The message of El Al Airlines President and CEO Elyezer Shkedy to employees last week was unambiguous: The failure to reach a new collective labor agreement is hampering the carrier's restructuring and jeopardizing the proposed investment by the First Israel Mezzanine Investors (FIMI) fund.

A turnaround is vital for El Al because next year the open-skies treaty between the European Union (EU) and Israel will come into force. It will not be a “big-bang-style” liberalization, but rather a gradual opening up of the EU-Israel air transport market over a five-year period. Still, the potential effects of the new open-skies environment will be a major challenge for Israel's airlines.

There are approximately 150 EU-registered airlines among the 28 member states, yet there are fewer than 10 in Israel, and all are quite small. El Al is the largest, with a fleet of just 37 aircraft serving 38 destinations. The carrier flies approximately 2 million passengers per year. More than 60% of its seat capacity is deployed on routes to Europe.

Unions at the country's main airlines—El Al, Arkia and Israir—fear that the increased competition from much larger European rivals and specifically low-cost carriers (LCC) will put Israeli airline employees out of work and possibly even drive some airlines out of business. Their concern is not groundless.

EasyJet has already started flights to Tel Aviv's Ben Gurion International Airport from London Gatwick and Luton airports, as well as Manchester, Geneva and Basel and will add a service from Rome Fiumicino Airport in September. Ryanair has indicated it also will serve Israel. The Irish low-cost airline aims to open routes from Bremen and Baden-Baden, Germany; Krakow, Poland; Kaunas, Lithuania; Eindhoven, Netherlands; Oslo, Norway; or Sicily. It hopes to start operating to Tel Aviv starting in early 2014, and some first flights could be launched to Ovda Airport, near the Israeli seaside town of Eilat, beginning in October. Ryanair targets carrying 2 million passengers to Israel annually—the total passenger numbers of El Al last year.

El Al management realizes there is no way back and that it must prepare to cope with a much higher level of competition. The airline plans to set up its own LCC, operations of which will start “no later than the summer of 2014” with five Boeing 737-800s. El Al has not yet revealed destinations, but these are likely to include several gateways in Eastern Europe and the Mediterranean basin. There has been much speculation about a tie-up with LCC Israir, but this is not under consideration “at this point in time,” Shkedy says.

As part of its ongoing restructuring, El Al continues to improve its product and reduce the number of aircraft types in operation to four. It has already phased out its Boeing 747-200s and 757s and will remove the remaining 767-200s during the coming months. In October it will start taking delivery of new 737-900ERs—it has six on order, plus two options.

Management has also taken steps to lower costs, increase online sales and reduce staff. But more measures are needed to boost productivity and efficiency at El Al, which has reported net losses in three of the past four years. Its market share (including its charter subsidiary, Sun d'Or) of traffic at Tel Aviv decreased to 33.6% in 2012 from 37.5% in 2009. Negotiations with union representatives over a comprehensive new labor agreement are progressing slowly.

In April, FIMI, the country's largest investment fund, agreed to put as much as $75 million into El Al in return for up to 47% of the carrier. El Al shareholders approved the bid, but the deal is subject to the signing of a new labor agreement that is acceptable to FIMI. FIMI has extended the deadline for an agreement by 45 days, to Aug. 29.

El Al is vulnerable. Shkedy was absolutely right when he said he hopes company employees grasp the importance of reaching a new agreement.