The Economic Implications of the O'Hare Modernization Program

The Economic Implications of the

O’Hare Modernization Program May 2004

Prepared by:

Jon F. Ash, Managing Director Global Aviation Associates, Ltd. (ga2) 1800 K Street, NW – Suite 1104 Washington, DC 20006 www.ga2online.com

Economic Implications of the O’Hare Modernization Program

Table of Contents LIST OF CHARTS .......................................................................................................... Ii LIST OF TABLES.......................................................................................................... IIii EXECUTIVE SUMMARY: O’HARE MODERNIZATION PROGRAM (OMP)................ 1 ES 1.0 BACKGROUND....................................................................................... 2 ES 2.0 OBJECTIVES OF THE STUDY ............................................................... 3 ES 3.0 SUMMARY CONCLUSIONS................................................................... 3 ES 3.1 Project Capital Cost ................................................................................. 4 ES 3.2 Financing Plan ......................................................................................... 5 ES 3.3 Economics Of The Project ....................................................................... 7 ES 3.4 Economic Impact Of The OMP .............................................................. 11

SECTION I. INDUSTRY IN TRANSITION .................................................................... 2 I.1.0 INTRODUCTION......................................................................................... 2 I.1.1 Strategic & Structural Change ..................................................................... 4 I.1.2 The Current Airline Industry Crisis............................................................... 5 I.1.3 Declining Major Airline Market Share ......................................................... 6

I.2.0 LONG TERM PROBLEM ........................................................................... 7 I.2.1 Marginal Profitability ................................................................................... 7 I.2.2 Contributing Factors .................................................................................... 8 I.2.3 Local Versus Connect Traffic ...................................................................... 8 I.2.4 Air Fare Trends........................................................................................... 9 I.2.5 Taxes And Fees ........................................................................................ 11 I.2.6 Labor Cost And Productivity ...................................................................... 12

I.3.0 THE FUTURE ........................................................................................... 13 I.3.1 Economic Recovery.................................................................................. 13 I.3.2 Yield Decline.............................................................................................. 14 I.3.3 Airport Congestion..................................................................................... 14

SECTION II. THE O’HARE CARRIERS ..................................................................... 16 II.1.0 RECENT TRENDS.................................................................................. 17 II.1.1 Airport Costs............................................................................................. 19

II.2.0 O’HARE CARRIERS CANNOT AFFORD COST INCREASES................ 22

Prepared by: Global Aviation Associates, Ltd.

Economic Implications of the O’Hare Modernization Program SECTION III. OMP IMPACTS..................................................................................... 26 III.1.0 BACKGROUND ...................................................................................... 27 III.2.0 FINANCING PLAN .................................................................................. 29 III.2.1 AIP Program ............................................................................................ 29 III.2.2 PFC Financing......................................................................................... 30 III.2.3 GENERAL AIRPORT REVENUE BONDS (GARBs) ............................... 30 III.2.4 THIRD PARTY FINANCING .................................................................... 30

III.3.0 ECONOMICS OF THE PROJECT .......................................................... 32 III.4.0 CITY ESTIMATES OF THE ECONOMICS ARE FLAWED ..................... 33 III.4.1 The City Claims OMP Would Cost Only $6.6 Billion ............................... 35 III.4.2 The City Claims OMP Would Increase Passenger Traffic By 42% To 46.5 Million Enplanements Between 2003 And 2012 ................... 36 III.4.3 The City Claims that Non-Airline Revenue Will Increase By 7.7% Per Annum Between 2003 And 2012................................................. 37 III.4.4 The OMP Seemingly Fails To Consider The World Gateway Program (WGP) ................................................................................. 37 III.4.5 The OMP Has No Contingency For Capital Cost Overruns .................... 37 III.4.6 The OMP Assumes That The PFC Will Increase By $1.50 Per Enplaned Passenger From The Current Legal Maximum of $4.50 To $6.00................................................................................... 38

SECTION IV: REPORTED ECONOMIC IMPACT OF O’HARE ................................ 41 IV.1.0 SUMMARY AND DISCUSSION.............................................................. 42 IV.2.0 ECONOMIC IMPACT OF CHICAGO O’HARE AIRPORT...................... 43 IV.2.1 Airport And Tenants ................................................................................ 44 IV.2.2 Chicago Visitors ...................................................................................... 44 IV.2.3 Access-Sensitive Impact ......................................................................... 45

IV.3.0 ECONOMIC IMPACT OF THE OMP ...................................................... 46 IV.3.1 The Future Economic Impacts Depend On Traffic Growth ..................... 46 IV.3.2 Economic Impact Gains Will Occur Without OMP .................................. 47 IV.3.3 Economies Of Scale................................................................................ 49 IV.3.4 Airport And Tenants ................................................................................ 49 IV.3.5 Chicago Visitors ...................................................................................... 50 IV.3.6 Access Sensitive Impact ......................................................................... 50

IV.4.0 COMPARISON WITH OTHER NORTH AMERICAN AIRPORTS ........... 51 IV.5.0 ALTERNATIVE ECONOMIC IMPACT ESTIMATE ................................. 54 IV.5.1 Incremental Economic Impact without OMP ........................................... 55 IV.5.2 Incremental Economic Impact of the OMP.............................................. 57 IV.5.2 Economic Impact Generated by the OMP............................................... 58

LIST OF APPENDICES............................................................................................... 61 Prepared by: Global Aviation Associates, Ltd.

Economic Implications of the O’Hare Modernization Program

LIST OF CHARTS Number

Description

Page

1

Traffic Controlled by Top 20 Carriers

2

2

Distribution of U.S. Passenger Enplanements

7

3

Net Profit Margins

8

4

U.S. Domestic Yields

10

5

U.S. Domestic Passenger Enplanements

10

6

Burden of Fees & Taxes on Air Travel

11

7

Southwest vs. Major Carriers

12

8

Domestic RPM Changes and Revisions

13

9

O’Hare Market Shares

17

10

LCC Impact on O’Hare Pricing

18

11

Large Hub Cost/Enplaned Passenger-2002

19

12

Comparative Fees/Enplaned Passenger

20

13

Total Annual Economic Impact

52

14

Airport & Tenant Economic Impacts

54

Prepared by: Global Aviation Associates, Ltd.

i

Economic Implications of the O’Hare Modernization Program

LIST OF TABLES Number

Description

Page

1

U.S. Carrier Earnings History

3

2

Domestic Hub Yields

9

3

U.S. Economic Growth Forecast

14

4

O’Hare Capacity and Traffic Mix

21

5

United and American Financial Performance

22

6

United Leverage

23

7

American Leverage

25

8

O’Hare Activity and Cost Forecast

33

9

Projected O’Hare Airline Cost/Enplaned Passenger

34

10

Projected OMP Cost Structure

36

11

Transportation Cost Overruns

38

12

ga2 Adjusted Forecast of OMP Base Data

39

13

Annual Economic Impact of Chicago O’Hare Airport

44

14

Incremental Economic Impact Generated by Additional Passenger Traffic 49

15

Revised Incremental Economic Impact

51

16

Revised Air Traffic Forecast

56

17

Incremental Economic Impact without OMP

57

18

Air Traffic Forecasts Following the OMP

58

19

Incremental Economic Impact with OMP

58

20

Economic Impact Generated by the OMP

59

Prepared by: Global Aviation Associates, Ltd.

ii

Economic Implications of the O’Hare Modernization Program

Executive Summary

Prepared by: Global Aviation Associates, Ltd.

ES-1

Economic Implications of the O’Hare Modernization Program EXECUTIVE SUMMARY: O’HARE MODERNIZATION PROGRAM (OMP) ES 1.0 BACKGROUND The City of Chicago currently operates two very successful commercial airports — O’Hare and Midway.

O’Hare and Midway today support a Metropolitan Statistical Area (MSA) with an 8.5 million population base generating over $92.2 billion in annual retail sales.

The area airports are a platform for increased trade and development, and generate substantial job creation and economic growth.

There is general agreement that demand growth for commercial aviation in the Chicago metropolitan area will exceed the existing capacity of both Midway and O’Hare if new airport facilities are not built — either at O’Hare or Midway or at a new airport in the region. The demand growth at the existing O’Hare and existing Midway has been a contributing (though not the sole) factor in substantial delays that have been experienced at both airports.

The City of Chicago has not presented any plan to increase Midway’s capacity.

Chicago has, however, put forward a plan — called the “O’Hare Modernization Plan” or “OMP” which Chicago says will significantly increase capacity at O’Hare and will significantly reduce delays.

Chicago has publicly released a number of documents containing its assertions as to the benefits of the OMP. According to Chicago, the OMP will: •

Allow O’Hare to grow from a current passenger traffic level of approximately 34 million boarding passengers (called “enplanements”) to 57 million enplanements by 2022.

•

Allow O’Hare’s current aircraft operational throughput to grow from 900,000 operations per year to 1.6 million operations per year.

•

Reduce overall delays by 79%.

•

Produce 195,000 new jobs and contribute an additional 14-19 billion dollars to the regional economy.

•

Cost $6.6 billion dollars which the City claims can be financed with a combination of federal grant Airport Improvement Program (“AIP”) funds, federally authorized Passenger Facility Charges (“PFCs), and airline backed General Airport Revenue Bonds.

Prepared by: Global Aviation Associates, Ltd.

ES-2

Economic Implications of the O’Hare Modernization Program ES 2.0 OBJECTIVES OF THE STUDY The communities of Bensenville and Elk Grove Village retained Global Aviation Associates, Ltd. (ga2), to assess the OMP, related documents, and public releases by the City in order to determine the potential economic impact of the OMP on major stakeholders such as O’Hare International Airport (ORD), airlines generally, ORD hub carriers United Airlines and American Airlines specifically, consumers, and the community at large.

This includes examining the assumptions underlying the forecast demand and capacity growth contained in the O’Hare Master Plan, the expected financing sources for the project, the likely capability of the airlines (particularly United and American) to support the financing, and the economic impacts attributed to the OMP by the City. ga2 was also asked to examine the impact on airline costs and airfares should the OMP be implemented as set forth by the City. Finally, we were asked to evaluate the program in the context of the airline environment as it exists today, and as it is likely to look in 2012 and 2013 when the OMP is to be substantially completed.

ES 3.0 SUMMARY CONCLUSIONS The study’s primary conclusions as outlined below and in more detail in the body of this study are: 1. The U.S. air carrier industry is in serious economic turmoil, and under extreme pressure to control costs.

2. O’Hare hub carriers United and American are unlikely to support the OMP as now structured because its $15 billion capital cost will produce only modest incremental traffic, thus making the per passenger cost untenable in the current competitive environment.

3. To finance the OMP will be a serious challenge, even if United and American support it. Both carriers’ balance sheets need repair and even American’s unsecured debt is rated below investment grade.

4. The OMP, if implemented, would drive the 2012 unit cost per passenger from today’s level of about $9 to over $26, a nearly 200% increase. It would also increase the carriers’ airport cost/revenue ratio from 5.4% to over 13%, a level that would normally be viewed as “unacceptable.”

5. The economic benefits attributed to the OMP are seriously exaggerated. The City ascribes to the OMP an additional $18 billion in economic output and an incremental 195,000 additional jobs. The City’s claimed economic benefits attributable to the OMP are unrealistic. First, Chicago’s claimed benefits are overstated because they assume that airspace capacity, and therefore traffic growth, is and will be unconstrained. Second, the City’s benefits are based on faulty economic multipliers and erroneously ascribe all forecast growth to the OMP. Third, Prepared by: Global Aviation Associates, Ltd.

ES-3

Economic Implications of the O’Hare Modernization Program airline costs would increase substantially (to over $26 per enplaned passenger) in order to pay for the investment, causing air carriers to increase airfares to the local Chicago air traveler. Given the elasticity of demand, certain traffic will opt to not travel, or to use alternative means and modes of transportation. This could well dampen travel, tourism, and investment, and result in losses to the region in terms of businesses, jobs and tax revenues, among other adverse economic impacts.

Under the most optimistic of circumstances (i.e. assuming unconstrained operations and traffic growth), Chicago has overstated the economic impact benefits by at least 150%.

The frame of reference and detailed background and supporting information for the above summary conclusions is set forth below.

It is important to note that our examination of all available public documents, including the OMP filed with the FAA in early 2004, the LOI document from Thomas Walker and Rosemarie Andolino filed with the FAA on March 1, 2004, and OMP documents available on the O’Hare International Airport OMP website, among others, suggest serious deficiencies in the transparency and consistency of information. Equally important, there is a lack of specificity with respect to a number of critical issues addressed in the Master Plan and OMP, thus leaving open serious questions relative to the Plan’s viability as currently constructed.

Consequently, we have worked with the information available, and have relied to the maximum extent possible on the information and data provided by the City, notwithstanding its limitations.

These deficiencies, discrepancies, or contradictions in data and information are set forth below, along with further explanation of our conclusions.

ES 3.1 Project Capital Cost It is clear from different documents filed in various versions of the Master Plan that the full capital cost of the OMP is not being dealt with in a fully transparent manner. Although the City claims the cost of the OMP will be $6.6 billion, our research and analysis indicate that the cost will be closer to $15 billion. For example, the OMP cost of $6.6 billion is a 2001 capital cost, while the World Gateway Program (WGP) cost is a 1999 capital cost as shown in Appendices 5 and 6. While nominal costs may have been utilized to arrive at the total annual airline burden of $938,005,000 in 2012, there is no documentation available to support these numbers. As shown in Table ES-1 the annual airline burden will be higher according to our estimates.

Prepared by: Global Aviation Associates, Ltd.

ES-4

Economic Implications of the O’Hare Modernization Program Table ES - 1

ga2 Adjusted Forecast of OMP Base Data 2012 Cost ($000) Airline Data Per City 1/ Retail Adjustment 2/ From: 7.2 % per Annum To: 3.0% per Annum

$938,005

Adjusted Cost/Passenger Percent G/(L) than OMP

Cost/Passenger

46,450

$20.19

$82,984

Passenger Growth 3/ From: 4.0 % per Annum To: 2.6% per Annum Absence of $6.00 PFC 4/ ($4.50 in place)

Passengers (000)

(5,283)

$63,000 $1,083,989

41,167

$26.33

15.6%

(11.4%)

30.4%

1/ City estimate per O’Hare Master Plan Table V11-9 2/ Retail adjustment to reflect historical growth 3/ Passenger growth to reflect historical trend 4/ Assuming no increase in PFC

Based on information that is available, we have developed an estimate of the full capital cost estimate in nominal dollars, using very conservative (i.e., favorable to the City) assumptions. That cost, $14.7 billion, with attendant cash flows is outlined in Appendix 9. This estimate includes only three components, OMP, WGP, and a 25% contingency based on recent experience in transportation infrastructure project cost overruns. (See Chapter IV, Table 10).

Questions relative to the transparency and adequacy of the capital investment cost estimates are being raised by others. A March 1, 2004, article in Crain’s Chicago Business stated “With the full $15 billion price tag for Chicago’s plan to expand O’Hare International Airport coming into focus, questions are emerging about how the city will pay for the costliest public works project in its history.”

And further, “Can the city squeeze 42% more passengers into the airport by 2012, and nearly 76% more by 2022.”

ES 3.2 Financing Plan The Plan to finance the expansion, as set forth in the various Master Plan and OMP documents is seriously flawed for several reasons.

First, the federal Airport Improvement Program (AIP) is presumed to fund significant portions of the OMP. The City, however, is requesting $30 million per year for ten years from the AIP, which will produce only $300 million, or 2% of the $15 billion required.

Prepared by: Global Aviation Associates, Ltd.

ES-5

Economic Implications of the O’Hare Modernization Program Second, the City assumes that the current Passenger Facility Charge (PFC) of $4.50 will be raised to $6.00 by 2011. The airlines appropriately view these types of charges either as another tax, or as an increase in their ticket price, and consequently will vigorously oppose any changes.

Given the difficult environment faced by airlines, their opposition to anything that increases prices, and the sympathy in Congress for the plight of the carriers, it is unlikely that any increase could be expected. Since the $1.50 increase assumed by the City would have generated roughly $63 million per annum, that amount becomes an additional burden the O’Hare carriers will have absorb as shown in Table ES-1.

Third, General Airport Revenue Bonds (GARBs) are expected to be a considerable source of financing, according to the OMP. The Master Plan stipulates that GARBs will finance 59%, 54%, and 58% respectively of the OMP Capital Improvement Program (CIP) and WGP. In light of United’s bankruptcy, and related rejection of airport lease agreements, there is a question as to how much and at what levels GARBs could be issued.

As the Master Plan notes, the issuance of GARBs is subject to Airport Use and Lease Agreements which must be approved by the carriers. This, of course, raises the question as to whether the principal carriers, United and American, let alone the others operating at O’Hare will have the inclination or the wherewithal to support this program.

Fourth, Third Party Financing is forecast to cover 10% of the OMP and 22% of the WGP (OMP Table VII-5, pg. VII-28).

A recent Reuters release dated February 6, 2004, reads, in part, as follows: “Special facility revenue bonds backed solely by an airline will no longer be used to finance large airport facilities in Chicago after defaults on outstanding bonds soured investors against them, city airport officials said on Friday.

Thomas Walker, Chicago’s aviation commissioner, said investors were not likely to buy any of those bonds, particularly in the wake of defaults like those by United Airlines when it filed for bankruptcy protection in December 2002.”

Separately, Fitch Ratings, according to Chicago Business Wire on March 31, 2004, “…believes that yesterday’s court decisions in the United Airlines’ bankruptcy proceeding regarding the treatment of the carrier’s special facility bonds sets a troubling precedent which may weaken security provisions behind certain municipal lease-backed, bonds, ..”

Thus, not only is the project cost apparently well beyond what has been stated by the City, but the underlying plan to finance the project is questionable.

Prepared by: Global Aviation Associates, Ltd.

ES-6

Economic Implications of the O’Hare Modernization Program ES 3.3 Economics Of The Project An initial underlying issue is whether or not the primary air carriers operating at O’Hare, and particularly United and American, are inclined to, or capable of supporting the financing of the OMP. Today, the airline industry is in the midst of a massive restructuring in response to a myriad of events that have occurred over the past three years. Air carrier losses, selected bankruptcies, and structural changes are evolving in response to: 1. A recession that began to impact the industry in early 2001.

2. The impact of 9-11 on the propensity of the public to travel.

3. Traffic declines resulting from the Iraq War and Severe Acute Respiratory Syndrome (SARS).

4. Increasing damage being inflicted by rising fuel prices.

5. Losses from 2001 through 2004 that will exceed $25 billion.

6. The successful incursion into markets formerly dominated by the Legacy Network Carriers (LNCs) by the Low Cost Carriers (LCCs) represented by Southwest, jetBlue, AirTran, ATA, Frontier, America West, and Spirit.

7. A significant shift in the airline distribution system, resulting from increasing Internet use to purchase travel, and the concomitant increase in the transparency of airfares for both leisure and corporate travelers.

These factors have produced the largest industry losses ever experienced.

Table ES-2 shows the actual and expected losses for airlines over the period 2001 through 2004.

Table ES - 2 Major U.S. Passenger Carrier Earnings History $ Billions

2000

2001

2002

2003E

2004E

$92.2

$78.9

$71.0

$71.7

$79.1

Operating Income

5.4

(8.3)

(9.5)

(5.8)

(0.7)

Net Income

2.3

(7.5)

(11.2)

(6.3)

(3.0)

13.2

12.3

11.3

11.4

11.6

9.9

10.3

10.1

9.9

9.6

72.8

70.3

72.3

72.8

74.9

Revenue

Yield (¢) Unit Cost (¢) Load Factor (%)

Note: Data excludes American Trans Air and American Eagle Source: The Airline Monitor

Prepared by: Global Aviation Associates, Ltd.

ES-7

Economic Implications of the O’Hare Modernization Program These losses, experienced principally by the major LNCs and resulting from the events described above, produced heretofore unheard of increases in unit costs, a reduction in the average fare paid by the consumer, and thus breakeven load factors (the percentage of seats that must be filled to produce a financial breakeven) close to 90%. While attempting to deal with this unprecedented economic environment, the LNCs found themselves having to increasingly compete with LCCs that could produce the same basic commodity, a seat, at a cost of at least 25% less than it cost the major carrier to produce the same seat.

Within this environment, United Airlines and U.S. Airways were forced to file for protection under Chapter 11 of the Bankruptcy Code. American Airlines narrowly escaped the same path through a last minute agreement with its labor unions.

This industry environment, which the major LNCs are attempting to deal with, is the framework within which the OMP must be evaluated.

Because of the economic turmoil and strategic restructuring in the airline industry, it is unlikely that the airlines will support a $15 billion program, which they will have to pay for through increased costs, and ultimately increased fares.

Raising fares in the current or future competitive environment will be difficult for the O’Hare LNCs. As noted below, Chart ES-1, the rapid growth of the LCCs at Midway (MDW), stated in percentage of Chicago area available seat miles (ASMs) has been a significant factor in driving the average fare at O’Hare down by 21% between 1999 and 2003 (Appendix 2).

Chart ES - 1 Impact of MDW LCCs on ORD Fares $200 $180 22%

Avg. Domestic Ticket Price

$160

20%

$140 $120

18%

$100 16%

14%

$80 $60

LCC % ASMs

$40 12% $20 10%

Average Domestic Ticket Price Average Domestic Ticket Price

MDW LCC of%Chicago ASMs MDW% LCC ASMs

24%

$1999

2000

2001

2002

2003

Note: 2003 Average Domestic Ticket Price is YE 2Q 2003

Prepared by: Global Aviation Associates, Ltd.

ES-8

Economic Implications of the O’Hare Modernization Program

Consequently, the O’Hare air carriers are going to be reluctant to support an investment of $15 billion, unless it produces both a significant increase in airport capacity, and a total cost per passenger that allows them to continue to compete with the LCCs at Midway.

Table ES-4 below, O’Hare Activity and Cost Forecast, displays the likely 2012 economics of the OMP. Under this scenario, aircraft operations at O’Hare would increase by roughly 15%, and the cost per enplanement would increase by 185%, from $9.24 today to $26.33 in 2012. In the context of the highly competitive environment, MDW’s cost per enplanement today is $5.39, and there is little likelihood that it will increase substantially over the next ten years since the MDW carriers are continuing to grow enplanements, despite capacity limitations.

Table ES - 4

O’Hare Activity and Cost Forecast 2012 – G/(L) 2003

2012

32,628

41,167

8,539

26.2

425,279

488,220

62,941

14.8

76.7 90.2 121.2

84.3 103.7 133.3

7.6 13.5 12.1

9.9 15.0 10.0

74.4%

77.8%

3.4 pts

$172.01

$196.68

$24.67

14.3

Cost/Enplanement

$9.24

$26.33

$17.09

185.0

Cost/Revenue Ratio

5.4%

13.4%

8.0 pts

Enplanements (000) 1/ Passenger A/C Departures 2/ Enplaned/ DPTR On-board/DPTR Seats/ DPTR Load Factor Average Ticket Price

Amt.

%

1/ Assumes 10% growth in seats/departure and 15% growth in passengers/departure 2/ Departures are forecast to growth to almost 15%, the amount by which all activity could grow assuming that 1.1 million departures per year is feasible.

The City estimates that in 2012 the airlines will have to support a total cost of $938,005,000 per annum, and that that annual cost will support 46,450,000 annual enplanements (Table ES-1). Under these assumptions, the cost per passenger enplaned to the airlines will average $20.19, according to the City.

We believe that this forecast of costs and enplanements is not realistic. For Prepared by: Global Aviation Associates, Ltd.

ES-9

Economic Implications of the O’Hare Modernization Program example, there are serious airspace capacity limitations that will impede traffic growth, regardless of runway configurations (See JDA Technology Solutions letter to Messrs. Cooper and Smithmeyer (FAA), dated January 16, 2004). In order to produce a more realistic estimate of future costs, we have made three adjustments to the City’s forecast: 1. Reduced retail revenue growth to 3% per annum, more consistent with likely traffic growth 2. Reduced traffic growth to 2.6% per annum, from 4% per annum to be more consistent with likely average growth, given the capacity constraints, and 3. Eliminated the $1.50 increase in PFC charges These minor adjustments raise the annual cost burden to $1.1 billion, reduce 2012 enplanements to 41.2 million, and increase the cost/enplanement by 30% to $26.33.

The capital cost of the program, and relatively modest incremental benefit in terms of capacity, raise serious questions as to the viability of the program: 1. When the carriers examine the cost of the project, and the return in terms of truly incremental capacity added, we believe they are likely to look for more reasonable and less expensive alternatives for capacity enhancement.

2. The City is going to be seriously challenged to finance a project of this scope, particularly given the creditworthiness of the carriers that would have to back the financing.

3. The City either overtly, or implicitly, ascribed all of the forecast growth at O’Hare to the OMP. It should ascribe only that portion of the growth that would be incrementally facilitated by the OMP investment. The ga2 forecast suggests that it is not unrealistic to expect a 26.2% increase in traffic at O’Hare between 2003 and 2012 as a result of the OMP; however, an increase in seats per departure (which is unrelated to the OMP) could produce more than 1/3 of the 26.2% growth. Additional growth in local demand can be accommodated through greater availability of aircraft capacity for local traffic and a commensurate shift of through (connecting) traffic to other hubs. Thus, a significant portion of the 26% increase can be attained without the OMP. 4. The City has not provided a Benefit-Cost Analysis to support the LOI filing of March 1, 2004.

In summary, It is clear that there needs to be more capacity in the Chicago area; however, it is also clear that financing the project will be challenging, and if financed, the OMP would significantly raise the cost per passenger to the airlines, both in an absolute sense and relative to the revenue generated, a key Prepared by: Global Aviation Associates, Ltd.

ES-10

Economic Implications of the O’Hare Modernization Program benchmark for airline cost control. Additionally, we estimate that a significant portion of the of the 26% increase in traffic that we forecast for the year 2012 can be secured at no cost through an increase in the average number of seats per departure to pre 9-11 levels.

ES 3.4 Economic Impact Of The OMP The estimates of economic impact and job creation attributable to the OMP by the City are excessive.

In fact, because of factors set forth in detail in this study, it could well be that the OMP, if implemented, would result in negative economic impacts. That situation could be driven by the combination of the massive cost of the project, modest incremental capacity produced, the higher fares that would have to be charged to the local point to point traffic to pay for the OMP, and the local businesses and related jobs that would be lost.

The City’s Economic Impact Study suggests the following (Table ES-5): Table ES - 5 Annual Economic Impact of Chicago O’Hare Airport (BAH-2000) Economic Impact Driver Airports and Tenants

Employment (Thousands)

Economic Output ($Billions)

Income ($Billions)

130

$4

$14

170

$4

$11

Access-Sensitive Impact

100-180

$3-5

$9-16

Total Economic Impact

400-480

$10-13

$34-41

Chicago Visitors

Source: Update of a Study on the Economic Impact of Chicago’s Airports, July 24, 2001, by Booz Allen Hamilton

Thus, according to the City, O’Hare generates $34-$41 billion in annual economic output, and 400-480 thousand jobs.

In addition, the City claims that the OMP will generate an incremental 195 thousand jobs and another $18 billion in Economic Output (http://modernization.ohare.com). This City’s forecast unrealistically assumes no constraints on O’Hare’s ability to achieve maximum airport operations and is based on a projection of 1.6 million annual operations. See, “A Proposal for The Future of O’Hare” issued by the City of Chicago. While we do not have access to the City’s detailed assumptions, and therefore cannot isolate the “drivers” of this presumed substantial economic benefit, it is clear that given airspace Prepared by: Global Aviation Associates, Ltd.

ES-11

Economic Implications of the O’Hare Modernization Program constraints and other factors, there are limits to the number of operations that can be handled at O’Hare, and therefore limits to the economic value that can be generated from the OMP. At best, the economic value is well below what is being claimed by the City, but the economic impact may well be negative due to to loss of jobs, businesses, and future investment resulting from the higher fares the airlines would have to charge in order to offset the increased airport costs that they would have to pay to fund the investment.

Under the most optimistic circumstances (assuming unconstrained operations and traffic growth) the City estimates overstate the OMP benefits by roughly 150%. Both the base case numbers and the incremental value imputed to the OMP reflect extremely aggressive forecasting.

That is, the real benefit that could be ascribed to the OMP might be 40% of that projected by the City BEFORE offsets related to lost economic value related to lost future investment (and jobs and economic value) in the region due to higher air fares.

There are numerous aggressive assumptions underlying the City forecast, and two which, on the surface, are patently unreasonable.

First, the prediction of economic impact gains from the OMP is presumably based on the idea that without the OMP, growth in air traffic at O’Hare would stagnate. That is, the economic impact gain from the OMP is relative to a “do nothing” scenario where no additional capacity is developed (again, no details are available to determine the assumptions made in the economic impact estimates). However, attributing all economic gains to the OMP is not realistic for a number of previously noted reasons. Substantial economic impact would occur even without the OMP. Second, our analysis determined that the incremental economic impact estimates in the City’s study fail to account for any significant economies of scale.

Economies of scale refers to the situation where the cost of producing one unit of a good or service decreases as the volume of production increases. Intuitively, this would seem to be case for the aviation industry. In the case of an airport, the cost of processing and servicing one additional passenger is lower than the average cost of servicing the existing passengers. The infrastructure and staff are already in place so there are fewer resources required to process that additional passenger. If the cost is lower, so is the economic impact.

We also examined economic impact studies for 18 airports (excluding O’Hare), and the results can best be described in Chart ES-2 below.

Prepared by: Global Aviation Associates, Ltd.

ES-12

Economic Implications of the O’Hare Modernization Program Chart ES - 2 Total Annual Economic Impact (Jobs) Versus Annual Enplaned Passengers 500 O'Hare: 35.7 million passengers 440,000 jobs

Employment Economic Impact (Thousands)

450

ORD

400 Atlanta: 38.3 million passengers 330,800 jobs

350

ATL

300 DFW

250

SFO JFK

200

MIA

150 OAK

100 50

YYC

YYZ SEA

BWI IAD

SJC MCI DCA YVR BNA

LGA

YEG

0 0

5

10

15

20

25

30

35

40

Enplaned Passengers (Millions)

Source: Economic Impact and passenger figures provided by the airports. Impacts include direct and multiplier impacts. Trend line based on all observations except O’Hare

The job creation numbers for O’Hare, at roughly 440,000, are substantially above those for any other airport, and even 33% higher than for Atlanta, despite Atlanta being a larger airport.

After adjusting for the two faulty assumptions listed above, and in recognition of the benchmarks provided by other airports, we have estimated the incremental impact of the OMP as follows, compared to the City’s original estimate. ga2 % G/(L) PARAMETER

CITY FORECAST ga2 FORECAST

ECONOMIC OUTPUT

than City

$18.0

$7.3

(60)%

195,000

69,000

(65)%

($billions) JOB GROWTH

The estimates of the economic impact and job creation attributable to the OMP by the City are clearly excessive. Moreover, should the OMP be developed as Prepared by: Global Aviation Associates, Ltd.

ES-13

Economic Implications of the O’Hare Modernization Program envisioned, it is not inconceivable that it could result in negative economic growth.

Even if all of Chicago’s most optimistic assumptions proved out (an unlikely scenario) the economic benefits claimed by Chicago would not produce the size of the benefits claimed. Our analysis suggests that less than half of the benefits claimed, even if all of Chicago’s assumptions proved true.

But it is much more likely that the high cost of the OMP will curb aviation growth and the jobs and economic benefits associated with such growth. The high cost per passenger at O’Hare with the OMP will force the major carriers to increase their fares to cover the cost. To compete with other hubs for connecting passengers, the O’Hare carriers will likely pass on this high unit cost primarily to the Chicago based traveler — leading to slower, if not negative growth at O’Hare due to elasticity of demand and other low cost carrier alternatives at Midway.

The high-cost O’Hare operating environment created by the OMP will put further stress on the ability of United and American (the principal O’Hare carriers) to compete effectively with low-cost carriers in today’s highly competitive environment.

-- END --

Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program

Section I

Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program

SECTION I. INDUSTRY IN TRANSITION I.1.0 INTRODUCTION In October 1978, then President Jimmy Carter signed the Airline Deregulation Act of 1978. This change in the historical regulatory environment governing commercial aviation changed the face of the competitive landscape forever.

However, it was not until the early 1990’s, and then more prominently in the post 9/11 environment that it became evident that the Low Cost Carriers (LCCs) would begin to shape the U.S. marketplace and in particular, drive the historical pricing models of the major legacy carriers to relative obscurity.

During the late 1970’s and early 1980’s it was evident that numerous existing carriers and new start-up carriers believed that they could drive the marketplace as long as they could control costs, and thereby, pricing. This proved to be erroneous, at least for a number of years to come. In the recession of the early 1980’s, as evidenced in Chart 1, there was a significant increase in the number of bankruptcies, and thus evolved a higher level of concentration than the proponents of deregulation would have predicted.

Chart 1 Top 20 Airlines’ Share of World RPMs

70

International Consolidation

RPM Share (%)

65 Domestic Consolidation 60

Deregulation

4 Alliances = 63%

55

50

Proliferation

45 1975 Source: Boeing,

80

85

90

95

2000

05

10

ga2

Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program Again in the mid-to-late 1980’s there was a re-growth of new entry into the market, with an accompanying decrease in the level of market concentration.

However, once again an early 1990’s recession led to substantial industry losses, a Presidential Commission to examine the health of the industry, and numerous calls for subsidy to the industry. Industry losses were once again at an all time high, erasing all of the earnings that had been produced since the Wright Brothers’ first flight at Kitty Hawk.

By the mid-1990’s, the economic cycle once again turned up, and there was a strong recovery through the year 2000. This recovery also produced a growing level of concentration and the development of LNC alliances. While these alliances were not entirely new, they evolved to a more sophisticated state by the end of the decade of the 90’s.

Table 1 Major U.S. Passenger Carrier Earnings History $ Billions

2000

2001

2002

2003E

2004E

$92.2

$78.9

$71.0

$71.7

$79.1

Operating Income

5.4

(8.3)

(9.5)

(5.8)

(0.7)

Net Income

2.3

(7.5)

(11.2)

(6.3)

(3.0)

13.2

12.3

11.3

11.4

11.6

9.9

10.3

10.1

9.9

9.6

72.8

70.3

72.3

72.8

74.9

Revenue

Yield (¢) Unit Cost (¢) Load Factor (%)

Note: Data excludes American Trans Air and American Eagle Source: The Airline Monitor

This growth in earnings led to relatively aggressive forecasts for future traffic and profitability. Following historical patterns, the air carriers responded by placing large orders for new aircraft at the end of the 1990’s just as the cycle was about to once again reverse itself. Consequently, by the time these new aircraft were being delivered in 2001-2002, the market had deteriorated beyond that which could have been forecast by any historical benchmark. The deterioration was driven by a failing economy, the events surrounding 9/11, and a vast improvement in the transparency of airfares created by online websites. While Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program traffic was declining, the average ticket price was declining as well, and unit costs were increasing. Breakeven load factors, the percentage of seats needed to be filled in order to generate a “0” profit or loss, escalated to the 90% range—a level clearly unattainable.

While the events of 9/11 produced nothing but negative consequences as far as the economic well-being of U.S. commercial aviation was concerned, the fact remains that the industry’s financial health was more at peril than many acknowledged at the time. The decline in economic activity and the attendant impact on “business travel” (relatively high yield tickets with minimum restrictions) was generally regarded as a temporary setback, typical of the cyclic nature of airline earnings. In retrospect, it was anything but typical. The slow-growth economy characteristic of late-2000 and early-2001 came at a time when airline customer dissatisfaction had reached record levels. Airport congestion, flight delays, declining passenger service, and a bifurcated pricing environment had the combined affect of curtailing activity generally but also driving loyal (and frequently high yield) passengers to explore alternatives to the major LNCs. I.1.1 Strategic & Structural Change In the more than twenty years since the airline industry was deregulated, a number of novel strategies and systems have been developed by carriers, put inplace, and further refined. Frequent Flyer programs, yield management systems, corporate discount programs, the hub-and spoke network, and code-sharing are some of the most obvious -- and there were many others to be sure. Given the highly competitive nature of airline operations during this period, the most significant of these innovations were adopted (and frequently modified) by virtually every major carrier in turn. With the obvious exception of Southwest Airlines and its imitators, the commonly accepted business model of how to run a profitable company was thought to fit within a relatively standard set of parameters -- until now.

The important conclusion is relatively simple: standard and generally accepted business practices can no longer be held as sacred. Given the dramatically different operating conditions post-9/11, every airline must assess precisely how they conduct business and make changes where necessary -- a re-engineering process that has only just started in earnest. Some of the more significant changes to be announced or contemplated are as follows: •

Hubs: The de-peaking by American at its Chicago O’Hare and Dallas/Ft. Worth hubs (in actual fact, copying an earlier experiment undertaken by Delta at its Atlanta hub) proved that these complexes operate far from optimally. Indeed, the long-held theory that hubs must consist of distinct waves of departure and arrival banks has recently been re-thought.

•

Aircraft: While it is far to soon to anticipate or even discuss an industry refleeting, concerted efforts are being made to eliminate older, more costly, and less efficient sub-types and “extraneous” (non-family) models of

Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program aircraft. This trend became quite apparent immediately in the wake of 9/11 as perhaps 1,000 units were removed from scheduled service and may be parked indefinitely.

•

Pricing: Management of virtually every legacy major has acknowledged that the pricing structure is terminally flawed; that fundamentally, there is a huge disconnect between business and leisure fares (6 to 1 ratio in coach). Unfortunately, no single carrier has the leverage to remedy the situation. Change has to come in a logical and unified manner by all legacy majors simultaneously -- an outcome that is highly unlikely.

•

Distribution: Long before its current ills, the U.S. airline industry had made great progress in extracting not only productivity gains but additional cost savings by embracing the Internet, and in turn, adding further distance from travel agents. Like the LCCs, the dynasty majors have also adopted high-tech strategies both on their own behalf (through proprietary portals) as well as through collaborative efforts such as Orbitz. Long-term, will this new-found fare transparency have a greater impact on airline revenue than on cost control?

•

Labor: Alaska Airlines was recently the first U.S. airline to provide for baseball-style arbitration with its labor unions – a sea change from the current process used by every other carrier and based on the Railway Labor Act of 1926.

By trying to be all things to all people, the major LNCs have actually satisfied relatively few, leaving the carriers with scant options to fall back on once industry fundamentals (a strong economy and a loyal user base of high yield travelers) has fallen so dramatically. With little hope of a return to the “good old days” any time soon, the concept of “business as usual” simply does not -- and cannot -- fly any longer.

I.1.2 The Current Airline Industry Crisis Former American Airlines CEO, Donald Carty, in Congressional testimony given in late-September 2002, highlighted the reasons for current airline industry ills.

Key to the industry’s problems, Carty told the House Aviation Subcommittee, “is that business travel -- the bread and butter -- of large network carriers continues to be way down, with remaining business travel being done at leisure fares.” He added, “Business flyers are ‘buying down,’ seeking lower, more restricted fares traditionally intended for leisure travelers.” The key problem for American, he concluded, is that, “only 1-in-12 passengers is flying full coach fare.”

•

Mr. Carty concluded by stating: “Our task going forward is to re-define our business model, not only to stay a step ahead of our old rivals, but to compare and win in an environment where newer, lower-cost competition represents an ever-increasing slice of the marketplace,” adding that American faces that type of competition on 70% of its routes. To change

Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program that model, American (like all Legacy Majors) recognizes the imperative to realign supply and demand and rebalance the revenue/cost relationship.1 This customer frustration is well expressed as follows:2 “Flights are uncomfortable and unreliable, and higher fares don’t address that.

For long trips, I’m willing to buy business or first-class tickets, but not at the 8 to 10-times price differential. Travel on mileage awards is losing its luster, making frequent flyer programs less attractive. I have been stranded at a hub for two days because my ‘free’ ticket meant I had the lowest priority for a seat after my connecting flight was canceled. This is on top of unpredictable airport situations that make even a 1-hour flight something that could take a day. I’m cutting back on my air travel; it’s down 50% this year and going lower next year. I’ll start flying again when the airlines offer me a better product, but that’s probably going to require a new generation of carrier.”

I.1.3 Declining Major Airline Market Share One of the most important developments to result from more than twenty years of airline industry deregulation has been the imperative that major carriers differentiate their “product” or the service they offer consumers. When routes and fares were subject to strict government oversight, the airlines had little, if any, incentive to be creative.

Today, the surviving major LNCs continue to provide much the same array of service that they traditionally had under regulation; products that appealed to both business (high yield) and leisure (discretionary) customers, on a vast system of domestic and overseas routes. The rise of “niche” carriers over the past years was a direct result of the inability by the majors to successfully be all things to all people.

Chart 2 demonstrates precisely how well the new, post-deregulation (Regional and New Entrant/Low Cost Carrier) segments of the airline industry have been at tapping into consumer desire for alternative air service options. Notably, their share of total domestic passenger enplanements has grown from less than a 10% to more than one-third of total traffic activity in the post-deregulation era.

1

“Carty to Analysts: AA Aims to Survive,” Aviation Week and Space Technology, 30 September 2002, page 47

2

Letter to the Editor, Aviation Week & Space Technology, 7 October 2002

Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program

Chart 2 Distribution of U.S. Passenger Enplanements

By Airline Type (U.S. Domestic Traffic 1980 – 2000) 100%

Share of Total Activity

80%

60%

40%

20%

0% 1980

1985 Majors

1990

1995

Low Cost/New Entrants

2000

1Q2002

Regionals

Source: U.S. Department of Transportation filings.

I.2.0 LONG TERM PROBLEM I.2.1 Marginal Profitability In year 2000, the 11 major airlines reported operating revenues of $92.2 billion, with an operating profit of $5.4 billion (5.6%) and a net operating profit of $2.3 billion (2.2%).3 This was before the recession and events of 9/11 resulted in a $7.5 billion loss in 2001. The mediocre year 2000 net operating profit illustrates a chronic problem for the major airlines; they consistently operate at net profit margins well below U.S. industry as a whole as shown in Chart 3.

3

U.S. DoT Form 41

Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program Chart 3 Net Profit Margin U.S. Industry vs. Airlines

Source: State of the U.S. Airline Industry: A Report on Recent Trends for US Air Carriers Air Transport

Association, 2002, page 10.

Nonetheless, the key point is that the U.S. airline industry is barely able to sustain itself, in capital terms, in good times, and now, faces growing economic and structural uncertainty with little or no reserve to sustain itself during difficult times.

I.2.2 Contributing Factors In the run-up to 9/11, it had become abundantly clear that the major LNCs were overly if not exclusively reliant on high yield (business) travel to produce the industry’s meager profit margins. Despite investments in the onboard product, record levels of consumer discontent toward the major LNCs focused on high fares, restrictive conditions, on-time performance, airport and airway congestion, and the perceived decline in service reliability overall. The resultant changes started in the late 1990’s, setting the stage for a large-scale (and potentially irrevocable) change in established consumer air travel patterns.

I.2.3 Local Versus Connect Traffic While yield management systems have become very adept at producing high load factors, the price of this “success” has been a widely divergent set of fares/yields on many flight segments. Contributing to this has been the “hub and spoke” operating system, which has become ubiquitous enough that the majority of the major LNC operations are hub to spokes.

Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program Many local markets from hubs are monopolies (the exceptions generally being spokes to other carriers’ hubs). As such, the dominant airline can command reasonable yields in exchange for nonstop service. The connecting traffic that flows through the hub is almost always subject to competition, and tends to be lower yielding than local origin-destination traffic to and from the hub. Table 2 illustrates this phenomenon with respect to a domestic hub spoke.

Two key points here are that the local traffic (that which originates its trip in a city and returns to the same city) contributes a greater percentage of onboard revenue than the flow traffic (that which connects over the hub), and that there is a significant yield premium in the local market -- approximately 60 percent. While this market may be profitable at an average yield of almost 20 cents, achieved by combining local and flow traffic, it is doubtful that profitability would be achieved if only flow traffic were available. Thus while the flow-through (connecting) traffic may be of lower profitability, it nonetheless contributes to the overall profitability of the flight through the hub. Similar results can be seen in international hub markets.

Table 2 Domestic Hub Yields By Market O-D Vs. Connect 2002

Traffic Category

% of Onboard Revenues

Average Yield

Local O-D

61.6%

$0.2440

Flow or Connecting

38.4%

$0.1540

Composite

100.0%

$0.1993

Source: Global Aviation Associates, Ltd. analysis

These results clearly show that connecting traffic is not as lucrative as local traffic, from a unit revenue perspective, but without it, load factors and total revenues would be insufficient to generate profitability on virtually all hub-based spokes.

I.2.4 Air Fare Trends Overall, domestic yield at Air Transport Association (ATA)-reporting airlines has declined in real (constant dollars) terms throughout the period of deregulation.

The trend in average yield decline and in various yield categories is illustrated in Prepared by: Global Aviation Associates, Ltd.

9

Economic Implications of the O’Hare Modernization Program Chart 4. Yield is assumed to measure the trend in base fares (exclusive of taxes) as it quantifies the ticket price in cents per revenue passenger mile. Yield is not a perfect measure of fare trends as the increase in flight stage and passenger trip lengths have contributed to the decline in yields; however, it is still a reasonable benchmark and widely accepted.

Chart 4 U.S. Domestic Yields (Constant YR2000) (1980 – 2002)

Yield(cents (centsper perRPM, RPM,2000$) 2000$) Yield

60 60 50 50

Full Full First First 40 40

Full Full Coach Coach

30 30 20 20

Average Average Yi ld

10 10

Discount Discount Coach Coach

11998 800 11998 811 1 1998 822 1 1998 833 11998 844 11998 855 1 1998 866 1 1998 877 11998 888 11998 899 11999 900 11999 911 11999 922 11999 933 11999 944 11999 955 11999 966 11999 977 11999 988 1 1999 999 22000 000 22000 011 22000 022

00

But as illustrated in Chart 5 below, the decline in the average fare is only part of the story. In fact, what has occurred is a decline in the discount coach fare used by an increasing majority of the passengers coupled with a slight increase in the real full first (including business class) and full coach fares.

Chart 5 U.S. Domestic Passenger Enplanements

By Fare Category 500 First Reduced Enplanements

450

First Full Enplanements Coach Reduced Enplanements

ENPLANEMENTS (Millions)

400

Coach Full Enplanements

350 300 250 200 150 100 50 0

Source: ATA

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000

Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program Today, in excess of 90% of U.S. domestic air travelers utilize discount coach tickets. This share of the air travel market (which excludes data from Southwest Airlines) has grown from the more balanced fare mix that existed in 1980, soon after deregulation. At that time, 49% of passengers traveled on reduced fare tickets with 45% traveling on full coach fares. In the first half of 2002, during the trough of the recession in the industry, only 2% of passengers traveled on full coach fare tickets! (Compared with 10% – 20% in 2000 – 2001.) If the expansion of reduced first (and business) fares is included, it appears that only about 3% of air travelers are currently paying full (walk-up) fare for the class they are flying.

I.2.5 Taxes And Fees Taxes and fees paid by airline passengers have grown substantially over the past 10 years. Northwest Airlines, reported that taxes and fees now total over $60, comprising 26% of the price of the average ($270 roundtrip) ticket. This is a 141% increase over 10 years as shown in Chart 6. These charges are assessed for a variety of reasons, not just the recent concern over security.

Some are embedded in the ticket price while others are added as surcharges.

Some charges are airport-specific (such as the PFC’s) while others such as the fuel tax support the AIP and part of the FAA’s expenses and equipment investments.

Chart 6 Burden of Fees and Taxes on Air Travel

Taxes/Fees Taxes/Fees as as part part of of aa $270 $270 Roundtrip Roundtrip Average Leisure Average Leisure Fare Fare Ticket Ticket

25.5% 25.5%

$68.76 $68.76

Pending Pending Excess Excess Security Security Fee Fee $4.00 $4.00

Security Security Fee Fee $10.00 $10.00 Segment Segment Fee Fee $12.00 $12.00

$28.49 $28.49

Excise Excise Tax Tax $27.40 $27.40 Fuel Fuel Tax Tax $1.38 $1.38 1992 1992

PFCs PFCs

10.5% 10.5%

Airline Airline Paid Paid

$18.00 $18.00

Excise Excise Tax Tax $20.55 $20.55 Fuel Fuel Tax Tax $4.21 $4.21 2002 2002

Source: Richard H. Anderson, CEO, Northwest Airlines, FAA Forecast Conference, 2002

Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program I.2.6 Labor Cost And Productivity LCCs such as Southwest had a significant operating cost advantage versus the LNCs as the 1990’s began. This gap actually had begun to close, when expressed on a cost per available seat-mile (CASM) basis by the middle of the decade, as shown in Chart 7. However, by the start of the current decade, there was substantial divergence, with the traditional majors’ unit operating costs climbing substantially versus those of Southwest.

If looked at closely, it can be seen that Southwest’s CASM grew faster than the major LNCs through 1996. Costs for both then converged until 1999, when the non-Southwest majors unit cost growth rate accelerated rapidly. By 2001, the traditional carrier CASM had risen to 129% of its 1990 level, while Southwest rose only to 112%.

Chart 7 Southwest vs. Legacy Major Carrier CASM 14.0

CASM (cents)

12.0 10.0 8.0 6.0 4.0 2.0

1990

1991

1992

1993

1994

1995

1996

Majors Excl. TZ & WN

1997

1998

1999

2000

2001

WN

Source: Annual Reports, US DOT Form 41, Global Aviation Associates analysis

A significant portion of the divergence in unit costs resulted from a pronounced difference in the unit (per ASM) labor costs of the traditional majors versus Southwest. For example, Southwest’s unit labor cost of 3.1 cents/ASM in 2003 was 16.2% below United’s bankruptcy driven labor cost/ASM of 3.7 cents.

Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program I.3.0 THE FUTURE CEO’s of the major LNCs are near universal in the collective mindset that however formidable the near-term obstacles, they will overcome them with their traditional strengths: strong brands, vast networks, effective regional partners, global alliances, newly-simplified fleets, conservative financial management, and powerful customer loyalty programs.

I.3.1 Economic Recovery A rising economy is the major impetus for growth in traffic, and conversely, recessionary periods are usually associated with downturns in traffic. This trend is illustrated in Chart 8.

Chart 8 Domestic RPM Changes and Recessions

Year-Over-Year Change

20% 15% 10% 5% 0% -5% -10% 1970

1975

1980

1985

1990

1995

2000

Recession Years Source: Air Transport Association

We are seeing signs of an economic recovery and as can be seen from the history, positive economics drive traffic. One forecast frequently used in the aircraft industry is that of DRI-WEFA. Their GDP forecasts (pre- and post- 9/11) are presented in Table 3. As indicated, the U.S. economy is forecast to recover at the same overall rate (over 5 years) as was anticipated before 9/11.

Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program Table 3 U.S. Economic Growth Forecasts Annual Growth Rate of GDP in %)

Pre-9/11 Post-9/11

2002 2003 2004 2005 2006 Total 2.6 3.4 2.5 2.8 2.5 14.6 1.1 3.1 0.1 5.1 4.5 14.6

Source: DRI-WEFA

I.3.2 Yield Decline Chart 4 portrayed the historic trend of the 2.5% long-term decline in yields that U.S. airlines have been able to provide. This decline contributed to the long-term rise in passenger traffic, although it has been the lesser influence when compared with GDP growth.

Beyond the immediate recovery period, the question is to what extent the historic yield decline can be sustained into the future. In previous years, airlines emphasized that continued improvements in employee productivity, acquisition of aircraft with lower operating costs, and reduced distribution costs would enable the reduction in yields to continue. Airlines now must also lower costs to survive financially and to compete with the New Entrant/Low Fare carriers.

I.3.3 Airport Congestion Among the myriad of exogenous factors limiting aviation industry growth in the long-term, those relating to infrastructure rank very near the top. While concerns about aviation capacity limitations remain post-9/11, the associated and oft-cited metrics -- flight delays and carrier on-time performance -- have been eclipsed by an overriding need for safety and security. Eventually, traffic will recover and the supply-demand disconnect will re-emerge as a critical issue.

I.3.4 Chicago and the O’Hare Carriers Where does this industry framework leave the Chicago region in terms of traffic growth, the O’Hare hub, and the major O’Hare hub carriers, United and American Airlines? Moving from the industry macro environment to the O’Hare micro environment, and the OMP for capacity expansion, suggests the following: 1. Historical, albeit weak, levels of profitability cannot be restored through conventional solutions.

2. Since the LCCs are increasingly driving the pricing model, carriers such as United and American will have to rely on product quality, cost, and fleet and network synergies in order to compete.

Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program 3. Neither United nor American, as will be noted in the following section, are in a position to invest directly or back a major capital investment that will not yield short term and measurable returns on invested capital.

Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program

Section II

Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program SECTION II. THE O’HARE CARRIERS II.1.0 RECENT TRENDS The O’Hare LNCs, particularly United Airlines and American Airlines, have a unique set of problems and challenges facing them. One, United, is in bankruptcy, and the other, American, narrowly avoided it. Both are high cost carriers, have extremely leveraged balance sheets, and face formidable competition on large portions of their respective route structures.

O’Hare, in part because it is situated within a large demographic area, and in part because it is a capacity limited hub, offers both carriers the potential for profitability. Historically, airports that are capacity limited tend to see higher fares than those that are more competitive. Consequently, there is opportunity for the major LNCs to be profitable serving O’Hare. However rates and charges need to be maintained at reasonable levels, lest the carriers be forced to raise fares to non-competitive levels. Should that happen, given the elasticity of demand, traffic will fall, some through diversion to other airports such as Midway, and some through foregone travel. That can have adverse impacts on the community at large, as well as the airport.

O’Hare is one of the few airports in the U.S. where more than one carrier competes with a fully functioning hub. This is reflected in the air carrier capacity shares at O’Hare which are set forth in Chart 9: Chart 9 O’Hare Capacity Share (2002)

17.6 47.5

34.9

UA

AA

Other

Source: U.S. Department of Transportation, T-100

The capacity share at O’Hare for United and American combined is 82.4%, suggesting that these two carriers should be able to control local market traffic Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program and pricing. However, as can be seen from chart 10 below, average fares at O’Hare have been declining steadily since 1999, when the average domestic fare was $178, to today when it is only $141. In fact, the decline in average fares is being influenced not only by macro industry trends, but also by MDW where Southwest and ATA, in particular, are impacting pricing at O’Hare. Thus, the market share of the Chicago carriers is somewhat different than the shares for O’Hare.

Chart 10 Impact of MDW LCCs on ORD Fares $200 $180 22%

Avg. Domestic Ticket Price

$160

20%

$140 $120

18%

$100 16%

14%

$80 $60

LCC % ASMs

$40 12% $20 10%

Average Domestic Ticket Price Average Domestic Ticket Price

MDW LCC of%Chicago ASMs MDW% LCC ASMs

24%

$1999

2000

2001

2002

2003

Note: 2003 Average Domestic Ticket Price is YE 2Q 2003

The average domestic airfare at Midway is $97, 31% below that of O’Hare. The Midway LCC’s operate with a cost structure roughly 25% lower than that of the network carriers at O’Hare.

Thus, the competitive situation in Chicago between Midway and O’Hare is significant, both in terms of carrier strategic positioning, and in terms of pricing to the consumer. Ultimately, carrier decisions made in these areas will significantly impact all stakeholders, including the airport.

Essentially, we have the LNCs at O’Hare competing in a number of markets with the LCCs at MDW, but at a significant cost disadvantage.

This cost differential is driven by many cost elements, one of which is airport costs.

Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program II.1.1 Airport Costs Airports are supported by two main streams of revenue. One is retail and concession driven, and often comprises roughly one-third of the total airport revenue. The other is revenue to the airport that is paid by the airlines in terms of landing fees, rental rates, and miscellaneous other charges such as into-plane fueling.

To gauge the acceptability of airport charges, airlines tend to view the ultimate composite amounts they pay to the landlord airport in terms of a unit cost per enplaned passenger. That is, to judge an airport’s cost efficiency, we look at total charges to the airlines, divided by the number of passengers enplaned in order to reach a unit cost per passenger.

Airport unit costs have risen at an unacceptable rate over the past few years, according to the ATA. The bar chart below summarizes the average cost per passenger at the large hubs for 2001 and 2002, the most recent year for which survey data is available. Notably, O’Hare had a cost per passenger in the survey of $8.70 (shown in Chart 11) and that cost has now risen to $9.24 in 2003.4 Chart 11

Large Hub Cost /Enplaned Passenger 2002 35 30.82

30 24.42

25

20.38

20

19.55 16.23

15 9.58

10

9.02

8.70 6.06

5.77

5.63

5.53

5.53

5

4.12 2.42

0 M IA

JFK

EW R

SFO

DEN

BOS

AV G

ORD

IA H

M SP

LAS

DFW

ST L

PHX

SEA

Source: AAAE 2001-2002 Survey of Rates and Charges

In a recent speech before the International Aviation Club of Washington, James May, Chief Executive Officer of the ATA set forth the challenges faced by the U.S. air carrier industry. According to May, the number one issue facing the airline industry is airport costs and charges. He stated, “The simple truth is that those revenues, AIP and PFC’s and airline landing fees and rents—are driven by customer demand and come directly from air carriers’ bottom lines.” In a lead-in to a synopsis of May’s speech, the ATA stated, “Too many in the airport community believe they are separate from the airline industry and that the 4

AAAE 2001-2002 Survey of Rates and Charges, Ricondo & Associates, OMP, pg. VII-34

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Economic Implications of the O’Hare Modernization Program national interests are best served by moving control of aviation revenues into airport hands.” 5 Among other things, May stated, “We need to focus our efforts on maximizing the national aviation system, improving those facilities that will add to national capacity, and forgo edifice complex projects.”

The O’Hare trend in facility cost per passenger to the airlines since 1998 has been reasonably favorable, both in an absolute sense, and compared to the other large hub carriers (Chart 12).

Chart 12 Comparative Fees/Enplaned Passengers Cost/Enplaned Passenger

$10 $8 $6 $4 $2 $0 2002

2000

Av e ra g e o f L a rg e Hu b s

1998 O RD

Source: AAAE Airport Rates and Charges Surveys

Notwithstanding the history, which has evidenced cost efficiency at O’Hare, it is the future that must be of concern to all stakeholders.

In particular United and American, which dominate the hub, cannot afford significant increases in the airport cost per passenger, given the trends in ticket prices at O’Hare, and the competitive pricing which they face from the LCC’s at MDW. A recent indication of trends at O’Hare is evidenced below, where we see not only a decline in traffic, but a substantial 22.5% decline in the average air fare.

This chart also highlights the trend toward smaller RJs, with the average number of passengers per departure declining by 9.1%.

5

Air Transport Association of America website

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Economic Implications of the O’Hare Modernization Program Table 4

O’Hare Capacity and Traffic Mix (Combination Aircraft) YE 2Q 2003 Departures (000) On-Board Passengers (000) Passengers/DPTR Average Airfare

YE 2000

2003 Percent I/(D)

425.3

426.1

(0.2)%

38,345.4

42,259.2

(9.3)%

90.2

99.2

(9.1)%

$172.01

222.1

(22.5)%

Source: Appendix 2

This trend of declining traffic and revenue is serving to not only drive up the cost per enplanement to the airlines, but also it is driving up the airport cost per revenue dollar generated. This is the worst of all worlds for the LNCs. As an example, the O’Hare cost per enplanement in 2000 was $7.90, or 3.6% of the average ticket price. By the year 2003, the average cost per enplanement had risen by 17% to $9.24, and the ticket price declined to $172.01, increasing the cost from a modest 3.6% of revenue to 5.4%, still an acceptable level.

Clearly this trend is the opposite of what is desirable in today’s market. While the cost is still only 5.4% percent of the average ticket price, the OMP, if implemented, would not only increase the cost per enplanement to over $25 by 2012, but it would raise the cost per passenger to over 13% of per passenger revenue generated (see Chapter III, Table 8).

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Economic Implications of the O’Hare Modernization Program II.2.0 O’HARE CARRIERS CANNOT AFFORD COST INCREASES The financial posture of United and American has deteriorated rapidly since 2000, their last year of profitability. Combined, they have generated operating losses between 2001 and 2003 of in excess of $14 billion. Their combined operating losses during these years represent 57.1% of the cumulative operating losses of all of the major U.S. carriers. There is also no doubt that the losses will continue into 2004, particularly in light of the increases being experienced in the price of jet fuel. Table 5 shows American and United financial performance.

Table 5

American and United Financial Performance ($ in Millions) AA

UA

TTL

US Majors

2003

-Op Profit/(-) -Margin

-844 -4.8%

-1,360 -9.9%

-2,204 -7.1%

-4,190 -5.3%

2002

-Op Profit/(-) -Margin

-3,330 -18.1

-2,837 -19.9%

-6,167 -18.9%

-9,986 -12.4%

2001

-Op Profit/(-) -Margin

-2,515 -13.3%

-3,771 23.4%

-6,286 -17.9%

-11,482 -13.2%

Total

-Op Profit/(-) -Margin

-6,689 -12.2

-7,968 -18.0%

-14,657 -14.8

-25,658 -10.4%

AA – UA % Majors Loss

57.1%

Both carriers have made progress in stemming losses, restructuring their route networks, and lowering costs across the board in both labor and non-labor categories.

However, the critical issues now are that both carriers must 1) repair their respective balance sheets, and 2) lower costs while maintaining product quality in order to compete with the LCCs which have grown dramatically over the past 10 years.

The United situation is more severe since it is in bankruptcy. On the other hand, bankruptcy has afforded United an opportunity to reject or re-negotiate aircraft leases and other contracts, including those with its labor groups.

However, it still has a substantial burden in terms of meeting pension obligations, maintaining a competitive cost structure, and delivering a product suitable and acceptable to its target market.

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Economic Implications of the O’Hare Modernization Program As can be seen from Table 6 below, United’s combined $8.0 billion in operating losses over three years contributed to the very substantial Long Term Debt of $13.9 billion and negative Stockholder Equity of $5.9 billion. Notwithstanding pension relief under recent legislation, it still has substantial debt, and will continue to have difficulty attracting the equity required in order to emerge from bankruptcy.

Table 6

United Financial Posture ($millions) Year Ended 12/31/03

UA 2001 – 2003 Operating Profit/ (Loss)

$(7,968)

Long Term Debt 1/

$13,964

Long Term Debt % Total Capital Stockholder Equity Cash on Hand 2/

63.5% $(5,916) $1,718

Source: UAL 10K Filing 1/ Including capital leases; UA, Ltd. is “subject to compromise” 2/ Unrestricted cash and short-term investments

United Airlines, the dominant O’Hare carrier, cannot afford to support expensive capital investments that yield little, if any, return. It is fighting for survival and attempting to secure pension relief so that it can emerge from Chapter 11 bankruptcy. The carrier is also attempting to lower its costs while producing a product quality that the consumer is willing to pay for.

While United had $2.4 billion in cash at year-end 2003, almost $700 million of that cash was restricted. It also faced strict covenants from its Debtor-inPossession lenders.

The progress made by United while in bankruptcy is not insignificant in terms of reducing its cost structure through reductions in staffing and renegotiated lease and labor agreements. The combination of these improvements has allowed UA to lower its unit cost for 2003 by 7.5%, and by 17.3% in the fourth quarter of 2003, versus the comparable period in 2002. However, breakeven load factors continue to remain at all-time highs, 87.6% for the year, and 83.1% in the fourth quarter, as a result of depressed yields (average fares).

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Economic Implications of the O’Hare Modernization Program Compounding its operating problems is a $13 billion pension liability, some of which will be resolved with legislation recently enacted. However, that legislative relief will still leave a considerable pension liability.

The company also has re-filed its application with the Air Transportation Stabilization Board (ATSB), set up after 9/11 to provide loan guarantees to carriers uniquely impacted by the events surrounding 9/11. At this time, there is little evidence that the ATSB will be sympathetic to United’s application, in part because we are now 2.5 years removed from 9/11, making it difficult to argue that the current plight of the company is 9/11 related.

Lastly, United’s action in renouncing airport lease agreements raises serious questions relative to future airline backed airport financing.

In comments on a March 30, 2003 court decision, Fitch Ratings evidenced concern.

CHICAGO--(BUSINESS WIRE)--March 31, 2004--Fitch Ratings believes that yesterday's court decisions in the United Airlines' (United) bankruptcy proceedings regarding the treatment of the carrier's special facility bonds sets a troubling precedent which may weaken security provisions behind certain municipal leased-backed bonds, but potentially strengthen bondholder security on other lease structures and provide guidance for structuring future transactions as true leases. The ruling came in response to a motion filed by United in which the airline asked the bankruptcy court to determine if certain special facility bonds issued on the airline's behalf constituted a true lease subject to the provisions of Section 365 of the United States Bankruptcy Code, or instead were 'disguised financings' that should be treated by the court as unsecured debt of the airline.”

The result of this decision is yet to be fully realized. However, it is clear that airline backed financing of airport facilities will face increased scrutiny and probably increased yields, which will likely increase the difficulty of bringing airline-backed debt to the market.

American Airlines, the second O’Hare hub carrier, is only modestly better positioned than United.

American has registered a cumulative operating loss over the last three years of $6.7 billion, almost forcing it into bankruptcy. Only a last minute agreement with its employees allowed AA to avert filing for Chapter 11 bankruptcy protection.

American did register solid progress in reducing its unit costs in the fourth quarter of 2003, and this has led to some strengthening of its position. However, it cannot afford to finance a major investment at O’Hare while at the same time it is Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program looking at a cost of roughly $30 per passenger at its Miami hub.6 While Miami is somewhat unique for American because it is the dominant carrier, and because of the mix of international to domestic traffic, it cannot afford the same economics at O’Hare where the traffic composition is predominantly domestic.

The American Airlines balance sheet also is in dire need of repair as shown in Table 7.

Table 7

American Financial Posture ($millions) Year Ended 12/31/03

AA 2001 – 2003 Operating Profit/ (Loss)

$(6,689)

Long Term Debt

$13,126

Long Term Debt % Total Capital Stockholder Equity Cash on Hand

44.8% $46 $2,606

Source: AA 10K Filing

On a combined basis, it becomes evident that O’Hare carriers cannot afford to see their airport unit costs rise without a commensurate increase in prices.

Thus, as of 2004 and into the foreseeable future the O’Hare hub carriers, United and American, are faced with severe strategic, competitive, and cost issues.

What neither carrier can afford is any major capital investment that does not produce a significant rate of return, i.e. a very short discounted payback period.

To merely see their airport costs rise from 5.4% of revenue to 13.3% of revenue would be extremely burdensome and would negatively impact their ability to compete effectively in today’s highly competitive low-cost environment. This dramatic rise in the cost per enplanement and the consequent increase in the percentage that airport costs take from revenues, is the likely range of the impact of OMP, should it be implemented as set forth in the documents submitted to the FAA in February and March of 2004.

6

Refer to Appendix 3

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Economic Implications of the O’Hare Modernization Program

Section III

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Economic Implications of the O’Hare Modernization Program SECTION III. OMP IMPACTS III.1.0 BACKGROUND O’Hare International Airport sits at the focal point as the second largest airport hub complex in the United States. It supports over 900 thousand operations per annum and handles roughly 70 million passengers (enplaned and deplaned). It is also an airport which over the years has been plagued by congestion and delays despite the best efforts of the FAA and airlines, including FAAadministered slot controls.

The 2001 FAA Terminal Area Forecast (TAF), projects enplanements growing to 48 million by 2014, and to 57 million by 2022. These enplanement forecasts are supported by FAA aircraft operations forecasts of 1.1 million in 2012 and 1.2 million in 2022 (Master Plan Exhibits III-1 & III-2).

Existing congestion and normal growth suggest that capacity needs to be expanded at O’Hare or at alternative airports in the region, or both. In regard to O’Hare, the City of Chicago has set forth the OMP to deal with those needs.

According to the City, the purpose of the OMP is: “…to reduce current and projected delays at O’Hare and throughout the national air transportation system and add incremental capacity for the Airport to accommodate demand beyond 2030. The OMP reconfigures the airfield into a modern parallel runway system allowing the Airport to operate more efficiently.”

“The OMP is a $6.6 billion (in 2001 dollars), multi-year plan to reduce aircraft delay and enhance the capacity of the Airport. The following proposed runway projects are included as part of the full OMP airfield development, along with the associated proposed supporting airfield infrastructure…” 7 The OMP is intended to add airfield and landside capacity through runway, airfield support, terminal, and ground access projects. The cost of the OMP has been variously estimated by the City of Chicago at amounts ranging from $6.6 billion to close to $15 billion.

The City has also variously estimated the added capacity to reach up to 1.6 million operations and to enhance passenger enplanements up to 75 million.

Recently emerging information and data provided by the City of Chicago would now suggest that the cost will be at the higher levels, and the airport capacity after OMP is implemented will be at much lower levels, at best. The City’s own 7

Master Plan, pgs. III-5 & 6

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Economic Implications of the O’Hare Modernization Program consultant Ricondo & Associates issued a report indicating that the Airport will experience worse congestion than today at 1.3 million operations. Joseph Del Balzo (former FAA Acting Administrator) advised FAA that O’Hare will reach capacity limitations (primarily due to airspace constraints) at 1.1 –1.2 million annual operations. See, JDA letter dated January 16, 2004.

That is, the OMP might be able to accommodate an additional 200,000 annual operations (i.e. total of 1.1 million- 1.2 million operations per annum), and the passenger enplanements may reach 42 million by 2012, the year in which the majority of the program is to be in place.

The OMP filed with the FAA in early 2004 outlines a Phasing Plan that has Phase I consisting of “construction of one new runway, the extension of an existing runway, and the realignment of an existing runway, respectively. In response to demand for additional gate facilities, implementation of the West Terminal Complex Satellite Concourse is also expected to occur during this period; however, it is independent of other Phase I components.” (Master Plan, pg. VII-1).

Phase II, according to the City, will, “consist of the construction of one extension of an existing runway and the realignment of the two existing 14-32 oriented runways. In response to demand for additional gate facilities, implementation of the West Terminal Building/Concourse, and the World Gateway Program (WGP) terminal development is also expected to occur during this period; however, construction of these components is completely independent of each other and of other Phase II components. “ (OMP page 9, VII-1).

According to the Master Plan, “The estimated cost of the OMP is approximately $6.6 billion in 2001 dollars. The first full year of operation for the completed OMP is assumed to be 2013.” (Master Plan, pg. VII-22) Since the OMP cost of $6.6 billion is stated in 2001 dollars, and since it does not include the WGP, there is clearly no reference in the document to the true full cost of the program. In fact, in a recent letter, the FAA asked the City to “Provide an OMP financial plan, which includes a discussion of what role/priority OMP plays in the Chicago O’Hare Capital Improvement Plan, funding sources (AIP, PFC, entitlements, discretionary, bonds, others), and amounts; Develop a cost benefit analysis for OMP; Provide documentation on the economic impact of OMP on the City of Chicago and the region; Discuss further how the goals and objectives of the OMP and WGP (World Gateway Project) work together to provide an overall more efficient and beneficial airport.”8 To date, the majority of this information has not been made public and consequently our analysis must proceed from currently available information, benchmarks, and other publicly available data.

Notwithstanding the dearth of information, a March 1, 2004, article in Crain’s Chicago Business, begins, “With the full $15-billion price tag for Chicago’s plan to 8

FAA letter to the City of Chicago, dated October 6, 2003

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Economic Implications of the O’Hare Modernization Program expand O’Hare international Airport coming into focus, questions are emerging about how the city will pay for the costliest public works project in its history.”

The article also raised a number of the legitimate issues including, “Can the city squeeze 42% more passengers into the airport by 2012 and nearly 76% more by 2022?”

A team led by Joseph Del Balzo, former Acting Administrator of the FAA, and J.E. Murdock III, former Chief Counsel of the FAA, examined the OMP, along with a team of experts on airport planning, demand forecasting, capacity and delay analysis, terminal and runway design, air traffic control, environmental analysis, cost analysis, and airport financing. Preliminarily, the team concluded, among other things:9 •

The OMP Runway Configuration Cannot Perform as Required.

•

The O’Hare Project Flunks the Cost-Benefit Test.

•

Chicago’s Claimed Economic Benefits are Illusory.

•

Chicago has Failed to Present a Viable Plan to Pay for the Proposed O’Hare Expansion.

Each of these conclusions of the team of experts reaches to the economic and financial aspects of the OMP.

III.2.0 FINANCING PLAN The Master Plan, pg. VII-25, Section 7.4 Financial Feasibility, stipulates, “This section demonstrates the City’s ability to fund the Master Plan Development.”

Quite the contrary, Section 7.4 leaves the vast majority of questions relative to financing the project either not answered, or answered in a manner that raises questions of credibility.

According to the Master Plan, page VII-28, Section 7.4.2, funding for the OMP will be derived from the following sources: 1. Federal grants-in-aid under the AIP program.

2. Passenger Facility Charges (PFCs).

3. General airport revenue bonds (GARBs).

4. Third-Party Financing.

III.2.1 AIP Program The AIP Program contains $500 million annually in discretionary funds. The City has already requested over $300 million in AIP grants requesting $30 million per year for ten years as part of Phase I (refer to Letter of Intent Thomas R. Walker and Rosemarie S. Andolino to Philip Smithmeyer of the FAA, dated March 1, 9

Joseph M. Del Balzo to Barry M. Cooper and Philip Smithmeyer, dated January 16, 2004.

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Economic Implications of the O’Hare Modernization Program 2004). This would raise only $300 million or 2% of the $15 billion. The FAA cannot approve an AIP grant without concluding that the balance of the cost of the project can be adequately financed. As discussed in this study, there are serious questions as to whether the non-AIP portion of the OMP can be financed.

The FAA is unlikely to provide AIP grants in amounts beyond the $30 million per annum because to do so would require diverting funds from other airports with equally or more significant needs. Moreover, the $30 million for Phase 1 already represents 6% of the entire AIP discretionary fund program.

III.2.2 PFC Financing The PFC Financing assumption is that PFC’s would increase from a maximum of $4.50 to $6.00 per enplanements. While this increase would theoretically raise an incremental $63 million per annum beginning in 2012, there is little rationale for the City assuming that the PFC can be raised, particularly since any change must be accomplished legislatively. As noted previously, ATA’s number one economic objective is to preclude additional airport capital programs and taxes.

ATA and the airlines will vigorously oppose any change in legislation, and probably successfully, given their financial plight and the fact that it is easier to thwart than it is to enable new, or modify existing legislation.

III.2.3 GENERAL AIRPORT REVENUE BONDS (GARBs) General Airport Revenue Bonds (GARBs) are apparently to be a significant source of financing. The airport has $3.2 billion outstanding long-term debt (Appendix 4), one of the largest amounts of the 31 large hub airports. In light of the United bankruptcy filing and the uncertainty this has had on the financial markets, there is a real question as to how much and at what level GARBs could be issued. As the OMP notes, the issuance of GARBs is subject to Airport Use and Lease Agreements, and those must be approved by the carriers.

In light of the limited resources available for this program under PFCs, AIP, and special facility financing, GARBs will likely have to support 90% of the required $15 billion project cost. The financing cost alone for this under a thirty year bond at 6% would be over $970 million ($15 billion x .90 = $13.5 billion @ 6% over 30 years).

III.2.4 THIRD PARTY FINANCING Third Party Financing is listed as the fourth source of funding. However, this includes, among other options, special facility financing. In this regard, an excerpt from a recent Reuters piece is telling.

“CHICAGO, Feb 6 (Reuters) - Special facility revenue bonds backed solely by an airline will no longer be used to finance large airport facilities in Chicago after defaults on outstanding bonds soured investors against them, city airport officials said on Friday.

Thomas Walker, Chicago's aviation commissioner, said investors were not likely to buy any of those bonds, particularly in the wake of Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program defaults like those by United Airlines when it filed for bankruptcy protection in December 2002.

Unlike general airport bonds, which are secured by a variety of airport revenue, special facility airport bonds are either unsecured debt, carrying only a promise from an airline to pay bondholders, or secured debt, backed by lease agreements with airports.

Last year, United Airlines, a unit of UAL Corp. (UALAQ.OB), defaulted on millions of dollars of unsecured debt issued through several airports.

Special facility bond financings will be limited to items such as hangers, maintenance facilities or private clubs in the future, according to John Harris, the city's first deputy aviation commissioner.

For a larger facility, the city would pool revenue from that facility to pay off bonds, he added.

To pay for elements of a 20-year master plan for O'Hare International Airport, Chicago plans to mainly tap federal airport improvement funds, passenger facility charges and general airport revenue bonds backed by airport-wide fees and revenue.”

The city submitted the master plan to the Federal Aviation Administration on Friday, officials said. It would cost roughly $14.8 billion in today's dollars, they added.”

With respect to Third Party Financing through Special Facility Bonds, the following is noteworthy: “Fitch Ratings believes that yesterday's court decisions in the United Airlines' (United) bankruptcy proceedings regarding the treatment of the carrier's special facility bonds sets a troubling precedent which may weaken security provisions behind certain municipal leased-backed bonds, but potentially strengthen bondholder security on other lease structures and provide guidance for structuring future transactions as true leases. The ruling came in response to a motion filed by United in which the airline asked the bankruptcy court to determine if certain special facility bonds issued on the airline's behalf constituted a true lease subject to the provisions of Section 365 of the United States Bankruptcy Code, or instead were 'disguised financings' that should be treated by the court as unsecured debt of the airline.” (Chicago Business Wire 3/31/04) Thus, it is unlikely that special facility financing is going to be available.

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Economic Implications of the O’Hare Modernization Program With only small amounts of financing available from AIP, and no incremental financing coming from either special facility debt or PFC’s, the burden of financing would seem to fall almost entirely on GARBs. The financing plan set forth in the Master Plan, pg. VII-28, Table VII-5 assumes that 59% of the OMP funds and 78% of WGP come from GARBs. Given the alternative financing available, it would appear that over 90% of the financing would have to be funded through GARBs.

III.3.0 ECONOMICS OF THE PROJECT Notwithstanding the above, an equally large issue looms.

That is the wherewithal of the major hub carriers, United and American, to finance the project, directly or indirectly. Ultimately, one way or another, they must foot the bill, and recapture the increased cost from their passengers.

As a consequence of the recent historical losses of the hub carriers, the extent to which they are leveraged, and the bankruptcy of United, there is a real question as to whether or not the carriers can finance the project.

In light of the recent cost and profit pressures on the major LNCs, it has become increasingly essential for them to evaluate all costs in the context of the competitive environment, and the resultant fares that can be charged in the market.

As noted in Chart 4 in Section I, airfares in the U.S. have been declining rapidly over the past few years. While that trend may be moderating, and in fact we expect to see some fare increases over the next few years, it is clear that fare pressure on the O’Hare hub carriers, American and United, will not abate. This is due in part to the general industry decline in fares caused by the 2000 recession, 9/11, and the increasingly widespread use of the Internet. It is also due to the presence at Midway Airport of Southwest and ATA, two low-fare carriers that are operating in a number of city-pair markets served by United and American.

Thus, it becomes essential for these carriers to ensure that unit passenger costs are maintained at the lowest possible level. This will require the airport operator, with the cooperation of the carriers, to maximize the return on invested capital.

In other words, each additional dollar of investment must produce incremental value in terms of the potential to generate added passenger volumes and/or incremental revenue adequate to ensure the return on investment.

Today, O’Hare is a competitive airport in terms of cost and thus productivity.

The airport cost per passenger boarded to the airlines was $9.24 in 2003 (Master Plan, pg. VII, Table VII-9). When examined on a comparative basis with other large hub airports, O’Hare is very competitive. As noted in Section II of this study, and repeated in Chart 11, a benchmark study performed in 2002 established O’Hare’s cost per passenger at $8.70, or 3.5% less than the average for large hubs of $9.02.

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Economic Implications of the O’Hare Modernization Program The significance of the existing cost structure cannot be underestimated.

Historically, depending on a number of operating and strategic variables, air carriers have generally been willing to accept airport charges per passenger enplaned that do not exceed 9-10% of the revenue generated by each passenger. In the case of O’Hare, the average cost of $9.24 represents only 5.4% of the average revenue generated per passenger of $172.01 (Table 4 in Section II).

III.4.0 CITY ESTIMATES OF THE ECONOMICS ARE FLAWED We have examined the City’s OMP and related documents including those filed as attachments to the LOI of March 1, 2004 with the FAA. Setting aside for the moment whether or not the project could ever be financed, given the previously noted financing limitations, the OMP would, if implemented, increase the cost per passenger enplaned from $9.24 in 2003 to an estimated $26.33 by the year 2012, an increase of 185%. This would also bring the cost per passenger to a level of roughly 13.4% of the forecast average airfare of $196.68 as shown in Table 8).

Table 8

O’Hare Activity and Cost Forecast 2012 – G/(L) 2003

2012

32,628

41,167

8,539

26.2

425,279

488,220

62,941

14.8

76.7 90.2 121.2

84.3 103.7 133.3

7.6 13.5 12.1

9.9 15.0 10.0

74.4%

77.8%

3.4 pts

$172.01

$196.68

$24.67

14.3

Cost/Enplanement

$9.24

$26.33

$17.09

185.0

Cost/Revenue Ratio

5.4%

13.4%

8.0 pts

Enplanements (000) 1/ Passenger A/C Departures 2/ Enplaned/ DPTR On-board/DPTR Seats/ DPTR Load Factor Average Ticket Price

Amt.

%

1/ Assumes 10% growth in seats/departure and 15% growth in passengers/departure 2/ Departures are forecast to growth to almost 15%, the amount by which all activity could grow assuming that 1.1 million departures per year is feasible.

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Economic Implications of the O’Hare Modernization Program We have developed a realistic set of assumptions related to activity at the airport based on a “likely scenario” with respect to growth in traffic, growth in the average seats per departure, and increases in airfares. Set forth as footnotes in Table 8, we assume that there will be traffic growth over the 9 years of roughly 26.2%, facilitated by increased demand and increased capacity generated by increases in the number of seats per departure and departures.

The City of Chicago has estimated the costs for airlines to operate at O’Hare under the completed OMP at $938.0 million in 2012 (Table 9). However, the City of Chicago has filed various and conflicting documents.

For example, in an August 14, 2003 letter from Ricondo & Associates to Thomas R. Walker, the City’s Director of Aviation, Ricondo stipulates that scheduled passenger airline operations will be 1.0 million in 2012, while enplanements will reach 42.2 million. This same document estimates the annual cost per passenger enplaned at $12.85. Yet, only six months later, Ricondo estimates that the 2012 enplanements will be 46.5 million, and the cost per passenger enplaned to the airlines will be $20.19 (Tables 9 and 10).

Table 9 Projected Airline Cost Per Enplaned Passenger ($000) for Fiscal Years Ending December 31 Intermediate Long Term Term Projected Projected

Short Term Estimated 2003 Net Signatory Airline Requirement

Estimated 2004

Projected

2005

2005 2006

2007

2012

2022

292,669

325,501

367,775

383,302

421,201

914,764

1,519,559

8,931

9,844

9,764

10,378

12,045

23,241

42,014

Total Airline Requirement

301,600

335,345

377,539

393,680

433,246

938,005

1,561,570

Total Projected Enplaned Passengers

32,628

37,735

38,825

39,914

41,003

46,450

57,356

Total Airline Cost Per Enplaned Passenger

$9.24

$8.89

$9.72

$9.86

$10.57

$20.19

$27.23

2003 Constant Dollars 1/

$9.24

$8.63

$9.17

$9.03

$9.39

$15.48

$15.53

Non-Signatory Airline Requirement

Source: 2003 Total Projected Enplaned Passengers – Ricondo & Associates, Inc.; 2004-2015 Total Projected Enplaned Passengers – FAA, 2001 Terminal Area Forecast; and 2016 – 2022 Total Projected Enplaned Passengers – Ricondo & Associates, Inc. as extrapolated from the FAA, 2001 Terminal Area Forecast. All FAA TAF enplaned passengers stated in FFY (ending September 30) have been converted to enplaned passengers state in Airport Fiscal Years (ending December 31).

Our examination of the limited supporting documentation for these estimates indicates that a number of costs have not been recognized. In other words, the Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program City’s projected capital costs, non-airline revenue, and thus cost/enplaned passenger is predicated on a number of ill-defined or tenuous assumptions including: 1. The OMP would cost only $6.6 billion.

2. The OMP would increase passenger traffic by 42% to 46.5 million enplanements between 2003 and 2012.

3. The OMP estimates non-airline (retail, parking, etc.) revenue increasing by 7.7% per annum between 2003 and 2012.

4. The OMP seemingly fails to consider the World Gateway Program (WPG).

5. The OMP has no significant contingency built into the capital cost, notwithstanding a history of significant overruns for major airport and other transportation expansion programs.

6. The OMP assumes that the PFC will increase by $1.50 per enplaned passenger, from $4.50 to $6.00, thus generating up to $70 million in 2012.

Each of the above major assumptions, or absence thereof, have serious consequences relative to the potential for actually undertaking the OMP. III.4.1 The City Claims OMP Would Cost Only $6.6 Billion An examination of both the OMP and the Letter of Intent of the City, dated March 1, 2004, refer to the OMP as a $6.6 billion program (Refer to LOI, pg. III-6). In fact, the program envisioned (that presumably would increase aircraft operations to 1.1 million per annum, and passenger enplanements to 46.5 million per annum) would cost at least $14.7 billion, in nominal dollars, as follows (Appendix 9): O’HARE MASTER PLAN WORLD GATEWAY PROGRAM CONTINGENCY-25% (BASED ON HISTORY - Table 11) Estimated Total Capital Cost (Appendix 8)

- $8.3 billion - $3.5 billion - $2.9 billion $14.7 billion

And this $14.7 billion does not include the on-going Capital Improvement Program (CIP) which, although not part of the OMP, must be financed and will cost an additional $4.1 billion in nominal or escalated dollars.

We cannot determine why the City has so often quoted the $6.6 billion number.

However, using this number certainly obscures the real size of the program. In fact, the $6.6 billion is an estimate of the cost of the OMP airfield component in 2001 dollars and gives no recognition to the fact that the WGP will be presumably be developed in order to facilitate the traffic generated by the OMP. In a March 1, 2004 article in Crain’s Chicago Business, “O’Hare’s Rosy Scenario”, Paul Marrion notes, “Overall, annual debt service would soar from $132.7 million in 2003 to more than $1 billion in 2022. “ And further, “One Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program assumption is that future refinancing of the airport’s existing $3.2 billion in debt will put off principal payments until 2019.”

With respect to the City’s ability to ever finance the project, the author states, “The city also assumes that a type of borrowing called special facility debt— usually backed by a single airline—will be used for a substantial part of the new terminals that will be built. The market for special facility bonds has been thrown into doubt by United’s attempt to default on that kind of debt in bankruptcy,…”

III.4.2. The City Claims OMP Would Increase Passenger Traffic By 42% To 46.5 Million Enplanements Between 2003 And 2012 The City’s own estimates of traffic growth seem to vary from month to month (Table 10). In August of 2003, Ricondo & Associates estimated the 2012 enplanements at 42.2 million, an increase of only 29.3% from the 2003 base of 32.6 million enplanements. Only six months later, in submitting the OMP to the FAA, enplanements for 2012 had grown to 46.5 million, an increase of 42.6%.

Without this roughly ten percent increase in forecast enplanements, the City’s own estimate of the cost per passenger to the airlines would have been $22.23, or 10% higher than they claim in both the OMP and the cost estimate materials made available on their website in March of 2003 (Appendices 5 - 8).

T a b le 1 0 P r o je c t e d O M P C o s t S t r u c t u r e 2012 ga2 E s t im a t e s

($ )

C it y o f C h ic a g o F o r e c a s t 8 /1 4 /0 3

1/

2 /0 4 O M P

2/

C a p it a l C o s t – –

1 2 .8 1 4 .7

C u rre n t N o m in a l

P a s s e n g e r A ir lin e O p e r a t io n s ( 0 0 0 )

3/

6 .6 NA

9 7 6 .4

1 ,0 0 1 .5

4 1 ,1 6 7

4 2 ,2 0 0 .9

4 5 ,4 5 0

$ 1 ,0 8 4 .0

$ 5 4 2 .5

$ 9 3 8 .0

A ir lin e C o s t /E n p la n e d P a s s e n g e r

$ 2 6 .3 3

$ 1 2 .8 5

$ 2 0 .1 9

R e v e n u e /P a s s e n g e r

1 9 6 .6 8

C o s t /R e v e n u e R a t io

1 3 .3 %

P a s s e n g e r s E n p la n e d ( 0 0 0 ) A ir lin e R e v e n u e R e q u ir e d ( M IL )

S o u rc e :

1 / R ic o n d o L e tte r o f 8 /1 4 /0 3 to T h o m a s W a lk e r , E x h ib its E 9 8 a n d E 1 0 1 , a d d e n d u m to $ 9 8 6 ,3 1 0 ,0 0 0 C ity o f C h ic a g o G e n e r a l A ir p o r t T h ir d L ie n R e v e n u e B o n d s 2 / O ’H a r e M a s te r P la n S u b m itt e d to F A A in F e b r u a r y 2 0 0 4 3 / R e f le c ts 1 4 .8 % in c r e a s e f r o m 2 0 0 3 A c tu a l

There are further issues of information consistency and reliability which make the various documents provided by the City of Chicago, suspect. For example, the projected growth of 42.6% is from the city’s stated base in 2003 of 32.628 million passengers. However, according to the OMP, page III-5, Table III-1, O’Hare enplaned 36.0 million passengers in 1999, and thus the increase that is being generated and attributed to the OMP is really only 17%, even assuming the Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program Ricondo & Associates projection of August 14, 2003 of 42.2 million passengers in 2012 is valid. This raises the question of aircraft type and fleet mix. The average aircraft size at O’Hare has been declining over the past few years due to the introduction of RJs. However, as it becomes increasingly essential for the O’Hare network carriers to accommodate natural demand, they will upgrade the 50 seat RJs in prominence today to 70 and 90 seat RJs. Consequently, one might reasonably expect that an additional 10% in traffic can be accommodated just by increasing the average seats per aircraft departure back to levels that existed prior to the introduction of the 50-seat RJ (Table 8).

III.4.3 The City Claims that Non-Airline Revenue Will Increase By 7.7% Per Annum Between 2003 And 2012 Our estimate is that traffic between 2003 and 2012 will increase by a compound annual growth rate (CAGR) of roughly 2.4%. However, the OMP projects retail revenue to increase by 7.7% per annum, suggesting a considerable increase in pricing. This significant disparity between volume and revenue increases is not explained in the Master Plan. However, the large increase does reduce the amount of revenue that is required to be generated from airline sources such as landing fees, rental rates, and fueling charges, etc,.

III.4.4 The OMP Seemingly Fails To Consider The World Gateway Program (WGP) There is a continuing reference within the OMP and in separate communications from the City of Chicago to a $6.6 billion OMP. However, as previously noted, the $6.6 billion is seriously understated because a) it is stated in 2001 dollars, b) it contains no contingency for overruns, and c) it ignores the WGP, estimated to cost $$3.5 billion over the term of the construction ($2.6 billion in 1999 dollars, OMP pg. VII-25).

Without the WGP, there likely would not be sufficient gate and ancillary support facilities to handle the added capacity and traffic generated by the $6.6 billion (in 2001 dollars) investment.

III.4.5 The OMP Has No Contingency For Capital Cost Overruns The history of major airport construction programs is replete with massive overruns. However, notwithstanding this history, there is little or no evidence within the OMP and WGP of any real contingency planning or funding allowances.

Table 11 below bears testimony to the need for contingency funding.

Consequently, we have included a contingency of 25% of the program cost. We believe that this is a conservative estimate, given recent history.

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Economic Implications of the O’Hare Modernization Program Table 11 Transportation Cost Overruns

Estimated Cost and Date of Estimate1/ Original Boston “Big Dig”

Latest/Actual

Cost Increase

$2.6b (1985)

$14.6b (2002)

460%

Denver Int’l Airport

$1.7b (1989)

$4.8b (1995)

182%

Virginia “Mixing Bowl”

$.24b (1994)

$0.68b (2003)

183%

Seattle Light Rail

$1.7b (1996)

$2.6b (2000)

53%

Source: 1/ Cato Institue Bulletin, Tax & Budget, No 17, September 2003

III.4.6 The OMP Assumes That The PFC Will Increase By $1.50 Per Enplaned Passenger From The Current Legal Maximum of $4.50 To $6.00 The U.S. airline industry is highly leveraged, under severe pressure from the LCCs, and aggressively focused on controlling its costs, principally because it has to compete with the LCCs for the increasingly price-sensitive passenger. In order to compete, it does not want to raise airfares, unless there is a clear demonstration that such an increase can be brought to the bottom line of the profit and loss statement.

The City of Chicago, on the other hand, assumes that it can raise PFC charges from $4.50 to $6.00, “Therefore this financial analysis assumes that the PFC program increases to $6.00 in January 2011.”10 While it can be argued that 2011 is seven years away, air carrier opposition to PFCs will not likely abate since PFCs are built into the ticket price charged. Thus, any increase in PFCs causes an increase in price and a reduction in demand for air travel, a source of great concern to the ATA. In his recent speech to the International Aviation Club of Washington James May, the organization’s CEO noted, “The simple truth is that those revenues—AIP and PFCs, and airline landing fees and rents—are driven by customer demand and come directly from air carriers’ bottom lines. We need to focus our efforts on maximizing the national aviation system, improving those facilities that will add to national capacity, and forego edifice complex projects.”

Given the size of the investment required for the OMP, and the relatively modest increase in capacity it would generate, incrementally, James May could have been referring to a future O’Hare, among others. This being the case, it is very unlikely that PFCs will be increased for the foreseeable future. That adds 10

Master Plan VII-29, Section 7.4.2.2

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Economic Implications of the O’Hare Modernization Program roughly $63 million annual burden for the airlines to bear (42 million passengers x $1.50 PFC increase per passenger).

In an effort to approach the economics from an alternative scenario, we examined the information submitted by the City to arrive at its forecast cost per enplaned passenger of $20.19 (Table 9) and then made adjustments to reflect what we believe are alternative and more realistic assumptions: 1. Traffic growth at 26% over the 9-year period, rather than the 42.3% forecast by the City.

2. Retail sales growth at 3% per annum, rather than the 7.7% the City had forecast, without any justification as to why retail sales would so substantially outstrip traffic growth 3. PFC rates have been maintained at the current $4.50, for the reasons cited above.

With these minor adjustments, the ga2 estimate takes the cost per enplaned passenger from the City’s $20.19 to $26.33, an increase of 30.4% (Table 12).

Table 12

ga2 Adjusted Forecast of OMP Base Data 2012 Cost ($000) Airline Data Per City 1/ Retail Adjustment 2/ From: 7.2 % per Annum To: 3.0% per Annum

$938,005

Adjusted Cost/Passenger Percent G/(L) than OMP

Cost/Passenger

46,450

$20.19

$82,984

Passenger Growth 3/ From: 4.0 % per Annum To: 2.6% per Annum Absence of $6.00 PFC 4/ ($4.50 in place)

Passengers (000)

(5,283)

$63,000 $1,083,989

41,167

$26.33

15.6%

(11.4%)

30.4%

1/ City estimate per O’Hare Master Plan Table V11-9 2/ Retail adjustment to reflect historical growth 3/ Passenger growth to reflect historical trend 4/ Assuming no increase in PFC

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Economic Implications of the O’Hare Modernization Program III.5.0 SUMMARY In summary, the capital cost of the program at roughly $15 billion, and the incremental traffic and capacity it is likely to produce raise serious questions relative to the economic viability of the OMP: 1. Can the City, even with the carriers’ support, finance a project of this scope?

2. When the carriers examine the cost of the project, and the return in terms of truly incremental capacity added, will they be prepared to support the OMP, or will they look for more reasonable and less expensive alternatives?

3. Why has the City, either overtly, or implicitly, ascribed all of the growth at O’Hare to the OMP, rather than ascribe only that portion that would be generated incrementally by the OMP investment? The ga2 forecast suggests that it is not unrealistic to expect a significant part of the 26.2% increase in traffic at O’Hare between 2003 and 2012 to come from an increase in seats per departure of roughly 10%, which would reflect a natural carrier response to runway and/or ATC limitations on operations.

4. Why has the City not provided a Benefit-Cost Analysis to support the LOI filing of March 1, 2004?

It is clear that, given natural demand growth, there needs to be more capacity in the Chicago area. However, what is also clear is that financing the project is questionable, and if financed, the OMP would seriously raise the cost per passenger to the airlines, both in an absolute sense and relative to the revenue generated, a key benchmark for airline cost control.

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Economic Implications of the O’Hare Modernization Program

Section IV

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Economic Implications of the O’Hare Modernization Program SECTION IV: REPORTED ECONOMIC IMPACT OF O’HARE IV.1.0 SUMMARY AND DISCUSSION There has been a great deal of publicity surrounding the economic benefits to the community that would derive from the OMP. This section examines the assumptions and conclusions of those studies, and puts the results of the City of Chicago’s study in context. While we do not have access to much of the detail, it is clear that the purported benefits of the OMP are significantly overestimated.

The City claims that the OMP will produce an additional $18 billion in economic output and an incremental 195,000 additional jobs. The City’s claimed economic benefits attributable to the OMP are unrealistic. First, Chicago’s claimed benefits assume that airspace capacity, and therefore flights and traffic growth, will be unconstrained with the OMP. However, aviation experts have challenged the OMP’s ability to achieve the significant increases in the level of operations and significant reductions in congestion and delays projected by Chicago. See, Del Balzo FAA Letter dated January 16, 2004. Second, the OMP will cause airline costs to increase substantially (to over $26.00 per enplaned passenger) in order to pay for the investment. This will force air carriers to increase airfares to the local Chicago air traveler. Given the elasticity of demand, certain traffic will opt to not travel, or to use alternative airports and/or other modes of transportation. This could well dampen travel, tourism, and investment, and lead to a loss to the region of businesses, jobs and tax revenues, among other adverse economic impacts. Third, even accepting Chicago’s unconstrained assumption that the OMP will allow for 1.6 million annual operations, the OMP will fall far short of the City’s claimed benefits. That is, assuming no external constraints on flights and capacity (i.e. no airspace constraints), Chicago has overstated the alleged economic impact benefits by at least 150%.

In July 2001, Booz Allen Hamilton (BAH) released the Economic Impact of Chicago’s Airport, commissioned by the Civic Committee of the Commercial Club of Chicago. The study estimated the economic impact of O’Hare and Midway airports in 2000, and was an update of a 1998 study by BAH, commissioned by the Chicagoland Chamber of Commerce.

We have obtained summary documents for the 1998 and 2001 studies from the Chicagoland Chamber of Commerce and the City of Chicago Department of Aviation. However, we have not been able to obtain technical details of the study methodology, which limits the extent to which we can comment on the methodology.11 The following sections summaries the findings from the 2001 study, and comments on the general scale of the estimates. Section IV.2 summaries the 11

We also contacted Booz Allen Hamilton to obtain a copy of the reports but received no response.

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Economic Implications of the O’Hare Modernization Program estimated current economic impact of O’Hare airport while Section IV.3 summaries the estimated economic impact of the OMP.

IV.2.0 ECONOMIC IMPACT OF CHICAGO O’HARE AIRPORT The 2001 study by BAH estimated that Chicago O’Hare generated 400,000 480,000 jobs and $34 billion - $41 billion in economic output within the Greater Chicago economy in 2000. Based on this estimate, O’Hare airport accounts for 10-12% of total employment is Greater Chicago.12 These figures were reported in the Request for Letter of Intent AIP Funding submitted by the City of Chicago to the FAA on March 1, 2004. The figures also appear on the OMP website and have been widely quoted in press releases by the City of Chicago and Chicago Department of Aviation.13 Studies over a number of years by organizations such as the U.S. Department of Transportation and the World Travel and Tourism Council (WTTC) estimate that travel and tourism, in total, tend to represent 1012% of world employment and output or GNP. That being the case, it is notable that an airport claims to, alone, generate this same magnitude of output and employment.

A breakdown of the economic impact, as reported by BAH, is provided in Table 13. Breakdowns into direct, indirect and induced impacts have not been obtained. We believe that the figures in Table 13 are the total economic impact (direct, indirect and induced combined). For example, BAH reports that the $11 billion in Economic Output generated by Chicago Visitors is based on tourism spending of $6.5 billion. The difference between the $6.5 billion in spending and $11 billion in economic impact is likely due to indirect and induced effects.

The following sections provide commentary on the figures in Table 13.

12

The Illinois Department of Employment Security data indicates that total employment the Chicago Primary Metropolitan Statistical Area (PMSA) was 4,094,714 in 2000.

13 OMP website: http://modernization.ohare.com.

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Economic Implications of the O’Hare Modernization Program Table 13 Annual Economic Impact of Chicago O’Hare Airport (BAH-2000) Economic Impact Driver Airports and Tenants

Employment (Thousands)

Economic Output ($Billions)

Income ($Billions)

130

$4

$14

170

$4

$11

Access-Sensitive Impact

100-180

$3-5

$9-16

Total Economic Impact

400-480

$10-13

$34-41

Chicago Visitors

Source: Update of a Study on the Economic Impact of Chicago’s Airports, July 24, 2001, by Booz Allen Hamilton

IV.2.1 Airport And Tenants It is estimated that the airport and its tenants generate a total of 130,000 jobs.

This includes personnel working at the airport, tenants on airport land and other businesses closely linked to the airport passenger and cargo operations. BAH report that over 51,000 personnel worked at the airport in 2000 including approximately 30,000 airline personnel. The remaining 79,000 are presumably personnel in businesses closely linked to airport activity but not located at the airport and the multiplier (indirect and induced) impacts. Based on jobs, this category accounts for 27-33% of the total impact.

IV.2.2 Chicago Visitors This is the economic impact generated by business and leisure visitors to Chicago utilizing O’Hare airport. The impact is generated by their expenditures on hotels, restaurant meals, retail, in-town transportation and entertainment.

BAH estimates that 4.5 million business visitors spent approximately $5.3 billion and 4.3 million leisure visitors spent a total of $1.2 billion, summing to a total of $6.5 billion. The spending of these visitors is estimated to support 170,000 jobs and generate $11 billion in economic output. Based on jobs, this category accounts for 35-43% of the total impact.

The economic impact of tourism spending by visitors using the airport is often included in airport economic impact studies. Of the 18 airport economic impact studies reviewed, 15 included tourism spending in their economic impacts. The case for including it is that the airport plays a key role in facilitating tourism, and that tourism levels would significantly lower if the airport did not exist in its current form. However, there are issues associated with including these impacts in the total economic impact of the airport:

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Economic Implications of the O’Hare Modernization Program • While the airport is an important facilitator of tourism, this tourism also depends on many other sectors of the economy. For example, the hotel industry in Chicago could also claim without a mature hotel industry, considerably fewer visitors would stay in Chicago. Likewise, tourism attractions, businesses, restaurants and retail all play a part in attracting and facilitating tourism.

• Just as airports facilitate the arrival of tourists to a region, they also facilitate local residents visiting other locations and spending money outside of the region. It could be argued that without the airport these residents would likely travel less and spend more money in their local neighborhoods. As far as we are aware, no study has calculated the net tourism spending impact on an airport (i.e., spending of tourists visiting a region minus spending of local residents in other locations).

This is not to say the economic impact from tourism spending of O’Hare passengers is illusory, rather it is a matter of attribution. Can this spending be attributed to the airport alone, or is it attributable to a range of industries? The rational conclusion is the latter.

IV.2.3 Access-Sensitive Impact This includes corporate/divisional headquarters, service organizations, R&D facilities and manufacturing units located close to O’Hare to benefit from the passenger and cargo air services provided at the airport. An estimated 100,000180,000 jobs in these businesses are attributed to the airport as well as $9-$16 billion in Economic Output. Based on jobs, this category accounts for 25-38% of the total impact.

Like tourism, the case for including this employment is that without the level of service (number of destinations served and flight frequency) provided at O’Hare, these businesses would locate elsewhere. However, it should be noted that a great number of factors determine business location such as general business environment, labor force, tax environment, presence of similar or complimentary businesses, etc. While it is reasonable to highlight that many businesses depend on the airport for their operations, and that the airport is an important factor in attracting these businesses, there are conceptual concerns with including these businesses in the economic impact of the airport.

Many of the 18 airport economic impact studies reviewed make mention of the fact that the airport supports certain access-sensitive businesses. However, only one of these studies actually calculates the employment impact - Hartsfield Atlanta International Airport (carried out by Martin Associates) - which estimated the employment at manufacturing companies shipping air cargo via Hartsfield airport. However, these jobs were not included in the airport economic impact figures, instead itemized separately as related jobs because:

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Economic Implications of the O’Hare Modernization Program “…the level of employment in these [manufacturing] firms is based on the demand for the products produced, not by the airport”14

IV.3.0 ECONOMIC IMPACT OF THE OMP According to the City, the OMP would reconfigure the airport's intersecting runways into a parallel layout and provide a new western terminal, enabling O’Hare Airport to accommodate up to 1.6 million annual aircraft operations and 76 million passenger enplanements (in 2000, the airport handled 909,000 operations and 35.7 million enplanements). Parenthetically, these estimates of operations and enplanements have since been revised downward, but still are reflected in the OMP document. The increase in traffic at O’Hare airport that the OMP is forecast to produce can reasonably be expected to result in economic impact. Increased levels of employment will be required to service and process the additional aircraft and passengers using the airport.

The OMP website (http://modernization.ohare.com) states that the modernization program will result in 195,000 additional jobs and another $18 billion in Economic Output. Again, these figures have been widely quoted in the press.15 There is little publicly available information on how these figures were estimated. The 2001 BAH summary report we have obtained does not provide an estimate of the increased economic impact resulting from the OMP. It is not even clear when this additional economic impact will occur - as traffic is expected to increase each year, the economic impact is expected to grow each year. At what stage the O’Hare economic impact reaches the additional 195,000 jobs is not made clear in any of the press releases.

IV.3.1 The Future Economic Impacts Depend On Traffic Growth The forecast increase in economic impact is driven by the expected increase in air traffic following the capacity expansion provided by the OMP. Traffic forecasts in the O’Hare International Master Plan indicate that total enplaned passengers are forecast to increase from 33.3 million in 2001 to 49.7 million in 2015 (an increase of 48% from 2000), and reach 57.4 million by 2022 (an increase of 61% from 2000).16 If the traffic fails to reach the levels predicted, the economic impact will necessarily be smaller. Also, airport capacity is just one factor in determining air traffic growth. Other factors may exist that prevent O’Hare from realizing its traffic potential: 14

Hartsfield Atlanta International Airport Economic Impact Study 2002, Executive Summary, City of Atlanta Department of Aviation.

15 “Mayor Dailey Supports O’Hare Improvement Bill,” March 6, 2002, City of Chicago Mayor’s Office; “Battle lines drawn over O’Hare expansion,” February 16, 2004, CNN Website (www.cnn.com) 16

The air traffic forecasts in the Master Plan are unconstrained forecasts (i.e., they assume no capacity constraints at O’Hare).

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Economic Implications of the O’Hare Modernization Program • Air space – capacity constraints in air space and air traffic control in North America and specifically in the Chicago area will limit traffic growth. Other deficiencies in the OMP layout could reduce this limited capacity gain even further.

• Market changes – changes in the types of aircraft used may impact capacity usage.

For example, many North American airlines are increasingly using larger RJs on domestic routes (US Airways, Delta and jetBlue have expressed an interest in or placed orders for new generation RJs such as the EMB190 or CRJ900). This will naturally increase capacity from current levels which are largely dependent on a mix of narrow, widebody, and 50-seat RJs. • Economic and Competitive Factors – changes in air carrier strategic positioning, pricing, fleet mix, and local economic and demographics, all of which can impact the propensity to travel.

While it is outside of the scope of this study to fully review the air traffic forecasts for O’Hare, it is worth bearing in mind that the predicted economic impact gains depend on many factors beyond just capacity expansion at O’Hare. Undertaking the OMP does not guarantee the economic impact gains. Equally important, many of the economic gains will likely develop, whether or not the OMP moves forward, in part or in its entirety.

IV.3.2 Economic Impact Gains Will Occur Without OMP The prediction of economic impact gains from the OMP is presumably based on the idea that without the OMP, growth in air traffic at O’Hare would be considerably lower or would stagnate. That is, the economic impact gain from the OMP is relative to a “do nothing” scenario where no additional capacity is developed (again, no details are available to determine the assumptions made in the economic impact estimates). However, attributing all economic gains to the OMP is not realistic for a number of reasons. That is, substantial economic impact would occur even without the OMP: • Operational and facility enhancements (de-peaking, AVOSS, etc.) will enable O’Hare to obtain some capacity increases without runway reconfiguration.17 • Airline fleet mix, as outlined in Section III, can have a substantial impact on traffic growth.

• Capacity enhancements at Midway and a third airport at Peotone would enable some of the forecast traffic to use other airports in Chicago.

• As airlines at O’Hare face capacity constraints, they will shift from servicing connecting passengers to higher yield point-to-point passengers. This 17

Determining absolute capacity is not exact science. The capacity of Heathrow airport was estimated in the mid-1990s at 50 million annual passengers, but now is already handling over 60 million.

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Economic Implications of the O’Hare Modernization Program would represent an acceleration of a trend already occurring in the air passenger industry: as traffic levels grow, airlines offer more point-to-point services. For example, the unconstrained traffic forecasts in the O’Hare International Airport Master Plan assume a higher growth in point-to-point passengers than in connecting passengers. Based on BAH own figures, connecting passengers have a much lower economic impact than point-topoint passengers, largely due to visitor spend impacts (see Table 13 below). In other words, low impact connecting passengers would be squeezed out, leaving more high impact point-to-point passengers.

Table 13 Annual Economic Impact of Chicago O’Hare Airport (BAH-2000) Economic Impact Driver Airports and Tenants

Employment (Thousands)

Economic Output ($Billions)

Income ($Billions)

130

$4

$14

170

$4

$11

Access-Sensitive Impact

100-180

$3-5

$9-16

Total Economic Impact

400-480

$10-13

$34-41

Chicago Visitors

Source: Update of a Study on the Economic Impact of Chicago’s Airports, July 24, 2001, by Booz Allen Hamilton

Hence, the economic impact gain from the OMP are substantially overstated as it fails to fully account for capacity and traffic changes likely to occur in the absence of the OMP.

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Economic Implications of the O’Hare Modernization Program IV.3.3 Economies Of Scale While the 2001 BAH study does not provide an estimate of the OMP, it does provide an estimate of the economic impact generated by incremental passenger traffic, reproduced in Table 14. As these figures are the most likely basis of the current OMP impact estimates, they are worth further examination.

Table 14 Incremental Economic Impact Generated by Additional Passenger Traffic Connecting North American Passengers

Point-to-Point North American Passengers

Connecting and Point-to-Point International Passengers

Economic Output ($ Thousands) Airport and Tenants

$306

$347

$1,240

N/A

$704

$528

Access-Sensitive Impact

$157

$314

$628

Total Economic Impact

$463

$1,365

$2,396

Airport and Tenants

2.8

3.2

11.5

Chicago Visitors

N/A

10.9

8.2

Access-Sensitive Impact

1.7

3.5

7.0

Total Economic Impact

4.6

17.6

26.7

Chicago Visitors

Employment

Source: Update of a Study on the Economic Impact of Chicago’s Airports, July 24, 2001, by Booz Allen Hamilton

The BAH report only provides the Economic Output impacts. We have inferred the employment impacts assuming a constant ratio of jobs to Economic Output, taking the ratio from the figures in Table 13. As might be expected, connecting passengers have a lower economic impact than point-to-point passengers, largely as they generate no tourism spending, and international passengers have the largest impact. As with the current economic impact, the incremental impact is made up of three components: IV.3.4 Airport And Tenants As traffic increases at the airport, increased levels of employment will be required to service and process the additional aircraft and passengers using the airport.

The impact of international passengers is over three times that of North American passengers due to the larger amount of handling and servicing required (e.g., immigration control).

Prepared by: Global Aviation Associates, Ltd.

49

Economic Implications of the O’Hare Modernization Program IV.3.5 CHICAGO VISITORS Each additional visitor utilizing O’Hare generates $528-$704 in economic output.

Again, there are issues as to the validity of claiming this tourism spending as part of the airport economic impact. Tourism depends on a number of sectors of the Chicago economy, such as hotels, tourism attractions, businesses, restaurants and retail -- not just air service.

IV.3.6 ACCESS SENSITIVE IMPACT Each additional 1,000 passengers at O’Hare generates between 1.7 and 7.0 jobs in access-sensitive businesses. BAH state that additional traffic at the airport leads to additional destinations being served from O’Hare, which attracts more access-sensitive businesses to Chicago. Again, there are conceptual issues with including these businesses in the economic impact of O’Hare airport.

Based on our own analysis, the incremental economic impact estimates in the BAH study fail to account for any significant economies of scale. Economies of scale refer to the situation where the cost of producing one unit of a good or service decreases as the volume of production increases. Intuitively, this would seem to be the case for the aviation industry. In the case of an airport, the cost of processing and servicing one additional passenger is lower than the average cost of servicing the existing passengers. The infrastructure and staff are already in place so there are fewer resources required to process that additional passenger. If the cost is lower, so is the economic impact.

It is well established that the aviation industry benefits from economies of scale.18 ga2’s joint venture firm, InterVISTAS, has conducted micro-studies which examined the incremental economic impact of an additional daily passenger flight. The research suggested that the incremental economic impact is 60-65% of the average impact. Therefore, a 10% increase in traffic would generate a 66.5% increase in economic impact.

To test whether the incremental economic impact estimates developed by BAH indicate any economies of scale, we multiplied the impact estimates in Table 14 by the 2000 passenger traffic figures for O’Hare. If the impact estimates accounted for economies of scale we would expect the total impact calculated to be considerably lower than the impact estimates in Table 13.

However, as can be seen in Table 15, the calculated impact figure is within the range of the BAH estimate. This suggests that little or no account has been made for economies of scale.

18

For example: Gillen, Oum and Tretheway, "Airline Cost Structure and Policy Implications: A Multiproduct Approach for Canadian Airlines," Journal of Transport Economics and Policy, January 1990, pp.934.

Prepared by: Global Aviation Associates, Ltd.

50

Economic Implications of the O’Hare Modernization Program Table 15 Revised Incremental Economic Impact (35% Reduction Applied) Connecting North American Passengers

Point-to-Point North American Passengers

Connecting and Point-to-Point International Passengers

Economic Output ($ Thousands) Airport and Tenants

$199

$226

$806

N/A

$458

$343

Access-Sensitive Impact

$102

$204

$08

Total Economic Impact

$301

$887

$1,557

Airport and Tenants

1.8

2.1

7.5

Chicago Visitors

N/A

7.1

5.3

Access-Sensitive Impact

1.1

2.3

4.6

Total Economic Impact

2.9

11.5

17.4

Chicago Visitors

Employment

IV.4.0

Comparison with Other North American Airports

The economic impact estimate for O’Hare International was compared with economic impact estimates for sample airports across North America. The airports were selected to provide a range of traffic levels and traffic mix. The economic impact estimates for these other airports were taken from studies commissioned by the airports and were carried out by various consulting companies or academics. 18 studies were examined (not including O’Hare).

Baltimore Washington International (BWI) - 2002 Calgary International (YYC) - 2001 Dallas Fort Worth International (DFW) - 2002 Edmonton International (YEG) - 2001 Hartsfield-Jackson Atlanta International (ATL) - 2002 John F. Kennedy International (JFK) - FY 2000/01 Kansas City International (MCI) - 2000 LaGuardia, New York (LGA) - FY 2000/01 Miami International (MIA) - 2002 Prepared by: Global Aviation Associates, Ltd.

51

Economic Implications of the O’Hare Modernization Program Nashville International (BNA) - 1999 Oakland International (OAK) - FY 1998/99 Ronald Reagan Washington National Airport (DCA) - 2002 San Francisco International (SFO) - FY 1998/99 San Jose International (SJC) - FY 1998/99 Seattle Sea-Tac International (SEA) - 1999 Toronto International (YYZ) - 2000 Vancouver International (YVR) - 2000 Washington Dulles International (IAD) – 2002 The total annual economic impact of these airports (and O’Hare), in terms of jobs, are shown in Chart 13, plotted against annual enplaned passengers.19 As can be seen there is a clear relationship between enplaned passengers and economic impact. The relationship appears non-linear, indicating the effects of economies of scale. While enplaned passengers is a good measure of airport Chart 13 Total Annual Economic Impact (Jobs) Versus Annual Enplaned Passengers 500 O'Hare: 35.7 million passengers 440,000 jobs

Employment Economic Impact (Thousands)

450

ORD

400 Atlanta: 38.3 million passengers 330,800 jobs

350

ATL

300 DFW

250

SFO JFK

200

MIA

150 OAK

100

SJC

50

YYC

MCI BNA

BWI IAD

YYZ SEA

LGA

DCA YVR

YEG

0 0

5

10

15

20

25

30

35

40

Enplaned Passengers (Millions)

Source: Economic Impact and passenger figures provided by the airports. Impacts include direct and multiplier impacts. Trend line based on all observations except O’Hare

19

The passenger enplanement figures are for the same year as the economic impact study in each case.

Prepared by: Global Aviation Associates, Ltd.

52

Economic Implications of the O’Hare Modernization Program activity, other factors will also effect the economic impact of individual airports: Cargo operations; Maintenance facilities at the airport (larger airports tend to have major maintenance facilities); Use of the airport as an airline hub (leads to great employment concentration at the airport); Traffic mix (international flights require more processing than domestic flights); Weather (cold weather airports may require additional maintenance and operations, such as de-icing).

It is clear from Chart 13 that O’Hare has the largest estimated economic impact of all the airports examined. Its total jobs impact is 33% greater than Atlanta despite having 2.6 million fewer passengers. There are number of operational reasons why O’Hare may have a larger economic impact: O’Hare acts as a major hub for two large network carriers – American and United (Atlanta also acts as a hub for Delta and the smaller AirTran).

O’Hare handles more cargo – approximately 1.3 million tons compared with 730,000 tons at Atlanta (2002 figures) O’Hare handles more international traffic – 4.4 million enplaned passengers compared with 2.9 million at Atlanta (2002 figures).

However, one of the major reasons for O’Hare’s large economic impact is the inclusion of access-sensitive business impacts. As previously described, the economic impact study for O’Hare is the only study that includes these impacts.

The other studies include only airport/tenant impacts and in some cases visitor spending impacts.

Chart 14 presents the Airport and Tenant Economic Impacts (i.e., excluding visitor and access-sensitive business impacts), plotted against annual enplaned passengers. This provides a more like-for-like comparison as it compares only airport activity impacts, and not spin-offs such as tourism. O’Hare remains the largest airport in terms of economic impact. The economic impact of the airport and tenants is 24% higher than the equivalent figure for Atlanta. This may be due, in part, to the reasons stated above.

Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program Chart 14 Airport & Tenant Economic Impact (jobs) versus Annual Enplaned Passengers 140

O'Hare: 35.7 million passengers 130,000 jobs

ORD

Employment Economic Impact (Thousands)

120 Atlanta: 38.3 million passengers 105,200 jobs

100

ATL DFW

JFK

80 MIA SFO

60

YYZ

YVR

SEA

40 YYC

20 YEG

IAD BWI

LGA

OAK MCI DCA SJC BNA

0 0

5

10

15

20

25

30

35

40

Enplaned Passengers (Millions)

Source: Economic Impact and passenger figures provided by the airports. Impacts include direct and multiplier impacts. Trend line based on all observations except O’Hare

IV.5.0 Alternative Economic Impact Estimate In this section we provide an alternative estimate of the economic impact of the OMP, taking into account our comments and criticisms of the aggressive assumptions used in the BAH analysis, and based on our own experience in airport economic impact studies. While we do not have the time or resources to carry out a comprehensive economic impact study, we can apply reasonable “rule of thumb” and benchmark methodology to provide a ballpark figure. We have not attempted a revised version of the current economic impact of O’Hare, just the incremental impact resulting from the OMP. We have made two major changes to inject realistic assumptions into the City’s analysis: • Accounted for the gains that can be expected, regardless of whether or not the OMP proceeds. The economic impact of the OMP should be measured against this base case, not against the “status quo,” as appears to be the case.

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Economic Implications of the O’Hare Modernization Program • Economies of scale – the economic impact of additional traffic is smaller than the average impact.

We have used the air traffic forecasts in the O’Hare International Master Plan as the basis for our economic impact estimates, including the implicit assumption that airspace capacity is unconstrained. The estimates are based on traffic levels in 2022. Although we have raised some criticisms of the inclusion of visitor and access-sensitive business impacts, we have included these in our estimates, for comparison and in order to be as generous as possible in our analysis of the BAH study results.

IV.5.1 Incremental Economic Impact without OMP To estimate the base case without the implementation of the OMP we have assumed the following: A 35% REDUCTION IN THE INCREMENTAL ECONOMIC IMPACT EFFECTS We concluded that BAH’s incremental impacts (Table 14) made little or no allowance for economies of scale. To correct for this, we have factored down the incremental impacts by 35%. The revised incremental impacts are provided in Table 15.

About 50% of North American traffic and 25% of international traffic is retained It is assumed that some of the forecast O’Hare traffic is retained either by O’Hare itself, through other capacity expansion techniques, or by Midway or a new airport at Peotone. Therefore, the growth in North American traffic is assumed to be 50% of the unconstrained forecast in the O’Hare International Master Plan, and international traffic growth is 25% of the unconstrained forecast. The forecasts are summarized below:

Prepared by: Global Aviation Associates, Ltd.

55

Economic Implications of the O’Hare Modernization Program

2000 Enplaned Passengers (Millions)

2022 Unconstrained Forecasts* Millions

% Growth

2022 Revised Forecasts Millions

% Growth

North American Traffic

31.7

46.69

48%

39.17

24%

International Traffic

4.05

10.66

163%

5.70

41%

Total

35.7

57.36

61%

44.87

26%

* Taken from the O’Hare International Master Plan

The proportion of connecting North American traffic is assumed to halve.

The O’Hare International Master Plan estimates that 58% of North American passengers at O’Hare are connecting. We assume this proportion declines to 29% by 2022, due to increased air carrier focus on point-to-point passengers.

The proportion of connecting international passengers is assumed to remain fixed. The resulting base case traffic forecasts are provided in Table 16.

Table 16 Revised Air Traffic Forecast Assuming No OMP 2000 Enplaned Passengers (Millions)

2022 Revised Forecasts Millions

% Growth

North American Point-toPoint

13.26

27.79

110%

North American Connecting

18.39

11.38

38%

4.05

5.70

41%

35.70

44.87

26%

International Traffic Total

The base case economic impact was estimated by applying the incremental impacts in Table 15 to the traffic forecasts in Table 16. The results are presented in Table 17.

Prepared by: Global Aviation Associates, Ltd.

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Economic Implications of the O’Hare Modernization Program Table 17 Incremental Economic Impact without the OMP Economic Impact Driver

Employment (Thousands)

Economic Output ($ Billions)

Airport and Tenants Chicago Visitors

30

3.2

112

7.2

33

2.9

175

13.3

Access-Sensitive Impact Total Incremental Impact

IV.5.2 Incremental Economic Impact of the OMP To estimate the impact of the OMP we have assumed the following: A

35%

reduction

in

the

incremental

economic

impact

effects

As before, we assumed economies of scale, using the same figures as in Table 14.

PASSENGER TRAFFIC REACHES THE LEVELS FORECAST IN THE O’HAREINTERNATIONAL MASTER PLAN THE IMPACTS ARE BASED ON THE 2022 FORECASTS AS FOLLOWS: 2000 Enplaned 2022 Unconstrained Forecasts Passengers Millions % Growth (Millions) 48% North American 31.7 46.69 Traffic International Traffic

4.05

10.66

163%

Total

35.7

57.36

61%

The proportion of connecting North American traffic declines in line with the Master Plan forecasts The air traffic forecasts in the O’Hare International Master Plan assume a reduction in North American connecting traffic from 58.1% to 50.5%. We have also applied this assumption. The resulting traffic forecasts for the OMP are provided in Table 18.

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Economic Implications of the O’Hare Modernization Program Table 18 Air Traffic Forecasts Following the Implementation of the OMP 2000 Enplaned Passengers (Millions)

2022 Forecasts Millions

% Growth

North American Point-toPoint

13.26

23.11

74%

North American Connecting

18.39

23.58

28%

4.05

10.66

163%

35.70

57.36

61%

International Traffic Total

The resulting incremental economic impact of the OMP is presented in Table 19.

Table 19 Incremental Economic Impact with the OMP Economic Impact Driver

Employment (Thousands)

Airport and Tenants Chicago Visitors Access-Sensitive Impact Total Incremental Impact

Economic Output ($ Billions) 80

8.6

105

6.8

59

5.2

244

20.6

IV.5.2 Economic Impact Generated by the OMP To understand the economic impact generated by the OMP, we subtracted the economic impact of the base case estimate (without the OMP) from the OMP economic impact estimate (i.e., subtract the figures in Table 17 from the figures in Table 19). This is presented in Table 20 alongside the original OMP economic impact estimates.

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Economic Implications of the O’Hare Modernization Program Table 20 Economic Impact Generated by the OMP Employment Impact (Thousands)

Economic Output ($ Billions)

Original Economic Impact Gain

195

18.0

Revised Economic Impact Gain

69

7.3

-65%

-60%

% Change

As can be seen, the revised estimates are less than half those quoted in the press and by the OMP supporters.

It is clear that, for whatever purposes, the City’s economic impact estimates as published in various documents including on the OMP website, are substantially overstated for two major reasons: 1. The City estimates fail to give recognition to the fact that, notwithstanding the OMP, there will be natural growth in the capacity and traffic at O’Hare and within the region.

2. The City estimates fail to recognize any economies of scale with respect to incremental traffic being added at employment and cost ratios that are probably two-thirds of the base unit rates. That is, the City has assumed that all economics and employment are variable and generated at ratios of 1:1, input to output.

Even these modest adjustments to the aggressive assumptions of the City reduce the value generated by the OMP, should it evolve, to only 34%-40% of the amounts claimed. That is, the City has overstated the value of the OMP by over 150%.

As described in Sections I and II, the network airlines now must lower costs to survive financially and to compete with the New Entrant/Low Fare carriers.

Since the LCCs are increasingly driving the pricing model, carriers such as United and American will have to rely on product quality, cost, and fleet and network synergies in order to compete. Both carriers have made progress in stemming losses, restructuring their route networks, and lowering costs across the board in both labor and non-labor categories. United and American, cannot afford significant increases in the airport cost per passenger, given the trends in ticket prices at O’Hare, and the competitive pricing which they face from the LCC’s at MDW.

Prepared by: Global Aviation Associates, Ltd.

59

Economic Implications of the O’Hare Modernization Program To merely see their airport costs rise from 5.4% of revenue to 13.3% of revenue would be extremely burdensome to the carriers and would negatively impact their ability to compete effectively in today’s highly competitive low-fare environment.

The increased costs would also require higher airfares. Higher fares inhibit traffic growth, tourism, and investment, thus adversely affecting regional economic development and job growth.

Prepared by: Global Aviation Associates, Ltd.

60

Economic Implications of the O’Hare Modernization Program

Appendix

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61

Economic Implications of the O’Hare Modernization Program LIST OF APPENDICES Number

Description

Page

1

Comparative Operating and Financial Data

66

2

Comparative Operating and Financial Data

67

3

Cost Per Enplaned Passenger

68

4

ORD 2002 Operating and Financial Summary

69

5

OMP Cost Estimates (2001 Dollars)

70

6

WGP Cost Estimates (1999 Dollars)

71

7

Projected Airline Cost per Enplaned Passenger

72

8

20-Year CIP Cost Estimates

73

9

Capital Cost Estimates

74

Prepared by: Global Aviation Associates, Ltd.

62

Economic Implications of the O’Hare Modernization Program Appendix 1

Chicago O'Hare International Airport Comparative Operating and Financial Data FINANCIAL DATA

2002

2000

1998

1996

TERMINAL RENT (PER ENPL) ORD LH AVG.

$3.53 $3.65

$4.35 $1.97

$3.19 $2.75

NR NR

LANDING FEES (PER ENPL) ORD LH AVG.

$3.74 $3.37

$3.54 $2.17

$3.43 $2.63

NR NR

LANDING FEES (PER 1,000 LB MGLW) ORD LH AVG.

$2.49 $2.01

$2.13 $1.69

$2.09 $1.79

NR $1.19

TOTAL FEES (PER ENPL) ORD LH AVG

$8.70 $9.20

$7.90 $5.42

$7.55 $8.38

NR NR

DEBT OBLIG-ORD ($BIL) ORD/PAX

$3.22 $95.20

$2.50 $68.75

NR NR

NR NR

LH AVG-($BIL) LH/PAX

$1.48 $94.69

$1.00 $61.83

NR NR

NR NR

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63

Economic Implications of the O’Hare Modernization Program Appendix 2

Chicago O'Hare International Airport Comparative Operating and Financial Data OPERATING DATA Pass. Departures (T-100) Dom Intl Total Onboard Passengers (T-100) Dom Intl Total Passengers/Departure (T-100) Dom Intl Total RPMs (000) (T-100) Dom Intl Total ASMs (000) (T-100) Dom Intl Total Load Factor (T-100) Dom Intl Total Average Ticket Price (OD1A) Dom Intl Total

Prepared by: Global Aviation Associates, Ltd.

YE 2Q2003

CY 2002

CY 2001

CY 2000

CY 1999

355,559 69,720 425,279

354,226 68,949 423,175

356,908 73,178 430,086

352,165 73,930 426,095

355,466 69,545 425,011

30,009,720 8,335,630 38,345,350

30,571,283 8,506,569 39,077,852

30,393,589 8,903,652 39,297,241

32,527,830 9,731,396 42,259,226

32,696,324 9,087,425 41,783,749

84.4 119.6 90.2

86.3 123.4 92.3

85.2 121.7 91.4

92.4 131.6 99.2

92.0 130.7 98.3

24,683,688 28,796,014 53,479,702

24,005,085 29,782,448 53,787,533

23,650,563 32,145,452 55,796,015

25,463,512 34,810,031 60,273,543

25,823,747 31,213,791 57,037,538

33,950,124 37,938,843 71,888,967

34,459,589 38,585,712 73,045,301

34,384,186 46,149,577 80,533,763

35,874,268 48,416,810 84,291,078

37,644,310 45,012,658 82,656,968

72.7% 75.9% 74.4%

69.7% 77.2% 73.6%

68.8% 69.7% 69.3%

71.0% 71.9% 71.5%

68.6% 69.3% 69.0%

$140.74 $456.75 $172.01

$146.22 $468.70 $179.32

$166.49 $487.41 $199.05

$187.15 $533.78 $222.08

$178.26 $513.16 $211.53

64

Economic Implications of the O’Hare Modernization Program Appendix 3 Cost/Enplaned Passenger

AIRPORT

AIRFIELD AIRCARRIER REVENUE (000)

ATL ORD DFW DEN PHX LAS IAH MSP EWR SFO JFK MIA SEA STL BOS PHL CLT LGA PIT BWI SLC IAD CVG FLL TPA MDW san DCA DTW ttl. Above SOURCE: 2001/2002

74,321.9 294,121.2 145,517.8 292,805.2 69,941.0 95,395.1 101,889.3 92,431.3 316,847.0 303,939.0 358,524.0 452,184.0 32,692.0 69,698.0 116,783.3 102,883.7 23,386.5 168,079.0 60,931.2 44,397.7 44,627.7 97,866.0 33,550.8 34,787.4 37,155.0 40,214.0 32,692.0 72,536.5

38,450.8 33,823.5 26,311.2 18,046.1 16,992.4 16,945.7 16,809.3 16,031.4 15,550.2 15,546.1 14,683.5 14,674.1 13,506.0 12,597.7 12,185.7 12,001.5 11,483.0 11,259.9 9,968.0 9,625.4 9,165.1 8,988.9 8,588.7 8,199.6 7,618.6 7,461.2 7,299.5 6,610.8

3,610,197.6

400,423.9

AAAE

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ENPLANED PSGRS.(000)

Survey

COST/ PSGR. 1.93 8.70 5.53 16.23 4.12 5.63 6.06 5.77 20.38 19.55 24.42 30.82 2.42 5.53 9.58 8.57 2.04 14.93 6.11 4.61 4.87 10.89 3.91 4.24 4.88 5.39 4.48 10.97 na 9.02

Data

65

Economic Implications of the O’Hare Modernization Program Appendix 4 ORD 2002 Operating and Financial Summary

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66

Economic Implications of the O’Hare Modernization Program Appendix 5 OMP Cost Estimates (2001 Dollars)

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67

Economic Implications of the O’Hare Modernization Program Appendix 6 WGP Cost Estimates (1999 Dollars)

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68

Economic Implications of the O’Hare Modernization Program Appendix 7 Projected Airline Cost Per Enplaned Passenger ($000s)

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69

Economic Implications of the O’Hare Modernization Program Appendix 8 20-Year CIP Cost Estimates (Escalated Dollars)

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70

Economic Implications of the O’Hare Modernization Program Appendix 9

Chicago O'Hare International Airport Capital Cost Estimates ($Millions)

OMP-6,600.0 WPG 2,643.8 Contingency @25%

2005

2006

2007

2008

2009

2010

2011

2012

825.4 340.5 285.5

849.4 350.7 294.0

875.7 361.2 302.9

901.9 372.1 312.0

929.0 383.2 321.3

956.9 394.7 331.0

985.6 406.6 340.9

1,015.1 418.8 351.1

1,045.6 431.3 361.6

2004 $ 1/ $7,212.0 3,064.9 2,569.2 $12,846.1

NOMINAL$ 2/ OMP-Nominal $8,384.6 WPG- " 3,459.1 Contingency @25% 2,900.3 $14,744.0 Nontes:

2004

1/ Costs from OMP Converted to 2004 Dollars 2/ Nominal dollars assume 3% annual inflation per OMP

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71