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What Impact Will the Brexit Have on Airline Profitability?

What Impact Will the Brexit Have on Airline Profitability?

 

When the British Government called for a referendum to allow its citizens to decide whether the United Kingdom (UK) should remain within the European Union or withdraw from it, not many people really expected what happened at the close of polls on June 23, 2016.

Now the Brexit vote is a reality and it brings along potential changes, which like it or not, individuals and businesses alike, including airlines will have to cope with sooner or later.

As a matter of fact, some large European carriers, namely EasyJet and Ryanair have recently lowered their respective financial outlooks for the last quarter of 2016. Obviously, investors reacted unfavorably to these profitability adjustments.

In this edition of Airline Profits, we are interested in the potential that impact the Brexit would have on airlines, especially in terms of profitability.

The Withdrawal Process and Possible Scenarios

From the time the British Government formally notify the EU of its intent to leave the union, both parties have to reach an exit agreement within a period of two years.

According to various sources, including IATA, there are typically three possible outcomes for the UK after 40 years of EU membership, namely:

  • The UK joins the European Economic Area (EEA)
  • The UK joins the European Common Aviation Area (ECAA)
  • The UK opts to fully break away from the EU

Scenario 1: The UK joins the European Economic Area (EEA)

The first scenario is the best case or the least painful option, depending on how you look at it. And that consists of both parties agreeing to preserve the progress made over 40 years of political and socio-economic relationship. In such a case the UK would agree to join the European single market, formally known as the European Economic Area (EEA).

The implications of this option are such that the UK would agree to abide by European laws pertaining to the single market. Besides, the UK would continue to pay membership dues to the EU. Moreover, in such a case, the UK will still benefit from existing trade agreements, contracted between the EU and other countries. In a nutshell, this scenario can be considered the easy way and is likely to be implemented quickly.

Potential Impact on Air Travel and Airline Profitability under Scenario 1

In the likelihood that the British Government chooses the easy way out, the economic landscape would likely change, but not very much. In such a case, one can expect air travel to and from the UK to be much similar to what it is today. Some immigration and custom changes can be expected for some international travellers, which would have very little or no impact on intra-European travellers. This scenario would also imply that UK-based airlines will continue to have access to the current markets.

As far as profitability is concerned, one would expect no major impact, either positive or negative as a result of the Brexit. Some anticipated impacts would be more driven by the economy in general. With that said, currency fluctuations resulting from the level of uncertainty pertaining to the Brexit is already proving to be damaging to airline profitability, as far as EasyJet and Ryanair are concerned.

All told, the EEA option is the scenario, which could lower the perceived level of uncertainty, if the British Government were to choose that approach.

Scenario 2: The UK joins the European Common Aviation Area (ECAA)

Joining the ECAA would be a more likely scenario for the UK. It is very similar to the first scenario, except that instead of being entitled to the benefits in connection with the entire single market, the UK would be taking advantage of the existing European aviation space, rules and regulations. Other European countries like Norway and Iceland, are part of the ECAA, without being members of the European Union.

Some of the drawbacks of this option are the contributions the UK would still have to make to the EU and the application of European aviation laws and regulations, in which the UK would not have much to say.

Potential Impact on Air Travel and Airline Profitability under Scenario 2

In the likelihood that the British Government opts for the European Common Aviation Area (ECAA), intra-European connectivity to and from the UK would remain like it is today. However, significant changes for international flights would be expected, since the UK would need to contract bilateral or multilateral economic agreements with other non-European countries before gaining access to a market as wide as today.

As far as airline profitability is concerned, although domestic intra-European routes would remain the same, therefore their financial contribution would likely follow general economic outlook of the European region. However, international routes would likely be reduced significantly. As a result, this would severely impact the overall airline profitability of UK-based airlines.

Non-UK carriers also would likely suffer some financial drawbacks, especially those that offer several direct or connecting flights through the UK.

Scenario 3: The UK opts to fully break away from the EU

The third scenario is tied to the likelihood of the British Government deciding to go the hard way and dive anyways into the unknown and face uncertainty head on. In this case, the divorce with the EU would be complete. As a result, the UK would break free from current European laws and chart the course of its future on its own.

An obvious consequence of this option would be the negotiation of bilateral agreements with not only EU members individually, but also non-EU members. As a result, on one hand the UK market would be restricted to many countries, at least temporarily. On the other hand, the access to many European and non-European markets would be restricted to British business, including airlines.

Potential Impact on Air Travel and Airline Profitability under Scenario 3

An anticipated consequence for airlines, whether UK-based or not, would be a very difficult environment, where access is restricted and traffic is negatively impacted. This market condition would persist until such a time when the British Government would conclude enough bilateral and multilateral agreements to re-create an economic environment similar to the one, which exists today under the EU membership. Even with a good dose of optimism, one could not expect such a market condition to happen quickly. In fact, it may take several years or decades to accomplish that.

Airline profitability would likely be severely impacted as a result of reduced traffic to and from the UK, especially knowing that London is one of the world’s major economic platforms and one of the busiest international destinations.

Summary

Despite intensified warnings from politicians and prominent business leaders about the devastating potential of the Brexit, the majority of British voters opted on June 23, 2016 to leave the European Union. Thus practically speaking, by the end of 2019, the UK could have officially left the union. The options available to the UK are essentially three folds, ranging from an economic co-existence or an aviation co-existence to a complete break-up.

Under an economic co-existence through the European Economic Area (EEA) or an aviation co-existence through the European Common Aviation Area (ECAA), which in both cases equates to a lower level of membership, one would expect some or most of the current arrangements between the UK and the EU to stay as they are. The effect on air travel to and from the UK would be somewhat negligible, although the ECAA option could affect international travel more severely.

Whereas, the full break-up will entail a great deal of uncertainty whereby the UK would have to re-negotiate dozens of bilateral or multilateral agreements both with EU and non-EU countries before accessing a market comparable in size to what currently exists through the EU membership. This scenario comes with a greater level of risk and uncertainty, but will also require a lot of time and energy to accomplish. In the meantime, UK-bound air travel will tremendously suffer in terms of traffic and ultimately profitability.

 Unfortunately for UK-based airlines, the uncertainty raised by the vote in favor of the Brexit and the subsequent currency plunge were somehow entertained by the lack of guidance as to as to which option the British Government is going to pursue and when it will engage the EU to trigger the exit negotiation process.

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Kofi Sonokpon

Kofi Sonokpon

Managing Editor of Airline Profits, the first aviation magazine devoted to improving airline effectiveness and profitability, Kofi Sonokpon has more than 20 years of international experience in aviation. Kofi holds an IATA sponsored Master of Business Administration (MBA) in Air Transport Management from the John Molson School of Business at Concordia University in Montreal. Kofi Sonokpon is also an author and speaker on the topics of leadership, effectiveness, and profitability.