Canada: Taking Flight: Expanded Canada/U.S. Open Skies to Begin September 2006

Beginning September 1, 2006, a new "Open Skies" agreement between Canada and the United States is scheduled to take effect. The expanded agreement, reached on November 11, 2005, will provide passenger and cargo carriers on both sides of the border with greater access and increased pricing flexibility.

The changes expand upon the earlier governing agreement entered into on February 24, 1995, which provided carriers with the ability to operate unlimited service to any points in the partners’ respective territory, without restrictions on capacity or frequency of service. The 1995 agreement also left prices unregulated, subject to both governments finding any fare inconsistent with a set of anti-competitive principles outlined in the agreement.

The new Open Skies agreement offers three primary developments:

1. Carriers have access to unconstrained "fifth freedom" rights. This provides carriers with the right to carry traffic from the other country’s territory to a third nation as an extension of service to or from its country of registration. For example, Westjet could fly from Toronto to any of its Florida destinations, drop off and pick up passengers, and continue to Nassau, Bahamas, one of the newest additions to its schedule.
2. Carriers are able to offer the lowest prices for passenger and cargo services between the other partner’s territory and a third country.
3. Carriers have access to cargo "seventh freedom" traffic rights. This permits carriers to operate stand-alone all cargo services between the other partner’s territory and third countries. The larger U.S. carriers may have the most to benefit from this provision. For example, UPS could now enter the Canadian international cargo market by operating a flight from Calgary to China.

While the new liberalized agreement is being applauded as a move in the right direction, several stakeholders do not agree. Some carriers in Canada worry that unconstrained fifth freedom traffic, also referred to as cargo coterminalization, will make it increasingly difficult to remain competitive. Prior to this agreement taking effect, the restrictions on cargo co-terminalization prevented carriers from operating continuous service between points in the other partner’s territory. For example, a U.S. carrier was not permitted to unload cargo on a continuous service between Memphis, Vancouver and Calgary. The Vancouver to Calgary leg was not permitted. Under the new agreement, however, cargo co-terminalization is permitted, thereby allowing a U.S. carrier to operate cargo service between Canadian points when originating from the U.S.

Despite the easing of restrictions on cargo co-terminalization, the new agreement maintains restrictions against cabotage. A carrier is not permitted to carry cargo solely between points in the other partner’s territory. For example, while a U.S. cargo carrier is now permitted to operate services between points in Canada when originating from the U.S., the carrier is restricted to dropping off U.S. originating cargo or picking up U.S.-destined cargo only at those additional Canadian segments. Any cargo travelling between points in Canada is off limits to the U.S. carrier.

The blanket restriction against cabotage, both in the passenger and cargo markets, is widespread throughout the industry. In fact, with the exception of the European Union, countries around the world continue to prevent foreign carriers from operating domestic service in their territory. However, several Canadian stakeholders have pushed forward the significance of what is referred to as "modified sixth freedom" rights or indirect cabotage.

Modified sixth freedom traffic rights would provide a Canadian carrier, for example, with the ability to offer services between two U.S. points via a Canadian hub. To illustrate, Air Canada offers direct flights between Toronto and New York, and Toronto and Seattle. Despite this, Air Canada is unable to sell a ticket from New York to Seattle via Toronto, as the current bilateral prevents carriers from marketing such services together. The only existing opportunity is for a consumer to purchase two separate air tickets covering this route, which in many cases would amount to a higher fare than if the ticket were sold as a unit.

It is interesting to note that the total mileage on a New York – Seattle route via Toronto would be 2,416 miles, compared to an average haul for that market of 2,462 miles. This means that a consumer’s travel distance on that route would be shorter via Toronto than a number of hubs offered within the U.S. Furthermore, due to the geographic location of many Canadian international airports north of the U.S. border, and the pre-clearance facilities established at these airports, an ease of this restriction would certainly prove beneficial to many consumers.

The Open Skies agreement, however, continues to prevent carriers from marketing or selling tickets involving this kind of routing. Modified sixth freedom rights did not form part of the latest bilateral negotiations although they may be raised in the next round.

The new Open Skies agreement between the two close trading partners is a move towards a further liberalized and integrated market. The ultimate beneficiaries of greater competition and less restriction are consumers. It will be interesting to see how this complex relationship develops as the U.S. continues to negotiate an open aviation area with the European Union.

© Copyright 2006 McMillan Binch Mendelsohn LLP