Rob Morris, head of Ascend Flightglobal Consultancy, here analyses the implications of the downward trend in oil prices
As 2015 opens and crude oil prices continue their slide – which commenced in July 2014 – the question on every aviation professional's lips must be: "What does this mean for commercial aircraft demand and values?"
Further, with the A350, A320neo and CSeries set to enter service this year, many are also asking: "How will this impact demand for next-generation aircraft?" These, after all, have been designed for significantly enhanced fuel efficiency over current-generation types.
At Ascend, we have been considering these questions over the past few months and, while it is difficult to make definitive judgements, there are a number of interim conclusions that can be made.
INTERIM CONCLUSIONS
Next-generation aircraft economics will always remain more attractive on a variable operating cost basis when compared with current-generation aircraft.
Consequent demand for next-generation aircraft is set to remain robust for the time being at least.
We expect jet aircraft order levels to decline in 2015 over 2011-2014 annual volumes, but this decline will be a function of the already-full orderbooks in the near term, rather than of lower oil prices driving reduced demand.
The level of attractiveness of next-generation economics varies, based upon network factors such as utilisation and sector length.
The delta cost of ownership, meanwhile, is impacted by current fuel price trends and with aircraft such as the Neo and Max sold on fuel efficiency, the value and lease rates for these new types can be expected to come under pressure if lower oil and fuel prices are sustained.
Sustained lower oil prices could stimulate global economic growth and consequent increased demand for new and used aircraft, thereby mitigating risk of an evolving capacity surplus as production rates increase.
Backlog risk – and thus supply and demand balance, and potentially asset values and lease rates – is increased marginally as some economies experience pressure as a result of current oil price trends.
NAVIGATING UNCERTAINTY
On the analysis lying behind these conclusions, the first point to be made is that the long-term trend in oil and fuel prices remains uncertain. "The interaction between oil price, oil supply and oil demand is notoriously eccentric," to quote a recent observation by our colleagues at petrochemical market information provider ICIS – a sister business to Flightglobal within Reed Business Information.
Both demand and supply are inelastic and prices respond not to reality, but to perceptions of reality. In that context, ICIS suggests that the drop in crude prices seen since July 2014 "was well overdue" and that "on paper, there is nothing to prevent oil prices from settling at around $70 per barrel (or lower) for a period of several years".
Equally well, just six months ago the futures market was confident on prices holding above $90 till 2020. It is within this uncertain scenario that airline fleet and network planners must set their capacity and aircraft requirements over the short, medium and long term.
But amid this uncertainty there is one clear fact: next-generation aircraft are typically at least 15% more fuel efficient than the current generation they are replacing. Focusing specifically on the A320ceo and Neo – an excellent case study because both variants have virtually identical payload-range potential – Ascend's analysis suggests that the block-hour direct operating costs of the aircraft are equal at a jet fuel cost of around $1.90 per US gallon.
There are a number of assumptions within that, but the key one is that the A320neo operating lease premium for a 2015 delivery over the same new A320ceo is around $50,000 on a monthly basis. The latest US Energy Information Administration data indicates that US Gulf Coast jet kerosene is trading at $1.55 per US gallon, placing the A320ceo in a more favourable light than the Neo today. However, this calculation is sensitive to ownership costs, and reducing the A320neo lease rate premium by $10,000 per month reduces the fuel price crossover point to $1.50 per US gallon, around where we are today. Another $10,000 reduction results in a further reduction, to $1.10. So, clearly, next-generation economics can remain attractive even at today's lower fuel prices, and it is simply the ownership premium – values or lease rates – for these new aircraft that will be expected to undergo some pressure.
As further evidence of the continued attraction of next-generation economics, order volumes continued to remain high in 2014, with at least 2,600 net orders in the year. An estimated 40% of these orders were contracted after 1 August, suggesting no reduction in demand for new aircraft even as oil prices commenced their downward trend. And those orders placed after that date included at least 800 next-generation aircraft types.
We do expect order volumes in 2015 to be lower than those seen in the past four years, but this will be more a function of the congested OEM order backlogs, where there remain extremely limited slots available for delivery in the next three to four years, rather than a function of lower oil prices per se. Airlines have in the large part committed to their near- and medium-term fleet plans and can thus afford to take some time to wait and see how the oil price scenario plays out before committing in significant volume to longer-term fleet planning decisions.
A second key point is that next-generation fuel burn will always be environmentally more efficient. In the context of carbon emissions specifically, A330-900neo for example is expected to burn around 14% less fuel than its current-generation A330-300 counterpart. Thus CO2 emissions per seat are also set to be 14% lower. The same is true for Boeing 787s replacing 767s today, or 737 Max jets replacing 737NGs in the near and medium term. IATA has a goal of achieving carbon-neutral growth by 2020 and, with traffic growth to average at least 5% per annum over that period, the continued application of more fuel-efficient aircraft, regardless of the fuel price, is a key enabler towards the achievement of this goal.
In the context of aircraft values, which are most fundamentally impacted by aircraft supply and demand balance, the potential impact of sustained reduced oil prices is another important consideration. Economists use a rule of thumb that each 10% fall in oil price can be expected to contribute around 0.1% higher global GDP growth. So if prices sustain at around 50% lower than they were six months ago, we might expect around 0.5% higher GDP growth in 2015.
The global gearing between GDP and passenger traffic demand might thus be expected to drive demand growth around 0.5-1.0 percentage points higher than previously hypothesised. The growth potential is further enhanced by fare reductions linked to fuel prices. Competition will encourage airlines to reduce ticket prices to reflect lower costs. IATA is projecting global passenger capacity to exceed traffic growth in 2015, but it now seems that these latest developments reduce the risk of a capacity surplus developing, which can only have positive implications for aircraft demand and consequent values and lease rates.
Although growth globally is set to be higher, there must be some losers, and the potential risk here is with economies in countries that are highly oil dependent. Key among these today is Russia, where the combined impact of oil-price reductions and exchange-rate fluctuations are set to drive significant reductions in international air traffic demand. With 42 new commercial aircraft deliveries worth almost $3 billion scheduled in 2015, and close to 500 commercial jets on lease with Russian airlines, there is potential risk for default on deliveries and unscheduled returns.
Indeed, 31 commercial jets went into storage with Russian operators in the final quarter of last year, including new A321s and 737-800s at UTair. AerCap, GECAS, AWAS and Aircastle have all accepted aircraft back from lease, in some cases unscheduled, in the very recent past. Although the numbers are small, there is potential for some short-term supply dislocations as a result which could have small-scale value and lease-rate implications.
The current oil price trend is set to be the theme of 2015 for aviation and aircraft finance professionals. The scenario is uncertain and long-term conclusions are difficult to draw at present. But Ascend will continue to monitor the situation and will update our market opinion as it evolves.
Source: Cirium Dashboard
