Perfect storm or squalls? Jan/Feb 2008

With over 7,000 narrowbodies and widebodies on order, the manufacturing backlog has reached epic proportions. At the same time airline economic prospects appear to be deteriorating and the sub–prime crisis is filtering throughout the global financial structure.

This may not represent the "perfect storm" that Michael O'Leary of Ryanair has predicted, but it does presage some violent squalls.

The European LCC sector, which accounts for most of narrowbody backlog, is going to go through an interesting phase. Ryanair has left itself exposed to continued high fuel prices through not having hedged — in contrast to easyJet. Some of the smaller newcomers have more fundamental problems — Vueling and SkyEurope appear to have failed to find a sustainable operating model and their attempts to expand beyond their base airports — Barcelona and Bratislava/Budapest — have proved to be very cash–draining.

Indian LCCs have transformed the domestic market — from 14m passengers five years ago to over 40m in 2007 — but multi–LCC competition on the main routes is just unsustainable (LCCs in Europe avoided direct competition in their developmental stages and even today avoid it wherever possible). There is a possibility that some of the Indian airline backlog will be used for leasing ventures.

The leasing companies themselves have some worries. Financing through securitisation products is becoming more difficult as lenders begin to worry about the underlying credit risk of the airline customers and the accuracy of residual aircraft value predictions. There could be some attractively priced portfolios for sale over the next year. In the widebody sector, the perpetual question is whether the Middle Eastern super–connectors' massive orderbooks can really be justified. The question remains unanswerable as long as they are underpinned by the oil wealth and political ambitions of their state owners.

One concern might be that a tail–off in the construction boom starts to deflate the volume of point–to–point traffic to the region. In any case, the scale of the competitive threat on Europe–Asia routes means that the European network carriers have to get their North Atlantic strategies right. A major comfort is that the US Legacies, although they have emphasised their international plans, have not yet made the investment commitment in new widebodies for this market.

A longer–term concern is that the “perfect storm”, that O'Leary says he would welcome, will provide the supply of widebodies at the price required to start a transatlantic operation.