76 Airline Economics February/March 2016 www.airlineeconomics.co

Iran has remained outside of the international business community for approaching forty years. First imposed by the US in 1979, sanctions were

expanded in 1995 and again in 2006 following Iran’s refusal to suspend its uranium enrichment efforts.

On January 16, 2016, it was announced that Iran had completed the requisite steps agreed to under the terms of the Joint Comprehensive Plan of Action (JCPOA) in July 2015. Iran agreed to scale back its nuclear efforts in return for an unfreezing of up to $100bn of assets and a lifting of nuclear-related sanctions.

Iran is the largest economy to re-join the global economy since the end of the Cold War and this could lead to

a potentially huge windfall for the civil aviation industry.

The markets appeared to be caught slightly by surprise by the speed with which Iran met the “Implementation Day” conditions and within hours of the declaration, Iran had announced a number of commercial deals, including one with Airbus that was later confirmed on January 28 for 118 aircraft.

In the days following the announcement, the media was full of stories of opportunities and potential transactions. However, while Implementation Day brings Iran out of isolation and creates enormous potential opportunities, the remaining sanctions and complexity around the US position in particular suggests operators, lessors, financiers and investors should still

tread carefully. Iran has spoken of driving $50bn of

investment per annum and deals with Airbus, PSA and Daimler in the first two weeks since lifting suggest this figure is achievable. While Boeing now has permission to look at Iran in the short term at least, US companies will be largely excluded from that effort given the non-nuclear restrictions they are still bound by.

Even in Europe, the picture is complex, with both industry and lawyers opining that we are still months from deliveries, though the mooted A340 placements from Airbus in the first half of 2016 would reinforce Iran’s commitment.

Fans of the film Spinal Tap will remember that the aging rockers used an

Iran: Minimising risk and maximising opportunityIBA’s Paul Lyons provides his assessment of the Iranian aviation market.

www.airlineeconomics.co Airline Economics February/March 2016 77

amplifier whose volume dial went to “11” rather than 10. Following conversations with various legal experts, we might assume that if Iranian sanctions were also at 11 before the JCPOA talks, EU restrictions are now down to a 5, while US constraints are still at 7 or 8.

The US position is at best complex, at worst ambiguous. Before proceeding, a business would need to be sure that the sector, individuals and companies aren’t caught by sanctions and that their banks aren’t connected to the US financial system and will process payments connected to Iranian business.

CURRENT STATE Iran is the 29th largest economy by GDP. While it has enormous oil and gas reserves, it is less reliant on energy

revenues than many of its neighbours with a developed manufacturing economy. The population of 80m is well-educated and GDP growth is forecast to jump from 2.5% to 8%, with some financiers forecasting that Iran could pass Saudi Arabia in the next decade as the largest economy in the region.

Iran’s GDP is around $406bn, similar to the UAE though Iran’s per capita figure of around $16,500 is considerably less than UAE’s at around $65,000.

It’s a large country; the 18th largest in the world by mass and home to some spectacular mountain ranges. Iran’s size, topography and lack of investment in transport networks make air travel improvements a priority. Indeed, alongside modernising the banking system, the unfrozen assets have also

been predominantly earmarked for improvements in transport across air and rail.

The airports need modernising and are not built to cope with the increased numbers forecast. While there are twin aisle jets operating in country, it is not at the rate of utilisation and frequency that they will see in 12-24 months and when the dozen A380s that were recently ordered commence flying, they will only add to the potential bottleneck caused by the creaking airport facilities.

THE DOMESTIC MARKETAs widely reported in news following Implementation Day, sanctions effectively froze the Iranian fleet in time. IBA’s JetData lists 243 aircraft operating in Iran, with 197 of them active. The

78 Airline Economics February/March 2016 www.airlineeconomics.co

IRANIAN AVIATION

youngest planes flying are still 11 and the average age of the active fleet is almost 23 years old.

To be competitive Iranian airlines need to urgently update fleets. More modern equipment will improve factors across the board:

• Iran has a mixed safety record, for instance only 27% of Iran Air’s fleet is permitted to fly in Europe.

• Costs are high too. MRO costs run at between 10-15% of direct operating costs on average and we understand that Iranian carriers spend upwards of 25% on maintenance as a result of old fleets and bespoke maintenance schedules. Due to sanctions, Iranian engineers were devising methods of keeping aircraft flying, which needed a lot of in-house support, i.e. engineering to manufacture their own parts when supplies dried up, especially cabin, hold, and ancillary components. As manuals were not updated they had to develop their own version of updated maintenance programmes without OEM support, and control this themselves. All this extra work has a direct impact on costs

• Fuel too is likely to still be running at over 35% of costs, again directly as a result of flying inefficient engines.

JetData highlights that there are 15 domestic airlines in Iran. Mahan is now the largest by fleet size, though that position may well change as it remains on the sanctions list for links to the IRGC (Islamic Revolutionary Guard Corps).

The high number of domestic carriers has not deterred foreign encroachment, particularly from the Gulf carriers and there are at least 16 carriers currently flying in and out of Iran. The position around international carriers remains very fluid and at time of writing – Air France, KLM, BA and Air Asia had all confirmed they were scheduling direct flights.

CIVIL AVIATION – WHAT IS THE OPPORTUNITY?The aviation sector is arguably second only to Oil & Gas in terms of importance to Iran.

Estimates of the scale of aircraft procurement vary between 400 and 600 aircraft over the next decade and $20bn-$50bn per annum. Latest official estimates suggest 581 aircraft and while we are interested to understand how smooth the adoption and rollout of new equipment will be, what is clear is that investment will be substantial and driven by three factors:

1. The replacement of aircraft by Iranian airlines

2. Capacity growth by Iranian Airlines. The more efficient aircraft will open up routes while the GDP growth will be matched by increased demand for flights – both domestic and international.

3. Inbound airlines juggling fleets or bolstering capacity to service the increased frequency.

Given the backlog, lessors and sourcing agent stand to benefit from all three drivers – with the increase in inbound traffic perhaps appealing to the more risk averse as trading with Iranian entities will bring additional risks.

Tourism, pilgrimages and large ex-pat communities are all expected to contribute to the growth:

• Iran is home to 19 UNESCO World Heritage sites and is looking to welcome 20m+ tourists a year.

• There are estimated to be 4-5m Iranians living abroad, many of whom will be looking to visit a more liberal Iran.

AND THE RISKS?Even the most optimistic investor would concede that capitalising on Iranian growth is not without risk. Let’s examine a few of them:

Assumptions don’t materialise: For instance, Iran’s middle class was identified as the driver of greater demand for air travel when the price of oil was significantly higher. Indeed, a lot of the assumptions around investment in fleets and airports were likely based on oil prices that we will not see again for perhaps two years.

Sanctions navigation: Two factors appear to cause the most concern: the level of remaining US sanctions

US Sanctions: Key changes

• The US has lifted the sanctions that prevented overseas/non-US businesses from engaging with numerous sectors.

• 400 individuals and entities have been removed from the Specially Designated Nationals (SDN) list allowing others to trade with them.

• Foreign subsidiaries of US businesses can gain a licence to engage in most of the transactions that non US persons can compete for.

• Foreign Financial Institutions can now conduct business with persons and entities removed from sanctions list, even if they have US branches.

• A specific licensing regime has been introduced which allows the export of commercial aircraft and components as long as they are for civil use.

What hasn’t changed?

• Most trade by US individuals and US companies remains prohibited.

• 200 individuals and entities, including Mahan Air – Iran’s largest airline by fleet size – remain sanctioned.

• US financial system – US dollar transactions and the movement of funds through the US financial system are still banned.

EU sanctions: Key changes

• Widespread lifting of EU sanctions on most sectors including prohibitions against commercial aircraft transactions. Licenses introduced for dual use goods (civilian and military). The vast majority of individuals and entities removed from the EU’s designated persons list.

What hasn’t changed?

• Transactions related to military goods or goods used for repression. Some technical services around transactions are also prohibited.

Legal position(courtesy of Pinsent Masons)

www.airlineeconomics.co Airline Economics February/March 2016 79

IRANIAN AVIATION

which prevent dollar transactions, or unwittingly trading with SDNs. The IRGC sanctions remain in place and new constraints were imposed as a result of the missile test in October – thought to be an effort by hardliners to disrupt the Implementation Day efforts.

The IRGC are classed by the US as SDNs and as result are blocked from US banks. It is IBA’s contention that this will result in a real challenge to progress as companies attempt to ensure they are not linked to sanctioned entities spread covertly across the economy of Iran and allegedly controlling over a third of the economy.

Snapback: The means of purchase remains a key concern. IBA understands Iran will look to lease aircraft, but leasing brings its own challenges given the long term exposure to the snapback. We believe that the snapback threat is less than many others, purely because of the political pressure to push on. One source suggested that, for example, another cruise missile launch would not be sufficient to trip the snapback, plus we understand the notice period is at least 65 days which, in theory, would potentially give a lessor plenty of opportunity to recover its asset, if not find an alternative lessee. The reality is that in terms of recovering an aircraft in a condition per the redelivery requirements and to meet next lessee terms a lessor may need a war chest of $2m to plug the gap.

It is vital to ensure you can recover assets if a deal turns sour or sanctions are reapplied. The legal environment also needs to be robust to ensure that contract conditions are respected.

Corruption: With sanctions relaxed you are still faced with the challenge of entering a difficult market. Iran, according to Transparency International, ranks 130th on the Corruption Perception Index – alongside destination likes Russia and Nigeria. The risk of corruption is currently high, as is the risk of unwittingly conducting business with an SDN given the opaque reach of the IRGC.

Infrastructure is a bottleneck: Tehran airport will be developed as soon as possible with $8bn earmarked for improvements across Iran’s 50+ airports. French contractors look in ACTIVE FLEET BY AIRCRAFT TYPE

ACTIVE FLEET BY MANUFACTURER

ACTIVE FLEET BY OPERATOR

Airbus

72

44

44

22

113

1

Fokker

McDonnell Douglas

BAE

Boeing

ATR

Dornier

Mahan Air

Iran Air

Iran Aseman Airlines

Zagros Air

Qeshm Airlines

Kish Air

ATA Airlines

Taban Airlines

other

Narrow

Regional

Wide

24%

15%

13%10%

6%

6%

5%

4%

17%

41%

23%

36%

Airbus

72

44

44

22

113

1

Fokker

McDonnell Douglas

BAE

Boeing

ATR

Dornier

Mahan Air

Iran Air

Iran Aseman Airlines

Zagros Air

Qeshm Airlines

Kish Air

ATA Airlines

Taban Airlines

other

Narrow

Regional

Wide

24%

15%

13%10%

6%

6%

5%

4%

17%

41%

23%

36%

Airbus

72

44

44

22

113

1

Fokker

McDonnell Douglas

BAE

Boeing

ATR

Dornier

Mahan Air

Iran Air

Iran Aseman Airlines

Zagros Air

Qeshm Airlines

Kish Air

ATA Airlines

Taban Airlines

other

Narrow

Regional

Wide

24%

15%

13%10%

6%

6%

5%

4%

17%

41%

23%

36%

Source: IBA JetData

80 Airline Economics February/March 2016 www.airlineeconomics.co

IRANIAN AVIATION

pole position to secure those deals. Passenger capacity is likely increase at a faster rate that airport development and that will bring its own challenges. As we saw with India a decade ago, unless infrastructure improvements are phased to accommodate growth delays and cancellations are very likely.

Safety: There is room for improvement in Iran’s air safety record and we would suggest that the growth forecasts assume that safety improves predominantly through the rollout of newer, more reliable equipment. International expansion won’t occur until improvements are tangible, and these improvements are needed across aircraft, infrastructure and MRO facilities

Will there be investment in training? We understand the Airbus deal includes training, which is encouraging. However, IBA has seen examples in modernising markets where training support has been cashed in and then not enforced. Various airlines have stipulated the need for training as part of any expansion effort.

Internal tensions: To add the complexity of the situation, there is tension within Iran between hardliners and reformers, regarding the speed of change and sourcing of kit. Khamenei stated there will be no cooperation with the West beyond the nuclear deal and that China and Russia would be the focus of commercial development. His views are shared by the defence ministry and local industry – much of which is embedded with the IRGC and would benefit little from US entry as they were looking to develop in-house.

WHAT IS LIKELY TO HAPPEN NEXT Typically when a market opens up, there is either a goldrush of sorts and many entrants rush in, or there is a “wait and see” approach, where competitors gamble they will learn more from observing those first in than they would gain by being a first-mover.

Here we have a rare position where one member of, what some call, a duopoly has been given a head start over its major competitor.

While Airbus looks certain have secured the first orders, with ATR and Embraer following suit, Iran is

on record that it is also open to buying from Boeing.

Initially, Boeing said: “There are many steps that need to be taken should we decide to sell airplanes to Iran’s airlines. For now, we are assessing the situation.” However, it was reported mid February that the US government had cleared the OEM to begin negotiations with approved Iranian carriers.

As of late February, if we breakdown Iran’s quoted figure of 581 aircraft, there are still at least 373 slots to fill, though almost 40% capacity has already been ordered and alongside the larger orders we are also now seeing individual airlines ordering aircraft in single digits (see chart opposite). Given the capacity and value available in some parts of the market, IBA would expect secondary transactions to feature heavily alongside high profile orders for new metal.

Boeing’s challenge is twofold, not only are US sanctions still more strict than EU sanctions, there are political ramifications. All Republican candidates have stated they will reverse the sanctions lifting if they win the presidential election in November so Boeing and other US OEMs and lessors are seemingly cautious.

Another area that will require more clarification is US licence approval for any aircraft containing more than 10% components from US companies. It is IBA’s understanding that Bombardier, ATR and Airbus would all need to be mindful of such a percentage.

Regardless of the fanfare, cash is at a premium and we understand that many of the airlines are already heavily in debt. This raises two concerns: how will

purchases be funded, and what options will seller have if a deal goes sour?

The banking system is acknowledged to be out-dated and there are question marks too around the robustness of the legal system – unsurprising given the lack of international interaction. The typical disputes that impact aviation – contract arguments, lease defaults, redelivery missteps and repossessions will happen so it is essential to enter, operate and exit with the right level of support.

Despite the positive nature of the Airbus deal, the majority of industry leaders we have spoken with highlight the various hurdles to negotiate – be they legal, regulatory, political, or commercial. Care will be needed in order to minimise risk and maximise opportunity.

Chart shows the proportion of aircraft ordered so far against Iran’s quoted required aircraft figure of 581.

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Faster, better value, intuitive

www.jet-data.com

Whether buying, selling, fi nancing, investing in or operating aircraft, it is essential to have an accurate picture of current and future values. With its unique combination of independence, industry expertise and access to proprietary data, IBA is ideally positioned to advise the global aviation industry.

Contact us on +44 (0) 1372 224 488 or email: sales@ibagroup.com

Unique insight, comprehensive support

Minimising Risk - Maximising Opportunity

View the possibilities...

www.ibagroup.com

IBA A4 Jan 2016.indd 1 05/01/2016 13:10

Airbus

ATR

Embraer

As yet unannounced

Potential Fleet

118

40

50

373

Faster, better value, intuitive

www.jet-data.com

Whether buying, selling, fi nancing, investing in or operating aircraft, it is essential to have an accurate picture of current and future values. With its unique combination of independence, industry expertise and access to proprietary data, IBA is ideally positioned to advise the global aviation industry.

Contact us on +44 (0) 1372 224 488 or email: sales@ibagroup.com

Unique insight, comprehensive support

Minimising Risk - Maximising Opportunity

View the possibilities...

www.ibagroup.com

IBA A4 Jan 2016.indd 1 05/01/2016 13:10