BA profits at risk if Brussels sacrifices Heathrow for open skies deal

More than one-third of British Airways' operating profits could be wiped out if Europe and the United States agree a deal in coming months to liberalise the transatlantic air market and open up Heathrow to all comers, according to new estimates circulating in the City.

Chris Avery, the respected aviation analyst with JP Morgan, says in a research note published yesterday that an "open skies" agreement between the two would "hurt BA's profits materially" in the first couple of years as new carriers entered Heathrow and slashed fares to the US. The note does not put a precise figure on the financial impact but investors calculate that BA's operating profits, which reached £540m last year, could fall by £200m. That would translate into a £200 reduction in the fare paid by every BA business-class passenger between Heathrow and the US.

The calculations come as the open-skies talks reach another key staging post today when the deadline passes for responses to the latest plan put forward by the US administration for clinching a deal.

After a decade of fruitless negotiations - first on a bilateral level between the US and the UK and then on a multilateral basis between the US and Europe - there is, at last, a palpable sense that an open-skies accord is near. Indeed, it could conceivably be ushered in as early as this November.

Under the present bilateral agreement, only four British and US carriers are allowed to fly across the Atlantic from Heathrow - BA, Virgin Atlantic, American Airlines and United Airlines. In the past, the refusal of the UK to open its jewel in the crown to other carriers and rank protectionism on the US side have frustrated attempts to reach a deal. But in the past couple of years things have changed.

First, there is general acceptance that if the global airline industry is to be liberalised, then it has to start with a deal which sweeps away the antiquated rules governing transatlantic flights and creates a common aviation area allowing US and European airlines to own one another and fly where they like.

Second, Brussels and not London is in the driving seat as far as the negotiations are concerned on this side of the Atlantic, and may be prepared to sacrifice Heathrow for the wider benefits that a deal could mean for the European Union as a whole.

And third, the US airline industry is badly in need of the injection of foreign investment that an open-skies deal could bring. In the past five years, it has lost $30bn and shed 100,000 jobs and seen four of its flag-carriers forced into Chapter 11 bankruptcy protection.

The deal the Americans put on the table in November would not remove the restrictions on foreign ownership of US airlines, which limit non-US citizens to 25 per cent of the voting rights and 49 per cent of the equity (the same limit which applies to EU airlines).

But it would change the definition of what constitutes "control", so that a foreign airline could determine all aspects of how a US airline operated, save in respect to safety, security and national defence. The US says that means a foreign investor could dictate commercial strategy, fares, routes, aircraft procurement and branding but if, for instance, the fleet needed to be used for military purposes in time of war, then the decision would rest with the US partner.

BA's director of government affairs, Andrew Cahn, describes the offer as a "clever wheeze" designed to allow American carriers to bust open Heathrow without giving anything of real substance in return. "The US proposals leave an awful lot of uncertainty for investors. This is not a legislative change but an administrative action which changes the definition of what constitutes control. If it can be changed so easily in one direction, then what is to stop it being changed back again?"

Mr Cahn, who is due to submit BA's formal submission to Washington today, says the only real way to give foreign investors certainty of control is to permit majority ownership. "We want a single aviation market covering the US and Europe but the best way of getting to that nirvana is to allow 51 per cent ownership. Allowing a foreign investor to own 25 per cent of the voting rights and then asking them to rely on administrative guidance from the US Department of Transportation is not a good basis for liberalisation."

Not surprisingly, bmi, which has been trying in vain to break into the transatlantic market from Heathrow for the past six years, disagrees. It is the second-biggest holder of runway slots at Heathrow but cannot use them to fly to the US because of the restrictive bilateral deal in force. Tim Bye, bmi's deputy chief executive who heads its open-skies delegation, says: "BA is using this argument to put a spanner in the works and defend its own position. It amounts to an excuse for doing nothing. Nobody expects that we will go to full liberalisation in one bound - the EU went through three stages to become an open aviation area - but it is a good first step."

He also argues it would make little practical difference whether the US offer was enshrined in legislation or administrative guidance because either way it would destroy Washington's credibility in future negotiations if it reneged on the deal.

It is one thing to strike a deal to open up Heathrow. But it will be quite another to implement it because the airport is already full to bursting. In theory, KLM, for instance, could scrap its twice daily service from Eindhoven using 50-seater Fokker aircraft and hand the slots to its US alliance partner Northwest Airlines, which could use them to fly 300-seater Airbuses into Heathrow from Detroit.

But Heathrow's capacity to handle that sort of increase in passengers will be restricted until Terminal 5 opens in 2008. A lot will also depend on whether the "Heathrow East" plan to redevelop the central terminal area goes ahead.

In theory, open skies could become a reality from the next winter season if the new DoT control rules are published in March and the EU's council of ministers approves them in June. But BA's Mr Cahn says there is still a lot to play for and it is imperative that the EU negotiators use the bargaining chip of access to Heathrow as effectively as their UK counterparts have done over the years. So far, the Secretary of State for Transport Alistair Darling has stood squarely behind BA, arguing that any deal must be balanced and provide proper access to the US for EU carriers.

When a deal with the Americans was rejected last year, the UK had the support of Germany, but there are rumours in Brussels now that it is in a minority of one. Mr Cahn says: "It is too early to say that. There is a new government in Germany and no one knows where it is going to position itself."

But JP Morgan's Mr Avery says: "I have heard it said the UK is isolated. The momentum has built to such an extent that both sides want a deal. In that case the UK's interests might well be sacrificed for the greater cause of reaching an agreement."