Regional aid and airlines: the real issues September 2003

Michael O'Leary, the Ryanair CEO, various French municipalities and British second–home owners are among those outraged by the implications of the Strasbourg Court decision declaring the airport’s payments to the low–cost carrier an illegal subsidy.

What are the real issues uncovered by this?

Acting on a complaint by Air France subsidiary Brit Air, the Strasbourg Administrative Court on July 24 cancelled two contracts, which bound the Chamber of Commerce and Industry of Strasbourg and Lower Rhine to Ryanair. Brit Air had filed its complaint in December 2002, the Chamber of Commerce is the airport operator.

Having failing to obtain a stay on the judgement, Ryanair stopped operating London–Strasbourg on August 24, terminating a service that was generating about 240,000 passengers a year, compared to about 30,000 a year with Brit Air, and immediately started up services to Baden Baden, 40km across the border in Germany. Ryanair has appealed the Strasbourg decision, says it is confident that it will be reversed, at which point it will resume its Strasbourg services.

Ryanair is clearly determined to play hard, lambasting Air France’s projectionist actions and threatening to withdraw services from any French airport where its agreements are challenged and to pull out of its Charleroi hub in Belgium where it is facing an EC investigation into possible illegal subsidies provided by the regional government of Wallonia, with a decision due in November.

In fact, the Strasbourg Court decision came as a surprise to local observers since the commissioner representing the French government on the Administrative Court had on June 28 recommended that the case against the Chamber be dropped. These courts often follow the advice given to them by the government commissioner.

The government commissioner had argued that the funds made available to Ryanair by the Chamber of Commerce were to promote the Strasbourg region, mostly on the Ryanair website. However, the Court ruled that these funds were not used for that purpose but were used mainly for the benefit of Ryanair and that this constituted financial aid to the airline.

In a somewhat complex arrangement, the Chamber of Commerce had committed to pay Ryanair a one–time sum of €150,000 for the launch of each new daily service from Strasbourg and €216,000 or €224,000 per year for each daily service operating from Strasbourg. In addition, the Chamber also had guaranteed the payment to Ryanair, by a combination of the Strasbourg Urban Community, the Alsace Region and the Department of Lower Rhine, of an annual sum of €492,000 for each daily service operated from Strasbourg. Based on two daily services between Strasbourg and London Stansted, the Chamber’s commitment to the airline amounted to €1.4m a year.

In its decision, the Court made a reference to EC Market Access Regulation 2408/92 (in effect the European air transport liberalisation legislation). The Court also quoted Articles 87 and 88 of the Treaty of Rome, relating to competition issues, which inter alia require that the European Commission is notified of subsidies before their execution. It was then up to the EC to approve the contracts or otherwise, said the Court, noting that the Chamber had failed to notify the EC.

The EC finds itself it a very awkward situation here (the EC being in this case represented not just by the Transport and Competition Directorates but also by the Regional Policy, Enterprise and Environment Directorates).

EC policy

The EC in general, has a pro–consumer role and is supportive of low–cost carriers providing affordable travel at high load factors which are seen to represent an efficient travel mode. It is against subsidies that distort markets, but cannot be seen to be attacking commercial, private airlines like Ryanair when it in the past has authorised €20bn–plus of state aid to ailing flag–carriers.

It has a fundamental role in promoting regional development, even more critical now that most of the EU has adopted the single currency, so restricting national governments' ability to influence economic activity through monetary policy.

Ryanair in some cases has acted as an catalyst for effective regional development.

The regional airports, forlorn and totally underutilised pre–Ryanair, and the local French and Italian authorities, certainly recognise Ryanair’s role in boosting tourism. For example, the town of Pau in the French Pyrenees raised local funds to persuade Ryanair to continue Buzz’s service there following the take–over of the former KLM subsidiary.

(The competing airport of Tarbes which has lost traffic to Pau takes a very different view of Ryanair.)

Another example: City of Derry airport located in the north west of Northern Ireland now has twice–daily 737 connections to London, a service that was inconceivable before Ryanair struck a deal with the airport’s local authority owners. As well as promoting tourism to Donegal and the Causeway Coast, the air link is credited with facilitating new business activity in the region, making the millions of euros of regional aid that the EU and the UK aid have pumped in work more effectively.

(The counter–argument, which sounds parsimonious, is that the local authority is financing Ryanair to export local consumer spending from Londonderry to London.)

Ryanair argues that the Strasbourg decision undermines the ability of publicly owned airports to act like, and compete with, privately owned airports. The so–called subsidy, it implies, is just the public sector equivalent of the incentives that private airports offer to new entrant airlines — in terms of deep discounts from rack rates, advertising support, yield–related charges, etc.

Also, Ryanair can point out that it guarantees exceptional levels of traffic to the regional airport as its side of the transaction. The question of openness arises here.

The use of taxpayers' money in whatever form surely has to be revealed and made public knowledge, and is in some circumstances notifiable to the EC, as pointed out by the Strasbourg Court. Yet Ryanair makes non–disclosure a key clause of its airport agreements — Michael O'Leary compares the confidentiality of his airline’s relationship with an airport to that of the confessional box. In reality, however, it is difficult to keep a major public agreement secret — see, for instance,Aviation Strategy, July/August 2001 on Ryanair and Charleroi. So how important are the airport "subsidies" to Ryanair’s business model?

In a recent teleconference with analysts Michael O'Leary seemed to imply that the Strasbourg airport income was not critical for Ryanair’s profitable operation of the route but it was essential if Ryanair were to meet its operating profit margin target of over 20%.

The Ryanair model is driven by an integrated series of strategies, all designed to complement each other and leading to the all–important goal of minimising and continuously reducing unit costs. For instance, Ryanair’s airport policy not only brings it low or non–existent airport charges but also reduced spending on advertising (which is carried by the airport or tourism bureau).

The high volumes of traffic Ryanair guarantees ties in with its main promotional tool — the offer of ultra–low or free fares — as well as enhancing its negotiating power with other potential airports. Quick turn–arounds at the uncongested airports are a vial part of its strategy of high aircraft and crew utilisation. Take away the regional airport element of the Ryanair strategy, and the whole model would probably revert to producing industry–standard profit margins.

PSO subsidies

The challenge for the EC is not to rule on legal technicalities but to assess where airport or route subsidies or quasi–subsidies fit into the deregulated intra–European aviation market.

It also has to recognise that aviation like all other industries benefits from aid intended to foster regional development.

In this regard, the EC might consider the Ryanair situation in the wider context of European route subsidies. Under Article 2408/92, as referred to by the Strasbourg Court, certain subsidies are perfectly legal in the European Economic Area (EEA, i.e. the EU plus Iceland, Norway and Switzerland) if they are designated as a Public Service Obligation (PSO).

The idea behind PSOs was to provide subsidies for services to peripheral points which could not be served on a commercial basis. PSOs have always been applied on domestic routes (with the nominal exception of Dublin–Derry) but could also be used for cross–border services.

Certain technical rules apply — the subsidised route has to be put up for tender at least once every three years, notified to the EC and the call for tender advertised in the Official Journal. The winner is the airline that offers the required service level (capacity, frequency aircraft type, etc.) at the lowest subsidy level.

That is the theory. In practice PSOs are operated on different criteria according to differing regional and socio–economic policies in the member states. The public interest criteria that regional or national authorities use when imposing a PSO are very vague.

Consequently, there is a wide variation in the usage of PSOs within the EEA .

There is also a wide variation in the transparency of the PSO administration. At the one extreme, Norway, which operates 13 mini–networks to tiny, isolated communities, is fully open about traffic, services and subsidy amounts. At the other, Greece has over 20 PSO routes mainly to the Aegean islands operated by Olympic Aviation, a subsidiary of Olympic Airways, but detail on this operation is lost in the intrigues of internal Greek politics and Olympic’s convoluted finances.

It is sometimes difficult to see a fundamental distinction between a Ryanair–type agreement and a PSO type. Indeed, at least one German airport with a Ryanair agreement has advertised its "call for tender" in a section of the OJ rarely visited by airlines, specifying the traffic volumes it had already presumably agreed with Ryanair, a total that no other airline could hope to match.

France itself is the European leader when it comes to route subsidies: PSOs are applied to 46 domestic routes, about 11% of domestic capacity (compared to just 0.7% in Germany), most linking regional points to Paris.

The most important subsidised routes (the amount of the subsidy is not openly available) are to/from Corsica. Notably, Air France operates a 5–6 daily A320 services on the Ajaccio–Paris PSO route that carries nearly 400,000 passengers a year. And there are another five routes with passenger volumes of over 100,000 passengers a year. The subsidy is administered by the Corsican authorities, and part–financed by a ticket tax on all departing passengers from French airports. The imposition of PSOs on Paris routes means that slots have to be preserved for these services at Orly.

So about 30% of slots at Paris Orly are ring–fenced for PSO and other domestic services, which creates part of the impediment to easyJet building a hub there. (However, there would be no legal reason why easyJet should not apply for a French PSO.)

Italy operates a similar regime: PSO routes link Sardinia with Rome and Milan. The main PSO route is Cagliari–Rome, operated with 12 daily MD80 or A321 frequencies by Alitalia. Traffic on the route is in excess of 800,000 passengers a year.

The other Sardinian routes are split between Alitalia, Volare and Meridiana. Alitalia is in the process of buying out Meridiana and has signed an extensive code–share with Volare, actions that have attracted the attention of the Italian and EC competition authorities.

Some of the Sardinian routes were until a couple of years ago operated on a commercial basis but became PSOs when the Italian government imposed new conditions on the operation of the services, including minimum size of aircraft, timetable requirements, maximum fares and special fares for Sardinians.

In the UK PSOs have been limited to services linking remote communities in the Highlands and Islands of Scotland to Glasgow. However, this year Scottish Enterprise and Invest Northern Ireland, the regional development agencies, have received central government funding (about €12m in total) with the general aim of improving air access. These funds could be used for new PSO services or airport investment.

The Northern Irish situation illustrates a variation of the regional aid theme. Northern Ireland is very well connected to London with multiple daily frequencies from two Belfast airports to four London airports.

However, a perceived problem has arisen because of the change in the operators on the route. easyJet (incorporating Go) has displaced BA and bmi on Belfast–London, with BA withdrawing completely and bmi downsizing and switching from Belfast International to Belfast City airport.

Whereas BA and bmi used to offer multiple frequencies into Heathrow, easyJet operates to Luton, Stansted and Gatwick with the result that the opportunity for connecting at Heathrow onto continental European points has been greatly reduced for Belfast originating or destined passengers. One proposal now is for a subsidy for direct services from Belfast to continental European points.

In brief, regional subsidies or support of whatever form, and whether designed as PSOs or not, comprise an integral part of the European aviation market. The Strasbourg ruling against Ryanair is only one part of the larger, complicated picture facing the EC. Ryanair could help the EC resolve its problem simply by being a little bit less aggressive.