Airlines Squabble Over "Open Skies" Treaties

A rift has occurred between the big three United States airlines -- United, American and Delta -- and the heavyweights from the Middle East -- Emirates, Qatar Airways and Etihad Airways.
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A rift has occurred between the big three United States airlines -- United, American and Delta -- and the heavyweights from the Middle East -- Emirates, Qatar Airways and Etihad Airways. At issue is alleged $42 billion of illegal subsidies received by these three government-owned Arabian Peninsula airlines. It is East versus West; the democratic system against autocracy; publicly traded airlines subject to rule of law competing with monarchies with no shareholders to answer to. While I am no fan of repressive regimes of any sort, a parse through some facts reveal some startling results.

This whole mess got started way back in the 1990's when our government decided to liberalize aviation rules and formalized treaties one by one with countries (now 112 of them) which allowed unfettered access to US airspace under the theory of creating a free-market environment. The US got reciprocal treatment. These arrangements are referred to as "open skies."

In an aggressively worded fifty-five page report submitted to the Justice Department, Delta, United and American claim that:

Fueled by massive government subsidies, state-owned Emirates, Qatar Airways and Etihad Airways are aiming to dominate global aviation by exploiting open skies policy. These three airlines... are using... subsidies to exploit their open and unfettered access to the US market. This threatens our US airline industry, airline jobs and the US economy.

Are these alleged government handouts evidence enough to abrogate or at least modify "open skies" provisions? The schism is great and CEO's from all involved are currently revolving through Washington lobbying hard their respective positions... at stake is billions in revenues.

What Kind of Subsidies Are at Issue
The amorphous list of relief included $12.4 billion in "interest-free loans and shareholder advances" as well as $11.2 billion in "equity infusions, grants and future committed subsidies." Next in the catalogue was $8.8 billion of "interest savings from government loan guarantees and interest free loans". Several billion is alleged illegal savings were the result of cheap labor costs from s non-union workforce. Another few billion of supposed ill-gotten advantage is from Dubai assumption of a $2.4 billion fuel hedging loss by Emirates. There are billions in below market airport charges and some of the aforementioned loans came with no repayment obligations. For a moment, let's assume this adds up to $42 billion and it is all true. The question becomes, as the sole shareholders is it an "open skies" violation for the governments of Qatar and the Emirates to make equity investments in their airline assets? Should they be free to guarantee third party loans or make their own low interest or zero interest loans? Do labor costs have to match those of the U.S. or Europe?

The U. S. Side of the Ledger
In America, corporations in general, and airlines in particular, access their own remedies to seek competitive advantage. Is not bankruptcy little more than a cudgel to realign labor costs and seek debt forgiveness? Every major airline, save Southwest, has pressed the bankruptcy lever at least once. United Airlines entered Chapter 11 bankruptcy in December 2002. The six year May 2003 labor agreement shaved $2.56 billion from labor costs. Bondholders recovered a mere 20 cents on the dollar. In 2005, a second round of labor talks further cost labor an additional $700 million annually. When American restructured in 2003 outside of bankruptcy pilots, flight attendants, mechanics et al were crammed down with $1.8 billion annual reduction in wages and benefits.

The 2005 Delta Bankruptcy reduced balance sheet debt to $7.6 billion from over $16 billion. Lowly bondholders got about a 50 percent recovery. Labor cost reductions and other savings resulted in an over $3 billion in annual total operating cost reductions. Bankruptcy also allows for the negating of leases, massive employee layoffs and airline schedules to be reshuffled. These majors sometimes form low cost subsidiaries to further contain expense. As a result of all these things domestic flight numbers have been sharply curtailed over the past ten years. In the case of United it also included rescinding over $10 billion in pension liabilities. Those obligations, with court approval, were handed over to the US Pension Benefit Guaranty Corporation (PBGC) or, as I see it, taxpayers. They got a 20 percent stake in the emerged entity, so many experts look at this as the watershed moment where the PBGC began to function not as a backstop but as an investor.

Other Giveaways
In 2001 in the aftermath of 9-11 the Senate with a 96-1 vote stuffed through a $15 billion airline bailout package... $5 billion in cash and $10 billion in government loan guarantees. Is there no irony that these loan guarantees seem remarkably similar to the very same loan guarantees United, Delta and American are whining about now? Airlines routinely are awarded tax-exempt bonds to renovate airport terminal areas. In New York alone American and Delta alone got over $2 billion of these low interest loans.

Certain US jurisdictions award jet fuel tax breaks to airlines. American is arguing for a continuation of a North Carolina subsidy set to expire this year that could cost the airline $15 million annually if not extended. Delta is involved in the same argument in Georgia. As giant area employers, both airlines carry big political clout in efforts to keep these goodies in place.

What Does It All Mean?
The circuitous route taken by US carriers in the end seems little different from what Gulf Airlines have done. All the merger partners of United, Delta and American also went through reorganizations: Continental now part of United, two bankruptcies and one bankruptcy each for US Airways now part of American and Northwest now part of Delta. I didn't include all the debt forgiveness and labor pain of those restructurings. To me bankruptcy is synonymous with subsidy. Adding the numbers above, our airlines have probably received close to $100 billion in subsidies. The big three plus Southwest now control ninety percent of domestic skies and they now reap rewards of punitive pricing powers reflective of an industry oligopoly.

Maybe this distillation to a few US airlines is preferable to the chaos of price wars and constant bankruptcies. Like it or not, airlines are a systemically critical part of our economy. Maybe the 9-11 subsidy was necessary to keep our economic activity flowing? Airlines suffer through things like Hurricane Katrina, the SARS virus and other exogenous disruptions. But if airlines are going to receive continued government largesse, perhaps the government should be compensated with an ownership position. As a taxpayer it is unfair, at every economic hiccup, to shower this industry with gratuitous taxpayer dollars.

The Bottom Line
In this dispute, the normally US biased US Travel Association on March 19 came down squarely on the side of the Gulf Carriers: "contravening these open and transparent agreements that were negotiated in good faith holds dire consequences for sustaining the US economic recovery and recent encouraging job growth." Additionally, economists from five major US universities concluded, "Gulf carriers competing in the US have caused a net increase in passengers and caused fares to decline... a net gain to society." These Gulf carriers are also buying a staggering number of Boeing aircraft. A couple of years back, Etihad Airlines placed a gigantic $52 billion order for 200 jets.

At the end of the day the US airlines whiny refrain remains constant: because they do not have absolute pricing power on international routes like they do on their domestic flights, like spoiled children they gripe and kvetch. Their complaints are hollow... and through it all not a murmur of grievance from Southwest Airlines, not coincidentally the only major American airline that did not suffer a bankruptcy.

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