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China-UK air service agreement permits growth as Chinese airlines constrained in most other markets
An agreement between China and the UK to more than double their air service agreement is good timing for both sides. Chinese airlines are finding an imbalance: they are taking delivery of widebody aircraft and more Chinese airlines are flying long haul but traffic rights to major markets – the US, Canada, Germany and France – are becoming depleted. Negotiations to add traffic rights have not succeeded, typically due to the foreign side being concerned about accessing Chinese slots or Russian overflight rights.
The agreement with the UK to expand the number of weekly passenger flights from each side from 40 to 100 reflects considerable pragmatism on the part of the UK: British Airways and Virgin Atlantic are not growing in China, and China is a large growth opportunity. The UK has lagged on Chinese tourism. It was only in 2015 that China became the UK's largest inbound market.
Chinese long haul secondary city air routes: BA's Chengdu exit does not reflect the broader market
The fastest long haul airline growth is not occurring with Gulf airlines but rather, with services to and from secondary Chinese cities. It is not a secret that local incentives and subsidies, generally common in any market, are especially large in price and duration for secondary Chinese cities. An airline might expect over a third of revenues to be subsidised. This drastically alters the business case in a low-margin industry, hence the proliferation of secondary city services. This extreme dependence on subsidies raises the question of how long governments are willing to issue generous subsidies, and how many routes can be sustainable without them.
British Airways' decision to exit its only secondary Chinese route to Chengdu, in Jan-2017, might suggest the music is ending and the secondary long haul bubble is popping. There is added colour given the recent UK-China air service agreement expansion, and Brexit/British pound depreciation overhangs.
BA's exit does confirm market fundamentals: secondary city yields are low, and some routes are ahead of their time. Yet a number of factors unique to British Airways suggest caution in concluding that BA's Chengdu exit could foreshadow other withdrawals.