Page last updated at 06:48 GMT, Monday, 14 July 2008 07:48 UK

Fuel concerns to dominate Farnborough airshow

By Jorn Madslien
Business reporter, BBC News, Farnborough

Boeing chalet
Many deals are sealed at the Farnborough airshow
Sixty years after the first Farnborough airshow, some 140,000 members of the defence and aerospace profession are braving the traffic that is clogging up the lanes around this small Hampshire town to return to what has become arguably the world's largest show of its kind.

With 35 countries represented, Farnborough International, with its associated cocktail parties and VIP dinners, has also emerged as one of the industry's most important networking events.

Two years ago, when the show was last held here at Farnborough - it alternates with Paris - orders totalling some $42bn were announced, and billions of dollars worth of deals will be announced this year too - even though the industry is suffering its worst downturn since the 9/11 attacks in New York in 2001.

But more importantly the ground is being laid for the deals of the future.

Sales people and hardware engineers mingle with purchasing managers and procurement officers, amid the 1,500 exhibits that fill up the large halls.

Analysts and journalist quiz executives over drinks in air-conditioned chalets and lavish pavilions.

While outside, on the airfield, menacing fighter jets and heavily armed helicopters are lined up alongside large Airbus and Boeing passenger planes and a scattering of smaller executive jets in a united display of might, fire-power and market forces.

Fuel, fuel, fuel

But this united front - this confident, imposing display of hardware - belies a growing threat that is striking fear into an industry well versed in the art of batting back challenging strikes, be they tight defence budgets, corruption scandals or global trade wars.

The way it goes is there will be higher fares and then lower traffic. The immediate effect of this is lower orders
Nick Cunningham, Evolution Securities

The aerospace and defence sector has been caught on the back foot by the surge in global oil prices - from less than $100 at the start of this year to more than $140 a barrel at its peak, and still climbing according to most forecasters.

Hence, this year the airshow will be dominated by three issues, according to Accenture's aerospace and defence partner Michael Hackerson: "It's going to be fuel, fuel and fuel."

With aviation fuel prices rocketing, everyone - from airlines and air forces to manufacturers and their suppliers - is forced to respond fast.

"We've only seen the start of that so far with the fuel surcharges that have gone on," says Evolution Securities' commercial aviation analyst Nick Cunningham.

"The way it goes is there will be higher fares and then lower traffic. The immediate effect of this is lower orders."

On show at Farnborough 2008

Airlines are ditching unprofitable routes as their executives begin to ask what they must keep on doing and what they can afford to shed. Aircraft are parked while old planes are retired more quickly than in the past. At least two dozen airlines have collapsed so far this year as the industry has clocked up $2.3bn in losses.

So the stream of new orders has slowed dramatically. Last year in Paris, some 600 aircraft were sold. This year some analysts say they expect less than half the number of sales to be announced, in spite of large orders expected from the Middle Eastern airlines Qatar and Etihad.

"In terms of orders, Farnborough is likely to be much more low-key," says Morgan Stanley analyst Rupinder Vig.

Agrees Mr Cunningham: "Everybody's too nervous to order airplanes, and also rather concerned that they ordered too many last year and the year before."

Others are eager to stress that it could be worse.

"There is a vague feeling that we are going straight off the edge of a waterfall, but I don't think it is that bad," observes Teal Group aerospace consultant Richard Aboulafia.

Fuel accelerator

Air chief marshals and their procurement officers, meanwhile, feel the soaring and unpredictable fuel costs could hint at potential fuel scarcity.

They see this as a strategic threat, as well as a financial risk that adds volatility and uncertainty at a time when defence purse strings are being tightened.

The process has brought added momentum to the search for composite material that helps reduce the weight of aircraft, for more efficient and thus less polluting engines, and for alternative energy sources.

"The only way out is to ensure aircraft are more fuel efficient," insists BGC Partners strategist Howard Wheeldon.

Certain future

What matters to end users - the airlines and the air forces - is the total cost of ownership, and this has been rising year by year in an unpredictable manner.

Farnborough airshow
Firms are also grappling with tighter defence budgets

So they are finding themselves in a tricky situation, not least when seen in the context of rising fuel costs and tighter defence and airline budgets.

In short; the military chiefs and airline executives no longer want to buy aircraft, which they then have to service and repair themselves. They want to pay for package deals, similar to leasing agreements, only much more complex.

"It's a fundamental change for the industry," says Mr Hackerson. "This goes through the entire supply chain."

Essentially, it changes the economics of the industry; in the past, manufacturers and parts suppliers would benefit when an engine needed servicing, repairing or replacing - as the customer would pay the garage bill, so to speak.

In the future, the customer pays a fixed fee per month or year, expecting their aircraft to work efficiently in return. The risk of ownership is being transferred away from them, back to the people who made the aircraft in the first place.

For the plane makers, breakages that used to make them money will now instead cost them, so they will be looking for ways to make aircraft work in more efficient ways. Parts will be monitored more closely. They will be serviced to extend their working lives. They will be replaced before they break.

New deals

On the ground at Farnborough, the deal makers are responding. Major manufacturers are sniffing around for partners prepared to share the risk of building new aircraft, whether parts suppliers or firms pitching for outsourcing contracts.

Farnborough airshow
Aerospace firms expect fewer aircraft orders this year

And the nature of the deals is rapidly changing, with sales people increasingly selling services rather than hardware.

"The whole trend is accelerated by fuel prices," says Mr Hackerson.

Yet at the show, expect the machines to remain in the limelight.

The Lockheed Martin F-22 fighter jet will wow the audience for the first time, and giants such as the Airbus A380 and the Eurofighter Typhoon will return to remind the industry that however tough the situation might seem for them right now, the remaining desire for personal travel and national defence will undoubtedly keep the orders ticking in for years to come.

"We see a bigger demand for replacing older, less efficient aircraft," says Boeing marketing executive Randy Tinseth, while rival Airbus is being asked to speed up production to replace old aircraft that consume too much kerosene, according to director-general Fabrice Bregier.

So over time, the soaring energy prices may even play to the manufacturers' advantage.

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