A Flight Plan Through Open Skies

The new U.S.-EU air transport pact is likely to lift passengers and some carriers. BusinessWeek.com maps out who it helpsand who hits turbulence

The air transport agreement will remove many rules on Europe and the U.S. will be lifted. But does it favor U.S. airlines?

On Mar. 22, European Union transport ministers approved a deal to liberalize air travel between the European Union and the U.S. The so-called Open Skies air transport agreement will remove restrictive rules on flights across the Atlantic and end three decades of fierce political wrangling between Europe and the U.S.

Despite the apparent progress, the issue is still highly contentious and complicated. Proponents of the deal say it will increase competition in a market currently worth $18 billion, drive down fares, create new jobs, and boost economic growth. But there remain critics on both sides of the Atlantic. Europeans charge that the treaty is biased in favor of the U.S., and both Europeans and Americans complain about the lack of clarity on legal restrictions to foreign ownership of U.S.-based airlines.

With so much confusion surrounding what is expected to become the most important aviation treaty in history, BusinessWeek.com attempts to explain the issues surrounding the debate:

What does Open Skies do?

Pretty much what it promises: It opens up the skies over the Atlantic to competition. The pact will replace existing bilateral treaties between individual European governments and Washington beginning in October. Under these previous treaties, European airlines have only been able to offer services between their home country and the U.S., a market that, in total, is currently worth $18 billion. Now under Open Skies European carriers can operate flights from any EU country to the U.S., although they will not be able to fly point to point within the U.S. In contrast, U.S. carriers will be able to fly between any cities within the EU.

The agreement also opens up Heathrow airport, which accounts for 40% of all transatlantic traffic, to a greater number of airlines. Under the Bermuda II Treaty between the U.S. and Britain, only four carriers are allowed to operate direct flights between Heathrow and the U.S.: British Airways (BAB), Virgin Atlantic, AMR's American Airlines (AMR), and UAL's United Airlines (UAUA). Now, with passage of the treaty, any U.S. or European airline able to pony up the cash for a slot at Heathrow can launch services between Heathrow and the U.S.

What is the impact of Open Skies?

According to the EU, the new treaty will boost transatlantic passenger numbers by 26 million, create 80,000 jobs, and provide $16 billion of economic benefits within five years. For consumers, increased competition will translate into more choices and lower fares, especially for business class. With strong demand for business and premium class travel between the world's two biggest financial centers, London and New York, and limited competition, fares have only gone in one direction—up. You only have to compare current peak business class ticket prices between London and New York (estimated cost: $8,000) with flights between London and Bangkok (estimated cost $7,600)—despite being twice the distance, the fare between London and Asia is cheaper, thanks to greater competition.

Some analysts say it might even lead to the launch of transatlantic services from no-frills airlines, although both Ryanair (RYAAY) and Southwest Airline (LUV), the biggest discounter in the U.S., have previously denied any interest in flying overseas.

Which airlines will benefit from Open Skies the most?

Pretty much every airline except BA and Virgin will benefit. Britain's BMI, which flies between Britain and Europe and owns several slots at Heathrow, is one of the biggest winners. Now it will be able to launch services to more lucrative long-haul routes in the U.S.

Other European carriers such as Air France-KLM and Lufthansa, which own highly desirable slots at Heathrow, are also winners.

Although the deal does favor U.S. airlines more than European ones, it is unlikely that they will rapidly ramp up services in Europe. That's because the vast majority are in tough financial straits. Moreover, even those looking to expand by offering increased service within Europe will find the competition from profitable powerhouses such as Ryanair fierce. Another obstacle: getting a slot at the already super-congested Heathrow. A planned fifth terminal is not expected to be completed until 2008.

Who are the biggest losers?

British Airways and Virgin Atlantic. The deal would cause BA to lose the protected position it has held at Heathrow for more than 30 years, and leave its most profitable area of business vulnerable to intense competition. Routes to the U.S. traditionally account for more than 70% of BA's profits.

Will Open Skies bring about consolidation in the aviation industry?

Some analysts expect the liberalization of transatlantic air travel could unleash a wave of mergers and acquisitions. The expectation is that stronger carriers such as British Airways, Deutsche Lufthansa (DLAKY), and Air France-KLM (AKH) may start buying weaker rivals. Already some European carriers have made known their eagerness to join the treaty. In a Mar. 21 statement to the Spanish stock market, Iberia predicted the deal will result in a "major consolidation process in which Iberia could have an important role." Also favoring consolidation is the treaty's provision allowing EU carriers to buy non-EU airlines while maintaining those airlines' landing rights in the U.S.

Why is the British government unhappy?

The government says an Open Skies deal is biased in favor of the U.S. It notes that the deal allows U.S. airlines to fly between points in Europe but prevents European carriers from flying domestically within the U.S. Another gripe: European carriers will still be limited to voting stakes in U.S. airlines of 25%; by contrast, U.S. airlines can buy 49% of European rivals.

Under intense pressure from the country's two transatlantic carriers, British Airways and Virgin Atlantic, the government has said that access to Heathrow should not be conceded until the U.S. has agreed to open up its domestic market. Britain wants guarantees that Washington will negotiate a follow-up deal to give European airlines more freedom in the U.S. But BA and Virgin believe such expectations are unrealistic because Britain cannot opt out of opening up Heathrow, which means the government will have lost its best bargaining chip with the U.S.

So why did Britain vote for the deal?

Some say the government realizes that opposing the deal would have been politically embarrassing because Britain has been one of the main proponents of free trade and increased competition within the EU. Moreover, the country benefited enormously from the liberalization of air travel between Britain and the rest of Europe more than a decade ago. The removal of previous restrictions has helped the British Isles create two of Europe's most successful low-cost carriers, Dublin-based Ryanair and London-based EasyJet.

Still, British Transport Secretary Douglas Alexander is demanding assurances from the European Commission that the issue of foreign investment in U.S. airlines could be renegotiated in a second stage of the deal in 2010, by which time a new U.S. President will be office. So far, the Bush administration has refused to give in to this key British demand.

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