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Energy’s Dynamics Disrupt Transportation Investment

Clean energy, zero-emissions, and an incoming Administration poised to rejoin the Paris Climate Agreement.  This year’s Covid lockdowns have cut global fuel demand 30% driving a global drop in carbon emissions (down 7% in 2020).  The lockdowns impacted transportation which accounts for 24% of global carbon dioxide (CO2) emissions. Road travel (passenger vehicles and trucking) accounts for 74.5% of transport emissions.  Aviation (which often gets the most attention in climate change discussions) accounts for only 11.6% of transport emissions.  Rail freight emits very little – only 1% of transport emissions.   By December year over year road transport emissions were down 10%, aviation emissions down 40%.   Globally, U.S. and European Union emissions were down 12% and 11% respectively (China a 1.7% drop).  In the U.S. refiners are idling plants in response to a drop in gasoline demand.  In California, the country’s most populous state, the Governor signed an order banning gasoline-powered car sales by 2035.  Many expect electric vehicles will offer a viable option to reduce emissions if conventional gasoline-powered vehicles are phased-out. 

The United States is the world’s largest petroleum consumer.  Through November U.S. rail carloads of petroleum and petroleum products were down 13.8% from 2019.  Gasoline prices are turning higher on hopes the Covid vaccines will return the world to normal levels of oil-fueled travel in 2021 (West Texas Intermediate crude, recently trading near $45 per barrel, could increase to $50 per barrel).  U.S. coal is consumed at electric power plants.  Approximately 70% of that coal is delivered by rail; it remains by far the highest volume carload commodity for U.S. railroads.  But coal volumes are down 25.5% year over year through November mainly because of the increase in U.S. natural gas production (due to extended fracking through horizontal drilling) which has led to sharply lower natural gas prices, making electricity generated from natural gas much more competitive. 

Commercial air passenger flights are estimated to account for 73% of total U.S. jet fuel consumption.  Lower fuel prices (U.S. Jet A1 Fuel Spot Price, December 11, $1.37) allow existing aircraft to remain in service longer as Carriers evaluate flights, using smaller aircraft where possible, and dropping routes that will not be profitable based on expected cargo and passenger revenue.  As newer aircraft are delivered, their upgraded engines will offer more fuel-efficient propulsion, less noise, and less pollution.  CFM’s LEAP-1B (737MAX) and LEAP-1A(A320neo) offer fuel efficiency of 15% above previous engines.  Pratt & Whitney’s Geared Turbofan (A320neo, A220) delivers similar lower fuel burn per seat. Yet low jet fuel prices diminish the benefit of these costly new engine technologies.    And OEM margins on new engines must be sacrificed to secure the longer-term and higher-margin aftermarket business.  

The OECD’s economic outlook expects the global economy will contract 4.2% in 2020 and then recover that loss in 2021.  In the U.S., the forecast is for 4% GDP growth in Q4 2020 and 3.3% in Q1 2021.  Even with the headwinds caused by a fall virus resurgence, the economy is recovering.  With the distribution of vaccines, the level of economic activity will increase.  The business case for transportation investment covers a 20-to-30-year horizon.  Investment thinking requires identifying key trends and responding.  Call RESIDO.  

Glenn P. Davis, 312-635-3161

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MAX Comes Back to Exacerbate Supply Amid Tepid Demand

On November 18, 2020, the FAA rescinded its Emergency Order that had grounded the 737 MAX since March 13, 2019. The order allows Boeing to resume delivering the jets and will allow U.S. passenger flights to resume pending mandated fixes and additional pilot training. American Airlines had taken delivery of twenty-four MAX aircraft before the grounding and expects to take ten more before the end of this year. Starting December 29th, with one flight per day scheduled between Miami and New York’s LaGuardia, American will be the first air carrier to put the MAX back into regular commercial service. United, with 14 MAX aircraft currently in their fleet, will return the aircraft to service in the first quarter of 2021.1 Southwest, the largest 737 operator, will return the MAX to service in the second quarter of 2021. Other county regulators will individually determine airworthiness requirements and timing for a return to service.2 Even with MAX deliveries resuming Boeing executives do not expect the company to generate cash in 2021.

The collapse in traffic caused by the Covid pandemic forced a shift from 2019’s inability to meet demand to a 2020 industry-wide fleet oversupply. Air carriers parked 30% of their fleets (27% single-aisle, 41% twin-aisle).3 Both Airbus and Boeing have reduced production and cut jobs. Through October Boeing delivered just 111 jets compared to Airbus’ 413 jets. Operators are generating cash by selling aircraft to leasing companies and leasing them back. Delta entered into sale-leaseback arrangements to raise $1.2 billion. United has even sold 737 MAX models that have not yet been delivered.4 To meet changing demand patterns Southwest (with their all Boeing 737 fleet) is considering replacing their 737-700s, which are nearing retirement, with newer Airbus 220s to serve shorter to medium-haul markets more efficiently (Delta has ordered 95 A220 aircraft, 45 A220-100s and 50 larger A220-300s). 

Domestic flight operations break-even points are estimated to require 60% to 70% of pre-pandemic operating revenues. The timeline for U.S. passenger operations to reach these levels remains uncertain. It is clear single-aisle aircraft that serve domestic markets will recover first. Thanksgiving Holiday traffic confirmed this. Air Carriers struggled with flight cancellations caused by pilot shortages as airport screenings rose above 1 Million, their highest in more than eight months.  Wide-body routes continue to be negatively impacted by international travel restrictions.  Uniform measures must be developed to support a return of international passenger flight. European air traffic control (“Eurocontrol”) outlined its ‘most optimistic’ scenario with traffic returning to pre-pandemic levels by 2024 but said the ‘most likely’ scenario would be 75% by 2024.  

With vaccines expected to be available in the U.S. late December (widespread public availability by mid-2021), equipment opportunities will exist in the fleet surplus that is expected to continue through 2023. It is private capital allocation that identifies the opportunities that raise productivity. As the recovery begins, remain focused on what you can control.  Strengthen customer relationships and position your equipment portfolio to deal with 2021’s flight operations challenges. Contact: Glenn P. Davis CEO 312-635-3161 davis@residco.com

1 Southwest has 233 MAX aircraft on order.  Thirty-four have been delivered and are currently in storage.

2 European regulators are expected to lift the 737 MAX grounding in January 2021.

3 Cirium Fleets Analyzer, October 26, 2020.

4 United has sold and leased back 22 planes in bid to conserve cash, CNBC, April 19, 2020.

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