March 2022 Letter

Dear Fellow Human Nightmare Observers,

Farnborough, 1990. I’m a twentysomething aviation analyst at his first air show. The USSR is crumbling, and, having spent grad school evaluating ways of destroying their military, I find myself in the back of their awe-inspiring An-225, a six-engine cargo jet and the world’s biggest aircraft. What a time to be alive, I think. These people are amazing creators; if they join the world rather than living in a closed economic and political system, aerospace, and the world, will be twice as great! The An-225’s Russian name was Mriya, or Dream.

A few days ago the Russian air force destroyed the only An-225. Thanks for the metaphor, Putin.

My February letter looked at the impact of Putin’s atrocious Ukraine invasion on commercial aviation markets. This letter is the sequel, dealing with everything else. You can find my commentary on defense spending here.

First, supply chain concerns. Russia has spent the past 32 years adding very little value to anything, and they have no presence in global aerospace manufacturing, except titanium (both with raw material and with castings and forgings). AeroDynamic Advisory founder/Managing Director Kevin Michaels has been warning about the world aerospace industry’s vulnerability here for years, and his concerns have proven well-founded. He says, “VSMPO-Avisma supplies over half the titanium used in jetliners, and 35-40% for the broader civil/military aerospace sector. It also provides landing gear forgings for the 787 and 777X through a JV with Boeing, and is a big supplier to engine/system OEM Safran.”

Kevin also rightly points out that castings and forgings are already vulnerable as a production bottleneck, and that capacity expansion in this industry isn’t easy, with massive investments needed and skilled workforce required. And while Boeing has suspended Russian Ti purchases, so far, Russian titanium, in all its forms, is available to Western manufacturers. Putin and company are pondering an export embargo on some raw materials, but I’m not sure titanium will be blocked. For one, it’s hardly in Russia’s interest for the West to invest in alternative titanium sources, so why encourage that with sanctions?

There’s also the bigger economic picture. Again, the Russian economy consists primarily of raw materials, and even that’s under threat with oil sanctions. As Eurasia Group’s Ian Bremmer points out, “Russia’s GDP stands to contract by some 10% given present sanctions, and that’s before we think about any material retaliation from Russia.” I’d add that like all other Russian material exports, there’s probably an oligarch or two bleeding off cash from this titanium revenue stream, and the last thing Putin wants is to give the oligarchs another reason to despise him.

Finally, the big titanium consumers in commercial aero are twin aisle jetliners. That’s the only really depressed part of the aerospace industry right now. In fact, the single most titanium-rich jet, the 787 (15% Ti by weight), isn’t just insulated by existing titanium inventories; there are 100+ already-built jets, sitting around waiting for Boeing and the FAA to resolve certification issues. Also, as Cowen’s Cai Von Rumohr points out, existing inventories are particularly high since Boeing has been preparing for higher 737MAX rates for years, and output has been a small fraction of expectations.

Second, Space. Since I know little about this, I asked AeroDynamic Senior Analyst Martha Neubauer for her views. She says: “The invasion increases a trend already present in the space industry – sovereignty. While it’s unlikely collaboration will end on the ISS, Russia’s invasion of Ukraine and the ensuing sanctions and retaliations have increased pressure on the US and Europe to become fully independent in space launch capabilities.

“Up until last year the US was dependent on Russian rockets to get astronauts to the ISS, and the EU relies partly on Russia to get navigation satellites into orbit. Russia has halted deliveries of RD-180 engines to the US, which power the Atlas V rocket to launch communications, reconnaissance, and missile warning satellites, but the Atlas V replacement, the Vulcan Centaur, uses US engines and is slated for first flight this summer. The US now has more satellite launch vehicle options thanks to SpaceX’s Falcon 9, so the loss of RD-180s is far from catastrophic, particularly since there’s an inventory of around 24 RD-180s at ULA. Still, the feared loss of navigation, communication, and reconnaissance will drive increased US space budgets and benefit US space launch companies for years.”

Third, Russian defense exports. This is about the only major value-add industry where Russia has done well – according to SIPRI, they’re the world’s second largest military exporter, after the US. Broadly speaking, their clients fall into two buckets: (1) pariah states and basket cases; and (2) non-aligned countries (or aligned countries seeking to assert non-alignment) looking for low up-front cost systems. The second bucket is far more important to Russia – it’s a bigger market and pays with something resembling money.

Most of Bucket 2 is India, along with occasional sales to Turkey, Egypt, Malaysia, etc. All of these countries are now in a difficult spot. In addition to reliability concerns as a result of embargoes and sanctions, there’s also the risk of Russian equipment customers being further sanctioned, as with US CAATSA rules. These customers are also watching a military using this equipment perform horribly (it’s largely logistical failures and demotivated troops that seem to be the problem, but it’s not exactly an advertisement for strategic cooperation with Russia). Also, there’s now a moral taint associated with buying Russian weapons. None of this augurs well for the future of Russia’s arms industry.

Speaking of geopolitical choices, let’s end on a slightly hopeful note. For the past few years, my biggest aviation market concern (and one of my biggest concerns overall) has been China de-coupling from the West. Russia today is a marvelous illustration of where decoupling leads. As Tom Friedman writes, the PRC needs to choose its future: isolated bully or global citizen. Yes, they can ally with Russia, but they’d need to bankroll them, and they’d be tying themselves to a fake superpower with miserable technology and a massively overrated military. In other words, this is the perfect moment for China, the world’s biggest aviation market, to make a course correction, and rejoin the rest of the world.

Yours, ‘Til The Mriya Is Physically and Metaphorically Resurrected,

Richard Aboulafia