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The announcement of the UK government’s approval for a third runway at Heathrow last month was welcomed in a strangely subdued way. You would think that a decision that big, and that long in the making might have received more fanfare. But there are many hurdles to go through before the bulldozers can move in. Local residents, for one, will be doing everything they can to stop the expansion going ahead.
The airlines are nervous, judging by the press releases that followed the announcement. Indeed they did not really welcome the decision at all. One of their concerns is the cost – expected to be in the region of £16 billion, more than doubling the value of the airport’s current asset base – and who is going to pay. The expectation is that the cost of building the new runway will be recovered through landing fees. However it is still up for debate how much these charges will be and how exactly they will be distributed across airlines.
Amongst the main concerns of the airlines when it comings to funding the new runway is the issue of pre-funding. This would allow Heathrow to recover at least some of the cost of building the new runway prior to it becoming operational. For the airlines, that is the worst of all worlds.
Pre-funding is a controversial topic. In a paper last year, the UK CAA – the regulator responsible for setting Heathrow’s charges – indicated that pre-funding was not off the table. There is also precedent here. Both Heathrow’s Terminal 5 and the Northern Runway at Dublin Airport were part-financed through pre-funding.
The airlines argue that pre-funding this means that today’s passengers (who are not using the new runway) are paying for benefits that will be accrued by future passengers using the runway. Replace the word ‘passengers’ with ‘airlines’ and you get what they’re really trying to say. Pre-funding would benefit an airline like easyJet, which does not currently use Heathrow but has expansion plans for the new runway once it is built, at the expense of the existing airlines at Heathrow such as British Airways and Virgin Atlantic.
Although the CAA has yet to make a decision on pre-funding, it clearly sees benefits to such an approach. Amongst these are that it makes prices more stable (no sudden overnight increases when the runway becomes operational), thereby reducing demand risk. Pre-funding can also reduce the perceived risk of the project, in turn reducing the cost of financing it.
The other argument put forward by the CAA is that pre-funding is simply proxying what we would see in a competitive market where capacity is constrained (as is the case at Heathrow). In such cases, prices would rise thereby providing the means to ration capacity so that those that get the most value out of accessing the limited capacity (and are therefore willing to pay more) are able to do so. Higher prices also act as a signal to the firm to expand its capacity, and the means to do so.
This sort of pricing is precisely what is not happening in the topsy-turvy world of airport charging. However, it is key to understanding some of the airlines’ opposition to pre-funding. You see, while Heathrow’s landing charges do not currently include an explicit premium to reflect the constrained capacity, the fares paid by passengers flying in or out of Heathrow do. This, in turn, reflects the value of those coveted landing slots owned by airlines. However, Heathrow Airport itself does not get the benefit of those higher fares.
To introduce pre-funding would be to transfer the capacity premium from the pocket of the airlines to the airport. And, were this not painful enough for the airlines, the value of those coveted landing slots (and therefore the premium that can be charged to passengers) is likely to decrease in the future as more slots become available. Plus British Airways, which currently has about 60% of the slots, will find it very difficult to maintain that percentage of slots once the new runway is built, thus opening a very valuable market up to its competitors.
Don’t expect the airlines to admit this during the consultation process. Instead, expect arguments about how Heathrow should we able to raise the necessary funds to construct the third runway on the capital markets (and at a lower overall cost than if pre-funding is used); that pre-funding weakens the incentives to ensure the runway is built efficiently; and that Heathrow should not be able to increase its charges above the current levels, anyway.
The Heathrow decision is timely. Europe is to soon start debating the amendments to the EU Airport Charges Directive. Right on cue, A4E has announced it will be hosting a discussion on the need for meaningful consultation when setting airport charges. With representatives from an airport, airline and regulator it could be a good indication of the substance of the debate to come. Just don’t mention the value of landing slots, or who owns them.
