Richard Aboulafia: March 2019 Letter

Dear Fellow World-Weary World Watchers,

Useful phrase for Boeing people in China: Zhè gāo yú wǒ de gōngzī děngjí. If Google Translate works, that’s mandarin for “That’s above my pay grade.” Over the past few weeks, Boeing’s China situation has deteriorated markedly, for reasons that are largely out of the company’s control, adding to the company’s woes after the Ethiopian 737MAX tragedy. There’s not much they can do, and since China is their biggest export market, there’s a lot at stake.

Losing China might be an emerging black swan event for Boeing, an event that might be obscured by the 737MAX situation, and accelerated by it too. In the aftermath of the second crash, China’s CAAC became the first regulatory agency to ground the MAX. The CAAC is well within its rights on this, but grounding a jet 19 hours after an accident means there was no process, investigation, or evidence involved in the decision.

Also, there is no separation between CAAC and the rest of the Chinese Government (including COMAC). Given everything else going on between the US and China (see below), the CAAC’s motivations are open to question. Any doubts about the politicization of this process were removed two weeks later, when the CAAC stopped taking applications for MAX certification. This was meaningless from a regulatory standpoint, but a great way to signal displeasure.

March also saw President Xi announce a Chinese order for 300 Airbuses. Ominously for Boeing, China’s order was rumored last year to be for just 180 Airbuses, not 300. Airbus’s backlog for Chinese customers (without this 300) is 168, including 31 for Chinese lessors. Boeing’s China backlog stands at 122 aircraft. But 104 of these are MAXs, which cannot be imported until the CAAC lifts its airworthiness certification ban. Until then, the backlog is effectively 18 planes, a multi-decade low, while Airbus’s is 468. Since the Airbus-Boeing situation in China has been
50-50 for many years, this is a notable departure.

To understand the Boeing China situation, consider the other issues between the US and China, issues well out of Boeing’s control. Consider these key four issues:

  1. The US-China Trade Confrontation. It would be impossible for Boeing to not be wrapped up in this giant mess, involving trade barriers, IP disputes, and tariffs. We may see a breakthrough in a few days or weeks; or we may see an impasse and a steady deterioration of trade relations. Either way, Boeing will be part of the headlines. After all, jetliners are the US’s biggest manufactured export, and it’s hard to see any other large products China would buy to make the US happy. To look at it the other way, it’s hard to see what  Chinese would conspicuously not buy to signal their displeasure.
  2. The US Navy in the Taiwan Strait. Before last July, the US sailed a ship through the strait around once a year; since July, there have been six such cruises, to counteract China’s aggressive naval posturing. Taiwan has always been a sticking point for China and the US, but the problem is worsening. I recently subjected myself to Operation Red Sea, a 2018 Chinese blockbuster. It’s like a fictional Black Hawk Down, but with Chinese special forces battling Arabs. It’s a relatively harmless nationalist fantasy, except at the very end, when, apropos of nothing, a Chinese naval force is shown confronting US ships, ordering them to leave Chinese waters immediately. Like the CAAC, China’s film industry is basically part of the government, and it seems to be spoiling for a fight over Taiwan.
  3. Taiwan Fighter sale (and more). The US hasn’t sold new fighter planes to Taiwan in around 25 years, but the Trump Administration is about to greenlight 60+ F-16Vs, on top of 140 upgrades for the existing fleet (Boeing can be thankful they didn’t ask for F/A-18s). An M1 tank sale may be approved too. In Washington, there seems to be a bipartisan consensus that it’s time to stand up to China in the South China Sea. Meanwhile, the Taiwanese Air Force is aging to the point of obsolescence, necessitating some kind of sales. The PRC, predictably, is unhappy.
  4. Huawei. I can’t begin to scratch the surface here, but the confrontation between the US and China over this telecoms giant dwarfs anything aerospace-related between the two countries. In January, the US filed fraud, obstruction of justice, and theft of trade secrets against Huawei, and one top executive is under arrest in Canada (predictably, the Trump administration has done little to back Canada against the inevitable retaliatory moves). As the March Aviation Strategy notes, Huawei’s revenues are now around $100 billion, or about the same as Boeing’s revenues. It’s easy to see China’s anti-Boeing moves as a form of symmetric retaliation.

For Boeing in China, all is not lost, despite this toxic soup of exogenous factors. While larger than expected, some kind of Airbus order was bound to happen on President Xi’s European trip, as part of China’s broader effort to sell its One Belt, One Road initiative to the EU. It’s possible that a US-China breakthrough trade agreement includes a large number of Boeings (MAXs or otherwise). The 300-aircraft Airbus order includes just ten twin aisles (A350s), so there’s plenty of scope for a Boeing twin aisle order. That Airbus China backlog sounds large, but China imports around 300-400 jets each year, so there’s plenty of room for Boeings too. If Airbus gets all of the China market, they’ll increase prices, perhaps leading to a Chinese shift back to Boeing.

Also, there are 942 737MAX orders (and 566 A320neo orders) that are for undisclosed customers, and many could be for Chinese carriers waiting for their government to officially take credit for delivering these orders. Both models also have many lessor orders, and some of these could be destined for Chinese carriers too. In short, there’s no reason that Boeing can’t recover to its historical 50% China market share.

It’s also possible, however, that US-China relations worsen, with Boeing suffering further collateral damage. As I argued in my February 2017 letter, Boeing might want to re-think its close relationship with President Trump. This coziness has certainly paid dividends, but it makes the company an even easier target for retaliation, particularly since the Trump administration has made China tariffs and trade negotiations a very high priority. But there’s not much else the company can do, particularly since it has its hands full right now dealing with the 737MAX.

Yours, ‘Til Taiwan Asks Trump For B-21s,

Richard Aboulafia