I’m on the homestretch now towards graduation from the University of Michigan (I’ll be done in December), and thus I’ve been very busy with school, work (writing this during a trip to New York City), other obligations, and somewhere I fit some fun in. I’ve been thinking about writing on here almost everyday since my last post in late May, but I simply don’t have enough time to research one topic, perform the data analysis, and write an entire post on it. Instead, on this post, I’m just going to do a “quick and dirty” coverage of some recent developments and rely on some second-hand resources for my support (click on the underlined links!)
The four different topics I want to cover here are: oil prices, my take on pilot training, updates on air carrier globalization, and progress on general aviation FAA Part 23 regulation.
The airlines are finally getting some good financial results lately. United Airlines had strong second quarter results after numerous quarters struggling to recover from a difficult reservation systems transition back in March of 2012, along with the high integration costs related to the merger. Virgin America also posted its first-ever second quarter profit (!!!), alongside strong performances at American Airlines and Delta. April through June is typically tough for the airlines, but the theme is that synergies from consolidation are becoming more visible and management at the carriers are becoming very capacity-disciplined (note that Virgin America’s 2Q capacity growth was flat).
Why have carriers become more capacity disciplined? Well, a decade ago, airlines were effectively flying their airplanes 70-75% full when the price of jet fuel was in the double digits and only 10% of the operating costs. Currently, at $120 per barrel and 30% of the direct operating cost (>50% of the cash operating cost), the airline business model has fundamentally changed and strict capacity management is the name of the game, especially when one or two empty seats makes the difference between a profit and loss on a single flight.
More recently, airlines have also coped with high fuel costs by retiring fuel-guzzling aircraft and making new orders for aircraft outfitted with more fuel efficient engines and newer technologies, such as the 737 MAX and A320 NEO (New Engine Option). This trend has led to a decrease in the average lifetime of commercial aircraft as newer ones are sought out. Coupled with low interest rates from the global economic slowdown, access to cheap financing is very easy and drives the incentive to buy new aircraft.
But what if oil prices FALL?
We all know from the oil crisis of the 1970’s and the aftermath of September 11th that oil prices can drastically change very quickly, leaving little time to adapt. I think the case for lower prices is stronger than higher prices, given a larger reliance on alternative fuels, continued slow to modest global economic growth, more moderate growth from China, and decreasing influence from oil-rich cartels will all culminate in lower demand. Higher reliance on alternative fuels is probably the least likely of those outlooks, but the remaining three are not completely implausible.
If oil prices fall back towards the $70 per barrel range, the business case for buying newer, more fuel efficient aircraft will suddenly come into question. Furthermore, lower oil prices would likely result in an increase of interest rates, thus limiting access to once cheap capital. Will the massive backlogs that Airbus and Boeing currently enjoy disappear overnight? Unlikely. But the incentive to keep older aircraft in service instead of being retired early will certainly be present, versus buying hundreds of new aircraft and dealing with the costs incurred with integrating a new fleet. This scenario would have profound effects on the supply chain in the long run, as suppliers to the Tier-1 manufacturers (e.g. Boeing, Airbus, Embraer, Bombardier) would have to cope with lower demand and less work.
Some carriers are better situated for a low oil price case than others. Carriers, like Delta, that have chosen to preserve their current fleets and have chosen not to buy new aircraft will be the in the best position if prices fall, since they would have preserved the capital that other carriers are using to “re-fleet”. With lower oil prices, their older fleets will be economically viable once again as well. The other carriers, on the other hand, may paradoxically end up dealing with higher operating costs as they must operate expensive equipment with the newest technology while fuel prices are lower. In a sense, lower oil prices have the extreme potential to reverse a decade’s worth of work done at the airlines. You could argue that oil prices have actually made the industry more efficient by creating the incentive to be more capacity disciplined and buy newer aircraft that burn less fuel.
AirInsight also wrote a good piece on lower oil prices here.
Sorry to disappoint, but it’s late now and I can’t focus enough to write about the rest of the topics I outlined at the beginning. I’ll cover them in a later post, hopefully by September before my final semester starts back up. To reiterate, here’s what I’ll cover in part 2 of this post:
- Pilot Training: my thoughts on how Asiana 214 and Air France 447 share the same root cause
- Air Carrier Globalization: new developments and what it means for a globalized airline model
- Part 23 Regulations: new developments on certification standards for light aircraft weighing less than 12,500lb and what it means for owner-operators and training providers
Until next time.