BAA plc: A report on the economic regulation of the South-East airports companies (Heathrow Airport Ltd, Gatwick Airport Ltd and Stansted Airport Ltd)

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Under the references made by the Civil Aviation Authority (CAA) on 13 December 1990 (see Appendix 1.1), we are required to recommend the maximum levels of airport charges at Heathrow Airport Ltd (HAL), Gatwick Airport Ltd (GAL) and Stansted Airport Ltd (STAL) for the period of five years beginning on 1 April 1992. We are also required to consider whether any of the three airport companies have, at any time during the 12 months ending with the date of the references, pursued a course of conduct (as specified in the references) which has operated, or might be expected to operate, against the public interest.

Airport charges account for only about 40 per cent of the income of the three airports, but in considering maximum airport charges, we have taken into account BAA's projections of income from its other, commercial activities. During the current five-year period, increases in income per passenger from airport charges have been restricted to 1 per cent per annum below the increase in the Retail Price Index (RPI); this requirement has been applied to airport charges separately at Heathrow and Gatwick, and to the three airports together, ie including also Stansted.

The profitability of the three airports has generally risen by more than expected. This is mainly due to the rapid expansion of traffic since 1986/87 which has led to greater income both from airport charges and from commercial activities. On the other hand, BAA has not charged the full amount allowable, particularly at Heathrow, and its profitability has also been reduced by the current arrangements for recovery of the costs of meeting additional Department of Transport (DTp) security directives, which allow BAA to pass on only 75 per cent of additional costs, after a delay of up to two years.

In considering the appropriate level of charges for the next five-year period, we believe it would be reasonable for BAA to earn a current cost rate of return of about 8 per cent. This would be achieved in the current circumstances of the South-East airports by requiring revenue per passenger from airport charges at Heathrow, Gatwick and for the three airports as a whole to increase by no more than the RPI less four percentage points. Such a requirement would in our view give BAA the incentive to improve efficiency to achieve any higher returns at which it may wish to aim.

We have also, however, considered BAA's need to earn an adequate rate of return on new investment, in particular in new terminal facilities at Heathrow. The cost of construction of that new capacity will be high, due to the expense of developing the only available site at Heathrow. BAA argued that these high costs of investment should be reflected in the current level of charges. We do not fully accept this argument: the rate of return on Terminal 5-which will not open before 2001/02 at the earliest-will depend on the level of charges over a long period, and whatever we recommend, we cannot bind our successors. On the other hand, we believe some account should be taken of BAA's need to finance construction of Terminal 5, and of the likelihood that increases in charges may be necessary in future reviews to earn an adequate return on that investment. We have therefore recommended that charges at Heathrow should be allowed to rise by 1 per cent above the RPI in the last two years of the quinquennium, and that the condition for the three airports as a whole should also be adjusted in those years (to RPI-1), on condition that BAA starts construction of Terminal 5 in 1995/96.

We have also recommended that BAA be allowed to recover 85 per cent of additional security costs in the year after the introduction of any new security requirements. We also believe that the CAA should modify the charging condition to ensure that BAA is fully compensated for the loss of intra-EC duty- and tax-free allowances, should these allowances be withdrawn within the next quinquennium, the appropriate increase in charges to be determined by the CAA at that time.

During the inquiry, we received many complaints about both airport charges and those activities of the three airports excluded from the airport charges formulae. The extent of the complaints may in part reflect BAA's dominance of the London area airports, and the dependence of airlines and others on BAA in the operation of its businesses. On several of the issues raised, relating to airport charges or relevant activities, BAA itself intends to review or change its approach and, should future developments prove unsatisfactory to users, these questions would, we feel, be better raised by complaint to the CAA under section 41 of the Airports Act. On the bulk of the issues raised with us, we do not believe that there are currently sufficient grounds to justify a conclusion that any of the three airport companies has pursued a course of conduct against the public interest.

We are, however, concerned about a range of charges excluded from the regulatory formulae where, given BAA's position as a dominant supplier, it is in a strong position to charge what it chooses irrespective of costs. The provision of inadequate information to users on the costs of the relevant facilities puts them in a weak position to judge whether they are being overcharged or to complain to the regulatory authorities. In our view, the provision of insufficient information to users about the costs of such facilities or services, or any other bases for the charges, may be expected to operate against the public interest. BAA itself intends to improve transparency of information but, in our view, a condition should be imposed on each of the three airport companies requiring each airport to provide to the CAA and to its users adequate information on the costs or other factors underlying these charges.

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