Jet fuel is suddenly looking very affordable. IATA’s online jet fuel monitor shows global prices have plummeted 21% compared to a year ago. The falling prices have saved the global airline industry $7 billion so far this year, IATA’s analysis suggests.
A lower fuel bill is always good news for airlines, but raises some questions for manufacturers.
When you are standing at the top of the mountain, it seems the only place to go is down. As of 31 October, Airbus and Boeing were sitting on a combined order backlog of 11,396 aircraft, with the capacity to deliver about 1,400 aircraft per year. That backlog was built partly upon demand created by sustained high oil prices, along with other factors such as low interest rates, profitable airlines and ample liquidity.
High oil prices have also figured large in product development strategies, motiving manufacturers to seek more efficient engines and lighter materials to lower fuel bills by 15-20% on each new aircraft model.
Yet, it appears that fuel prices are headed for a long-term retreat. The latest short-term energy outlook released by the US Energy Information Administration notes that spot prices for North Sea Brent crude oil plunged from $95 per barrel on 1 October to $84 per barrel by Halloween. The EIA attributes the change to slower demand caused by weakening global economic growth and a supply glut caused by a recent influx of Libyan crude oil and rising US production.
As a result, EIA slashed its 2015 forecast for Brent crude oil to average $83 per barrel, or $18 per barrel lower than predicted only a month ago. Meanwhile, another popular benchmark, West Texas Intermediate, is trading below $76 per barrel, according to Flightglobal sister company ICIS.
The effect of that over-supply in the market could be offset if OPEC nations agree to slash production, but no such consensus appears to have emerged on eve of the annual summit scheduled to begin on 27 November. Some analysts believe the price per barrel of oil could drop to the mid-60s if output is not reduced.
Despite the prospect of a prolonged period of lower fuel bills, manufacturers do not appear to be panicking. James McNerney, Boeing chief executive and chairman, reassured Wall Street analysts a month ago that his company’s commercial order backlog is not threatened until the price of a barrel of oil drops “well south” of $70.
McNerney’s analysis checks out with Rob Morris, head of the Ascend Flightglobal consultancy. Morris compares operating costs of a leased Airbus A320 equipped with sharklets to a leased re-engined A320neo with a 13% lower block hour fuel burn. Although the monthly lease rate for the A320neo is assumed to be 13.7% higher, the re-engined aircraft is still cheaper to operate until a barrel of crude declines below $55, Morris says.
“I don’t believe this will be a sustainable long-term [oil] price,” Morris adds. “So the case for the next generation sustains.”
That prediction compares well with an analysis presented by Thomas Gendron, chief executive of control systems supplier Woodward, who addressed Wall Street analysts in October.
“What would throw off the aerospace backlog? That would be if you had sustained, my opinion is, sustained oil prices below $60 a barrel,” Gendron says. “They could dip, but sustain below could have an effect on our aircraft orders. We don’t really believe any outlook I see that we’re going to have sustained oil prices that low.”
This analysis contradicts a traditional notion that lower fuel prices tends to stifle demand for buying new aircraft. It is a view recently explained by Walter Howley, chairman and chief executive of TransDigm, a component supplier to Airbus and Boeing.
“The traditional rule of thumb is if the oil prices drop down, they keep the old planes running longer and that would tend to give you a little more aftermarket. Whether that'll happen, I have no idea how to speculate on that. But that's the traditional wisdom,” Hawley told analysts in October.
Speaking at the Future of Air Transport conference in London on 24 November, Air Arabia chief executive Adel Ali says he subscribes to Hawley's rule of thumb. The A320 operator has stopped shopping for replacements while oil remains at $80 per barrel or lower, he says.
In an era when production lines are sold out for several years, however, there are some prominent industry officials who believe the convention wisdom no longer applies.
Air Lease president and chief operating officer John Plueger noted in a briefing with Wall Street analysts in October that predicting long-term oil price trends is a dangerous game for any airline.
“The most effective way to hedge against fuel price volatility is with the most fuel efficient and modern aircraft,” Plueger says. “Our customers are taking long-term views on their needs over the next decade, which is helping demand remain very strong.”
This new paradigm applies even if oil prices remain at comparatively lower levels for a prolonged period, he says. Plueger cites the example of Allegiant Airlines, which recently decided to buy A319s and search for A320s to replace older, less-efficient McDonnell Douglas MD-80s, which are subject to corrosion problems common to aging aircraft.
“Even if fuel prices went down, it’s still going to be the major cost, so why not continue to reduce fuel burn?” Plueger says.
Another prominent lessor, AirCap chief executive Aengus Kelly, agrees that demand for new aircraft will not decline in the long-run due to lower fuel prices.
“We don't see any evidence yet that our customers are altering their longer-term fleet plans based on the recent decline in the price of oil. They are, of course, looking to extend some older assets. But overall, the longer-term view of the airlines is that the best hedge against their single largest exposure item is a modern fuel-efficient fleet,” Kelly said in a conference call with analysts in October.
Some airline executives have confirmed that long-term view on aircraft demand has trumped short-term swings in fuel prices. Ryanair, for example, has recently placed orders for hundreds of new 737s and the re-engined 737 Max, despite a strategy focused on beating competitors on costs.
“Lower oil prices, yes, it may around the edges have lessened the effect,” chief executive Michael O’Leary told analysts. “But I think there's no doubt when fuel is our biggest cost and we have an aircraft here that has 4% more revenue opportunity, 4% more seats and an 18% lower per seat fuel savings, almost regardless of what the fuel price is, it's a huge unit cost advantage for us in five years' time that nobody else will have.”
Although the long-term view seems promising, there are some important caveats. Fuel prices are not the only major ingredient that created the five-digit order backlogs today. The industry has benefited from an unusual combination of extremely high fuel prices and historically low interest rates, says Richard Aboulafia, vice-president at the Teal Group consultancy. As fuel prices are trending lower, central bankers in New York and London are discussing raising interest rates higher, meaning that new aircraft could soon be marginally more expensive to buy and incrementally more expensive to operate.
“The real danger isn’t just $70/bbl fuel; it’s $70/bbl fuel and higher interest rates,” Aboulafia says. “My assumption has always been that we're living in an impossibly perfect world in terms of this combination of drivers. The OEMs would be very wise to moderate their production ramp plans; after all, things seldom stay perfect forever.”
Source: Cirium Dashboard
