The Battle for China's Lucrative Skies


By Dexter Roberts and Frederik Balfour It was a day of deals, all aimed at tapping China's high-flying aviation sector. On Dec. 5, London-based petroleum player BP (BP) announced it was spending $44 million for a 20% share of China Aviation Oil, China's biggest jet-fuel importer, helping that troubled company avoid bankruptcy. And in a far larger deal, Chinese Premier Wen Jiabao on a state visit to France, announced that his country would purchase 150 Airbus A320 aircraft.

The purchase is valued at more than $9 billion based on list prices -- though airlines receive steep discounts, especially on big orders like this one -- giving the European consortium a boost in its battle with archrival Boeing (BA) for Chinese aircraft market share. As part of the deal, Airbus says it may establish a plant for single-aisle aircraft in China, in what would be the planemaker's first assembly line outside Europe.

China's soaring economic growth and a boom in Chinese travel are behind deals of this magnitude. The economy rose 9.5% the first three quarters of 2005. And tourism has exploded, with Chinese holiday trippers traveling not just on the mainland but in growing numbers to everywhere from Austria to Australia.

Passenger traffic is expected to grow in the teens, while cargo growth will be up 20% to 30% this year, says Allen Chien, managing director and head of Transport & Logistics Sector Investment banking, for HSBC in Hong Kong. "Consider the population base and that the industry is starting from a low base, and this is a market that neither Boeing nor Airbus can ignore," says Chien. "How many countries can make orders of 100 to 150 planes at one time?"

"ALWAYS FULL." The world's aviation companies will continue to salivate over China because the market there still has so much room to grow. While China's three big carriers -- Air China, China Southern, and China Eastern -- each have fleets today with well under 200 planes, the average U.S. airline has a fleet often triple or quadruple that in size. China is plagued by a lack of capacity. "Planes are always full, and they always take off late," says China Economic Quarterly Editor Arthur Kroeber.

Yet even as economic fundamentals drive the dealmaking, politics are never far below the surface. China has a long history of using the two aircraft rivals to reward or punish the U.S. and Europe governments depending on how diplomatic relations are going. When President George W. Bush visited China in November, Beijing announced it was buying 70 Boeing 737s, in a deal worth around $4 billion. Theat was hardly a surprise. "Beijing has always been careful about getting locked into one supplier -- they are very good at playing them off each other," says the Quarterly's Kroeber.

The Boeing-Airbus rivalry in China goes back decades. Just weeks after President Nixon's historic visit to China in 1973, then-Boeing President E.H. "Tex" Bouillioun arrived in Beijing to curry favor with China's top brass and left with an order for 10 Boeing 707s. But by the mid-1980s, under the stewardship of dynamic President Jean Pierson, Airbus began selling planes and giving Boeing a run for its money in what was then still a fledgling market.

A NECESSARY PARRY. In 1985, Airbus followed a Boeing practice and began outsourcing some of its airplane work when it signed its first agreement with Xi'an Aircraft to produce and assemble access doors for Airbus A300/A310 widebody aircraft in China. Today, five Chinese companies are involved in producing parts for Airbus aircraft: Chengdu Aircraft, Shenyang Aircraft, Xn Aircraft, Hong Yuan Aviation Forging & Casting, and HAFEI Aviation Industry.

Now, Airbus plans to ratchet up its sourcing in China. It announced on Dec. 4 that it plans to quadruple procurement to $60 million by 2007 from last year and to $120 million by 2010. That's still just a fraction of what it sources elsewhere but, again, is a necessary parry in the dual with Boeing. Chicago-based Boeing sources part of the fuselage for its 737 jets from a factory in Xi'An.

Even with the new orders, Airbus still has a way to go in closing the gap on its American rival in China. At the end of October, Chinese carriers had 232 Airbus planes in operation, compared with 488 Boeings and 54 McDonnell Douglas jets.

SERIOUS BOTTLENECKS. Martin J. Craigs, president of Aerospace Forum Asia, a pan-Asian association that acts like the Chamber of Commerce for the aviation supply chain, warns that focusing on the dogfight over who sells the most planes is obscuring the challenge facing China's aviation industry. "The forum applauds the capabilities and ambitions of airlines in China but is concerned that the overall infrastructure can expand at the rate at which new metal is coming in," says Craigs. "China is on track to get a new airliner every two to three days for the next 20 years." That means increasing fivefold the number of trained pilots from 11,000 today to the 50,000 needed by 2024, a daunting task by any measure.

Craigs also points out that China faces serious bottlenecks in expanding air-traffic management capabilities and airspace. For example, Beijing airport only allocates two slots per day for nonscheduled aircraft, which makes it virtually impossible for business jets to land there. "How can you have that situation 2 years before the Olympics?" he asks. "There's a potential loss of face if the infrastructure doesn't catch up with the hardware deliveries.

Meantime, Beijing has never disguised its ambition to build up its own modern commercial aircraft capabilities, and technological transfers and parts contracts have long been a factor in the battle for market share by aircraft makers. In the early 1990s, McDonnell Douglas, now owned by Boeing, had a tie up with state-owned China National Aero-Technology Import & Export Corp. to assemble a local version of its single-aisle MD 90 jet in Shanghai, but the project was aborted after just 20 planes were built.

BALANCING ACT. If the plans for final assembly of a single-aisle Airbus do materialize in China, it won't be the first foreign jetmaker to do so. China Aviation Industry said in September it expects a maiden flight of the ARJ-21, which is being assembled in the northern city of Xi'An in partnership with Brazilian regional jetmaker Embraer. The company predicts that China will need 640 of these jets in the next two decades.

Clearly, both Boeing and Airbus will benefit from growth in China. But for now the European planemaker still trails Boeing, which holds around 60% of the Chinese market. However, Beijing's desire to balance its reliance on the rivals could mean future sales for the Europeans.

It can't hurt that France has been a vocal critic of the Tiananmen-era European Union embargo that China has long lobbied to have lifted. Indeed, when French Prime Minister Dominique de Villepin held a joint press conference with China's Premier Wen on Dec. 5, he made a point of reminding his Chinese guests that his country considers the embargo an "anachronism." That's the sort of stance that will help Airbus win future deals from a Beijing that still mixes economics with politics.

Roberts is BusinessWeek's Beijing bureau chief, and Balfour is Asia correspondent in Hong Kong


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