Printed headline: Middle Age Plateau
The link between low oil prices and demand for older aircraft is often made but rarely demonstrated. For the record, in the last four years the average price of Brent crude has declined by half; in the same period, the average age of the global Airbus fleet has risen to 9.5 from 8.7 years, while the average age of Boeing aircraft has climbed to 12 from 11.8 years. Data from consultancy IBA also show the average age of Embraer aircraft rising to 10.1 from 8 years and Bombardier aircraft to 13.7 from 11.4 years.
“If you look at retirement rates and oil prices, it appears that there is certainly a correlation, as retirement rates dropped significantly in the low-fuel-price environment,” says Dermot Manifold, executive vice president for commercial operations for aircraft lessor GECAS.
However, Manifold also points out that rising passenger demand continues to outpace airlines’ capacity plans, forcing them to seek alternatives to new aircraft, which mostly come with long lead times. “This may be playing as big or bigger role than fuel, as airlines simply need airplanes to serve their customers,” Manifold says.
Demand for midlife aircraft stems principally from the U.S. and Europe as operators there “have consciously chosen to move into midlife aircraft as they see them as more economical for their networks,” Manifold notes. Asian carriers, in contrast, prefer to buy or lease new aircraft, although they tend to retain equipment throughout its economic life.
Another influence on the midlife market, at least in the short-term, has been delays to new narrowbody deliveries caused by engine manufacturing defects and the unreliability of certain new-generation widebody powerplants. Durability problems with the Rolls-Royce Trent 1000, for example, has disrupted Boeing 787 services and caused several airlines to seek interim replacements. In June, Air New Zealand said it would lease two Boeing 777-200ERs to cover for two of its 787-9s.
“There has certainly been some positive boost to midlife aircraft because of new-technology engine teething, but most of the demand boost for midlife aircraft is related to the need of airlines for lift,” comments Manifold.
Capacity needs aside, airlines also like midlife aircraft because of their reliability. Current-generation Airbus A320 and Boeing 737 narrowbodies form the bulk of the midlife market, and their respective engines—the IAE V2500 and CFM56-5B/7B—are reliable workhorses that can be operated between overhauls for longer than originally expected, thus reducing maintenance costs.
“The continued reliability of these engine types makes operators more comfortable retaining midlife aircraft, as the on-time performance and reliability metrics are not impacted by the aging of the aircraft,” says Manifold.
The definition of midlife changes from airline to airline and lessor to lessor. GECAS classes midlife assets as being 12-16 years old; others say middle age begins after an aircraft’s first lease, which can last 8-12 years.
Either way, the growing popularity of midlife aircraft presents opportunities for most sections of the aftermarket. Second overhauls of aging airframes and engines provide an example, but plenty of business also stems from cabin refits and repainting jobs as aircraft transfer between operators.
That said, Lufthansa Technik points out that current demand for midlife and older aircraft easily could change, complicating forecasts for MRO demand related to older aircraft. “Two important reasons for this situation are the uncertainties about . . . fuel prices and the current delivery delays of new aircraft,” says a spokesperson.
Regarding lease transfers, Manifold says GECAS clients tend to extend their agreements, but when aircraft do have to be placed with new operators, this occurs “with relative ease, as there is a large operator base and strong market for midlife narrowbody aircraft.”
At about six years, second leases are often half the length of those for new aircraft. Naturally, lease rates for midlife aircraft are also much lower than for new ones, although airlines will pay more in maintenance reserves. Since overhaul intervals for older equipment tend to be shorter, the volume and hence cost of work per event is often greater, reserves—monthly payments to cover scheduled maintenance for engines, airframes and components—are higher than for new equipment.
One consequence of higher midlife aircraft demand might be more disputes between airlines and lessors when it comes to lease returns. Airlines are advised to start preparing for returns up to two years advance, but even the largest can make mistakes. In June 2018, Wells Fargo sued American Airlines for $900,000 for what it alleges was the late return of three 737-300ERs following a lease extension.
That said, lessor sources indicate disputes are usually minor and rarely reach court. Airlines need to be careful nonetheless, because a lessor’s refusal to accept an aircraft due to unmet return conditions can mean expensive and time-consuming maintenance plus ongoing lease payments while the aircraft is out of service and being repaired.
Sourcing Aircraft and Parts
The last few years have seen plenty of midlife aircraft trades between lessors. In many cases, sellers are large lessors wanting to focus on new and young aircraft, while buyers have been lessors of all sizes seeking quality midlife aircraft. For example, in late 2017, U.S. lessor Aircastle acquired 20 current-generation A320s and 737s from Dublin-based SMBC Aviation Capital. In April 2018, another U.S. lessor, Apollo Aviation, finalized a $950 million fund to invest in midlife aircraft.
Aircastle CEO Mike Inglese says that while the lessor has no specific goals for midlife aircraft purchases, “we continue to invest in aircraft which represent, in our view, the best relative value investment at the time of acquisition.” Aircastle defines midlife as aircraft 5-15 years old and says they comprise 70% of its portfolio.
Acquirers of midlife aircraft have three options: purchases from airlines, purchases from lessors and sale-leaseback deals with airlines. Of these, Inglese says purchases from lessors represent the best opportunities.
“It’s easier in the current environment because lessors can run into concentration issues which require exposure and portfolio management assistance,” he explains. Sale-leasebacks and airline purchases are difficult, however, due to strong competition in the former market and airlines’ ongoing need for capacity, which makes them unlikely sellers.
Strong demand for midlife aircraft also creates challenges for the MRO market. On the one hand, older equipment requires more maintenance, but then airlines want the most economical solutions to keep their aging assets in service. As engines age, for example, operators tend to move away from full-service maintenance contracts to more bespoke arrangements.
Such deals often offer used serviceable material (USM) instead of new replacement parts to minimize costs. Demand for USM is at an all-time high, with the market for second-hand engine parts worth $2.7 billion in 2016 and forecast to almost double by 2026, according to consultancy ICF.
However, sourcing USM is increasingly difficult in a market where fewer aircraft are being retired by airlines, many of which prefer to operate them into their sunset years. Part-out specialists, who comprise one supply line for USM, also face strong competition for feedstock since the operating value of older aircraft and engines still exceeds their teardown value.
For midlife aircraft owners, however, strong part-out demand provides an extra layer of residual value protection, albeit a minor one, according to Manifold, who says: “The demand for more part-outs is good as is any added liquidity in any market, but we are quite comfortable with our residual values as is.”
In the past 12 months, oil prices have risen about 50% to roughly $65 per barrel as of late June. “We are closely monitoring to see if the recent increase in oil prices will reverse the retirement trend,” says Manifold.
Although more expensive fuel eventually leads to more aircraft retirements and a shift to younger fleets, much depends on airlines’ views about long-term trends. “In case of a further increase in fuel price, older aircraft might be phased out earlier than planned,” says a Lufthansa Technik spokesperson, adding: “This would mean less work for MRO suppliers but more available spare parts in the market.”
Another factor is interest rates and expectations. Higher rates increase the financing burden for expensive new aircraft, potentially pushing some carriers to use older models. On the other hand, many airlines aim to keep young fleets as a hedge against rising fuel costs.
“Midlife aircraft currently in-service and owned by an operator will be viewed advantageously in the shorter term over new equipment with higher financing costs, but the airlines that take a longer-term view will see benefits of investing in their future fleet, too,” says Manifold.
In the near term, then, it is difficult to see a contraction in midlife demand. That view could change quickly, however, if there is a global economic slowdown and fuel prices continue to rise.