Skylark
Among the many trials and tribulations visited on aviation by the Covid-19 pandemic, the question of how airport charges should be set is probably not foremost in public policy terms, but is nonetheless crucial for the viability and financeability of the airport industry, and by implication the sustainability of the airport infrastructure on which the aviation industry relies.
Within the traditional framework in Europe and elsewhere, airports deemed to have significant market power (SMP) are subject to economic regulation, and those without operate within a competitive market. The evidence is that airports without SMP are finding that their airport charges are being squeezed hard by airlines facing a surplus of airport capacity, either through discounts or deferred payments. However, this article mainly concerns airports with SMP, subject to one form of cost related regulation or another.
As has been pointed out by other commentators, the basic arithmetic of cost related regulation is that when traffic slumps, charges must proportionally increase given the relatively fixed cost nature of airports. Where the slump is occurring midway through a regulatory period, the charges increase is delayed until the regulatory reset (and in the meantime the airport takes the hit). Whereas where the slump occurs at the beginning of the regulatory period, the airlines/consumers incur the increase in charges contemporaneously with the decrease in demand, and revenue to the airport is kept relatively steady. This is illustrated in the graph below, assuming a single till approach and making simple assumptions about traffic and other elements.
Return forecasts based on a 10 million passenger airport that incurs a 75% traffic loss in year one of the slump. This is then recovered over the next two years and pre-slump levels are achieved 3-4 years post-slump.
That’s the theory but the general belief is that given the magnitude of the current Covid-19 crisis, the level and distribution of increase in airport charges under regulation is almost inevitably unsustainable and impractical. So what is to be done?
One answer proposed by commentators is to work within the existing framework but nudge it, essentially to recover today’s losses at a future date. One method would be to adjust the profile of the depreciation of the Regulated Asset Base (RAB) to match volumes rather than asset lives. Therefore, the recovery of the RAB could be aligned to a future recovery period. An alternative is to add today’s losses to the RAB and again recover the losses over the longer term. Attractive though these or similar methods may sound in theory, the practicality is that tomorrow’s airlines are unlikely, unwilling, or both, to pay charges resulting from today’s crisis. Reprofiling charges is likely simply to defer the issue and be unlikely to convince, say, lenders to airports to extend credit lines.
A further solution would be for governments to step in as they have for the airline industry. There has been limited support of this approach as airports are generally not seen as deserving candidates.
Making any prediction about a Covid-19 recovery is guesswork at this stage, however Skylark expects that this issue will play out in one of two ways.
1 One is that building block regulation is essentially abandoned or at least suspended in the name of deregulation. The deregulation could be for a limited period of time, dependent on ‘good regulatory behaviour’. Within the UK there are already precedents for this as a policy response in the shape of the Contracts and Commitments regime at Gatwick Airport (in the context of Gatwick’s accepted SMP) and UK Civil Aviation Authority’s (CAA) statement within the previous regulatory period that it would welcome Heathrow Airport’s achieving commercial deals with its airlines, in the context of its regulatory settlement. This would have various benefits. It would make explicit what is already implicit, that regulation does not have an answer to this crisis. Secondly, it would save the not inconsiderable costs of regulation at a time when the industry can ill-afford it. Thirdly, for regulated airports, the promise of deregulation on the basis of good regulatory behaviour, as it did for Gatwick under contracts and commitment, could enhance shareholder value and assist in making airports and airport infrastructure more fundable.
2 The second is that airports bite the bullet (or are forced to bite it by their financiers) and make cost related charges stick, either over the short term or medium, even if the airport charge increases are eye-watering. Clearly, some airport traffic is footloose and will cease flying or take capacity elsewhere, but it is likely that a significant proportion of surviving traffic is highly dependent on its airport origin and destination to be sustainable (that is after all what SMP implies). Such residual traffic will pay higher charges. Furthermore, we expect that following the shake-out of airlines, reduced capacity due to Covid-19, fares will inevitably rise. In that context higher airport charges (and other related costs such as handling) would be a natural corollary and charges need not increase as a percentage of the overall travel cost. In a sense, we would be resetting the world to the 1980’s where on a smaller traffic base, and embryonic commercial revenues, airports had no choice but to recover costs, or fight for limited public sector borrowing, and for many, ticket prices were higher than they are now.
The regulator will need to balance consumer protection against airport survival, as in a sense, they do at present. However, one intervention could be related to discriminatory pricing, which regulation (for example the EU Charges Directive) takes a dim view of. To have any chance of sticking, charges would need to be tailored to the ability to pay. The least elastic categories would pay the most under a Ramsey pricing type approach, essentially setting a price markup over marginal cost inverse to the price elasticity of demand. A regulator would need to set aside discrimination concerns to support such an approach, again in the interest of airport survival.
Both of these outcomes would probably lead in the short term to the same outcome – higher airport charges for those with SMP. What of those airports without? It is difficult to offer much comfort prior to a sustained traffic recovery, aside from the old adage about “all boats being raised by a rising (pricing) tide”.
For more information about this article and Skylark’s capabilities, please contact Simon Morris at simon.morris@skylarkcg.com.
