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Troubles with regional flights


The Russian market for regional air transportation is in trouble

This fact became so obvious that the government has taken actions, introducing measures to support leasing solutions for regional aircraft. No doubt, these measures have been necessary. Sadly, a comprehensive approach to the issue is not shining through yet. This makes us think that these measures might bring controversial outcome.

Despite the remarkable growth of air traffic in Russia – in 2011 the number of passengers grew by 12.6% - the regional air transportation system continues in stagnation, to describe the matter in most shy words. The economy of this system is of a complex matter. Solvent demand is low, while the airplanes are expensive. Surely, in absolute terms, the regional airplanes are cheaper to buy than larger mainline airliners, but the relative price of one seat in them can be twice as more expensive. In plain words: the regional passenger is low on money, while transportation services being ordered to him are costly.

There is an additional problem to that: the need for a massive fleet renewal. Today, the backbone of the Russian regional fleet is formed by Antonov An-24 and An-26-100 turboprops (90 and 26 units respectively), Yakovlev Yak-40 and Yak-42 tri-jets (55 and 59), and Tupolev Tu-134 twin jet (60). Some of these airplanes have been operational for dozens of years. Their modernization requires considerable investment, regardless of manufacture date: these types are morally obsolete. Leasing seems an effective solution, as it helps the airlines solve a complex problem of structuring financial packages for purchase of expensive assets. In the past few years the aircraft leasing has established itself in the Russian market. Only few years ago the club of specialized aircraft-leasing firms was limited to Ilyushin Finance Company (IFC) and the Finance Leasing Company (FLC) – the latter went nearly bankrupt, though. Most recently, almost all largest banks in the country have established daughter companies specializing in aircraft leasing. In most instances, however, such a company needs not only capital, but also knowledge of leasing operations and skills to implement leasing schemes in the conditions of the given market sector. This is especially true in case of the regional air transportation system.

IFC did a study into the matter. One of the findings has been that the regional transportation market in the European part of Russia considerably differs from that in the country’s Asian part. Each part has its specifics. In the European part of the country there are 11 airlines operating regional air routes. Runways of all 36 airports in their route network have artificial surface: runways are paved with concrete. Typical flight distances fall within the corridor of between 200 km and 800 km. Passenger flows and runway conditions permit usage of the ATR-72 и the Bombardier Q400.

The situation on the other side of the Ural mountain chain is different. There are 18 airplanes operating regional air routes there. Out of 119 airports, those with unpaved (grass) runways account for 43%. Typical flight distances fall between 400 and 3,000 km. The ATR-72 does not have enough range to operate all of the routes. The Q400 fit in better, along with the Antonov An-140 turboprop and the An-148 regional jet.

So, there is no a universal solution for the Russian regional market. By rough estimates, the demand in new regional aircraft in this market is estimated at about 200 units by 2030. After the prime minister publically expressed his concern about the ageing regional fleet, the Russian government looked into the issue and came out with the Order 1212. Issued late last year, it allocates funds for slashing rentals on aircraft with up to 55 seats regardless of engine type, and up to 72 seats for turboprops specifically. In practice, the Order 1212 provides a one-time subsidy that makes it possible to reimburse prepayments for a regional aircraft being acquired on leasing terms. Surely, this governmental measure has been a good step forward. But it must be noted that the airplanes with seating capacity between 50 and 110 passengers (including turboprops) are still subjects for customs duties. In effect, a considerable part of the subsidies will be spent on customs duties when a foreign-made regional aircraft is imported into Russia. It seems that a better solution would be removal of the customs duties on imported regional airplanes with turboprop power units, seating up to 72 passengers. But this issue is yet to be agreed between the governments of the Customs Union members: Russia, Belorussia and Kazakhstan.

Under command of the prime-minister, the Russian government issued Order 1211 to support regional air transportation system with more subsidies from the Federal Budget. It expands the application of earlier introduced reimbursements to air fares that are paid by the passengers travelling from Far East of Russia to the European part of the country. These measures are applicable to passengers with age below 23 years and senior citizens. However, at a closer look, the new measures will not work on 90% of the 162 air routes listed. The text of the government order says that the subsidies are provided on co-financial terms with the administrations of the given regions. Since most of the listed air routes are between regions, subsidizing ticket prices on those routes can be rendered misuse of federal funds. In order for the federal budget’s subsidies to be applicable to these routes, a number of changes are required to the law base with general idea to permit consolidation of the regional administrations’ budgets and using their budgetary allocations to reimburse air fares.

“As of now, what we see is a fragmentary approach [from the side of the government]: although the commands of the prime-minister have been addressed, the new governmental measures produce only a minor effect. What is needed is a comprehensive plan for fleet renewal and subsidies to carriers”, IFC general manager Alexander Rubtsov says. “It is also necessary to address expenses on additional equipment for airports and their certification, personnel training, modernization of air traffic control system. Besides, there is a key issue, that of making possible operating lease solutions [in the Russian practice]. This requires changes to the Law of Leasing so that budget subsidies [already available for finance lease solutions] can be [also] applicable to the operating lease”.

IFC believes that the operating lease shall be added to the portfolio of solutions applicable in the Russian market. This is a more flexible tool, since contracts are normally five year term, against 15 year typical for the finance leasing. Besides, airline customers can reduce their expenses by some 15-20% as soon as they do not actually buy the airplane [in a hire purchase, as in the case of the finance lease]. That is very important in relation to airlines operating regional air routes – in most instances, their economics are not very stable.

At the same time, arranging operating leases requires higher skills of leasing company’s staff members. In contrast to the finance lease, where the focus is placed firmly on the quality of the company that acquires the asset (the airline must show its ability to repay credits), the operating lease is more flexible and shifts focus on the quality of the asset itself – the airplane in our case. Operating leases are often short term; besides, the airline customer may experience economic difficulties (which are not out of the ordinary in the stagnating market) and cancel the leasing deal prematurely or even cease operations entirely. In that case the lessor needs to re-arrange the deal or place the airplane with another airline. To reduce the down-time, a new operator for the airplane shall be found fairly quickly. In order to be able to do that, the lessor shall be careful in watching the residual value of the airplane and seeing to its technical condition. In some instances, companies like IFC even undertake to perform certain repair work on their aviation assets themselves.

It needs to be stressed in the summary that encouragement of operating lease in Russia is seen as an important step, along with many others leading to creation of more favorable conditions for development of the nation’s regional air transportation system. It requires changes to the law base and, also, development of new skills and competences of the Russian leasing companies. These companies must improve their skills on monitoring the changing market conditions and understanding market trends, and their ability to work closely with aircraft suppliers and airline customers. More importantly, the lessors must develop their remarketing skills since they accept higher risks. Cases are known when certain Russian airlines discontinued paying rentals for a number of reasons. This placed banks which possessed the assets into a complicated situation after their assets were taken out and… not placed with other operators. Grounded airplane brings loses… while finding a good new operator (able to effectively employ the asset and pay rentals) requires time and skills.

Original story is available at http://kommersant.ru/doc/1912139
Author: Alexei Sinitsky, chief editor, the Air Transport Observer magazine