June 12, 2013
Credit: 747 photo: Boeing
Today’s news is peppered with accounts of the early retirement of passenger jets. In 2012 alone, 50 aircraft aged 15 years or less were retired from fleets. While such statistics make for good headlines, in reality those 50 accounted for less than 10% of the aircraft retired last year. It is the sheer magnitude of retirements for aircraft of all ages that will have a profound impact on the aerospace and maintenance, repair and overhaul (MRO) industries for the rest of the decade.
About 1,700 commercial jets were retired in the 1990s. My firm, ICF SH&E, anticipates that number will reach an unprecedented 6,000-8,000 this decade, driven by a unique cocktail of high fuel prices, low cost of capital, fleet demographics and new-technology aircraft and engines. So what are the implications of this “retirement tsunami?”
First the good news: The wave of retirements will help sustain the large backlog of new aircraft orders and high levels of manufacturing output. Between 45-50% of new aircraft deliveries in the next decade will be replacements , well above the recent norm of approximately 20%. This is welcome news for aerospace manufacturers in a decade that will likely see sub-par air travel demand growth, the primary driver of deliveries. The removal of older, less fuel-efficient aircraft from the global fleet will also reduce airline fuel expenses and help to slow the growth of aviation-related greenhouse gas emissions.
The airline industry also will reap substantial savings in maintenance costs, both from the honeymoon offered by new aircraft and by capitalizing on a burgeoning market in surplus parts. Airlines can save 30% or more by acquiring parts and engines from surplus dealers that salvage components from retired aircraft. Independent MROs, which often compete on the basis of price, are quite happy to leverage used material into their repairs and overhauls.
We estimate that operators and MROs are spending approximately $3 billion per year on surplus parts —netting cost savings of more than $1 billion to the airlines. Moreover, the surplus-dealer business model continues to transform as aircraft lessors enter the market as an extension of their businesses. A 15-year-old aircraft, for example, might be worth more parted-out than leased. Aircraft parting has become such a lucrative business that it is attracting investment from hedge funds and wealthy individuals in search of high returns.
But there are also downsides to the retirement trend. Some original equipment manufacturers (OEMs) will face significant challenges in growing their aftermarket businesses as the ever-increasing supply of surplus parts replaces sales of new parts and competes with overhaul services. OEMs with substantial aftermarket revenue from older-model aircraft are particularly vulnerable.
For example, Southwest Airlines is partnering to recycle CFM56-3 engine parts from its retiring Boeing 737 Classic aircraft. Even more dramatic is Delta Air Lines ‘ recent acquisition of dozens of used MD-80 and MD-90 aircraft, some of which will be parted out to enable Delta to better influence the worldwide supply of MD-80/90 and Boeing 717 parts.
Aircraft lessors also face challenges. Lease rates for many mid-generation and even some new-generation aircraft models declined during the most recent industry downturn, making the part-out decision relevant for a number of aircraft sooner than originally anticipated. That may be a reason some lessors have moved into surplus parts trading as they reposition their portfolios.
Several dynamics will determine the magnitude of the aircraft retirement tsunami. An increase in interest rates will make purchases of new jets less attractive and reduce airlines ‘ desire to retire older aircraft, reducing the supply of part-outs. Similarly, a decline in fuel prices—a genuine possibility as growth in the global economy slows and the North American energy boom continues—will also make older aircraft models more viable.
Therefore, it is prudent to think in terms of scenarios. Our low-case scenario for total retirements in 2010-19 is 6,000. This model includes falling fuel prices , increasing interest rates and possibly delays in one or more aircraft introductions. Our high-case scenario for retirements is 8,000 units, or 800 aircraft per year. This situation assumes a continuation of low interest rates, high fuel costs and new-aircraft production targets being met.
Regardless of which case proves true, the balance of this decade promises to provide an interesting journey for the aircraft MRO business.