What Happens When People Stop Flying? Analyzing the Cascade of Downstream Effects
March 20, 2020|Jeff Davis
What happens when people just stop flying?
We tried to look at that simple question and expand it into the cascade of downstream effects that the coronavirus-caused collapse in air travel has caused, and will cause.
Underlying cause: people stop flying. On March 19, 2019, TSA screened 2.4 million passengers entering U.S. airports to get on airplanes. Yesterday, they only screened 623 thousand. So 1.8 million passenger per day have stopped flying in the U.S., and that may get worse.
Those 1.8 million missing daily passengers either aren’t buying new tickets or else they canceled existing reservations (which, depending on the precise cancelation policy, also hits the bottom line of the airlines).
- First-order effect #1 (immediate): Airlines instantly start losing what could be more than 70 percent of their expected daily operating revenue – causing an immediate cash crunch.
Those missing 1.8 people per day aren’t going to the airport, so they aren’t paying the airport for parking. And they aren’t paying the $4.50 per head Passenger Facility Charge that most airports collect on enplaning passengers.
- First-order effect #2 (immediate): Airports instantly lose about 20 percent of their daily operating revenues. (Parking and PFCs were 27 percent of total airport revenues in 2017, and a 75 percent cut in passengers coming to the airport reduces 20 percent of total revenues, immediately, because 0.75 x 27 = 20.)
And, since those 1.8 million people per day aren’t in an airport at all, they no longer do the things that people in or near airports do.
- First-order effect #3 (immediate): The companies who rent space from airports to provide dining, retail, and rental car concessions immediately see a 75 percent drop in their expected daily cash income.
And, there is one first-order effect on the U.S. Treasury.
- First-order effect #4 (immediate): Excise tax receipts for the Airport and Airway Trust Fund dry up. Over 90 percent of annual AATF tax revenues come from the combination of the 7.5 percent tax on airfares, the $4.30 per per passenger domestic segment fee, the $9.50 per passenger Alaska-Hawaii segment fee, and the $18.90 per passenger fee on international arrivals and departures. Few to no passengers means little to no tax money coming in. Fortunately, the Trust Fund has enough of a built-up balance to go at least a year with few to zero new tax receipts before it runs out of money to pay air traffic controllers, safety inspectors, and airport grants, but it’s a long-term problem.
Then what happens? What do airlines do when people largely stop flying? They have to immediately cut costs to stop the bleeding. Contractual obligations with labor unions and suppliers limit some areas of reduction, so the airlines restrict daily cash flow whenever they can.
Initial airline response #1: Airlines are reducing the number of daily flights (quite drastically overseas and still very significantly domestically). Per FlightStats, ten days ago the number of daily flight cancelations in the U.S. was around 400. On March 17 there were 2,000 flights canceled.
The average over the last two days is 4,500 canceled flights per day. (March 21 update: The March 19 U.S. canceled flights totaled 4,726 and the March 20 cancelations were 5,278.) Two days ago, Delta’s CEO told employees that they would eventually be canceling 70 percent of their systemwide flights.
- Second-order effect #1: By reducing flights, airlines are now no longer paying landing fees to airports, or buying fuel at airports, for those missing planes. Those daily fees and fuel sales were another 15 percent of airport revenues in 2017, so losing 70 percent of that would cut overall airport revenue by another 11 percent or so starting in the next week or so.
Initial airline response #2: The Delta CEO’s letter said the airline was “deferring nearly all our capital spending, including all new aircraft deliveries.” The other major carriers are doubtless doing the same. By refusing to take delivery of new aircraft that are on order, they are saving the millions of dollars per plane that they would have paid upon delivery. And, presumably, the airlines are also suspending any orders of new aircraft that they had earlier considered making, which lets the airlines keep the initial deposits they would otherwise have put down with the manufacturers.
- Second-order effect #2: Boeing and Airbus see major hits in monthly operating revenue. Boeing was already having a problem in the delivery department due to the 737 MAX, but the coronavirus is causing blanket cancelations of all orders and deliveries, MAX and non-MAX planes. In the last good quarter (1Q 2019), Boeing’s 10-Q reported $11.8 billion in revenues from commercial airplanes, about 52 percent of total company revenues. By the fourth quarter, that number had fallen to $7.5 billion ($32.3 billion on the year, down 44 percent from 2018). The 2019 drop was a MAX issue, but the suspension of deliveries and orders of other, profitable airframes like the 787, 767, and the new 777X could cause that post-MAX $7.5 billion per quarter revenue to drop precipitously.
Initial airline response #3: The Delta CEO said that they would “temporarily consolidate airport facilities” at their hubs.
- Second-order effect #3: Once airlines consolidate the number of gates they are using at airports, at some point, that reduces the rent they pay to airports for the use of those gates. Terminal facility rental was another 19 percent of total airport revenues in 2017. We’re not sure how long the average lease goes for, but eventually, those consolidations of gate and other terminal space by airlines will reduce that revenue stream for airports.
Initial airline response #4: With far fewer flights in the air, at the terminals, and in the maintenance hangars, far fewer employees are needed. So far, U.S. carriers haven’t begun layoffs but have been urging employees to take unpaid leave (while maintaining health care and other benefits). But, eventually, U.S. airlines may have to do what more international carriers have started doing, and lay off workers. (March 21 addition: Yesterday, after this article went to press, United Airlines CEO posted a letter to employees, cosigned with the heads of United’s unions, which said “if Congress doesn’t act on sufficient government support by the end of March, our company will begin to take the necessary steps to reduce our payroll in line with the 60% schedule reduction we announced for April. May’s schedule is likely to be cut even further.”)
- Second-order effect #4: Laid-off airline employees file for unemployment insurance, increasing the cost of that program to both federal and state governments.
Also, let’s not forget first-order effect #3, above, which will eventually and inevitably lead to:
- Second-order effect #5: The companies that rent space from airports to provide dining, retail, and rental car concessions will start laying off employees fairly quickly with their daily business down 75 percent or more for more than a couple of weeks, which will add to the unemployment rolls. (March 21 addition: Today’s New York Times reports that the dining/retail concessionnaire at the NYC-area airports fired 1,200 workers yesterday, with health benefits cut off as of March 31.) Then, at some point not long after that, some of those companies will either begin trying to get out of their airport leases or else default on lease payments. Lease revenue from terminal concessions and rental car facilities formed another 12 percent of total airport revenue in 2017.
Then, we start getting into the third-order effects:
- Third-order effect #1: Boeing and Airbus stop paying their suppliers. Somewhere north of two-thirds of the revenues that the two big manufactures make from selling commercial airplanes goes downstream to the manufacturers of components. The suspension of 737 MAX production has already disrupted these purchases, but now the cancelation of deliveries and new orders for all the other commercial airplanes sold by both of the majors will result in billions of dollars per quarter being withheld from the smaller business, who will then start to have cash flow problems of their own, eventually leading to slowdowns and layoffs. Those suppliers support north of 2 million U.S. jobs.
And then the eventual first-order effects:
- First-order effect #5 (eventual): Airlines run out of money. Their trade association says that in the worst case scenario (which is consistent with the drop in demand and travel bans we have seen in the last week), the seven major U.S. passenger carriers could run out of liquidity by May. They could declare bankruptcy (many have in the past), but if there is no end to the coronavirus problem by that point, no one in their right minds would provide debtor-in-possession financing during bankruptcy, and the carriers might eventually have to suspend operations and just shut down entirely. The airlines’ status as common carriers means that if they stop operating, the federal government is obliged to step in and provide the service somehow (as happened when most of the railroad common carriers ran out of money starting in the late 1960s – the federal government wound up running most Northeast railroads directly, as Conrail, from 1976 to 1986 and is still running Amtrak today).
- First-order effect #6 (eventual): Airports run out of money. The ability of airports to cut direct labor costs through layoffs may be limited by the fact that many airport employees may be classified as local government workers with contractual or civil service protections. But the airports have over $7 billion in debt coming due this year, securitized by general airport revenues or PFC collections (or both), and with those revenue sources dwindling quickly, the ability to pay debt service will become an issue by the end of the year. Since almost all airport authorities are subsets of municipal governments, local governments share some of the responsibility for keeping them solvent, but this only adds to the (mounting) problems that the recession is causing them through collapsing sales tax revenue (and, eventually, reduced income tax revenues as well). And across-the-board downgrades or defaults on airport bonds will have a negative effect on the rest of the muni bond market, at the worst possible time.
- Second-order effect #7 (eventual): Aerospace manufacturers run out of money. This will hit Boeing and Airbus first, but if they have to suspend production and shut off the assembly lines, the smaller aerospace manufacturers who make their components won’t be far behind.