This is something of a public service announcement. You may have noticed that I haven’t been updating this blog recently. That’s because I now post all my aviation and travel related content on my consulting company’s site at gridpoint.consulting.
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I may still post the odd thing here for topics that don’t fit in with aviation and travel focus of GridPoint.
A spot of sunshine amidst the COVID-19 airline gloom?
Spain’s beaches are once again open for business
At the end of May, Spain confirmed that it would welcome UK tourists back from the start of July and last week the UK lifted its quarantine restrictions for travellers returning from most countries in Europe, including Spain.
Spain is Britain’s biggest tourist destination and airlines are ramping up their schedules, with many Britons seemingly anxious to escape the COVID gloom and the unreliable British weather and head for the beaches.
Let’s take a data driven look at how things are going on the main London – Spain markets. My thanks go to Pablo Fernandez for assistance with data extraction and visualisations.
Airline capacity ramps up
Although airlines have begun to resume flights and capacity is being progressively increased, it remains significantly below normal levels at what would usually be peak season. For the London-Spain market, published capacity for next week is 74% below the same week last year.
Published schedules show capacity rapidly increasing in the next few weeks with capacity for the first week of August only 20% below last year. Some smaller markets show capacity almost at last year’s levels.
However, published schedules look very unreliable, even four weeks out. For example easyJet are publishing schedules which suggest they will grow compared to last year.
That is clearly not what is going to happen. As recently as June 24th, they guided the market to an overall system capacity for the July-September quarter at 30% of the planned pre-COVID-19 capacity. To hit that number would require 66% of the published flights for the period from 20th July to the end of September to be cancelled. Frustrated customers have noted that the airline is delaying cancelling flights until the last minute, presumably to avoid the need to provide refunds, instead showing flights on their website as “sold out”.
I’m sure there will be downward adjustments made to other carriers published schedules too, but the gaps to the likely reality look much smaller. I’d guess that capacity on London-Spain for August will end up down about 50%, but that depends in part on how bookings go over the next few days and weeks.
Will there be demand to fill the seats?
There do seem to be some encouraging signs of returning demand. UK interest levels for flights to Spain on Kayak were running at 90% below last year during the lock down. But the figures have been improving during June and were only 34% down last week.
Google searches show the same pickup, although it is only really evident on Alicante, Barcelona, Ibiza, Malaga and Tenerife.
But even if bookings are now picking up, all airlines will be missing many bookings that should have been taken in earlier weeks.
Price war or price hikes?
One of the big questions has always been whether airlines would dump prices in order to make up for lost time and stimulate traffic, or whether prices would rise as airlines deal with the additional costs of new procedures and capacity restrictions in the new environment.
As usual, Ryanair have predicted a price war, something they do as a matter of course in difficult times. “When this thing is over there is going to be such massive discounting going on that there will be a large spike upward in travel and tourism for a period of time.” O’Leary knows that statements like this will generate headlines and free publicity for his cheap fares, and perhaps also deter nervous investors from providing finance to prop up less financially strong competitors.
Let us look at the evidence so far on flights from London to Spain. On the 6th July, I looked at prices selling on Expedia.co.uk for a return flight from London for twelve of the biggest markets. The itinerary was for outbound on the 1st August and back on the 10th.
Let us look first at the minimum round trip available fares to get an idea of “how low” each of the carriers was prepared to go.
Immediately evident are the low prices for all carriers for both Barcelona and Madrid, two markets which in normal times have a strong business market and a lot of capacity.
On the big tourist markets of Malaga and Palma da Mallorca, easyJet are offering some very low lead in prices, generally on their less attractively timed flights. However, most of the itineraries on sale are at much higher prices, as shown here looking at the average fare version.
You can also see the different pricing approaches of the three biggest carriers, British Airways, easyJet and Ryanair. Averaging across the markets, British Airway’s prices are 59% higher than easyJet’s, which in turn are 19% above Ryanair’s.
Average Price (£)
Average prices for all markets, all itineraries
How do these prices look compared to usual?
Unfortunately, I don’t have comparable data for what pricing looked like on these markets at the same time last year. easyJet’s average passenger yield per round trip for the July-September quarter in 2019 was £128. So an average fare of £229 looks very high. However, we are only really seeing the late booking part of the yield curve, which is always a lot higher than the average as many seats are usually sold early at much lower prices.
The equivalent figure for Ryanair’s July-Sep quarter in 2019 was £92 of fare revenue per round trip, so Ryanair’s current average fares to Spain of £193 are slightly more than double that.
BA certainly have a few lower lead-in fares, but with an average round trip fare of £363, they are clearly going for a yield maximisation strategy at this stage. The decision to concentrate flights at Heathrow may also be limiting their ability to compete on price, with per passenger airport fees much higher at Heathrow than at other London airports.
My overall conclusion is that carriers seem to be trying to keep late booking yields relatively high. easyJet are trying hard to stimulate volume on the big markets with some good headline prices, but are also trying to protect yields by restricting availability to their least attractively timed flights.
That is positive for yields but I think the upturn in bookings won’t be enough to fill all the flights now on sale and we will see some significant cancellations closer to departure, especially for easyJet.
Of course, there remain many more deeply troubled parts of the market. Business traffic will not return in September as strongly as it normally would. Also troubling for long haul airlines, top markets such as the US, India and China remain subject to travel restrictions and recent news from the US suggests that isn’t going to change any time soon. That doesn’t bode well for Virgin Atlantic’s rumoured £900m rescue deal.
So even if capacity and volumes will be significantly down on last year, the UK-Spain market does seem to be a somewhat sunnier spot amidst all the gloom.
Airlines worldwide have been scrambling to shore up their finances in the face of the COVID-19 tsunami that has engulfed the industry.
Back in April, Virgin Atlantic was one of the first to appeal for government aid, going cap in hand to the UK government for £500m of assistance. With Virgin Atlantic jointly owned by Delta, the biggest and richest airline in the world and Richard Branson, one of the world’s richest men, it wasn’t a good look.
Understandably, the UK government pushed back. They said they would only consider helping once Virgin Atlantic had demonstrated that they had fully exhausted all private sources of financing.
Three months later, we are approaching the moment of truth. Virgin have been in lengthy discussions with their shareholders, private equity groups and presumably also the UK government, reportedly seeking a £900m rescue package. So what kind of shape was Virgin in going into this crisis?
Pre crisis results
The last disclosed accounts are for the financial year ending December 2018. On the face of it, they showed a respectable level of cash at £489m. However, 20% of the cash was “restricted”, meaning that it wasn’t freely accessible and so couldn’t be used in a crisis. Unrestricted cash of £392m was well below the £620m of “deferred revenue on air travel and tour operations” shown on their balance sheet. That means that they didn’t have the cash required to refund customers if they had to cancel flights and holidays, something that any customer trying to claim a refund in recent times will know all too well.
Profitability was also signalling trouble ahead. In a year where arch rival British Airways made operating margins of 15%, Virgin Atlantic couldn’t even manage to break even, with an operating loss equal to 0.5% of revenues.
2018 is a long time ago, so what did the 2019 accounts show? We still don’t know. Virgin traditionally filed their accounts in April, but last year started dragging their feet and waited until July 3rd. 2019 was another strong year for British Airways, with operating margins of 14.5%. Something tells me that if the Virgin accounts show a return to profitability and an improving balance sheet, we would have seen them before now.
Burn baby, burn
British Airways is said to be burning £178m of cash a week. Virgin has not given any guidance on its cash burn rate, but in normal times its cash costs are about 25% of those of its larger rival. That suggests cash burn of about £45m a week. With the airline industry now having been grounded for about 15 weeks, that suggests it will have burnt £675m of cash. Even if things are somewhat better than that, it must be the case that Virgin has burnt through all of its cash and has a large stack of unpaid invoices and un-refunded customers on top.
£900m rescue package
There has been much written about the impending £900m rescue package and where it will come from. Reading between the lines of the reports, I’d guess the make up of the package will look something like this:
Branson / Virgin Group
1 year of brand licence fees
Outstanding JV payment
1 year of services fees
New private equity debt
Lessors / other suppliers
£900m package, only half new money
Of this total, only £450m would actually be new cash (private equity debt and Virgin Group equity). The rest is either deferral or waiver of unpaid invoices or very near term costs.
There is also talk of “freeing up £250m of credit card cash”. Remember that £200m+ gap between Virgin’s unrestricted cash and the customer money they were sitting on? Well that is what this item is related to. If Virgin customers are due refunds and Virgin doesn’t have the cash to pay, it is the credit card companies that are on the hook. So all this means is that if the restructuring goes forward, the first £250m of cash from new bookings won’t be withheld by the credit card companies, as would otherwise be the case. It is not new money.
So if this restructuring goes ahead, where will that leave Virgin? I think the best case scenario is that this deal will really only put them back into the same cash position as they were at before the crisis. Given that they didn’t make money in the pre crisis world, I really can’t see how this is anywhere near enough money to see them through the crisis, which is far from over.
UK government to the rescue?
Maybe the “£900m private money“ headline will be enough to provide cover for the UK government to stump up equity, debt or guarantees on the several hundred millions of additional financing that are likely to be required to see Virgin through the losses it will incur during the rest of 2020.
The big question which nobody seems to have answered yet is how a business that consistently lost money in the boom years is suddenly going to become viable and able to repay its debts in the much more difficult post COVID world.
British Airways reportedly reaches union deal for pilot reductions
According to media reports, a deal has been reached between British Airways and its pilots which will see pilot numbers reduce by 650, with 350 permanent job losses and 300 pilots placed into a “rehire pool” on 50% pay. Working pilots will take a 15% pay cut, half of which is permanent and half will “snap back” once all the pilots in the rehire pool have been brought back.
What does this deal say about BA’s short and longer term plans for capacity and for its attempt to rebuild profitability in a post COVID world?
Implications for capacity
650 pilots represents about 15% of BA’s pilot force. Capacity reductions during 2020 have been and will continue to be much greater than that. So I think that 15% lines up with reduction in the number of flights that BA is planning for summer 2021, compared to the pre-crisis level. The flying reduction might be a little more than this due to “natural attrition” of pilots every year. The reduction in flying could be less, if the deal contains any pilot productivity elements, although that looks unlikely to me.
The “rehire pool” suggests that BA intends to add back close to half of those flights quite quickly, maybe within 1-2 years, depending on how well demand recovers and how the competitive environment develops.
Is this the end for the 747-400?
In terms of overall capacity, it is highly likely that BA will be skewing its flight reductions towards the larger aircraft types, trying to retain its overall network shape whilst aligning seat count to reduced demand. Almost certainly the ageing 747-400 fleet will bear the brunt of the reductions, consistent with reports that the majority of the “pooled” pilots will be from that fleet. When they return from the pool, I’m sure they will be retraining for different aircraft types.
The big question is the future of BA’s largest aircraft type, the A380, of which it has 12. Air France KLM have already taken the decision to retire its A380s and Lufthansa have reduced their fleet and withdrawn them from Frankfurt, although it may still operate the aircraft from Munich from 2022. Personally, I think that BA will continue to operate the A380, preferring to accelerate the retirement of the entire 747-400 fleet whilst minimising capital spend on new aircraft. BA has just started taking delivery of A350-1000 and 787-10 aircraft, which will be the most fuel efficient of all its wide-body aircraft types. I would expect BA to continue taking deliveries of these types, albeit at a reduced rate.
What does the deal mean for unit costs?
Taking into account the impact of focusing reductions on larger aircraft, I would expect BA’s seat capacity to fall by more than its number of flights or flying hours. So a 15% reduction in pilots probably equates to at least a 20% overall reduction in capacity, which would align with the reduction in demand expected by most commentators for next year compared to pre-COVID levels.
Whilst the pilot pool is in place, the cost per operating pilot would be reduced under this deal by 10.9%. This is less than the headline 15% pay cut due to the non-flying pool pilots getting half salary. That means that pilot pay costs during this phase fall by 24%, which should be at least in line with the capacity cut. That will be needed, as it is clear that average yields will be down too. Business travel seems certain to recover more slowly than leisure and prices will be under pressure as airlines fight to rebuild their businesses and stimulate demand.
Once the pooled pilots have been brought back, total pilot costs will be down 15%, with cost per pilot down 7.5%. Again, a helpful contribution to counteract ongoing yield pressures.
Overall, this looks to me like a carefully crafted deal which should help BA get back to profitability, provided that demand recovers at least as well as expected in 2021 and government restrictions are lifted to allow airlines to meet that demand.
Profits are certainly going to be needed, as BA will need to start rebuilding its balance sheet after what looks set to be a brutal 2020 of eye-watering losses and rapidly mounting debt levels.
A number of people have conducted surveys in recent weeks on the intentions of consumers to take flights or travel more or less than before the crisis. What do they tell us about the likely level of demand over the next year?
I was triggered to take a look at this by this article in today’s FT (apologies if you are hit by the paywall). It references a survey conducted by UBS in mid May of 1,000 UK consumers, which showed that 31% of people were intending to fly less over the next year for travel to Europe, with 10% intending to fly more. That sounds quite alarming, but even if you assume a halving of the travel of the “fly less” group and only a 20% increase in those keen to make up for lost time, that would equate to a 14% drop in demand compared to pre-COVID levels. That is actually somewhat better than the 20% drop most airlines are expecting for next year.
Interestingly, the results for “worldwide” travel were no different from those for Europe. Many commentators have predicted that long haul travel will be hit harder. This might still be the case of course, if government restrictions are lifted on European travel but not on other long haul destinations.
BCG have also been posting the results of their consumer sentiment surveys on their incredibly useful Travel Recovery Insights portal. For UK consumers, they are a little more pessimistic, with 38% of consumers intending to travel “a lot less” and 24% “somewhat less”. Assigning a 50% drop to the “lot less” group, “20%” to the “somewhat less” and equivalent increases to those planning to spend more, gives a drop in demand of 21%, much closer to the current consensus. Maybe this tells us that airlines are more likely to believe consultants than investment bankers?
It should also be noted that the BCG survey asked people about their spending plans for travel over the next 6 months, rather than intention to fly in the next year. You would expect people to be more cautious nearer term and the two sets of figures could be consistent with a 21% drop over the next 6 months followed by a 7% drop in the 6-12 month timeframe. A much rosier view for the level of demand next year than most commentators are expecting.
What is also clear is that there are going to be some fantastic deals on offer once the travel industry is allowed to get going again. So even the 62% of consumers who expect to spend less on travel may be able to achieve that objective without reducing the actual number or duration of their trips. Whilst that won’t be good for airline yields, maybe the volumes will recover faster than people are thinking.
One final caveat: all this is based on consumer intentions. It all relies on people being allowed to travel and on the flights being there for them. Which fits with the current focus of the industry on getting governments to lift restrictions on travel and to get on with allowing travel to resume where this can be done safely. The survey evidence suggests that the consumer demand for travel will be there if they do.
The contrasting stories of two of Europe’s biggest airline groups
Air France-KLM (AF-KL) entered the COVID crisis in decent shape from a balance sheet point of view. Even before the injection of funds from the French government, the March 2020 cash position was €6.4 billion, equivalent to 23% of 2019 revenues, almost matching the 26% ratio at well capitalised IAG. Net debt of €6.6 billion was actually lower than IAG’s €7.5 billion.
However, it was much less profitable than IAG, with operating margins in 2019 of 4.4% compared to IAG’s 14.8%. This meant that as a ratio to EBITDA, a standard measure of debt affordability, net debt levels were a little higher at 1.6x compared to 1.4x at IAG. But still pretty solid and much better than Lufthansa which had cash levels of only 9% of revenue and net debt / EBITDA of 3.3x.
AF-KL’s profitability had lagged behind IAG’s for many years. So how did it come to be in such a relatively solid position from a balance sheet perspective? To answer that, we need to look back at the last few years of history, because the two companies have been on very different tracks.
The back story
Since 2015, IAG has returned €4.1 billion of cash to shareholders in the form of dividends and share buybacks. It also spent €1.4 billion buying Aer Lingus and had to put €3.3 billion into plugging the historic pension fund deficit at BA, totalling over €8 billion of cash outflows.
AF-KL is almost a complete mirror image. It hasn’t paid a dividend since 2008 and since 2015 has raised €1.3 billion of new equity (€751m from industry partners Delta and China Eastern plus the conversion of bonds into €523m of equity). It generated €1.3 billion from disposals (mostly €884m of Amadeus shares and a €246m sale of LHR slots to Delta), giving total cash inflows of €2.6 billions.
So IAG has been buying things and returning money to shareholders whilst AF-KL has been selling things and raising new capital. The result is that despite the fact that AF-KL was slightly bigger than IAG in revenue terms, prior to the COVID induced sell off in all airline shares, IAG’s market capitalisation stood at 3.5 times that of its less shareholder-friendly and profitable rival. If it hadn’t been for the drag of BA’s historic pension fund deficit, the difference would have been even starker.
The immediate COVID response
The other big difference has been the two companies’ response to the COVID crisis. At the end of March 2020, IAG still had access to €2.6 billion of undrawn facilities, whilst AF-KL had drawn all of its remaining facilities and still had less cash than IAG. AF-KL went straight to the French and Dutch governments of course and was rapidly granted €7 billion of state or state backed loans by the ever helpful French government, with the potential for another €2 to €4 billion to come from the somewhat more reluctant Dutch state. IAG got €1 billion of loans backed by the Spanish government and €300m from the UK, giving it €10 billion of liquidity at the end of April. At the same date, I estimate AF-KL had secured €12.9 billion of liquidity and were looking to raise another €2-4 billion from the Dutch government.
So why does AF-KL need €5-7 billion more liquidity than IAG says it does? That is a question that I am sure the Dutch state is also trying to get answered.
The next few months
The answer doesn’t seem to lie in the cash requirements of the next few months. With revenue effectively wiped out for both companies, the cash requirements are driven by 1) the level of cash costs during lock-down 2) any immediate loan repayments required and 3) working capital effects. Let’s take them in turn.
For IAG, as I outlined in this article, I think the monthly cash burn is in the €800 – €900m range, quite similar to the figure given by Lufthansa. In their Q1 results announcement, AF-KL quoted a monthly cash burn of €400m, which seems oddly small for a company with slightly higher “normal” cash operating costs (€1.9 billion a month versus €1.7 billion at IAG). One factor will be the better fuel hedging position, with AF-KL disclosing a €455m “ineffective fuel hedge” loss compared to over €1.3 billion at IAG. That will turn into cash over the remainder of 2020. Another factor is undoubtedly the €570m of tax and social charges payments which were disclosed to have been “deferred beyond 2020”, once again thanks to the largesse of the French government. There is something of a pattern developing here.
When it comes to loan repayments, at the end of March AF-KL showed €900m of debt repayments due for the remainder of 2020. IAG don’t give a figure for this, but at the end of December 2019, the current portion of their long term debt (which means it was due in 2020) was shown as €1.8 billion, so perhaps €1.4 billion for the April – December period. So on the face of it, that doesn’t seem to explain it either. Much of these “loan repayments” are actually lease obligations and I’m guessing that IAG, with its much better financial track record, will have been able to secure deferrals on much of this. That won’t have been the case I think for AF-KL, in large part because the lessors will have known that the French state would step in.
Finally, working capital requirements. One of the biggest items here is deferred revenue on ticket sales. This is money that airlines have received from customers for future travel. With much of those bookings on flights that have been cancelled, there is a potentially big cash outflow from refunds during a period when no new bookings are coming in. These are big numbers. For IAG at the end of December 2019, this item stood at €5.5 billion. Perhaps there is a difference here which might explain why AF-KL needs more liquidity? In fact, the corresponding figure for them was only €3.3 billion. Maybe they are being more helpful in allowing cash refunds, rather than insisting on vouchers? Nope. In response to questioning from UK politicians during a Select Committee hearing, Willie Walsh said that IAG had already made refunds totalling €1.1 billion by early May. In contrast, AF-KL were singled out by consumer watchdog Which? for “… not just delaying refunds but flatly refusing them”.
Beyond the immediate crisis
So what is the real reason that AF-KL has secured so much extra liquidity at the taxpayer’s expense? I think that IAG is determined to take the necessary steps to get back to profitability quickly and is being vilified by UK politicians for doing so. In contrast, AF-KL knows that it cannot do so (it was barely profitable even before the crisis) and isn’t going to rock the boat with its political paymasters by even trying.
One final thought. Shareholders in AF-KL should take note that almost all of the largesse from the French state has come in the form of loans and tax deferrals, which will need to be repaid or refinanced with equity at some point. Given the awful track record of the company when it comes to how it treats shareholders, I would suggest that the 3:1 ratio of the current market capitalisations of the two companies might not be representative of the proper relative valuations.
By way of fair disclosure, I am a shareholder in IAG and do not own any AF-KL shares. I’m not that stupid.
Many people have commented on the difference between the the amount of money which Germany has put behind their main airline group Lufthansa, compared to what has been done by the governments of the UK and Spain for IAG. I thought I would have a look at the figures to explain why Lufthansa needed the support and IAG could avoid going “cap in hand” to the government for a bailout, and also to look at where the huge bailout for Lufthansa leaves IAG from a competitive point of view.
In the case of Lufthansa, a bespoke €9 billion “stabilisation package” has been assembled, all backed by the German government, About 55% of this is in the form of equity from the government, with 45% in the form of government backed debt. For IAG, they have had access to the government guaranteed COVID loan schemes in the UK and in Spain which were available to all companies, adding up to “only” €1.3 billion.
Given the huge disparity, where does that leave the two companies in relative liquidity terms? IAG started from a much healthier position, with liquidity of €9.5 billion at the end of March compared to €4.25 billion at the larger Lufthansa. However, despite being smaller than Lufthansa, IAG seems to me to be burning cash at a somewhat higher rate currently.
It is difficult to compare the companies as they quote figures on a different basis. In their Q1 2020 releases, Lufthansa gave a cash burn figure of €800m a month, whilst IAG cited “normal run-rate cash operating costs” of €200m a week, or €857m a month. To put the IAG number onto a more comparable basis to Lufthansa’s figure, you need to make two main adjustments. Lufthansa’s number includes fuel hedging losses, whereas I believe that IAG’s does not. IAG declared “ineffective fuel hedging” losses of €1.3 billion, versus €950m for Lufthansa. This seems to reflect IAG being more highly hedged in the near term than Lufthansa was. In any case, a large part of the hedging losses will materialise in cash terms in Q2, which will increases IAG’s cash burn in Q2 by around €270m a month based on my estimates. The other adjustment needed is to include the revenue that is being earned. With flights operating at around 10% of normal capacity in Q2, that will be a fraction of the usual €2 billion a month that IAG would normally generate in Q2. However it probably adds about €165m a month, taking IAG’s monthly cash burn to €962m on the same basis as Lufthansa.
So let us do a crude calculation of the predicted liquidity position of IAG and Lufthansa at the end of Q2, by which time both companies are expected to have recommenced “a meaningful operation”. Lufthansa will have liquidity of €4.25 billion (the March position), plus the €9 billion stabilisation package, less three months of cash burn at €800m a month giving €10.9 billion. IAG gave a figure of €10 billion for their liquidity at the end of April, which I think went up from up €0.5 billion from the position at the end of March due to €1.3 billion raised from the UK and Spanish governments, offset by cash burn for April. That suggests a cash burn in April of €836m, slightly below the figure I calculated above. By the end of Q2, they will have burned another €1.9 billion, giving them €8.1 billion. Expressed in terms of their “normal” cash operating expenses when operating at full capacity (where Lufthansa is 1.7x the size of IAG), this gives Lufthansa 115 days of liquidity compared to IAG’s 147 days. Of course they both have many more days of liquidity than this, as this metric assumes zero revenue and full operating costs, but it is a good basis on which to compare the two companies.
Given the amount of assumptions that have gone into these calculations, my conclusion is that both companies will start the third quarter with similar levels of liquidity compared to the size of their pre COVID cost bases, with IAG in a somewhat better position (c 25% better). The big difference, of course, is how much backing it will have required from governments to get to that position. For Germany, it took €9 billion, compared to €1.3 billion for IAG, of which the UK government has only provided €0.3 billion.
I think that UK Government MPs, who have been very critical of British Airways and IAG, would do well to reflect on these differences, As well as being thankful for their good fortune in having such well capitalised airlines based in the UK, I would suggest that they could consider being more helpful going forward if they don’t want to see the lead that UK airlines had over their European rivals going into this crisis being squandered as a result of COVID and the different policy responses.
It should be the case that as the lower cost and more profitable operator pre COVID, IAG should be able to get back to profitability and cash generation at a faster rate than Lufthansa. However, the UK government seems to be doing its best to offset this advantage by the inept way in which it is dealing with the resumption of air travel. The ill thought through introduction of quarantine requirements for arrivals into the UK, just as other countries are relaxing theirs, is the current prime case in point.
I hope this won’t be another example of the UK failing to realise that “You don’t know what you’ve got till it’s gone”. We no longer have a car industry to speak of due to government neglect. Let’s not let the UK’s previously strong global position in the airline and aerospace industries be casualties of this dreadful crisis.
So the Brexit saga continues with Captain May still at the controls of H.M.S. Titanic, despite hitting a rather large iceberg yesterday when Parliament comprehensively rejected her EU withdrawal deal.
In trying to predict what will happen now, my natural inclination is to look at the logical outcomes. I’m fully aware that this might seem hopelessly naive. Politics is not logical, either in Parliament or in the electorate at large.
But bear with me for a moment. My logic is as follow. There is no version of a Brexit deal that can be agreed with the EU and also get through Parliament. No deal would be a disaster that almost nobody wants. The only way to break the political logjam will be another referendum.
I’m aware that politicians don’t want this and that another referendum might give the same result. But at least going back to the people would enable us to move forward. In the end I think politicians will be forced to accept that this is the only option.
The key thing will be to ensure that all the options that we ask the people to choose between are real, implementable, options.
There is a famous game, at least amongst economists, known as “Bidding for a Dollar”. In this game, players participate in an auction for a dollar bill. The bill goes to the winner, who therefore stands to make a profit if their winning bid is less than $1. However, the bidder who comes second has to pay over the amount of their final losing bid.
The game starts off sensibly enough with bids of 5, 10, 15, 20 cents and so on, with the participants trying to land the winning bid and maximise their profit. However, as the bids mount and approach $1, it begins to dawn on the players that the best they can hope for is to make a very small profit. However, the second highest bidder realises that dropping out now means that they will lose money. That is hard to accept, so the bidding continues until the highest bid stands at $1.
If they hadn’t realised it before, this is the moment when the participants work out that this is a “no-win” game and continuing to play now guarantees a loss. However, having started, it still makes sense to keep on bidding and so a bid of $1.10 is placed. Better to lose 10 cents than a $1.
It seems to me that this is the point that the UK has arrived at in the Brexit negotiations. We spent the first two years after the Referendum with the different Brexit factions squabbling over the “Brexit dividend”, or which faction was going to get what share of the dollar bill. Reality has now dawned that there isn’t any Brexit dividend and the factions are now desperately trying to minimise their losses and make sure the blame for this fiasco lands somewhere else.
Theresa May attempted to clarify the government’s vision of what life after Brexit would look like in her Mansion House speech on Friday.
In it, she made reference to the need for the country to face up to some “Hard Facts” about Brexit. I think that should be welcomed, as facts have been something that have been sadly missing from the Leave camp to date.
However, those hard facts were buried pretty deeply in the usual sea of platitudes and slogans. Sifting through the 6,700 words of the speech and the Q&A which followed, I have tried to extract what seem to me to be the facts that we all need to face up to in the Theresa May vision of our post Brexit future.
1. No customs union
The government has finally admitted that regaining the freedom to negotiate trade deals with the rest of the world, one of the key objectives of Brexit, means not being part of the customs union.
Brexiteers believe that other countries will be more willing to open up access to their markets to the UK than they are to the EU as a whole because we are more willing to open our markets to them than the EU is. Whether deeper access to the UK market is worth more to other countries than shallower access to the whole of the EU is hard to judge. Personally I doubt it, but only time will tell.
So the first hard fact that comes from this is that our access to EU markets will reduce. Theresa May was fairly up front about admitting this.
The second consequence is that there will be a border in Ireland, or between Northern Ireland and the rest of the UK (or perhaps both). Theresa May did a lot of dancing on the head of a pin to avoid saying this, but the graphic above demonstrates that this is unavoidable. The only question is how “soft” those borders can be. The government seems to be placing its faith in technology to solve this. Maybe with a sufficiently long implementation period that might be possible, but nobody really knows.
2. We will still need to abide by EU rules in many areas
The Brexiteers are famous for wanting “have their cake and eat it”. This was obviously never going to work, given that the other side has a stronger negotiating position. It is more likely that the UK will end up neither having nor eating the cake. To paraphrase Theresa May, we will end up with the rights of Canada and the obligations of Norway.
My take on Theresa May’s speech is that the government has made a subtle shift of strategy. Rather than trying to keep the good bits and lose the bad bits at an overall UK-EU relationship level, they are now trying to cherry pick sector by sector. Hard Brexit for agriculture, soft Brexit for the Automotive Industry and so forth. The hope seems to be that the EU will take a pragmatic approach and give the UK a continuing say in regulations for sectors where the UK is a major player, such as Pharmaceuticals, Air Transport and Financial Services.
The challenge as ever is whether the EU will play ball. Making the EU single market work is already a famously complicated business. Overlaying a bespoke set of sectoral arrangements with the UK will make this harder. In the real world of EU politics, trading off the interests of one sector against those of another is a key tool for getting to agreement amongst the member states. Allowing the UK to participate selectively is a big ask. Ironically, it might have been easier to achieve this from within the EU. In two of the most sensitive areas, monetary policy and border controls, the UK secured an opt out, participating in nether the euro nor the Schengen Agreement.
In the end, I remain of the view that the whole Brexit decision was a big mistake. As the hard facts of what is possible to negotiate become clear to people and the cake eating wishful thinking is revealed for what it always was, I hope that it is not too late to reconsider. But I am not holding my breath.