Hot Flash - February 23, 2004
Oil Prices: Boeing's New Best Friend
Plan on it. The days of oil prices in the mid $20s are gone for a while. Maybe permanently. More than likely, the fundamental price will hover in the low $30 per barrel range. And that's going to cause a lot of changes in how the airline industry operates.
The reasons are simple supply and demand - much of it driven by events in the Far East. In particular, the folks in China have traded in their water buffaloes for Volkswagens. And Buicks. And Pugeots. And lots of other vehicles. Add that to a hyper-booming economy that runs increasingly on imported oil, and that stuff we learned in Econ 101 starts to come into play.
Obviously, this means a big-time hit on the economics of running an airline. When oil goes from a fundamental price of say, $28 a barrel to a fundamental price of, say, $32, that means that the juice for the moose pumped into airplanes is costing a whole lot more, too. And if, as it seems, this is a near-permanent change in the airline cost equation, that means carriers will need to make further adjustments to how they operate.
Cutting to the chase, most cost-saving mechanisms have already been exhausted, or are in the process of being addressed. The only area remaining where carriers can offset the increase in prices for fuel is, obviously, to use less of it. That means acquiring airplanes that have better fuel consumption. New airplanes - the kind that burn less fuel, and have lower maintenance costs to boot.
True, new airplanes cost a lot of money to buy. But debt or lease costs are spread over a period of years. Operational cost savings are immediate. One airline found that shifting from almost paid-off DC-9s to B-717s provided an 8% to 9% net reduction in costs. So expect the start of a re-bound in airplane orders in late 2004 or early 2005.
Winners & Losers. The fall-out from structurally higher fuel costs will affect more than just orderbooks at Boeing, Airbus, and Embraer.
Boeing's 7E7, assuming it comes off as advertised, and turns out to be a concept not easily copied by Airbus, will be the odds-on favorite to replace aging fleets of 767s and some 757s, and do so much earlier in the product cycle than now expected.
Regional jets could face a much shorter useful operational life. The economics right now are fairly thin for 50-seaters, and materially increased fuel costs won't help. One ominous example: United Airlines' latest financials break out what seem to be described as the what they are paying small jet providers versus the on-segment revenue these services provide. The net is a $68 million shortfall. While United's financial reports are somewhat opaque due to the bankruptcy, and while these data don't reflect the system revenue contribution of this SJP flying, the message is clear: RJ economics are increasingly dicey. Jack up fuel costs, and things don't go in the right direction. Not good news for Bombardier, which now has all of its airliner eggs in the RJ basket.
Dancing On The Beach In Rio. Higher fuel costs only make the Embraer 170/190 series airliners more attractive as replacements not only for older 737s and DC-9s, but also for some percentage of existing RJ fleets. Since nobody else has an airliner anywhere close to the 170/190 platform, our friends in Brazil can expect to be very popular in the coming months.
Rural Air Service - The Bar Just Went A Notch Higher. The main barrier to rural air service is that the costs of providing it have risen, while the revenues that such service can deliver have remained static. Turboprops were getting more and more expensive to operate, what with higher required passenger weights and increasing maintenance costs, not to mention the fact that consumers are increasingly (if irrationally) averse to flying them. They are not coming back, regardless of fuel prices. So the price of air service admission will increasingly be the ability to support the costs of 50-seat jets. And those are going up. Do the math.
Lessors & Financial Houses: Sing The Blues. A lot of perfectly good airplanes are going to come off lease and find themselves all dressed up with no place to go. Except the desert.
Of course, it's possible that oil prices could drop. In that case, all this is off. But don't plan on it
Oil Prices: Boeing's New Best Friend
Plan on it. The days of oil prices in the mid $20s are gone for a while. Maybe permanently. More than likely, the fundamental price will hover in the low $30 per barrel range. And that's going to cause a lot of changes in how the airline industry operates.
The reasons are simple supply and demand - much of it driven by events in the Far East. In particular, the folks in China have traded in their water buffaloes for Volkswagens. And Buicks. And Pugeots. And lots of other vehicles. Add that to a hyper-booming economy that runs increasingly on imported oil, and that stuff we learned in Econ 101 starts to come into play.
Obviously, this means a big-time hit on the economics of running an airline. When oil goes from a fundamental price of say, $28 a barrel to a fundamental price of, say, $32, that means that the juice for the moose pumped into airplanes is costing a whole lot more, too. And if, as it seems, this is a near-permanent change in the airline cost equation, that means carriers will need to make further adjustments to how they operate.
Cutting to the chase, most cost-saving mechanisms have already been exhausted, or are in the process of being addressed. The only area remaining where carriers can offset the increase in prices for fuel is, obviously, to use less of it. That means acquiring airplanes that have better fuel consumption. New airplanes - the kind that burn less fuel, and have lower maintenance costs to boot.
True, new airplanes cost a lot of money to buy. But debt or lease costs are spread over a period of years. Operational cost savings are immediate. One airline found that shifting from almost paid-off DC-9s to B-717s provided an 8% to 9% net reduction in costs. So expect the start of a re-bound in airplane orders in late 2004 or early 2005.
Winners & Losers. The fall-out from structurally higher fuel costs will affect more than just orderbooks at Boeing, Airbus, and Embraer.
Boeing's 7E7, assuming it comes off as advertised, and turns out to be a concept not easily copied by Airbus, will be the odds-on favorite to replace aging fleets of 767s and some 757s, and do so much earlier in the product cycle than now expected.
Regional jets could face a much shorter useful operational life. The economics right now are fairly thin for 50-seaters, and materially increased fuel costs won't help. One ominous example: United Airlines' latest financials break out what seem to be described as the what they are paying small jet providers versus the on-segment revenue these services provide. The net is a $68 million shortfall. While United's financial reports are somewhat opaque due to the bankruptcy, and while these data don't reflect the system revenue contribution of this SJP flying, the message is clear: RJ economics are increasingly dicey. Jack up fuel costs, and things don't go in the right direction. Not good news for Bombardier, which now has all of its airliner eggs in the RJ basket.
Dancing On The Beach In Rio. Higher fuel costs only make the Embraer 170/190 series airliners more attractive as replacements not only for older 737s and DC-9s, but also for some percentage of existing RJ fleets. Since nobody else has an airliner anywhere close to the 170/190 platform, our friends in Brazil can expect to be very popular in the coming months.
Rural Air Service - The Bar Just Went A Notch Higher. The main barrier to rural air service is that the costs of providing it have risen, while the revenues that such service can deliver have remained static. Turboprops were getting more and more expensive to operate, what with higher required passenger weights and increasing maintenance costs, not to mention the fact that consumers are increasingly (if irrationally) averse to flying them. They are not coming back, regardless of fuel prices. So the price of air service admission will increasingly be the ability to support the costs of 50-seat jets. And those are going up. Do the math.
Lessors & Financial Houses: Sing The Blues. A lot of perfectly good airplanes are going to come off lease and find themselves all dressed up with no place to go. Except the desert.
Of course, it's possible that oil prices could drop. In that case, all this is off. But don't plan on it
