Civil Aviation Auth.

Airport Regulation

Civil Aviation Authority
14 July 2000

CAA SETS OUT KEY ISSUES FOR AIRPORT REGULATION

An issues papers setting out possible approaches for charge controls at
Heathrow, Gatwick, Stansted and Manchester Airports to apply from April 2003 was
published today by the Civil Aviation Authority.

The CAA plans to refer these airports to the Competition Commission in December
2001 in order to set new conditions relating to airport charges for the five
years from April 2003.

The price cap covers only airport charges - that is charging for landing,
aircraft parking and use of the passenger terminals.

Today's paper - executive summary attached - outlines possible approaches and
identifies key issues to be considered. It also highlights themes which
distinguish airport regulation from the regulation of some utilities. There is
no presumption that the way charge controls were set in the past will be adopted
in the future.

'This is the first stage of the process leading to the formulation of new price
control formulae for the airports concerned,' said Doug Andrew, Group Director,
Economic Regulation, CAA.

'We hope all interested parties will study our paper carefully and respond with
any comments or suggestions. At this stage we have no fixed views on the way in
which the charge controls will be set. The industry faces major challenges and
it is important that the relevant key issues are identified and addressed in the
process.'

Starting in September the CAA will publish consultation papers on key issues for
the regulatory review. The CAA plans to announce its final decision on the price
caps in October 2002 and they will come into effect in April 2003.

For further information contact Chris Mason on: 020 7453 6026.

A full version of today's publication, Issues for the Airport Reviews -
Consultation Paper, is available on the CAA Website: www.caaerg.co.uk

The proposed review timetable is as follows:

* July 2000 - CAA publishes paper outlining issues to be addressed in the       
 reviews

* From September 2000 - CAA publishes consultation papers on key issues for the 
 review

* June/July 2001 - CAA publishes reports on BAA and Manchester performances     
 during the current quinquennium

* August 2001 - CAA publishes for consultation a detailed position statement on 
 all issues for the reviews

* October 2001 - CAA publishes final conclusions on all issues, including       
 preliminary recommendations for price caps, for further comment

* December 2001 - CAA publishes final report and recommendations and makes      
 references to the Competition Commission

* June 2002 - Competition Commission reports to the CAA

* July 2002 - CAA publishes Competition Commission reports and its own          
 proposals on charges and any public interest matters

* August/September 2002 - CAA considers written representations and holds       
 hearings with main parties

* October 2002 - CAA announces final decision on price caps and public interest 
 matters

* April 2003 - New price caps take effect.


Notes to editors:

The CAA is required by the Airports Act 1986 to set limits on user charges at
designated airports every five years. The designated airports are Heathrow,
Gatwick, Stansted and Manchester. As part of the process the CAA is also
required to refer the airports to the Competition Commission.

The CAA last referred BAA's London Airports (Heathrow, Gatwick and Stansted) to
the Commission in December 1995 and in October 1996 set a price cap for the
period from 1 April 1997 to 31 March 2002. Manchester was referred a year later,
in December 1996, and a price cap was set for the five years from 1 April 1998
to 31 March 2003.

In May 1999 the CAA extended the price cap for BAA's London Airports one year to
31 March 2003 to allow it to take into account the Government's final decision
on BAA's planning application for Terminal 5 at Heathrow on the assumption this
would be published in late 2001. This means the CAA will review all four
airports and refer them to the Commission at the same time. New price caps will
be set for the five years for each of the four airports from 1 April 2003 to 31
March 2008.

The present charging formulae for Heathrow and Gatwick taken together is RPI-3
per cent and for Stansted, RPI+1 per cent. For Manchester it is currently RPI-5
per cent.

Executive Summary

The Civil Aviation Authority (CAA) has begun the quinquennial reviews of the
four airports designated under the Airports Act 1986: Heathrow, Gatwick,
Stansted and Manchester. The CAA plans to refer these airports to the
Competition Commission in December 2001 in order to set new conditions relating
to airport charges for the five years from April 2003. This paper sets out some
key issues that the CAA proposes to address in the review. It invites comments
on these and welcomes other topics for consideration.

Some important themes have emerged or intensified in recent years in the
airports sector:

* Demand for access to Heathrow and Gatwick increasingly exceeds available      
 capacity;

* In the absence of an efficient market in take off and landing slots,          
 utilisation of existing capacity may not be optimal:

* The question whether the incentives under the current regulatory framework    
 for the promotion of appropriate investment in capacity are the best           
possible, consistent with achieving sustainable development of the industry:

* The importance of unregulated commercial revenues and costs (eg. from the     
 provision of retail, car parking and office facilities and services) in        
setting airport charges;

* The importance of service quality for customers and consumers and the wide    
 variation in quality that different users may require.

Given these issues the CAA intends to undertake a fundamental review of its
approach towards the regulation of designated airports within the existing
framework of the Airports Act 1986. The best approach to future airport
regulation may differ from that taken in the past. It may also differ from the
approaches adopted in some other regulated industries.

The various approaches the CAA could take under its statutory objectives are
likely to involve trade-offs. For example, setting airport charges purely on the
basis of average costs might conflict with incentives to seek to increase
terminal or runway capacity to meet demand. Where these trade-offs arise, the
proposed guiding principle is maximising the total value to society. Given the
longevity of airport investments the CAA will be concerned to ensure that the
final regulatory policy is creditable and sustainable beyond the review period.

Comment is invited on other approaches within the framework of the Act.
Possibilities include the price cap being based on:

* Separating the price cap from the airport's accounting costs, possibly        
 through benchmarking against industry best practice. Potentially, bench        
marking could be used to underpin the price cap or as a cross check to other   
methods of setting the price, to estimate incremental costs (see below), for   
comparisons of delivered quality or to assess the scope for efficiency         
savings.

* Pricing on the basis of incremental costs of increasing capacity. For         
 example, prices could be set by reference to the costs of extra terminal or    
runway capacity, rather than by reference to the accounting costs of existing  
terminal or runway capacity.

* Setting higher prices for additional output or capacity than for existing     
 output levels. For example, the price cap might increase if passenger numbers  
or the number of flights were to increase.

* Encouraging and facilitating contracting between the airport and users        
 outside of the price cap. This might involve a 'default' price cap which       
would be available to all users, but permit individual users to set up         
alternative contracts with the airport if that were amenable to the parties    
concerned. This might allow individual users to contract for higher quality    
service at a higher price, or vice versa.

* Focusing on the monopoly airport services rather than the 'single till'.      
 Under this approach the regulated airport charges would not take into account  
the net revenues generated by unregulated commercial activities.

A number of areas and issues for amending and improving the current framework to
better incentivise investment and service quality include:

* What should the form of the price caps be? Should they be based on revenues   
 per passenger (as at present), on some other weighting of charges or on        
specific prices for specific services?

* Cost pass throughs - What criteria should be used to decide where automatic   
 cost pass throughs are appropriate for specific cost categories? For example,  
should security costs be left outside the price cap, or should the costs of    
additional security requirements continue to be automatically passed on to     
users?

* Volume term - should the risk of differences between actual and forecast      
 volumes be shared between the airport and users?

* Profit sharing - should there be a more direct link between the profits of    
 the airport and the prices paid by users?

* Treatments of capital expenditure and operating expenditure.

* How should issues of service quality be dealt with?

* How should the cost of capital be estimated?

* How should the delay in the decision of whether or not to allow Terminal 5 at 
 Heathrow to go ahead be treated, given that the 1997-2003 price cap had the    
effect of allowing some up front funding of Terminal 5?

* Should a price cap be applied separately to each of the BAA London airports,  
 or to all three airports?

* To what extent should the criteria to be adopted in the review of Manchester  
 differ from those for the BAA London airports?

Public interest - have any of the airports pursued a course of conduct since the
previous references which may have been against the public interest?

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