Middle East carriers drop fares to lure passengers

Since hitting an all-time peak of $147 in July of last year, oil prices have tumbled to below $35 in recent weeks, bringing at least some measure of relief to carriers that were struggling to cope with the enormous fuel costs that were impacting their bottom line.

Unfortunately, one of the main reasons for the price plunge has been the deepening of the financial crisis, which means travel budgets are also likely to take a severe hit.

The dramatic speed and scope of the changes that the aviation industry has witnessed over the past year has made experts cautious about predicting the extent of the downturn in the industry.

'No one knows how bad it's going to get or how long it is going to last,' says Bill McKnight, Associate Director, A.T. Kearney Middle East.

'Anyone who thinks that they can predict which airlines are going to make it and which ones aren't over the next 12 months either has a magical crystal ball or they just like to hear themselves talk.'

McKnight believes we are likely to see a fairly sustained period of depressed traffic and revenue throughout the world, including the Middle East, which will create a dilemma for carriers.

'Right now the industry is extremely reluctant to raise prices, and at the same time it is not at all clear that lowering prices through sales and promotions and so forth are going to do much to stimulate demand in this kind of environment either,' he said.

Removal of surcharges

He noted that a number of carriers have lowered or removed some of their fuel charges that they had in place. 'But that was almost what I would call a necessary step because those price increases were put in place specifically to cover the extraordinary increases in fuel prices that the carriers suffered last year,' he said.

Airlines are also considering cutting back on routes, but this creates a whole new set of problems. 'You have this extremely expensive asset (the airplane) sitting around, and you probably can't get rid of it, because in many instances airlines lease their equipment, and the lessors are not going to take the airplane back. So you are going to have to keep making the substantial monthly lease payments.

'Then you are stuck with your pilots. What do you do with them? Most pilots are in unions, so that means you have to lay off the most junior guys. But the seniority bumps all the way through the system and you end up having to retrain a lot of pilots. And then when the economy begins to turn around you have to go out and either rehire or retrain all these people again.'

'So shrinking your way into profitability in this business is quite difficult,' he said.

Fare cuts take hold

Faced with the economic downturn and the fact that January and February typically are slow travel months, airlines have little choice but to offer discounts, said Rahul Rao, Sales Manager at Al Tayer travel in Dubai.

'Almost every airline is offering discounted rates, and the rates they are offering are the lowest we have seen in seven or eight years, especially in business class,' he said.

Indeed, Emirates, the largest carrier in the region, offered major discounts on business-class travel from Dubai to London, with fares as low as Dhs7,430 ($2,022). Under the offer, fares were 30% lower than what the carrier charged a month ago, and Dhs8,600 less than comparable Abu Dhabi-London business class flights from Etihad Airways.

Etihad is also offering discounts, with fares as low as Dhs350 through its 'Gottogo New Year Super Savers' promotion, and Jazeera Airways recently offered passengers one-way fares for just KD10 ($35), including all taxes and fees.

Other carriers in the region that have announced fare discounts include Egypt Air and Saudi Airlines.

Carriers have had to quickly adapt to a whole new set of challenges, said Kareem Murad, Transportation Lead Analyst at Shuaa Capital. 'A couple of months ago we were looking at the impact of fuel prices on the profitability of airlines. Today, with the global financial crisis, what we must focus on more closely is the demand side of the business,' he said.

Murad believes that we will see a shift in traffic from conventional airlines to low-cost carriers because of the high price elasticity of demand for the aviation industry. 'Historically, during a crisis, we see the load factor for conventional traffic dip and traffic for low-cost carriers rise,' he noted.

Meanwhile, in the longer term, there is likely to be more consolidation in the Middle East, particularly acquisitions of companies that are going through tough times. 'But for the next few months, everyone will be just sticking it out and keeping their cash just in case', he said.

Pressure on balance sheets

McKnight conversely believes that the airlines that will perform better during the crisis are not necessarily the low-cost airlines, but rather the ones that are in a stronger financial position.

'The financial crisis is going to put a lot of pressure on the balance sheets of some of these companies,' he said.

With a greater focus on their balance sheets, airlines are also likely to think twice about adding to their fleets. 'Any responsible airline management team is clearly going to have to take a look at their order books and make some pretty hard decisions about whether to take the airplanes on the schedule they have in place or whether they need to defer some of those orders,' he said.

Usually carriers can work with manufacturers to defer orders, but if carriers on a global basis are all trying to do the same thing, that is going to make it a much more difficult process. One carrier in the region that has benefited from the delay in orders is Gulf Air.

The airline ordered planes last year but was told that delivery of the aircraft would be delayed because other carriers had orders from several years before that were still being fulfilled. However, because of some deliveries being deferred by other carriers, Gulf Air has been able to advance delivery of some of their airplanes up to this year from 2011 and 2012, McKnight said.

Asked if we are likely to see a spike in mergers, McKnight said the greatest obstacle to mergers in the Gulf is that each of the large carriers is an instrument of their local government.

'In my mind it's hard to see these national airlines merging, but what you might see is some of the larger airlines in the Gulf looking beyond this region and forming alliances, partnerships, or code equity positions on a more global basis to strengthen their worldwide networks,' he said.