BRENDAN SOBIE / SINGAPORE
Chinese manufacturers are relying on regional jet growth over the next decade to mirror the sector's success in the USA in the 1990s
China's aircraft manufacturers and their Western partners are banking on regional jets proliferating in China over the next decade, creating a sales boom that could mirror the rapid ascent of regional jets in the USA over the previous decade.
This year China began offering its airlines a choice of two locally built regional jets: a Chinese-developed aircraft designed to carry between 76 and 105 passengers starting in late 2007 and a Brazilian-developed but Chinese-assembled aircraft capable of carrying between 37 and 50 passengers starting early next year.
The two projects represent two vastly different approaches. For the larger regional jet, China Aviation Industry Corp I (AVIC I) has formed a new company to develop an aircraft from scratch and has enrolled four of its subsidiaries to manufacture major components. For the smaller regional jet, two China Aviation Industry Corp II (AVIC II) subsidiaries have forged a joint venture with Brazil's Embraer to assemble ERJs in China from over 1,000 imported components.
Both projects help China expand commercial aircraft manufacturing capabilities and allow government-owned manufacturers to corner the domestic market. Imported aircraft under 25t are now taxed at 23%, giving the two local regional jets a competitive advantage.
ERJs assembled in China will be taxed less than identical ERJs that are assembled in Brazil or Bombardier CRJs built in Canada. "The product will be attractive to Chinese airlines because it's a local product," says Guan Dongyuan, vice-chairman of new joint venture company Harbin Embraer Aircraft.
In the 70- to 90-seat market, AVIC I's ARJ21 stands to have a tax advantage over the Bombardier CRJ700/900, Embraer 170/190 and possibly a relaunched Fairchild Dornier 728JET. Bombardier and the new 728JET owner D'Long are trying to forge their own deals with Chinese companies. But AVIC I Commercial Aircraft Company (ACAC) president Tang Xiaoping says there were "arguments internally" before the Chinese government approved the Harbin Embraer project and it will "definitely not" consider a third regional jet project.
China launched the ARJ21 in late 2000 with a $600 million commitment. Last year it agreed to pour another $12 million into Harbin Embraer, giving Chinese carriers a wider choice of locally built regional jets and an aircraft that is available nearly four years earlier.
Harbin Embraer began assembling its first ERJ-145 last month and the aircraft is due to be rolled out and make its maiden flight in December. The first aircraft could be in revenue service as early as January as new certification is not required. "This is not a new product," Guan says. "We're doing everything to Embraer standards."
ACAC will cut its first piece of metal for the ARJ21 in December, kicking off a slow process that will end in late 2007 with first delivery. The company has just completed supplier selections - including General Electric engines, Hamilton Sundstrand power systems, Honeywell flight control system and Rockwell Collins avionics - and is now focused on meeting projections for 500 sales. "Our target is by the end of this year we'll have launch orders for 35 aircraft," Tang says.
Harbin Embraer believes there is a market to support a production plan that calls for the assembly of seven aircraft in 2004 and 24 aircraft annually from 2005 or 2006.
Both companies kicked off sales campaigns at the beginning of this year but they essentially lost four months because of SARS, which brought an abrupt halt to all airline fleet planning studies in March.
Talks with potential customers resumed in July and both companies are expected to announce launch orders in Beijing this week. Shanghai Airlines last week announced its intention to acquire five ARJ21s. Harbin Embraer is believed to be close to selling several ERJ-145s to China Southern Airlines, which in early 2001 announced its intention to buy 20 of the type but never secured government approval for the deal. Embraer was so confident approval would come that it started building aircraft for China Southern, and several ERJ-145s were produced and painted in the carrier's colours.
Most Chinese airlines, however, remain reluctant to make fleet decisions so soon after the SARS crisis. Traffic has returned to pre-SARS levels, but Tang believes it will take another three to four months for the airlines to recover financially.
Chinese airline managers are also now focused on completing a spate of mergers stemming from an effort to consolidate the industry into three large groups.
The three groups - Air China, China Eastern and China Southern - may be reluctant to order aircraft until integration efforts are complete. But in the long term the mergers could spur regional jet orders as China's second-tier airlines focus more on regional routes.
"It may take a little bit of time to complete this process," Guan says. "In the long term it will open the possibilities of regional aircraft in China. The reason behind this consolidation is the Chinese government wants the airlines to be more competitive and make better use of the smaller airlines."
China is encouraging its big three airlines to use their new subsidiaries to develop a US-style hub and spoke system and improve air service to interior regions.
"In the USA, the small companies do the regional jet business," Tang says. "I have confidence that in five years this will happen here."
About 30 new airports are expected to open in China by the end of 2005, further spurring demand for regional jets. Many airports will be located in remote western cities and scenic areas that may not have the demand to support mainline aircraft.
ACAC is developing the ARJ21 to operate into high-altitude airports that other aircraft can only serve with payload restrictions, especially during the summer. Tang says the ARJ21 is also being developed as a "low-cost product" that can be profitable in China's low-yield environment. "Most of the regional jet flights [in China] lose money. Something has to change," he says.
ACAC believes the ARJ21 will be the only product priced to enable smaller Chinese airlines to adopt the US regional airline business model and give up their Airbus A320s and Boeing 737s, which they now rely on to offset losses from their regional jet operations.
Tang says the Harbin-built ERJs may be too expensive for the Chinese market because "all their costs are fixed". Bombardier agrees 50-seaters cannot be profitable in China and rejected a joint venture deal with Harbin before the Embraer contract was signed.
"Regional aircraft will play a big role in China over time, in particular in the west," says Bombardier International group president and chief operating officer Robert Greenhill. "But the only regional jets that will make money in China will be 70- to 90-seaters. The yield levels are too low for 50-seaters."
Some industry observers believe the Harbin Embraer venture will be short-lived, similar to the AVIC I McDonnell Douglas MD-90 assembly project in the 1990s. But Guan says China's only ERJ operator, Sichuan Airlines, is successfully deploying its five aircraft on shuttle services, and 50-seaters are needed throughout China to develop business markets.
Embraer also foresees huge growth for larger regional jets in China, estimating a market of 400 aircraft with between 61 and 110 seats and 200 aircraft with 30 to 60 seats in the next 20 years. If demand for 70-seaters soars, as anticipated by every manufacturer, Bombardier and Embraer think they have a big advantage over ACAC because they are offering Chinese airlines 70-seat jets today.
The first ARJ21 variant, seating 78 in a two-class configuration or 85 in an all-economy layout, is not scheduled to be delivered until the end of 2007, with a second variant seating 98 or 105 available two years later.
In November Shandong Airlines will take China's first two 70-seaters and Bombardier believes these CRJ700s will prove that large regional jets can be profitable, unlike the 26 loss-making 50-seaters operating in China today. Even D'Long plans to beat ACAC to market, with first delivery in 2006.
"I don't think it's realistic they'll (ACAC) be in the market in 2007," says D'Long 728 project manager Werner von Anhalt. "That's a big advantage we have."
In fact, industry observers give the ARJ21 low odds at ever coming to market and say the government is exploring alternatives. Bombardier, D'Long and Embraer are all ready to offer joint ventures on assembling or co-developing large regional jets should China tone down its ambitions for a 100% indigenous regional jet.
D'Long is already in talks with Chinese manufacturers interested in supplying major components - including the wing, tail and fuselage for a relaunched 728. The investment company plans to keep final assembly in Germany, but believes by sourcing some of the aircraft in China it too would qualify for tax breaks.
Greenhill says Bombardier will look to source regional jet components in China, but declines to discuss talks with AVIC I regarding a possible joint venture.
Tang, however, insists that talks between AVIC I and Bombardier over potential CRJ700/900 co-production are dead and the aircraft cannot compete against the ARJ21. He also dismisses any possibility of co-operation with D'Long. "I'm in charge of ARJ21 and I don't think it will happen," Tang says. "Dornier has some new technology. But we don't need it. We can develop it ourselves."
Bombardier, Embraer and D'Long, however, are not ready to cede the entire market to ACAC even if the ARJ21 programme survives.
Tax cut pledge
China has pledged to lower the 17% value-added tax (VAT) that applies to aircraft of less than 25t as part of its admission into the World Trade Organisation. The tax was put in place in 2001 in a move that many believe was done to essentially block regional jet orders until indigenous products were available.
Greenhill says a lower VAT will make it easier for all manufacturers to sell into China - presumably VAT also applies to Chinese-built aircraft although this has not yet been tested because there have been no such sales - and the 6% import tax is small enough to be overcome.