Program Review and Investigations Committee




<MeetMDY1> October 14, 2010


Call to Order and Roll Call

The<MeetNo2> Program Review and Investigations Committee met on<Day> Thursday,<MeetMDY2> October 14, 2010, at<MeetTime> 10:00 AM, in<Room> Room 131 of the Capitol Annex. Senator John Schickel, Chair, called the meeting to order, and the secretary called the roll.


Present were:


Members:<Members> Senator John Schickel, Co-Chair; Representative Kelly Flood, Co-Chair; Senators Jimmy Higdon, Vernie McGaha, R.J. Palmer II, Joey Pendleton, Dan "Malano" Seum, Brandon Smith, and Katie Kratz Stine; Representatives Dwight D. Butler, Terry Mills, Rick Rand, and Arnold Simpson.


Guests:  John Mok, Chief Executive Officer, Cincinnati/Northern Kentucky International Airport;  Charles T. “Skip” Miller, Executive Director, Louisville International Airport;  Bob Whitmer, Executive Director, Owensboro-Daviess County Airport;  Richard Roof, Manager, Barkley Regional Airport; Brian Ellestad, Deputy Director of Air Service & Community Relations, Blue Grass Airport; and James Parsons, Of Counsel, Covington, Taft Stettinius & Hollister.


LRC Staff:  Greg Hager, Committee Staff Administrator; Rick Graycarek, Christopher Hall, Colleen Kennedy, Van Knowles, Lora Littleton, Jean Ann Myatt, Sarah Spaulding, Cindy Upton, and Stella Mountain, Committee Assistant.


Approve Minutes for September 9, 2010

Upon motion made by Representative Simpson and seconded by Representative Mills, the minutes of the September 9, 2010 meeting were approved by voice vote, without objection.


Staff Report:  Air Service at Kentucky’s Commercial Airports

Rick Graycarek gave an overview of the report, which describes air service in Kentucky and the United States and incentives for air service that have been provided by airports, local governments, private entities, and state governments.


Commercial airports, the focus of the report, provide regularly scheduled air service and have at least 2,500 passenger boardings annually. The five primary commercial airports in Kentucky are Cincinnati/Northern Kentucky International, Louisville International, Blue Grass in Lexington, Barkley Regional in Paducah, and Owensboro-Daviess County Regional.


Mr. Hager said the first of the report’s six major conclusions summarizes proposals from the Northern Kentucky, Louisville, and Lexington airports to increase air service.


Their first proposal is to establish a tax increment financing (TIF) program for development of air service. Statutory requirements are that TIF projects be capital projects with minimum capital requirements for a project ranging from $10 million to $200 million. State tax revenues that may be pledged are specified. These do not include all tax revenues that would be generated by increased air service. The three airports note that the existing TIF programs are not appropriate for increasing air service.  Mr. Hager said that increases in aircraft fuel tax revenues would be limited by a statute that caps an air carrier’s aircraft fuel tax payment at $1 million per fiscal year.


Their second proposal is that the state should establish a revolving loan fund by issuing bonds. 


Their third proposal is for authority to establish separate operating units to provide aeronautical services that airlines now typically provide for themselves such as baggage handling. The airports suggest that services could be provided for a lower cost through a private company instead of governmental employees who would participate in the Kentucky Retirement Systems.


The second conclusion is that the air transportation industry has undergone significant changes such as high fuel prices, the recession, airline bankruptcies, and airline mergers, which in turn affect the public and airports.


Mr. Graycarek said the third conclusion is that for Kentucky’s five commercial airports, from 2000 to 2009, total flights decreased by more than 25 percent, the number of passenger boardings declined by nearly half, and the number of available seats decreased by 49 percent.  Most of the decreases were at the Cincinnati/Northern Kentucky airport.  Passenger boardings over this period were down approximately 18 percent at the Louisville airport and 11 percent at the Lexington airport, but the number of flights increased at both. Average air fares were higher at Kentucky’s commercial airports than the national average.


            The fourth conclusion is that Federal Aviation Administration (FAA) policies restrict the use of airport revenues. Airport owners and operators are prohibited from using airport revenues for purposes unrelated to airport and for direct airline subsidies. Waiving or discounting landing fees for a limited period is allowed but must be offered to all users of the airport.


            Airport operating revenues come from many sources. Landing and terminal arrival fees (fees paid by airlines) account for a large portion of Kentucky’s airport revenues, but so does parking and ground transportation.


Federal revenue is an important source of funding but is mostly for capital projects.  Through the Airport Improvement Program, Kentucky airports received     $32.2 million in Fiscal Year 2009. Examples of projects are runway improvements and planning. The Essential Air Service Program provides a subsidy to airlines providing service to smaller communities. Currently, Paducah receives $570,000 and Owensboro $1.1 million. The Small Community Air Service Development Program (SCASDP) is a federal program that can be used to provide incentives to airlines to help smaller communities enhance air service. Since 2002, seven communities in Kentucky received grants.


            The fifth conclusion is that airport-airline use agreements can affect an airport’s ability to provide incentives.  Use agreements establish rights, privileges, and obligations between airport and airline tenants.  A residual agreement gives airlines greater control over airport finances, but poses less financial risk to airports (Cincinnati/Northern Kentucky Airport has a residual agreement).  A compensatory agreement gives airports greater financial control, but also more financial risk.  (Louisville and Lexington airports have compensatory agreements). Agreements can affect airports’ use of revenues.


            The final conclusion is that there are numerous examples of airports, local governments, and private entities providing incentives to airlines to expand or maintain air service.  Cases of state governments providing incentives are less common.  There appear to be only two states with ongoing programs for funding incentives for air service.


            Mr. Hager said the effectiveness of services being provided with and without incentives is unknown. There are four basic categories of incentive techniques.                The minimum revenue guarantee establishes a minimum level of revenue that an airline will get for a specified service. If revenue from passengers on the guaranteed flights is less than the agreed-upon minimum, then the airport or other entity making the guarantee is responsible for making up the shortfall. In a guaranteed ticket purchase program, also called a travel bank, businesses or individuals deposit funds in a bank account to be used for purchasing tickets on a specified airline over a specified time period. Cost subsidies are financial incentives to reduce an airline’s costs for providing a specified service. Examples would be waivers or reductions in landing fees. Airports may also provide, for a fee, ground services that an airline would otherwise have to provide itself. The most common technique is marketing or advertising for an air service that is provided or purchased by the airport or other entity. 


The Station Services program at the Mobile Regional Airport is an example of an airport providing ground services to maintain air service.


A state-funded incentive that has not worked out as well is the more than $16 million that the Ohio state government offered to Continental Airlines to expand its capacity at the Cleveland airport. The airport’s situation has changed from plans in 2007 for significantly increased domestic and international service to a legal agreement, after Continental’s merger with United Airlines, to limit reductions in service.


Kansas is one of the two state programs. In 2006, the state legislature established the Affordable Airfare Fund to provide more flight options, more competition for air travel, and affordable air fares. To date, state appropriations to the program have totaled nearly $25 million. Almost all incentive money has gone to AirTran to provide service to Atlanta from Wichita, but some has gone to another airline for flights to Denver. A report done by Wichita State University estimated that the overall economic impact over a 5-year period of the added AirTran service was approximately $130 million.


The Wyoming legislature created the Air Service Enhancement Program in 2003 due to the lack of competition among air carriers. The legislature has appropriated $1.5 million annually for a total of $18 million to date. The Aeronautics Commission, part of the Kansas Department of Transportation, decides which projects submitted by airports will be awarded state funding and how much local matching funding is required. Most funding has been used for incentive payments from airports to air carriers, but funds have also been used for marketing and facilities’ enhancement.


Proposed bills to create two more state programs were introduced in 2010 but were not enacted. In South Carolina, a bill would have created the Air Service Incentive and Development Fund of up to $15 million to be administered by the Aeronautics Commission. In Louisiana, a bill would have created an Air Service Fund that would receive $9 million each year from existing state aviation fuel tax revenues.


Senator Schickel noted that a business plan was requested from Delta at the joint meeting with the Interim Joint Committee on Economic Development and Tourism in August. A document was received October 12. Officials from the Northern Kentucky airport had requested it in August. Copies of the document were placed in committee members’ folders. 


In response to a question from Senator Stine, Mr. Graycarek said that he was unsure how it is determined which communities have insufficient air carrier service or unreasonably high airfares to be eligible for the Small Community Air Service Development Program (SCASDP) Grants.


In response to questions from Senator Stine, Mr. Hager stated that the $1.6 million SCASDP grant was for a community in Florida and that he would provide more specific information.  Statutory changes would be required to establish the tax increment financing program and revolving loan fund proposed by the Northern Kentucky, Louisville, and Lexington airports, but it is conceivable that airports could create separate operating units to provide services to airlines under existing law.  Employees of the Northern Kentucky airport are participants in the County Employees Retirement System.


In response to a question from Senator McGaha, Mr. Hager said that airport officials could better answer but he would speculate that some of the decreased traffic at Northern Kentucky is handled by other Delta hubs such as Detroit.


In response to a question from Senator Stine, Mr. Graycarek responded that the airport-airline agreement at Northern Kentucky expires in 2015.


In response to a request from Senator Stine, Mr. Hager noted that staff could provide information on nonstop flights provided by the different Kentucky commercial airports.


In response to a question from Representative Mills, Mr. Hager said that for the report, staff did not research the interaction between officials in different states regarding benefits of and incentives for airlines at the Northern Kentucky airport.


In response to a question from Senator Schickel, Mr. Hager said that it is possible that airports may prefer to provide services themselves rather than contracting for them because the airports assume they could perform the services better and have more oversight of them.


In response to questions from Senator Stine, Mr. Hager noted that staff did not research airport commercial operating units internationally, but that his understanding is that they are common.  If airports’ provision of ground services reduces cost to airlines, then this would provide an advantage to that airport.  The advantage would be reduced if additional airports began to provide ground services.  In the U.S., Mobile and Owensboro are known to provide ground services, but staff would provide further information on other airports providing ground services.


In response to the report, Mr. Miller addressed the proposal for limited liability corporations (LLCs) as providers of airport services, something being done at other airports in the country.  The three Kentucky airports would prefer statutory changes that specifically authorize the creation of separate operating units in order to avoid any potential legal challenges.


In response to questions from Representative Simpson, Mr. Miller noted that the Labor Cabinet or County Employees Retirement System are examples of entities that might challenge the establishment of a limited liability corporation by an airport authority on the grounds that it would circumvent labor agreements or the retirement system.  Illinois law authorizes creation of LLCs by an airport authority.  Mr. Miller and Mr. Mok noted that the employees of their airports are covered under the County Employees Retirement System.


Mr. Mok summarized the proposal for a revolving loan fund.


Mr. Parsons summarized the proposal for tax increment financing that could be used to increase air service.  The existing state TIF program is not appropriate; statutes need to be amended. 


In response to a question from Representative Simpson, Mr. Mok stated that the Northern Kentucky airport has unsuccessfully tried to get assistance from Ohio state government.


Representative Simpson suggested that the Cincinnati chamber of commerce would be better suited to get assistance from the State of Ohio. 


In response to a question from Representative Simpson, Mr. Parsons noted that the airports’ suggestion for using TIF funding to increase air service is a new idea.


In response to a question from Senator McGaha, Mr. Miller stated that the FAA prohibits airports from providing direct subsidies to airlines using airport revenues.  Mr. Mok said that the FAA regulations do not prohibit this outright if incentives are available for everyone.  A practical limit on providing funds for increased air service is that existing airlines fund the airport.


In response to a question from Senator McGaha, Mr. Mok said that the Northern Kentucky airport has had a residual contract since the 1970s, when this was the prevailing contract type.  Mr. Miller noted that the Louisville airport has a compensatory contract but probably had a residual contract in the past.  After deregulation in 1978, hub-dominated airports typically stayed with residual agreements; airports that were not major hubs were more likely to use compensatory agreements.


In response to a question from Senator McGaha, Mr. Mok said that Delta is in compliance with its agreement with the Northern Kentucky airport.


Mr. Whitmer said that the Owensboro airport provides above- and below-wing services for Allegiant Air.  The airport does this with part-time employees because Allegiant only has three to four flights per week, so there is not enough of a market to attract the private sector.


Senator Stine commented that this model would make Kentucky airports more appealing internationally. 


In response to a question from Senator Stine, Mr. Mok said that the Northern Kentucky airport has been very aggressive in pursuing international service.


Mr. Whitmer stated that Allegiant Air at other airports contracts privately for some ground handling services but prefers that airports provide those services.


In response to a question from Senator Schickel, Mr. Whitmer said that the ground handling employees are part-time; only full-time employees of the Owensboro airport are under the Kentucky Retirement Systems.


Senator Schickel commended the airports for cooperating.


The meeting adjourned at 11:50 a.m.