Economy could take toll on luxury of Middle East airlines

On a Dubai-New York flight on Emirates airlines late last year, Jeff Rosenthal awoke in his first-class private suite with a craving for vanilla ice cream covered in chocolate.

Still in his pajamas, the textile executive from New York asked a flight attendant if the dessert was a possibility.

"She grabbed a martini glass and scooped some ice cream on it, but she couldn't find chocolate syrup. She just replaced it with chocolate liqueur. I had it in five minutes," says Rosenthal, who flew the Dubai-based carrier 57 times last year as he met with suppliers and vacationed in Bombay, Mauritius, Johannesburg, Maldives, Seoul and Singapore.

At a time of global economic meltdown, the top airlines in the Persian Gulf region — Emirates, Doha's Qatar Airways and Abu Dhabi-based Etihad Airways — continue to expand. They're adding new planes and luxurious services unimaginable in the USA at a time the rest of the industry is retreating.

But there are some ominous signs on the economic horizon, raising questions about when the good times for the world's elite airlines could start to taper off.

Most American travelers have never heard of these carriers. Etihad didn't start flying until late 2003. Aided by strong backing from their governments, they reached for the sky, with the ambitious goal of turning their home bases into international hubs.

By rolling out some of the industry's newest planes and touting their unique location on the globe, the Gulf carriers have expanded routes rapidly to Asia, Europe, Africa and in North America, with the aim of overtaking industry stalwarts in premium international flying, such as Singapore Airlines, Lufthansa and American Airlines. They're positioning themselves as the world center, where travelers can connect between Europe/North America and Asia/Africa/Australia and spend lavishly at some of the world's finest duty-free stores.

Air traffic growing fast

Since 2000, passenger traffic to and from the Middle East grew by 75% to about 170 million, partially fueled by the region's building boom as contractors, multinational executives, bankers and nannies arrived to fill vacancies unaddressed by the areas' small labor pools. Rising oil prices that have enriched their primary shareholders — their governments — also fueled the airlines' fortunes.

"Abu Dhabi, Dubai and Qatar have each realized the critical importance that a successful aviation sector can deliver to an economy," says James Hogan, CEO of Etihad Airways.

Emirates, the largest and most established of the Gulf airlines, boosted its capacity by more than 240% since the end of 2000, according to data by OAG — Official Airline Guide. Qatar Airways, the country's national carrier, has grown more than six times during the same period, including service from Houston that will start at the end of March.

Etihad started flying in late 2003 from Abu Dhabi on a government mission to launch a national carrier on par with nearby Dubai's Emirates Airlines. Etihad now flies to 50 destinations worldwide. Earlier this year, the heavily courted airline announced that it will begin flying to Chicago starting in September, its third city in North America after Toronto and New York.

The Gulf region has not been immune to the global economic crisis, and there are gloomy signs of a slowdown. The Middle East was the only region to register air traffic growth in January, up 3.1% from a year ago, according to the International Air Transport Association's latest monthly report. But the region's passenger and cargo traffic growth is expected to slow this year to 1.2%, compared with 7.6% in 2008 and 16.4% in 2007, the Geneva-based organization says.

The real estate bubble that fueled Dubai's boom has finally popped. And falling oil prices have also dimmed the prospects of the entire Gulf Arab region, which includes the United Arab Emirates, Kuwait, Qatar, Oman and Bahrain.

The International Monetary Fund projects the Gulf's economy to grow only 3.5% this year, vs. nearly 7% in 2008. That means fewer business travelers willing to pay $15,000 for first-class seats.

Customers such as J. Rossi of Butler, Pa., have the Gulf carriers concerned. The marketing executive of Burt Hill Architecture is a huge fan of Emirates' service and is willing "to fly with them anywhere."

But her firm laid off about 50 employees earlier this year as several key projects in Dubai have been canceled, and she expects less travel to the Gulf.

In the latest sign of the region's vulnerability, Emirates said earlier this week that it will stop flying the Airbus A380, the world's largest passenger plane, for its Dubai-New York route due to a drop in traffic. The carrier will switch to Boeing's smaller 777, and redeploy the two A380s freed up from New York to its services to Toronto and Bangkok.

Emirates' net profit fell 88% in the fiscal first half of 2008 to $77 million. The airline, which is the only major Gulf carrier to disclose financial data publicly, largely blamed fuel prices at the time, and said it will continue to grow in 2009. Qatar Airways and Etihad have yet to turn profits. As a group, the Mideast carriers are projected to have about $200 million in net losses for all of 2009, according to IATA.

"Some Middle East carriers are star performers, but it is still a mixed picture," says Brian Pearce, IATA's chief economist. "For the region as a whole, the profits are still exceptionally slim."

Geography is key

UAE was established in 1971. Blessed with bountiful oil, the country has attracted multinational workers streaming in for jobs in construction, telecom, oil, tourism and retail industries. The worker migration, coupled with heavy infrastructure investment, fueled demand for air service.

"The region needs foreign labor. Oil creates much more dynamic activity, and not necessarily just in the oil industry. And that creates a very large business and leisure travel," says Abdul Wahab Teffaha, who heads Arab Air Carriers Organization.

Still, with only about half their passenger traffic arriving in the region as their final destination, they've bet heavily that its central location will draw connecting passengers if they can deliver competitive fares, second-to-none quality of service and world-class airports where travelers can actually enjoy themselves.

"The strategy we've adopted is (to have) a global network ," says Ali Al Rais, executive vice president of Qatar Airways. "The Middle East has always been in the middle of the world, and we've capitalized on the geographical location. With new airplanes, we can fly from one hub to another in one flight."

Rosenthal, the textile executive, is a convert. He used to fly United or Lufthansa to Frankfurt before catching a connecting Emirates flight to Asia and the Middle East. But when Emirates introduced A380 service to Dubai from New York, he became loyal to flying the large jet.

"I get my own room with a minibar. It has a shower spa. A lounge," Rosenthal says. "I can arrive wherever I'm going without feeling like I was stuck on a plane for 15 hours."

But with Emirates now switching to 777s, Rosenthal says he may revert to connecting in Europe to avoid long flights.

A first-class round-trip ticket between Dubai and New York in April costs about $15,800 on Emirates, according to its website. An economy ticket is priced at about $1,100.

New fleets, industry awards

With their global ambition, the Gulf carriers have been aggressive purchasers of large and fuel-efficient planes from Boeing and Airbus. The new planes are crucial in their quest for loyalty of the most discriminating customers who hop between continents.

Boeing expects to deliver more than 1,500 new planes to the Middle East in the next 20 years, making it the fastest-growing market in the world. Etihad was the talk of the Farnborough International Airshow last year when it placed the single largest order in the show's history — a $22 billion order for 100 Airbus and Boeing aircraft, with purchase options for an additional 105 aircraft.

The Gulf carriers were also among the first customers for the much ballyhooed A380 jumbo jet. European and Asian airlines are starting to cancel orders. But the Gulf carriers, so far, have held steady.

Along with their fresh-from-the-factory planes, the Gulf carriers provide some of the most luxurious services in the industry, and have garnered notable industry awards. Qatar Airways is one of only six airlines in the world to win the 5-star designation by Skytrax, an aviation research consulting firm. Emirates and Etihad have 4 stars; most U.S. airlines have 3 stars.

All three offer free limousine service from the airport for first-class customers. First-class passengers on some Emirates aircraft get a private suite with a shutter door, a fully flat bed, a minibar and a 23-inch flat-screen TV. Etihad's in-flight entertainment system, which has won industry awards, has more than 600 hours of on-demand video and audio programming.

"It's enough to make you want to connect" in Dubai or Abu Dhabi, Teffaha says. "And that's actually the point."

Despite world-class amenities, the region's carriers may not be immune to the luxury backlash and belt-tightening among corporate customers who can no longer justify $15,000 first-class trips in the battered economy. In January, premium traffic worldwide fell 16.7%, according to the IATA. While the region hasn't been hit as hard, premium traffic between the Middle East and nearly all regions of the world also fell.

"If the front cabin drops off, then you're in a world of hurt," says aviation analyst Michael Boyd. "It depends on how far the global economy sinks. Us mortals behind the curtain don't pay the bills as much. Will those passenger flows from Australia, India and Europe continue?"