Fall Should Answer Some Big MRO Questions

Capacity, pricing and senior aircraft retirements should be much clearer in autumn.

It’s been a nice ten-year roll for aviation and aircraft maintenance, but all good rolls must come to, well, not an end, but maybe a change. Two significant changes at least look possible not so long from now.

On the upside, capacity has tightened considerably for both airframe and engine shops, according to Jonathan Berger, managing director of Alton Aviation Consultancy. The downside possibility is that higher fuel prices will trim traffic growth and park more maintenance-hungry older jets.

“There was excess capacity, now it is all consumed,” Berger notes. “Ultimately, you will see MRO pricing increase.” Before that happens, operators will begin to have trouble finding slots. “We are starting to see that.”

Scarce capacity can only be dealt with in two ways, higher pricing, which will encourage overtime work, higher wages and investment in new capacity, and operators making longer-term commitments to shops. Both possibilities favor MROs, and airlines will probably choose a mix of approaches.

The summer traffic bump will delay this effect for a while, as aircraft will by flying rather than seeking hangars, especially in Europe and The Middle East. “There are slots to be had now,” Berger observes. “But then comes fall and winter.”

The other big change in markets comes from oil, with Brent crude prices pushing toward $80 per barrel. Once again, few expect that to change much in the short term. Carriers do not make quick decisions on fleets, and most have hedged at least some short-term fuel prices. Add in that summer jump in demand, and there should not be any problem for a while.

But don’t kid yourself, significant and enduring fuel price increases affect costs, fares, traffic and fleets. Oil is now more than 30% higher than it was in late 2017 and nearly double the level of two years ago. A 30% boost in a cost that was 17% of airline operating costs boosts expenses 5%, and that boost must either come out of profits or increase fares.

U.S. carriers averaged a 13% operating margin last year, so they, especially the more profitable LCCs and ULCCs, can probably absorb much of the increase in operating costs. But Europe and Asia averaged only 5%, Latin America 3%, The Middle East less than 1% and Africa had a loss. These regions have little if any room to absorb increased costs. If fuel prices stay up, fares will likely go up. Medium-term elasticity of demand hovers around 1, so a 3-5% increase in fares would nick 3-5% off traffic growth.

If fuel prices stay up. Fracking has blunted the worst tendency in oil markets, to swing widely up and down. Fracked supplies begin to offset losses in conventional production at $50 to $60 per barrel, but they can take time to kick in fully. Right now oil markets are expecting neither a return to 2017 pricing, nor a continued run-up in fuel costs. By June 1, Gulf Coast jet-fuel futures were forecasting a slow decline from $2.15 per gallon in June 2018 to $2.00 per gallon by April 2021.

That is still above the $1.75 gallon at which the more fuel efficient neos and MAXs yield better economics than ceos and NGs. And it probably means a slightly faster pace in retiring older aircraft. Investment firm Cannacord Genuity judge that under reasonable demand assumptions retirements will have to increase from 2% to 3% of the active fleet to justify the new aircraft that OEMs are planning to build and deliver. If that is going to happen, we should probably see early signs of it by autumn 2018.

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