A Lesson that Never Gets Learned

As of August 30th, the USAirways’ (now American) flight operations center, subsidized by taxpayers, will close.  Around 650 jobs will either move to Fort Worth or disappear altogether—the result of the airline’s merger with American Airlines.  Such is the nature of business.  Firms are constantly being created, closing their doors, and /or moving.  Government placing expensive bets on the success or retention of specific businesses is problematic on several levels.

 

The first and foremost is that taxpayers should not be bankrolling private investment and second is that there are issues of favorable treatment for some companies and third there is the moral hazard issue. Yet politicians seem to be unable to stop doing it. So many examples of recent memory come to mind; Solyndra and other solar energy companies, Kvaerner Shipyards in Philadelphia, and locally Sony, Lazarus, Lord and Taylor’s to mention a few prominent ones.

 

Recall that USAirways in 2007 asked three cities to put together a financial package to bid on getting a new flight operations center.  USAirways had just merged with America West Airlines, who had such a center in Phoenix but deemed it too small (150 people) to accommodate the new combined airline’s needs.  Pittsburgh, which at the time had the USAirways’ flight operations center, was asked to compete against Phoenix and Charlotte to host the new center.

 

Naturally the news reports of Pittsburgh’s victory were glowing. The center was to cost $25 million and employ 600 people—with 450 coming from USAirways’ current center with 150 new jobs although as reported in the news “the 150 employees in Phoenix will have the option of moving to Pittsburgh once the consolidation is complete.”  The financial aid package put together by the state and County totaled more than $16 million which consisted of $3 million in grants, $12.5 million in loans and $750,000 in state tax credits tied to the number of jobs created by the project.

 

We asked at the time (Policy Brief, Volume 7, Number 54) “will government officials ever learn that lavishing tax dollars on firms is not an antidote for market trends?  It seems a simple lesson, but one that currently escapes them.  The Pittsburgh region suffers dreadfully from this affliction…”  We noted the inexplicable loyalty to USAirways from elected officials.  “Still the most galling case is the region’s support for USAirways over the years.  Allegheny County built the airport facility, designed to accommodate 50 million passengers per year at a cost of half a billion dollars largely to house the USAirways hub and the anticipated surge in traffic through the airport.”

 

Unfortunately, the highest passenger count since completion of the new airport occurred in 1997 (20.7 million).  All Pittsburgh travelers received from this new hub was a strong USAirways’ monopoly, and, for years, the highest airfares in the country.  For a long time, the Allegheny County Airport Authority was stuck trying to make huge debt service payments until money from new external sources (gaming and Marcellus Shale production) came along.

 

In 2007, the time of the bidding process, O&D traffic came in at just over 9.8 million but was slipping and recently has settled in at about eight million origination and destination passengers.

 

We also noted in 2007 regarding the airline’s financial difficulties:  “Almost continuous financial problems arising out of extraordinarily high costs at the airline finally led to bankruptcy in 2002 and again in 2004.  Those bankruptcies eventually resulted in a merger and a dramatic drop in the airline’s presence at Pittsburgh International Airport with flights falling precipitously from well over 500 per day to just over a hundred currently.  USAirways’ employment in the region fell in concert with the decline in flights from 12,000 in 2001 to below 3,000.”

 

Another red flag was raised not long after the announcement Pittsburgh had won the rights and the expense to host the new center.  Flights were again cut from 108 daily to 68 beginning in January 2008.  These flight reductions came with 450 local jobs being lost and the relocation of 500 pilots and flight attendants.  Employment at USAirways in Pittsburgh fell to 1,800.  As we commented, “so the more than $16 million in subsidies used to guarantee 450 flight operations jobs, for which ground was also broken in September, will not offset the loss of 450 jobs and the relocation of 500 others.”  The CEO of USAirways at the time commented that the cuts may continue while the then Allegheny County Chief Executive responded, “the flying public makes that decision. I wouldn’t hold my breath until they figure out how to be competitive in Pittsburgh.”

 

And of course he was correct.  Upon the announcement of the merger with American Airlines in March 2013, the CEO told the media that the flight operations center would close “a couple years from now.”  News reports place the final cost of the 72,000 square foot flight operations center at $32 million and employed 650 people.  It opened in 2008 and lasted seven years.  It is not clear if USAirways repaid the $12.5 million in loans used to build the center, but state and county money ($3.75 million) and the gamble using taxpayer money did not reap the rewards for which elected officials had hoped.

 

As we concluded in that Brief from 2007: “The ongoing USAirways saga should be an object lesson for government officials.  Stop using taxpayer money to support private firms in decisions that are not financially viable absent the subsidies. It is far better to keep taxes low and create a favorable labor climate. But of course if those were present, all this doling out of subsidies would not be necessary to persuade companies to invest in the region and state.”

 

And we might add in this case that given the awful experience with USAirways in the first few years of the new century, the decision to reward them again for a chance at some jobs that were likely to be gone in a few years anyway—not to mention the other significant cuts that were already scheduled—was ill advised at the time and the repercussions are now in full view.

Pittsburgh International Still Struggling Despite Fee Reductions

Pittsburgh International Airport’s (PIT) struggles to grow passenger counts and flights have been well chronicled in past Policy Briefs.  One obvious culprit has been the high fees charged to airlines doing business at PIT. The high fees are driven by the need for the airport to generate revenue to pay off debt incurred building the facility more than twenty years ago.  However, thanks in large part to money coming from gaming revenue and from a recent lease allowing drilling for natural gas on airport property, PIT has been able to reduce some of these fees.

 

Everything equal, the reduction in fees should encourage more flight activity. But, it might be an uphill battle.   Note that passenger counts for 2013 (through November) were below 2012 levels which were below 2011 levels.  Whether the airlines and travelers respond positively to the lower fees, remains to be seen. And that leads to the inevitable question. What can be done to make passenger counts take off at PIT?

 

The terminal at PIT, built at the request and to the specifications of USAirways, has become a financial albatross for the Airport Authority.  According to the most recent comprehensive annual financial report (2012), PIT still owes $375 million in revenue bonds associated with the construction.  Coupled with more than $20 million in other debt, and PIT’s annual debt service is projected to be just over $68 million in 2014. It dips to around $67 million in 2015 and 2016 and to $63 million in 2017 before falling to just over $23 million per year for 2018 through 2022. With operating revenues in 2012 exceeding $135.8 million, debt service (interest and principal) consumed about half of PIT’s operating revenues.

 

The largest component of operating revenues at PIT is terminal fees (42 percent), followed by parking revenues (21 percent) and landing fees (13 percent).  The terminal fee rate for signatory airlines (those who have an agreement with PIT) at the facility has been well above that charged by similar airports.  In 2012, the rate was $129.06 per square foot.  By comparison, Indianapolis ($92.80), Denver ($70.219), Kansas City ($30.09) and Cincinnati ($28) were much lower.  After PIT raised the fee nearly ten percent in 2013, it was reduced to $138.82 for 2014, but remains above the 2012 figure.

 

Meanwhile, the signatory landing rate was $3.4148 per 1,000 pounds in 2012 and was much more competitive with other airports. In fact, it was lower than Denver ($3.914) and Cincinnati ($3.998).  The landing fee was also raised for 2013 (slightly) before dropping nearly 20 percent to $2.81 for 2014.

 

Given the large debt load, it might seem to be counterproductive to lower the fees that comprise the bulk of the operating revenues.  But since the airport is no longer a major hub, and appears unlikely to become one again, it has to rely on enticing carriers to offer point-to-point service for passengers using PIT for the origination and destination (O&D) of their travel.  This effort to reduce carrier costs received a boost when the airport was the recipient of money from the state’s gaming law, which from 2010 through 2012 amounted to $39.4 million, to be applied specifically to debt service at PIT.  They were allotted $150 million under the law, but the first $42 million was intercepted by the County Executive at the time and used for the County’s budget.

 

In another fortuitous circumstance, the natural gas boom in the Marcellus Shale formation had drilling companies bidding on the rights to drill on airport property.  The winning bidder paid an upfront bonus, reportedly up to $40 million, and will pay royalties when extraction commences.  This allowed PIT to lower airline fees midway through 2013 then again at the start of 2014.

 

Whether or not these cuts will be enough to attract airlines to offer more service to more destinations remains to be seen.  In another attempt to lure airlines, the Airport Authority has recently unveiled plans to offer a subsidy to airlines that are willing to offer nonstop flights to select locations, such as San Diego or Seattle.  The subsidy will take the form of either marketing assistance or a waiver of landing fees.  This is a direct attempt to cater to the O&D market as the list of cities was chosen based on a survey of businesses.

 

And of course that is the point; PIT is no longer a hub that can rely on a large number of flights carrying passengers who are connecting with other flights, so it must work to increase the number of O&D travelers.  While they can work on promotions such as the one mentioned above, and make efforts to reduce airline costs, they will be relying heavily on the regional economy and to some degree on the strength of the national economy.

 

Unfortunately, the local labor market has not been overly supportive. While private employment growth in the seven county Pittsburgh metropolitan statistical area (MSA) has outpaced that of the state, it still has not been robust.  In 2013 only two months, September and October, posted growth rates in private employment that were two percent over the same month a year earlier.  In 2012, this only happened in the first four months.  Thus, the remaining sixteen months over the last two years had growth rates less than two percent over their year earlier totals.  The good news is that job gains in the region have been stronger than the state growth.

 

That being said, some of the sectors that have lead the job gains (such as education and health, and leisure and hospitality) are not sectors that are big drivers of employee air travel. The Marcellus Shale boom has caused jobs in the mining and logging sector to more than double over the last few years, but total employment in that sector accounts for only about one percent of the total private jobs in the MSA.

 

The major and somewhat surprising bright spot in job creation has been the professional and business sector, specifically the professional and technical subsector.  The professional and technical subsector has grown at a year over year rate ranging from 5 to 8 percent during 2013 and accounts for a significant fraction of all net new private jobs. As we wrote previously, detailed data as to which areas within this subsector are experiencing the most growth are not available at the MSA level, giving some cause for concern about the accuracy of the numbers being reported.  But the positive news for PIT is that these may be employees with a need for air travel or at least with enough income to stimulate demand for travel.

 

Moving forward, PIT needs to do all it can to right its financial ship, such as using the new found sources of revenues to lower debt obligation and lower carrier fees further thereby becoming more competitive with other airports in attracting airlines and flights.  It also ought to be involved in trying to promote more business friendly policies to stimulate regional economic growth and demand for air travel, be it for business or pleasure.

USAirways Merger with American Hits Turbulence

The Federal Department of Justice has been joined by the attorneys general from six states (including Pennsylvania) and Washington DC to stop the proposed merger between USAirways and American Airlines.  They have filed suit in Federal court claiming that the merger would create the world’s largest airline resulting in higher fares and less service and competition.  This is an unexpected turn of events.  Since the two companies had announced their merger plans earlier this year, things had been moving along without turbulence as the plan was approved by each company’s shareholders along with American’s creditors as that airline departs bankruptcy. 

 

 

So what does this mean for Pittsburgh?

 

As we had written in a Policy Brief earlier this spring (Volume 13, Number 17), the burning question for local officials is the fate of USAirways’ flight operations center which was partially funded by taxpayers.  If the merger goes through it will certainly mean that facility would be closed in favor of American’s center in Dallas.  Shuttering the facility will mean the loss of 600 Pittsburgh jobs. And those would be in addition to the thousands of employees at the airport who have lost jobs since the USAirways bankruptcies and tremendous downsizing and the de-hubbing of Pittsburgh International (PIT).  Clearly, there are many workers who will be hoping for the merger to be blocked by the courts.

 

The suit to stop the merger has come at nearly the last minute as the bankruptcy court was set to hear final arguments for the plan to exit bankruptcy, a plan supported by the unions and creditors. 

 

The Justice Department, in moving to block the merger, asserts the merger would be strongly anti-competitive.  And there is some reason to agree with that.   Although it is interesting to note that the Justice Department in recent years approved the mergers of Delta/Northwest, United/Continental and Southwest with Airtran.  If this merger is allowed, it would leave the country with four airlines controlling 80 percent of the market. On the one hand, American argues that United and Delta are already hogging the markets in several cities. But would any of the smaller point-to-point discount carriers, such as JetBlue Airways step up and enter more markets if the merger is not allowed and American is forced to shed routes?  Profits are a strong motive for new entrants in any industry.  As USAirways’ CEO once said, the airline industry is “far too hard to predict”. 

 

But there is a broader question. If the merger is denied what happens to American’s effort to get out of bankruptcy?  Will its creditors and employees be at substantial risk of loss? Will American have to cut service?  Lots of questions for the bankruptcy court to ponder.   If the merger is denied by the courts through the lawsuit and American fails to come out of bankruptcy, then there would still be less competition. 

 

If the Justice Department prevails, the traffic control center in Moon will almost certainly get a reprieve and many workers can breathe a sigh of relief.  And a diminished American presence at the airport could provide an opening for USAirways to offer more flights to take up the slack.  Of course other carriers might go after good routes.

 

But as we have written before, PIT is now an origination and destination (O/D) airport that needs to concentrate on lowering fees to entice more airlines, be they the major players or smaller flyers, to start offering more flights thus drawing more O/D passengers.  With the advent of drilling money from future Marcellus Shale wells entering the picture and gaming money being used to lower terminal related debt, PIT has already taken a step in that direction.  A growing economy that generates both increased business and pleasure travelers will be key to helping O/D demand to rise and possibly induce more carriers offering more seats to more destinations.

 

Nonetheless for the time being the holdup in the merger has added to the uncertainty about will happen at the Pittsburgh airport.

US Airways Taking the Area for Another Ride?

USAirways has entered into a merger agreement with American Airlines.  If the merger passes regulatory muster-it has already received approval of American’s bankruptcy judge-the USAirways brand will disappear from the landscape and possibly most of the remnants of the once powerful airline’s presence in the Pittsburgh area-its birthplace. 

 

The last two operations-other than local flight operations-remaining in the area are the airline’s flight operations center and a heavy aircraft maintenance center.  The former has already been mentioned as a candidate for closing, entailing the elimination of 600 jobs. Meanwhile, the maintenance center employees may want to cross their fingers.  Normally in the course of business, firms come and go and jobs are created and destroyed, but what makes this instance so egregious are the enormous sums of money state and local officials have thrown at the airline over the last twenty plus years in an effort to keep the carrier happy and jobs in place.  It has turned out to be quite futile.

 

At its peak the airline employed more than 12,000 people locally with more than 500 flights per day.  Since 2001 the airline has gone through two bankruptcies and a merger with America West.  These and other events impacting the carrier have lowered local employment that today stands at 1,800 with fewer than 50 daily flights.  The job count is likely to be reduced further if the merger is approved. 

 

What makes this particular news disturbing is the $16.25 million financing package of state and local subsidies that included grants, tax credits and a low interest loan that was provided in 2007 as an incentive to build the $25 million operations center and to retain 600 jobs.  But USAirways has a habit of disappointing the Pittsburgh airport despite receiving heavy subsidies and getting a new terminal built to handle the expansion projected twenty five years ago. They abandoned the airport first as a principal hub and then as a “focus city”.  While the latest developments may come as a mild shock, it should not come as a surprise. 

 

In 2006, USAirways pitted Pittsburgh against Phoenix and Charlotte to see which would offer the best deal to host the operations center.  We commented at the time (Policy Brief Volume 7, Number 54) that “the competition was almost certainly a ruse.  Moving the heart of the operations system on the fly is clearly impossible.  To move the center during operations would have required creating a parallel system at great cost.”  Prior to bidding, Phoenix had a smaller center serving America West that was not adequate to accommodate the much larger USAirways traffic. The odds were very much in Pittsburgh’s favor with or without a subsidy.  The situation with American and Dallas is very different, making the Pittsburgh center odd man out.

 

Not long after Pittsburgh’s “victory” in obtaining the operation center, USAirways announced a large round of flight cuts with 450 local jobs eliminated along and the relocation of 500 pilots and flight attendants.  We also noted in the 2007 Brief, “…that may not be the last of the reductions.”  At the time, the CEO was asked if this is the last of the cuts. He responded “you never say never.”  In defending the cuts he also noted that the nature of the airline industry is “far too hard to predict.” 

 

And he has been proven correct in that assessment.  The airline industry has changed dramatically since the events of 9/11/2001.  Other cities have suffered the loss of hubs as mainline carriers have faltered and discount carriers, with point to point service, have become more prominent.  Thus, showering taxpayer subsidies on airlines seems like a losing proposition-their business is too hard to predict.  The danger for taxpayers now is the temptation for local officials to throw even more money at the newly merged airline in a vain effort to keep the center open.  Phoenix’s operations center may not have been much of a competition for Pittsburgh, but the American operations center in Dallas is.  Short of including the sun and the moon any such offer will almost certainly be rejected.

 

The focus now should be on making Pittsburgh’s airport as attractive as it can be for carriers (in terms of costs of operations, quality of service, etc.) who will compete for and stimulate origination and destination travelers.  One positive arising from the reduced USAirways presence has been the advent of more competition for local air travelers.  Gaming tax revenue is being used to service airport debt, incurred for the new terminal that was built to USAirways specifications, allowing the Airport Authority to lower airline fees. Moreover, the agreement to drill for natural gas on airport property should help drive costs down even further, enhancing the attractiveness to other carriers.  Lowering airline fees still further could entice carriers to offer even more service. 

 

Will area policy makers learn something from the USAirways experience?   Sadly, history is not encouraging on that question.