Cleared for take-off

The grand reform that awaits Ukrainian airports and aviation

In early March, the Cabinet of Ministers of Ukraine announced the state-wide special programme on airport development up until 2023 (hereinafter, the “Programme”). The first legally formalised attempt in the history of Ukraine to tackle the issue of airport reforms has caused a ruckus in the press: emotions range from cautious optimism to claims of further “betrayal.” Since the author of this article has consulted the relevant work group on legal matters during the preparation of the document, he will try to shed some light on the issue.

In high turbulence: what is currently going on with the airports?

The Ukrainian aviation and airport infrastructure is made up of approximately forty airports and airfields. The airports “Boryspil” and “Lviv” are state-owned while others belong to territorial communities and are in decay. Although there had been a few attempts to modernise, they were quite disorganised – private investors were engaged in erratic construction and development in municipal airports (Kharkiv, Dnipropetrovsk, Odessa, and Kyiv’s Zhuliany Airport) at different times; the state-owned airports’ (Boryspil, Lviv, Donetsk) grand scale repairs were financed from the state’s Euro-2012 budget.

In our opinion, the absence of a systematic approach on the part of the state has always been one of the main problems in this industry. The state has not been able to attract serious investors and acts as the classic dog in the manger: it is unable to efficiently develop the airports and is not willing to let the private sector take over. The regional airports have simply turned into Soviet-era architectural monuments; their terminals are desperately outdated, have very low pass-through capacities, and consequently can no longer remain in operation.

Such infrastructure will not be able to support the growing demand for air travel, especially when it comes to domestic flights. Ukraine has not taken advantage of its unique geographical location for organising large transit routes through its airports, unlike its neighbours – Poland, Turkey, and Latvia.

Currently, the industry remains in the high-turbulence zone. The economic crisis, war, loss of territory (which also means the loss of air corridors), bans on flights to Russia, and currency devaluation hurt air travel and passenger flow the most.

In this context, the appearance of a certain strategy for airport development is a significant event, and the document itself deserves attention.

Coming out of a nosedive: how the industry’s problems should be solved.

For better or for worse, the existence of the Programme is not part of the government’s reaction to the current crisis. Heated debates regarding the reform can be traced back to 2012. Since 2013, Deloitte along with other consulting firms has assisted the Ministry of Infrastructure (MIU) with the preparation of the Programme. Its concept was approved in October 2013 and the Programme itself was approved in March 2016. In other words, the ideas imbedded in the document passed the test of time, surviving multiple crises and governments.

The key goals of the Programme are: the allocation of the airport facilities to airfields and facilities that do not belong to them, the establishment and development of the unified airfield network in one enterprise, nationalisation of the main municipal airfields, signing the Common Aviation Area (CAA) agreement with the EU and liberalisation of the international air carriage market. 

Even a layman understands that the state is taking on an ambitious and complicated reform, as it is establishing, allocating, and returning something and, moreover, signing an agreement with the EU. Let us analyse how realistic this is and what it should lead to.

Principles of aerodynamics: what is the main essence of the Programme and how will it take off?

In our opinion, the main purpose of the Programme is to engage private investors in the airports’ development through the establishment of a civilised base for different forms of public-private partnership (PPP). The first two steps are the allocation of functions in the air transport management sphere and the allocation of the airports’ property.

The government’s intention to simultaneously own, manage and profit from air transportation is a rudiment of the past epoch. Our state cannot pride itself on being an efficient owner, which we can attest to as every-day users of the public infrastructure. At the same time, the state’s primary task is to ensure the full safety and security of its citizens, including transportation security.

The separation of administrative (including the state security function) and commercial functions between the regulator and commercial entities is the latest trend in the transformation of Ukrainian infrastructure. This approach is, in one way or another, applicable to sea, river and railway transportation (see the respective laws and draft laws). Air transportation should not be an exception.

The allocation of functions will come into effect along with the allocation of property. To clarify its essence, one should describe in a simplified form the real estate status of any civil airport.

From a technical and organisational point of view, the airport may be relatively divided into two specific parts.

The first part includes the necessary facilities for carrying out flights: the facilities and territory where an airplane lands, taxis, parks (runway, taxiway strip, ramp, related air navigation facilities, etc.). Let us call this part the “Airfield.”

The second part is nonflying, it includes passenger-carrying and cargo terminals as well as other infrastructure intended for ground servicing of airplanes, passengers, crews, luggage handling and other types of non-aviation activities. Let us call this part the “Terminal.”

Although the Airfield and the Terminal are bundled into the single concept of an airport, their investment opportunities are inversely related due to substantial differences in legal regulation and functions.

The Airfield is an important component of the state’s transportation safety. It may be used during wartime and for other strategic purposes, independent of the Terminal. The Air Code of Ukraine bans the disposal, sale, privatisation, exchange, and pledge of the state and municipal airfields. The runways have “strategic character” according to law and cannot be leased. Hence, the burden of constructing, maintaining and repairing airfields falls on the state. The repairs alone amount to hundreds of millions of US dollars. In this respect, the Airfield is of no interest to an investor.

The Terminal, on the other hand, is less regulated and attracts private investment, mainly because of the various sources of non-aviation profits. Passengers already start spending money as they approach the Terminal, e.g. at the paid parking lot or at the car rental. Once inside the Terminal, passengers find themselves in an enclosed space where their main occupation is spending money in duty free shops, restaurants, etc.

Maintaining this part of an airport’s infrastructure also requires serious investment; however, it can generate considerable returns. For comparison, leading international airports’ shares of non-aviation income, the majority of which are managed by private operators, exceeds 40 percent, while in the state-owned “Boryspil” it amounts to approximately 20 percent.

The law states that a terminal complex may be transferred to a private investor as part of a PPP and rent agreement. The Programme adds that a terminal complex must be transferred.

As a result, the Airfield and Terminal operate under different legal and economic regimes, first and foremost in regard to the private investor’s participation in their development. The Airfield is a strategic asset while the Terminal is an investment asset. At the same time, the vast majority of Airfields and Terminals in Ukraine are inextricably connected as assets on the balance sheet of the same public companies – airports. These companies face a wide range of country- and industry-specific problems: inefficient, non-transparent management and very expensive “strategic” property, which does not allow raising private funds.

In addition, even the most successful airports during times of better economic conditions in Ukraine did not manage to maintain sustainable profits and were burdened with debt taken out to cover construction and repairs for the Euro-2012 tournament. Lastly, there is a problem with allocating airport property between the central government and municipalities.

The most logical way to transform Ukraine’s airports into investment-grade assets is to separate its facilities into strategic and investment components. As a result, investors can invest in the Terminal while the Airfield remains under state ownership, meaning they are centrally managed and developed (allocation of functions).

Selling air: is it profitable to unite the airfields?

The Airfields will be handed over to the operating state enterprise in charge of the aviation industry or to the newly formed SE Airfields of Ukraine. Among the existing enterprises, Ukraeroruh is considered to be the main contender for such consolidation. It is the state monopoly in charge of providing air traffic and navigation services. Actually, Ukraeroruh literally sells air by collecting fees from airlines for using Ukraine’s airspace.

Ukraeroruh is unique in its function and very profitable (although it has reported losses in light of the events of recent years). Even Ukraine’s Law “On Management of State Property,” which requires all unitary state enterprises to pay a tax rate of at least 30 percent of net profits makes an exception only for several entities, and Ukraeroruh is among them.

The MIU has not made a decision in favour of Ukraeroruh yet, but the public has already voiced its objection. The Air Traffic Control Association of the Labour Unions wrote an open letter calling the attempts to burden Ukraeroruh with non-core assets, thereby trying to develop the airports at its expense, “confusing and even criminal.” In addition, there was a concern that these operations might violate the principles of the ICAO (International Civil Aviation Organisation) and EUROCONTROL (European Organisation for the Safety of Air Navigation), which may ban Ukraeroruh from conducting air navigation due to its "non-core" activities.  

In response to these concerns, the management of MIU and Ukraeroruh held a briefing where they stated that such an association does not violate international rules. Their position may be supported by reference to international experience: in Norway, the association of airports was established on the basis of Avinor state enterprise, which manages the country’s air navigation system. In any case, the final decision should be made after its comprehensive examination on compliance with Ukraine’s international obligations in the sphere of civil aviation.

The enterprise of associated airfields will be able to profit from their exploitation centrally, by collecting fees for takeoffs and landings, above-norm parking, aviation security, etc., and to further redistribute resources based on the needs of the entire industry. This principle is already implemented in Ukraine’s Law “On the Sea Ports of Ukraine” where the administration of seaports performs similar functions. However, unlike seaports, where privatisation is prohibited and acceptable PPP arrangements were not implemented until recently, such reallocation may serve as motivation for receiving funds for runway repairs from investors, as long as the local council consents.

Moreover, we have already mentioned the high cost of airfield repairs and the current inability of the airports to take out loans to cover such costs. The Minister of Infrastructure of Ukraine, Andriy Pivovarsky, has pointed out that a newly established legal entity will be able to raise the necessary funds from international financial institutions.

Taxi into the city at a low price: who will finally set things straight at the airports?

Terminals may be leased to investors, who in turn can be granted concession, management and joint activity.

The final and most difficult (after the reallocation of property) stage of the Programme in terms of PPPs is the preparation and implementation of investment projects in the Terminals.

It is one more part of the plan where one may spot “betrayal”; the state allegedly covers infrastructure expenses while profits are "shared", as usual. As a response to these risks, the MIU and other relevant government bodies should demonstrate the highest possible transparency and legitimacy of their actions.

An alternative to this convincing reform is maintaining the status quo, where many airfields have grown over with wild grass and terminals look like crumbling sheds with no future. One spectacular example is the small municipal airport Izmail in Odessa Region. In the late 2000s, the airport received flights from Kiev, Odessa, Donetsk, Moscow, Izmir (Turkey) and Barcelona. Although it may be difficult to believe, today it is nothing but a wasteland. From a logistical point of view, the location is very promising; it is close to the Danube Delta with the EU just across the border.

There are large seaports (which harbour large cruise ships), beaches and vineyards. After establishing the ferry line up the Danube into Romania and after reopening of the Odessa-Reni highway, the airport may be in high demand. Izmail may be relaunched again at a relatively low cost, which the regional council inevitably cannot afford. All that is needed is an investor.

The full range of organisational, financial, legal and tax issues related to the investor’s entry will not be able to (and should not) be resolved only by property holders and the Ministry. It is likely that the involvement of international donors and investors will become a crucial factor. As the result of transparent tenders, the leading international operators should invest in the main terminals in Ukraine.

As passengers, we will immediately feel investors’ presence, which will involve convenient parking lots, high quality and variety of services, the absence of long queues, competitive prices, and the absence of the old mantra in Arrivals, "Taxi into the city at a low price."

International flight: who has already done it?

Planned activities are not part of the Ukrainian "know-how". We relied on the experience of other developing countries (Turkey, Mexico, China) where, due to the limited state budget, private investors fund the terminals’ modernisation while the state takes care of the airfields. The consolidation of airports into one public structure, which effectively manages and redirects revenue streams, attracts investors to terminals and develops airfields, is a global practice (Norway, Sweden, Finland, Spain, Portugal, Lithuania, Greece, Turkey, India, and others).

Many countries, including the US, UK, Germany, China, Turkey, Mexico and Georgia allow various types of PPPs in airports.

Flight on schedule: when will the Programme be executed?

According to the special Act “On State Targeted Programmes,” the Programme is “a package of interrelated tasks and measures” and is not an obligatory regulatory legal act. It is rather an instrument of state planning. However, we hope that due to the importance of the Programme’s goals for the industry, the government will consider it as a duty to society, and MIU will treat it as a top priority.

The market and experts should actively participate in the aviation infrastructure reform, instead of idly waiting for it. The Cabinet of Ministers is legally obligated to find early solutions regarding airfield property and its management.

During the Programme’s initiation in 2013, its implementation was planned for 10 years, until 2023. In the final version they decided not to shorten the deadline; consequently, there are less than eight years left.

The main legal argument in favor of a more rapid implementation of the Programme is the time limit for setting up the required standards and appropriate decision-making bodies. We focused on this issue in the past and tried to find legal loopholes that would not call for the adoption of new laws.

Unfortunately, the inefficiency of the legislative work of the Ukrainian Parliament (Verkhovna Rada) can stall any reform, including the abovementioned aviation reform, especially considering that the parliament has traditionally ignored infrastructure-related issues (e.g. the draft laws on rail and domestic water transportation have been sitting on the shelf for a long time).

In general, the Programme has managed to "shun" the parliament; achieving its main goals does not require adopting new laws or amending existing laws. Most importantly, the Programme does not envisage privatisation. Legislators will only be needed to amend the annual state budget, in case it is necessary to include the state’s guarantees for investments in the airports, which has already been mentioned in the Programme.

Moreover, the change from communal to a state form of airfield ownership with subsequent aggregating. Formally, these issues are not under government control and will require consent from local councils. Often troublesome jural relationships related to property will significantly complicate the task. However, if the Cabinet of Ministers wants to run its own programme, then it will need to capture the minds of the local authorities to convince them that the region will benefit from investors and air communication. In other words, the communities have to want to participate in the implementation of the Programme.

Open and clear skies: when will passenger traffic increase?

The Programme focuses on airports’ problematic issues, but also addresses aviation transportation issues (i.e. the promise to sign the agreement on the Common Aviation Area with the EU and to make the aviation market more competitive). The Programme’s implementation will mainly affect air transportation. All key indicators regarding passengers (passenger traffic, transit and airport capacity) are expected to double.

For example, in the best years of Ukrainian aviation (i.e. 2013) the passenger traffic in Ukrainian airports amounted to nearly 15.1 million passengers. For the years 2014-2015, passenger traffic fell to approximately 11 million (10.9 million in 2014 and 10.7 million in 2015). The Programme promises to more than double passenger traffic, increasing it to 24.3 million people by 2023.

An expected result regarding the speed of ground servicing of planes is forecasted with high precision, 30-40 minutes. The Programme’s implementation cost estimate is also quite accurate: UAH 8.6 billion, of which 1.2 billion is sourced from private investments while 5 billion are from other sources, including state guarantees.

In this regard, two important points are to be noted.

Firstly, despite the accuracy of the abovementioned indicators, the criteria for the most important result,  airport PPPs, were vague. Its literal formulation was as follows: "PPP activation and the creation of a favourable investment climate." We are striving for more accurate KPIs, measured in projects, terminals, budget revenue, etc. Such KPIs can be agreed during the subsequent stages of the Programme.

Secondly, the Programme is mainly aimed at developing airports. It is worth remembering that air transportation and an airport are not the same thing, figuratively speaking, they are as different as heaven and earth.

Large construction projects in Ukrainian airports for Euro-2012 and life after the championship have revealed to the industry a simple, but unobvious truth: despite the number of built airports, it is not enough to attract planes filled with passengers. The sky may be open for flights and vacant at the same time.

One should not expect rapid growth in the number of airlines immediately after joining SAP. The signing of the agreement between Ukraine and the EU is now blocked because of the dispute between the UK and Spain over the status of Gibraltar.

However, the importance of this issue should not be overestimated for our aviation prospects. Moldova, for example, managed to join SAP two years ago, however, there has been no rapid development of aviation. Even the experience of a unilateral implementation of the "open sky" regime in Lviv and Odessa shows that such a step on its own does not lead to the increase of passenger traffic.

So, how can we bring Ukrainian airports back to life, especially the regional ones, and fill the Ukrainian skies with airplanes and the airplanes with passengers?

Airport a la Turkey: how did the neighbours do it?

The author values Turkey’s experience. The aviation industry in this country has done really well for the last few years. The Turks were not in a hurry to build airports. They started with simpler things, like high-quality “all included-service” leather factories and textile mills. First, they developed their economy, improved the purchasing power of their domestic consumers and appealed to foreigners. Domestic passengers will buy  airplane tickets only when they can afford it and foreigners will comes to the country when there are opportunities for business. Upon solving these problems, it is the right time to develop airports.

Turkey’s success is exemplary: between 2002 and 2013, the number of civil airports doubled (from 26 to 52), its air fleet grew by 180 percent, the number of passengers increased from 34 to about 150 million (a 343 percent increase). Istanbul’s Ataturk Airport is third in Europe in terms of passenger flow, surpassing Frankfurt’s international airport, and the new airport in Ankara will become the largest in the world.

When the author brought up this argument at one of the Programme’s working group meetings in MIU, the First Deputy Minister, Vladimir Shulmeyster, joked that in this situation MIU’s work on airport-related matters must be stopped and passed on to the Ministry of Economy. The comment was really a half joke as it is necessary to understand the position of the Ministry of Foreign Affairs and the Parliament (Ukraine is waiting for a visa-free travel regime with the EU) as well as the Antitrust Committee (antitrust regulation is in the works, which should result in lower airfares).         

Furthermore, we have to get the ball rolling and the relevant authorities must deal with the issue of airports immediately. In the past, Ukraine’s airports were unable to accommodate growing passenger flows. Moreover, transit is another important aspect of the aviation business; it is influenced neither by passengers’ purchasing power nor by a region’s tourist allure. One look at the geographic location of Kiev and Odessa in relation to Istanbul is enough to gauge Ukraine’s transit potential.

Air flight for the price of a bus ticket: when will "low costers" finally come?

I think that any state official who, after so many promises, will finally bring Ryanair to Ukraine will immediately gain serious political weight and will have a bright political future. Perhaps some of the Programme’s authors, who were charged with the task of increasing the low-cost airlines’ market share to 30 percent, have also thought about it.

While working on the Programme, we asked representatives of the Eastern European aviation authorities which actions our airports and local communities should take to provide favourable conditions for low-cost airlines (e.g. reduced airports fees, municipal grants, etc.). The status quo in Ukraine is that there is no need for “low-costers” and no need to provide any conditions for them. "Low-costers" will flock to Ukraine only when favourable economic and political conditions appear, and they would offer different options for mutually beneficial cooperation.

The first step is to work on the implementation of the Programme and contribute to Ukraine’s economic growth.

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