Phileas,
The fuel issue is one that is already called out in the report. As for the 'you wouldn't fill a DHC-7, again, maybe not all the time, but the idea would be to make the upcountry routes more practical, bringing in passengers that aren't currently accounted for - and again, the potential loss of the helicopter service would result in a significant increase in the number of passengers needing to be carried by an already busy fixed wing service.
It wasn't that long ago people insisted that there wasn't capacity for a couple of islanders flying in and out of lands end either.
Aero,
The runway is currently only 600m, whether extending it to 700m would help is the point. Yes, the Otters are great, however they do tend to be used primarily for Newquay and the upcountry flights, with the islanders being the main ones on the Lands End route.
Many would argue the system IS broken, due to the relatively high cost of the short flights, with the flights to Bristol etc being even worse. The main reason for looking at larger aircraft or more efficient ones would be in the hope that could bring prices down - if they couldn't then so be it, but it's at least worth looking.
Extending the runway (or other improvements) to allow larger/more economical aircraft to operate is one thing the authority could do to help bring prices down.