Air China's announcement of a possible acquisition of East Star Airlines opened the curtain on 2009, a year of potential mergers and restructures in the Chinese aviation market.

The state-run parent of Air China has begun preliminary talks about buying all or part of East Star, a private carrier in Wuhan City, Hubei Province, but it was still unclear whether any agreement would be reached, it said.

The move accorded with China's aviation regulator's call for mergers among domestic carriers to optimize market structure to avoid cut-throat competition.

The most expected merger this year will be between China Eastern Airlines, the country's third largest carrier, and Shanghai Airlines, the fifth largest.

The State-owned Assets Supervision and Administration Commission, controlling shareholder of China Eastern's parent group, and Shanghai state-owned asset regulator, controlling shareholder of Shanghai Airlines, are believed to have discussed merging the two carriers.

Both carriers denied they had talked with each other about the merger and said the issue was still being discussed at the government level.

But market speculation intensified after the parent of China Eastern secured a 7-billion-yuan cash injection from the central government and Shanghai Airlines indicated it was also applying for cash.

Earlier reports had suggested that there could be a merger after Shanghai Airlines got the cash.

"A simple cash injection can't fundamentally solve carriers' problems. Policy support and industry restructure will be a key to the aviation market this year," said Li Shurong, an analyst of Shenyin & Wanguo Securities Co.

China Eastern said its fair-value losses on hedging deals totaled 6.2 billion yuan as of December and warned it would post a "significant" loss in last year's earnings. Fuel prices, which tumbled 70 percent in less than six months, have hit many carriers which, anticipating a continued rise, had hedged their fuel contracts.

Air China said fair-value losses on contracts widened to 3.1 billion yuan in the third quarter last year and Shanghai Airlines suffered hedging losses of 98 million yuan by the end of October.

Executive salaries

China Eastern plans to carry out 256 measures to battle the economic crisis, including selling part of its stake in Happy Airlines to Aviation Industry Corp of China, transferring its stake in its Yunnan branch to the Yunnan government and cutting executives' salaries by as much as 30 percent.

China Southern Airlines, the country's largest carrier by fleet size, cut executives' salaries by 10 percent to save 1.3 billion yuan. The carrier has also cancelled staff bonuses this year.

The Civil Aviation Administration of China announced suspension of a 10-percent landing fee surcharge at Chinese airports for six months and an exemption of fuel surcharge tax till the end of next year.

"They have understood the challenges that the industry faces. Their efforts to deliver efficiencies with a six-month suspension of the 10 percent landing fee surcharge is an example for others to follow. We look forward to working closely with them to strengthen China's aviation industry with further efficiency gains," said Giovanni Bisignani, Chief Executive Officer of the International Air Transport Association.

The measures are included in a list of 10 stimulus policies issued last month. They also included encouraging mergers and waiving fees and taxes. It also urged carriers to cancel or postpone plane deliveries due this year.

The Ministry of Transport said the country aimed to increase air passenger volume by 11 percent to 220 million this year and the volume of cargo and mail by 8 percent to 4.37 million tons.

"Demand on domestic routes is expected to recover in the second half of this year and the international aviation market will rebound next year," said Liu Shaoyong, chairman of China Eastern Airlines.

Mao Ang, an analyst with Galaxy Securities Co, said the price of jet fuel would be 4,500 yuan per ton this year, 40 percent down on last year, which means that gross profit margin for the industry might rise by more than 10 percentage points.

(Shanghai Daily January 15, 2009)