House of Commons - Environment, Transport and Regional Affairs

Select Committee on Environment, Transport and Regional Affairs Eighteenth Report

AIR SERVICE AGREEMENTS BETWEEN THE UNITED KINGDOM AND THE UNITED STATES

Bermuda II

6. International air services are governed by rules established at the international aviation conference attended by fifty-two nations in Chicago in 1944. The principal achievements of the conference were the creation of the forerunner of the International Civil Aviation Organisation (ICAO), and the declaration that "no scheduled international air service may be operated over or into the territory of a contracting state, except with the special permission or other authorisation of that state, and in accordance with such permission or authorisation", which has ever since put aviation negotiations in the hands of national governments.[21] The conference defined the first five 'freedoms' of the air. They are the rights of an aircraft registered in one country (1) to over-fly another country, (2) to make a technical landing[22] in another country, (3) to set down passengers from its country of origin in another country, (4) to pick up passengers in another country and fly them to its country of origin, and (5) to pick up passengers in another country and fly them on to a third country.[23] First and second freedoms are subject to a multilateral agreement between states:[24] bilateral negotiations between countries usually take place over third, fourth and fifth freedom rights.[25] Other rights might also be negotiated: sixth freedom rights allow aircraft from one country to carry traffic between two other countries via their country of origin, seventh freedom rights permit the carriage of traffic between two other countries without going to the country of registration, and eighth freedom, or cabotage, rights allow aircraft from one country to undertake domestic services within another country.[26]

7. Following the Chicago Conference countries began to negotiate air service agreements, building up what is now a "complex web of bilateral ... agreements".[27] The CAA told us that bilateral agreements have generally been used by Governments severely to restrict competition by limiting, for example, the number of carriers each side could designate on routes between countries, the routes which may be served, the frequency with which services may be operated, and the prices which airlines can charge.[28] Underlying bilateral agreements has been a central principle: that to exercise rights under a country's bilateral air service agreements an airline must be majority-owned and effectively controlled by nationals of that country.

8. One of the first bilateral agreements reached was between the United Kingdom and United States, which resulted from a conference held at Bermuda in 1946. The terms of the Bermuda Agreement were liberal: it did not attempt to predetermine the frequency at which airlines of either country could fly on any given route, and it did not prohibit the designation of more than one airline on any agreed route by either party to the Agreement,[29] although the International Air Transport Association (IATA) was given a role in the administration of fare levels.[30] In essence airlines of either country could introduce as many services as they saw fit within the overall capacity constraints set out by the Agreement, although it remained open for either Government to object that the airlines of the other country were putting too much capacity on a route, a matter which would then be reviewed, possibly leading to a reduction or an increase in frequency.[31]

9. As time went on, the liberal nature of the Bermuda Agreement began to be questioned. It became clear that airlines based in the United States had become more powerful than those in the United Kingdom, and derived significant benefits from their exclusive access to the US domestic market.[32] For example, in the 1960s US airlines began to develop the practice of combining non-stop trans-Atlantic services from 'gateway' airports in the United States with feeder services from cities within that country: the beginnings of the so-called 'hub and spoke' system.[33] Thus its "privileged access to a major part of the US market" led to "the growing dominance of the US airline industry",[34] which was reflected by the fall in the share of the market between the United States and the United Kingdom operated by British carriers[35] from 37.8 per cent in 1961-62 to 30.9 per cent in 1966-67.[36] In response to concerns about the dominance of United States airlines, and wishing to offer more rights to operators of non-scheduled services, the British Government announced in 1976 that it intended to renounce the Bermuda Agreement. A new round of bilateral negotiations resulted from that decision, leading to the conclusion of the Bermuda II agreement in 1977, which came into force in 1978.[37]

BERMUDA II

10. The Bermuda II agreement is considerably more restrictive than its predecessor. Although its provisions are extremely complex, in simple terms it imposed a limit on the number of entry points, or 'gateways', in the United States which could be served from London,[38] it placed additional restrictions on services from Heathrow, in terms of the airlines permitted to operate trans-Atlantic services from the airport (initially British Airways, Pan American and TWA) and the gateways in the United States which could be served from Heathrow,[39] and it instituted controls on fares, which had to be approved by regulatory authorities from both countries,[40] although the activities of non-scheduled airlines were substantially freed from restrictions,[41] and rights to operate many more routes between points in the US and Gatwick airport were granted.[42] In short, Bermuda II was "a unique agreement which enshrine[d] an elaborate system of controlling capacity on routes between the two countries",[43] in an attempt to "provide a framework within which the airlines of the two countries can compete on broadly equal terms".[44]

11. Because Bermuda II is a prescriptive agreement it has frequently required review and alteration to adapt to changing circumstances.[45] However, although both Governments have for a long time sought a "new air services regime that would enable airlines themselves to determine the price and supply of air services in a fair competitive framework",[46] progress has been limited to a number of specific amendments to the terms of the Agreement. For example, in 1990 the Governments agreed that US airlines should be allowed to operate direct air services on certain routes to and from Manchester airport.[47] This 'Manchester agreement' was followed in October 1994 by a unilateral offer by the then Secretary of State for Transport to ease access to all regional airports,[48] and from 1996 access for US carriers to all United Kingdom airports other than Heathrow and Gatwick under third and fourth freedom rights has been liberalised.[49]

12. The most significant amendment of Bermuda II was prompted by the demise of Pan Am and TWA in 1991. The renegotiation of Bermuda II that followed led to an agreement which permitted American Airlines and United Airlines to operate instead from Heathrow. In return a second British carrier, Virgin Atlantic, was permitted to operate trans-Atlantic routes from Heathrow alongside British Airways, United Kingdom airlines were permitted to serve additional gateways in the United States, new fifth freedom rights were obtained for flights between the United States and Asia, Australia and Central and South America, and seventh freedom rights were also obtained in respect of services between points in Europe and the United States. In addition United Kingdom airlines were given rights to 'code-share'[50] with US carriers.

THE CURRENT AVIATION MARKET

Passenger services between the United Kingdom and the US

13. Whether because of, or in spite of, Bermuda II, the market for air services between the United Kingdom and the United States has grown substantially since the agreement was signed. In 1977, 3.1 million passengers flew on scheduled flights between the United Kingdom and the United States,[51] a figure that had increased to 17.13 million by 1999. A further 1.12 million flew on charter services in 1999, making a total of 18.25 million passengers.[52] It is the dominant sector of the aviation market between the European Union and the United States: in the year to May 1998 it accounted for 40.5 per cent of that market.[53] By contrast, over the same period journeys between Germany and the US made up only 16.9 per cent of the total (6.63 million passengers), between France and the US only 11.9 per cent (4.66 million passengers), and between the Netherlands and the US only 10.4 per cent (4.10 million passengers).[54] During the Summer of 2000 there will be 111 daily flights in each direction between the United Kingdom and the US, compared with 42 from France and 48 from Germany.[55] As well as being a major market for the United Kingdom,[56] services between the two countries comprise the third largest international passenger market for the United States.[57]

14. The market between the United Kingdom and the US is dominated by flights to and from London, and specifically Heathrow. In 1999, 15.88 million passengers travelled on scheduled flights via London, of whom 10.43 million used Heathrow and 5.44 million used Gatwick.[58] Eleven US destinations are currently served from Heathrow,[59] and 23 from Gatwick:[60] routes to seven US cities are served by both airports.[61] In 1977 only nine non-stop routes were operated from London to the United States.[62]

15. In total thirteen airlines operated scheduled trans-Atlantic services from the United Kingdom during 1999. Only two were British: British Airways, which carried 40.2 per cent of all passengers on such routes, and Virgin Atlantic, with 17.5 per cent of the market.[63] There were seven US carriers: American Airlines with 13.9 per cent of the market, United Airlines with 12.1 per cent, Continental with 6 per cent, Delta Airlines with 4.3 per cent, Northwest with 2.2 per cent, USAir with 1.7 per cent, and TWA with 0.9 per cent.[64] The remaining four carriers were based in third countries, and operated flights between the United Kingdom and the US under fifth freedom rights. The airlines concerned were Air India, Aer Lingus, Air New Zealand and Kuwait Airways, which together carried only 1.3 per cent of all passengers on these routes.[65]

16. Under Bermuda II only British Airways and Virgin Atlantic on the British side and American Airlines and United Airlines on the US side are permitted to operate from Heathrow. The dominance of the British airlines at the airport is marked: despite the fact that the number of flights operated by airlines from the United Kingdom and the US is only split 54 per cent to 46 per cent, British Airways and Virgin Atlantic account for 64 per cent of passengers, and the two US airlines for only 36 per cent.[66] This is because the British airlines favour larger aircraft, such as the Boeing 747 and Airbus A340, whereas American Airlines and United Airlines prefer smaller aircraft such as the Boeing 767 and 777:[67] thus the average number of passengers on each flight of a United Kingdom airline is 271, and on those of US carriers it is 181.[68]

17. The importance of the United Kingdom to the US market for the two British airlines is illustrated by the fact that services to the US carry 17 per cent of British Airways's total passengers, and represent 36 per cent of its revenue passenger kilometres and an estimated 29 per cent of its total revenue.[69] Virgin Atlantic's US routes account for 80 per cent of its revenue passenger kilometres, and the airline has become the third largest European carrier across the Atlantic.[70] The gross revenues to the two airlines from services between the United Kingdom and the United States was estimated to have been £3.5 billion in 1999.[71]

18. The strength of the British airlines under Bermuda II is reflected in their share of the market on specific routes, particularly when the route is served from Heathrow, and when it is operated by both British Airways and by Virgin Atlantic. For example, on the London to Los Angeles route, which is served only from Heathrow, the two British airlines have a 72 per cent share of the market. Similarly on the Heathrow to San Francisco route the British share is 58 per cent, and on the Heathrow to Washington/Baltimore route it is 55 per cent. On the Miami route, which is served from both Heathrow and Gatwick, the British airlines have an 81 per cent share of the market, on the London to Boston route they have a 68 per cent share of the market, on the London to New York route they have a 65 per cent share and on the London to Newark route they have 58 per cent. Of the routes served by both British airlines from Heathrow, only on the London to Chicago route do the US carriers out-perform the British airlines, with a 68 per cent share.[72] US airlines also tend to enjoy a larger proportion of the market on routes where they compete with one British carrier.[73]

19. Another illustration of the strength of British airlines under Bermuda II is the degree to which British Airways in particular is able to attract connecting passengers onto its services at Heathrow and Gatwick. In 1998, of the airline's 6.50 million passengers on flights to the United States, 3.17 million, or 49 per cent, had connected with such flights in London, 28 per cent from European Union states, and 7 per cent from regional airports in the United Kingdom.[74] In total 3.52 million passengers on the trans-Atlantic flights of British airlines connect with those flights in London. By contrast, on average only 25 per cent of the passengers, or 1.33 million, on flights to the United States operated by US carriers connect from other flights in London,[75] although those carriers with access to Heathrow fare noticeably better: 31 per cent of passengers on American Airlines flights connect in London, as do 26 per cent of those on United Airlines. Conversely, US airlines are much more successful in attracting connecting passengers to their flights at United States gateways. In 1998, of 5.37 million passengers on trans-Atlantic flights from the United States operated by US carriers, 2.51 million, or 47 per cent, connected with their flight at a US gateway, whereas only 881,214 passengers on British airlines, 10 per cent of the total number, connected from other flights.[76]

Services from regional airports

20. Away from London the number of flights and of passengers carried on direct routes to the United States is much smaller. In 1999, 1.26 million passengers flew to and from Manchester, Birmingham and Glasgow on direct flights to the US.[77] Flights from these regional airports serve six US destinations, all of which are also served from London: from Manchester, British Airways serves New York, Virgin Atlantic serves Orlando, Delta Airlines flies to Atlanta and to New York, Continental serves Newark, and American Airlines operates to Chicago and Dallas/Fort Worth; from Birmingham and Glasgow Continental serves Newark, and American Airlines operates to Chicago.[78] What is particularly striking is that British Airways and Virgin Atlantic together carry only 21 per cent of passengers on flights from regional airports to the United States, and thus US carriers dominate, with 79 per cent of passengers,[79] although on the Manchester to New York route British Airways out-performs its rival Delta Airlines, with 53 per cent of the market.[80] In addition to the services offered by British and US carriers, services are operated under fifth freedom rights from Belfast to New York by Aer Lingus,[81] and now, on five days a week, from Manchester to New York by Pakistan International Airlines.[82]

21. The number of services operated from regional airports in other European Union members states is, except in Germany, much more restricted than from regional airports in the United Kingdom. In France, for example, the only airports away from Paris which offer direct services to the US are Lyons and Nice, and then only to New York; in Spain, away from Madrid there are direct services from Malaga to New York, and from Barcelona to Atlanta and New York; and in Italy, if Milan is taken to be the main airport, then additional services are only offered from Venice and Rome to New York, and from Rome to Atlanta, Miami, Newark and Philadelphia.[83] By contrast, in Germany there are large numbers of routes served from regional airports. If Frankfurt is taken as the 'capital' airport for the country, direct services to the United States are offered from Dusseldorf, Hamburg, Munich and Stuttgart, to a total of eleven destinations, namely Atlanta, Chicago, Fort Myers, Los Angeles, Miami, Newark, New York, Orlando, Philadelphia, San Francisco and Washington.[84]

Charter services

22. In 1999, 1.12 million people flew to and from the United States on non-scheduled, or charter, flights. The charter market is dominated by six British-based airlines, which carry 1.02 million such passengers, or 91 per cent of the total number.[85] A further 8.9 per cent of the charter market is accounted for by a US carrier, American Trans Air, and the remainder by Aer Lingus, operating under fifth freedom rights.[86] The market from the United Kingdom is focussed on routes from a number of airports in the United Kingdom[87] to Florida and to Las Vegas.[88]

Cargo flights

23. The market for air freight between the two countries is also significant. In 1999, 724,687 tonnes of cargo was carried on scheduled air services between the United Kingdom and the US.[89] A further 28,907 tonnes was carried on chartered cargo aircraft. Most cargo is carried in the holds of aircraft operating scheduled passenger services: in 1999, 628,289 tonnes, 83.4 per cent of the total, was carried in that way. A further 12.8 per cent was carried on scheduled all-cargo flights, and the remainder on passenger and all-cargo charter flights.[90] Thus the air cargo market is of interest not only to all-cargo airlines,[91] but also to those generally regarded as passenger airlines, such as British Airways,[92] which carried 253,673 tonnes of freight in 1999, 33.7 per cent of the total. A significant, and growing, force in the industry are the express parcel delivery companies, known as 'integrators', such as DHL, Federal Express and UPS: just these three companies account for almost 8 per cent by weight of the air freight market between the United Kingdom and the United States.

Onward, or fifth freedom, flights

24. As well as services between points in the United Kingdom and in the United States, Bermuda II permits a very limited number of onward flights under fifth freedom rights. The two Governments have agreed that British cargo airlines can fly certain routes to the United States and then on to points in South and Central America.[93] US cargo services may operate on routes to the United Kingdom and then on to a limited number of points in Europe, the Middle East and India.[94] Rights for passenger flights are even more closely controlled: United Kingdom airlines have been given permission by the US to fly between the US and points in Luxembourg, the Netherlands, the Republic of Ireland, Belgium, France and Germany, but only the Republic of Ireland has given permission for such fifth freedom services.[95] US airlines are permitted to operate services between Shannon and Prestwick or Glasgow, as well as services from the United Kingdom to Berlin, Frankfurt, Hamburg, Munich, Oslo, and another point in western Europe. In practice, very little use is made of these fifth freedom rights: no passenger services are operated under them by either side, and no British cargo carriers operate fifth freedom services from the United States. US cargo airlines do make some use of them: we were told that Federal Express operates a service from Stansted to Frankfurt and from Prestwick to Bombay, that Polar Air Cargo operates from Prestwick to Amsterdam, and that UPS operates to Cologne-Bonn from East Midlands and Stansted.[96]

Airline Alliances

25. As the global aviation market has grown in size, airlines have inexorably been drawn together through the need to improve their efficiency and to develop a more 'seamless' service. They have sought to do so by offering such benefits as integrated time-tabling of services, through-ticketing from point of departure to destination, shared fare offers and marketing campaigns, and common branding in terms of facilities, loyalty schemes, and so on. The simplest way to co-ordinate airline activities would be through acquisition and merger, but attempts at consolidation, at least until recently, have not generally been successful. In part this is because airlines have had a 'national' identity, particularly for the purposes of air service agreements, and are governed by rules affecting their ownership and control: no more than 25 per cent of a US carrier may be foreign-owned, and the equivalent limit in the European Union is 49 per cent.[97] In addition, Governments and other regulatory authorities have generally sought on competition grounds to discourage airlines from working too closely together. Thus, for example, attempts by British Airways in recent years to merge with USAir and then with American Airlines have failed, in part because of the attitude of competition authorities in the United States and in Brussels.[98]

26. Instead of formally merging, or taking each other over, airlines have attempted better to co-ordinate their activities through alliances and groupings. They have developed 'code-sharing' arrangements, under which two or more airlines agree to operate services which connect well with each other, and which fly under a single flight code, and have put in place other forms of co-operation. In recent years five major airline groupings have come to the fore: KLM/Northwest, the Star Alliance, Qualiflyer, oneworld, and SkyTeam, which between them control approximately half of the world's aviation market.[99]

27. The oldest alliance is between Northwest and KLM which, together with Continental Airlines, reached an agreement in 1989 which has led to common branding, purchasing, management and marketing. The ties between KLM and Northwest were reinforced by the conclusion of a liberal bilateral deal between the Netherlands and the United States in October 1992, and also by an exchange of equity between the parties: Northwest has taken a 14 per cent stake in Continental Airlines,[100] and at one time KLM held equity in Northwest, although that has since been sold. The KLM/Northwest grouping has annual sales of $16.8 billion, and a 4.6 per cent share of the world market.[101]

28. Next to be established, in May 1997, was the Star Alliance, now the biggest airline grouping, which was founded on the decision of the US competition authorities not to object to co-operation between Lufthansa and United Airlines in the market between Germany and the United States. In addition to those airlines, the Alliance includes Singapore Airlines, All Nippon Airways, Air Canada, Thai International, Varig (Brazil), SAS (Scandinavia), Air New Zealand, Ansett Australia, Mexicana, Austrian Airlines and British Midland. Members of the alliance are linked through code-share agreements bolstered by bilateral agreements between individual airlines, and, to a limited extent, through the exchange of equity: Air New Zealand owns 100 per cent of Ansett Australia, and is itself 25 per cent owned by Singapore Airlines, and Lufthansa and SAS own 20 per cent each of British Midland.[102] As well as code-sharing, attempts have also been made to consolidate fares, and to provide common branding, for example, through the use of airline lounges, loyalty programmes and joint check-ins. It is intended that co-operation will be strengthened over cargo, joint purchasing, advertising and promotions. The Star Alliance has annual sales of $69.6 billion, and 18.8 per cent of the global market.[103]

29. In March 1998, the SAirGroup, a Swiss Company which owns Swissair, launched the Qualiflyer Group, building on its ties with Austrian Airlines and its then minority stake in Sabena (Belgium), and incorporating Turkish Airlines, TAP (Portugal) and AOM (France). It has since attracted support from Air Europe (Italy), LOT Polish Airlines, LTU (Germany), Air Littoral (France), Portugalia and Volare (Italy), in which SAirGroup has taken equity: as well as owning 85 per cent of Sabena and 70.9 per cent of Crossair, it owns 49.9 per cent of LTU, 49 per cent each of Air Europe, AOM French Airlines and Air Littoral, 42 per cent of Portugalia, 37.6 per cent of LOT Polish Airlines, 34 per cent of TAP Air Portugal and 34 per cent of Volare.[104] It also owns 20 per cent of South African Airways, although that airline is not yet a member of Qualiflyer. Thus the alliance is currently focussed wholly on Europe. It has linked sales and services, ranging from a joint ground handling company to call centres. There is also much co-operation on computer systems, baggage handling, sales, training, cargo and maintenance.[105] Qualiflyer has annual sales of $16.2 billion, and has a 3.4 per cent share of the world market.

30. The oneworld alliance was launched in September 1998. At its core are British Airways and American Airlines, but, because of the fact that the airlines do not enjoy immunity from US anti-trust legislation, they cannot code-share on trans-Atlantic routes. Thus the alliance has concentrated on global marketing, and the co-ordination of benefits such as airport lounges, transfers between carriers, and fares through the 'oneworld Explorer' product. However, code-sharing has been possible with other recruits to the alliance, namely Qantas (Australia), Cathay Pacific (Hong Kong), Iberia (Spain), LanChile, Finnair and Aer Lingus. There has been some exchange of equity between the alliance partners: American Airlines owns 1 per cent of Iberia, and British Airways a further 9 per cent of Iberia, as well as 25 per cent of Qantas. The alliance now has a 12.8 per cent share of the world market, on sales of $50 billion each year.

31. The most recent alliance to be established is SkyTeam. It has grown from an initial deal between Air France and Delta Airlines in June 1999, which was supplemented by an agreement with Aeromexico in September 1999. In June 2000, the three airlines were joined by Korean Air to form SkyTeam. As well as introducing common branding, the alliance aims to integrate information technology between the airlines, allowing ticketing, checking-in and other services to be integrated. In addition, passengers on each airline will be able to access any of the alliance members' lounges and other facilities, and in the future there will be co-operation over cargo services, and other benefits will be introduced.[106] The alliance has annual sales of $29.4 billion, and an 11.2 per cent share of the global market.[107]

32. Since their inception, membership of the alliances has frequently changed, often as the ownership of airlines has changed:[108] for example, Air Canada, a member of the Star Alliance, has purchased 82 per cent of Canadian Airlines, and as a result Canadian has left the oneworld alliance.[109] Austrian Airlines, one of the original members of the Qualiflyer grouping, has since left to join the Star Alliance, despite the fact that SAirGroup continues to own 10 per cent of the airline, and Air France holds a 1.5 per cent stake.[110] Delta Airlines, in which the SAirGroup holds a 4.6 per cent stake, has nonetheless left the Qualiflyer Group to join Air France in SkyTeam: likewise, Singapore Airlines has left the Group to become part of the Star Alliance. Now also associated with, although not part of, the Star Alliance are USAir, currently the subject of a possible merger with United Airlines, Virgin Atlantic, in which Singapore Airlines has taken a 49 per cent stake, and Spanair (Spain), in which SAS has a substantial share. Finally, the development likely to cause the most upheaval is British Airways's proposal to merge with KLM: that would have significant implications not only for the companies involved, but their partners, including American Airlines, Northwest and Continental Airlines.

21 See The Bermuda Conference and Anglo-American aviation relations at the end of the Second World War, by David Mackenzie, Journal of Transport History. Back

22 A stop to refuel and/or to change crew, at which no passengers are set down or picked up. Back

23 See AS01, Annex B. Back

24 The International Air Services Transit Agreement. Back

25 See British Air Transport in the Seventies, Report of the Committee of Inquiry into Civil Air Transport, May 1969, Cmd.4018, paras.23 and 24. Back

26 See AS01, Annex B. Back

27 AS05, para.6. Back

28 See ASS05, para.6. Back

29 The analysis of British Air Transport in the Seventies, para.335. Back

30 IATA was founded in Havana, Cuba, in April 1945, as an organisation of 57 airlines from 31 countries (mainly from Europe and North America). Today it has over 230 members from more than 130 nations. The modern IATA is the successor to the International Air Traffic Association founded in the Hague in 1919 (http://www.iata.org/history.htm). Back

31 A process set out in British Air Transport in the Seventies, para.336 ff. Back

32 See comments of British Airways in 1993, in HC (1993-94) 47-II, p.56. Back