Select Committee on Transport Minutes of Evidence


Memorandum submitted by Mr David Starkie

ECONOMIC REGULATION

Introduction

  1.  The CAA is responsible for the economic regulation of the airports and of air traffic services provided by NATS. Economic regulation of both sectors involves a large number of technical issues, some of which might be considered arcane. It is an extensive subject and therefore in this Memorandum I shall be highly selective in two respects. First, I shall focus on airports because I consider that the economic regulation of NATS is less controversial and the processes involved are more in accordance with those adopted in other regulated utilities. Second, I shall focus not on the nuts and bolts" of economic regulation but on the basic framework applied to airports; on the broad thrust of the CAA's current approach in relation to the designated" airports, and what I believe to be important issues arising therein.

Permission to levy charges

  2.  Economic regulation operates at two levels under the 1986 Airports Act. First, it applies to all airports with a turnover in excess of £1 million per annum (in two of the last three financial years). All airports exceeding this threshold have to apply for permission to levy airport charges; there are currently 55 airports with a Permission (see Annex). Although seeking this Permission is generally a formality, it does mean that some very small airport businesses are involved, including a few that are concerned only with general aviation and private flying. The £1 million threshold was fixed in 1986 and probably requires revision. (There cannot be many UK businesses that have to obtain formal approval to continue to charge customers once their annual turnover exceeds £1 million). It is the responsibility of the Government to alter the threshold but the CAA can advise.

Designation

  3.  A more important issue is the subject of designation" under the Act. Designated airports are subject to more stringent regulation whereby their maximum charges are controlled through the setting of a price-cap". Four airports (London Heathrow, Gatwick, Stansted and Manchester) were designated in 1986 and the number has remained unaltered since, although the competitive environment has changed considerably in the mean time, particularly as a consequence of the low-cost airline concept with many more airports offering extensive scheduled services. The Government set out criteria for designation in the mid-1990s but these lack clarity. As matters stand, there appear to be anomalies in the selection of designated airports. It is not clear, for example, why BAA's Scottish airports were not designated in 1986 because this group dominates the Scottish market to an extent similar to BAA's dominance of London and the south east (and where the more recent acquisition of Southampton airport by BAA has added to this dominance). Another anomaly was the designation of Stansted at a time when its annual passenger throughput was only half a million. Stansted has never had any pricing power and currently heavily discounts (through extensive marketing support) the charges that it is able to charge under its price-cap.

  4.  It is arguable whether designation is now required at all and whether airports could not be subject to normal competition law with its focus on the abuse of a dominant position. Alternatively, Manchester and Stansted, could be de-designated, with the threat of future designation providing the incentive to control behaviour. In this context, it is to be noted that BAA caps its charges at its Scottish airports on a voluntary basis. When judging this issue, it has to be borne in mind that formal price regulation brings with it significant costs, not just the direct cost involved but the indirect cost of diverting management time; there is also the increased cost of capital associated with the uncertainty of regulatory outcomes. Influenced by such considerations Australia removed price-caps from its airports in 2002 in spite of having few, if any, directly competing airports.

  5.  Because of its relatively weak market position, Stansted is probably the leading candidate for de-designation although this option has been complicated by the commencement of the next price review process for BAA's London airports. But there is time to consider whether it is necessary to subject Manchester to another price-cap review. The CAA is currently undertaking an analysis of passenger market areas, which will show the areas of overlap for different airports and thus indicate the extent of competition between them. However, in making a final judgement on this issue, to my mind, the question to be answered is not whether airports have market power, per se, but whether they have disproportionate market power when set against other forms of economic activity that we choose not to price regulate. In the case of Manchester Airport, there are other considerations such as whether incentive regulation, the chosen method of price control, works well in the context of an airport whose objective is less focused on shareholder returns. Put simply, is it appropriate to subject the trading activity of local government to direct price control when we would normally assume that such a body would act in the public interest?

Interface with the Competition Commission

  6.  The CAA shares its role as airport regulator with the Competition Commission, in so far as it is required to consult with the Competition Commission before setting maximum charges at the designated airports. This is done by means of a reference to the Commission, which subsequently reports back to the CAA with its recommendations concerning the price-cap and with conclusions as to whether the airport company has acted against the public interest. With respect to the setting of charges, the CAA has ultimate responsibility. This process is different from that mandated for the other regulated industries including NATS; in the case of the latter group, the Competition Commission is involved only following an appeal by the regulatee regarding a decision by the regulator. This difference in procedure in the case of airports is unfortunate. It inevitably extends the period of regulatory uncertainty and this uncertainty was emphasised during the last price-cap review when the CAA and the Competition Commission formed different views on a large number of, sometimes important, matters. This, in itself, was instructive in underlining the fact that the process and methodology of price regulation does not lead to precise, unequivocal outcomes and suggests that the unintended costs of regulation are perhaps quite high. Prior to the Utilities Act 2000, the Government proposed to align the regulatory process for airports with that of the other regulated utilities. However, the relevant Clauses relating to airports were subsequently omitted. The CAA has to work within this less than satisfactory framework and this is to be borne in mind when judging its performance.

Constructive engagement

  7. Following the difficulties experienced with the 2003-08 price-cap review, the CAA has decided to try a different approach whereby it acts more as a facilitator to encourage constructive engagement between the airports and their airline customers. The intention is that the parties themselves reach agreement on key determinants of the price-cap, such as the potential for efficiencies in airport operation, the appropriate amount of capital to be invested and the quality of service to be expected. The CAA will continue to lead on some technical issues, such as the cost of capital, where it considers it has a comparative advantage. In the absence of agreement, the CAA will reach a decision on an appropriate price-cap through a traditional regulatory-led process, but this is seen as a fall-back position. This new approach is now underway and the CAA was able to report at the end of last year that good progress had been made at both Heathrow and Gatwick. Unfortunately, at Stansted this was not the case and, therefore, for this airport the CAA is adopting the traditional regulator-led process.

  8.  Notwithstanding the difficulties at Stansted, which might be expected given the controversial decision to develop a second runway, the otherwise encouraging progress with the engagement" process holds out the prospect for a lighter regulatory touch in general, for less regulatory risk and a lower cost of capital. Importantly, it also moves the airports industry in the direction often taken in other competitive industries (not subject to economic regulation), where large strategic investments are secured by agreement between a business and its major customers in the context of long-term contracts. In this regard, there is a paradox in the airports case. The regulatory process has tended to focus on air passengers and not on air cargo and, yet, the latter is more concentrated with nearly all the UK's export/import cargo concentrated through five airports. Heathrow is the largest cargo centre, but with most cargo carried in the hold of passenger aircraft. The second largest air cargo centre is Nottingham East Midlands Airport, which is a hub for dedicated freighter aircraft. It is not designated" under the 1986 Act but there has been little or no controversy about airport charges because the freight integrators (DHL, Fedex) have secured their significant investment at the airport in logistics infrastructure through long-term contracts. It is an instructive example to be borne in mind when considering arguments for setting aside formal price-caps at Stansted and Manchester.

Transparency

  9.  The CAA undertakes research into a number of issues that bear upon the economic regulation of airports and produces reports of a high quality, an example of which would be the recent report on regional air services. With respect to the airport price-cap reviews, the Competition Commission's reports have also contained a wealth of data and information, which generally has allowed for careful examination of proposals. It is to be hoped that the provision of high quality information will continue in the future. However, there is one area of concern in this context. It was noticeable that, during the last review of the price-caps of Manchester and BAA, Manchester was more forthcoming in providing certain types of information. An example would be information on projected operating expenditure for which Manchester provided a complete picture but the BAA did not, treating, for example, projected expenditure on maintenance and equipment as commercially confidential. This made it impossible for those outside the regulatory bodies to build up a complete picture for this important component in the setting of price-caps for the three BAA designated airports. The Airports Act gives power to the Secretary of State to direct the CAA to exclude from published reports matters that appear to the Secretary of State to be against the public interest or the commercial interest of a person. These powers were invoked in the above example but it is not apparent why there should have been a marked difference between the two airport operators in this regard. It is to be hoped that the CAA will press for greater transparency in the current review.

20 January 2006

Annex

  As at 1 January 2006, the following airports held a permission to levy airport charges under the Airports Act:
AberdeenHumberside
Biggin HillLeeds Bradford
BirminghamLiverpool
BlackbusheLondon City
BlackpoolLuton
BournemouthManchester*
BristolManston
CambridgeNewcastle
CardiffNorwich
CoventryNottingham East Midlands
DenhamOxford
Durham Tees ValleyPlymouth
EdinburghPrestwick
ElstreeRetford (Gamston)
ExeterShoreham
FairoaksSouthampton
FarnboroughSouthend
FiltonStansted*
Gatwick*Sywell
GlasgowThruxton
GloucestershireWhite Waltham
Heathrow*Wolverhampton
Highlands and Islands Airports (1)Wycombe Air Park
Source: CAA
*  Airports designated by the Secretary of State
(1)  The Highlands and Islands Airports are Barra, Benbecula, Campbeltown, Inverness, Islay, Kirkwall, Stornoway, Sumburgh, Tiree and Wick.

Belfast City and Belfast International airports are also regulated under the Airports (Northern Ireland) Order 1994.





 
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