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When Delta Air Lines, one of the US’s big three traditional airlines, held a conference for investors last December, it found itself with unexpectedly good news to announce.
The airline has been far slower than American, United Airlines and Southwest Airlines, its chief rivals, to introduce more fuel-efficient aircraft. But the average price of a gallon of jet fuel had fallen over the course of the year from nearly $3 to about $1.80. The company was consequently facing not only far lower outgoings on aircraft purchases than its rivals, but also bills that were far lower than had been feared for the extra fuel its older aircraft consume.
Delta told investors it expected falling fuel prices to cut its costs by $1.7bn annually.
Delta’s sudden boost exemplifies the effects of lower fuel prices on demand for aircraft. The fall is making it both more viable to add capacity and more profitable to operate flights with older, less efficient aircraft, which consume up to 20 per cent more fuel on a given flight than the latest models.
Leasing companies are able to sign long leases for aircraft that are 15 years and older, when it was previously hard to find anything other than very short-term leases.
The question is whether, as some analysts have speculated, a long-term lowering of fuel prices could make airlines reluctant to invest in more fuel-efficient aircraft such as Airbus’s A320neo, Boeing’s 737 Max and A350 and 787 wide-body jets.
An earlier scramble among airlines to secure orders for the less fuel-hungry aircraft has left Boeing with a backlog of more than 5,650 orders and Airbus with nearly 6,400.
Randy Tinseth, head of marketing for Boeing Commercial Airplanes, predicts that the fall in fuel prices will have no effect on customers’ willingness to order new aircraft. Oil was about $40 a barrel when the company launched the 787 in 2004 — still below the current rate of about $65.
“The aeroplane made great sense to our customers at that time, and at today’s fuel prices it looks even better,” he says. “They buy planes to use for 20 years or more and they know that fuel prices are volatile.”
Nevertheless, Richard Aboulafia, analyst for the Virginia-based Teal Group consultancy, says the fuel-price fall should serve as a warning to original equipment manufacturers (OEMs) — that the continued expansion of production rates for narrow-body jets could pose risks if demand falls.
Boeing is working to increase production of its 737 family to 52 per month but the rate could increase, Mr Aboulafia says, to nearly 60. “I’m not concerned about numbers falling,” he adds, referring to the potential for current orders to be cancelled. “But I am concerned about OEMs concluding that 60 narrow-body jets per month may be a good thing. This is a good time for caution.”
For the moment, however, the main effect of the oil price decline is on the market to lease second-hand aircraft.
Ron Wainshal, chief executive of Aircastle, a leasing company that owns more than 150 aircraft, points out that, for many European airlines, the decline in the price of jet fuel has been offset by the decline in their own currencies against the dollar, in which jet fuel prices are quoted.
He says that the change is prompting airlines to lean towards keeping aircraft with current technology and up to 15 years old in use for longer. Among the deals that point to the change, he mentions his own company’s successful leasing of five 15-year-old Boeing 737-700s to Southwest Airlines for 10 years — a term that airlines would probably not have considered for older aircraft when fuel prices were higher.
“That will take them to the end of the economic lives, so we don’t need to worry about them again,” Mr Wainshal says.
One possible effect of the fall in fuel prices could be to shift airlines away from the very high-density seating plans that were popular during the high fuel-price era.
Mr Tinseth says that most airlines have opted in recent years for 787 layouts featuring nine seats to a row in economy, rather than the eight that Boeing originally envisaged would predominate. However, there remains flexibility for airlines to choose other configurations.
The extra demand for leased aircraft mainly provides the extra capacity airlines are introducing, thanks to their improved economics, rather than substituting for new aircraft.
Nevertheless, the key factor in airlines’ continued enthusiasm for ordering new aircraft is, according to Mr Tinseth, likely to be their profitability. And signs for that have so far been promising. US airlines remained robustly profitable in the first quarter — when many traditionally make losses — and airlines are forecasting operating profit margins for this year well into double figures.
This follows a surprisingly strong performance for most US airlines during the difficult economic conditions of recent years. Most maintained profit margins by restraining capacity increases and keeping yields high.
However, that discipline could yet collapse, wrecking operators’ profitability and casting fresh doubt on their orders. Worries have grown more intense since late May when Doug Parker, chief executive of American Airlines, said that his company would “compete aggressively” with low-cost airlines that were adding capacity, to ensure American retained market share.
The remarks sent shares in American and United down some 10 per cent and shares in Southwest down 9 per cent. These falls reflected fears that the remarks could foreshadow a return to the kind of price war that ended many previous periods of stable profitability for airlines, and ushered in uncertainty for their suppliers.
“We’re not going to lose customers on price,” Mr Parker said. “We’re not going to give anyone else an advantage and allow them to expand at a rate that takes away customers and is not good for our shareholders.”
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