Friday, December 12, 2014

Drop in fuel prices could keep old aircraft flying longer, lessen new jet demand

As the price of jet fuel plunges, down 33 percent in the last year, many are wondering if this could undercut airlines' demand for new Boeing and Airbus aircraft.

The issue is being closely watched in many circles, and a just-released UBS Securities update on global scrapped aircraft suggests there could be a long-term issue, at least if fuel costs keep dropping and stay down.

While UBS aerospace securities analyst David Strauss said that so far oil prices haven't impacted the level at which airlines are parking aircraft, he suggests that could change.

"We estimate 30 percent of all parked aircraft are 15 years of age or younger, equivalent to 781 aircraft, which we think could come back into service, particularly given the drop in oil prices," he wrote.

This month the International Air Transport Association (IATA) reported that jet fuel was selling at $2.04 a gallon at the refinery, down 33 percent from a year ago.

Currently Boeing (and Airbus) are riding on a seven-year backlog and each quarter continue to win more orders than they build. But that could start to change, some analysts suggest, if older aircraft become relatively more economical to operate if fuel prices continue to drop.

"The speed at which new aircraft will be introduced and will be retired will be slowed down," said Adam Pilarski, senior vice president of Avitas Inc., a prominent Washington, D.C.-area aerospace consultancy. "A number of orders we have will start getting canceled, and that is more serious."

To be sure, Pilarski has definite and somewhat radical views on this subject, including a long-held contention that crude oil will get down to $40 a barrel.

While it did dip down to $57 dollars a barrel this week, that's still a long way from a sustained $40 level. Crude has traded at over $100 a barrel for much of the past four years. Before the recession it was higher, but it did take a radical and brief plunge to $40 during the fall of 2008.

Seattle-area aerospace analyst Scott Hamilton takes a more nuanced view, saying that while he doesn't expect crude oil to go as low as $40, and he doesn't expect order cancellations, he does think lower oil prices could lighten the pressure for new orders.

But that may not be such a problem, Hamilton contends, because the seven-year backlogs are so huge that lifting some of the pressure would bring some flexibility into the market without any great penalty to Boeing or Airbus.

The level of aircraft scrapping is an interesting litmus test, and the December UBS Securities report said that level has sunk to about 1.8 percent of the global fleet, "well below the level of past years," as carriers put relatively new aircraft into storage without scrapping them.

"We think the sustainability of all-time high production rates out of Airbus and Boeing is partially dependent on high levels of aircraft (4-5 percent) being removed from the fleet," said the report.

While the actual scrap aluminum in a jetliner is only worth $30,000 to $50,000, according to reports, recovered components such as engines and landing gear can be sold at far higher prices.

Part of the reason for the parking is that Boeing and Airbus are delivering new aircraft at record high rates, especially the smaller single-aisle Boeing 737s and Airbus A320s.

The study said 188 Airbus A320s were parked in December, versus 90 Next Generation Boeing 737s.

A Boeing spokesman sent statements suggesting that Boeing sees the current fluctuations as short term, and doesn't think they will hurt orders.

"Current oil prices and volatility are in line with our range of assumptions for the long term," the statement said. "In the mid-to-long term, efficiency and capability will remain the key drivers of market demand."

New aircraft have other improvements in addition to fuel efficiency that also drives orders, Boeing said.

"Regardless of exactly where in the range fuel prices trend to over the long term, new airplanes are a 20-plus year investment," the Boeing statement said.

There's also an upside to the lower fuel prices for Boeing, because this will help airlines increase expected 2015 profits to $25 billion, up from the $20 billion expected for 2014, according to the International Air Transport Association.

More money will help some carriers more easily make long-term aircraft investments.

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