The Persian Gulf region is home to three rapidly growing airlines: Emirates, Qatar Airways, and Etihad Airways. This year, the top U.S. airlines -- American Airlines (NASDAQ:AAL), Delta Air Lines (NYSE:DAL), and United Continental (NASDAQ:UAL) -- have invested a considerable amount of effort in proving that all three are state-subsidized enterprises.
The three Gulf carriers have expanded rapidly in the U.S. in the past few years, thanks to Open Skies treaties that have ended government regulation of which airlines fly which international routes. But American, Delta, and United want the U.S. government to step in again, arguing that Emirates, Qatar Airways, and Etihad Airways are competing unfairly.
The U.S. legacy carriers purportedly uncovered $42 billion in state subsidies and similar benefits to the three Gulf carriers over the past decade. Some aspects of the charges they have leveled are debatable. However, in the case of Etihad Airways, there appears to be overwhelming evidence of massive state subsidies.
Aviation as a strategic industry
The governments of the United Arab Emirates and Qatar have wisely realized that their oil wealth won't last forever. As a result, they have actively worked to diversify their economies.
The airline and air cargo businesses have been central to those plans. Not only do they provide jobs directly, they also help boost the broader economy by making it easier to do business in the region.
As a result, the government of Qatar and the emirates of Dubai and Abu Dhabi have all set up airlines -- Qatar Airways, Emirates, and Etihad, respectively -- and invested heavily in them. Emirates is the oldest of the three, having been founded in the 1980s. Qatar Airways launched in the early 1990s, while Etihad Airways was only launched in 2003.
Living on government subsidies?
In January, the Partnership for Open & Fair Skies -- backed by American Airlines, Delta Air Lines, and United Continental -- released a white paper detailing subsidies and quasi-subsidies to the Gulf carriers. The report quantified the subsidies as follows: at least $17 billion in subsidies for Etihad, more than $16 billion for Qatar Airways, and at least $5 billion for Emirates.
Each of the Gulf carriers has rejected these claims to one extent or another. In the case of Emirates, the oldest and largest of the three, the subsidy claims are weakest. The biggest part of the supposed subsidies to Emirates came in the form of fuel hedging losses that Emirates moved off its books in 2008-2009. Yet Emirates has countered that this was done only for accounting purposes and that it ultimately covered the losses.
The other main subsidy allegation for Emirates relates to Dubai's policy of keeping airport usage fees dirt cheap despite its heavy spending on airport infrastructure. However, since any airline operating in Dubai can benefit from this policy, this isn't a clear case of government subsidies to Emirates.
The case against Etihad Airways is compelling
Even if Emirates doesn't rely on government subsidies to stay in business, the same can't be said for the other Gulf carriers. The evidence that Etihad Airways relies upon subsidies from Abu Dhabi's government is especially compelling.
In June, Etihad acknowledged that it had received $14.3 billion in capital from the government in the form of $9.1 billion of equity and $5.2 billion in loans. Even the loans are more like equity investments, as Etihad is not paying interest and has no set repayment schedule. Furthermore, in the past week, Etihad revealed another $2.5 billion capital injection that occurred last year.
Etihad Airways has argued that the government's investments in it don't automatically make it a subsidized business. However, if the government does not expect a reasonable return on its investment, then the cash infusions look much more like subsidies.
Etihad earned a "record" paper profit of just $73 million last year, and would have lost hundreds of millions of dollars had it not sold a subsidiary to a different part of the group. If it were publicly traded, Etihad's market cap would be a tiny fraction of the sums Abu Dhabi's government has "invested" in it -- and the company might even be totally worthless.
This isn't very surprising. The Gulf carriers are chasing the same passengers with similar business models. Given that Etihad is the youngest and smallest of the three, it is fighting from a position of weakness. And since all three airlines are growing so quickly, they need to reduce fares for economy passengers and offer ever-more luxurious accommodations for first-class customers to stimulate demand. That's a clear recipe for weak profitability.
The case for action is mixed
Unfortunately for American, Delta, and United, offering a strong case that Etihad (and perhaps also Qatar Airways) is state-subsidized may not cause the U.S. government to act to slow its growth.
Several U.S. airlines rely on the sanctity of Open Skies treaties to smooth their global expansion plans. Others benefit from connecting traffic generated by the Gulf carriers. U.S. consumers are saving money thanks to the availability of cheap fares to many international destinations.
Perhaps most significantly, the three Gulf carriers have firm orders for hundreds of Boeing planes worth tens of billions of dollars (even after customary discounts). Etihad alone has 92 firm orders outstanding -- probably worth nearly $15 billion after discounts.
In other words, there are strong competing economic interests arguing for allowing Etihad and its rivals to grow unchecked in the United States. Even if they are competing unfairly against American, Delta, and United, the U.S. government could reasonably decide not to intervene.
Adam Levine-Weinberg owns shares of The Boeing Company and United Continental Holdings, and is long November 2015 $40 calls on American Airlines Group and long January 2017 $40 calls on Delta Air Lines, The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.