Squeezed by the fast-growing state carriers in the UAE and Qatar on one side and budget airlines on the other, Riyadh is looking to transform its aviation sector. Central to this plan is turning flag carrier

Saudi Arabian Airlines (Saudia) into a brand able to compete with the best in the region, as well as sprucing up its transport infrastructure and opening up the sector to outside operators.

It is a tough challenge. Many of the country’s airports are in a poor state of repair, a situation that the General Authority of Civil Aviation (Gaca) is attempting to redress with major airport expansion initiatives. This includes a public-private partnership (PPP) to overhaul Medina International airport.

There is also a move to make the ticket pricing system more competitive and to incentivise investment in better services, by removing the price cap on domestic ticket sales.

Aviation revamp in Saudi Arabia

After many years of inaction, there appears to be a concerted effort to revamp Saudi Arabia’s aviation sector. The question is whether it is too late to play catch up in a highly competitive regional market that is being driven by ambitious rivals Qatar Airways, Emirates and Etihad.

Riyadh thinks not. Late last year, after the death of Crown Prince Sultan bin Abdul-aziz, who combined the roles of defence and civil aviation minister, King Abdullah bin Abdulaziz al-Saud announced a significant reorganisation of the aviation sector. A royal decree ordered the establishment of an independent civil aviation authority, with its head also in charge of the board of Saudia. The move was an indication that Riyadh wanted to quicken the pace of privatisation of the carrier.  

It really seems to be a focus of the government as every single airport is being refurbished right now

Project financier at Saudi bank

In January, this was followed by a significant fundraising exercise by Gaca. The aviation body closed a SR15bn ($4bn) sukuk (Islamic  bond) to help underwrite the SR27bn funding of its Jeddah airport redevelopment. The King Abdulaziz International Airport is being expanded to increase the airport’s annual passenger capacity from 13 million to 30 million.

Further funds will be made available to rehabilitate smaller domestic airports, as well as international hubs. In October 2011, Gaca awarded a PPP contract to redevelop Medina airport to a consortium led by Turkey’s TAV Airport Holding Company. The project involves using private support to help Gaca handle the rising number of pilgrims arriving at the airport. The financing package for the $1.5bn project is to be agreed by early June.

Gaca has also invited bids for a mid-June deadline for a project management contract to expand Riyadh’s King Khalid International airport, to cater to an expected capacity increase from 14 million passengers to 24 million.

All this activity means Gaca is dominating the Saudi projects market this year, say local bankers. With airport expansion schemes being funded on both engineering, procurement and construction projects and private partnerships, there is a wealth of financings waiting to be arranged.

“It really seems to be a focus of the government as every single airport is being refurbished right now,” says a project financier at a major Saudi bank.

“They are in an awful state so it’s about time. But the real reason is that it’s a big country and the government is keen to bring the various parts of the country closer together.”

Open competition for Saudi Arabia’s airlines

Revamping dilapidated airport infrastructure is only one part of the equation. Equally important is making the aviation sector a more compelling investment prospect.

Despite the improvements in operational performance, Saudia continues to lose money on ticket prices that are well below other Gulf states. Passenger numbers grew 17 per cent year-on-year on domestic flights to 1.057 million in February.

Saudia’s ongoing failure to keep pace with Qatar Airways and Emirates is a source of embarrassment for the kingdom, the GCC’s largest economy.  

There is also frustration at its inability to provide a level of service to domestic and international passengers on a par with its neighbours. However, this is likely to change as plans are under way to open the kingdom’s aviation sector to new operators beyond the two incumbents, Saudia and private budget carrier Nas Air. Debt laden Sama Air closed down last year.

A Gaca spokesman says that 15 companies have bid to take up licences to operate local and international services, with a final deadline of late August set for proposals.

Although Gaca is aiming to increase the level of competition, there is still a long way to go. Some analysts question whether Saudia and Nas Air are ready for competition when they themselves are not making money.

Aviation strategy in Saudi Arabia

The opening up to non-Saudi operators may be undone by apathy, since many potential operators are focused on growing their own networks rather than feeding off a domestic or regional operation in another country.

Things are going in the right direction, but Riyadh’s decision to open up the licences represents a reactive, rather than pro-active move, says Saj Ahmad, chief analyst at the UK’s StrategicAero Research.

“The Saudis have seen what’s going on in Qatar and the UAE, but it may be too late to be doing this now. If you look at the licences that were up for grabs in Saudi Arabia, you’d have expected at least the likes of Qatar Airways or FlyDubai to want to have a secondary base in one of biggest Middle Eastern markets where there are only two carriers,” he says.

Despite the end of its monopoly in 2007, Saudia still controls about 90 per cent of domestic traffic and 84 per cent of international traffic in the kingdom, according to the Centre of Asia Pacific Aviation. Making inroads into the company’s significant market share would be difficult for new operators even of the pedigree of Qatar’s flag carrier.

The Saudis have seen what’s on going in Qatar and the UAE, but it may be too late to be doing this now

Saj Ahmad, StrategicAero Research

The state airline is also not quite ready to give up ground to its competitors just yet. Saudia is undergoing a four-year turnaround programme, due to be completed in 2013. This involves a strategic refit of its route network, a fleet modernisation with more Airbus A320s and plans for buying the 787 Dreamliner, alongside the ongoing overhaul of the kingdom’s aviation infrastructure.

Saudia is also becoming more ambitious. In 2011, it became the first GCC carrier to bid to join the 15-member SkyTeam alliance, one of three global airline alliances. Its formal accession was imminent at the time of going to press.

Once a member, Saudia would be connected into a worldwide network, enabling it to offer new daily services between destinations such as Paris and Riyadh. The prospect of joining the likes of Air France and Delta was the reason the Saudi carrier decided to upgrade its fleet in the past couple of years. Saudia also signed a code share arrangement with Air France in January 2011.

Nonetheless, the SkyTeam alliance will still prove challenging for Saudia if it finds traffic being filtered off through the partner networks to destinations that it does not serve.

“There will be pressure on them to further integrate code share operations and to launch services to new destinations,” says Ahmad. Ultimately, he says, it could involve greater expenditure commitments, but not necessarily more revenues. There is no guarantee that new routes equal decent load factors.

Riyadh also needs to do more to overhaul its regulatory framework that has hindered the operations of Saudia and its smaller rivals, in particular, the price cap. The rule restricts operators from charging flights above pre-determined levels and which fail to adequately reflect increases in fuel prices.

Gaca director-general Khalid al-Molhem has lobbied hard for pricing reform, supported strongly by Nas Air. Despite this, there is still no sign of imminent tariff changes that would underscore the commercial case for investing in new aircraft and better services.

“They haven’t given a real sense of pricing freedom for the airlines that operate there,” says Ahmad. “They are still red-taped and bottlenecked by what they can and can’t do and it doesn’t give them the flexibility to compete with Emirates and Etihad, which are expanding at such a frenetic rate.”

Without substantial reforms in the regulatory framework, there is little likelihood of any pickup in the slow pace of privatisation for Saudia first mooted 12 years ago, but still very much a work in progress.

Momentum lacking

The official relaunch of the privatisation process in 2006 envisaged the airline’s break up into six units: catering; cargo; maintenance; airlines; flight academy; and ground handling. Each was to be sold individually later via an initial public offering (IPO).

Saudia’s cargo operation has been sold, with 30 per cent now owned by Tarabut Air Freight Service, while the ground handling services unit was merged last year with National Handling Services and Attar Travel Company.

The sale of its catering unit is still awaited, but the sluggish pace of the IPO market in the Gulf in 2012 suggests that this is likely to be delayed.

Some effort is being expended on top-down reform in preparation for privatisation. The royal decree in November 2011, appointing Prince Fahd bin Abdullah bin Mohammed to head up Gaca with a clear brief to steer the privatisation of the state carrier, at least suggests an ambition to accelerate the process

All things being equal, Saudia would make a strong candidate for privatisation. The problem is not in its management, rather that it is hindered by government regulation. The Saudi flag carrier does not have a free hand to change prices or to buy and sell aircraft and launch new routes, as its regional competitors do.

Without an injection of momentum into the reform process, the danger is that it could end up marginalised as Kuwait Airways or Gulf Air have been in recent years.

In that case, no matter how many 787s or A380s are on its books, it will matter little if it lacks a network capable of supporting long-term growth.