The Gulf carriers have connected 10 more US cities to the Middle East in the last decade, flying an additional 22 city-pairs and increasing US airport income by over $50m per annum, so why all the fuss? Did they spot a genuine opportunity that everyone else missed, one so large it justifies ordering over 600 new large jets – or is there something else behind the rise of the Middle East Big 3?
The heavyweight USB3 of United, American and Delta continue to fight the MEB3 of Emirates, Etihad and Qatar over market access, state subsidies, quality of service and any other angle that can be used to score a point off the other side in what risks becoming the defining battle of the year.
It is notably hard to get inside the financial workings of any airline, never mind those that are privately held, so rather than try to unravel the allegations of state aid versus chapter 11 bankruptcy protection, here we take a quick look through the some of the facts and figures behind the MEB3 and why the USB3 and (some) European majors are finding competition a difficult pill to swallow.
The core issue is that of access to – and exploitation of – the market between the US and Middle East/ South Asia. Going back a decade, the Middle East market was flown by an uncontested daily Emirates Dubai to New York service. Wind forward to 2014, and there were almost 8,000 annual departures, or 21 daily frequencies, heading from 11 US gateways to Abu Dhabi, Dubai and Doha.
Middle East to US services in 2005...
...and a decade later
The issue for the US carriers is that out of these 23 airport-pairs, only two are served by US carriers: United flies Washington to Dubai alongside Emirates whilst Delta operates a daily Atlanta to Dubai service. Every other route is flown by one of Emirates, Etihad or Qatar Airways.
As shown in the chart to the below, capacity growth measured in ASKs has been substantial, propelled by the non-US airlines who now offer fifteen-times the number of ASKs of their US counterparts. Whereas the MEB3 have been growing strongly year-on-year, there has been no increase in capacity by US carriers since 2009.
This growth has, according to the US majors, been underpinned by billions of dollars of illegal or semi-legal state aid, creating an uneven playing field – the MEB3 have access to the vast US domestic market, whilst the US carriers only have rights to fly to (and theoretically, within) the relatively tiny local Gulf states. However, whilst it is true that the US population is more than 25 times that of the UAE and Qatar combined, the real issue isn’t in the O&D market between these countries, it’s in the ability to feed traffic into the countries surrounding the Gulf States, which are fast-growing and have a large populations.
So what’s happened to capacity between the US and some of the countries neighbouring the Gulf (India, Pakistan, Saudi Arabia, Kuwait, Bahrain, Oman)? The US carriers showed strong growth to 2008 compared to a 2005 baseline, but have subsequently reduced capacity back to 2006 levels, whilst the non-US carriers – in this example Air India, Saudia, PIA and Kuwait Airways – plot slower but steady increases.
The overall picture is one in which US carriers offered limited but growing services between the US and Middle East / South Asia from 2005 to 2009, but have since been reducing their penetration into this market, whilst network carriers from the emerging hubs of Abu Dhabi, Doha and Dubai have piled on capacity, not only to the US but to a wide network of beyond-points closer to home. At the end of 2014, the share of ASKs from the US to the core Middle East and South Asia countries was back at 2005 levels.
Share of ASKs 2005-14, US to UAE, Qatar, India, Pakistan etc
There is already a good level of competition between these markets from Europe’s network carriers, who have substantial reach into the US via their immunised joint ventures with the USB3, and who are competing to bring passengers over their hubs. With the addition of non-stop services by the MEB3 it is perhaps unsurprising that the US carriers feel somewhat cut-off from what is likely to be a high-growth region for the foreseeable future. Some of this is also due to geography, as noted in our story from last month.
Of course, the only viable way for US carriers to access the wider Middle East / South Asia market is to fly some very long non-stop services, the economics of which look fairly challenging given that the traffic mix is not high-yield.
The greater focus on high density seating configurations plays a role in delivering results on these routes for Emirates. The airline achieves attractive seat economics through a high density economy cabin with no 'economy plus' / extra legroom product, coupled with a competitive business and first class offer. Etihad and Qatar have similar long-haul products which, in contrast to their US and European competitors have fewer or no first class seats and similar or higher economy capacity.
Taking a look at the economics of an ultra-long range route such as Los Angeles to Dubai using the B777-300ER, we see how these differences play-through to route economics. American has 310 seats on board in a configuration with four seat-pitch variations, compared to Emirates at 354 in a standard three-class config, which means that the total seat capacity offered by AA on a daily service is 32,000 less per year than Emirates. To break-even at an 85% load factor, our analysis suggests a market size of 190,000 versus 220,000 passengers which hypothetically gives an advantage to American. However, using the same assumptions for other operating cost items (fuel price, airport fees etc), having a higher seat capacity means that Emirates can amortize operating costs over a greater number of passengers leading to it being able to offer lower fares than its US counterpart – USD820 one way in this example, compared to USD990.
Los Angeles to Dubai Route, Market Size and Cost Estimate
Source: RDC Apex, http://www.rdcapex.com/
On a day-to-day operational level, the MEB3 carriers operate with a lower number of premium cabin seats and a similar or high-density economy class which is more appropriate to the market segment in which they operate. Combined with flying longer average sector lengths, the MEB3 have a more attractive cost-base on a seat-km basis.
Comparison of Published Revenue and Cost Data
Source: Airline Financial statements, RDC Apex, http://www.rdcapex.com/
At a network level, the MEB3 are simply playing the US network carriers at their own game – they are able to leverage a protected network of feed routes, backed with local traffic rights, to exploit access to a market. It’s something the US airlines have been able to do for years in reverse, having benefited from exclusive access to the vast US domestic market as feed for their own international networks.
The airport angle
One area where the MEB3 all enjoy a cost advantage is at their home-hub airports, although not necessarily through uneven treatment. Our analysis of the published charges at a range of hub airports shows that it is common practice to offer discounts from the full passenger charge for transit and transfer passengers. Airlines carrying a higher percentage of connecting passengers have a greater benefit than those that don’t, and by definition this policy benefits the home-based carrier – i.e. an Emirates service landing in Dubai with 75% transfer passengers on board will pay less in airport fees than a United flight carrying no transfer passengers. That said, the same goes at the US end of the route, where Emirates will have no transfer passengers but United will. However, in general the MEB3 carry a higher proportion of transfer passengers than the US carriers, and therefore enjoy a cost advantage, as shown in our analysis in the table below:
Three US and three Middle East airports, B777-200ER Landing Charges
Source: AirportCharges, http://www.airportcharges.com/
Without transit/transfer passengers on board, the Middle East hubs are similar in cost to JFK and LAX for landing, but all three Gulf airports offer a more substantial discount for transfer passengers. Our analysis shows that with 75% transfer passengers, the costs fall below the US hubs, averaging around USD12 per passenger.
There is an upside for the US industry though. With higher fees being levied for international terminating passengers over connecting, and assuming no discounts or incentives are being offered to the Middle East carriers, the fees and charges generated by last year’s 20+ daily services equates to an additional USD50m per annum aeronautical income for the US airports compared to a decade ago, not mention the non-aeronautical revenue to the airport operator and wider catalytic economic activity driven by inbound tourism and improved business connectivity.
What Next – Look North?
It may seem strange that the US carriers have chosen now to highlight and challenge the rise of the MEB3, given that they’re in better financial health than practically any time within living memory and these challenger carriers are operating on the opposite side of the world. In part, it’s probably true that the legacy airlines in the US and Europe were blindsided by the rise of the MEB3. We’re all pretty familiar by now with the dynamics of the US, European and US to Europe markets: deregulation took place decades ago, LCCs have made their mark and network carriers that failed to restructure fell by the wayside. Smart money would have been on something from China or India, backed by a massive domestic market, to be the next disruptive “big thing” – not a triumvirate of airlines from two tiny states. So what happened?
There’s no doubt Western Governments were outfoxed by negotiators from the UAE and Qatar when it came to open skies. So busy were they protecting access to core markets that requests for liberal bilaterals were granted far more easily than they would be today. Only the Canadians didn’t fall for it – they still have the same three-weekly Toronto to Dubai this year as they had in 2007, although the Emirates PR machine is in full swing in the hope of getting a more relaxed bilateral.
As the dysfunctional Gulf Air-of-old fell to pieces, there appeared to be little by way of threat or opportunity to be found within the UAE, Bahrain, Qatar or Oman. But in piecing together a patchwork of open skies and fifth-freedom traffic rights, all of a sudden it has become evident that there is a bigger game in play. No longer is it impossible to see an airline doing at a global level what Ryanair has achieved in Europe or Southwest in the US. Once traffic rights are not an issue, it’s a straight race to the finishing post where the strongest will win. The Emirates service from Milan to New York may well be the first of many routes launched off the back of fifth freedom rights. And that will be a big concern to the incumbent carriers.
More recently there have been other signs that this is indeed what is at stake. Since the founding of Etihad in 2003, there has been something of a space-race between the near-neighbours, each vying to place the largest order at one of the major airshows. Our fleet data shows there still is a vast difference in size between the US and MEB3s with the smallest of the US (United) over 3 ½ times the size of the largest ME (Emirates). But in terms of forward orders it’s much more even between the airlines with the MEB3 each having similar or greater numbers on order than Delta and United. Add to that the fact that the US carrier orders are replacements as well as additional aircraft, whereas the MEB3 orders are generally in addition to their current fleet, and it would appear that someone has spotted an opportunity that the legacy carriers have missed.
Current Fleet Size and Aircraft Orders
In spite of the war-of-words between carriers at the moment, the MEB3 are doing their bit for the US airframe industry, with over 350 Boeing aircraft on order. We’ve added Turkish onto the chart, pushing the Boeing order up over 450, as we see Turkish as a more conventional challenger brand for the European and US carriers. It is backed by a substantial local population, is geographically well located; has an improving economy and will move to an impressive new airport within the next five years. The emergence of Turkish on top of the MEB3 adds to the unease.
This all feeds into a geopolitical game that encompasses oil, aircraft orders and even the strategic partnerships within the Middle East. The US and European governments are trading the lobbying of their airlines against all of these other factors which push towards greater market access for the MEB3.
On top of the large order-book, there are other signs of a bigger play. Qatar Airways has joined the oneworld alliance, made a strategic 9.9% investment in IAG and the Qatari sovereign wealth fund owns 20% of Heathrow Airport. Emirates is cleverly being positioned as the identity of Dubai, backed by a massive global advertising push, the like of which other airlines can only dream. From blanket sponsorship of the F1 season to seven of Europe’s most successful football teams and grand-slam tennis tournaments, the Emirates brand is becoming global. Up the road in Abu Dhabi, Etihad is making equity purchases in a range of “strategically important airlines” that, from a distance, don’t seem all that obvious. We admire the bravery of taking on Alitalia and Air Berlin, where the short-term solution is cash and the long-term quite difficult to see; but where the likes of Darwin and Air Serbia feature is rather less clear. The last time an airline went about buying up minority stakes in European airlines was Swissair with its Qualiflyer Group, and that didn’t end too well - although the Swiss didn’t have oil and the world was a different place. Nonetheless, it appears that the strategic view of the future is different for each of the MEB3, which has to be a good thing.
So maybe there is a big picture, one where international barriers have been eroded, where overseas ownership of airlines is accepted, one that everyone in the US and Europe missed; to get there requires the backing of a State’s vision, money, ambition – and it’s only just becoming apparent that’s really what’s been happening for the last 10 years.