In search of constant growth in the Gulf aviation industry

The Gulf’s big three airlines are expanding fast, but they are not having it all their own way, with several governments resisting requests for greater market access. Published in MEED, 10 June 2011

When Dubai-based Emirates airline unveiled its latest set of financial results on 10 May, they made for impressive reading. Revenues and profits had both risen sharply and the carrier boasted of filling 80 per cent of its seats – its highest ever passenger load figure, which came despite a 13 per cent increase in capacity.

Even as Dubai’s economy has floundered in recent years, its airline has consistently risen above the turmoil. Its two main rivals, Abu Dhabi-based Etihad Airways and Qatar Airways, may not make a profit, but their governments have been happy to bankroll similarly aggressive expansion.

However, the three main Gulf carriers are not having it all their own way. High fuel prices are pushing up their operating costs, several governments have been resisting their requests for greater market access and rival airlines having been merging to form more serious competition. Taken together, these factors mean the current period of growth may not last much longer.

Political barriers to growth in the Gulf aviation sector

The two countries where the airlines have met the most resistance to their growth plans are Germany and Canada. The governments have proven to be keen protectors of their national carriers, Lufthansa and Air Canada, particularly when it comes to lucrative long-haul routes.

In Germany, the government has resisted calls to amend the existing bilateral air transport agreement to allow UAE carriers greater access. Although there is no limit on the number of flights they can operate, they are currently restricted to serving just four cities.

The two sides have agreed to politely disagree for now, but in Canada the situation has been more acrimonious. Emirates and Etihad Airways currently only fly to Toronto, while Qatar Airways is due to launch a Montreal service in late June. The UAE airlines would like to expand into other gateway cities, such as Calgary and Winnipeg. However, the Ottawa government has refused them more landing slots beyond their current allocation of three. The UAE’s failed lobbying efforts have developed into a diplomatic spat.

At the start of the year, the UAE substantially increased visa fees for Canadians. In 2010, it declined to extend an agreement giving the Canadian military access to Camp Mirage in Dubai. Such pressure has so far failed to convince Ottawa to change its position and the re-election of the government with an increased majority in early May means the situation is unlikely to change soon. There are potentially wider ramifications of the UAE’s actions.

The way the UAE has dealt with the Canada issue could make other countries pause before considering new bilateral deals, says Carter Stewart, managing director of UK-based TWC Aviation Consulting. “Other countries where the UAE might want to do some expansion might take a slightly dim view,” he says. “All any country has to do is look at how the UAE has treated the Canadian situation and you start to see where the damage is done.”

Evidence of the growing disquiet among other parts of the airline industry were highlighted in January by Ulrich Schulte-Strathaus, secretary general of the Association of European Airlines. In a speech to the International Aviation Club of Washington, he suggested that more governments could be asked to restrict market access to the three main Gulf carriers. As a longer-term measure, he called for the International Civil Aviation Organisation to draw up new rules on “capacity dumping” and other issues.

Akbar al-Baker, chief executive officer of Qatar Airways, responded a month later, saying: “Where would protectionism end if his calls are heeded by the governments? Isn’t it the right of any consumer to get access to the best prices and the best value for money?”

Growth areas

For now, most governments appear to be taking a more accommodating approach to the Gulf airlines. That is just as well as, with hundreds of aircraft on order, they constantly need to find new routes to service.

Asia is likely to be a key area of activity. While India is already well served by all three airlines, only four Chinese cities are included in their route networks. Africa and the Americas are other markets with substantial room for growth, but the airlines’ ambitions now cover all corners of the world.

The latest generation of aircraft, including the Boeing 787 and the Airbus A350, make it easier to reach further-flung destinations, while the superjumbo Airbus A380 allows airlines to increase capacity on existing routes without the need for new take-off or landing slots.

“The parts of the world growing most strongly are the ones where the Gulf sits best to offer a one-stop product to, given you can’t go non-stop on some of these routes,” says John Strickland, director of the UK-based JLS Consulting, a specialist aviation consulting firm. “They’re in a good position to exploit Latin America, Africa, the Middle East and Asia as the most likely growth markets in a way the established European airlines can’t.”

Their reliance on long-haul routes means the Gulf airlines have been relatively insulated against the impact of the political turmoil in the region this year. However, some business has been lost, particularly in transporting workers from Asia to the likes of Tunisia, Libya or Bahrain.

“The political unrest in parts of the Middle East and North Africa region has undoubtedly affected Emirates, particularly from an operational perspective, with flights to Tripoli in Libya suspended indefinitely,” says Ahmed Khoory, senior vice-president for the Gulf, Middle East & Iran at the Dubai-based carrier. “However, by swiftly adjusting our flight schedules, redeploying aircraft to balance the network and optimise revenue we have been able to keep our other Middle East operations going. We continue to closely monitor the situation in other parts of the region and are prepared to act quickly if the situation changes.”

Aviation fuel costs

A further complication in the current market is the high cost of aviation fuel. While this affects every airline in the world, Middle East carriers are more exposed than most due to the efficiency of the rest of their operations. In Emirates’ case, for example, fuel accounted for 34 per cent of its operating costs in the most recent year to 31 March 2011, compared with just 12 per cent in 2002-03.

James Hogan, chief executive officer of Etihad Airways said in April, when announcing first quarter results that “fuel prices will be a major challenge for the airline industry this year”. He added the airline had hedged more than 75 per cent of its fuel requirements for 2011.

“In the Middle East, fuel is a bigger expense for airlines than in the West, as a percentage of the operating costs,” says Diogenis Papiomytis, principal aerospace consultant at the US’ Frost & Sullivan. “They have lower costs when it comes to airport fees and charges and they don’t have legacy costs, so fuel is basically their biggest expense.”

Even so, the fuel efficiency of their young fleets means the Gulf airlines can continue to compete effectively with carriers from other parts of the world, most of which have far older aircraft and more complex operating environments. That is one reason why the Gulf airlines have to date not joined any of the global airline alliances, such as Oneworld or Star Alliance, confident as they are that they can take on all rivals. Similarly, they have steered clear of acquisitions, while focusing on organic expansion.

“These airlines run a very efficient, very high-end operation and they do it without any labour difficulties,” says Stewart. “As long as that stays the same why would they want to expose themselves to any baggage you could get from a merger?

“I don’t think there’s a brand out there today that wouldn’t drag Emirates down a little bit. Could someone have a route network that was of interest to them? Sure, but not anything they couldn’t reproduce themselves and still have full control of.”

That strategy is likely to remain for now, although there have been some signs of a shift in thinking. Codeshare deals with other airlines around the world are now common. Qatar Airways has also held open the possibility of joining an international alliance and is expected to buy a minority stake in European all-cargo airline Cargolux in the near future.

Consolidation looms for some airlines

Such deals could be a foretaste of other strategic shifts that will be needed in the future. There is speculation that, once their current fleet expansion programmes are completed over the next decade, the Gulf airlines will need to change their approach. Instead of relentlessly chasing growth, they will instead have to concentrate on cementing market share and fending off competition from the emerging airline groups.

There has been a series of cross-border mergers in Europe in recent years, including KLM of the Netherlands with Air France and British Airways with Spain’s Iberia. The major US airlines have been undergoing a similar process. Delta joined forces with Northwest in 2009, and United and Continental merged the following year. Such groups could prove to be formidable rivals.

“They’re not a big threat at the moment, but I think the Gulf airlines’ rivals in the future will be the huge airline groups that are being formed in the US and Europe,” says Papiomytis. “Basically what’s happening is consolidation. These airlines will have immense networks that will be a threat. At some point in time, Emirates, Etihad and Qatar Airways will have to say: ‘we cannot grow any further, we cannot compete in terms of size and economies, so we’ll compete on quality’.

“Once this round of aircraft orders finishes, I don’t see them expanding any more. At that point, we could see a big merger within the Middle East because the focus will be on differentiation and quality rather than growth.”

Despite their problems in Canada and Germany at the moment, in the future the major Gulf airlines may look back fondly to these days when few airlines could compete in terms of growth and levels of service.