An Overview of the Aircraft Engine Aftermarket in Mid-2016
There are vast quantities of fan jet engines in operation world-wide and on order – these expensive and complex products have created a massive aftermarket opportunity which is addressed by a bewildering array of service providers. I attempt here to look at some of the most important factors shaping this market.
The OEMs continue to dominate the market particularly for large engines MRO with a variety of maintenance packages which are usually based on fixed price hourly or cyclic usage. Some are time limited, some life limited, usually covering the operator’s entire fleet of installed and spare engines. Some include provision for all spare engines, some for ‘top-up’ spares only. The airline benefits from easier budgeting and the OEM from controlling the entire aftermarket and the revenue therefrom. In addition, the service provider typically offers engine health monitoring, technical support and, depending on the scheme type, certain technical upgrades (but not performance upgrades). Operational mishandling and FOD and the like are obviously excluded.
Non-OEM leasing companies have historically had difficulties with these schemes as they prevent the lessor’s collection of security in the shape of reserves, and because of difficulties in realising value in the engines at lease end. The OEMs have listened to these concerns and some steps have been made to improve access for lessors, although these solutions remain lawyer- and technician-heavy. Tri-partite agreements between the OEM MRO, the airline and the lessor can wrap up warranty and technical support arrangements for everyone’s benefit and provide solutions in the event of a repossession. Questions however remain about access to cash upon the expiry of term-based agreements. Diligent attempts by some OEMs and lessors working in concert have been made to create a really portable package but these have mainly foundered on the issue of compensating for transition between benign and harsh operating environments.
Much is made of the claim by the OEMs that these schemes preserve residual value of the engine because it has always been operated under the watchful eye of the OEM and has only had installed on it original OEM components, or used ones refurbished under OEM repair schemes. This is true at face value, but not if the lessor is unable to extract sufficient cash from the fund to reflect the hours and cycles burned off when it comes to the first shop visit after expiry of the scheme. Top-up schemes are sometimes available to the lessors to carry them through from the expiry of a package through to the next shop visit whilst in operation with a second airline lessee.
The larger, more powerful independent MRO shops are the only ones who can hope to offer a competing product by virtue of them having a close association with the OEMs, and so ultimately they become part of the same system, operating under the same rules regarding non-OEM parts, and inevitably compromising true competitive choice.
All this is particularly marked for the larger engines where Rolls are linking a massive majority of their engine orders to total care agreements, viz. 100% of the Farnborough announcements for Virgin Atlantic and Gulf Air. GE continue to dominate the GE90 and GEnX in the same way.
By contrast there was little in the rash of Farnborough announcements that narrow body engines were being contracted on the same basis. We counted well over 300 orders announced at the Airshow for aircraft powered by CFMI’s LEAP and P&W’s GTF engines. CFMI have stated that they will continue with their successful policy of a world-wide network of third party MRO shops, whilst Pratt’s policy is not so clear. The latter have stated that they intend to control the entire spare engine aftermarket, which we understand has not gone down well with some airlines who want choice.
The OEMs’ objectives, if not always desirable, are understandable; they invest large sums of R&D in developing new engine types with the profitability of these programmes relying upon spare parts sales and that is being challenged by the increased number of alternatives that there now are for the supply of spare parts. A decade or so ago, there was big noise made about PMA eroding the OEM parts market share, but in reality this activity has only achieved a very small market share. It received hugely controversial publicity when P&W announced that they were going to reverse engineer the CFM56-3C and that prompted all sorts of defensive measures, but it fizzled out as P&W got on with what they should have been doing all along, and that is developing a real competitor to CFMI’s successful family of engines.
However a much bigger competing industry has been threatening the OEM’s spare parts sales, as illustrated by the massive growth in the USM (Used Serviceable Material) supply chain. We understand that the engine parts USM business alone is worth between $5bn and $10bn per annum, and we have counted over 60 companies operating in that space. The availability of materielhas been facilitated by the trend for breaking ever younger aircraft. Lessors, receiving an aircraft back from 12 years leasing will make the decision whether to go through the costly, time consuming and uncertain process of remarketing, refurbishing and reconfiguring the aircraft or simply selling it into a receptive parts market, i.e. to a company who strips out the valuable rotables and other items which can be refurbished and sold back into an MRO market hungry for components that are available at a fraction of the price of new parts. The engine is after all the largest, most expensive rotable of all.
The engine OEMs’ counter has been the introduction of programmes currently labelled ‘True’ or ‘Pure’ within which only components themselves fully traceable within a similarly fully traceable ‘system’ of parts (i.e. the host engine) can be accepted in one of their shops, owned or franchised, which of course means all engine MRO shops. These practices can restrict choice for lessors who are looking to extract the final years’ value out of their assets (and the most valuable part of an aircraft by percentage is increasingly the engines as it ages).
Any lessor is making constant decisions about its aircraft/engine assets as they reach mid- to later- life about whether to invest further to refurbish, part refurbish or scrap. Sometimes the lessor will wish to place an aircraft for a medium term lease of say three years only and for that limited use would not be able to justify a full engine performance restoration and certainly not a full LLP life replacement, so for example would like a rebuild for only 10,000 cycles, which means that it is does not want new LLPs with 25,000 cycles. Therefore it turns to the USM market for a cost effective solution but cannot install the part it wants unless the full traceability tests are passed. Getting that full trace is axiomatic if the lessor has owned the engine since new but may be very difficult if not, since it may have no relationship with the original operator (who in any case may no longer exist). Lessors, in the vast majority of cases support the OEMs by forbidding the installation of PMA and DER find their end of life solutions restricted thereby.
Part of the solution is offered by the very nature of the companies operating in the engine USM business. They frequently acquire engines with some hours or cycles remaining, so before parting them out, they extract maximum value by leasing them in order to burn off the ‘green time’, effectively selling power in the short term leasing market. Other innovative solutions are available, such as engine exchanges, which are more likely to be available in the older engine families.
The rapid growth of the USM business has probably resulted in an excess of supply over demand, which combined with the OEM’s actions will probably cause a contraction in that field. This will be exacerbated as aircraft retirements (a) reduce demand for parts whilst (b) simultaneously creating additional materiel. This will create challenges for the sector as far as dealing in classic generation equipment is concerned. New generation engines are proving so reliable that when they reach a performance restoration event, most of the LLPs will require expensive replacement, so there is in the parts companies’ judgement relatively few components worth refurbishing. Regarding the new models coming on to the market, they will ultimately undoubtedly have similar reliability, will be more strongly protected by the OEMs’ practices and in the large part will be composed of new materials such as ceramics whose suitability for successive repair is in question.
Some of the parts companies who initially started leasing engines they had bought for part-out in order to monetarise the green time, have developed into fully-fledged lessors in the short term engine leasing market and some have been climbing up into longer-term leases at the same time that the traditional long- to medium-term lessors have been increasing their activities in the short-term lease market, thus creating a bit of a logjam in the middle ground shared by both sets of companies. This has provided an unparalleled variety of choice for the airlines who are increasingly taking a risk by under-sparing their fleets and by taking a chance on sourcing engines in the spot market as and when they need a spare. This is a risky business though, depending as it does on a good supply/demand balance. 12 months ago, for example, there was a surplus of V2500-A5 engines in the market, which drove down rentals, but today they have all been swept up and there are simply none available, at any price.
We at Engine Lease Finance have recognised the growing importance of the shorter-term lease and that it is a very different animal from a long-term lease; to the extent that we have established a separate group within the company to facilitate this activity, including a full AOG service. It is our objective to operate in all sectors of the engine leasing market and to continually adapt and evolve, something we have been doing for 27 years now. We look forward to running up the half-century.