Aerospace manufacturing adapts to California’s GHG rule

The aerospace sector is navigating the shift toward carbon neutrality and an increasingly stringent regulatory environment against a backdrop of concerns surrounding recent aircraft safety failures during flights.

Aerospace manufacturers have faced escalating costs arising from labor shortages, IT investments and the need for higher-quality materials. Now, they have the added burden of adapting to regulations such as new California greenhouse gas emission rules and the Securities and Exchange Commission’s new climate-related disclosure requirements. This confluence of factors is exerting unprecedented pressure on the sector, setting the stage for a period of intense transformation.

Over the past two decades, aircraft safety failures have led to significant changes in Federal Aviation Administration (FAA) safety regulations. These changes have included additional training requirements, and updated processes and technologies to meet the administrative burden of these new standards, further increasing the costs to original equipment manufacturers (OEMs). Now, the FAA is “finalizing new rules requiring charter, commuter, air tour operators, and aircraft manufacturers to implement a key safety tool aimed at reducing accidents,” Reuters reported. “U.S. airlines have been required to have SMS [safety management systems] since 2018 and some aerospace companies already voluntarily have SMS programs.”

The current landscape

Aerospace OEMs have started to recover from the hit they took earlier in the pandemic, with air travel trends returning to pre-pandemic levels over the last year. In 2023, the aerospace and defense industry saw a resurgence in product demand, with Q4 air travel nearing 98.2% of 2019 levels, according to the International Air Transport Association. IATA projects that the number of air travelers will reach 4.7 billion in 2024, marking growth of approximately 9% over 2023 and nearly double the long-term projections from the prior year.

This anticipated demand is welcome news but comes as companies are also adapting to two major California climate-related disclosure laws affecting both private and public companies. The first (California Senate Bill 253) requires certain companies with annual revenues of $1 billion or more to report their Scope 1, Scope 2 and value-chain greenhouse gas emissions beginning in 2027. This will affect over 5,000 companies. The second (California Senate Bill 261) requires certain companies with annual revenues of $500 million or more to prepare a climate-related financial risk report on or before Jan. 1, 2026, and will affect over 10,000 companies. 

Because of the amount of aerospace manufacturing activity in California, we expect these rules will have a significant impact on the industry. In addition, regulations in California are often harbingers of rules other states may later enact. Nearly 70,000 NASA jobs—30% of the agency’s workforce—are in California, according to the American Institute of Aeronautics and Astronautics. Those jobs contribute approximately $16.6 billion in economic output annually and the state of California accounts for 27% of NASA’s total procurement spending. California also has approximately $10.5 billion in annual aerospace and defense exports.

Companies are also adapting to the SEC’s new rules requiring publicly traded firms to disclose climate-related risks to their business, effective for annual reports for the year ending Dec. 31, 2025.

For the government and defense sector, which lags other industries when it comes to environmental and sustainability matters, this will present an incredible uplift. (Refer to our piece on Federal Acquisition Regulation Part 23 here.)

It remains to be seen how these new regulations, combined with the expected demand spike, will affect spending decisions, but companies will need to be intentional about assessing their core business operations, prioritize innovation and use technology to remain competitive while also ensuring safety and quality. Any aerospace OEMs that haven’t already felt pressure almost certainly will soon, and companies need to prepare for how it will affect lead times, production schedules, and investor and customer confidence.

The M&A outlook

Aerospace OEMs are facing a potential capital crunch that could hinder the industry’s efforts toward achieving carbon neutrality and strain the financial resources required for innovation, quality control and cost management. The introduction of new regulatory standards and recent safety incidents underscore the necessity for more effective deal-making, altering the capital financing landscape in the aerospace OEM sector. 

Access to credit might help; only about 20% of senior executives from middle market businesses reported an ease in credit access even with expected interest rate cuts by the Federal Reserve, according to the Q1 2024 RSM US Middle Market Business Index report. Still, future deal activities will need to intensify to counteract the impact of recent safety concerns. In value terms, mergers and acquisitions activity decreased by 52% in Q4 2023 compared with the previous quarter’s total of $8.2 billion and fell by 36% as compared to Q4 2022, according to GlobalData. 

We anticipate increased M&A activity as a swift strategy to enhance quality and market performance ratings. The United States is currently the leading exporter of aerospace parts. However, a production slowdown for some aircraft through production adjustments, furloughs and financial stress is expected to strain suppliers, potentially affecting the ability to meet payment obligations. Canceled orders resulting from recent scrutiny have a widespread impact on the sector, and particularly on OEMs that rely on the larger players.

We expect to see significant costs related to production slowdown and inventory management as OEMs figure out how to pivot to alternative revenue streams. Across the broader economy, some businesses have shifted focus to their core operations and shed underperforming assets, which could put pressure on larger companies’ aerospace divisions because of recent challenges in the sector.

In this environment, aerospace OEMs should harness data analytics to gain an all-encompassing perspective on present and anticipated supply chain requirements, promoting greater cooperation and openness. Data analytics can help to identify and track relevant information needed for new greenhouse gas emissions and climate-related disclosures. Companies can also perform simulation modeling to quantify and compare various strategic imperatives, balancing the various operational objectives with required outcomes data needed. This strategy facilitates efficient problem-solving and decision-making across different functions.

Focusing on digital transformation along with business model transformation (i.e., processes, people and functions that IT systems will support) will allow companies to redirect investments toward cutting-edge technologies to control expenses. These investments are crucial for OEMs as they navigate the challenges of the modern aerospace industry, including supply chain issues, price increases and hiring challenges. Digital transformation not only helps OEMs become more efficient and competitive but also opens up new opportunities for innovation and growth. 

The takeaway

Amid disruption in the aerospace sector, executives will need to reevaluate companies’ spending decisions and figure out how to balance innovation with new regulatory requirements. More effective deal-making strategies and the use of data analytics can be pivotal solutions.