Heathrow ordered by CAA to rein in 3rd runway costs – to ensure it is built economically and efficiently
The CAA has inserted a significant new clause into Heathrow’s licence, starting in January 2020, amid concerns that costs on the vast 3rd runway project will spiral out of control. Heathrow will be penalised if it fails to build its £14bn expansion scheme efficiently — the first time such a condition has been imposed on the airport. Airlines, especially British Airways, are nervous that Heathrow will try to get them to pay up-front for construction costs, which would put up the price of air tickets, deterring passengers. The CAA polices the fees the airport charges passengers. It said the new licence clause was needed to “set clear expectations for Heathrow to conduct its business economically and efficiently”. Heathrow says this is disproportionate and could put off investors. IAG boss Willie Walsh has repeatedly complained that Heathrow’s runway scheme is a “gold-plated”, and that there is little incentive for Heathrow to keep costs down. Under a complex incentive system, the more Heathrow spends, the more its owners can earn. Heathrow has already spent £3.3 billion on its plans, which have not even yet passed through legal challenges, let alone the DCO process.
The Civil Aviation Authority (CAA) has inserted a significant new clause into its licence, amid concerns that costs on the vast project will spiral out of control.
Heathrow’s plans for the third runway are a complex feat of engineering that will see it straddle the M25. That has stoked a fear in airlines, including British Airways owner IAG, that rising costs will fall on passengers and make flying to and from the airport unaffordable.
The runway is caught in a political storm over spending and environmental concerns. Boris Johnson pledged to lie down in front of bulldozers to stop Heathrow expanding when he became a local MP in 2015. Labour has suggested it could stop the project.
The CAA, which polices the fees the airport charges passengers, said the new licence clause was needed to “set clear expectations for Heathrow to conduct its business economically and efficiently”. Heathrow argued it was disproportionate and could put off investors.
IAG boss Willie Walsh has repeatedly complained that the runway is a “gold-plated” scheme, and that there is little incentive for Heathrow to keep costs down. Under a complex incentive system, the more Heathrow spends, the more its owners can earn.
Investment is recouped through passenger charges, which can be levied years before a project is completed. An attempt to bill passengers for £3.3bn of early spending has already hit opposition.
The CAA said the clause, which comes into effect next month, was necessary because the “commercial pressure that airlines can bring to bear on Heathrow is not sufficient to ensure it always acts efficiently in the interests of consumers”.
Heathrow is Europe’s busiest airport, handling more than 80m passengers a year. It said it is “extremely efficient and viewed as a benchmark for major infrastructure projects . . . The current level of scrutiny and transparency around capital investment is already unmatched globally.”
How Heathrow is happy to pay way over the odds, to increase its RAB, allowing more revenue
The City Editor of the Financial Times, Jonathan Ford, has written about how the reasons for Heathrow’s anticipated costs for its possible 3rd runway. The cost of £17 billion, or now £15 billion are exceptional. But Jonathan explains how Heathrow’s investors seem happy to spend so much. It is because of the curious incentives that operate in the topsy-turvy world of utility financing. As with most ventures that have monopolistic aspects, Heathrow is not subject to ordinary restraints on capital expenditure. The principal check is the willingness of the airport’s regulator, the Civil Aviation Authority, to sign off on the mechanism by which these costs can be recovered from captive airline customers through passenger charges. Heathrow often pays far above the going rate for building, new technology etc, because this adds to the airport’s regulated asset base (RAB) on which it gets an allowed return, and thus permits it predictably to expand its own revenues. Since taking over BAA in 2006, Ferrovial has been extremely active, tripling Heathrow’s RAB to £15bn. It is a system that has allowed the airport’s owners to finance these expansions with vanishingly little equity capital. Heathrow is encouraged to fund everything with debt by a regulatory system that allows it to keep the gains from financial engineering. Heathrow’s owners hope to shrug off the risks of completion, but transfer them on to customers.
Heathrow regulator, the CAA, demands answers urgently on Heathrow’s 3rd runway plan
The CEO, Richard Moriarty, of aviation watchdog body, the CAA, have written to the Department for Transport (DfT) asking that they should “decisively and urgently” address major concerns about the funding for the 3rd runway scheme – at least £14 billion, and doubtless more with cost over-runs and things not going to plan. They say Heathrow must “provide assurance that its revised timetable is realistic” and would “ensure timely delivery” of the expansion. The CAA threatens enforcement action against Heathrow to force it to provide clear evidence about how it would finance the scheme, while avoiding pushing up costs for airlines and passengers. The CAA says the project had been hit by a further delay, with a public consultation on detailed plans for the new runway now scheduled for June rather than in the first three months of next year. Heathrow is already the most expensive airport in the world, with landing charges of over £20 per ticket, and that is likely to rise – regardless of flimsy Heathrow assurances. Mr Moriarty said there is a “lack of high quality and comprehensive information” about how Heathrow would keep costs down, while being commercially viable, and these concerns had “not been adequately addressed, despite repeated requests”.
Heathrow plans to increase 3rd runway costs – to £2.9 bn – before approval, hoping it will be too costly to scrap its plans
Heathrow plans to triple the amount it spends on its third runway proposal, to £2.9bn – well before getting final approval. This either means air passengers using Heathrow would be charged more (something the industry and the government do not want), or else the taxpayer will be charged. Even if the runway never goes ahead. The CAA has a consultation about the costs and how Heathrow has been speeding up the process, spending ever more money. (The legal challenges are now going to appeal in October, but Heathrow is pressing ahead with its DCO consultations). Especially on carbon emissions, air pollution and noise grounds, it is entirely possible the runway will be blocked and the DCO will not be granted. The CAA says it has asked Heathrow “to consider different options for this spending and the implications of this spending for the overall programme timetable and the interests of consumers.” [Not to mention the taxpayer, who may end up paying …] Heathrow is increasing the amount of its “Category B” costs and “early Category C” costs. They want to increase the amount spent already to be so large, that it effectively cannot be cancelled. Detailed costs still have to be outlined, but Heathrow is expected to submit its initial business plan to the CAA for review towards the end of this year.
Jonathan Ford (FT) on the serious financing doubts: “Who will pay for Heathrow airport’s £14bn 3rd runway?”
With the vote on a possible 3rd Heathrow runway expected on 25th June, Jonathan Ford and Gill Plimmer write, in the Financial Times, of the very serious doubts over how the runway could be funded. They say: “Most agree that this leveraged structure is wholly inappropriate to support a project as large as the 3rd runway. It offers no leeway for construction risk on what will be a highly complex engineering challenge. There is also the question of how Heathrow might meet the financing costs, which could run to £2bn-£3bn over the six-year construction period, assuming an interest rate of between 4 -7%.” And …”investors have been pulling out more in dividends than Heathrow has been earning. Last year they received a payout of £847m even though post tax profits were just £516m, implying that the corporate debt was used, in part, to fund these returns.” … And “A key question is how much debt the markets will lend against the £2bn of operating cash flow Heathrow expects to have by the time construction begins in 2019.” … The Airports Commission said it could saddle Heathrow with up to £27 billion of debt. Ford also questions the opaque structure of Heathrow, with at least 10 corporate layers between Heathrow Airport Limited ….and shareholders.”
How Heathrow’s new runway would be funded, (higher landing costs, more costs to taxpayer) – all unclear
Heathrow’s plans for a 3rd runway, and associated building, are due to cost the airport at least £18 billion (not including unexpected over-runs and engineering problems etc). Heathrow now wants the right to make airlines and passengers contribute to any unexpected higher costs. The CAA controls the amount Heathrow can charge airlines. Heathrow has asked the CAA to factor in a huge array of risks from building the 3,500 metre runway across the M25 into the charges it is allowed to claw back from carriers. Heathrow keeps insisting its landing charges would remain close to current levels, aviation experts said there are few credible alternatives to charging users more. IAG believes the huge construction costs will lead to charges doubling to landing charges per passenger, from about £40 now to £80 for a return ticket. Heathrow is mainly owned by overseas investors. As well as higher than expected costs of construction, there are risks such as lack of interest from airlines in taking up the new landing slots; financial markets turning against the airport, leading to a downgrade of its credit rating; higher debt costs; and politics. There is real fear that if the Heathrow expansion project was allowed, the costs – many £ billion – might fall on the taxpayer – if the enterprise becomes a bit of a white elephant. The Airports Commission and DfT have said little about this massive risk to the public finances.