Air Canada 2010 Annual Report Download - page 75

2010 Management’s Discussion and Analysis
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Economic and Geopolitical Conditions
Airline operating results are sensitive to economic and geopolitical conditions which can have a significant impact on Air
Canada. For example, economic and geopolitical conditions may impact demand for air transportation in general or to or
from certain destinations, and may also impact Air Canada’s operating costs, future pension plan contributions, fuel costs,
and costs and availability of capital and supplies required by Air Canada. Especially in light of Air Canada’s substantial fixed
cost structure, any prolonged or significant impact arising from economic and geopolitical conditions, including weakness
of the Canadian, U.S. or world economies could have a material adverse effect on Air Canada, its business, results from
operations and financial condition.
Airline fares and passenger demand have fluctuated significantly in the past and may fluctuate significantly in the future.
Air Canada is not able to predict with certainty market conditions and the fares that Air Canada may be able to charge.
Customer expectations can change rapidly and the demand for lower fares may limit revenue opportunities. Travel, especially
leisure travel, is a discretionary consumer expense. Demand travel for business and premium travel are also impacted by
economic conditions. Depressed economic conditions in North America and other areas served by Air Canada, as well as
geopolitical instability in various areas of the world, concerns about the environmental impacts of air travel and tendencies
towards “green” travel initiatives where consumers reduce their travel activities, could have the effect of reducing demand
for air travel in Canada and abroad and could materially adversely impact Air Canada’s profitability.
Pension Plans
Canadian federal pension legislation requires that the funded status of registered pension plans be determined periodically,
on both a going concern basis (essentially assuming indefinite plan continuation) and a solvency basis (essentially assuming
immediate plan termination).
Pension plan solvency valuations are influenced primarily by long-term interest rates and by the investment return on plan
assets, which in turn may be dependent on a variety of factors, including economic conditions. The interest rate used to calculate
benefit obligations for solvency purposes is a prescribed rate derived from the interest rates on long-term Government of
Canada bonds. Deteriorating economic conditions may result in significant increases in Air Canada’s funding obligations, which
could have a material adverse effect on Air Canada, its business, results from operations and financial condition.
Refer to section 9.8 of this MD&A for additional information relating to Air Canada’s pension funding obligations. In particular,
as of 2014, the Air Canada 2009 Pension Regulations will cease to have effect and Air Canada’s pension funding obligations may
vary significantly based on several factors, including regulatory developments, assumptions and methods used and changes
in the economic conditions (mainly the return on fund assets and changes in interest rates). Underfunded pension plans or
a failure or inability by Air Canada to make required cash contributions to its registered pension plans could have a material
adverse effect on Air Canada, its business, results from operations and financial condition.
Fuel Costs
Fuel costs constituted the largest percentage of the total operating costs of Air Canada in 2010. Fuel prices fluctuate widely
depending on many factors including international market conditions, geopolitical events and the Canada/U.S. dollar exchange
rate. Air Canada cannot accurately predict fuel prices. During the last five years, fuel prices increased and fluctuated near or
at historically high levels. Should fuel prices fluctuate significantly or increase significantly above current levels, fuel costs
could have a material adverse effect on Air Canada, its business, results from operations and financial condition. Due to the
competitive nature of the airline industry, Air Canada may not be able to pass on increases in fuel prices to its customers by
increasing its fares. Based on 2010 volumes, management estimates that a US$1 per barrel movement in the average price of
West Texas Intermediate (“WTI”) crude oil would have resulted in an approximate $25 million change in 2010 fuel expense
for Air Canada (excluding any impact of fuel surcharges, foreign exchange rates and fuel hedging), assuming flying capacity
remained unchanged and that refining spreads between WTI crude oil and jet fuel as well as foreign exchange rates remained
constant.