* Some data in the report has been updated to end 2012

Confidential

Hong Kong Aviation 2022: A Review of Challenges and Opportunities in the coming decade

Strategic Access Ltd

December 2012

1

Contents

1. Executive summary, conclusions and recommendations 2

2. Setting the scene: the Hong Kong aviation hub today – 2012 5

2.1. Hong Kong holds the “Best In Class” track record 5

2.2. Economic contribution of the aviation sector today 10

2.3. Challengers 14

2.4. Challenges 17

3. The Decade ahead 23

3.1. Expected trends and implications for Hong Kong 23

3.2. Mainland developments: opportunities and challenges 25

3.3. Low cost carrier operations 31

4. Specific challenges facing Hong Kong’s aviation hub development 36

4.1. Supply-side constraints 36

4.2. The regulatory challenge: “open skies” versus “progressive liberalisation” 38

4.3. Adequate supplies of skilled manpower 39

2

1. Executive summary, conclusions and recommendations The retirement of the Donald Tsang Government and the succession of a new administration to be led by CY Leung constitute a major policy watershed for Hong Kong. A wide range of policies and policy priorities are being fundamentally reviewed. Many personnel are retiring, being replaced, or moving to new portfolios. It cannot be taken for granted that key decision-makers at the heart of the new administration are familiar with – or endorse – the policy priorities that have shaped the very successful development of Hong Kong as an aviation hub (and as a critically important driver for competitiveness and economic development) over the past decade. As such, it is timely to draw up a succinct, policy-focused review of the foundations underpinning Hong Kong’s successful development as an aviation hub, of the criteria that need to shape future policy, and of the challenges that need to be addressed if competitiveness is to be sustained. The study leads to a number of clear conclusions:

• The world-wide recession triggered in 2008 by the collapse of global financial system has inevitably impacted Hong Kong and the growth of its aviation hub. But with China managing to maintain moderate growth, and intra-regional trade continuing to grow above global trends, the hub and local airlines have fared better than many counterparts worldwide. While regional economy recovery is not expected before 2014-15, Hong Kong’s economy has maintained slow but steady growth.

• Aviation development across the Chinese Mainland is expected to be colossal over the coming two decades. This constitutes both a challenge to Hong Kong, as Mainland hubs like Shanghai and Guangzhou build critical mass, and a huge opportunity, as up to 150 new airports are opened, and air traffic activity explodes. Hong Kong cannot – and probably does not want to – compete to serve many of these domestic Chinese destinations, but will need to hone carefully its Mainland air service strategy to ensure it builds strong links with those cities that can best drive and complement its regional and intercontinental services.

• Capacity pressures on the 14-year-old Hong Kong International Airport continue to grow, with predictions that full capacity is likely to be reached by 2018 at the latest. Recession has reduced, but not reversed, the pressure to develop additional capacity to enable the hub to accommodate growth up to 2030. It has also not reduced the pressure to recruit and train skilled and semi-skilled workers equipped to maintain the current excellence and professionalism of airport operations.

• Hong Kong has maintained its position as a regional aviation leader, both for passengers and cargo, but regional competition is fierce. Competition comes not just from traditional challenges like Singapore, Shanghai or Seoul, but from the emergent Pearl River Delta hubs of Guangzhou and Shenzhen, and new Europe-facing hubs like Dubai and Chengdu. Structural changes – like environmental pressures on long-haul flights into Europe, and the shift of Chinese manufacturing into interior provinces – call for a highly nimble and proactive stance on aviation development.

• Hong Kong’s success in developing a world-leading airport and aviation hub has made a strong direct contribution to Hong Kong’s economy. Even more important, the airport has proven critical in facilitating and encouraging the development of Hong Kong as a world-leading headquarters hub. The airport thus plays a critical role not just as a direct source of economic growth, but at the very heart of the economy, facilitating the development of

3

financial, legal, accounting and many other professional services that thrive on the demand driven by the thousands of headquarter offices based in Hong Kong.

• An erosion of Hong Kong’s competitive leadership would inflict large but as yet unquantifiable damage not just on aviation and logistics but – more important – on the city’s attractiveness as a hub for global and regional multinationals and the thousands of high-value-adding professionals that serve them.

• The Hong Kong administration’s past preference for carefully targeted “progressive liberalisation” rather than unilateral “open skies” has served Hong Kong well, preserving our regional leadership, keeping our economy open to fierce competition on most air routes, and giving Hong Kong-based travellers choice unmatched in almost any other hub in the region.

• The role of our “Home Carriers” in steering future air service growth should also not be underestimated. Unlike foreign carriers, these have an indissoluble alignment of interests with those of Hong Kong’s broad economy, as was illustrated during SARS in 2003, when almost all foreign carriers halted services to and from the city.

• Hong Kong’s airport faces the prospect of reaching capacity by 2018 or early, but cannot add new runway capacity until 2024 at the earliest. In this six year period after 2018, Hong Kong will be unable to accommodate future growth in passenger and cargo services, with the result that this will be diverted to other regional competitors. This potentially endangers Hong Kong’s future as a regional aviation leader – and our attractiveness as a headquarter hub – as these competitors build critical mass and improve their services. The longer the airport is unable to accommodate new demand, the greater the danger of Hong Kong’s hard-earned standing as Asia’s “world city” being lost to other cities in the region.

• Those in the community calling for a stay on airport development put not just the future of the aviation hub and logistics economies at risk – they put at risk the competitive future of the entire economy.

These conclusions point to a number of recommendations for the consideration of the new administration:

• Press forward urgently with planning and building a third runway at HKIA, and begin examination of how to build a fourth, since this is also likely to be required by the early 2020s. The concerns of “no-growth” advocates need to be listened to and addressed, but should not delay the completion of a critical piece of Hong Kong’s economic infrastructure.

• Liaise closely with neighbouring aviation hubs – in particular Shenzhen – to secure complementary growth where possible. Both airports share common concern over access to Mainland air space, and should approach Beijing jointly.

• Hong Kong faces the certainty of acute and worsening capacity constraints at HKIA for at least the next 12 years. The Administration should consider the creation of a task force – perhaps answering to the Airport Authority – to focus on optimal management of this challenge.

• As HKIA becomes progressively more congested, careful strategic choices will need to

be made over the service priorities at the airport. It will be recalled that the old Kai Tak airport become progressively a “jumbo” hub in the mid 1990s as it sought to handle as many passengers and as much cargo as possible with limited growth in flight movements. Despite pressure to accommodate demand from Low Cost Carriers, and from business jet operators, the administration will need to chart a careful strategic course to satisfy demand growth as effectively as possible until the time when a new runway can come into service.

• Compounding this prioritisation challenge is the fact that Hong Kong faces the prospect of very strong growth in demand for air services with Mainland cities, as more airports come

4

into operation, and more Mainland Chinese travellers move by air. This presents an exciting opportunity, but has the potential to swamp the Hong Kong hub unless careful analysis and prioritisation is undertaken to clarify those routes best suited to complement Hong Kong’s regional and intercontinental connectivity. The administration should develop a carefully

targeted strategy in collaboration with local carriers to refine, clarify and prioritise

those “thick” Mainland routes that can best complement Hong Kong’s regional and intercontinental connectivity.

• The skilled and semi-skilled workforce needed to ensure effective growth in airport-related services is in short supply. Careful attention must be paid to attracting and training staff with the skills needed to facilitate Hong Kong’s competitive future.

5

2. Setting the scene: the Hong Kong aviation hub today – 2012

Aviation plays a pivotal role at the heart of Hong Kong’s economic dynamism. Its importance goes far beyond aviation per se, but underpins competitiveness in many sectors. To maintain Hong Kong’s competitiveness as a world class city and a regional hub for business and finance, it is critically important that the aviation hub provides optimal support to the wider economy. 2012 has been a challenging year for Hong Kong. Not only has the global economic environment been challenging, but we have a new Government and a new Legislative Council. The convergence of these key elections has created a fevered and destructive political climate which has frustrated progress on virtually all policy fronts. Unless this destructive political environment is calmed, the capacity of the administration either to introduce new initiatives, or simply administer existing ones, is likely to be severely constrained. For the aviation sector, 2012 has been an equally challenging year. Oil prices remain at historic highs; the global economic downturn has inflicted damage on many airlines – their cargo businesses in particular as global trade has contracted. Although Hong Kong has managed to maintain growth and its leading aviation hub status through 2008 and the subsequent deep global economic crisis, it would be complacent and dangerous to assume this will automatically continue. Hong Kong faces many challenges to its leading position as an Asian aviation hub. These include competitive challenges from airports in the Pearl River Delta (PRD) and from hubs further field like Dubai, Singapore and Seoul; uncertainties arising from the establishment of direct air links between Taiwan and the Chinese Mainland, and of course the implications for aviation of the severe global recession. Other factors clouding the horizon include climate change and emissions, and the rapid evolution of China’s multi-modal transport infrastructure, in particular in the PRD (focusing on challenges from high speed rail, and on improving transport linkages between Hong Kong and its hinterland region). It is timely for the new administration to reflect on the opportunities and challenges facing the Hong Kong aviation sector now and in the decade ahead, and to identify policy measures needed to protect and enhance Hong Kong’s competitiveness in aviation.

2.1. Hong Kong holds the “Best In Class” track record

Despite the various challenges faced by Hong Kong over past decades, it has consistently surpassed competitors as the Asian region’s leading aviation hub – both for international passengers and international cargo. Tokyo and Beijing handle more passengers in total, but many of these are domestic travellers (see Tables 1, 2, and 3).

6

Table 1: Top 20 World Airports by Passenger in 2011

Airport Total Passengers

1 Atlanta (ATL) 92,365,850 (+3.4%)

2 Beijing (PEK) 77,403,668 (+4.7%)

3 London (LHR) 69,433,565 (+5.4%)

4 Chicago (ORD) 66,561,023 (-0.5%)

5 Tokyo (HND) 62,263,025 (-2.9%)

6 Los Angeles CA (LAX) 61,848,449 (+4.8%)

7 Paris (CDG) 60,970,551 (+4.8%)

8 Dallas/Fort Worth TX (DFW) 57,806,152 (+1.6%)

9 Frankfurt (FRA) 56,436,255 (+6.5%)

10 Hong Kong (HKG) 53,314,213 (+5.9%)

11 Denver (DEN) 52,699,296 (+0.9%)

12 Jakarta (CGK) 52,446,618 (+19.2%)

13 Dubai (DXB) 50,977,960 (+8.0%)

14 Amsterdam (AMS) 49,754,910 (+10%)

15 Madrid (MAD) 49,644,302 (-0.4%)

16 Bangkok (BKK) 47,910,744 (+12.0%)

17 New York (JFK) 47,854,283 (+2.9%)

18 Singapore (SIN) 46,543,845 (+10.9%)

19 Guangzhou (CAN) 45,400,152 (+10.8%)

20 Las Vegas (LAS) 41,479,572 (+4.3%)

*Preliminary Ranking for 2011

Source: Airports Council International

7

Table 2: Top 20 World Airports by Cargo in 2011

Airport Total Cargo (Metric tonnes)

1 Hong Kong (HKG) 3,968,397 (-4.7%)

2 Memphis (MEM) 3,916,535 (-0.01%)

3 Shanghai (PVG) 3,103,030 (-4.3%)

4 Anchorage (ANC) 2,625,201 (+0.5%)

5 Incheon (ICN) 2,539,222 (-5.4%)

6 Dubai (DXB) 2,269,768 (0.03%)

7 Frankfurt (FRA) 2,215,181 (-2.6%)

8 Louisville (SDF) 2,187,766 (+1.0%)

9 Paris (CDG) 2,095,773 (-4.0%)

10 Tokyo (NRT) 1,945,110 (-10.3%)

11 Singapore (SIN) 1,898,850 (+3.1%)

12 Miami (MIA) 1,840,231 (+0.2%)

13 Los Angeles (LAX) 1,688,351 (-7.2%)

14 Beijing (PEK) 1,668,751 (+7.7%)

15 Taipei (TPE) 1,627,461 (-7.9%)

16 London (LHR) 1,569,450 (+1.2%)

17 Amsterdam (AMS) 1,549,686 (+0.8%)

18 Chicago (ORD) 1,506,117 (+1.0%)

19 New York (JFK) 1,351,259 (+0.1%)

20 Bangkok (BKK) 1,321,842 (+0.9%)

*Preliminary Ranking for 2011

Source: Airports Council International

At the same time, the new Hong Kong International Airport (HKIA), opened in July 1998, has consistently ranked as one of the world’s most highly-regarded airports. For example, it has been selected by Skytrax as the World’s Best Airport for eight out of the past 12 years. Travel Trade Gazette (TTG) has picked HKIA as the Best Airport for six of the past eleven years. There are numerous other awards that acknowledge Hong Kong airport’s outstanding service standard. The airport’s reputation for efficiency and reliability underpins this high regard. This leadership has been maintained in spite of the excellence of other regional hubs. In spite of the progress made among regional challengers, Hong Kong remains the region’s dominant force both for passengers and cargo (see Table 3 below, and Chart 1 and 2).

8

Table 3: Top 10 World Airports by International Passengers in 2011

Airport International Passengers

London Heathrow 64,687,737 (+6.2%)

Paris 55,674,880 (+4.8%)

Hong Kong 52,749,262 (+6.0%)

Dubai 50,192,013 (+8.4%)

Amsterdam 49,680,283 (+10.1%)

Frankfurt 49,477,184 (+6.9%)

Singapore 45,429,263 (+11.0%)

Bangkok 35,009,002 (+11.4%)

Incheon 34,537,845 (+4.8%)

Madrid 32,449,857 (+4.7%)

Note: International Passengers refer to traffic performed between the designated airport and

an airport in another country/territory. The figure is to deduct Direct Transit Passengers and

Domestic Passengers from Total Passengers. Hong Kong passenger traffic is international

only, as Taiwan and Mainland traffic are not counted as domestic passenger traffic.

Source: Airports Council International

9

Chart 1: Passenger Traffic in 2011

Chart 2: Cargo Traffic in 2011

10

This high reputation is built on international connectivity and flight frequencies that other hubs have yet to match. (see Table 4). However, the ambitions of Guangzhou’s airport, based on the potential eventually to build to five runways, has seen its international connectivity rise strongly, while the Baoan Airport in Shenzhen has already built significantly stronger connectivity than Hong Kong to cities across the Mainland.

Table 4: Comparison of International Passenger Connectivity

Destinations Countries

Served

Weekly

Flights

Destinations with

Daily Flights

Hong Kong 74 37 1,676 43

Beijing 91 58 732 26

Shanghai Pudong 66 30 884 32

Guangzhou 31 21 577 30

Shenzhen 9 6 76 4

Macau 13 7 226 4 Note: Excluding flights between the Mainland, Hong Kong and Macau. The data is based on the

schedules for the week of July 12-18, 2010.

Source: CPU, Study of Hong Kong’s Aviation Industry: Current Challenges and Future Strategies,

CPU. Hong Kong: CPU. P 6.

2.2. Economic contribution of the aviation sector today

Aviation is a key sector of the Hong Kong economy. Synergies are well-established with the four pillars of Hong Kong’s economy – financial services, trading and logistics, tourism and producer and professional services – which together account for hundreds of thousands of jobs, and 58% of Hong Kong’s GDP.1 The economic significance of aviation also has close linkage with the well-being of the society as a whole, in both economic and social terms. In sum, it is arguable that absent the superb fluency and efficiency of the airport hub and aviation services build up around it, the foundations underpinning financial services, trade-related services, headquarter operations and services and high value-adding professional services would quickly crumble. At present, Hong Kong is by far Asia’s most important headquarter hub. But such headquarter operations are extremely pragmatically based, and could quickly be uprooted to Singapore, Shanghai, Beijing or Tokyo if these competing hubs offered comparable facility in moving executives into and out of the hub to business destinations across the region. So the bald data significantly understate the value and importance of aviation services to the economy overall, and understate the damage that would be done to the economy in the event of any erosion of aviation services.

2.2.1. Value-added to the Hong Kong society

But what do the bald data describe? A recent Oxford Economics study estimates that the Hong Kong aviation industry supports 254,000 direct, indirect and induced jobs in Hong Kong, equivalent to 7% of the working population, and contributed 5.5% (HK$ 88.9 billion) of the city’s GDP in 2009.2 It also has a significant ‘fiscal footprint’ to sustain the Hong Kong society: “The aviation sector pays over HK$ 5.9 billion in tax, including income tax receipts from employees, social security contributions and corporation tax levied on profits, while passengers paid HK$ 2.8 billion in

1 Hong Kong International Airport (HKIA) (2011), HKIA Master Plan 2030. Hong Kong: HKIA. 2 Oxford Economics (2011), Economic Benefits from Air Transport in Hong Kong. Oxford: Oxford

Economics.

11

passenger departure taxes. It is estimated that an additional HK$ 3.7 billion of government revenue is raised via the aviation sector’s supply chain and another HK$ 2.3 billion through taxation of the activities supported by the spending of employees of both the aviation sector and its supply chain.” 3 Scoping it down to the air transport services industry alone, where historical data is available to monitor the growth trend of the industry, Census data from 2011 show 49,704 people engaged directly in the air transport industry, up nearly 1.6 times from 1998, and growing at an average of 3.9% a year during the period.4 The pace of growth has been more robust in recent years, at around 4.3% per year, reflecting the industry’s vigorous growth performance.5 (see Table 5)

Table 5: The Economic Contribution of the Air Transport Services Industry

1998 2008 2009 2010 2011

Gross output (HK$ mln) 46,878 125,852 102,444 129,859 n.a.

% of contribution to GDP at basic prices

1.8% 1.7% 2.4% 3.2% n.a.

Value Added (HK$ mln) 21,643 27,375 37,422 54,456 n.a.

Business receipts and other related income (HK$ mln)

44,494 112,215 91,303 118,705 126,466

No. of people engaged 30,381 44,064 45,845 47,318 49,704

No. of establishments 684 1,203 1,204 1,232 1,395 Source: Census and Statistics Department (2012), Statistical Digest of the Services Sector 2012. Hong Kong:

Census and Statistics Department, HKSAR; Census and Statistics Department (2012), Statistical Digest of the

Services Sector 2012. Hong Kong: Census and Statistics Department, HKSAR.

Business receipts from the aviation industry have tripled in the past decade, from HK$ 45 billion in 1998 to HK$ 126 billion in 2011.6 In spite of a sharp fall in business receipts in 2009, when Hong Kong, alongside other advanced western economies, was hit by the global financial crisis, the business of the air transport services industry recovered and returned to growth in 2010. In 2011, business receipts of the industry were 12.7% above receipts in 2008.

2.2.2. The Contribution of the Hong Kong International Airport

The direct economic benefit arising from the centripetal pull of the Hong Kong International Airport (HKIA) is substantial. This important piece of Hong Kong infrastructure generated HK$ 78 billion in direct value-added in 2008, representing 4.6% of Hong Kong’s GDP.7 Income was generated from a vast network of economic activities engaged by the operation of airport, comprising organisations such as the Airport Authority, airlines, air cargo terminal operators, catering operators, aircraft maintenance and services operators, etc, as well as non-aviation business at HKIA, including retail, food and beverage, hotels, and conventions and exhibitions.

3 Oxford Economics (2011), Economic Benefits from Air Transport in Hong Kong. Oxford: Oxford

Economics. p. 4. 4 Census and Statistics Department (2012), Statistical Digest of the Services Sector 2012. Hong Kong:

Census and Statistics Department, HKSAR. 5 Data refer to period of 2007-2011. Census and Statistics Department (2012), Statistical Digest of the

Services Sector 2012. Hong Kong: Census and Statistics Department, HKSAR. 6 Census and Statistics Department (2012), Statistical Digest of the Services Sector 2012. Hong Kong:

Census and Statistics Department, HKSAR. 7 Hong Kong International Airport (HKIA) (2011), HKIA Master Plan 2030. Hong Kong: HKIA.

12

These activities create careers across the gamut of skills, and support and improve the well-being of thousands of families and individuals. The recent proposal to expand the infrastructure of the HKIA, if endorsed, will add many thousands of new jobs, including low-skilled staff and school leavers who need to build skills and capabilities at the start of their careers. (see Table 6)

Table 6: Economic Impact Analysis of the HKIA

2008 (Actual) 2030*

Economic contribution (Direct + indirect + induced)

HK$ 78 billion HK$ 120 – 167 billion

% of GDP 4.6% 3.3% - 4.6%

Direct employment 62,000 101,000-141,000 Indirect + induced employment 124,000 143,000 – 199,000

186,000 244,000 – 340,000

* based on the estimate for 2-runway option and the 3rd runway option for expansion.

Source: Hong Kong International Airport (HKIA) (2011), HKIA Master Plan 2030. Hong Kong: HKIA. p. 43.

2.2.3. Consumer benefits beyond the price tag on an air ticket

Many ignore the fact that the value of air transport generated for its consumers (passengers and shippers) extends far beyond the price tag on an air ticket and the jobs directly associated with the industry. The reliability and speed of the hub and its operators characterise the importance of air transport and aviation to people’s personal lives and business operations. People and business rely on air transport for holidays and visiting friends and families, and for meeting clients and delivering goods and services. In a way, the air fares that consumers are willing to pay do not fully reflect the value that they actually place on the flight they pay for. Economists call this gap the ‘consumer surplus’ – the satisfaction that consumers enjoy but do not pay for in monetary terms. This economic concept is key to understanding consumer demand on certain products and services, and their response to price changes. While there are calls for attention on the social cost of air transport, the concept of consumer surplus should also be taken into the frame of discussion. It provides a better, and fairer, understanding of the ‘true value’ (or satisfaction created) that a product or service brings to a consumer. Although consumer surplus is often difficult to measure due to a lack of available and systemic collection of data, estimates of consumer surplus built on informed economic theory and modelling can provide a valuable point of reference. Based on 2009 air traffic data from Hong Kong and a rather conservative estimation methodology, Oxford Economics calculated that “air passengers and shippers valued the air transport services they used in Hong Kong at over HK$ 454.3 billion and HK$ 104.9 billion respectively. Contained within these amounts, the consumer benefits derived on top of those measured by expenditure on travel and shipments were about HK$ 191.2 billion for passengers and HK$ 30.8 billion for shippers… out of the consumer benefits generated by Hong Kong air transport and on top of that measured by expenditure, Hong Kong citizens derived HK$ 95.6 billion in value and Hong Kong shippers around HK$ 14.8 billion in value.” 8 Clearly, the satisfaction that aviation generated for people and businesses is far higher than the price they actually pay for aviation. The true benefits and significance of air transport and aviation continue to be understated.

8 Oxford Economics (2011), Economic Benefits from Air Transport in Hong Kong. Oxford: Oxford

Economics. pp. 7-8.

13

2.2.4. An aviation hub, core to enhancing Hong Kong’s competitiveness

Critically important, Hong Kong’s aviation hub status facilitates the city’s position as a headquarter economy, which in turn drives not only financial services, but a wide range of other high value-adding professional services. As of end 2012, Hong Kong was home to 1,367 regional headquarters (RHQs) of multinational companies – by far the largest clustering in Asia. These directly employ 140,000 people.9 About 70% of the RHQs comment that Hong Kong’s transport infrastructure is a significant factor in choosing it as headquarters. A convenient and efficient airport and air service network certainly plays a significant role in this regard. Over half of the RHQs engage in trade, wholesale and retail businesses, while one-fourth are involved in professional, business and education services, and financing and banking. Clustering of these high value-adding industries in Hong Kong in turn further strengthens it as a business hub, attracting the world’s leading legal and accounting firms and many other professional services providers. The symbiotic dynamic between an aviation hub and a business hub is noteworthy, distinguishes the aviation economy from the maritime economy based on Hong Kong’s port, and plays a large part in driving Hong Kong’s fundamental success as a business services hub. The economic penalty for weakening this clustering of high value-adding services would be huge and would imperil the very prosperity of Hong Kong. In short, the economic significance and symbiotic importance to the broader Hong Kong economy of being, and continuing to be, a world-leading aviation hub cannot be underestimated, especially in employment creation. The cascading impact of weakening the aviation economy is estimated at HK$ 1.1 billion for each 1% reduction in aircraft movements.10 The growth potential of aviation remains strong due to impressive demand for aviation in the region, and being prepared for the growth opportunities will be important, underpinning the urgent need to address the capacity challenges facing the Hong Kong International Airport. Commitments to support the growth of our airport and to advance the competitiveness of Hong Kong as an aviation hub must be a policy priority of our Administration and our community. Clearly, diversion of future growth away from HKIA to other airports is likely to put in jeopardy the hundreds of thousands of aviation-stimulated jobs that are at the heart of Hong Kong’s economy, and would be perilously damaging to the fundamental livelihood of our entire community. This point may seem self-evident, but appears to be unrecognised by a growing proportion of (in particular young) Hong Kong people who argue that Hong Kong can afford to forego economic growth and should instead prioritise ‘quality of life’. The dangerous implications of this “no growth” perspective are reviewed later (see page 38).

9 Census and Statistics Department (2012), Report on 2011 Annual Survey of Companies in Hong Kong

Representing Parent Companies Located Outside Hong Kong. Hong Kong: Census and Statistics Department, HKSAR.

10 The estimation is based on the research work of Professor Fung Ka Yiu, Executive Director of the

Aviation Policy and Research Centre at the Chinese University of Hong Kong. Fung, Ka Yiu (2010), ‘香

港國際機場是否需要「第三條跑道」’, Hong Kong Economic Journal, April 15, 2010, p. 35.

14

2.3. Challengers

2.3.1. Singapore, Seoul, Dubai and Shanghai

Several hubs in the region are competing head-to-head with Hong Kong. Singapore has been a long-standing competitor of Hong Kong. Hong Kong’s rate of air passenger growth has generally surpassed that of Singapore over the past decade and as a result Hong Kong’s air passenger traffic today remains significantly higher than Singapore in absolute terms. However, we have seen Hong Kong’s growth slow notably during the most recent economic downturn. In 2011, Singapore marked 10.7% air passenger growth, while Hong Kong grew by 5.9%. Other fast-growing hubs - Shanghai, Seoul and Dubai – have also been catching up very quickly in building hub traffic in international passenger and cargo services in recent years. Both Seoul and Dubai have grown at an annual average of 14% over the past 11 years in air passenger traffic. Dubai’s air passenger traffic has tripled in a decade. (see Chart 3)

Chart 3: HK vs the Key Challengers - Passenger Traffic in 2001-2011

On air cargo, Hong Kong still outshines all other leading air cargo hubs in the world. In 2010, it recorded a world-beating level of air cargo traffic of 4.1 million tonnes. This leadership may be unassailable in the near future, but the rise of Shanghai, Dubai, and Seoul in air cargo, especially in international cargo, has created some pressures for Hong Kong. Seoul, Dubai and Shanghai grew at an annual average of 10.8%, 13.9%, and 14% respectively in the period between 2001 and 2011. This compares with 5.8% for Hong Kong. If we look at a shorter timeframe, say the past five years, Dubai and Shanghai managed to grow at an annual average of 8.7% and 7.5%, while Hong Kong grew at a slower pace of an average of 2.5% per annum. (see Chart 4)

15

Chart 4: HK vs the Key Challengers - Cargo Traffic in 2001-2011

2.3.2. Shenzhen and Guangzhou in the PRD

In the PRD region, competition is intense. While Hong Kong is still dominant in the PRD air services market, Shenzhen and Guangzhou have been growing at an exceptional pace in the past few years. Robust demand for air transport services has for a large part been driven by the economic strength of Guangdong, China’s richest province. As the manufacturing hub of Southern China, it has strategic advantages which have the potential to draw hub services away from Hong Kong. (see

Chart 5 and 6)

Infrastructure development in the Shenzhen Baoan airport and the Guangzhou Baiyun airport has been breath-taking. In September 2009 Guangzhou’s Baiyun airport completed two “corridors” (East 3 and West 3) to increase the airport's capacity to 45 million passengers a year.11 The capacity limit was quickly met in 2011. Baiyun airport has set a clear target: to be able by 2015 to handle 75 million passengers and 2.17 million tonnes of cargo a year, and by 2020 to handle 80 million passengers and 4 million tonnes of cargo, with the airport having five runways, three terminals and three logistics parks.12 In July, the National Development and Reform Commission (NDRC) gave approval for Baiyun to build a new terminal and a third runway. The infrastructure expansion will support Baiyun to extend its services and build hub traffic. In Shenzhen, Baoan airport has also rolled out its grand plan to build capacity to handle 45 million passengers and 2.4 million tonnes of cargo volume by 2020.13 (see Table 7)

11 Interview with Guangzhou Airport Authority. 12 Data provided by Cathay Pacific Airways. 13 Interview with Shenzhen Airport Authority.

16

Chart 5: Air Passengers, PRD Airports, 2007-2011

Chart 6: Air Cargo, PRD Airports, 2007-2011

17

Table 7: The Expansion plans of Guangzhou and Shenzhen airports

2011 2012 2015 2020

Guangzhou Baiyun Airport

- 3rd runway

• 2nd Terminal

• High speed rail services linking airport to city

• 5 runways

• 3 terminals

Shenzhen Baoan Airport

2nd Runway 3rd Terminal - • 4th Terminal

• 3rd runway

Source: Interviews with and materials provided by GZIA and SIA; Cathay Pacific, 2009; Guangfa

Securities Ltd.

Hong Kong faces clear and intensifying challenges from the operations of increasingly substantial and sophisticated air services hubs in Guangzhou’s Baiyun and Shenzhen’s Baoan airports. If the PRD manufacturing economy is set to reduce its reliance on export processing activity, and instead focus on meeting demand from within China’s domestic consumer economy, then it is possible that Hong Kong’s long standing locational advantages will be eroded. To date, the pressures faced by the Hong Kong aviation industry have increased in such a highly competitive regional environment. Our competitors are challenging us with their improved infrastructures, extended services networks, better airport services, airline-friendly measures, and unabashed policy support to local carriers. These developments should not be taken lightly, in terms of Hong Kong’s competitive future as an aviation hub. These demand careful attention from the Administration, so that Hong Kong can stay competitive in the region as a leading aviation hub.

2.4. Challenges

2.4.1. Global recession

The global economy has been in trauma since 2008, and is still struggling. Four years after the financial crisis hit Europe and US, these advanced economies have yet to return to a stable growth path. The European Union’s GDP has been falling and recently returned to negative growth of 0.3% in the 2Q 2012. Many are predicting further sharp contraction in Europe in 2013 and perhaps full-blown recession.

18

Chart 7: Real Quarterly GDP (Y-o-Y), 4Q2010 - 2Q 2012

As shown in Chart 7, the emerging economies are also showing signs of slowing down. The IMF’s forecasts for global growth have given little comfort, predicting a protracted period of weak growth. While the Fund maintained its forecast of 2012 world economic growth at 3.5 percent, it has cut its forecast of growth in 2013 to 3.9 percent, down from the estimate of 4.1 percent made in April. In 2010, the world economy expanded 5.3 percent.14 Hong Kong has inevitably been affected, as export orders from Europe and US have dropped. The grim trade outlook can be expected to persist through to 2014 at least, until clear signs of recovery are noted in Europe and US. Hong Kong’s Financial Secretary John Tsang has warned of growing risks of a technical recession and rising unemployment after retail sales and exports have shrunk for several months. He has lowered the official forecast for Hong Kong’s 2012 economic growth to 1% to 2%, down from 1% to 3%. 15 The poor economic outlook inevitably looms over prospects for aviation. There has been acute financial stress faced by many airlines, as global aviation has been hit severely both in terms of passenger and cargo traffic since the 2008 financial crisis. Routes and frequencies have been cut sharply, with some airlines disposing of, or parking aircraft, and cutting staff costs. In 2008, the industry reported a net loss of US$ 10.4 billion. Air traffic and profitability revived in 2010, after stimulus was put in place in many countries to prevent the global economy from diving deep into a recession. The International Air Transport Association (IATA) reported passenger demand for the full year 2011 rose 5.9% compared to 2010, though cargo markets contracted by 0.7%. While the rebound in 2010 proved to be short-lived, IATA has estimated that the global airline

14 ‘I.M.F. Trims 2013 Forecast for Growth to 3.9%’, New York Times, July 16, 2012,

http://www.nytimes.com/2012/07/17/business/economy/imf-clips-global-growth-forecast-for-2013-to-3-9.html?_r=0

15 ‘Hong Kong faces risk of recession, Tsang says’, South China Morning Post, September 3, 2012.

19

industry made a profit of US$ 7.9 billion in 2011.16 To date, there is an emerging consensus that any recovery is fragile. IATA says that prospects for 2012 and 2013 are far from encouraging, due to the uncertain economic outlook in Europe and US, and a slowdown in Asia. IATA has warned of big downside risk on the weak profitability of European airlines, which would drag on global profitability.17 Global profits could more than halve in 2012 owing to surging oil prices and the eurozone crisis, IATA says, with European carriers expected to suffer losses of US$ 1.1 billion. While Asia, China in particular, is expected to maintain growth in aviation, the pace of growth in China slowed to 8.1% in the first quarter of 2012 - its slowest pace in nearly three years. Anxiety over weak growth in the aviation industry has intensified as many airlines have reported poor results in their recent financial statements. In response, some airlines have cut fleet expansion plans and cut staff. Some have looked for airline alliances to stay competitive. (see Table 8)

Table 8: Latest Full-year Financial Results in 2011/2012, Selected Airlines

Airlines Turnover/Revenue Net Profit

Cathay Pacific +9.9% -60.8%

Air China +19.3% -41%

China Southern +6% -12%

Singapore Airlines +2.2% -69%

Qantas Airways +6% -197%

Emirates +16.2% -72%

Air Asia +13.8% -47%

Asiana Airlines +4.4% -136%

IAG (BA and Iberia) +10.4% +455%

AirFrance-KLM +4.5% -379% Source: Financial reports of the respective airlines.

2.4.2. Oil prices

Oil prices matter immensely to the health of the aviation industry. They now account on average for 33% of costs. Increases in fuel prices affect airlines in two ways: first, the cost of fuel has an obvious and direct impact on the cost of operation, squeezing profits; and second, fuel cost increases have repeatedly triggered economic recessions, which in turn result in a substantial decline in demand for air travel and air cargo. Back in April 2008, when oil prices spiked to a record high level, six airlines were forced to close down in a month, and 10 more filed for bankruptcy protection. The US Air Transport Association (ATA)’s comment struck the chord to the industry: “This is all to do with the cost of jet fuel. Carriers simply cannot afford it.”18 (see Chart 8)

16 ‘State of the Air Transport Industry’, IATA, June 8, 2009.

http://www.iata.org/pressroom/speeches/Pages/2009-06-08-01.aspx 17 ‘Big Downside Risks on Weak Profitability-European Losses Deepen’, IATA, June 11, 2012.

http://www.iata.org/pressroom/pr/pages/2012-06-11-02.aspx 18 ‘Fuel costs kill off a US airline every week’, The Observer, May 25, 2008,

http://www.guardian.co.uk/business/2008/may/25/theairlineindustry.usa

20

Chart 8: Industry Fuel Costs and Net Profits

Source: IATA.

Table 9: Fuel Impact on Operating Costs

Year % of Operating

Costs Average Price per

Barrel of Crude Break-even Price

per Barrel Total Fuel

Cost

2003 14% $28.8 $23.4 $44 billion

2004 17% $38.3 $34.5 $65 billion

2005 22% $54.5 $51.8 $91 billion

2006 26% $65.1 $68.3 $117 billion

2007 28% $73.0 $82.2 $135 billion

2008 33% $99.0 $82.5 $189 billion

2009 26% $62.0 $58.9 $125 billion

2010 26% $79.4 $89.6 $139 billion

2011 F 30% $111.2 $116.1 $176 billion

2012 F 33% $110.0 $111.9 $207 billion Source: IATA.

The global airline industry’s fuel bill is forecast to total US$ 207 billion in 2012. This is an increase of US$ 31 billion over 2011 and is almost five times 2003’s fuel bill of US$ 44 billion. Extraordinarily, airlines have managed to raise efficiency levels almost in line with these rising costs. According to IATA the average airline break-even point for fuel has risen over 4-fold, from US$ 23 to US$ 112. (see Table 9) Industry profits are expected to fall from US$ 7.9 billion in 2011 to US$ 3.0 billion in 2012.19 Fuel costs are now estimated to account on average for at least one-third of an airline’s operation cost, as compared with 14% in 2003. Brent crude oil has tripled since December 19 ‘Fact Sheet: Fuel’, IATA, http://www.iata.org/pressroom/facts_figures/fact_sheets/pages/fuel.aspx

21

2008, from a low point of about US$ 41 per barrel to US$ 125 per barrel in March 2012, the second highest price in a decade. After easing back for a short period of time, oil prices have been on a rising trend since June 2012. In August, oil prices exceeded US$ 100 per barrel again, at US$ 113 per barrel. IATA has estimated that for each dollar increase in the average annual oil price, airlines face an additional US$ 1.6 billion in jet fuel costs.20 In the absence of pricing power – the ability to pass these costs along in the form of higher air fares – these increases come right off the bottom line. Airlines have been forced to look for extreme responses to deal with persistently rising fuel cost, including mergers, cost-cutting measures, and investment in aircraft that optimize energy-efficiency.

2.4.3. Environment

Environmental challenges have come to the top of aviation’s agenda. Pressures from civil society and national governments are growing, calling for “sustainable aviation”. In 2009, the global aviation industry produced an estimated 628 million tonnes of carbon dioxide. 21 This is 2% of the global total of over 30 billion tonnes produced by humans worldwide. The airline industry is under acute pressure to cut its carbon footprint. As the UN’s International Civil Aviation Organization (ICAO) failed to deliver a global plan to cut carbon emissions, the industry, led by IATA, voluntarily presented proposals in 2009 to commit itself to halving emissions from the sector by 2050, improving fuel efficiency by 1.5 per cent annually to 2020, and ensuring emissions decline in real terms thereafter. The proposal was welcomed by ICAO, and laid a platform from which ICAO was able to make the first agreement on a sectoral framework for addressing international aviation emissions. However, ICAO goals are relatively modest compared to those of the industry. It calls for a 2% annual improvement in fuel efficiency, a collective medium-term aspirational goal of capping aviation’s carbon emissions from 2020, and a global CO2 standard for aircraft engines to be applied from a target date of 2013. Clearly, the aviation industry wants a global approach – led by UN’s ICAO – to address the challenges of climate change, as some countries set their own emission reduction schemes targeting aviation. The industry argues that unilateral actions by national governments are counterproductive and impede fair competition in the aviation industry. The controversial unilateral EU Emission Trading Scheme (ETS) on aviation is a case in point. The scheme aims to demonstrate how a worldwide sector approach to emission reduction would work, and from the start of 2012 until recent suspension of the measure, required all flights in and out of Europe to pay for their emissions. The scheme has faced intense opposition from airlines and countries around the world. The cost implications of the ETS are significant for airlines, but more importantly the scheme’s impacts affect different airlines differently, distorting competitiveness and competition. IATA argued that ETS would cost airlines US$ 1.6 billion over the course of 2012, and Chinese carriers claimed that the scheme would cost the country's airlines 800 million yuan (or about US$ 127 million) in 2012, 3 billion yuan in 2020, and cumulatively 17.6 billion yuan over the next nine years.22 Some airlines had already begun to pass on some of the cost to their customers. Delta Airlines added US$ 6 to the cost of a return ticket between America and Europe alongside Lufthansa and Brussels Airlines, both

20 ‘Airline Industry 2011 Profit Outlook Slashed to $4 Billion’, IATA, June 6, 2011,

http://www.iata.org/pressroom/pr/pages/2011-06-06-01.aspx 21 Air Transport Action Group (2010), The right flightpath to reduce aviation emissions. Available at

http://www.enviro.aero/Content/Upload/File/AviationPositionPaper_COP16_normalprinter.pdf 22 ‘China bans airlines from paying EU carbon costs’, Wired News website, February 6, 2012,

http://www.wired.co.uk/news/archive/2012-02/06/china-bans-airlines-paying-eu-carbon-costs

22

of which said they would add currently unspecified surcharges.23 Air China estimated that for each additional service to Europe, the additional cost of ETS will be 15 million yuan,24 which would lead to an increase of 200-300 yuan for each air ticket from Beijing to a European destination. For airlines unable to pass on the cost, the unequal compliance costs of the ETS have been damaging and unwelcome.25 In November, the EU responded to massive international resistance by suspending its scheme pending a global proposal from ICAO. By then 26 countries had formed a “coalition of the willing” to lodge formal protest against ETS, including China, Russia, and India. China was the first country that prohibited its carriers from paying the European Union carbon tax, and China’s tough stance encouraged non-compliance of other countries. Then in August, the US congress passed a bill to prohibit US airlines from participating in the ETS.26 In November, the EU decided to suspend the application of the ETS for extra-EU flights. 27 However, the EU decision to suspend the ETS is temporary, based on assurances that ICAO will in due course agree an international deal. If the negotiation of an international deal fails, the EU will automatically reinstate the ETS to extra-EU flights in autumn 2013. As the controversy has continued, so uncertainty has added significant pressure for the already-struggling industry. These challenges have placed acute pressure on the competitiveness of the Hong Kong aviation sector. While the Administration may have little direct influence to correct the gloomy global economic outlook, nor oil prices, close monitoring of latest economic developments will be imperative if the economy is to minimize the harmful impacts on aviation and the wider economy. As to the environment challenges faced by the aviation sector, the Administration will need to be keenly attentive. The EU ETS has the potential to be a “game changer” for current international hubbing activity. For instance, Qantas has made plans to move hubbing operations for European services from Singapore to Dubai to cut costs, including to minimize the compliance cost of the EU ETS policy. As a leading aviation hub in the region, Hong Kong will need to keep a close eye on the impacts of the EU ETS, or more broadly, on the environmental challenges that may threaten Hong Kong’s hubbing status.

23 ‘China bans airlines from paying EU carbon costs’, Wired News website, February 6, 2012,

http://www.wired.co.uk/news/archive/2012-02/06/china-bans-airlines-paying-eu-carbon-costs 24 ‘China bans airlines from paying EU carbon fees’, Xinhuanet, February 6, 2012,

http://news.xinhuanet.com/english/china/2012-02/06/c_131394306.htm 25 ‘China bans airlines from paying EU carbon costs’, Wired News website, February 6, 2012,

http://www.wired.co.uk/news/archive/2012-02/06/china-bans-airlines-paying-eu-carbon-costs 26 ‘U.S. Senate Committee Advances Anti-ETS Legislation’, AIN Online, August 6, 2012,

http://www.ainonline.com/aviation-news/ain-air-transport-perspective/2012-08-06/us-senate-committee-advances-anti-ets-legislation

27 ‘EU suspends aviation inclusion in ETS for international lights’, Air Transport World, November 12, 2012, http://atwonline.com/international-aviation-regulation/news/eu-suspends-aviation-inclusion-ets-international-flights-1112

23

3. The Decade ahead

3.1. Expected trends and implications for Hong Kong

3.1.1. Demand-side growth remains robust

In spite of gloomy views on the global economy in the coming two years, Asia will continue to play a key role in driving the global economy forward. Hong Kong continues to enjoy the locational advantage of being at the heart of Asia and at the heart of a greater China region. HKIA’s demand forecast for air services for the next 20 years is 4.2% for air cargo and 3.2% for air passengers on an annual compound growth basis.28 Comparing with an average annual growth of 7% for air cargo and 5.8% for air passenger traffic in the past 11 years, the forecast is modest, reflecting anxiety over the possibility of protracted recession in the advanced western economies for much of the coming decade. There are reasons to believe that Asia’s robust demand for air services, especially in China and the ASEAN economies, will sustain the growth trend in the region. If the global economic focus has shifted to Asia, this will draw air traffic flows to Asia for business and trade. These provide the fundamental factors for Hong Kong to be able to recover a more robust growth trend. The implications are that the demand growth is likely to be steady, and that Hong Kong should make itself ready to capture this growth, strengthening its hub status in the region. If Hong Kong fails to do this, other hubs will almost certainly supersede it. Furthermore, the growth pattern may change, as the demand growth in different markets may differ. For instance, how can Hong Kong take advantage of demand growth in air services in China? How should Hong Kong play the role as a key aviation gateway for China? This will require careful strategic planning in route development, and traffic management, with respect to the current airport capacity of Hong Kong.

3.1.2. Air cargo: new capacity comes on stream

The air cargo capacity of the Hong Kong International Airport will be strengthened, as new capacity will be added at the airport. A new cargo terminal being constructed by Cathay Pacific Airways is scheduled to open in early 2013. This HK$ 5.7 billion facility will feature a state-of-the-art, HK$ 1.4 billion cargo handling system. It will be one of the largest cargo terminals in the world with a capacity of about 2.6 million tonnes each year. The new facility will boost Hong Kong airport's annual cargo handling capacity to 7.6 million tonnes in 2013, with the airport expected to handle as much as 8.9 million tonnes of air cargo by 2030 - double the current capacity limit of the two-runway airport at Chek Lap Kok. The new capacity and state-of-art facilities clearly increase Hong Kong’s competitiveness in air cargo services, allowing it to strive for greater efficiency and quality handling of air cargo, amid intense competition with other fast-growing air cargo hubs in the region, such as Seoul, Dubai and Shanghai. In spite of an uncertain global economic outlook, Hong Kong still has great potential in sustaining growth in trade and international air logistics. Getting Hong Kong prepared for capturing the potential growth is important. A strategic approach to optimize the use of the new capacity and capture growing demand for air cargo services in the region is critical to the development of the aviation sector. If Hong Kong fails to address the capacity constraint, effectively gifting future growth to competing hubs, Hong Kong could give away its competitive edge in air cargo services to

28 Hong Kong International Airport (HKIA) (2011), HKIA Master Plan 2030. Hong Kong: HKIA.

24

other hub competitors, falling behind and losing market share. Such a loss would cost tens of thousands of jobs in the aviation and the related industries. The success of Hong Kong’s air cargo development does not depend on adequate capacity alone: it also depends critically on other factors, including the manufacturing cluster in PRD, freight-forwarder networks, adequate air traffic rights and efficient customs facilities however, the dynamics of these critical factors may be – and indeed some have already been – subject to change. For instance, the importance of the PRD as China’s manufacturing base is diminishing as manufacturing activities, especially labour-intensive manufacturing, move westward. Industrial upgrading in the PRD and Guangdong is now central to the national policy along with increasing focus on China’s domestic markets, rather than exports. The business models of air cargo services need to adapt to this change accordingly. A senior air cargo executive said, airlines need to develop niches, carrying high-value, sophisticated products, rather than focusing on mere volume as in the past. The market for such large volume goods has begun gradually to shift to the modern and efficient air cargo handling facilities in inland Chinese hubs such as Chengdu and Chongqing, meaning that routine air cargo no longer needs to pass through Hong Kong. In raw terms, growth in air cargo in bare tonnage terms is likely to slow; the balance of trans-shipment cargos will change; new air cargo routes will open up, particularly towards Europe; air-freight forwarding clusters will develop in other hubs. All of these factors will challenge Hong Kong’s own expert and flexible cluster to adapt. These key developments will affect Hong Kong directly in the coming decade, calling for careful attention from the Administration in reviewing Hong Kong’s air cargo development strategy. This will in particular involve developing policies that support Hong Kong home airlines to maintain a reasonable market share on key air cargo routes, while developing new routes that will enable Hong Kong to build on its current competitive leadership.

3.1.3. Air passenger capacity: the third runway and beyond

The Administration’s commitment to address capacity constraints at the airport is crucial to the competitiveness of the aviation industry, as well as tourism and other headquarters-related industries. The aviation industry, the airport authority, and all academics called upon to evaluate future demand trends, reach the same conclusion: Hong Kong urgently needs new runway capacity. While the government has made a clear commitment to address this pressing issue by building a third runway, the construction time-frame is long, and the process of getting approval from the Legislative Council is challenging. The inevitable environmental challenges to such a large new project have sparked anxiety over the time required for the third runway project to be completed. There is also concern that the official demand forecast is too modest, not fully capturing the new dynamics of global economic development. For instance, the rise of wealth in Asia will boost people and business flows in the region, and thus the demand for air services. It is possible that by the time a third runway has been built, the new capacities provided will already be fully used, with calls for new capacity and possibly a fourth runway. The Administration needs to think “out of the box” not just pressing forward with a third runway in operate by 2022 (the earliest date expected, provided that every stage of the project goes smoothly throughout the process), but also planning for capacity needs up to and beyond 2030. Our analysis suggests that, even if a new runway is put in place on schedule, the new capacity will be fully utilised as soon as 2025, and even faster if we see early recovery from the current global recession. By then, Hong Kong will face the capacity problem again, a few years after the third runway starts in operation. While it is true that capacity cannot be

25

expanded indefinitely at the current airport, it is important to address this growth challenge head-on. What are the practical limits on growth? What innovations could give us extra years of growth? What collaborations with our neighbouring region could be built to find a longer-term solution? For our new Administration these are questions for now, not the future.

3.2. Mainland developments: opportunities and challenges

It is implicitly clear that Hong Kong’s long-term supply-side challenges in aviation can only be tackled by intensive and creative collaboration across the PRD region. So it is perhaps now appropriate to review and assess aviation developments occurring across the Mainland.

3.2.1. China growth trends and implications for HK services

Aviation growth trends in China are extremely strong, despite the global economic outlook. Strong domestic growth, rising affluence, more leisure time and tourism both at home and overseas, point in only one direction – strong future growth in aviation. In the past 11 years, China’s aviation industry has grown at an annual average of 12.4%.29 Air cargo also reported double-digit growth in the same period. (See Chart 9 and 10) Officials predict that air passenger traffic in the Mainland will grow at an average annual rate of 14.7% for the foreseeable future, lifting passenger totals from 230 million nationwide in 2009 to 700 million in 2020 before reaching 1.5 billion by 2030. (see Table 10) A recent forecast by Boeing projects that China will need 5,260 new commercial aircraft by 2031.30 Officials are planning more than 150 new airports to handle this aviation activity.

Chart 9: Air Passenger Traffic (transport volume), China, 1990-2011

29 The number charted in Chart 9 and 10 refers to the volume of air passenger and cargo transported by

aviation. In and out airport traffic is not counted, therefore the number is often far lower than air traffic throughput data reported by airports. When comparing air traffic performance of airports, throughout data is often used. China’s air cargo data refers to both air freight and mail; but Hong Kong’s air cargo figure refers air freight only, air mail excluded.

30 ‘Boeing Forecasts China Will Need 5,260 New Airplanes by 2031’, Boeing, September 5, 2012, http://boeing.mediaroom.com/index.php?item=2403

26

Chart 10: Air Cargo Traffic (transport volume), China, 1990-2011

Increase in demand for air services has implications for Hong Kong on two counts – competitive challenges and complementary opportunities. Demand growth in air services provides incentives for Mainland airlines to expand capacity and compete for market share. As discussed above, fierce competition is occurring not just between airlines, but also between airport hubs. Airports and airlines are competing for better services networks and more frequencies. This raises the question how Hong Kong is placed versus such competition, and how it will build on its competitive edge to secure Hong Kong’s share of the growing market. Passenger demand within China has already made Beijing and Shanghai busier airports than Hong Kong, and it can only be a matter of time before other Mainland hubs also overtake Hong Kong. When and where will a challenge emerge from international services? Some trends in China will have significant implications for Hong Kong’s aviation future and hub strategy. Firstly, as already noted, China has made ambitious plans to build 150 airports in the next decade (see Map 1), supporting the hub strategy that China wants to develop alongside its industrial and manufacturing upgrading plans. Currently, a few hubs such as Chengdu and Chongqing in central and western China have been identified and begun to develop into air cargo hubs. Although Beijing intends to build Chengdu and Chongqing into cargo bases for goods delivered to Europe and the Middle East, the passenger traffic of Chengdu and Chongqing has also shot up in recent years, alongside Shanghai and Guangzhou. For Hong Kong, the competitive challenge is substantial.

Map 1: Building 150

Table 10:

Passenger totals (million)

Passenger flights per year

Airports Note: passenger total refer to total passenger transported by air.

Source: Presentation at China Civil Aviation Development Forum, Beijing, May 12, 2010

Secondly, China is ambitious in developing international air services. traffic accounts for only 8% of total air passenger traffic and 3International air passenger traffic has tripled in 11 years, while international cargo times. This trend is expected to persist in the future. China is wellof international air services in the Chinese economy, as it plays a key role in international trade and investment. For instance, international air services will complement China’s ‘reflected by Beijing’s support to the three major Chinese airlinesservices networks. Inevitably, this gateway to China. Hong Kong will faceroutes. Many might argue that this is a nice challenge for Hong Kong to have: such strong growth is almost certainly not a zero-sum game for Hong Kong, and will deliver enviable opportunities. Butthis almost tumultuous expansion of services in so many new hubsand smart collaboration will be a clear priority for our new Administration.

31 CAAC (2012), Statistical Report on the Development of Civil Aviation Industry in China 2011

CAAC.

27

: Building 150 Mainland Airports by 2020

Table 10: CAAC Projections 2009 to 2030

2009 2015 2020

230 420-460 660-700 1,500

0.18 0.27 0.47

166 220 270 Note: passenger total refer to total passenger transported by air.

Source: Presentation at China Civil Aviation Development Forum, Beijing, May 12, 2010

in developing international air services. Currently, international air % of total air passenger traffic and 35% of total cargo traffic.

International air passenger traffic has tripled in 11 years, while international cargo persist in the future. China is well aware of the strategic importance

of international air services in the Chinese economy, as it plays a key role in international trade and investment. For instance, international air services will complement China’s ‘reflected by Beijing’s support to the three major Chinese airlines’ ambitions to

this puts pressure on Hong Kong’s position as gateway to China. Hong Kong will face greater challenges in maintaining

Many might argue that this is a nice challenge for Hong Kong to have: such strong growth is sum game for Hong Kong, and will deliver enviable opportunities. But

this almost tumultuous expansion of services in so many new hubs means the need for strategic focus and smart collaboration will be a clear priority for our new Administration.

Statistical Report on the Development of Civil Aviation Industry in China 2011

2030

1,500

-

-

Source: Presentation at China Civil Aviation Development Forum, Beijing, May 12, 2010

Currently, international air % of total cargo traffic. 31

International air passenger traffic has tripled in 11 years, while international cargo has increased by 5 aware of the strategic importance

of international air services in the Chinese economy, as it plays a key role in international trade and investment. For instance, international air services will complement China’s ‘go global’ strategy,

ambitions to develop international puts pressure on Hong Kong’s position as a key international

its share of long-haul Many might argue that this is a nice challenge for Hong Kong to have: such strong growth is

sum game for Hong Kong, and will deliver enviable opportunities. But the need for strategic focus

Statistical Report on the Development of Civil Aviation Industry in China 2011. Beijing:

28

3.2.2. Mainland hubs: potential synergies? Potential challenges?

Although Beijing is a dominant airport in China, Shanghai (Pudong and Hongqiao combined) and Guangzhou are forecast to be the key Mainland hubs in the next decade for air passenger and cargo traffic. Their passenger volumes are likely to reach 90.5 million and 55 million by 2015 respectively and 145 million and 87 million by 2022. Chengdu and Shenzhen are expected to be following close behind. (see Table 11)

Table 11: Estimates of Air Passenger Throughput by 2015, 2020 and 2022,

Hong Kong and Mainland’s Top 15 Airports

Rank

(2011) Airport

2011

Passenger

(millions)

Average

Growth Rate

2007-2011

Passenger (Projected)

(millions)

2015 2020 2022

1 Beijing Capital

78.7 21.7% 95.7 134.2 153.6

Hong Kong 53.9 4.1% 65.5 91.9 105.2

2 Guangzhou 45.0 11.5% 54.7 76.7 87.8

3 Shanghai Pudong

41.4 9.6% 50.3 70.6 80.8

4 Shanghai Hongqiao

33.1 11.7% 40.2 56.4 64.6

5 Chengdu 29.0 13% 35.2 49.4 56.6

6 Shenzhen 28.2 9.1% 34.3 48.1 55.0

7 Kunming 22.2 9.2% 27 37.8 43.3

8 Xi’an 21.1 18.0% 25.6 36.0 41.2

9 Chongqing 19.0 19.1% 23.1 32.4 37.1

10 Hangzhou 17.5 12.2% 21.3 29.8 34.2

11 Xiamen 15.7 17.9% 19.1 26.8 30.6

12 Changsha 13.7 16.2% 16.7 23.4 26.7

13 Nanjing 13.1 16.1% 15.9 22.3 25.6

14 Wuhan 12.5 16.0% 15.2 21.3 24.4

15 Dalian 12.0 13.6% 14.6 20.5 23.4

Note: 2015 projection based on an average annual growth rate of 5% between 2011-2015; 2020 and

2022 projection based on an average annual growth rate of 7% between 2015-2025.

Source: CAAC, Strategic Access’ estimates

All five leading Chinese airport hubs each have their contrasted strategic positioning. With Beijing as the national capital, and serving cities to the north and east of China, Shanghai assumes market domination in the Yangtze River Delta (YRD), while Guangzhou targets the Pearl River Delta

29

(PRD). Shenzhen also focuses on the PRD, but it will play more a supplementary role to Hong Kong. Chengdu is intended to take advantage of its geographical importance in central and western China. It has set the goal to be the fourth largest hub in China, in particular for international air cargo.32 As these hubs strive to grow, competition may be inevitable unless synergies are being developed to enhance their complementary roles. In Hong Kong, there are calls for Hong Kong to collaborate with Shenzhen so it can combine the strength of the two airports. While it may work for airport hubs to focus on their geographical markets, the argument of synergy of two adjacent hubs is moot. There is no evidence around the world that suggests such airport collaboration can be developed successfully. Nevertheless, the pressures for hub collaboration will be strong, as competition becomes intense and capacity expansions become more demanding. The Hong Kong Administration will need to be cautious when examining the potential benefits or – more likely – damage to the optimal operation of the airport hub in Hong Kong if a collaboration strategy is pursued. Our own studies, endorsed by many others, suggest that synergies cannot plausibly be captured. Macau is far too small, and its flight path already compromises access to/exit from the Hong Kong runways. Shenzhen’s own ambitious expansion plans make it questionable whether it will have any capacity at Hong Kong’s disposal, and a “division of labour” – for example by channelling regional flights into Shenzhen and intercontinental ones into Hong Kong – is impractical and can offer no competition advantages to either hub.

3.2.3. Challenges of Mainland airlines

China is keen to consolidate Mainland airlines in order to build a few champion airlines, with some of them intended to be among the world’s top five. Currently, Air China, China Southern and China Eastern airlines dominate the Chinese aviation market, with each of them having their respective market positioning. Air China has its home-base in Beijing, while China Southern and China Eastern mark their strategic bases in Guangzhou and Shanghai. The airlines are encouraged to strengthen their market share by forging strategic partnerships or merging with smaller regional-based private-run Mainland airlines. The strategic partnership between Shenzhen Airlines and Air China is a case in point. As shown in Table 12, China Southern has an extensive air services network. In recent years, it has keenly developed its international network. The airlines have also adopted ambitious fleet expansion plans, making them key drivers for China’s demand for new aircraft. Air China ranked the world’s 12th airline group by revenue in 2011, at US$ 15.3 billion.33 China Southern and China Eastern ranked 14th (US$ 14 billion) and 16th (US$ 12.9 billion). They still have a long way to go before they challenge the market leaders in US and Europe. For instance, Air China’s revenue is a third that of Lufthansa, which ranked top of the world by revenue. Nevertheless, the growth potential of Mainland airlines is perceived to be strong due to robust growth in future demand for air services in the Chinese market.

32 ‘Chengdu works to become a core area for western growth’, China Daily, May 8, 2012,

http://www.chinadaily.com.cn/regional/2012-05/08/content_15236333.htm 33 The ranking is based on Flight Global Data Research, see ‘World Airline Ranking s: Top Airline Groups

by Revenue’, Airline Business, August 2012 edition, pp.44-51.

30

Table 12: Overview of the Three Major Mainland Airlines and the Two Hong Kong Home

Airlines (2011)

Air China China

Eastern

China

Southern

Cathay

Pacific

Hong Kong

Airlines

Capacity – Available seat kilometres (mln)

151,590 127,891 151,064 126,340 n.a.

Fleet*

• freighters

432 12

377 19

444 19

164 24

26 6

Destinations

• International

• Regional

• Domestic

143 43 4 96

100 20 2 78

153 63 2 88

167 146 21 -

29 7 22 -

Future delivery of aircrafts

167 (2012-14)

200 (2012-15)

180 (2012-16)

93 (2012-19)

n.a.

* refer to the Airline Group company.

Source: The website and annual report of the respective airlines. For the three Mainland airlines, regional destinations

refer to those in Hong Kong, Macau and Taiwan; for the two Hong Kong home airlines, regional destinations refer to

destinations in China, Macau and Taiwan.

Beijing has been providing strong backing to nurture these three airlines. During the financial crisis in 2008, the State-Owned Assets Supervision and Administration Commission of the State Council (SASAC) injected capital totalling 6 billion yuan into China Eastern and China Southern. 34 Government influence on the operation of the three airlines, especially in terms of fleet expansion, route planning, and funding support, is strong. It is reasonable to believe that Beijing will not loosen its control over aviation development, especially through strategic influence over the country’s major airlines. China is determined to build strong airlines that not only compete head-to-head with the European and American airlines, but also tap into strong domestic airlines to develop an influential international air logistics sector that furthers China’s ‘go-global’ strategy in trade and investment. In this context, state-driven support to the Mainland airlines is likely to increase, alongside investment in airport infrastructure. It is important for Hong Kong to keep a close eye on the trends in China, and continually to reassess the foundations of Hong Kong’s future aviation competitiveness.

34 ‘东航南航公布国资委注资细节’, Sina Financial News, December 10, 2008,

http://finance.sina.com.cn/stock/s/20081210/22565618823.shtml

31

3.3. Low cost carrier operations

Whether low-cost carrier (LCC) operations can flourish successfully in the Asian region remains moot. The rise of AirAsia of Malaysia and JetStar of Australia in launching LCC services within Asia in recent years has prompted many to predict strong growth potential, even though both of these operators emerged out of distinctive local markets with weak “national” carriers and a traditional of poor oligopolistic services. Some industry experts have argued that the penetration rate of LCCs in the Asian market could rise as high as 50% by the middle of the decade.35 But the fragmented structure of Asia’s aviation markets continues to put such predictions in doubt.

Currently, Asia accounts for just above 40% of all LCC operators in the world; but it only accounts for 24% of the world’s total LCC seat capacity. (see Table 13 and Table 14) In terms of market share, the seat capacity of LCCs in Asia is only 17% as compared with 28% of Europe and 24% of North America.

Table 13: LCC Operations in Selected Markets

No. of LCC November 2012

Asia Pacific 49

• Australia 2

• Japan 7

• Korea 5

• Singapore 5

• Malaysia 2

• China 4

• Hong Kong 1 (in application*)

• Taiwan 0

Europe 27

North America 12

World total 118 Source: Center for Aviation (CAPA). Data as of November 6, 2012.

Table 14: LCC Capacity Share (%) of Total Seats in Asia, Europe and North America, 2011

2005 2011

To/From Asia Pacific 0.8% 4.3%

To/From Europe 0.7% 4.1%

To/From North America 2.4% 7.2%

Within Asia Pacific 6.2% 19.1%

Within Europe 20.5% 35.9%

Within North America 26.9% 27.6% Source: Center for Aviation (CAPA)

35 ‘LCC market share expected to rise to 50 pc in Asia’, Macau Daily Times, September 6, 2012,

http://www.macaudailytimes.com.mo/macau/38426-lcc-market-share-expected-to-rise-to-50pct-in-asia.html

32

There is strong evidence that the environment in which European and US LCCs have emerged and thrived cannot be replicated in Asia’s aviation region. Even as Asian governments have begun to liberalise and dismantle the oligopolies of “national carriers”, and opportunities for LCCs have emerged, so the highly fragmented nature of Asia’s aviation region has constrained the capacity of LCCs to lower costs or simplify or speed up passenger travel. Absent a single regulatory region for aviation, as you now see in Europe and the US, the economies and efficiencies that LCCs strive to offer remain elusive. While China – Asia’s only large unified aviation region – remains relatively closed and tightly regulated by the country’s military, so LCCs are likely to face severe challenges to commercial viability.

Chart 11: LCC Capacity Share (%) of Total Seats in China (Including Hong Kong and

Macau): 2001-2012*

Although the market share of LCCs has begun to grow in China (including Hong Kong and Macau) over the past decade, the share remains small, at only 6.4%. (see Chart 11) While this remains the case, strong regional LCC operations are unlikely to emerge. This is particularly moot for Hong Kong as an LCC hub, which can only naturally thrive for LCCs if the Mainland cities in Hong Kong’s hinterland are opened to LCC competition. This remains the only market with the critical mass required to unleash the LCC market potential in the region. 36 Apart from the profound regulatory constraints on the capacity of LCCs to build a competitive alternative to the region’s scheduled carriers, several other factors on both demand and supply sides suggest limited short term potential.

First, the region’s scheduled carriers have tended to build around an economic model using wide-bodied aircraft which enable them to build on two income streams – passengers and cargo. This strategy relying on a double income stream has been highly successful and effective both for regional

36 ‘Asia’s LCC Boom: a China Twist’, Orient Aviation, May 2012 edition, pp. 12-15

33

passenger and cargo movement, making it difficult for LCCs to construct a competitive challenge, as their own operations rely on just one income stream – passengers.

Second, on the supply side, most of Asia’s aviation hubs are severely slot-constrained after two decades of extremely strong growth. LCCs have found it extremely difficult to obtain slots at times convenient to passengers. Airport operators have also been reluctant to lose revenues in response to LCC calls for lower fees. It is noteworthy that in other regions, LCCs have grown most effectively in second-tier hubs willing to offer low fees in exchange for attracting a critical mass of business. As for Hong Kong, a leading first-tier hub with all facilities in fierce demand, LCCs have found market entry very challenging.

3.3.1. Two LCC cases – Oasis and JetStar Hong Kong

Oasis: In Hong Kong, the failure of Oasis has left painful scars for both the Government and the airport authority, forcing keen attention on an LCCs business model, and focusing concern on the need to ensure service reliability. Even though the airline was built clearly as a local carrier, and was well funded, an unfocused business model left it vulnerable from the outset. It lacked any cargo income stream, was unclear about “fit-for-purpose” fleet, and strove to build around both long- and short-haul services, despite evidence that LCCs everywhere find it hard to compete on long-haul routes. High operating costs from Hong Kong made it impossible to deliver the lower-cost services that are critical to the profitability of a low cost carrier. After accumulating losses in the hundreds of millions of dollars, Oasis folded suddenly, stranding passengers, and focusing Government attention on the need for local air carriers to operate to a high standard of reliability.

JetStar Hong Kong: The recent license application of JetStar Hong Kong, a budget airline founded by Qantas and China Eastern, has renewed industry attention to low-cost air services in Hong Kong, and deserves more detailed attention in the context of LCC development. It raised three important policy questions: Would it develop as a “local carrier” committed long term to building the range and quality of services for Hong Kong-based passengers? Would it add to the present range of choice available to passengers, in terms of routes served and price competitiveness on routes? And is its business model credible or will it repeat the failure of Oasis?

The Administration’s examination of these issues over the coming months will need to answer these questions positively. At this point, the carrier appears to fail on all three counts, raising afresh questions about how effectively LCCs can build businesses in Hong Kong.

• JetStar Hong Kong’s own application to Australia’s Australian Competition and Consumer Commission (ACCC) makes it clear that the airline will be hard-pressed to qualify as a home carrier in Hong Kong. Its ownership and control is split between Qantas in Australia and China Eastern in Shanghai. Despite recent appointment of a local chief executive, it appears that overall policy direction will come from, and be coordinated by, the group’s Australia-based team. The application makes it clear that the airline will operate from Hong Kong as an integral part of Qantas’ regional business plan. As such, services are likely to be increased or cut as part of Qantas’s regional strategy, rather than in response to the needs of the Hong Kong hub. The 2003 SARS crisis taught Hong Kong painfully that only clearly committed “home carriers” would think and plan with Hong Kong’s long term aviation interests front-of-mind. JetStar’s competition application in Australia makes clear that it has no such priority. Hong Kong’s aviation regulators will be hard-pressed to entrust future growth of air services through the hub in the hands of an airline that is so clearly not a local carrier.

34

• JetStar’s application to base operations from Hong Kong appears unlikely to offer service enhancement, as should be expected by Hong Kong travellers. Exact route applications have yet to be made public, but are expected to be focused on Mainland Chinese cities (excluding Beijing and Shanghai, which it cannot serve), and north east Asia destinations in Japan and Korea. As can be seen from Table 15 below, most of these routes would already be subject to intense competition – some contested by as many as 10 carriers if complementary services from Shenzhen airport are taken into account. Key Mainland destinations like Chengdu, Chongqing, Hangzhou, Xiamen and Haikou are already subject to fierce competition and are at present invariably loss-making. In the absence of new routes, or a clear enhancement to competition on existing routes, Hong Kong’s regulator will be hard-pressed to see merit in its application.

Table 15: Intense regional air service competition

City

Destination

HKIA SZX

Hong Kong

carriers on

route

Overseas

carriers on

route

Total # of

carriers on

route

Carriers on

route

Total # of

carriers on

route

Incheon CX, HX OZ, KE, LJ, AI, 7C, TG

7 KE, OZ, ZH 3

Narita CX, HX DL, JL, UA, NH

6 CA 1

Taipei CX, HX, KA

BR, CI, TG 6 ZH, CZ, CI, B7

4

Hangzhou KA, HX MU 3 ZH, CZ, MU, CA, HU, MF

6

Chengdu KA, HX CA, 3U 4 HU, CZ, ZH, CA, 3U, EU

6

Xiamen KA MF 2 HU, CZ, ZH, MF

4

Haikou KA, HX 2 CZ, ZH, MU, HU

4

Chongqing KA, HX CA 3 3U, CA, ZH, HU, CZ, PN

6

*Sample of Mainland China and North Asian city destinations.

Data on airlines served on the destinations taken from the flight schedules available on websites of HKIA and

Shenzhen Baoan Airport (SZX)

Even in the most favourable of circumstances – with a buoyant global economy, low and stable fuel prices, and strong growth in the region’s passenger and cargo activity – past experience demonstrates that LCCs find it hard to build a viable or sustainable business in Asia.

But to launch such operations in the teeth of the world’s most severe recession in eight decades, with fuel prices at close-to record highs, and no recovery anticipated for at least three more years, would be challenging for even the most intelligently structured business plan.

To launch in Hong Kong, which due to the Government’s carefully-targeted progressive liberalisation strategy is one of Asia’s most well-served, and most ferociously cost-

35

competitive hubs, would similarly be challenging even for the most competitive and committed new entrant. In scrutinising the viability of JetStar’s business plan, the Hong Kong administration might in other circumstances leave it to the operator to struggle with the challenge of operating profitably. But in light of the Oasis collapse, concern to ensure that local operators are reliable, and the need to optimise the use of landing- and take-off slots that will be in increasingly short supply over the coming decade, scrutiny will need to be more meticulous and more challenging.

Hong Kong has developed to become a successful and ferociously competitive aviation hub in recent decades on the back of carefully focused, carefully justified liberalisation. Resisting pressure for a “blunderbuss” open skies policy, our Administration has liberalised aggressively but in a targeted way that has capitalised on our fortunate location, and focused carefully on the demanding requirements of the passengers and cargos that need to use the hub. Regarding our air traffic rights and the development of services as a valuable resource that has to be used optimally in the interests of the economy and the businesses based here, or wanting to base here, the market has so far told our administration that LCCs have yet to develop a formula that optimises long-term value for the economy and the businesses based here. This may change as the Mainland aviation market deepens and becomes more liberal. But in the meanwhile, Hong Kong continues to grow strongly in spite of severe global recession on the back of fiercely competitive full service operations.

36

4. Specific challenges facing Hong Kong’s aviation hub development

4.1. Supply-side constraints

Over the past two decades – since plans to build the new Hong Kong International Airport at Chek Lap Kok were first conceived – demand for air services in Hong Kong has grown consistently faster than anticipated. As a result, an airport that was opened just 14 years ago in the middle of 1998 is wrestling with demand that was forecast for 2025. Demand has consistently outpaced forecasts, putting acute pressure on supply, even through the deep global crash of 2008. An airport that was supposed to reach capacity 15 years from now is already congested at most hours a passenger wants to fly, and will even by generously conservative Government forecasts hit capacity by 2018. This is placing keen policy focus on:

• Optimisation of use of existing airport infrastructure and short term enhancements that can “buy time” before major new infrastructure can be in place

• Possible collaboration with other regional airports

• The case for building a third (and a possible fourth) additional runway

• Whether, in view of the strategic economic significance of the HKIA, a “stand-still” on aviation development is acceptable, or would be destructive of future jobs, incomes and the economy’s economic prospects.

Present airport capacity (based on a maximum 60 flights an hour) is just over 57 million passengers/annum and is close to being reached (Hong Kong handled 56.5 million passengers in 2012). Assuming even a low level of growth in demand for the next 10 years of just 4-6% – far below historic averages – demand is expected to be not less than 60-66m passengers by 2015, and 74-90 million by 2020. During this time, the volume of dedicated air cargo aircraft is also expected to grow, which would impinge upon the capacity to handle passengers. Current capacity is clearly insufficient to meet even the most modest forecasts of future demand.

4.1.1. Productivity improvements helpful, but not enough

The options of productivity improvements of the current two-runway airport have been examined in detail in previous studies.37 These consistently show that, even in a ‘perfect world convergence’ of all potential local capacity and productivity improvements – boosting hourly flight movements, expanding runway operating hours, lifting the ratio of large aircraft, improved air space management in the PRD, and adding new terminal facilities and aircraft parking bays – demand will outstrip all potential available capacity by the end of the decade. 38 If any of these enhancements fail to materialise, or cannot be optimised, then Hong Kong hits supply-side buffers even earlier.

37 The findings presented in a research report of Strategic Access in 2011, Meeting Future Capacity

Challenges at the Hong Kong International Airport: Assessing the Potential of Alternatives to

Constructing a Third Runway. 38 The findings presented in a research report of Strategic Access in 2011, Meeting Future Capacity

Challenges at the Hong Kong International Airport: Assessing the Potential of Alternatives to

Constructing a Third Runway.

37

4.1.2. Collaborations with neighbouring airports not practical

Our past studies show that the call for collaboration with Macau and/or Shenzhen airports is impractical,39 and would anyway not resolve Hong Kong’s core demand-driven challenge. First of all, there is no evidence of successful inter-airport collaboration elsewhere in the world. Examination of 12 cities around the world served by two or more airports shows no single example of meaningful collaboration between airports. Most of the airports studied are distant from each other, ill-connected, consciously competitive, and positively discouraging of any form of inter-airport collaboration or exchange of passengers.40 Where customer and/or destination segmentation between airports has occurred, this has been through competitive rather than collaborative forces. There is recurrent evidence that passengers are not attracted to inter-airport transfers or any of the opportunities offered by “collaboration”. To passengers, inter-airport transfers and “collaboration” merely imply inconvenience in the form of land-transfers that add stress and time to already long and stressful journeys.41 Furthermore, there is no evidence to suggest that inter-airport collaboration with the airports of Shenzhen or Macau is viable. The boundaries separating Hong Kong, Shenzhen and Macau from each other severely complicate any form of inter-airport collaboration, not to mention other issues such as the absence of shared air service rights for “home carriers” based at each of the airports, and which might otherwise allow a carrier to split its operations across multiple airports. The idea of “collaboration” between the airports of Hong Kong, Shenzhen and Macau assumes that Shenzhen and Macau have spare capacity and are willing to provide what would in effect be “outsourced capacity” to Hong Kong. Such an assumption is unrealistic. First, Macau’s tiny airport cannot conceivably add capacity on a scale that would make any material impact on Hong Kong’s growing need. Second, for Shenzhen, any surplus capacity available to Hong Kong would be short-term, with strong local demand growth expected to more-than absorb any additional capacity created. Interviews make it clear that even in the unlikely situation of short-term capacity availability; there is no prospect of Shenzhen’s ambitious airport operator, or its local airlines, being willing to “gift away” to Hong Kong their own future growth potential.

4.1.3. Pressing needs for a third runway, and can’t afford further delay

All these factors point to the pressing need for a third runway at HKIA – and potentially a fourth – to be built and in operation as quickly as possible. Since an Environmental Impact Assessment and other required regulatory procedures for a third runway will not be complete until 2014, and a runway would take approximately 10 years to build, it is clear that no new capacity bringing relief to increasing congestion can possibly be in place before 2024 – fully six years after the present airport bumps up against full capacity. By 2018 at the latest, inefficiencies due to congestion, and diversion of traffic to other competing hubs like Shenzhen, Guangzhou or other regional airports, can be expected.

39 The findings presented in a research report of Strategic Access in 2011, Meeting Future Capacity

Challenges at the Hong Kong International Airport: Assessing the Potential of Alternatives to

Constructing a Third Runway. 40 The findings presented in a research report of Strategic Access in 2011, Meeting Future Capacity

Challenges at the Hong Kong International Airport: Assessing the Potential of Alternatives to

Constructing a Third Runway. 41 The findings presented in a research report of Strategic Access in 2011, Meeting Future Capacity

Challenges at the Hong Kong International Airport: Assessing the Potential of Alternatives to

Constructing a Third Runway.

38

The damage this will inflict on Hong Kong’s regional leadership as an aviation hub is inevitable and is likely to be large, even if at present it is difficult to quantify in any precise way. Anyone complacent about this challenge is playing poker with the livelihoods of literally tens of thousands of families in Hong Kong. They are putting in jeopardy the headquarter hub operations that depend on Hong Kong’s unmatched connectivity, but can easily migrate if other hubs develop the critical mass of services that currently sit uniquely with Hong Kong.

4.1.4. ‘No-growth’ vision is not an option for Hong Kong

There are “no growth” advocates in Hong Kong, particularly built around Hong Kong’s “Post-80s Generation”, who have made it clear that they would be willing to forego future growth in aviation as well as in other sectors. They argue that the Government should (and, indeed, could) instead focus on improving our quality of life. They have unsettled the assumption that economic growth should be the Administration’s over-riding policy priority. This “no-growth” vision assumes that such a policy would only affect future growth. But such an assumption is open to challenge, because evidence worldwide demonstrates that only a rather small number of massive aviation (and logistics) hubs have developed over the past 50 years and that this has been achieved on the basis of a virtuous circle underpinned by “clustering”. Hong Kong is one of that tiny number. Whatever the original factors pushing Hong Kong into a virtuous circle, it is this clustering that has driven Hong Kong to be the world’s largest international hub for both passengers and air cargo. To forego future growth at the airport once present capacity limits are reached (from as early as 2015) would be willfully to begin the process of forcefully dismantling the virtuous circle that has made Hong Kong such an aviation success story, thereby undermining Hong Kong’s aviation and logistics cluster. The British Government’s decision to refuse an additional runway at Heathrow is just such an example. Since Heathrow is by most counts already close to capacity, it may become apparent quite soon how much damage this decision has done to London’s pre-eminence in Europe as an aviation hub, as airlines (including British carriers) transfer future growth to other airports in Europe. Losing competitive leadership in our aviation and logistics cluster is no small matter, and not without grave implications for Hong Kong. Clearly, diversion of future growth away from HKIA to other airports is likely to put in jeopardy the hundreds of thousands of aviation-stimulated jobs that are at the heart of Hong Kong’s economy, and would be perilously damaging to the fundamental livelihood of our entire community.

4.2. The regulatory challenge: “open skies” versus “progressive liberalisation”

As noted earlier in the examination of the JetStar application to establish a base in Hong Kong, Hong Kong has developed to become a successful and ferociously competitive aviation hub in recent decades on the back of carefully focused, carefully justified liberalisation. Resisting pressure for a “blunderbuss” open skies policy, our Administration has liberalised aggressively but in a targeted way that has capitalised on our fortunate location, regarded our air services potential as an important and limited resource to be developed to optimal economic effect, and focused carefully on the demanding requirements of the passengers and cargos that need to use the hub.

39

Regarding our air traffic rights and the development of services as valuable resources that have to be used optimally in the interests of the economy and the businesses based here, or wanting to base here, the market has so far told our administration that a unilateral “Open Skies” regime would hurt rather than help our hub: Having unilaterally gifted away to foreign carriers the unfettered right to provide services to and from Hong Kong, the administration would thereafter find it impossible to command the attention of foreign Governments as Hong Kong seeks to improve aviation services to foreign cities on behalf of our own home carriers. The stable and committed services of home carriers would be eroded at the expense of fickle foreign carriers which – as was dramatically illustrated during SARS when foreign carriers retreated en masse from Hong Kong – have no more than a “fair weather” commitment to the hub. This was also well illustrated recently when Qantas uplifted its Europe-bound hubbing services from Singapore and transferred them all to Dubai. Clearly, no home carrier would make such a “commercially pragmatic” move away from its home hub. By preferring a “progressive liberalisation” strategy which has focused liberalisation on those destinations and markets of greatest strategic value to Hong Kong and the businesses based here, and by ensuring inbound services by foreign carriers are appropriately counterbalanced by opportunities to our own home carriers who have commercial interests more closely aligned to the broader interests of the Hong Kong economy, our administration has succeeded in maintaining Hong Kong’s regional leadership as an aviation hub over the past two decades. Hong Kong’s hub has continued to grow strongly in spite of severe global recession on the back of fiercely competitive full service operations.

4.3. Adequate supplies of skilled manpower

To support growth and the development of the aviation hub in Hong Kong, appropriate supplies of skilled manpower are as important as a strong infrastructure. Government commitment to ensure a well-stocked skills pool that is capable of supporting future growth of the aviation industry is vital. According to a recent government report on manpower projections to 2018, Hong Kong can expect shortfalls in manpower resources for positions that require education levels of ‘upper secondary, craft, technician & sub-degree’, and ‘first degree & above’.42 The shortage of semi-skilled labour, often referred to as technicians and craftsmen, are of significant concern for the aviation industry, because semi-skilled staff form a large part of the industry’s labour force, in particular in the many ground services at the airport that support aircraft and cargo operations. The manpower resources issue demands serious policy attention from the Administration. Equally pressing is the labour gap among low-skill and unskilled workers at the airport. HKIA and airlines have expressed worries over the difficulty in hiring cleaners, catering workers, cargo loading staff and other unskilled personnel needed at the airport. Vacancies at the airport currently exceed 5000, with most of these low-skilled and unskilled workers. 43 The legislator representing the transport sector has said that any disruptions at the airport due to typhoons or accidents would lead to severe shortages of workers to load cargo. One cargo company has reportedly paid an additional HK$ 1 million to recruit casual workers and pay overtime to expedite cargo handling after disruptions this summer. This not only puts pressures on cost, but also adds stress to the workers.

42 HKSAR Government (2012), Report on Manpower Projection to 2018. Hong Kong: HKSAR

Government. 43 ‘機場各業缺 5000人手 航運議員倡研輸外勞’, Ming Pao News, December 3, 2012. p. A07.

40

According to Cathay Pacific Airways, as of September 2012, they had 631 such job vacancies, with over half of the jobs at manual worker level. HK Aircraft Engineering Co Ltd (HAECO) also has over 200 cleaning vacancies, even though salaries are well above the minimum wage level, and response rates have apparently been discouraging. Although special allowances are provided to compensate for travelling long distances to work, and for shift duty arrangements, these manual work positions have still proven hard to fill. Shortages of such important but low skill workers have clear damaging impacts on the operation of airlines and the airport.