In December 2010, Airbus appeared to gain a first-mover advantage by launching the A320neo before Boeing's decision to re-engine the 737. With oil prices depressed, the European manufacturer was in pole position to start raking in the orders.
Aviation Capital Group, CIT and GECAS were the first lessors to place large speculative A320neo orders with Airbus. Eventually, the manufacturer gained orders from 12 lessors for 728 A320neos – 21% of the total 3,436 orders for the variant, Airbus data indicates.
When Airbus launched the new engine option for its most popular aircraft, oil was circa $90 a barrel. Between the start of 2011 and 2014's midpoint, the price averaged around $110 and kept within the range $89-127. But after trending sharply downward in 2014's second half, it dipped below $50 in January 2015 and below $40 by the end of that year. After falling below $28 in January 2016, it is currently back at the $50 level.
Airline profits, meanwhile, were dramatically hit by the financial crisis of 2008 – particularly those of North American carriers – resulting in industry net losses of more than $26 billion that year, IATA recounts in a report setting out its mid-year 2016 forecast. Losses continued into 2009, with a further $4.6 billion collective net loss, before Asian carriers led a profits bounceback, to $17.3 billion, in 2010. Rising fuel prices subsequently tempered profits to $8.3 billion in 2011, though they have since steadily improved and, buoyed by that sharp fall in fuel prices, jumped to new record highs.
From 2011 through 2014, though, fuel accounted for 32.2% of operating expenses on average, the same IATA report indicates. Hence, it is no surprise that airlines demanded more efficient equipment, and that the OEMs embarked on their re-engining initiatives.
When airline were beset by oil prices averaging $110 and sometimes climbing above $120, the lower operating costs of the A320neo validated an ownership cost premium. But the picture is very different with oil at $50 or, for that matter, at the lows it reached in January, the very month in which Airbus delivered its first A320neo to launch customer Lufthansa.
With IATA forecasting that fuel will account for 19.7% of operating cost in 2016, it is difficult to see how the A320neo – which offers a 12% fuel savings and lower maintenance costs – can command a 9% premium over its older sibling.
DEMAND AT A PREMIUM
Historical data from Flight Ascend Consultancy shows that the expected lease rate for a 2015-vintage A320neo was $415,000 a month at the start of the year. This fell to $385,000 upon re-evaluation later in 2015.
In 2016, the lease rate for a 2015-vintage A320neo is $360,000 and for the 2016-vintage $375,000. It is telling that a 2016-vintage started out the year with a lower lease rate than the 2015 achieved the previous year.
But with A320s offered at $340,000 a month, the monthly premium for a new A320neo over an A320ceo is $35,000. So, in this low-fuel-cost environment, are airlines opting to pay the premium?
"Neos were invented when oil prices were well over $100 a barrel and people thought they would stay over that figure," says Adam Pilarkski, senior vice-president at Avitas.
When lessors placed speculative orders, an efficiency premium would have been built into their assumptions.
"There is no way on earth that those will actualise because oil prices are lower," says Pilarski, who believes that neither airline nor lessors will get the expected returns for the 737 Max or A320neo.
If the leases were agreed before oil prices fell, the lease rate could be sufficient to make the expected return, but most lessors only began placing A320neos last year after fuel costs had already significantly fallen.
"Most lessors started working on placements about 12 months ago, so you missed the boat on significant premiums," says one lessor.
"The placements I've seen for the Neo are at unspectacular rates," notes a second, adding that there is still availability for 2017 and 2018.
After speaking with a number of lessors, FlightGlobal understands that the lease-rate factor for an A320neo is around 0.8-0.85, but below 0.7 for sale-and-leasebacks on both the A320neo and A320ceo.
"Can you get your 15% return on a Neo?" asks the first lessor. "No one is making it in the sale-and-leaseback market at the moment."
One Asia-based airline executive agrees that the lease-rate premium has evaporated, adding that there are a number of Neos being delivered next year that are seeking homes.
He notes, however, that the fuel-burn savings on the GTF are looking pretty good.
Both lessors believe the tide might be turning for the A320neo now even despite depressed oil prices.
"Rates might be coming back because most Ceos are placed, so only Neos are on offer – and lessors might just be able to start charging a premium for those placements," says the first lessor.
Another reason rates have been driven down from expected premiums might lie beyond placement issues.
It all comes down to price for lessors. However, lessors are competing not only against each other – and a larger pool of lessors in general than 10 years ago – but against all the capital that has flooded into this industry over the past few years.
The supply of liquidity gives airlines the ability to put pressure on capital providers, including lessors which placed speculative orders gambling on higher oil prices.
Therefore, in addition to the operating cost environment shifting, it is also possible that the oversupply of finance is driving down funding costs for airlines and therefore making it more difficult for lessors to extract a premium for the Neo versus the Ceo.
Eventually, the A320neo or 737 Max will be the only available narrowbody options offered by Airbus and Boeing. By then, fuel prices are likely to have risen. In the meantime, lease terms are critical depending on whether you have older or new technology – particularly the tenor. Typically, lessors will opt for the longest lease possible, and so they should, especially when it comes to the last-off-the-line aircraft.
Given the competitive finance environment and indeed low fuel costs, for the newer and more efficient re-engined jets it would behoove lessors to agree mid-range tenors, so as not to be locked into disadvantageous lease terms were oil prices to rise again.
One aviation analyst compares the new engine option to new technology for which airlines simply expect to pay the same for better performance. But the OEMs must sell the new aircraft models at a premium to recoup the cost of development.
Back in the early part of this decade, Airbus might have had first-mover advantage. But more and more, if oil does not remain as low as it is now, 737 Max investors might finish the race with better returns on equity when the aircraft comes to the market almost two years later, if fuel costs rise over the next 20 months.
Only the crystal ball, however, can predict where those prices will be when Boeing makes it first Max delivery next year.
Additional reporting by Ellis Taylor in Perth