Economic advisors, Prof Peter Mackie & Brian Pearce respond to Heathrow questions by Transport Select Cttee
As part of their inquiry into the plans for a Heathrow 3rd runway, in the Airports NPS, the Transport Select Committee wrote on 16th January – with a list of questions – to two economic experts, Professor Peter Mackie, (Institute for Transport Studies, Leeds University) and Brian Pearce (Chief Economist, IATA UK) who advised the Airports Commission (and who were critical of the way the Commission worked out alleged future economic benefits of a Heathrow runway). Mackie & Price have replied in some detail, and some of their comments can be seen below. Asked about the economic impact of the airport not being full in 2 -3 years, but (as John Holland-Kaye has said) over 10 – 15 years, they say: “…that ought to be reflected in the capacity model and profile of shadow costs over time.” Asked about carbon costs, they say: “… we cannot comment either on the probability of a fully effective international carbon trading scheme being in place in the timeframe, nor on the striking price of carbon and its trend over time.” And on Heathrow landing charges they say the DfT’s main case assumes “the benefit of the reduced shadow cost will be fully passed through to travellers while increases in landing charges to fund the infrastructure will be absorbed by airlines. This particular combination seems a bit unlikely.”
See below for link to their critical comments to the Airports Commission in 2015
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Letter from the Transport Select Committee on 16.1.2018
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Brian Pearce Chief Economist IATA UK The Metro Building 1 Butterwick Hammersmith London W6 8DL
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Professor Peter Mackie Institute for Transport Studies 34-40 University Road University of Leeds Leeds LS2 9JT
Reply from Mackie and Pearce to the Transport Select Committee dated 30.1.2018
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Just taking a few extracts:
The Transport Select Committee (SC) asked:
The demand growth profile for an expanded Heathrow has also changed to that forecast by the Airports Commission. The DfT have now forecast capacity at the airport to fill-up within the space of two-years from 2026. Putting aside the debate around the plausibility of the opening date, this seems to be a highly optimistic assumption made by the DfT.
It was refuted by several witnesses who appeared in front of the Committee. This outcome also appears to counter Heathrow’s own commercial expectations in which they anticipate phased growth. The updated forecasts have also led to some highly unusual growth profiles for other airports which seem detached from real-world expectations. This seems to occur because of the suppressed demand at Heathrow assumed in the modelling which sees demand flow quickly away from other airports upon capacity being released.
Is there enough evidence of that scale of suppressed demand for Heathrow?
How does the DfT model allocate traffic between the airports more generally?
The DfT has conducted sensitivity analysis with a phased growth profile, albeit over a 10- year period.
Should phased growth be part of the DfT’s central appraisal case?
Given the additional effect of discounting, what might the implications be on the net present value benefits by compressing capacity growth within a two-year period, rather than phasing it over a longer-period?
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To this, Mackie and Pearce replied:
SC Q — Phasing of growth after 2026
A Our understanding of the model is that as capacity limits are approached, a shadow cost is added to the surface access costs of reaching constrained airports so as to ration demand to available capacity. This is a model representation of mechanisms such as full planes and higher fares out of the constrained airport causing people at the margin to choose alternatives. The model is predicting that these capacity limits will really begin to bite at LHR in ten years or so (hence the importance of the background growth rate discussed above). If runway three at LHR is built, the shadow costs at LHR is reduced so that
Traffic transfers from competing airports because people are able to access their preferred airport
A wider range of Os and Ds and higher frequencies are offered at the hub
The hub is better able to compete with other hubs in the INT to INT market, so there are second round effects on profitable frequencies.
In a commercial market, we could envisage these responses occurring quite rapidly. But presumably the demand model (NAPAM) is fed with capacity limits which assume that runway and terminal capacity at LHR are in synch. If the reality is that for a time after runway three is open, terminal capacity is the governing constraint, that would act as a brake on growth and should be reflected in the capacity modelling. Similarly, if the regulator decided that it would be prudent to roll out the new slots over a period rather than in one fell swoop, that ought to be reflected in the capacity model and profile of shadow costs over time.
The sensitivity test carried out by the DfT shows the present value of passenger benefits reduced by £0.5 billion if capacity was instead phased in over a 10 year period. That is just 1% of estimated passenger benefits so would appear to be a marginal issue. But given an overall NPV of -1.8 to 3.3 for the LHR options it perhaps is more significant.
The Transport Select Committee asked, on carbon emissions:
Carbon costs
The DfT’s updated appraisal now only uses one carbon scenario to forecast demand, compared with the Airports Commission which forecast passenger demand under carbon capped and carbon traded scenarios. Previously, a carbon capped scenario would have resulted in a higher carbon price being applied, resulting in lower demand. The DfT have assumed that more of the carbon reductions can be met through supply side abatement policies without having to use a higher carbon price to reduce demand. Is it a realistic approach to be using a single carbon scenario to forecast demand?
The final point concerns how carbon costs are monetised as part of economic appraisals. The monetised costs of carbon were estimated at £19.2 billion by the Airports Commission, including £18.5 billion for air travel. In the economic case the carbon costs from air travel are excluded from the appraisal. It has become apparent that the exact allocation of these costs in the economic appraisal is dependent upon effective carbon trading being in place. The DfT has assumed a fully-effective international carbon trading scheme to be operating after 2030 and hence the carbon costs from air travel are excluded in the economic case. Is this a reasonable approach to be taking? How should carbon costs of air travel be allocated in an appraisal under a scenario of an absent or ineffective international emissions trading scheme?
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To this, Mackie and Pearce replied:
SC Q Is the carbon trading approach reasonable?
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The approach is reasonable but we cannot comment either on the probability of a fully effective international carbon trading scheme being in place in the timeframe, nor on the striking price of carbon and its trend over time.
We note that a significant proportion of international aviation CO2 emissions are covered by those States that has already committed to participating in the voluntary first phase of the ICAO Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA), which suggests there is a reasonable chance for a scheme being in place from 2020. This will not be a trading scheme but a cap-and-offset mechanism, so the carbon price faced by airlines and their passengers will be determined by the cost of offsetting carbon reduction investments. Since the marginal abatement cost curve for carbon reductions to take place within aviation is so steep i.e. it quickly gets very costly for airlines to make reductions beyond normal fuel efficiency gains, airlines would be meeting the cap of a trading scheme through investing in offsets anyway, so the planned CORSIA cap-andoffset scheme can be treated as equivalent to a trading scheme. The effectiveness of such a scheme, as we have seen with the EU ETS, will depend on how rigorously States enforce a cap that is sufficiently below baseline emissions to change behaviour. The use of the BIES traded carbon prices as an input into the forecast price of air travel to model the impact of such a scheme on demand, and then the use of domestic measures to further reduce UK international aviation emissions to the 37.5 MtCO2 planning assumptions looks to us to be a sensible approach.
In the absence of such a scheme (ie an actual carbon price) we would need to fall back on a shadow cost of carbon approach with the aviation sector included in the UK aggregate emissions budget in some appropriate way. The shadow cost would then be that required to bring aggregate carbon emissions to the constrained target level at each point in time. In comparing various Do Something cases with the Reference Case, the difference in the carbon shadow costs would then enter the CBA table as an unpriced real resource cost. We conjecture that in that situation, the net cost of carbon emissions would be higher than in the world carbon trading scenario.
The Transport Select Committee asked, on carbon emissions:
Landing costs rising at Heathrow:
The DfT also seems to have assumed that any changes in airports charges at an expanded Heathrow airport would be absorbed by the airlines, rather than being passed through to passengers. Is this a realistic assumption to be making? What effect might a real change in airfares, because of higher landing charges, have on passenger demand at an expanded Heathrow Airport? The demand growth profile for an expanded Heathrow has also changed to that forecast by the Airports Commission. The DfT have now forecast capacity at the airport to fill-up within the space of two-years from 2026. Putting aside the debate around the plausibility of the opening date, this seems to be a highly optimistic assumption made by the DfT…..
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To this, Mackie and Pearce replied:
SC Q What effect might a real change in airfares because of higher landing charges have on passenger demand at an expanded Heathrow?
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It would have a dampening effect by partially offsetting the reduction in shadow costs. We think it is important that the economic case and the financial case should be in reasonable synch. As we understand it, the Department’s main case assumes that the benefit of the reduced shadow cost will be fully passed through to travellers while increases in landing charges to fund the infrastructure will be absorbed by airlines. This particular combination seems a bit unlikely. In their sensitivity analysis of October 2016, the Department tested the sensitivity of demand and benefits to alternative pass through assumptions, but decided not to change the basis of their main case in this respect.
Going beyond this particular question, this could be seen as one of a series of questions about the appraisal which include the appropriateness of the 60 year appraisal period and the use of the public sector discount rate for a scheme which is predominantly funded from private revenue streams (aero charges and ancillary revenues).
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Letter from two expert economic advisors to the Airports Commission:
A Note from Expert Advisors, Prof. Peter Mackie and Mr Brian Pearce, on key issues considering the Airports Commission Economic Case
May 2015
Two extracts from that letter:
“Our assessment of the PWC approach is that there is a high degree of overlap between the direct and wider impacts. So for example a benefit accruing proximately to a business traveller going abroad to negotiate an export contract might also show up as a trade effect. We think there is likely to be some double counting between the direct and wider impact channels in the PWC calculations”
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“Furthermore the interpretation of the result – what exactly do they mean and is their basis transparent – is an issue. Overall, therefore, we counsel caution in attaching significant weight either to the absolute or relative results of the GDP/GVA SCGE approach (PwC report) within the Economic Case. We would accept that there is some useful indicative material for the Strategic Case but care is required in assessing its robustness and reliability.”
5.5.2015 Letter at
https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/438981/economy-expert-panelist-wider-economic-impacts-review.pdf
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