In this article TWC Aviation’s Carter Stewart examines some of the recent news on EU ETS (European Union Emissions Trading Scheme) and offers his perspective on some of the prominent stories of the past few weeks, and examines what may be next for the EU ETS controversy.

I feel compelled in each conversation that I have with clients, the public, or news outlets to say at the very start that I personally believe that the inclusion of Commercial Aviation into the EU ETS framework was not in the best interest of airlines, passengers, or the industry.   What is important to remember, however, is that this is now law both in the European Union and in each of its member states- including the United Kingdom.

While much noise has been made in the world media over the past few weeks about the formal introduction of aviation within the EU ETS, there appears also to be a great deal of media spin on the stories that are coming out.

Take for instance the reports that many U.S. airlines began collecting a $3.00 surcharge per passenger travelling to/from the European Union to offset the carriers EU ETS obligations.   I do not believe that this is necessarily true.   Some airlines have called this additional charge simply miscellaneous.      I believe that some carriers may well be using the revenue for the EU ETS obligations, while some others may well be using it as a form of fuel surcharge.    Spikes in Jet-A fuel prices in Q4, as well as unusually heavy west-bound Atlantic winds, have been slowly eating away at revenues.  There is also some considerable uncertainty over fuel prices and Iranian politics that are likely also influencing the various revenue teams around the world.

While it is reasonable to assume that carriers would want to offset their obligations, it is also important to point out that all carriers who had flight operations over a certain threshold have also received certain allotments of Aviation ETS credits from the E.U. nation who host the majority of their movements.    In effect, for this first year, both E.U. and foreign air carriers have been given an allotment of free credits that run into millions of Euros.   This is a fact that many trade groups, news outlets, and even foreign governments appear to leave out of their press statements. 

While the time for EU ETS political advocacy on behalf of the industry has long since passed us by, the rest of the world has seemingly only awoken up to the reality of these new laws.    While many trade groups and individual carriers had filed for hearings in the European Court of Justice, the court has made their position clear that their view is that EU ETS is not only legal, but does not violate international law.  It is at this point where I believe commercial aviation trade groups will turn their attention away from European Capital, and instead spend their valuable time and money lobbying their own legislators for a diplomatic solution.

Many other jurisdictions such the United States, China, and India take an opposite view and have begun exercising their diplomatic and legal powers in search of a remedy to this situation.

I do believe that the future of EU ETS is likely to place pressure on E.U. relations with some countries.     The United States Congress has introduced draft legislation in both the House of Representative and The Senate to propose making it illegal for a U.S. air carrier to acquire and spend E.U. ETS Credits.   India has hinted that they are to re-examine several bi-lateral agreements with E.U. nations, carefully only alluding to E.U. ETS as a primary driver.

 I personally believe that no country can afford an aviation trade war at this moment in time.     While it would appear that the European Union had not learned from British History that occasionally “taxation without representation” can create political difficulties, it does not yet appear to have successfully created a credible legal argument against the new laws that each individual member-state has passed in their own jurisdiction that make up E.U. ETS.    There is even some debate regarding which existing body is fit and proper to hear any new legal or treaty challenge. 

Having said that, U.S. Lawmakers may do well to also remember the post 9/11 TSA security fees and demands for APIS (Advanced Passenger Information) often flew in the face of other nations’ sovereignty as well.   While I am not comparing these items directly, what I would compare is the unilateral action taken by one party against another while exercising their treaty rights (i.e. operating international commercial airline flights).    

Whatever the lofty arguments for or against E.U. ETS may be, the real challenge is what individual member states will do with individual carriers who do not comply with the new emissions framework.    That is where I predict we will see the next credible legal set of arguments.

 

 

As we talked about in our previous Airline Anchluss column, Lufthansa is in an interesting position in the European market at the moment.  With the new deal of Austrian Airlines moving ahead, they are well positioned to take advantage of the market once the recession crisis is over.   In the interim, they are in an excellent position to execute on their longer term strategies.  One of those strategies is what to do with bmi, which we will explore hypothetically in this post.   First, however, lets have a look at the latest earning reports.

 

The Latest on Earnings

 

This week Lufthansa reported a net loss of €265 MM compared with a restated profit of €44 MM from a year earlier. Hit hard in the past year has been the cargo business, as well as the other ancillary aviation businesses that Lufthansa’s has a stake in.  Specifically, we feel that as their airline customers look for cost savings of their own in areas like catering and handling where Lufthansa has significant global holdings. Click here for quick view of Lufthansa’s holdings in a .pdf format. (please note that this opens in a new window, and is in German.)

 

 The real bad news was that the deficit was wider than the €180 MM loss estimates that were coming from leading industry analysts.    

 There are few people who cover this sector better than Holly Hegeman of www.planebusiness.com.  

 

To quote Ms. Hegemann, ,  “Lufthansa reiterated that it will report “clearly positive” operating profit for the year, albeit with a “considerable” decline from 1.35 billion euros in 2008.

 

First quarter revenue fell 11% to 5 billion euros. The operating loss was 44 million euros compared with operating profit of 172 million euros the year before.”

 

 The tangled web that is Lufthansa

 

In our previous blog, Airline Anchluss, we went over the details of the Lufthansa/Austrian deal, and how that single deal could impact aviation in Western Europe.   In today’s instalment we want to take a broader look at Lufthansa ownership of British Midland, or bmi, and what implications that may have for the commercial aviation market in the EU.

 The fate of Heathrow’s Second Largest Airline is basically in Lufthansa’s hands

 

Sir Michael Bishop, the long-time Chief Executive of bmi agreed last year to sell a majority share of the carrier to Lufthansa.

 

Currently the bulk of the remaining shares are with Scandinavian Airlines (The SAS Group), which  is undertaking a painful reorganisation, focusing on freeing cash from assets such as its interests in Spanair, and its 20% stake in bmi.

 

Earlier this year Sir Richard Branson has “confirmed” his interest aquiring bmi, as it would allow him to create the short haul networks in Europe that have strategic value.  Since that first comfirmation, however, neither Virgin or Lufthansa have made any public comment.

 

So what is going on with bmi today?

 

bmi has had some changes in key management positions, this year, including a new the head of Marketing Katherine Gershon and new VP of Operations Martyn Bridger, both formerly of the British all-business class carrier Silverjet.    While Gershon has managed to begin to change the way people may thing about the carrier through a revised website and new ad campaign, we don’t see the revenue numbers reflecting a return on the new marketing budget. bmi has made some shrewd operational changes including new markets in the Middle East, Israel, and Russia while also cutting some domestic routes. 

 

bmi is also remained a member of STAR Alliance and coordinates with its other airline partners in the alliance.

 

So the stage is set, and you can begin to see why Lufthansa’s position is an enviable one.  Through long term strategic investment they have managed to now successfully gain majority control of London Heathrow’s second largest airline.   When you take a look at the strength and breadth of the airline holdings that Lufthansa has built you can be forgiven for thinking that Lufthansa has spun one of the strongest webs in modern airline history.

 

The Lufthansa “Fantasy Playbook” for bmi

 

With the Austrian Airlines deal seeming settled, it become interesting to thing about the commercial opportunities that bmi offers Lufthansa, particularly if it were to pick up the SAS share.

 

So we took out our numbers and began to look into our airline crystal ball (which as you all know comes without warranty for all but a glimpse of 1 hour into the future of aviation.)  None-the-less we stated to play Fantasy LH Boardroom.

With that we have come up with four potential scenarios:

One: If it is not broke then don’t fix it.  In our view, however, bmi is not poised to do anything unique in the market that Lufthansa could not do better, and more cost-efficiently, themselves.

 

Two: Keep bmi as they do Swiss, Germanwings, Lufthansa Italia and Austrian- as separate entities under their wing but with a shuffle of the boardroom chairs.

 

Three: Acquire the whole of bmi and promptly sell it off to a willing buyer with cash.  Logically this would be either BA or The Virgin Group, both of which are a little cash strapped at the moment.  We don’t see this happening, as the value to Lufthansa would be too great to simply sell, unless it began to desperately need the cash.  Well in the frame for interest in bmiBaby and bmiregional could be another regional player in the UK: Flybe.  This is a rumour that they strongly deny as ”pure industry rumour.” 

 

Four /Step One: Do nothing at the moment, but leverage bmi Heathrow real estate for an assault on lucrative London trans-Atlantic traffic when the numbers, especially business class numbers, begin to improve.

 

Four/ Step Two: Having taken the cream Heathrow slots for Lufthansa metal to begin taking London transatlantic market share, they could then move the focus of short haul operations to Dublin’s new terminal two building and take on Aer Lingus (if they are still around) and Ryanair.  In essence give Irish consumers a true choice from Ireland that has some service that might wine and dine passengers rather than nickel-and-diming them.   Obviously some rebranding may be required, as bmi may not sell as well as say Lufthansa Eire.

 

Would they be cannibalising their own traffic?

 

The short answer is that we do not think that they would be losing much of their trans-Atlantic loyalty from their German operations by doing setting up direct London-US routes.   Taking into account the new Swiss product offering, our estimates were less than 4% of Lufthansa and Swiss London traffic connecting across the Atlantic.  

We credit most of the up to their PrivatAir agreements, strong demand out of London City,  and a few hard to reach non-stop jewels like Portland (PDX) and Seattle which are smart bets for a busy business traveller.

 

If they were to try focus on Ireland, we believe that they could gain a significant competitive advantage by feeding Westbound Asian traffic through Frankfurt, Zurich, and Munich, while at the same time serving the Ireland-UK market at a decent profit.

 

So what are your thoughts on the subject?

 

We would love to hear your thoughts on the subject, and what you think may or may not happen in the scenarios discussed in this article.   Do you have any alternate theories?  So you think our numbers are out of the park?   Or do you think we might be on to something?    We look forward to your comments!

Disclosure: The author does not maintain any positions or contracts with the airlines and companies mentioned in this blog.

 

Blogroll:

 

Plane Business Banter at www.planebusiness.com