the value of new-technology single-aisles

Executive Summary

Given the precipitous drop in oil prices, the value of new-technology aircraft

has been questioned, but is this warranted? New-technology aircraft create

revenue opportunities and reduce operating costs, enabling airlines to

build competitive moats that support sustainable business models. Airlines

with less fortunate geography will now be able to improve their economic

geography by operating routes not previously possible. Not all airlines value

fuel efficiency the same. The trade off between increased ownership cost and

fuel savings is dependent on utilization. To better understand which types of

airlines value new-technology, we analyzed the forecasted share of single-

aisle deliveries from 2016 to 2019. New-technology aircraft account for two-

thirds of high-growth, high-utilization airlines’ deliveries, demonstrating that

the business case for these types closes at any fuel price if the operator flies

enough. During this decade’s technology transition, a variety of options will

permit airlines to acquire the right tools to meet their needs. Lessors will play

a key role, providing access to OEM’s overbooked skylines and transitioning

used aircraft between operators. While the price paid for the new-technology

will be crucial to continued competitiveness, the timing of the adoption may

be more so.

By Steve Mason & James K.D. Morrison

The Value of New-Technology Single-AislesNew-technology aircraft create revenue opportunities and reduce operating costs

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The Value of New-Technology Single-Aisles

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Introduction

The value of new-technology single-aisle aircraft is being

challenged given the precipitous drop in oil prices. Some airlines

have opportunistically questioned the premium OEMs and lessors

are seeking for re-engined and clean-sheet designs. The past

decade’s high fuel prices overshadowed the other benefits of

these aircraft. When Bombardier’s C Series, Airbus’ A320neo,

Boeing’s 737 MAX, and Embraer’s E2 were launched, fuel cost

was at the forefront of the manufacturers’ minds. Brent crude oil

peaked at $143 per barrel in July 2008, and by 2011 appeared set

to stabilize at more than $100 indefinitely. The manufacturers’

focused their marketing efforts on one prime advantage of their

new-technology: fuel cost savings.

This singular focus missed a key point: aircraft do more than

burn fuel. New-technology aircraft create revenue opportunities

and reduce non-fuel operating costs, enabling airlines to build

competitive moats that support sustainable business models.

While lower fuel bills will decrease early adopters’ costs, the

relative cost advantage will dissipate once the competition takes

delivery of the same models in a few years’ time. Competitive

advantage must be built and can’t be easily replicated. The

increased payload-range, airfield performance, lower noise

footprint, and product branding opportunities of new-technology

aircraft will enable early adopters to gain a first-mover advantage

in developing new network structures and leveraging new

revenue opportunities that can’t be matched with old metal.

Fuel costs can be managed

Historically, jet fuel has been four times more likely than the S&P

500 to have a year-over-year price change in excess of 30%,

up or down (EIA, S&P). While incredibly volatile and inherently

uncertain, airlines have become exceptionally capable at

managing fuel costs.

Pricing is an airline’s strongest tool. By dynamically pricing

seat inventory to reflect changes in costs, airlines mitigate their

exposure to fuel price fluctuations. Changing economic and

competitive environments make it challenging to fully offset

sudden changes in fuel prices with revenue, but on an industry

level, airlines have been highly successful at adjusting passenger

yields to track jet fuel price changes.

With a 0.93 coefficient of determination over the past decade,

changes in the industry’s passenger yields and fuel prices have

a stronger correlation than the oft cited relationship between

growth in passenger traffic and world GDP at 0.80 (IATA,

ICAO, IMF).

Airlines have the option to use financial instruments to hedge

their fuel price exposure, providing greater cost certainty within

their planning horizon. While some airlines have used hedges to

build a cost advantage spanning several years (e.g. Southwest

Airlines between 2003 and 2008), airlines that hedge tend to pay

higher fuel costs over the cycle, revealing an important lesson:

hedging costs money.

New-technology aircraft act as long-term hedges against fuel

cost increase. On recent earnings calls, Alaska Airlines indicated

a cost of $3 per barrel (7¢ per gallon) for call options on fuel

prices six months in advance, while American Airlines stated a

fixed price option premium of $8 to $10 per barrel (19¢-24¢ per

gallon) one year out. Depending on the airline’s strategy, the cost

of hedging one single-aisle aircraft could range from $15,000 to

$50,000 per month, which makes one question the benefit of

paying to place bets instead of paying for the sure-bet of new-

technology.

Not all airlines value fuel efficiency the same. The trade between

increased ownership cost of new-technology aircraft and fuel

savings is dependent on utilization. Airlines that fly fewer than

six hours per day do not benefit from the fuel cost savings of

new-technology, whereas the business case for new-technology

aircraft closes at any fuel price if the operator flies enough.

Competitive advantage must be built

Competitive advantage is built by doing something that the

competition can’t. Long delivery lead-times will create technology

monopolies for early adopters to exploit. In addition to fuel cost

savings, new-technology single-aisles offer revenue and operating

cost opportunities.

Figure 1: With elevated oil prices, the manufacturers focused their marketing efforts on fuel cost savings.

Data Source: EIA, OEMs. EIS – entry-into-service

Figure 2: The airline industry has been highly successful at adjusting passenger yields to track jet fuel price changes.

Data Source: IATA



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Revenue Opportunities of New-Technology Single-Aisles

New-technology single-aisles will open network opportunities

with smaller-gauge, lower risk aircraft. Direct flights in markets

previously only served with connections will shorten travel times,

attracting passengers willing to pay higher fares.

The first carrier to build a network made possible by new-

technology will create a lasting incumbent advantage.

Bombardier’s C Series, Boeing’s 737 MAX, Embraer’s E2Je and

Airbus’ A320neo families will enable airlines to open routes that

historically would have only been possible with twin-aisles or

Boeing’s 757, aircraft which may be too large to support the

passenger demand.

The transition from Boeing’s 737 Classic to Next Generation

allowed for US east coast to west coast operations, a market

today that is three times the size of France’s entire domestic

market. New-technology single-aisles will transform markets in

the rest of the world in the same manner as the last technology

transition changed US trans-con.

For western European carriers, the re-engined single-aisles

are capable of serving the US east coast, typically their largest

market. While twin-aisles will continue to consolidate passenger

traffic from hub airports, the re-engined single-aisles allow for

direct trans-Atlantic service between smaller cities (such as

Manchester, Milan, and Barcelona to places such as Boston,

Montreal, and Ottawa) and between business focused airports

(such as Westchester, Hartford, and London City).

New-technology single-aisles will allow for the right-sizing of

aircraft by season and departure time. TAP Portugal and jetBlue

(USA) have both ordered the A321LR, hinting at new trans-

Atlantic service.

Traveling east from Europe, Norwegian has stated that the UK

city of Manchester is a “very interesting area, especially if you

think about India.” While Turkish Airlines has been successful

using current-generation single-aisles to flow east-west

passengers through its hub in Istanbul, new-technology single-

aisles will enable many markets to be connected non-stop.

An operator based in Seoul or Tokyo will now be able to open

markets in Malaysia, India, Thailand and Indonesia. For Indonesian

operators, the aircraft will open markets in China, India, South

Korea and Australia. The list goes on.

Today, Copa Airlines (Panama) benefits greatly from the perfect

marriage of geography and its single-aisle fleet’s range capability,

maximizing revenue opportunities connecting the Americas.

Airlines with less fortunate geography will now be able to use the

A320neo and 737 MAX to improve their economic geography by

operating single-aisle aircraft routes not previously possible.

Not only will the new-technology single-aisle aircraft open range-

dependent revenue opportunities, but they will also bring runway

performance improvements. The A320neo offers enhanced

take-off performance due to aerodynamic, engine and control law

improvements resulting in up to four tons more take-off weight

compared to the A320ceo on occasions when the A320ceo

would have been otherwise limited, the equivalent of 30 to 35

more passengers.

Optimized use of cabin space as well as innovations in seat

design and monument layout have resulted in one to two

more seat rows on new-technology single-aisles with the same

passenger comfort. Increased available floor space is also being

used to expand premium economy cabins and experiment with

differentiated business class products, such as jetBlue’s Mint.

While some of these cabin enablers are available for retrofit, the

cost is not always economical. Airbus’ Cabin Flex option on the

A321neo is only available on the re-engined variant, enabling

four additional seats in a two-class configuration and up to ten

additional seats in high-density. Boeing’s 737 MAX 200 adds

a new exit door to the 737-8, enabling Ryanair (Ireland) and

other low-cost carriers to fit 200 seats in a hull that formerly

accommodated up to 189.

Non-fuel Operating Cost Savings of New-Technology

Single-Aisles

The smaller noise footprint of new-technology single-aisles

may enable access to certain airports previously only served by

turboprops and will extend curfews. 128 airports that account

for 15% of scheduled passenger take-offs worldwide have

implemented noise charges (Boeing, Innovata). An additional 181

airports have curfews or other noise limits. In total, 309 airports

accounting for 32% of take-offs have implemented some type of

noise restriction.

Frankfurt Airport has implemented higher charges for aircraft

movements operated during the late evening or early morning.

City airports, such as London City, Toronto City, and Bromma-

Stockholm City, restrict operations based on aircraft noise

characteristics. While restrictions reduce revenue opportunities,

noise charges increase the cost of operations. Airbus estimates an

A320neo with two landings a day at London Heathrow will save

$60,000 per month over the A320ceo just on lower noise charges.

Aviation noise is a policy issue on all continents, affecting human

health and welfare. He et al. (2014) estimated the capitalized

monetary impacts of aviation noise in 2005 to be $23.8 billion

around 181 airports worldwide, including 95 in the United States.

As urban areas encroach on airports, technology will be relied

upon to reduce the burden of air transport on local communities.

Figure 3: The trade between increased ownership cost of new-technology aircraft and fuel savings is dependent on utilization.



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While engine manufacturers are targeting equivalent

maintenance costs to the previous generation, they are

accomplishing this by keeping engines on-wing longer and by

providing competitive maintenance agreements. Airframers are

using advanced materials to extend heavy maintenance intervals,

and in some cases, repackaging maintenance checks to bring

greater maintenance cost efficiencies.

Data analytics will be used to diagnose issues faster and

improve maintenance forecasting, reducing line maintenance

requirements and aircraft on ground situations. New-technology

aircraft will require fewer man-hours to be maintained and will

spend fewer days on the ground, generating more revenue

service days and spreading ownership costs over more flights.

High-utilization airlines favor new-technology

Not all airlines are positioned to take advantage of the benefits

new-technology aircraft deliver. Airlines replacing existing

capacity may not require additional payload/range capabilities.

Airlines that operate out of airports without noise restrictions will

not assign an economic value to smaller noise footprints. Low-

utilization airlines may not save enough fuel to pay for increased

ownership costs.

To better understand which types of airlines value new-

technology, we analyzed the forecasted share of single-aisle

deliveries from 2016 to 2019. During this period, Airbus, Boeing,

and Embraer will transition production from their A320ceo, 737

NG, E190/195 families to A320neo, 737 MAX, and E190/195 E2.

Bombardier will ramp-up C Series production, while COMAC

and Irkut plan to deliver their first C919s and MC-21s. Airlines

operating single-aisles in 2015 were segmented based on

utilization (greater or less than 8.8 hours per day) and by

average single-aisle fleet growth since 2012 (more or less than

6.1% annually). These thresholds were selected to roughly

split evenly the number of deliveries forecasted by Ascend to

announced passenger airlines (52% new-technology vs. 48%

current-generation) and within each quadrant defined by

utilization (high/low) and single-aisle fleet growth (high/low),

ranging from 23% to 27%.

New-technology aircraft account for two-thirds of high-

utilization, high-growth airlines’ deliveries. High-utilization,

low-growth airlines also prefer new-technology single-aisles,

although replacement demand is higher in this quadrant,

resulting in a lower propensity to select new-technology.

Low-utilization, low-growth carriers’ are indifferent in their

technology selection. With fewer flying hours per day, the

business case for new-technology is weaker, while current-

generation types can fulfill near-term replacement demand.

Low-utilization, high-growth carriers demonstrate a preference

for current-generation aircraft which are available sooner without

the complexity of integrating a new type.

Segmenting by region, Middle East operators with orders have

the highest average single-aisle utilization, and 61% of deliveries

this decade will be new-technology. Although European

operators are the most exposed to noise charges, they have

a low average utilization: 48% of deliveries are to be new-

technology. While Asia Pacific has the fastest growing single-

aisle fleet, it also has a low average utilization: 54% of deliveries

will be new-technology. Latin America has bet heavily on the

new-technology types, accounting for 78% of deliveries this

decade, while North America has the lowest share of the major

regions for new-technology at 43%.

Trends are harder to discern on an airline-by-airline basis, but

differences in rivals’ business models can be compared. Rapidly

expanding low-cost carriers, such as IndiGo (India) and AirAsia

(Malaysia), have high utilization operations favoring new-

technology. Mature low-cost carriers, such as Ryanair (Ireland)

and Southwest (USA), are relying on current-generation types

to renew their fleets. Both categories of LCCs will experience an

increase in fleet complexity as they operate multiple generations

of single-aisles in parallel.

Table 1: New-technology single-aisles as a percentage of forecasted 2016-2019 deliveries by operator business model.

Data Source: Ascend Fleets. Lessor orders placed with an airline included.

Unannounced operators excluded.

Figure 4: 309 airports accounting for 32% of take-offs have implemented some type of noise restriction.

Data Source: Boeing, Great Circle Mapper



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Network carriers generally have low-utilization due to the

need to align flight times with hub banks. Delta’s fleet strategy

diverges from its US mainline competitors as it focuses on

current-generation types, while United and American have more

balanced fleet plans. Lufthansa (Germany) and British Airways

are focused on new-technology single-aisles, whereas Air France

has yet to commit. Most Chinese carriers are relying on current-

generation types to fuel their rapid expansion.

How much is new-technology worth?

Manufacturers desire payback after their costly period of

product development, but new-technology brings a different

value proposition to each airline. During this decade’s technology

transition, a variety of options will permit airlines to acquire

the right tool to meet their needs. New-technology aircraft will

appeal to high-utilization operators, airlines looking to develop

new network structures, and carriers operating out of noise or

runway-restricted airports. Current-generation aircraft will meet

the needs of low-utilization carriers and fast growing carriers in

need of a lift.

The operator’s business case will drive their maximum

willingness to pay. Given that some operators will see little

value in the early adoption of new-technology while others

are relying on it to transform their network, the value of

new-technology must not be benchmarked against the lowest

return business case. Deliveries will flow to those carriers that

make best use of the assets, opening new revenue opportunities

while optimizing costs.

There remain more than 300 airlines operating single-aisle

aircraft today with an average age of 13 years that have no

aircraft on order. Lessors will play a key role, providing access to

OEM’s overbooked skylines and transitioning used aircraft to new

operators, supporting a strong secondary market.

The advantages of adopting new-technology early will dissipate

as the world’s fleet shifts to the new types. It will be the early-

adopters who fully utilize the benefits of new-technology that

build lasting competitive advantage. While the price paid for the

new-technology will be crucial to continued competitiveness, the

timing of the adoption may be more so.

About the Authors

Steve Mason is Director and Head of

Aircraft Evaluation and Asset Strategy

at CIT Aerospace. Steve joined CIT in

2012 after 12 years spent working with

Rolls-Royce PLC and International Aero

Engines, where he was responsible for

aircraft engine sales for Western Europe

and leasing markets. In his current role,

Steve is responsible for aircraft investment

analysis, new aircraft strategy, airline

market assessment and aircraft valuations.

James K.D. Morrison is an Assistant Vice

President at CIT Aerospace. Jim is a

Professional Engineer and holds a Master

of Science in Technology and Policy from

the Massachusetts Institute of Technology.

Prior to joining CIT in 2015, Jim was a

Research Assistant at MIT’s International

Center for Air Transportation and held

marketing and strategy roles with

Bombardier Commercial Aircraft.

For more articles like this visit cit.com/aerospace

Figure 5: New-technology single-aisles as a percentage of forecasted 2016-2019 deliveries by region.

Data Source: Ascend Fleets

Figure 6: New-technology single-aisles as a percentage of forecasted 2016-2019 deliveries by operator.

Data Source: Ascend Fleets