News Analysis: Downturn may force BA to delay US deal

The planned link with American is threatened as air transport heads into a slowdown
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BRITISH AIRWAYS may postpone its transatlantic alliance with American Airlines to avoid Heathrow airport being opened up to a wave of competing carriers just as the world airline market is heading into a downturn.

City analysts believe there is now more danger of the alliance being put on hold than at any time since the two airlines first announced the link-up more than two years ago.

BA's chief executive, Bob Ayling, is already under pressure because of the company's abysmal share-price performance. In the past two months the value of the airline has halved as the world economic outlook has deteriorated.

Going ahead with the alliance just as the aviation market slumps could prove a self-inflicted wound from which Mr Ayling might not recover.

If BA wanted a convenient excuse for grounding its ambitious alliance, there is no shortage of opportunities. In the past week the prospects for the alliance finally gaining regulatory clearance on both sides of the Atlantic have deteriorated markedly. First, negotiations on an open skies agreement between the UK and US broke down after American negotiators walked out of the talks.

Then the US Department of Transportation scrapped plans to hold a final round of hearings on the BA-AA alliance later this month. Executives from the two carriers had been hoping to clear up the final regulatory hurdles to the link by Christmas, but this timetable is beginning to look overly optimistic.

Approval for the alliance and the signing of an open skies agreement are interdependent. The BA-AA link-up will bring together the two most powerful airlines across the Atlantic, vastly increasing their dominance. Together they would control 60 per cent of seats on direct flights and 87 per cent of prime time runway slots at Heathrow for transatlantic services. For this reason, the Clinton administration will only allow the alliance to proceed provided the market is opened to other US airlines at the same time. Under Bermuda 2, the present bilateral agreement, only four airlines are allowed to fly to the US from Heathrow.

The European Commission has ruled that the alliance may proceed only if BA and American give up 267 weekly runway slots at Heathrow and Gatwick to competitors. Analysts believe that were the aviation market not heading fast into recession, then BA and American could accept these conditions.

But with growth forecasts for the transatlantic market now being cut back sharply, BA could find itself surrendering its most valuable asset - its pre-eminent position at "fortress Heathrow" - just as traffic begins to fall. In these circumstances, the arrival of a host of US airlines would make a ruinous price war more likely.

To understand why Heathrow is so pivotal to BA's profitability, you only have to look at how much slots at the airport change hands for. The 267 slots the EC wants BA to surrender are worth perhaps pounds 500m. In total BA has 3,241 slots at Heathrow - 36 per cent of the total number available.

Historically, air traffic across the North Atlantic has grown at 8 per cent a year. The latest International Air Transport Association forecasts are that growth will slow from 7 per cent this year to 5 per cent in 2002. Other forecasts suggest it will drop to 3 per cent, and BAis understood to have drawn up a worst-case scenario in which growth falls to just 1 per cent.

Chris Tarry, aviation analyst at Dresdner Kleinwort Benson, says: "There is no point in going ahead with the alliance if it is going to hurt like hell. If traffic was still growing at 8 per cent it would be fine, but at 1 to 3 per cent it becomes questionable. BA could end up doing itself a great deal of damage by inviting more competition. It might be prudent and sensible not to go ahead with the alliance now."

BA's fall-back could be to strengthen its relationships with American and other carriers in the newly forged oneworld alliance - Cathay Pacific, Canadian Airlines and Qantas. Dresdner Kleinwort Benson estimates that the alliance with American, even as it stands, is worth pounds 20m to BA's bottom line per quarter.

Mr Ayling denies that oneworld is a "consolation prize" in the event BA-AA does not go ahead, insisting that BA remains hopeful of final clearance.

But others are not so sure. One senior US airline executive says: "It is quite possible to envisage a situation where BA and AA give up on a full-blown alliance ... and go for something much more modest based on marketing link-ups."

The Clinton administration is said to regard the successful conclusion of an open skies agreement as a top policy priority. But with the UK pressing for the right to fly domestic US routes and ownership limits on the agenda, it is not clear how easy it will be to broker a deal.

Perversely, that might just be the window of opportunity BA needs to put the alliance on hold and save as much face as possible. It would mean allowing other alliances, notably the Star Alliance led by Lufthansa and United, to steal ground. But that may be a price BA calculates is worth paying in the short run.