MIAMI — Middle Eastern carriers Emirates, Qatar Airways, and Etihad are under the public eye, after a consortium of US airlines publicly released documents that allege that the three carriers received more than $42.3 billion in subsidies and unfair benefits from their respective governments since 2004. A joint operation between United Airlines, Delta Air Lines, and American Airlines, the investigative efforts have culminated in the public release of a presentation and 55-page white paper that detail the allegations.

Of the total amount, $39.2 billion are alleged as quantified subsidies, primarily to Qatar Airways ($17.5 billion) and Etihad ($18.0 billion). The subsidies for Qatar Airways and Etihad appear to have primarily taken the form of interest-free loans (and the accompanying interest savings) and direct equity infusions, whereas for Emirates, they were primarily related to fuel hedge losses and subsidized airport charges. The unfair benefits were primarily related to local labor laws that prevented unionization, and the resultant cost savings accrued by the so-called Middle East Big 3 (MEB3).

The US3 Have a Legal Case

The white paper and presentation indicate that the big 3 US carriers (US3) have thrown serious financial resources and time behind an investigative effort that they believe will pay dividends. The forensic accounting that underlies these numbers is painstaking and accurate, and despite the early misstep by Richard Anderson, their effort to date has been well-planned and implemented.

Based on initial assessment by trade lawyers, and with the caveat that I am not a legal professional and thus that my second hand relay should not be treated as a firm legal opinion, there is a case to be made before the WTO and the US government that the MEB3 have been unlawfully subsidized. These equity infusions and interest free loans match the WTO’s standards for subsidies. As noted in the report, “The WTO Agreement on Subsidies and Countervailing Measures defines “subsidy” as a ‘financial contribution’ by a government that confers a “benefit” on its recipient (i.e., government support on better than commercial terms).” Even if the WTO is not necessarily the arena in which this case will be judged, the WTO’s rules and definitions will still play a critical role in framing the legal debate in the US.

And if the US3 may have a case with the WTO, that bodes poorly for the MEB3’s prospects in the arena where this case will actually be judged, by US government agencies. The entire Open Skies project, which has seen scores of aviation markets opened up to the US since the 1990s, has unquestionably been a success. But while the language of these agreements allows for unlimited service by foreign carriers, one phrase that appears in many agreements would appear to do the MEB3 in. Essentially, the language notes that US carriers can expect to have “unrestricted, fair competition to determine the variety, quality and price of air service.” And unfortunately, subsidies would likely violate this condition.

The US government has the power to alter or halt the Open Skies bilaterals with the UAE or Qatar if it finds violations of this nature, and the Obama administration is already deep into its investigation. There is real danger that they will find in favor of the US3.

US3 have financial skin in the game because of JVs

When Delta last month fingered the MEB3 as the reason that it does not serve India nonstop from the United States, it was just the latest in a series of hyperbolic statements about a supposed loss of service due to the MEB3. In reality the US3’s lack of success in India (United excepted?) is driven by a mix of factors of their own doing. First and foremost, the US3 do not offer a strong base economy class product (in particular skimping on baggage allowance), which hurts them with value-conscious Indian travelers. Moreover, if you actually wanted to cite competition as the reason for lack of nonstop service, you would actually have to point the finger at Indian flag carrier and perennial basket case Air India. Air india offered nonstop service with massive Boeing 777-300ER aircraft on Chicago-New Delhi and New York JFK – New Delhi in direct and indirect competition with American and Delta respectively. These services eroded any potential for the US airlines to earn a nonstop premium on fares, and that, more so than competition from the MEB3 helped kill the US-India nonstops. In fact across nonstop markets that the MEB3 has “stolen” from US airlines, India is the only market that would actually be large enough for US carriers to serve nonstop. Eastern Africa, Sri Lanka, Bangladesh, Yemen, Oman, Iraq, Afghanistan, and the Central Asia smorgasbord (basically the ‘Stans’)  aren’t large enough markets to ever have a nonstop. I suppose you could make an argument for Islamabad or Karachi from New York (and only New York), but the chances of a US airline serving Pakistan in the immediate future are about as good as the chances of Airbus launching an A340-500neo.

So it’s not really the loss of nonstop opportunities that is affecting the US3. Their financial losses are more indirect. While the US3 don’t carry many passengers between the US and South Asia, East Africa, Central Asia, or the Middle East, their joint venture partners Lufthansa, Air France, and British Airways undoubtedly do. And due to these joint ventures, on a USA – Europe – South Asia/East Africa/Central Asia/Middle East routing, the US airlines are entitled to a profit share for the USA-Europe leg. And they’ve lost out on a not inconsequential amount of revenue due to the market share captured by the MEB3. That amount isn’t more than $30-40 million dollars per year (a bound, not an estimate), but it is still something.

Fifth Freedom is what really scares the US3

At the end of the day the loss of $30-40 million in revenue in and of itself wouldn’t scare the US carriers into action. Rather, they perceive a much larger threat on the horizon; fifth freedom service. Thanks to the US’ liberal attitude towards aviation policy, many of its Open Skies agreements also contain provisions allowing third party carriers (airlines not from the two countries governed by the agreement) to fly so-called fifth freedom services between the US and the country covered by the agreement. In the past, these rights were mostly used by airlines who could not reach the US with nonstop flights (such as Air India’s longstanding services via London Heathrow), airlines who needed the financial boost of an intermediate destination, or airlines for whom security concerns require an intermediate stop (such as Pakistan International Airlines in Manchester or Barcelona).

The MEB3 don’t necessarily embody the spirit of these rights, and thanks to Emirates’ recent foray into the New York JFK – Milan market, where it recently introduced the Airbus A380, the US carriers are increasingly worried about the prospect of a widespread MEB3 invasion onto key trans-Pacific and trans-Atlantic routes. One of the arguments against the MEB3 having a major impact on US airlines has always been that the MEB3 have little relevance on routes between the US and Europe or East Asia (and Latin America) due to the fact that nonstop routings are much shorter than those through the Middle East. But because of the way that most US open skies agreements are written, that is not necessarily true any more. In fact, it’s not hard to envision a future under status quo bilaterals where Emirates serves Los Angeles – Sydney, Qatar Airways serves Tokyo Narita – San Francisco, and Etihad serves New York JFK – Amsterdam. And that prospect terrifies the US3.