Moderate oil prices are lowering credit risk in aircraft financing. Higher prices will strain aircraft industry profitability, leading to more airline bankruptcies and lower values for older aircraft, though high oil supply will create a natural price cap

Growth in global oil demand is expected to slow, while supply should grow only modestly at current price levels so the market is projected to be well balanced. Scope expects Brent crude to average between USD 60 and USD 70 per barrel for the second half and for full-year 2019.

“Supply will increase if oil prices increase, and this will put pressure on oil prices, thereby providing a natural cap, even if this enhances volatility and can lead to higher oil prices over shorter time periods,” said Marlen Shokhitbayev, associate director in the corporates team of Scope Ratings and co-author of a report out today.

The oil price increases of the past two years should be manageable for airlines that have good control of their operating costs. A fuel-efficient aircraft fleet is important for airlines in a rising oil-price environment. Older-technology aircraft are less fuel efficient but more reliable than new-technology aircraft. This balancing-out effect means that in today’s market, the value depreciation of older aircraft is stable. The lower reliability of new technology translates into a value disadvantage.

“The higher the oil price, the higher the present value of fuel-efficient new-technology aircraft compared to less fuel-efficient older-technology models. Increasing oil prices therefore provide less of a credit risk for investors invested in new-technology aircraft compared to older-technology aircraft,” said Helene Spro, director in the project finance team of Scope Ratings, the report’s other co-author.

A strong rise in oil prices will increase airline bankruptcies. This will increase the credit risk of aircraft financing transactions. The impact of higher oil prices will depend on the timing of the increase. Airlines will be better positioned if a sharp increase in oil prices happens when they are able to fully utilise the increased efficiency of the B737MAX and A320neo. The reliability of older-generation aircraft at current oil price levels continues to support their higher fuel consumption compared to the less reliable new-technology aircraft.

The full report can be downloaded here.