By Daniel Tsang
Cheap oil exacerbates divergence in passenger & cargo markets growth
When full, 509-seat A380 has 16.8% lower block fuel burn per seat against 264-seat 777-300ER
83% full A380 burns similar fuel per seat against a full 777-300ER
On payload-tonne basis, 777-300ER is ~25% more fuel efficient than A380
In 2012, each 1% of oil price change affected route profitability by 2%; 2016: 0.56%
1.7% widebody up-gauging mainly done via denser configurations
37.5% of total A330 fleet leased, 20.6% 777 & 16.6% A380
Lessors should remove refitting cost penalty to boost A380 appeal
Excluding Amedeo, only 11% of total A380 fleet is leased
On the surface, the 75% slump in oil prices since July 2014 has enabled Airbus Group SE (OTCPK:EADSF, OTCPK:EADSY) to improve the relative competitiveness of its A380 superjumbo, while postponing the service entry date of an upgrade including equipping the people-mover with a next-generation engine to as late as 2024 or 2025.
Yet, the broader implications of the oil price collapse go far beyond, prompting changes in the air travel demand mix, which tilt the balance in favour of price-sensitive leisure travellers as carriers slash airfares to grab a bigger market share and stimulate further growth. At the same time, the upcoming influx of belly cargo capacity brought on by the deliveries of Boeing 787, 777X and the Airbus A350, means the current cargo doldrum symbolises a paradigm shift that is unlikely to reverse course.
This analysis examines the effects of these cost and demand driver changes, and whether their confluence could spur new A380 sales, should these favourable trends be sustained.
Attractive seat economics when filled
The superjumbo received a crucial shot in the arm in December last year when Japan's All Nippon Airways (ANA) ordered 3 new-built examples in return of the favour Airbus did when the French plane-maker, a major creditor of the bankrupt Skymark Airlines, had supported ANA's turnaround bid at the last minute and scuppered Delta Air Lines's effort to acquire a roughly 20% stake in the beleaguered carrier, in spite of ANA's public dismissal of the notion.
Immediate focus is placed on ANA's plan to deploy the A380 on the Tokyo Narita-Honolulu route from 2018 onwards, where the Star Alliance carrier lags its arch-rival Japan Airlines (JAL) in seat share at 19% against the latter's 35%, with an over 90% load factor achieved in the overall Tokyo-Hawaii market. JAL operates 4 times daily on the route, deploying the 312-seat 2-class Boeing 777-200ERs on a flight, the 199-seat 2-class 767-300ERs "Sky Suite 767" (SS6) on two flights and the remaining flight on a 186-seat 2-class 787-8 Dreamliner. ANA, on the other hand, flies twice-daily using the Air Japan 214-seat 767-300ERs. As the figures show, the 428 daily seats operated by ANA on the route is half that of JAL's 896 seats and two daily A380 flights in a configuration of around 500 seats would enable ANA to take the lead back easily.
The A380 is particularly well-suited on the route given its seat economics, providing room for the carrier to cope with any competitive response from JAL, on which it used to fly the 2-class 447-seat Boeing 747-400 configured with 55 Business and 392 Economy seats. On the other hand, as Tokyo Haneda has a daytime operational ban on the superjumbo between 0600 and 2300, the A380 will have little impact on the Tokyo Haneda-Honolulu route, where both JAL and ANA fly once daily using the 2-class 777-200ER and 767-300ER, respectively.
Most importantly, while the A380's unique characteristic of having a superb seat economics when filled is nothing new, as International Airlines Group (NYSE:IAG) chief executive Willie Walsh remarked, "its unit costs, if you can fill the plane, are very attractive"; little research has been done to illustrate the point and to its critics, the superjumbo's inflexibility and the adverse impact of a yield dilution in an effort to fill the superjumbo up.
In a modelled ANA operation more representative of its normal network deployment, the lucrative Tokyo Narita-Los Angeles route is being looked at, where 4-class offerings with a premium economy product are featured prominently. ANA flies a daily flight using the 4-class 264-seat 777-300ER revamped with 10-abreast economy seats, alongside its joint venture (JV) partner United Airlines's 252-seat 787-9 daily flight. JAL and its partner American Airlines (AA) operate a daily 777-300ER flight in a 244-seat 4-class and 310-seat 3-class configurations, respectively. The ANA/United and JAL/American alliances divide up the route pretty evenly at 35.61% and 38.23% seat shares, respectively, with the remainder held by Singapore Airlines's daily 4-class 379-seat A380 flight featuring an all-Business upper deck.
On the return sector with 56 knots en-route headwind, a fully-laden A380 in a hypothetical 4-class 509-seat configuration - 8 First Class, 78 Business, 52 Premium Economy and 371 Economy seats and 8 tonnes of belly cargo can have a 16.80% lower block fuel burn per seat of 3.4327 litres (L) of fuel per passenger per 100 kilometres (km), compared to the 4.1257L used by ANA's 4-class 10-abreast 777-300ER. This per-seat fuel efficiency stems from the A380 supplying 92.20% more capacity or available seat kilometres (ASKs), but only using 59.91% more trip fuel at 137.75 tonnes against the 777-300ER's 86.14t. The A380's faster long-range cruise (LRC) speed at Mach 0.85, albeit in reality it is often considerably higher, leads to 18 minutes shorter block time and a cruise fuel burn of only 71.20% higher at 111.36t versus the 777-300ER's 65.05t.
As the 777-300ER is much smaller and hence easier to fill up, any realistic aircraft evaluation comparing the two should take into account a correspondingly lower load factor assumption for the A380. In doing so, the sensitivity of the A380 to load factor could be discerned from a per-seat block fuel burn perspective. A load factor equal to 83% would yield a per-seat block fuel burn of 4.136L per passenger per 100km, and any lower figure would tilt the balance in favour of the "Big Twin".
Reduced emphasis on fuel saving helps A380 business case
Admittedly, the actual make-or-break load factor figure could be somewhat lower, since the A380's luxurious cabin outfit, such as Etihad Airways's US$32,000 "The Residence" complete with a butler and a dedicated shower facility that is proving more popular than originally anticipated, as well as Qatar Airways's "revolutionary" New Business Class currently under development, will have a positive accretive effect on yields.
Nevertheless, Boeing (NYSE:BA) and its proponents are likely to point to the 83% figure on per-seat fuel burn as a reflection on the inflexibility of the A380, whose use is limited to trunk routes where frequencies do not have an outsized importance in an expansive global network, as IAG chief executive Willie Walsh alluded to. As unit cost increases when the A380 is not fully filled, as fewer passengers share the fixed costs such as capital costs, the US$1.4 million 3C base check conducted every 6 years and the 22 flight attendants versus just 16 on the 777-300ER, the break-even load factor (BELF = Cost per ASK/yield) would inevitably rise faster than the higher yield could compensate for.
In addition, Boeing often touts the cargo-hauling capability of the 777-300ER and that of its successor, the 777-9. At 5,200ft³, the -300ER's revenue cargo volume out of a 7,120ft³ total cargo volume means it is able to carry 23 tonnes of belly cargo even after fully loading passengers' luggage. This is in stark contrast to the A380's total cargo volume of 5,875ft³ and a revenue cargo volume of 2,995ft³, enabling it to only ferry 8 tonnes of belly cargo. In fact, on a per payload-tonne basis, the 777-300ER burns 2,148.28L of fuel, a whopping 24.94% more efficient than the A380's 2,861.98L per payload-tonne, underlining the -300ER's mini-freighter credentials.
Yet, the changing dynamics of the marketplace are beginning to work in the A380's favour, and new sales could be spurred should they prove to be a longer-term phenomenon.
First and foremost, the low oil price means the route profitability is not as susceptible to the former's fluctuation as it used to be. Where Airbus found in 2012 that a 1% change in oil price will impact a route's profitability by 2%, today's Singapore jet kerosene price of just US$37.54 per barrel, down from around US$135 per barrel in July 2012, yields a sensitivity figure of just 0.56%. This means the premium airlines place on the 777-9, which promises a further 20% reduction in block fuel burn per seat compared to a 777-300ER and a 15% lower cash operating cost (COC), and in natural extension to the A380 given their identical unit costs at present, is drastically reduced.
Indeed, it deserves to be asked whether the airline industry is facing a new normal with sustained low oil price for an extended period of time, or "lower for longer". Not least there is a 1.8 million barrels per day surplus going into the stockpile, compounded by Iran's 0.5 million barrels per day production capacity joining the international oil market last week, there are signs that Saudi Arabia's strategy of driving high-cost shale producers out of business is faltering. According to the consultancy Wood MacKenzie, the cash cost of US's shale oil is at US$15 per barrel and even at a price of US$30 per barrel, only 6% of production worldwide fails to cover its average variable costs and faces shutdown. Moreover, the US shale oil industry has been becoming more productive, with a well in the Bakken region originally producing 200 barrels a day in 2011 now producing close to 700 barrels a day, reckons ANZ commodity strategist Victor Thianpiriya.
Airlines favour denser 350-seater, not 777X/A380, for incremental up-gauging
An unintended consequence of the low fuel price is the extra boost provided to the growth in passenger numbers, which increased briskly by 6.55% from 3.327 billion passengers in 2014 to a forecasted 3.545 billion last year, according to the International Air Transport Association (IATA). The growth rate is expected to accelerate further this year to 6.85%, carrying 3.782 billion passengers. Since 2004, passenger number has almost doubled from 1.975 billion passengers, significantly outpacing both the 45.58% growth in number of tonnes of airfreight from 36.2 million to 52.7 million, and the 53.36% growth in the number of flights from 23.8 million to 36.5 million.
Yet it would be unwise to jump to the conclusion that the apparent up-gauging explaining the link between growth in passenger numbers and the considerably slower growth in flight numbers would benefit the A380.
For one thing, the up-gauging appears to be concentrated in the narrowbody market, where Boeing reckons its seat count is growing by 4-5% annually to converge around the 162 seats sweet spot as the larger A321 takes up an increasing proportion of deliveries. The widebody market, on the other hand, the Chicago-based plane-maker says the seat count in this segment is only increasing at a 1.7% per annum pace. This could be proven by taking the weighted average of the seat count growth figures with the 30,630 single-aisle and 10,270 in-service widebody aircraft by 2034, which combined to yield a 3.21% overall up-gauging rate.
This 3.21% overall up-gauging rate plus a 3.34% growth in the number of flights leads to a 6.55% 20-year forecast growth in passenger traffic, which is quite realistic as worldwide passenger traffic grew by 6.0% in 2014 and 6.5% in 2015, accelerating to a 6.7% growth this year. Putting aside the disagreements on the narrowbody up-gauging trend first given the popularity enjoyed by the Airbus A321 and the re-engined A321neo, the above reverse-engineering of long-term traffic forecast nevertheless vindicated the 1.7% up-gauging rate in the widebody market.
Intriguingly, on paper this 1.7% up-gauging rate would call for the development of a 777-9 and a stretched A350-1000, loosely dubbed as the -1100, as in 10 years' time the average widebody seat count of 297 seats would become 352 seats, the exact 777X configuration in realistic airline use. But the market is deeply divided on whether the "sweet spot" of the widebody market would move up from a 350-seater such as the 777-300ER and A350-1000 that burns 25% less block fuel. On the one hand, while proponents such as Qatar Airways's vociferous chief executive Akbar Al-Baker said "we would be interested in a stretch of the A350-1000. Airbus has no alternative - to be competitive it will have to do something that is bigger and better than the 777-9X. It would be bigger than the -9X and we believe it will have a superior fuel burn"; the versatility of such a "mini-people mover" remains questionable - AerCap's chief executive Aengus Kelly lamented in an Aviation Week interview that it "would not be a lessor aircraft" due to a limited operator base.
In fact, airlines worldwide seem to be accommodating more seats into the same 350-seater rather opting for a bigger plane in a push to slash per-seat operating cost, whose trip cost rises at a slower pace than the seat count, thus producing better per-seat economics. From Air France's 468-seat configuration with 10-abreast economy class at 17-inch seat width, to Air Canada's 458, Emirates's 427 and Qatar's 358, now 75% of total 777 deliveries are made in such a configuration.
For Airbus, relying on the A350-1000 and Spaceflex concept to increase its seat count to 366 seats not only reduces development and production costs, simplifies its assembly line, whilst satisfying most airlines' demands. This could also eliminate the dilemma where an A350-1100 inevitably cannibalises further A380 sales. Facts that Virgin Atlantic is imminently placing an order for 12 A350-1000s, possibly at the expense of its order for 6 A380s, TAM switching 12 existing A350 orders from the -900 variants to -1000s and Air Caraïbes' 439-seat 10-abreast A350-1000s illustrate the point further - the "sweet spot" is converging around 350-seaters such as the A350-1000.
Image Courtesy of Boeing
Secondary market could alleviate demand gap
Make no mistake, while one day the marketplace may eventually demand the higher-capacity 777-9 and A380, this would only happen when airlines exhaust their primary means to make existing assets more operationally efficient through the adoption of denser configurations. This could take as late as 2034 for the average seat count to reach 416 seats, an around 83% load factor for a 500-seat A380.
Therefore, it is best for Airbus to postpone the launch and entry into service (EIS) date of the A380neo, which burns 10-13% less block fuel per seat, as much as possible to wait for some of the up-gauging demand to materialise first, before launching the re-engining programme 5-6 years before EIS. This means an A380neo decision as late as 2018 or 2019, in Aspire Aviation's view, despite calls by Emirates president Sir Tim Clark that "we would like them to get on with it. But for us to have ordered another 100 A380s, believe me if we could at Dubai International Airport, we would".
"We obviously want more than one customer and we're looking at that in cold blood. This is not going to be an emotional decision. We're building a plane for customers who want the aircraft and it'll have to be at a good price," Airbus Group chief executive Tom Enders said of the A380neo.
During these intervening years, establishing a secondary market for the superjumbo is crucial in alleviating the demand gap. As things currently stand, the A380 lags behind other widebody aircraft in lease penetration. The A380 has 30 in-service leased examples, including Doric, Novus Aviation Management, BBAM over Emirates, ICBC over a China Southern example, with 20 ordered by Amedeo and another 3 by Air Accord. This gives the A380 a 16.61% leased fleet. This figure seems artificially high, as Amedeo has so far failed to place a single aircraft with airlines. Excluding Amedeo, the leased fleet percentage would drop to 11.04%.
This compares to the 20.61% leased 777 fleet and the A330's 37.52% with 603 aircraft being leased. The 10.30% and 13.57% A350 and 787 figures, while seemingly low, these aircraft programmes are at an early stage in their life-cycles and when many airlines begin to receive their deliveries, sale-and-leaseback (SLB) would be a popular means to line up financings around 6 months in advance.
Improving the A380's low proportion of leased fleet is important since liquidity declines as aircraft size increases. The average refurbishment and period between consecutive leases is just 28 days, especially on popular single-aisle aircraft that can be quickly redeployed across different markets. Should potential aircraft buyers deem the risk of being unable to resell the aircraft and the search cost being prohibitive, demand in the primary market would be dampened.
So much so that Lehman Brothers wrote in 1998, "the ratings agencies require an 18-month source of liquidity because this is the length of time they feel it will take to market and resell the aircraft in order to maximise value". While Amedeo has tried to lower the refurbishment cost by standardising the A380's configuration with an all-Business upper deck, the US$25 million refitting cost penalty faced by Singapore Airlines (SIA) on its 5 early-built A380s is self-defeating. The existence of such a barrier only goes to deter interested potential lessees and threatens to become a self-fulfilling prophecy. The removal of the refitting cost penalty would be a step in the right direction in attracting more airlines in the high-volume business, such as Saudi Arabian Airlines on Hajj pilgrimage flights and Turkish Airlines.
A key opportunity has arisen lately with British Airways (BA), whose home base at London Heathrow has long hit full capacity. "We see second-hand A380s as an attractive opportunity. I don't mind where the aircraft come from. What we've said is we're interested and therefore if there are aircraft available, don't be afraid to talk to us. We've already had some discussions with potential lessors," International Airlines Group chief executive Willie Walsh declared.
A potential feedstock could come from fellow oneworld member Malaysia Airlines Berhad (MAB), whose 6 Rolls-Royce-powered aircraft are built in the 2012-2013 timespan and will be replaced by 4 smaller A350-900s. As the beleaguered carrier seeks its path to return to profitability, it would look to withdraw the A380s from its fleet sooner rather than later. British Airways may even be able to acquire the aircraft, instead of leasing them, if the price is sufficiently low. With United Airlines vacating New York John F. Kennedy airport's Terminal 7 due to its loss-making Premium Service (p.s.) transcontinental operation there, thereby vacating enough gates to make way for an A380-compatible one, BA does seem to require more A380s for its Blue Ribbon 6-times daily service. 4 of them are currently operated by the refurbished 275-seat 747-400s and the remainder by 224-seat 777-200ERs. A 469-seat A380 will provide 11 more Club World seats, 25 more World Traveller Plus and 158 more World Traveller seats than a refurbished 747-400.
Japan's ANA now also becomes a prime candidate for leased A380s, given the high fixed cost and investments involved in training and maintenance support. These measures, especially the removal of the US$25 million per aircraft refitting cost penalty, should make the A380's secondary market more liquid.
If any of the challenges above seemed insurmountable, at least Airbus could find solace in its arch-rival Boeing 747-8. With a dwindling backlog of just 20 examples, comprising 4 from now-defunct Transaero and 2 from Nigeria's Arik Air that are unlikely to be delivered, this prompted the world's biggest plane-maker to slash the 747 production rate from the current 1.3 per month, to 1 per month in March 2016, then to just 0.5 per month from September onwards.
By taking a US$885 million pre-tax charge and US$569 million on a post-tax basis, Boeing is pinning its hope on a 2019 recovery in the cargo market. Even this seems to be a long shot for Boeing, as Seabury reckons a modal shift from air to sea has meant the air tonnage growth is reduced from 7.3% to just 2.6% between 2000 and 2013, which looks set to continue now that the West Coast seaport congestion is resolved. The latest cargo traffic figures showed a 2015 growth of just 2.2%, according to the International Air Transport Association. The market consensus is for Boeing's 747 production to end after completing the Air Force One requirement, with investment bank Credit Suisse predicting a 2018 fourth-quarter programme termination.
In conclusion, the oil price collapse has led to a moderately improved appeal for the A380 superjumbo. When fully filled, the A380 can burn up to 16.8% less fuel per seat than a competing 777-300ER depending on mission profiles and configuration settings. But the modest 1.7% widebody up-gauging trend is indicative of airlines' reliance on using denser configurations over the 350-seater 777-300ER and A350-1000 instead of opting for a physically larger aircraft. This will shift the demand for the 777-9 and A380 further out in timeline.
It takes more than the recent flurry of orders, including Iran Air's order for 12 examples, to prove that the A380 is finally coming of age.
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