, ,

Aviation Energy Economics Reshape Flight

Air carriers invest to improve profitability and expand share in the markets they choose to serve.  Selecting the right aircraft and engines are vitally important to financial success.  The process requires input from marketing, maintenance, engineering, finance, and the flight operations teams.  There are numerous factors to consider, beginning with the composition of the carrier’s existing fleet.  While newer aircraft are more fuel efficient, the issue is whether advanced technologies will give enough of a bottom line boost to supersede what is being enjoyed with the current fleet or available market alternatives.  

The answer to that question has been the price of a barrel of oil.  How much fuel does an aircraft burn in relation to the number of passengers, or ton of freight, for the distance flown?  A review of air carrier earnings performance compared to fuel cost volatility shows an inverse correlation.  Jet fuel pricing peaked in 2008 (fuel was 36% of total operating expense).  Fuel prices then dropped significantly.  The global airline industry’s fuel bill was $133 billion in 2016 (accounting for approximately 19% of operating expenses [Brent oil averaging $43.55 per barrel]).  The forecast for 2017 anticipates an average oil price of $54.0/barrel for Brent Crude reflecting a balance between OPEC supply cuts and new supply from U.S. shale oil producers.  Fuel burn per available seat mile (fuel productivity) and gallons consumed per block hour are part of the solution to this business management puzzle.  Technology, load factors, and flight operations are other critical variables that can  maximize flight segment earnings.

Since the first jet airliners in the 1950s, little has changed in basic designs.  Gas turbines were conceptualized at the turn of the twentieth century though practical designs did not emerge until the late 1930s (too late for WWII).  Rapid development followed.  With their high ‘thrust to weight’ the deployment of gas turbines made affordable intercontinental flight possible.  They have become so reliable that two-engine aircraft now fly not only across the Atlantic but also on many transpacific routes.  Added fuel efficiency gains have been made with improvements in airframe aerodynamics, materials, and engine designs.  Lighter planes burn less fuel, alternative fuels reduce carbon emissions, new carbon fiber materials weigh less (and withstand higher heat, allowing more efficient fuel combustion), new engine gear systems for the fan and turbine enable more thrust with less fuel, winglets reduce drag (and cut a plane’s fuel emissions).  The global market for jet engines is dominated by four makers.  Rolls Royce first in 1953, followed by General Electric and Pratt & Whitney, and CFM International, a joint company established by GE and French Snecma Moteurs in 1974.  Pratt & Whitney’s ‘Geared Turbofan’ engine is expected to cut operating cost 20% (about $1.7 million per plane per year), dampen noise, and reduce CO2 emissions.  By using lightweight composite materials, such as carbon fiber fan blades to achieve energy efficiency gains, the CFM International ‘Leap’ engine achieves many of the same benefits (while using tested conventional turbofan architecture, and without the added weight of a gear box).

/0 Comments/by
, ,

Economies of Energy Stabilize Coal by Rail

U.S. domestic coal production peaked in 2008.  The decline that followed was driven first by the politics of climate change and then by the shale gas revolution.  Our coal production takes place in three major coal-producing areas, ‘Appalachia’, the ‘Interior’ (Illinois, Indiana), and the Powder River Basin’s ‘Western Coal[1]’.  Substantially all moves by rail.  With the politics of pipelines delays, many thought crude by rail would take the place of lost coal volume.  But the real drivers for coal, crude by rail, and shale gas are the economics of energy[2] production and transportation.  The politics of exiting the Paris climate accord and curbing of environmental regulations will not change market forces.

Often viewed in isolation, energy commodities are connected by transportation economics.  Historically, the railroads have generated more revenue from coal than from any other single commodity.  Even with its decline, coal continues to represent a major share of rail tonnage and top line revenue[3].  Exports of coking coal, used to make steel, have been a traditional area of strength, and coal pricing has been supported by ongoing demand from China which imported 23.5% in the first six months of 2017[4].  At current prices U.S. steam coal exports are competitive in Asia (East Coast or Gulf Coast to India, California to China or North-East Asia[5]).  Amazingly, after our exit from the Paris Climate accord, steam coal exports to Europe have grown.  France’s nuclear regulator ordered safety checks on a number of the country’s reactors (almost 80% of France’s electricity comes from nuclear energy[6]) requiring the country to rely more on coal fired power.  While Germany is replacing its nuclear units with renewable energy (wind and solar) it has increased its use of coal as a backup to renewables (over 55% of German electricity generation comes from fossil fuels[7]).  Shale gas is more efficient and burns ‘cleaner’ but prices have been rising and power producers have responded by switching back to coal.  Meanwhile, environmentalists are arguing ‘fracking’ poses public health risks due to water table contamination, waste fluid air pollution, earthquakes, and unknown climate change impacts[8].  There is no question that domestic coal production is facing headwinds.  According to data from the American Association of Railroads, 22% of the country’s 220,000 coal gondolas were in storage this May and 26% of the 142,000 hoppers had not been used in the last 60 days[9].

History demonstrates energy commodity shifts take years to fully transition.  Wood gave way to coal in the 1800s.  Until the shale revolution ushered in a new era of plenty, the prospect of oil supply running out was a doomsday scenario.  Now coal is being squeezed by shale gas.  How rail traffic behaves in the years ahead will depend on energy pricing competitiveness.  Coal is becoming more competitive as natural gas prices increase (the U.S. is expected to become a net exporter of natural gas in 2018[10]).  Since the industry can expect fewer government regulations and a more supportive administration in Washington, the future role of coal in the U.S. energy mix is expected to stabilize.

Our investment strategy is to seek those exceptional or minority cases where we are confident of current cash flows and future values.  The answers are in the economics.  If you are looking for rail insight, call the Rail Experts.  Call RESIDCO.

[1] At 1.13 billion tons Wyoming accounted for 41% of U.S. coal production in 2016.  Association of American  Railroads.

[2] Department of Energy, August 2017 report: Shale Gas(economics) are to Blame for Coal Plant Closures.

[3] In 2016 coal accounted for 31.6%[3] of originated tonnage for U.S. Class I railroads, far more than any other commodity.

[4] Reuters, July 31, 2017, U.S. Coal Exports Surge.

[5] The Asian benchmark price for thermal coal (Australian port of Newcastle ended at $92.28 a ton on July 28, steady from $94.44 at the end of 2016, but almost double the $50.63 at the end of 2015.

[6] Institute for Energy Research, October 24, 2016.

[7] Ibid.

[8] As a result, New York, Maryland, and Vermont have banned fracking!

[9] The Blade Business Writer, Rail Unit Profits The Andersons, May, 28, 2017.

[10] U.S. Energy Information Administration, Natural gas prices in 2017 and 2018 are expected to be higher than 2016, January 23, 2017.

/0 Comments/by