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:
| Aberdeen | Humberside
|
| Biggin Hill | Leeds Bradford
|
| Birmingham | Liverpool |
| Blackbushe | London City |
| Blackpool | Luton |
| Bournemouth | Manchester* |
| Bristol | Manston |
| Cambridge | Newcastle |
| Cardiff | Norwich |
| Coventry | Nottingham East Midlands
|
| Denham | Oxford |
| Durham Tees Valley | Plymouth
|
| Edinburgh | Prestwick |
| Elstree | Retford (Gamston)
|
| Exeter | Shoreham |
| Fairoaks | Southampton |
| Farnborough | Southend |
| Filton | Stansted* |
| Gatwick* | Sywell |
| Glasgow | Thruxton |
| Gloucestershire | White 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.
|
| |
|
