Despite the disastrous impact of hedging on the bottom line last year, analysts are advising airlines to start hedging again, saying the window to take advantage of the low fuel prices will close with the second quarter. But they paint a far more pessimistic picture for airlines than they had only four months ago and today expect it will take five years to resume growth. Forecasters also agreed that investors, with a great deal of cash, are waiting to return to the market.

“Oil will continue to go up,” said G2 Solutions Principal Michel Merluzeau. “Oil is not going to stay where it is for a long time. It will eventually bounce back. It's the basis on which we should forecast product allotments and future market trends.”

“The opportunity for hedging will be gone by May or June of this year,” said InterFlight Consultants Chair Oscar Garcia, speaking at a recent Aviation Today webinar. “I think the fuel situation and volatility is well taken care of with the billions of dollars that are already pledged to alternate fuels and new technologies. They are taking their course and there are tremendous breakthroughs happening. By 2018, 2020, this volatility and dependence on OPEC countries, it's over. We've started a path of development of an alternative to fossil fuel and we're not turning back from that.”

While Boeing predicted that alternative fuels will be available in as little as three years, distribution and fleet retrofits will remain a problem until, as Garcia suggests, the last part of the next decade.

As for recovery, Teal Group Analyst Vice President Richard Aboulafia, likened the industry’s woes to a heart attack, laying out three scenarios for the industry. “Basically, we do take a three-year hit to civil production, not including the after market which is an awful lot. But civil world production declines between '09 and '12, hits bottom, resumes growth in '13. The military side stays okay and it will be more of a plateau there. But we suffer three down years. It isn't quite as terrible as post 9-11. But again, there's an awful lot we just don't know about the broader economy.

“The baseline scenario is we're assuming that this is a nasty heart attack to the system, the worst popping of several bubbles,” he continued. “It's the accumulated tech and com bubbles that were never really dealt with back in '02-'03. What we're seeing now, of course, is the economic fallout from those popped bubbles and basically Wall Street hitting Main Street and all those other clichés. But nothing fundamental has changed. Basically, this industry gets back on track and demand resumes in, say, 2011, 2012, especially, and then delivery growth resumes in 2013.

“As for the two departure scenarios,” he continued, “one posits that we're still in freefall here. Certainly there are some very bad gloomy indicators and a few good ones. But then, of course, a massive injection of liquidity could restore things. Many people believe that there's a lot of cash waiting on the sidelines and that somehow we could just arrest the fall and then come back to a certain extent by re-inflating fast. The third scenario but it's the kind of end of the world as we know it where we just fall and lose a decade. Basically, we resemble Japan in the '90s.”

Merluzeau, however, predicted a more menacing scenario in which, as he put it, the economic crisis is compounded by a political one. “That is a distinct possibility,” he said, pointing to Iran, Pakistan. “It then becomes a question of what Israel or the U.S. or NATO will do. I think that is the biggest question mark of this year that would potentially disrupt our economies further. The likelihood of a catastrophic event taking place this year is significant and, factoring in that impact, we're looking at possibility of two to three years prolongation of the economic depression that we're witnessing right now. This is, to me, an unknown that needs to be carefully weighed.”

Even without a political event, Aboulafia is worried. “There are two major threats I'm concerned about,” he said. “One is threats to free trade, free and open trade between countries is a real slice of our business, given the supply chains that and customer base. And the other demagogic populism that goes after business jets. Business jets are now – the economic value of business jets is now about the one-third the value of Airbus and Boeing jets. It's a huge industry and we need to make sure it isn't vilified.”

Merluzeau predicted that general aviation volatility will continue to be significant over the next six to seven years. “We all know there is always an element of correlation between Wall Street and business jets,” he said pointing to a chart illustrating it. “Now if the indicators are there and we're looking at the Dow Jones Industrial Average collapsing, I'm predicting a 30% plus reduction in deliveries over the next few years. We should see a significant drop that should bring us back probably to where we were in '03 or '02.” He also pointed to the potential growth of the personal jet market being a bright spot, especially as they replace older turboprops. “But overall, this is going to be a very, very stagnant road to recovery in my opinion.”

Garcia agreed saying aviation and transport – whether general aviation or airlines – will continue to decline this year and then stagnate, growing by 2014. Merluzeau suggested production would take a 30-40 percent hit.

“I think the crash has caused the end of linear thinking in terms of analysts' ability to forecast,” he said. “There are multiple things that could happen between now and the next five years that could make 50% look like a conservative estimate or make it a grossly overstated estimate. It's increasingly more complicated to give precise answers as to where this economy, where orders, are going to go. So, as far as the 50% itself, I agree with Richard. It's probably exaggerated.”

He also agreed about cash waiting on the sidelines. “There is liquidity accumulated but where is that liquidity executed,” he asked. “Certainly we are facing one of the points where there's more money market investment available than I've seen in the last 20 years. However, it's the execution of that liquidity that remains to be seen. In my opinion, if that liquidity is executed, we will see the bottom of this hockey stick or V-shape which is somewhere in between. Basically, we are where we were before 9-11 and, if that's the case, we are okay. Now, if the bottom is below where we were prior to 9-11, then it's going to be interesting. I was trained to stay optimistic, but it's increasingly difficult, to be honest.”

Garcia expects production rates will drop 15%, 20%, noting that aircraft values are coming down. “For all those with cash ready to invest, there is no asset better than aircraft,” he said. “This year and next year, you can get $0.50 on the dollar. After that, you'll be able to get good prices. But the values are going to decline for the next three years. Regarding air transport, basically a decline followed by a slow stabilization and incline.”

“We had an awful lot of froth in terms of order activity relative to fleet size in '06, '07, '08,” said Aboulafia. “Now we're coming down. But the key takeaway here is even though we've got this enormous backlog that might not put us in very good stead through a downturn, things weren't way out of trend. Things were not ridiculously inflated. I don't think we're going to have a terribly soft landing, but dire predictions of the 50% cut, I think those a bit overdone.”

Aboulafia suggested that Merluzeau might be right as to the end of linear forecasting. “There was a book published a couple years ago by a professor – former hedge fund forecaster named Taleb, I believe, called The Black Swan,” he said. “It argued that the future is not just chopped up bits of the past extrapolated forward. Very often there are these major shattering events that appear and they challenge everyone's assumption and the whole concept. If you're a forecaster in this business, that's exactly what you do. And you've got 60 years of post-war economic and air travel growth that you think you can keep extrapolating from. Well, what if we're wrong?”

Aboulafia put Airbus in better shape that Boeing, noting a 7,500-aircraft backlog in the mainline jet production industry. “Increasingly, Airbus is in decent shape,” he said. “Boeing really had them on the ropes in '06, '07. But Airbus has made a respectable comeback. But, almost all of that comeback has come from the A350. The A380, at this point, is more of a sideshow than anything else. The 350 is what matters. The biggest question for Europe is how quickly this can get to market. I think, ironically, Airbus is going to benefit from this because this is the ultimate shovel-ready project. They've already gotten a $6 billion aid package. They'll get more. And there's nothing the U.S. can do about it because the only possible retaliatory measure would be – what? Bailing out Detroit? I think Airbus could actually benefit from this crisis.”

Merluzeau predicted an Airbus decade, won on the back of Boeing problems. “I think delays in the 787 program and uncertainties regarding the next generation or revamped 777 are all positively impacting Airbus. So, I'm actually thinking that we might witness an Airbus decade of very strong growth where Boeing will have to respond more and it could directly influence the markets.”

The scenario is different for regional airliners, said Aboulafia, pointing out that this is a segment of the market that has failed to grow over the past five years. “There are an awful lot of players who want to get into it this market,” he said, adding the industry missed out on the good times. “You've got Bombardier and their strategy is move into the C series. You've got Embraer whose strategy is do business jets. ATR is hanging in there with turboprops. And then there's the newbies from China, Russia, and Japan. The jury's still out on how much they're going to make of a bad situation.”

Garcia likened Embraer’s strategy to Boeing and EADS, diversifying into government and non-government sectors. Indeed, Meluzeau wondered what was next for Embraer, which has preferred to extend its aircraft missions while waiting for the market to clarify as to what the next needs for the industry will be.

“I think the CSeries will be a moderate success,” he said, noting that Aboulafia disagrees. “I think it serves a growing niche that I believe eventually Embraer will have to respond. I don't see Embraer going into the 150-pax-plus market. I think they're not in a position against Airbus and Boeing, for various reasons. But I do not think that Embraer will want to concede entirely that market space to Bombardier regardless of the forecast potential of the CSeries. Bombardier's numbers, I believe, are somewhat exaggerated, a little too optimistic. I think there is definitely a market for the CSeries around 900 to 1,000 aircraft over the life of the program. That's a conservative estimate. But again, you know, the problems that existed prior to the crisis are still with us. So, those will need constant investments. Because once the economic recovers, four, five, six years from now, they're going to reappear. This is exactly what happened after 9-11. Air traffic control got easier and now we're back to square one.”

All three analysts heavily criticized the stimulus package saying it did very little for aviation. “What you're trying to do is compensate for inadequate wealth, slack demand, and over capacity,” said Aboulafia. “The most you can do is ride it out and try to prevent the worst collapse or the worst downturns from hitting society. But trying to effect the pace of markets in terms of demand and capacity, that's kind of a fool's game for government.”

Merluzeau questioned the package further. “Where is the funding for the next big technology that's going to drive the U.S. aerospace industry,” he asked. “This is why I call this stimulus a short-term political stimulus because it is based on an election cycle, as most politicians – they only do what they know best. They're working in terms of very short-term projections. That's why I find it very disappointing. And for the future of the aerospace industry, I would've liked to see a program that would've driven innovation and research and would've driven research and development with small and medium businesses where the best ideas usually come up.

“But what I don't like is that funds are being diverted from market-determined users to politically determined users,” he continued. “And I think that's a bad combination. That growth of the government spending will be to the detriment of the private sector. This stimulus will take away from the economy productive capability and that's what I'm concerned about. Over the long-term, we're not having any intangible benefits. It's a very short-term approach to a very, very serious problem.”

If the stimulus fails, he added, so, too, do the forecasts. “The revised forecast we've put out together recently may actually be too optimistic if the stimulus actually fails to generate a solution to our crisis,” he said. “What I'm more concerned about is what's going to happen in China. If China witnesses a severe downturn of their economic growth this year, this could lead to not only financial instability over there, but also social instability. We are seeing signs of it. We can migrate from the 11,000 riots we've seen over the past five, ten years annually in China to double or triple those numbers.”

Despite the pessimism and the uncertainties, the three analysts pointed to the underlying strength of the aerospace industry, especially since they do not expect military spending to drop significantly.

The aerospace industry is a good thermometer,” said Garcia. “For 2009, the prediction is for aerospace industry to grow 4% to 5%, bringing the gross sales close to $25 billion. So, I think coming at the end of 2008, the aerospace industry was stronger and more attractive to the financial community than one would.

However, both he and Merluzeau cautioned that investment is needed. “My word of caution with a recession is that where we cannot allow this recession to effect the innovation and in the management of technology,” said Merluzeau. If we let the recession penetrate those silos, then the industry is going to look very bad.”

Garcia echoed his sentiments. “We cannot allow this crisis, recession, whatever we call it, to affect the way we approach innovation, research and development and all the competitive tools that have made the aviation and aerospace industry competitive,” he said. “We know the emerging countries can benefit from that.”

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