John Mowry, managing director, Alton Aviation Consultancy (New York), examines how rising fuel costs and geopolitical tensions are reshaping airline viability, investor confidence and industry dynamics
Given your expertise in aviation finance, how severe is the threat to the industry’s structural integrity right now?
It’s important to distinguish between the challenges that the airlines are having and also the suppliers, including the lessors. Unfortunately, from a cost perspective, it’s the airlines who are the most directly impacted in this environment. The suppliers, be they the manufacturers, the MROs, the aftermarket providers, or the lessors – are one separate move away. The lessors have negotiated very long-term lease contracts with “hell or high water” restrictions that aren’t easily terminated, irrespective of what happens in the market, so the lessors are much more protected than the airlines.
Let’s talk about flight cancellations. Is tracking airline schedule data not so reliable now that the airlines are making changes to their schedules so quickly?
Yes. It’s a dynamic environment; airlines are shifting the schedules they’re publishing and also what they actually fly, so it’s hard to look at a schedule change and to infer or conclude something. Schedules are useful because they are forward-looking, but it’s also crucial to track what’s happening on the ground. Flight tracking data products like Flightradar24 or FlightAware help monitor how many hours planes are actually flying; if they are parked up or if airlines are scaling back on utilisation.
Also, commercial products that track exactly where the aircraft moves from and to, and on which dates, are more reliable information sources.
In some of the press, you’ll see talks about flight cancellations and discussions around capacity reductions. It’s important to distinguish between those two. You might have a shorthaul flight within Thailand cancelled, but that’s not what we think of as system capacity, which is defined by the Available Seat per Kilometer (ASK) metric and more heavily influenced by longhaul flight cancellations. Some flights routing around the Middle East or changing flight plans can change the ASKs as well. Headline numbers of cancellations and capacity changes don’t always correlate, so it takes a nuanced analyst or reporter to unpack that.
You fly often, so as a passenger, what are you looking out for when you book now?
Like all businesses, airlines at certain times have ceased operations and gone out of business. Being in the industry, it’s something that I track and monitor closely. As a consumer, you need to think about the viability of airlines. When certain airlines are teetering on the viability of continued operations one can consider the various insurance products that can provide relief, or refundable fares that afford more flexibility. While most airlines will weather this storm as they have other pressures on the industry, certain carriers aren’t as well-positioned, so the consumer needs to be a little bit more cautious and careful.
How is this sudden unreliability in airline schedules and capacity directly impacting aircraft leasing agreements and investor confidence?
We’re still seeing a significant amount of investor confidence in the aircraft leasing sector. One potential indicator is the publicly listed aircraft lessors, of which there’s a few. The largest lessor is a company called AerCap; their share price is up year-to-date, signalling that there’s still confidence in the sector from the public markets. In the private markets, there are a number of M&A processes still happening, which means the investors aren’t hitting pause and there’s still money to be deployed.
The investors are taking a long-term view on the attractiveness of air travel and aircraft leasing as being essential to supporting those airlines. So, some investors will look through the short-term turbulence. Even at the transaction level, lessors are buying and selling aircraft with the leases attached to them, and we still see trading volumes, so the investor confidence is there, although the risks have changed from what they were three months ago.
With the dual threat of the jet fuel crunch and war in Iran, how are lessors and operators factoring these into their mid-term planning?
We’re still in the near-term approach because it’s only been a couple of months since the conflict began and the fuel price has increased. But I think there will be a tendency to fly the older aircraft less, because they burn more fuel and the economic differential between those new generation aircraft and the current generation aircraft is changing a lot. Some of the big airlines like Lufthansa, for example, have early-retired some of their older aircraft – 747s, A340s – the four-engine gas guzzlers. That’s the tendency if the fuel prices continue to stay high.
But that’s actually good for sustainable aviation, isn’t it? Will it make that happen faster?
Yes, it should accelerate for sure, but it also would be a result of less demand because the supply of new aircraft coming into the system isn’t going to be any greater. Airbus and Boeing are maxed out at their current production levels. Yes, airlines may take out the aircraft, but it’ll just mean less flying for now if they take out the least fuel-efficient aircraft first.
Are we entering an era where only well-capitalised airlines can survive fuel shocks?
There are a large number of different airline business models, and some airlines in certain environments have done very well with having fuel-efficient aircraft, or the newest and youngest aircraft.
If I go back 15 years ago, we had an environment of high fuel prices. That’s when Airbus and Boeing came to the market and said they’re “going to re-engine these older planes and come to the market with the neo and the Max aircraft”. Once they made those announcements, shortly thereafter, fuel prices declined – and they’ve been fairly moderate since that time. The value proposition of those aircraft with new technology lessened because the fuel prices had also come down. We’re now in an environment where fuel prices have increased quite significantly, so the value proposition of those new aircraft comes back to the foreground. They become very valuable assets relative to older technology. If fuel prices are sustained at this level, you’ll probably see those new aircraft retaining their values well.
The market consistently adapts to these cycles, but rapid transitions in fuel prices inevitably cause short-term distress because it takes time for the market to adjust.
Okay, so who’s folding? Is it airlines with weak credit, and is the era of low-cost carriers (LCCs) over?
Ryanair – based in Ireland and operating all throughout Europe – is one of the most profitable airlines. It’s an ultra-low-cost carrier with a very successful business model. So we can’t say that the LCC model is over or broken. Those carriers serve a very valuable market. It’s simply challenging when dynamics change very quickly and those carriers have to adjust. In terms of the winners and the losers here, we need to look at how much an airline is hedged on fuel prices along with the mix of traffic they carry.
Airlines that have hedged their fuel costs should be better positioned to weather the storm. Frequently, but not exclusively, the larger flag carriers and full-service carriers, some of which are state-owned, have had the balance sheet strength to effectively hedge. These airlines are also targeting the higher-end customer who is less price-sensitive, where the demand elasticity is lower, and so should be able to better pass on increased fuel costs through higher airfares without as much impact on demand.
An LCC that is not hedged, doesn’t have a great balance sheet and is serving a more price-sensitive market tier will be more impacted.
From a financing and leasing perspective, what’s the worst case scenario for the aviation market if these shortages persist through the summer?
The industry has, for as long as it’s existed, gone through cycles and waves of challenges. The Covid-19 pandemic impacted the aviation market more than any other downturn because traffic demand fell so substantially. What we have here is a supply shock to the system. Demand is still there, so it’s a very different kind of environment. Covid was very much a worst-case scenario. It’s hard to see that repeated.
We’ve already gone through rising fuel prices in the past; right now the airlines are on a spectrum of being really strong, well-capitalised, or able to withstand some short-term changes.
There are some airlines who have already been teetering on the edge. It will be very challenging for them if fuel prices are sustained for the long term. For other airlines, physical fuel availability would represent another concern altogether.
Are you seeing an influx of new players or individuals who are wanting to enter the aircraft trading market just because there’s a lot of fluctuation right now?
There continues to be investor interest in the sector, but since the market isn’t distressed, there isn’t a wave of new distressed investor capital that is coming into the market. In past crises and downturns, there has been new capital entering the market. It’s still pretty early in the crisis, and there’s no shortage of liquidity or capital at the moment.
It’s been three months since the conflict began, so what would you count as a medium term?
The summer season for the northern hemisphere carriers is always a very strong season because schools are on holidays and there’s much more demand. It’ll be interesting to see how the airlines come through the summer season, and then how they manage in the fall when demand naturally falls back a bit. Traditionally, in the northern hemisphere, carriers make most of their profit in the summer season, and they might break even or even incur losses in the winter season.
We’re coming into an environment where families have already booked their holidays and vacations, so the demand has been there. Hopefully there’s a resolution by the fall; a key point to watch is what happens with forward bookings at the end of the fall season.
