As aviation emerges from the worst crisis in its history, airlines look forward to a cleaner, greener future in which their march to net-zero emissions proceeds in lockstep with improving profitability and lower debt.
Of course, such a symbiotic relationship is pure fantasy, especially as airlines look to repair their balance sheets from years of borrowing and losses.
Airlines losses could top $200 billion over the 2020-2022 period because of the crippling impact of COVID on air travel, according to the International Air Transport Association (IATA). The losses are made up of $137.7 billion in 2020, $51.8 billion in 2021, and $11.6 billion in 2022 for a total of $201 billion.
And while the pandemic further prioritised investing with conscience across all sectors, it is yet to be seen whether this is merely a trend or a fundamental shift in how people invest.
The stickiness of ESG investors is critical if the aviation industry is to meet its 2050 net-zero goals. Will the sustainability focus shift from a corporate plan to a somewhat moral one with passengers helping to pick up the tab for greener skies?
Critical regulation
A lessor source argues government regulation will be required for a full-fledged adoption of a sustainable mentality as "airlines will be motivated by the dire state of their finances to look at cost-cutting".
Without regulatory mandates and subsidies, airlines will always go for the cheapest option, the lessor adds. Does this mean governments will need to collect a fuel surcharge - so that the price of flying increases one way or the other?
An aviation banker agrees that sustainability targets "ultimately will be regulated", adding: "It is a matter of time." However, he notes change will come at both the consumer level and investor levels.
While some consumers support sustainability efforts, they don't necessarily want to pay for it.
According to IATA, aviation contributes around 2-3% on average of global carbon dioxide emissions annually. However, with dramatic growth forecast during the next 20 years, the challenge of lowering emissions will intensify as passenger numbers rise.
And with high debt burdens, airlines may struggle to hit sustainability targets.
The good news is that investors across all asset classes have become more engaged with ESG concerns since the onset of the crisis. And linking profitability to a green plan is becoming more common as consumer consciousness increases.
Data from Bloomberg Intelligence's ESG 2021 mid-year outlook shows that ESG assets are on track to exceed $50 trillion by 2025.
UBS said in a recent note to clients. "The crisis underscores the relevance of ESG considerations to company performance and investment returns, and we expect that this will continue to influence corporate and investor actions going forward."
The bad news is that the industry is saddled with debt as it approaches the transition to sustainable aviation.
Sustainability versus debt
Airlines were given essential liquidity from governments and investors during the pandemic to survive a collapse in traffic..
“Financial support was a lifeline for many airlines during the crisis. Much of that—approximately $110 billion— is in the form of support that needs to be paid back. Combined with commercial borrowing the industry is now highly leveraged,” said IATA director general Willie Walsh said at a October meeting in Boston. “We don’t want handouts, but wage support measures to retain critical skills may be necessary for some airlines until governments enable international travel at scale. And regulatory alleviations—like continued slot wavers while international traffic recovers—will be needed well into 2022.”
Airfinance Journal’s Airline Top 100 research, which covers every airline that has reported its financial since 31 December 2020, indicates that a number of airlines are hanging on by their fingernails in terms of liquidity and access to capital - 29 had liquidity of less than 5% of normalised revenues in the 2020-21 timeframe.
The sample includes 112 airline groups and 128 individual airlines.
In aggregate, AFJ's sample of airlines experienced negative cash flow from operations of $72 billion and incurred $53 billion of investments in 2020-21. Loan repayments were an additional $113 billion outflow. This was funded by loan drawdowns of $241 billion, equity raised of $40 billion and proceeds of sales and leasebacks of $8 billion. Cash at the beginning of the period was $76 billion and increased to $155 billion by the end of the year.
But all of this came at the cost of balance sheets. Balance sheet debt (including operating lease liabilities under ASC 842/IFRS 16) increased from $392 billion to $596 billion and the debt/equity ratio more than doubled from 2.3x to 5.4x.
Fixed charge cover (FCC), which best illustrates the affordability of increased debt servicing, can only be assessed on an individual carrier basis. Clearly all 65 who had an EBITDAR loss had a negative FCC ratio.
Of the positive-EBITDAR airlines, 25 had FCC of greater than one, and 28 had a value between zero and one.
To achieve net-zero, Walsh estimates that $2 trillion is needed to support an industry-wide resolution by 2050.
Not only will the sector have to invest billions of dollars in sustainable aviation fuel (SAF), air traffic control and infrastructure, but manufacturers will have to develop newer, greener aircraft designs.
Walsh has said that incremental change in aircraft efficiency is not good enough. To get to net zero, he is demanding a "fundamental change".
To be fair, the sector has not seen any obvious examples of airlines stepping away from their environmental targets during the pandemic. If anything, with the IATA commitment, more airlines are making individual commitments than pre-pandemic.
But if the industry is to meet its 2050 goal and decarbonise airlines need SAF that is cheaper and more widely available.
Refuelling
SAF prices are currently about five times higher than prices for conventional jet fuel, data on European spot market prices collected by OPIS show.
To hit its net zero emissions target, IATA wants 65% of all aviation fuel to be SAF by 2050. It says 450 billion litres a year of SAF will be needed in 2050.
SAF is currently less than 1% of the aviation fuel, but IATA believes one billion passengers will have flown on a SAF-blend flight by 2025, and penetration should approach a tipping point of 2% of jet fuel.
Norway was the first country known to add a quota requirement for SAF, 0.5% of annual fuel from 2020, with a target of 30% by 2030. Other European countries have announced plans for similar mandates in the past two years. Sweden, Finland, France, Spain, Germany and the Netherlands have either confirmed or are planning mandates.
Also, released as part of the European Commission's 'Fit for 55' climate package, the ReFuelEU Aviation proposal confirms imposing a mandate on fuel suppliers to include SAF in aviation fuel supplied at EU airports. The obligation would commence from 2025 at 2% SAF, gradually increasing to 63% in 2050.
But SAF is not the only alternative being researched to cut emissions. This year Air Liquide said it would study liquid hydrogen supply at 30 airports globally with Airbus. Airbus' chief executive officer Guillaume Faury told a sustainability event in September that the manufacturer is confident its hydrogen-powered aircraft will enter service by the target date of 2035.
Passenger pressure?
Some airlines think passengers will help fund the transition to net zero.
British Airways' Better World initiative invites passengers to pay for sustainable aviation fuel for their flights and contribute to carbon reduction projects, such as reforestation.
United Airlines is giving customers the ability to contribute funds for additional SAF purchases or for use on initiatives that will help decarbonise aviation.
But passengers haven't been big supporters of green measures to date.
According to the Aviation Environment Federation, the take-up rates by passengers on the option to offset their carbon emissions when they buy a ticket is very low – typically not more than around 1%.
As Airfinance Journal went to press, delegates descended on Glasgow for the most critical environmental conference of the year.
Ahead of the Cop 26 Climate summit, Reuters leaked documents revealing that the United Kingdom, the conference's host country, is pushing for countries to support a global target to cut aviation emissions to levels compatible with the Paris Agreement.
The leaked draft said that those who sign the deal would commit to supporting the UN's International Civil Aviation Organization (ICAO) adoption of an "ambitious long-term aspirational goal that is compatible with net-zero global emissions by 2050", the leaked draft said.
The move is essential as the Paris Agreement does not address international aviation emissions but commits countries to limit global temperature increases to 2C this century and aim for 1.5C.
But for these efforts to materialise, there needs to be a paradigm shift in investment that supports a green agenda in aviation. But also, the industry needs to structure opportunities that support this change in investment.
There are also many questions about how nation states should leverage their burgeoning involvement in aviation. For example, should airlines that received bailout money be allowed to bring back older, less fuel-efficient parked aircraft?
Another lever might involve tying new route authorities to airlines tracking along stated ESG goals. Then there is the possibility of export credit agencies accelerating the transition to more efficient fleets with low-cost loans.
Al Gore made this point speaking ahead of the COP26 climate conference. He called for increased regulation and disclosure to force banks, traditional asset managers, private equity firms and other asset owners to overhaul how they deal with climate change risks.
"It is suicidal for the human race to continue on this track and to pretend that it can be somehow negated by promising to plant trees here, there or elsewhere. This is simply not realistic."
He was also critical of the market for carbon offsets in the push for net-zero emissions. Offsets "can't be a get-out-of-jail-free card," he said in the Financial Times. They have "a role to play", he said, but as a last resort. "The focus has to be on reducing emissions."
Of course, a sure way to lower emissions is to fly less, but that view is not part of the sector's sustainability focus. Instead, the flying public, governments and investors need to be on board to fund and enforce the transition to net zero.
