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Saturday, February 26, 2011

New Aircraft Financing Rules Set To Unfold

During the years in which Emirates has grown from an important regional carrier to a worldwide powerhouse, rivals have often claimed—with modest proof—that the airline merely has benefited from a range of special privileges and circumstances. Soon the accusers will have the opportunity to test their hypothesis as one of those supposed perks—cheap export financing for aircraft—goes by the wayside. And judging from Emirates’ reaction, this perk, like most of the others, appears to count for less than meets the eye.
“Export credit agency (ECA) financing accounts for only about 20% of our fleet,” says Emirates President Tim Clark. The carrier has raised about $22 billion to purchase aircraft from the commercial markets and is exploring new sources, including Islamic financing. “ECA financing is a last resort for us because it tends to be more expensive,” Clark says.
And it became even more expensive as the Organization for Economic Cooperation and Development (OECD) formally adopted new rules on export credit financing on Feb. 25. The new Aircraft Sector Understanding (ASU) will mitigate the so-called “home market rule,” which made airlines from the U.S. and the Airbus-producing countries of the U.K., France, Germany and Spain ineligible for financing from the Export-Import Bank of the United States or European export credit support agencies.
Airlines from these countries contend the home-market rule tilted the playing field toward competitors not subject to the rule and allowed successful airlines like Emirates and other Persian Gulf carriers access to ECA financing. “We are at a total disadvantage and have appealed to the OECD, the European Commission and the German government to end this unprecedented advantage for airlines from these countries,” says Thomas Kropp, senior vice president for international relations and government affairs at Lufthansa.
To allay some of these concerns, the new ASU does not eliminate the home-market rule but uses a formula based on an airline’s credit rating to determine whether it can be eligible for cheaper financing. These new rules will make it considerably more expensive for carriers like Emirates to use ECA support, while preserving access to more favorable financing for airlines from less-affluent countries, explains Scott Scherer, senior vice president for strategic regulatory policy at the Boeing Capital Corp. “The new rules go some way toward leveling the playing field for both airlines and manufacturers,” he says.
Although Emirates’ Clark dismisses the importance of ECA financing for the airline, he notes European and North American airlines that lobbied their governments to push for the OECD rule change have long been claiming Emirates benefits from unfair advantages. These have included allegations that the carrier gets subsidized fuel from the government of Dubai and does not pay fees at its home airport, charges Lufthansa’s Kropp backed away from as “impossible to prove.”
“A group of airlines, mainly European, have used every trick in the book to try and contain us,” says Clark.
This protectionist impulse is extending to landing rights, particularly in two countries, Germany and Canada. Emirates has sought access to the Berlin market but has been denied. Germany, under the terms of its air service agreement with the United Arab Emirates (UAE), allows each airline from the region to serve four cities in Germany with unlimited frequency or capacity.
Lufthansa says the current agreement meets consumer demand for travel between Germany and the UAE. Emirates currently flies to Frankfurt, Munich, Dusseldorf and Hamburg with a total of 49 flights per week. Lufthansa operates 14 weekly flights to Dubai. “If Emirates requests to exchange one of these four destinations with Berlin, they would find no opposition,” says Lufthansa’s Kropp. “Qatar Airlines has chosen to cut service to another city in order to serve Berlin,” he notes.
In Canada, the situation has escalated to a trade dispute. The bilateral air service agreement between Canada and the UAE allows Etihad Airways and Emirates to operate three flights a week to Canada; both have chosen to serve Toronto. Emirates wants to serve other cities in Canada, including Vancouver and Calgary, without giving up any of its Toronto service.
Negotiations hit a fever pitch last fall when the closure of Camp Mirage, a military base in the UAE used to support Canadian forces in Afghanistan, was linked to the air services talks. “Canada could not accept that a commercial request for landing rights was linked to use of Camp Mirage,” says Melissa Lantsman, speaking for Canadian Foreign Minister Lawrence Cannon. “What the UAE was offering in exchange was not in the best interests of Canada.”
Canada’s transport ministry argues that the Canada-UAE market is well-served by the current agreement. “The rights under the current Canada-UAE air transport agreement meet the market demands of travelers whose origin and destination is either Canada or the UAE,” says Transport Canada official Maryse Durette.
And this could be the rub. “Few Canadians actually travel to Dubai as a destination and even fewer residents of Dubai travel to Canada,” says Air Canada CEO Calin Rovinescu, adding that further liberalization could result in “the UAE dumping seats into the Canadian market.” Even Robert Crandall, former chairman of American Airlines, calls this protection of the market “wise public policy on the part of Canada.”
“Canada is worried that it will be little more than a spoke to hubs in the UAE,” says William Swelbar, an economist in the Massachusetts Institute of Technology’s Department of Aeronautics and Astronautics. Swelbar likens the challenge posed by Emirates to the battle between network airlines and low-cost carriers in the U.S. in the 1990s. “Emirates is taking advantage of its low costs and geography to force incumbents either to cut costs and get efficient or go out of business,” he argues.
Emirates’ cost advantage is partly attributable to the lower operating costs of a younger fleet, but also to lower labor costs. Deutsche Bank estimates that personnel costs at Emirates are 16% of total expenses, compared with 33% at Air France-KLM, 24% at British Airways and 22% at Lufthansa. Yet, adjusted operating margins at Emirates are 5.7%, comparing favorably with its European peers, says analyst Michael Linenberg.
But concerns that North American and European carriers could be run out of the sky by Emirates are overblown, according to a report by the Royal Bank of Scotland. Dubai’s geography gives it an advantage in traffic to South Asia from North America, as well as between North Asia and Africa. European carriers, however, have the geographical advantage for traffic between Europe and China, and the Europe-India market is well developed, notes RBS analyst Andrew Lobbenberg.
Ultimately, it boils down to fending off competition at all costs, says Clark. “Protecting domestic markets simply does not make sense in the 21st century,” he says. “We’ve been hearing these allegations for the last 18 years, but there’s plenty of flying out there for everyone, and we’re not going away.”

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