The Gulf’s airlines are facing up to the challenges of a grim international climate in 2009, and industry observers predict it is only a matter of time before the global downturn takes its toll on the sector.

Globally, long-haul markets suffered most towards the end of 2008, with the number of premium passengers (business and first-class) falling by an average of 12.2 per cent in November, with a 6 per cent drop in the number of economy travellers.

By contrast, the Middle East premium travel sector grew by 10.8 per cent from January to November 2008, compared with the same period in 2007.

Over the past decade, leading Gulf carriers have been pressing ahead with aggressive expansion plans, securing large aircraft financing packages to expand and modernise their fleets, while expanding their global reach and increasing the frequency of flights.

Growth strategies

Dubai-based Emirates Airline has been exploiting its location mid-way between Europe and the Far East as part of the government’s bid to transform Dubai into a global aviation hub.

Following Emirates’ lead, Qatar Airways began a major fleet expansion programme in 2005 and, more recently, Abu Dhabi’s Etihad, which launched in 2003, has poured resources into expanding its fleet and routes.

Emirates has 168 planes on order, worth a total of $58bn at list prices, Abu Dhabi’s Etihad expects to receive 11 new jets this year alone, while Qatar Airways plans to boost its fleet to 110 aircraft by 2013, from its current 65 planes.

While not pursuing the same global aviation hub strategies as Emirates, Etihad and Qatar Airways, smaller, regionally focused airlines, such as Saudi Arabia’s Sama, are leasing new aircraft to meet domestic demand. In January, a new regional carrier, Wataniya, was also launched in Kuwait.

But this impressive growth has been achieved against the background of favourable economic conditions. Strong economies in Western Europe and the US, as well as emerging economies such as India, have translated into strong sales for Middle East airlines, as both tourists and business travellers pass through the hubs of Abu Dhabi, Dubai and Doha. The number of passengers passing through Dubai International airport increased by just over 9 per cent to 37 million in 2008, from 34 million in 2007.

But no Middle East airline is immune from the troubled global economy. “We have not yet seen a major effect on the airlines in the Middle East, but they will feel the impact,” says Simon Marielle, vice-president at Natixis Transport Finance (NTF), a French bank dedicated to aircraft financing.

“They [Gulf airlines] will be affected by the decline in economic activity in other regions. For example, the flow of passengers transiting from Europe to Asia through the Gulf will slow down or even decrease.”

The International Air Transport Association (IATA) says that in December 2008, the volume of passengers in the Middle East was up by 10 per cent on the same month in 2007, yet the revenue from each passenger per kilometre had only risen by 3.9 per cent.

A sharp decline is already apparent in the cargo business, with the volume of cargo carried in the Middle East in December 2008 down by 9.2 per cent on the same period in 2007.

This is not as bad as the global trend, with IATA members’ air cargo business slumping by 22.6 per cent on average over the same period. But banks fear that a gloomy picture will emerge as more company data is published.

“The results we have seen so far from the airlines are not reflecting what is happening right now,” one senior banker tells MEED.

Of course, the positions of Middle East airlines vary considerably from one company to another. Kuwait Airways, for example, has been engaged in a painful overhaul as it prepares for privatisation. Gulf Air is also in the early stages of a recovery programme, having finally become a wholly Bahrain-owned carrier after the withdrawal, over several years, of its other national shareholders ended in 2005.

Saudi Arabian Airlines (Saudia) has an advantage in that it has a large home market and can rely on the pilgrimages to Jeddah. But it has reported a SR1.79bn loss for 2008, which it blames on the failure of 3.61 million passengers – the majority on domestic routes – to show up for their flights even after reconfirming their reservations.

By contrast, Morocco’s Royal Air Maroc has cleverly exploited its Maghreb location to carve out a niche in the Europe-Africa travel market, steadily extending its coverage of destinations across the west and centre of the continent. Despite high fuel prices and increased price competition, the company maintained net profits of MD190m ($22m) in 2008, the same as in 2007.

“Even traditional national carriers can maintain themselves in the face of international competition if they are well run and concentrate on their areas of geographical strength,” an airlines analyst at one leading international investment bank tells MEED.

For Middle East airlines, GCC states remain the key market, and it is their performance in this region that defines them. “We can loosely categorise Gulf airlines into four groups,” says one aviation finance specialist in Dubai.

“There are several carriers that have been growing rapidly, gaining substantial market share and developing solid revenue streams, and which also enjoy the explicit or implicit backing of their governments: Emirates, Qatar Airways and Etihad.”

The analyst says these airlines are viewed as “particularly strong” in financial terms.

Commercial uncertainties

A second grouping of the Gulf’s low-cost carriers, including Air Arabia and Kuwait’s Jazeera Airways, which were established in 2003 and 2005 respectively, have had time to establish a good market presence and customer base.

“The third group [comprises] the more traditional national carriers, such as Kuwait Airways and Gulf Air, which have inherited considerable ‘legacy’ challenges,” says the aviation finance specialist. “[The fourth group is] new companies such as Fly Dubai and Wataniya, which are having to take their first steps against the tough background of today’s difficult business and financial climate.”

The companies that have led the revival of Gulf airlines over the past decade will now have to adapt their strategies to cope with a market that, at the very least, is far less dynamic.

“In just five years, Etihad has grown from a standing start to [having] 42 aircraft, serving 50 destinations and carrying more than 6 million passengers,” James Hogan, chief executive officer of the Abu Dhabi carrier, told delegates at an International Aviation Club conference in Washington on 4 February.

Hogan said Etihad could adapt to today’s conditions and insisted the airline was required to run as a commercial business. “We get no state-funded hand-outs – no help with oil subsidies, for instance, or deeply discounted landing charges at our home airport,” he said. “We hedge fuel. We go to the markets in Europe, as well as to our local banks, to raise money.”

Etihad and Qatar Airways also benefit from the market perception that both are effectively national economic risks, with solid financial backing from the government if needed. Emirates publishes its financial accounts and is known to be a well-managed company. However, the current international economic crisis, and its effect on Dubai as a whole, has raised concerns over the outlook for Emirates.

“Dubai is raising a lot of concern among banks,” one banker who asked to remain anonymous tells MEED. “The crisis might be most sorely felt in Dubai.

“I am sure that Dubai will want to support its airline, but the question is whether Dubai will have the resources to do it, given all the real estate projects that are in trouble. Dubai will have to get Abu Dhabi’s backing.”

Airlines in the Gulf are exposed to two other factors that affect the industry as a whole: the effect of 2008’s huge fluctuations in the cost of fuel, and the as yet unquantifiable impact of the downturn on the availability of new aircraft.

The effect of fluctuating fuel prices has been complicated by airlines’ use of hedging deals to shield themselves from the price rises.

It is thought that as oil prices rose in 2008 – peaking at $147 a barrel in July – some Middle East carriers signed hedging contracts to secure fuel supplies based on crude prices of about $90 a barrel. This seemed sensible at the time.

But in common with many other carriers, they may have been caught out by the subsequent collapse in prices.

Meanwhile, like all airlines, the Gulf’s carriers are exposed to the huge commercial uncertainties created by the state of the leasing market. The vice-president of one major aircraft leasing company says the global economic crisis means many airlines will be unable to finance the planes that are due for delivery this year, and those that do secure financing will have to pay a premium.

“Some airlines may even have to defer aircraft orders because of the slowdown in business or lack of bank financing,” he says.

However, there are still reasons to be positive. “The sector in the Gulf is showing itself to be robust in the current climate, and that is supported by the orders and activity we are seeing,” says Roger Clarke, who heads the aviation practice at UK law firm Trowers & Hamlins.

Trowers has been advising Abu Dhabi-based Waha Leasing on its recent acquisition of an Airbus A330, a plane currently leased to Qatar Airways. “Liquidity is tough out there,” says Clarke. “People are still doing deals, but the Gulf is not immune to the same liquidity issues that we are facing elsewhere.”

In such a difficult operating environment, even the Middle East’s strongest airlines will face major challenges.

“The well-run Gulf carriers do have a genuine competitive advantage because of the region’s strategic location, their access to cheap labour and the modern hub airports that are being developed, particularly at Dubai, Doha and Abu Dhabi,” says one UK aviation analyst. “[But] there may be too many Middle East airlines at the moment.”

There may be room in the market for only two or three major international carriers based in the Gulf. For those airlines without cost-efficient business models, a modern, reliable fleet and the ability to react to changing market conditions with fare offers, the alternative to being a flagship, international Middle East carrier may be to stick to fewer, regional routes.