Wednesday, June 25, 2008

Oil Surge May Cost Jet Makers Orders

Airbus, Boeing Face the Deferral or Loss
Of Up to a Third of Their Record Bookings
By J. LYNN LUNSFORD and SUSAN CAREY
June 25, 2008; Page B1

As rising oil prices cause even the strongest airlines to struggle, Airbus and Boeing Co. face the possibility that as many as a third of their orders for new jets could be postponed or canceled.

[Boeing 737]
Bloomberg News/Landov
Boeing could see fewer orders for its 737 (above), as airlines scale back purchases.

Driven largely by demand from airlines outside the U.S., the rival manufacturing giants over the past three years have collected almost 7,000 orders for modern fuel-efficient jets. For now, both jet makers say they are sold out for much of the next three years and are continuing with plans to raise production rates to meet demand.

But the landscape is shifting as oil prices rattle the underlying economics of the airline industry. Some airlines, including JetBlue Airways Corp. and Delta Air Lines Inc., are already taking steps to defer deliveries or rid themselves of orders. Others are starting to repeat steps they took after the Sept. 11, 2001, terror attacks, such as permanently parking gas guzzlers and selling newer jets to leasing companies for cash before leasing them back on a monthly basis.

The combined value of the orders for Airbus and Boeing planes exceeds $500 billion at list prices, so large-scale cancellations and deferrals could easily amount to tens of billions of dollars and affect suppliers of engines and other parts in addition to the jet makers.

Officials at Boeing and Airbus, a unit of European Aeronautic Defence & Space Co., say orders for their jets are spread across a diverse group of carriers world-wide, insulating them from regional economic swings. But they acknowledge that they are in almost daily talks with airlines seeking to cancel or defer deliveries. Although most of these discussions involve U.S. carriers, signs of stress have emerged from India to Europe.

"Everything is on the table when an airline is looking for cash," says Steven Udvar-Hazy, chairman and founder of aircraft-leasing giant International Lease Finance Corp., a unit of American International Group Inc. and one of the manufacturers' largest customers.

Mr. Udvar-Hazy predicts that 25% to 30% of the two makers' order books -- roughly equivalent to the number of planes that were intended to accommodate airline growth rather than replace aging planes -- could be subject to what he called the "flake-out factor" if oil prices continue their unprecedented rise.

[chart]

Indeed, with oil at more than $135 a barrel, some analysts, and even the manufacturers themselves, see potential game-changing circumstances on the horizon. Douglas Runte, a strategist with RBS Greenwich Capital who follows the airline industry, says that world-wide, "many airline business models cease to work at $135-a-barrel oil prices."

Airlines -- particularly the big U.S. carriers that withstood years of financial trauma after the 2001 attacks -- are in a quandary: They can't afford to fly their old gas guzzlers, and many of them can't afford to buy lots of new planes. Yet after years of putting off much-needed purchases, they also can't afford to wait to purchase more fuel-efficient replacements.

John Leahy, chief operating officer for customers at Airbus, says the bulk of orders should be safe as long as business travelers continue to fill seats, but that's no certainty as oil prices rise. "I think oil is going to have to go a bit over $150 a barrel before it forces a world-wide recession, which is when you would expect to see business travel start to taper off," he says. If that happens, he adds, "airlines would obviously have to take a closer look at their plans."

Scott Carson, president of Boeing Commercial Airplanes, says the U.S.-based aerospace company has been in close contact with "a number of our customers," particularly as fare increases have failed to keep pace with rising energy costs. "I don't think I've talked to any airline that believes this is a phenomenon that can be sustained given today's business model," he says. "We haven't seen any cancellations," he adds, "but we have had a couple of carriers ask to move their deliveries out of 2008 and into later years."

With demand for fuel-efficient airplanes hitting a record, both manufacturers say that some cancellations or deferrals would give them needed breathing room in their overbooked production schedules. The handful of delivery slots that have opened up are being snapped up by such carriers as AMR Corp.'s American Airlines, which is racing to replace some of its 300 MD-80 aircraft with new Boeing 737s, which are 25% cheaper to operate. The airline has also signaled it may try to accelerate the pace of adding new planes.

Continental Airlines Inc. and US Airways Group Inc. have relatively large numbers of planes on order and say they are committed to taking them. (UAL Corp.'s United Airlines has made a virtue of having not a single new plane on order and is now targeting 100 older aircraft for early retirement from its fleet.)

[chart]

But some other U.S. carriers are beginning to trim around the edges of their orders, even as they accelerate the retirements of their oldest, least-efficient planes. Discounters JetBlue and AirTran Holdings Inc.'s AirTran Airways are both scaling back their once heady growth rates. JetBlue last month said it would defer deliveries of 21 Airbus A320s for about five years. AirTran said in April that it sold two nearly new 737-700s and deferred delivery of 18 more for four years.

Even Southwest Airlines Co., the most financially sound U.S. airline, says it is scaling back its growth rate and deferring some options to buy aircraft. The low-fare airline will take all 29 new planes it committed to this year, but it will accept only 14 in 2009 and similar numbers in subsequent years.

Delta recently disclosed that 34 of the 36 Boeing 737s it had on firm order were sold to third parties, enabling it to cut capital spending by $1.4 billion between now and 2010. A Delta spokeswoman says the airline took the step when it was in bankruptcy-court protection, not because of today's economic environment.

US Airways 18 months ago "in a different economic climate," decided to get rid of its old 737s, 757s and 767s and order new Airbuses, says Andrew Nocella, senior vice president of schedule planning. The airline is now "looking at a few changes to the order with Airbus" involving deferrals, he says, without disclosing details.

Northwest Airlines Corp., which remains eager to receive the 18 Boeing 787s it has on firm order, is nonetheless shrinking. It says it plans to sell 14 757s and A320s that it owns and that are paid off, and it will remove 33 elderly DC-9s from its fleet and try to find buyers, mostly outside the U.S., or sell them for parts.

"In the current environment, capacity has to come out of the industry," says Dave Davis, Northwest's chief financial officer. "That comes from retiring planes in the fleet and not taking delivery of new planes."

Write to J. Lynn Lunsford at lynn.lunsford@wsj.com and Susan Carey at susan.carey@wsj.com

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