Boeing's been touting its new fuel-efficient planes continuously over the last few years -- when oil prices were well above the $100/barrel mark and it made sense for airline operators to replace their aging fleet with the latest models that sipped fuel instead of guzzling it. Orders for new Boeing planes such as the 787 Dreamliner, the 737 Max, and the 777X have been going through the roof, and backlogs have reached epic levels.
But the scenario has changed with the fall of prices in 2014, and in the first week of December, U.S. crude prices dropped to below $70/barrel for the first time in the last five years. Boeing's situation was aptly summed up by Morningstar analyst Neal Dihora in a KPLU article when he said, "You have to admit that lower oil is not good for somebody selling fuel-efficient airplanes."
There's been no evidence of a slowdown in new orders yet, but are Boeing's good days numbered? Here are three reasons to assure investors that it may not be as bad as they think.
Boeing 777X. Source: Boeing.
Fuel cost makes for about a third of the total operating cost of a carrier now compared with 13% in 2001. So far this year, the oil-price drop has saved the airline industry as much as $7 billion. Obviously, declining oil prices is welcome news for operators, but this need not necessarily deter them from ordering newer planes. Planes that promise advanced technology and better fuel efficiency, which would cut 15% to 25% of the operating cost could push profitability of operators to even higher levels. Oil makes for a good chunk of the cost, and it's therefore more reasonable to cut down on fuel burn by opting for a better plane instead of continuing with an aging fleet with dated technology.
Oil prices started falling consistently from August this year, and to see if there's any truth in Kelly's statement, it might be worthwhile to examine the new orders received by Boeing during this period.
Investors can see from the chart that order trends have been moving upward on the whole despite the oil price drop. There has been no sudden fall in demand in the post-August period. On the contrary, Boeing has bagged 224 orders in November, which is 2014's second highest monthly order tally. The company had won the highest number of orders in June, at 324.
It would be interesting to see what the December tally looks like given that oil prices have fallen more drastically during the month. But Boeing has already announced a big win for 100 737 MAX 200s from Ryanairon December 1, and in the week ended December 16, it's added 30 737s and six 777s from unidentified customers. So, there's no sign of any slump in the ordering activity.
McNerney pointed out that earlier, replacement of airplanes accounted for a quarter of total sales, but now, replacement demand makes up for half the sales. The big technology and engine advances made in the new planes are difficult to resist for airlines. The CEO sounded pretty confident in the next-generation planes and believes replacement demand will remain strong over the next decade.
Ryanair is a good example of an airline that, despite looking to lower costs, has placed orders for quite a number of 737s and the 737 Max. The carrier doesn't seem to be overly optimistic about falling oil prices, and it ordered for new planes as a long-term solution to cut costs. Company CEO Michael O'Leary explains this strategic move, saying that when there's a plane offering higher seat capacity, better fuel economy, and greater scope for earning revenue, it brings "huge unit cost advantage" that far outweighs the benefit of declining fuel price.
Boeing 737 Max, Source: Boeing.
Historically, airlines have been found shying away from new planes when Bent crude oil price is $81 or below.But this time, it's different. The steep plunge in oil prices is not showing in the order flow as airlines are enthusiastic to fly the finest workhorses available. While the risk of volatile oil prices cannot be overlooked completely, Boeing's backlog is in fine fettle.
The article Could Low Oil Prices Affect Boeing's Order Book? originally appeared on Fool.com.
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