Above and Beyond - Rolls Royce Holdings

Rolls Royce is a vitally important British manufacturer. Expertise at producing reactors for the British military could put it at the forefront of a nuclear renaissance.

Rolls Royce Holdings is a British-based civil aerospace, power systems, and defense company. It is arguably Britain's most significant strategic manufacturer, producing nuclear reactors for Royal Navy submarines and engines powering Western air forces. One of the world's most important jet engine manufacturers, it builds large engines for widebody aircraft. Rolls Royce has struggled to maintain this position in the context of the broader deindustrialization of Britain's economy and cuts to military budgets worldwide. It is now far smaller than its competitors in revenue and size, not producing engines in crucial aerospace markets. 

However, Rolls Royce has a new CEO, Tufan Erginbilgic, who has seen the stock price triple in under a year. Erginbilgic seems determined to cut costs and grow the company, with a distant eye on returning Rolls Royce to manufacturing jet engines for the lucrative narrowbody aircraft market. Although dependent on partners for orders of civil aerospace engines and parts, Erginbilgic also hopes to grow its business by abandoning its traditional aerospace business model of relying on maintenance contracts. Due to its naval nuclear reactor experience, Rolls Royce is one of the best-placed companies to successfully build small modular reactors and help the West embrace a nuclear renaissance. Erginbilgic’s success in cutting non-essential projects means under his leadership, he will not hesitate to cut even this promising project if the British government continues to drag its feet on choosing a partner for its SMR project. Rolls Royce's leadership change and an expected new Government offer that government a rare opportunity to elevate a latent strategic partner into a world-defining asset.  

Civil Aerospace

Rolls Royce is currently the world’s largest civilian large jet engine manufacturer, with a 54% market share in 2022. Over 30% of the group's total revenue came from the large engine component of its civil aerospace business. The ability to manufacture safe, reliable, and increasingly energy-efficient engines makes Rolls Royce a vital part of the world economy. Its large engine offering includes the Trent 7000, XWB, and 1000 engines, which equip the widebody Airbus 330, A350, and Boeing 787 planes, respectively. Rolls Royce has a close relationship with Airbus and is currently due to deliver 1287 engines to the European aircraft manufacturer. Airbus, along with Boeing, forms a duopoly in civilian aircraft manufacturing. Together, they comprise 90% of aircraft orders. For decades, Airbus was the smaller company in the duopoly. However, after the Boeing 737 Max was grounded worldwide after two crashes in 2019 that killed over 340 people, Airbus overtook Boeing in revenue. Most airlines still tend to mix their orders between the two companies. Since the pandemic, massive orders from Air India and Turkish Airlines have favored Airbus, and Rolls Royce is set to benefit from these orders.

Even before the Russian invasion of Ukraine, major Russian civilian aircraft manufacturer United Aircraft Corporation struggled to sell its domestically produced aircraft abroad (and was heavily reliant on Western engines and parts). It will likely have to spend years reestablishing its supply chains after being cut off from Western parts. A joint Russian/Chinese effort to develop a narrowbody aircraft (the Comac C919) was delayed for years and is only expected to sell aircraft within China and Russia, and like UAC’s effort, was heavily reliant on Western parts, with more than 40% of its components being Western origin. There are currently no alternatives to the widebody aircraft that Airbus and Boeing produce, and the only major competitor that Rolls Royce faces in large engine manufacturing is General Electric (GE), an American aerospace company. GE produce the General Electric GEnx, a turbofan engine that is the competitor for Rolls Royce’s Trent 1000 on the Boeing 787. Around 70% of all the engines produced for the 787 have been produced by GE.

A Trent XWB Engine on an Airbus A350

This large engine success masks a current major weakness of Rolls Royce - failure to compete in engines for the narrowbody aircraft market, such as the Airbus A320 and Boeing 737 planes, which conduct short haul/intercontinental flights and are the workhorses of most airlines. It left narrowbody engines in 2011 after deciding to focus on widebody aircraft engine production. The narrowbody engine market is split between CFM International (a GE/Safran collaboration) and Pratt and Whitney. Although large engines cost more, Rolls Royce’s share of all engines sold is only 18%.  

Rolls Royce executives at the time were reluctant to commit to new engines for large numbers of retrofits rather than new aircraft. Older airframes have less time to make money back for engine manufacturers. Rolls Royce executives also believed that demand for widebody aircraft would be higher than it turned out to be. This prediction proved poor due to improved range from narrowbody aircraft and delays to widebody aircraft - caused in part by problems with engines. This meant airlines did not want to invest in the much more expensive widebody aircraft. This decision has cost Rolls Royce billions in revenue over the years, and its leadership believes it has missed the opportunity to reenter the narrowbody engine market until at least the late 2020s. As Erginbilgic looks for future growth potential, correcting this past misstep will surely be among his options. 

Along with prior costly decisions, Erginbilgic has also had to deal with the legacy of some poorly performing engines. Rolls Royce suffered financially and reputationally from delays to Trent 1000 engines certification for the Boeing 787, as the contracts for the engines put most of the risk of engine malfunctions on Rolls Royce themselves, rather than sharing it with the aircraft manufacturer and/or final purchasers. The troubled development of the Trent 1000 engine cost the company over $2.4 billion. 

A long-term problem for Rolls Royce has been their business model for selling engines. Previously, they made a loss per engine sold but made money back over time by relying on maintenance (shop visits) and upgrades. By doing so, they locked in revenue generation and buttressed themselves against new entrants who cannot credibly guarantee to be around servicing engines in a decade or so’s time. However, this reliance on maintenance contracts and repairs for revenue became a problem for Rolls Royce as their engines became more reliable, requiring fewer spare parts and less maintenance. As a part of his new strategy, he has raised engine prices to offset the declines in revenue from maintenance contracts. This has not been without consequences. Erginbilgic was embroiled in a public fallout with Emirate Airlines over cost increases for XWB-97 engines which were due to power an order of A380-1000 jets. Emirates refused to order the jets from Airbus without engine reliability improvements for desert conditions. 

Despite this, investors seem to believe he can significantly strengthen the company. Listed on the London Stock Exchange, Rolls Royce’s share price has risen over 200% in 2023. Cynically, one could argue that this is merely a rebound from the pandemic lows across the aerospace industry, but this cynical view does not reflect the changes he has made to the business or that the current share price is a 30-year high. Although some cost-cutting began under his predecessor, Erginbilgic accelerated this. He closed a direct carbon capture project that was started in 2021. He has shut Rolls Royce’s in-house AI start-up, even as funding for AI businesses worldwide has boomed. 

Defense 

One part of the company that is unlikely to be spun out or shut down as Erginbilgic reorganizes the company is the defense component. Its revenue was £3.6 billion ($4.58 billion), and in 2022, it was the most profitable part of the whole company. If Rolls Royce were just a defense company it would be the 22nd largest in the world. Although the current largest contributor to the defense component of the business is its production of aircraft engines for jets, helicopters, and turboprop aircraft, its production of naval nuclear reactors makes the company vital to British interests. 

The Royal Navy currently operates ten nuclear submarines - six attack submarines armed with torpedos and land attack missiles responsible for sinking enemy ships and striking coastal targets in a war¹. The Royal Navy also operates four Vanguard-class ballistic missile submarines carrying Britain's continuous at-sea nuclear deterrent. Rolls Royce builds the reactors that power both classes of submarines and has built the reactors for every British nuclear submarine. The maximum thermal power output of the PWR2 reactors Rolls Royce builds is estimated at 148MWt. It is a highly technical and specialized capability, with higher engineering standards on military vessels required to demonstrate the ability to survive battle damage, operate in a harsh environment, and regularly change power output, which civilian reactors do not have to do. Despite significant delays and cost overruns with the Astute class submarines, it does not appear these have been caused by Rolls Royce. Such a long history of precision engineering is an accomplishment. 

Producing the components utilized in naval reactors takes up to 4-8 years, involving precision machining, welding, grinding, heat treatment, and nondestructive testing of sizable specialized metal forgings. The knowledge required to create steel for nuclear reactors and the sensitive nature of production led to the nationalization of Sheffield Forgemasters, a supplier to Rolls Royce, in 2021. Although Rolls Royce is in a far healthier financial position than some of its suppliers, if Rolls Royce ends up in financial distress, its nuclear reactor business is so critical to the strategic deterrent that this part of the business would be nationalized or sold off to another British firm. 

There are only three Western private companies that can build nuclear naval reactors. In the US, despite a far larger nuclear submarine program and the US Navy’s supercarriers also being powered by nuclear propulsion, only BXW and Bechtel have contracts with the US Navy. The French company which produces reactors for the Marine Nationale’s Triomphant and Barracuda-class submarines is state-owned. Rolls Royce's position as one of the very few Western manufacturers of naval nuclear reactors led to it being awarded the contract for the Australian nuclear submarines being developed as a part of the AUKUS agreements. 

While Rolls Royce is nowhere near the primary manufacturer of F135 engines for the F35 fighter jet (Pratt & Whitney, the American aerospace company, build the majority), it is responsible for the LiftSystsem, which enables vertical take-off and landing (VTOL) on the F35B variant - although operationally the aircraft tend to use runways and not exclusively take off and land vertically to save on engine wear and fuel. The F35 program is the largest military procurement program in history, and around 10% of all F35 orders are currently F35Bs. Rolls Royce previously manufactured the Harrier SVTOL aircraft, which enabled British victory in the Falklands War and found popularity in the US Marine Corps due to its ability to take off from smaller decks at sea. Britain, the USMC, Japan, and Italy, all of whom operate smaller carriers than the US Navy’s supercarriers wanted a VTOL variant of the F35, and Rolls Royce's experience with successfully manufacturing the Pegasus engine for Harrier landed them the contract for the LiftSystem. 

Rolls Royce manufactures the EJ200 engine for the Eurofighter, which has current orders for the Qatari military. They maintain the RB199 for the Tornado multi-role combat aircraft operated by German, Italian, and Saudi air forces. The company has a contract to produce F130 engines to power B52 bombers as a part of the modernization program, which will power them until 2060. Away from jet engines, they build AE 1107C engines for the US military's Osprey aircraft,  CTS800 engines for the Royal Navy’s Wildcat helicopters, and AE 2100D3 turboprop engines for aircraft including the C-130J Hercules. The company has also produced drone engines, notably the Global Hawk and Triton ISR aircraft. These various programs demonstrate the significance of Rolls Royce to Western military power as a whole.

The company is likely to play a part in producing engines for the Tempest sixth-generation fighter jet project, a joint collaboration between the British, Japanese, and Italian governments, as there are no Italian or Japanese companies with the ability to manufacture jet engines. Tempest is partly an attempt to keep non-American fighter jet production viable in Western countries. If the project is successful, Rolls Royce could see future orders with Western-aligned countries, who will also struggle to afford large numbers of American-made aircraft. 

Bing imagines what the Tempest jet may look like.

Who is going to build the Nuclear Renaissance?

The production of advanced jet engines and propulsion systems for nuclear submarines certainly makes Rolls Royce an interesting company. However, a proposed system of small modular nuclear reactors (SMRs) for the civilian market could make it far more influential.

Current nuclear power plants have extremely high up-front capital costs. Over-regulation and over-engineering contribute to these high costs, but another important aspect is that most Western nuclear reactors are bespoke projects. Different regulatory considerations, builders, and reactor designs mean new lessons have to be learned repeatedly, rather than perfecting a standardized process for building plants which would lower costs in the long term. Making the problem worse is that in many countries that struggle to find investment for nuclear power plants, wind, and solar energy are massively subsidized, making any prospective investment in a nuclear power plant even less attractive.

However, due to increased concerns about energy security, the unreliability of intermittent renewables, and a continued desire to reduce emissions from fossil fuel production, small modular reactors - which can be produced in factories and then assembled at a lower cost on a smaller site - have attracted a great deal of interest from states around the world. Although Rolls Royce’s proposed 470MW reactors are far larger than their reactors for the Royal Navy, the company has decades of experience in constructing small reactors, making it a promising partner for the British government's desire to add a fleet of SMRs to the national grid. 

At the moment, there is little urgency on the part of the British government to see these SMRs connected to the National Grid or to support a British company in exporting them. The SMR process is expected to find a winner to partner with Great British Nuclear (GBN) “by 2030” with an ambition to have SMRs connected to the grid in the mid-2030s. GBN claims this is the fastest kind of competition in the world, giving the impression Britain is leading the world in SMR deployment. This is laughable. The competition for SMRs has been running since 2015 - back then, the ambition was to have SMRs operational by the mid-2020s.

More concretely, in Texas X-Energy is due to start building a 320MW SMR facility for the chemical giant Dow in 2026. By this time, GBN will still be three years away from making a final investment decision, due in 2029. Although it is very unlikely that Chinese SMRs will be built in Western countries for now, in South China's Hainan province the Linglong One project will come online in 2026. It is plausible that by the time any GBN SMR project is running, the Linglong will have been running for over 10 years. China’s National Nuclear Corporation may be finding export partners in Pakistan even before a decision is made by GBN as to which British company will build the UK’s SMRs. GBN is not the only stick in the dam. HM Treasury (the British finance ministry) has refused to commit to funding any SMRs, regardless of who wins the bid. 

This slovenly approach to approving SMRs is a massive wasted opportunity. Although prospects of exporting SMRs to France or Germany might be thin due to French domestic nuclear power and German fondness for coal-fired energy, outside Europe countries are desperate for new power sources. Furthermore, Rolls Royce is one of a few British manufacturers with a history of delivering complex projects to US companies. In states such as Texas and California, which are seeing increasing grid instability due to an influx of intermittent renewables, the company could use its SMRs to deliver reliable energy to individual US companies. Being the supplier of private nuclear power plants to the world’s most important companies is an aspiration any British government should want for a British company.

More speculatively, given the high costs of intermittent renewable energy it is not impossible that some countries will decide to reverse commitments to renewable energy and instead opt for a long-term nuclear strategy to lower their renewable emissions (as Ontario has done). In this world, a track record of a successful SMR buildout would be the most successful Western nuclear project of the 21st Century and would make Rolls Royce a natural partner to build larger reactors at scale. This may not be in the plans of the current Rolls Royce leadership but it does not require a large leap of imagination. 

To capture the economic benefits of a successful fleet build-out and start exporting to other countries, the British government's SMR rollout time scale needs to accelerate. With 70 designs from companies in 18 countries planning their own SMR builds, GBN's slow-paced competition seriously risks the benefits of adding more low-carbon, reliable nuclear energy to the grid. It also risks losing out entirely on the influence and profits a nuclear industry export capacity would bring.  

A future Rolls Royce large nuclear reactor factory, churning out hundreds of gigawatts of capacity a year.

Conclusion 

Tufan Erginbilgic and his team are focused on making Rolls Royce a growing and competitive company. Although Rolls Royce is unlikely to ever abandon its contacts for reactors for the Royal Navy in order to invest more in the largest part of the business and recapture market share in narrowbody aircraft engine production, any future British Government should not blithely assume that RR will stick around until 2029 for a project that will not start seeing returns until the 2030s. Erginbilgic has confirmed that Rolls Royce will run out of money for SMR development in 2024. In 2024, Britain will face an election. The winners of that election have the opportunity to speed up, or abandon entirely, a treacle-like competition to contribute to critical national infrastructure and build a new export industry. This is the very least they should do. A Government serious about seizing opportunities should commit financial support to whoever is chosen, and the usual absurd planning and regulatory mountains should be abandoned. Rolls Royce is perhaps Britain's most strategic asset - maybe the government should start treating it like one while it has the opportunity. 

1. 5 Astute class and 1 Trafalgar class - 2 more Astute class submarines are under construction, and HMS Triumph is due to be retired in 2024 when HMS Agamemnon commissions.