Airbus And Boeing Face A Dark And Painful Future

sunset-airline-120.jpg

01 Jul 2008
View all related to air travel | aircraft manufacture | biofuels | Kristen Lagadec

Airbus and Boeing: a Gloomy Market Outlook

by Kristen Lagadec for GlobalPublicMedia

When you google 'Airbus Boeing Peak Oil', the top result is this article that I wrote in the summer of 2006. Being a Cassandra proved right gives one all sorts of uneasy feelings, but I will carry on in that direction and offer a revised version of my prophecy, adorned with new details.

In a nutshell: people are talking a lot about the difficulties for airlines with $150-a-barrel oil. But we also have to understand that it is going to be much worse for aircraft manufacturers. They probably know it; but they cannot believe what they know, and they cannot say it either. This is not just another crisis for air transportation and aerospace construction: this is the last crisis until the end of the fossil fuel era.

Hard times for airlines

First an important premise: there are no serious alternatives to jet fuel for airliners. And even if there were, they could never be cheap in a world of expensive energy. The problem is not that oil is scarce: the productionhas never been this high -- that's why we call it Peak Oil. The problem is that energy supply is not meeting global demand: until demand abates, any type of energy will end up costing the same, be it classical kerosene, gas-to-liquid synthetic jet fuel, or biodiesel. Regardless of the environmental footprint. Just know that if it was technologically feasible, filling an A380 tank with biofuel would use up 150 hectares of yearly yield,considering an optimistic figure of 2000 litres per hectare for Jatropha biodiesel. You'd need 150x2x365x150 = 16 millionhectares -- the arable land in France -- to power the currently ordered A380 fleet.

Meanwhile the fuel efficiency improvements do not come anywhere close to compensating the price surge. Boeing claim that their new 787 will burn 20% less fuel than current jets of the same category (namely the 767 or A330). 20% is how much oil prices rose between the beginning of April and mid-May 2008: 30 years of technological improvement in aircraft and engine design will offset six weeks of price increase, and no technological Deus ex Machina will change that deal.

The obvious consequence is that cheap flights are gone for good. We are currently witnessing a fast concentration of the market, because the fierce competition prevents airlines from transferring the whole fuel bill to their passengers. As the weaker players exit the arena, ticket prices will rise until the few remaining airlines can break even financially. We will see a trend of de-democratization of air travel, and people will gradually change their travel habits, starting with the poorer and newer travelers.

There is a second key element that will drive air traffic down: as planemakers' market forecasts point out, air traffic growth is consistently correlated to world GDP growth. No need to be a psychic to imagine that GDP growth will seriously suffer from expensive energy. When people's purchasing power shrinks because of the energy bill, they will think twice before flying. Note that a major economic downturn could very well stop the rise in oil prices or even reduce them for a while. But it will not help air traffic - unemployed people do not fly all that much.

Meanwhile, environmental awareness is growing worldwide: the global warming theme is increasingly popular with the sort of middle class travelers who used to fill economy seats for exotic vacations. There will be less scuba-diving in the Maldives; less horseback-trekking in Mongolia; less leopard-spotting in Tanzania. Flying is losing political correctness points by the day. This is even beginning to reach the corporate world, although sometimes only for mere greenwashing concerns: more firms are asking their employees to fly less, to favor teleconferencing or to merge meetings. Business travel, the spine of airline profitability, is probably weaker than most hope.

I also see a final, more tricky contributor to airline misfortunes: many airlines have based their financial model upon the resell value of their aircraft. Planes are a huge investment, with a long lifetime -- a bit like homes. Maybe you see what I am hinting at. Just as the housing crisis brought many people to bankruptcy, many airlines will lose their financial footing when the industry's obvious overcapacity and gloomy outlook pulls the market value of second-hand aircraft down. All this will contribute to reduce air traffic over the next decades, to the levels of the 1990s, then the 1980s, then the 1970s ...

Harder still for aircraft manufacturers

The average natural decay of a fleet because of ageing is around 6% a year. When yearly traffic is constant from one year to the next, 6 planes for every 100 go into retirement, and are replaced by newer planes. This means that if airlines cut the world's capacity by a mere 6% each year, old retiring planes will not need to be replaced, and no new aircraft will be sold at all. A 6% capacity reduction is equivalent to just changing the Tuesday flight of the daily San Francisco to Tokyo service from a 747-400 to a 777-300ER. A reduction the economic press or the general public would hardly notice can make Airbus and Boeing assembly lines grind to a halt. US carriers will reduce capacity by 10% to 15% this third quarter of 2008 alone.
All told, the industry will cut capacity by 9% in 2008, according to James Higgins, analyst for Soleil-Solebury Research. (quote from CNNmoney.com)

In short: airlines make money in proportion to air traffic; aircraft manufacturers make money in proportion to air traffic growth. In a world with negative air traffic growth, the former float, the latter drown. Therefore, although we will probably not see the end of air traffic any time soon, this extremely nasty leverage effect will make aircraft manufacturers suffer considerably.

One might argue that in a world of expensive oil, airlines should scrap all old, gas-guzzling planes and buy new, soberer ones instead. That would be easy if they were making a lot of profit or could promise a bright future. But when the industry is consistently in the red zone, and getting redder, bankers do not follow. Few airlines have sufficient cash to sign billion-dollar contracts without external investment. Therefore airlines will be like people in poor countries: they will be running old vehicles which use up tons of gas because they cannot afford the newer models which make twice the miles per gallon.

Admittedly, a handful of airlines will be a position to buy the new planes. When all the world's money ends up in oil exporters' hands, they have to buy things from us to avoid drowning under the heap of green bills. Aircraft are a great choice, as they are both hard-currency-intensive and fossil-fuel intensive, which oil producers have a lot of, as per design. Consequently, aircraft sales may in fact undergo an increase because of high oil prices. This I call the "Aboulafia effect". I conjecture that such an increase is inherently short-lived. Middle-East carriers will probably become prominent players, and gradually snatch the bulk of the market from the traditional airlines. But air traffic will shrink nonetheless, and all they will need to do is buy back the recent new planes from their victims, scrap the old ones, and make the mostof a declining market -- something they are becoming good at.

As if matters could be any worse, there will finally be a mean backlasheffect: thanks to cheap liquidity seeking asylum, the years 2003-2007 wereabsolutely euphoric in terms of aircraft orders. Manufacturers had toinvest massively in infrastructures and people in order to ramp up production and honor those orders. But these planes will not materialize into deliveries before a couple of years. There is plenty of time for many airlines to go bankrupt or otherwise hit financial turbulence. This will mean massive delivery deferrals, then cancellations, so that assembly lines cannot even hold onto their current backlog. Who knows, we may witness the very curious artefact of a negative net yearly order-book. In the real world, that's called jumping off a cliff with a lot of momentum.

The combined value of the orders for Airbus and Boeing planes exceeds $500 billion at list prices, so large-scale cancellations and deferrals could easily amount to tens of billions of dollars and affect suppliers of engines and other parts in addition to the jet makers. (from the Wall Street Journal)

What next?

When that happens, it will be catastrophic for all the people, organisations, or communities, which now contribute to the aircraft manufacturing adventure. This could send Seattle or Toulouse the way British textile, or French foundries went not so long ago. And do not get influenced by prejudice. Aerospace does not have an intrinsically highervalue than those industries we have come to regard as lowly. Today's ghost slums were full of very busy and extremely proud people at the peak of their flourishing trade.

I do not know what the smartest move for aircraft manufacturers is, and I am glad I am not in Tom Enders' or Scott Carson's shoes. Publicly acknowledging that the air travel industry is on the brink of inevitable decline would discourage investors and hasten the fall. And yet, the earlier they can start downshifting, the smoother the forced landing. They should be cancelling the B787 (a little too late for that one) or A350 developments, and simply offer to fit new generation engines on good old 767s and A330s. That would already be at least half the fuel economy, for a much smaller cost, while not forcing new capacity on the market place. Or silently work on a totally new kind of bird, absolutely optimized for fuel efficiency, even if it changes the rules of the game: a Mach 0.62, 20,000ft, turboprop, middle-range, high-capacity, DC-4-comfort machine that would be the soberest flying camel to get people where trains can't go for the next half century.

Or maybe steer away from this dwindling trade altogether and find a new frontier. How about giant wind turbines? If those do not sell, nothing will anyway, so that may be worth a try.


Something else to consider

Something that should be considered in all this - and something that makes it all worse - is that Airbus and Boeing have been making the same versions of their aircraft for years now...this means that even their latest 150 passenger aircraft (the sweet-spot of the market) won't be appreciably more efficient than the one they sold to airliens 4 years ago (A320/B737-600/700/800/900). (only the 767 class 787 and A350 will be appreciably more efficient and airline industry capacity for that class of aircraft with oil over $100 a barrel has probably already been ordered). So, here's the problem....to make things worse...as the airlines go bankrupt and push alot of latest generation slightly used aircraft on the market that will be just as efficient as a brand new one from Boeing, but will be sold for firesale prices. This actually occured, to a small extent, in the recession around 1980-81...Boeing wasn't finding alot of people ordering new 727's since used 727-200 advanced aircraft were available for nothing on the used market. Things will be worse now, if we're really looking at conventional oil production peaking as the fuel price problem won't go away. I could see Boeing choosing to exit the market, although Govt sponsored Airbus will probably stick around. Also, of note, the vast majority of money needed to develop the 787 is already spent, it wouldn't make sense for Boeing to stop the 787 project now - it might make sense for Airbus to cancel the 350 (its much earlier in its development) and use that money to rapidly launch a A320 replacement that makes use of Pratt's ducted fan they developed and have made available (engine development paces aircraft programs). Boeing would probably like to wait for a new version of GE's UDF to be resurrected, but by then it will very late to get an aircraft out. Both manufacturers postponed their 150 seat replacement development over the last several years because their current models were selling so well - talk about slitting your own throat - and ensuring they'll be competing against themselves in the bloodbadth that will be the used commercial aircraft market in the next 5 years.

alternative aircraft

NASA with the military side of Boeing and a separate group in UK are doing work on blended wing body (BWB) aircraft, both apparently using turbo-fans, and neither apparently aware of peak oil (nothing mentioned on this by either group on the web). The UK effort goes by "silent aircraft" and they are apparently making compromises to efficiency in an effort at greater noise reduction (odd to me, given how much quieter new jet aircraft are now). BWBs appear to offer a considerable improvement in fuel efficiency, even using turbofans. What do you think about going to turboprop-powered BWBs? (The BWB design is reported to have an exceptionally low stall speed.)

The Future of Air Travel

Great article. But let me add a few more thoughts. Keep in mind that people/travelers take airline flights. But airlines run a travel system. How much does it cost to fly from here to there? Well, that depends. Add up the costs for the equipment, the fuel, the labor, the overhead and whatever else you want to throw into the pot. Then divide by the number of passengers flying so-many seat miles over some period of time. You can get some sort of very rough guess at how much a ticket "ought" to cost. Yes, the rising fuel costs are currently killing the airlines. It's a slow death, as they lose money on almost every flight. It's only creative accounting and credit (not cash flow) that is keeping the planes aloft. Still, do airlines really buy the airplanes? Some do. Many don't. Many airlines lease planes from leasing companies. The leasing companies buy the aircraft from the manufacturers. In some cases, the leasing companies provide the heavy maintenance as well. At the end of the lease, the airline turns the bird back over to the leasing company. Or if the airline goes into bankruptcy, it breaks the lease. The leasing company is left to hold the bag concerning resale. So resale may not be part of the business model of an airline. As long as there are leasing firms out there who will buy aircraft, the manufacturers will still have a market. What if governments decide that "saving" the air-travel industry in some fashion is a national and/or international priority? What if fuel subsidies go to flying, or oil price-controls somehow moderate the economics of running an air travel system? So far, most of the world's so-called "demand destruction" has been due to people voluntarily driving less, as the price of gas rises. (Well, some might dispute how voluntary it is. Folks are going broke paying for gas.) But evidently this is not enough on a world-demand curve to keep the oil prices under control. What if the demand destruction gets more draconian. What if governments simply restrict driving, via ration coupons for fuel or some other form. For example, in World War II the use of motor fuel was severely restricted within the US, and that was when the nation had ample oil supplies. More up to date, there is "congestion pricing" in London. There is excedingly tght control over cars in Beijing during the Olympics. What if governments simply ban the private ownership of any car with more than a four-cylinder engine? In other words, there will be only so-much motor fuel and that's it. If you drive without displaying your driving "permit," you are in big trouble. And these are some of the "nicest" forms of coercion to moderate oil-demand. I'm sure there are other ways of "destroying" oil demand in a hurry, if people put minds to it. Will the ground-pounders take to such restrictions on fuel and mobility, to subsidize the existence of a viable air traffic system? One way or the other, losing the air traffic system, its jobs, the mobility for travel & trade, and the underlying businesses... all of it is bad for business. No sane government could allow that to happen. So something is going to give.

A Simple Solution

They should switch to unmanned aircraft.

Then they could switch to solar powered planes.

All those passengers just give them grief anyway.