Cabin pressure

In May, Silverjet became the third business class-only carrier to suspend operations within the last six months.
Maxjet Airways ceased operations in December last year as fuel prices soared - leaving jets on tarmacs.
Maxjet Airways ceased operations in December last year as fuel prices soared - leaving jets on tarmacs.
SILVERJET: The airline grounded jets for good in May.
SILVERJET: The airline grounded jets for good in May.


When Silverjet suspended its operations in May, it became the third business class-only carrier to close within the last six months. With fuel costs soaring and heavily subsidised competition, the Gulf's non-state-owned airlines could be next to face turbulent times.

While the news might have come as a shock to hundreds of passengers left stranded in New York, London and Dubai, analysts weren't so surprised when business class-only carrier Silverjet suspended its operations two months ago.

Like Maxjet Airways and Eos, the business class-only airline collapsed within the last six months, crippled by soaring fuel prices and reduced consumer confidence. Now the budget airlines of the Middle East are facing mounting cost pressure as they struggle to compete with state-supported carriers.


The global aviation industry is braced for at least US$2.3 billion losses this year if the price of crude oil remains at current levels, with analysts particularly concerned about the Middle East's low-cost carriers.

"A large part of the budget airlines passenger segment is much more price sensitive," says Brian Pearce, chief economist for the International Air Transport Association (IATA). "If budget airlines try to recover the increase in fuel costs they are going to lose more passengers. Fuel also makes up a much larger proportion of their costs than for network airlines."

Silverjet launched routes between London and New York in January 2007, adding its London-Dubai route in November amid great fanfare. It offered a unique selling point: a ticket on an all-business class carrier for two thirds cheaper than a traditional carrier's business-class seat.

Despite the offer, Silverjet struggled from the start. During its first year the carrier's market value plunged from US$155 million to US$21 million. In January alone shares plunged 28% after a broker gave the airline a "0 pence" valuation, saying it was "likely to fail".

In November, property tycoons David and Simon Reuben agreed to loan the airline US$19.4 million, convertible into shares. However, the brothers later declined to convert the loan, blaming market conditions. "Having seen the other two airlines in this category fail already, it looked increasingly like the writing was on the wall for Silverjet," says John Strickland, director of the aviation specialist company, JLS Consulting.

The carrier fought to the last, and just two months ago Hunt assured reporters that Silverjet would survive. The CEO thought he had secured a US$8.4 million loan facility from Abu Dhabi-based investment house Viceroy Holdings, which would secure the carrier's immediate future.

However, the deal never materialised and Silverjet suspended its operations. It entered administration, forcing disappointed customers to seek refunds from their credit card or travel companies.

"The airline business is a very risky, low-margin business, so you have to spread your revenue sources," says Paul Griffiths, former executive director of Virgin Atlantic and current CEO of Dubai Airports. "When you get a carrier that is purely basing its revenues on a fairly narrow sector of the market, then it is even more exposed to variances in that market without any cushion.

"Because of the huge cutback in the banking sector and the dire straits that the economies of the US and Europe are now in, unfortunately Silverjet was exposed to extremely weak markets where it just couldn't sustain the level of revenue required in order to offset the increase in the cost of fuel."

The cyclical nature of air travel also served to clip Silverjet's wings. It is widely accepted that the business class market is particularly time and day-of-the-week sensitive - demand for business class services drops dramatically mid-week and Saturdays.

Without a strong economy to counterbalance infrequent demand, Silverjet and its peers were left vulnerable to tickets sales variations that were rarely influenced by price. Indeed, the airline discovered that several two-for-one deals and special offers launched in this year failed to improve the carrier's prospects.

For most analysts, Middle East budget carriers operating at the opposite end of the air travel market are exposed to similar risks. "Budget airlines are at completely the other end of the spectrum because they rely on high load factors, and variable prices to get those high load factors," Griffiths says.

"The budget airline business model is far more resilient than the business class-only model, but whether it'll be resilient enough to make the whole thing work, we'll have to see."

There are six low-cost carriers operating from bases across the GCC, including Jazeera Airways, Bahrain Air and Air Arabia. While low-cost carriers still only account for 2% of passengers in the Middle East, the industry is booming and airlines are adding more scheduled flights to cope with demand.

However, Hemant Patel, a senior aviation analyst at Indian financial services firm Enam Securities, warns that budget carriers are particularly prone to fuel price fluctuations. Moreover, price increases are likely to hit passenger numbers among expatriates from the Indian Subcontinent, a key demographic within the Gulf.

"Budget airlines will be very much affected by rising oil costs because they are targeting customers which are in the value segment and are extremely price sensitive," he says. "Those looking at a budget airline will think about deferring travel plans if the cost of travel is going to be very heavy, and will take fewer trips in a year."

According to Lehman Brothers, crude oil prices have risen from US$100 per barrel to US$148 since the start of Q2 2008 - a huge increase from the average $73 price last year. "We saw the cost of oil rise to US$126 billion for the airline industry last year, which is just under 30% of airlines' operating costs," IATA's Pearce says.

According to IATA, for every dollar that crude oil rises, the industry's costs increase US$1.6 billion. It predicts $6.1 billion losses this year if oil prices remain at US$135 a barrel. The aviation body also recently revised its industry financial forecast for 2008 to US$2.3 billion losses - a US$6.8 billion swing from the previously-forecast industry profit of US$4.5 billion based on a US$86 average oil price.

"Our fleet plans are constantly under review because of the fuel issue," says Sama's Andrew Cowen. The Riyadh-based carrier's CEO adds: "The market has great potential and we intend to have a very significant share of that market, and to be a significant player. However, unless we see compensatory cost reductions elsewhere, oil at US$135 makes a lot more destinations more marginal.

"Fuel represents about 35% to 40% of our costs - and we are a low-fares airline that relies on large volumes of passengers, each one of whom represents quite a small profit - so fuel going up by even a little can wipe out your profits on a whole swathe of routes."

Sama, which launched in March 2007 and operates to 23 destinations, was founded by Investment Enterprises Ltd, chaired by HRH Prince Bandar Bin Khalid al Faisal. Its initial investors number 30 major Saudi private and institutional funders, including Olayan Financial Co and Xenel Industries Ltd. But while the shareholder group is prestigious, Sama hasn't been able to count on the Saudi government's unqualified support - to its considerable cost.

"[State-owned carrier] Saudia gets an 80% discount on fuel which we don't get," Cowen says. "That is not a level playing field and we're really pressing the policy decision-makers to really resolve that manifest unfairness. Our shareholders are saying, and quite rightly so, that this is not right."

Sama is under further pressure due to Saudi Arabia's air fare cap, which limits the price airlines can charge for domestic flights within the kingdom. Flight prices remain while costs continue to rise. To make matters worse, Sama's state-owned competition pays 80% less for its fuel.

"We can't compensate for [the price cap] with heavily discounted fuel, so our submission to the government has been that this needs to be addressed - both the fare cap and the disparity on fuel," Cowen says. "Everything is not just about Saudia; they need to look at the other guys and stop protecting the flagship carrier."

Industry figures admit preferential treatment is common across the Gulf, with nations trying to build state-owned carriers in response to increased competition. But gaining a competitive advantage isn't restricted to fuel subsidiaries.


Handling, catering and other services are monopolised at most of the Middle East's airports, further driving up costs for non-government carriers, while civil aviation authorities jealously guard their airspace.

"We can fly all over the Levant, but we can't fly to Dubai because the civil aviation authority won't let us," Cowen says. "It is protectionism from the different civil aviation authorities in the region. Why keep protecting the state carriers, when it just results in higher fares and average quality? What has an airline like Emirates got to fear from us?"

By contrast, Sama has much to fear from Emirates. In March, the Dubai carrier announced plans to establish its own low-cost service, which will fly across the Gulf and probably hold good relations with the region's civil aviation authorities. FlyDubai, as it has now been named, will start its operations next year.

Likewise, Qatar Airways is working on a low-cost service, while Saudia has also said it will launch a budget service in Sama's own backyard.

"It used to be the case that state-owned carriers could treat the budget carrier model as a fad, something that would go away," Cowen says.

"Now you can see that's demonstrably not the case - if you've got 30% market share in Europe, the United States and South East Asia, then carriers like Emirates Airline and Qatar Airways are recognising that what has happened elsewhere is likely to happen here."

It can be argued that the budget carrier model may not be a fad, but if the Gulf's privately-owned low-cost airlines are unable to withstand soaring fuel costs and heavily-subsidised competition, they face joining Silverjet, whose existence was as fleeting as its flight times.

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