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Crisis control: Troubled year highlights problems in Brazil's air transport market

Brazil's air transport market has experienced exceptional growth, but a troubled year marked by crashes, air traffic control strikes and flight delays has highlighted a lack of government foresight

In many ways it has been a year to forget for Brazil's air transport sector. First the mid-air collision between a Gol Boeing 737 and an Embraer Legacy corporate jet in September 2006, and then Brazil's worst air disaster in July, when a TAM Airbus A320 overran the runway at São Paulo Congonhas and burst into flames.

Richard Lark
"We have one of the best safety systems, but this is now being questioned, with emotion taking over"
Richard Lark, Chief financial officer, Gol
In between, Brazil suffered serious breakdowns in its air traffic control network due to malfunctioning radio communications and work-to-rule and strike action by controllers, which resulted in severe flight delays and cancellations, throwing the spotlight once again on inadequacies in the airport infrastructure. The government reacted hastily, dismissing defence minister Waldir Pires and José Carlos Pereira, the head of airport authority Infraero. Operating restrictions were also imposed at São Paulo's city-centre airport.

"What is happening in Brazil are attempts to find the guilty parties, to initiate criminal proceedings rather than concentrating on discovering the cause of the accident," says Richard Lark, chief financial officer at Gol. "Once you introduce a blame culture, people will start to withhold information. This situation creates a disincentive to find the truth. We have the best safety system along with Canada and the USA, but this is now being questioned, with emotion taking over from rational thought. Passengers are unhappy, airlines are not making money, and government lacks vision and co-ordination."

Pires was replaced by Nelson Jobim, who is deemed to be a future presidential candidate. "Sorting out the issues of air transport is a popular campaign strategy," says Lark. "Soundbites of looking at how airlines operate, cutting jet fuel costs [Brazil imposes a 33% tax on aviation fuel] and reducing landing fees, all go down well with the public. The politicians are consulting with the airlines, but there is always the desire to please the voting public."

Jobim's plan to legislate an increase in seat pitch, because he feels uncomfortable on-board aircraft, also appears to reveal a lack of appreciation of the wider malaise. Respicio A Espirito Santo Jr, a professor at the Federal University of Rio de Janeiro and president of the Brazilian Institute of Strategic Studies and Public Policies in Air Transport, says the events of the past several weeks are a clear indication of government being reactive rather than proactive.

He also cites a lack of investment in infrastructure, which he believes could be overcome with a more liberal policy towards public/private partnerships and foreign ownership. The same applies to airlines, which have limited access to capital.

"There is still a military approach to foreign ownership," says Espirito Santo. "Brazil very much follows the US example, which has steadfastly refused to permit more than a token foreign holding in its airlines. Brazil has an even lower limit of 20% compared to 25% in the USA."

This reluctance to open up its air transport industry reflects the erratic political and economic regulations that have dogged Brazil's air transport. "With such uncertainty a foreign investor will be wary, because he cannot be sure what will happen on the regulatory side from year to year. It is a big barrier to progress. A bill was presented to the Senate some years ago to permit an increase in foreign ownership to 49%, but this is only now being ­revived, and only because of recent events."

On a more positive note, in January Brazil's President Luiz Inácio Lula da Silva initiated an accelerated growth plan that envisages major investments in airports for the 2007-10 period, with the emphasis on modernisation, making better use of existing facilities and addressing congestion.

A new recruitment drive has also been launched for more air traffic controllers. While Brazil's airlines generally welcome the new urgency displayed by the authorities, TAM president Marco Antonio Bologna says: "We are going to have an infrastructure bottle­neck. Over the next two years the government has announced a series of measures to remedy the situation, but we will see a slowdown in growth. It is difficult to maintain double-digit growth in 2008 and 2009, which also means more capacity discipline." Both Gol and TAM have already announced capacity reductions.

While everything has conspired to create chaos over the past 12 months, Lark argues that restructuring has been an ongoing and difficult process since the mid-1990s. It began with deregulation and an economic stabilisation plan, which was good for wealth creation, less so for inefficient companies, but set up a more competitive dynamic. "This combination, together with TAM's move towards regional jets, created a sort of tsunami that put other airlines such as Varig, Transbrasil and VASP on the path to problems," says Lark. "TAM came in with a good product, but its growth created a demand/supply imbalance, added a great deal of capacity, and provided the opportunity for Gol to come in as the other companies lost market share. Gol then had a huge cost advantage and within a short time had grabbed a 10% market share."

He adds that up until 2001, annual passenger numbers had been steady at five million and this was mainly business traffic. "Now passenger numbers have almost doubled. We also have record load factors in the industry. Pre-Gol, these were hovering around 57%, but are now around 70%." A great deal of credit for this must go to Gol, says Espirito Santo: "Gol has made air transport affordable for the poor and lower middle class by enabling tickets to be bought on credit at low interest rates, and for a period of 24-36 months." In what he calls a "very Brazilian way", this facility is provided by banks, credit card companies and even friends. Both Gol and TAM emphasise, however, that such sales represent only a very minor part of overall revenues and have no impact on cash flow.

Although there was not much growth until 2004, air traffic in the past three years has exceeded the global average. Figures released by the Agência Nacional de Aviação Civil show that domestic growth in 2005 was 18.9%, with double-digit growth also achieved in 2006 and so far in 2007. The downside was that infrastructure became overstretched and the growth curve went ahead of the cycle of air navigation and airport development, says Lark.

At the end of July TAM had a domestic market share of 49.3%, compared with Gol/Varig's 43% (see table). Internationally, the dominance of TAM was even more marked with a 65.6% share (see table). However, following the acquisition of Varig by Gol, the battle is now on as the "new" Varig embarks on rebuilding its former network.

TAM serves several regional destinations, principally from São Paulo and Paraguay's capital Asunción. Connections are provided from São Paulo to Miami and New York as well as to London, Paris and Milan, with Frankfurt to be added at the end of November and Madrid in December. The transfer of its codeshare arrangement from American Airlines to United Airlines means Los Angeles is likely to be added, as is future service to South Africa. The more immediate changes will be upward adjustments next year in frequencies on existing routes, probably to London, New York and Paris. TAM is also looking at adding more flights from cities other than São Paulo, with Rio de Janeiro in the south and Recife and Salvador in the north-east tipped for future international hub status.

Varig, as of mid-October, only flew to six international destinations: Bogotá, Buenos Aires and Caracas in South America, and Frankfurt, Paris and Rome in Europe. Services to Paris and Rome, inaugurated in September, are part of its expansion plan, which includes the addition of daily flights to London, Madrid, Mexico City, Montevideo and Santiago by the end of the year.

Gol flies regionally to Argentina, Bolivia, Chile, Paraguay, Peru and Uruguay. Any duplications of regional and domestic routes with Varig are clearly separated, offering passengers a choice between the low-fare, no-frills Gol offering and the full service provided by Varig.

"The main reason for buying Varig was for the domestic routes, especially its strength in São Paulo, but we also saw it as an opportunity to use a strong existing brand as a way into the long-haul market," says Lark. "We always had such a business plan, but we never reached the point of feeling comfortable to enter this market with the Gol brand. We would have got there, but it was never a short-term project." Gol, which is 69%-owned by family-run Fundo Assas, could soon become a private company in a move that would leave LAN as the only remaining publicly-listed airline in Latin America. Fundo Assas announced in September that it was considering buying back all available shares and de-listing the operator.

In the domestic sector, TAM has forged regional agreements with several smaller carriers, including NHT, Pantanal, Passaredo Transportes Aéreos, Total Linhas Aéreas and TRIP. The main agreement, Bologna says, is with TRIP, which is pursuing a growth strategy with increased capital and presents a good opportunity for TAM. Earlier this year, TRIP ordered seven ATR 72-500s, followed in June by Total, which signed for two 72-500s and three ATR 42-500s. Both airlines also took out a further five options each.

BRA Transportes Aéreos, which was originally founded as a passenger and freight charter company but transformed itself into a low-fare scheduled airline in March 2006, has a 3.2% share of the domestic market and 6.6% internationally, putting it fourth among Brazil's airlines in both categories. Its recent growth was facilitated by a capital injection from global investment consortium Brazil Air Partners, which now owns a 20% stake in the airline. Founding brothers Humberto and Walter Folegatti hold the remaining shares. BRA operates to 32 domestic destinations, to Bariloche in neighbouring Argentina, and to Lisbon, Madrid and Milan. The carrier also serves Cologne, Oporto, Oslo, Rome, Stockholm, and Tel Aviv with Boeing 767s, and plans to serve Dakar in Senegal, West Africa with a weekly service from November.

No new international routes have been announced to date, but in the meantime the airline plans to upgrade and substantially increase its domestic network with a new Embraer 195 fleet, which will replace its six 737-300s and three 737-400s. BRA signed a firm contract for 20 E-195s, plus options and purchase rights that would take the overall total to 75 aircraft. The importance of this ­contract was highlighted during the signing ceremony in August, which the Brazilian president attended (see picture).

BRA had a short-lived, three-month codeshare agreement in the summer with OceanAir, but this arrangement was severed because the two airlines have "distinct client profiles". OceanAir, whose owner Germán Efromovich also controls Colombia's Avianca under the Synergy Group label, is moving towards becoming a full-service airline. It already provides a feeder service to Avianca at São Paulo's Guarulhos airport. But despite operating to 25 destinations in 12 states along the length of the eastern coastal belt and inland to the capital Brasilia, OceanAir's domestic market share is just 1.9%. There are ambitious plans to increase this to 15% over the next decade, but details on how this is to be achieved have not been released.

However, OceanAir intends to use São Paulo's third airport, Viracopos at Campinas, as a base for further domestic expansion, using nine A320s ordered by Avianca that would replace its ageing Fokker 100s and Fokker 50s. The airline has acquired a 767-300ER, with which it plans to begin flights to Mexico City, Bogotá and Lima. Lagos and Luanda in Africa will be added in spring 2008 to foster energy sector traffic between Brazil and Africa. OceanAir plans to take three of the 787-8s ordered by Avianca to modernise its long-haul fleet by 2010.

Air traffic in Brazil is now concentrated in the south and north-east of the country with three-quarters of traffic handled by just 10 airports. Across much of the country there is no real alternative to air transport. Only one-fifth of roads are passable, says Bologna, and the limited rail network caters mostly for cargo.

This clearly shows how important a cohernet air network is for Brazil. Espirito Santo blames the lack of public service obligations in the country for service reductions over the past decades.

He believes the high cost of aviation fuel in small towns is the main reason for this. "Brazil should be studying the essential air service programme in the USA, so it can establish an efficient air transport network."

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