Introduction and Background

Good morning. Mr. Chairman and members of the Subcommittee, on behalf of the 45 airline members of the Regional Airline Association, thank you for inviting me to appear before you today to discuss escalating fuel costs and impacts on regional airline operations and Essential Air Service in the wake of Hurricane Katrina.

I am Deborah McElroy, President of the Regional Airline Association, or RAA. RAA represents regional airlines providing short and medium-haul scheduled airline service connecting smaller communities with larger cities and hub airports operating 9 to 68 seat turboprops and 30 to 108 seat regional jets. Of the 664 commercial airports in the nation, fully 479 are served exclusively by regional airlines. This means, at 72 percent of our nation’s commercial airports, passengers rely on regional airlines for their only source of scheduled air transportation.

Of those communities, 99 communities in the lower 48 states as well as three in Hawaii and 33 in Alaska receive subsidized air service by regional carriers through the Essential Air Service Program, or EAS, which was enacted as part of the Airline Deregulation Act of 1978. The EAS program was crafted to guarantee that small communities served by certificated air carriers before deregulation would maintain a minimum level of scheduled air service after deregulation.

The program has been in effect each year since 1978 at various funding levels and through several eligibility criteria adjustments that take into account distance from nearby hub airports and other factors. Most recently, in Fiscal Year 2005, the EAS program was funded at $104 million. The House appropriation for FY06 was $105 million and the Senate Appropriation at present stands at $110 million. RAA estimates the program will need a full $127 million in order to function as enacted during FY06 and we remain committed to working with Congress to ensure that the larger EAS appropriation – critical for the program – is enacted.

With your permission, I will return to this topic. First I would like to discuss some characteristics of regional airline service. Many of you already know that the majority of regional carriers operate in partnership with the major airlines under code-sharing agreements. In fact, in 2004 99 percent of the 135 million passengers transported by regional carriers traveled on code sharing airlines. Code sharing agreements, which provide benefits for passengers, regional and major airlines, have two broad methods of revenue sharing. The first, prevalent among larger regional carriers operating regional jets, occurs when a major and regional airline enter into a “fee for departure” or “capacity buy” agreement where the major compensates the regional airline a predetermined rate for flying a specific schedule. Within this arrangement are mandatory standards for customer service, on-time performance and baggage handling requirements and incentives rewarding excellent performance.

A second arrangement, common to smaller, turboprop operators, occurs when major airlines pay regional airlines a portion of passenger ticket revenue. This is referred to as “pro-rate” or “shared revenue” flying.

While regional airlines with pro-rate agreements are most vulnerable to cost increases and the recent fuel cost crisis, it is important to note that fee-for departure carriers also suffer when fuel costs increase this dramatically. Even if the regional airline is compensated by the major airline for fuel costs, the majors must take those increased costs and the market’s profitability into consideration when route and capacity decisions are made. Major carriers have no choice but to eliminate regional routes that lose money for long periods, even if those routes contribute some connecting revenues to the mainline system. As you know, most of the major airlines are experiencing some of the most daunting challenges in the history of the industry. They cannot afford to continue unprofitable routes and when this service is discontinued, regional airlines and passengers in small communities suffer as well.

With jet fuel costs expected to rise by more than $9 billion this year, regional airlines are being hit hard. In July 2005, jet fuel averaged $1.66 per gallon – 52 cents more than in July 2004. According to one RAA member, this meant that the 592 gallons of fuel required for a 40 seat regional jet to fly approximately 600 miles cost $1,024 in July 2005 compared with $600 just one year before. The effect of Katrina has produced an even more dramatic jump in fuel costs so that even with load factors at an all-time high, the U.S. airline industry collectively is struggling financially due to the unprecedented jump in oil prices and an even more dramatic increase in the price of jet fuel.

Regional airlines are providing critical service to smaller communities with airplanes that use much less fuel than larger aircraft. Turboprop aircraft are among the most fuel efficient aircraft for short-haul routes and RJs have some of the most modern, fuel efficient engines in the airline industry. Like our major airline counterparts, regional carriers have sought to minimize fuel burn by tankering fuel, lowering cruise speeds, safely altering approach plans and reducing onboard weight, making every effort to manage escalating fuel costs with an eye toward conservation. Nonetheless, fuel now ranks as the second highest cost for airlines, ranking just behind labor.

Regional airlines with both types of compensation arrangements are certainly feeling the strain. But Essential Air Service carriers, whose rates are set at two-year levels by the Department of Transportation (DOT), are seeing major troubles as well. There were problems before Hurricane Katrina devastated the gulf coast on August 29, 2005, but that tragedy has made a bad situation even worse.

Hurricane Katrina

Fuel costs were already devastatingly high for U.S. carriers before Hurricane Katrina crippled oil and gas operations in the Gulf Coast and shut down most of the output from the region. Because my colleague from the Air Transport Association went over these numbers in detail, I will focus on service impacts, except to underscore the fact that Katrina initially wiped out 19 percent of domestic refining capacity, including 13 percent of the nation’s daily jet fuel production. Further, oil imports are down 10 percent because of Katrina’s extensive damage to Louisiana's major oil-import terminal.

By September 1, jet fuel prices had risen 49 cents per gallon to $2.36, from $1.87 on August 17. While recovery efforts and action by various federal agencies have led to the price of jet fuel being $2.00 per gallon today, this cost remains untenable for major and regional carriers alike.

Some lawmakers have suggested that carriers pass along fuel increases to passengers. But competition has not become less intense just because fuel prices have skyrocketed. In fact, regional airlines compete not only carrier to carrier. In short-haul markets, we compete with the automobile. Data from the most recent DOT Inspector General’s “Aviation Industry Performance” report indicates that scheduled flights in markets of 249 miles or less declined 26 percent when you compare July 2005 to July 2000. For regional airlines, significant fare increases can mean significantly fewer passengers.

Business passengers, who constitute more than 65 percent of regional airline travelers, have embraced advances in communications technology, making traveling more elective than ever and highly price-sensitive. Airlines may be able to enact fuel surcharges, but these surcharges would still fail to recoup the losses incurred due to the recent spike in fuel costs. Further, given the numerous differences in pro-rate agreements for smaller regional airlines, it is likely that the increase in revenue from their pro-rata portion of the fuel surcharge would not fully compensate them for their increased fuel costs.

Essential Air Service

The Essential Air Service program is administered by the Department of Transportation, where “best and final” competitive proposals are submitted by regional carriers. The Department selects carriers and establishes EAS subsidy rates based on that bidding process.

If a carrier is the only airline serving an EAS eligible community and wishes to exit the market, DOT regulations require it to file a 90 day service termination notice. DOT may hold that carrier in the market during this period, while a subsidy eligibility review or competitive bidding process is undertaken. Likewise, carriers operating EAS subsidized routes must also file a 90 day service termination – subject to even more onerous hold-in policies – in order to trigger a renegotiation of rates if costs increase significantly during the lifetime of the rate agreement.

As part of the EAS application process, carriers negotiate in good faith with DOT on subsidy rates that remain in effect for two years. As part of the competitive bidding process, EAS carriers must project costs and profits over this two-year timeframe – no easy task in today’s volatile cost environment. In cases of unexpected cost increases, EAS carriers have no tool to renegotiate rates and must instead enter into the unpalatable process of filing notice saying that the carrier intends to terminate its service in 90 days to begin the process for seeking compensation rates that cover their increased costs. This inevitably causes ill-will between an airline and community, in some cases fostering a sense of unreliability that ultimately undermines the use of the air service and further drives up subsidy rates (as fewer passengers traveling causes air fares to climb). And the process also forces carriers to operate at a loss for 180 days while DOT reopens the competitive bidding process. This is true despite a cornerstone of the original EAS law which provides that no carrier should ever be forced to serve any community at a loss.

During deliberation of Vision 100, the most recent FAA Reauthorization bill, Congress noticed the destructive effects of rising fuel costs on the EAS program. Under the leadership of this Subcommittee, Section 402 of Vision 100 included a provision giving DOT flexibility in its rate-making process in those instances where carriers experienced “significantly increased costs.” With an eye to preventing deliberate cost underestimation, Congress included an index where “significant increase” is defined as a 10 percent increase in unit costs that persists for two or more consecutive months. Unfortunately, DOT has declined to use the tool Congress afforded it to reconcile fuel cost increases and EAS subsidy rates, citing the need for a specific appropriation. As a result, carriers are losing money on EAS routes in unprecedented numbers.

As just one example, in July 2004, the fuel cost for a Beech 1900 on a one-hour (block time) flight was $133.41. In July 2005, the fuel cost had increased to $202.12, nearly 52 percent higher. Only two months later, for the week ending September 2, fuel costs for that flight were $272.51, up 35 percent from July. These figures utilize jet fuel purchasing formulas commonly employed by regional airlines, based on cost data tracked in the Energy Information Administration’s Weekly Petroleum Status Report. It is important to note that these figures calculate base fuel cost only – they do not include “into plane fees” and federal, state and local fuel taxes. The overall losses across all EAS carriers are staggering and the program, as we know it, is in jeopardy.

In fact, we estimate that current fuel cost increases for all carriers in the program will drive up program costs significantly even if not one more community becomes eligible in the next fiscal year. Yet, according to the DOT website, there are currently 60 EAS-eligible, single-carrier markets which could come into the program. (While more than 60 communities are technically “eligible” I am referencing those that received service pre-deregulation and do not meet other disqualifying factors such as distance to nearby airports). Of those 60 communities, anywhere from 15 to 30 could begin to require subsidy should the carriers file termination notices. Given the significant reductions in small community service and substantial cost increases affecting the airlines, it is reasonable and responsible to plan for more than half of all eligible communities to soon require subsidy. Under even the most optimistic scenario, therefore, the DOT will need at least $127 million in Fiscal Year 2006, to run the program. This Appropriation should also contain a line-item directing DOT to utilize the rate-adjustment tool afforded by Vision 100 to accommodate dramatic fuel cost increases.

Early versions of a Senate appropriation sought to fix this problem by prohibiting newly eligible communities from collecting subsidy; yet such a prohibition runs counter to the original intent of the law, which guarantees air service to eligible communities.

RAA stands ready to help Congress enact further EAS program reforms as the next FAA reauthorization takes place. We are eager to discuss a rewrite of the eligibility criteria, realizing that some rules set nearly three decades ago no longer apply. Nonetheless, the most important thing Congress could do right now to help passengers in EAS communities and the airlines is to release the full authorized amount of $128 million for the EAS program in FY06 and to require DOT’s cooperation in making real-time rate adjustments for cost increases.

Request for Congressional Action

• Considering the staggering impact that increased fuel costs have brought for U.S. regional and major airlines alike, RAA requests, along with our colleagues at the Air Transport Association, that Congress provide a tax holiday on the $4.3 cents-a-gallon tax on jet fuel. Further, we request that any fuel surcharge charged by carriers be exempt from the existing 7.5% passenger ticket tax.

• We further request that Congress reconsider changes to the jet fuel tax rate that were made as part of the American Jobs Creation Act enacted last year and the additional proposed change included in the Highway bill that would require airlines to pay 24.4 cents up front for fuel purchases and file for a rebate from the Internal Revenue Service (IRS). This system, which places the burden on airlines to apply and wait for a refund of the difference, with tax on jet fuel at $4.3 cents per gallon, is causing a severe cash crunch for smaller regional airlines. Changes already implemented by the American Jobs Creation Act brought the upfront costs to 21.4 cents per gallon with the highway bill poised raising the burden even further. Regional airlines do not have any ticket tax payments to offset the fuel tax payments because, in modern code sharing relationships, we do not issue the tickets. We urge you to amend the law and, in the interim, to require IRS to refund the taxes on a monthly basis. This tax and refund procedure places a tremendous burden on airlines and impacts cash flow at a time when carriers are already struggling mightily from fuel costs.

• Finally, we urge you to work with your colleagues on the Appropriations Committee to educate them on the need to appropriate the full, authorized amount of $127 million dollars to keep the important EAS program afloat during this period of dramatic fuel cost increases. The fuel cost increases resulting from Hurricane Katrina have further injured the financial state of EAS carriers who, without rate adjustments and compensation for increased fuel costs, cannot continue to sustain service at a loss. Only a full appropriation of $127 million can prevent service losses at multiple EAS points across the nation.

Conclusion

Thank you for the opportunity to testify on this important issue today. I look forward to responding to your questions at the conclusion of the panel.