By Bjorn Fehrm
18 Jan 2015: The subject of the first day at the Growth Frontiers 2015 in Dublin has been very much “what will happen with lower fuel prices”. The conference is the yearly gathering of the aircraft financing community with investors, banks and lessors gathering to learn how key factors in the market affect their industry. With the first day behind us, it is clear the top subject is the low fuel prices and how these will affect aircraft orders and prices going forward.
The panel for fuel pricing and fuel hedging gave a very clear view on the base causes for the present fuel price dip and a good handle on how long it is likely to last.
Paul Horsnell, head of commodities research of Standard Chartered, gave a very concise view on what is going on in the oil market and thereby in the aviation fuel market. The market for oil production is made up of many different oil producing countries and cartels, we can call them OPEC (cartel headed by Saudi Arabia) and non-OPEC (US, Canada, North sea, Russia and 3rd world). These all have very different production costs, examples given where ($ per barrel production cost):
Historically OPEC, with Saudi Arabia as driving force, has regulated the world market price at around $100 by virtue of their dominant handle of world-wide supply, but also their very strong costs versus revenue position. They can thus increase and decrease their production capacity fast, thereby controlling the price of the market. Since the summer they have stopped regulating supply and kept or increased production. This has let the price of oil plummet from around $100 past $50 a barrel. This action has been done to drive a number of higher cost players to shut down their production and to stop investing in their exploration assets.
We are only a couple of months into this tactics Horsnell said, but Saudi Arabia has been very successful in their actions. US shale oil capacity has diminished with 13% and capital investment in this type of exploration has virtually stopped. A side effect is that a number of non-OPEC producers are in major trouble (like Russia) as they have production cost way higher than today’s oil price.
The tactic of OPEC according to Horsnell, is to keep the oil price down until around Q2 this year, then to let it climb gradually to what would be $80-100. He does not think the low oil price will drag on, there is no-one in the market gaining from that. Should the low fuel price stay year out there will be major repercussions, not for the airline industry but for countries and economies that are dependent on oil income.
Fuel and aircraft orders and prices
Many speakers then latched onto this with analysis and discussions what this will mean for airlines, lessors and aircraft manufacturers.
Airlines: There is consensus that the lower oil price is good news for the airlines. The lower price of oil was likened by one speaker as “a worldwide tax cut”. What this means is that the travelling public will increase their air travel. Cheaper fuel will therefore be good news for airlines in two respects:
As fuel experts expect the low price to be short lived most of the lower cost will probably stay with the airlines as an improved bottom line, rather than be passed on as lower prices for the consumer.
Lessors: A number of lessors has given their view on the situation included the worlds largest, AerCap with CEO, Aengus Kelly. He has placed some 80 aircraft over the last months and of those a large number of A320neo recently.
He has seen no change in the discussion with the airlines, their fleet planners are not planning to supply new aircraft for 2015 or 2016, they are looking at 2015 all the way out to 2020-2030. As no banks or financial institution will be ready to hedge an airlines fuel bill over any meaningful time, the simple fact is according to Kelly: “no airline dear gamble with the airlines major operating cost item over such lifespans, the discussion of fuel at below $2 dollar per US Gallon just does not come up”.
This is then also good news for the aircraft manufacturers according to Kelly. With the existing duopoly no-one of them is going to rock the market with non expected movements, be it in price, production or any other means. It means a continued stable market for the aircraft OEM.
What AerCap has seen is that aircraft that they expected to be put in the desert, like a 747-400 or A340-300 could be kept on in operation with their operator until the next major engine overhaul (with 4 engines a bill of $10-15 million) or cabin overhaul (could be up to $10 millon). But these event then form a “hard stop” for any further exploration of these older aircraft. So the extra capacity is there but not for a long period. Overall these extra usage of existing aircraft could most probable be the short term capacity increase needed as the travelling public gets a bit more freedom to book extra air travel because of the world wide “tax cut”.
There is no evidence anywhere to suggest that the fuel cost “tax cut” is being used by consumers for anything other than savings, or paying down debt. I have zero confidence that there will be any increase in passenger traffic over the seasonal norms, and little to no boost in consumer spending generally.
Actually there is much effidence that this happens. You overestimate many consumers all over the world. A large Proportion of People “spend what they have”. If they save $ 100 per month on gas, they’ll spend them otherwise. Even if they save $ 50 or pay back dept they still can spend 50$ more.
US is the only healthy economy
China lost 8% stock market today
Europe is in trouble, Russia is in a lot of trouble.
Where do the travelers come form and go to?
The long term investment is valid, but not all the rhetoric is.