Over the past three years, aviation has seen its fair share of turbulence. Air traffic demand surged during 2022, leading to the recovery of capacity to pre-Covid pandemic levels. In parallel, the Russian war on Ukraine resulted in more than 250 aircraft being trapped in Russia, with several legal battles involving insurance companies and lessors unresolved.

This is against a backdrop of rising labour, fuel and materials costs. The energy crisis, for example – exacerbated by the war in Ukraine – has driven up fuel prices to the point of 35% of the industry’s total operating costs, according to Aero Affaires.

Sector stability will continue to be challenged, and with the current climate of global economic uncertainty and record inflation figures dominating the headlines, it would be natural to assume an expected decrease in demand for leisure travel.

However, air travel demand in 2022 is robust and has remained steady throughout this year. According to the World Economic Forum, air travel within the EU has recovered strongly to 86% of pre-Covid-19 levels.

If air travel demand remains robust throughout 2023, those airlines with cost-resilient operating models and right-sized balance sheets could be well-positioned to adapt to challenges in the operating environment and will likely find themselves able to weather the storm.

Aviation’s post-Covid-19 recovery

Despite the challenges, there are bright spots in the long-term outlook for the air travel industry. Asset values and lease rates have recovered strongly, especially for new-generation and fuel-efficient aircraft. Since 2021, leasing platforms have raised almost $15bn in new equity. This is paired with a strong backlog of lease and loan securitisations that are ready to come to market following a shutdown of new issues in the capital markets following the war in Ukraine. Although there is still some hesitancy from investors due to supply shortages, the sector could see a return to the record issuance volume of approximately $10bn across 16 deals, which we saw in 2021. 

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This activity is driven, primarily, by attractive and rising unlevered yields in lease assets following the recent growth in lease rates relative to asset values. Positive signs for 2023 and 2024 include: the capacity recovery, recent performance of the underlying assets and the new capital that is ready to be deployed by leasing and lending funds.

The impact of the Russian invasion on the aviation industry

Despite this, the recovery has of course been limited by the impact of Russia’s war on Ukraine.

The war has resulted in the impairment of approximately $8bn of Russia’s and Ukraine’s aircraft, which has led to lessors and insurance companies facing huge legal battles over billions of dollars in claims. Since the start of the war, more than 250 aircraft on lease to Russian airlines remain in Russia, with fewer than 50 recovered by lessors and transported out of the country.

The Russian government has announced plans to scrap foreign aircraft for replacement parts needed to keep their own models in operation. In addition, any aircraft that is recovered from Russia will likely face value pressures due to the lack of reliable maintenance records since the start of the war. This only serves to add to the supply shortage that all airlines and asset owners are currently facing.

These issues have been a significant cause of the slowdown in the securitisation market. Although the market appeared set for a rebound earlier in 2022 as capacities recovered following Covid-19, the uncertainty that rose from these leases potentially losing all value has caused investors to wait on the sidelines.

The cost of the supply breakdown

An additional issue facing the aviation industry is rising costs. When paired with fears of a prolonged global economic slowdown, increased operating expenses for airlines present a significant credit concern. Questions remain as to whether consumers will be able to pay the higher fares required to maintain already embattled airline profit margins.  

Supply chain breakdown is also becoming more evident from rising costs. The industry is experiencing a shortage of critical supplies, as well as a significant backlog of deliveries from original equipment manufacturers.

In the immediate term, the largest concern for airlines is ensuring that ground and flight operations can scale profitably to deliver on the high levels of demand for air travel from both consumers and businesses that could fuel the recovery that began in 2021.

What is the flight path for 2023?

Rising costs and geopolitical tensions will continue to impact the outlook for airlines and aviation investors over the next year. We have seen major UK and European airlines revising down their 2022 and 2023 expectations, lowering capacity guidance by as much as 20% or more due to these operational constraints. Furthermore, the CWT and the Global Business Travel Association’s 2023 Global Business Travel Forecast predicts airfares will rise by more than 48% in 2022, followed by an 8.5% increase next year to cover high costs.

It is expected that there will be a divergence between winners and losers as operating models and balance sheets are tested. Low-cost carriers appear to be well positioned to withstand economic shocks resulting from these rising costs and could even see an increase in demand as consumers are forced to consider lower-cost flights.

All eyes are on travel activity over the upcoming holiday season. This will be a good indicator, at least in the short term, for travel themes in 2023. Uncertainty in the market is balanced by a strong backlog of investor demand, historically robust capital markets and the prediction that air travel demand will outpace GDP growth in almost all Western geographies.

Overall, this holiday season will be extremely telling for future profitability and asset returns predictions for the industry. In the near term, the largest uncertainly will be whether the effects of a prolonged downturn, compounded with rising costs, will hamper demand. If they do not, we are likely to see the continuation of the post-pandemic air travel recovery in 2024. If we do, we may see significant divergence between airlines that have the balance sheet strength and operational agility to cope with that downturn, and those that don’t.