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Airlines

Up in the air

As the UK prepares to leave the European Union, Satu Dahl analyses the various scenarios that may come into play for the aviation industry
 

In the event of the UK leaving the EU with no deal at the end of October, uncertainty for the aviation sector is growing. Several organisations within the industry are preparing airlines, airports and other businesses for this daunting outcome.

 

Esther Samtlebe, Senior Consultant at Lufthansa Consulting explains that when asked in autumn 2016 what advice Lufthansa Consulting was giving to its airline and airport clients to prepare for the expected Brexit, the company’s message was clear: prepare for the worst – a no-deal Brexit. Now, almost three years later, the advice remains unchanged. Samtlebe says: “Continuing the [as yet] non-acceptance of the Brexit agreement between the EU and the UK by the British Parliament, as well as recent statements of the new British Prime Minister, require airlines and airports to plan for a no-deal scenario simply due to time constraints.”

 

The European Regions Airline Association(ERA) has been actively lobbying the UK and the EU to ensure the best possible outcome for its members. Regarding the progress on what has been achieved by the UK Department of Transport and the European Commission so far during negotiations, Montserrat Barriga, Director General of ERA comments: “Three years after the UK referendum on EU membership, the exacttime and conditions of Brexit are still unclear, with the possibility for a ‘hard Brexit’ still on the table if the Withdrawal Agreement is not ratified by 31 October.” Barriga says this has presented a high degree of uncertainty related to future airline operations.

 

ERA welcomed the Commission’s regulation on common rules ensuring basic air connectivity in the event of no deal, but further clarification is needed in relation to its certain provisions as well as its validity, she adds. “We have suggested that the new set-up of the EU institutions puts negotiating a comprehensive aviation agreement between the UK and the EU on its agenda with utmost priority.”

 

To the unknown

But what exactly are the risks of a no-deal Brexit for the sector? “The biggest risk for both airlines and airports, and also all third-party aviation service providers are, in fact, that no-one really knows what to prepare for,” Samtlebe says. “Even though the UK has repeatedly stressed that Britain still wants to be part of the European Common Aviation Area, there is no guarantee that this will happen. Accordingly, airlines and airports are currently preparing for the worst.” Samtlebe mentions that one of the imminent risks of a no-deal Brexit is of course the risk for airlines to lose traffic rights. “Even though the UK was able to negotiate new bilateral agreements with the US, as well as eight other countries for which traffic rights used to be granted under EU law, the continued access of the UK to the EU’s single European skies has still not been resolved.”

 

Samtlebe notes that while the UK Government has clearly stated its desire to secure liberal aviation market access arrangements even in a no-deal Brexit scenario, it is still not certain whether the respective agreement with the EU can be reached. “While the UK has envisaged that it will continue to grant traffic rights to EU carriers, EU’s position on traffic rights in the event of a no-deal exit has not been explicitly stated. Accordingly, airlines are advised to apply for individual traffic rights in order to ensure that they areauthorisedto operate current routes even after a no-deal Brexit.”

 

As an alternative, UK airlines may apply for an EU AOC (Air Operators Certificate) and EU carriers may apply for a British AOC. “However, while several low cost carriers such as easyJet, Ryanair and Wizz Air were able to obtain the respective AOC due to their bases in the respective countries, this is, of course, not an option for the majority of the airlines.” Lufthansa Consulting advises the majority of its clients to apply for individual traffic rights to ensure that they are able to continue current operations to and from the UK after Brexit.

 

Barriga says that a no-deal outcome could have disastrous consequences for the aviation industry, including the grounding of many flights across EU countries and the UK. She says in the event of no deal, 100% of ERA member airlines will be affected significantly, either directly or indirectly, in their operations – this is 51 airlines operating all together more than 1.8 million routes in Europe.

 

“The directly affected category applies to members with cross-border operations, totalling to nearly 50% of ERA member airlines,” Barriga indicates. The indirectly affected category applies to at least one fourth of the airlines feeding regional traffic into a hub or a national airport, connecting those passengers or cargo on cross-border carriers. “If Community Carriers are denied access to the UK market, demand on the regional carriers will decline, eventually causing European connectivity to suffer enormously in a manner that will inflict serious harm on local communities. This is in direct conflict with the EU’s Aviation Strategy,” she states. Those affected are both UK-based and EU-based carriers. The complications for cargo operations arise with future customs processes and whether that framework will support operators’ financial objectives.

 

Further to this, an extensive report published by IATA discussed multiple critical areas of aviation in which a no-deal outcome would have a significant impact, including air services agreements, aviation safety and security framework, border management and environment. Even if there is a deal, there is a lack of clarity about EU ownership rules that could potentially ground big and small airlines alike, unless there is some form of moratorium.

 

ICF, a global consulting services company which provides services for the aviation industry, says that many of the risks associated with Brexit relate to a downturn in economic performance and hence travel relating to trade, business and holidays. ICF also specifies Air Service Agreements and border management as major areas to address, saying that it is worth noting that the impact of Brexit has been assumed within the latest GDP outlooks but these do not capture the impact of a hard Brexit.

 

EASA membership

 

ERA’s position on Brexit has been on ensuring open and free traffic rights for all EU and UK carriers between the EU and the UK. ERA is also focussing on ensuring that EASA (European Union Aviation Safety Agency) regulations continue to apply to UK carriers and that EU and UK carriers can continue to freely lease aircraft to each other without prior approval. “A number of documents, including the EC stakeholder notices and UK’s technical notices which set out plans in case the UK leaves the EU without a deal, have been distributed to aviation stakeholders with an aim to prepare them for different scenarios,” Barriga states. “We encourage ERA's airline members that wish to continue to be recognised as Union air carriers to take all necessary measures to ensure that they meet the relevant requirements.”

 

Both ICF and Lufthansa Consulting see the membership of EASA as one of the key issues. “Following Brexit, the UK would cease to be a member of EASA and would need to introduce interim measures to ensure a continuation of standards. This would prove a challenge as the CAA does not have the scale to absorb such areas at such short notice,” ICF says.

 

However, airlines can neither be sure that the traffic rights and/or new licenses will be granted, nor whether the necessary approvals can be obtained in due to the timeframe. “Accordingly, they cannot even be sure whether they may still sell tickets on the respective routes for dates beyond Brexit, Samtlebe continues. “It may thus be necessary to sell tickets for travel dates after 31 October with a caveat advising passengers that the operation of the respective routes may be subject to governmental approval or may depend on the regulatory environment. However, whether such a caveat emptor is sufficient to prevent possible compensation claims from customers depends on the legal situation of the airline’s home or base country.”

 

The cost of Brexit

 

Moving on to cost implications, Samtlebe says that these are inevitable. “Of course, this all leads to rising costs. Not to mention, potential flight disruptions due to lacking rights and/or certification in case of a no-deal Brexit, which could be disastrous for airlines already suffering from rising fuel costs. In addition, demand has already suffered due to the uncertainties relating to Brexit and the weakness of the British pound, and is expected to decrease further.”

 

Due to the high competition and overcapacity in the low cost and regional sector in Europe, Samtlebe reckons it is unlikely that the reduction in volume can fully be compensated by increasing fares. Instead, it is more likely that airlines will try to increase revenues generated through extras and/or ancillary services. A rise in service fee as well as a rise of prices for ancillary services can thus be expected.

 

Samtlebe notes that as low cost carriers traditionally generate a higher share of revenues from ancillary services, legacy regional carriers need to make sure that they have the appropriate pricing strategy as well as a professional ancillary revenue concept in place – both crucial components to offering attractive and competitive base fares in a highly competitive market while still generating the required revenues to operate intra-European routes profitably.

 

ICF, in turn, says that airlines that could be most exposed to impacts from Brexit such as further GBP forex erosion, which would be those with the most exposure to the UK market. “Following the referendum vote in 2016, we saw the GBP deteriorate which had a notable impact on carriers such as easyJet and Flybe, both with significant exposure to the UK market. Airlines operate with significant USD exposure due to aircraft leasing, fuel, spare parts, and so on, so this meant that overnight their cost base increased whilst their revenues didn’t. This has been a significant factor in both carriers’ downturn in financial performance. Naturally under this scenario, carriers would wish to increase their fares but the level to which they could pass these costs on/absorb would be determined by the market.

 

“On the flip side, if demand conditions were to deteriorate following Brexit, we would expect airlines to respond by potentially reducing capacity/slowing growth alongside price discounting to ensure their aircraft maintain high load factors, as is the business model for LCCs. If bilateral agreements were to limit supply, then fares could rise on certain markets,” ICF predicts.

 

ERA has already seen the negative effect of Brexit on its members. “The uncertainty and unfairness surrounding Brexit has already been one major factor leading to one of our members, (flybmi), failing, and it is affecting many more. The disastrous consequences for the aviation industry, both in the UK and the rest of Europe, will be significant and I believe this airline failure is only the beginning if we do not resolve the uncertainty,” Barriga states.

 

Overcoming challenges

 

When it comes to envisaging any positive aspects that could come out of Brexit for the industry, ICF says that these could include an increase in air cargo volumes in the short term as some potential border chaos could drive logistics companies to take advantage of air transport, and inbound tourism for the UK – if the GBP was to depreciate further, the UK could, at least from a relative cost perspective, appear a ‘bargain’ to visit.  However, most UK airports are dominated by outbound demand so net impact is likely to be negative, ICF notes, and says that another potential benefit for airport operators could be more passengers being eligible for duty free purchases, though no doubt this would not offset potential wider demand side downsides. “It is worth noting that if Brexit can deliver a positive economic outcome, then that could drive greater demand, at least in the short term.”

 

Samtlebe says that the only aspect that may be considered as positive is the fact that Brexit is likely to speed up the long-overdue consolidation in the European aviation market as well as a reduction in the related overcapacity. “Most likely, airlines registered in the UK and with a British AOC will be hit hardest by Brexit, followed by airlines that strongly depend on traffic to/from the UK. But low cost carriers may also have to reduce capacities and/or raise fares, which may eventually lead to the re-establishment of ‘healthy’ prices for air tickets on highly competitive routes.”

 

Barriga concludes that the industry will be able to adapt following the upheaval: “The airline industry will show once again its resilience and ability to adapt to any challenges no matter how hard the environment is. It happened in 2008 with the financial crisis, with the terrorist attacks of 2011 and it will be the case with Brexit.”


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