Following is the response from the management of SriLankan Airlines to the opinion article titled “Cancellation of the four Airbus A350-900 leases and the downfall of SriLankan Airlines” written by Sanjana Fernando.
In June 2015, the Cabinet of Ministers approved the restructuring proposal of SriLankan Airlines, which included the decision to not accept or operate the A350-900 aircraft as one of the initiatives to restore the airline’s viability.
This decision to terminate the leases was driven by a detailed analysis which demonstrated that the A350 could not be operated profitably by the airline under numerous scenarios. The market conditions on the routes for which the A350 was a candidate, had changed drastically from the time of the lease commitment – with a sharp drop in fare levels and increased competition. This was particularly noticeable on routes to Europe, which historically had a relatively lower yield per kilometre. This drop in fare levels, along with an anticipated lower passenger load factor owing to the higher seat capacity of the A350 relative to the aircraft it will replace, meant that the operation of the A350 would have resulted in a further decline of SriLankan’s Unit Revenue. However, this decline in Unit Revenue would not have been offset by a lower Unit Cost owing to several reasons.
The cost of obtaining an aircraft on operating lease is not limited to its Base Rent – but also includes other components such as the Maintenance Reserves, which are periodic payments made towards heavy maintenance of the aircraft. The Maintenance Reserves of the new technology A350 aircraft, along with its Base Rent, would have resulted in a monthly cash pay-out of close to $ 2 million per aircraft per month.
In addition, the introduction of a new aircraft type, powered by a new engine model, would have necessitated the procurement of at least one spare engine and its associated components – resulting in a major setup cost to be borne by the airline. Accordingly, the cash pay-out for aircraft rent, maintenance reserves and the engine costs alone, would have exceeded over $ 100 million in the first full year of operating four A350 aircraft.
Over and above these costs, each aircraft type requires pilots, cabin crew and maintenance employees who are trained to operate on that specific aircraft type. The introduction of the A350 would have required the training and establishment of a completely new crew and maintenance staff category to operate these aircraft, thereby creating additional operational complexities and costs. It would also have led to inefficiencies in crew utilisation as there would be three types of aircraft in the fleet.
The A350 is a long-haul aircraft capable of operating flights of up to 17 hours in duration. The discontinuation of several of SriLankan’s long-haul routes to European destinations – owing to fare levels declining to non-viable levels – meant that the airline would have been forced to operate these long-haul aircraft in a sub-optimal network, which would have limited the efficiency gains.
The airline’s proposal to terminate the leases carefully considered all of these factors as well a range of possible sensitivities – including different jet fuel prices – and demonstrated that the termination of the leases presented a better option for the company’s long term future. The key factors which influenced this, were the prevailing market conditions, as well as the high lease rentals, which offset the efficiency of a newer generation aircraft. This analysis was verified by two internationally-reputed industry consultants who subscribed to the same views. Most notably the reports state that “at no historic fuel price would the ownership cost of the A350s offset the possible fuel savings”.
Had the airline opted to take delivery of these aircraft, not only would the financial performance have been under-stress for the lease duration of 12 years, but also the airline’s prospects of attracting a potential PPP partner could have been at risk. A one-off cancellation cost was the most pragmatic of the possible scenarios, painful though it would be in the short-term.
Industry sources indicate that the three completed A350 aircraft for which SriLankan terminated the agreements are still in storage and have not been delivered to a new operator. The owner has had to bear the storage, maintenance and insurance costs, which are estimated to exceed $ 10 million a year, while not gaining any rental income for the aircraft.
Had SriLankan taken delivery of these aircraft, it would have already incurred cash costs of well over $ 100 million – exceeding the penalty payment made with a view to safeguard the airline’s long term interests. With over 15 months having passed since the termination of leases, this highlights the difficulty in placing these expensive aircraft with another operator and provides a glimpse as to why the airline had to pay a large penalty payment to terminate the leases.