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February 2022 Letter

Dear Fellow Horrified Observers,

It’s one of those strange months where I wish I didn’t have a great topic for my monthly letter. Putin’s despicable (and strangely incompetent) Ukraine invasion, sadly, provides material for 10 letters. I’ll limit myself to two – this one commercial, next one everything else.

First, there’s damage to the air travel market. Russian air traffic is around 0.5% of the world’s total, but there are myriad complications and knock-on effects. According to Jefferies, another 2% of world traffic is at risk since it’s connected to neighboring countries. But according to AeroDynamic Principal Jonas Murby, “At least 5% of global RPKs are at risk, driven by in-region travel blockage, reduced passenger sentiment in neighboring regions and greater cost of long-haul travel due to longer routes [necessitated by closed airspace] and higher fuel prices.” Since most of the indirect damage is to international traffic, this war will worsen the K-shaped recovery we’ve been seeing between domestic and international RPKs.

Second, let’s look at the damage to the jetliner market. Russian and Ukrainian jetliner orders are just under 1% of the total Airbus/Boeing backlog, but again there’s more at risk, thanks to likely damage to international RPKs. Speaking of K-shapes, the consequences of this war will further widen the gap between single and twin aisle jet deliveries. Widebodies will get hit yet again due to international market uncertainties. Even before this crisis, the Airbus/Boeing output plan this year was for an 85-15 split between singles and twins. This ratio will likely hold for another few years.

This jetliner output bifurcation is further worsened because single aisles won’t be hurt, and might even be helped. With fuel prices well over $100/bbl, the business case for replacing an older jet with a Neo or MAX just got better. This could be complicated by rising interest rates, but if they don’t go higher than anticipated, that combination of strong domestic traffic and expensive fuel is great for new single aisle demand.

As AeroDynamic Senior Associate Mike Stengel points out, cargo will be impacted too: “There are 31 dedicated freighters among Russian operators, representing only ~1% of the global freighter fleet, but there’s already a shortage of air cargo capacity.” If international flights get cancelled due to the war, that means less belly capacity too. He also notes that we don’t yet know the jetliner production impact of Volga-Dnepr Airlines being offline, and no longer able to fly large structures and engines for Boeing and GE.

Third, there’s the finance dimension. Russian carriers operate just over 300 jetliners leased by Western lessors. These lessors have until the end of this month to repossess these jets, thanks to EU sanctions, which forbid any jetliner leasing to Russian customers. AerCap and other lessor share prices immediately took a big hit as sanctions were announced. It’s far from clear that they even have the resources to repossess those jets.

There’s a further complication. The Cape Town Convention, signed in 2001 by most major countries, including Russia, has played a significant role in keeping finance costs reasonable, since it reduces lessor risk by guaranteeing repossession rights. But it has never been seriously tested by a war, and the Russian government has violated so many international treaties at this point that Cape Town will likely have no meaning to them. As I write this, there are online reports of Russian government discussion of outright fleet nationalization. If Russia doesn’t respect this treaty, Russia might be a no-go zone for jetliner financiers (and financiers in general) for many years to come.

Also, if, or when, Russian courts or other agencies, or thick-necked goons in trench coats, simply seize the jets (and then start cannibalizing some for spares), that could reveal Cape Town to be easily abrogated. What will that mean for the broader agreement? What will it mean for jetliner financing terms in other risky markets that had previously been thought of as safe because of Cape Town? And, if these leased aircraft in Russia are permanently lost due to damage or confiscation, will insurance cover the losses? Lessor insurance policies may also have been jeopardized by sanctions.

Fourth, and perhaps most of all, let’s look at Russia’s civil aviation industry. It isn’t just those leased jets being repossessed; Airbus, Boeing, and Embraer have also cut off supplies of spares (and new aircraft, of course). Existing parts stockpiles, and then cannibalization, can keep planes flying for a few weeks or months, but beyond that Russia’s airliner fleet will simply grind to a halt. Thus, Russia’s 1,000 Western jetliners will be out of service in a short time.

There’s no Plan B. There are a handful of old Tupolevs and Ilyushins still in Russian service, with miserable economics and worse availability rates. They won’t be able to haul more than 1-2% of Russia’s pre-war traffic, if even that. As for building new jets, it will take years before the Russianized MS-21 and Superjet variants (models with sanctioned Western engines and components replaced by Russian ones) are in production, and years after that to build more than a handful of them. The three-decade post-Cold War concept of Russian jets with Western engines and avionics, by the way, has just died, probably forever.

So, on top of the broader trade, financial, and cultural sanctions and massive economic pressure, Russia will also soon be a historical oddity: a developed country – geographically the world’s largest – with almost no national air transport industry; less than Iran’s, and perhaps less than North Korea’s. Russian business jets are also banned from flying to most places oligarchs would want to go. Russia will be grounded.

The aviation industry will therefore play a significant role in either causing the Putin regime to stop its murderous war, or, if Putin chooses, in hastening Russia’s total economic collapse.

Yours, ‘Til Tucker Carlson Gets An MS-21 For His Private Jet,

Richard Aboulafia