The world’s airlines will collectively lose $9bn this year, according to the International Air Transport Association (IATA). The market is so tough that in July, Roland Busch, a board member of German airline Lufthansa, said the industry was experiencing “the worst crisis in its history”.

In many ways, the Middle East stands apart from the global gloom. In much of the Gulf, confidence appears barely dented and, with only a few exceptions, airlines are continuing to expand. But even so, the established carriers are keenly aware of costs, and the growing threat posed by low-cost rivals such as Flydubai.

The global recession has not passed entirely unnoticed in the Middle East. In April, Bahrain’s loss-making Gulf Air abandoned a plan to lease four Boeing 777 aircraft on three-year deals because of commercial and other business considerations. Uncertainty also hangs over Kuwait Airways, which is waiting for its long-planned privatisation, and Iran Air, which has been badly hurt by the ongoing US trade and financial sanctions against Tehran.

Expansion plans

But most of the region’s carriers are riding out the global downturn in relative comfort. Among the Gulf’s largest national carriers, and in its growing no-frills travel sector, traffic growth and heavy capital investment remain the dominant themes.

At the Paris Air Show in June, Abu Dhabi-based Etihad Airways announced a $14bn order for engines for its growing fleet. The following month, Flydubai - which was launched in March 2008 - finalised a $320m deal to acquire four Airbus A320 short-haul jets.

These airlines’ continued ability to grow is partly due to geography. Situated at a natural crossroads between Europe, Asia and Africa, the Gulf countries are ideally located to carve out a strong position in the global air travel business.

While Kuwait Airways and Gulf Air were the first to seriously target the travel market between the surrounding regions, in more recent years, Qatar Airways, Etihad and Dubai’s Emirates have poured investment into developing this area of their business.

The long-term investment strategy these three companies have been pursuing means that despite the dramatic slowdown in global economic activity, they have continued to implement massive fleet and route expansions.

And they have the financial clout to continue doing so. Qatar Airways and Etihad are owned by governments with huge oil and gas revenues, meaning they are able to make costly investments.

Dubai does not have the same level of natural resources to draw on to fund the expansion of Emirates, but it has had more than two decades to develop its business, which now has a solid track record of profit. The strength of its business has allowed Emirates to build up an order book that now stands at 160 planes, worth about $50bn at list prices, including 58 of the double-decker Airbus A380s.

Expansion is not simply about buying more planes. Hareb al-Muhairy, head of corporate communications at Etihad, says his company has also been investing in facilities such as flat beds in business class, and a nanny service for children at Abu Dhabi International airport.

Such perks have a purpose. At a time when many companies are struggling to persuade passengers to continue travelling in first and business class, improved levels of service may help Etihad attract travellers who are still prepared to pay premium fares.

The importance of service quality has long been recognised among Gulf carriers, but as a cost it is minor compared with the expense of buying new aircraft. With a $30bn order book, Qatar Airways aims to almost double the size of its fleet by 2013, while Etihad plans to expand from 46 aircraft to 65 by the end of 2012. “We will receive seven Airbus aircraft and one Boeing 777 this year,” says Al-Muhairy.

Gulf airlines’ faith in continuing to expand their fleets is being boosted by the surprisingly robust market conditions some are enjoying. Al-Muhairy says Etihad’s passenger numbers and revenues are still on course to meet its goal of breaking even in the first quarter of 2011.

Gulf airlines are also continuing to expand their route networks. In January, Saudi Arabian Airlines (Saudia), for example, added three new Indian destinations - Lucknow, Bangalore and Calicut - to its route network. But despite all this activity, considerable uncertainty hangs over the aviation industry, even in the Gulf. Passenger traffic is still increasing, but freight volumes have been declining despite an increase in capacity since June 2008 (see table).

While the biggest and best-resourced Gulf airlines remain confident of their long-term strategies, they have nevertheless taken precautions to guard against the possibility that growth rates may decline.

Etihad has a total of 205 aircraft on order, but has made firm commitments to buy only about half of these. “Some 105 are confirmed aircraft and 100 are under option,” says Al-Muhairy.

Etihad prefers to buy its planes directly from the manufacturers, with the support of bank finance. By contrast, Emirates sometimes opts for leasing arrangements, which removes the up-front capital cost of aircraft acquisition. In July last year, DAE Capital, the aircraft financing arm of Dubai Aerospace Enterprise, announced an 18-plane sale-and-leaseback deal with Emirates, including nine long-haul Boeing 777 aircraft, which will be delivered in phases through to 2014.

“The main reason airlines opt for leasing is because it frees up cash,” says one Gulf industry executive. “This is very important for an airline. The aircraft is taken off the balance sheet.”

Accessing finance

The DAE Capital deal was funded by a $450m loan from the US’ Citibank and underwritten by the US Export-Import Bank (EximBank). Such arrangements are normal practice in the aviation sector, where sales of Boeing and Airbus planes to Middle East customers are routinely covered by Western export credit agencies.

They are relatively low-risk deals for the agencies. The political risk factor cannot be totally discounted in the Middle East, but it is not an overwhelming issue, and is far outweighed by financing and technical issues when it comes to negotiating a deal. The region’s airlines do not normally benefit from formal government guarantees for their aircraft purchases, but they are generally seen as national champions that would be too important to be allowed to fail.

A senior figure at one leading Western export credit agency points out that the big Gulf and North African carriers also now have a strong financial record, and it is in Europe and the US that airlines are struggling the most.

Leasing has also become a popular option with low-cost operators. Flydubai agreed a sale-and-leaseback package with US-based GE Commercial Aviation Services for the four Boeing 737s it ordered in July. At a time when the carrier is pushing hard to compete with the well-established Air Arabia, which is based in the neighbouring emirate of Sharjah, the deal means it can expand more rapidly than its finances would otherwise have allowed.

Such financial issues are particularly important at a time when even the strongest companies can face problems raising bank loans or new capital at an affordable rate.

Jazeera Airways, a privately owned airline based in Kuwait, has also rethought its approach to acquiring new aircraft. The airline has suffered from lower demand and its load factor - a measure of the percentage of seats filled on each flight - has dropped.

“Jazeera’s previous policy was to purchase its planes itself by taking credit from banks and other financial institutions,” says Semir Murad, an airline analyst at NBK Capital in Kuwait City. “Now, from what I understand, it is going to be moving more towards leasing.”

However, as Murad points out, the trend is not universal, with some airlines taking a very different approach to financing.

“Air Arabia’s approach was the opposite to Jazeera,” he says. “It started off with leasing, but now it is moving more towards purchasing, because it has the cash.”

Even so, both companies remain sufficiently robust and confident to stick with relatively long-term deals when they lease planes.

“I do not think either Air Arabia or Jazeera will opt for short-term leases,” says Murad. “Both, when they lease, opt for six or seven-year deals.”

In the current challenging market, the low-cost carriers are helped by their simple business models. In sticking to short or medium-haul routes, they are able to rely on just one model of plane: the Airbus A320 for Jazeera and Air Arabia, the Boeing 737 in Flydubai’s case. This simplifies the aircraft procurement process and keeps maintenance, training and other costs down.

Matters are more complex for the national carriers, particularly the smaller players, such as Gulf Air, Kuwait Airways and Oman Air, which lack the huge resources and passenger volumes that underpin the Gulf’s largest airlines.

Gulf Air, in particular, has been wrestling with huge procurement dilemmas. It has 59 aircraft on order and has brought forward the delivery dates for some, but it is operating under tight financial constraints and is thought to still be losing up to $1m a day.

Oman Air faces a challenge of a different nature. Since the sultanate withdrew from any involvement in Gulf Air in 2007 - making the latter a purely Bahraini company - Oman Air has been mandated to fill the role of national carrier. However, Oman has relatively limited resources and setting up a comprehensive route network will take many years.

All airlines, even those with hefty financial resources behind them, realise that the current market conditions require them to be prudent in their spending plans. According to the IATA, most airlines around the world are not expecting any upturn until the end of the year at the earliest. If passenger volumes start to decline in the Middle East in the same way that cargo traffic levels have, Gulf airlines might have to scale back their ambitions even more.