Analysis – Jet makers’ inflation can’t keep up with soaring costs

© Reuters. FILE PHOTO: An Airbus A321 is assembled in a final assembly line hangar at Airbus America’s manufacturing facility in Mobile, Alabama, on September 13, 2015.REUTERS/Michael Spooneybarger/File Photo

Tim Heffer

DUBLIN (Reuters) – Inflation terms that determine how much airlines pay for new planes have entered “over-escalation” territory, pushing up plane prices but still preventing manufacturers from fully passing on the surge, industry executives told Reuters. the cost of.

The move to the top inflation band is a rare move in the industry, experts warned at a major conference in Dublin, the global hub, over the past week, that could trigger higher airfares for airlines and out-of-pocket for manufacturers. aviation finance.

Airlines buy the jets at a base price agreed in confidential negotiations, but the final price includes adjustments for inflation based on U.S. factory inputs and labor costs during long production waits, regardless of where the planes are built.

Those “upgrade” clauses have discreetly boosted planemakers’ profits over the years as price revisions outweighed their long-term procurement costs, people familiar with the contracts said.

Now, with the main U.S. cost index posting its biggest rise in more than a decade, the price adjustment has been more drastic and the buffer between the upgrade and the actual cost has evaporated.

“It’s always been a windfall game for (manufacturers), as long as they’re efficient enough to make sure their own costs don’t grow as fast as the upgrades,” said AerCap CEO Aengus Kelly at Airline Economics said at the meeting.

The rapid spike means some manufacturers may be out of pocket for the terms, which were negotiated at a time when inflation fears were low.

However, Kelly said those rental companies that ensured their exposure was limited would be in a more comfortable position than some rivals during a decades-long period of calm inflation.

“It’s certainly something we’re watching closely … We’re seeing very strong inflationary pressures in the U.S.,” said Steven C. Udvar-Hazy, senior vice president at Century Rentals Aviation Capital Group in Tokyo.

“We are concerned about the inflationary environment in the U.S. as this could have a knock-on effect on a broader supply chain upgrade,” he told the Airfinance Journal conference.

share risk

Inflation is a double-edged sword for aircraft leasing companies that own half of the world’s fleet.

They benefit from the impact of inflation on the value of the aircraft they own. But they also have to contend with rising purchase prices, which has prompted some to insist on limiting price increases.

The exact terms depend on the buyer. But in a common type of structure, the minimum upgrade is paid entirely by the airline or lease buyer, and is often capped at an average rate of around 3 percent, sources familiar with the process said.

After that, there could be a second range of up to 5% or so, with manufacturers taking all the extra risk.

When inflation rises to its highest level, triggering so-called “excessive escalation” clauses, the two sides usually agree to share the extra burden, they said.

“That’s where we’re at right now, in hyperinflation territory, and that’s causing a lot of pain for everyone,” a senior industry source told Reuters.

In rare cases, preferred clients may have exit clauses that allow both parties to exit the deal entirely if inflation exceeds extreme levels, one of the sources said.

Airbus, Boeing (NYSE: ) and Embraer declined to comment on the contract. All are said to face tough negotiations over the terms of future aircraft deals.

“We don’t often see the current high levels of inflation, but the impact of what’s happening is huge. The upgrade is going to be a big talking point going forward,” Embraer commercial aviation chief executive Arjan Meijer told Reuters.

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