These are good times for air travel in the Gulf – if you are a customer. Intense competition between the conventional carriers and low-cost carriers, such as Flydubai and Sharjah-based Air Arabia, has kept fares low, even as rising operating costs are eating into profit margins. 

The need to keep passenger numbers up is forcing both low-cost carriers and state airlines to hold back on fare increases. With state-backed operations such as Qatar Airways in an expansionist mood and seeking to win market share, they are willing to bear the cost to retain passengers.

“This industry is highly price-elastic. Even a 1 per cent change in prices will yield a big change in passenger traffic,” says Kareem Murad, transport analyst at UAE-based investment banking house Shuaa -Capital. 

Figures from the International Air Transport Association (IATA) show the impact of the increasing number of budget airlines in the first eight months of 2009. Demand for air travel in the Gulf grew by 8 per cent, but this was outstripped by a 13 per cent increase in capacity.

Passenger traffic migrates to low-cost carriers in a recession, as both leisure and corporate customers seek savings. In turn, this has been driving down the fares of conventional carriers.

The four major Gulf carriers –  Bahrain’s Gulf Air, Emirates Airlines, the UAE’s Etihad Airways and Qatar Airways -– have taken a lead from the relatively new arrivals, such as Air Arabia and Kuwait’s Jazeera Airways, introducing cut-price fares and packages. Emirates, the region’s largest airline, has cut its standard Dubai-Amman fare from AED1,800 ($490) to AED1,400.

Predatory pricing

Cut-price fares are also being introduced to win market share in the long-haul market.

 In February 2009, just days after Emirates announced lower prices to 85 destinations, Etihad launched a counter-promotion with cut-price flights to Africa, Europe, North America, Asia and the Middle East.

Meanwhile Qatar Airways has reduced fares on UAE routes where it wants to compete for -market share with rivals. For -example, it has cut prices on the Dubai-London route, aiming to win customers from Emirates.

By 2013, Qatar Airways will double the size of its present 71-strong fleet and Etihad will expand its fleet from 46 aircraft to 65. More routes will be needed to justify the substantial investment, and the best way to win market share, at least in the short term, is to compete on price.

Air passengers are highly sensitive to price; surveys show that for nearly 50 per cent of passengers it is the most important factor in deciding which airline to use.

The Gulf carriers also have to contend with global carriers.

In October last year, Germany’s Lufthansa Airlines launched special fares from the UAE, Kuwait, Doha and Oman to more than 40 destinations in Europe, with return flights from the UAE costing AED990, and Kuwait to Europe starting from KD79 ($276).

Gulf airlines have little option but to compete on price or face greater losses, says Murad. Although occupancy rates have been reduced to 60 per cent, which hurt their margins, the alternative, he says, is far worse. “If airlines lose customers, they will get another hit on margins as well, which would be far greater.

But not all Gulf airlines are willing to slash fares. Kuwait’s Wataniya Airways, which focuses on the premium market, has no plans to revise its rates in response to economic conditions.

It is prepared to allow a lower load factor than lower-cost carriers, such as Jazeera, also from Kuwait. While Wataniya is aiming for a load factor of 50 per cent in its first full year of operation, Egypt’s HC Brokerage estimates the Gulf airlines’ 2009 seat occupancy rate to be a healthy 66 per cent.

Airlines can, however, expect some respite from the price war in coming months. As the global economy recovers, passengers  will return to the region in greater numbers, and fares are likely to rise.

Fuel surcharges

Another reason for confidence is that Gulf carriers have hedged well against rising fuel prices.

“A lot of them hedged during a period of lower prices,” says Murad. “They could have enhanced profitability and decided not to do anything to maintain passenger levels. But they [airlines] are saying that since we have hedged at this level, let us keep prices where they are in order to attract more traffic.”

Emirates wrote down fuel-hedging losses of AED1.57bn for 2008-09. That higher cost led the Dubai carrier to post an 80 per cent drop in profits to AED982m from AED5bn in 2007-08.

But the reward is now being felt. Unlike European airlines, such as British Airways, the Gulf airlines are not yet levying fuel surcharges on their passengers, despite the return of oil prices to more than $80 a barrel.

Murad says this predatory pricing environment is likely to outlast the economic downturn, as competition for passengers intensifies between low-cost and conventional carriers world-wide. “This is not a specific rivalry between, say, Qatar Airways and Emirates, or Emirates and Etihad,” says Murad. “All airline business are competing with each other – it is natural competition with the aim of attracting more customer traffic.”

But for airlines, judging when and by how much fares should rise will be a risky decision in the coming months. “They must make sure they do not raise prices to a point where they lose passenger traffic and see their loads suffer,” says Murad.