TAIWAN AVIATION - DIRECT LINKS, HIGH-SPEED RAIL,

C O N F I D E N T I A L SECTION 01 OF 03 TAIPEI 003414

SIPDIS

SIPDIS

STATE FOR EAP/TC, EB/TRA
STATE PASS USTR
COMMERCE FOR 3132/USFCS/OIO/EAP/WZARIT
TREASURY FOR OASIA/LMOGHTADER'
USTR FOR STRATFORD, ALTBACH

E.O. 12958: DECL: 10/02/2016
TAGS: EAIR ELTN ECON PREL TW CH
SUBJECT: TAIWAN AVIATION - DIRECT LINKS, HIGH-SPEED RAIL,
FUTURE OF UNCERTAINTY (PART 1 OF 3)

REF: A. 05 TAIPEI 3752


B. 05 TAIPEI 4161

C. TAIPEI 3210

Classified By: AIT Acting Director Robert S. Wang, Reason 1.4 d


1. (U) Summary: Taiwan's aviation market has suffered
from dramatic declines in domestic air travel that will
worsen with the opening of Taiwan's high-speed rail. In
addition, air cargo growth appears to have stagnated,
Taiwan airlines face increasing competition from expanded
U.S.-China air capacity, and high oil prices have eroded
profits. End summary.


2. (U) This is the first of a three part report on the
challenges facing Taiwan's aviation industry. This part
focuses on factors creating a difficult environment for
Taiwan air carriers. Parts two and three will look at
the effects on Taiwan airlines and U.S. companies,
respectively.

Declining Passenger Loads
--------------


3. (U) Taiwan's passenger aviation market has suffered
from a dramatic decline in domestic air travel in the
last eight years. The total number of passenger/trips on
Taiwan airlines' domestic routes has fallen from a peak
of 18.6 million in 1997 to just 9.6 million in 2005, for
a decline of 49 percent in eight years. Four airports --
including Taichung, Taiwan's third largest city -- have
seen the number of passengers fall by more than 60
percent since 1997. The decline is due in large part to
improvements in Taiwan's highway and rail systems.


4. (U) Falling domestic air travel has been mitigated by
increasing international traffic. Passenger/trips on
Taiwan airlines' international routes have increased from
10.5 million in 1997 to 17.1 million last year. As a
result, Taiwan airlines have seen their total number of
passengers per year fall by 8.3 percent since 1997, but
total passenger kilometers flown have increased by 39
percent. This growth has helped keep Taiwan's major
carriers, China Airlines and EVA Air, profitable, but has
offered little relief for the four small carriers,
TransAsia, Far Eastern Air Transport (FAT),UNI Air and
Mandarin Airlines. The following chart shows the number
of passengers for Taiwan airlines:

-- Total Domestic International
Year Passengers Passengers Passengers
-------------- -------------- -------------- --------------
1997 29,061,262 18,606,508 10,454,754
1998 27,475,242 16,670,311 10,804,931
1999 28,205,795 16,051,808 12,153,987
2000 26,334,787 13,118,367 13,216,420
2001 25,378,878 12,055,845 13,323,033
2002 24,674,971 10,748,282 13,926,689
2003 22,258,388 9,949,410 12,308,978
2004 26,173,804 10,435,597 15,738,207
2005 26,652,530 9,571,448 17,081,082

High-Speed Rail Challenge
--------------


5. (U) Taiwan's domestic airlines are preparing for an
even more severe decline in sales with the opening of
Taiwan's high-speed rail scheduled for January 2007.
Eventually, the high-speed rail will stretch 345
kilometers between Taipei and Kaohsiung, connecting all
of Taiwan's major population centers on the west coast.
With speeds of up to 300 km per hour, rail travel time
between Taipei and Kaohsiung will be cut from four and a
half hours to 90 minutes (only about twice the time for a
plane flight). The government has approved a Taipei-
Kaohsiung ticket price of NT$1,231 (about US$37.50) each
way, just over half the cost of a plane ticket, currently
at NT$2360 (US$73).

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6. (C) Airlines expect to be affected by the high-speed
rail starting sometime in 2007. Because of unfinished
work on a tunnel, the new rail line will not provide
service all the way to downtown Taipei until some months
after service begins. Initially, the line will terminate
in the Taipei suburb of Banqiao. However, when full
service begins, Taiwan's Civil Aeronautics Administration
predicts passenger loads on flights connecting west coast
cities, the most highly used routes, will drop by 67
percent. Far Eastern Air Transport (FAT),one of
Taiwan's small, primarily domestic airlines, predicts its
total revenue will fall 15 to 20 percent. In trying to
put an optimistic spin on the likely impact, FAT's
Chairman Stephen Tsuei told us the drop in revenue would
be much less severe than the 60 percent predicted by some
analysts.

Stagnating Cargo Volumes
--------------


7. (U) The air cargo market has not seen the precipitous
decline of the passenger market. However, after years of
strong growth, the market declined slightly last year.
(ref B) The outlook is weak again this year.
International air cargo dominates Taiwan's air cargo
market, accounting for nearly 98 percent of the cargo
that passes through Taiwan's airports. Total
international cargo fell in 2005 for the first time since
Taiwan's recession in 2001, slipping 0.1 percent from
1.788 to 1.786 metric tons. The decline was due mainly
to lower air shipments of Taiwan exports. Exported air
cargo fell 5 percent from 735,346 to 701,857 metric tons.
Performance for the first half of 2006 was up slightly
with a 0.5 percent increase in total cargo compared to
the first six months of 2005. However, export cargo
continues to fall, down 1.7 percent from the same period
a year earlier. The following chart shows Taiwan's
international air cargo in metric tons.

Year Total Import Export Transit
-------------- -------------- -------------- -------------- --------------

2001 1,278,618 433,502 607,824 237,293
2002 1,476,530 460,002 684,542 331,986
2003 1,584,673 465,237 726,441 392,995
2004 1,788,778 525,807 735,346 527,625
2005 1,786,771 519,566 701,857 565,348
Jan-Jun 857,820 243,831 340,944 273,048
2006
Jan-Jun 862,426 251,532 335,080 275,814


8. (U) The recent slowing in air cargo traffic,
especially in export cargo, appears to be due largely to
the transfer of Taiwan's IT hardware manufacturing to the
PRC. Taiwan's air cargo exports are dominated by
electronics goods, which made up 63 percent of total
export cargo in July 2006. In previous years, high-tech
industry investment in the PRC drove rising air cargo
volumes as Taiwan-made components were shipped to
Mainland factories for assembly into final goods.
However, as Taiwan investment in the PRC has moved
farther up the supply chain, growth in air cargo volumes
has slowed.


9. (C) Changes in the composition of Taiwan's trade have
also affected the air cargo market. With Mainland China
accounting for a growing share of Taiwan's exports,
Taiwan carriers are in an increasingly difficult position
because they cannot provide direct service from Taiwan to
the PRC. FedEx Taiwan Managing Director Michael Chu told
us that while Taiwan's export traffic to Asian
destinations has grown, trans-Pacific traffic, which
often brings in more revenue, has declined. In addition,
Taiwan carriers are disadvantaged because they cannot
provide direct service for PRC exports (often produced by
Taiwan firms) to other destinations.


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U.S.-China Aviation Expansion
--------------


10. (C) The rise in transit cargo, up by 34 percent in
2004 and 7 percent in 2005, has been one of the few
bright spots in the cargo market for Taiwan carriers.
However, Taiwan airlines believe this growth will not
continue as U.S.-China air cargo capacity increases.
Under the U.S.-China Aviation Agreement signed in July
2004, the number of flights will gradually increase
almost fivefold by 2010. In addition, the growth of
Chinese airlines has allowed them to expand their cargo
capacity. FAT's Tsuei described expanding U.S.-China air
capacity to econoff as a greater threat to Taiwan's
aviation industry than the high-speed rail.

High Oil Prices
--------------


11. (C) Higher oil prices have compounded the various
challenges facing Taiwan's airlines. When AIT Director
Young recently asked Minister of Transportation and
Communications Tsai Duei about the future impact of the
high-speed rail on Taiwan's airlines, Tsai highlighted
oil prices as a more serious concern. China Airlines
(CAL) Vice President for Corporate and Marketing Planning
echoed Tsai's comments, saying that high fuel prices are
the most important challenge facing Taiwan's aviation
industry today. Recent declines have helped give the
industry some breathing room. However, as Mandarin
Airlines President Harris Wang pointed out, fuel now
accounts for 30 percent of his airlines' expenses
compared to 25 percent more than a year ago. FAT's Tsuei
explained that even though his company has increased its
revenue in 2006, fuel prices have caused higher losses.

Next: Taiwan Airlines - Impact and Survival Strategies
-------------- --------------


12. (C) The confluence of these factors has created an
extremely challenging environment for Taiwan's airlines.
They are pursuing various strategies to overcome these
difficulties. In the next part of this series, we will
look at how the airlines have been affected and how they
hope to survive.
WANG