VZCZCXRO9074
RR RUEHCN RUEHGH
DE RUEHGH #0053/01 0301122
ZNR UUUUU ZZH
R 301122Z JAN 09
FM AMCONSUL SHANGHAI
TO RUEHC/SECSTATE WASHDC 7571
INFO RUEHBJ/AMEMBASSY BEIJING 2477
RUEHCN/AMCONSUL CHENGDU 1716
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RULSDMK/DEPT OF TRANSPORTATION WASHINGTON DC
RUEHGZ/AMCONSUL GUANGZHOU 0172
RUEHHK/AMCONSUL HONG KONG 1886
RHEHAAA/NSC WASHINGTON DC
RUEHUL/AMEMBASSY SEOUL 0342
RUEHSH/AMCONSUL SHENYANG 1705
RUEHGP/AMEMBASSY SINGAPORE 0216
RUEHIN/AIT TAIPEI 1506
RUEHKO/AMEMBASSY TOKYO 0507
RUEHGH/AMCONSUL SHANGHAI 8200

UNCLAS SECTION 01 OF 03 SHANGHAI 000053 
 
SENSITIVE 
SIPDIS 
 
STATE ALSO FOR EB/TRA/AN 
TRANSPORTATION FOR X1, X40 
TRANSPORTATION FOR OFFICE OF INTERNATIONAL AVIATION 
USDOC FOR ITA DAS KASOFF 
NSC FOR TONG, LOI 
TREASURY FOR OASIA/ISA HAARSAGER, WINSHIP 
 
E.O. 12958: N/A 
TAGS: CH EAIR ECON EINV ETRD PGOV
SUBJECT: SHANGHAI AIRLINES FACES TURBULENT TIMES 
 
(U) This cable is sensitive but unclassified and for official 
use only.  Not for distribution outside of USG channels or via 
the internet. 
 
¶1.  (SBU) Summary:  Shanghai Airlines (SAL), China's fifth 
largest and first independently-run local airline, struggled 
through a string of economic blows in 2008, and the global 
economic slump is promising to bring more hardship in 2009. 
Shanghai Airlines Senior Vice President Gu Jiadan said the 
airline is struggling against sagging demand as Chinese 
consumers tighten their belts on business and holiday travel. 
To ease financial difficulties, Shanghai Airlines has requested 
a capital injection from the Shanghai Municipal Government. 
Shanghai Airlines lost close to USD 25 million from fuel hedging 
contracts in 2008 and is expecting to double the overall losses 
it suffered in 2007.  Gu welcomed the Government's reduction in 
the fuel surcharges and said that the company would likely use 
the opportunity to boost ticket prices.  He also said the 
airline will not postpone or cancel orders for Boeings in 2009, 
despite Government calls to delay aircraft orders from foreign 
manufactures.  Gu was tight-lipped about rumors of a possible 
merger with China Eastern, but hinted something was possibly in 
the works.  End summary. 
 
2008 Tough Year for Shanghai Airlines 
------------------------------------- 
 
¶2.  (SBU) Gu said 2008 was a very difficult year for Shanghai 
Airlines.  Although the company made a profit during the first 
four months, a number of factors contributed to record losses 
for the year.  During the first half of 2008, skyrocketing oil 
prices drove up costs substantially.  The unusual snow storms in 
early 2008, which blanketed the south-eastern part of China, hit 
during the peak travel season of Lunar New Year, causing demand 
to sag as passengers decided not to travel.  Shanghai Airlines 
was also forced to cancel flights because of the inclement 
weather.  The May 2008 Beichuan Earthquake was particularly hard 
on Shanghai Airlines because it occurred just at the beginning 
of the summer tourist season and negatively impacted the flow of 
tourists to China's western provinces, one of Shanghai Airlines 
leading destinations.  Gu added that many government officials 
were also banned from traveling in general to show respect for 
the victims, which added to the slump. 
 
¶3.  (SBU) Chinese travelers have become more frugal on business 
trips and holidays as a result of the economic crisis, further 
dampening demand, Gu said.  He added that, although there has 
already been a marked decrease in passenger loads from the 
economic crises, the impact has not yet been fully felt.  Of all 
the factors, Gu said the Olympics hurt the airlines more than 
anything else.  As the Government tightened air travel security 
for an extended period - before, during and after the Olympics - 
domestic passenger loads plummeted.  Passenger flow to Beijing, 
however, picked up rapidly after restrictions were loosened, and 
the Shanghai - Beijing route has returned to being one of the 
most profitable routes for Shanghai Airlines. 
 
Hedging Roulette - This Time on the Losing Side 
--------------------------------------------- -- 
 
¶4.  (SBU) When asked if Shanghai Airlines had suffered losses 
from oil hedging, Gu said the company only hedged a small 
amount, much less than other airlines, such as Air China. 
During the first half of the year when Shanghai Airlines' peers 
had all hedged heavily on fuel prices, he felt the company was 
too conservative.  Now, he said he felt the company was very 
lucky compared with Air China, which lost several billion of RMB 
on hedging.  In total, Shanghai Airlines lost RMB 170 million 
(USD 25 million) from fuel hedging contracts in 2008.  (Note:  A 
subsequent Shanghai Airlines statement released on January 21 
said that the airlines losses in 2008 might be double those of 
2009 due to "high oil prices, weak travel demand, and heavy 
hedging losses."  The company lost RMB 435 million (USD 64 
 
SHANGHAI 00000053  002 OF 003 
 
 
million) in 2007.) 
 
Fuel Surcharge Reduction - A Welcome Break 
------------------------------------------ 
 
¶5.  (SBU) Gu also noted that as domestic jet fuel prices have 
fallen so have fuel surcharges.  (Note:  The National 
Development and Reform Commission (NDRC) and the Civil Aviation 
Administration of China (CAAC) on December 25 lowered fuel 
surcharges from RMB 150 to RMB 40 for flights beyond 800 km, and 
from RMB 80 to RMB 20 for those under 800 km.  On, January 15 
the fuel surcharge was completely eliminated.)  Gu explained 
these surcharges are factored into the price of the ticket, and 
Shanghai Airlines is considering raising fares - although the 
overall ticket price would likely be cheaper.  According to Gu, 
lower global crude oil prices should translate into cheaper 
airline fares and increase the number of passengers in the long 
run. 
 
High-Speed Rail May Cut into Regional Business 
--------------------------------------------- - 
 
¶6.  (SBU) Gu also noted that a large part of China's stimulus 
package was tied up with railway development.  Some of the new 
lines may eventually cut into the airlines' business.  Gu cited 
the Shanghai - Beijing high speed railway as an example, which 
is nearing completion.  The travel time between Shanghai and 
Beijing will be cut to five hours, which is close to the current 
flight option if ground transportation and check-in time is 
factored in.  However, in the larger picture, Gu said that high 
speed rail would give consumers more choice, but it was 
impossible to fully replace airlines, even on the 
Shanghai-Beijing route.  Gu believed that as economic ties 
increase between the cities, there will be increased demand for 
both air and train transportation. 
 
Capital Injection Hopefully on the Way 
-------------------------------------- 
 
¶7.  (SBU) Gu noted that both China Eastern and China Southern 
had each received RMB 3 billion (USD 440 million) from the 
Central Government to reduce debt burdens.  As a result of their 
injections, Shanghai Airlines decided to also seek assistance to 
help reduce its debt; however, the company is seeking assistance 
from its main share holder - the Shanghai Municipal Government. 
Gu said Shanghai Airlines is seeking far less than the RMB 3 
billion provided to the other two airlines but would not 
disclose the amount.  Although the Shanghai Government has not 
yet provided any capital to the airlines, the city has agreed in 
principle to support the company.  When asked whether the 
Central Government's stimulus package would help the airline 
industry, Gu replied that the additional funding would likely 
help in the long run.  Some of the stimulus package will be used 
for building and improving regional airports, which will support 
some of Shanghai Airlines' domestic routes.  There is a current 
government study underway looking into a tax reduction for the 
airline companies in China, which, he added, would be a real 
boon for the industry. 
 
Despite Beijing "Guidance", SAL Still Ordering Boeings 
--------------------------------------------- --------- 
 
¶8.  (SBU) Despite CAAC's recent promptings for domestic airlines 
to suspend or cancel purchases of new planes from foreign 
manufacturers, Gu assured that Shanghai Airlines would not 
change their purchase orders for Boeing planes in 2009.  (Note: 
On December 9, CAAC asked domestic airlines to suspend purchases 
of foreign planes to cut operation costs and maintain a balance 
between demand and supply.)  However, he quickly added that 
Shanghai Airlines will consider reducing its 2010 order if 
things get worse.  According to Gu, Shanghai Airlines has close 
ties with Boeing, and the majority of its aircraft are purchased 
from Boeing.  However, Gu did complain that Boeing's delayed 
 
SHANGHAI 00000053  003 OF 003 
 
 
delivery to Shanghai Airlines of the 787 Dreamliner (currently 
nine on order) caused Shanghai to postpone plans for a direct 
flight between Shanghai and Hawaii.  (Note:  Shanghai Airlines 
was one of the first airlines to order the Boeing 787.)  When 
asked about Shanghai Airline's plan to purchase China's 
newly-developed regional jet, Gu said the ARJ21 would only 
replace its current Bombardier CRJ-200 jets, given the ARJ21 has 
more seats and lower maintenance costs.  Shanghai Airlines has 
ordered five of the new planes.  The ARJ21 will not replace the 
company's Boeing jets because they have different functions. 
Shanghai Airlines currently has 55 Boeings in its fleet.  In 
total, the company hopes to have a fleet of 100 aircraft by 2010 
capable of handling almost 18 million passengers a year. 
 
Merger with China Eastern in the Works? 
--------------------------------------- 
 
¶9.  (SBU) Regarding the widespread rumor on a possible merger 
with China Eastern Airlines, Gu said he was unable to comment, 
but hinted something is possibly in the works.  However, he said 
his personal point of view was that it was not beneficial to 
create such a giant airline company that would dominate the 
market.  It will reduce consumer choice and stifle competition. 
The current economic slowdown should not be used as a reason for 
industry consolidation, said Gu.  He added such a tie-up would 
also be very complicated since China Eastern Airlines and 
Shanghai Airlines are owned by two different levels of 
government - central and municipal.  (Comment:  Gu's views on 
airline consolidation are largely out of step with those of the 
Central Government and the Shanghai Government.  The Central 
Government has been urging industry consolidation for years. 
For example, a December 9 statement released by the CAAC said 
the agency will support further alliance and consolidation of 
the country's airlines to help increase their overall 
competitiveness.  Many rumors also abound that the Shanghai 
Government also supports such a tie-up.) 
CAMP