The European Commission's ruling on Ryanair's agreement with Charleroi airport has set clearer guidelines for airport-airline relationships - however much it has annoyed Ryanair
Ryanair chief executive Michael O'Leary must have hoped for a better start to the new year. A European Commission (EC) ruling against some of the subsidies Ryanair receives at its Charleroi base in Belgium, a first-ever profits warning and plunging load factors have seen the Irish low-cost carrier on the defensive.
O'Leary has never been afraid to take on what he sees as the establishment, but the combination of cut-throat competition in the low-cost sector and Brussels taking a firm, but in the view of many in the industry, fair stance on the issue of state subsidies, has put Ryanair and its chief executive under pressure.
The Charleroi episode has thrown into the open the sometimes murky world of financial packages designed to attract airlines to airports. The EC had quickly received a complaint from rival low-cost carrier Virgin Express, which is based at the city's main Brussels Zaventum airport. That came in 2001, shortly after Ryanair selected Charleroi as its first continental base in the spring of that year. It was not long before rumours started circulating within the industry about the terms of the deal, suggesting that Charleroi and its owner the regional government of Wallonia had agreed a loss-making arrangement. Wallonia is the poorer, French-speaking half of Belgium, with a long tradition of socialist government.
Brussels insiders admit that they were a bit slow to see this problem coming. Traditionally, the EC has regarded airports in a similar vein to motorways - pieces of infrastructure serving different markets rather than competing against each other. The rapid growth of the low-cost sector, and the accompanying plethora of secondary airports, often but not always offering themselves as alternatives to established mainline airports, has changed all this. As soon as the Charleroi case landed on her desk, EC transport commissioner Loyola de Palacio realised that the rules on airport incentives needed to be updated.
Against this background, the EC has taken the opportunity to establish a much clearer framework for airline-airport relationships. The yardstick used by the Commission in its deliberations is the private market investor principle. In other words, public bodies have to prove that if a private investor were making the investment, they could expect to make a reasonable return and achieve long-term profitability. Ironically, this principle has been used by Brussels to crack down on state aid to struggling flag carriers - with Ryanair cheering them on from the sidelines.
Regional benefits
Charleroi and the Walloon region argued that when the wider economic benefits to the region are taken into consideration, the deal complies with this principle. The airport handled 2.5 million Ryanair passengers last year.
Brussels largely rejected this argument. "Since the private market investor principle had not been adhered to in this case, the advantages granted to Ryanair constitute state aid," the EC says. There are three criteria for applying the state aid rules under Article 87 (1) of the Treaty of Rome. It must be shown the aid comes from national or local government; distorts competition; and affects trade between member states. To qualify as state aid, the subsidies have to meet all three criteria. Specifically, the EC believes that Ryanair benefited from preferential rates for landing charges of €1 ($1.3), around 50% of the standard rate. In addition, Brussels believes that the airport authorities have provided:
A contribution towards promotional activities of €4 per boarding passenger over 15 years and for up to 26 flights a day; initial incentives of €160,000 per new route opened for 12 routes - €1.9 million in total. €750,000 in reimbursements for pilot training and €250,000 for hotel accommodation; and a preferential rate of €1 per passenger for ground handling, compared with the normal rate for other airlines of €8-13.In each case, the EC is quick to point out that no other airline benefited from similar deals, and says that no private operator would have granted Ryanair the same advantages.
"The investigation showed that when the contract was signed with Ryanair, Charleroi was exposed to the risk of losses exceeding the company's aggregate current result over a 10-year period," states the ruling. The EC estimates the state aid granted to Ryanair to be around €35 million, and predicts that this would have wiped out any chance of getting a fair return during that period.
In addition, the EC says that the business plan of Charleroi airport factored in €27 million from hypothetical carriers that were unlikely to set up regular services. Furthermore, Brussels says the airport failed to account for its contribution to the marketing costs of all 26 potential flights agreed with Ryanair - which amounted to €6 million. "These two factors were sufficient to reduce almost to zero the result expected for the period in question," it says.
The deal also allowed for a subsidy to cover maintenance costs and fire, which amounted to €14 million over 10 years, and that Ryanair also benefited from the process by which 35% of aviation charges were transferred into an environmental fund. The EC is careful to point out that, as this money is not being invested directly in airport infrastructure, it should not be classed as regional development aid. Rather, it classes the support as "operational aid", or basically a form of state aid.
It would be well wide of the mark to suggest that the EC's ruling is wholly negative from a Ryanair point of view, however. Brussels has decided that some of the aid should be authorised under Article 87 (3) of the EC Treaty, which allows regional/economic aid that does not affect "the common interest". This includes Charleroi's financial contribution to joint promotion and publicity company with Ryanair, which Brussels considers to be start-up support.
While it gives the nod to this type of support, Brussels sets down some guidelines that have to be met. The support must be, "necessary for the opening of new routes"; serve as an incentive; be proportional to the stated objective; and should be transparent and open to all carriers. A key criticism of the Ryanair-Charleroi deal, from other airlines and airports as well as Brussels, has been that it was shrouded in secrecy.
Lack of transparency
Ryanair and Charleroi have steadfastly maintained that the deal was on offer to other carriers, but the commercial secrecy of the deal makes this hard to prove. "The lack of transparency was a big mistake," says one aviation lawyer. The EC says: "In future the Walloon region will still be able to introduce a new standard rate which acts as an incentive, but it must be applied transparently to all airlines." One-shot incentives are also fine, the Commission says, but should not be on a flat rate. Rather they should be tied to certain objectives.
Brussels points out that reduced airport charges are possible, but they must be non-discriminatory and for a limited period. As a benchmark, it uses the example of Manchester Airport's pioneering deal with American Airlines back in 1993, that saw the US carrier start flying to the UK airport earlier than it originally intended. The EC also calls for airport support deals to include a mechanism for imposing penalties if carriers fail to keep their commitments, and warns that the support should not be lumped together with social aid.
The other key point tackled by the Commission is timing. Rather than the 15-year timeframe of the Charleroi deal, Brussels wants to see a five-year limit for point-to-point intra-European services, and says that financial support should not be more than 50% of start-up costs, and should be available to all future carriers as well, with the exception of carriers flying previously operated routes. Ryanair was ordered to repay start-up aid on the Charleroi-Dublin route as this service actually started in 1997.
Ryanair ran a high-profile media campaign in the run-up to the verdict, making few friends in the process. The likes of ACI Europe, representing airports, the Association of European Airlines (AEA) covering mainline carriers, and even arch-rival easyJet, have all broadly supported the EC. Ryanair is appealing against the decision, but is looking isolated and many lawyers see this as a stalling strategy.
Brussels has made its annoyance with Ryanair plain, and ran its own counter-campaign in the run-up to the verdict at the beginning of February, making it clear that the penalties were going to be less severe than Ryanair was claiming. Brussels estimates that the carrier will have to pay back up to €4 million covering the 2001-3 period and will keep 75% of subsidies. Around 20% of Ryanair's services are to state-owned airports, which will be affected by the ruling. Chris Avery, financial analyst at JP Morgan, predicts that the ruling will knock Ryanair's operating margins from 25% to 22% - still way above the average for mainline carriers.
Indeed, with January load factors of 71%, compared with 76% for a year earlier, Ryanair's more immediate challenge may come elsewhere. The carrier issued its first-ever profits warning at the end of March, estimating that yields in the March quarter will be down by 25-30%. It is also trying to rein in its massive expansion plans, aiming to defer the delivery of five Boeing 737-800s by a year, taking 25 instead of 30 of the type in the 2005 financial year.
Ryanair, which also recently lost a UK court ruling on wheelchair access for disabled passengers, is under fire from a number of quarters. The carrier is a founder member of the fledgling Low Fare Airlines Association (LFAA), and although its aggressive strategy has served it well in the past, it may need to be a little more co-operative in the future or risk fighting too many battles at once.
REPORT BY COLIN BAKER IN LONDON
Source: Airline Business
