Manufacturers have been raising production rates in prospect of growing demand, especially in the key narrowbody sector. But how will prices hold up, asks Chris Tarry of CTAIRA
A new mood of optimism appears to have taken hold of late among those who make and finance aircraft: demand appears to be returning, stored aircraft numbers falling and prices stabilising. Manufacturers have duly announced a series of production rate increases on the prospect of better times ahead. However, questions still remain about the speed with which the demand will actually materialise and at what price?
A starting point is to consider the role of market expectations. According to behavioural theory, if we expect something to happen, then we tend to act as if it has already happened and in so doing ensure that it does indeed occur. In effect, it becomes a self-fulfilling prophecy. So, airlines plan to acquire more aircraft because of expectations over growth and replacement. So too, planned production rates rise due to this expected increase in demand.
Given the relatively long-lead production items it is still somewhat an act of faith that the demand will materialise at the price that is desired. While there was clear evidence of this type of behaviour in the latter part of the 1980s, as carriers worried about losing out on future growth opportunities if they did not secure aircraft production slots, the environment now would appear to be quite different. But this time around it may not be the airlines that blink first.
The short-haul aircraft market is a case in point. Given the volumes of highly tradeable aircraft in the 150-seat segment, this is arguably the nearest thing that air transport has to a commodity. As such, the laws of supply and demand should dictate pricing.
It is already clear that short-haul and low-cost operators are focusing attention on the likely future value of aircraft and negotiating deals accordingly.
Some commentators have suggested that demand is pretty much assured in the short-haul aircraft market, not least due to significant opportunities from low cost carriers in Asia. However as was clear from Jetstar Asia's announcement that the absence of a deregulated environment is acting as a break and that it will have to lease out surplus aircraft, should act as a reality check. Furthermore there has been another profit warning from Virgin Blue.
Both Airbus and Boeing have announced increased production rates for their core narrowbody families. The latest consensus view suggests that the combined production rates of the Boeing 737 and Airbus A320 families will peak at just under 600 aircraft in 2007 – some 50% higher than in 2003. Looking at the backlogs it seems that there are few open production slots for this year but from 2006 the opportunity for the buyer and the challenge for the manufacturer increase. Looking at the current order backlog across these types it appears that some 30% of production slots are still open in 2006, with just over 40% open in 2007 and 60% in 2008.
Attention will clearly focus on the market clearing price. Given that the level of supply is fixed, buyers could find themselves with a good deal of leverage when it comes to future negotiations on price. When Ryanair and easyJet first placed their massive orders in the depressed market of 2002, it was clear that they had the upper hand. The recent order announcement from Ryanair for an additional 70 firm orders, which appeared to take the market by surprise, clearly enabled the company to benefit from a pricing opportunity which was clearly evident from the number of open positions from 2007 onwards. Indeed, Ryanair's finance director was reported to have remarked that Boeing's order book looked a little empty beyond 2008.
Of course, benefiting from lower aircraft prices reduces ownership costs which will show through in lower fares and/or an opportunity to change the economics of the business. However markets are not infinite whether for economic or regulatory reasons which raises the issue of over-expansion.
Money may be cheap and available at the moment but we have already begun to see re-assessments being made by some aircraft valuers and leasing companies to shorten the depreciation period and planned economic life of aircraft in the 150-seat segment by two or three years. While there is a benefit to be obtained from low aircraft prices, even a good thing can be dangerous in excess.
Given the current environment the probability is that new aircraft prices in the 150 seat segment are likely to continue to fall. The risk is that the airlines will continue to suffer from a capacity overdose, potentially damaging to their health. For some, perhaps, it is better to resist the temptation and just say no. That could prove a painful period for the manufacturers too.
Source: Airline Business
