High Price To Pay

Oil.

Environmental campaigners can’t live with it. Much of the modern world can’t live without it.

Below is a 12-month snapshot of Brent crude oil prices.

Doesn’t take a rocket scientist to establish that in about a year, wholesale prices have all but doubled. Neither then, is it a surprised to see airlines order A350XWB’s and 787’s in droves.

A senior executive at an airline that has ordered these new generation airplanes describes the situation as “critical“.

“We need those airplanes now. Not tomorrow, not a year from now, but right now. Some airlines may fold by the time the 787 and A350 arrive, our balance sheet is strong for now, but even the best of airlines will be struggling without them.“

Back in the early 1970’s, twin engine airplanes were just emerging into the marketplace - the oil price woes back then lured customers toward the A300 and saw Boeing launch the highly successful 767 family, signalling the slow demise of the L1011 Tristar and (eventually) the DC10 families as the drive for greater efficiency became the number one mantra for airlines.

Today, the 747-8 family and A380 family are faced with turbulent geopolitical uncertainty and commodity prices showing no sign of rescinding from their peaks. The stark difference is that the 747 family has been here before and survived, becoming the most popular quad-jet on sale nearly a half decade on from its inception.

For the Airbus A380, this is all very new. Breakeven on the airplane is a distant a dream with EADS reluctant to say just how many need to be sold before it gets to that point, and costs have spiralled beyond the $10bn earmarked for the project.

On the horizon, there is nothing to suggest that fuel costs are or will be coming down to levels seen even twelve months ago - thus further pushing airlines to place orders for the more fuel efficient 787 and A350XWB.

Boeing’s own 747-8I has been a [relatively] slow seller compared to its 747-8F sistership - and in hindsight, not developing an all new large airplane to rival the A380 has proven to be a smart move, aside from the fact that the 747-8 applies pricing pressure to the big Airbus jet. The strategic shift towards the more economical twin engine airplanes has been slowly working it’s way to the forefront of commercial operations for the last quarter of a century and today’s oil prices seem to bring a greater sense of urgency to shift away from quad jets.

One only look at the A340 family and Airbus attempts to revive sales by offering airlines cashback for its increased fuel consumption. It didn’t work then and is unlikely to be entertained during this current economic climate.

Grounded

At what price will fuel burgeon to before carriers call time on flying older airplanes? Too many parameters to consider, some may argue - afterall, Northwest Airlines has only recently decided to retire its DC9 fleet.

Low cost carriers, many of whom sport junk credit ratings like Lion Air, AirAsia and Skybus are already amongst the first to feel the pinch of fuel costs - their poorly thought out fuel hedging strategies for this invisible and unsustainable explosive passenger growth may be headed for a screeching halt. Too many airlines chasing the same customers will invariably lead to the death knell of the weaker competitors.

Let’s not forget, the US legacy carriers combined operate some of the oldest airplanes in the in the skies for which relatively few have ordered new replacements. Realistically, that will have to be addressed - with Airbus and Boeing having backlogs across their portfolios - coupled with Open Skies just weeks away, competition will be more than cut throat.

Image courtesy of Boeing

Cutting costs will rank high too. What will it take then, for airlines to start grounding these or any airplanes in their fleets?

Already, Delta Airlines and United Airlines have made no secret of their plans to ground jets as prices continue their upward trend.

“Continued uncertainty about the overall U.S. economy with the price of fuel at historically high levels has put significant pressure on all U.S. carriers,” Tilton said.

Economic uncertainty isn’t helping either. With fuel now the single biggest cost for carriers, increasing income will have to come from the continued increases in surcharges and by cutting back on capacity to offset a decline in revenue. And what of the effect on Airbus and Boeing if carriers start to defer or even cancel orders as a result of shoring up capacity?

A $200+ barrel of oil is all too real- with few signs of a long term price reduction, just how long can airlines continue to operate these older jets - some of which whose maintenance costs are high?

By no means is it a benchmark or trend, but the recent decision by PIA to call time on its Boeing 747 Classic operations is a good indication of what the wider industry should now be waking up to. Airlines are already queuing up for the 787 and A350 and it won’t be long before we see the eyes peering over new 737 and A320 replacements too.

5 comments March 25th, 2008