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OO RUEHCN RUEHGH RUEHVC
DE RUEHGZ #0681/01 1640847
ZNR UUUUU ZZH
O 130847Z JUN 07
FM AMCONSUL GUANGZHOU
TO RUEHC/SECSTATE WASHDC IMMEDIATE 6153
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUCPDOC/USDOC WASHDC
RULSDMK/DEPT OF TRANSPORTATION WASHDC
RUEHRC/DEPT OF AGRICULTURE WASHINGTON DC
RUEAIIA/CIA WASHDC
RUEKJCS/DIA WASHDC
RHHMUNA/HQ USPACOM HONOLULU HI

UNCLAS SECTION 01 OF 05 GUANGZHOU 000681 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EAP/CM AND EB/TRA 
USDOC FOR 4420/ITA/MAC/MCQUEEN 
TRANSPORTATION FOR ASSISTANT SECRETARY STEINBERG/GLATZ/RAO 
USPACOM FOR FPA 
 
E.O. 12958: N/A 
TAGS: EAIR ECON CH HK
SUBJECT: Airline Expansion in South China 
 
REF: A) 07 Guangzhou 670 
     B) 07 Guangzhou 206 
     C) 07 Guangzhou 109 
     D) 06 Guangzhou 32347 
     E) 06 Guangzhou 32163 
     F) 06 Guangzhou 18105 
     G) 06 Guangzhou 16330 
     H) 06 Guangzhou 13550 
     I) 06 Guangzhou 11471 
     J) 06 Guangzhou 8841 
 
(U) This document is sensitive but unclassified.  Please 
protect accordingly. 
 
¶1. (SBU) SUMMARY: Rich and populous South China has become 
an air traffic hotspot.  To win market share, airlines in 
the region are sharpening their competitive edge by opening 
new routes, buying more aircraft, and expanding cooperation 
with other airlines.  As the Chinese Government deregulates 
domestic civil aviation, an increasing number of foreign 
carriers and budget airlines have entered the regional 
market and now directly compete with major domestic 
airlines.  A shake-out in this market is inevitable, given 
the number of companies that have been lured into it by the 
prospect for sharing in what seems to be an ever expanding 
demand for airline services.  END SUMMARY. 
 
Air Traffic to Grow in the PRD Region 
------------------------------------- 
 
¶2. (SBU) The Pearl River Delta (PRD) region boasts one of 
China's fastest growing manufacturing centers.  Spurred by 
strong economic performance, the demand for air transport 
in South China is growing rapidly.  China's General 
Administration of Civil Aviation (CAAC) has predicted that 
air traffic in the PRD will grow by 15 to 20 percent each 
year through 2010.  Airlines are fiercely competing to 
capture a larger share of the soaring air traffic market. 
(See Ref A which goes into challenges faced by airports in 
the PRD.) 
 
China Southern Getting Stronger 
------------------------------- 
 
¶3. (SBU) China Southern Airlines carried 49.2 million 
passengers in 2006, up from 44.1 million in 2005.  The 
airline's main hubs are in Guangzhou and Beijing. 
Secondary bases exist in Urumqi (from which the airline 
just launched its new service to Jeddah, Saudi Arabia) and 
Shenyang.  On March 28, China Southern inaugurated its 
Guangzhou-Dubai flight on the heels of the Guangzhou- 
Kathmandu route opened on February 5.  China Southern also 
announced the scheduled opening of eight new international 
routes from Guangzhou to Yangon, Phuket, Siem Reap, 
Vientiane, New Delhi, Sendai, Sapporo, and Luanda later in 
the year.  As these new routes are launched, the number of 
international outbound routes from Guangzhou will increase 
from 18 to 26.  Weekly international flights will rise from 
136 to 182, an increase of more than 30 percent.  China 
Southern is expected to become a member of the SkyTeam 
airline alliance (Delta, Northwest Cargo) in the second 
half of 2007.  To help support this expansion, the 
airline's president said China Southern planned to purchase 
68 new aircraft by the end of 2007. 
 
¶4. (SBU) China Southern has a 60 percent stake in Xiamen 
Airlines.  Xiamen Airlines carried 7.76 million passengers 
and 110,000 tons of cargo in 2006, up 12.1 and 9.0 percent 
respectively, and has turned a profit for the 20th 
consecutive year.  Xiamen Airlines has an all-Boeing fleet 
of 43 aircraft that currently fly 140 overseas and domestic 
routes.  Fueled by regional economic development and 
increasing business ties between Xiamen and Taiwan (though, 
of course, without any direct flight connections), Xiamen 
Airlines plans to add 60 new Boeing 737-800 aircraft by 
2013, as well as a few leased jets.  As one of Boeing's 
most loyal customers, Xiamen Airlines is negotiating with 
Boeing for a purchase of 25 jets worth USD 1.8 billion. 
More routes will be opened to Southeast and Northeast Asia, 
and the airline's capacity will likely double in five years. 
 
GUANGZHOU 00000681  002 OF 005 
 
 
 
¶5. (SBU) Approved by CAAC, China Southern is setting up a 
joint-venture airline, Chongqing Airlines, with the 
Chongqing Development and Investment Company.  The new 
airline will involve a total investment of RMB 1.2 billion 
(USD 157 million).  China Southern will invest RMB 720 
million (USD 94 million) for a 60 percent stake and will 
also supply aircraft and technical support.  Su Liang, 
Secretary of the Board of Directors of China Southern, told 
 
SIPDIS 
the consulate that Chongqing Airlines will be officially 
established on June 18, but there is no date (perhaps July) 
for when it will be ready to offer a full range of flights. 
(Comment: The June 18 establishment is likely a symbolic 
date tied to the 10th anniversary of Chongqing's 
designation as a directly administered city, like Beijing 
and Shanghai.  End Comment.)  The new airline initially 
will have three Airbus 320 aircraft and will operate 
domestic routes from Chongqing to Beijing, Shanghai, 
Guangzhou, and Lhasa.  Chongqing Airlines will add other 
domestic destinations as its inventory of aircraft 
increases. 
 
Shenzhen Airlines Triples Profits 
--------------------------------- 
 
¶6. (SBU) Shenzhen Airlines posted a record profit of RMB 
360 million (USD 46.5 million) in 2006, more than triple 
the previous year's result.  Shenzhen Airlines President Li 
Kun credited the success to the carrier's May 2005 
transition from a state-owned enterprise to a privately-run 
company.  During its reorganization, the airline earned RMB 
2.72 billion (USD 353 million) from the sale of a 65 
percent stake, originally held by Guangdong Development 
Bank, to Bright Ocean Corporation and Huirun Investment 
International.  Shenzhen Airlines has been China's leading 
private carrier since reorganization and the country's 
fifth-largest airline.  Passenger service grew more than 24 
percent year-on-year to 7.1 million, and the load factor 
rose nearly 78 percent.  This year, Shenzhen Airlines 
expects to maintain revenue growth of at least 40 percent 
and serve 10 million passengers.  It continues to pursue 
its "3-6-9" strategy to expand its fleet to 70 in three 
years, 100 in six years and 160 in nine years.  The airline 
took delivery of 12 aircraft last year and now operates 45 
A320s and B737s.  Shenzhen Airlines will likely add more 
flights from Shenzhen to other airline hubs like Guangzhou, 
Zhengzhou, and Shenyang. 
 
¶7. (SBU) Shenzhen Airlines has partnered with Lufthansa 
Cargo AG and Deg-Deutsche (a large European development 
finance institution) to operate Jade Cargo International. 
Last December, Shenzhen Airlines signed an agreement with 
the U.S. Mesa Air Group to create a regional airline 
specializing in feeder airline services.  Shenzhen Airlines 
is discussing another commercial aviation partnership with 
a Hong Kong company. 
 
Ambitious HNA Group Ready to Win More Market Share 
--------------------------------------------- ----- 
 
¶8. (SBU) A source at HNA Group told ATWOnline that the 
company's next step is to integrate the regional operations 
of its subsidiary carriers to "grab two-thirds of China's 
regional market share by 2012."  The paperwork/permits for 
HNA to form the Grand China Air Group (GCAG), which would 
integrate Hainan Airlines and six other subsidiaries, are 
near completion.  Having obtained USD 25 million from 
investor George Soros, USD 60 million from Pan American 
World Airways, and RMB 1.5 billion (USD 194 million) from 
the Hainan Provincial Government, HNA Group Chairman Chen 
Feng said the group had successfully completed financing 
for GCAG and is now waiting for its public air transport 
enterprise license. 
 
¶9. (SBU) On March 30, HNA Group launched a new regional 
airline, Grand China Express Air Co. Ltd., in Tianjian. 
The new airline will begin operation this September and 
will initially operate 78 routes linking 54 cities.  By 
2012, it plans to buy 100 commercial jets from Brazil's 
Embraer and fly on more than 450 domestic regional routes 
 
GUANGZHOU 00000681  003 OF 005 
 
 
linking 90 cities. 
 
¶10. (SBU) Hainan Airlines carried 14.39 million passengers 
and 198,700 tons of cargo in 2006, up 12.41 and 22.55 
percent respectively.  On April 12, the company announced 
that it recorded a net profit of RMB 181.6 million (USD 
24.49 million) in 2006, a stark change from a loss of RMB 
215.82 million (USD 21.92 million) in 2005.  The airline 
plans to buy two Boeing 737s and one A319 aircraft worth a 
total of RMB 1.16 billion (USD 150.6 million), and plans to 
lease two A330s and two A319s this year.  Hainan Airlines 
started operating an Osaka-Beijing route on March 25 by 
expanding a code share agreement with JAL, and a Beijing-St. 
Petersburg route on May 4.  Reopening a direct flight from 
Beijing to Geneva is under consideration. 
 
¶11. (SBU) With JAL as its sponsor, Hainan Airlines is 
applying for the membership in the OneWorld Alliance (with 
American Airlines) to compensate for its limited overseas 
connections.  President Chen Feng announced that a 
taskforce had been established to help prepare the carrier 
to join the alliance.  The application is expected to be 
approved in 2007.   However, industry analysts put Hainan 
Airlines in an inferior negotiating position, as alliances 
are targeting carriers in Beijing, Shanghai, and Guangzhou, 
while Hainan Airlines is based in the southern provincial 
capital of Haikou.  OneWorld Managing Partner John 
McCulloch has told the media that his group was also 
negotiating with China Eastern Airlines based in Shanghai. 
 
¶12. (SBU) On March 8, a subsidiary of HNA Group, Yangtze 
River Express, started its inaugural air cargo flight from 
Massachusetts to Shanghai.  It also launched a Shanghai- 
Anchorage-New York-Boston cargo service.  HNA Group is 
accelerating the development of its overseas route network 
as it tries to play a stronger role in the global market. 
 
Foreign Airlines Eye the China Market: 
Cathay Pacific Links Up with Air China 
-------------------------------------- 
 
¶13. (SBU) Cathay Pacific, Swire Pacific, Air China, CNAC, 
and CITIC Pacific Limited reached an agreement to change 
the shareholder structure of Cathay Pacific, Dragonair, and 
Air China in 2006.  Under the agreement, Dragonair will be 
wholly owned by Cathay Pacific.  Air China acquires a 17.5 
percent stake in Cathay Pacific, and Cathay Pacific doubles 
its shareholding in Air China to 20 percent.  Dragonair 
will continue to operate under its own name, but with 
Cathay Pacific management.  Cathay Pacific and Air China 
have developed closer cooperation on many fronts, including 
the establishment of an air cargo joint-venture in Shanghai. 
 
¶14. (SBU) Cathay Pacific's first annual report after the 
restructuring showed a 24 percent rise in net profits in 
¶2006.  The Center for Asia Pacific Aviation (CAPA) 
commented that the radical airline ownership restructuring 
will unlock "fantastic synergies" for Cathay Pacific.  CAPA 
believes that Cathay Pacific and Air China can potentially 
form the world's biggest combined carrier with a mix of 
private equity (via the Swire linkage) and government 
support (via Beijing).  Eyeing the huge mainland cargo 
business, Cathay Pacific started cargo flights to Beijing 
in 2006 and added six more weekly flights to Shanghai in 
January 2007.  On March 27, the CEO of Cathay Pacific 
announced the link with Air China and plans to establish a 
Shanghai-based cargo joint venture this year.  He also 
cited "increasing competition" as the reason for Cathay and 
Dragonair's combined cargo volume decline in the first two 
months of 2007.  The airline plans to add 11 more cargo 
planes by the end of 2009 as exports from China surge. 
Cathay Pacific expects to boost capacity by 10 percent in 
2007, 15 percent in 2008, and 10 percent in 2009, with 
growth primarily in cargo services. 
 
Deutsche Lufthansa Invests USD 1 billion in Shenzhen 
--------------------------------------------- ------- 
 
¶15. (SBU) Early in October 2004, Lufthansa Cargo 
established Jade Cargo International with Shenzhen Airlines 
 
GUANGZHOU 00000681  004 OF 005 
 
 
and Deg-Deutsche.  As the first cargo airline in China with 
foreign ownership, Jade Cargo International started 
operations with a commercial flight from Shenzhen to 
Amsterdam on August 5, 2006.  It now operates twelve 
flights weekly from China to Europe.  On March 16, 2007, 
the President of Lufthansa Cargo met with Shenzhen Mayor Xu 
Zhongheng and disclosed that Lufthansa had invested over 
USD 1 billion in Shenzhen.  Jade Cargo will receive six new 
Boeing cargo planes in 2007 and will rapidly expand its 
route network in Asia, Europe, and America. 
 
Budget Airlines Stir Up Aviation Market 
--------------------------------------- 
 
¶16. (SBU) CAPA predicted that budget airlines will take up 
20 percent of the market share in the Asia-Pacific region 
by 2010.  CAPA statistics show that passenger throughput 
for budget airlines increased by 55 percent in 2006, while 
airlines providing comprehensive services only registered 
0.9 percent growth.  As the Chinese Government deregulates 
the domestic civil aviation market, budget airlines are 
emerging and stirring up the market with their low fare 
strategy.  Despite the existing industrial monopoly, 
outdated civil aviation policies, and airport capacity 
shortages, budget airlines should continue making headway 
in the market so as to be able to compete directly with 
major airlines. 
 
Chinese Spring Airlines Fined for Offering Cheap Tickets 
----------------------- -------------------------------- 
 
¶17. (SBU) Spring Airlines based in Shanghai, the first 
airline to announce a budget travel strategy in China, 
earned more than RMB 20 million (USD 2.6 million) in 
profits last year.  A spokesman attributed this success to 
the company's slashing of fares by an average of 61.8 
percent since its launch in July 2005.  Fare reductions 
have contributed to an average occupancy rate of 94.4 
percent, the highest of any Chinese airline.  Spring 
Airlines' budget travel strategy has caused regulatory 
problems.  The company was fined RMB 150,000 (USD 19,405) 
for selling over 400 one-yuan tickets on the Shanghai-Jinan 
route last year.  The fine was for violating the pricing 
rule set by CAAC, which sets the lowest discount rate at 55 
percent off the standard rate.  This is not the first time 
Spring Airlines has been targeted by the authorities for 
offering cheap fares.  The airline submitted a report to 
CAAC and the National Development and Reform Commission in 
2005 requesting a more flexible pricing system, but never 
received a reply. 
 
¶18. (SBU) The airline will place an aircraft purchase order 
worth RMB 4 billion (USD 517.5 million) for 10 Airbus A320s 
in 2007.  Due to the capacity shortage at Shanghai Airport, 
Spring Airlines is planning to build its second home base 
in Hainan Province this year.  Spring Airlines' routes from 
Shanghai to Guangzhou and Zhuhai are popular, and customers 
are expecting more routes to be opened in the Pearl River 
Delta region. 
 
Foreign Budget Airlines Expand Business 
--------------------------------------- 
 
¶19. (SBU) Thai AirAsia, a branch of the budget airline Air 
Asia, entered the China market in April 2005 by opening a 
Bangkok-Xiamen route.  Since then, the route has enjoyed an 
average occupancy rate of 85 percent.  Due to the rising 
number of tourists and business travelers, on March 25, 
Thai AirAsia increased the number of its Bangkok-Xiamen low 
fare flights from four to seven per week.  This year, the 
airline plans to open two to four new routes in China. 
However, the Vice President of Air Asia blamed China's 
airport capacity shortages for raising the airline?s 
operating costs and said the official aviation monopoly has 
been a barrier for opening new routes in China.  As a 
result, Thai AirAsia has to operate on less traveled routes. 
 
¶20. (SBU) Singapore's Tiger Airways launched its inaugural 
flight to the Chinese mainland with a Guangzhou flight on 
April 25, 2006.  Since then, it has opened additional 
 
GUANGZHOU 00000681  005 OF 005 
 
 
flights from Singapore to Guangzhou, Shenzhen, and Haikou. 
On March 25, 2007, an additional two weekly flights to 
Shenzhen and Guangzhou were added to its summer flight 
schedule to meet the strong demand for low fare air travel 
on these popular routes. 
 
¶21. (SBU) Other budget airlines are also winging their way 
into long-haul territory.  Oasis Hong Kong Airlines began 
to offer flights to London's Gatwick Airport on October 25, 
¶2006.  It hopes to expand its Hong Kong service to Oakland 
and Chicago this year.  Oasis is taking aim at Cathay 
Pacific Airways by offering promotional one-way economy 
class fares for HK 209 (USD 27), compared with Cathay's 
current fare of about HK 530 (USD 68).  Oasis' chief 
executive and founder Stephen Miller noted that Oasis is 
trying to coordinate its schedules and operations with 
those of other budget airlines in Britain and the United 
States.  If it succeeds, Oasis could wind up forging the 
first links of a world-wide network of low-cost carriers. 
"It would be a sort of strategic alliance," said Miller. 
Oasis executives say they have met with counterparts from 
Britain's easyJet, but an easyJet spokeswoman declined to 
confirm such talks. 
 
COMMENT: CAAC Plays a Key Role 
------------------------------ 
 
¶22. (SBU) As economic growth continues and average incomes 
rise, the tremendous growth in air travel demand will 
continue to make South China a hot spot for airlines.  As 
airlines rapidly expand their business in the region, a 
price war can be expected in the near future.  Problems 
with slot allocation and route networks will worsen and 
hinder commercial aviation development.  CAAC will have to 
step up to reform China's civil aviation management system 
and create a healthy business environment in the aviation 
sector, otherwise growth may stall. 
 
¶23. (U) This cable was coordinated and cleared with 
Consulate General Hong Kong and Embassy Beijing. 
 
Airlines At-A-Glance: 2006 
-------------------------- 
                                                Potential 
Airline           Passengers      Cargo (tons)  Alliance 
 
China Southern    49.2  million     851,580     SkyTeam 
Cathay Pacific    18.1  million   1,308,000     OneWorld 
Hainan Airlines   14.39 million     198,700     OneWorld 
Xiamen Airlines    7.76 million     110,000     SkyTeam 
Shenzhen Airlines  7.05 million     107,000 
Tiger Airways      1.3  million 
Spring Airlines    1.13 million 
Thai AirAsia       1.13 million 
 
 
GOLDBERG