Etihad jolts the status quo again – Jet Airways and (wait for it) Air Canada are its newest partners

With the far-reaching purchase of Jet Airways, the UAE is entrenched as India's main international hub, although as Etihad/Jet expands, Emirates' powerful position in the Indian market will be eroded.

Other sixth freedom airlines, notably Lufthansa, whose gateway access is limited to a handful of points and is subject to capacity controls, will see their roles significantly diluted.

Etihad's growing virtuous circle develops: a remarkable sequence

Etihad is moving so fast to tie up new arrangements, almost all of which are ground-breaking in their own right, that it becomes increasingly hard to interpret the implications - there are so many new permutations being created with each new move. But, assuming that the array of deals can be effectively managed, the momentum is now such that it is almost creating a virtuous circle.

Each piece that "UAE's national airline" now adds to its jigsaw of alliance relationships begins to have - usually very positive - knock on impacts for other partnerships.

For example, as CAPA has previously wondered aloud, what happens in the American Airlines "love triangle"? Here American, recently bought by US Airways, is at the apex of all three major Gulf carriers.

Close partner Qantas/oneworld has eloped with Emirates; and equally close British Airways/Iberia have tied up with Qatar Airways. American is at the heart of oneworld's US market access. Yet Etihad has a vital (for Etihad) and extensive codeshare arrangement with American. Although today's world is becoming much more complex than a contest between the apparently simple three global alliance teams, it strains credibility that American could have a deep and meaningful relationship with all three, Emirates, Etihad and Qatar. Alliance promiscuity can only go so far before conflict arises; but today's question perhaps becomes more about how to manage that conflict rather than how to avoid it.

Until the Jet Airways purchase - and an extremely important Abu Dhabi US pre-clearance agreement - Etihad looked like an easy call for American to walk away from. Not any more.

The combination of easy US passenger access and a much stronger hold on the large and growing Indian market not only makes Etihad much more attractive for American, but also Abu Dhabi soars as a desirable transfer point. In this respect, there are few better holistic examples of airline-airport-government policy working together. European governments take note.

The US-India market is not small, with around a million passengers in each direction and roughly evenly distributed origin and destination; importantly it is growing fast - and US airlines have a relatively small part of the action. Non-stop service is possible, but to establish a combination of frequency and city pair access, intermediate stops outside India will remain an attractive proposition. If pre-clearance is possible too, the attraction of Etihad and Abu Dhabi increases considerably.

India-US in one-way passenger numbers

Source: IATA MarketIS

The Etihad-Jet Airways deal, 24-Apr-2013 in a nutshell:

• Etihad will invest USD600 million in Jet Airways;
• This includes an equity investment of USD379 million, giving Etihad Airways 24% of an enlarged share capital of Jet Airways;
• A further USD220 million will be injected "to create and strengthen a wide-ranging partnership between the two carriers". As part of this Etihad Airways previously announced it had paid USD70 million to acquire Jet Airways' three pairs of Heathrow slots through the sale and lease back agreement announced on 27-Feb-2013. Jet Airways continues to operate flights to London utilising these slots;
• Etihad will also invest USD150 million to buy a majority equity share in Jet Airways' frequent flyer programme "Jet Privilege". Etihad has majority ownership of airberlin's frequent flyer programme too. And Etihad has leased two A330s from Jet;
• Codeshare expansion will significantly extend Etihad's reach into India's fast growing 42 million passenger travel market, feeding Etihad's Middle East, North American and European destinations, and opening up Jet Airways' access from up to 23 Indian cities;
• An expanded India-UAE bilateral access agreement gives Jet the lion's share of almost 40,000 new seats weekly;
• Together the carriers will establish "a Gulf gateway for flights to the US, Europe, Africa and the Middle East";
• The respective frequent flyer programmes will be "fully integrated", with reciprocal 'earn-and-burn'

Jet Airways' future is now assured, if India's politicians deliver

In an overall deal encompassing around a billion dollars, Jet Airways' previously fragile position is greatly enhanced. The size and scope of the agreement also means that Etihad will seek to ensure that the partnership will work to their mutual benefit.

Accompanying the purchase arrangements, an essential part of the equation was to secure adequate support from the Indian government too.

India has a sad reputation when it comes to practical implementation of foreign investment measures introduced by its relatively forward looking leaders, so Etihad and its government owners were anxious to ensure that this major addition to the airline's armoury would not be unravelled by the usual prevarication and obstacles. The UAE had previously fallen foul of India's waywardness (with a negative experience by the UAE telco in India), and so was seeking an Investment Protection Treaty; however because these can take a long time to negotiate it was eventually dropped as a pre-condition, but remains on the agenda.

Expanded UAE-India bilateral access sealed the deal

However bilateral access became a central feature of the deal. If Etihad was to spend several hundred million dollars buying into Jet, it was essential that they be able to leverage market access. India and Abu Dhabi agreed to the revised bilateral agreement shortly before announcement of the purchase, and within 24 hours the Jet-Etihad deal went ahead. The short-notice negotiations displeased some in the Indian industry, but is merely another example of India's ad-hoc "policy" implementation.

Under the revised terms, each side has been granted an additional 36,670 weekly seats, taking the current 13,330 entitlements to just 50,000. The increased entitlements will be phased in over a period of two years, with 11,000 additional seats effective immediately. There are now 23 designated points of call in India - all of them in principle available for use by the Jet-Etihad partnership.

The bilateral agreement does still have to be approved by Cabinet and, given the likely severe impact on Air India, political opponents will undoubtedly seek to exploit this as a reason for reneging on the deal. Prime Minister Manmohan Singh has however continually stressed the importance to India's overall interests in abiding by its international commitments, as repeated failure to do so in the past has seriously jeopardised inbound investment.

Also, the other Gulf carriers, along with European carriers, are likely to seek additional concessions, apart from increased seats, as a result; for example, Lufthansa and Emirates are currently not permitted to deploy A380s in the Indian market and will almost certainly now request that access. Meanwhile too, Turkish Airlines is seeking an increase to 56 weekly frequencies (to allow double dailies to Delhi and Mumbai and dailies to four Bangalore, Chennai, Hyderabad and Kolkata).

Previously, Etihad, Emirates, Air Arabia and Qatar Airways had together been seeking approximately 150,000 additional weekly seats in total, so it can be expected that the noise will intensify now.

Agreement on US pre-clearance in the UAE will also be a major asset

The intricate details accompanying this major move by Etihad further enhance the value of the Jet purchase to Etihad and the UAE. Important among these is a US-UAE agreement to establish a US Customs and Border Protection (CBP) pre-clearance facility at Abu Dhabi International Airport. The US is India's biggest air market by far and Indian (and US) travellers are forced to endure the less than tender mercies of America's immigration and security authorities. If these processes can be provided in a civilised way by flying through Abu Dhabi, that is an enormous incentive for travellers to use the joint services of Etihad/Jet Airways.

There are currently 15 CBP pre-clearance facilities in Canada, Ireland and the Caribbean and all have been well patronised.

Understandably, this has already invoked the envy - and wrath - of European airlines, whose trade body, the Association of European Airlines (AEA) has argued this will provide a competitive advantage to Etihad Airways and will be "detrimental to a level playing field in the transatlantic aviation market…European airlines are forced to change their flight schedules in order to avoid rush hours at the customs clearance in the USA, putting connectivity, commercial opportunities and passenger convenience at stake. The measure in Abu Dhabi has a distortive effect on the liberalised EU-US transport market, which is the largest in the world with clear benefits to industry, consumers and the economy. AEA calls on constructive discussions between the respective parties in order to deal with this issue and to avoid further conflicts."

While this neglects to point out that the exclusive US-Europe liberalisation had also previously delivered a powerful advantage to European airlines, it also sends a message to European governments to work to support the interests of their national industries - airports and airlines.

Meanwhile, US airline pilots, always fast to jump at any improvement in the system that could possibly affect their well-being, have, through the Air Line Pilots Association (ALPA), actually called on the US government to repeal the agreement. The Association is, somewhat quaintly, concerned that no US airline currently services Abu Dhabi and therefore cannot benefit from it (although US airlines will now certainly see the agreement as an added incentive to operate to the airport). ALPA argued the US government was "putting US airlines and American jobs at great risk" with the agreement and called on Congress to act if the Department of Homeland Security does not rescind the agreement.

The Air Canada codeshare is potentially a major breakthrough for Etihad

Following an acrimonious aviation policy dispute between the governments of Canada and the UAE which resulted in a series of diplomatic spats, peace has now been restored and Air Canada has tentatively embarked on a whole new realpolitik course. A staunch member of the Star Alliance, Air Canada has strictly adhered to the historic application of bilateral air services terms, where capacity is to be allocated reciprocally, based on third and fourth freedom traffic flows (these are the provisions described by a former IATA CEO as "archaic"; most countries now regard consumer interests ahead of flag carrier protection).

The codeshare announced by both airlines on 25-Apr-2013 relates mainly to these end-to-end flows, with long-haul reciprocal codesharing limited to the Toronto-Abu Dhabi sector, both non-stop and via London. Etihad also has codeshares on Air Canada metal over Toronto. One result is apparently to allow Etihad effective daily service to Toronto; its capacity-limited three times weekly non-stop service to Toronto will now be able to be augmented by one-stop codeshare operation on Air Canada over London. If the London routing is to be useful this would however imply that Canada is now prepared to grant Etihad additional one-stop capacity. Technically, the two parties have "signed a Memorandum of Understanding (MoU) for a commercial cooperation agreement", so it is still subject to potentially substantial elaboration.

But - and here again the magic of the virtuous circle may come into play - once Etihad/Jet is able to deliver high levels of traffic from 23 points in India, the proposition for Air Canada to become more intimate with Etihad becomes very powerful. Currently, Air Canada does not serve the large Indian market non-stop, preferring to codeshare on - once again, the virtuous circle - Jet Airways over London. It also connects with Lufthansa over Frankfurt and Swiss over Zurich.

According to the airlines' media releases, "the two parties have commenced discussions to finalise details with the objective of introducing codeshare services in the third quarter 2013."

It would not be fanciful to think that the passage of another few months will see further evolution of this fast moving alliance scene, as Jet falls increasingly into line with a wider Etihad strategy. There will now be much for Air Canada to gain from a closer relationship with Etihad, in ways that its Star partners may not be able to deliver, both in India and elsewhere.

Domestically, Air India, along with Delhi and Mumbai Airports lose ground - but the wider outcome is generally positive

Etihad's investment was made possible since India recently, after much delay, moved to allow expanded foreign airline ownership of Indian carriers. Ironically, the long delay in introducing the change was mostly due to Jet Airways' influential opposition, as it feared that its own position would be eroded if other airlines like Kingfisher were strengthened by receiving foreign airline support.

Now, in the current circumstances, with Kingfisher out of the picture, the impact of the Etihad-Jet combination will be devastating for the country's largest international carrier, Air India, just as it was starting to show signs of improvement.

The logical response, if it is unable to compete, is to allow Air India to fail - or at least drastically downsize - but logic is rarely the first refuge when national flag carriers are concerned. Nonetheless it will become increasingly difficult to justify injecting a billion dollars a year into an airline that now has a negligible prospect of independent survival, now that Jet has been so substantially empowered. And, so long as the Indian Government's policy incoherence continues, there is little hope for a reversal. This surely must be the last nail in the flag carrier's coffin.

As a consequence, with India's largest carrier now effectively moving its hub to Abu Dhabi, Air India struggling and likely to be further weakened, Kingfisher grounded and all other airlines being point-to-point LCCs, there is no longer an Indian carrier with the ambition and capability to support the development of hubs at Delhi and Mumbai Airports. Jet Airways was the leading candidate for that role but no longer; it will now focus on feeding its new Abu Dhabi hub.

This has implications for the private operators of India's gateway airports and for future airport investment. Their outlook is now more likely to be as spokes rather than as hubs, making them less attractive investments. At least that will be the case until eastbound markets open up - as they surely will, as Asian traffic grows. But for the time being India's commercial links are mostly to the long-established old-world markets of Europe and North America.

Ad hoc and incoherent decisions unfortunately have characterised India's aviation development for many years, usually heavily influenced by interested parties.

On this occasion, the outcome is probably to the advantage of the wider Indian community and for airline consumers generally. They will be unconcerned at the way the outcome is achieved, breaking a logjam of market access that looked to be encumbered, with little hope of radical change. But given the importance of the sector and of tourism and travel to the economy, it is inescapable that the market needed a solid jolt if it were to have a hope of a sustainable and publicly viable future.

And Etihad continues, criss-crossing the global alliances with its 'new business model'

Although India is the object of this week's developments, the real story here is however Etihad's remarkable expansion path.

Aside from the investment in Jet Airways, over the past year Etihad has acquired stakes in airberlin (nearly 30%), Air Seychelles (40%), Virgin Australia (8.56%) and Aer Lingus (nearly 3%), the airline "will continue to explore opportunities where they make financial and strategic sense", according to CEO James Hogan, who believes "the new business model delivers benefits which previously were available only through full mergers or acquisitions". The high level of involvement in Air Seychelles for example (which announced an important codeshare with South African Airways on 25-Apr-2013) has de facto provided additional market access for Etihad in capacity limited Hong Kong, as well as generally being a highly positive outcome for the Seychelles' previously ailing airline.

In addition to these direct equity stakes in its airline partners, Etihad has also been quietly accumulating majority shareholdings in the frequent flyer programmes of some of its acquisitions (although foreign airline ownership is subject to restrictions, no such inhibition exists on FFPs). Etihad's growing network creates synergies that expand the value of the programmes, while at the same time making them available for data mining. As loyalty programmes assume greater intrinsic value, the possibilities in this still relatively young marketplace may be extensive.

The fast pace of Etihad's ascension to a major player and game changer has been accompanied by this suite of equity investments and, while the efficacy of minority shareholding connections remains unproven in the airline industry, it increasingly appears that Etihad's combination is working well for it. Notably, where the airline invested in is in a weaker position, Etihad's ability to deliver it sustainability creates a greater reliance on the UAE flag carrier - and therefore the minority shareholding takes on greater significance, almost in proportion to the weakness of the acquired airline.

In the process of establishing its partnerships, equity or otherwise, Etihad, like its Gulf siblings, has been careless of global alliance affiliations; relations with the leader of SkyTeam, Air France-KLM, go side by side with its extensive codeshares with oneworld's American and its acquisition of oneworld's airberlin; Star Alliance members, led by arch enemy Lufthansa, have been more resistant, but a budding partnership with Air Canada may alter that status, along with its proxy codeshare with SAA through Air Seychelles.

The result, for the global system, is disruption, something the airline industry badly needs if it is to move towards profitability. That path will not be smooth and not all can follow it, but it is surely inevitable sooner or later.

See related articles:

• Radial Alliances and Virtual Airlines. Reshaping the partnership model in a new world
• Etihad's potential investment in Jet Airways to be a game-changer for India
• Air India outlook: a business model beleaguered on all fronts
• Air India: The time has come to stop procrastinating and act the final scene is near

CAPA India Aviation Outlook Report 2013/14

CAPA will release it detailed 100+ page India Aviation Outlook Report 2013/14 on 10-May-2013 incorporating further analysis of the impact of the Etihad-Jet Airways deal. In this fast-changing environment, having access to up-to-date research and insights into the direction of the market is critical for any business with exposure to Indian aviation.

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