WORLD ROUTES: UK CAA Reports on Economic Regulation of London Airports

The UK Civil Aviation Authority (CAA) has published for consultation its final proposals for the economic regulation of Heathrow and Gatwick airports to protect passengers after April 2014. The proposals are tailored so each airport remains globally competitive and can deliver the customer experience that passengers expect of airports in the 21st century. They challenge airports to operate more efficiently, and to work more closely with airlines to develop competitive offerings for travellers.

Our proposals demonstrate how we can regulate airports more flexibly where this seems best for passengers, but also setting a tough efficiency challenge. We expect the airports to work closely with airlines to provide high-quality services to passengers," said Dame Deirdre Hutton, CAA Chair.

Heathrow Airport

At the UK's main hub airport, Heathrow, management has called for a 4.6 per cent annual real-terms increase in its charges over five years. Its airlines have asked for a 9.8 per cent per year cut. The CAA is proposing a price control that will not allow prices to rise by more than inflation (measured by RPI). That compares to its initial proposals for RPI minus 1.3 per cent. A key reason for this change, according to the CAA is due to an increase in the cost of capital driven by higher debt costs, offset to some degree by more challenging targets for operating efficiency.

The proposals will put an end to over a decade of prices rising faster than inflation at Heathrow. This has supported significant investment in Heathrow over the last decade and the regulator argues current proposals will also create a supportive environment for further capital expenditure.

“Tackling the upward drift in Heathrow’s prices is essential to safeguard its globally competitive position. The challenge for Heathrow is to maintain high levels of customer service while reducing costs," said Dame Hutton. "We are confident this is possible and that our proposals create a positive climate for further capital investment, in the passenger interest."

With today’s final price proposal for Heathrow Airport, the CAA has left the airport’s customers with the burden of forking out almost an extra £1 billion over the next five years, according to IAG chief executive Willie Walsh. He said the CAA had neglected its new primary statutory duty to further the interests of passengers by endorsing a settlement that allows the UK’s monopoly hub to ignore its inefficiencies and over-reward investors by imposing excessive charges on users.

“It is a bad day for our customers who have been let down by the CAA. With this settlement, Heathrow will continue to levy charges well above other major hub airports," said Walsh. “As the only hub airport in the UK, Heathrow exerts monopoly power over its users. Like other airlines at Heathrow, we cannot move to a better-run UK hub that offers customers real value for money.

"No such alternative exists today but these excessive charges combined with a complacent management team at Heathrow make an alternative hub look more attractive and more realistic. We want a Heathrow that is efficiently run, fairly rewarded and priced comparably with other airports. We will carefully consider our next steps,” he added.

Heathrow Airport officials have reacted to the proposal by describing it as the toughest Heathrow has ever faced. The CAA’s figure is derived from its forecasting of future passenger numbers, retail revenues, operational efficiencies, and the cost of financing capital investment. Since the publication of its Initial Proposals in April, Heathrow has argued that the CAA has fundamentally underestimated the cost of raising capital to invest in new facilities.

"The CAA’s proposed cost of capital of 5.6 per cent is below the level at which Heathrow’s shareholders have said they are willing to invest. The CAA’s settlement could have serious and far-reaching consequences for passengers and airlines at Heathrow," said Colin Matthews, chief executive officer, Heathrow Airport.

“We want to continue to improve Heathrow for passengers. Instead, the CAA’s proposals risk not only Heathrow’s competitive position but the attractiveness of the UK as a centre for international investment. We will now carefully consider our investment plans before responding fully to the CAA,” he added.

Heathrow has invested £11 billion over the last ten years in new facilities such as Terminal 5 and next year the new £2.5 billion Terminal 2 will open, continuing this progress. Yet Heathrow’s rate of return on capital investment as set by the CAA has declined from 7.75 per cent in Q4 (2003-2008) to 6.2 per cent in Q5 (2008-2014).

The CAA’s current proposal of 5.6 per cent return in Q6 provides "no incentive" for shareholders to fund improved facilities," according to the airport operator. Since 2008 Heathrow has made a pre-tax loss every year and shareholders have not received the return on their investment allowed for by the regulator. "This is unsustainable," said Matthews.

Heathrow’s own proposals, submitted to the CAA in July, would have delivered a £3 billion investment to further improve the airport and passenger experience. This would see airport charges increase by around one pound a year per ticket. To ensure prices remain competitive, Heathrow’s proposals committed to taking £427m out of operating costs and delivering further cost-efficiencies to airlines through the modernisation of the airport.

Heathrow has to compete for investment on the global stage, and its international shareholders are all looking for a fair return corresponding to their investment risk. If the UK does not offer a competitive rate of return, international investors will be discouraged from investing in regulated British companies, it argues. "International investors will not fund billions of upfront investment in UK infrastructure if the lesson from history is that their return will be cut as soon as they have built it," it said.

Gatwick Airport

Meanwhile, at Gatwick Airport the CAA has supported the plans set out by its operator through a package of price commitments to its users, with the average price to grow by RPI + 0.5 per cent per year for seven years. The CAA has ruled this is a "fair price" and the airport’s commitments are in passengers’ interests. They will now be backed by a licence to ensure that they are honoured. The licence will also ensure the CAA can continue to act where appropriate to protect users, for instance if there are reductions in service quality that are against the passenger interest.

“Gatwick has tabled a revised price offer to airlines that we consider fair, and its new commitments framework offers a chance for a more commercially driven and tailored approach," said Dame Hutton. "To protect the diverse interests of passengers, we propose a licence based on the commitments. We would monitor the success of such a new approach and adjust our regulation over time to ensure it remains proportionate.”

In response to the announcement, easyJet, the largest operator at Gatwick Airport said the CAA was right to view the facility as a monopoly airport and the continued regulation is necessary to protect the interests of all passengers who use the airport.

"easyJet agrees with the proposed new approach of allowing the airport and its airlines to engage constructively to reach agreements, within a regulatory framework, which are in both parties interests - and the interests of passengers," said Carolyn McCall, chief executive officer, easyJet.

However, the carrier is disappointed with the increase in proposed average charges of RPI +0.5 per cent, saying this is based on the airport’s proposals and ignores those views of the airlines who gave evidence to support a lowering in charges which would have led to a reduction in fares paid by passengers.

"Our greatest concern is about the lack of regulatory control of a proposed second runway at Gatwick where the CAA has handed Gatwick Airport a licence to print money and has significantly enhanced the value of the future sale of Gatwick Airport by private infrastructure fund GIP," explained McCall. "Using Gatwick Airport's own figures passengers could be paying £28 more per flight for years in advance of the opening of a new £9 billion runway without any real oversight by the CAA."

Stansted Airport

At Stansted Airport, the CAA has echoed its previously announced viewpoint that it will consult on how new long-term contracts with airline partners at the airport may affect the market power assessment before making a final decision on whether Stansted should be regulated and if so, on the appropriate regulatory approach for the airport.

Since taking over ownership of Stansted in April this year, Manchester Airport Group (MAG), has reached long-term commercial agreements with its two principal customers, easyJet and Ryanair.

Ready for Regulation

The CAA's proposals were made using powers set out in the Civil Aviation Act 2012, which allows more flexibility than in the past, so the CAA’s current regulatory proposals reflect the unique circumstances of each airport. The CAA is required to assess the level of market dominance at airports it proposes to regulate, explaining clearly why regulation will achieve better outcomes for consumers than the market and then set out its proposals.

To qualify for regulation, an airport must have, or be likely to get, substantial market power, and economic regulation must be likely to improve outcomes for passengers. The CAA will publish its decision on market power for both Gatwick and Heathrow and, where appropriate, its final decision on the necessary form of regulation in January 2014, it confirms.