AN airline backed by the royal family of Abu Dhabi, the Gulf state that recently bought Manchester City football club, has held initial discussions about a merger with BMI British Midland in a deal that could value the airline at up to £600m.

Senior sources in the Gulf say Etihad, the national carrier of the United Arab Emirates, has approached both BMI and Lufthansa, the German airline that holds a stake in BMI.

Lufthansa has an option to take complete control of BMI later this year or early next. However, it is understood it wants to sell its stake for around £200m and that talks with Etihad were held in the summer.

With many airlines reeling from high oil prices and the credit crunch, Etihad executives believe now is the best time to snap up bargains in the industry.

Etihad's emergence as a potential player will increase the swirl of speculation about the future of BMI, which holds a vital position at Heathrow. Acquiring a major stake in BMI, which owns 11% of the take-off and landing slots, would give Etihad the second strongest position at BA’s home airport and potentially spark a new round of takeovers.

BMI's future remains in the hands of Sir Michael Bishop, the group's chairman, who controls a majority stake. Under a shareholders’ agreement struck in the 1990s, Lufthansa has an option to buy out Bishop at an agreed price. While commentators have speculated that Lufthansa will be able to exercise the option from the end of the year, the full terms of the agreement have never been made public.

Etihad chief executive James Hogan is familiar with BMI’s operations. Between 1999 and 2002 he was the airline's chief operating officer and a member of the BMI board alongside Bishop.

BMI’s position at Heathrow is its greatest asset. However, some analysts believe Lufthansa may be considering its position given the current crisis in the airline industry. Taking control of BMI would leave it with a large operation at the London hub.

Etihad is keen to expand its operations and could either take part of the BMI slot holding or buy Lufthansa’s option with a view to developing at Heathrow.

Times Recommends

• Gazprom brands Ukraine 'a barbarian' in gas row
• Services sector raises fears over UK jobless
• Retailers surge as profits survive sales plunge