#110 Mike Stengel, AeroDynamic Advisory: Gulf crisis impact on air travel

Mike Stengel 0:00

If you believe we're moving into a more geopolitically fragmented world, resources become more important and, the larger entities will do everything they can to gobble up those resources and capabilities. And to your question about who might lose out, it's hard to say exactly who, but the smaller entities and the tail end of any competitive set would be the ones to lose out because they just don't have the scale or the capital to support that sort of investment. It's more of a broader theme, and it's harder to highlight exact tactics to fulfill that. But the resources flow to the largest entities.

Jim 0:47

Hey everyone, welcome back to The Vertical Space and our conversation with Mike Stengel, a partner at Aerodynamic Advisory. We reached out to Mike when we heard about his recent study where he addresses the impact on aviation from the Middle East conflict. Mike is a coworker of Richard Aboulafia, a two-time star guest on The Vertical Space. This is an excellent discussion. Hope you enjoy it, and thanks for joining us, Mike Mike Stengel, welcome to The Vertical Space. Great to have you on.

Mike Stengel 1:14

thank you for having me.

Jim 1:16

Mike, first question we ask everybody, is there anything that very few agree with you on? And,

Mike Stengel 1:21

I, I'd say that's a tough question. If I could dance around the question a little bit, I would say, there's a lot of in today's aerospace industry that we have to explain to clients and help unpack a lot. And, I think when we explain things like why we think production, for example, will take longer to recover than expected because a lot of, very, de- deep-rooted supply chain problems, it just takes time to explain that. I, I don't know that people necessarily disagree, but it's just a lot of nuance to unpack and, and complexity to understand.

The tide is rising for all major end-markets

Jim 1:57

what is it from your standpoint of the status of the industry that people generally will not necessarily agree with you on

Mike Stengel 2:05

Oh, I mean, I would say, a- again, I don't know how much people disagree with, with me on this, but it's, the, the tide, despite a lot of, constraints in the industry, I'd say the tides are rising for almost all the major end markets. So whether you're, playing in commercial aviation or military aviation or business aviation, the, the tides are rising for, for all three. and there are not many times in history where that happens.

Jim 2:30

Tell us a little more about that

Mike Stengel 2:32

because, commercial aviation, it's primarily tied to, people's willingness to travel, discretionary income and all that. that is, we're back to kind of a, a normalized growth profile after the initial, kind of whipsaw effect we saw after COVID when there was all that revenge travel. but historically speaking, air travel demand grows about five-ish percent per year, that's only continued to be true. There's al- there's always gonna be some geopolitical or other, black swan events that might temporarily interrupt that, but it's a long-term trend that continues to be the case. that's fueling demand for aircraft. And, airlines can't even get new aircraft as fast as they would like, and they're older aircraft around to, to offset that, which is a, a tailwind for the aftermarket, which is, know, we would call it the l- the aftermarket, we would call the lifeblood of the industry. It-- what fuels the majority of the profits the supply chain, at least for the major manufacturers. And it keeps... I, I, I say it pays for the whole party. It pays, it, funds the R&D, which eventually pays for the new aircraft, the new engines, and so forth. And then, business aviation, that's, on a kind of a, a new normal compared to pre-COVID too, with, you higher use of business jets, more people trying out business jets, that might have been flying commercial first class before. And, that's for the benefit of, of people like NetJets and other fractional providers. it's a sort of resilience we did not see before COVID. And then in military, of course, there's, geopolitical headwinds are a tailwind for military, and, just with the, the more, aggressive posture we're seeing from a variety of countries around the world. and that- that's putting an emphasis on defense budgets and capabilities and, and new technologies.

Luka 4:18

Aviation is clearly a, a system of systems of systems, layer upon layer of, of complexity. and so when you said that some of your clients might have difficulties grasping the complexity in your view, what layers contribute most to that complexity

Mike Stengel 4:33

the supply chain's a common one. especially if you sit, higher, in the higher tiers of the supply chain, it, it's hard to, have consistent visibility, deeper down into the supply chain and understand exactly what's going on, within, raw material suppliers than, your sub mach- or your machining suppliers, and understanding the, the challenges that they face, maybe not on an individual company basis, but, on a collective basis. especially at the, the tier three machining level, a lot of mom-and-pop shops that, may struggle to have a, collective voice to amplify their concerns and, what they have to deal with on a day-to-day basis. So I think getting that sort of visibility, multiple layers down, it, it's kind of like Inception, you Go multiple layers down and it gets harder and harder each level you-- further you go down.

Jim 5:23

Mike, I'm gonna stick on what people may not agree with you on. I really like your comment about all three military, commercial and, business aviation all doing well. On the demand side and the capacity side as well?

Mike Stengel 5:36

Y- yeah, I think, it's a good point. I would say this is probably the first time in the industry's history where it's a supply-constrained environment rather than demand-constrained. backlogs for, really any sort of aircraft you're looking at only seem to be getting longer. it's longest for your commercial transports, extending up to a, a decade for narrow-body aircraft. business jet backlogs are growing. we're seeing, up to three or four years now for certain manufacturers, just did not used to be the case, for business aviation who, know, used to chase higher rates, in pursuit of market share, and now they're showing a little bit more disciplined posture.

Jim 6:16

Yeah, that's something. That's a cool perspective. Okay, would love to talk about the guts of this talk, which is the impact of the Middle East conflict on aviation. you recently did a really interesting study. Give us a highlight of, uh, your conclusions?

Mike Stengel 6:33

you know, given all the events that happened in the Middle East, we had to quickly get up to speed on, the basics of the oil and gas market, how crude oil flows, and then who depends on imports for jet fuel and so forth. and unfortunately, it paints a picture that there's not really any s- one silver bullet to solve any of the developments that's ha- that have happened over the last, two months now. so East accounts for about 20% of global crude oil flows. and so it's not, not 20% of the tap that's been turned off because, there's a pipeline that goes across Saudi Arabia that's been able to offset of which that can't go through the, the Gulf. but we're still down about 10 million barrels a day in global crude flows. a lot of that, gets exported to Asia Pacific and Europe as far as, jet fuel supply, those are the two regions most immediately impacted by the developments in the Middle East.

Luka 7:32

And sorry, Mike, give us a sense of, what the ten million barrel per day is relative to the total demand. Is that roughly 10%

Mike Stengel 7:39

so I think global crude flows, uh, were about 75 million barrels a day in 2025. So we're down about 10. Yeah.

Luka 7:49

Okay.

Mike Stengel 7:50

right. So Asia-Pacific and Europe most heavily impacted because they rely, the most on imports for jet fuel from that region. and right now we're just seeing, evidence of jet fuel stocks getting diminished, in certain places. you're-- we're tracking like nodes in, in Amsterdam and Singapore, places like that. so unless there's kinda mitigation action taken to find alternative sources pretty quickly, you start to, it starts to paint a picture of, there might be a, hard decisions that need to be taken in the summer, to potentially trim schedules, because of poor demand, travelers sitting back and not flying, but rather because of jet fuel availability. so we're, we're seeing airlines take, some cuts to their schedules more near term focused because they want to see how this plays out. But, again, if this isn't resolved soon, then there could be, more medium term implications for airline schedules, which, would mean more cuts, potentially put some aircraft grounded. But, North America, of course, has been a net exporter of, of crude for a while now. so as far as, supply of fuel goes, they're rather insulated, but still feeling the effects of the higher prices of jet fuel.

Luka 9:06

Is there a reasonable way to substitute that, 10 million barrel per day gap

Mike Stengel 9:11

a tricky question. it, again, doesn't seem like there's a, an immediate, easy answer to find an alternative source. the, top producers that come to mind would

Luka 11:10

link in that chain is the primary constraint in coming up with an alternative? mean, you mentioned there's capacity elsewhere that perhaps can be tapped into, or, production can accelerate in some of these places. But then there's, there's this idea that US shale is supposedly the swing producer. Um, also, what about strategic reserves? Is it, is it about, finding the right match for refining, given the demand, where the demand is coming from? What, what really is the, primary constraint in coming up with this alternative?

Mike Stengel 11:43

for US exports, so as far as we can tell, it's some of the, export infrastructure, like literally at the ports. but you also bring up a good point because, the US is primarily dealing in, lighter grades of crude oil, which are not as ideal for production of jet fuel. you can do it, but it just affects the e-economics and yields of the refineries, so it, it's not an ideal answer either because jet fuel is primarily from a, a medium grade, crude source, which is where, where the Middle East filled such a, a, a nice role. so the, even if the US steps up, then you still have to deal with, non-ideal grades of crude to turn into jet. the other lever, the, know, oil and gas industry could, could pull is, well, at the refinery, can I shift the product slate? In other words, the product mix towards more jet fuel. Now that's a possibility, but then, that would potentially come at the expense of, diesel and gasoline, and then, that could af-affect prices for, general consumers, right? Not just for air travelers. So there's a little bit of a, risk-reward balance that the industry and, policymakers would have to take. And, and refinery capacity in Europe is, has come down since 2000, I think down something like 16%. And, that's a result of, green policies and greater competition for, in refining from overseas. And, are, multi-year investments to stand up, so it's not like you can just turn a refinery back on and start pumping jet fuel. not, nothing in the next, few months, definitely at least.

Luka 13:47

Europe, which is hedging about 70% of crude, oil prices. and as you do that, I'd be really curious to get your thoughts on why are we seeing this phenomenon in North America? you mentioned in the report, you highlight premium and transaction costs as a reason. and I wonder if this is a symptom, what the underlying current is. did something change in the worldview of the US airlines where perhaps they have, seen, the US shale production and thought that, crude oil pricing would be a, a domestic production, phenomena and the, tails on the pricing are not going to be as fat as they had been in the past, and whether this contributed to a change of posture. anyway, t- take it away. It was a long question, but please, put some transparency to this complex topic

Mike Stengel 14:39

Sure. So, um, you know, if, if you're following airlines back in the 2000s, the last time fuel was consistently high, you there was a l- Southwest was, like, the last holdout,

Luka 17:06

the On, on the premium costs, you have to put it in context to what you are hedging against to, to see whether this is expensive or not. And so, was there gave US airlines a false sense of comfort and security that that they don't need to hedge, and therefore hedging premium and transaction costs started to look too expensive relative to this new world that they were expecting in the future? To what extent did that have any impact on their decision? Because otherwise, if you feel like th- that there is a ton of price volatility and variability, then, yes, those fees are annoying, but, they, they ultimately tend to make sense.

Mike Stengel 17:55

I, I would say that was probably a consideration, just the, the US becoming more self-sufficient in crude oil. and you even today, when you look at the, of jet fuel prices around the world, it does tend to be lower for the US even in today's environment. so, with that supply advantage and more insulated nature of today's market, know, the US airlines still have, somewhat favorable jet fuel prices compared to the rest of the world. I think if you're looking at, I haven't looked at it today, but if you were to look at the spot prices in Singapore, for example, they, they might be around$5 a gallon or more versus, you think they're about$4.20 a gallon in the US right now.

Jim 18:34

But aren't you more saying that the, essentially the price elasticity of demand is far different than what it was five years ago? So regardless of the source and, and access to fuel, that the US carriers are much more confident they could just pass along the cost to the premium traveler.

Where to expect service reductions

Mike Stengel 18:53

been one of their, one of their ar- point-- m-main arguments, points was that they have a, this more resilient customer base. over the weekend, we saw Spirit Airlines liquidate and stop operations. that's probably an example of a carrier. low-cost carriers by definition, You have a customer base that is more sensitive, more sensitive to inflation shocks, and they can't absorb those price increases. So, I-- this, this pricing, this fuel price environment was the nail in the coffin for Spirit, I think.

Peter 19:23

So I-in a scenario where jet fuel prices remain elevated and in short supply of the fuel, if you look across the industry, where do you see more of those price-insensitive customers, and where do you expect the service reductions will therefore appear?

Mike Stengel 19:41

It's still playing out, but, one clue of that is, know, the-- what the US airlines have hinted at so far in their network adjustments is, flights on the margins on their schedule. So think flights, Saturday night, red-eye flights. flights that may, you know, not very popular in the first place going into this situation that were, on the teetering on the edge maybe, so they're trimming those first. I do think it if this goes on, it probably hurts, more of your regional routes as well, the operating economics of your, you 76-seat aircraft, you know, CRJs and E-jets, higher fuel prices. They are, more heavily impacted by their unit costs, you cost per available seat mile, compared to the operation of a larger narrow body or wide body, a-as long as you can fill those aircraft, of course. and so I, I think that means your routes from hubs to secondary or tertiary cities, might be at risk,

Peter 20:49

and how does that compare, in, in the US market, how does that compare to the rest of markets around the world?

Mike Stengel 20:56

Well, the, the US is famously more reliant on those regional jets for s- flights to those

Peter 21:04

Okay

Crack spread

Mike Stengel 21:06

so I, I think it, probably hurts, prospects for some service to those smaller cities, which have already, those are already heavily impacted during COVID because the regional jet, regional airlines were, were really impacted by the pilot shortage a lot of service to small cities still haven't, hasn't recovered. elsewhere outside the US, you, you don't see that same use of regional jets. It's more of more of a narrow body and wide body world. But again, if you, if these, if you're looking at routes that, you know, have high overload factors already and, not much business travel, n- not much premium revenue to offset higher fuel costs, then those would be the most at risk first.

Luka 21:48

When we're talking about hedging, I think it's important to clarify that w- what the airlines have been hedging or are hedging still elsewhere in the world is the price of crude. but the difference between the price of the refined jet fuel and the crude, the so-called crack spread, that's not something that is hedged. and what does the current situation reveal about the price movement of that crack spread? And do you think that this is something that the industry should be hedging?

Mike Stengel 22:20

Uh, it's a good question. So yeah, just a recap on that. So, we focus a lot on crude, the impacts with, turning off the tap on crude. But, you you also had refineries get damaged across the, the Gulf. lot of these refineries might have been producing jet fuel to send around the world. so with refinery capacity damage, that means, that crack spread is elevated. So the, the airlines kind of got a double whammy from, not just the higher crude, but also higher crack spread cost. So where, you in, in other words, the price, the higher jet fuel prices have outpaced broader gasoline and diesel prices, so like what you might see at the pump for your car. and you're right that the, the hedging contracts have, typically do not cover these, the crack spread. It only covers the underlying crude. So if you're an airline that counted on, hedging for safety, you still may have had to increase your fares because you're still facing the, the variable, crack spread, a higher crack spread today. I don't know how... common it is to include the crack spread in these hedging agreements, but from what I understand it, they're typically not included.

Luka 23:35

How do you think that Delta is looking at their Monroe acquisition right now? Obviously, when the crack spread is, large, they look like geniuses. But at the same time, I think they have reportedly tried to divest that part of the business because in, quote,"normal times," it is a drag on the business. But in times like these, that crack spread is margin that they get to, they get to keep. you know, net-net, what do you think of that level of vertical integration, as a strategic move?

Mike Stengel 24:05

Yeah, I think they are feeling a little bit vindicated today because you're right, they, they got a lot of questions from Wall Street over that move back in 2012, and I think part of their argument was, you look, this is,$300 million-ish investment. That's the, roughly the cost of one wide-body aircraft at list price. so you know, I, I don't think they've said much publicly about it since. But if I were in their shoes, and if you're looking at the wor- around, at the world today and you're seeing it become more fragmented and everyone kind of fighting for their own resources, then yeah, maybe in the very long term it is a smart move to have your own refinery in, in that kind of case. is, is can every airline do that? I, I'm not sure about that because I think the, the, specific facility they purchased was, uh, opportunistic as well, where it was already, underutilized and, it, they-- there was a case for them to, to jump in and, and add value for themselves, where, know, that may not be the case today. I don't know how many other available assets are there out there like that.

Luka 25:11

if you were advising other major carriers, would you them to go find their own Monroes?

Mike Stengel 25:18

I would tell them to keep an open mind. I think it, you under the right circumstances it can be creative and it, I think they, in Delta's case, they

Widebodies and the mega-hub model

Luka 25:27

Mike, talk about important role that the Gulf airlines have for widebodies and also for, serving as the global, mega, hub for, for, air travel. And what the war, how it might shape those two things going forward

Recovery scenarios

Mike Stengel 28:35

to put it in a little context, you know, see an airplane, I think it's important to distinguish, you who's buying narrow bodies versus who's buying wide bodies. And in, in short, the audience of people that buy narrow bodies is much, much wider than it is for wide bodies. narrow bodies I-- you know, you-- are analogous to your Yellow Cap, right? Everyone has them. They're easy to operate. You know the operating economics. wide bodies a different animal. You need to generally put them on more business-heavy routes or if they're a freighter, for cargo. and there's-- they just require a different business model. and the Middle East carriers, Emirates, Etihad and Qatar have been very successful in establishing the UAE and Qatar as ideal connecting hubs really, to go around the world. whether it's US to Asia, maybe you're going US and ending in the Middle East. and they really kinda headaches for, legacy carriers in Europe and Asia, and it took a little bit of traffic away from them because, they're, they were able to convince the flying public,"Hey, stopping over in Dubai is better for your journey and your itinerary than stopping over in Europe or elsewhere." and for that reason, those carriers have been some of the largest customers for wide-body aircraft from Airbus and Boeing. So you look at the 777X that Boeing is, nearing certification on, uh, the Middle East carriers account for about two-thirds of that order backlog. so they're enormously important. Airbus and Boeing count on, on those carriers to, be, future customers to fuel more orders for these large, very profitable aircraft. so that, that concentration of the backlog is, is-- can be concerning in a situation like this where the carriers, there are, flying 40, 45% less than just two months ago. And you wonder, okay, at what point do they start to make more permanent decisions? Maybe accelerate the retirement of a portion of their fleet, or maybe they defer the delivery dates for some of these new-build wide-bodies. and that would of course be, not great news for Airbus and Boeing if that, if that becomes true. But no, no announcements have been made yet. I think it's, again, going back to the question of the longevity of this conflict and, you what the outcome is.

Peter 31:04

So what do the recovery scenarios from here forward look like? I mean, the duration of the strait closure, and the accumulated deficit of, crude oil globally, plays a role in this. The amount of destruction of production infrastructure in the Gulf region plays a role in this. And so, here in early May, we sit with a certain status, right? A certain situation. What would a recovery in the near term look like versus what would a recovery after resumption of combat or after a more extended closure of the strait look like? And how do those scenarios play out in your analysis?

Exposing aviation's structural fragilities

Mike Stengel 31:52

And yeah, there was a fourth scenario too that we, we called a q-quick recovery that we consider more or less off the table right now. That, that's, that window has passed. we, we kind of put it in terms of, as you said, you much infrastructure is damaged, which means, more refineries damaged, and that means fuel prices stay even higher for longer. And then how long the conflict lasts, and that means how long the, the strait stays closed. I think we're... Right now, as of today, we're between a couple of the scenarios right now that's not really firm, just because of the fluid nature of the, the negotiations. But, you could kind of the situation freeze in place where there's no near-term breakthrough it evolves into something similar like we see with Russia and Ukraine right now. and, you know, that would mean strait stays closed or partially closed, then we have to, deal with, lack of crude from, coming from that, that region for the foreseeable future. I'd say if you see more escalation, then the strait also remains closed in that case, but then, that's where you could see more damage to the infrastructure refining capacity, could push prices up, further in the near term. in the worst case scenario, it's, know, an expansion of the conflict, so more of the neighbors getting involved. and that would probably mean more downside for traffic in that area, especially out of the main hubs. in the more m-moderate scenarios, you might see traffic resume at, a moderate level but not fully recovered yet. but, you know, if things were to escalate, that would be, have more global implications, because then that's, you airlines not just dealing with, potential lower fuel availability but, you much higher prices, and then you're looking at more route and schedule cuts and so forth.

Luka 33:55

what's interesting to me, what this entire situation highlights is that, and I'd love your thoughts on this, but it is revealing some structural fragility of the industry that has otherwise been hidden by cheap energy and the assumption of, stable environment over the last, 30, 35 years, this wasn't really a question. Yes, there were, were temporary, disruptions, but the underlying assumption is that, hey, we can optimize for scale and efficiency and trade off resilience in the process. and so the industry has learned to operate on, near zero margins on, on energy, on airspace or routing, on and on. Every, every one of those layers in the aviation system systems has been, independently optimized for a world view, like that. And so we are into the future and, there's two scenarios where this is either another disruption where, the, industry, y- powers through this and we come out the other end and we're, back to business as, as normal, And, and in which case every investment that, you know, airlines and, and other, parts of the value chain make today on improving resilience will look like you're solving a yesterday's problem, and the return on investment on those efforts will be, limited. Or we're facing a world where this is becoming a lot more common and, not just common, but longer lasting and perhaps more permanent. in which case, there's a lot of investment and rethinking on, on energy, on fleets, on airspace and routing. How do you make sense of this structural fragility that is exposed?

Mike Stengel 35:41

gla- I'm glad you brought that up because, you in our firm we do an exercise, a year on estimating the outlook for air travel demand and activity. You passengers number-- ba-

Luka 35:51

what parts of, uh, of of the board number of days of stock of fuel, whether this is the aging of the fleet and the fact that airlines are operating, older aircraft at the worst possible time to be operating older aircraft. is it about, route availability or planning or airspace? what part of that system you expect the most long-term change as a result of what we're seeing

Mike Stengel 38:29

I would, I would parse that into, near term moderate and long term kind of concerns. So near term it's, you jet- definitely jet fuel availability and price. I, I would say in the medium and long term, there are some sticky concerns around, we just talked about, geopolitical, volatility. that's probably, most impactful for wide-body aircraft demand. and then, other areas we've been, know, flagging are, things like, labor availability, literally pilots and mechanics. especially for mechanics, like that kind of goes under the radar compared to pilots. The, the demographics there aren't exactly favorable either. It's, it's pretty, quickly aging workforce. and yeah, getting your hands on new aircrafts and the backlogs for 737s and A320s are extending towards a decade. So even if you try to get new aircraft today to deal with higher fuel prices, like you're in the back of a long line. can maybe work with lessors to get aircraft sooner, but you know, if you need a lot of aircraft, near term, gonna have a-- you're gonna be hard pressed to do that. it's all... You put this all together and it kind of points to a continued aging of the fleet, for the foreseeable future. We don't see that reversing anytime soon.

Luka 39:51

with respect to the two paths, two po-potential paths where on the one hand, this is a pricing event, not so much a, a change in, in, in worldview or a regime change, and the other path is structural long-term change where the industry needs to revisit all of these points of fragility. Where do you land between those two?

Mike Stengel 40:15

I think there will be airlines that will have to reconsider some of the ways they do business. so you know, if you're an airline that is, you know, to having and operating a younger fleet and, you know, getting rid of aircraft by the time they're 10 or 12 years old, maybe you have to reexamine that and say,"Okay, What do I need to have myself now to deal with a structurally older fleet? I just need to get used to that as part of my business model, and how do I adapt to that?" Um, so that, that's a, that's a mindset change. Um- You know, nor-- we see it all the time in the ways different airlines treat their fleets. North American carriers buy aircraft new and keep them till they die. They don't lease them, they own them for their lives, and that gives them a lot of maintenance flexibility. Outside of the US, there are a lot of airlines that rely more heavily on leasing, and they don't like keeping aircrafts, like I said, more than 10 to 12 years old. Um, so you know, basically they, they keep it through the maintenance honeymoon or through the first maintenance cycle, but they don't wanna deal with any of the issues or challenges that come after that. Um, maybe they, they revisit that, and that's just, that's a, that's a pretty s- underappreciated shift in posture that would be required, and that's just one small example in, in maintenance. so there, there's a lot of considerations like that across like the, know, air- airline value chain that would need to be reexamined.

Lessors as a natural buffer

Luka 41:45

about that, the financial layer, the, the insurers, the sources of capital, the lessors? what kind of stress are they facing as a result of what's going on in the world right now? you haven't put a lot of focus, in the deck on that layer, but what are some of the KPIs or indicators that you're watching, to perhaps, get a better sense of, what might be happening at that layer of the value chain?

Mike Stengel 42:09

No, I think it's, it's probably a good thing that we have the ecosystem of, of lessors that we do because they kind of function as a natural buffer in times like these where they can be absorber of, of risk, right? If, airlines are performing poorly in one region and they may not need as many aircraft, you can return aircraft to lessors. lessors naturally, remarket and redistribute those aircraft where they are needed. I'm-- so I'm not seeing stress from them. If anything, they're, doing-- they've been doing incredibly well collectively over the last few years because they're getting very rich lease rates on older aircraft. so you know, so they, they're able to, I think, pretty quickly adjust their, their, rates and such to match the risk profile of the industry today. So they're-- I think they're a rather nimble group in that regard and probably one of the most important sources of buffer of risk in the industry. and that was, that was not a group that really existed 30, 35 years ago, and now half the fleet is leased. that's a pretty big development, over... compared to, prior, conflicts and, and black swan events. not sure about the, the, the other like insurers and things like that, but, you in a way your lessors are kind of too.

Jim 43:34

Like, let's say we're in the same situation 60 days from now. what airlines, airports, other people in the chain, who is doing better and who is doing considerably worse?

Mike Stengel 43:48

So we did flag Spirit, and of they've stopped operations over the weekend. the other carrier that comes to mind that in as, dire straits as Spirit is, is JetBlue. they're not in bankruptcy now, but, you they're... that's been another kind of low-cost or hybrid carrier that's been, struggling in a post-COVID world. and they're, you they have lower margins, a little bit more highly leveraged. I think the others that come to mind would be, specific countries that come to mind for exposure on fuel availability are, those with stretched supply chains. So I think of corners of the world like Australia and New Zealand. think of p- countries that relied on China for imports, like Vietnam, who have said that, some airlines there have said that they're preparing for schedule cuts as high as 30% if this, situation for the foreseeable future. but I think carriers are, are more insulated from all this. But, you just to put it, to put it in perspective too, I mean, I don't think this is a COVID-like event. I don't think we're gonna see traffic drop s- the same magnitude that we did in March 2020, where it was down, like, over 90%. I d- we're not dealing with this, any sort of magnitude like that. I think we're probably... I think in the worst case, we're probably looking at, you know, a mid-single digit percent decline in, in flying activity.

Luka 45:25

Yeah, on the, on the one hand, this is definitely not a black swan type event like COVID was, but, what gives me pause is that this is a different kind of stress to the system that is potentially a lot more likely to repeat and persist, because it is not a one-time event. We've seen, geopolitically triggered disruptions before, depending on what perspective we take on the future, stability of the world, this might become a lot more frequent.

Mike Stengel 45:53

Yeah.

Luka 45:54

perhaps not, certainly not in, the, amplitude of the impact, but the frequency, might be the driving factor here.

Mike Stengel 46:01

are hotspots people ki- keep their eye on, like, you the, with airspace over Middle East largely, unusable. And then so airlines are flying north of that, like over Turkey, right? But then just north of that is, restricted Russian airspace, which Western carriers can't use. So you, in that specific quarter, y- Asia to Europe, you have this, like, narrowing window where you can fly through. y- yeah, to my, to our scenario about, conflict expansion and more neighbors getting involved, like, yeah, if, if Turkey got involved in this in a meaningful way, like, that would be, much worse off for, for global traffic. That, that's where the, you the, the impact spreads to, just in that region to carriers in other regions too. But that, that's... It, it's a lot of considerations that are very difficult to bake in into a, into a model and, and quantify.

Luka 46:57

what kind of, context does this for sustainable aviation fuels? Is that in a net positive or net negative

The impact on SAF

Mike Stengel 47:06

Yeah, so This, I think there are a lot of headwinds for SAF. people were realizing, what the cost differential was versus jet A, you know, between two and three times the cost of jet A at the time. difficulty in getting the feedstock for these fuels would've been difficult. so on the one hand, now that jet fuel is higher, it narrows the cost differential. on the other hand, I don't know how it, it-- I don't think anything's necessarily improved on the refining side or, these feedstocks for sustainable aviation fuels, a lot of them still come from hotspots. all you-- if you were to fully migrate to SAF, like all you've done is transfer your geopolitical risk from the Middle East to somewhere else. So, like one of my favorite examples is, you you could potentially use sunflower seeds a feedstock for sustainable aviation fuels, but, Ukraine is one of the bigger exporters of sunflower seeds, so it, it's not like that's a viable source either.

Peter 48:10

Yeah, I mean, it feels to me like the case for development of SAS would-- it would require real clarity that there would be an extended conflict, extended closure of the strait. But in-- in-- from what I can see, as this drags on, the countries in the Gulf region are going to expand pipeline capacity or do other things to find alternative routes to get their product could change so quickly, and then it-- your, your investment would be stranded.

Mike Stengel 49:03

Yep, I agree. And, and yeah, worth noting, the reason

Jim 49:07

All right

Mike Stengel 49:08

Arabia exists at all is because of, the, conflict with, the Iran-Iraq War back in the'70s or'80s, right?

Peter 49:16

Does anybody know how much time and money it would take to, increase the capacity of that pipeline?

Mike Stengel 49:22

I'm not sure. No.

Peter 49:23

Has that been discussed?

Mike Stengel 49:24

far as I know, it's at capacity right now, the one that is there now. Yeah.

Peter 49:29

one that they have, yeah. Yeah,

Mike Stengel 49:30

were to establish a parallel one, I'm not sure.

Peter 49:33

Mm-hmm.

Jim 49:34

Mike, if you had to point to one or two categories where you think durable companies may come from this conflict, what are they?

Mike Stengel 49:42

If you were, if You were to narrow it down to-- for airlines specifically, I think it's, premium passenger base is I think a part of it. You just a, a customer base that can more easily absorb these cost increases not blink too much of-- blink an eye at it,

Jim 49:59

What about new companies? What about new capabilities?

Mike Stengel 50:02

Hmm. Yeah, there's only so many different ways to rearrange a cabin.

Jim 50:06

Where do you think there could be a capital shift because of what's going on right now? Where do you think people may be investing more that they wouldn't have done three months ago?

Mike Stengel 50:17

man, you're asking good questions I'm struggling to answer.

Jim 50:21

let me, give some potential. For example, is there a

Mike Stengel 50:24

Hmm.

Jim 50:27

dynamic routing, speed optimization, trajectory-based operations? These are all, on the edge, but there are ways of getting more out of the, I'll say, the limited capabilities that we have today.

Mike Stengel 50:42

That's a good point. Yeah, there are a couple of startups in that space. yeah, especially in areas outside the US where you're dealing with more fragmented airspace. Yeah, I could absolutely see that being value proposition and, anything to help reduce your fuel consumption and fuel footprint. and, and we have seen that come up in some, investor interest before. but again, it's have large, continuous, portions of airspace like the US, it's, not as valuable. But, you where you have multiple jurisdictions that you're crossing pretty frequently, then yeah, absolutely could be of value.

Jim 51:19

It could be as things become less predictable, dynamic capabilities become a little bit more important. whether they're

Mike Stengel 51:26

Yeah.

Jim 51:27

a small gain or a larger gain,

Mike Stengel 51:29

And, you are-- where you're talking about are solutions on-- to help on the cost side for airlines, I think You know, the airlines are also experimenting with that sort of dynamic behavior on the revenue side. You

Jim 51:39

Talk more about that.

Mike Stengel 51:40

Yeah, I think we're just, you know, I haven't been in the weeds on it, but, we've seen more evidence of airlines using dynamic pricing behavior on airfares. and they're getting, they're trying to segment their cabins different ways and play with different fare rules. and, you was, that was one way that actually the US majors helped, uh, push back against, the emergence of Spirit. you know, Spirit had these bare bones fares, and then US majors countered by saying,"Okay, we'll introduce a bare bones fare, that can actually be quite competitive, but-- and, the, the passengers also get, the advantage of our broader service." and so it's that sort of fare innovation I think you can play with, that can be more impactful than people realize.

Luka 52:23

Mike, If Delta-Monroe acquisition was controversial in 2012, what's the equivalent move airline might do today?

Mike Stengel 52:32

boy.

Jim 52:32

Good question

Mike Stengel 52:34

their own ships to, to pull in crude or pipelines, yeah, if you're talking about oil infrastructure.

Luka 52:42

More,

The resources flow to the larger entities

Mike Stengel 52:42

Right.

Luka 52:43

Vertical integration. Well, it could be, energy infrastructure or supply chain or,

Mike Stengel 52:48

theme of, again,

Jim 52:49

It's kinda like what would a Richard Anderson do today? and the other question would be is, is there any possibility of s- really spitballing, like a multimodal... Is there, is there a chance that airlines would move more into a multimodal approach? you know, Continental 20 years ago with the experiment at Newark with the rail, Ed Bastian, we had him on several months ago. Very cool w- how they're expanding their organization. and this isn't multimodal, but you know what they're doing with Wheels Up in Europe and, the expansion of the services that they offer. I wonder would they be more or less bullish in doing such things, do you think,

Mike Stengel 53:26

No, I, I mentioned how, we're seeing headwinds for services to smaller cities, that were, primarily regional jet routes. my hometown, Allentown, Pennsylvania, is one of those cities, and, like, I can't fly direct to that city anymore from where I live now in Michigan. but you know, you can fly Even out of Detroit Yeah,

Jim 53:48

Even out of Detroit

Mike Stengel 53:49

the, victims of the, pandemic and the pilot shortage. you... I noticed you can f- if you were to fly United or American, you can still book a ticket to my hometown, but they actually fly you to Newark or Philly, and then you take a bus, to your final destination. And it's all operated by the airline, and, and it's post-security too. So it's like if you get on board in Allentown and to go to Newark, you can board post-security and go to s- you know, they... You go directly to your connecting flight.

Jim 54:18

Huh.

Mike Stengel 54:19

you, you could potentially see more of that behavior for smaller cities that are within a certain proximity of the hub. You it-- Allentown is an hour and a half from Newark or Philly. Maybe doesn't work if you're four hours away, but maybe if you're within two hours' drive, that might work. and yeah, maybe like, I know there's, advanced air mobility that's been thrown around. I don't know how much...

Jim 54:41

I do

Mike Stengel 54:41

I don't think we're big. Uh, we don't see a, a lot of network expansion opportunity there'cause most of the concepts that have, are coming to fruition aren't big enough, right? It's, you know, these airlines need not five-seaters to, to work. but I think the challenge on some of those mul- more multimodal, like, especially if you're depending on, like trains and, and rail networks, um, that might have to be, you know, some sort of, you know, partnership with the government and because those are more interstate pursuits. so you're dealing with a lot of different jurisdictions. but it would be a, it would, be a novel kind of approach like,"Hey,

Jim 55:25

to a good question, Luka. You got me thinking on that one.

Mike Stengel 55:46

sort of concept.

Jim 55:47

Cool.

Mike Stengel 55:48

Oh,

Jim 55:49

This was kind of a last minute, episode because we saw the good work that you were doing, but it's extraordinarily timely. What... Here, let me ask you this. What's the most novel part of what you've described? I've learned a lot, but people knew fuel prices were going up. They knew it was a constrained environment. Probably they didn't know a lot about the effect on the airlines. What do you think is the effect on the airlines most reading The New York Times or The Wall Street Journal may not have previously known?

Mike Stengel 56:18

Y-

Jim 56:18

What's the news?

Mike Stengel 56:19

out of this is how, it-- the impact is a little bit of a patchwork of, on the airlines. Like you may-- Being based in the US, you may have read the headlines about,

Jim 56:32

And

Mike Stengel 56:40

makes our life, little tricky to track all these developments and how airlines are reacting, but it's a, a... Just you're-- we're seeing the patchwork of responses in real time. There's no one single response or silver bullet.

Jim 56:54

that generally speaking, the, the larger US airlines are absorbing this better than most. I also think your comment about the military, the business, and the commercial doing well right now, you haven't seen this in a long time,

Mike Stengel 57:08

Right. I mean, when you think about what's happened over the last 30 years, you had the fall of the Berlin Wall and relative peacetime and expanding globalization, and that was great for commercial travel, whether it was airlines or business jets. but defense budgets tanked, so it's not great for military. And then

Jim 57:28

Excellent.

Mike Stengel 57:29

you had, uh, military booming'cause of, you know, expanding, wars in Afghanistan and Iraq and... But the airlines were doing terribly,

Jim 57:37

Anything else you'd

Mike Stengel 57:37

aviation took a nosedive

Jim 57:39

like to Thank you, Mike. Thanks for joining.