Newsletters 2012

8/10/2019 Newsletters 2012

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Newsletters2012


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Introduction

AirInsight began its weekly newsletter series in January 2012 with a small mailing list. Over the

first year, that list has expanded remarkably, with readership not only within the commercialaviation and airline industry, but also within the financial community and news media. While itwas never our intent to have such a mass media following, our goal was a small list targetinginfluential people in the industry.

More than a year since we began our newsletter, our readership has exceeded all expectationsand goals. We now reach a majority of the people we had hoped to reach, and we are read inthe executive suites of industry players and those influencing the industry.

We sincerely thank you for your interest in our views and work. We are fortunate to work andinteract with truly exceptional people in the industry, whose brilliance is changing the waypeople travel. We are thrilled to work in such an exciting industry, where there seems never adull moment, and inspiration is only a breath away.

Wed also like to thank our readers who have taken the time to provide additional input andfeedback during our first year - we love hearing from you and getting behind that what to thewhy and how of the industry - the insight that our name implies.

We hope you enjoy this compilation of our first 51 newsletters from 2012.

In appreciation,The AirInsight Team


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ContentsIntroduction .............................................................................................................................................. 1

No. 1, January 10, 2012 How Bankruptcy Will Help American Airlines .................................................... 4No. 2, January 17, 2012 A Three Way Engine Race Again? ...................................................................... 7

No. 3, January 24, 2012 India's large aircraft orders in doubt ............................................................... 11

No. 4, February 1, 2012 Drip -feed of Information .............................................................................. 14

No. 5, February 7, 2012 Split Orders-A New Trend in single-aisles? ...................................................... 16

No. 6, February 7, 2012 Delamination Difficulties for 787 - How Serious an Impact? ........................... 20

No. 7, February 21, 2012 US takes aim at CSeries .................................................................................. 24

No. 8, February 28, 2012 The Impact of Fuel Prices ............................................................................... 27

No. 9, March 6, 2012 Airworthiness ....................................................................................................... 31

No. 10, March 13, 2012 Yellow flags waving throughout Commercial Aviation .................................... 34

No. 11, March 21, 2012 Republicans ratchet up attack on Ex-Im Bank ................................................. 37

No. 12, March 27, 2012 Winglets - A Triumph of Marketing over Reality ............................................. 40

No. 13, April 3, 2012 The Boeing 737 MAX and the GTF ........................................................................ 42

No. 14, April 10, 2012 Combining American, US Airways: Which hubs survive? ................................... 44

No. 15, April 17, 2012 The Demise of the 50-seat Regional Jet ............................................................. 47

No. 16, April 24, 2012 The Resurgence of the Turboprop in Regional Operations ................................ 53

No. 17, May 1, 2012 India Plans a 90 Seat Turboprop -Dont Count on it Soon ................................... 59

No. 18, May 8, 2012 More on MAX ........................................................................................................ 62

No. 19, May 15, 2012 Southwest Evolves into Legacy LCC .................................................................... 65

No. 20, May 22, 2012 Lower oil prices will benefit airlines, but will slow impetus for new aircraft ..... 69

No. 21, May 29, 2012 Price matters in Airbus vs. Boeing comparisons ................................................. 73

No. 22, June 4, 2012 Coach Seating and Comfort .................................................................................. 76

No. 23, June 12, 2012 Right-sizing in the 100-149 seat market ............................................................. 79

No. 24, June 19, 2012 Why the COMAC C919 threat is overblown ....................................................... 83

No. 25, June 26, 2012 The Continuous Improvement of the A330 ........................................................ 86

No. 26, July 3, 2012 Huge backlogs presenting dilemma for Airbus, Boeing ......................................... 90No. 28, July 10, 2012 Air Show Day 1 ..................................................................................................... 92

No. 29, July 17, 2012 Farnborough fails low expectations ..................................................................... 94

No. 30, July 24, 2012 Assessing the MAX Story ...................................................................................... 98

No. 30, July 31, 2012 Why New Technology Airliners are Late ............................................................ 100

No. 31, August 7, 2012 The 100-149 Seat Segment is viable, if now a niche ....................................... 104


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No. 33, August 21, 2012 Will the bankruptcy process result in a stand-alone business plan forAmerican? ............................................................................................................................................. 107

No. 34, August 28, 2012 Boeing and the Sporty Game of Product Strategy ........................................ 109

No. 35, Sept. 4, 2012 A320, 737 Values at Risk .................................................................................... 115

No. 36, September 11, 2012 Comparing the OEM Aircraft Market Forecasts ..................................... 117No. 37, Sept. 18, 2012 EADS-BAE merger could lead to 'commercial' company ................................. 121

No. 38, September 25, 2012 New LCC battle shaping up in Asia ......................................................... 123

No. 39, October 2, 2012 The Pratt & Whitney Geared Turbofan is Much More than Simply a Gear .. 125

No. 40, October 9, 2012 Appoint a Trustee at American Airlines ........................................................ 127

No. 41, October 16, 2012 Pressure is on Boeing for 787 ..................................................................... 130

No. 42, October 23, 2012 Airbus opens its A350 FAL ........................................................................... 132

No. 43, October 30, 2012 Longest range is sexy, but R&D and ROI doubtful ...................................... 134

No. 44, November 6, 2012 Upside Down-Under? ................................................................................ 136

No. 45, November 13, 2012 Big Twin Competition Gaining Momentum ............................................ 138

No. 46, November 20, 2012 The C919 - Quietly Gaining Traction and Building Backlog ..................... 140

No. 47, December 4, 2012 The Iron Dome ........................................................................................... 143

No. 48, December 11, 2012 Comparing Very Large Aircraft: The A380 and 747-8 .............................. 145

No. 49, December 18, 2012 Sequestration's Impact on Commercial Aviation .................................... 148


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Air Insight | Analysis of Current Events

No. 1, January 10, 2012 How Bankruptcy Will Help American Airlines

American Airlines and its affiliates and subsidiaries are now bankrupt. There continues to bedebate over the benefits of the filing.

General agreement is that AA will shed costs by dumping its pension plan, as did the other USlegacy carriers, restructure debt and dump aircraft. American Eagle will be radicallyrestructured. There appears to be a general misunderstanding on some other key elements.MD-80 s will be the main target of financial restructuring and contract rejections. Although AAdrove down rates and debt costs on all aircraft following 9/11 in a consensual restructuringoutside Chapter 11, the costs are well above market today. The ex-TWA MD-80s leased fromBoeing Capital willbe a prime target for rejection or massive restructuring. AA had a Day 1

rejection list. There is a Day 60 list, too. Day 60 is when AA either has to cure past duepayments or return the airplanes.

Boeing 757 s will also be a prime target for cost reduction and potential rejection. Maintenancecosts are climbing (AirInsight, http://tinyurl.com/ 7kjok3b) on the type. AAs 737 -800sare a bitsmaller but can accomplish any domestic mission operated by the 757. AAs 737 -900ERs onorder are closer in size and likewise can undertake any domestic mission except Hawaii.

AA can shed routes to cut costs. While one observer notes, correctly, that AA can cut routesoutside bankruptcy, he misses the larger point. It is well known that airlines have difficultshrinking to profitability because foundational costs continue: costs of airport facilities, costs ofthe airplanes. Merely cutting routes doesnt, well, cut it, as long as these other costs remain.Under bankruptcy, AA can now withdraw from money-losing cities by rejecting airportcontracts or, if a presence to other profitable routes is required, restructuring these costs. Theairplanes assigned to these routes can be rejected or costs reduced. The assertion thatbankruptcy brings no benefit to cutting routes is incomplete.Labor : There is an argument put forth that AAs bankruptcy had nothing to do with labor costs.We disagree. AA has negotiated with pilots for five years to obtain a new labor contract that ismore economic and productive. The long-standing MOU for 42+58 Boeing 787-9s remainsincomplete due to the lack of a pilot contract.

AA has the basis to go into bankruptcy court to argue that after five years, the pilot contractshould be rejected. This follows the path that union scourge Frank Lorenzo took in 1983 withthe bankruptcy of Continental Airlines. Though labor laws were then much more conducive tounilateral management rejection of contracts, it is still possible today to do so.

AA pilots argue that their wages and benefits are better than some peers but worse than othersand therefore management is playing games. There may be some merit to these arguments.But there is no disputing that the Scope clause is a detriment to AA and that Southwest Airlines-


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-now the largest US domestic operation--gets much more productivity out its pilots than doesAA.

American chose a path following 9/11 that was admirable in trying to protect employees,lenders, lessors and other stakeholders from the damage that comes from bankruptcy. But the

company has been in a major competitive disadvantage as one peer after another filed forChapter 11 and shed airplanes, gates, costs and pensions. AA had no choice but to finallysuccumb and follow suit.

Evening the gap: the GTF vs. LEAP battlePratt & Whitney has been the also-ran in single aisle engines ever since it made the disastrousstrategic decision to forego offering Boeing an engine for the 737 Classic and ceding this marketto CFM as the exclusive supplier for this iconic airplane. PW made the bet that up-gaugingwas then underway and the Boeing 757 would become the new backbone for the airlines.

PW was only 30 years to soon on its up-gauging conclusion. With the development of theGeared Turbo Fan, PW is clearly back in the game as a supplier of single-aisle engines.PW has announced 2,200 orders for the MRJ, CSeries and A320neo family.

CFM, with its LEAP engine, is the exclusive supplier on the new COMAC C919, After a slow start,COMAC has picked up and CFM now has LEAP orders for 2,398 engines for the C919 and737MAX (251 orders and commitments for C919, according to Ascend data base and 948 ordersand commitments for the 737MAX). CFM has an additional 820 LEAP orders for 485 A320neos(through November). This is a market share split of 39.5% for PW and 60.5% for CFM.

But when you look at the only market segment where the two companies compete, theA320neo, the market share is more evenly split. The order book is 410 airplane for PW (820engines) and CFM 485 (970 engines) (through November). But if you delete the 60 neosordered by CFM family member GECAS (which buys only GE/CFM engines), the score is PW 410and CFM 405 aircraft supplied. If you also delete the Frontier Airlines order for 80, where CFMand GECAS combined to financially restructure prior deals, the score is PW 410/CFM 325. This isclearly a major comeback for PW from prior years.

Where is the 100-150 seat market?Many experts believe the 100-150 seat mainline jet market is the Bermuda Triangle for new jets. They point out that there is a general up-gauging trend. There certainly is no question

about this, most recently evidenced by Southwest Airlines and its new order for Boeing 737NGsand the 737 MAX. There wasnt a 737 -700/7 MAX in the order; it was all -800 and 8 MAX. To besure there are substitution rights to the smaller airplane. Observers also point out the lastnew airplane in this category was the unsuccessful MD-95 (renamed Boeing 717 after theMcDonnell Douglas merger).

We argue that the MD-95, which is a very good airplane, is truly nothing more than a shrink andwe all know these have limited success.


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Embraer is far more successful with its E-195, which seats 122. This and the 100 seat E-190 havesold quite well, actually--because these airplanes were designed for this segment as a clean-sheet offering. The last time there was a clean sheet before EMB were the DC-9, 737-100/200and the Boeing 727-100.

Bombardiers cle an-sheet CSeries recognizes this, and thats the point. While aircraft aremoving up in size, a vacuum is created in the segment. The A319 and 737-700 REs are betterthan their older siblings, but still cant compete on economics. Airbus and Boeing can crush BBDon pricing, and narrow the economic gap. But there still is a market segment that BBD and EMBcan fill with better airplanes. And they will. It will only be a matter of time.


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Air Insight |Analysis of Current EventsNo. 2, January 17, 2012 A Three Way Engine Race Again?News emerged last week 1 that Boeing has issued Requests for Proposals to all three majorengine OEMs for a 100,000lb thrust engine for the conceptual 777X. The significance of thisgoes beyond the airframe ideas Boeing is floating to meet the Airbus A350 threat. It is anothervalidation of the Pratt & Whitney Geared Turbo Fan concept.

Most will have forgotten by now but at the 2008 Farnborough Air Show, it emerged that one ofthe Big Two airframe OEMs had approached PW to inquire about the GTF for a 777-sizedairplane. Airbus said it wasn't them and while then-CEO of Boeing Commercial Airplanes ScottCarson didn't come right out and confirm that Boeing had talked with PW, he didn't deny it,either. Even then Boeing was thinking about a re-engine for the 777 or for a new, similarly sizedairplane.

As Boeing considers a 777X, one option is a variant of the GE90 combining GEnx technology.Rolls-Royce is developing a 97,000lb thrust engine for the A350, the Trent XWB. Would RRfurther upgrade this engine of come up with an entirely new one? As for PW, studies havealready demonstrated the GTF, currently offered from 24,000lbs to 33,000lbs, can be scaled upto 110,000 lbs.

PW, which once dominated jet engines, powering 707s, 727s, 737-200s, DC-8s, DC-9s and MD-80s almost exclusively (a few RR engines were on 707s and DC-8s), made a major strategicmistake by foregoing the 737 Classic and allowing CFM exclusivity. PW split the 757 market withRR in a duopoly. Boeing's 747, 767 and initially the 777 used all three engines but GE dominatesthe 777 market today. PW is not a participant in the 787 program and has limited presence onAirbus widebodies. Only through its JV with RR did it power the A320 family. (PW last yearbought out RR from the JV.) Today, GE powers around 92% of Boeing's airplanes. But thisrelationship has been under tension and there are key Boeing people who would like to seemore choices.

The GTF has already sold more than 2,200 engines on single-aisle airplanes. If the GTF isselected by Boeing to power the 777X, this will be a huge breakthrough in the cutthroat enginemarket.

The 777X RFPs will once again pit RR and PW against each other. The JV had evolved into acontentious relationship. The two companies sued each other over patent claims (PWprevailed). And a new JV was formed with PW and RR to develop GTF variants for single-aisleairplanes. But this kind of awkward competitiveness is not new. PW and GE have a JV for EngineAlliance Partners to power the A380 in competition with RR, while PW and GE/CFM are bittercompetitors in the GTF/LEAP marketplace, where some pretty nasty things are said.

1 http://www.aspireaviation.com/2012/01/11/boeing-eyes-787-improvements-along-with-production-ramp-up/
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GE will move heaven and earth to retain exclusivity on this airplane. Since 777X will be aderivative, Boeing may have no choice in the end for the 9X. Whether there is an opportunityfor RR or PW on the 8X remains to be seen.

The GTF is already an established disruptive solution in the single aisle market. It will likely dothe same thing in the twin aisle market too.

Assessing the RR-AF A350 disputeThe reported dispute 2 between Air France-KLM and Rolls-Royce over the engines for the long-awaited A350 order comes down to Rolls insistence that it perform the maintenance on theengines and AFs desire to not only do its own maintenance but to also be free to in-sourcework for other airlines.

One way engine makers make money on deals is to follow up the orders with MRO/spare partscontracts. It is not uncommon for the engines to be sold at huge discounts, far greater thanthose routinely associated with airplane sales, as long as an MRO/spare parts contract isconnected to the deal. Its also not unknown for the engine OEMs to actually give the enginesaway, as in free , in connection with an MRO/spare parts deal.

For example, in the lawsuit between Rolls-Royce and Pratt & Whitney, court documentsrevealed that discounts of around 80% or more were given for the engines on the Airbus A380.RR competes with the PW-GE joint venture Engine Alliance Partnership to supply engines.Engines were being sold for this giant airplane for less than $3m.

Airbus and Boeing have been known to discount their list prices by up to 60%, depending on thecustomer; 80% is unheard of when it comes to these deals, and of course, neither Airbus norBoeing have been reduced to giving airplanes away free in return to MRO/spare parts deals.

Ryanair moves on ETS, providing guidanceRyanair introduced its ETS offset fee at 0.25 per person. The airline estimates this wouldgenerate between 1 5 million -20 million and cover its ETS bill for 2012. Ryanair has madethe move with an estimate 0.25 will cover the effective cost. This may work well for a shorthaul airline, but for long hauls this may be too low.

When one extrapolates that amount across the EU airlines it adds up fast. Using the

Association of European Airlines data one can see the EU could be raking in a lot of "new"money. One can readily see why the EU targeted airlines.

2 http://www.bloomberg.com/news/2012-01-10/air-france-talks-on-airbus-a350-order-drag-out-on-engine-dispute.html
http://www.bloomberg.com/news/2012-01-10/air-france-talks-on-airbus-a350-order-drag-out-on-engine-dispute.htmlhttp://www.bloomberg.com/news/2012-01-10/air-france-talks-on-airbus-a350-order-drag-out-on-engine-dispute.htmlhttp://www.bloomberg.com/news/2012-01-10/air-france-talks-on-airbus-a350-order-drag-out-on-engine-dispute.htmlhttp://www.bloomberg.com/news/2012-01-10/air-france-talks-on-airbus-a350-order-drag-out-on-engine-dispute.htmlhttp://www.bloomberg.com/news/2012-01-10/air-france-talks-on-airbus-a350-order-drag-out-on-engine-dispute.htmlhttp://www.bloomberg.com/news/2012-01-10/air-france-talks-on-airbus-a350-order-drag-out-on-engine-dispute.htmlhttp://www.bloomberg.com/news/2012-01-10/air-france-talks-on-airbus-a350-order-drag-out-on-engine-dispute.htmlhttp://www.bloomberg.com/news/2012-01-10/air-france-talks-on-airbus-a350-order-drag-out-on-engine-dispute.htmlhttp://www.bloomberg.com/news/2012-01-10/air-france-talks-on-airbus-a350-order-drag-out-on-engine-dispute.html


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Looking back over the last few years note that had the ETS been in force, the EU could havecomfortably brought in between 80 billion and 90 billion ever year. With a slowdown in theEU his year, IATA forecasts a growth in EU traffic of 2.5% and in a "bank crisis" sees a -3.7%shrink in traffic. We assume the crisis will be averted and used the 2.5%. For 2011 AirInsightestimates the EU traffic managed to achieve a 2.5% growth rate.

It appears the ETS impact, reviled as it is by airlines everywhere (and now subject to legaldisputes), and is simply not that big a number for passengers. After all, compare the 0.25 withthe UK's departure tax of 26 (starting April 2012) for flying less than 2,000 miles. If the ETS feeis reviled, the UK tax is an order of magnitude worse.

A380 "issue" not all it's cracked up to beFrom the start this program has attracted attention - it is the biggest airliner and carries morepeople than any other. When the A380 first was being built an engineer, Joe Mangan3,attracted a lot of attention by saying the airplane is unsafe. That story was a flash in the pan.The bigger news was the struggle Airbus had with the program. Airbus had to rewire the initialbatch of airplanes by hand because the first harnesses were of incorrect lengths. Being thebiggest airplane has meant the A380 attracts attention - witness the media frenzy around theQF31 engine failure. A lot of time was spent talking about "what if" - the event was nearlycatastrophic, but what that A380 endured and then managed to land safely. This wasremarkable. Very few airplanes could withstand such an event and come back as that A380 did.Volumes of credit go to the superb crew handling that flight. Qantas had four senior pilots whomanaged to deal with the event perfectly. The event demonstrated the A380's inherentstructural strength and design.

Now there is frenzy over hairline cracks on five A380s. Two are flying for Singapore, one forQantas, one for Emirates and on an Airbus factory A380. The A380 has been flyingcommercially for five years and has carried over 10 million passengers. The airplane's dispatchrate exceeds 97%. It had a rough start, but operators are pleased with the A380's performanceand passenger appeal is very high.

The cracks were found in wing ribs. Not only have they been identified - they have been fixed.The airplane remains safe to operate. Lufthansa reported that it has not found the same cracks

3 http://en.wikipedia.org/wiki/Joseph_Mangan
http://en.wikipedia.org/wiki/Joseph_Manganhttp://en.wikipedia.org/wiki/Joseph_Manganhttp://en.wikipedia.org/wiki/Joseph_Manganhttp://en.wikipedia.org/wiki/Joseph_Manganhttp://en.wikipedia.org/wiki/Joseph_Manganhttp://en.wikipedia.org/wiki/Joseph_Manganhttp://en.wikipedia.org/wiki/Joseph_Mangan


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in its A380s. Other operators include Air France, Korean and China Southern plus the biggestoperator, Emirates. Were these cracks of a threatening nature, you can sure these operatorswould ground the A380 immediately. Less than a centimeter in length, these cracks were foundon the L-shaped feet of the wing ribs. These feet attach the rib (a vertical fixture) to the coverof the wing. The Sydney Morning Herald reports that Airbus "traced the problem to an

aluminum material used in the wing ribs called 7449 which tends to be more sensitive to theway the parts are assembled on the wing." The WSJ reports the cracks were first discovered onthe QF31 A380 being repaired by Airbus engineers.

A lot of media attention is going to be given to the Australian Licensed Aircraft EngineersAssociation - Steve Purvinas union secretary is quoted by the UK Daily Mail as saying "We can'tcontinue to gamble with people's lives and allow those aircraft to fly around and hope that theymake it until their four-yearly inspection". This is language that will attract media attention.There is nothing like the threat of a crash to get attention. It bears consideration that the unionhas had a running battle with Qantas. Much of the heated language should be discounted asrhetoric.

The cracks are described by Qantas, Singapore and Airbus as "non-critical". We view the rush toturn this news into something bigger as banal.


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Air Insight | Analysis of Current EventsNo. 3, January 24, 2012 India's large aircraft orders in doubt

The airline industry in India is failing, largely as a result of government interference in themarketplace. The root cause of the problem is government subsidization of the failing Air India,which is currently pricing at below cost, resulting in massive losses and continued bailouts bythe taxpayers. While this has been going on since a botched merger forced by governmentbureaucrats in which Air India absorbed the domestic Indian Airlines operations, the carrierdramatically increased its financial losses to unsustainable levels.

By setting fares below cost, other carriers in the country are also suffering. Kingfishers troublesare well known, and aircraft repossessions are imminent. ATR has removed all Kingfisheroutstanding orders from its books as a result of the financial problems. Two carriers were

recently cited for safety violations that were attributed by the Indian regulators to their weakbalance sheets and cash flow issues, yet the root cause of the problem is being ignored forpolitical reasons.

No unstable situation can last forever, and this week the Indian banks have finally discoveredrationality, refusing additional loans to the weak carriers who in the current industry structurehave no hope of ever repaying those loans. As a result, a cash crisis is now hitting the airlineindustry harder than ever, as virtually all of its carriers have gone negative in cash flow andwatched their balance sheets erode dramatically as they need to price below cost to competewith the subsidized national airline.

So what will the Indian government do? It appears to be once again putting its head firmly inthe sand, with a recommendation for significant and continuous investment in airline equitiesas a way out of the situation. Expecting investment in companies without a clear futurepotential to generate a return has about the same odds for a profitable return than winning thelottery - about one in a hundred million. No rational investor will throw good money after bad,and this strategy will also fail - just ask Kingfisher why it cancelled its planned stock offering.The vultures will soon be circling.

The net result will be the failure of several privately owned airlines in India. Those large aircraftorders from Airbus and Boeing will be in jeopardy unless the government can deal with the

fundamental problem - Air Indias subsidized pricing below cost. Breaking up or privatization ofAir India entails political risk, but not doing anything will likely result in the other extreme - nosuccessful private airlines and safety and cash flow concerns for those that somehow manageto survive. Without the ability to earn a fair return, Indias private airlines are doomed.


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New leadership at Bombardier points EastBombardier announced a new President of its Aerospace unit, Mike Arcamone, who mostrecently was President of General Motors South Korean operations. With 30 years in theautomotive industry, he will bring an outside perspective to an organization at a key moment inits history, trying to bring the all-new CSeries to market on time while maintaining cash flow

from its existing CRJ NextGen and Q400 product lines that have each experienced significantmarket erosion during the last two years.

Choosing an executive with significant Asian experience appears significant for Bombardier.With Asia a key target for the CSeries, and Bombardier and COMAC in discussions regardingcommercial cooperation, Bombardiers plans have a strong Asian component. As a Montrealnative, he should readily fit within the Bombardier corporate culture, while providing specificskills that complement their geographic strategy.

ETS negatively impact European airlinesNow that the EU does not appear to be backing down from its Emissions Trading Scheme forairlines, the question is how will the impact the competitiveness of European airlines andairports over the long term. We believe the impact will be significant, and negative as this taxpackage evolves.

Remember that all airlines in the first year have an 85% credit provided by the EU. Of course,like any other tax, this loophole wont last. US carriers have added $3 per passenger to coverthe 15% airlines are responsible for today, but this could grow to $60 per passenger withoutsuch credits. As the only two certainties are death and taxes, the long-term direction isobvious.

The key question is will the difference in fares be enough for traffic that currently connectsfrom North America to the Middle East and Subcontinent over Europe choose to connect viaother routes. Emirates, Etihad, Qatar and other Middle-Eastern airlines are ecstatic over thepotential to bring travelers from the US to India and other destinations without a stopover inEurope, particularly as European carriers are forced to increase fares. The question is whethersuch increases will be able to shift traffic from Heathrow, Schiphol, Frankfurt and de Gaulle toDubai, Abu Dhabi or Doha instead.

From a service perspective, the arguments are already compelling: aircraft are more modern,the airports are more modern and on-board service more attractive for the middle-eastern

carriers. The question is how quickly they can continue to build their route structures andglobal connecting hubs, and what proportion of the premium fare business travel market theycan attract away from European carriers? From the East Coast USA to Europe, a six hour flightis really too short to sleep well - but a 10-12 hour non-stop to the Middle-East is ideal for a mealand an evening rest, followed by a convenient connection onward to India or Southeast Asia.

Any factor that can shift traffic is critical to an airline. The EU just provided another weapon tothe carriers it complains about being unfair competitors while forcing its own airlines to eat a


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tax increase to remain competitive. Normally governments protect their own businesses, butthe net impact of the ETS is the opposite of protectionism. Fewer passengers lead to fewerflights lead to fewer gates and airport operations, and the net result over a long period could bea downward spiral. How soon can those US airports be ready for A380s?


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Air Insight | Analysis of Current EventsNo. 4, February 1, 2012 Drip-feed of Information The latest kerfuffle in commercial aviation is over the wing bracket cracks in the Airbus A380.The London Telegraph4 perhaps sum med it up best: there was a drip -feed of information tocome out about this issue, which taken as a whole has been made out to be more serious thanit really is. Cracks in airplanes are as old as aviation itself and more often than not (much moreoften, fortunately), these are discovered and fixed before they become safety issues.

We well remember the issues Boeing had with the early 747s, which were known as Section41 repairs. Section 41 is the nose section of the airplane. Here is what was synopsize d in theUS Federal Register at one point: This document proposes the supersedure of an existingairworthiness directive (AD), applicable to certain Boeing Model 747-100, -200, -300, 747SP, and

747SR series airplanes, that currently requires repetitive inspections to detect cracks in variousareas of the fuselage internal structure, and repair, if necessary. This action would add newrepetitive inspections for cracking of certain areas of the upper chord of the upper deck floorbeams, and repair, if necessary. This proposal is prompted by the results of fatigue testing thatrevealed severed upper chords of the upper deck floor beams due to fatigue cracking. Theactions specified by the proposed AD are intended to prevent loss of the structural integrity ofthe fuselage, which could result in rapid depressurization of the airplane.

This isnt strictly comparable, of course (wing brackets vs. floor beams) but the underlying pointis made. Cracks in airplanes arent unknown. You find them and you fix them. In t he case of theA380, the fix is known, it is costly but its reasonably easy to accomplish. The hand -wringingabout grounding the airplanes is aviation hysteria that emerges now and then, just as it did overthe whole business of fires and composites with the Boeing 787. The Dan Rather HDNet reporton this issue tended toward hyperbole instead of a comprehensive understanding of the issuesthen at hand. Composites have been on and in airplanes since the days of the Boeing 727. Theyare understood and any fire by definition is hazardous to life and the environment.So its time to move on. And we will.

Getting back to the point of drip-feeding information, aviation is unfortunately prone to this alltoo often. Airbus, Rolls-Royce, Boeing, CFMall of the OEMSclam up when things go south,as we say. This forces aerospace analysts and aviation writers to turn to sources,

stakeholders, the airlines and others to try to find out what is going on with a program.Transparency is a concept that is all too ofte n foreign. All the OEMs need to be moreforthcoming. Sunshine news isnt the only time to be transparent.

4 http://www.telegraph.co.uk/finance/newsbysector/transport/9043828/Airbus-finds-quick-fix-for-superjumbo-wing-cracks.html
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Boeings 787 2012 delivery plan When Boeing issued its 2011 year-end earnings report and forecast 35-44 787 deliveries for thisyear, the numbe r seemed very low. Boeings Z24 production rate ramp up calls for 45 airplanesto be produced at Everett and Charleston. Then there are the nearly 40 787s sitting around

Everett awaiting rework. Surely, we thought, there would be much more than 45 airplanesdelivered (new production rate build 45+xx previous build).

So what happened? Simply, the rework that is still necessary on the previous-build airplanesand the rework necessary on half those new build will dramatically slow the delivery rate. Itturns out half the new build airplane will require rework that will take up to three weeks each.The previous build aircraft require much more work and much more time. This is why projecteddeliveries this year fall below the Z24 production table.

Airbus NEO vs. Boeing MAX Sole-source Boeing customers American Airlines, Garuda and Norwegian Air Shuttle eachordered the Airbus A320neo. American and NAS split their orders for neo and MAX. We thinkthere is at least one other customer from the Boeing camp that may place a neo order in thenot-too-distant future. It might be another split-decision situation. We also think there is a verygood chance the Boeing-minded executives now running United Airlines will order theA321/321neo to replace the aging Boeing 757s at legacy United. The 757s at ContinentalAirlines are still pretty young and may not be ready for replacement just yet.


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Air Insight | Analysis of Current EventsNo. 5, February 7, 2012 Split Orders-A New Trend in single-aisles?

Weve recently seen two narrow -body aircraft orders in which both Airbus and Boeing havebeen each been victorious at the same airline - American and Norwegian Air Shuttle. While theorders may to some degree be a result of limited delivery positions available from eachmanufacturer, the inroads made by Airbus on former Boeing- only customers cant be sittingwell in Seattle and Chicago.

We believe similar announcements may be forthcoming, with one or more airlines preparing tosplit orders between the two giant OEMs. It appears that the era of winner-take-all orders fornarrow-body campaigns is over. The implications are interesting.

First, this means airlines can afford to have mixed fleets without a significant detrimentaleconomic impact from a lack of commonality. We have long held that as long as a fleet has acritical mass (between 50-100 airplanes is certainly critical mass) that the benefits of fleetcommonality almost disappear in our economic analyses. These recent and pending orderscertainly underlie that point.

This also bodes well for aircraft such as CSeries, which has better economics than thecompeting A319neo or 737-7MAX, and could be a profitable sub-fleet to serve lower densityroutes, just as weve seen E190s at JetBlue. The Southwest myth that a single aircraft type canmeet all needs appears to have been proven false. Lufthansa certainly believes that a mix of

CSeries and A320 family makes sense in its group's operations.Second, we believe that airlines are now also beginning to hedge their bets, and not putting allof their future with one manufacturer. A fair number of airlines are cautious by Boeing after the787 debacle. Many acquired the Airbus A330 as a result of these delays. Now Airbus is feelingthe pinch, with some airlines buying the 777-300ER as a hedge against delays in the A350-1000program.

Some airlines question whether the 737MAX will meet either proposed specifications or itsprojected EIS date, largely because of the continuing uncertainty of the design and workstatement. The A320neo is viewed as more mature in design, containing a lower workstatement, it could be a lower risk option, and it should be available sooner.

Many in the industry believe the neo will have better economics than MAX, based on theinability to fit a large fan engine under the wing of the 737 without lengthening landing gear.Recent comments by Michael OLeary at Ryanair cast doubts on the fuel sa vings of the MAX, aswell as on the performance of the LEAP-1B engine, with claims that the engine is overweight.


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Combined with the recent pronouncement by Airbus COO John Leahy at a Credit Suisseconference that the GTF will have a 1.5% better fuel burn on neos due to the larger fan, evenwhen accounting for drag, there is additional concern about LEAP, as the development of LEAPfor MAX comes later than the neo or C919 versions. There are still issues to work through(which GE will certainly do) regarding fuel burn and weight, as well as improving SFC through

higher operating temperatures and pressure ratios. By the time LEAP for MAX enters service,the P&W GTF will have about one million hours in operation across its several applications.

Third, with Norwegian's selection of both the GTF and LEAP for their orders, it means that sub-fleets of different engine types are also feasible in todays environment. With most enginesnow covered by by the hour maintenance agreements with the OEM, airlines can afford to beindifferent on engine choices, and perhaps in the future even run fleets of different engines onthe same aircraft type. With increasing OEM participation in MRO, the economics of enginechoice is also changing.

The bottom line: We are now in a new ball game, in which airlines no longer trust the OEMs'ability to deliver on time and on performance. Delays are commonplace, and continuing, withA350XWB joining A380, 747-8i and 787 on the list of aircraft with revised EIS dates. With initialengines not performing to specifications, and PIP kits required after delivery to meet initialspecifications becoming more commonplace, there is increasing doubt as to whether 737MAXwill initially perform well enough to effectively compete with Airbus A320neo and CSeries.While time will tell, airlines appear to be speaking with their wallets, and hedging their bets.

Bombardier's Q400The Q400 had a tough 2011. It was significantly outsold by the ATR. ATR sold 157 turboprops in2011 compared with 80 in 2010. Bombardier's sales of the Q400 have been anemic and itsbacklog is just 29 aircraft. In 2011 ATR got orders for 13 ATR 42s and 144 ATR 72s, giving ATR80% market share. Orders were 40% above its previous record year in 2007. ATR holds optionsfor a further 79 aircraft. It delivered 54 units during the period, against 51 a year earlier,including its first ATR 72-600.

There are rumors that Calgary-based WestJet is going to select the Q400 for its 40 turboproporder.

Looking at the 2011 sales numbers may not provide the whole story. We believe the Q400 andATR72 serve slightly different markets. The Q400 is essentially a 50-seat regional jet

replacement. It has tremendous performance for a turboprop. It flies 100mph faster than theATR. This performance comes at a cost though it burns more fuel and costs more to buy.

The key difference between the airplanes is how they are pitched. Bombardier talks about500NM stages when discussing its Q400. ATR focuses on 300NM ranges or less. Thisunderscores that the Q400 really is competing with regional jets on ~500 mile routes. Airlineswith 50-seat regional jets are trying hard to figure out how to replace them. For many of theseairlines who are flying the Bombardier CRJ the Q400 offers a good option. But firs these airlines


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need to offload the CRJs. A Q400 offers 78 seats compared to 50 seats and operates at 40%lower cost than a regional jet. But that leaves the Q400 as a tightly focused product.Another item to consider is that Bombardiers Q400 is a sole offering. ATR offers a family ofairplanes. This means airlines can consider a range of sizes and performance characteristicswhen considering a turboprop. This means the ATR offering is a lot more attractive. Moreover,

the ATR is up to $5m cheaper to buy.

EADS is a key ATR shareholder, offering deep pockets and other technical resources Bombardierhas to fund itself. This is why ATR has been able to regularly refine its ATR 42 and 72.Bombardier focused its resources on one turboprop and bet on the regional jet replacementmarket. ATR has been able to focus on the turboprop replacement market with appropriatepricing and performance.

Bombardier is bullish on turboprop prospects though. Rising fuel costs and increased air travelbetween secondary cities keep the turboprop popular.

Bombardier expects to see its turboprop grow in size it was first talking about a 90-seatturboprop in 2008. What Bombardier needs is an innovative path that allows customers to seethat it is able to leapfrog the ATR72-600 with a Q400X just as the first Q400 was able toleapfrog the earlier generation turboprops. Markets where the Q400 is doing well includeIndia - where SpiceJet appears ready to exercise its option for 15 more Q400s. India is a primemarket for turboprops and Bombardier has a foothold with an Indian airline in a growingmarket.

ATR has been successful with its new generation airplanes because it has been innovative.With better engines, an upgraded flight deck and cabin - enough to be a significant step up forits current customers or current turboprop users without pricing like a regional jet .

Bombardier should rapidly accelerate it plans for an improved Q400 - it too must innovate. Theinnovation lesson of Airbus neo is there f or all to see.

P&W, CFM neo competition heats upThe coming engine selection by AviancaTaca could be a real test of Pratt & Whitney's newbusiness models for International Aero Engines and its Geared Turbo Fan partnership. P&Wbought out Rolls-Royce from IAE and simultaneously agreed to form a new JV with R-R thatprioritizes the GTF. This puts P&W on an equal footing with CFM in terms of incumbency for

orders for the Airbus A320neo.CFM was in a position to cut "global" deals on previous contracts for A320s equipped with theCFM56. PW was inhibited from doing so on A320s equipped with IAE's V2500 because therewas nothing in it for R-R -- a GTF neo sale contributed nothing to R-R's bottom line and therewas no incentive for it to go along with a recasting of any existing IAE contract or to providecut-rate deals on IAE orders tied to new GTF contracts. Now, with R-R out at IAE and P&W the


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controlling shareholder, P&W can cut "global" deals. That's where the AviancaTaca deal comesup.

The table below shows some of the most recent orders.If one were to assume the incumbent engine

supplier (at Spirit and Volaris) has theadvantage this could mean that the P&WGTF might see another 150 orders. AtAviancaTaca there is a mixed enginesituation; Aviancas A320s uses CFM56s andTaca A320s use the IAE engine. This is a realshoot-out and this might actually be the leadof this piece. P&W and CFM can compete onmore of an equal footing.

But we also know that CFM -- part of the GE family -- has much deeper pockets and morebusiness opportunities than P&W. GECAS, the mega-lessor, can offer financing on the airframesthat P&W cannot. GE can offer engine maintenance deals that P&W cannot. We would neverdiscount the GE/GECAS/CFM combination for overcoming competitive obstacles.

Norwegian has not flown any Airbus and its 737 fleet is CFM powe red. The A320neo order wasmatched by an equal order from Boeing for MAX but this does not automatically mean a CFMwin on the neos. When Norwegian takes neo deliveries in 2016, the only engine available willbe the GTF. Its not clear how many of Norwegians neos will be GTF powered. The airline willhave the engine makers fight over the rest of the order. By buying from both aircraft makers itcould be the airline also decides to split its engine buy for the same reason reduce risk.

There is one more twist here and that is called Bill Franke. His company, Indigo, is a privateequity firm (no relation to the Indian airline IndiGo) with interests in airlines all over the world.Among them are Spirit and Volaris. He also has interests in other airlines with A320s, WizzAirand Tiger. Wizz and Tiger A320s and IAE powered. It appears that airlines Mr. Franke invests inare likely to go with the P&W engine.


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Air Insight | Analysis of Current EventsNo. 6, February 7, 2012 Delamination Difficulties for 787 - How Serious an Impact?

A delamination problem has emerged with the Boeing 787 which Boeing has characterized asminor, but could be costly both in terms of repairs and potential production process issues tocorrect the problem. A series of never ending problems with quality keep emerging with theprogram, the latest emerging from the former Vought unit that Boeing has since acquired. Thekey question is whether this will mean another major delay in delivering airplanes, and howdifficult it will be for Boeing to meet its planned schedule of 10 aircraft per month in 2013.

Our view is that while Boeing is trying to minimize the impact as quickly as possible, anotherdelay of a month is likely for existing aircraft under construction, as inspections themselves willrequire considerable effort for a fleet of about 50 aircraft in various stages of assembly in

Everett, and perhaps a bit longer for those aircraft that require repairs.

The difficulty for this problem is with the longerons, which are the side stiffeners running thelength of the aircraft. There has been delamination in longerons around Section 48 of theaircraft. This section is where the rear stabilizer joins the fuselage, and the de-laminations haveoccurred just above and below the indented opening or birds mouth that holds thehorizontal stabilizer.

In composite materials, delamination results when layers of the composite material comeapart, reducing structural strength and setting up the potential for additional decompositionshould additional moisture further erode the structure. Delamination is a serious problem thatneeds correction in composite structures, but can be repaired with additional filling materialsand epoxy to hold the plies back together. As a result, additional repair work will be requiredto the three aircraft that Boeing has identified serial numbers 56- 58, and a significant numberof additional aircraft that may also have experienced such problems, according to our sources. Boeing is quietly inspecting the entire fleet for the additionalproblems, including aircraft already in service.

This particular problem appears to have been caused bycomponents that when placed together have gaps that, oncetightened with fasteners, could result in stresses that causestructures to delaminate, resulting in a foreshortened fatiguelife. Boeing has faced this problem before, as horizontalstabilizers build by Alenia were assembled without therequired shims to ensure that the structure fit together well,and required those assemblies to be torn down for repair. Inthis case, a similar problem appears to exist, yet Boeingasserts that it can complete the required repairs without


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tearing down the assembly or removing components from the aircraft.

We understand that Boeing is inspecting more than 50 aircraft to determine how widespreadthis problem is among aircraft with that section already completed. As the longeron isunderneath the skin, which is attached to it, installing a shim would require additional work on

the interior of the structure. Boeing has indicated that their repair process, which is underdevelopment, will be relatively straightforward, and not impact their production schedule.While we hope that will be the case, until engineers have had a chance to both examine theproblems and complete an FAA approved repair process, we cant yet reach that conclusion. We see similarities to problems Alenia experienced with shims on the horizontal stabilizer,which required them to be disassembled for repair. The key question is whether fasteners andpanels will need to be removed to repair the structure, or if it can be shimmed and filled inplace with resins that will cure the problems in place. Boeing believes the latter, but rumors ofproblems in additional areas of the aircraft are emerging, so stay tuned to the continuingadventures of 787 growing pains.

The MALV gap is quickly filled at BudapestThe demise of the long-suffering Hungarian state-owned carrier MALV has resulted in a rapidrush by low fare operators to increase operations at Budapest. Ryanair has announced plansfor 26 additional routes from Budapest, up from its planned 5, and Wizz Air will base anadditional 2 A320 aircraft at Budapest as it takes on additional routes and frequencies toBucharest and other existing destinations. Lufthansa has announced additional frequencies toBerlin and Hamburg, and Air Berlin has announced an additional frequency from Berlin as well.Smart Wings, an LCC based in the Czech Republic, has also announced fights to Paris andTelAviv from Budapest.

So far, only WizzAir has made an offer to former MALV passengers, who were left high anddry. Wizz Air is offering 50,000 seats at about US$45 to those stranded by the shutdown. Inthe Hungarian bankruptcy, MALV ticketholders have lost their purchase price, with littlelikelihood of recovery.

While not all routes of the former carrier will be immediately filled, as potentially 20destinations will not be served by other carriers, the ability to travel in and out of Budapestwith other carriers will have only short term constraints until new routes can be initiated.

The speed at which the gaps will be filled at Budapest tells us several things about the state of

airlines in Europe. First, excess capacity exists that can quickly be shifted to potential growthmarkets. Ryanair had initially planned 5 flights as it entered Budapest, but was able to quicklyexpand to 31. The ability to quickly grow service that rapidly implies that aircraft were less thanproductive on other routes. Second, it tells us that competition in Europe will be cut-throat,with several low-fare carriers pouncing on the opportunity to invade a market once dominatedby a national carrier. Will this competition cause this market to also soon becomeunprofitable? Third, the old line carriers that havent been able to restructure, either due tounion constraints or other factors will soon be dead as well. The Czech government is seeking


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bids for CSA, LOT Polish is in a similar position, and with strong low-fare competition in eachmarket from WizzAir and others, and these carriers could soon share the same fate as Malv,which was also for sale for a number of years.

The only potential silver lining for Budapest is that the airport, the privatization of which

included some guarantees for volume in the event of the demise of the national carrier, maynot need to be invoked if the LCCs step up and maintain traffic levels. Lets hope th at is thecase, as the last thing the Hungarian government needs is an airport in addition to an airlineseeking subsidies. While some in the government hold out hope of a restructuring and re-start, we dont believe a re -start will be feasible. RIP MALV, 1946-2012.

Indias Government is destroying their Airline Industry, and Kingfisher will be the first to fall . Wehave spoken quite often of the Indian governments destructive behavior with respect to itsairline industry, propping up Air India with subsidies while the carrier prices it product belowcost, forcing competing carriers to match unrealistic prices that are so low it is driving thecompetition out of business. If the objective is to gain a monopoly for Air India, the strategy isworking - but if India wants a healthy airline industry, its counterproductive policies need to bechanged, and changed quickly. Airlines in India lose about $20-$30US per passenger today,primarily the direct result of government policy.

Kingfisher, despite efforts to the contrary, is dead. But since airlines take a long time to die, itwill still continue to operate for a few more months until it completely runs out of cash.Airplanes have already been repossessed, the schedule slashed, with no hope of profitability inview. The crisis at Kingfisher is finally bringing the incompetence of the Indian government tothe forefront, and a proposal that would help the industry by allowing airlines to import jet fueldirectly, without paying local state taxes, which can be as high as 28%, is now beingconsidered. This would go a long way to making Indias airlines more competitive, as their fuelcosts are disproportionately high, even in a high fuel cost environment. But in itself, it wontsolve all of the problems. The solutions are clear and well known - but the political courage toimplement them is lacking in a corrupt Indian government.

The key question is whether the current government and recently appointed Minister ofAviation will learn from the demise of Kingfisher. With a flamboyant CEO, Kingfisher wont goquietly into the night without making some political waves. Lets hope that the high profilefailure will cause the Indian government to consider reversing the policies that have made itnearly impossible for an airline to be profitable and enabled competing countries to gain

market leadership in travel to and from India. Nobody in Indian politics has the will or politicalcapital to cope with a shut-down of the national carrier, but it is now to the point that it shouldbe restructured and privatized. But as that will cost jobs, given the rampant overstaffing at thecarrier and with Indias economy slowing as a result of the crisis in Europe that simply wont fly,politically.

With a growing economy, India has a strong potential for a sound airline sector, but it beingheld back by woeful infrastructure, which is being addressed, and anachronistic government


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policies, which are not. Until reform comes to the latter, Indias airlines will langui sh and fail,while its businessmen choose Emirates for premium class international travel instead of anIndian carrier. With the market capitalization of most Indian carriers at levels below theirfinancing requirements for 2012, this will be a tough year, as the market will no longer bewilling to throw good money after bad. Unless some drastic actions are taken, we can expect

several Indian carriers to fail this year.


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Air Insight | Analysis of Current EventsNo. 7, February 21, 2012 US takes aim at CSeries

If there was ever evidence that the business case for the Bombardier CSeries is sound, the newsSaturday (Feb. 18, 2012) that it is now official US policy to take on the airplane on behalf ofBoeing is it.

Dominic Gates of The Seattle Times has this story5 that details how the Obama Administrationhas instructed the US Export-Import Bank to provide financing for the Boeing 737 to head offorders by US airlines for the CSeries if Canada's export bank offers financing for the CSeries.

Boeing has previously largely dismissed the CSeries as a threat to the 737-700 and,subsequently, the 737-7 MAX. Airbus has been even more vociferous in claiming there is no

business case for the CSeries.

We believe that when any product becomes the target of official US policy, this validates thethreat of that product. In fact, despite the massive PR campaigns against the CSeries by the BigTwo OEMs and some credible aerospace analysts, the CSeries had a decent year last year.

Orders in the 100-149 Seat MarketBombardier didn t do badly in orders for its CSeries last year if you actually compare apples-to-apples and look at only the 100-149 seat market. Aerospace analysts, some consultants andmost media look at the orders of Airbus and Boeing for the A320 and the 737 families andcompare them to Bombardier and say how poorly BBD is doing. The problem with thisapproach is that BBD does not compete in the 150-seat and above market, where most of theorders are.

Gross ordersIn 2011, Boeing recorded orders for 64 737-700s and none for the 737- 600. (It hasnt sold a -600 since 2005 but the airplane is still offered for sale.) Of the 64, Southwest Airlines ordered40 and lessor Aviation Capital Group ordered 20. Four were ordered by unidentified customers.On the Airbus side, there were 31 A319s ordered. (There were two A318 Business Jets ordered,but none from airlines.) Bombardier announced orders for 43 CSeries, all from commercialcustomers.

When you look at the market share of orders, Boeing was first, followed by BBD and thenAirbus.

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But the Aviation Capital Group order is somewhat misleading. ACG always orders the 737-700because this is the least expensive model, which therefore requires a lower down paymentthan the more expensive 737-800, which it prefers. ACG routinely converts the -700 order to -800s as the build date nears.

If you look at the order market share taking this into account, Boeing still retains the lead onthe strength of Southwest, but only barely. And we eventually expect Southwest to convert its -700 orders to -800s in the same fashion as ACG.

Either way, BBD had a solid showing in the 100-149 seat market.

Viability of the 100-149 seat marketWhat, then of the viability of the 100-149 seat market? Many analysts assert this is theBermuda Triangle of new airplanes.


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There is no question, this is a small market compared with the 150-210 seat segments. But thisdoes not mean it doesnt exist. Its been reduced to a niche market. Embraer has done quitewell in the market with its E-190/195 airplanes, seating 100-122 in 31 inch pitch. It has sold 676aircraft in this market segment since the E-Jets went into service in the last decade.

There are thousands of aging aircraft in this market segment that need to be replaced. BBDforecasts a need for about 7,000 in the next 20 years. Embraers forecast isnt strictlycomparable because it looks at the 90-120 seat segment it competes in. For this segment, EMBprojects a requirement for nearly 5,000 jets.

BBD believes it will obtain a market share of 50%, which we think is optimistic. We believe themarket will largely be split four ways. And at the moment, Embraer is leading market share for2011 orders.

Based on this data, BBD would build 1,350 of 7,000 airplanes over 20 years if its forecasts arecorrect. But we expect BBDs share to pick up once the CSeries is flying and after it entersservice.


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Air Insight | Analysis of Current EventsNo. 8, February 28, 2012 The Impact of Fuel Prices

The refrain is constant fuel costs are too high. With tensions in Gulf up again, oil is nowaround $107/bbl and likely to go higher. Airlines are unable to plan reliably because of thepricing volatility.

Airlines face a scenario where fuel is ~50% of costs. If this could be counted on to be a constantfor an extended period of time, airlines could adjust. But it is volatility that causes so much cashflow damage. If an airline sells seats 21 days before a flight and then pays the fuel vendoraround 90 days later - meaning a gap of approximately 100 days when the airline is exposed tofuel price fluctuations (assuming no hedges). With break-even load factors routinely around86%--and profits, if any, increasingly coming from fees, even a small variance in fuel prices

wreck the finely balanced edge between profit and loss.

The airline cannot go back to its customer and ask for more once the seat is sold. The fuel risk isentirely on the airline, which is why so many airlines now have a fuel surcharge. This highlightsan opportunity why is no airline offering customers an opportunity to share the risk ofchanges in fuel price? For example instead of a blanket fuel surcharge the airline could create ascheme that puts half the fuel volatility in the hands of a customer. This transparency would goover well as it would be a fee that makes sense.

Among US airlines the impact is well illustrated by research from the MIT Airline Data Project6.(See Chart.) Note that fuel charges have risen by 178% while revenue and operating expenseshave only risen 138%. Even as airlines have been squeezed by the ever rising price of fuel, notealso the positive impact of ancillary revenues. But for this positive impact of ancillary revenues,the problem of higher fuel costs would be substantially worse.

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The key take away from this chart is that fuel accounted for ~30% of the airfare in 2010.Airlines simply dont have any margin to offset fuel spikes. Given the airline business is so risky,it seems clear that airfares need to rise to not only cover fuel costs but also for the ability of theindustry to reinvest and provide investors with a return. This squeeze explains in part the rushby airlines to more fuel efficient airplanes. Absent ancillary fees, the chart demonstrates thatUS airlines cannot make profits.


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Without higher fares the industry is in more trouble which accounts for growingconsolidation. Airlines are being forced to consolidate to secure survival. Consolidationensures higher fares. The boom in cheap air travel transferred economic wealth to consumers isnow likely to swing away towards transferring economic wealth to airlines.

Promising BiofuelsEven as fares go up, we believe an area that deserves much more attention is biofuels. Airlinesneed these because they can reduce fuel price volatility. Biofuels can be sourced in many placesin the world. Places subject to much less political unrest than where oil comes from. A growingbiofuel supply is necessary not so much for the positive eco-impact as for fuel price stability.

At the same time, pricing today for biofuels are exorbitant and have a long way to go beforebecoming an economical alternative to fossil fuel.

Many airlines are conducting biofuel blend test flights. Lufthansa has one planned to cross theAtlantic. Airline industry groups such as IATA are encouraging biofuel development. A primaryconcern is that biofuel suppliers need to reduce their risk, too. They will not build plants tocreate fuels based on airline demand alone. They need a steady demand for large quantities -and airlines are too risky a customer base. The only viable customer that can offer the desiredlevel of stable demand is the government the US military is the ideal customer most oftenmentioned.

Even as the need for biofuels is obvious, the impact of biofuel production on other parts of theeconomy is a concern. In 2005 the US had 16 million acres growing corn, and in 2011 46.5million acres were growing corn. The reason is demand for ethanol production. In 2005 10% ofthe corn crop went to ethanol production and last year it was 27%. If biofuels impact the foodchain then we are solving one problem but creating another. The US Department of Agriculturereported in February 2012 that US ethanol refiners for the first time consumed more corn thanlivestock and poultry farmers.

The problem with ethanol is two-fold, however. It has less energy than fossil fuels and thecarbon footprint to produce it is higher than the benefits achieved.

Consequently the opportunity to develop biofuels from waste materials, algae and biomasswhich are not part of the food chain is why Boeing, Airbus and key Tier 1 suppliers focus onthese alternatives. There are numerous input options so the problem is not insurmountable or

massively complex. Governments can play a crucial role at the front end by offering taxincentives to generate supply by growing plants like jatropha and high oil grasses on marginalland unsuitable for crops. Purdue Foods is looking into biofuel production from waste comingfrom its chicken plants. In addition, governments can encourage biofuel demand by acting as alead customer by buying blended diesel and jet fuels. A crucial first step would begovernments supporting supply development and offering a more certain demand.

In January Airlines for America, the industry trade organization for the leading U.S. airlines, and


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Boeing today released several recommendations 7 to the U.S. Department of Agriculture (USDA)to accelerate the commercial viability and deployment of aviation biofuels. You can downloadthe 49 page report here 8. The US Department of Agriculture (the lead agency responsible forfeedstock development and production systems) joined with Airlines for America and theBoeing Company to accelerate the availability of sustainable aviation biofuels in the United

States, increase domestic energy security, establish regional supply chains and support ruraldevelopment. Another US-based organization committed to the development of sustainablebiofuels is the Commercial Aviation Alternative Fuels Initiative9, an organization that notes "U.S.commercial aviation consumes about 3 percent of U.S. total energy use, it drives about 6percent of the U.S. gross domestic product and just under 9 percent of national employment."There are many commercial aviation industry people getting behind the process of developingbiofuel options for airline use.

IATA anticipates that airlines could be using biofuel blends by 2017 for 1 percent of fuelrequirements. At the moment this is still a dream. But it could easily become reality if keyplayers stepped up. The airline industry truly needs this process to get started immediately.The numbers demonstrate that airlines cannot survive current fossil fuel price volatility andcurrent airfare levels. Failing airlines will set off downstream impacts on layoffs throughout thetravel industry. The EU has seen five airlines fail within the past six months. More are on thebrink - from the EU to India.

The fact that a biofuel investment boom produces a cleaner environment is an exquisitecoincidence.

7 http://www.airlines.org/Documents/Farm_to_Fly_Recommendations-A4A-Boeing-Jan2012.pdf 8 http://www.airlines.org/Documents/usda-farm-to-fly-report-jan-2012.pdf 9 http://www.caafi.org/
http://www.airlines.org/Documents/Farm_to_Fly_Recommendations-A4A-Boeing-Jan2012.pdfhttp://www.airlines.org/Documents/Farm_to_Fly_Recommendations-A4A-Boeing-Jan2012.pdfhttp://www.airlines.org/Documents/Farm_to_Fly_Recommendations-A4A-Boeing-Jan2012.pdfhttp://www.airlines.org/Documents/usda-farm-to-fly-report-jan-2012.pdfhttp://www.airlines.org/Documents/usda-farm-to-fly-report-jan-2012.pdfhttp://www.airlines.org/Documents/usda-farm-to-fly-report-jan-2012.pdfhttp://www.caafi.org/http://www.caafi.org/http://www.caafi.org/http://www.airlines.org/Documents/Farm_to_Fly_Recommendations-A4A-Boeing-Jan2012.pdfhttp://www.airlines.org/Documents/Farm_to_Fly_Recommendations-A4A-Boeing-Jan2012.pdfhttp://www.airlines.org/Documents/Farm_to_Fly_Recommendations-A4A-Boeing-Jan2012.pdfhttp://www.airlines.org/Documents/usda-farm-to-fly-report-jan-2012.pdfhttp://www.airlines.org/Documents/usda-farm-to-fly-report-jan-2012.pdfhttp://www.airlines.org/Documents/usda-farm-to-fly-report-jan-2012.pdfhttp://www.caafi.org/http://www.caafi.org/http://www.caafi.org/http://www.caafi.org/http://www.airlines.org/Documents/usda-farm-to-fly-report-jan-2012.pdfhttp://www.airlines.org/Documents/Farm_to_Fly_Recommendations-A4A-Boeing-Jan2012.pdfhttp://www.caafi.org/http://www.airlines.org/Documents/usda-farm-to-fly-report-jan-2012.pdfhttp://www.airlines.org/Documents/Farm_to_Fly_Recommendations-A4A-Boeing-Jan2012.pdf


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Air Insight | Analysis of Current EventsNo. 9, March 6, 2012 Airworthiness

There has been much in the press recently about fatigue cracks in brackets on wings of the newA380 that have been vastly overblown with respect to safety of flight. One general reporter,apparently without a lot of aviation knowledge, expressed concerns about flying on this aircraft(which industry experts recognize as perfectly safe), apparently because of a small problem thatis under control, represents no immediate threat to safety, and will be corrected on a timelybasis on all aircraft in service.

Another over-reaction included a reader poll by a news organization that was one of the mostegregious of the Chicken Little style of reporting, and of course, that poll showed that itsreaders had concerns about flying the A380, primarily as a result of their sensationalist

reporting. While over-reaction tends to occur to a degree every time an aviation incidentoccurs, the media has increasingly become less credible in its aviation coverage, apparently dueto a lack of understanding of the processes that underlie aviation safety.

The Airworthiness Directive process is an integral element of aviation and needs to beunderstood within the context of the industrys maintenance and safety practices. ADs, as theyare called, are issued by the FAA or other regulatory authority as a notification to owners andoperators of certified aircraft that a known safety deficiency exists, and must be correctedwithin a certain time frame for the aircraft to remain airworthy. As a result, compliance ismandatory if the operator wishes to continue to fly the aircraft. While an aircraft manufacturercan strongly recommend change in parts or maintenance procedures, and routinely do, only aregulator can mandate those and require them to be performed.

Most airworthiness directives result from manufacturer service bulletins andrecommendations, which are, in turn, based on the experience of their operators with the in-service fleet and their analysis of the literally hundreds of thousands of maintenance reportsgenerated each year. In this case, after a review of the facts, and the discovery of the cracks insome brackets, Airbus recommended to the regulatory authorities that a change out of thesecomponents become mandatory, and the regulators concurred with their assessment. Hence,the issuance of the ADs.

The frequency of airworthiness directives, ranging from minor to noteworthy, is higher thanthose unfamiliar with the industry would think, but in context of an aircraft with millions ofparts in which that one-in-a-hundred thousand event can occur, is nevertheless statisticallywhat we would expect each year for each type of aircraft. Most of these are relatively minor inscope, and dont result in the grounding of aircraft. But on very rare occasions, an emergencyAD will be issued requiring immediate compliance prior to further flight. "Grounding" in this


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context is vastly different than requiring an inspection by a certain point in flying hours or acalendar date.

This last major grounding of a commercial aircraft occurred in 1979 when the Douglas DC-10fleet was grounded after an engine fell from the wing of an American Airlines aircraft departing

from Chicago on May 25th of that year. While maintenance issues, and not the design of theaircraft, were ultimately found responsible for the crash, this was the most severe AD issuedsince the disintegration of several De Havilland Comet Jets in the early 1950s due to metalfatigue that resulted in a grounding of that type as well. Two incidents in 60 yearsdemonstrate the strong track record of the industry, and the increasing reliability and safety ofaircraft.

Before the Comet, the Douglas DC-6, Lockheed Constellation and Martin 202 were all groundeddue to emergencies in the late 1940s. Thus, it is clear global aviation has come a very long wayin safety, and the process of ADs has been instrumental in this progress.

Well over 99% of airworthiness directives are more routine items with less urgency, dealingwith potential safety defects by requiring either additional inspections or repairs to an aircraft.ADs are fairly commonplace, and typically will number in the hundreds for a typical aircraft as itmatures in service as potential maintenance issues are discovered and dealt with through theroutine inspection and safety processes in use by the industry.

The A380, the current media target, was introduced in 2007 and has 43 airworthiness directivesto date. The other very large jet, the Boeing 747, introduced in 1969, has more than 840airworthiness directives over its life, and is viewed as one of the safest aircraft in the skies. Yetthe 747 had a much more serious structural issue with the fuselage in the forward section ofthe aircraft, called Section 41, two decades ago. An AD was issued, but as these cracks instructural supports were also caught early, no accidents or fatalities resulted. The Section 41problem resulted in an expensive inspection and repair process, and was potentially much moreserious than the current A380 issues. But once solved, the problem has long been forgotten, aswill the current issues with A380.

The new 747-8, which entered service late last year, has since been discovered to have flutterissues with the aft fuel tanks. These have been sealed off pending a fix.

The Boeing 787, recently introduced and now with only five aircraft in service, has issues with

its carbon fiber fuselage. Some areas will require shims to avoid potential problems aroundfasteners. Boeing is currently inspecting all 55 aircraft in process in Seattle before they enterservice. At least 15 are said to require repairs. This problem was caught early at the factory.Regardless of how a problem is discovered, the industry has established practices to determinewhether they are applicable only to one airplane or the entire fleet, and if the latter, correct theissues on a timely basis to ensure the safety of operations.

Even the popular narrow-body A320 and 737 series have hundreds of ADs, but are considered


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among the most safe aircraft ever built. And as aircraft age, additional issues can emerge, as isthe case with crown skins on some Boeing 737 classics, one of which recently separated in flighton a Southwest flight. Boeing has discovered the cause of the issues, and an appropriate ADhas been issued to monitor and correct the situation.

Clearly, the issuance of an AD does not bring aircraft crashing down from the sky, but ratherprevents this from happening. Virtually all are issued with the full cooperation of, and typicallyat the suggestion of, the aircraft manufacturer, as safety is the number one priority in theindustry. It is time that the responsible press recognized that strong processes are in place, theywork quite well. To those Chicken Little reporters, let me be perfectly clear: The sky isnt fallingand both older and newer model airplanes are taking off and landing safely every day, thanks tothousands of people in this industry who put safety as their first priority, every day, and followestablished processes that work quite well.


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Air Insight | Analysis of Current EventsNo. 10, March 13, 2012 Yellow flags waving throughout Commercial Aviation

Although Airbus and Boeing came off a record year for orders in 2011 and Boeing is expected tohave a record year this year as nearly 1,000 commitments for the 737 MAX are converted toorders, there are plenty of worrisome signs across commercial aviation and throughout theworld that this year and next could be worse than appears on the surface.

Airlines and leasing companies are reporting decent earnings. But there not only is plenty ofvisible evidence that all is not well, behind the scenes there are plenty of concerns.

The visible signs of emerging trouble: Aviation in India is an unmitigated disaster, with Kingfisher, Air India and Jet Airways all

experiencing difficulties. Kingfisher is on the verge of collapse and Air India is operatingonly through the largess of the government. Jet is struggling.

Carriers in Asia and Australia are struggling10. AirAsiaX found that its low-fare, long haulservice is unsustainable in European markets. It used Europe's ETS scheme as an excuseto withdraw, but economics of low-yield service from Asia to Europe as problematiceven in the best of circumstances. The fuel pricing environment today hardly falls withinthat characterization. Australia has seen recent air carrier failures and the financialresults from several Asian airlines are poor.

Europe has seen the collapse of several airlines. Ryanair and easyJet, which have depended on aircraft sales of middle-aged aircraft to

boost income, now find the market for these aircraft dried up with financing unavailableto potential buyers 11.

Fuel prices passed the $100bbl mark again, on the way to $105bbl and even higher. TheMiddle East's geopolitical situation appears to be getting worse, particularly with therhetoric of the US presidential campaign heating up. Some Republican candidates areopenly advocating military action against Iran and Israel is threatening to unilaterallybomb Iran's nuclear facilities. President Obama is trying to walk a fine line betweensanctions and being forced into military action. The situation in Syria remains volatileand the situations in Egypt and Libya remain unstable.

Some lessors are finding increasing numbers of aircraft between leases or soft leaserates. Boeing 757 lease rates are coming under severe pressure as United Airlinesprepares to place a major order next month for a replacement. United's management,dominated by the Continental group following the merger of the two carriers, wants todump the older, Pratt & Whitney-powered 757s operated by legacy United(Continental's newer 757s are Rolls-powered). This means leases rates being demanded

10 http://www.aspireaviation.com/2012/02/29/dark-clouds-over-asiapacific-airline-industry/ 11 http://www.aviationweek.com/aw/generic/story.jsp?id=news/awst/2012/03/05/AW_03_05_2012_p24-431328.xml&headline=Despite%20New%20Aircraft%20Surge,%20Used%20Market%20Sags&channel=awst
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by United from lessors to keep the airplanes for a few more years are reported to be aslow as $90,000 per month.

AirInsight is viewing the next 18 months with growing caution as these and other factors buildin frequency across the globe. Cargo traffic remains a leading indicator for passenger airlines,

and this was softening in the last few months of 2011. Although we fully expect airplane ordersto continue to be strong, we also believe the OEMs will face growing skyline managementissues.

Competition in twin-aisle race becomes clearerAs details emerge on Boeing's 777X, the line-up in the twin-aisle competition is now becomingclearer. The following table is based on known data and our estimates of some of the technicaldetail.

What is emerging is that the 777-8X--ostensibly a replacement for the 777-200 series--is inreality closer to the current specifications of the 777-300ER. The 777-9X is an entirely newairplane category, mid-way between the current 777-300ER and the 747-8. Boeing's proposed787-10 will be the replacement for the 777-200.

Airplane Pax 3 Class Length Range-NM

767-300ER 218 180ft 5,990787-8 210* 186ft 7,925

A330-200** 253 192ft 7,200787-9 250 206ft 8,250A350-800 270 198ft 8,500

A330-300** 295 208ft 5,828777-200ER 301 2