How China’s Civil Aviation Handles Huge Losses
Civil Aviation in Early Years
After the founding of the People’s Republic of China in 1949, China’s civil aviation industry initiated in 1950 had only 12 flight routes to nine cities in five countries and transported 10,400 passengers every year.
To manage all non-military aviation in the country The General Administration of Civil Aviation of China (CAAC) was formed on November 2, 1949. It was initially managed by the People's Liberation Army Air Force, but was transferred to the direct control of the State Council in 1980. In 1987 the airline was divided up into a few airline named after the region where they had their hubs.
CAAC as an airline
CAAC emerged as an international airline operator following a 1980 instruction by Deng Xiaoping to begin planning for civil flights. On March 5, CAAC formed an airline operation division with offices in Beijing, Shanghai, Guangzhou, Chengdu, Lanzhou (later moved to Xi'an) and Shenyang.
In 1987, the aviation regulation division and the airline operation division were separated, and the airline division further divided into Air China (which inherited the IATA and ICAO code of the original CAAC), China Eastern Airlines, China Southern Airlines, China Northwest Airlines, China Northern Airlines and China Southwest Airlines, each named after the geographic region of the location of their headquarters and main operation areas.
CAAC used the IATA code CA on international flights only; domestic flights were not prefixed with the airline code.
Current Status of the Air Transport Sector
From 1978 to 2004, the total turnover, passenger transportation volume and cargo transportation volume of China’s civil aviation industry (excluding Hong Kong, Macao and Taiwan) increased at an annual average rate of 18.2%, 16.5% and 15.6% respectively, twice as fast as the world average. In 2004, the total turnover, passenger transportation volume and cargo transportation volume reached 23.1 billion ton-kilometer, 121 million person-times and 27.67 billion tons.
In the ranking of the total turnover volume of regular flights of civil aviation in China (excluding Hong Kong, Macao and Taiwan) in the signatory states of the International Civil Aviation Organization (ICAO), China rose from a 37th place in 1978 to 3rd place in 2004. Also in the same year, China was elected Class I councilor of ICAO for the first time.
China’s air transport sector has been undergoing rapid growth during the past 20 years and is expected to peak in the next decade. In 2006, the first year to implement the "11th Five-Year Plan", China civil aviation saw a fairly good start, continued its fast developing momentum that had been gained at the end of the "10th Five-Year Plan". The total air traffic, passenger traffic and cargo and mail traffic carried by the whole industry in the whole year hit 30.58 billion ton-km, 159.678 million people and 3.493 million tons, increasing by 17.0%, 15.5% and 13.9% respectively over that of the previous year. Air passenger traffic has been growing 16% annually between 1958 and 2002.
In 2006 all the civil airports open to traffic handled a total of 332 million passengers, a 16.7% increase over that of the previous year and 7.532 million tons of cargo and mail, a 19.0% increase. 7 airports handled more than 10 million passengers each with Beijing Capital Airport handling 48.748 million passengers and becoming one of the ten leading airports in the world. The total number of regular flight routes reached 1336 at the end of the year, covering a route mileage of 2.1135 million kms (unrepeated calculation). These flights served 140 cities at home (Hong Kong and Macao not included) and 91 cities in 42 foreign countries, and 37 mainland cities had air connections with Hong Kong and 5 with Macao. By the end of the year, 135 aircraft had been added, bringing to 998 in total the fleet of transport aircraft for the whole industry. The average daily utilization of registered aircraft was 9.48 hours, an increase of 0.1 hour over that of the previous year, the average regular flight passenger load factor was 73.5% and that of flight load factor was 65.7%, representing increases of 2.0% and 0.7% respectively.
The main targets for the civil aviation in 2007 are: the whole industry will carry a total air traffic of 34.8 billion ton-km, 187 million passengers and 3.85 million tons of cargo and mail, representing increases of 15%, 16%, and 12% respectively over those in 2006. The operation hours of general aviation will see an increase of about 10% over that of the previous year. The total investment in fixed assets will be 26 billion yuan.
Nonetheless, it is estimated that only 5% of the Chinese population has flown on an airplane. China is expected to soon become the largest Asian market and leading hub for air passenger traffic including international cargo traffic and is expected to overtake Japan’s recent leading position. It is forecasted that the air transport volume is expected to reach 3 0 billion ton kilometers by 2010 with passenger and cargo & mail traffic of 140 million passengers and 4.7 million tons.
Airfare Pricing Policy.
The PRC Civil Aviation Law provides that airfares for domestic routes are determined jointly by the CAAC and the agency of the State Council responsible for price control, primarily based upon average airline operating costs and market conditions. From February 1999 to March 2001, all domestic airlines were required to adhere to unified domestic airfares published by the CAAC from time to time and discounted sales were prohibited. In 2001, the CAAC gradually relaxed its control over domestic airfare pricing and, effective March 1, 2001, domestic airlines were permitted to offer discounts on several major domestic routes.
On March 17, 2004, China’s State Council approved the Pricing Reform Plan for the Domestic Civil Aviation Industry, or the Pricing Reform Plan, effective April 20, 2004. Pursuant to the Pricing Reform Plan, the governmental authorities responsible for price control no longer directly set the airfares for domestic routes, but indirectly control the airfares for domestic routes by setting basic airfare levels and permitted ranges within which the actual fares charged by Chinese airlines can deviate from such basic airfare levels. Chinese airlines are able to set their own airfares for their domestic routes within the permitted ranges and adopt more flexible sales policies to promote their services.
The CAAC and the National Development and Reform Commission, or NDRC, jointly publish the pricing guidelines from time to time, which set forth the basic airfare levels and permitted ranges. Pursuant to the current pricing guidelines, the basic airfares for domestic routes are the published airfares implemented by Chinese airlines immediately prior to the approval of the Pricing Reform Plan (the average basic airfare for domestic routes is RMB0.75 per passenger-kilometer). Except for certain domestic routes, the actual airfare set by each Chinese airline for its domestic routes cannot be 25% higher and 45% lower than the basic airfare. Domestic routes that are not subject to the deviation range restrictions include short-haul routes between cities in the same province or autonomous region, or between a municipality and adjacent provinces, autonomous regions or another municipality. Certain tourist routes and routes served by only one Chinese airline are not subject to the bottom range restriction. The CAAC and the NDRC announce the routes that is not subject to the deviation range restrictions through the airfare information system known as Airtis.net. Chinese airlines can apply to the CAAC and the NDRC for exemption from the bottom range restriction for a particular route. Chinese airlines are also required to file the actual airfare they set for their domestic routes within the ranges through Airtis.net 30 days prior to its implementation.
The CAAC and the NDRC regularly review the average operating costs of Chinese airlines, and may adjust the basic airfare for particular domestic routes, which, in their view, is not at a reasonable level.
Under the PRC Civil Aviation Law, maximum airfares on Hong Kong and international routes are set in accordance with the terms of the air services agreements pursuant to which these routes are operated. In the absence of an air services agreement, airfares are set by the airlines themselves or by the CAAC with reference to comparable market prices, taking into account the international airfare standards established through the coordination of the International Air Transport Association, which organizes periodic air traffic conferences for the purpose of coordinating international airfares. Discounts are permitted on Hong Kong and international routes. For the airline industry in China as a whole, the airfare per kilometer is substantially higher for Hong Kong and international routes than for domestic routes.
Acquisition of Aircraft and Spare Parts
Most Chinese airlines are required to purchase their aircraft, aircraft spare parts and other aviation equipment through the China Aviation Supplies Import & Export Group Corporation, or the CASC Group, an entity controlled by the CAAC. If a Chinese airline plans to acquire an aircraft, the airline must first seek approval from the CAAC and NDRC and must, as a condition of approval, provide specific acquisition plans, which are subject to modification by the CAAC and NDRC. If approval of an aircraft acquisition is obtained, the airline negotiates the terms of the acquisition with the manufacturer together with the CASC Group because the CASC Group possesses the license required to import or export aircraft and is entitled to receive a commission.
Domestic Fuel Supply and Pricing.
The Civil Aviation Oil Supply Company, or CAOSC, which is controlled by the CAAC, is currently the dominant civil aviation fuel supply company in China. The PRC Government determines the fuel price at which the CAOSC acquires fuel from domestic suppliers and the CAAC issues a guidance price. The retail price at which the CAOSC resells fuel to airline customers is set within a specified range based on this guidance price.
Chinese Airport Policy
Prior to September 2003, all civilian airports in China were operated directly by the CAAC or by provincial or municipal governments. In September 2003, as part of the restructuring of the aviation industry in China, the CAAC handed over 93 civilian airports to provincial or municipal governments. The CAAC retained the authority to determine the take-off and landing charges, as well as charges on airlines for the use of airports and airport services. Prior to 2004, Chinese airlines were generally required to collect from their passengers on behalf of the CAAC a levy for contribution to the civil aviation infrastructure fund, which was used for improving China’s civilian airport facilities. Our revenue for the previous years is shown net of this levy. In 2003, the levy was 5% of domestic airfares and 2% of international airfares. The levy was waived by the CAAC from May 1, 2003 to December 31, 2003. With effect from September 2004, the civil aviation infrastructure levies, now paid to the Ministry of Finance, have been reflected in the ticket prices of Chinese airlines rather than collected as a separate levy.
Foreign Investment in Civil Aviation
Fields of Investment: The field of foreign investment in civil aviation includes civil airport, public aviation transportation enterprises, general aviation enterprises and the projects related to aviation. Foreign investors are forbidden from investing in and managing air traffic control systems.
Forms of Investment: 1 The foreign investors can invest in the civil aviation industry in the form of Sino-foreign equity joint venture and Sino-foreign cooperative joint venture, or by the purchase of shares issued overseas by civil aviation enterprises or other approved investment forms.
2 Specific regulations:
(1) The foreigner investing in the public aviation transportation and the general aviation enterprises engaged in the flight for business, aerial sightseeing or for the purpose of industrial service by form of Sino-foreign cooperative joint venture, the qualification of Chinese legal person must be obtained.
(2) When investing in the public aviation transportation companies and civil airports, under the same conditions, the enterprises with advanced management and operation system will be preferred.
(3) Chinese party shall be the majority shareholders when foreigners investing in the civil airports.
(4) When foreigners investing in public aviation transportation enterprises, Chinese party shall be the majority shareholder and the proportion of shares of a single foreign investor shall not exceed 25% (including its affiliated enterprises);
(5) When investing in the general aviation enterprises engaged in the flight for business, aerial sightseeing or for the purpose of industrial service, Chinese party shall be the majority shareholder; while when investing in the general aviation enterprises in the fields of agriculture, forestry and fishing, the proportion of foreign investment should be negotiated by both Chinese and foreign parties.
(6) When investing in the fields of aircraft repair (having the obligation of contracting business of international repair market) and aviation petrol, Chinese party shall be the majority shareholder; in the projects of freight transportation and storage, ground service, aviation food, parking lots and etc., the proportion of foreign investment should be negotiated by both Chinese and foreign parties.
(7) The management term of jointly operated enterprises with foreign investment should not exceed 30 years.
Principles and Conditions for Verification and Approval: 1. Foreign Investors are encouraged for the construction and operation of civil airport, not including the airfield for both civil and military usage. The foreign-investing civil airport is classified into two items:
(a) Flying areas of civil airports, including the runway, taxiway, connecting apron, parking apron, and flight assisting light;
(b) Terminal buildings.
2. Foreign Investors can invest in the existing public aviation transportation enterprises; in the general aviation enterprises engaging in agriculture, forestry and fishery operations. They are allowed to invest in the general aviation enterprises engaged in the flight for business, aerial sightseeing or for the purpose of industrial service.
3. The aviation and transportation related projects includes air fuel, the aircrafts repair, the freight transportation and storage, the ground service, aviation food, parking lots and other approved items.
Regulatory Framework
The General Administration of Civil Aviation of China (CAAC) is a ministry-level organ, which is responsible for the national civil aviation affairs and functions under directly under the State Council. CAAC is authorized by the Civil Aviation Law Of People’s Republic Of China to “enforce the unified supervision and regulation on the civil aviation activities of the whole country, and to issue regulations and decisions concerning civil aviation activities within its jurisdiction. CAAC is responsible for safety administration, market regulation, air traffic management, macro-control, and international cooperation, including drafting laws and regulations on airline industry regulation, formulating rules and policies for the industrial regulation and standards for civil aviation safety and technology, carrying out the safety supervision on civil aviation activities according to Civil Aviation Law and other laws, regulations and standards for safety and technology, ensuring flight safety and security, presiding over and participating in investigations into serious flight accidents, administrating and supervising air transport market and maintaining fair competition, conducting air traffic management, guaranteeing chartered flights, working out overall plan for the industrial development, carrying out macro-control of the civil aviation industry, representing the country in dealing with civil aviation affairs involving foreign countries, and undertaking other tasks assigned by the Party Central Committee and the State Council.
Under the CAAC, there are 7 regional administrations, which is responsible for the administration and supervision on the civil aviation affairs within their respective regions. They are: CAAC Northern Regional Administration, CAAC Northeast Regional Administration, CAAC Eastern Regional Administration, CAAC Central South Regional Administration, CAAC Southwest Regional Administration, CAAC Northwest Regional Administration, and Urumqi Regional Administration of CAAC. The regional administrations are department-level organs.
The CAAC regional administrations have 26 CAAC Safety Supervision Offices (SSMO), which represent the regional administrations and are in charge of safety supervision and market regulation of civil aviation enterprises like airlines and airports within their respective regions. The 26 CAAC SSMOs are located in Tianjin, Hebei, Shanxi, Inner Mongolia, Heilongjiang, Jilin, Dalian, Jiangsu, Zhejiang, Anhui, Fujian, Jiangxi, Shandong, Xiamen, Henan, Hubei, Hunan, Hainan, Guangxi, Shenzhen, Chongqing, Guizhou, Yunnan, Gansu, Ningxia and Qinghai.
Responsibilities of the CAAC
1. Studying and putting forward the guiding principles, policies and strategies for the development of civil aviation industry, drafting civil aviation laws and regulations and supervising its implementation, promoting and guiding the structural reform of civil aviation industry and the corporate reform;
2. Drawing out plans for civil aviation industry’s medium and long term development, carrying out macro-control over the industry, and responsible for comprehensive statistics and informatization of the whole industry;
3. Formulating policies, rules and regulations to ensure civil aviation safety, supervising and administrating the flight safety and ground safety, formulating the criteria for accidents and incidents, and investigating and handling aircraft accidents as provided;
4. Formulating civil aviation flight standards and administrative rules and regulations, carrying out operational certification and continuous supervision and inspection on civil aircraft operators, responsible for the management of credentials for civil aviation pilots and flight dispatchers, examining and approving the flight procedures and minimum operation requirements for airports, and taking charge of the civil aviation sanitary tasks;
5. Formulating the standards and rules and regulations on aircraft airworthiness administration, taking charge of aircraft type certification, production licensing, airworthiness certification, nationality registration, maintenance licensing and qualification regulation of maintenance personnel and ensuring such supervision and inspection are carried out in a continuous manner;
6. Formulating the standards, rules and regulations on the civil aviation air traffic management, drawing out the civil aviation airspace plans, responsible for the construction and management of civil air routes, air traffic management and air traffic controllers’ qualification regulation, and administrating the civil aviation navigation communication, aeronautical information and aeronautical meteorology;
7. Formulating standards, rules and regulations for airport construction and safe operation, supervising the airport construction and safe operation, examining and approving the general airport plans, issuing certificates to airports, carrying out industrial regulation on airport airfield, environmental protection and airport-occupied land;
8. Formulating standards and regulations for civil aviation security, administrating civil aviation security, supervising, inspecting, preventing and dealing with hijacking and aircraft explosion, providing guidance on the handling of major unlawful interference incidents affecting civil aviation safety, administrating and guiding airport security check, public security, firefighting and rescue and relief work;
9. Formulating policies, rules and regulations for air transport and general aviation, regulating air transport and general aviation market, issuing operation permits to civil aviation enterprises, organizing and coordinating important transport tasks;
10. Studying and putting forward pricing policy and economic regulation measures for civil aviation industry, monitoring the economic benefits of civil aviation industry, managing relevant budget funds, examining and approving the applications of enterprises for purchasing and leasing civil aircraft, studying and putting forward industry salary policy, regulating and providing guidance on wage policies of entities affiliated to the CAAC;
11. Leading the various administrations in different regions, autonomous regions and municipalities and regulating civil aviation related institutions and colleges, supervising cadres within the extent as provided, organizing and providing guidance on training and education;
12. Representing the country in handling civil aviation affairs involving foreign countries, responsible for negotiating and signing Air Service Agreements with foreign countries and supervising their implementation, safeguarding the national aviation interests, taking part in the ICAO activities and inter-governmental organizations as well as multilateral activities concerning civil aviation affairs, and handling civil aviation affairs involving Hong Kong, Macau and Taiwan;
13. Responsible for strengthening the Party and masses relationship and the ideological work;
Performance of Selected Airlines
There are currently approximately 14 passenger airlines operating in China. All of these airlines operate under the regulatory supervision of the CAAC. In July 2005, the CAAC introduced new rules to further open the civil aviation industry to domestic investors, including private-sector investors, which may result in the establishment of more new Chinese airlines and create more competition. China Eastern Airlines, Air China Limited, or Air China, which is based in Beijing and listed on the Hong Kong Stock Exchange and the London Stock Exchange, and China Southern Airlines Company Limited, or China Southern, which is based in Guangzhou and listed on the Hong Kong Stock Exchange and the New York Stock Exchange, are the three leading air carriers in China, both in terms of revenue tonne-kilometers and size of operations. Each of these three airlines operates at least 400 routes and has a fleet of at least 200 jet aircraft. As of December 31, 2006, China Eastern Airlines, Air China and China Southern accounted for 23.0%, 28.8% and 26.3%, respectively, of the total commercial air traffic (as measured in tonne-kilometers) handled by Chinese airlines.
Air China
Air China is the People's Republic of China's state owned and second-largest commercial airline after China Southern Airlines. It is the flag carrier and the only airline to fly the PRC national flag on its entire fleet. Its logo consists of a phoenix in the form of the abbreviation VIP, and "Air China" in both English and Chinese, which was autographed by Deng Xiaoping. It operates 4,945 flights each week worldwide and is also the 18th largest airline in the world by fleet size (216, including cargo and 72 orders).
Air China's main hubs are Beijing Capital International Airport, Chengdu Shuangliu International Airport and Shanghai Pudong International Airport, with other focus cities at Hangzhou Xiaoshan International Airport, Chongqing Jiangbei International Airport, Tianjin Binhai International Airport and Hohhot Baita International Airport. Out of all Asian airlines, Air China currently flies to approximately 120 destinations; the most destinations from its own Beijing Hub. It also serves the most destinations out of all Asian airlines.
The airline flew 33.97 million passengers in 2006, with a passenger load factor of 75.9%. In the same year, it made a profit of 2.7 billion yuan, with an operating revenue of 44.9 billion yuan and total expenses standing at 42.4 billion yuan.
Air China Limited is currently the world's largest carrier by market capitalisation. It overtook Singapore Airlines in 2007. It is the 4th largest airline in Asia, 5th largest in the world in terms of Domestic cargo traffic and 18th largest airline in the world by terms of fleet size.
Air China was established and started operations on July 1, 1988. Formerly the Beijing-based international carrier division of Civil Aviation Administration of China (CAAC), it was renamed in 1988, when the government decided to split the operating divisions of CAAC into separate airlines, each with its own name. At first dependent on Soviet aviation technology, by the 1980s the Chinese were fielding fleets of modern Western jets as they began to compete with Western airlines on international routes.
Difficulty adapting to new marketplace competition and a series of accidents between 1979 and 1983 created pressure for the organization to change. The CAAC was reorganized in late 1984, producing the following four regional divisions: Eastern, Southern, Southwestern, and Northwestern. Air China, based in Beijing, was given chief responsibility for intercontinental flights, and took over the CAAC's long haul aircraft (Boeing 747s, 767s, and 707s, as well as medium-haul 737s) and routes when it was granted its autonomy on July 1, 1988. Because of the commercial importance of Guangzhou (formerly Canton), China Southern was also cleared for international flights, along with Shanghai-based China Eastern.
At its launch in 1988, Air China operated 32 international routes to 31 destinations, and also connected 30 cities within China. It was China's largest carrier, and the only one allowed to carry China's national flag. In 1989, Air China posted a net profit of $106 million on revenues of $383 million. (The carrier had 6,000 employees at the time.) In that same year, Air China entered a joint venture with Lufthansa German Airlines, which provided 40 percent of the capital, or $220 million, to create the Beijing Aircraft Maintenance Center (Ameco Beijing). It specialized in the upkeep of the Boeing aircraft that comprised Air China's fleet. The venture was expanded with another $218 million in 1992. Ameco Beijing employed nearly 4,000 people, a little fewer than 50 of them from Lufthansa. Air Transport World reported the company preferred to source its needs through joint ventures due to the country's lack of hard currency. Its Beijing Air Catering was 40 percent owned by a large Hong Kong caterer.
Operating revenues for Air China were $1.05 billion in 1994, producing a net income of $36 million. Further deregulation of the aviation business took place in 1994, enabling foreign investment in airports and facilitating the import of aircraft built outside mainland China. By 1996 the country had 108 airports with scheduled airline services and around 30 different airlines. In 1997, the airline reported sales of $1.38 billion. The fleet had grown to 65 aircraft and the carrier was flying 144 routes overall. By October 1997, Air China was planning a public stock offering. China Eastern Airlines and China Southern Airlines had listed on the Hong Kong and New York exchanges earlier in the year. Air China delayed plans based due to poor financial performance and a downturn in business caused by the Asian financial crisis. About 16 million passengers flew Air China in 1998.
Rumours of a state-prompted merger between Air China and China Southern Airlines abounded in 1999. By this time, China Southern, based in the commercial centre of Guangzhou, had become the country's largest carrier. At the time, China had 30 airlines, and Beijing wanted to group them into several, more globally competitive units. Altogether, mainland airlines lost more than ¥6 billion in 1998.
The October 1999 opening of a new terminal (Beijing Hub) at Beijing Capital International Airport, where Air China operated the vast majority of flights, promised not only to relieve travellers of cramped conditions but also to allow Air China to devote more resources to its lucrative ground handling business for international carriers. One-fifth of Air China's 15,000 employees worked in ground handling.
Although the Chinese aviation industry as a whole was expected to earn $120 million in profits in 1999, Air China and other individual airlines were struggling to break even and mitigate their collective losses of 1998, which totaled $300 million. Air China was not publicly traded and was not quite as open with its own sales figures as China Eastern and China Southern.
Early in 2000, Air China teamed with China National Aviation Co. Group (CNAC), the CAAC's Hong Kong-listed commercial arm, to establish a Hong Kong branch (95% owned by Air China). Direct flights to London from Hong Kong soon began. Air China faced competition at its home base from Air France, which increased its four flights a week to Beijing, begun in 1997, to daily service. British Airways also wanted to increase its frequencies (it was operating 18 flights a week to China).
In mid-2000, the CAAC repeated earlier calls for a consolidation of the ten airlines it controlled into three. (Air China, China Southern, and China Eastern were to each acquire the smaller airlines.) Apart from the ten CAAC airlines, there were another 24 smaller carriers that had been formed by provincial or private interests.) Price wars had proved so destructive that the government banned discounting. However, no deadlines or plans for financial support for ailing carriers were made. To aggravate the airlines' financial troubles, the CAAC blocked a proposed merger in September 2000 between Air China and China Southern on anti-competitive grounds.
In January 2001, the CAAC's ten airlines announced they had agreed on a merger plan. Air China was to acquire China Southwest Airlines and China International Airlines, the country's fourth strongest domestic airline. This was to create a group with assets of ¥56 billion (HK$ 52.5 billion), including 118 aircraft. On October 28, 2002, Air China consolidated with China National Aviation Corporation and China Southwest Airlines.
During 2004 as part of a consolidation of the Chinese aviation industry, Air China absorbed Zhejiang Airlines (a subsidiary of CNAC). On 15 December 2004 the company listed its shares on the Hong Kong and London Stock Exchanges. Air China has shareholdings in Air China Cargo (51%), Air Macau (51%) and also holds majority shares of Shandong Airlines.
In March 2005, Air China was in talks with Swire Group, the largest shareholder of Cathay Pacific, for talks with Air China acquiring Cathay Pacific, and Cathay Pacific acquiring a majority stake of Dragonair. In return, the Swire Group would become the largest individual shareholder of Air China's parent company. Both airlines subsequently announced that the airlines will not merge completely in the foreseeable future, and Swire expressed its commitment in remaining as the largest shareholder of Cathay Pacific. It was also announced that Air China would cooperate with Cathay Pacific by codesharing flights in late 2005, and would partner with Asia Miles in the second-half of 2005.
As of January 2005, Air China is owned by China National Aviation Holding Company (CNAH) (69%), public floatation (21%) and Cathay Pacific (10%). On May 22, 2006, Air China signed an agreement with Lufthansa and was officially invited to join Star Alliance, a rival airline alliance of Oneworld, of which Cathay Pacific is a member. A few days later on June 9, 2006, a joint announcement revealed a new shareholding structure in which Air China will acquire a 17.5% stake in Cathay Pacific, while the latter will own 20% of the former. Air China is scheduled to join Star Alliance on December 12, 2007.
Meanwhile, Air China is aiming to become a super airline by considering acquiring a stake or full ownership of China Eastern Airlines, which has had its shares go down in recent years. Other airlines bidding to acquire China Eastern are Singapore Airlines and Cathay Pacific.
Financial Performance
For fiscal year ending December, 2006:
Sales: $5,747.4M
One year growth: 21.1%
Net income: $422.7M
Income growth: 38.1%
China Eastern Airlines Corporation Ltd.
China Eastern Airlines is an airline based in Shanghai, China. It is a major Chinese airline operating international, domestic and regional routes. Its main base is Shanghai Pudong International Airport, with a hub at Shanghai Hongqiao International Airport. It currently doesn't belong to an airline alliance
The airline was established on June 25, 1988 on the basis of the CAAC Huadong Administration. In 1997, China Eastern took over loss-making China General Aviation and also became the country's first airline to offer shares on the international market. It founded China Cargo Airlines in a joint venture with COSCO in 1998. In March 2001 it completed the takeover of Air Great Wall. China Yunnan Airlines and China Northwest Airlines merged into China Eastern Airlines in 2002.
China Eastern Airlines is owned by the Chinese government (61.64%), publicly held H shares (32.19%) and publicly held A shares (6.17%), and has 29,746 employees (as of March 2007).[1] It had only 16,435 employees in January 2005. After receiving an approval from the State Council of China, it was announced that on September 2, 2007 Singapore Airlines and Temasek Holdings (holding company which owns 55% of Singapore Airlines) would jointly acquire shares of China Eastern Airlines. On November 9, 2007 Singapore Airlines and Temasek Holdings signed a final agreement to buy a combined 24% stake in China Eastern Airlines: Singapore Airlines will own 15.73% and Temasek Holdings - 8.27% stake in the airline.
As of December 31, 2006, CEA had a fleet of 205 aircraft, including 182 jet passenger aircraft that have more than 100 seats and 12 jet freighters.
Financial Performance
A perusal of financial data shows that the airline has been incurring losses for four of the last five years. The losses have been mounting every year; in 2006 it went up by over 2000 RMB over that of 2005. Physical performance in terms of revenue tonne kilometres
Key Financial Data
|
|
| Year Ended December 31, |
| |||||||||||||
|
|
| 2002 |
| 2003 |
| 2004 |
| 2005 |
| 2006 |
| |||||
|
|
| RMB |
| RMB |
| RMB |
| RMB |
| RMB |
| |||||
|
|
| (in millions, except per share or per ADS data) |
| |||||||||||||
| Consolidated Income Statements Data: |
|
|
|
|
|
|
|
|
|
|
| |||||
| Revenues |
|
| 13,332 |
|
| 14,470 |
|
| 21,386 |
|
| 27,454 |
|
| 37,489 |
|
| Other operating income |
|
| 63 |
|
| 50 |
|
| 85 |
|
| 245 |
|
| 424 |
|
| Operating expenses |
|
| (12,350 | ) |
| (14,454 | ) |
| (20,239 | ) |
| (27,685 | ) |
| (40,905 | ) |
| Operating profit (loss) |
|
| 1,045 |
|
| 66 |
|
| 1,232 |
|
| 14 |
|
| (2,991 | ) |
| Finance costs, net |
|
| (777 | ) |
| (775 | ) |
| (641 | ) |
| (578 | ) |
| (757 | ) |
| Profit (loss) before income tax |
|
| 235 |
|
| (741 | ) |
| 586 |
|
| (577 | ) |
| (3,616 | ) |
| Profit (loss) attributable to equity holders |
|
| (365 | ) |
| (1,391 | ) |
| 459 |
|
| (1,383 | ) |
| (3,661 | ) |
| Basic and fully diluted earnings (loss) per share |
|
| (0.08 | ) |
| (0.29 | ) |
| 0.09 |
|
| (0.28 | ) |
| (0.75 | ) |
| Basic and fully diluted earnings (loss) per ADS |
|
| (7.51 | ) |
| (28.59 | ) |
| 9.43 |
|
| (28.42 | ) |
| (75.22 | ) |
Source: Company Annual Report
Selected Operating Data
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|
| Year Ended December 31, |
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|
|
| 2002 |
| 2003 |
| 2004 |
| 2005 |
| 2006 |
| |||||
| Selected Airline Operating Data: |
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|
|
|
| |||||
| Capacity: |
|
|
|
|
|
|
|
|
|
|
| |||||
| ATK (millions) |
|
| 4,366.6 |
|
| 4,774.5 |
|
| 7,071.2 |
|
| 8,751.5 |
|
| 11,065.6 |
|
| ASK (millions) |
|
| 27,962.5 |
|
| 29,780.0 |
|
| 41,599.1 |
|
| 52,427.9 |
|
| 70,468.3 |
|
| AFTK (millions) |
|
| 1,850.0 |
|
| 2,094.3 |
|
| 3,327.3 |
|
| 4,033.0 |
|
| 4,723.4 |
|
| Traffic: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Revenue passenger-kilometres (millions) |
|
| 18,206.4 |
|
| 18,002.7 |
|
| 27,580.8 |
|
| 36,380.6 |
|
| 50,271.9 |
|
| Revenue tonne-kilometres (millions) |
|
| 2,652.2 |
|
| 2,907.7 |
|
| 4,340.7 |
|
| 5,395.2 |
|
| 6,931.0 |
|
| Revenue passenger tonne-kilometres (millions) |
|
| 1,629.2 |
|
| 1,611.1 |
|
| 2,466.0 |
|
| 3,243.7 |
|
| 4,487.0 |
|
| Revenue freight tonne-kilometres (millions) |
|
| 1,023.0 |
|
| 1,296.6 |
|
| 1,874.7 |
|
| 2,151.5 |
|
| 2,444.0 |
|
| Kilometres flown (millions) |
|
| 158.8 |
|
| 176.5 |
|
| 242.8 |
|
| 287.7 |
|
| 434.6 |
|
| Hours flown (thousands) |
|
| 234.6 |
|
| 259.4 |
|
| 360.4 |
|
| 467.8 |
|
| 678.3 |
|
| Number of passengers carried (thousands) |
|
| 11,533.1 |
|
| 12,040.2 |
|
| 17,711.0 |
|
| 24,290.5 |
|
| 35,039.7 |
|
| Weight of cargo carried (millions of kilograms) |
|
| 344.7 |
|
| 459.8 |
|
| 663.6 |
|
| 775.5 |
|
| 893.2 |
|
| Average distance flown (kilometres per passenger) |
|
| 1,578.6 |
|
| 1,495.2 |
|
| 1,557.3 |
|
| 1,497.7 |
|
| 1,434.7 |
|
| Load Factor: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Overall load factor (%) |
|
| 60.7 |
|
| 60.9 |
|
| 61.4 |
|
| 61.7 |
|
| 62.6 |
|
| Passenger load factor (%) |
|
| 65.1 |
|
| 60.5 |
|
| 66.3 |
|
| 69.4 |
|
| 71.3 |
|
| Break-even load factor (based on ATK) (%) |
|
| 59.9 |
|
| 63.6 |
|
| 62.2 |
|
| 66.0 |
|
| 71.1 |
|
| Yield and Cost Statistics (RMB): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Passenger yield (passenger revenue/ passenger-kilometres) |
|
| 0.55 |
|
| 0.57 |
|
| 0.56 |
|
| 0.57 |
|
| 0.61 |
|
| Cargo yield (cargo revenue/cargo tonne-kilometres) |
|
| 2.39 |
|
| 2.46 |
|
| 2.36 |
|
| 2.31 |
|
| 2.30 |
|
| Average yield (passenger and cargo revenue/ tonne-kilometres) |
|
| 4.71 |
|
| 4.62 |
|
| 4.60 |
|
| 4.79 |
|
| 5.20 |
|
| Unit cost (operating expenses/ATK) |
|
| 2.87 |
|
| 2.94 |
|
| 2.86 |
|
| 3.16 |
|
| 3.70 |
|
Source: Company Annual Report
and revenue passenger kilometres have been impressive, between 2002 and 2006 both having risen by 2.75 times. However, passenger load factor, as well as overall load factor has remained rather flat as a result yield (both passenger and cargo) has also remained static. Though unit cost has been rising it has remained lower than average yield. These and other numbers presented in the table above indicate that while the airline has been enhancing flying distance and flying hours these had little effect in improving the passenger load factor, more importantly the yield to unit cost ratio has come down from 1.64 in 2002 come down to 1.40 in 2006, thus cost management remains an issue. Fuel costs represented approximately 33.3% of operating expenses in 2006. Fuel costs in China are affected by costs at domestic refineries and limitations in the transportation infrastructure, as well as by insufficient storage facilities for aviation fuel in certain regions of China. In 2006, fuel expenses of the airline increased by 53.1% as a result of increased weighted average domestic and international fuel prices and the expansion of fleet. In particular, in 2006, the weighted average fuel prices paid by China Eastern Airlines increased by approximately 33.6%.
For the airline other operating income appears to have been an important source of revenue. Other income was primarily generated from government subsidies and fair value gains on financial instruments held by the airline. The net amount of other operating income increased from RMB245 million in 2005 to RMB424 million in 2006 primarily due to an increase in government subsidies from RMB193 million in 2005 to RMB462 million in 2006.
China Southern Airlines
China Southern Airlines is an airline based in Guangzhou in the Guangdong province of the People's Republic of China. Operating domestic, regional and international services, it is Asia's largest airline in terms of fleet size, 2nd largest in Asia in passengers carried, 7th busiest in domestic passenger traffic, 7th largest in scheduled domestic passenger-kilometres flown and the largest in China in terms of passengers carried. It is a member of the SkyTeam airline alliance.
Its main operation hubs are Guangzhou Baiyun International Airport and Beijing Capital International Airport, with other focus cities at Shenyang Taoxian International Airport, Urumqi Diwopu International Airport, Changchun Longjia International Airport, Shenzhen Bao'an International Airport, Wuhan Tianhe International Airport, Zhengzhou Xinzheng International Airport and Dalian Zhoushuizi International Airport.
The airline started operations in 1989. In 1996, China Southern began long haul intercontinental routes with the first route being Guangzhou-Beijing-Amsterdam route. In March 1997, the next route was the transpacific Guangzhou-Los Angeles, which is currently China Southerns longest flight. It also made history of being the 1st airline to fly a Boeing 777 twin engine non-stop across the Pacific. In June 1997 China Southern Airlines initial public stock offering on the New York and Hong Kong stock exchanges generated over $700 million. In July 2000, it also added 2 more long haul routes to Sydney and Melbourne. Civil Aviation Administration of China (CAAC), selected China Southern as one of three airlines to lead the restructuring of China's air transport industry. It acquired Zhongyuan Airlines on 4 August 2000. In January 2003 the airline absorbed China Northern Airlines and its subsidiaries Beiya Airlines and China Northern Swan, as well as China Xinjiang Airlines, into its domestic operations. In November 2004 the acquisition was completed as China Southern acquired the holding company that owned China Northern and China Xinjiang .
In 2004, the company achieved a turnover of around 40 million passengers, becoming one of the top ten passenger carriers in the world. Among all Chinese airlines, it boasts the largest fleet with the most bases, most extensive domestic networks and highest flight frequencies. Renowned for its excellent passenger services, the airline has won Five-star Diamond Award for flight services and has been honoured as China's best airline by TTG Asia Magazine
The airline is owned by China Southern Air Holding (50.3%), private Hong Kong and non-China investors (H shareholders) (26.84%) and private China investors (A shareholders) (22.86%). It has 34,417 employees as at March 2007.
In August 2007, China Southern Airlines overtook All Nippon Airways to become 2nd largest Airline in Asia and is expected to overtake Japan Airlines in terms of passenger numbers within a few years, which is currently Asia’s largest airline in passengers carried. It will also announce a large scale international boost, after rapidly increasing services to other countries.
The airline signed a Memorandum of Understanding on August 28, 2004 with the SkyTeam alliance. On November 15th, 2007, China Southern was officially welcomed as the 11th full member of the SkyTeam alliance, thus becoming the first mainland Chinese airline to enter a global airline alliance.
Financial Performance
The profit for 2006 is RMB188 million, as compared to a loss of RMB1,848 million for 2005. Operating revenue increased by RMB7,926 million or 20.7% from RMB38,293 million in 2005 to RMB46,219 million in 2006. Passenger load factor increased by 1.6 percentage point from 70.1% in 2005 to 71.7% in 2006. Passenger yield (in passenger revenue per RPK) increased by 9.1% to RMB0.60. Average yield (in traffic revenue per RTK) increased by 8.8% from RMB5.14 in 2005 to RMB5.59 in 2006. Operating expenses increased by RMB6,309 million or 15.9% from RMB39,598 million in 2005 to RMB45,907 million in 2006.
As a result of improved passenger load factor and average yield, operating profit was RMB312 million in 2006 as compared to an operating loss of RMB1,305 million in 2005. Net non-operating income was RMB45 million as compared to a net non operating expenses of RMB548 million in 2005. The improvement in non operating result was mainly attributable to the net effect of increase in exchange gain of RMB272 million, increase in interest expense of RMB454 million, increase in share of results of associates and jointly controlled entities of RMB369 million and increase in gain on disposal of property, plant and equipment of RMB367 million.
Substantially all of the operating revenue is attributable to airline and airline related operations. Traffic revenue accounted for 97.6% and 97.7% of total operating revenue in 2006 and 2005 respectively. Passenger revenue and, cargo and mail revenue accounted for 92.2% and 7.8% respectively of total traffic revenue in 2006. The other operating revenue is mainly derived from commission income, income from general aviation operations, fees charged for ground services rendered to other Chinese airlines and air catering services.
The increase in operating revenue was primarily due to a 21.0% rise in passenger revenue from RMB34,328 million in 2005 to RMB41,549 million in 2006 resulting from increased traffic volume. The total number of passengers carried increased by 11.5% to 49.21 million passengers in 2006. RPKs increased by 12.4% from RMB61,923 million in 2005 to RMB69,582 million in 2006, primarily as a result of the increase in passengers carried. Passenger yield increased by RMB0.05.
Key Financial and Operating Data
Total operating expenses in 2006 amounted to RMB45,907 million, representing an increase of 15.9% or RMB6,309 million over 2005, primarily due to the total effect of increases in jet fuel costs, and aircraft and traffic servicing expenses. Total operating expenses as a percentage of total operating revenue decreased from 103.4% in 2005 to 99.3% in 2006.
Flight operations expenses, which accounted for 53.7% of total operating expenses, increased by 27.2% from RMB19,394 million in 2005 to RMB24,667 million in 2006, primarily as a result of increases in jet fuel costs, operating lease payments, catering expenses and labour costs for flight personnel. Jet fuel costs, which accounted for 65.6%
Source: Company Annual Report
of flight operations expenses, increased by 35.7% from RMB11,929 million in 2005 to RMB16,193 million in 2006 mainly as a result of increased fuel prices and fuel consumption.
There was an operating profit of RMB312 million in 2006 as compared to an operating loss of RMB1,305 million in 2005. This was mainly because operating revenue increased by RMB7,926 million or 20.7% in 2006 while operating expenses increased by RMB6,309 million or 15.9% in the same period.
Conclusion
Chinese aviation can be divided into three phases. The first starts with the setting up PRC and lasts till 1978. During this period civil aviation functioned under an overall military command. The CAAC doubled up both as a regulator and an airline; it was the lone airline company of China. In economic strategy for growth aviation did not form an important part and consequently from the perspective of development of civil aviation these were uneventful years. At this stage of development there were two important distinctions between china and India’s aviation; India had separate regulatory authority and also had separate airlines to run international and domestic operations. In china management of airports were in the hands of the army while in India evolution of an unified authority for airport management were still a few years away.
The second phase starts with economic reforms of Deng Xiaoping. Civil aviation was separated from military administration and given an independent identity. Much of the work during this period involved reforms in the regulatory framework and growth of the civil aviation sector itself was nothing impressive. The most significant development of this period was the separation of airlines regulation division and airlines operations division. China now had six airlines (all owned by the government and the number later went up to nine) catering to their respective geographic regions, competition among airlines was very restricted as each airline had full monopoly within their own region.
The third phase coincides with China’s joining of the WTO and can be said to start in 2000. As a part of the process of joining WTO China had to commit to introduce large-scale reforms in the civil aviation that would eventually open up the sector. In order to comply with the regulations of the WTO on state-owned enterprises and enhance the competitiveness of the domestic civil aviation industry, China’s civil aviation industry has gone through restructuring of state-owned air transportation enterprises including service and logistics enterprises. In 2002, the State Council issued “Plan of the Reform of Civil Aviation System” and in over two years, the whole industry launched a new round of reforms, which was the most extensive and profound one since the establishment of civil aviation in China Firstly, air transportation enterprises were restructured. In October 2002, the nine air transportation enterprises directly under the General Administration of Civil Aviation of China (CAAC) were restructured into Air China, China Eastern and China Southern, and CAAC would no longer exercise the rights of the owner of state-owned assets on behalf of the state, but would focus on its supervisory roles. Secondly, air transportation services and logistics enterprises were restructured. China Aviation Supplies Import & Export Corporation Group, China Aviation Oil Corporation Group and China Aviation Information Corporation Group were established and disconnected with CAAC. Thirdly, the airport management system was reformed. Except the Capital International Airport and airports in Tibet, all other airports under the administration of CAAC were transferred to local governments. Management of airport police was also transferred to local governments. Fourthly, the industrial administrative system was reformed. The original three-tier administrative system, “CAAC - local administration bureaus - provincial (regional, municipal) bureaus”, was reformed into “CAAC-regional administrative bureau”, a two-tier administrative system. CAAC no longer exercises the rights as the owner of those disconnected enterprises’ state-owned assets but instead undertakes five major functionalities including security management, market management, air traffic management, macro-regulation and foreign relations. Fifthly, the air traffic administration system was reformed and a three-tier management and operation system framework, CAAC - regional air traffic administration bureaus - air traffic administration centres (stations), thus took shape. Sixthly, air police was set up for aviation security. Seventhly, as supplementary measures of the reform of the administration system, the Plan of the Reform of the Prices of Domestic Air Transportation and the newest Management Measures of the Collection and Use of Civil Aviation Infrastructure Construction Fund were promulgated. In general, after this round of reform, a new industrial management system compatible with socialist market economy was established.
2.1 China has used the instrument of mergers for structuring, restructuring and re-restructuring its airlines. The focus of these mergers has been to consolidate the industry into a more homogenous and manageable entity. China’s civil-aviation industry last underwent a major restructuring in 2002, when 10 domestic state airlines were merged into three groups under Air China, China Southern Airlines, and China Eastern Airlines. There were 45 airlines at that time, this number has now come down to 13. The process of mergers, however, does not seem to have been over; Air China is considering a merger with China Eastern while at the same time there is a possibility that China Eastern would soon be selling off 24% of its stake to Singapore Airlines and Temasek.
3.1 The aviation industry in China still highly regulated thus performance of airlines is also significantly affected by factors associated with operating in a highly regulated industry, as well as a number of other external variables, including political and economic conditions in China, competition, foreign exchange fluctuations and public perceptions of the safety of air travel with Chinese airlines.
3.2 Because nearly every aspect of airline operations is subject to the regulation of the CAAC, operating revenues and expenses are directly affected by the CAAC regulations with respect to, among other things, domestic airfares, level of commissions paid to sales agents, the aviation fuel price, take-off and landing charges and route allocations. The nature and extent of airline competition and the ability of Chinese airlines to expand are also significantly affected by various CAAC regulations and policies. Changes in the CAAC’s regulatory policies, or in the implementation of such policies, therefore have a significant impact on future operations. Thus in the domestic sector airlines primarily compete on the basis of safety, quality of service and frequency of scheduled flights.
3.3 An unfortunate by-product of these controls is that they have delayed the advent of genuine domestic LCCs in China’s market. China’s nascent independent private airline sector find the going tough in this environment and largely remain confined to serving niche roles
4.1 Financial subsidy plays an important role in the growth and development of civil aviation in China. Under the existing policy, the General Administration of Civil Aviation (CAAC) gives subsidies to regional carriers and to small and medium airports.
4.2 It is estimated that all regional carriers and more than 80 percent of the Chinese mainland's 147 airports will benefit from subsidies. The policy, which channels subsidies to carriers providing regional flights that are less than 600 km long, is intended to increase circulation at small and medium airports. There are no restrictions on the types of planes that can be used for regional flights. But exceptions are made for those that link regional airports with Beijing, Shanghai, Guangzhou and some popular tourist destinations, which have an average seat occupancy rate of more than 80 percent.
4.3 The administration also gives subsidies to airports with annual passenger throughputs of less than 5 million. The smaller the airports, the more subsidies they get. Only 19 airports have passenger throughputs of more than 5 million and they will not get any subsidies.
5.1 Problems face by China’s civil aviation is similar to India. It faces a severe shortage of pilots and till recently did not encourage recruitment of foreign pilots. Development problems of lack of technical personnel, airspace and airport ability are also getting more pronounced. All this has recently prompted the CAAC to put a ban on approval of new airlines till 2010. Pilots won’t be allowed to work overtime and airlines will have to slow their fleet expansion if they don’t have enough pilots.
5.2 In recent weeks the regulator has introduced a time table for reducing flight landings at Beijing’s airport, which is badly overstrained. Beijing will immediately cut 48 movements a day, including 10 from each of the big three airlines—China Southern, Air China and China Eastern. The target is fewer than 1,000 movements a day at the airport by March 2008, down from the present 1,100. Peak usage will fall to 55 movements an hour from 60. The authorities have also introduced a system of penalizing airlines for flights into Beijing that routinely run late. Air China and China Eastern have each had one service canceled for that reason.
5.3 Exceptions, however will be granted to these restrictions if certain conditions are met. New airlines will be allowed if they carry freight (directly supporting manufacturing employment), use mainly foreign pilots (relieving the shortage of Chinese pilots) and promise to fly mostly at night (when there is spare airspace capacity). Carriers that serve the west and northeast of the country (whose development isn’t keeping up with that of the thriving east) will also be allowed. the most important exception is that new airlines will be allowed if they use Chinese-made aircraft.
6.1 Continued growth of the economy and air travel demand, have positioned China as the most influential player in the region, one which other governments are anxious to engage. The big decision for the country’s policy makers is its potential role in an aviation bloc – specifically whether to join the ASEAN grouping or seek closer ties with its North Asian neighbours – with whom tensions have fluctuated – as it seeks to exert its influence on the global stage against rising North American and European blocs. The seeds for this could be sown in 2008.
