Airlines Look for Best Flight Path Through Rising Interest Rates, Fuel Prices. Learn more.

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Clouds on the Horizon?
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Mounting Risks
Airline executives have a growing sense of optimism
about their industry’s short-term outlook. Low interest
rates since the financial crisis of 2008 have reduced
financing costs, and oil prices have tumbled since mid-
2014.
Most, however, are wary that this environment of low
rates and low fuel prices won’t last. They are concerned
that as both begin to rise, the competitive landscape in
key markets will be reshaped. The decline in fuel prices
over the past year enabled many carriers to invest in
new routes that were not feasible at higher fuel prices.
Operators have extended existing aircraft leases to give
them the ability to adjust capacity to match passenger
demand.
These are the conclusions of a recent survey of more than
100 global airline fleet and finance executives conducted
by the Harris Poll on behalf of CIT. The survey found most
executives believe their airlines are operating with the
proper amount of aircraft and have the right amount on
order. However, they expect both interest rates and fuel
prices to rise, creating additional risk. At the same time,
currency weakness and the unrelenting growth of low-
cost carriers (LCCs) will continue to present significant
headwinds.
Rates and Financing Costs
Most of the executives surveyed agreed that interest
rates will rise by more than 100 basis points in the next
two years. That’s not surprising. In the U.S., short-term
Treasury yields have been rising in anticipation of action
by the Federal Reserve in the final months of 2015. While
the central bank left rates unchanged at its September
meeting, a majority of Fed officials indicated they still
expect to raise rates before the end of the year. Higher
rates in the U.S. along with global market volatility could
further strain other major economies such as Europe.
Although economic growth in China has slowed in recent
quarters, an examination of the Chinese and Asian market
by CIT found that China is under-ordered in terms of
their aircraft requirements. While Asia has experienced
some overcapacity, this has been mostly limited to South
East Asia. A recent CIT analysis shows that of the top 50
carriers in Asia, representing 84 percent of seats flying
in the region, 70 percent reduced their capacity growth
rates in the 3rd quarter of last year, and eight carriers
actually cut capacity.1
As a result, Asian carriers now have
a more rational growth strategy in place.
Most airline executives surveyed said that higher rates
and volatile global markets will change their companies’
view on aircraft purchases, and many said they expect
By Steve Mason
Executive Summary
Airlines are enjoying a period of relative prosperity with both financing costs and fuel prices low. But many in the
industry believe these accommodating factors are not here to stay, and changes are coming to the competitive
landscape that will create additional headwinds.
CIT recently surveyed more than 100 global airline fleet and finance executives, polling them on their outlook for rates,
fuel costs, competition and a variety of other pressing issues. The general consensus we observed is that the industry is
bracing for increased risks after a period of unpredictable but widely appreciated calm.
At CIT, we have seen strong demand for aircraft leasing giving industry participants additional flexibility to tackle these
issues. Leased aircraft are an effective tool for achieving this goal by allowing airlines to meet growing demand and
optimize fleet strategy, while availing of the latest technology aircraft.
1
Mason, Steve. “Clear Skies or Turbulence Ahead for the Asian Aircraft Order Book?” CIT Insights, November 2014.
http://www.cit.com/wcmprod/groups/content/@wcm/@cit/documents/information/s4013603.pdf

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their airlines to increase the percentage of leased aircraft
in their fleet.
Fuel Price Volatility
Oil prices have fallen to less than half of their 2014 peak,
giving airlines a break on their biggest cash operating
cost, although some of this benefit has been offset by
currency weakness outside of the United States. While
current forecasts show oil prices may continue to be
volatile, most predictions indicate that rising demand will
cause prices to increase in the next five years.
Half of the airline executives surveyed said they believe
fuel costs will increase in the next 18 months. More than
80 percent said they expect an increase in the next three
to five years. Such projections are widely supported. A
consensus of oil price forecasts from the U.S. Energy
Information Administration, the International Energy
Agency, the World Bank and the International Monetary
Fund show average global prices for Brent crude rising to
about $60 a barrel in 2016.
An analysis of past periods of oil price volatility indicates
that oil markets trend higher after periods of extreme
price fluctuations. Historically, airlines have relied on
financial hedges to offset rising fuel prices, but hedging
strategies can be expensive and may be ill-timed to
specific market changes. As fuel prices remain volatile,
hedges are likely to become even more costly. New,
more fuel-efficient technology is the only truly long-term
hedge against fuel price increase.
In the short term, airlines will look to find some additional
capacity and revenue benefits. We have seen an increase
in leasing demand for midlife aircraft in the past year as
fuel prices have fallen. While fuel prices may be less of
an immediate concern, many airlines recognize that lease
extensions, as an example, afford them added flexibility
to adjust capacity with oil price fluctuations.
While the industry will continue to chip away at marginal
expenses such as taxes, regulatory costs and airport-
related expenses, carriers that don’t have the most fuel
efficient aircraft will find themselves at a competitive
disadvantage. After all, fleet decisions are long term and
must account for multiple industry cycles.
Competition Drives Consolidation
The legacy airline model is under pressure in Europe.
Among the European airline executives polled, 55 percent
said they see their most significant challenge in the
next two years as mounting competition from different
types of carriers. In North America, only 29 percent of
executives saw this as a major concern.
Rising competition underscores the need for existing
carriers to become bigger and leverage economies of
scale. In the U.S., this change has already occurred. The
four biggest carriers control 83 percent of all domestic
seats flown, compared with 41 percent in Europe and 26
percent in Asia.
As a result, the consolidation that has already begun
among European carriers is likely to continue and
intensify. We believe consolidation will follow the
“conglomerate style,” in which the operating companies
are combined but the airlines continue to fly as separate
brands. For example, International Airlines Group, formed
through the merger of British Airways and Iberia in
2011, continues to operate both carriers separately, and
recently reached an agreement to buy Aer Lingus, which
it intends to operate under a similar arrangement.
In addition, improved service offerings from LCCs in
Europe are capturing more of the domestic and short-
haul markets, taking market share from legacy carriers
such as Air France/KLM and Lufthansa. This, too, will
encourage more consolidation as legacy airlines acquire
LCCs, such as IAG’s purchase of the Spanish LCC Vueling
in 2012.
In addition, carriers across Europe and Asia are seeing
a growing competitive threat from expanding Middle
Eastern carriers such as Emirates and Qatar Airways. In
Europe, for example, Emirates has made in-roads into
secondary markets, offering fewer stops on long-haul
flights than many legacy European carriers do to the
same destinations.
In Asia, and more recently in China, LCCs are grabbing
a growing piece of the market, driven largely by rising
demand for air travel. The Asia-Pacific region will add 1.2
billion people to their middle-class population by 2023,
according to a recent report by Airbus, compared with

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just 15 million for Europe and North America combined.2
That growth, combined with ongoing regulatory
liberalization, such as an open skies agreement in
Southeast Asia, will create expansion opportunities for
LCCs.
The industry appears to be returning to a more rational
growth pattern, after fare wars and aggressive expansion
undercut profitability in 2014. Of the 22 LCCs that
operated in Southeast Asia last year, only about one in
five was profitable.3
So far in 2015 operating margins
remain thin, but we are seeing an improvement in
profitability across all types of airlines in the region driven
by this slower capacity growth and lower fuel prices.
The Need for Newer Aircraft
These issues underscore the need for carriers to keep
costs low and improve customer service offerings to
remain competitive. Newer aircraft represent the most
cost-effective tool for achieving these goals. More than
90 percent of the executives surveyed said they expect
improved and more efficient aircraft designs in the
coming years, and almost three-quarters are counting on
that technology to benefit their company and help them
remain competitive.
At CIT, our long history as an aircraft lessor gives us
a unique perspective on these market conditions. We
understand the value of flexibility in lease arrangements
with airlines, and we have built a reputation on our
responsiveness and efficiency that enables our customers
to navigate rapidly changing markets.
Despite the challenges facing airlines, most executives
surveyed indicated they are expecting to increase the
number of aircraft in their fleets and routes in their
networks. The airlines that have the best competitive
position in the future, when both interest rates and fuel
prices begin rising again, will be those that have the
most advanced aircraft technology and the most flexible
financing.
About the Author
Steve Mason is Vice President of Aircraft Evaluation
and Strategy at CIT Aerospace. Steve joined CIT in 2012
after 12 years spent working with Rolls-Royce PLC and
International Aero Engines, where he was responsible
for aircraft engine sales for Western Europe and leasing
markets. In his current role, Steve is responsible for aircraft
investment analysis, new aircraft strategy, airline market
assessment and aircraft valuations.
1
Airbus-Global Market Forecast 2014
2
http://centreforaviation.com/analysis/southeast-asia-airline-sector-endures-a-rough-and-unprofitable-2014-but-outlook-for-2015-is-brighter-220189