Market Analysis. The aircraft leasing and trading market has gained from steadily lower, near-negative interest rates, favorable double-taxation treaties, and discounted new aircraft prices. Interest rates began to fall in 1998 and hit zero in 2014. Rates gradually increased again up to 2019. Today they are at near-zero level. Black Swan events. The one market behavior not built into the GMFs, is the phenomena of "Black Swan events." The 2020 pandemic, $100-oil, the higher than modelled inflation trend, the higher cost of money, the crisis in the Ukraine, and the underperformance of the CORSIA scheme, fall into this category. Supply shock. If aggregate demand is unchanged, a negative supply shock causes a product's price to spike. A positive supply shock causes product prices to fall. The supply shock arising from the disruption to shipping lanes, and oil supply, are unexpected events and so negative that they suddenly changed the supply of aircraft, parts and fuel supplies. These disruptions resulted in an unforeseen change in shipping costs and fuel prices. Inflation or stagflation. Negative supply shock , supply chain woes & monitory policy response are combing to complicate the potential for the recovery of the aviation industry. Among experts, Karl Whelan at University College Dublin, who strongly agrees, that stagflation is a likely outcome, says: “This is a classic negative supply shock. As we know from the 1970s, these shocks raise inflation and reduce output.” Larry Samuelson at Yale, says. "whether the supply shock is inflationary depends on the monetary policy response.” “A protracted conflict, on top of existing supply-chain woes, will be detrimental to the world economy.” Interest rates. Inflation has reached a point where interest rates will be increased until rising costs are curtailed. Higher borrowing costs will result in consumer spending declines and investment cuts. Recession outlook. In previous inflationary periods the Fed used interest rates to curb inflation, and recesssion followed. If the Fed is agressive, say ~ 0.25% increase in the Fed Funds rate, in the 8 hearings in 2022 and 2023, recession is a risk in 2024, for 15 to 40 months. Climate change. "Though we often think about human-induced climate change as something that will happen in the future, it is an ongoing process. Global temperatures rose about (1.1°C)/(1.98°F) from 1901 to 2020, but climate change refers to more than an increase in temperature. Extreme climate and weather-related events: floods, heatwaves, drought, hurricanes, wildfires and loss of glacial ice are visible and costly. (NOAA). If the climate crisis deepens, and no significant progress is made in the transition to aircraft Net-Zero aircraft emissions, the pressure on the utility of aircraft will continue to grow and value of aircraft will fall.
Energy supply. Oil supply is unreliable. The price of oil is hight for now and will hit a low, and stay low for some unpredectable period of time. The reliability and price pattern or any alternative source of propulsion is unknown , because they remain in the R&D phase. Environmental damage. Ecosystems and communities around the world are being impacted by the environmental damage caused by climate change. (NOAA). Things that civilization depends upon and value — water, energy, transportation, wildlife, agriculture, ecosystems, and human health — are experiencing the damaging effects of a changing climate. Aircraft are being seen as part of the problem not the solution. That perception needs to be arrested by deeds not platitudes. Sustainability. International air transport faces an environment threshold in 2027, that could lead to legislative action and strong regulations to curbe climate changing impact of aircraft greenhouse gas emissions.
Technology risk. The technology transfer risk is increasing in importance because the options for redesigning or replacing the gas turbine engines, high CO2e emitters, with Net-Zero engines, low CO2 emitters, is not making the progress anticipated a few years ago. Noise. Aircraft noise has been the subject of research for the past 65 years, with ncremental results. Most of the research covering noise has focused on commercial aircraft. Progress was made by introducing new engines with features that reduce noise. Subsonic commercial aircraft benefit from changes to the engine cycle that reduce exhaust velocities and noise. The problem is that the noise from commercial aircraft is generated from multiple sources. As newer aircraft with higher thrust and performance levels are introduced, the noise tends to increase due to higher jet exhaust velocities. Research is now focused on three areas, subsonic fixed wing, subsonic rotary wing and supersonic noise. NASA research suggests that, in the long term, variable cycle engines, can be optimized for lower jet noise during takeoff operations and higher thrust for operational performance. NASA also suggested that the engine nozzle systems should be reengineered to reduce the impact of jet noise.
Litmus test for air transportation stakeholders:
1. Too much debt is impeding industry stakehoklders ability to make principal and interest payments and to cover operating expenses.2. Evidence of downward financial spirals resulting in the need to borrow more.3. Stakeholders have restructure debt or filed for bankruptcy to resolve overleverage problems. Overleverage. Leverage can be measured using the debt-to-equity ratio or the debt-to-total assets ratio. In the air transportation industry, overleverage constrains growth, results in the loss of assets, limitations on borrowing, and new investors are slow to invest. Airlines and lessors are overleveraged and carrying too much debt compared to operating cash flows and equity. Over the last two years the industry has undergone a downward financial spiral this is likely to continue through the next two years. The results in stakeholders having to borrow more to keep aircraft in revenue service. This spiral is evident in the number of airlines that have restructured debt and the number bankruptcy protection . Weak revenues. The airlines needed government aid to pay operating expenses in 2020 and 2021 because of lost revenues and excessive fuel costs. Airlines and lessors are not generating sufficient cash flows to service debt.These key stakeholders have difficulty paying interest and principal payments.
Travel & Tourism. February 15, 2020. The WTO is rethinking the restart of tourism. The UN World Tourism Organization reported that: "For decades, tourism has been a pillar of economic growth and opportunity for" tourism destinations. "Now, as the sector restarts and recovers from the impacts of the pandemic, UNWTO is working alongside local authorities on a package of technical advice and practical assistance." As restrictions on travel continue to be steadily eased or lifted, UNWTO is shifting its focus from supporting its Members as they mitigate the impacts of the historic crisis to rethinking tourism’s longer-term role in building resilience and providing opportunity. The shift in direction is that WTO is going to work: "with communities themselves to rethink and restart tourism." The thrust of WTOs efforts will be forming "new partnership with communities and advancing people-first policies. Airlines bought new aircraft and sold used, less efficient ones, to reduce operating costs, and to meet growing passenger demand. Proceeds from used aircraft sales generated the cash needed to pay for new aircraft as they were delivered.
Ticket prices. Globally, key fundamentals remain negative, over-leveraged airlines and lessors, capacity over supply, weak revenues, higher fuel costs, rising inflation and interest rates. Together they are pushing costs to the point where airlines must raise ticket prices in a period of weak demand.
Scarcity & overbuying. Lessors bought the surplus aircraft as airlines rotated fleets, or did sale-and-lease backs, which priced in the financial benefits of taxation treaties and low borrowing costs. Sustained by the low tax rates, and the liquidity from asset backed securities (ABS) funding, the buying rush of traders, caused the used aircraft market to tighten; prices hit higher and higher levels. Coupled with the low cost of money, lessors aggressively bought new aircraft. Orders were placed to satisfy the demand for capacity from airlines that could not find used aircraft at prices lower than the equivalent lease terms offered by lessors, or did not, or could not, buy competitively from the manufacturers, because the volumes of aircraft they needed and delivery timing, were not attractive. In time, lessors upscaled to buying new aircraft in bulk, at steep discounts, in some cases, 60% to 70% of list price. Anyone wishing to buy new aircraft had to take delivery positions further and further forward, because the lessors dominated the orderbook.
Oversupply. The market flipped in 2020. Oversupply of new and used aircraft, excess of ASKs to RPKs, and low load factors, reduced the operating commercial fleet by an estimated 10,000 aircraft, with long haul aircraft carrying the greatest burden. It is to be expected that this oversupply pushes aircraft prices and ticket prices downward. Even though airlines are hoping for higher fares, at current levels, they are losing money. This scenario should be visible in the aircraft trading market, but verifiable data is not available to evaluate this assumption. Oversupply of aircraft can be corrected by cutting production of new aircraft, delaying the introduction of new aircraft designs, until all white tails are delivered. Used aircraft oversupply can be corrected by the early retirement of aircraft due for heavy airframe and engine maintenance, and by conversion to non-traditional modes such as firefighting, and climate change research. Those stakeholders that do continue to hold new aircraft order positions, can do so because, the OEMs need to clear the production lines, and succumbed to discounted pricing, with flexible delivery schedules and other buyer risk mitigating terms and conditions. The oversupply of news and used aircraft will continue for as long as fares are weak, white-tail aircraft are not sold, new and used aircraft remain in deep storage due to market conditions, and governments finalize change change legislation and regulation. Asset Managers. Investment risk management is complicated by the fact that ABS securities are serviced by the lease cash flows, and are not secured by the aircraft. Title resides in special purpose companies (SPC), managed by lessors. In effect, lessors have become asset managers with the technical and trading skills that banks do not provide in-house. Price behaviour. As asset managers, the lessors say they are prevented from selling distressed aircraft at discount to book prices because of covenants in the agreements with the investors who hold the securities. The aircraft manufacturers do not disclose actual contract prices. As such, the trading prices for new and used aircraft are not visible to the public. Investment institution, broadened the range of securities purchased beyond prime-asset US treasury securities, in search of higher returns,. They created products based on cross-border tax benefits and ABSs serviced by the cash flows produced by aircraft leasing, a non-prime, alternative-asset class. In effect, the ABS market replaced the traditional aerospace bank financing. Aircraft manufacturers enjoyed the benefits from a growing orderbook that filled production lines and created healthy profits and high stock prices. Supply chain. As the industry consolidated around two major manufacturers, Airbus and Boeing, they lost considerable pricing power, an advantage previously held by them. The airlines, as launch customers, previously held sway over the introduction of new aircraft designs, have come to the realization, that lessors have a say in what aircraft are built and the quantities sold. Gradually, it became apparent, that the traditional supply change has been disrupted. The lessors had become the main sales conduit between manufacturers and the airlines. Lessor expectations. It may be, that the lessor’ asset management approach, is based on traders’ expectation that the market will return to the long-term trends, being the market conditions in 2019, and that prices will also recover.
Investor paradox. In any normal market, the outcome from market disruption would be a glut of surplus aircraft, and fire sale prices. If this has occurred, it is not visible to market observers. This can be explained in part by the legal constraints on investment institution portfolio-mix decisions. They cannot cut off the flow of investment funds to alternative asset classes, even brown assets, that offer high yields, because they need them to generate the returns expected by their customers, corporations, government agencies, pensioners, and insurance policy holders. Residual values. The lease-financing business model is dependent on the sale value of the aircraft at the end of its lease life. The appraisal profession treatment of residual value is facing downward pressure, in part because they are projected 10, 20, 30 years into the future. Pressure on aircraft future values will increase the closer we get to the next review of the CORSIA scheme in 2027. Brown asset, stigmatization, and wasted asset phenomena. For as long as humanity has thought about flying, the image was one of new frontiers and revolutionary breakthroughs in unimagined technologies. For the most part, these things have been realized and the shift is now to space frontiers. Much of the goodwill surrounding aircraft remains to this day. However, the realization in the public mind, that aircraft are significant contributors to greenhouse gas emissions, and that very little seeming to be changing, may erode that goodwill. Civil society groups and many investment institutions are skeptical that the stakeholders in the aviation industry are willing to solve the emissions problem. Observers point to the doubt being expressed about the intentions of stakeholders in the oil, coal, gas and cement sectors, to transfer responsibility for climate change to other industries and to consumers. This "blame-others" strategy has stigmatized these industries in the public mind. Investment institutions, aware of the problem, categorize oil, coal, gas, and cement as “brown assets.” They may not like the impact they have on the environment, but they are assets that offer high returns. Banks will continue to invest in brown assets, until is established that we have a high temperature or low temperature climate scenario in 2050. Pension and insurance companies, have a fiduciary duty to manage both scenarios until then. Imagine the legal liability that pension fund and insurance managers would face, if in 25 years’ time, the world economy is still based on fossil fuel energy and their portfolios are overweight in green bonds! Those investors who continued to hold brown asset securities would see returns rise. That that abandoned fossil fuel would see the value of green assets fall! The same outcome would result if climate change were addressed, and portfolios are awash with brown asset securities. Aircraft as brown asset may seem inconceivable. The risk is that if the promises made by the aviation industry do not begin to show results in the next few years, aircraft will be stigmatized as brown assets, in ways that could pressure governments to force airlines to cut emissions through punitive legislation and restrictive regulations. Should that occur, lessors will have to manage pools of wasted assets. Market forecasting. The Global Market Forecasts (GMF) published by manufacturers, banks, and lessors, reinforced the decision of all players, to buy delivery positions far into the future, five and seven years, or more. GMFs project market trends in twenty-year cycles, the latest being 2021-2040. Invariably the projections are bullish based on the analysis of air traffic and fleet pattern evolutions. The belief that air-traffic always returns to its long-term trend after a recession, stems from this concept. The Airbus projections account for factors such as demographic and economic development, tourism trends, air cargo trends, aircraft efficiency, sustainability, energy-prices, and airline network development. The GMFs highlight future traffic growth and aircraft demand in the over 100 seats commercial aircraft category and include technical services forecast. These developments created a speculative asset-price boom-busts over the last few decades. Traffic trends. Traffic growth rates in 2020 and 2021, did not follow the post-financial crisis pattern of 2010 and 2011, possibly because the pandemic decoupled the air transportation industry from the global economy. War risk, impact on GDP, inflation and recession. An overwhelming majority of experts think that the economic and financial sanctions that have been implemented to date will lead to a deep recession in Russia; and nearly four in five consider that the fallout from the invasion will both reduce global growth and raise global inflation in 2022. A slightly smaller majority agree that a total ban on oil and gas imports from Russia carries a high risk of recession in European economies. Foreign exchange. Asked about the potential effects of the weaponising of dollar finance, on its role as the dominant world currency, reactions are mixed. (IGM Forum at Chicago Booth).The economic and social upheaval being caused by the Russia-Ukranian War, makes is unlikely that traffic will grow ~10% in 2022.