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Wednesday 10 March, 2004

Civil Aviation Auth.

CAA Speech

Civil Aviation Authority
10 March 2004



SPEECH BY SIR ROY MCNULTY, CHAIRMAN UK CIVIL AVIATION AUTHORITY, GIVEN AT
EUROPEAN TRANSPORT CONFERENCE 2004 - 10 MARCH 2004,

'UK AIRPORTS AFTER THE WHITE PAPER'


CAA REAFFIRMS APPROACH TO ECONOMIC REGULATION OF BAA'S LONDON AIRPORTS


Good morning ladies and gentlemen.  It is a pleasure to be here and to have the
opportunity to present the CAA's views to you today.


The White Paper which Alistair Darling presented last December brought much
needed clarity to the discussions of airport development in the UK and has
therefore been generally welcomed by the industry.


We are certainly overdue in tackling the issue of airport capacity in the UK.  I
think I'm correct in saying that only two runways have been built in the UK's
major cities in the last 50 years - the development of London City Airport and
Manchester's second runway.  Elsewhere in the world, airports have been growing
considerably faster, yet the UK certainly has an aviation industry that is
worthy of investment and development. Indeed, despite the recent world-wide
downturn, the UK industry is still one of the most successful in the world.


  • Year-on-year airlines operating out of the UK are carrying more
    passengers;

  • The UK has been a leading force in the development of aviation in Europe,
    most recently in the successful development of low-cost carriers; and

  • More people are flying to more different destinations than ever before.


The White Paper will require the CAA actively to engage in following up a number
of critical areas including safety, airspace policy and the environment.
However, this morning I want to focus on economic regulation, and economic
regulation at Stansted in particular.  The economic regulation issues at
Heathrow are a more distant subject, given that further expansion at Heathrow
depends on progress towards meeting some challenging environmental limits.


The continuing build-up of demand foreseen by the White Paper, supported on the
supply side by the development of new business models and increased efficiency,
provides a favourable commercial backcloth for new airport development.
Ensuring that this leads to viable airport projects requires airport developers
everywhere to adopt approaches that match what is developed with users' needs.
That is the essence of a sound investment programme.  However, before, during
and since the publication of the White Paper, there has been speculation about
how the development of an additional runway at Stansted will be funded.
Interest has principally focused on whether an additional runway could be
viable, given the CAA's approach that BAA's London airports should be regulated
on an individual, or 'stand-alone', basis.


Under 'stand-alone' regulation, the price caps on BAA's London airports are set
by reference to the costs, assets and market conditions of each airport
individually.  In other words, in setting a cap at any one of BAA's London
airports, no allowance is included for the costs of developing another.

The CAA formally decided on this approach in February last year, when it
replaced a system approach towards regulation.  (Under the system approach,
price caps at each airport were set in order to allow recovery of costs across
the three BAA London airports.)


The central rationale for this stand-alone policy is that it helps to encourage
efficient future investment.  It is a policy designed to provide BAA with a
strong incentive to match the development at Stansted closely to what both
current and future users of Stansted want and will be prepared to pay for.  In
practice, this approach to regulation represents no more (or less) stringent a
test than that which would apply in any other normal commercial situation.  The
key principle is that investments - particularly large investments - have to pay
for themselves.


Admittedly, there is a caveat to the current stand-alone policy.  The CAA
acknowledged that it would be prepared to consider modifying it if there was
compelling evidence that to do so would be genuinely in the interests of users
as a whole, and that such a change would not be unduly distortionary or
discriminatory as regards other airports in the South East.


It is possible that this policy will have to be re-examined by the CAA, and the
Competition Commission, at the next five yearly airports review.  But this is
not automatic.  It may, or may not, happen.  If it does, the CAA will be legally
bound to consider the arguments, and the evidence, available to it at that time.


But any such review would need to take into account the fact that the policy is
designed to improve the efficiency of investment and therefore - to that extent
- was intended to apply long term.


Within this policy the CAA will continue, as required by law, to set price caps
for Stansted.  Decisions, as always, will be dictated by the circumstances at
the time.  But the CAA has already demonstrated in the last airports review that
it is very much alive to the need to incentivise investment.  We braved a great
deal of airline criticism for the T5- driven decision on price increases at
Heathrow.  And at Stansted, the CAA adopted a more permissive approach than that
recommended by the Competition Commission, rejecting the Commission's proposal
to tighten the price cap there.


Against this background, it seems entirely reasonable that the working
assumption should be that the CAA will continue to regulate BAA's designated
airports on an individual - or stand-alone - basis both up to 2008, and beyond.
Equally, it would be reasonable for BAA and users to work on the basis that in
setting the maximum prices that BAA might charge at Stansted, the CAA will take
account of its duty to encourage investment, just as we have done in the past.


But we should not overlook the fact that, on past experience, it is not the
regulatory cap on Stansted prices that will make or break this investment; that
will depend on identifying a project that users are willing to pay for.


So much for regulatory policy.


Government policy, on the other hand, deals with the bigger picture, which is as
it should be.  Government has stated that it will support the development as
soon as possible of one additional wide-spaced runway at Stansted and that it
expects it could be completed around 2011 or 2012.  The Government - wisely in
our view - has avoided specifying any particular airport development in detail.


The challenge for BAA is to develop plans for Stansted that are compatible with
both government policy and regulatory policy.


So what can we expect this to mean in practice?


In practical terms, the key challenge for BAA will be to develop plans for
expansion that meet both their customers' and their shareholders' needs.  BAA's
Stansted customers will only use the airport if it matches what they want and
are prepared to pay for.  Shareholders - on the other hand - will only want to
proceed with the investment if there is evidence that there is a good business
case.  Both sides - in our view - should be interested in exploring all of the
possible alternative developments to determine which options are best.


This means it is in BAA's interest to conduct an effective consultation with its
users in order to find out what sort of development they would like.  For their
part, users should have a genuine interest in discussing options with BAA to
ensure that all potentially beneficial options are fully and properly explored.

In more detail, we would expect BAA to do five things:


1.  BAA should develop plans that are grounded in the reality of demand at
Stansted.  This means taking as the starting point the nature of the passengers
and airlines currently operating out of Stansted.  The proportion of leisure
passengers at Stansted is somewhat higher than for London airports as a whole.
But, more critically, 84% of air traffic movements are from so-called low cost
carriers, compared to 23% across London airports as a whole.  Of course the
nature of demand may change over time, and BAA has to plan developments on the
basis of the best possible information on likely future use.  But, as a starting
point, we would expect BAA to initiate their planning by taking full account of
the needs of its current users;


2. BAA should recognise, and embrace as far as possible, the flexibility
within the Government's conclusions.  The Government has wisely left
considerable room for manoeuvre in its White Paper.  In particular, it has left
open what precisely should be built - and when - in terms of supporting
infrastructure to an additional runway (particularly in relation to terminal
development).  This poses some important questions for BAA about the precise
nature and functionality of the development.


It also provides an opportunity for BAA to identify the key trade-offs as
regards cost, specification and phasing, and to share these options with users -
at Stansted and more widely - seeking to build consensus in the way it proposes
to take the project forward, and recognising that there is no point in building
something that users will not pay for.


3. in consulting on its plans with users, BAA should take care to present
properly justified and costed options for development.  Throughout the process
of consultation, users should feel that their views are being properly addressed
and responded to.  BAA will need to adopt a transparent process whereby users
can examine what the main options are, how the project is being costed, and see
for themselves why costs are as they are;


4. in setting out the relevant trade-offs, BAA should have regard to the
option to postpone or bring forward certain development in order to match the
emerging picture of future demand.  The Government has indicated a challenging
target date for the completion of an additional runway and supporting
infrastructure at Stansted.  However, the Government has been careful not to set
a precise deadline.  In our view, this gives BAA the freedom to follow a
timetable that ensures there is adequate effective consultation on the plans for
development, including a planning enquiry.

It also gives them the freedom to phase development in line with demand.
Developing an airport in stages may well carry additional costs compared to
single phase development.  However, such benefits need to be properly weighed
against the risks of building capacity too far in advance of demand.  We would
expect BAA to want to share these trade-offs with users before decisions are
taken; and


5. we believe that it is in BAA's interests to begin to engage with users
early on in the planning and development phases of the project.  Such an
approach would clearly be consistent with the logic of any commercial
development, which would normally take place at the speed demanded by the
customers.


Consultation works only if both sides engage fully and constructively.  And
therefore - as well as having implications for BAA - the combination of
Government and regulatory policy also requires airlines to play their part.  I
accept that this is not a requirement on airlines - and airlines cannot be
forced to engage in the process - but it would be odd, and apparently contrary
to their interests, if airlines failed to engage with BAA in discussing the
merits of alternative development options.


So we would expect to see active engagement of airlines with BAA.  This would
provide airlines with an opportunity to express their preferences over the
scale, specification and timing of the development.  However, in setting out
their preferences, the airlines will need to recognise the context, and
constraints, within which BAA has to operate, including those such as
environmental and surface transport concerns, which are driven by public policy.


In addition to influencing the nature and phasing of development, airline
engagement will also provide an important check on BAA's costs, which will be
key to viability.  But getting costs right is only one side of a viable
investment.  Prices also need to be right.  And this may entail some unwinding
of discounts offered to carriers at Stansted in circumstances very different
from those prevailing today.  BAA's ability to demonstrate and sustain
appropriate pricing will be one key part of developing a viable investment
proposition at Stansted.


To summarise, there is a challenge for BAA, in consultation with users, to
develop and, where relevant, to implement plans for Stansted that fit within
both Government and regulatory policy.  The key challenge for BAA is to win as
much legitimacy as possible for its capital expenditure programme, not only from
the White Paper, but also from the engagement of users who will pay for it.  The
CAA very much hopes that all concerned can rise to this challenge.


We believe that approaching the development in the way I have described will
enhance the prospects of viability.  I know that the last big development at
Stansted has taken time to grow volume and income but it is fair to acknowledge
that the goalposts were moved significantly after the project got underway and,
with hindsight, too much was built too soon.


The foreseen growth in demand provides the opportunity to do a much better job
at Stansted this time round. I believe the regulatory approach the CAA has
adopted provides the right framework to do so.  And I believe that the best
outcome for BAA, airlines and consumers can be realised only if all concerned
work closely together in the planning and implementation of the Stansted
project.


Ends.


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



Notes to Editors

1) The CAA is responsible for economic regulation of BAA's London and Manchester
Airport, in accordance with its statutory duties.  The CAA published in February
2003 the results of its Quinquennial Review of BAA's London Airports up to March
2008.  Amongst the conclusions reached by the CAA was that prices at London
airports should be set to reflect the market, cost and assets of each airport
individually, so ending the arrangement whereby investments at one airport could
be remunerated through higher charges at another.  This is known as 'stand-alone
regulation'.


2) Charges at designated airports (currently Heathrow, Stansted, Gatwick and
Manchester) are set by the CAA as the independent economic regulator.  The CAA's
decisions are made under its Airports Act duties, which require the CAA:


(a)  to further the reasonable interests of users of airports within the United
     Kingdom;

(b) to promote the efficient, economic and profitable operation of such
    airports;

(c) to encourage investment in new facilities at airports in time to satisfy
    anticipated demands by the users of such airports; and

(d) to impose the minimum restrictions that are consistent with the performance
    by the CAA of its functions under those sections.




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