Select Committee on Transport, Local Government and the Regions Appendices to the Minutes of Evidence

Memorandum by National Air Traffic Services (NAT 6)


  1.1  The Committee has announced its intention to undertake an inquiry into the financial situation of NATS and the implications of that situation on air traffic control in the United Kingdom and the development of the Two Centre Strategy. This memorandum is a contribution to the inquiry and explains the current financial position of the Company, following the downturn in air traffic after 11 September, and the steps NATS is taking to address the situation.


  2.1  There has been a good deal of media speculation, as well as interest in the House, about the NATS PPP. The PPP was established on 26 July last year and it was only a matter of weeks before the Company was facing the most serious financial challenge in its history. The Company's response needs to be set in the context of the objectives set by Government for the PPP:

    —  maintaining high safety standards as the overriding priority;

    —  separating safety, airspace and economic regulation from air traffic service provision;

    —  introducing a structure of incentives and disciplines to maximise NATS' efficiency;

    —  injecting commercial and management skills into the company;

    —  establishing the basis for access to investment finance; and

    —  achieving an acceptable level of proceeds for the taxpayer.

  2.2  The rationale for establishing the Company as a PPP remains sound, with a clear alignment between the public interest and the interests of the airline community in maintaining a safe, effective and efficient air traffic control service. NATS remains committed to delivering to its customers and stakeholders the benefits which the PPP was designed to achieve, while at the same time maintaining the Company's status as a world leader in the safe operation of ATC systems by:

    —  introducing increasingly competitive charges;

    —  improving the procurement and delivery of new technology;

    —  bringing private sector business skills and experience to the areas of procurement, planning and delivery of major capital investment projects;

    —  developing a sustainable, long term investment programme for the introduction of advanced systems; and

    —  establishing a leading position for the United Kingdom as we move towards European integration under the Single European Sky initiative.

  2.3  The establishment of the PPP has given NATS the commercial freedom and structural incentives required to improve the efficiency of the business. However, the scale of the present downturn in the air transport industry since 11 September has been unprecedented. The company has addressed the impact in the same way as any other commercial business by adjusting its costs and financial commitments to take account of the new conditions.

  2.4  The PPP continues to be supported by the key stakeholders, who have a shared interest in ensuring that the Company succeeds.


  3.1  At the time of writing, the outlook for the airline industry remains uncertain and it is still not possible to predict with confidence the future level of demand for NATS' services. The initial response from the industry to the events of 11 September was to put in place a significant reduction in capacity, with reductions in frequencies and aircraft sizes, and some shedding of routes. The introduction of Winter schedules saw scheduled services reduced by up to 20 per cent on the North Atlantic and by up to ten per cent on some European routes, though the market for services provided by the low cost carriers on European and domestic routes remained quite strong.

  3.2  NATS financial performance is driven by numbers of flights, aircraft weight and distance flown. Between October 2001 and March 2002, total UK flights have dropped nearly five per cent compared to the same period a year ago. The fall in North Atlantic traffic has been even greater—down 16 per cent. This is significant because, although the North Atlantic segment comprises only 14 per cent of NATS total UK flights, it accounts for 44 per cent of NATS income. Each North Atlantic flight is worth roughly four times a non-North Atlantic flight in terms of Chargeable Service Units (CSUs), since the formula used to calculate CSUs depends on both aircraft weight and distance flown through UK airspace and both these factors are increased for North Atlantic flights. As a consequence, NATS income in terms of CSUs has fallen ten per cent between October and February. Even more significantly, when compared to the six per cent CSU growth forecast which formed the basis for setting the Price Cap, the total decline in revenues since October against budget has amounted to 16 per cent.

  3.3  Whilst the indications are that the worst may now be over, recovery is expected to be slow and initially limited to returning to pre-11 September traffic levels. Passenger confidence is returning but airlines are not necessarily responding by increasing capacity. There are increasing pressures on yields due to high oil prices, low fares and high labour costs. The continuing troubles in the Middle East also add to the uncertainty. Year on year growths in either flights or CSUs are unlikely to become positive until the start of the Winter schedules in October 2002 and this will largely be due to comparisons with the severely depressed period following 11 September. Real growth is not expected until the financial year beginning March 2003.

  3.4  NATS has prepared revised forecasts following 11 September and the revised base case is illustrated in the chart below. To provide an appreciation of the scale and duration of the downturn, the chart compares the current position and the forecast with the equivalent period before and after the Gulf War.

  3.5  NATS is forecasting revenues for its financial year ended 31 March 2002 of £552 million against a budget of £607 million, a reduction of £55 million. Most of this fall is a direct result of the traffic downturn described above. Despite this revenue shortfall and the higher interest costs of the PPP financing arrangements (net debt was £727 million at 31 March 2002), the Company is forecasting a small profit before tax and exceptional items.

  3.6  There is continuing uncertainty about the financial consequences for the Company, and about the overall scale and duration of the downturn and the longer term recovery profile. Based on NATS' base case forecast, agreed with shareholders and lenders, the effect of 11 September will be to reduce income by around £230 million over the course of the next four years compared with the CAA's original demand forecast against which the Price Cap was set. Faced with this revenue shortfall NATS management has responded in the following ways to restore the financial position.


Short term liquidity

  4.1  In the aftermath of 11 September, the Company maintained its process of regular meeting with lenders and shareholders, but focused on quantifying the revenue loss and determining appropriate next steps. The level of co-operation between the stakeholders has been excellent.

  4.2  In order to manage the short term cash shortfall, a number of actions were initiated, including savings in operating costs, suspension of non-essential capital expenditure, a re-assessment of the capital programme and reductions in working capital. These actions improved the cash position at the end of February by £42 million. In addition, the Government and lenders have provided up to £60 million of additional loan facilities to meet operating cash flow requirements to the end of September 2002. This is a commercial loan on commercial terms and is intended to provide bridging finance while the steps outlined below are implemented. In a written answer on 20 March the Secretary of State reported that "A short-term loan facility for National Air Traffic Services has now been agreed. It is for a maximum of £60 million over the period to 30 September 2002, £30 million of which is to be provided by the Government and the other £30 million by a group of four lending banks. Each party will lend on the same commercial terms. Its purpose is to relieve NATS' cash-flow position until arrangements are put in place to secure the long-term financial stability of the company following the unprecedented events of 11 September 2001." In addition, further options for strengthening the balance sheet are under review.

Business Plan

  4.3  An accelerated programme of cost savings has been identified through the Company's business planning process. This is expected to realise additional savings in excess of £200 million in the remaining years of the current Control Period and is designed to strengthen the Company's financial position and protect against further demand risk. The Company will not make any changes that could compromise either the safety of operations or the integrity of NATS systems.

  4.4  The NATS (En Route) Ltd element of the Business Plan was submitted to the CAA at the end of March as required by the Licence. Work is continuing on the NATS (Services) Ltd element of the Plan, to establish the full scope of the business development opportunities open to the Company.

  4.5  The main strands of the Business Plan are as follows:

    —  a Long Term Investment Plan that provides capacity ahead of demand yet maintains flexibility to adjust project timings to match traffic growth.

    —  a competitive sourcing approach for Commercial Off The Shelf (COTS) based systems.

    —  targeted cost savings in engineering and R&D, through staff reductions arising from efficiency measures, reductions in requirements and collocation, as well as through optimisation of maintenance contracts. In addition, the number of support staff is being reduced.

    —  a continuing increase in the number of air traffic controllers—140 are being recruited this year.

    —  Overall staff numbers are planned to decline from 5,700 to around 4,500 (21 per cent) by 2005-2006 as a result of modernising and standardising NATS equipment systems, bringing in greater automation, rationalising NATS accommodation arrangements and other good housekeeping measures. There is a firm commitment to ensuring the staff issues are managed properly, for example maintaining the commitment to the current Staff Surplus Agreement.

    —  a Human Resources and Change Plan to drive up management capability, introduce new performance management processes and improve employee relations.

    —  business efficiency measures to reduce overhead and support costs through organisational change, improved business systems, a shared services approach for Human Resources, Procurement and Facilities Management, and a new accommodation strategy.

    —  validating the safety implications of each aspect of the business plan.

  4.6  The Plan has been approved by the NATS Board, which comprises both Government and Airline Group directors, and has been the subject of extensive consultation with customers. There were a series of staff open meetings in December and the Plan was discussed at the first meeting of the Stakeholders Council held on 24 January. The Plan will have a major bearing on the application currently with the CAA for an increase in prices.

Prices and the CAA Application

  4.7  When the PPP was established, the regulatory regime was set at RPI—three per cent for 2002, RPI—four per cent for 2003 and RPI—five per cent for 2004 and 2005. The Company has implemented the RPI—three per cent reduction in en route charges for 2002, unlike our European counterparts where prices have increased by an average of 12 per cent and by up to 40 per cent following 11 September.

  4.8  As noted above, NATS has assessed the size of the revenue loss from the reduction in traffic at £230 million. The application to the CAA therefore includes a proposal to increase prices by RPI + 4 per cent, + 3 per cent and + 2 per cent respectively in each of the remaining years of the current Control Period to repair the shortfall caused by 11 September. The CAA is now assessing the application and has indicated that it will include a statement of regulatory principles in its decision. The CAA's consultation document is expected to be issued in May.


  5.1  The Company's capital expenditure programme was one of the key areas for review during the development of the Business Plan. A series of review principles were adopted when considering priorities for investment, as follows:

    —  complete the Swanwick Centre. This was the top priority and Swanwick was successfully introduced into operational service on 27 January;

    —  complete essential system replacements;

    —  continue with planning for sectorisation capacity developments, which allow relatively inexpensive increases in capacity;

    —  contine research studies into future capacity productivity tools;

    —  continue with evaluation of new centre systems for Scotland and elsewhere;

    —  contine feasibility studies into the best programme for Flight Data Processing (FDP) system replacement;

    —  delay major projects where feasible in the light of the reduced traffic demand situation;

    —  assess the feasibility of bringing forward necessary projects to allow the closure of the West Drayton site to realise operating cost savings.

  5.2  The major projects considered suitable for delay included the programme for replacement of NATS' radar network and the New Scottish Centre (NSC) project. This view was accepted by the Airline Group and Government after careful consideration, on the basis that all stakeholders remain committed to the NSC project and to the Two Centre Strategy.

  5.3  Against the background of reductions in North Atlantic traffic, and depending on the final extent of the downturn, the Company took the view that the start of the main work on the NSC building could be delayed by around eighteen months to two years. The precise timing for the resumption of building work will depend on future traffic levels, however the delay is temporary. The requirement to construct the NSC is a contractual obligation on the Airline Group, agreed as part of the PPP transaction, and this obligation remains in place.

  5.4  Work has continued on the building design and piling contracts. Work has also continued on the evaluation of air traffic equipment systems for deployment in the new Centre. The ATC system contract with Lockheed Martin has been terminated in order to implement the Airline Group's strategy of establishing an open competition for the system using COTS based products. The cost of work under the former contract has been written off and will be charged to the Profit and Loss account as an exceptional item.

  5.5  NATS is using the additional time to produce a high quality product and is currently engaged with suppliers in evaluating systems proposals. We expect to commence the competitive selection process in the course of this year. This should enable the Company to complete the project in an accelerated timescale when the traffic situation becomes clearer. In the meantime, the recent refurbishment of the Scottish domestic Operations Room has provided a number of potential extra sector positions, which allows for some further growth in capacity ahead of the transfer to NSC. The Company believes this should provide sufficient capacity potential to cover the additional time needed to complete NSC once the project re-commences. In addition, the recent interim facilities upgrade has provided a new radar processing system, which addressed the most immediate systems issue.

  5.6  In recent discussions with the Secretary of State for Scotland, NATS' Chief Executive Officer re-affirmed the Company's commitment to the Two Centre Strategy, including the completion of a new air traffic control centre at Prestwick in the 2008-09 timetable.


  6.1  The PPP structure has been the subject of an unprecedentedly severe financial test. The financial problems have demonstrated that, as an institutional structure, the PPP is working well even in the most difficult circumstances. There is a clear alignment of interests between the key stakeholders and this underlying strength of purpose will serve the Company well in the future. The Partnership gives the company a commercial cutting edge, but it also preserves the best of the old NATS in terms of high safety standards and commitment to public service.

  6.2  The PPP provides the structural incentives to ensure that the company looks to its customers first, rather than simply passing on its costs. Unlike its European counterparts, the Company has reduced its charges in 2002, which is clearly critical to airlines as they trade through the current difficulties. The Company is seeking modest increases in charges for the three years to 2005.

  6.3  NATS has responded in a commercial and responsible manner following the traffic downturn, with the continuing safety of air travellers as the clear priority. Rapid action was taken to contain costs, whilst maintaining safety and service standards. The Company has delivered the new Swanwick Centre into operational service and developed a Business Plan, which meets customer requirements. Through the Business Plan, it has committed to delivering additional savings of more than £200 million, through a wide variety of good housekeeping measures, without damaging the business in any way.

  6.4  The measures summarised in this memorandum will be sufficient to address the revenue shortfall and restore NATS' financial position. On this basis, NATS is confident that it will continue to be able to discharge its obligations to provide air traffic services while maintaining safety and service standards.

National Air Traffic Services Ltd

11 April 2002

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