Price cap regulation and competition: BAA London airports

1. Price cap regulation and competition: BAA London airports Nienke Hendriks

2. Outline • CAA 2003 airport price cap decision • Move away from system approach to airport-specific “stand alone” approach • Regulation and investment • More radical change needed?

3. CAA decision 2003: Background • Statutory duties • Objectives of the review • Regulatory process • Key elements of the 2003 CAA decision

4. Statutory duties • further the reasonable interests of users of airports • promote the efficient, economic and profitable operation of airports • encourage investment in new facilities at airports in time to satisfy anticipated demands by the users of such airports • Impose minimum restrictions

5. The CAA’s objectives • Appropriate airport capacity • Service quality • Best use of capacity • Cost-effectiveness • Trade offs: use cost benefit analysis • Transfers ignored

6. Regulatory process • CAA presented proposals to Competition Commission • Competition Commission advises CAA • CAA makes final decision • No appeal against CAA decision except JR

7. CAA 2002 proposals • Price path commitment – move to incremental output focus • Move away from single till • 10 year view • Strong focus on improved information disclosure and consultation • Incentives for BAA to contract with airlines to share output-related risks

8. Competition Commission • Did not accept the CAA proposals • Reversion to RAV based regulatory approach instead of greater output focus • AICC and 7.75% CoK • Triggers for investment delivery • Service quality standards

9. Key elements of 2003 CAA decision (1) • Investment focus • Service quality concerns

10. Key elements of 2003 CAA decision (2) • Heathrow: RPI+X: P • ATM incentive • Move away from system approach to stand alone approach • Stansted: non-binding cap • Gatwick: marginally binding

11. Implications of regulatory review • Modestly improved allocative efficiency • Usual price cap incentives for cost efficiency • ATM incentive • LHR cap reflects funding for T5 • Mix of “highish” and low powered incentives • 10 year path to P=LRIC • Plus cost-base approach: CC But • Incentives/accountability remains an issue • Are there any alternatives?

12. Wider regulatory framework • Government’s airports policy: • Presents LHR/STN options • LGW after 2017 • Private funding • Planning system

13. ‘System’ approach (1) • BAA earned CoK on the RAV of all three airports • No link between return and financial performance at Gatwick and Stansted • Higher prices at Heathrow to deliver CoK

14. ‘System’ approach (2) • Heathrow: higher prices • Improves allocative efficiency and dynamic efficiency • But this could have been done anyway • Gatwick and Stansted: poorer investment incentives • All investment profitable regardless of true profitability • Anti-competitive e.g. Luton/Birmingham • System approach fails Cost-Benefit test c/f alternative

15. From 2003 onwards ‘Stand-alone’ approach Stansted: non-binding price cap better investment incentives if cap can be kept non-binding regulation doesn’t distort competitive interaction

16. ‘Stand-alone’ approach Heathrow and investment • Economic regulation (incl. price caps) and investment – problematic, unless • Long-run price caps with prices linked to outputs

17. Economic regulation and investment • Airport charges not perfectly linked to outputs • e.g. more PAX through existing Heathrow terminals but implications for service quality • still below customers WTP (Qantas: £20 million for two pairs of slots:>10X airport charge/PAX) • Regulatory risk with 5-year price caps • Regulatory framework: CAA/CC roles • BAA: sunk investment risk and/or high profits

18. Regulatory framework • Time inconsistency problem • Independent regulator reduces risk • But doesn’t eliminate it • CAA/CC roles & no appeal • Long-lived investments but 5 year price control • Regulators appointed for duration of 1 or 2 reviews

19. More radical change needed? • Package: BAA divests Stansted and Gatwick to separate owners • Repeal Airports Act (thus reducing the risk of re-regulation) • Government airport policy: acknowledgment that Gatwick may wish to work with local community on expansion plans instead of ruling out Gatwick runway full stop

20. Airports • Clear property rights • More incentive to contract with users

21. Monopoly pricing risk • Heathrow main issue • But prices  then volume risk for BAA  • Airlines have a strong influence • Airport charges small proportion of airlines total costs

22. Deregulation of Heathrow • Unlikely to have adverse effects on allocative efficiency • Better productive efficiency • Better dynamic efficiency • BAA earns retail profits from increased passenger numbers  reduces incentives to fully monopoly price

23. Cost of regulation • Accountability • Regulatory uncertainty • Implications for economic efficiency • Allocative efficiency • Productive efficiency • Dynamic efficiency • Cost to customers/consumers (who bears the downside risk)? • Time inconsistency problem

24. Conclusion (1) • Regulation comes at a cost • Regulation should be last resort not first option • Competition always preferable • Are there any credible alternatives to regulating BAA London airports?

25. Conclusion (2) • Time to move on • Government’s key issue is investment in new aviation infrastructure • But investment should be efficient Voluntary break up of BAA would encourage efficient investment