Following record years, 2014 looks fairly quiet in terms of new aircraft orders. Given the massive backlogs, manufacturers say they are not concerned. But should they be?

Both Airbus and Boeing are planning significant production increases in the next few years. Deliveries are going to go from the current 1,400 to around 2,000 in the 2018-19 timeframe, a roughly 20% boost. The key question is whether the boost in output is justified by underlying market trends. On the darker side, it could mean that the manufacturers will be taking bigger risks for weaker pricing. After all, moving production rates up and down is very expensive and has always been avoided by Airbus and, to a lesser extent, by Boeing.

The huge order backlogs seem to logically call for higher production rates. As of June 11, Airbus had 5,457 aircraft on firm order, Boeing listed 5,199—a combined 10,500 aircraft yet to be delivered for the two leading manufacturers alone. But firm orders are not always as firm as they might seem. The recent cancellation of 70 Airbus A350s by Emirates has not by itself created an overcapacity issue and given the airline’s move to even larger aircraft does not signify market weakness. But it illustrates that nothing should be considered “firm.”

So is there a risk of a bubble emerging?

Orders this year and next should not serve as a template for the future. After a hugely successful 2013, orders now are likely to be around half of last year’s level. By the end of May, Boeing and Airbus were at a combined 750. “We don’t need orders, we have enough,” says The Airline Monitor’s Ed Greenslet. He points to 2007, when the duopoly reached 2,600 orders, and to 2009—when the market collapsed—and notes there were a combined 750 orders at the peak of the global financial crisis.

Follow Aviation Week's coverage of the 2014 Farnborough Air Show

The Farnborough International Airshow is likely to reflect the slower pace of orders this year. As D.A. Davidson analysts point out, Boeing and Airbus collected a total of 1,450 orders worth $295 billion (list prices) at the past two big air shows in Le Bourget and Dubai last year, so given that, “we have modest expectations going into Farnborough.” But that does not mean a cessation of orders. Middle Eastern carriers may well “continue to be active” and China needs more aircraft for the 2016-20 planning cycle, orders for which could be announced at the show. Ethiopian Airlines is also close to ordering larger narrowbody aircraft.

Where budget concerns may have driven defense attendance in 2012, the shifting security situation globally is taking its toll on attendance this time around. At the last Farnborough gathering, the U.S. dramatically scaled back its presence because of budget concerns. This year, a delegation of military officials will attend to trumpet the introduction of the F-35 Joint Strike Fighter to the international stage. And the political situation in Ukraine portends a reduced military presence for Russia, which proudly displayed its Sukhoi Su-35 fighter at the Paris air show just last year (see page 55).

Other civil orders may come if the only major product strategy decision is announced in Farnborough—the launch of the reengined Airbus A330—unofficially called the -A330neo. Air Lease Corp. founder and CEO Steven Udvar-Hazy recently stated he sees a market well in excess of 1,000 units for the type, and many other airlines, including Delta, Lufthansa and Air Asia X, have made clear their interest as well. Airbus has been noncommittal so far; Executive Vice President Marketing and Strategy Kiran Rao recently stated that the decision is “not a slam dunk.” Chief Operating Officer for Customers John Leahy also cautioned that the A330neo launch may not come in time for Farnborough.

Industry experts are still split about what to expect in terms of market growth. Greenslet argues that “there is not an overwhelming risk of a bubble over the next five years. Production rates are an honest reflection of needs.” He tracks traffic development and the rate of aircraft retirements as the key drivers behind demand for new aircraft. “Traffic will be pretty good,” Greenslet predicts, and that is going to be primarily driven by emerging markets in Asia, the Middle East and Latin America. In the U.S. the rate of growth is slower, but from a much higher base.

Greenslet argues that in order to predict what is likely to happen over the next few years, “past patterns don’t really matter.” He expects airlines to retire a much larger number of aircraft over the next five years than in the preceding five. He calculates 3,800 aircraft will be leaving the active fleet up to 2019—that is about 1,000 more than since 2009. So even with deliveries nearing an annual 2,000, the net output will still be “500 aircraft short of demand.”

Leahy concedes that 2014 is likely turning into a “slow year,” but he does not anticipate a bubble. “We have been extremely conservative in production, therefore we’re smoothing out the order cycle.”

The cost of fuel, however, is a major unknown. Price hikes could trigger calls for more fuel-efficient new aircraft and retirement of older types, although airlines might be unable to purchase new aircraft if traffic is choked off through higher fares and thinner profit margins. Conversely, if fuel prices drop, airlines might be tempted to fly aging aircraft longer.

Greenslet is assuming fuel costs will remain constant and retirements mainly will consist of MD-80s, Boeing 737 Classics, 767s, early Airbus A320s and A340s. He sees the rate of aircraft leaving the fleet generally higher in the narrowbody segment than for long-haul types. The replacement process is likely to pick up in speed as Boeing nears full 787 production and Airbus ramps up output of the A350 beginning next year.

In spite of anecdotal evidence to the contrary, Greenslet still sees an average aircraft retirement age as 25 years, although he concedes that almost 30% of the 2013 retirements affected aircraft 20 to 25 years old. “That was almost directly linked to improving fuel efficiency,” he says.

Another reason to dismiss past experience is the development of load factors, Greenslet argues. In 1993, the global airline industry was operating at an average 65% load factor. In 2014 this will have risen to almost 80%, and may move to 82-83% in the next 15 years as airlines fine-tune their capacity offerings. The implications are highly relevant for manufacturers: In the past, airlines could grow traffic by finding ways to fill more seats on existing aircraft. That option is no longer so viable for the future. In other words: If airlines are operating at beyond 80% load factors, chances are they will need a lot more new aircraft to grow traffic further compared to past projections for the same planned rates.

Adam Pilarski, senior vice president at Avitas, argues that two key factors influencing future demand could turn out quite differently from Greenslet’s projections. “In the long run, fuel will come down,” Pilarski believes. Also, “demand forecasts are moving to lower numbers.” To him the consequence is clear: “I definitely believe the risk of a bubble exists.”

But it is almost impossible to foretell when and how his predicted bubble might burst. “Bubbles are created through irrational behavior and the way they come down again is also irrational,” Pilarksi notes. A single event such as a political crisis could trigger a downward spiral.

In the short term Pilarski points at the “troubling developments in the Middle East,” particularly in oil-rich Iraq. “A civil war in Iraq can reduce oil production and could cause a spike in prices,” he warns. But on the other hand “even fanatics want to sell oil.”

Away from politics, Pilarski sees risks inherent to the current position of both Airbus and Boeing. The very fact that backlogs are already so big causes more speculative orders. Airlines are buying aircraft because they want to avoid a situation where they are the only ones in their respective market without available production slots and thus no opportunity to grow along with the competition. Consequently, “many orders probably should not be there,” he avers. While Airbus is likely to easily absorb Emirates’ A350 cancellation because it is linked to the specific fleet strategy of one airline, things might look different if big lessors are having second thoughts about their commitments.

Pilarski warns of another element of speculation in the backlog that he calls “double counting—airlines count on the same traffic, but all cannot win.” A large European airline might have placed a substantial order for long-haul aircraft to be operated mainly into Asia, but many of the putative passengers may instead fly Etihad Airways or Emirates in the future. And leasing companies are counting on the same airlines to take their aircraft.

The cost of oil also has ramifications for the way passengers decide to fly, Pilarski points out. Very high fuel prices mean stopping in the Middle East, even though traveling between Europe and Asia makes a lot more sense because the tankering of fuel is becoming so uneconomical, while the 6-to-8-hr. sectors typical for that kind of medium- to long-haul operation are much nearer to an ideal fuel-efficiency curve.

Pilarski concedes that Greenslet has a point as far as high load factors providing less flexibility inherent in existing fleets, but that could still be overcompensated by a market that may be weaker than most people perceive. He sees some markets, such as India, growing fast, and where business models like the low-cost carriers are not yet at the end of their above-average development in emerging regions, -myriad events could change the equation. “Environmental regulation is a complicating factor, and there is always an unknown level of competence in government agencies,” Pilarksi says.

While Boeing concedes that it is as subject to the same “unknowns” as any other industry player, it also believes the dynamics behind today’s huge order backlog are fundamentally different from historical order surges, making today’s backlog much more robust than in the past. “The dynamics and the buying patterns of our customers have changed,” says John Wojick, senior vice president of global sales and marketing for Boeing Commercial Airplanes (BCA). “They are buying much further out than we thought they would . . . to make sure they can rejuvenate their fleets and replace older equipment.”

The numbers back up this argument, says Randy Tinseth, BCA marketing vice president. “The case closes for replacement and that really establishes a strong base for them to order from and gives us a really strong position from which to start our production lines. In the last three years about 1,800 aircraft have left service. So over that time there have been more replacement aircraft delivered than there have been for growth. So even though we talk about all these numbers, that base is true.” 

Tinseth also says a key factor is the continued growth of direct services across the capacity spectrum from single-aisle to large-widebody markets. “Fragmentation is alive and well. The International Air Transport Association has reported a doubling of frequencies over the past 20 years, and the cost of travel over that period has halved. That has not happened because everyone is flying in A380s, it is because they are flying in the best product for the particular market and they are a business application.” The biggest impact of fragmentation, in terms of units, continues to be seen in the narrowbody market, where the battleground is squarely between the A320 and the new neo version and the 737 and the MAX derivative, both on the way to setting records for commercial jetliner manufacturing rates.

Richard Aboulafia, vice president of analysis at the Teal Group, believes current narrowbody production rates are sustainable today, “but going up further can be a real problem. You can go up to 50 or 60 [aircraft per month], but if the slightest thing happens you are in real trouble.” He cautions that “the idea to go up further is a great way to engineer overcapacity.”

Both Airbus and Boeing have already decided to move production rates up for the narrowbody models—Airbus is boosting the A320 line to 46 aircraft per month from 42, and Boeing is moving 737 production to 47 per month from 38 and is pondering 52. Airbus is also looking at rates higher than 50 when the transition to the A320neo is completed.

Aboulafia also is concerned that some emerging players such as Lion Air or Norwegian may not fulfill their promises. Both airlines have large orders for new narrowbodies with Airbus and Boeing. From a macroeconomic point of view, this is worrisome, he says. 

To an extent, the situation for manufacturers is as good as it is because of low interest rates (which encourage investment) and the high cost of fuel. These factors can change, and if Airbus and Boeing are unlucky, fuel will become cheaper and interest rates will rise in parallel. Therefore: “We are taking it too far,” Aboulafia contends.

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