Commercial aviation in international markets has never come under the disciplines of the World Trade Organization (WTO). It is instead loosely governed under a system of bilateral and sometimes regional “Open Skies” agreements which embody rules establishing mutually beneficial rights for services between signatory countries. The U.S. has over 120 separate agreements which generally promote flexibility in setting schedules, fares and capacity between the parties. They require non-discriminatory treatment of carriers in the markets of each participant. Most agreements require that each party provide a fair and equal opportunity to compete on generally accepted commercial terms for both landing rights and associated support services such as financing and provision of airports and ground transport. The most important exception to the functioning of this system comes from the large and growing competition from subsidized carriers in the Gulf states of Qatar and the United Arab Emirates.
While the history of commercial aviation in its early years was dominated by state-owned (and often subsidized) carriers, in the last three decades the industry has moved toward a private sector model. Open Skies agreements have proliferated since 1992 in response to this new model and accommodate the huge growth in traffic. The commitment to use generally accepted commercial terms is the only effective check on government subsidies in the absence of WTO rules.
The biggest outliers to this model, although not the only ones, are the three Middle East-based carriers: Emirates, Etihad and Qatar airlines. Since the mid-1980s Emirates has become the world’s largest carrier in terms of capacity, and along with the others is rapidly taking market share from traditional carriers in the U.S., Europe, Australia, and Hong Kong, to name a few of the hardest hit. The U.S. lost six percent of its total international market share after 2007. Its market share declined from 48 percent to seven percent in travel to and from the Middle East. Massive subsidies approaching $50 billion to the oil-rich Middle East carriers have fueled this growth.
In late 2017 and early 2018 the U.S. State Department signed memoranda of understanding (MOUs) with the United Arab Emirates and Qatar under Article 15 of their respective Open Skies agreements to “seek disciplines on subsidies, transparency and state-owned enterprises.” High level support by the U.S. government was signaled by the presence of both then-Secretary of Defense Jim Mattis and then-Secretary of State Rex Tillerson at the signing ceremony for the Qatari MOU.
While the evidence is not yet clear regarding a major rollback of subsidies under the MOUs, the new transparency requirements have allowed documentation of a major breach on the part of Qatar. In late 2017 Qatar bought a 49 percent stake in bankrupt Italian domestic airline Meridiana. The majority stake was retained by the Aga Khan Charitable Foundation. Meridiana was soon rebranded as Air Italy and its aging fleet of 11 Boeing 767s began to be retired and replaced by its new Qatar Airlines investor with Boeing 737 MAX and Airbus A330s. This would allow expansion of the previously short-haul domestic dominated carrier to major international routes. There is no evidence of how Air Italy is to pay for this massive transfer worth billions of dollars from the Qatar order-book to modernize its fleet.
There is however evidence that at least $30 million of the initial Qatar Airways injection into the holding company for Air Italy has been forgiven by the Middle East airline company. Additionally, Qatar Airways received a $491 million cash injection from the government of Qatar in 2018 partially to offset its operating loss that year and to facilitate the continued aid to Air Italy. Finally, Qatar Airways guaranteed a $30 million loan to Air Italy from HSBC, which carried a 2.5 percent rate of interest. Another $28.8 million loan from the parent holding company to Air Italy carried the same coupon rate. Such favorable loan terms could never have been approved for a startup just emerging from bankruptcy without backing from a larger and more stable firm. The Aga Khan majority owner has provided no fresh cash or loans to assist the new entity, and all major operating leaders of Air Italy came from Qatar Airways, indicating fairly clearly that the latter is in firm control.
The heavy subsidization of this small but growing airline is of concern for two principal reasons: it is in breach of the 2018 MOU with the U.S. and it threatens in the long run the ability of U.S. carriers to compete in major parts of the normally lucrative transatlantic markets. U.S. carriers have already seen their share of this market fall from 42 percent in 2005 to 34 percent in recent years. After righting their performance in the last three years, the three major U.S. carriers are building new capacity in an effort to reclaim lost share in the transatlantic market.
The clear target of Air Italy is to expand as a competitor in transatlantic routes to Italy, and it appears to be doing so at highly subsidized rates. I noted earlier the acquisition of a new fleet of long-haul equipment by Air Italy. Starting in 2018 and expanding this year, this new entity is using the international hub of Milan to offer direct flights to New York, Miami, San Francisco and Los Angeles, and has announced service to Chicago starting next year. Even offering new direct flights from Europe to the U.S. violates an understanding the American side asserted as part of the 2018 MOU. According to U.S. officials the parties to the MOU are barred from initiating new flights from third countries such as Italy. Additionally, the prices offered in a three-week test period this spring for these routes appear designed to win market share at the risk of losing money, a practice called dumping under WTO rules. Average fares for the four cities served by Air Italy averaged 28 percent less than those of competitors (which include Emirates Airways in the New York-Milan route) and fully 60 percent in the normally more profitable business class submarket. I did searches on the Air Italy website on June 10 and July 2 and found the following prices for round trip economy fares:
San Francisco-Milan: $618
Los Angeles-Milan: $593
New York-Milan: $545
Air Italy has announced its intention to eventually offer direct service to Rome. A one-stop (Milan) connection from Miami to Rome was priced at $383 for flights last spring and $440 for fall flights.
While financial reporting for the Italian carrier is not transparent enough (another violation of the MOU) to estimate the actual cost for these flights, it is difficult to imagine such prices allow for a market-based profit. Air Italy has announced plans to quadruple its flights by 2022 as it acquires new aircraft, escalating the pressures on U.S. and European airlines, which have lost one-third of their market share to Asia partially as a result of competition from the subsidized Mideast carriers.
There will be some who will not lament displacement of U.S. and European airlines from important international routes, especially price hungry consumers in search of even lower fares (and narrower seats). But tens of thousands of U.S. workers and suppliers will bear the brunt of subsidized competition from the deep pockets of the oil sheikdoms. Having a large domestic aircraft fleet is certainly important to U.S. transportation needs in times of conflict or emergency, especially given the demise of the U.S. commercial naval fleet and defense transport fleet. Trying to maintain a global trading system based on clear rules for transparency, fair play on a commercial basis, and reciprocity is also an important reason for pursuing Qatari violations of the spirit and letter of the 2018 MOU.
Qatari Emir Sheik Tamin bin Hamad al-Thani will visit President Trump and other senior officials in Washington on July 9. This offers a timely opportunity to raise the issues arising from poor implementation of Qatari commitments from the MOU. The circumvention of this understanding represented by the Air Italy expansion should be at the center of the discussions.