beyond the US In 4 of the top 10 destinations beyond the AEA homemarket the official currency for airline tickets is the USD. Where tickets are issued in local currency, de facto exchange rates still link airline accounts to USD developments. Country % traffic beyond Currency IATA recommended AEA homemarket* Ticket Price currency De facto exchange rate regime vs USD USA Japan Canada Russia India South Africa Israel Brazil China Egypt USD US Dollar JPY Japanese Yen CAD Canadian Dollar RUB Russian Rouble INR Indian Rupee ZAR South African Rand ILS Israel New Shekel BRL Brazilian Real CNY Chinese Yuan Renminbi EGP Egyptian Pound USD LC LC USD LC LC USD USD LC LC Synchronised Synchronised Synchronised Free Pegged Free Total % * 2003 Passenger data LC = Local Currency Source: AEA, IATA, OANDA AEA_YB_04007 I 6 ASSOCIATION OF EUROPEAN AIRLINES

12 TRAFFIC TRENDS 2003 At the outset of 2003, the projection was for a year of recovery from the previous year s depressed figures, with consequently the expectation of above-average growth rate. The substantial cloud on the horizon was the anticipated likelihood of war in Iraq and its consequences, for which the industry foresaw three basic scenarios: clean and clinical, contained and prolonged and escalating. In the very early days of the year, however, the Base Case was that war could be avoided. This scenario was soon abandoned and as early as mid-february the European, Middle Eastern and Far Eastern volumes were below 2002 levels, while the strong recovery-induced growth rates on the North Atlantic had been halved. half the Middle East traffic disappeared during the first three weeks of the war. While the political and military circumstances of the war contained elements of all three scenarios, the traffic loss tended towards the less-severe end of the range of projections. The European market returned to growth within five weeks of the outbreak of war. On the North Atlantic, with a relatively more buoyant underlying growth (see above), an increase was recorded within three weeks. The Middle Eastern market, as might be expected, remained below previous year until June WEEKLY TRAFFIC EUROPE-FAR EAST 10% change in RPKs 2003 WEEKLY TRAFFIC EUROPE-MIDDLE EAST 0-10 Beginning of Gulf War II 20-Mar-03 End of "hostilities" 14-Apr SARS virus first recognised end Feb-03 "Disease contained" 05-Jul W05 W10 Source: AEA AEA_YB_04028 W15 W20 W25-60% change in RPKs W10 Source: AEA AEA_YB_04027 W12 W14 W16 W18 W20 The Iraq War actually began in the third week of March and the effect on AEA traffic levels was immediate, with -15% in Europe, -10% on the North Atlantic and a figure somewhere between the two on the Far East. With many routes suspended, about Traffic on Far Eastern routes did not return to growth at all during the early Summer. Within three weeks of the beginning of the Iraq War, the recovering market was hit with the reaction to the SARS outbreak, sparking a series of massive traffic decreases which persisted throughout the Summer. Reaching a peak of more than 30% in the middle of May, the traffic losses persisted at ASSOCIATION OF EUROPEAN AIRLINES I 7

13 more than 20% for nine weeks from mid- April through mid-june. The subsequent recovery back to positive growth figures was even more persistent, with no year-on-year increase recorded until well into October. To illustrate the severity of the SARS phenomenon, during the six months from the start of the outbreak until the market returned to growth, Far Eastern traffic declined by 23.1% and the loss of passenger revenue amounted to US$ 900 million. These losses came close to the corresponding figures for the North Atlantic market in the six months following 9/ % of the Market and $1289 million in lost revenue. The SARS impact was not confined to Far Eastern routes. The illness took a brief foothold in Canada, and the loss of longhaul traffic invariably affected shorthaul routes as connecting passengers stayed away. It must be said that, despite the evident seriousness of the SARS epidemic and its human consequences, the effect on air travel was always disproportionately high and bore signs of apprehension overload following 9/11, the Bali bombing, and the Iraq War. year, cleaned of Iraq War and SARS effects, was 4.7%. The European RPK total for 2003 was at the same level as the 12-month total to March 2001 in other words, zero growth in 2 years, nine months. On the North Atlantic, the annualised traffic was the same as it had been in March 1999 four years and nine months previously. The 2003 traffic pattern was closely mirrored, for the most part, by capacity developments, with the result that load factors remained high. Overall, the figure of 73.4 was just 0.2 of a percentage point below the all-time high of 2002, while the load factor on European services, at 65.2, was the highest on record. The exception was on Far Eastern services, where the severity of the crisis, the speed with which it struck and the length of time it persisted, took the industry by surprise. Although capacity cutbacks were instated, they did not match the traffic losses and load factors for the year slipped by 3.8 points to 76.7%. PASSENGER LOAD FACTORS 85% Passenger Load Factors 80 Max in It was not until late October or early November that 2003 traffic began to exhibit what might be described as normal patterns, with growth rates of around 4-5% in Europe, 7-8% on the North Atlantic, and about 4% to the Far East, giving an overall figure, including other regions, of around 6% min in Overall for the year, traffic in passengerkilometres grew by just 1.5%; in passenger boardings, there was a drop of 0.2%. Estimated true RPK growth rate for the Total Europe Source: AEA AEA_YB_04008 North Atlantic Far East/ Australasia Total Scheduled I 8 ASSOCIATION OF EUROPEAN AIRLINES

14 OPERATING RESULTS saw the 5 th consecutive yearly deficit for AEA airlines, with an operating loss of US$ 1.5 billion ( 1.4bn) after interest, almost twice the $0.8bn recorded in Operating ratio (revenue:expenditure) fell from 98.8 in 2002 to With traffic and capacity moving more or less in step, with virtually no change to load factor, the main contributing factor was a weakening of the cost:revenue ratio, with costs almost 6% above the previous year, outstripping revenue growth. The accompanying graphic shows AEA profitability by quarter for the period The years 2000 and 2002 describe a normal pattern for the industry, with losses in the winter quarters and profits in the Summer. In 2000 the plusses outweighed the minuses, in 2002 they did not. In 2003, the first quarter posted a catastrophic loss with an operating ratio of just If anything, the build-up to the long-anticipated Iraq War and rising tensions worldwide had a more tangible impact on operating results than the military campaign itself which lasted just 6 weeks after the launch attack on 20 th March. the 2000 and 2002 results and while the fourth quarter was again negative, it was much less so than in previous years. The AEA airlines continue to address their structural cost base. Since 2000, they have trimmed back their workforce by 8%, equating to a reduction in head-count of 32,000. Personnel costs continue to be subject to constant review. Significant changes continue to be made to sales procedures, such as the reduction or abolition of agents commissions, internet booking and the introduction of e-ticketing. Shorthaul services have seen a move towards simplification of schedules, higher aircraft utilisation and ongoing product review. These changes, accelerated by competition from no-frills carriers, have accompanied flexible and competitive fare structures in Europe which, combined with the steady reduction in premium passengers, has seen real yields falling steadily. OPERATING RATIO AFTER INTEREST 106 Total Operating Ratio after Interest The first quarter alone contributed a loss of $1.86bn to the annual total The second quarter of 2003 suffered from both the ongoing War effects and the impact of SARS, which in mid-march had been classified by the WHO as a worldwide health threat, concentrated in Asia but also identified in Canada and to a lesser extent in Europe and Africa. Consequently this was the first non-profitable second quarter of the 2000s. Despite ongoing weaknesses in the Far East market which persisted through the Summer, the third quarter was in line with Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q Source: AEA AEA_YB_04009 Q4 ASSOCIATION OF EUROPEAN AIRLINES I 9

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16 CONTENTS AEA Serving the industry for 50 years i SECTION I AEA AIRLINES IN 2003 I-1 At a Glance I-2 The Global Economic Environment I-4 Flying through Currency Upheavals I-6 Traffic Trends 2003 I-7 Operating Results 2003 I-9 SECTION II OUTLOOK FOR 2004 II-1 Looking Forward... II-2 Sustaining the Recovery II-3 Financial Outlook 2004 II-4 New Market Opportunities, in Europe and Globally II-5 SECTION III RESHAPING THE INDUSTRY III-1 Comparing Business Models Network and No-Frills Carriers III-2 No-Frills Carrier Developments III-4 No-Frills Carriers and the Charleroi Decision III-5 Mergers and Alliances Strengthening the Networks III-6 An End to Bilateralism? III-7 SECTION IV REGULATION TOO MUCH OR NOT ENOUGH? IV-1 Security in the Aftermath of 9/11 IV-2 Does Europe at last have its Single Sky? IV-4 Airports A Fair Deal for Airlines and Passengers IV-5 Compensating the Passenger IV-6 The Great Gaseous Emissions Debate IV-7 SECTION V SPOTLIGHT ON THE AEA V-1 AEA Highlights V-3 Who s Who at AEA V-5 AEA Fast Facts V-6 Airline Profiles & Review of 2003 V-7 SECTION VI KEY STATISTICS VI-1 Key Statistics - Total AEA VI-2 Key Statistics - By Carrier VI-4 What do we mean by? VI-9 ASSOCIATION OF EUROPEAN AIRLINES II - 1

17 LOOKING FORWARD +0 to 0.5 bn US$ Financial Result* Total Scheduled (0 to 0.4 bn) +8.5% growth in Passenger Traffic* Total Scheduled RPKs The traffic recovery in 2004 projected to provide a passenger-kilometre increase of 8.5% will at last see aggregate traffic volume for the AEA airlines surpass the previous annual high-point, which was attained in Load factors too are projected to reach their highest-ever level, nudging 75%. While the airlines are working hard to contain costs, their efforts are being undone by runaway fuel prices, ascending into levels never before experienced. The stabilised traffic situation in 2004 should have produced the first consolidated profit for the AEA airlines since 1998, a modest figure of perhaps US$ 0.5bn. Latest indications are that the fuel price effect will wipe out most or all of this surplus. CRUDE OIL & JET FUEL SPOT PRICES Crude Oil Benchmarks and ARA-Jet Fuel (fob) 60 US dollar per Barrel Strong demand + Market Anxiety 50 Strong world oil demand Gulf War II 40 US military strike on Iraq September Economic slowdown in Asia ARA Jet Fuel BRENT WTI Source: EIA AEA_YB_04012 * estimates for 2004 II 2 ASSOCIATION OF EUROPEAN AIRLINES

18 SUSTAINING THE RECOVERY Following the upheavals of 2003, traffic growth patterns in 2004 were bound to produce some unusual results. Most obviously, the 30% losses sustained on Far Eastern routes during the height of the SARS epidemic would require increases of around 43% just to restore volume to the 2002 level, and well over 50% to encompass two years of normal traffic growth. Consequently, traffic figures in the early part of 2004 have shown wide variances over the corresponding 2003 levels. By the middle of June, European traffic was 7% up, North Atlantic almost 10% and Far East more than 20%. Increases in the second half of the year are expected to be lower. PROJECTED TRAFFIC GROWTH 2004 over 2003 Revenue Passenger Kilometres growing at a rate which equates to about 3% per annum, compounded over two years. This is perhaps half the annual increase which prevailed through the 1990s. Domestic markets within Europe have been even more sluggish, with no significant growth currently being recorded. Longhaul markets are faring somewhat better. Again, discounting the severe fluctuations in year-on-year increases and looking instead at average annual growth rates over two years, North Atlantic traffic has expanded at 6%-7% in early This is in line with historical medium-term trends, although still constitutes only a partial recovery from the traffic losses sustained after 9/11. Route Area Europe cross-border Europe domestic North Atlantic Far East RPK % change Allowing for additions to membership, the AEA traffic volume on the North Atlantic in 2004 is projected to be about the same as it was in On an annualised basis, the market is still about 10% smaller than it was at its highest level (March 2001). Total International Total Scheduled Source: AEA AEA_YB_04029 Translating these figures into mediumterm trends produces much more modest growth rates over two years in other words, compared to a 2002 baseline which was itself still depressed in the aftermath of 9/ Far Eastern traffic in 2004 is in the process of fully recovering the previous year s Iraq War and SARS-related losses. Over two years from 2002, the market is expanding at an average of about 5.5% per annum. Overall, the expected 8% increase on all services in 2004 follows on from a growth of just 1.5% in 2003, equivalent to an annual growth rate over two years of just 4.7%. Through the first half of 2004, AEA crossborder traffic within Europe has been ASSOCIATION OF EUROPEAN AIRLINES II 3

19 FINANCIAL OUTLOOK 2004 The anticipated 2004 increase in AEA scheduled traffic of 8.5% is expected to be accommodated within a capacity growth of 7%, which would push passenger load factors to an all-time high of close to 75%. Nonetheless, yields remain an area of concern, with Euro-denominated levels in 2004 predicted to be 4% down on the previous year. More alarming, however, is the impact of fuel prices. The average benchmark price for crude oil has reached US$34/barrel, almost 20% above its 2003 level, with daily peaks of near $50 noted in August. Jet fuel, as a derivative, is quoted even higher, already exceeding the $50/barrel mark in July 2004, with prices expected to stay high throughout the year. Typically, AEA airlines consume close to 8 billion US gallons of fuel per annum, representing about 12% of their total costs in a normal year. Some recourse from the high fuel prices is provided by hedging, fuel surcharges and in the current price environment advantageous currency effects. Nevertheless, the current round of inflation could add an extra $1bn to the AEA fuel bill for Following five consecutive years of losses, 2004 brought the prospect of a return to profitability with a modest operating surplus, for the AEA membership as a whole, of up to $500m. This positive outcome was predicated on an estimated drop of 5-6% in (Euro-denominated) unit costs, reflecting the efforts the airlines have made to contain expenditure, offsetting the projected 4% drop in yields. However, once this scenario is modified to take account of the current fuel crisis, it becomes increasingly clear that hopes of a financial recovery were premature. In the longer term, higher energy prices threaten the fragile economic recovery which is a crucial feature of air travel demand growth. Prospects are not encouraging; the US Department of Energy s EIA is predicting only a slight moderation of fuel prices in 2005 before resuming an upward trend in PROFIT / LOSS ON TOTAL SCHEDULED ROUTES 2.5 billion current USD after interest US$ billions estimate Source: AEA AEA_YB_04011 II 4 ASSOCIATION OF EUROPEAN AIRLINES

20 NEW MARKET OPPORTUNITIES, IN EUROPE AND GLOBALLY On 1 st May 2004, the European Union experienced its biggest-ever expansion. The 10 countries, with a combined population of 75 million will increase the size of the Community by 20% in terms of population, and 23% in land area. ACCESSION COUNTRIES - Main Economic Indicators COUNTRY Cyprus Czech Republic Estonia Hungary Latvia Lithuania Malta Poland Slovak Republic Slovenia AC - 10 EU - 15 EU - 25 POPULATION (million) GDP (bn Euro) Source: Eurostat, PriceWaterhouseCoopers, IMF, OECD AEA_YB_04013 GDP/Capita in PPP EU-15 = Evidently, the new markets are not large, either individually or collectively, in overall EU terms. As a benchmark Portugal, which has a population size very similar to that of Hungary or the Czech Republic, has almost 400,000 weekly seats to/from EU destinations. In terms of GDP per capita, only Cyprus, Malta and Slovenia would not rank below all the existing EU members. In spite of this, or perhaps because of it, the new countries bring a considerable growth potential to the aviation single market. anywhere near the frequency of service to the other EU capitals. In 1995, the year following the last round of EU enlargement, traffic between Brussels and Helsinki/Stockholm/Vienna grew by 28%. AEA members REAL GDP avg % growth p.a REAL GDP % growth intra-european traffic at Helsinki and Stockholm exhibited growth well into double digits (although the Vienna increase somewhat lower). was Of the ten Accession countries, Malta and Cyprus, and to a lesser extent Slovenia, are established leisure destinations. Some city markets (Prague, Tallinn, Krakow) are already, or will become, established on the short-stay itinerary. While the level of economic advancement will, in the short term, constrain outbound travel from the new Member States, they are likely to be a magnet for inward investment, with the consequent generation of travel demand. The Accession States have relatively underdeveloped airline infrastructures. Most have only a single airline of any significant size, so any second-tier expansion encouraged by single-market ease of access will be difficult to gauge fully in the near future. At the most basic level, they have a need to upgrade their communications with the EU s institutions. The average distance from Brussels to the ten capitals is 1400km so air links are essential, yet only Warsaw and Prague come Of the established carriers CSA and LOT are fully-fledged global alliance members (of SkyTeam and Star respectively). Malev is also associated with SkyTeam, and Adria with Star. Air Malta and Cyprus Airways are unaligned at present. ASSOCIATION OF EUROPEAN AIRLINES II 5

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