How does COVID-19 government support steer strategy for airlines?

COVID-19 has created unprecedented turmoil in the airline industry. Many airlines have had to rely on a series of financial restructuring measures—equity injections, debt-for-equity swaps, interest payment holidays—to survive. Others have turned to governments for support. For several restructurings, as far as we can see, the government intervention has been purely financial, and apart from a general requirement to restructure airlines to become viable (as in the case of Norwegian, Singapore, Thai, and Korean) there is no strategic imperative.

But in some cases, there are non-financial strings attached in the form of government-led conditions and targets—and these strings can tell us a lot about the airline’s future strategic direction. We’ll provide examples of these commitments and agreements in the section below.

A snapshot of non-financial aviation targets imposed by government

The multi-billion refinancing of Air France-KLM is linked to significant non-financial targets. The French government has emphasised the importance of halving emissions by 2030 (and 2024 for domestic operations), upgrading the fleet, and reducing domestic flying significantly on city pairs where there is a 2.5-hour high speed rail alternative. Although these are targets rather than requirements (and re-state some existing features of Air France-KLM’s plan), they set a clear strategic direction for the airline. Air France/KLM’s co-owners, the Dutch government, also intends to provide support—and it will be interesting to see if there are similar conditions attached to that support when it comes through.

Similarly, Austrian Airlines agreed to a range of commitments with the Austrian government and the Lufthansa Group (its parent company) in order to secure a €600 million aid package, including a €150 million equity injection from the Lufthansa Group. A number of the commitments are environmentally focused, such as reducing CO2 emissions by 30% by 2030 (relative to 2005 levels), increasing jet fuel efficiency by 1.5% per annum, reducing average CO2 emissions per 100 passenger kms of the entire Austrian Airlines fleet by 11% by 2030, and promoting a modal shift to rail on a travel time of less than three hours. On this final commitment, the objective is also to serve the interests of the parent airline by ensuring the airports in Austria's provincial capitals continue to be connected to a Lufthansa hub. The other commitments revolve around safeguarding Vienna as an aviation hub, including its flight connections to Central and Eastern Europe (CEE) and to long-haul destinations. Finally, on June 8, 2020, the Austrian government announced timely changes to airfare and charges regulations in order to reduce emissions—including a €40 price floor on airfares and a €30 tax for routes under 350km, as well as a 2% blending mandate for alternative fuels. The entire financing package is dependent on state aid for Lufthansa in Germany.

Elsewhere, a condition of Lufthansa’s state funding (up to €9 billion from the German Economic Stabilization Fund [WSF], to be approved) is the requirement to give up slots at its hub airports, Frankfurt and Munich. This can be interpreted as an attempt to rebuff accusations of unfairness from airlines that may not receive any type of state-aid to dampen the COVID-19 related impacts, but more generally indicates a strategic direction from the German State to increase competition at key hub airports.

Meanwhile, Alitalia’s refinancing by the Italian government is being positioned alongside a fundamental restructuring of the airline as part of the airline’s nationalization plan, in which the government will initially take a 100% stake in the airline. Here, the goal is to encourage a focus on long-haul travel.

On the other hand, U.S. legislation focuses on protecting employee welfare and domestic connectivity through September 2020, after which demand for air travel is expected to rebound. In terms of employee welfare, U.S. airlines can apply for financial support under the Payroll Support Program (PSP) through the Coronavirus Aid, Relief and Economic Security Act (CARES Act), subject to the applicable minimum domestic frequency requirements. For example, American Airlines, the largest U.S. carrier, secured a USD $5.8 billion loan dedicated to payroll support under the CARES Act, and is also negotiating terms for a separate USD $4.75 billion low-interest federal loan. Although some U.S. members of Congress recently (June 2020) raised concerns about some airlines not complying with the spirit of the law (cutting worker hours and decreasing employee pay and benefits), employee welfare appears to remain a key theme of the U.S. relief system.

ICF’s analysis of U.S. flight activity shows that COVID-19 has had a relatively lesser impact on the connectedness of the U.S. domestic network compared to most other domestic markets around the world, although most routes have still experienced a severe net decline in commercial flight frequencies. While the CARES Act has likely extended a lifeline to many U.S. domestic routes that would have otherwise been cancelled, we expect that a large share of airline routes operate at far below their break-even point, implied by unsustainably low load factors.

The short- and long-term effects of government support on airlines

Government aid raises a critical issue about the extent of market impact caused by state-level intervention, particularly when such support (varying in extent and nature) has so far been very disproportionate between countries. Whether or not the support is fair, its effects are sure to be felt in the long-term—and the ultimate beneficiaries of financial aid may change between the short- and long-term. In the short-term, the benefit is clear given many airlines would not otherwise survive. However, these airlines will likely be held to the commitments they agreed to under their respective financial aid agreements.

Governments appear to be aligning airline strategies with certain non-commercial objectives, including environmental, competition, and employment. The European financial relief examples have a certain coherence in that they indicate a public preference for national carriers to cede short-haul and domestic to rail or low-cost, thus accelerating an existing trend stemming from environmental pressures. Paradoxically, the impact of the U.S. approach is to prop up the domestic network connectedness, at the likely expense of unprofitable services due to the ‘variable flying costs’ incurred (such as fuel, airport charges, and navigation) in order to sustain such frequencies. But overall, the crisis appears to have provided various types of governments the opportunity to influence how their national airlines operate. In this world, environmental and employment considerations are as important as return on capital.

While in the short term, government involvement has helped individual airlines survive, a key question is whether the strings attached may impact competitive dynamics down the road. Will government-imposed conditions result in stricter (and potentially less competitive) standards in the longer term, which will not apply to airlines that did not have to agree to such conditions—and who potentially stand to benefit as a result?