The Green financing of aviation assets. Market Insight & Outlook.
Disclosures.This material does not constitute the rendering of investment, legal, tax or insurance advice or services. It is intended for informational use only and is not a substitute for investment, legal, tax, and insurance advice. State, national and international laws vary, as do individual circumstances; so always consult a qualified investment adviser, attorney, CPA, or insurance agent on all investment, legal, tax, or insurance matters. The effectiveness of any of the strategies described will depend on your individual situation and on a number of other factors. After reviewing your own situation, we may recommend that you not use any strategy in this document but instead consider various other strategies available through our sevices.
If the transition to the green economy as measured by Net-Zero emissions, (but more likely to Zero emissions), requires costly decarbonization of aircraft, airlines and airport infrastructure, who will pay the cost (a) private capital, (b) the traveling public, (c) State, regional and city enterprises, (d) airside service providers, and how will competition policy change to enable funding support?
If airlines & lessors are to replace or retire aircraft powered by gas turbine engines (GTE) & replace them with Net-Zero engine (NZE) aircraft technology, then (a) where will the funding come from to pay for the replacemts, and (b) where will the retired aircraft go?
What if the OEMs cannot design aircraft that meet the CORSIA scheme emissions goals, what then is the outlook for financing new and used aircraft?
Where to start in finding answers to these questions.
A good place to start is to understand what the UN expects the air transportation industry to do.
Presume that the global economy for 2050 will be a binary scenario.
Depending on the level of success in defeating climate change, the world will have a low-carbon economy or it will have a high-carbon economy, in 2050.
That being so, there’s nothing that would prevent financial markets from sharing climate risk. Insurance companies have been hedging other macro risks for centuries. The complexity of the climate change risk and the time frames of impact, could take 5, 10, or 20 years to show up. Depending on the level of success in defeating climate change, the world will have a low-carbon economy or it will have a high-carbon economy, in 2050.
If it is a low carbon economy, then green-assets will earn higher returns than brown assets.
If it is a high-carbon economy, brown assets will earn higher-returns that Green assets.
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If the economy is a high-carbon one in 2050, then investment institutions will reap returns from the cumulative holdings of brown investment assets built up over prior decades.
If the economy is low-carbon then investment institutions will reap returns from the cumulative holdings of green investment assets.
I’m a parn protecting customer returns, investors strategy will consist of a blend of green and brown assets, which will be adjusted to optimize returns as the resolution of the crisis becomes clearer. agraph. Drag me to add paragraph to your block, write your own text and edit me.
Investment institutions have a fiduciary duty to invest client funds now, and to maximize returns for their customers.
This obligation to invest will carry a high levels of litigation risk, for as long as the climate change crisis is unresolved.
Pending the declaration of a climate change winnrer, the low carbon economy or the high carbon one, fiduciary investors must continue to invest client monies and maximize the returns on those funds.
The challenges for fidiciary institutions is that:
1. The state of uncertainty about the economy in 2050, could continue until the mid-2030s or 40's.
2. Banks are encountering green assets for the first time. As an asset class, and in terms of managing risk, they have no track record.
3. Fiduciary investors cannot wait until the outcome is clear. Investment clientfunds must always be fully invested to provide continuous returns to them.
The question is which strategy should they implement? At a minimum, they have to hedge bets with an investment strategy that balances green assets and brown assets. But what if they get that balance wrong, given that the outcome of the climate change crisis is an unknown variable?
In protecting customer returns, investors strategy will consist of a blend of green and brown assets, which will be adjusted to optimize returns as the resolution of the crisis becomes clearer.
In protecting customer returns, investors asset class strategy will blend green and brown investments. The portfolio mix will be adjusted to optimize returns as the resolution of the crisis becomes clearer.
Why asset classes are relevant to climate change financing.
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Markets focus on asset class as a way to help investors diversify their portfolios to maximize returns. Investing in a range of different asset classes to diversify investment risk. Each asset class, commercial aircraft being one, is expected to reflect different risk and return investment characteristics and perform differently in any given market environment. The fact that oil prices increase aircraft operating costs, or that gas tubeine engines, emit greenhouse gasses, is priced into the investment pricing calculation.
Which asset class has the best historical returns?
The stock market has proven to produce the highest returns over extended periods of time. Since the late 1920s, the CAGR (compounded annual growth rate) for the S&P 500 is about 7.63%, assuming that all dividends were reinvested and adjusted for inflation. In other words, one hundred dollars invested in the S&P 500 on Jan. 1, 1920, would have been worth about $167,500 (in 1928 dollars) by Dec. 31, 2020. Without adjusting for inflation the total would have grown to more than $2.2 million in 2020 dollars. By comparison, the same $100 invested in 10-year Treasuries would have been worth only a little more than $8,000 in today's dollars. (Investopia).
Agree on how mutch must be invested in aircraft?
How much is needed to solve the aircraft climate change problem?~$1.5Tn of Net-Zero aircraft financing is needed.
This a challenge in an era of retrenchment!
Deciding what it will cost to finance the Net Zero transition.
The investment returns from the aviation industry have been wiped out. Between increasing FAA regulatory scrutiny, and the pandemic led, weak global economy, airlines are much less profitable than they were in 2019. The uncertainty of oil supplies, and spikes in oil prices, the unknown cost of envoronmental compliance, have eroded the value of low interest rates. How thren is the cost of capital to be agreed upon? Between low interest rates, stiff regulations, a lackluster global economy, and high compliance costs, banks are much less profitable than they were a decade ago.
Understanding cost of capital is one thing but calculating how much it will cost at some future date is annother matter. The fundational assumption is that an investors is willing to take the financial risk because of the expected return on investment it will generate. The base data needed to decide the desired return is to identify the investment that carries near-zero risk.
Government bonds such as the 10-year Treasury note issued by the US federal government is a good measure for this purpose. The yield is 2.0% p.a. depending on the date quoted. So any other investment would have to pay a premium on top of that to justify the risk of loss. If an investment return offers 20% p.a. it will attract investors because the risk return is ten to one. As more investors buy-in, the value of the investment should rise. On the other hand, if the investment returns 2.% p.a; few if any investors will buy-in and the value will fall. Time and experience has enabled investors to develop statistical models that establish the relationship between the cost of the investment, and return it is expected to offer. The challenge for airlines, airports and lessors, in a trading maket that has decoupled from the Dow Jones Transport Index, is how much that return should be, in order to hold on to existing investment institutions and avoid loss in hard asset values. In other words, what will it cost the stakeholder to get an investment institution to invest is asset based securities. This cost is the cost of capital and the cosgt of equity.
Type of funding - two seperate pools are needed for aircraft financing, depending on which of the two climate change outlooks prevail!
The cost to renew the GTE aircraft fleet, or the cost to replace it with NZE aircraft could range 50% below or above the estimates. The hard number will depend on which of two climate change outcomes, wins out: Outcome One: Net-Zero is achieved. NZE aircraft replace GTE aircraft, in a timely manner.In that scenario, the World meets the Paris Agreement emissions targets, the air transportation industry meets the emissions standards set out in the ICAO CORSIA scheme, and NZE aircraft replace the GTE aircraft fleet in an orderly manner and on time for 2050. This scenario could include GTE aircraft whose engines are swapped out to comply with Net-Zero emissions standards. If the NZE technology does emerge to universal acclaim, Investment institutions would have a fiduciary duty to add NZE aircraft to their portfolios and liquidity would flow into the market. Outcome Two: Net-Zero is not achieved. No NZE technology emerges to replace the GTE aircraft fleet. What would happen on the ICAO CORSIA scheme fails to reach its goal of greening the current GTE aircraft fleet by 2050, and NZE aircraft do not replace the GTE aircraft fleet in an orderly manner or on time, but other industries reliant on fossil fuel energy, particularly in the transportation sector, do decarbonize? This scenario could stigmatize aircraft as an investment asset class. Investment institutions could redefine the in-service fleet as a brown assets similar to power plants and cement factories. The consequences for financing the GTE fleet could be catastrophic. Investment institutions would have a fiduciary duty to down grade the asset class and withdraw liquidity from the market. No GTE aircraft type or model would be spared a reclassification or downgrade. The percentage of the operating fleet that has a about third or less of the utilization-life-cycle remaining would not be flown, A pool of wasted assets would emerge. Airline and aircraft owner regulatory costs to bring the GTE powered fleet into compliance with prevailing emissions regulations would skyrocket.The older parts of the wasted asset fleet would be treated as abandoned assets.
Developing Country funding & aviation finance.
Developing countries are the beneficiaries of development country funding. Access to these funds could be a source of liquidity for domestic airlines and airports. Between 2013 and 2014, the Copenhagen Accord and Cancun Agreements reached by the COP (Conference of the Parties) to the UNFCCC established and confirmed a collective commitment by developed countries to mobilize $100 Bn per year by 2020 to address the needs of developing countries. Commitments came from a wide variety of sources, public and private, bilateral and multilateral, including alternative sources.
Agree on what airline, airport & infrastructure problem is being solved.
The emissions of GHGs from aircraft powered by GTEs, polution of communities from surrounding airport and infrastructure; must fade away in line with the ICAO CORSIA scheme targets. Emissions must stop completely within the timeline set out in the Paris Agreement.
Why solve the problem? It offers Aviation a historic investment opportunity.
The majority of global investment institutions share the sentiment articulated by Blackstone that solving the climate change problem will create a "historic investment opportunity that is in the financial interest of investors, and the economy as a whole." For our purposes the economy refers to the air transportation economy.
What will happen if the aircraft climate change problem is not solved?
The risk is that commercial aircraft will be carbon stigmatized and consigned to the same investment categoy as cement factories and powerplants. At that point fiduciary investment institutions would have to reduce their commitments to the air transportation sector. Most aerospace stakeholders, the air transportation industry, and the aircraft financing sector, agree that if the climate change problem, being the greenhouse gas emissions from GTE powered aircraft, is not solved, it will reshape the way aircraft are finance, risk the reclassification of aircraft as brown assets, creation a pool of wasted assets and abandoned assets. It would drive away a significant allocations of capital.
What needs to happen to solve Aviation's climate change problem?
The air transportation industry must be seen to be successfully taking action on climate change emissions, by a wide range of stakeholders including Civil Society Groups (CSGs) focused on strong legislation and heavy regulation of aircraft emissions and noise, Investment Institutions like Blackstone, that have declared they are shifting investment capacity away from hydrocarbons to clean energy; the other sectors of the economy that do not create emissions polution, and those, especially in transportation, that are more advanced in solving GHG emissions than aircraft manufacturers, airlines, lessors, CAMOS and MROs.
What role do aviation investors have solving climate change problems?
What funding tools are availabe to solve the problem?
The three primary asset classes--stocks, bonds, and cash, are accessable to a narrow range of projects because of quality and risk concerns. Other "alternative asset" investment structures are used for a boad range of higher-risk projects. The physical assets, suitable for the alternative investment approach include:
1. Transportation assets, railroads, roads, ground vehicles, ships and aircraft.
2. Natural resources. such as biofuel and green hydrogen.
3. Real estate, airport building, hangards, warehouses, and infrastructure.
4. Emerging global markets segmented on a geographical basis.
5. Greening bank project financing.
Physical risk.
Hafrd assets like aircraft, hangards and airside warehouses, are subject to physical risk due to wear and tear, and rebuild due to safety requirements, that may make then less attractive as collateral at times of greatest need.
Accurately assessing values and risks may be difficultThe performance of an alternative asset such as aircraft can be challenging to research, price, and understand.Greater investing freedom can increase potential for mismanagement or loss from sector exposure.Alternative asset classes, that are subject to less regulation, provide tfewer constraints to prevent potential manipulation or to limit risk from highly concentrated financial exposure. Reuse of surplus to requirement real estateReal estate has a relatively low correlation with the behavior of the stock market and is often viewed as a hedge against inflation. Airlines and airports may investments in commercial, and/or land. Direct investment involves the purchase, improvement, and/or rental of property; Indirect investments are made through an entity that invests in property, such as a real estate investment trust (REIT). Conversion of natural resourcesAirports require large areas of land for future development that can be repurposed. Most natural resources such as timber, biomass for biofuel and oil are done through limited partnerships. In some cases, such as timber, the resource replenishes itself; in other cases, such as oil, the resource may be depleted over time. Timberland produces income from the trees harvested, but may also grow in value and be converted for use as a real estate development. Timberland may be subject to natural disasters.and may involve special considerations such as storage and insurance.
Why take high risk?
Part of sound portfolio management is investment diversification in such a way that it spreads risk over the economic life cycle and investment classes. The prime assets, gold, government bonds and cash offer security and safety but lower returns. Aternative asset classes provide that additional layer of diversification consistent with prodent investment in the prime asset classes. Even though alternative assets can offer returns that are not correlated with prime markets, asset class diversification cannot guarantee profits or loss mitigation. Other advantages that may have investment value include:
1. Certain asset classes can take advantage of looser regulatory requirements.
2. Alternative investments, such as revenues from aircraft, receive favorable tax treatment.
3. Assets such as forest harvesting, sustainable aviation fuel and carbon capture offer solutions for excessive corporate climate emissions. subject to punative penalties and taxes.
Build networks that enable you to employ these tools for your airline!
In secting the right mix of investor relationships, capable of providing the financial tools, needed to proceed to the R&D, and development phases of Net-Zero compliant commercial aircraft, consider some of these selection parameters.
1. Work with greening banks that:
a. seed, b. develop, c. manage a broad range of liquid & illiquid alternative strategies; d. spaning the full spectrum of investment vehicles, structures, and terms.
e. ensures business & strategy continuity, f. aligns alternative investments with clients needs. 2. Work with a variety of platforms including: a. opportunity funds, b. bridge funds, c. alternative asset funds, d. crowd funding.
3. Develop trading relationships with nvestment institutions and corporations that trade hard assets across global markets.
4. Work with organizations well resourced with technology, market research, distribution infrastructure, and investment talent.
5. Institutions that encourages and cultivates long-term relationship building.
6. Asset managers skilled in climate change risk management.
7. Fiduciary investors, known for sound corporate governance and sustainable
business practices.
8. Work with partners capable of long-term value creation for an airline, airport, lessor and MROs.
9. Organizations that possess a track record of operating in an inflationary economy.
10. Corporate investors that historically pay high and growing dividends.
11. Understand technology transition risk.
12. Investors with a commitment to invest in emerging sustainable technologies.
Where to look and what to look for.
Step One: Look to your own network operations.
Step Two: Look to stabilization funds.
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Step Three: Look to equity, debt, monetization, securitization and reorganization.
Lessors may have issues with some ICAO suggestions!
Though aviation stakeholders may not have access to a given investment type or structure, because of investment suitability requirements, such as earnings and balance sheet makeup, certain funding sources may be off limits, but not all of them, as illustrated in the above ICAO table.
Where to look.
Green banks, hedge funds, private equity funds, family funds, sovereign investment funds and the like, provide liquidity for projects in alternative asset classes.
Greening banks.Green investment financial organizations are less concerned with maximizing returns on investment for stakeholders, as they are in providing low-cost seed capital and cheap loans to very high risk projects, that if they succeed, will contribution to solving the GHG emissions problem, sooner rather than later. These institutions are held to a different standard than fiduciary institutions because funding is providing is provided by government agencies, corporations, and civil society groups, with a specific mandate to invest in projects addressing climate change emissions, rather than to invest in projects that maximize loong term investment returns. Hedge Funds.Hedge funds are private investment vehicles that manage money for institutions and wealthy individuals. They generally are organized as limited partnerships, with the fund managers as general partners and the investors as limited partners. The general partner may receive a percentage of the assets, additional fees based on performance, or both. Hedge funds originally derived their name from their ability to hedge against a market downturn by selling short. Though they may invest in stocks and bonds, hedge funds are typically considered an alternative asset class because of their ability to implement complex investing strategies that involve many other asset classes and investments.Private Equity Funds.Alternative asset investment can be dependent on counter-cyclical strategies, or based on unique skills osuch as computerized trading prograns. Hedge funds may invest in projects based on a element of subjective judgements, that would not meet the risk standards used by mutual funds.Like stock shares, private equity represents an ownership interest in a company. However, unlike stocks, private equity investments are not listed or traded on a public market or exchange, and private equity firms often are more directly involved with management of the business than the average shareholder. Private equity often requires a long-term focus before investments begin to produce any meaningful cash flow--if indeed they ever do. Private equity also typically requires a relatively large investment and is available only to qualified investors such as pension funds, institutional investors and wealthy individuals. Private equity can take many forms. The following are some examples: • Angel investors are individual investors who provide capital to startup companies and may have a personal stake in the venture, providing business expertise, industry experience and contacts as well as capital. • Venture capital funds invest in companies that are in the early to mid-growth stages of their development and may not yet have a meaningful cash flow. In exchange, the venture capital fund receives a stake in the company. • Mezzanine financing occurs when private investors agree to lend money to an established company in exchange for a stake in the company if the debt is not completely repaid on time. It is often used to finance expansion or acquisitions and is typically subordinated to other debt. As a result, from an investor's standpoint, mezzanine financing can be rewarding because the interest paid on the loan can be high. • Buyouts occur when private investors--often part of a private equity fund--purchase all or part of a public company and take it private, believing that either the company is undervalued or that they can improve the company's profitability and sell it later at a higher prices.
• MBOs. In some cases, the private investors are the company's executives, and the buyout is known as a "management buyout (MBO)."
• LBOs. A leveraged buyout (LBO) is financed not only with investor capital but with bonds issued by the private equity group to pay for purchase of the outstanding stock. Family funds.
Fund platforms are popular with wealthy families, members of investment clubs and other groups looking to preserve wealth by collectively investing in a range of asset classes. Asset pools can be consolidated, provide a broader range of funding options.
Sovereign wealth funds.
Sovereign wealth funds are owned by many countries. Sovereign wealth funds are designed to stabilize a national economy through diversification , and to generate wealth for future generations. They tend to invest directly or indirectly in big-name companies and assets. Concern have been raised that these funds seek to have a say in resources and technologies that are of global economy. strategic importance.
Key Takeaways.Alternative asset classes are ways to invest excess capital into markets or other investments.Many investment institutions use funds as a way to hedge against downturns in prime asset markets.
In the case of wealth funds, they accrue profit for the benefit of the nation's economy and its citizens.
In all these cases, it is strongly recommended that climate change mitigation projects get expert advice and guidance when financing alternative assets such as airlines, aircraft, airports, MROs, aircraft lessors and after-market parts suppliers.
In all these cases, it is strongly recommended that climate change mitigation projects get expert advice and guidance when financing alternative assets such as airlines, aircraft, airports, MROs, aircraft lessors and after-market parts suppliers.
Retrenchment as a source of funds.
Retrenchment is employed to improve business performance. Aviation companies are using it to ensure financial stability by reducing expenditure. They are also using it in order to defend the business from attach and to protect distinctive competences. The strategy can involves the abandonment of products or services because of changing circumstances, such as when the equipment suppliers remove previous-generation aircrafrt part-numbers from catalogues, because they are no longer profitable or they do not have the experienced technical staff to offer post sale support due to retirements. A very visible retrenchment was the 2018 sale of the Bombardier C Series commercial aircraft production line to Airbus and Investissement Québec. Bombardiers couls not sell the aircraft in sufficient quantities to recover its $2.1Bn development cost. The C Series was designed to compete with Airbus A320 family, Irkut MC-21, B737 MAX, Embraer E-Jets and E-Jets E2 and Sukhoi Superjet. Selling the A220 (C Series) with the A320 undermines a key selling point for Airus, offering the concept of a "family" of aircraft, and the benefits that brings. A retrenchment strategy may also presen opportunities for small and regional airlines, MROs, AM and AI startups to acquire aircraft, engines, equipment and technology rigjts when a particular business is so small that it does not make any sizable contribution to the total earnings of the divesting company.
The liquidation strategy is very relevant in the Pandemic economy. It is an effective strategy for airlines, MROs, lessors and vendors that have already pursued a retrenchment strategy and a divestiture strategy, without success, or when an organization’s only alternative is bankruptcy. Liquidation represents an orderly and planned means of obtaining the greatest possible cash for an organization’s assets. A company can legally declare bankruptcy first and then liquidate various divisions to raise needed capital.(c) when the stockholders of a firm can minimize their losses by selling the organization’s assets.
Transformation strategies in response to crisis.
The transformation strategy becomes applicable for aviation companies when major change occurs in operations, or the market outlook, or the company is moving from one kind of business to another. Transformation involves substantial change and corporate flexibility because it is difficult to implement the strategy. According to Joe G. Thomas, firms may undertake a transformation when:(a) Returns on current operations are lower than desired.(b) Opportunities in other areas are especially attractive.(c) Investments needed in the current operations exceed what the firm is willing or able to spend.(d) A strong, flexible management team exists.(e) The firm has a strong financial base to support its transformation.
Two financing pools are needed for aircraft, depending on one of two climate change outlooks!
The cost to renew the GTE aircraft fleet, or the cost to replace it with NZE aircraft could range 50% below or above the estimates. The hard number will depend on which of two climate change outcomes, wins out: Outcome One: Net-Zero is achieved. NZE aircraft replace GTE aircraft, in a timely manner.In that scenario, the World meets the Paris Agreement emissions targets, the air transportation industry meets the emissions standards set out in the ICAO CORSIA scheme, and NZE aircraft replace the GTE aircraft fleet in an orderly manner and on time for 2050. This scenario could include GTE aircraft whose engines are swapped out to comply with Net-Zero emissions standards. If the NZE technology does emerge to universal acclaim, Investment institutions would have a fiduciary duty to add NZE aircraft to their portfolios and liquidity would flow into the market. Outcome Two: Net-Zero is not achieved. No NZE technology emerges to replace the GTE aircraft fleet. What would happen on the ICAO CORSIA scheme fails to reach its goal of greening the current GTE aircraft fleet by 2050, and NZE aircraft do not replace the GTE aircraft fleet in an orderly manner or on time, but other industries reliant on fossil fuel energy, particularly in the transportation sector, do decarbonize? This scenario could stigmatize aircraft as an investment asset class. Investment institutions could redefine the in-service fleet as a brown assets similar to power plants and cement factories. The consequences for financing the GTE fleet could be catastrophic. Investment institutions would have a fiduciary duty to down grade the asset class and withdraw liquidity from the market. No GTE aircraft type or model would be spared a reclassification or downgrade. The percentage of the operating fleet that has a about third or less of the utilization-life-cycle remaining would not be flown, A pool of wasted assets would emerge. Airline and aircraft owner regulatory costs to bring the GTE powered fleet into compliance with prevailing emissions regulations would skyrocket.The older parts of the wasted asset fleet would be treated as abandoned assets.
Climate Intervention: Carbon Dioxide Removal and Reliable Sequestration, negative emissions technologies.
Inventors advancing direct air capture (DAC) technology, as a carbon dioxide removal approach that extracts carbon dioxide (CO2) emissions from the atmosphere , tend to discount the relative paucity of research on NETs and recommended development of a research agenda that covers all aspects of NETs from fundamental science to full-scale deployment. Commercial Aircraft financeachieve goals for climate and economic growth, "negative emissions technologies" (NETs) that remove and sequester carbon dioxide from the air will need to play a significant role in mitigating climate change. Unlike carbon capture and storage technologies that remove carbon dioxide emissions directly from large point sources such as coal power plants, NETs remove carbon dioxide directly from the atmosphere or The subject matter is extremely complicated and so we direct any airline, airport, MRO or other stakeholder to the "Commercial aircraft handbook, published by Routledge, London. It is available through this link - https://www.routledgehandbooks.com/doi/10.4324/9780203713303-3.
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As commercial aircraft ownership and operating leasing grew in visibility, investment opportunities increased from 2012 to 2019. Approximately 40% of new aircraft deliveries up to 2020 were funded by operating lease finance. The investor pool was constantly expanding. Investors continue to look for the ‘next big opportunity’, The trends from 2020 to 2022 show aircraft leasing to be overleveraged. The question now is if the decade long, performance of investing in commercial aircraft iwill return to pre--COVED levels, and will lessors attract fresh equity and reduce leverage?Market changed from traffic growth to CO2 emissions.
The Climate change retirement-aircraft scenario is different in many ways but it is not unprecedented (Box 2). It is important for investment institutions to be aware of previous periods in which the aircraft technology had to be phased out and a new one phased in. The aircraft industry does have a history of transitioning from one aircraft technology event to another.
The construction of the civilian versions of the jet aircraft began in the early 1950s. It began with small orders from a few international airlines, mostly government owned, with route rights protected under the Chicago Convention, or under the regulatory protection of CAB. The engine technology was introduced gradually, in line with the development of the travel and tourism industry, a process that took about 20 years.
Transition to new aircraft technology today.Today’s climate change economy is complex. Market conditions that could emerge, as early as 2024 to 2027, could include a disruptive one, where stringent emissions and noise legislation and regulations, are introduced at an International or national level. The timeframe in which this transition would be worked through, could be the mid-2030s, when the ICAO CORSIA scheme ends. The net outcome would be that GTE powered aircraft would be phased out creating a potential for abandoned assets. The hoped-for outcome is that emissions and noise compliant technology does emerge that could be retrofitted to aircraft in the current fleet, installed early enough for the fleet to complete its normal 30-year life cycle.
Precident exist for this outcome.
The noise regulations introduced in the 1970s to reduce engine noise was in the form of retrofit kits, that cost about $3M each to install. That market went into steep decline when the CFM56 was introduced on the A320 in the 1980s. The conundrum today is that if a phase-out of gas turbine engine (GTE) and phase-in of Net-Zero engine (NZE) technology does happen, the costs will be enormous because, (a) the NZE engine technology does not exist, and none are beyond the concept drawing phase, (b) no conversion kits for the GTE exist, and (c) airlines, MROs, and lessors will have to operate two systems, one phasing out the other over two to three decades. Airports may have to invest in infrastructure that caters for two separate aircraft technologies. The overall problem for the world as a whole, is that we are trying to compress a process that’s requires seventy to eighty years to develop, into a stop-gap measure!
Box 2 - Aircraft, airline and airport technology transition timeline.
1. Technology transition occured ifirst n war economies when a bulge in aircraft production occurs. 2. In the first event, Post WWI, the aircraft built during the five years of conflict were destroyed after hostilities ended, because there was no civil market for them. A few did find their way into civil use, but in very small numbers and at prices based on engine time, about $10 to $20 each. 3. The effective outcome was that most of the promising new aircraft manufacturers went out of business. 4. After multiple crisis, some safety issues, some competition and some regulatory shortcomings, aircraft production recover to viable levels in the mid-1930s, when the air transportation business first became profitable.5. In the second event - WWII, the end of hostilities corresponded with a change in propulsion technology from internal combustion engines (ICE), (radial piston engines) to gas turbine engines (GTE), both based on the same heat engine engineering, and both used fossil fuel as an energy source.6. The technological benefit was that the cost of developing GTE engines was paid for in government war budgets. 7. The GTE launch, which had been in the R&D phase since the early 1920s, coincided with the end of hostilities or shortly thereafter, at a point in time when the performance of the radial engine had reached the end of its on-wing performance capabilities.8. The first commercial airport was built in the mid-1920s, but very little investment was put into airports for another decade or so. 9. In many cases, the airports, the fuel supply infrastructure, customs clearance, airport communications, airways navigation, and ground handling were established, based on the US aviation infrastructure model. As a result, the international air transport system is standardized. 10. The global air transport navigation system was built in the five-year period of WWII. It was mostly paid for by the USA and to a lesser extent by European countries. 11. This dramatically reduced the time and the cost of building the global commercial air transportation route networks, still in use today.12. As the jet age approached, hydrocarbon production and supply was under the control of the major oil companies in the USA and Europe.
13. The fuel that powered WWII aircraft was in over-supply, and cost per USG was measured in cents not dollars. 14. Aircraft costs were less than the metal value. The typical price for an ex-US Army Air Force DC3 was $25,000 compared to the average cost of $250,000 to build one.
15. The large US carriers established prior to the war, with exclusive route rights granted by the CAB (Civil Aeronautics Board), re-established operations and began the process of opening international routes, employing bilateral agreements to control route access.
16. Start-up airlines, intent on competing with them, entered the market at the point of least resistance, because the target routes were regulated by individual States, not the CAB. *
17. Companies like Boeing, Douglas, Lockheed, their engine, and systems suppliers, survived the post-war slump when they became, what would later be called, the backbone of the military-industrial complex, as it emerged in anticipation of the Cold War. These companies received much of the R&D funding provided by the Air Force and the Federal government, almost exclusively, on the basis that they would retain their trained work forces and build aircraft for the military.
18. The transition from the old to the new technology began in military markets as the Cold War expanded.
* The intrastate market, the commuter/regional markets, developed into the point-to-point markets. Only one of these carriers is in service today – Southwest!
Commercial aircraft delivery funding fell 40% in 2021!"In 2022, the global economy should enjoy some growth, as international equity markets and corporations expect healthy profits, expected robust consumer spending, in the USA, European economic growth, tempered by a slowdown in China, the gradual reduction of stimulus from central banks, persistent inflation, and the emergence of COVID variants."
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18. A decade later, that technology was used by these companies to build commercial air transport aircraft. 19. Building the first US jet aircraft to become a commercial aircraft in the USA, was contracted out to civilian manufacturers but the design cost was covered by governments. 20. That phase took about ten years to complete.
"The projected cost of transitioning the world to Net-Zero emissions is based on a working number with limited application because of the uncertainties about technology and global politics. It is in the range of $95 trillion through to 2050. This raises a very important question - How much money is needed to found the purchase of the Net-Zero aircraft and to build out the Net-Zero infrastructure over the next 20 years? An estimated US$4.1 Tn in incremental investment is needed for the low carbon transition to deliver on the 2-degree Celsius goal."
Funding platforms & sources for aircraft & Net-Zero engine emissions technology.
Shannon Aero has studied the sources of funds that the aviation sector relies on to capitalize the industry. In 2021, at the industry level, commercial aircraft delivery funding volume totaled $59Bn a 40% decrease from 2019 levels.1. I n many cases, countries have insufficient information about th green financing needs of the air transportation industry in their jurisdictions. The affected countries need financial and technical resources to adapt the green banking and fianncing model to the unique circumstances of airlines, especially regional airlines, regional airlines, and MROs. 2. New forms and sources of domestic and international capital are needed because many commercial banks have been exited the market, in part, concerned about the negative implications of financing gas turbine engine powered aircraft, seen as the cause of greenhouse gas emissions. 3. Shannon Aero is encouraging State and private sources of financing to form relationships focused on pension funds and sovereign wealth funds situated domestically, and multilateral development banks and climate fundabroad.Although World Bank research analysis shows that the financing needed to transition the air transportation industry to Net-Zero emissions can only come from three sources, one other source is emerging:1. Multilateral banks.2. Bilateral development banks. 3. National banks.4. Green banks.
Shannon Aero green banking goals. Ref: https://greenbanknetwork.org/reports-white-papers/
Introduction: Aircraft transaction types.Traditionally, commercial banks have provided loans to aircraft buyers priced at open market rates. The transaction could be for new or used aircraft, one or multiple aircraft, with deliveries spread out over several years. Funding may be subject to the credit risk of the owner, airline or lessor. Credit status may be enhanced by support of an Export Credit Agency (ECA).Lease vs. Loan analysis.The financing platform for airlines, airports, MROs and new technology start-ups is decided by analysis of a ‘lease versus own’ analysis. The following criteria will have a hand in the operator’s decision.Financing platforms.Aircraft financing transaction platforms are a combination of lease financing, mortgage financing or equity. Tax benefit. Aircraft financings frequently has a tax-benefit that enhances the investor return, based on the tax treates between a number of countries. Funding may be raised through public or privately placements (securities) to reduce the interest cost to levels only available in the capital markets or through venture capital funding. Lease Financing.The leased aircraft is owned by an investor (owner, airline, lessor), or a lessor (asset manager) with a portfolio of similar aircraft assets. The airline operates the aircraft for various lease periods - six months to 10 years for an operating lease, and 10 to twenty years (lease term) for a financial lease. The aircraft is returned to the owner/lessor at the end of the operating lease term in accordance with the terms set out in the transaction documentation. In the case of a financial lease, the operator may have the right to purchase the aircraft at the end of the term. Mortgage Financings.The mortage lease is, in effect a ‘Capital or Financial Lease’ featuring most of the same characteristics as the Operating Lease. The lessor is treated as a mortgagee not a lessor. The mortagee of the aircraft (whether a lessor or airline/operator) takes out a loan to finance or refinance the purchase price (or value). The aircraft is used by the lender as collateral in the form of a Security Interest to secure repayment of the loan.
Aircraft transaction parameters.
Sources of funds.
The two primary forms of sourcing funding for capital expenditure are debt and equity. Debt financing, works differently from equity financing , and offers different options to the borrower. Selling bonds, bills, or notes to institutional investors in return for debt capital, proved very effect in financing aircraft lease portfolios. The investor is treated as creditors to the business. On the negative side, debt financing for capital expenditure, is available to large companies with strong track record. For the startup doing R&D to build climate emissions technology, sourcing loans from traditional or alternative business lender is more common. The type of loan, how you access the capital provider and the repayment terms do vary.
Debt financing.
1. Bank loans.
2. Venture Debt Financing.3. Research & Development Grants.3. Merchant Cash Advance.4. Business Line of Credit.5. Business Credit Cards.
Conventional loan products include:
1. Installment loans.
2. Revolving loans.
3. Cashflow loans.
The institutions that providers debt in the aviation industry are concerned with fewer criteria than equity for assessing their return which is primarily covered by:
1. Up-front fees; and
2. Interest earnings.
3. Collateral coverage.
4. High annual revenues
Back-leveraged Lease financings and in mortgage financings there is a requirement for debt. Providers of debt have more simple criteria than equity for assessing their return which is primarily covered by: (i) up-front fees; and (ii) interest earnings.The economic return requirements of debt providers will necessarily factor in the Risk Factors spelt out above and, similarly, the tenor of a transaction will have a bearing on the risk assessments and return requirements.
Investors in Aircraft Asset debt components include:• commercial banks;• non-bank lenders: insurance companies, finance companies, pension plans and funds (for example, Fidelity);• public debt/capital markets;• ECAs (directly or through guaranteed-debt); and• OEMs.The interest of these equity and debt participants in Aircraft Finance rise and fall with market developments and cycles. Boeing Capital, in their annual ‘Current Aircraft Finance Market Outlook, 2013–2017’ provides a useful snapshot of the current trend lines for the various Aircraft Finance funding sources; see www.boeingcapital.com/cafmo/
Placement.IAircraft financing consists of debt and equity, in a variety of forms. Look to two criteria before placing the transaction:
1. the type of placement.
2. the identity of the buyers of the debt and equity.Securities buyers.Two sources can be consodered:1. third party equity, provided by the owner or lessor in the transaction; and2. the debt provider.Equity lease financing.The aircraft buyer is the owner, lessor or asset manager, and is usually experienced in aircraft asset magement. Pricing factoers in:
1. end-of-transaction asset residual returns; 2. rental and supplementary lease payment cash flow (rent); and/or
3. tax benefits.
Economic return pricing risk factors.
The risk factors used to build the economic return from a placement include:1. Credit risk based on the financial performance aircraft lessee including the credit support providers.2. Residual value risk: Aircraft asset value stability, technological obsolescence, life cycle phase, used aircraft demand and pricing, and in
the specific case of the climate change emissions problem, the timely availability of GTE retrofit kits or new NZE technology.3. Country/legal risk: The ability to enforce the terms of the transaction, repossess the asset in the event of default. – country risk4. Black swan event risk: Airline industry performance (local and international; terrorism, SARS, and so on).5. Economy performance: (local and international).6. Regulation: Airline regulatory developments (airworthiness directives (ADs), noise rules and so on).
7. Change-of-law/accounting rules.8. Fuel costs:
9. Fuel supply reliability:10. Climate stigma risk: Two scenarios can arise. The ICAO CORSIA scheme emissions targets will be met in 2050 or they will not. If the
targets are meet with the existing aircraft types, then the GTE powered aircraft will run out over tthe norn=mal life cycle. If GTE
technology failes to produce the emissions required and no NZE succeeds, and all the other industry sector do cut CO2 emissions,
then investment Institutions may have a fiduciary duty to reclassify aircraft from alternative asset class to a brown asset class, similar
to the classification of power plants and oil refineries. Investors in Aircraft Asset equity include:1. Banks - commercial: (for example, SMBC);
2. Lessors: traditional operating leasing companies (AerCap, GECAS, ACG, and so on);3. Lessors - SVP: specialized operating leasing companies (Vx, Apollo, Compass Capital, and so on);
4. Finance companies (for example, Siemens Credit);5. Investors - tax-based investors (for example, MetLife);6. Hedge Funds:
7. Private equity funds (Strategic Value Partners, Fortress, Wayzata, and so on);8. Pension funds.
9. Family funds.
10. Sovereign funds.
1. Operational flexibility - operating, financial lease, debt. equity.2. Cost: a. lease rates versus debt rates versus equity return; and b. ability to take advantage of tax benefits.3. Residual risk: a. long-term view of asset value appreciation, residual value, abandoned assets; b. financial risk appetite; c. view on emergence of new aircraft models and technology - in effect can GTEs be replaced by NZEs in time to meet the CORSIA scheme requirements, or will retrofit equipment be installed on GTEs, what will the cost be of the CORSIA goal is not achoeved?; d. view on current and future aircraft needs, OEM order book for future deliveries generally (replacement & growth ‘lift’ projections) and gaps (taking into consideration the aircraft, or how far forward is the next available new aircraft delivery slot is); e. future maintenance costs, factoring major structural change that may be required to bring GTEs into compliance with Climate emissions standards; f. perceived future availability of asset model from other sources, used aircraft, reengined aircraft.4. Corporate policy: a. maintaining a low-time fleet, typically by rotating the fleet based on an average portfolio age ~10 years. b. interest in de-leveraging (in a Lease Financing, the lessor would be the one to bear the burden of debt financing); and c. accounting policy to minimize on-balance sheet debt.5. Technological advancements: a. technology transition from GTE to NZE technology imposed by legislative and regulatory enforcement to achieve Net-Zero emissions targets set for 2050. b. cheaper maintenance for newer models as an offset against high capital cost; c. better fuel burn for newer types and models taking into consideration the 1% annual improvement in fuel buring since the 1960s. the energy efficiency of Jet-A vs. Sustainable Aviation Fuel vs. battery/electric propulsion vs. green hydrogen. e. ability to retrofit these advancements on GTE aircraft.6. Access to capital: a. debt markets; b. equity markets; c. lessor markets. d. Venture capital; and e. Government R&D financing.7. Tax based financing: a. ability to take advantage of tax benefits available to an owner (for example, depreciation.
Financing Structures
Financing Structures.Many structures for financing sustainable, renewable energy transition project are available. They vary by source of financing, the type of participants, and allocation of profits & losses. Corporate Financing. One Corporate financing structures mostly used by utility companies. The corporation reaps all the benefits of the project because the corporate parent must have sufficient capacity for tax credits and benefits to be of use. Corporation develops the project and finances all costs. There are no other investors or lenders involved. The project may be set up as a subsidiary of the corporate parent. However, with 100% ownership, the subsidiary would have to be consolidated into the parent's financial accounts.Sale before Construction. The Entrepreneur builds the project and sells it to a strategic investor in return for a development fee. The Entrepreneur hands over a turnkey project after acquiring the lease, land rights, permits, interconnection agreements, power purchase agreements and any renewable certificates or feed-in-tariffs. The Entrepreneur's risk is limited to the development capital.The strategic investor can arrange bridging finance for the project or add it to its own balance sheet. The strategic investor owns and operates the plant.Sale after Construction The Entrepreneur seeks bridge financing from lenders:Construction Loan: Bank is repaid in full at completion of construction. Alternatively, bridge is converted into long-term loan.Cash Equity Bridge: Bank is repaid at completion of construction with funds from sponsor. Entrepreneur may provide limited guarantee for cash equity.Tax Equity Bridge: Bank is repaid at completion of construction with funds from tax investor, who will only come in once the plant produces tax credits.Investor Ownership FlipThe investor contributes almost all of the equity and receives a pro-rata percentage of the cash and tax benefits prior to a flip in allocation.At a given level of IRR (internal rate of return), the ownership flips back to the Entrepreneur, after which most of the cash and tax benefits are allocated to the Entrepreneur. Only the production tax credits will continue to go to the tax investor even after the "flip". If the investor is a tax investor rather than a strategic investor, the pre-flip allocation may not be pro-rata, and all tax benefits may go to the investor instead.Leveraged Ownership Flip and Pay-As-You-Go ("PAYGO")This is the most common project finance structure.The tax investor makes contributions before production begins, though a portion may be deferred until the project receives production tax credits, which are initially allocated to the tax investor, though a high percentage is paid to the Entrepreneur as an equity contribution. This serves as a claw-back should the project not perform. The leverage is at project level with long-term debt of up to 18 years, based on the PPA (Power Purchase Agreement). This structure also includes a return-based flip in the allocations.As the term for the production tax credits is usually, an additional loan may be secured against those flows.Back Leveraged Structure. Similar to the Investor-Ownerhip-Flip structure. However, the Entrepreneur is leveraging its equity stake in the project using debt financing.The tax investor commits equity upfront.
Pre-Flip: Initially, 100% of cash goes to the Entrepreneur until return of investment (similar to a development fee). Then 100% goes to the investor.Post-Flip: After the investor's pre-agreed IRR (typically 7% - 10% depending on project risks) is reached ownership and cash flow allocations go back to the Entrepreneur, including most of the tax benefits.Leveraged Lease Construction is funded by sponsor equity and a construction loan. Once constructed, the sponsor sells the project to the investors that have formed a trust and immediately leases it back.The Entrepreneur repays the construction loan from the sale proceeds. The trust is financed with cash equity and a non-recourse term debt. Lease payments are likely to be assigned to a lender. For tax purposes, a minimum of 20% equity is usually required.Leasing generates a "time value of money" cost saving achieved by deferring tax payments. It also improves cash flow.If set up as Operating Lease, the lease may only be for 5 years with the option to re-lease.Homeowner Model When homeowners invest in renewable energy generators, they will own 100%. However, quite frequently, they can get bank finance, in some cases up to 100% of the capital costs!Depending on the jurisdiction, homeowners may have to set up a company to run the generator, in which case they will also be able to profit from tax benefits.However, unless they can offset the investment against profits elsewhere, the overall tax benefits are not significant. The lack of tax benefits, however, is often compensated for by higher feed-in tariffs for small installations.
Between 2013 and 2014, the Copenhagen Accord and Cancun Agreements reached by the COP (Conference of the Parties) to the UNFCCC established and confirmed a collective commitment by developed countries to mobilize $100 Bn per year by 2020 to address the needs of developing countries. Commitments came from a wide variety of sources, public and private, bilateral and multilateral, including alternative sources.
Interest rates & inflation can be priced into buying Net-Zero aircraft from existing data.
ECB Green monetary policy would involve buying green bonds for the manufacture of Net-Zero Aircraft.
The role for central banks in green bond financial markets, could reverse climate change. The research presented by the European Central Bank (ECB) clarifies the role that central banks can play in achieving carbon-neutral economies. The implementation of the ECB Green monetary policy that permits the purchase of green bonds, can contribute to changing capital allocation – and in so going it could determine CO2 emissions – in the wider economy. An analysis of purchasing data shows that the ECB bond portfolio does not align closely with the market portfolio. A first step would be the ECB buying corporate bonds in proportion to sectors.To date, companies in the aviation sector that could accelerate R&D investment in Net-Zero engine emissions technology capable of meeting the ICAO CORSIA scheme standard, have not issued green bonds, suggesting that any talk of the launch of Net Zero emission engine technology is premature.
Central banks do provide incentives for the issuance of green bonds by making suitable suitable for central bank operations (ECB, 2020). The ECB’s executive board, has argued, "buying green bonds does not necessarily protect from market failures. The bank notes that attempting to maintain neutrality in the face of an economy composed of sectors more or less heavy in emissions can end up with the policy supporting those that emit more heavily." For the ECB to intervene in the financial markets to support young renewable energy firms, wanting to upscale Sustainable Aviation Fuel (SAV), electric propulsion or green hydrogen, would require them to be in the position to issue the green bonds, the ECB Green green bonds program could purchase to reduce their funding costs. The ECB policy makers say they need a greater supply of green bonds to change policy in favor of the aviation sector. World Bank date guidance.
In 2015, the World Bank Group entered into an agreement on Common Principles for Mitigation and Adaptation Finance Tracking, with the International Development Finance Club in 2015. The World Bank did this knowing finance activities will play a critical role in development activity that provides climate benefits during the transition to low carbon, resilient economies. Qualifying activities include those that:1. Activities that promote efforts to reduce or limit greenhouse gas (GHG) emissions or enhance GHG sequestration.2. Activities maintaining or increasing adaptive capacity and resilience in ways that reduce the vulnerability of people, or natural systems, to the impacts of climate change, and risks related to climate variability. A stepping stome to air transportation financing.Though air transportation financing needs do fit the above criteria, it is proving challenging to unlock the type of financing needed to transition the global aircraft fleet from gas turbine engines (GTE) to Net-Zero engines (NZE).Interest rate guidance for Net-Zero aircraft orders.
The cost of funding and inflation in the delivery of any Net-Zero aircraft could dash any prospect for a robust recovery in new aircraft orders.In this regard the oversight of the central bank in each of the major economies, will want to stimulate a transition to climate-neutral economy using green monetary policy instruments & insights. Green monetary policy instruments that will guide interest rate levels.1. ‘Brown’ collateral haircuts increase the financing costs and decrease the volume of carbon intensive investments.‘
2. "Brown’ collateral haircuts are an instrument in a central bank’s collateralized lending framework.3. “Brown’ collateral haircuts decrease the exposure of the central bank balance sheet to climate-related risks. 4. "Brown’ collateral haircuts remain the recommended policy because “green” hair growth is not necessarily ‘market neutral’Carbon tax policy possibility.The synergy of a price instrument and ‘brown’ collateral constraints results in a significantly lower and potentially politically more feasible carbon tax.Green monetary policy instruments that will guide investment and carbon intensity and emissions.1. ‘Green hair growth’ increase carbon neutral investment and decreases carbon intensive investment and emissions2. ‘Green hair growth’ policy has a stronger effect on investment & emissions. However, it cannot be broadly applied across central banks. 3. ‘Green hair growth’ has a similar effect but conflicts with market neutrality and, therefore, it is not as broadly used.Monetary policy relates to the money supply in a given economy. Unconventional monetary policy can be ineffective in times of deep economic turbulence and so it warrants further evaluation. This mechanism is an example of "QE" (quantative easing) an example of which is asset purchases.
By changing short-term interest rates, it influences other interest rates in an economy such as those offered by banks or other financial institutions for loans or savings accounts. Economic activity that depends on monitory policy and drive the demand for new aircraft include:
1. GDP growth and2. Job creation.Central banks uses the lever of monetary policy for:3. Price stability maintenance. The purchase price of any new aircraft is escalated based on an index, a formula set on the the contract documents. 4. Inflation control. Historically, bricks & mortar values rise in line with iinflation. Hard assets such as aircraft have experienced a similar pattern.
The tools that central banks use to control the money supply and its cost include:5. Interest rates. The saving event with respect to the collapse of the asset backed security market for aircraft during the Pandemic is that interest rates went close to zero, a life saver for many lessors.6. Short term interest rates, known as Central Bank policy interest rate, are likely to rise begining in 2022 . The lower interest rates are, the less is the benefit of aircraft tax based financing. 7. QE (quantitative easing) is used by the cental banks to purchase assets such as corporate and government bonds. 8. Unconventional monetary policy is predominant. Central banks employ it as a tool in asset purchases. This is because interest rates have already been lowered to levels close to the minimum possible. Central banks may turn to unconventional monetary policy to maintain price stability leading to:1. Lower interest rates such as seen sicne 2020. They have been owered further than under conventional policy rate adjustments,2. Lower borrowing costs. Asset purchases have become more frequent in several countries during the Covid-19 crisis. The ECB, for example, have turned to unconventional monetary policy in response to Covid-19, to asset purchases under the pandemic emergency purchase programme. From 18 March 2020, the temporary programme was set in motion with €750 billion available.Unconventional monetary policy and environmental concerns.
Central bank, such as the ECB, have to have decide the mix of bonds to buy when purchasing assets. The typical mix is government bonds, mortgage-backed securities and a corporate bonds. Principle of market neutrality.The traditional view is that central bank monetary policy asset purchases should adopt a principle of market neutrality because intervention in the market changes the overall capital allocation in an economy, which can in turn set off price instability. This usually translates into central banks purchasing bonds proportional to the amount of bonds outstanding.This principle is in place to ensure that asset purchases have a minimal impact on relative price distortionsy targeting . Market influence is controlled by buying specific sectors over others.
Buying green bonds as a tool to manage climate change risk? 1. Many bankers and politicians argue that central banks cannot and should not ignore risks associated to climate change (ECB,2020). Te hunknown is what the outcome would be in the case of purchasing corporate bonds. This question is intricately linked to the question of green monetary policy.2. The appropriate role of central banks in engaging with efforts to combat climate change is a pressing question for policy-makers. They have been urged to undertake greater engagement with environmental issues (van’t Klooster, 2020).The Bank of England has strong position on addressing the financial risks that come with global warming (Barber and Giles, 2020). In practice, central banks tend to adopt a pssive approach in purchasing bonds proportional to the amount of bonds outstanding.
Regulatory oversight of Green financing.
Financial regulation & the transition to a low-carbon economyThe International Monetary Fund (IMF) reports that "there are demands on central banks and financial regulators to take on new responsibilities for supporting the transition to a low-carbon economy. Regulators can facilitate the reorientation of financial flows necessary for the transition. But the IMF warns their powers should not be overestimated. Their diagnostic and policy toolkits are still in their infancy. They cannot (and should not) expand their mandate unilaterally. Taking on these new responsibilities can also have potential pitfalls and unintended consequences. Ultimately, financial regulators cannot deliver a low-carbon economy by themselves and should not risk being caught again in the role of ‘the only game in town.’
Green Banks could fill some of the expected delivery funding needs.
Green bank profile.
Green Banks facilitate private investment into domestic low-carbon, climate-resilient infrastructure. For the most part, green banks are funded with public capital and with a public purpose in mind —to accelerate low-carbon, climate-resilient, and sustainable economic development. Sixty one green banks are established in 36 countries, and another twelve countries are exploring the model. The countries that do have green banks account for 53% of global GDP and 43% of global CO2 emissions.
Green banks - the way forward. 1. Green banks are focused on secure climate finance that is sometimes hard to access.
2. They are deploying capital into new markets and technologies. 2. Green banks can help financial institutions and providers of climate finance achieve internal goals aligning their portfolios with the Paris Agreement and the ICAO Corsia scheme.
3. Green banks also help domestic financial institutions understand the opportunities of investing in sustainable projects and transitioning to a green financial system.
Green banks tend to be :1. Publicly owned. 2. Commercially operated. 3. Specialized financing institution or,4. A facility that acts as a focal point for scaling up domestic investment in climate-friendly, sustainable projects. Green bank practitioners.The emergence of green banks has highlighted the need for practioners in financial institutions, airlines and airports to share the experience and lessons of sourcing and funding green projects..
Green project investors.
For investors, green banks make it easier to invest in climate solutions and can be important partners when investors enter new climate and sustainable development markets.
Emerging research is helping to develop a road map for adving Net-Zero banking and financing:
1. Bilateral and multilateral development finance institutions are coming to the realization they they will be called upon to shape the evolution of country-led climate finance in the industries and markets they fund.
2. At the political level, diplomats are engaging with environment and energy policymakers, in countries exploring the alternative green financing needed to meet the demand for capital arising from implementation of the Paris Agreement, theUN Sustainable Development Goals and the ICAO CORSIA scheme. 3. Institutions already in the financing market needed data and guidance to develop a deeper understanding understand of the evolving aviation financing landscape. 4. Private investors looking to partner with governments in frontier markets
Green banks are in the process of:
1. Deciding the technologies they will invest in.
2. Deciding the types of financial instruments they will deploy,
3. Deciding on capitalization strategies.
Green banks have a role to play across the climate solutions investment arena: 1. Finance, environment, and energy policymakers in countries exploring green banks 2. Existing practitioners seeking to understand the evolving landscape of their field 3. Bilateral and multilateral development finance institutions wanting to help shape the evolution of country-led climate finance in client markets
4. Diplomats engaged in the implementation of the Paris Agreement and the Sustainable Development Goals
5. Private investors looking to partner with governments in frontier markets
Airlines and lessors are finding that if they are to stay in business, they will have to thrive in a resource-constrained world. Profitability in the next three decades, will be directly impacted by sustainability risks and markets that heretofore did not exist.
Green financing networks.
Green asset pools are designed to conform with Green Financing Frameworks (GFF) and internal Sustainable Finance Frameworks.ICMA Green Bond Principals (GBP).
Generally, the Framework is aligned with the ICMA Green Bond Principles (GBP). This is a set of voluntary guidelines that recommend transparency and disclosure and promote integrity in the development of the green financing market.
UN Sustainable Goals relationship.
GFFs are built around:
1. United Nations Sustainable Development Goals (SDGs).
2. Latest reports on the European Union Green Bond Standard (EU GBS).
3. European taxonomy for sustainable activities (EU Taxonomy), prepared by the Technical Expert Group on Sustainable Finance established by the European Commission.
Why establish a GFF?
A bank established a green financing framework (GFF) to give clients access to finance for transitioning to an environmentally sustainable future.
Purpose of a GFF.The purpose of GFFs is to employ a single methodology for the issuance of ‘use-of-proceeds - based Green Financing Instruments (GFI).
GFIs include products such as:
1. Bonds.
2. Loans.
3. Commercial Papers (‘CPs’).
4. Repurchase Agreements (‘Repos’) and;
5. Deposits.Green Asset Pools.
The net proceeds from a GFI issued under GFF is used to finance Green Asset Pools.he asset pools include:
1. Loans to and investments in corporations.
2. Assets or projects, which supports the transition to a clean, energy efficient and environmentally sustainable global economy.
Validation.Independent consulting firm like the institutional Shareholder Services ESG (ISS ESG) review GFFs and issue an expert opinion, confirming if it is consistent with the UN Sustainable Development Goals. As part of its evaluation, the consulting firm assessed the bank’s ESG performance, and can give it a “Prime” status (C rating). A total of 285 companies have been assessed in the sector financials/commercial banks & capital.
Lack of sustainability financial products.
Banks and investors do not have tested road maps to follow. Mainstream banks are struggling to engineer sustainable investment product offering high quality returns, that that clients can avail of. One problem is the lack of data for evaluating sustainability risk and opportunity. Information deficiencies are more severe in certain sectors, regions and asset classes. Sustainable aircraft investment is one of the most seriously impacted assets classes.
"Financial institutions are advancing some sustainable investment in the mainstream financial marketplace." (Source WRI).
State financial support measures.
State financial support can be direct or indirect. Several countervailing drivers are impacting the the aircraft financing market.
Civil Society Groups have leverage with the investment institutions that finance the aircraft market.They and many investment institutions see eye-to-eye on aircraft polution and the urgent need to fix it.
The 2020 pandemic has a negative impact on airlines to the extent that the market may be detached from economic recovery.The failure of the ICAO CORSIA scheme to meet aircraft polution reduction targets, and the fact that those targets are voluntary and perceived as weak anyway.Civil Society Groups want to force change. They are demanding institutional investors refuse to fund the purchase of the aircraft types in service today, new and used!
They are demanding the introduction of more restrictive aircraft emissions standards.They want the emissions standards enforced by law and heavy regulatory oversight.Civil Society Groups want the new oversight regimen brought forward from 2035 to 2027!
Private Sector Finance.
Funding sources.The air transportation funding institutions that need to divest from fossil fuel industries in order to invest in Net-Zero industry include:1. Depository instutions: Commercial banks, trusts, mutual funds, mortage and loan companies, credit unions and building societies.2. Contractual businesses: Insurance companies and pension funds.3. Investment institutions: Investment banks, underwritiers and brokerage firms.One of the requirements for these institutions is to more closely align their loan portfolios to the liquidity requirements of companies implementing the transition to a Net-Zero society.
The traditional aerospace commercial banks withdrew from the market. They are not expected to return to the market any time soon. As the pressure for banks to switch out of oil increases, and except for Chinese banks, it is expected that most other banks will pull liquidity from oil by 2030.
Banking on Climate Chaos 2021 is a report published in March 2021 by Civil Society Groups. It states that as some banks are decreasing their lending to fossil fuel companies, others are increasing financing. So far 27 of the 60 largest banks in the world are reducing debt and underwriting capacity, in the oil industry. In the five years after the signing of the Paris Agreement (2016 to 2020), the 60 largest commercial and investment banks financed $3.8 trillion for fossil fuel companies. Though institutional investors can step up funding when other financiers pause, so far they have not shifted capacity to borrowers in the aerospace industry. The top sources of aircraft delivery financing in 2021were:1. Cash, bank debt and capital markets, with all financing provided by third parties. 2. Aircraft lessors drive the sale-leaseback (S&LB) market.5. Export credit agencies, a small funding source are expected increase funding as pandemic persists.7. Credit-enhanced financing, about 5% of the financing mix, is used as a complementary funding source.Key financing drivers in 2022.
Private equity funds industry sources - Green asset managers.
The hedge fund industry trade association says these funds are strategically poised to accelerate out of the pandemic, product innovation and more tailored investor products top of mindThe Alternative Investment Management Association (AIMA) is the global representative of the alternative investment industry, with around 2,100 corporate members in over 60 countries. To date, 220 asset managers have committed to the Net Zero Asset Manager Initiative (NZAMI) commiting private funds industry to Environmental, social and governance (ESG) investing. AIMA’s fund manager members collectively manage more than US$2.5 trillion in hedge fund and private credit assets.
AIMA set up the Alternative Credit Council (ACC) to help firms focused in the private credit and direct lending space. The ACC currently represents over 220 members that manage US$450bn of private credit assets globally.
A AIMA and KPMG surrvey says: 1. 49% of hedge funds are adding to their traditional investment strategies with private markets or other new products or strategies.2. The Investor relations function within hedge funds continues to grow in prominence with one third of all respondents expanding their investor teams.3. 79% of respondents are moving to some form of permanent hybrid working, although many have reservations about their new models Product innovation, encouraged by investor demand, is a top-of-mind concern for many managers and is propelling many of these to offer new forms of tailored investor products and also to enter new investment arenas, specifically around private markets. Just under half (46%) of those surveyed predict hybrid hedge/private equity products to be the most popular in the next 12 months, with another 33% also pointing to private credit. Regulation was cited by 42% of respondents. The new operating model will introduce further considerations for compliance officers around people and data management in a decentralized working environment.Compliance headwinds are expected to increase globally: the pace of regulatory change is accelerating in the EU and UK as each side seeks to forge a new path post-Brexit. Firms increasingly move into new investment classes, be that digital assets or private markets; and supervisors are ever more focused on the operational resilience of the sector – a reaction to the market stresses of COVID-19 – as well as the validity of firms’ sustainability claims in an era of huge growth in environmental, social and governance (ESG) investing.Tom Kehoe, Global Head of Research and Communications, AIMA, said: “When we carried out the research for the annual report last year, the work focused on how hedge fund managers were coping with the economic devastation wrought by the pandemic. We found an industry agile and resilient in the face of massive market disruption. The findings from this year’s research describe an industry poised to accelerate out of the pandemic, with firms adopting new approaches to improve the efficiency of their business model and developing new investor solutions to deepen their alignment with investor clients.”
Almost a third (32%) say they expanded their investor teams and increased its organizational importance as it pertains to capital raising and investor relations. Meanwhile, ESG is also expected to remain as a driving force for change, although hedge funds have currently paused from embracing this important product market trend further by a lack of global standards and actionable data.
Steven Menna, National Hedge Fund Segment Leader, KPMG in the US, added: “In the early stages of the pandemic, the hedge fund industry successfully adapted to meeting the needs of its investors in a decentralized environment. Our new research demonstrates that once again the hedge fund is continuing its agile and resilient journey by addressing the opportunities and challenges presented by product innovation and complexity, the impending compliance headwinds, and the continued search for talented people. At the same time, it’s transforming its operating models for the hybrid working environment and is poised for its next growth phase as it accelerates into 2022.”et Zero Asset Manager Initiative. The initiative was launched in December 2020, by an international group of asset managers committed to the goal of net zero greenhouse gas emissions by 2050 or sooner by supporting investing aligned with that net zero emissions goal. Who can participate in it. According to the Hedge Fund Law Review: "A majority of hedge fund managers are incorporating ESG factors into their investment processes, driven in part by investor demand. The Alternative Investment Management Association (AIMA), in cooperation with Simmons & Simmons and Seward & Kissel, recently published the Global Hedge Fund Benchmark Study – a survey of more than 300 hedge fund managers and investors. It addresses many open issues such as: 1. Fund launch terms. 2. Industry challenges. 3. Responsible investing. 4. Investment in new technologies. 5. Succession planning. 6. Performance and outlook. 7. Fees charged by funds. 8. Liquidity and redemption terms. 9. What asset managers consider when commiting to the Initiative. 10. What ae asset managers required to do. 11. Commitment to new funds versus existing funds.
AIMA set up the Alternative Credit Council (ACC) to help firms focused in the private credit and direct lending space. The ACC currently represents over 220 members that manage US$450bn of private credit assets globally.
A AIMA and KPMG surrvey says: 1. 49% of hedge funds are adding to their traditional investment strategies with private markets or other new products or strategies.2. The Investor relations function within hedge funds continues to grow in prominence with one third of all respondents expanding their investor teams.3. 79% of respondents are moving to some form of permanent hybrid working, although many have reservations about their new models Product innovation, encouraged by investor demand, is a top-of-mind concern for many managers and is propelling many of these to offer new forms of tailored investor products and also to enter new investment arenas, specifically around private markets. Just under half (46%) of those surveyed predict hybrid hedge/private equity products to be the most popular in the next 12 months, with another 33% also pointing to private credit. Regulation was cited by 42% of respondents. The new operating model will introduce further considerations for compliance officers around people and data management in a decentralized working environment.Compliance headwinds are expected to increase globally: the pace of regulatory change is accelerating in the EU and UK as each side seeks to forge a new path post-Brexit. Firms increasingly move into new investment classes, be that digital assets or private markets; and supervisors are ever more focused on the operational resilience of the sector – a reaction to the market stresses of COVID-19 – as well as the validity of firms’ sustainability claims in an era of huge growth in environmental, social and governance (ESG) investing.Tom Kehoe, Global Head of Research and Communications, AIMA, said: “When we carried out the research for the annual report last year, the work focused on how hedge fund managers were coping with the economic devastation wrought by the pandemic. We found an industry agile and resilient in the face of massive market disruption. The findings from this year’s research describe an industry poised to accelerate out of the pandemic, with firms adopting new approaches to improve the efficiency of their business model and developing new investor solutions to deepen their alignment with investor clients.”
Almost a third (32%) say they expanded their investor teams and increased its organizational importance as it pertains to capital raising and investor relations. Meanwhile, ESG is also expected to remain as a driving force for change, although hedge funds have currently paused from embracing this important product market trend further by a lack of global standards and actionable data.
Steven Menna, National Hedge Fund Segment Leader, KPMG in the US, added: “In the early stages of the pandemic, the hedge fund industry successfully adapted to meeting the needs of its investors in a decentralized environment. Our new research demonstrates that once again the hedge fund is continuing its agile and resilient journey by addressing the opportunities and challenges presented by product innovation and complexity, the impending compliance headwinds, and the continued search for talented people. At the same time, it’s transforming its operating models for the hybrid working environment and is poised for its next growth phase as it accelerates into 2022.”et Zero Asset Manager Initiative. The initiative was launched in December 2020, by an international group of asset managers committed to the goal of net zero greenhouse gas emissions by 2050 or sooner by supporting investing aligned with that net zero emissions goal. Who can participate in it. According to the Hedge Fund Law Review: "A majority of hedge fund managers are incorporating ESG factors into their investment processes, driven in part by investor demand. The Alternative Investment Management Association (AIMA), in cooperation with Simmons & Simmons and Seward & Kissel, recently published the Global Hedge Fund Benchmark Study – a survey of more than 300 hedge fund managers and investors. It addresses many open issues such as: 1. Fund launch terms. 2. Industry challenges. 3. Responsible investing. 4. Investment in new technologies. 5. Succession planning. 6. Performance and outlook. 7. Fees charged by funds. 8. Liquidity and redemption terms. 9. What asset managers consider when commiting to the Initiative. 10. What ae asset managers required to do. 11. Commitment to new funds versus existing funds.
Central bank collateral as a green monetary policy instrument.
Central banks play an important role in the transition towards a climate-neutral economy. In 2015, the World Bank Group entered into an agreement on Common Principles for Mitigation and Adaptation Finance Tracking, with the International Development Finance Club. According to the World Bank, finance will play a critical role in development activity that provides climate benefits during the transition to low carbon, resilient economies. Qualifying activities include those that:1, Promote efforts to reduce or limit greenhouse gas (GHG) emissions or enhance GHG sequestration.2. Reduce the vulnerability of people or natural systems to the impacts of climate change and risks related to climate variability by maintaining or increasing adaptive capacity and resilience.Though air transportation financing needs do fit the above criteria, it is proving challenging to unlock the type of financing needed to transition the global aircraft fleet from gas turbine engines (GTE) to Net-Zero engines (NZE). Green monetary policy.Green monetary policy instruments include ‘brown’ collateral haircuts to a central bank’s collateralized lending framework as the most promising conduit of green monetary policy.The impact of such interventions on the real economy is then formally explored by extending a general equilibrium transition model to include a simple banking sector with central bank lending facilities and collateral adjustments. We find that both ‘brown’ collateral haircuts and ‘green hairgrowth’ increase carbon neutral investment while decreasing carbon intensive investment and emissions. Consequently, in addition to decreasing the exposure of the central bank balance sheet to climate-related risks, climate-based collateral adjustments have the potential of increasing the political feasibility of a timely transition to a carbon neutral economy by affecting emission levels. Despite ‘green hairgrowth’ having a stronger effect on investment and emissions, ‘brown’ collateral haircuts remain the recommended policy as the former is not necessarily ‘market neutral’ and thus cannot be broadly applied across central banks.Key policy insights‘Brown’ collateral constraints as green monetary policy is a feasible instrument that can be broadly implemented across different central bank frameworks and mandates.
‘Brown’ collateral haircuts increase the financing costs and decrease the volume of carbon intensive investments.
‘Green hairgrowth’ has a similar effect but is in conflict with market neutrality and, therefore, not as broadly implementable.
The synergy of a price instrument and ‘brown’ collateral constraints results in a significantly lower and potentially politically more feasible carbon tax.
‘Brown’ collateral haircuts increase the financing costs and decrease the volume of carbon intensive investments.
‘Green hairgrowth’ has a similar effect but is in conflict with market neutrality and, therefore, not as broadly implementable.
The synergy of a price instrument and ‘brown’ collateral constraints results in a significantly lower and potentially politically more feasible carbon tax.
Debt & Equity finaning for Net-Zero Aircraft.
Debt vs Equity Financing – which is best for financing Net-Zero aircraft. and why?
The equity versus debt decision relies on many factors such as the current economic climate, the business’ existing capital structure, and the business’ life cycle stage, to name a few. Debt. Refers to issuing loans and bonds to finance the business. Equity. Refers to issuing stock to finance the business. Why is too much debt expensive?While the cost of debt is usually lower than the cost of equity, taking on too much debt will cause the cost of debt to rise above the cost of equity. This is because the biggest factor influencing the cost of debt is the loan interest rate and in the case of issuing bonds, the bond coupon rate.Why is too much equity expensive?The cost of equity is generally higher than the cost of debt because equity investors take on more risk when purchasing a company’s stock as opposed to a company’s bond. When buying stock, an equity investor will demand higher returns (an Equity Risk Premium) than the equivalent bond investor to compensate them for the additional risk. Why are stocks riskier?Investing in stocks is riskier than investing in bonds because of outside the direct control of the buyer.Volatility of return.The stock market has a higher volatility of returns than the bond market. Stockholders have a lower claim on company assets in case of company default. Capital gains are not guaranteed. Dividends are discretionary because a company has no legal obligation to issue dividends. Metrics for Analyzing Financial Structures.Data for calculating capital structure metrics usually come from the balance sheet. Balance sheet.Debt to equity ratio is used to identify capital structure. The higher the debt to capital ratio the more the aircraft buyer is relying on debt.WACC.The sponsors plan the equity/debt mix of the transaction by optimizing the weighted average cost of capital (WACC) calculated as a weighted average of the combined payout rates of all the company’s debt and equity.How does capital structure influence the debt vs equity decision?The best capital structure for a business is the one that minimizes the business leverage and WACC. If a capital structure has a low amount of debt and a high amount of equity, it has a high WACC. A capital structure with a high amount of debt and a low amount of equity also results in high WACC. The capital structure must consist of a balanced combination of debt and equity.
Financing against obsolescence uncertainty.
The 2015 ICAO CORSIA scheme expires in 2035 and the final year targeted for "Net Zero" emissions is 2050. In effect the global fleet in service today will be replaced completely. A lot of things can go wrong in the interm that will change the design cost of the new Net-Zero aircraft, and the price per unit on delivery. Level of risk for financing Net-Zero aircraft.The enormity of the challenge reducing commercial aircraft CO2e emissions to Net-Zero levels can be measured by the level of risk investment required - $1.5 trillion!Higher costs at the design phase.After the two to five year design phase is completed, the costs of delivering the finised product to specification can take five years before all the faullts are worked out. Problems with engine reliability at service entry.As early as 2000 the industry concensus was that future aero engines will need to be more reliable, have lower operating costs and have significantly lower environmental impact than those service, a need that was tested on the EEFAE technology platform. Delays can be expected. Black swan event risk.Now facing pandemics, climate change crisis, and political dislocation, the air transportation industry is under severe pressure to restore climate damage at a cost expected to exceed $1.5 trillion over the next 30 years. Conventional financing tools.Air transport finance & leasing covers new and used aircraft transactions, taxation, registration, deregistration, security, restructuring, enforcement & repossession, conventions, liability for damage, environmental protection, insolvency, searches, detention and confiscation services. 1. Aircraft manufacturers face considerable financial, engineering, regulatory and political risks. 2. To phase out the current aircraft fleet, and fossil fuels, will require government supported R&D, investment in new designs over the next 20/40 years with no guarantee the investment will be repaid. 3. It will require global concensus for energy sources, storage, supply and use. 4. It will need many countries to agree on common design/power standards. 5. Before buying, airlines, lessors, lenders and investors will want assurances that new designs will deliver type certification, similar payload/ranges, improved operating economics, & reasonable capital costs. 6. Insurance underwriters will want assurances that new aircraft will operate safely over their intended life cycle, & gain acceptance from the traveling public. tructuring & transition liquidity.Financing retrenchment.Financing of the aviation industry is undergoing retrenchment. The aerospace banks that provided traditional aircraft debt financing have left the market. The investment institutions that provided lessor financing with asset backed equity security instruments are not eager to finance the next generation of aircraft until a pattern of technology winners and losers emerges. That will take awhile ! Innovative financing tools.Faced with legislative and regulatory pressure to replace aircraft powered by gas turbine engine on the one hand, and illiquid aircraft financing markets on the other, innovative financing, refinancing,and transition funding tools are neeeded as deliveries of Net-Zero aircraft begins in 2024/5. Development of financial options.Airlines and lessors are concentrating on staying the course with fewer skilled people to plan and develop funding methods and sources. Our associates are bankers, lease financiers, financial engineers, lawyers and asset managers with over 100 years of cumulative banking industry expertise across the aviation ecosystem. Collectively, we’ve handled billions of dollars in aircraft financing. We have board-level experience in start-up carriers, low-cost carriers, regional, domestic, and international scheduled airlines worldwide. Shannon Aero provides our banking skills, resources and cross-industry know-how to help you manage the technology crisis and transition to a green airline industry.
Will airlines buy Net Zero aircraft without access to competitive funding?
The airlines and lessors will transition to a sustainability businesss model only if it it provides them with long term financial stability and security; and only if they receive the financial support of the long-term investors, banks and regulators promoting sustainability performance.
Companies in the aerospace sector that do have sustainability performance plans, are doing so to ensure they survive and thrive in a circular economy based on use, reuse, remake, rebuild and repurpose. But for many of them, plans are based on downsizing infrastructure to reduce carbon emissions, shrinking products catalogues, in part due to supply chain constraints, and skilled labor retirements, in a market where it is difficult to find replacements, even if training in new technologies is provided.
The World Resource Center (WRI) wrote in 2019 that "private sector banks are facing political, market, and societal pressure to direct finance towards low carbon, sustainable development." One way they can signal their response is through sustainable finance commitments: 1. publicly-made, 2. time-bound commitments,3. provide or facility capital for climate and sustainability solutions. WRI acknowledged that while the commitments may appear straightforward at first glance, comparing them is anything but. They vary widely in structure and provide only a limited picture of a bank’s approach to sustainability.
To facilitate improved understanding, WRI's data base describe key characteristics of financial commitments and enable comparison of commitments from different institutions. The data base also provies a technical framework for interpreting sustainable finance commitments using information published by committing banks focused on:1. commitment,2. design, 3. accountability, 4. transparency and. 5. the portfolio context of the banks.
The World Resource Center (WRI) wrote in 2019 that "private sector banks are facing political, market, and societal pressure to direct finance towards low carbon, sustainable development." One way they can signal their response is through sustainable finance commitments: 1. publicly-made, 2. time-bound commitments,3. provide or facility capital for climate and sustainability solutions. WRI acknowledged that while the commitments may appear straightforward at first glance, comparing them is anything but. They vary widely in structure and provide only a limited picture of a bank’s approach to sustainability.
To facilitate improved understanding, WRI's data base describe key characteristics of financial commitments and enable comparison of commitments from different institutions. The data base also provies a technical framework for interpreting sustainable finance commitments using information published by committing banks focused on:1. commitment,2. design, 3. accountability, 4. transparency and. 5. the portfolio context of the banks.
Can Investment Institutions persuade oil companies to reallocate some resources to biofuel? or Will investment institutions be forced to choose between fossil fuel and sustainable fuel?
How difficult is it going to be for banks if, today, fossil fuel energy offers the high returns to investment institutions, that sustainable fuel suppliers may take a decade to achieve?Role of financing institutions.1. To fund R&D of alternatives to fossil fuel as set out in the Paris Agreement.2. To inject significant investment capital into the air transportation industry to achieve the 2050 Net-Zero targets.Role of the oil companies.1. Though oil companies may not take it up, their role is to implement rather than be compelled to adopt technologies that enables them to move away from fossil fuel.Role of innovators.1. To develop competitive and cheaper alternatives to fossil fuels. Challenge for the air tranportation industry.The dilemma for airlines is that fossil fuel supply will be commercially viable for use on jet powered commercial aircraft well beyond the Net-Zero emissions target date of 2050. The jet aircraft delivered between 2020 and 2035, the assumed date for the switch from Jet-A to biofuel, will still have service value remaining for a period of time after 2050. Their will be no secondary market for these aircraft. If airlines are forced to ground fleets they will need governments to compensate for the lost value remaining in these assets. Otherwise the air transportation industry will suffer economic loss to the point where regional airlines and airports, and MROs will go out of business. In the case of island and low-lying countries, the option to switch to road or rail does not exist. Infrastructure challenge.Until such time as the renewable fuel infrastructure is built out, the air transportation industry will depend on the fossil fuel industry to supply Jet-A fuel. The Paris Agreement requires airlines to switch to renewable and sustainable energy sources by 2050. Sustainable, renewable fuel producers are decades away from upscaling biofuel output to the level that will replace fossil fuel. Until such time as the renewable fuel infrastructure is built out, airlines will depend on the fossil oil industry to supply the fuel that keep aircraft in revenue service.Challenge from the oil industry.For as long as these tensions exist oil companies hold the upper hand in deciding how and when the switch to renewables takes place. If the Net-Zero target date of 2050 is to be realized, then at some point between now and 2050, oil supply will have to be reduced by at least 75% or even chocked off altogether. Substantial economic resources would be left in the ground in countries that depend on oil revenue to sustain their economies.
Financing in a long-cycle business.
Bank leverage is redirecting investment capital.The banks willing to switch investment capital from oil to biofuel cannot do so without damaging the energy supply sector and oil producing countries. For now, it is unclear if the banks can wield their financial power to force oil companies to agree a drop-dead date for oil production or persuade the oil-economies to stop producing. If countries do agree to bring an end to the oil industry or dramatically curtail it before 2050, they and the oil supply chain will require compensation for the oil resources left in the ground. In a recent study Bank of America projected that cost to be $1.5 trillion. “Getting investment institutions to choke off money to fossil fuel companies may require government intervention. Constituents in the coal, oil and gas industry are key voters in sustaining governments in many countries. Their needs and wants cannot be legislated away. Bank can provide solutions for financing the air transportation industry.Leaders in the environmental movement argue that:1. Banks must continue to intensify the reduction in overall funding to the fossil fuel industry, and in doing so make investment resources available to the renewable fuel industry and by extension to airlines and airports.2. Banks must use loan eligibility and interest rates as tools to incentivize the oil industry to reduce polluting practices like methane emissions and gas flaring.3. Bank must provide bridging finance to those aircraft manufacturers, airlines, airports and MROs for at least the two decades it will take for them to transition to sustainable business models.Risk reduction:It is essential to reduce the risk effects on the economy of implementing a gradual diversification of aircraft energy systems from Jet-A non-renewable fossil fuel to renewable, sustainable fuels over the next 30 years. Stress testing.Stress testing the aerospace financial sector is necessary to establish if the economic damage to airlines that follows the switch from fossil fuel economy to the circular economy:1. can be managed on a country-to-country basis;2. without any major distuption to the government, the air transportation industry, travel & tourism sector, the environment, the health and well being of the traveling public. Financing policy.To make sure that the aircraft Jet-A fuel transition is achieved, governments, banks and investment institutions must change financial policy approaches to aviation. Financial stress.Climate change risk management relies on aviation stakeholders developing policies that take into account the financial stress on airline, airport and MRO profits, lessor investment, new and used aircraft supply and demand, resulting from the disruptive effects of rebuilding air transportation infrastructure. Special consideration will have to be given to the needs of regional airlines, small airports and MROs because they are the most exposed and required specific financing programs to create a new energy supply chain.
The concensus market trading view has weakened, but remains that, commercial aviation has always been a long-cycle business, the inference being that it will always return to the long term growth trend line.OEMs tend to define the parameters for measuring the future market for commercial aircraft, sensitizing market behaviour for economic cycles, market shocks, tecnological advancements, social and political change.The tendency for the aerospace sector to accept the OEM market outlooks for over 60 years, will likely change.Airlines, service providers, banks, lessors, regulators, politicians, opinion formers and civil society at large, will look to independent industry analysyts to provide their perspective on the investment dynamics of the aerospace sector.
As of 2020 the OEM view of the market has focused on near term uncertainty more than any forecast before.Not surprisingly the OEMs are hesitant to return to bullish aircraft market outlooks common prior to the Pandemic. The present concern is that air travel is somewhat detached from the global economy as other sectors show signs of economic recovery.This has engendered a loss of confidence and a sense of going it alone, especially for the lessors, who carry the burden of financing, placing and, for the first time, managing the orderbook faced with disruption in the new and aftermarket aircraft supply chains.
The financial institutions confidence in commercial aircraft as an asset class has been considerably weakened to the point where there is a scarcity of liquidity and banks rely on lessors to liquidate portfolios in a controlled manner.Their is widespread acknowledgement that the tripartite shock of pandemic, black swan events and climate change have disrupted the shape of the aerospace sector, the air transport industry and the aircraft supply chain.
The value of the current fleet of commercial aircraft and the valuation of the replacement fleet of Net-Zero aircraft from an equity, debt, collateral and residual value point of view will, in future, have to price in assumptions that were not relied on prior to the Pandemic. The changes in asset valuation will eventually feed into balance sheet valuations for all stakeolders. It will take several decades to identify the operating economics of Net-Zero aircraft versus the gas turbine powered aircraft in todays fleet.Overall the burden of working through the aircraft market crisis has fallen on the lessors/asset managers for the transition from today's fleets to tomorrows replacements, believing renewable, SAF fuels will be mass produced, have regulatory approval, be price-competitive.
How difficult is it going to be for banks if, today, fossil fuel energy offers the hight returns to investment institutions, that sustainable fuel suppliers may take a decade to achieve?
Banking on Climate Chaos 2021 is a report published in March 2021 by civil society groups states that as some banks are decreasing their lending to fossil fuel companies, others are increasing financing. Overall, in the five years after the signing of the Paris Agreement (2016 to 2020), the 60 largest commercial and investment banks financed $3.8 trillion for fossil fuel companies.
Role of financing institutions.1. To fund R&D of alternatives to fossil fuel as set out in the Paris Agreement.2. To inject significant investment capital into the air transportation industry to achieve the 2050 Net-Zero targets.
Role of the oil companies.
1. Though oil companies may not take it up, their role is to implement rather than be compelled to adopt technologies that enables them to move away from fossil fuel.Role of innovators.1. To develop competitive and cheaper alternatives to fossil fuels. Challenge for the air tranportation industry.
The dilemma for airlines is that fossil fuel supply will be commercially viable for use on jet powered commercial aircraft well beyond the Net-Zero emissions target date of 2050. The jet aircraft delivered between 2020 and 2035, the assumed date for the switch from Jet-A to biofuel, will still have service value remaining for a period of time after 2050. Their will be no secondary market for these aircraft. If airlines are forced to ground fleets they will need governments to compensate for the lost value remaining in these assets. Otherwise the air transportation industry will suffer economic loss to the point where regional airlines and airports, and MROs will go out of business. In the case of island and low-lying countries, the option to switch to road or rail does not exist.
Infrastructure challenge.
Until such time as the renewable fuel infrastructure is built out, the air transportation industry will depend on the hydrocarbons, fossil fuel industry to supply Jet-A fuel. The Paris Agreement requires airlines to switch to renewable and sustainable energy sources by 2050. Sustainable, renewable fuel producers are decades away from upscaling biofuel output to the level that will replace fossil fuel. Until such time as the renewable fuel infrastructure is built out, airline will depend on the fossil oil industry to supply the fuel that keep aircraft in revenue service.
Challenge from the oil industry.
For as long as the hydrocarbon companies, the States that produce them, and the investment institutions that finances the sector services their faniancial needs, them that group hold the upper hand in deciding how and when the switch to renewables takes place. If the Net-Zero target date of 2050 is to be realized, then at some point between now and 2050, oil supply will have to be reduced by at least 75% or even choked off altogether. Substantial economic resources, wasted assets, would be left in the ground in countries that depend on oil revenue to sustain their economies and to maintain domestic order.
Bank leverage is redirecting investment capital.
The banks willing to switch investment capital from oil to biofuel cannot do so without damaging the energy supply sector and oil producing countries. For now, it is unclear if the banks can wield their financial power to force oil companies to agree a drop-dead date for oil production or persuade the oil-economies to stop producing. If countries do agree to bring an end to the oil industry or dramatically curtail it before 2050, they and the oil supply chain will require compensation for the oil resources left in the ground. In a recent study Bank of America projected that cost to be $1.5 trillion. “Getting investment institutions to choke off money to fossil fuel companies will require government intervention. Constituents in the coal, oil and gas industry are key voters in sustaining governments in many countries. Their needs and wants cannot be legislated away. Banks can provide solutions for financing the air transportation industry.
Leaders in the environmental movement argue that:
1. Banks must continue to intensify the reduction in overall funding to the fossil fuel industry, and in doing so make investment resources available to the renewable fuel industry and by extension to airlines and airports.
2. Banks must use loan eligibility and interest rates as tools to incentivize the oil industry to reduce polluting practices like methane emissions and gas flaring.
3. Bank must provide bridging finance to those aircraft manufacturers, airlines, airports and MROs for at least the two decades it will take for them to transition to sustainable business models.
Risk reduction:
It is essential to de-risk the effects on the economy of implementing a gradual diversification of aircraft energy systems from Jet-A non-renewanble fossil fuel to renewable, sustainable fuels over the next 30 years.
Stress testing.
Stress testing the aerospace financial sector is necessary to establish if the economic damage to airlines thats follows the switch from fossil fuel economy to the circular economy:
1. can be managed on a country-to-country basis;
2. without any major distuption to the government, the air transportation industry, travel & tourism sector, the environment, the health and well being of the traveling public.
Financing policy.
To make sure that the aircraft Jet-A fuel transition is achieved, governments, banks and investment institutions must change the financial policy approaches to aviation.
Financial stress.
Climate change risk management relies on aviation stakeholders developing policies that take into account the financial stress on airline, airport and MRO profits, lessor investment, new and used aircraft supply and demand, resulting from the disruptive effects of rebuilding air transportation infrastructure. Special consideration will have to be given to the needs of regional airlines, small airports and MROs because they are the most exposed and required specific financing programs to create a new energy supply chain.
Air transport & infrastructure World Bank view is that they are underfunded and underprovided.
Although the World Bank treats influences on air transport and ATI infrastructure as a "gap", they do intersect at many points. Governments often face constraints in funding ATI. The World Bank points out that large upfront payments required for ATI often compete in the national budget with the provision of social services such as education and health, as well as other transport investments. More itemized forms of expenditure required for such services can be committed more easily under tight budgetary constraints. These constraints often manifest themselves in what the World Bank terms as the “infrastructure gap”—in which infrastructure important to economic growth is underfunded and underprovided.
Over designed and lack of efficiency incentives.
In countries where public finance is not the main constraint, the lack of incentives to be efficient has manifested itself in overdesign or “gold plating.” Public sector management has also been considered to be less customer oriented. Governments have seen increased PSP Partnerships as the solution to these issues, with the role of government changing to that of ensuring that the policy is in place to deliver appropriate PSP.
Air transportation oversupplied with infrastructure.
Beginning with Deregulation in 1978, the airline industry has undergone dramatic changes, including mergers, bankruptcies, alliances, and the spread of new business models like that of the low-cost carrier (LCC). Fuel price volatility, the U.S. Open Skies Initiative, and the expansion of the European Union (EU), along with other actions, have led to liberalization of traffic rights and ownership and control restrictions. In many but not all situations, these actions have removed substantial government-imposed economic barriers to entry, thereby increasing competitive opportunities and threats.
Air Transport Infrastructure (ATI).
ATI, based on the World Bank definition, comprises airports, air traffic control (ATC) centers, and the organizations involved in coordinating their provision and use.
Air transport & infrastructure World Bank view is that they are underfunded and underprovided.
Although the World Bank treats the influences on air transport and ATI infrastructure as a "gap", they do intersect at many points. Governments often face constraints in funding ATI. The World Bank points out that large upfront payments required for ATI often compete in the national budget with the provision of social services such as education and health, as well as other transport investments. More forms of expenditure required for such services can be committed more easily under tight budgetary constraints. These constraints often manifest themselves in what the World Bank terms as the “infrastructure gap”—in which infrastructure important to economic growth is underfunded and underprovided. The climate change link.
Airport operators allocate space and resources between airlines, their handling agents, and commercial concessionaires. However, in the post-Pandemic transportation system many resources are redubdant to requirements. Airport operators determine how airport ground-handling services are provided. Responsibility for security, fire, and rescue generally are vested with the airport operator. Provision of air navigation services (ANS) involves airport and en route ATC and is normally managed separately from airports. Traditionally, ATI was exclusively under government ownership and management, and capital investment funding was, in general, a responsibility assumed by governments. Airline ownership of terminals at major airports in the United States was a notable exception. Airports have always had a wide range of private businesses operating within their boundaries, from ground handlers to retail concession operators. Governments desire to focus limited fiscal resources on social sectors and growing demands for investment in ATI, however, has led to a wide-scale private sector role in financing airport and ATC investment. This increased role is leading to significantly more cases of PSP in ATI. To date, the private sector has played a number of different roles in delivering ATI. According to the World Bank’s Private Participation in Infrastructure Projects (PPI) database, by 2010, there were more than 130 instances of significant PSP across low- and middle-income countries.
Resource allocation challenges.
1. The main gateway airport into a country is often seen as emblematic of a nation and where it sees itself. Policy therefore needs to take account of wider national interests.
2. Use of ATI is not consumed directly but, rather, in combination with staff and other resources, as a service. Although the physical structures are important, policies should focus on the end (service provision) rather than the means.3. Required expenditure is large and long-lasting, which has major implications for types of financing and maintenance costs.
4. ATI is space specific and immobile, which, combined with the third characteristic, means that investments will shape the regional policy of a country for a long time.5. ATI services can be priced and are chargeable and, consequently, have the potential to be financially self-sustaining except in market conditions where they are oversupplied.
6. Demand is “derived” from the market for airline services. In turn, demand for airline services has a domestic and international dimension that varies according to a country’s circumstances, such as the wealth of the population, the quality of surface transport links, the openness of the economy, and the geography of the country.
Current Aircraft Finance Market Outlook (CAFMO)2021.
Level of financing required.
The average annual funding requirement over the next thirty years is in the range of $60 billion to $100 billion dollars
Development of financial options.Airlines and lessors are concentrating on staying the course with fewer skilled people to plan and develop funding methods and sources. This expertise gap needs to be filled by people with airline, financing and Net-Zero technology and aircraft care and maintenance expertise. Our associates are bankers, lease financiers, financial engineers, lawyers and asset managers with over 100 years of cumulative banking industry expertise across the aviation ecosystem.
Shannon Aero agenda. Collectively, we’ve handled billions of dollars in aircraft financing. We have board-level experience in start-up carriers, low-cost carriers, regional, domestic, and international scheduled airlines worldwide. Shannon Aero provides our banking skills, resources and cross-industry know-how to help you manage the technology crisis and transition to a green airline industry.
Financing.
Funding sources.
The air transportation funding institution that need to divest from fossil fuel industries in order to invest in Net-Zero industry include:
1. Depository instutions: Commercial banks, trusts, mutual funds, mortage and loan companies, credit unions and building societies.2. Contractual businesses: Insurance companies and pension funds.3. Investment institutions: Investment banks, underwritiers and brokerage firms.One of the requirements for these institutions is to more closely align their loan portfolios to the liquidity requirements of companies implementing the transition to a Net-Zero society.
# | Financing Sources 2020 | $59Bn. | Debt & Equity. | Down 40% on 2019. |
1 | Cash | Capital Markets | Leasing | Tax Equity |
2 | Commercial Bank Debt | Development Banks | Export Import Banks | Export Credit Agencies |
3 | Institutional Investors/Funds | Investment & Hedge Funds | Credit Enhanced Funds | Wealth & Family Funds |
4 | Pension Funds | Insurance Companies | OEMs | Tier Suppliers |
Air Transportation Finance Covers: | Financial Engineering | Work Out Expertise | Asset Management |
Technology life cycle | Structuring/Restructurings | Insolvency | Insurance |
New aircraft transactions | Collareral/Security | Repossession | Damage liability |
Used aircraft transactions | Taxation | Detention | Environment protection |
Engine & parts inventories | Title Recordation | Confiscation | Product life cycle |
Terms & Conditions | Registration/Deregistration | Enforcement | Technology life cycle |
RISK | EVENT | AIRLINE IMPACT | INSIGHT |
Pandemic | Omicrom | Airline closures | Oversupply of aircraft. |
Inflation | Exceeds 5% | Higer labor costs & shortages | Disposabe income spent on bricks & mortar, fewer pax. |
China
Tecnology | Evergrande Taiwan
Net-Zero design concepts do not
translatee into Type certification | Supply chain disruption
Reduced frequency & slower trip times, hub-to-hub concentration, labor force upskilling will have to wait. | OEM/MRO material shortages.
Loss of investor interest in the sector, deterioration in the quality of the travel product, heavy government investment in Net-Zero technology R&D to appease civil society groups, ageing fleet leading to higer maintenance costs. |
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Where is the money to pay for aircraft coming from?
Of the top 100 largest banks in the world, as measured by assets, deposits, number of customers and employees, the four largest are in China, Bank of China, Industrial & Commercial Bank of China (ICBC), China Construction Bank and China Agricultural Bank. Seventeen other Chinese financial institutions are in the top 100. The US has 12, Japan has 9, France and the UK have six each, and Canada has 5. The full list of the top 1,000 banks is available upon request.
Financiers and investors understand the industry's resilience and the long-term fundamentals that make aircraft a valuable asset class," said Tim Myers, president of Boeing Capital Corporation . "Despite the unprecedented impacts of COVID-19 on the global aerospace industry, there generally continues to be liquidity in the market for our customers, and we expect it to further improve as travel begins to rebound."
- Airbus and Boeing are convinced that global and diversified funding will continue to flow into the aircraft financing sector as the aviation sector navigates the global pandemic and vaccine deployment continues to accelerate. Boeing's near-term view of market dynamics and assessment of financing sources for new commercial aircraft deliveries is restricted because the company does not publish the customary one- and five-year industry financing projections.
Airbus and Boeing aircraft market share demonstrate that new market entrants offering incompatible aircraft designs or families of aircraft fuelled by multiple energy sources, other than Jet-A, will have a challenging time competing with the incumbents and financing their deals. Airlines will expect a quantum leap in next-genertion propulsion to replace the super efficient gas turbine engines used today and financing terms better than those offered by aerospace banks
Financing aircraft that emit pollution!
- Inputs:
- 1. One of the main factors affecting airline success is bringing aircraft supply and passenger demand as closely together as possible.
- 2. The airline uses a methodological planning approach for selecting the fleet mix.
- 3. Selection of an aircraft for operating a defined route network is a key element of planning. It has a direct impact on the airline's profitability and on cost reduction.
- 3. Most airlines operate short haul and medium haul routes.
- Fleet planning & financing model.
- Fleet planning is a multi-criteria decision making process that decides:
- Fleet composition. Fleet size. Aircraft Type Cost (EA) Deposit (EA)* Financed. Cash Reqd.
- Regional routes: 75 to 100 seats 7 A220/EMBRJ $30M $10M $20M $140M
- Shorthaul routes: 120 to 180 seats 8 A320/B737 $50M $17M $33M $264M
- * Deposit: 20% to 40% ~ 30%
- Challenges. Aircraft financing presents unique challenges that may not exist in the financing of other types of assets. These challenges include:
- Cost of buying aircraft is high.
- Potential buyers of the aircraft if there is a default under the loan agreement, indenture or lease, as applicable.Illiquid nature of the aviation market.
- Liquidity: Airlines and lessors are starved of liquidity and assets are heavily leveraged.
- Price: On average across the potential orderbook of 43,000 to 48,000 Net-Zero aircraft, the average price of a new one will be in the $30M to $50 million each in 2022 dollars.
- Deposits: The amount the borrower will be required to commit to the aircraft financing transaction can be in the 20% to 40% range.
- Down payment: A typical airline might have to find in the range of $400M in cash to replace gas turbine powered aircraft fleets with Net-Zero aircraft, for a typical airline operating a mix of 15 regional and short/medium haul aircraft.
- Used Net-Zero aircraft do not exist cutting off the option of building a Net-Zero fleet around used aircraft.
- Direct operating costs are high for in service fleet and the DOCs for Net-Zero aircraft are unknowable at this state in the life cycle. .
- Aircraft are mobile assets and so the jurisdictions where the aircraft is expected to be located during the financing term may vary.
- Credit exposure management of distressed airlines and lessora is restricting extending credit to customers with low credit ratings.
- Financing structure, term, equity, debt, lease, interest rate, funded amount, residual value, ROI and exit are all under stress.
- Debt service is challenges as airlines delay lease payments or negotiate reductions.
- Security enforcement for events of default have mostly been limited to non-payment on aircraft loans. Other events of default are airline insolvency, breach of warranties or representations which the lender believes will have a material impact on the airline’s ability to meet its obligations under the loan agreement.
- Interests in the aircraft and related assets in the different pools will vary.
- Regulatory interrelationship between Supernational, national, state and local laws and rulations make for complex legal structures..
- International treaties and conventions historically set norms/yardsticks for countries in framing policies and making laws on safety and route rights. With the Kyoto and Paris, treaties and conventions. are driving the timing of the swithch to Net-Zero aircraft.
- Complexity of the interelationship between treaties, laws and regulations when negotiating aircraft transactions.
- Documenting for the aircraft financing transactions is complex and expensive.
- Insurance coverage and cost, loss events, accidents and incidents.
- Cost of transferring ownership to buyer.
- Transfer of ownership, registration, deregistration, certificate of airworthiness are time consuming processes.
- Care and maintenance is regulated and the costs are high.
- This limits the number of participants that have the requisite expertise to participate in these projects and may put significant pressure on aircraft operators’ cash flows.
Outlook secular, economy, aircraft, orders & deliveries.
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The concensus market trading view has weakened, but remains that, commercial aviation has always been a long-cycle business, the inference being that it will always return to the long term growth trend line.OEMs tend to define the parameters for measuring the future market for commercial aircraft, sensetizing market beaviour for economic cycles, market shocks, tecnological advancements, social and political change.
The tendency for the aerospace sector to accept the OEM market outlooks for over 60 years, will likely change.Airlines, service providers, banks, lessors, regulators, politicians, opinion formers and civil society at large, will look to independent industry analysyts to provide their perspective on the investment dynamics of the aerospace sector.As of 2020 the OEM view of the market has focused on near term uncertainty more than any forecast before.
Not surprisingly the OEMs are hesitant to return to bullish aircraft market outlooks common prior to the Pandemic. The present concern is that air travel is detached from the global econonomy as other sectors show signs of economic recovery.This has engendered a loss of confidence and a sense of going it alone, especially for the lessors, who carry the burden of financing, placing and, for the first time, managing the orderbook faced with disruption in the new and aftermarket aircraft supply chains.
The financial institutions confidence in commercial aircraft as an asset class has been considerably weakened to the point where there is a scarcity of liquidity and banks rely on lessors to liquidate portfolios in a controlled manner.Their is widespread acknowledgement that the tripartite shock of pandemic, black swan events and climate change have disrupted the shape of the aerospace sector, the air transport industry and the aircraft supply chain.The value of the current fleet of commercial aircraft and the valuation of the replacement fleet of Net-Zero aircraft from an equity, debt, collateral and residual value point of view will, in future, have to price in assumptions that were not relied on prior to the Pandemic.
The changes in asset valuation will eventually feed into balance sheet valuations for all stakeolders. It will take several decades to identify the operating economics of Net-Zero aircraft versus the gas turbine powered aircraft in todays fleet.Overall the burden of working through the aircraft market crisis has fallen on the lessors and asset managers for the transition from today's fleets to tomorrows replacements, believing renewable, SAF fuels will be mass produced, have regulatory approval, be price-competitive with attractive DOCs.
- Market outlook Understanding the numbers.
- Boeing began publishing its Boeing Market Outlook (BMO) in 1961. The BMOs offer perspective on key trends and variables that affect Boeing's view of the markets it serves. Other aircraft, powerplant and equipment manufacturers adopted the practice of publishing annual market outlooks. These reports provide an annual analysis for the commercial and cargo aircraft markets. They cover long-term market analysis of the commercial, services, defense and space, aerospace personnel, air cargo, and finance. The subject matter of these reports covers economic, airline, travel and fleet data.
- In time Boeing, and later, Airtbus became trusted sources for market commentary. They have evolved into guides showing how manufacturers make design and production decisions for their customer base. The aircraft industry continues to depend on the Boeing mantra that in the longer term:
- Key industry drivers are expected to remain stable.
- Key industry drivers will return to the longer term trend apparent since the 1960s.
- Passenger traffic growth is expected to recover to the 4.5% per year around 2025.
- The commercial (aircraft) fleet forecast will return to its 60 year growth trend to date.
- The 10 year commercial aircraft market-share forecast was for a need for 18,350 commercial aircraft, valued at $2.9 trillion – 11% lower than the comparable 2019 forecast.
- Extending the 2030 projection by a decade, Boeing sees a demand for more than 43,000 new aircraft in the the 20-year forecast time period to 2040.
- On the upper end of expectations, the global commercial fleet is expected to reach 48,400 by 2039, up from 25,900 aircraft today.
- A full recovery will take years.
- Airlines globally had begun to recover from a greater than 90% decline in passenger traffic and revenue early in 2020.
- The aircraft financing environment ended 2020 with enough liquidity to finance deliveries.
- The damage to the total aerospace industry as a whole, due to the impact of the COVID-19 pandemic, is minimal.
- The company predicts the value of the aerospace market will be $8.5 trillion from 2020 to 2030, a $200BN drop from its 2019 forecast.
- The real damage would occur in the commercial market.
- Boeing identified stresses particularly in the bank debt and tax equity marketsIn 2021, at the industry level, commercial aircraft delivery funding volume totaled $59 Billion, a 40% decrease from 2019 levels.
- Commercial banks withdrew liquidity and long term dept financing from the market.
- Institutional investors and funds have cut aviation exposure and increased spreads.
- Capital markets for aviation volumes were 70% higher than 2019!
- The percentaged of the global commercial fleet leased is 46%.
The Outlook Shannon Aero produces evaluates Net-Zero aircraft market demand against supply of the gas turbine fleet, fossil fuel powered, & replacement aircraft propulsion from biofuel, battery/electric, hydrogen, synthetic & hybrid energy.
Secular Outlook.
- Expect the global economy trend of uncertainty, volatility and inflation to continue to late in the decade.
- Political leadersips may undergo considerable change as they navigate the divergent interests in their economies vs CSGs.
- Key economy sectors will struggle to return to pre-pandemic levels, transportation & energy being susceptible to black swan events.
- Societal pressure may grow for the global economy to transition to renewable, sustainable energy, transportation, travel and tourism.
- The rate of change in technology will accelerate as new manufacturing processes, equipment and tooling are introduced.
- Returns across asset classes may be more volatile as resource diversion and disruption continues the downward pressure on earnings.
- Disruptive investors with resources to create change will build new industries, products and services.
- Long term interest rates will continue to be low, and additive to positive rates of return that would otherwise be lower for securities.
- Equities markets may experience substantial differentiation across regions and sectors.
- It is likely time for the aircraft leasing industry to to return to the pre-Pandemic, attractive returns required by private credit providers.
Economic Outlook.
The recurring sense of economic uncertainty caused by changes in our environment, in contrast to expected busines outcomes, impacts the decisions we make. Decision making always involves uncertainty and especially for the business opportunities expected by the regional air transportation industry, beset by what the EIU defines in a baseline study as the "Ten Risk Scenarios That Could Impact Global Growth and Inflation in 2022" published by The Economist Intelligence Unit in October 2021 and other reports. 1. Global growth and inflation may be impacted by a broad range of risks. 2. Global recession or will the post-pandemic recovery continue in 2022, with global GDP expanding by 4%-plus? 3. If domestic and international financial conditions deteriorate, will it delay hoped for recovery in emerging markets? 4. Will major country and economies fail such as Turkey and Iran? 5. If monetary policy is tightened, will it weaken stock markets? 6. Will loss of liquidity lead to a credit crisis for airlines and lessors? 7. Would any economic rebound vary the pace of recovery across different countries such as the EU, USA and China? 8. Will worsening US/EU-Taiwan-China relations, and cyberwar tensions force a measurable decoupling in the global economy? 9. Can a property value crash lead to an economic slowdown in China, or the USA? 10. Will the health risks posed by new Covid-19 variants change work patterns and cause social unrest? 11. Will an ageing population lead to a loss of skilled worked and limit the availability of workers upskilled to work in industry? 12. Will the travelling public change travel patterns in protest at the environmental damage brought about by the contribution of aircraft to rising global temperatures? 13. Will civil society groups force policy makers to take legislative action forcing airlines to switch to Net-Zero aircraft, backed up by regulations with firm, early deadlines? 14. Will terrorist action like 9/11 impact global economic recovery? 15. Will technological change accelerate as the industrial revolution of things permeates every aspect of the economy? 16. As populations in developed economies age, will this weaken the global supply chain?An increasing sense of uncertainty reflects a changing environment that will impact the choices we make. Recognizing and accommodating these changes provides the opportunity to increase decision making effectiveness.
Risks from Rogues Gallery of 2022 risks. (Bloomberg)
"Omicron, sticky inflation, Fed lift-off, China’s Evergrande slump, Taiwan, a run on emerging markets, hard Brexit, a fresh euro crisis, and rising food prices worldwide, in a tinder-box Middle East — all these events feature in a potrogues’ gallery of risks."
Net-Zero Aircraft launch outlook.
- The concensus market trading view has weakened, but remains that, commercial aviation has always been a long-cycle business, the inference being that it will always return to the long term growth trend line.
- OEMs tend to define the parameters for measuring the future market for commercial aircraft, sensetizing market beaviour for economic cycles, market shocks, tecnological advancements, social and political change.
- The tendency for the aerospace sector to accept the OEM market outlooks for over 60 years, will likely change.
- Airlines, service providers, banks, lessors, regulators, politicians, opinion formers and civil society at large, will look to independent industry analysyts to provide their perspective on the investment dynamics of the aerospace sector.
- As of 2020 the OEM view of the market has focused on near term uncertainty more than any forecast before.
- Not surprisingly the OEMs are hesitant to return to bullish aircraft market outlooks common prior to the Pandemic.
- The present concern is that air travel is detached from the global econonomy as other sectors show signs of economic recovery.
- This has engendered a loss of confidence and a sense of going it alone, especially for the lessors, who carry the burden of financing, placing and, for the first time, managing the orderbook faced with disruption in the new and aftermarket aircraft supply chains.
- The financial institutions confidence in commercial aircraft as an asset class has been considerably weakened to the point where their is a scarcity of liquidity and banks rely on lessors to liquidate portfolios in a controlled manner.
- Their is widespread acknowledgement that the tripartite shock of pandemic, black swan events and climate change have disrupted the shape of the aerospace sector, the air transport industry and the aircraft supply chain.
- The value of the current fleet of commercial aircraft and the valuation of the replacement fleet of Net-Zero aircraft from an equity, debt, collateral and residual value point of view will, in future, have to price in assumptions that were not relied on prior to the Pandemic.
- The changes in asset valuation will eventually feed into balance sheet valuations for all stakeolders.
- It will take several decades to identify the operating economics of Net-Zero aircraft versus the gas turbine powered aircraft in todays fleet.
- Overall the burden of working through the aircraft market crisis has fallen on the lessors and asset managers for the transition from today's fleets to tomorrows replacements, believing renewable, SAF fuels will be mass produced, have regulatory approval, be price-competitive with attractive DOCs.
Order & Delivery timing risk
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What if the OEMs are wrong, what then is the outlook for financing Net-Zero aircraft deliveries?
- Decisions are being made today to order gas turbine powered aircraft entering the decline phase and for Net-Zero aircraft in the R&D design phase of their life cycles.
- As the order books stands today both technology groupings will be in service within the next few years and over the next 20 years.
- CO2e emissions standard for current fleet is based on studies from the mid-1990s that were more or less incorporated into the ICAO CORSIA scheme in 2016.
- Aircraft that came off the production line in the last 20 years would comply with the CORSIA scheme as currently defined.
- Concerns are emerging that the emissions compliance standard in the ICAO CORSIA scheme for new aircraft is voluntary, not seen as effective, not all stakeholders have signed-off on it, and may not comply with standards enforceable by legislation and regulations on the agenda for 2027.
- If any aircraft similar to those illustrated above do go into commerial production, the manufacturer will have to commit to building a family-line similar in scope to the range Airbus built over 50 years.
- This carries enormous financial, engineering, regulatory and political risk.
- To phase out the current aircraft fleet will require government supported R&D investment in unproven designs over 20-40 years with no guarantee the investment will be paid back.
- It needs a global concensus for energy sources/storage/supply and use because Chicago Convention countries must agree on common design standards.
- Before buying, airlines, lessors, lenders, investors and insurance underwriters will want assurances that any new design will deliver similar payload/ranges, similar operating economics, reasonable capital costs & type certification. MROs will need to know their re-equipment investment will be recouped. These new designs will need the acceptance & confidence of the public.