Aircraft market balance: from boom to bust again? August 2000

It is now seven years since the commercial aviation industry climbed out of its worst ever recession. Since then traffic demand growth combined with capacity constraints has meant that the jet aircraft market has remained more or less in balance. The Asian crisis threatened to create global over–supply but this was mostly averted by a switch in capacity from the Asia/Pacific markets to the Atlantic (which did cause over–supply in that sector) and by postponement and cancellation of deliveries.

However, observers of the aircraft market continue to wonder about the current buoyancy of jet orders and the increased production rates. Based mainly on current orderbooks the jet predication rate for the next five years is going to be around the 1,200 unit a year level in contrast to an average of just over 700 units a year during the 90s.

The sheer volume of orders announced at the Farnborough Air Show (see page 1923 for details) gave the impression of an over–heated market. The final total, according to a tally by Reuters was 824 aircraft valued at about $41bn. As always, the firmness or otherwise of the orders is questionable — for example, Global Airlines, a paper company set up with the intention of acquiring TWA, placed a 250 aircraft order for the Alliance StarLiner, a paper 70–100–seater.

But $41bn is still a remarkable figure, almost equivalent to the expected annual global expenditure on aircraft. Moreover, the leasing companies played a prominent role in the Farnborough ordering spree, accounting for over half the value of the announced orders. This is superficially at least reminiscent of the mega–orders placed by the mega–lessors in the boom of the late 80s.

Ed Greenslet in his industry–standard ESG forecast, published in July, plaintively states that all his indicators that there are more than enough aircraft available yet production rate continue to rise. Factoring in a mild recession in 2002–03 (solely on the basis that there has got to be some form of slow–down in economic activity at some point) produces a global surplus of over 1,200 jets in 2002 and 2003. This compares with an estimated surplus of 1,094 jets in 1993 at the trough of last recession. Measured as a percentage of the global fleet, however, the surplus equates to about 7.2% as against 9%-plus in the early 90s and early 80s.

Key differences

What are the key differences between the early 90s and the early 00s?

The leasing companies are generally much less speculative now. They are aiming at the US replacement market as their core business, and can be fairly confident that the US majors will take their new generation 737s and A320s as they finally retire elderly and noisy 727s and DC–9s over the next few years. The gap in the market has appeared because of the refusal of key US majors to commit themselves to re–equipment programmes at a time when they were battling their unions and restoring their financial fortunes.

This is a very different market from that of the early 90s when lessors concentrated on under–capitalised start–ups, developing world carriers and generally mediocre credit risks. Then, the strategy of lessors like GPA was highly speculative: to block off production slots and rely on increases in the prices of new and second–hand aircraft, regardless of the financial state of the airlines. That strategy ended in disaster for GPA and other lessors.

Today there is not the same opportunity to bet on inflating new and second–hand prices. This is largely because cost savings achieved by the manufacturers have been passed on to purchasing airlines through discounts to list prices. Indeed, it could be argued that the increased demand for new jets is partly the result of the reduction in unit prices.

Aircraft retirement remains an infuriating problem for market analysts. The ESG forecast pushes up the scrapping rate to 300- 440 units a year for the period 2000–04 from an estimated 1999 level of 213 units. The scrapping level has almost always been overestimated, but the new level seems reasonable, maybe even low, given the implementation of Chapter 3 noise rules and the probability that as many as 400 aircraft currently listed as parked may never return to airline service.

Returning to ESG’s assumption of a mild recession, it should be pointed out that at present there is no sign of a downturn. On the contrary, the OECD’s latest Economic Outlook (June 2000) "economic prospects are brighter than they have been for some time". Globally, economic growth is projected at 4% this year and 3% next year. All the major economies are moving forward in harmony, with the exception of Japan, and even there there are clear signs that its long recession is coming to an end. However, the danger is that the economy is too strong, that inflationary pressures will exert themselves (as they already have done in oil prices and, until recently, Internet company stock prices), governments will be forced into deflationary policies, and the boom will turn to bust.

Structurally, the new element in today’s market is the regional jet market sector of 35–100 seats, which will account for around a third of all jet deliveries according to ESG.

Orders for these types at Farnborough accounted for $4bn. If there is a speculative bubble in the aircraft market, it is in this sector. GECAS certainly seems to have taken a serious punt through its order for 50+100 CRJs and 50+100 728JETS announced at the Berlin Air Show in June, a transaction that could be worth nearly $5bn.

In this sector much depends on the attitudes of the unions in the US and Europe to the scope clauses in their contracts — whether they will agree to operation of jets of less than 50 or less than 100 seats by pilots who are not in the main airline. The regional jet sector was able to grow so rapidly because flying was outsourced to lower cost operators. Recently, the Majors have being trying to reassert control over their regionals (Delta’s purchase of Comair, Air France’s of Regional, for example), which almost inevitably will lead to higher operating costs. Whether this cost escalation will bring to a halt or even slow the regional jet bandwagon is not at all clear, but there is a risk here.

And there are risks for the overall supply/ demand balance in the aircraft market. Overall though, Aviation Strategy’s tentative conclusion is that the combination of factors needed to cause serious global overcapacity are probably not in place at the moment.

Two points are worth highlighting about the ESG detailed delivery forecast reproduced below. First, Boeing is shown as losing market share to Airbus, which is an interesting viewpoint from a US analyst. Second, the A3XX appears in 2006 and meets its sales targets.

ESG has decided that there is a market for the A3XX. It has done this by looking at the 747 capacity flown by the top 20 airlines in 1979 then extrapolating forward to 2015 in order to estimate the amount of capacity the top 20 airlines might be providing with A3XXs, and hence the number of A3XXs needed to supply that output. The final demand figure is 520 units.