AS OIL PRICES FALL, NEW AIRCRAFT LOSE COMPETITIVE EDGE - Aviation, Aerospace & Defense
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Aviation, Aerospace & Defense AS OIL PRICES FALL, NEW AIRCRAFT LOSE COMPETITIVE EDGE AUTHORS Tim Hoyland, Partner Andrew Medland, Principal
The decline in jet fuel prices could stymie the airline industry’s deliberate march toward a new generation of narrow-body aircraft. Aircraft manufacturers developed new planes and engines, and airlines ordered them, to reduce fuel consumption at a time when oil prices seemed stuck at historic highs (with the added benefits of reducing emissions and noise). However, as airlines wait to receive their new 737 MAXs, Airbus neos, and other efficient and innovative aircraft, fuel prices have dropped. This dramatic shift offsets the operating cost advantage highly utilized new aircraft would hold against older models in an environment of higher fuel prices and low interest rates. According to an Oliver Wyman analysis, jet fuel prices at $2.40 a gallon or less would make older aircraft increasingly competitive with new planes, particularly in lower utilization networks or as spares. This price point will vary by airline based on the business models employed for maintaining aging fleets. This could lead to overcapacity in the North American aviation industry, following strict capacity discipline during the last couple of years. Low fuel prices spur airlines to keep their current planes in operation while adding new fixed orders to their fleets. Considering current profitability, investors might seize this opportunity to start new airlines with older aircraft. After a decade of rising fuel costs, prices declined during the past year, with year-over-year jet fuel prices down 30 percent at $1.48 a gallon as of January 15. Other than a few short months during the recession in 2009, the last time fuel was this low was in 2005. According to the Energy Information Administration, “The November price decline reflects continued growth in US tight oil production along with weakening outlooks for the global economy and oil demand growth.” The decision by the Organization of Petroleum Exporting Countries to leave its production target unchanged has further weighed on prices. Copyright © 2015 Oliver Wyman 2
FUEL BURN
As fuel prices decline, older aircraft become more profitable to operate at higher utilizations than new aircraft that are
about to be delivered. The inflection point for any airline can be plotted on the curve based on the intended utilization
of the airline’s new and aging fleets.
Exhibit 1: Aircraft generational profitability curve: Exhibit 2: Jet-A fuel price at a four-year low
Where is your fleet’s inflection point?
JET-A PRICE
US$ US$
3.00 4.50
Oct 2013 Airlines make
$2.89 purchasing decisions
New-generation aircraft are more about new-generation aircraft.
profitable than the current generation.
3.00 Linear
trend line
Fuel prices drop Non-recession jet-A prices (inflation
2.00 have not been consistently adjusted
below $2.10 since 2005. to 2014)
1.50 Inflation-
adjusted
Jan 2015 price
$1.48 to 2014)
New generation aircraft are less
profitable than current generation. Spot
1.00 0 price
2,000 2,400 2,800 3,200 3,600 4,000 4,400 4,800 2000 2007 2014
Utilization in hours
Exhibit 3: Global crude oil production: Exhibit 4: Global crude oil consumption
2000-2020 (projected)
BARRELS BARRELS
BILLION BILLION
40 35
2014 rate of crude oil production:
33.56 billion barrels per year
35
30
30
25 25
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2012 2013 2014 2015
Assumptions and methodology Estimated actual lease payments in US dollars, assuming a six-year term, with maintenance reserves included, for a 2015 build.
Includes inflation. Assumes you start a new six-year lease every six years. Fuel burn includes 20 minutes of APU fuel.
Sources BLS.gov, indexmundi.com, EIA, Aircraft Value Analysis Company, Aircraft Value Reference 2012 report, using standard specification and maintenance condition
assumptions; “Aircraft performance degradation” May 2009, Airbus; Aircraft performance statements issued by Airbus and Boeing.
Copyright © 2015 Oliver Wyman 3Exhibit 5: Benefits of new planes extend beyond fuel efficiency
CO2 EMISSIONS NOISE EMISSIONS
KG PER SEAT KM EFFECTIVE PERCEIVED NOISE IN DECIBELS
0.25 100
0.20 80
0.15 60
0.10 40
0.05 20
0 0
A320 A320neo 737-800 737 MAX A320 A320neo 737-800 737 MAX
Airbus Boeing Airbus Boeing
Sources Boeing, Airbus, Atmosfair, FAA.
The volatility in fuel and other costs in the past decade prompted airlines to evaluate their
total cost of ownership models. Almost every airline ordering new aircraft has a finely tuned
total cost of ownership model based on many things, including purchase price, crew costs,
landing fees, financing costs of the aircraft, inventory, utilization, specific maintenance
agreements, and expected fuel costs. Prior to making a purchasing decision and with some
diligence, an airline can exercise control over all variables in the model, except for some
future financing costs and the future cost of fuel.
Manufacturers listened, pouring billions of Exhibit 6: Airbus A320neo vs. Boeing 737 MAX
dollars into technology to reduce emissions, firm orders by year (all variants)
improve on-wing life, curtail noise, and 1,250
increase fuel efficiency. Boeing, Airbus,
Embraer, Mitsubishi, and Bombardier 1,000
now offer planes with these sought-after
750
benefits. GE and Pratt developed engines
to boost the cost benefits. Combined, 500
these efforts produced aircraft that, Boeing
737 MAX
according to manufacturers’ marketing 250
materials, improve fuel consumption by Airbus
0 A320neo
at least 20 percent. Further, updated seats
2010 2011 2012 2013 2014
and better airflow systems make the ride
more comfortable for passengers. Sources Airbus, Boeing.
Copyright © 2015 Oliver Wyman 4Airlines opened their wallets, ordering an unprecedented number of aircraft. Now, after
years of allowing their fleets to age as they waited for a new total cost paradigm, some
airlines are planning to replace their fleets in the next few years.
The new planes promise to reduce fuel burn and the cost of maintenance, although
financing costs are higher. This trade-off looked like a boon when oil prices were high.
But if low fuel prices continue, as financing costs rise, it could spoil the party for the
supposed winners of the new generation of aircraft: the owners and manufacturers of the
innovative planes.
Instead, if fuel prices remain low, the winners could be the airlines flying older aircraft
at lower utilization; maintenance, repair, and overhaul companies; and maintenance
mechanics, as older aircraft need repairs and updates. Some airlines could keep low-cost
spares available to improve on-time performance.
The market could watch the reaction of lessors, which represent large order books, as a
leading indicator of a shift in new-generation aircraft economics. If lessors expect low fuel
prices for the long term and rising interest rates, they might sell, cancel, or delay orders and
rebalance their portfolios toward aircraft currently in operation.
Exhibit 7: Net new deliveries will substantially increase active-service aircraft by 2020
AIRCRAFT DELIVERIES (RETIREMENTS) TOTAL ACTIVE-SERVICE AIRCRAFT
# OF AIRCRAFT (BY REGION) # OF AIRCRAFT (BY REGION)
2,000 30,000
Net change
1,500 25,000
North America
Deliveries
1,000 20,000
Asia: Adding
2,800+ aircraft
Europe
500 15,000
Asia Pacific
Europe: Adding
0 10,000 1,400+ aircraft
South America
Retirements
-500 5,000 North America:
Adding 1,600+ Middle East
aircraft
-1,000 0 Africa
2013
2014
2015
2016
2017
2018
2019
2020
2013
2014
2015
2016
2017
2018
2019
2020
Sources Airline Monitor, ICF, ACAS, Airbus, Boeing, Oliver Wyman analysis.
Copyright © 2015 Oliver Wyman 5If they aren’t getting the profit boost they expected out of the new aircraft, airlines, too,
could start eyeing the older planes as quick revenue generators and add capacity. While
that might be a rational decision for individual carriers, for the industry, more capacity
could bring the North American airline industry back to earth.
The risk of adding too much capacity is acute. North American airlines have recently
achieved their best margins in a decade and seem to have finally lifted themselves out of
a boom-and-bust cycle. Industry yield has grown steadily since 2002. A flood of capacity
could unravel those gains.
THREE ROUTES INTO THE FUTURE
Given the uncertainty of jet fuel prices, three scenarios could unfold, each with a different set of winners and losers
across the industry.
SCENARIOS WINNERS LOSERS
1. Jet fuel enters an extended •• All airlines benefit, as fuel is 30 percent of their •• All airlines lose, as capacity expansion will cut
period below $2.40 a gallon. costs. In particular, airlines with access to older into pricing and margins. In particular, airlines
aircraft and any start-up carriers that use current switching to new fleets without the older aircraft
aircraft can add capacity cheaply. mix and airlines with fuel hedging programs
•• MROs benefit as older aircraft remain in service, through 2015 are affected.
increasing total shop hours. •• OEMs lose if orders are delayed or canceled.
•• OEMs with aftermarket capabilities win. •• Lessors with portfolios weighted with orders
•• Lessors with portfolios weighted with current for new aircraft lose.
and older aircraft win.
2. Jet fuel prices enter a period •• All airlines win, if orders get canceled and •• Airlines that made long-term bets on older aircraft
of volatility for the next production declines as capacity is constrained and airlines that delay orders for new aircraft lose.
three years or so, with broad on the supply side.
fluctuations and return above •• Airlines with hedges enjoy price certainty.
$3 a gallon.
•• Airlines with young fleets would immediately win
from the dip in fuel prices, then benefit more as
oil prices rise just as new aircraft are delivered.
3. Jet fuel prices quickly snap back •• With only a short-term dip in prices, those airlines •• Airlines with older aircraft lose, including any
above $3 in 2015. and lessors that are poised to take on new aircraft start-up using older fleets.
with better fuel efficiency win. •• MROs lose as the influx of new aircraft will
•• OEMs win as order books remain unchanged. decrease total shop time in coming years.
•• Lessors with portfolios weighted with orders •• Lessors with portfolios weighted with current
for new aircraft win. and older aircraft lose.
Copyright © 2015 Oliver Wyman 6ABOUT OLIVER WYMAN Oliver Wyman is a global leader in management consulting. With offices in 50+ cities across 25 countries, Oliver Wyman combines deep industry knowledge with specialized expertise in strategy, operations, risk management, and organization transformation. The firm’s 3,000 professionals help clients optimize their business, improve their operations and risk profile, and accelerate their organizational performance to seize the most attractive opportunities. Oliver Wyman is a wholly owned subsidiary of Marsh & McLennan Companies [NYSE: MMC], a global team of professional services companies offering clients advice and solutions in the areas of risk, strategy and human capital. With over 53,000 employees worldwide and annual revenue exceeding $11 billion, Marsh & McLennan Companies is also the parent company of Marsh, a global leader in insurance broking and risk management; Guy Carpenter, a global leader in providing risk and reinsurance intermediary services; and Mercer, a global leader in talent, health, retirement and investment consulting. For more information, visit www.oliverwyman.com. Follow Oliver Wyman on Twitter @OliverWyman. ABOUT OUR AVIATION, AEROSPACE & DEFENSE PRACTICE Oliver Wyman’s global Aviation, Aerospace & Defense practice helps passenger and cargo carriers, OEM and parts manufacturers, aerospace and defense companies, airports, MROs, and other service providers develop growth strategies, improve operations, and maximize organizational effectiveness. Our deep industry expertise and our specialized capabilities make us a leader in serving the needs of the industry. Also, Oliver Wyman offers a powerful suite of industry data and analytical tools to drive key business insights through www.planestats.com. For more information on this report, please contact: TIM HOYLAND ANDREW MEDLAND Partner Principal tim.hoyland@oliverwyman.com andrew.medland@oliverwyman.com Elizabeth Souder edited this report. www.oliverwyman.com Copyright © 2015 Oliver Wyman All rights reserved. This report may not be reproduced or redistributed, in whole or in part, without the written permission of Oliver Wyman and Oliver Wyman accepts no liability whatsoever for the actions of third parties in this respect. The information and opinions in this report were prepared by Oliver Wyman. This report is not investment advice and should not be relied on for such advice or as a substitute for consultation with professional accountants, tax, legal or financial advisors. Oliver Wyman has made every effort to use reliable, up-to-date and comprehensive information and analysis, but all information is provided without warranty of any kind, express or implied. Oliver Wyman disclaims any responsibility to update the information or conclusions in this report. Oliver Wyman accepts no liability for any loss arising from any action taken or refrained from as a result of information contained in this report or any reports or sources of information referred to herein, or for any consequential, special or similar damages even if advised of the possibility of such damages. The report is not an offer to buy or sell securities or a solicitation of an offer to buy or sell securities. This report may not be sold without the written consent of Oliver Wyman.
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