Industry girds for glut of retired regional jets

 - August 29, 2008, 1:35 PM

When Bombardier and Embraer ended mass production of their respective 50-seat jets by 2006, it appeared that the regional airline industry’s love affair with the little RJs had run its course. With most major airline scope clauses relaxed to allow 70-and even 76-seat jets in their regional partners’ fleets, demand for the less cost-effective 50-seaters had essentially evaporated.

Now, as capacity cuts and $120-a-barrel oil spare no sector of the industry, operators, leasing companies and manufacturers find themselves forced to “manage” a glut of 50-seat RJ inventory accumulated during the 1990s’ boom. Some of the most recent plans to cut small regional jet fleets involve ExpressJet, American Eagle and Republic Airways, all of which expect to ground ERJ 135s/145s this fall. In fact, Embraer next month expects to start taking delivery of 12 ERJ 135s from Republic as that Indianapolis-based airline grounds 15 of the 37-seat jets at the behest of code-share partner Delta Air Lines.

Embraer predicts that over the next five years North American airlines will shed between 250 and 350 fifty-seat regional jets–far fewer than some analysts predict but certainly more than the number removed over the past five years. According to Embraer commercial vice president Mauro Kern, roughly 100 Embraer jets have changed hands since 2001. Although he said he expects that rate to increase over the next few years, Kern scoffed at suggestions that the market faced an imminent crash, along with any associated collapse of aircraft values.

“The 50-seat jets are kind of challenged these days,” he conceded. “That doesn’t mean that they’ve lost their role in the industry. We don’t see that. The huge number of 50-seat jets in the U.S. is basically a consequence of the numerous scope clauses, but they play a key role in the hub-and-spoke system in the U.S. The great majority of passengers are connecting passengers when they fly, for example, international or on hub-to-hub in the mainline.”

Still, Kern holds no illusions that the industry won’t have to address an oversupply of 50-seat jets, particularly in the U.S. He expressed confidence, however, that a healthy secondary market will develop to absorb the spillover. “We have seen already some moves in the past years, at a slow pace, from main markets to secondary markets,” he said.

“Of course, when you see something like 300 airplanes in the next five years, that’s a higher pace of airplanes flowing, and we’ll see a bigger number of those airplanes going to maybe Russia and CIS countries,” said Kern. “We see Eastern Europe holding good potential for these airplanes, we see Latin America as a good potential [market] for these airplanes, and some African countries as well.”

Kern said another avenue for remarketing the airplanes will open in the field of corporate conversions, particularly of ERJ 135s, the model on which Embraer based its Legacy business jet. Embraer has begun to study the possibility of performing conversions itself but hasn’t reached any conclusions yet. “There are several different possibilities; we don’t have a firm decision on that right now,” said Kern, who noted that 10 percent of the second-hand Embraer jets sold since 2001 have undergone corporate conversions.

Of course, such efforts reflect the fact that Embraer–and every other manufacturer–maintains a vested interest in ensuring its airplanes find homes. No aircraft maker wants to see its airplanes languish in storage losing value. So far, according to Kern, residual values of ERJ 145s have held relatively steady, although the coming influx of airplanes into the second-hand market might change conditions in a short time.   

“Those airplanes will get redeployed but they’re going to get redeployed at lower prices; it’s as plain and simple as that,” said Anthony Diaz, executive vice president of CIT Aerospace, Commercial Airlines. “The seat-mile costs are just too high.” Engaged primarily in leasing Boeing and Airbus airliners that seat between 150 and 250 passengers, CIT also maintains a small portfolio of some 20 regional jets it inherited with its 1999 purchase of Canadian leasing company Newcourt Capital. Since then it shed the few turboprops it also inherited and, when the opportunity presents itself, it will likely move out of the regional jet market as well.

“I think what happened [in the 50-seat market] was that Bombardier and Embraer sold a disproportionate number of aircraft in that niche because of the scope clauses,” said Diaz. “So there was this artificial reason to go with the 50-seat airplane. And the real issue you have is that, while the trip cost is lower, the seat cost is pretty high. And that was the reason we could never get comfortable from an operating lease standpoint with those airplanes.”

With CIT and other lessors hesitant to dive into the RJ risk pool, historically the airline industry depended on the maker of the engines in the CRJ and Embraer E-Jets–General Electric–for RJ operating leases. “The airplane made sense for an artificial reason, and the concern we had was, ‘What happens when a SkyWest or Chautauqua moves out of the airplane?’” said Diaz. “Let’s say we did a five- or seven- or eight-year lease, where do you go? Where’s the next operator?”

An International Market

Kern would argue the next operator would likely reside outside North America, and he cites Aeromexico’s recent acquisition of 28 used ERJ 145s as a prime example of the model’s resale potential. In fact, CIT itself placed two CRJs a year ago with Georgian Airways, the flag carrier for the Republic of Georgia. “There were a number of carriers interested, so there was a market for it,” conceded Diaz. “The real issue is that the price of the airplane, if you’re selling it, or the lease rate, if you’re leasing it, is probably going to be lower than it had been.”

Conventional wisdom holds that fuel prices have made the smallest jets the most likely candidates for retirement due to their high seat-mile costs. “You just don’t have enough seats to generate the revenue to offset the costs,” said Diaz.

In an effort to debunk that notion, Embraer ran an analysis that shows that a rise in jet fuel prices from $2 to $4 per gallon affects the overall operating cost of a 150-seat airplane to the same extent it does a 50-seater. “We see that both increase proportionally,” said Kern. “Depending on the airline and the operation profile, we even see some advantage go to the smaller airplane. So, if you have to reduce capacity in the overall system, it’s very much expected that you’ll reduce capacity throughout the system.”  

Still, for various reasons, including the timing of lease expirations and maintenance schedules, much of the capacity reduction involving North American regional fleets will center on 37- and 50-seat jets.

Not all the major airlines that have announced cuts have yet issued details on which regional airplanes they plan to remove, but so far it appears Embraer’s E-Jet series, which range in capacity from 70 to 110 seats, will escape largely unscathed, apart from the 12 E170s grounded by Republic’s recent divorce from Frontier Airlines.

Similarly, most of the 70-seat CRJ700s and 76-seat CRJ900s in service stand as unlikely candidates for retirement, notwithstanding Delta Air Lines’ most recent effort to end Mesa Air Group’s contract to fly CRJ900s from JFK Airport in New York and Horizon Air’s decision to retire its CRJ700s.

In the first case, Delta said it plans to reallocate Mesa’s seven subleased CRJ900s to other carriers. In the second, Horizon plans to replace the lost CRJ700 capacity with Q400 turboprops.

Horizon’s decision to commit to an all-turboprop fleet might not signal a trend, but it certainly raises questions about the merits of regional jets relative to turboprops. Meanwhile, Continental Airlines’ replacement of ERJ 145 service into Newark with Q400s flown by Colgan Air has reinforced the notion that a U.S. operator can overcome the so-called turboprop-avoidance factor. If Horizon and Colgan represent the vanguard of a movement toward more turboprops in North America, the 50-seat jet, many of which fly short to medium-range routes perfectly suited to a larger turboprop, appears the most likely target for replacement.

Consistently brisk worldwide demand for the 78-seat Q400 has resulted in a backlog surpassing 100 aircraft, and the other manufacturers have taken notice. Even Embraer, which long ago dismissed turboprops as yesterday’s technology, has reconsidered its position.

Kern told AIN that a decision on Embraer’s next new commercial airplane model would come “not before one or two years ahead,” but that a turboprop remains a possibility.

“The launch will depend on how we see the world in eight or ten years,” said Kern. “It’s important to understand what will be the future noise requirements, and what will be the overall scenario in terms of congestion at the big hubs, and, of course, technology.” Kern said Embraer is collaborating with engine makers on new turboprop technologies, but he wouldn’t identify the companies involved.