US embassy cable - 05OTTAWA3095

UNCLAS SECTION 01 OF 04 OTTAWA 003095 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR WHA/CAN - BREESE AND HOLST 
 
STATE PASS USTR FOR CHANDLER 
 
USDOC FOR 4320/OFFICE OF NAFTA/GWORD/TFOX; 
3134/OIO/WESTERN HEMISPHERE 
 
PARIS FOR USOECD 
 
E.O. 12958:  N/A 
TAGS: ETRD, EIND, EINV, EAIR, CA 
SUBJECT:  BOMBARDIER AND THE WORLD AIRCRAFT SUBSIDIES GAME 
 
REF:  OTTAWA 822 
 
SUMMARY/INTRODUCTION 
-------------------- 
 
1.   (U) SENSITIVE, BUT UNCLASSIFIED.  NOT FOR 
DISTRIBUTION OUTSIDE USG CHANNELS. 
 
2. (U) This report outlines an increasingly 
significant part of the backdrop to large aircraft 
subsidies issues:  Canada-based Bombardier Aerospace 
and the future of the market for commercial jets 
carrying 100 to 130 passengers.  While these 
airliners are at the smallest end of the product 
ranges offered by Boeing and Airbus, they are 
sufficiently large to be covered by the OECD Large 
Aircraft Sector Understanding - LASU.  Brazil's 
Embraer is already in this market with models of 
around 108 seats.  Bombardier's proposed "C series" 
aircraft, if it proceeds, would offer 110 to 130 
seats. 
 
3. (U) Bombardier announced in May 2005 that final 
assembly of its proposed "C series" aircraft (if 
built) would occur in the Montreal area, after it 
played the Canadian federal and Quebec provincial 
governments off against other jurisdictions for 
subsidy commitments.  This represents a solid 
renewal of Canadian governments' commitment to 
subsidies in manufacturing industry (reftel).  If 
the C series goes ahead, it also represents a major 
venture by Bombardier into the 100-seat-and-up 
product range, and a further escalation of its 
decade-long competition with Embraer in regional 
jets. 
 
4. (SBU) Bombardier's political connections in 
Canada are legendary.  In a bitter dispute (1996- 
2001) with Embraer, the GOC proved willing to play 
hardball to support the company in WTO trade 
litigation and in the market.  Bombardier's domestic 
critics are unable to calculate the economic value 
of this support, particularly on the export 
financing side, due to lack of data.  Bombardier and 
its suppliers account for some 30,000 jobs, many of 
them in politically crucial constituencies around 
Montreal.  Moreover, Canada can afford to continue 
this support.  END SUMMARY/INTRODUCTION. 
 
THE COMPANY 
----------- 
 
5. (U) Canada's aerospace industry, with more than 
400 firms employing over 80,000 people (see industry 
website www.aiac.ca ), claims to be the largest in 
the world after those of the United States and the 
European Union.  As in other Canadian manufacturing 
industries, integration with the U.S. market 
(including access to defense contracts) has 
facilitated growth particularly among parts 
manufacturers and service providers since the 1940s. 
Canada's own very small military budget has been a 
disadvantage for this sector, providing few 
opportunities to produce entire aircraft, and (as in 
shipbuilding) this has been used as a rationale for 
direct government support. 
 
6. (U) Bombardier - which pioneered the snowmobile 
in the early twentieth century and later expanded to 
motorcycles, boats and rail/subway systems - claims 
to be the world's largest manufacturer of railway 
rolling stock (which it admits is a risky and not 
very profitable business, with margins only around 
2.6 percent).  Since July, its rail division has 
announced over US$800 million worth of contracts in 
Europe, the United States and Mexico.  Bombardier 
entered aerospace in the 1990s through acquisition 
of Canadair (Quebec), de Havilland (Ontario), Shorts 
(U.K.) and Learjet (U.S.).  Combining existing 
strengths in turboprops and business jets, 
Bombardier caught a strong trend in the 1990s toward 
the use of 50-to-70-seat regional jets on inter-city 
routes in North America.  While profits in this 
business have slumped along with that in airlines 
since 2001, Bombardier's private and business jet 
products/services (which include Flexjet and 
Learjet) have prospered. 
7. (U) Bombardier's current commercial offerings, 
all based on designs more than a decade old, are 
turboprops carrying from 37 to 56 passengers and 
jets ranging up to 90 seats (see website 
www.bombardier.com).  In the late 1990's, Bombardier 
considered developing a 115-seat model, but held 
back - a decision that may have been fortunate given 
the post-2001 sales slump.  With airline profits 
reviving, Bombardier is discussing the 110-to-130- 
seat "C Series" with prospective customers and has 
selected Montreal as the assembly site but has not 
made a final launch decision. 
 
SUBSIDY PROGRAMS 
---------------- 
 
8. (SBU) Taxpayer funding to Bombardier is channeled 
through the following major routes: 
 
TECHNOLOGY PARTNERSHIPS CANADA (TPC):  This is a GOC 
program of loans to finance research and development 
(see website www.tpc-ptc.ic.gc.ca ).  While the 
loans are nominally repayable, less than five 
percent of the value of all TPC loans has been 
repaid so far (data for individual firms are not 
released).  And while TPC loans are nominally 
available to industries other than aerospace, the 
bulk of funding is awarded to Bombardier and a few 
other aerospace players, including Canadian branches 
of some U.S.-based firms.  GOC officials argue that 
the time frames for loan repayment are necessarily 
long, and Industry Minister David Emerson has 
commented that expecting full repayment would not be 
realistic.  Critics of Bombardier's influence in the 
GOC say that TPC's repayment conditions are 
deliberately pitched so high that they will never be 
triggered. There is little publicly available 
information on the terms of these loans, as the GOC 
considers this commercially sensitive information. 
An ongoing lobbying scandal pushed Emerson to 
announce on September 20 that TPC will be 
restructured into the "Transformative Technologies 
Program" (TTP).  The Canadian Taxpayers Federation 
(a vocal critic of TPC and Bombardier -- see website 
www.taxpayer.com ) estimates that including its 
commitment to the C Series, the GOC's cumulative 
direct contributions to Bombardier total C$1.12 
billion (about US$900 million).  As a result of 
adverse panel findings in the dispute with Embraer 
(see below), TPC had already been crafted to 
withstand WTO challenge. 
 
EXPORT DEVELOPMENT CANADA (EDC):  This is the GOC's 
official export credit agency (counterpart to 
Eximbank).  While details of loans made on EDC's own 
account are not publicly available, EDC claims 
compliance with the OECD's "consensus arrangement" 
for official export finance.  In addition to lending 
its own funds, EDC sometimes supports Bombardier 
sales (and those of a very few other exporters) with 
funds drawn directly from the GOC treasury (the 
"Canada account"), with case-by-case approval from 
the GOC.  This mechanism has even been used to 
support Bombardier sales to Air Canada.  See website 
www.edc.ca .  At the end of 2004, EDC had C$6.8 
billion in exposure to aerospace customers (about 
one-third of EDC's total exposure) and C$7.3 billion 
in exposure to surface transportation customers, 
another major business segment for Bombardier. 
 
DIRECT RESEARCH:  Over the past year the GOC has 
constructed and staffed an Aerospace Manufacturing 
Technology Centre, located in Bombardier's hometown 
of Montreal, whose mission is to help this industry 
reduce manufacturing costs.  See website www.iar- 
ira.nrc-cnrc.gc.ca . 
SUB-FEDERAL SUPPORT:  Like the GOC, the provincial 
Government of Quebec supports Bombardier with 
"repayable" loans (including a promise of C$118 
million for the C Series), equity guarantees to 
aircraft buyers, and other measures such as 
infrastructure investment (constructing buildings, 
usually in or around Montreal's two airports, and 
leasing them to the company), worker training and 
tax holidays. 
 
THE BATTLE WITH BRAZIL 
---------------------- 
 
9. (U) Bombardier's most direct competitor is 
Brazil's Embraer, a larger firm with a wider range 
of planes offered (a 118-seat commercial jet is 
expected to be certified for service in 2006) and a 
stronger defense products business.  Unlike 
Bombardier, Embraer started as a state-owned firm, 
but during the 1990s it was privatized and, like 
Bombardier, prospered by catching the trend toward 
"regional jets."  The main subsidy mechanism for 
Embraer is an export financing program called Proex, 
which purports to compensate for Brazil's high 
interest rates. 
 
10. (U) Bombardier first enlisted the GOC to 
complain to Brazil about Proex in the mid-1990s, 
eventually impeding (some say killing) Canada's 
plans to conclude an FTA with the Mercosur trade 
bloc.  Special envoys appointed to resolve the 
dispute proposed a bilateral pact based on OECD 
subsidy rules, but (by Canadian accounts) Brazil 
refused this solution.  The countries traded WTO 
complaints in 1998, and the resulting panel found 
Proex and TPC, as well as the use of the Canada 
Account mechanism for aircraft sales, to be illegal. 
 
11. (U) Both countries adjusted their programs but 
Brazil's revised "Proex 2" was also successfully 
challenged by Canada at the WTO.  Meanwhile, 
however, Embraer continued to win sales orders for 
regional aircraft.  In 2001, faced with a situation 
where it felt that it was winning at the WTO but 
losing in the marketplace, Canada decided to match 
the Proex advantage by offering Bombardier's 
customers expanded below-market financing through 
EDC and the "Canada Account."  As a result, 
Bombardier won two critical orders from U.S. 
airlines (for a total of 225 planes). 
 
12. (SBU) While Bombardier regained its competitive 
position, trade policy watchers believed that Canada 
lost moral credibility at the WTO by resorting to 
unauthorized retaliation.  Moreover, the escalation 
in the diplomatic dispute with Brazil (which also 
involved a spat over beef trade, provoking 
widespread bitterness in Brazil) scuttled any 
prospect of Canada-Brazil collaboration on wider 
trade policy goals such as hemispheric free trade. 
 
13. (U) The dispute wound down in 2002-03 with a 
negotiated peace.  Bombardier and Embraer split 
major orders from US Airways and Air Canada.  In the 
Air Canada deal in September 2003, while the two 
suppliers divided the units evenly between them, 
Embraer obtained all the orders for larger planes - 
underscoring the need for Bombardier to bring 
forward a new design in the 100-seat-plus market. 
 
COMMENT - KEY QUESTIONS 
----------------------- 
 
14.   (SBU) In our view, two key sets of questions hang 
over the market for commercial aircraft seating 100 to 
130 passengers: 
-- How will Boeing and Airbus respond to 
encroachment from Bombardier and Embraer?  Boeing is 
discontinuing its 106-passenger 717 model, but still 
offers versions of the 737 with from 110 to 189 
seats.  The Airbus A320 "family" covers a similar 
range. 
 
-- Even if Boeing and Airbus were to effectively 
cede the smaller end of this market, how would 
Bombardier and Embraer manage the resulting duopoly? 
Will they continue to induce customers to split 
major orders between them?  And if so, might their 
sponsor governments have an incentive to reduce 
subsidy levels in this industry? 
 
15. (SBU) We see little prospect that subsidy levels 
to Bombardier in Canada will decline.  The firm and 
its suppliers are the flagship industry in Quebec 
constituencies which are intensely contested by 
federalist and separatist parties at both the 
federal and provincial levels.  Bombardier watchers 
say the firm's political connections will survive 
any foreseeable change in government and will keep 
the dollars flowing. 
 
WILKINS