Pontifications: Assessing the benefit of new airplanes in low oil pricing

Hamilton KING5_2

By Scott Hamilton

Dec. 7, 2015, © Leeham Co.: Oil for West Texas Intermediate Crude closed Friday at $39.97. International Brent closed at $43.05. These figures continue to breathe life into used aircraft and raise questions about new orders.

In recent weeks, we’ve seen Delta Air Lines extend use of 15 Boeing 757s. Earlier United Airlines decided to refurbish 21 Boeing 767-300ERs. United is also leasing in 38 used Airbus A319s. Southwest Airlines is acquiring more than 20 used Boeing 737-700s through leases.

New aircraft orders are off for Boeing this year. Through Dec. 2, Boeing posted 568 net orders. Unless there is an explosive month in the remaining 24 days of this year, Boeing won’t meet a book-to-bill rate of one.

Airbus hadn’t posted its November orders as of Friday, but through October, the company recorded 850 net orders, comfortably more than a 1:1 book:bill. It announced 108 firm orders in November, with 14 of these representing a swap from A350-900s to A330-900s.

What is the affect of lower oil prices on the new airplanes?

During the Nov.10 earnings call for AerCap, the world’s No. 2 lessor, Michael Linenberg, the aerospace analyst for Deutsche Bank, recounted a conversation he had recently with an unidentified airline official. From the earnings call transcript:

Linenberg: I recently had a conversation with an airline management team and they were talking about the fact that fuel prices have come down a bit. And they said look, Boeing and Airbus, they’re going to have to start accounting for that in the pricing of new airplanes. And I said all right, well, how should we think about it? And they said look, if you look at a new airplane versus an older aircraft like a CEO versus a NEO, The NEO probably gives us $800,000 of savings a year or at least that is what it was when oil was over $100 a barrel.

That has now been cut in half and so the savings are more like $400,000 a year for the differential…. And then they went on to say that over time that they should probably see that in the lease rate as well. And I was just curious about whether or not is that accurate, is that how it plays out and if it does, does it ultimately find its way into the lease rate the lag? Can you talk about that.

Aengus Kelly – AerCap Holdings NV – CEO.Sure. We are placing NEO 787s 350s all the time. We observe still very good re-lease rates for the NEOs. As I said before, when the airlines are looking out 12, 14 years which is what they do when they take new aircraft, where fuel is today is not something they look at. The events of July 2008 are indelibly marked on their minds where when fuel went to $1.48–and airlines can’t hedge themselves [and] of course no bank will write a derivative for the long-term for an airline to hedge fuel. The only way to do it ultimately is have the most fuel efficient assets out there.

So we don’t see a deterioration in demand for the NEOs. Now it is true, of course, that fuel is a lot less so the benefit of the NEO is not $800,000, it was about–the benefit is closer to $1m a year….

In any event, we do see continued strong demand for the NEOs, the lease rates that we are putting them out at we don’t see much change. It is more influenced by interest rates to be fair than where oil has been on the NEOs at this point. They bounce around depending if you have very strong credit of course or weak credit or what have you but fundamentally it is more interest rate at the moment that have impacted us.

To be sure, this is but one data point—but it is worth remembering.

 

18 Comments on “Pontifications: Assessing the benefit of new airplanes in low oil pricing

  1. It’s not just the fuel saving, the NEO offers more range/payload on certain missions. But, I agree in some cases it will pay airlines to retain older paid for aircraft. Lease rates on older aircraft will also become more attractive.

  2. I think low fuel prices prolong the time old aircraft are operated. If fuel goes up they can be quickly put into the desert. Only airlines with cash issues will buy lower performing aircraft.

    • Lower fuel prices should transform into more growth.
      lower energy cost should free up some income for travel
      increasing demand while airlines can expand faster by keeping older frames longer ( while still getting new frames delivered )

    • Its not a matter if oil prices will go up,they will go up but when is anybodies guess.The instability of the world can spike oil very fast as has been seen in the past. Its a tough call to make whether to keep and acquire older frames or go with new. Delta seems to do well with older MD-90’s and 717’s.
      Fuel savings or avoid acquisition costs,pick one.

  3. The three fundamental variables governing the bubble of airplane orders are all potentially subject to change. We have had a situation where buying new was a no brainer but things are subtlety changing to make that less the case.

    1/ The purchase cost is affected by the low borrowing costs, the only thing that is remaining into the short and medium term and possibly the most fundamental. Effectively free borrowing is what has stoked the fires of the purchasing boom more than any other aspect.
    2/ The fuel/ running costs look like we are into a medium low cost outcome but who knows (I think I have lived through peak oil three times now!!). They provide the rationale for the purchase of new aircraft but being volatile no airline management can predict with any certainty the economic risk they pose.
    3/ the residual values of the very many aircraft are in the toilet, as has been pointed out recently on this blog, why divest or alternatively why not pick up a few used examples on the market.

    So this bubble will pop but probably only when interest rates start rising and critically are expected to rise over the medium term. If I were running an airline I would be looking at good old fashioned fleet management and pushing frames out to 20+ years

  4. The current NB situation / prospects seems unacceptable for Boeing.

    They managed to soften / push out the bad news, but 2015 numbers and a few more Leahy retirement slam dunks might push the red button in Chicago, pulling NSA forward 5-7 yrs.

    The Lionair 737 “-9 MAX” order seems to be transforming into a 737 “MAX” order (Lionair: 50% of 737-9 backlog).

    United (25% 737-9 backlog) is totally interested in 737-9 development(s) too, wondering why everybody buys the other one.

    UA could be a good Boeing NSA launch customer (~200?), but need they a solid plan, not a promise.

    MoM/NMA will probably be sacrificed for the longest NSA variant.

  5. There are many other factors to consider as oil prices or interest rates. This portrait of Anderson Delta illustrates a few:
    http://www.barrons.com/articles/deltas-ceo-has-the-right-flight-plan-1440228272

    The same Anderson that had the project according to aircraft acquisitions, the last few months:
    http://aviationblog.dallasnews.com/2015/07/delta-says-itll-cancel-4-billion-aircraft-order-after-pilots-turn-down-proposed-contract.html/

    And I do not know exactly where exactly, but the same Anderson stressed that the most important criterion that loomed on the horizon for the purchase of aircraft was the rise in government regulations to make them pay more polluting aircraft. Presumably, with the COP21 conference in Paris, sooner or later, this criterion will be a reality shared by many. However, actually, the choice for green airplane were not many … Well, it would be that humanity is facing a new SARS or another virus such that everything that comes to say, counts for nothing at all in the equation …:

    http://www.afro.who.int/en/clusters-a-programmes/dpc/epidemic-a-pandemic-alert-and-response/outbreak-news.html

  6. Oil prices might get back up significantly over the long term… or not.

    As a counter-argument, with the seemingly unstoppable and growing climate change hysteria, there will be unending pressure from green lobbies and the mainstream media to de-carbonize the economy, even if this is not an optimal economic choice.

    Airplanes will still require petroleum-based fuel for the foreseeable future, but oil demand elsewhere could be going down indefinitely, thus ensuring continuing downward price pressure.

    Reminds me that it has been a while since I heard about “peak oil.”

    • ‘peak oil’ is a bit like saying its only ’15 days till Xmas’, it justifies rushing out and spending a lot of money, oh and it comes around almost as often.

  7. No matter how low the fuel prices are, an investment in a modern fleet will always give you an advantage in todays stiff competition. New aircraft means less demand for gasoline, less maintenance and reduced emissions; todays interest rates are also very low.

    If you take a look at Cathay Pacific`s Fleet in 10 years from now, with all the A350s and 777s, they for sure will have build up a very efficient fleet with great cargo capabilities to suit their needs.At the same time Lufthansa will still fly around with completely outdated „gas guzzling“ models from seattle and elsewhere!

    •  “New aircraft means less demand for gasoline, less maintenance and reduced emissions; todays interest rates are also very low.”

      It ain’t so simple, not everbody drives a new car for a reason.

  8. This is an important and timely topic – a couple of thoughts: Buying a fuel-efficient re-engined airplane gives you a natural fuel-hedge, all included in the price. Designing and setting up a fuel-hedge financially 5-10 years into the future through, e.g., a layered system of call-options can be quite pricey, perhaps an additional 2%-5% on fuel cost. Moreover, it’s much easier to possess a natural hedge than to continuously monitor and design a hedge through a system of financial instruments.

    With respect to deferred retirements, fleet operations often use this method as a quick and easy way to temporarily boost capacity above the long-term fleet plan. And passenger numbers are very strong this year, in the domestic U.S. up 4.6% year-to-date relative to last year. While the lower fuel price is beneficial, retirement deferral decisions are sometimes made on other grounds entirely.

  9. And while there have been a lot of comments on the 787 vs the A350, keep in mind that there are a huge number of various options on the 787 that if exercised actually take the on order numbers up into the 2000 range.

    Obviously not all the option type will be taken (Qantas) but there are new sales as well with the various options that go with it.

    If Boeing can get the mfg numbers up to 15 a month then that will sell even more (and or options brought forward)

    • The b787 programme appears to becoming the defining wide body of its era but at what cost to Boeing. The potential to make money is minimal even over 2,000+ sales over 15 years. It is interesting to note the aims of ‘de costing’ the programme with substantial reductions in the use of titanium and other costly components. not sure what the impact will be on the efficiency of the overall package but it appears that the high tech, plastic, titanium approach is being scaled back considerably. To see the a330neo near compete or b777x with a350 really shows the lack of significance we should be placing on plastic

      • Ah, it’s the lithium ion batteries on the ’87 I really worry about, (LOL)

Leave a Reply

Your email address will not be published.