US airline attacks on Gulf carriers: more rhetoric than consistency - but it makes for good politics

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This is the first in a two part report about US airline views on their Gulf counterparts. The second part will examine fifth and sixth freedom traffic flows at Gulf carriers and the threat or otherwise that they pose.

These issues will also be discussed in depth at CAPA's World Aviation Summit in Antwerp, 20/21 November, 2014. For more information please see:
CAPA World Aviation Summit.

Are the Gulf airlines subsidised? US airlines cannot decide

The classic, and now worn, argument against Gulf airlines is that they are subsidised. But US airline managers do not have a consistent view on this topic.

United CEO Jeff Smisek, in an Aug-2013 PBS interview, made no subsidy claim, saying: "I would compare the policies of United Arab Emirates, which has done a terrific job recognising the value of transportation, of travel. They're quite supportive. And by support, I don't mean subsidies. I mean understanding the value and the jobs this industry drives." But at a Jun-2014 Deutsche Bank conference, Mr Smisek apparently changed his mind, saying: "The Middle East carriers are heavily subsidised by their governments."

American Airlines CEO Doug Parker is open about his undecidedness, saying in Sep-2014 (as reported by ATW): "The Gulf carriers...are encouraged by their governments to grow and are given everything they need to grow - perhaps by subsidies."

Mr Parker's oneworld joint venture counterpart IAG CEO Willie Walsh has a much clearer view. He said in 2010 of Emirates: "I just got a copy of its [financial] accounts the other day, and they look like a normal set of accounts to me. I have much more experience in dealing with Emirates, and have no doubt that they acted in a rational, commercial way in every way that I have seen."

US airlines have been subsidised, and benefit from market distortions like Chapter 11

If we take this subsidy argument at face value, it is unclear what the implication is. The US could subsidise its airlines, as it partially does through Essential Air Services and as it did after 9/11, delivering USD5 billion in direct grants and USD10 billion in loan guarantees, a package that became controversial for misappropriation and limited effects.

Airlines levy subsidies as distorting markets, yet the Big Three US airlines have benefitted (in some instances, multiple times) by Chapter 11 bankruptcy protection. This has long been a complaint of its foreign airline competitors, permitting major cost adjustments whenever their management excesses are too prolonged. To be clear, this is not a subsidy but does provide protection seldom seen elsewhere and has a distorting affect.

American Airlines for many years tried to resist Chapter 11 - an admirable aim which few analysts respected - but eventually had to join the party its peers already attended. Now Southwest Airlines, which few would label as mismanaged, faces severe competition that occurred through extraordinary bankruptcy restructuring - and the associated mergers which helped sterngthen the power of the three major full service airlines.

And, while domestic markets are typically restricted to home grown airlines, the US carriers are beneficiaries of the largest closed breeding ground in the world; they also fiercely protect even locally established airlines from having foreign investment above a threshold which is now one of the lowest in the world.

US airlines focus on Gulf airlines while ignoring subsidies to their own partners

Mr Anderson has recently been more careful with his words, saying Gulf airlines benefit from national policies like low or no taxes. References like "foreign airlines receiving government subsidies" (as Mr Anderson told a US House committee hearing in Jun-2014) are abstract and do not explicitly point fingers, even if the targets are obvious.

Mr Anderson's more focussed attack is on the topic of government-owned airlines. Yet this implies a system in which no others are government owned - or at least not liable to criticism. Mr Anderson singles out Gulf airlines while ignoring for example his own partners, many of which are government-owned, and some of which have received considerable subsidies, whereas Gulf carriers have received no known direct subsidies, aside from Emirates' seed capital at its launch.

Delta has a JV with Alitalia, which has received EUR2.7 billion in capital injections from the government. More recently, the Italian government orchestrated behind the scenes funding from private companies via political horse-trading. That proved not to be enough and the Italian government eventually gave its blessing to Etihad in Aug-2014 to take a stake in Alitalia.

As part of the Alitalia-Etihad deal, shareholders (once again mobilised by the government), agreed to inject more capital or restructure existing debt amounting to EUR1.2 billion. This would seem to conflict with Mr Anderson's Jun-2014 support of policies "allowing US airlines to compete in international markets free of government distortions".

See related report: Etihad & Alitalia agree and affirm their partnership vision. Protectionist voices will become louder

Delta's Chinese partners, with which it says it hopes to one day have a JV, are government-owned and receive subsidies. China Southern, for example, would not have been operationally profitable in 1H2014 without subsidies. China Eastern's North American network is unprofitable but China Eastern will grow it, partially at the request (perhaps unofficially) of the government.

See related reports:

• China Southern Airlines, now with 600 aircraft, has a weak 1H2014 and faces new challenges
• China Eastern Airlines seeks to revitalise its position with 777 long-haul growth and new brand

And there are historical examples, such as the nearly EUR3.9 billion Air France received in the 1990s, according to an Emirates study.

American and United also have partners who - unlike the Gulf carriers - are known to have received direct subsidies. American's Pacific partner Japan Airlines received from a state-controlled investment fund a capital injection of JPY350 billion (USD4 billion), which gave JAL a lower cost base than All Nippon Airways, a partner with United.

United's Star Alliance is often the most vocal against Gulf carriers but the Emirates study identified significant subsidies Star carriers have received.

Emirates study of government subsidies for Star Alliance members: 1995-2011

Source: Emirates

The Abu Dhabi pre-clearance "debate" was petty, and the US now plans more pre-clearance facilities

Norwegian Air Shuttle's attempt to secure an Irish AOC for trans-Atlantic services has brought a rare marriage of interests between US airline management and their unions (an alignment of views that should naturally be a worry for consumers).

But Air Line Pilots Association president Lee Moak differs from airline management about Gulf carriers. Mr Moak delivered a concise assessment: "I don't have a problem with the United Arab Emirates' government policies. Or with Qatar and Turkey, both of which are setting up super hubs… They have decided to make it their national policy to promote aviation. I can't change what they are doing, and in fact, I envy it a little bit."

Mr Moak did have a complaint regarding the proposed (and now in service) US pre-clearance facility in Abu Dhabi. As he explained: "What I do have a problem with is what our government is doing to support those airlines to the detriment of American airlines."

The Abu Dhabi pre-clearance facility is funded about 85% by the UAE, and fulfils the American government's objective to stop potentially suspicious passengers before they enter the US. But one objection raised by Mr Anderson was that the Abu Dhabi gateway is not served by any US airline with its own metal, thus supposedly giving a foreign airline a benefit that was unavailable to American carriers, even though there is an open skies agreement with the UAE - an argument with Alice in Wonderland overtones in its obliquity.

The facility is not necessarily of enormous benefit to the airlines concerned, even if it does support US offshore processing goals. For Etihad, the results are not yet clear and Emirates (with more extensive US services than Etihad) by contrast sees pre-clearance as a logistical challenge it would prefer not to address.

Pre-clearance requires a separate facility at Emirates' already stretched hub, and would significantly inflate minimum connection times when Emirates' objective is to reduce them even by five minutes - seemingly mere digits but a difference in traffic flows and maximising scheduling. A passenger arriving on a late inbound flight connecting to a US flight would need extra time in order to go through pre-clearance, meaning the US flight gets delayed or the passenger misses the flight.

This dispute over pre-clearance facilities seems to be a battle (an unnecessary one) the US airlines have lost. US Customs and Border Patrol said in Sep-2014 it wants to double the number of pre-clearance facilities from 15 to 30 over the next decade.

CBP aims to pre-clear 33% of all US-bound passengers by 2024. Given the relatively limited gateways that US airlines now serve internationally, much of this processing will occur at ports where they are (choose to be) absent.

The unarguable: US government needs to support its aviation industry. Gulf aviation should be a model, not casualty

Pre-clearance was a small fight that became grossly inflated at a time US carriers were not making progress on a number of domestic initiatives, including reducing taxes, which is a significant matter that could deliver meaningful impacts. The plight of US carriers for a more supportive regulatory framework is not new (and so will not be examined in detail). But Gulf carriers are accustomed to receiving far more supportive government approaches.

While this is fine, the danger some airlines incur in their rhetoric is wanting to handicap the Gulf airlines to bring them into a less conducive environment that stifles traffic and economic growth. As CAPA has observed in a European context, where the image of the mythical level playing field is often invoked, it is in no-one's interests to handicap one airline by requiring it suffer from the same disdain as the European airlines' own governments apply to them. And, as Mr Smisek remarked, "Our government clearly is not here to serve or protect in relation to the Gulf carriers… They don't have the teeth, nor do they have the desire."

First, it should be noted one of the world's largest airlines is effectively asking for protectionism.

Second, Mr Smisek seems to imply that if the US at present will not support its own airlines, it should hurt others. The objective for US airlines (and others) should be to propel their government's approaches to a more advantageous framework that grows traffic and economies. After all, the US majors do have the great advantage of conducting most of their operations within a closed market - which, in today's consolidated industry, is allowing them to generate yields and load factors, along with profits, that few other airlines in the world can aspire to. That they are highly taxed is a cost, but it is margins that count.

Airline lobbying does have its positives too

In other areas Mr Anderson has proven successful in government lobbying in positive ways. He pushed the US to accelerate visa processing of Chinese nationals, which led to an increase in Chinese visitors.

Non-immigrant US visas issued in China and year-over-year change: 2003-2013

Source: CAPA - Centre for Aviation & US Department of State

But far more remains to be done, and not just in China. The US, against the repeated wishes of airlines and airports, does not facilitate international transits without visas, which would allow the US to take on a stronger hub role on many long haul routes.

There is also the matter about the Ex-Im bank, but it is not new for US carriers to raise issue with it, which is created by the US, and not the Gulf airlines or their governments. Further, the suggestion is that Ex-Im funding for Gulf carriers is used in a minority - not majority - of aircraft acquisitions. Perhaps its greatest value is not in directly funding aircraft but rather setting benchmark prices for lessors and capital markets.

There may be genuine efforts to give US airlines the sound government policy they need and deserve. But as CAPA previously wrote when looking at the cost structure of Gulf carriers and those in the UK: talk of creating a "level playing field" often actually means no more than aiming to remove the efficiencies of a new model that has clearly shown itself to be successful.

Analysing each aspect of this new model should be the starting point for every government's travel strategy. Yearning for the inefficiencies of the past may offer a level of nostalgia, but provides a poor roadmap to the future. "It is the nature of a man as he grows older, a small bridge in time, to protest against change, particularly change for the better." (John Steinbeck)

See related reports:

• Unit cost analysis of Emirates, IAG & Virgin; about learning from a new model, not unpicking it
• US airlines and A4A face a battle to replace airline "milk cow" thinking by a valid national policy
• US carriers push for national airline policy as red tape, tax burdens threaten to crush their plans
• US airlines deliver a 0.1% profit margin as government-induced havoc looms

Part II: The second part of this report will examine the fifth and sixth freedom traffic flows of Gulf carriers and what this threat is, if any, to US airlines.