Monday, July 14, 2008
RJ 50s to be Slashed, Scope Clauses Changing, Used Market Robust
Chiessi said that RJ 50s are too entwined in airline service and restrictive scope clauses are still in effect for any immediate reductions. He added that 39 percent are serving monopoly markets where airlines have more pricing flexibility. Chiessi reported in a presentation to New York analysts that both Continental and American have already broached pilots about liberalizing scope clauses. He pointed to earlier moves by US Airways and others allowing them to reduce their exposure to the higher-cost, 50-seat jets. Continental, for instance, has a scope ceiling at 50 seats meaning most of its Express fleet is 50-seaters although Colgan recently introduced the Bombardier Q400 turboprop.
“United and US Airways have already achieved 60 percent of fleet at 75-seat aircraft, and 40 percent with 50 seats,” he said. “Delta and Northwest are going in the same direction and have an increasing backlog in the larger equipment. American and Continental are going into negotiations to reform their scope clauses. Continental will probably end up at the same level as United and US Airways at 75 seats. The tendency is to move to 75 seats, keeping about 40 percent of RJ 50s to balance capacity the demand in small markets.” Story continues below.
The secondary market, however, will be robust as emerging markets demand more than enough to absorb 250 aircraft. He pointed to Mexico, which has already grown its RJ fleet dramatically in the last two years as well as South America, Africa and Russia where a large number of 30-seat Yak 40s and 70-seat Tupolev Tu-134s are averaging 33 years old. Related Story
“More than 450 aircraft need replacement so there will be a natural movement of those 50 seaters out of the U.S. to Russia,” said Chiessi, who noted the recent certification of the ERJ 145 in Russia and the emergence of a Ukrainian airline that wants the ERJ 145 once the aircraft gains certification there. “To sell them a brand new aircraft will not work,” he said of the CIS. “However, used aircraft will work."
Embraer expects competition to change in 2012 with the advent of the Sukhoi SSJ which is slated to begin deliveries next year, although reports are circulating that the first delivery to launch customer Aeroflot has been delayed a year. The larger end of the Russian market will likely be absorbed by the SSJ, said Chiessi, adding current orders cover two year’s production, making used equipment a good solution, before sales open up.
He said China has a very unbalanced fleet with regional aviation growing at slower pace than expected. He said it is unlikely used RJ 50s will enter the Chinese market which will probably take new units to balance out market demand. Chiessi noted that in 2003 there were 196 markets and 45 regional aircraft in China while, three years later, there were 223 routes and only 61 aircraft.
Embraer expects fuel prices to stabilize at $100 per gallon but not for another two years, according to Chiessi. He also expects any softening of U.S. demand will have little impact on export growth for the manufacturer since demand in emerging markets such as the Middle East, India and China as will more than compensate for U.S. declines.
He noted that Embraer has delivered 874 of the 915 firm orders for ERJ 135/140/145s with another 41 yet to be delivered from the Chinese AVIC I production line and a further 75 on option. Embraer has also delivered 1,000 145 platforms with its Legacy business jet and defense sales.
Deeper Market Analysis Yields RJ Picture
“If you get deeper into market analysis in the U.S. and look at domestic distribution by market density, you see that 60 percent of the smaller ERJs are serving low-density markets,” he said. “This emphasizes the importance of RJ 50 to small communities.” While some of these communities may be at risk, he acknowledged, he pointed to economic and political reactions which could soften the blow.
“One of the important things to remember is two out of every three passengers are connecting passengers and, at some communities, it is as high as three out of every four,” he added, noting without that feed, many international routes would not be economically viable. “RJ 50s are essential to support international expansion,” he said. In 2000, RJ 50s accounted for only three percent of domestic enplanements and in 2007 it was 18 percent or 19 million passengers per year. RJ 50s carried more than 90 million passengers, two thirds of which – 61 million – connected. Story continues below.
Chiessi said there is a great deal of misunderstanding about the economics of the 50-seat jet, citing the fact the most of the differences in operating costs are based on the disparate distances the small and narrow-body jets fly, not the airplane size. While narrow-body aircraft do have a 42 percent cost advantage over the RJ 50, according to Form 41 data, when compared on similar stage lengths the advantage declines to only 12 percent.
“The impact of fuel prices is roughly the same on a narrow body at $2 to $3 per gallon as the RJ 50 at 21 percent and 19 percent, respectively,” he said. “What we have found is airlines have already announced the elimination of 174 RJ 50s. We expect that over the next three to five years another 250 to 270 aircraft will be eliminated, leveling off to meet natural demand rather than that created by current scope clauses. What we do see is that RJ 50 feed is fundamental to system and is not going to be destroyed overnight. Just as after 9/11 airlines are being forced to restructure. At that time, there were turboprops serving a small catchment area. With the advent of the RJ’s speed and range at 2,000 nm, airlines found they could steal passengers from a competitor’s catchment area. Those operations will be eliminated in favor of short operations and long and thin routes.”
As for the European market, Chiessi said the developing rail market on the continent would likely hit narrow-body equipment harder that RJs since rail development was occurring between major cities rather than small communities. He also indicated that 50-seat exposure on the continent was far less since only 15 percent of the fleet is RJs because of the more liberal scope clauses which did not create a false demand for the equipment. There, he said, regionals fly 115-seat jets.
Chiessi reiterated the emerging trends outlined earlier by Executive Vice President – Commercial Mauro Kern, of right sizing equipment, already being done successfully by Air Canada, US Airways and Finnair. Related Story However, he did not address the financing of such aircraft as major carriers ground aging equipment in a market in which they are expected to collectively lose billions of dollars this year and at a time when capital markets are constrained. He also expects world transport demand will keep growing despite the U.S. slowdown.
Larger RJ Prospects
Chiessi forecast that the 75- to 120-seat market will far surpass the nearly 900+ deliveries of the ERJ 145. He said 27 percent of sales would be replacement for 50 seaters that have developed still-growing markets. In addition, reiterating analysis presented by Kern, 53 percent of worldwide deliveries will go for right sizing, substituting for larger narrow bodies. The rest of orders will be direct replacement of smaller capacity narrow bodies and the development of new markets. Story continues below.
Chiessi indicated that the largest area for rightsizing was in the Middle East where 78 percent of the market is using Ejets for rightsizing. Worldwide it is 53 percent. He quoted Air Canada as saying the ERJ 190 was 20 percent cheaper than the Airbus A319, adding the airline calls the aircraft a “game changer.”
The ERJ 170/175 can deliver $2.2 million in annual fuel savings compared to Avro RJ 85, DC 9s, Fokker 70s and BAe 146s and an additional $1.3 million in annual maintenance cost savings. The ERJ 190/195 delivers $2.7 million in annual fuel costs along with $1.2 million in maintenance cost savings compared to the Boeing 717 and 737-500/300, Fokker 100, , the DC 9-30 and MD 87. “Nearly 700 aircraft in the current fleet need replacement in the short term,” said Chiessi. “That is 26 percent of the fleet. Forty five percent of Ejets are being used to compete against narrow bodies, compared to the CRJ, 60 percent of which are being used to fly monopoly routes. Only 43 percent of ERJs are on monopoly routes. Story continues below.
He also compared the ERJ to emerging programs such as the Bombardier CSeries, Chinese ARJ 21, the Sukhoi SSJ and the Mitsubishi MRJ. He noted that the Chinese, Japanese and Russian products suffered from the fact they are new to the market and new to commercial aircraft manufacturing and must develop worldwide customer support programs.
“I personally believe the three programs are more related to national objectives than private company objectives,” he said. “One way or another the three national governments are involved to different extents. It is not easy to bring China and Russia to accept the WTC. The Japanese are more sensitive to international law. One thing I can tell you we are following closely the Japanese developments and we will act if and when needed. But for China and Russia, it would be a wasted effort.”
He said the ARJ 21 and SSJ were conventional aircraft carrying little risk in terms of new systems or engines, whereas the CSeries and MRJ carried the risk of incorporating new engine technology with the Pratt & Whitney Geared Turbo Fan (GTF). Even so, he noted Bombardier already has a worldwide support network. He also said that direct operating cost comparisons are impossible until aircraft pricing is known and depends on how aggressive competitors will be on the pricing side.
The fuel burn on the ARJ 21, he said, was higher than the ERJ 175, but the GE CF34-10E engine, which is also used on the ERJ 190, is mounted on a smaller aircraft which will naturally drive up cash and direct operating costs. Chiessi pointed to the huge need in China, making demand high for the ARJ 21 in the domestic market as well as in countries with high Chinese influence. The Chinese market alone will take up the first five year's of production so it is unlikely the ARJ 21 will compete on the world stage until the middle of the next decade.
Chiessi said the SSJ 95 compares with the ERJ 190 with similar specific fuel consumption. Consequently fuel burn, cash operating costs will be similar although direct operating costs are expected to be lower with the aggressive pricing Embraer is hearing from customers. He pointed to the strong market need domestically and inside the CIS. He also noted that Western Europe was growing in dependence on Russian energy products and could account for some sales in the west. He also expects the aircraft to focus on domestic markets before spreading out to Eastern and Central Europe.
The MRJ 90 compares with the ERJ 175, said Chiessi, who added the Japanese regional jet was a new concept, with higher risk owing to the incorporation of new technology and the Mitsubishi’s lack of experience in the commercial airline market. Embraer expects the fuel burn to be lower with similar cash operating costs. However, the direct operating costs are unknown but the fact that it is being manufactured in Japan means production costs will be higher than the ERJ 175. Chiessi added that while the Japanese are producing and gaining composite experience from the Boeing 787, it will be unable to translate that into benefits for the MRJ since the technology is protected by Boeing, meaning, like Bombardier, they will have to develop the technology for themselves.
“The CSeries is a sounder offer on the market,” he said. “We believe they will launch but we don’t know whether it will be at Farnborough or later in the second half. We also believe they will ultimately go for a 150-seat version. The low specific fuel consumption of the GTF is an important consideration.” However, he departed from earlier Embraer statements that the GTF would include a noise penalty by saying it will have a low noise footprint. Related Story
“The GTF will end up as good engine, but there may be issues with the gearbox which could impact schedule reliability at least in the beginning,” he concluded. “The most importance piece is the lower fuel burn and this area is very active at all engine manufacturers right now. Engine developments, including the GTF and GE’s open rotor, is more advanced and we have to see what the specific fuel consumption will be once the engine is installed on an aircraft.”
GE is exploring conventional turbofans, announced in May, with the next-generation CF34 promising 20 percent improvement in fuel burn and targeting the 70- to 120-seat market. Recently, GE joined with NASA to study an open-rotor architecture, an unducted fan program that was cancelled two decades ago when fuel was 65 cents a gallon. It is dusting off all the old material to analyze the program in light of current economics focusing on overcoming both noise and complexity issues as well as any applications of new technology not available 20 years ago. It wants to see a reduction of noise, 15 percent better than the latest Stage 4 requirements, as well as 70 percent lower NOx and up to 15 percent lower fuel burn than the current CFM 56 powering the 737. Large airframers want engine replacements by 2011.
“While Pratt offers an 11 to 12 percent improvement on fuel burn, the open rotor is promising a 10 percent improvement on that,” said Chiessi. “We are following developments closely. We have to wait. This is a big leap in terms of fuel burn and open rotor technology will be clearer around 2010. We can make no decision on new product offerings until we have a clear grip on what the open rotor can deliver. At the same time, we also know there will be second generation GTF around 2017 which could yield perhaps a five to eight percent improvement on the GTF.”
In comparison with the ERJs, however, Chiessa noted that the CSeries is larger and optimum usage would be 130 seats, imposing a weight penalty on the 110-seat version, especially with a bigger wing designed for a 3000-nm range.
“We think the low specific fuel consumption will be destroyed by the weight and drag of the bigger aircraft,” he said. “The family requirements will cancel the benefits of the GTF most probably. The impact of bigger wings and engines will make it 5.5 tons heavier. When comparing similar capacity between the CSeries and the ERJ 195, we have a big advantage in smaller fuselage. There will be a 12 percent larger drag which will eat up a lot of the specific fuel consumption of the engine.”
Embrear expects to capture 45 percent of the 60- to 120-seat market to Bombardier’s 32 percent, and until the new regional jets are actually available to the worldwide market, the remaining percentage will be taken up by the 737 and A318. In the 30- to 120-seat market, Embraer leads market share with 46 to Bombardier’s 43 percent.
“Just as food for thought,” he said, “in 1990 the average seating capacity was 130 and by 2001 it was 120, largely related to the influx of 50-seat regional jets. The message we like to bring in times of crises is that smaller aircraft are more a part of the solution than they are the problem. You can better adjust to market with smaller aircraft than with bigger-capacity aircraft. While this crisis is different than 2001 because of fuel prices, we cannot deny, with small capacity units, we can adjust to degrees in demand better.”