Select Committee on Transport, Local Government and the Regions Eighteenth Report


NATS' income

3. NATS estimated that its revenue for this financial year would be £55 million less than forecast, about £40 million of which it estimated had been lost since 11 September.[3] The revenue loss for the remainder of the first control period (CP 1), from 2001 to 2005, is estimated by NATS to be £190 million in present value terms.[4] The CAA places a figure of £176 million on the revenue loss for CP 1.[5] NATS' new business plan is designed to mitigate the £230 million in revenue loss in actual values expected by the end of CP 1, in 2005.[6]

4. Several factors contributed to the decline in NATS' revenue. Three-quarters of its revenue comes from 'en-route charges' calculated on the basis of aircraft weight and distance flown.[7] Since 11 September, not only has the number of air traffic movements declined, but airlines have introduced smaller aircraft.[8] The decline in air traffic has been most rapid and profound on trans-Atlantic routes, which generate 44 per cent of NATS' revenue.[9] NATS does not expect demand to recover as quickly as occurred after previous downturns.[10] However, we are less pessimistic about the likely timing of a recovery in traffic.[11] Before 11 September, there had already been a down-turn in aviation, particularly on north Atlantic routes, as a result of a general economic slowdown.[12] Those factors combined with the financial structure imposed by the PPP have put pressure on NATS' finances.

5. To relieve the immediate difficulties, the Government agreed to lend NATS £30 million, and a matching short-term loan was negotiated with NATS' bankers on the same commercial terms.[13] The Government considers its support for NATS to be the appropriate reaction of a "responsible shareholder".[14] That £60 million facility, repayable at the end of September 2002, provided bridging finance while NATS sought a permanent solution.[15] As yet the company has not made use of the loan facility.[16] NATS has also undertaken to make cost savings of £200 million during the remainder of CP 1.[17]

NATS' financial structure under the PPP

6. When the PPP was negotiated, the management of both NATS and the CAA expressed reservations about elements of the financial structure. In particular they drew the Government's attention to the high level of debt and high gearing ratio with which the part-privatised company would be established.[18] The CAA wrote to the Department on 23 May 2001 to express its:

    "profound reservations about the proposed high debt financing of NERL [NATS en-route service], its subsequent ability to meet its obligations under the loan facilities and its ability to fund its development programme if it is buffeted by plausible adverse shocks".[19]

7. The CAA also informed the Department that the high level of debt would have the effect of airlines "both bearing the risk and paying for it to be borne by others"; and concluded: "This might be sustainable if it could be demonstrated to be to the benefit of customers but it is by no means obvious".[20]

8. On 20 July 2001, Sir Malcolm Field, then chairman of the CAA, wrote to the Department:

    "NERL would still have an initial debt-RAB [Regulatory Asset Base] ratio of around 100 per cent, rising over the medium term to finance NERL's investment. This goes well beyond any precedent we have seen in regulated utilities in the UK. The strong likelihood is that under the proposed arrangements NERL's financial resources would still be severely constrained on a continuing basis, unless traffic volumes are much stronger than expected or NERL is able to make more efficiency gains than expected."[21]

9. The Department responded to those concerns by revising the proposed structure to reduce the amount of debt by £100 million.[22] Sir Roy McNulty, the present chairman of the CAA and previous chairman of NATS, told the Sub-Committee that he was not sure that the Department had responded fully to the points made by NATS before the PPP, but that he had accepted that it was the Government's "prerogative in the end to decide on the deal with the bidders".[23] The revised level of debt reduced the gearing ratio to just over 100 per cent, which Sir Roy told the Sub-Committee was "still high by any standards".[24] Mr Doug Andrew, Group Director of Economic Regulation at the CAA, thought that the changes made to the initial financial structure mainly reflected the reduced demand already identified in the industry.[25]

10. The air transport industry is subject to cycles of demand, and is particularly vulnerable to 'downside demand shocks' caused by external political or economic events.[26] NATS' original high gearing ratio did not provide the flexibility required to withstand those relatively frequent shocks. The CAA considered the original "inconsistent" financial structure left NATS "quite exposed to adverse shocks".[27]

11. The seriousness of NATS' financial situation is due to the reduction in air traffic that followed the 11 September terrorist attacks and the company's dependence on north Atlantic traffic. The financial structure created by the PPP inflated the company's difficulties. The Government failed to give due weight to the concerns expressed by both NATS and the CAA about the high debt levels imposed on the company. The Government failed to heed the warnings about the impact the financial structure would have on the viability of the company in the event of a downside demand shock. The weaknesses of the financial structure suggest a failure of due diligence at the time of the sale of NATS, when traffic was already declining and there were already moves towards the use of smaller aircraft.


12. In evidence to the previous Transport Sub-Committee, the CAA expressed a confidence in the PPP process as the next logical step in the development of NATS.[28] Similarly, NATS believed the PPP would lead to "increasingly competitive charges" and bring "private sector business skills and experience to the areas of procurement, planning and delivery of major capital investment projects".[29]

13. Correspondence between the CAA and the Department in 2001 showed the deep concern about the future of the PPP's regulatory regime given the proposed NATS' financial structure.[30] A letter from Mr Andrew to the Department stated: "It would clearly call the whole PPP and regulatory regime into disrepute if the price cap needed to be opened up soon after it had been completed".[31] Sir Malcolm Field's letter to the Department states:

    "A consequence of the proposed financial structure is that there is a much higher probability that NERL and the CAA may be faced with the need to re-open the price cap in the short term, within the first five years to ensure that NERL is able to carry out the investment programme which would meet users' preferences. This was never the policy intention."[32]

14. In response, the Department refuted "any suggestion that the NATS capital structure, as revised, is inconsistent with PPP policy; that it unduly limits the CAA's freedom as regulator; or sets unwanted precedents for other regulated utilities".[33] Nevertheless, Sir Roy McNulty told the Sub-Committee that the financial structure was "not the optimum" and had "proved to be inappropriate".[34]

15. A number of other structures have been proposed for NATS, including an independent publicly-owned corporation, such as exists in New Zealand, Germany and the Netherlands, or a non-profit-making trust, such as exists in Canada. Our predecessor Committee's Air Traffic Control Report expressed "reservations about the privatisation as a profit-making company of such an important national organisation".[35] The Report concluded that other countries had been able to provide air traffic control with access to funds for investment and greater management freedom, while not requiring the service to become a profit-making company.[36] The Committee's Reports on the Future of National Air Traffic Services and The Proposed Public-Private Partnership for National Air Traffic Services Limited said that the Government should continue to explore other options for restructuring NATS, such as applying the Canadian or Dutch models.[37] We repeat our predecessor Committee's recommendations to the Government to consider alternative funding models for NATS, contained in their Reports into the Future of National Air Traffic Services and the Proposed Public-Private Partnership for National Air Traffic Services Limited.

3   Q 54; Ev. p 51; NATS' Response to the CAA Consultation on NATS' Application to Reopen Eurocontrol Charge Control, June 2002 hereinafter NATS' Response, para 3.4. Back

4   NATS Response, para 3.4. Back

5   IbidBack

6   QQ 168, 251; Ev. pp 51-52, 77; NATS' Response, para 3.4. Back

7   NATS en-route services are provided by NATS En-Route Limited (NERL). Back

8   QQ 56, 95; Ev. pp 51, 73. Back

9   Ev. pp 45, 51. Back

10   Q 26; Ev. p 51. Back

11   Eleventh Report from the Transport, Local Government and the Regions Committee, Air Transport Industry, HC (2001-02) 484-I, para 25. Back

12   Ibid, paras 3-8. Back

13   Q 168; Ev. pp 45, 52. Back

14   QQ 14-15, 169. Back

15   NATS' Response, paras 1.7-1.8.  Back

16   QQ 168, 248. Back

17   Q 168, 251; Ev. p 45.  Back

18   QQ 6-11, 113, 361. Back

19   Ev. p 58. Back

20   IbidBack

21   Ev. p 59. Back

22   QQ 118, 120, 176-177; Ev. p 58. Back

23   Q 118. Back

24   Q 121. Back

25   Q 114. Back

26   See HC (2001-02) 484-I, paras 4-8. Back

27   Q113. Back

28   Third Report from the Environment, Transport and Regional Affairs Committee, The Proposed Public-Private Partnership for National Air Traffic Services Limited, HC (1999-2000) 35, pp 41-44. Back

29   Ev. p 50. Back

30   Ev. pp 58-60. Back

31   Ev. p 58. Back

32   Ev. p 60. Back

33   Ev. p 59. Back

34   QQ 354-355. Back

35   Fourth Report from the Environment, Transport and Regional Affairs Committee, Air Traffic Control, HC (1997-98) 360-I, para 77. Back

36   IbidBack

37   See Third Report from the Environment, Transport and Regional Affairs Committee, The Future of National Air Traffic Services, HC (1998-99) 122, para 34; and Third Report from the Environment, Transport and Regional Affairs Committee, The Proposed Public-Private Partnership for National Air Traffic Services Limited, HC (1999-2000) 35 paras 75, 82. Back

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