The eruption of a volcano in Iceland’s on April 15 forced the closing of European air space for a week and the volcanic ash poisoned not only the air but also the profitability of European airlines to a degree not seen since the September 11, 2001 terrorist attacks in the United States. In the aftermath, airlines have requested aid from the European Union to help them deal with the economic disaster. But can the toxic cloud coming from Iceland really be compared with the crimes committed at the World Trade Center in New York nearly a decade ago?
While the closing of European air space is unprecedented, “we believe that the current situation cannot be compared with previous ones such as 9-11,” notes a report by Nomura, the Japanese investment bank. To justify their position, Nomura’s analysts compared the impact of the volcanic eruption on profits with the rate at which airline stock prices declined on the region’s stock exchanges. Their emphatic conclusion: The markets have reacted excessively.
Estimates suggest that the total impact that the Icelandic toxic cloud at Air France may be about US$300 million, compared with some $360 million that went up in smoke on stock exchanges as a result of the volcanic eruption. There are similar results for British Airways (US$195 million of real impact versus US$300 million of impact on stock exchanges) and for Lufthansa (US$268 million of lost business versus US$707 million lost in stock value.)
Although markets overall have punished these stocks excessively, investors have nevertheless fled these companies to a lesser degree than they did after the September 11, 2001 disaster. Comparing the first three days following the attack on the Twin Towers – when U.S. air space was closed – with the three days following the eruption of the Eyjafjöll volcano, show that European airlines have suffered much less than they did nine years ago.
Less Impact on the Stock Market
On average, during the three days following the attacks on September 11 investors penalized airlines four times more than they did after the recent disaster. Eleven years ago, KLM Royal Dutch Airlines suffered the most when it lost 36.88% of its market value and was forced to merge with Air France to avoid bankruptcy. Air France plunged 23.48% after the attacks in the U.S., but fell just 6.21% this time around. At Spain’s Iberia, which had just signed a merger with British Airways, there was a similar story. It fell 22.52% in 2001, but dropped only 5.2% last month. More generally, airline values dropped by 26.25% in 2001 but by only 4.94% during the first three days after European air space closed. European airlines alone lost 7% of their value on average during the nine days when European air space was partially closed (although the worst days were between April 15 and 21).
“The eruption of the Icelandic volcano is a temporary event, and the market will manage it as such,” says Manuel Romera, director of the finance department at the IE Business School. “Just as airlines were penalized on the stock exchange, they will recover after the sense of alarm passes.”
Despite these comparisons, the aviation sector insists that this crisis is worse than after the last major crisis nearly a decade ago. According to IATA (the International Air Transport Association), companies have seen about US$1.7 billion of business lost from the eruption. It forced the cancellation of 30% of scheduled flights, affecting an average of 1.2 million passengers a day.
Alejandro Lago, professor of operations at IESE, thinks today’s situation is comparable the earlier disaster, making the volcanic eruption one of the worst blows to the aviation sector in history. The downtime for the European air space represents about 2% to 3% of the days of the year, which suggests that profits will fall by a similar amount. And since the profits of even the best-performing airlines represent barely 4% of revenues, “the difference between having those planes shut down during the closing of the air space, and what would have happened if they had been flying, is the difference between [the airline] making a profit and losing money.”
The airlines have made this case from the start of the ash-related groundings, noting that they confront this problem in an already weakened position. The EU says it is prepared to adopt a similar framework that it set up nine years ago, which will permit member states to offer aid to compensate the companies. Meantime, given the tenuous profit picture for most airlines, they “are moving toward a restructuring, especially after the emergence of low-cost carriers, and this is the real, fundamental problem,” says Romera. “The problem with the aviation sector is that it is doing poorly.”
What’s more, both catastrophes occurred during an especially delicate time for the aviation sector. “In both cases, the sector was living through a period of recession and economic crisis,” says Lago. The 2001 attacks in New York took place after the bursting of the technology bubble, just when it appeared that the economy was starting to take off. This time,”the volcano arrived at a time when countries are trying to recover from the serious financial crisis.” One likely result: an acceleration of the industry’s restructuring.
Restructuring – or Bankruptcy?
Restructuring is one potential outcome. But will this disaster lead to the bankruptcy of some air carriers? Josep Francesc Valls, professor of marketing and tourism management at ESADE, says that some of the hoped-for capital injections are unlikely to occur. “Companies must handle these matters by dealing with their own insurance companies.”
This crisis has again raised the question of the legality of state aid versus when companies should handle losses on their own. A European Union rescue of the airline sector opens the door to many other companies affected by the closing of air space. In fact, airport operators have already held meetings with the European Commission to analyze this situation. Companies in the tourism sector are also demanding compensation for their losses at hotels, restaurants and other tourist destinations.
“Companies in the sector, along with governmental authorities, must recognize that these sorts of natural catastrophes can recur. This time, it was a volcano that erupted but tomorrow it may be acid rain, or it could be some birds that live near airports and can put planes at risk. Above all, governments are increasingly going to make the security of their passengers a priority,” warns Lago.