26 September 2014
Deliveries from just Airbus and Boeing last year reached $92 billion in value, another record after two other record years. In 2012, they rose 29.4% in value over 2011, capping a remarkable 55.5% growth spurt in 2008-2012. The jetliner industry never had it so good. Deliveries from just Airbus and Boeing last year reached $92 billion in value, another record after two other record years. In 2012, they rose 29.4% in value over 2011, capping a remarkable 55.5% growth spurt in 2008-2012.
The problem is that these fantastic numbers are disconnected from all the usual jetliner demand drivers. While jetliners grew at a record pace, the world economy had its worst years since World War Two. The macroeconomic recovery has since been anemic, and air travel demand only marginally better. While airline revenue passenger kilometers recovered at a respectable 6.9% pace in 2011, growth fell to just 5.3% in 2012, and has stayed at about that level in 2013 and this year.
The primary driver behind jetliner deliveries, instead of the usual economic and travel demand factors, is a very unusual divergence between the cost of capital and the cost of oil, coupled with a lack of other investment opportunities. Historically, oil prices and interest rates have followed a similar line. When oil was cheap and airlines didn't need to re-fleet with more efficient jets, interest rates were low. When fuel was expensive and new jets were essential, interest rates were high enough to make airlines baulk at new orders.
But for the first time in decades, the past four years have seen an astonishing divergence between fuel and cash costs (as indicated in our chart on the next page). Fuel prices, which normally fall during economic downturns, have remained stuck near all-time highs. Meanwhile, central banks around the globe have attempted to promote growth by providing very cheap cash. The US Federal Reserve interest rate is now around 0.1%. Even if the retail price of money is a few points higher, that rate is a good indicator of the low cost of financing, particularly with ongoing high levels of backstop financing from government export credit agencies.
Jets, of course, have become a very attractive asset to finance. It isn't just that they are mobile, revenue producing tools with a high degree of durability and safety; it's also the absence of competing demands for investment money. That is the third variable that's in record territory. Returns on investment in almost any other segment (whether stocks, bonds, or housing), spent 2008-2011 at close to record low levels.
In short, three unusual drivers have catalyzed a sudden and unprecedented jetliner output surge. This isn't mere speculation; many airlines really do want new jets, and, for now at least, they can get financing at good rates. This is a one-off event, but probably not a bubble. Unfortunately, Airbus and Boeing production plans seem to indicate a desire to engineer one. Current output expectations call for an additional year of strong growth, followed by modest, incremental increases, culminating in a $104 billion market in 2014.
The industry seems to be thinking, "we deserve a recovery from that downturn." Of course, there was no downturn. The years 2004-2013 saw ten remarkable years of growth at a 9.9% annual rate.
It's important to remember that each of the three factors that created this output surge can only get worse. It's difficult to imagine interest rates lower than 0.1%. At 80-100/bbl, oil is in a sweet spot—if it gets more expensive that starts to hobble airline profitability and/or travel demand. If it gets less expensive, that makes older jets more competitive relative to new build ones. Meanwhile, the economic recovery, particularly in the US, will likely start to accelerate. This will create new investment opportunities, attracting money that otherwise might be put into jets. Recoveries in US equities and the housing market already imply more attractive investments elsewhere, particularly since the jet-leasing returns on investment have been falling due to a high level of jet supply.
The only jet demand driver that can be improved, in short, is air traffic growth. There are few short and mid-term hopes of faster air travel demand.
Therefore, when it comes to predicting future demand, this is a dangerous starting point. After all, every year Airbus and Boeing release a 20-year market projection anticipating a roughly 5% annual growth rate in deliveries. Six years ago, the base year for projecting this market would have been about one third smaller in size. Yet the long term growth expectations haven't changed. Every year, the two primes re-set long-term demand by starting at a new high level reached because of an extremely unusual combination of factors. If the two primes execute on their current output plans, we'll see a 2015 starting point that is an even less reliable indicator of the times ahead.