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:: March 2016 Letter ::

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Dear Fellow Global Conflict Observers,

Spend time on tall buildings in Tel Aviv, as I did recently, and you often hear the word “operation.” People say, “Looks like an operation” or “Some kind of operation” or “Must be an operation going on.” Jet fighter exhausts glow in the dusk sky, helicopters fly in formation, a King Air or two do figure eights. These air strikes, troop movements, and recon flights are readily observable almost every day, right near a large beach city.

You notice this in Israel because the country is tiny, and surrounded by enemies. But these scenes are playing out in much of the world, from Yemen to Afghanistan to Africa to almost anywhere in the eastern Mediterranean. The world seems to have become one big air power operation. Few people have the stomach for boots on the ground right now, but the US, and now even European countries and Russia, have made air power the default response against any thug-o-crat or Islamic wannabe motorcycle gang. Few US or European citizens notice or care about this; unlike residents of Tel Aviv, they typically live thousands of miles from staging areas or strike zones. But this trend is having a strong impact on aircraft markets.

In the US, we haven’t seen a military market environment this great in years. DoD’s Procurement budget is safely stuck above $110 billion after a few years where it threatened to go as low as the 80s. Neither of the two presidential front runners will change that. Nobody is concerned with Sequestration anymore; it’s like a bad dream we once had. According to the latest SIPRI numbers, last year saw $1.68 trillion in international military spending. That 1% rise from 2014 was the best in five years.

Combat aircraft have done particularly well. FY 2016 saw $2 billion added by Congress for additional Super Hornets and F-35s in Overseas Contingency Operation (OCO) funding. This year will likely see something near that, for the same planes. And recently, House lawmakers have called for a study of F-22 line restart costs, and an assessment of possible larger B-21 buys, up to 200 bombers.

Outside the US, export markets are strong, too. Our latest fighter forecast calls for output to rise from $18.2 billion last year to $27 billion each year after 2020. We’re forecasting 3,149 deliveries worth $246.8 billion in 2016-2025. For comparison, a total of 2,616 fighters worth $181.5 billion (also in 2015 dollars) were built between 2006 and 2015.

This strong market is changing the outlook for OEMs. In the last decade, it looked like F-35 would be the last man standing by now. But today, everyone is still doing well, with the exception of the F-16. The prospect of a Qatar F-15 buy and a Kuwait F/A-18E/F buy, coupled with that Navy OCO cash, promises to extend Boeing’s St. Louis fighter work into the 2020s. Kuwait’s Eurofighter buy is also rescuing Eurofighter, extending that program into the 2020s too. Compared with their rather thin past, the Gripen and Rafale programs are also enjoying export success. There’s even the prospect of new players entering this large market – South Korea and Turkey look interested.

One big driver of this market is dual sourcing. The people behind many of these “operations” are mindful of the risks of being cut off from spares and support, and of the need to cultivate strategic relationships through arms deals. Egypt last year decided to source from France, after decades of US exclusivity. Kuwait and Qatar are also going from single to dual source buys. They’re joining the UAE and Saudi Arabia, which continue on dual source tracks. The US’s unwillingness to sell F-35s in the Mideast market outside Israel helps the other players too, as does the F-35’s stubbornly high price tag.

Beyond crewed aircraft, the market for UCAVs looks very strong. Teal is now forecasting $21 billion in deliveries over the next ten years, up from almost nothing over the last 10 (we count MQ-9 Reapers in our ISR bucket). Last year saw drone strikes outnumber strikes by crewed aircraft for the first time in Afghanistan (or any other conflict in history), with 56% of bombs and missiles fired by UAVs. In early April, just after the date at the top of this note, the Air Force redesignated its MQ-1 Predator reconnaissance units as “attack” squadrons.

Then there’s the ISR market, because there’s no point in shooting if you can’t spot and track. This is harder to quantify than fighters and UAVs, since it’s much more fragmented. I recently attended a CSIS lecture by General Joe Dunford, Chairman of the Joint Chiefs of Staff. He commented that the US military had seen a 1200% increase in ISR capabilities since 2001, and a 600% increase since 2008, and yet ISR was now meeting just 35% of demand. Global sales of ISR platforms are booming too.

Any strategic shift produces losers alongside winners. Focusing on air operations and turning away from boots on the ground is not good news for rotorcraft. Thanks to the Iraq and Afghanistan wars (and subsequent Surges), the military side of these grew by a remarkable 186.4% between 2003 and 2014. But now, US procurement funding is set to fall by 40% over the next five years. Teal’s forecast calls for the market to shrink by 25% over the next ten years.

As an aside, selling Sikorsky in the midst of this strategic shift away from ground deployments (and alongside the oil and gas downturn) might have been the best-timed move ever for UTC. Or, from Lockheed Martin’s perspective as the buyer, perhaps the worst.

How long will the good times last for the fixed-wing combat OEMs? The current trend towards air operations has a lot of traction, and we aren’t seeing much risk. If Hillary Clinton is elected president, she might even accelerate it – she and her people have a track record of being more pro-intervention than Obama. And of course Donald Trump and Ted Cruz have expressed a fondness for carpet bombing.

T.E. Lawrence once famously said that “war upon rebellion was messy and slow, like eating soup with a knife.” That’s true, and using air power for anti-insurgent operations has a poor track record. But for the world knife industry, business is excellent.

This month’s Teal aircraft binder reports include the F-35 and F-15, A320, A380, A400M, 767/KC-46, the G150/280, and the H365/H155/H160/H175 series. Have a great month.

Yours, ‘Til Someone Invents A Precision Nail-Seeking Hammer,
Richard Aboulafia
 

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