The Hong Kong Question

Borghetti says Hong Kong is a route covered by just two carriers, Cathay Pacific Airways and Qantas, who have got the market “by the throat” and Virgin intends to break that duopoly and bring real competition on the route. Brave words indeed.

But the reality is that five flights a week from Melbourne to Hong Kong will hardly break the back of a duopoly that operates multiple daily flights from every major Australian capital city to Hong Kong. And there are other major hurdles in the way which mean that clawing into the dominance the two incumbents have to China’s Special Administrative Region (SAR) is going to take some time indeed. For Virgin to really have an impact it needs to be flying from Sydney to Hong Kong and that is a tough act.

Hong Kong remains one of the most protectionist regimes in Asia in terms of air access. Even Qantas has been unable to use Hong Kong effectively as a hub for flights to mainland China or elsewhere in the world due to the restrictive nature of an Australia-Hong Kong air services agreement that was forged in 1998.

Australia may have recently signed an open skies deal with China but Hong Kong handles its own air service agreement negotiations. And it isn’t playing ball, until now refusing to enter into new talks aimed at negotiating a deal that will allow more capacity.

The reason for that is simple. Hong Kong’s Chep Lap Kok airport (HKIA) with its two runways, is severely congested and slots are like gold ingots. While a third runway, at a cost of some A$14. 5 billion, is being built it isn’t scheduled to be running at full capacity until 2020 at the earliest.

For Hong Kong-designated carriers there is currently no more available capacity under the Australia-Hong Kong bilateral air services agreement for any additional flights to Australia’s four major gateways – Brisbane, Melbourne, Perth and Sydney. Available capacity to these gateways has been fully utilised by Cathay Pacific, which flies 74 times a week to Australia. That means any increase in capacity has to come through larger aircraft and not additional flights, evidenced by the fact that two of Cathay’s four daily services to Sydney have now been up-guaged from Airbus A330-300 services to the larger Boeing 777-300ER and a third will replace an A330 in October.

The situation isn’t quite so dire for Australian operators.

At the same time, a relatively new entrant into Australia, Chinese Hainan Group’s Hong Kong Airlines, had no choice but to start its services to points not covered by the cap, operating from Hong Kong to the Gold Coast and Cairns.

The situation isn’t quite so dire for Australian operators, thus allowing for Virgin’s entry. But it is still restrictive. Qantas has been able to grow its Hong Kong operation with extra flights during peak periods but efforts to permanently expand operations have been held up by the HKIA slot problem. As Qantas chief executive Alan Joyce put it in 2015: “You might have open access or more access in the bilateral but if you don’t have the slots it is academic. ” That was a view underscored at a CAPA Centre for Aviation airport innovation summit in Brisbane last August by Stephen Borthwick, the Department of Infrastructure and Regional Development’s general manager for aviation industry policy.

“Unfortunately, until the third runway is built in Hong Kong it means there is limited growth opportunities for Australian carriers compared to Hong Kong-based carriers and that needs to be recognised in any bilateral discussions,” Borthwick said. “We’ve got plenty of room to grow in the current bilateral, the trouble is we can’t get the slots to grow. ” He said that although Hong Kong was one of the countries being prioritised, attempts by Australia to negotiate changes to the bilateral have been rebuffed in recent times.

Routes between Australia and Hong Kong have always been highly competitive, particularly from Sydney. The latest full-year statistics show that in the year ended June 30 2016 a little over 2. 5 million passengers flew between Australia and Hong Kong, up from 2. 3 million in 2015. Nearly half of that traffic, or a little over one million passengers, flew between Hong Kong and Sydney.

Interestingly, Cathay, which has a 5. 1 per cent share of Australia’s total international traffic, operated its inbound flights with an average load factor of 89. 2 per cent and outbound flights with a load factor of 89. 8 per cent, the highest of any carrier operating into the country. For example, average load factors from the United Arab Emirates are 82. 4 per cent and from the US 80. 1 per cent. Qantas load factors to Hong Kong are 80. 2 per cent and from Hong Kong 84 per cent. In terms of passenger numbers, in the 2015/16 year Cathay carried 917,857 passengers into Australia and 924,575 back to Hong Kong. Qantas carried 321,950 to Hong Kong and 334,343 back to Australia. On its services to the Gold Coast and Cairns, Hong Kong Airlines carried 10,827 passengers from Hong Kong and 11,095 in the opposite direction.

For the time being, in Melbourne, Virgin will be competing with Cathay’s three daily flights to Hong Kong, two with the A330 and one with the new A350-900, as well as one Boeing 747-400 daily service operated by Qantas. Virgin will be using the A330-200 five days a week, with 20 business class and 255 economy seats.

Cathay Pacific has a 5. 1 per cent share of Australia’s international traffic.

While that certainly makes Virgin a player in the Melbourne market it isn’t exactly the biggest threat the incumbents have ever faced. In addition, there is a danger that its product will be outgunned. The A330 is a good aircraft but Cathay has already introduced one A350-900 and may up the stakes with more. The aircraft is becoming an increasing part of Cathay’s Australian network. It is already flying to Brisbane as well as Melbourne and will be introduced to the Hong Kong-Perth route in October. Cathay already has 12 A350-900s in its fleet with 10 more due for delivery by the end of this year and has also signed for 26 of the larger A350-1000, which are due to arrive in the 2018-2020 timeframe.

Qantas is also eagerly awaiting the arrival of its first 787-9 later this year and although there has been much publicity about it operating non-stop from Perth to Europe, it will also likely replace the rather ageing 747-400s on Asian routes such as Hong Kong. For cash-strapped Virgin, with no such aircraft on order, it adds up to formidable opposition.

Virgin will probably go close to filling up its flights to Hong Kong from Melbourne, at least in the initial days of operations. It is already offering return economy fares of $766. The current cost of a similar ticket from Cathay or Qantas hovers around the $1,000 to $1,200 mark, though consumers can certainly expect some attractive offers from the big carriers to dull the impact of Virgin’s arrival. Whether that sparks a price war, or whether all sides realise to head in that direction will be damaging to everyone, remains to be seen.

One thing that is certain, Qantas and Cathay won’t stand by and allow any brash newcomer to eat into their business. There is another element in the equation, the fast growing presence of China’s major airlines in the Australian market. Passengers, particularly the high-end corporate travellers who habitually travelled into China through Hong Kong, now have a wide range of alternatives to fly non-stop, right over the top of Hong Kong, with the likes of Air China, China Eastern and China Southern.

Cathay itself is clearly feeling the heat, as evidenced by its latest financial results released in March. It suffered its first full-year loss since the global financial crisis as intense competition and increased capacity hit revenue. Income plunged into a A$96. 5 million deficit from a $1 billion profit a year earlier. Cathay blamed “intense and increasing competition” as the biggest drag on performance, with mainland Chinese carriers launching more direct flights to international destinations. Competition from low-cost carriers also increased, with overcapacity a particular problem.

Nevertheless, Cathay still chases through-traffic from Australia with onward flights aboard its regional subsidiary Cathay Dragon, formerly Dragonair, which flies to dozens of Chinese destinations from Hong Kong. Qantas also believes it has China well covered through strong codeshares with China Southern and China Eastern.

Virgin certainly has not ignored this. An alliance with HNA Group (owner of Hainan Airlines and now a 13 per cent stakeholder in Virgin it plans to increase) and Hong Kong Airlines will enable Virgin passengers to connect through Hong Kong to 13 destinations in mainland China and allow travellers on Hainan Airlines, Hong Kong Airlines, Capital Airlines and Tianjin Airlines to connect onto Virgin Australia’s expansive domestic and trans-Tasman network.

It probably also should not be forgotten that Australia isn’t the only Australasian player in the Hong Kong market. While few Australians would want to fly to Hong Kong through New Zealand unless a particular business itinerary demands it, Air New Zealand is deepening its ties with Cathay. While some may see it as sleeping with the enemy – Air NZ is a Star Alliance airline while Cathay is in oneworld – the fact is the Auckland carrier had little choice but to join hands with Cathay because there were no Star options.

Cathay and Air New Zealand are now extending their strategic alliance partnership on services between Hong Kong and New Zealand for a further five years until 2022, subject to continuing regulatory approvals. This came at the same time Cathay announced it will launch its first direct service to Christchurch from December this year, complementing its existing services to Auckland. The non-stop Christchurch service will operate seasonally three times per week, departing Hong Kong on Wednesdays, Fridays and Sundays, also using the A350.

All in all, for Australia and its airlines, there is no doubt that Hong Kong and Greater China will continue to present huge opportunities. In its last annual report covering the 2015-2016 year the International Air Services Commission chairperson Dr Ian Douglas pointed out that China is now Australia’s third largest country for origin/destination passenger traffic with a 9. 2 per cent share. Only the United States with 9. 3 per cent and New Zealand with 14. 7 per cent are larger.

“Passenger traffic between Australia and China has recorded an average annual growth rate of 12. 4 per cent over the last five years and an increase in the latest year of 17. 7 per cent. The Hong Kong origin/destination market is ranked eleventh in terms of passenger traffic. Passenger traffic between Australia and Hong Kong has recorded an average annual growth rate of 4. 1 per cent over the last five years and an increase in the latest year of 6. 8 per cent. ” A report by ratings company Nielson said that Hong Kong is Australia’s 10th largest inbound market based on visitor arrivals and the ninth largest market when ranked on total visitor expenditure. Visitor arrivals and expenditure growth from Hong Kong to Australia did slow in the year ending September 2016, however performance remains solid. Typhoon Nida, which tracked past Hong Kong in late July 2016, caused hundreds of flight cancellations and a temporary dampening of outbound travel and airline passenger numbers into August.

The ongoing growth out of the Hong Kong market is being driven by an upbeat holiday segment, with holiday arrivals up 31 per cent and holiday spend up 24 per cent in the 12-month period. Consumer confidence in Hong Kong saw an eight point boost in the third quarter of 2016, after two previous quarters of declines.

It all points to bright prospects but to what extent Virgin can take advantage, given its rather moderate entry into the Hong Kong market, remains to be seen.

The real returns probably won’t come until after it launches to Beijing.

But the timing of that will also depend on a number of factors. Not only is Hong Kong a congested hub, Bejing’s Capital airport is in a similar position, with huge demand for slots and not enough to go around. A second airport for the Chinese capital is being built in the Daxing District about 46 km south of the city centre at a project cost of more than A$16 billion, but it won’t be opening until late 2019.

Virgin needs to get on to the Sydney-Hong Kong and Sydney- Beijing markets if it is to fully exploit the opportunities available in Greater China. Anything less and it will, essentially, be picking at the crumbs left over by its bigger rivals. The real returns likely won’t come until after Virgin launches to Beijing.