The Global Battle over Subsidies for Money-Losing Airlines

The US and EU slug it out with the United Arab Emirates and Qatar.

By MC01, a frequent commenter, for WOLF STREET:

In March 2014, EU Transport Commissioner sought a mandate from EU members to open talks with unspecified “Persian Gulf States” over “unfair airline subsidies,” following a formal joint request by the Dutch, French, and German governments. This wasn’t granted until December 2015, when the Transport Commissioner was given a new mandate to “negotiate” with extra-EU governments “suspected” of having airline subsidies in place. And that was about it. Since then no meaningful process has been announced.

In 2015, the three main US airlines, American, Delta and United, presented to the US Senate an investigative report they had commissioned regarding subsidies three Gulf carriers had received from their respective governments: Emirates (United Arab Emirates, or UAE), Etihad (UAE), and Qatar Airways (Qatar). The three airlines and the two governments were held to be in violation of air transport agreements the US government had signed with Qatar in 2001 and with the UAE in 2002. In Article 12, it explicitly targets “prices that are artificially low due to direct or indirect government subsidy or support.”

These agreements have no built-in penalty for violations, but they do authorize one party to demand documentation from the other in case of suspected violations.

While Qatar and the UAE are widely suspected of having released only a small part of documents dealing with airline subsidies, what the Obama Administration eventually obtained, despite a brazen charm and advertisement offensive by Emirates in the US press, was highly illuminating.

For example: The Government of Dubai, part of the UAE and hence a signatory to the 2002 agreement, admitted paying $7.8 billion for the construction of the exclusive Emirates terminal at the Dubai Airport; and the wholly state-owned Investment Corporation of Dubai paid for Emirates’ fuel hedging contracts for years, thus allowing Emirates to shift the savings to their own books and show large profits.

Etihad engaged in what can only be called highly creative accounting up to 2015, including selling its own cargo division to itself in 2014 to show a profit. Given the sums involved and the Etihad corporate structure, the Abu Dhabi government, which, as part of the UAE is signatory of the 2002 air transport agreement, must have been in the know about these accounting methods: Etihad’s board of directors is chaired by Hamed bin Zayed Al Nahyan who also is the director of the state-owned Abu Dhabi Investment Authority and the half-brother of the Emir of Abu Dhabi and UAE president Sheikh Khalifa bin Zayed Al Nahyan.

Once this creative accounting was put under control, Etihad started to book enormous losses: $1.8 billion in 2016 and $1.5 billion in 2017. How these large losses are dealt with remains an open question.

This led to long negotiations between the US government on one side and Qatar and the UAE on the other, which resulted in yet another agreement being signed earlier this year, apparently satisfying all parts involved.

Despite the headlines, tensions had merely been simmering under the surface, and the row exploded again in December 2018 when 11 US Senators reopened the issue of subsidies to Gulf airlines. And this time Italy is the unlikely battleground.

In October 2017, Qatar Airways bought a 49% stake in Italian-based carrier Meridiana. This is the maximum stake any extra-EU investor can hold in an EU-based airline, a measure introduced after Etihad and Qatar Airways aggressively acquired stakes in various European air transport companies in the aftermath of the 2009 financial crisis.

Intriguingly, the remaining 51% of Meridiana is owned by companies that are part of the Aga Khan Fund for Economic Development (AKFED), ultimately controlled by the worldwide leader of the Nizari Ismailites, Aga Khan IV.

In February 2018, Meridiana was renamed Air Italy and given a completely revamped livery. It announced grandiose expansion plans, which were so different from the old pattern of Meridiana activity they immediately attracted widespread attention inside and outside the air transport industry.

This expansion has so far been generously bankrolled by Qatar Airways, which has not merely provided financial support but has also:

  • Transferred a number of their Airbus A330 to the fledging air company to start long haul flights right away.
  • Wet-leased (explanation) a number of their own brand new Boeing 737 MAX to Air Italy at very favorable conditions, with more to come.
  • Seconded many of their flight and cabin crews to help operate the new aircraft.
  • Planned to transfer to Air Italy a number of the 30 Boeing 787-8 Dreamliner that Qatar Airways has on order.

This is not the first time Italian airlines have attracted the attention of Gulf carriers: In 2015 Etihad bought a 49% share in perpetually troubled flag carrier Alitalia, which effectively saved the company from bankruptcy. Just two years later, however, the agreement was terminated as Alitalia slipped into bankruptcy protection anyway and effectively became a ward of the state.

While Emirates, Etihad and Qatar Airways are coming under renewed scrutiny in the US, so far they have dodged similar treatment in the EU, but things may be changing.

The Lufthansa Group and Air France-KLM have constituted an interest group called, “Europeans for Fair Competition,” whose aim is to put pressure on EU authorities to launch a serious investigation into the practices used by the three Gulf airlines to fuel their aggressive expansion plans.

The situation in the EU may be more complicated than in the US, however. The Strasbourg-based European Parliament has little of the power of the US Senate, and Emirates has already made its displeasure known by opting for Boeing aircraft over Airbus in the much anticipated 2017 widebody maxiorder. The issue of how Gulf carriers exert political pressure on foreign governments by shifting aircraft orders around is well known but very little discussed in public.

On top of this, European airlines have so far shown little in the way of the unity of intent displayed by their US rivals. This may be due to the general cutthroat nature of the European air transport market; and due to IAG — the holding group for British Airways, Iberia, Aer Lingus, Vueling, and other companies – which has Qatar Airways among its main shareholders.

Recently Air Italy has started to use the newly arrived Boeing 737 MAX to aggressively expand on internal EU routes (example), which have so far been the preserve of European low cost carriers such as Ryanair and EasyJet, and at a time when US private equity firm Indigo Partners (no relationship with Indian low cost carrier IndiGo) is renewing its commitment to the European market by putting out feelers to add ailing Icelandic carrier WOW Air to their investment portfolio.

This means that the highly favorable environment these three Gulf carriers have enjoyed in Europe so far may be starting to sour. The court-appointed liquidators of Air Berlin, the German low-cost carrier which collapsed so spectacularly in summer 2017,  are seeking between €500 million and €2 billion in damages from Etihad, citing a letter of intent dated April 2017 which promised financial support “for 18 months.” Regardless of the outcome, this will be a nasty and expensive legal battle for both sides, a far cry from the warm welcome Qatar Airways CEO got from the EU Parliament back in May.

With interest rates ticking up and wary investors finally questioning the sanity of taking huge financial risks for very little reward, the air transport industry in Europe is bound for a major and prolonged correction. A necessary part of this correction will be addressing the issue of state aid, both inside and outside the EU, and hopefully come up with the same set of rules for everyone, not the usual “let’s make up the rules as we go” environment we have been forced to endure so far. By MC01, a frequent commenter, for WOLF STREET

Huge aircraft orders, booming traffic, dozens of upstarts with easy mega-funding, fierce competition, already a big collapse, and allegations of shady business. Read… The Wild East: Airlines in South & Southeast Asia

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  24 comments for “The Global Battle over Subsidies for Money-Losing Airlines

  1. Master Baker says:

    According to analyses by a Dubai banker (see link below) the whole UAE and GCC is in the process of rapid economic decline because the trade, finance and real estate parts of the economy are collapsing (causes: dropping oil prices and armed regional conflicts amongst others); and tourism income cannot replace them due to the high prices (dirham is pegged to the USD).

    Etihad is apparently insolvent and had to be rescued by Emirates

    • MC01 says:

      All the Gulf countries bar Saudi Arabia and Kuwait have been pitching themselves very aggressively through Europe: TUI, the largest tour operator by a fair margin, has deals in place with Oman, Qatar and the whole UAE to promote tourism. Prices are ridiculously low, about the same as Egypt if not a little lower, raising some pretty interesting questions on who’s backing this scheme and why.
      It would be hilarious if Doha or Dubai had to deal with the same kind of “tourism” Barcelona and Florence have to deal with though.

      Etihad is not “apparently insolvent”. It’s a cash burning machine on the same level as Tesla: whatever profit they have shown over the years is the result of accounting wizardry. Think Norwegian Air Shuttle, only backed by the Abu Dhabi Investment Authority instead of yield-crazed PE firms and pension funds: it was set up as a money losing-operation from the start, albeit for what reason it remains obscure.

      • Silly Me says:

        Chances are it’s losing money to affiliated parties…

        • MC01 says:

          One of the very first things I’ve learned when dealing with Gulf States (bar Iran) is that the boundaries between “State-owned”, “Government”, “Property of the Ruling Family” and “Property of a Family Closely Allied to the Present Ruler” are incredibly thin, if they exist at all. It’s a different situation from honest State-owned companies that exist to supplement the government budget such as Codelco and Statoil or even cash-burning Wards of the State such as Air India and INCJ.

          Traditionally losses from poor investments, overoptimistic expansion plans or just plain old bad calls have been papered over using cash obtained from both State-owned energy companies such as Aramco and Qatargas and “State-owned” investment funds, but lately Gulf countries have taken to juggling their losses around in an attempt to disguise what part of their economy is productive (hint: it’s not the steel mills Saudi Arabia built over the past four years) and which is not (another hint: it’s not drilling for natural gas).

          While a budget disaster like that experienced by Saudi Arabia under King Saud (who ended up being ousted for his profligacy by his brother Faisal) is unlikely, the whole Gulf region is heading for one major and painful correction: Saudi Arabia has been running budget deficits since FY2012 and their most recent budget assumes to reach budget parity in FY2019 exactly the same average level of oil production as 2018 (10.2 million barrels per month), but at twice the average selling price. How is this to be achieved, we are not told, but maybe buying a few less jetliners and battle tanks would help more than wishful thinking.

  2. MCH says:

    Here you run into the double edged sword. Fair competition for the US and European airlines mean Airbus and Boeing gets to suffer. Don’t like Emirates? Kiss the 777x line goodbye and close down the A380 line now. So, the politicians have a lot to think about, preserve the manufacturing jobs or preserve the service jobs in the airline industry.

    • walter map says:

      “So, the politicians have a lot to think about, preserve the manufacturing jobs or preserve the service jobs in the airline industry.”

      Which is symptomatic of deeper injustices and imbalances, none of which have any chance of resolution. That’s just how commerce rolls, and has always rolled:

      If you can’t do it, fake it, and if you can’t fake it, cheat, and if you can do it, cheat anyway. Jay-sus and Mohammed seem to be on the same page here, although it seems likely they’re just proxies for the almighty Mammon.

      You may be pleased to know that I am reasonably certain that none of this has any obvious relation to the latest Trumper Tantrum, not that I myself would be privy to all the possible devious backchannels.

      When do we get to talk about the increasing shortage of airline pilots? Somehow I can’t imagine Siri or Alexa surrogates being up to the task.

      • MCH says:

        Haha, that’s when they have those unidentifiable drones flying around near your airports. Sorry, can’t take off, danger to air travel… read, we put pilots onto other airport more important than yours.

        As for Trump, too much is attributed to him, the sad part is that even the good policies that were promulagated under his administration by more thoughtful member of his staff are going to get tarred and feathered due to association with him.

    • MC01 says:

      The EU and the US are way past signing renewed air transport agreements: the world has changed a lot in the meantime and new, fair and clear rules are needed.
      Were both on the same side regarding dealing with the Gulf Three, using aircraft orders for political leverage would be a whole lot less effective than it is right now because who’s going to sell them the aircraft? Russia?

      • MCH says:

        This is technically true, there is no one else for the moment but the big three. But neither Boeing nor Airbus management will think long term. The Gulf three knows this better than anyone else, they have the big two by the balls, squeeze even a little, and they’ll go squawking to their respective governments.

        Besides, if the Gulf three suddenly decided to stop buying planes today, they have more than enough to still make life miserable for everyone else. But imaging, now the Gulf three takes things a step further, not only do they cancel their orders with the west, they pour $5B into China for development of wide body. Sure, it’s unrealistic to see delivery for the next five to ten years, but that will literally scare the living daylights out of the big two, and watch their unions ramp up the political pressure on their respective governments. I would guess that Airbus would cave first in that case, but Boeing wouldn’t be far behind.

        Then the bigger question is how much people might consider expanding what would rapidly become a trade war with the Gulf states that supply a good part of the world’s energy. This can blow up really fast if people do stupid things.

        • MC01 says:

          It takes about seven years from the start of a completely new project to first flight these days and usually two more years for the first production aircraft to be introduced in service. That’s a long time, and the sums involved are staggering: You are looking at over $15 billion for the airframe alone without engine development and integration: a narrowbody turbofan is a further $10 billion and the Trent XWB program cost Airbus and Rolls-Royce $15 billion.
          If you think aircraft manufacturers are led by wide-eyed hopefuls or the typical “Dotcom Bubble Computer Dude”, you are in for a surprise. No decision is ever taken without thinking many years into the future.

          Boeing has been vacillating about the provisionally named Yellowstone-1 (Y1) for a decade now: Y1 is the long-awaited aircraft that should replace both the 737 and 757 families. The company simply could not reach a decision because the staggering number of variables they need to consider and I suspect there was a collective sigh of relief when Airbus announced a modestly improved version of the A320 thus “forcing” Boeing’s hand into announcing the 737 MAX.

          And you are much overestimating both China and the Gulf monarchies. In fact I dare to say you are in the realm of pure science fiction…

  3. walter map says:

    Don’t think of it as corrupt industrial policy on the part of oil-exporting nations. Think of it as underhanded, backhanded strategies for achieving economic diversification, insofar as these countries are bound to be in a bad place when their oil runs out and/or becomes obsolete in some Finer Future.

    Fresh cash cows don’t grow on trees, y’know. In due course somebody ought to tell these guys that US airlines have pretty much a lock on more than half the profits from the global airline industry, and there’s little chance of ambitious newcomers changing that. They may be able to overcome initial barriers to entry but profitability is nearly impossible to achieve given the difficulties, and they don’t have an infinite amount of money to throw at it.

    • MC01 says:

      You have to understand that differently from EU companies such as Ryanair and Wizz Air, US air transport companies are very much US-centric: those profits they make chiefly come from the fact the internal US market (Tucson to Detroit, Houston to Las Vegas etc) is both well developed and already mature, meaning the chances of “disruption” are minimal.
      American, Delta and United are not concerned about this market.

      What they are mostly concerned about are their other routes, especially to Europe, where competition was already intense in the 90’s and is now becoming downright cutthroat.
      Emirates has been using the charter called “Freedoms of the Air” to aid more capacity on these routes: they run daily flights from New York to Milan (Airbus A380) and Athens (Boeing 777) and hence to Dubai to maintain the fiction, but in reality they are just seeing how far they can push things before somebody starts making a fuss. The chief reason Emirates picked Milan and Athens over, say, London and Munich, is very simple: Italy’s flag carrier is a terminally ill patient and Greece’s was liquidated years ago. Less people that can make a fuss.
      Air Italy should be seen again in that contest and the recent angry rebuffal by Qatar Airways executives on the matter tells me I am right on the matter.

  4. carlito says:

    Another clear indication that globalizing without tariffs works very well for the billionaire owners (Ryan air and al) but in the end destroys the service and jobs of the locals in the first world.
    It’s been the agenda for 40 years and the result is ever expanding wealth gaps and pervasive un/underemployment for the masses. With a giant underclass barely escaping slavery, even with 1/2/3 jobs.
    The result has also been a burgeoning middle class in the third world.
    The dilemna for politicians, who either belong or at paid by the billionaire owner class is whether their allegiance is to their masters or their electorate ( I will neglect here the minute upper middle class that benefit greatly from the game).
    The irony is that the subsidies to the industries go straight to the pockets of the rich, while being paid by the masses of the poor.
    Socialism in essence, for what it really is, if you study it carefully.

    • MC01 says:

      A little bit of history here: the base of the present legal frame for air travel was set in 1944 at the Convention on International Civil Aviation in Chicago which went into effect in 1947. Nobody had even heard the word “globalization” then and the chief reason for this convention was to allay fears the British and US air transport industries would come to dominate the world after the war by using their political leverage to force both their weaker allies and the defeated Axis powers to sign favorable bilateral agreements. In short the same set of rules for everybody who had signed the dotted line.

      Sorry then, no sinister conspiracy by hooded figures here, unless the Viscount Swinton had a secret passion for LARPing as a necromancer.

      • carlito says:

        Globalization is today’s word for dumping/slave labor/unfair advantage/free to exploit etc.
        Nobody had heard it because it wasn’t used. You’re making a semantic point. Not a conceptual one.
        Gee I can’t even understand the words that you use in the last paragraph. Maybe it’s just me.
        Doesn’t matter.
        My point stands.
        Merry Christmas.

        • MC01 says:

          Inside joke: Viscount Swinton was the delegate for the British Empire at the Chicago Convention. Basically the only name I remember from the list because he later went on to become the Minister of Civil Aviation.
          He was a pretty uptight character.

          LARP means Live Action Role Playing: basically people who dress up as paladins, elves and wizards and play role games such as Dungeons and Dragons by walking around in the woods or abandoned houses. I became acquainted with the term when I learned a group of students were using a series of abandoned maintenance tunnels to LARP.

          Now imagine an uptight British peer c.1945 dressing up as a necromancer and going around his estate with his friends pretending to command an army of the undead. Personally I find it histerical.

          And merry Christmas to you as well.

  5. raxadian says:

    Airlines arw as far as everyone is the business has told me, a money sink. It would be way shorter to list the airlines that are actually making profit (real orofit not just borrowing money and or have the state help them) that the vast mayority that are sitting ducks being gunned down by blind hunters. Sooner or later the blind hunters get lucky shots.

  6. Ptb says:

    Bring it into balance by giving the home team equivalent subsidies. All great, other than you’re basically funneling tax $ or € into a product purchased mainly by the relatively well off. Oh and the carbon output too, not that anyone gives a flip.

  7. Javert Chip says:

    Wow! Holy crap: the US government actually negotiated a kick-ass airline agreement with no (aka zero, nyet, zippo, nada) penalties.

    Other than the fabulous hotels, beautiful city and great food, why did the US government dudes even bother to go to the UAE?

  8. Tyson Bryan says:

    The UAE dirham was officially linked in 1978 to the special drawing rights of the International Monetary Fund; in practice, however, the UAE dirham was pegged to the United States dollar. The rate of Dh3.67 to US$1 has held constant since the end of 1980. The Central Bank’s responsibilities include issuing currency, maintaining gold and foreign currency reserves, regulating banks, and controlling credit to encourage balanced economic growth. Balanced economic growth? If your central bank sets policy that somehow makes it possible to frack oil at a loss, you may as well set policy to provide air service at a loss also. If the passenger jets fly at half occupancy, that gives your planes twice the air hours per passenger mile. This also doubles CO2 emissions per passenger mile as an added collateral benefit / damage. Without spelling out the ultimate policy objective, we notice the global CO2 ppm keeps climbing steadily & relentlessly higher. Military air fuel consumption adds further CO2 to no apparent constructive end.

    • Julian says:

      A country like the UAE can’t continue to hold a peg with the US Dollar. That is madness. The peg will snap at some point in the near future.

      • Tyson Bryan says:

        The dirham is denominated in USD petrodollars. Petrodollars are denominated in barrels of oil. The US and the rest of the planet are transitioning to a more generic e-dollar (energy dollar) (or KWH). The further transition ongoing, is to the d-dollar (data dollar) which is based on data speed, or how fast your credit ledger refreshes. The credit data being refreshed may be fiat or fake, but if your data is more liquid (faster) or higher resonance than anyone else’s, then you own the ledger of final reference. The dynamo humms.

  9. Nicko2 says:

    I used to get seat sales Cairo>Dubai>JFK Business for around $1600 return in low season. For that sweet price, you get to ride a shiny A380, open bar, champagne, and the best fold-out bed.

    Qatar is still the clear leader, with superior service and prices (killer seat sales in the Gulf/MENA region – Qatar also has a separate business/first class terminal in Doha, complete with spa…….perhaps that’s why Saudi/UAE/others ganged up on little Qatar with the regional air embargo. Of course, Qatar has an endless supply of LNG dollars, they are riding out the storm. Still miss flying their dreamliners. —- plus they stocked better quality bubbly.

    The point is, let the oil sheiks battle it out establishing a foothold in the ‘post-oil’ economy, the 500 million strong and growing middle class in the MENA region (and over 1 billion in Africa) benefit – but woe to the legacy NA and EU carriers.

  10. BDL -Med says:

    As an expat US over-seas, Id rather fly any good, major foreign airline than US carriers. They are patently terrible. Happy to see them suffer. They can all rot along with others like Ryan Air etc. Nicko2 above says it best.

    Try service with a smile and stop nitpicking the passenger with absurd rules, lack of service and charges for even breathing. Dont miss them at all. Long live Emirates and others. Delta and the rest go away. Like flying in a rat trap.

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