UK Civil Aviation Authority Indicates Emerging Thinking on Price Regulation of BAA’s London Airports

Date: 23 November 2006

Speaking at the Global Airport Development conference in Rome today the CAA’s Group Director, Economic Regulation, Dr Harry Bush, indicated that the CAA was on track to set out in December its initial proposals on the issues involved in setting BAA’s price caps for the period 2008-13. He said that, while the CAA’s proposals remained to be firmed up, some directions were emerging, and it was timely to give some indication of these in respect of Heathrow and Gatwick. However, as the CAA identified in its December 2005 consultation paper, the regulatory challenge at Stansted is somewhat different and remains under consideration.

The CAA has been engaged with its advisors in a detailed evaluation of the issues around the setting of an appropriate cost of capital for BAA’s airports. Dr Bush commented that:

“For capital intensive businesses, in particular Heathrow which has been engaged in a substantial and continuing investment programme, the setting of an appropriate return on capital is of key importance to both the airports’ incentives to invest and airport users’ charges. It is therefore incumbent on the CAA carefully to identify the key issues, some of which will undoubtedly benefit from Competition Commission scrutiny next year from a cross-regulator perspective. In the meantime, the CAA will be exhibiting its own preliminary analysis of the emerging evidence on cost of capital, including from market developments. In so doing, it will be mindful of the continuing need to incentivise investment, so that airlines and passengers benefit in a timely way from enhanced facilities and extra capacity, and to pay due regard to regulatory consistency and commitments. It will also consider the risks to investment over time of too low a cost of capital as compared with the impact on airport charges arising from setting the allowance too high.

“The CAA has made it clear that the choice of financing arrangements is a matter for the airports’ owners. It is not the CAA’s intention to accommodate any particular set of financing arrangements but rather to take a view on an allowance that would permit an efficiently financed company to earn its cost of capital while undertaking the continuing investment planned at the airports.

“The CAA will be setting out its thinking in full in December but its current assessment, taking account of the reducing cost of debt generally and the increasing proportion of debt in company financing compared to that assumed in 2003, points towards a marked reduction in the cost of capital allowed compared with the 7.75 per cent (real terms, pre tax) allowed in 2003.”

Dr Bush also spoke about the continuing need for improved efficiency in costs and operating processes at BAA’s airports. He indicated that the evidence the CAA had assembled suggested that, while in some areas BAA was a good performer, the challenge was to bring the rest to the standard of the best as well as to seek continuous improvement generally.

Dr Bush cautioned against mechanistically translating any reductions in the cost of capital allowance, or increased efficiencies, into price caps, in particular at Heathrow:

“The need to remunerate investment undertaken since 2003, not currently reflected fully in prices; to pay for ongoing investment; to reflect lower traffic growth at Heathrow than forecast; and to recognise legitimate cost pressures, not least on security, mean that the direction of prices at Heathrow is likely to remain significantly positive in real terms.”

The CAA wrote to BAA airports and airlines in September encouraging them to work together at BAA’s airports to overcome difficulties arising from enhanced security standards. Dr Bush commented:

“The enhanced security standards imposed on the airports following 10 August severely tested both airports and airlines, and showed that more could be done to improve the way they work together. Unless they do, passengers suffer. BAA is already discussing these issues with its airline customers. The CAA welcomes this and wishes both sides to give consideration to how best to build greater resilience into current arrangements so that any future changes in security requirements could be better dealt with. In particular, the CAA wishes consideration to be given to the appropriateness of the current passenger queuing standard, and whether staffing up for a faster processing of passengers in normal circumstances would provide a more secure base against which to cope with security changes to the benefit of passengers. The CAA will want to consider the cost implications in its reviews alongside other operating cost issues.”

For further information contact the CAA Press Office on 020 7453 6030.

Notes for Editors

The CAA is responsible for the economic regulation of designated airports under the terms of the Airports Act 1986. Four airports are designated for these purposes: BAA’s London airports (Heathrow, Gatwick and Stansted) and Manchester airport. Under the Airports Act, the CAA is required to set maximum limits on airports charges at designated airports. In doing so, the CAA must set maximum limits in a manner best calculated to:

(a) further the reasonable interests of users of airports within the United Kingdom;
(b) promote the efficient, economic and profitable operation of such airports;
(c) encourage investment in new facilities at airports in time to satisfy anticipated demands by the users of such airports; and
(d) impose the minimum restrictions that are consistent with the performance by the CAA of its functions under those sections.

The CAA published, in February 2003, the results of the last review of BAA’s London airports, covering the five year period up to 31 March 2008. In 2006/07, the price caps are £8.51 at Heathrow, £4.73 at Gatwick and £5.83 at Stansted. For Heathrow, the maximum increase per annum is set at RPI plus 6.5 per cent; and for Gatwick and Stansted at RPI.

Timetable for BAA designated airports reviews

December 2006: CAA publishes initial price control proposals for consultation

February 2007: Consultation closes

end March 2007: CAA makes price control reference to Competition Commission

September 2007: Competition Commission reports to CAA on price control reference

November 2007: CAA publishes firm proposals for Q5

January 2008: Consultation closes, oral hearings

March 2008: CAA price cap decision for Q5

April 2008: Q5 starts 1 April


Security

The costs of security staff and facilities at BAA’s designated airports form a significant part of the cost base which is recovered through regulated airport charges. Following the heightened security status imposed at UK airports from August 2006, BAA has been reviewing with its airline users the levels of resourcing and operating processes necessary to meet the new security requirements in a sustainable manner and to provide adequate resilience to cope with any future changes. The CAA has encouraged this process, and will consider the outputs from this in the early part of 2007 as it develops its initial price control proposals prior to making the mandatory reference to the Competition Commission. In the current price caps, BAA can recover 75% of the additional costs (above a minimum threshold) arising from new security requirements. (The thresholds are £14m at Heathrow, £6m at Gatwick and £3m at Stansted.)

The CAA has set a standard under which 95% of passengers should queue for no more than 10 minutes at security in Heathrow and Gatwick. If the standards are not met BAA has to pay rebates to airlines.

Cost of capital

At the last price control decision in February 2003, the CAA set price caps on the basis of an assessed cost of capital for each airport of 7.75%, on a pre-tax real basis. As part of the current price control review, the CAA is conducting an assessment of the costs of capital in order to inform the level of the price controls in the next five year period (1 April 2008 to 31 March 2013). The CAA will publish, for consultation, analysis and evidence on this issue as part its initial price control proposals in December 2006.