The fuel effect; or old is beautiful

By Bjorn Fehrm

19 January 2016, ©. Leeham Co: When Willie Walsh, the CEO of IAG, said that the Airbus A340-600 “is a fantastic aircraft at fuel below $60 a barrel but perhaps not at $120,” he put operational words to something the Growth Frontiers 2016 conference in Dublin had been grappling with since it opened on Monday morning.

A340-600

What is going to happen now? Crude is falling below $30 a barrel and Jet fuel is below $1 a gallon. This must have an effect on how people decide, whatever the lessors and aircraft OEMs say.

And it had to be a senior airline CEO that broke the mantra that everyone was repeating: “We don’t see fuel prices having any effect on fleet planning for airlines.”

Earlier Peter Morris, chief economist at Ascend, had shown that the underlying basic demand for air travel stays intact, regardless of hic-ups on the Chinese stock markets. China’s people have decided they will go to meet relatives at Chinese New Year and they will continue that even if stockbrokers in Shanghai are nervous.

So “have money” and “will travel”, only question is on what airplane? New or old?

Morris then showed a curve on how the premium lease rate for an Airbus A320neo declined according to Ascends models as a result of oil price going down. The value of a fuel efficient A320neo is simply not the same with fuel at $4 a gallon versus $1. Something will happen and Morris showed in the graph what Willie Walsh put in words. The values of fuel guzzlers versus zippers just don’t stay put when fuel change at four to one.

The Walsh speech was preceded with the oil price experts’ panel where Standard Chartered’s Paul Horsnell and Mike Corley, Mercator Energy advisors, could agree that none of them knew what would happen next. Whereas last year Horsnell on the same stage was pretty sure we’d soon be back to about $60 a barrel, now they were adamant “we don’t give any forecast; no one knows what will happen.”

Corley said that what could happen was a further fall to $20 but then it would most likely bounce at that level and raise back up quickly. But he was not sure. That he repeated over and over again.

Horsnell said the whole party was spoiled by the Saudi Arabians, who kept on producing 2m barrels more per day during the year than everyone had predicted. This made the prices go south and the Iranians coming to peace with the world over the weekend did not help. They will be hungry for oil cash now that they can repair their production wells and pump faster.

AerCap’s CEO, Angus Kelly, then took the stage and we were back in mantra mode. “We don’t see a decline in airlines appetite for the latest fuel efficient models.” My row colleague nudged and whispered, “so all is fine; would one expect anything else.”

The fact is that things have changed. Our analysis of the Boeing 767 as a refresh long-hauler a week ago shows that it is once again a good choice if the lease is short. The sale of a super-efficient Bombardier CSeries is difficult to that major airline when a re-engined Boeing or Airbus model that they already operate is only a single digit less fuel efficient.

41 Comments on “The fuel effect; or old is beautiful

  1. Perhaps this is the time for the world to reflect upon the damage flying does to the environment and find a mechanism to tax aviation fuel. Lets start at $1/gallon.

    • Yes, and add exhaust filters 😉

      Taxing was killed last time because it could affect competitive position / margin /stock values / salaries / jobs / them-us, you know the drill / deadlock..

    • Not long ago (2008) the price of oil was $147 per barrel as opposed to less than $30 today. That’s would be roughly equivalent to a tax of %400 above today’s prices yet nobody stopped flying – business continued as usual. The new Asian LCC’s kept growing at an extraordinary rate as the emerging middle classes could afford air travel for the first time – the industry continued to expand.
      The most noticeable effect was large orders by airlines for newer more efficient aircraft.
      If business and consumer behavior was not altered due to an effective tax of %400 above today’s prices then its unlikely to succeed now.
      Taxes exist for the purposes of revenue raising or making politically correct statements in the hope of winning votes – they do not alter peoples behavior.

      • “Taxes exist for the purposes of revenue raising or making politically correct statements in the hope of winning votes – they do not alter peoples behavior.”

        Are you sure about that? Back in 2005, Jetblue started flying all over the Caribbean for about $59-69 each way to most of these islands. On top of that, taxes were really low for most of those countries as well. As a result, me and a few of my buddies from work would visit a different Caribbean island (when possible) about tree times a year. Then the 2008 crisis came and Oil skyrocketed in the subsequent years. On top of that, governments of these islands started imposing major taxes to international flights (right now you might pay 150% more for taxes than the price of the ticket itself on some flights). End result, trip that would cost us about a thousand dollars (4 night stay in hotel plus rental car and airfare) went up to about $2,500.00 dollars for the same trip. So now we travel perhaps once a year there instead of three times as before. So, yes, it had changed our travel behavior a bit.

        • Karl – fair enough. However it sounds like your case was the imposition of a tax on total ticket prices rather than just a tax on fuel.
          My comments were directed at an industry level – I’m sure there are lots of individual cases that may differ.
          Most airlines imposed fuel surcharges when oil was above $100 per barrel – these provide an insight as to what level extra fuel taxes would impose on a standard fare. It was an irritation but people kept flying.
          Issues that do modify flying habits include terrorism, epidemics such as SARS or Ebola and significant exchange rate movements which do impose a significant increase in air fares..
          I retain my cynicism regarding the motives of politicians & governments who increase taxes whenever they see an opportunity to do so. Once taxes are imposed or increased they are never removed or decreased.

      • It might not impact travellers’ behavior a whole lot, but it certainly impacts fleet planning strategies for airlines who are generally diligent about managing fuel costs. So even if the same number of people travel, higher fuel costs will translate into more efficient aircraft, which in turn *does* help the environment

      • “Taxes exist for the purposes of revenue raising or making politically correct statements in the hope of winning votes – they do not alter peoples behavior.”

        When I was a very young man and first started work, everyone was saying “I’ll stop driving when petrol cost £1 per gallon.” and “I’m giving up drinking when beer costs £1 per pint.”

        Now petrol costs £1 per litre and beer costs at least £3 per pint. Nobody stopped driving and nobody stopped drinking.

    • And what will higher fuel taxes accomplish? The funds will go into government coffers and be used to offset declining tax revenues.
      The automobile is the main cause of pollution and fuel taxes have done nothing to curb smog in major cities around the world.
      People seem to like feel good programs that have little or no effect on the problems they are supposed to remedy.

  2. There are other reasons to modernize a fleet other than fuel. Maintenance, capacity & product (particularly IFE) for instance and the wisdom of fixing the roof while the sky is blue. But the sudden fall in fuel costs might make any airline that did invest in new types vulnerable to competitors operating older, less fuel efficient types. The logic doesn’t stop there though, if the OEMs want to shift metal, they’ll have to tempt airlines the only way they can – lower prices.

  3. This does point to the need for a carbon pricing system for fuels. And it’s not just planes. My brother excitedly announced yesterday that he’d bought a 4 year old Range Rover. I looked, it gets 12mpg in the city. His previous car, a perfectly suitable top of the line Volvo sedan, got 21mpg. He was willing to take over a 50% hit since gas is cheap (right now).

    • I wonder how many millions are doing a similar thing. Buying a large vehicle with a 3 to 7 year payment book based on today’s price of oil. Now is the time to buy a Toyota Camry or Corolla since these are falling out of favor due to big car sales. Airlines would also be foolish to think oil will stay cheap for years, the only thing that stays the same is change. Oil will go up, when and how much is hard to predict. New fuel efficient planes will pay off in the long run on lower maintenance costs and fuel savings and even more so when jet fuel climbs back up.

    • “… announced yesterday that he’d bought a 4 year old Range Rover. I looked, it gets 12mpg in the city..”

      I bet he didnt look at the price after 3 years of ownership. Compared to other large SUVs he could have made a better choice for long term value. And thats if he can find a buyer then ( even if fuel prices remain low)

      Much the same applies to planes, end of us costs matter too

      • Good point, I would never own a British car, no where near the reliability of many other cars. Let the British be known for Bass Ale, not cars.

        • I’m confident Nissan, RR, Caterham, Toyota, Lotus, Peugeot, BMW, Vauxhall, Bentley, Aston Martin, Ford, Honda, Jaguar, Morgan and the most successful formula 1 teams would dismiss your swathing suggestion.

          As for Bass Ale, whilst its the oldest trade mark is the in the world, you should know it’s no longer the epitome of a true British Real Ale.

          • Don’t forget the Nobel Car Co who this year is going to break the land speed record in South Africa with a upside down aircraft on wheels driven by a ex R.A.F Wing Commander Andy D. Green O.B.E with his brave wive Mrs Green in the control tower in charge of saying Go No Go.

          • Why are we talking about cars on an aviation blog?

            Hamilton

          • Over the past 30 or so years my working experience with British cars has been disappointing. Lucas electrical systems are the worst for reliability, and parts are much higher than other lines of Japanese and American cars.
            No one in my neighborhood drives formula 1 cars or Morgans, but they do drive Toyotas, Nissans, Hondas, Fords and other makes who I did not degrade in my comment.
            I am aware that Bass ale is mass produced but it beats most American beers like Budweiser by a mile. I don’t claim to be a purest, but foreign beers especially those from from Europe are far superior. Just my take on cars and brews.

          • Rolls-Royce Cars and Mini is owned by BMW and Bentley by VW.

            Originally VW bought the Rolls-Royce car company but the brand name belongs to the Rolls-Royce which builds the aircraft engines. BMW made long ago a deal with RR aero engines about the brand RR cars.

  4. “The sale of a super-efficient Bombardier CSeries is difficult to *that* major airline when a re-engined Boeing or Airbus model that they already operate is only a single digit less fuel efficient.”

    Yes, the drop in fuel prices couldn’t happen at a worst time for the C Series, but…

    — Why the emphasis on that *that*?

    — Why the continuing comparisons between the smaller CSeries and larger A320/B737? The A319neo and B737-700max are more direct competitors and not selling much.

    — Beyond their nuisance potential against the C Series and E2-195, are the A319neo and B737-700max programs worth pursuing? Would they still be alive if the C Series and E2-195 weres not in the picture?

    — Why would carriers be satisfied with depending on a duopoly? Over the long term, what would carriers gain by encouraging the emergence of third and fourth (western) competitors in the small mainliner category?

    • “Why would carriers be satisfied with depending on a duopoly?” They probably aren’t. But neither does any one airline want to offer itself as the sacrificial lamb by buying an OEM’s products just to support the industry as a whole…

  5. Why aren’t all the A345 put back in service? If they can be picked up for a low price, low cost of ownership should make them cheaper to operate than new build A330ceo, 777, 787, or A350.

    • It takes time to swing from one op mode to the next.

      Leases are for multi year terms, so not everyone can drop them on a dime and you still have to configure the cabin for your ops.

      And then you already have your setup and to change it suddenly just to change it back eventually takes some long term thought.

      If you own the aircraft you can’t just dump them and if you lease them your leaser is going to be offering you much better deals.

      It will be interesting to watch

    • *cough* Iran! *cough*

      See what next week’s Iranian visit to Paris brings. Apparently, it’s 114 Airbuses including a number of A340s.

  6. “— Why the continuing comparisons between the smaller CSeries and larger A320/B737? The A319neo and B737-700max are more direct competitors and not selling much.”

    In reality you can’t ignore the 2000 A319/737-700s moving around either. They are the “ist” situation.

    Ted, the A340-600s are picked up already..

    • The largest stock of A340-600 is still owned and operated by Lufthansa. Several of Ludthansa’s A340-300 will be transferred to Eurowings.

      Maybe Lufthansa will sell a few after receiving A350s.

  7. Maybe governments should just apply a fuel tax that is equivalent to the “administrative surcharge” (formerly fuel surcharge) that so many airlines implemented when oil was high and have maintained ever since.

  8. What are the chances of airlines delaying deliveries of NG aircraft in the short term? I’m expecting oil to be around the $20-25 range over the next two years and I as an airline wouldn’t want the debt on my books for new aircraft that are only going to provide a small operating cost advantage. Keep the old guzzlers, take an occasional AOG hit and still have a healthy balance sheet. Hell I could significantly reduce my debt over the next two years as no one airline has reduced fares inline with low fuel costs, so why should I.

    Gives reason for thought?

  9. if the price of oil has dropped by that much, why havnt ticket prices followed suit? why is it just the lcc’s, you would think that the major’s would follow to keep sales up rather than increase profits! with iran now about to go full on production very soon, it will keep oil prices low for a substancial period.

  10. It won’t be long before airlines’ decision-making on fleet composition and operations, among other things, will be made to meet required carbon emission caps and reductions — irrespective of the market price of fossil fuel. ICAO will be proposing new standards by Sept 2016, the EPA will be demanding limits consistent with national goals. Likewise the EU etc. Rules and regulations may be in place in 2017. Smart airlines will be figuring out how to accelerate replacement of old less efficient aircraft, not extend their use.

    • Precisely my point thanks Jim. I suggested a tax to keep matters simplistic but it is more a case of charging for carbon emissions. It seems a major anomaly that the airline industry has dodged the bullet. This is especially the case when you consider that the emissions are considered proportionately more harmful given the altitude at which they occur

  11. Pingback: » Daily Aviation Brief – 20/01/2016

  12. Aircraft orders in recent years were based on the fact that the higher capital cost of new aircraft was more than compensated for by lower fuel consumption. Now, that formula has been reversed – higher capital costs exceed fuel cost savings. So, we should expect a dramatic reduction in new aircraft orders until fuel prices increase again. The oil price drop has very negative implications for Airbus and Boeing in the medium term. They currently have large backlogs, but their production ramp up will likely deplete their backlog in the next 5 years.

  13. Time has come (‘the Hatter said’ …) to scratch your head about what to do next … and if sovereign Ruling will levy taxes upon air travel to maintain an incitation for innovation, but also to regulate the traffic growth rate (it seems that RASK elasticity to fuel guzzling is negative, or seat-kilometers are an essential good ?), we’d want those taxes to be reinvested into innovative R&D such as E-fanned paxliners, fuel-cells, hybrid thrust, ceramic composites, nano-stringer technology, disruptive light-weight structures, anti-gravity etc ? How can we make sure that will be the case ?

    http://www.sciencedomain.org/abstract/1298#.UYpH5oLnyBN

  14. First 320neo delivered today!
    Congrats to Airbus, it is a fine looking aircraft. I love the big engines. 🙂

  15. Well a test point, Sri Lakan is retiring the last A340

    More a hint as you don’t usually operate a fleet of 1, Still a shift to an A330 vs say a 777-200 ER is interesting.

    Still worth a note. Also interesting they were an L1011 operator, I flew one of those once, solid aircraft, odd nose up attitude at altitude the attendant had a prob lme with the carts

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