Article in The Business by Keith Boyfield

A Market in Airport Slots

By Keith Boyfield

Airlines must compete to survive. As Chris Tarry argued in last week’s Business, “airfares have only one way to go: down”. Whether they are paying out of their own pocket or their employers’, passengers are increasingly reluctant to pay excessive fares in order to prop up inefficient national flag carriers. And with increased competition, they don’t have to.

Yet national airlines such as BA, Air France and Lufthansa remain protected from the full gales of competition by the so-called grand-fathering rights they enjoy at major hubs such as Heathrow, Paris CDG and Frankfurt. Under existing EU rules, carriers do not pay for slots. Incumbent airlines can retain their lucrative slots so long as they use them for at least 80 per cent of the time. Last week the European Commission made things easier by bowing to intensive lobbying by national flag carriers. As a temporary measure aimed at alleviating mounting losses in the aftermath of the Iraq War, airlines that hold slots at congested airports will be able to retain them, even if they do not use them.

However, pressure is mounting to free up slots and allow them to be auctioned to the highest bidder. The goal would be to encourage leaner, more efficient carriers to fly from major hubs and, in the process, promote a more competitive airline industry.

The scarcity of slots at congested airports, such as Heathrow and Gatwick, represents a major barrier to new entry. The only way to break into this tightly protected market is to buy slots on an unofficial secondary market. However, it tends to be the entrenched incumbents who are building up their portfolio of slots at Heathrow. Last year, for example, BA acquired slots from Air Lithuania.- The estimated OF THE SLOTS AQUIRED FROM OTHER CARRIERS IS now shown on BA’s balance sheet. In the company’s latest quarterly results, landing rights are valued at £65m, up from £32m the year before.

A newly published report from the IEA, a pro-market think tank, recommends that the existing tightly regulated regime is replaced by a slot allocation system based on more rational economic logic. The proposed new regime would rely on auctions, backed up by a transparent secondary market, to allocate slots. Phased in over a decade, it is suggested that a random batch of 10 per cent of the available slots at London’s three main airports should be auctioned to the highest bidder each year.

If auctions were introduced, a higher percentage of the ticket price would flow to the airport operator, the provider of the runway slot, to reflect the value of this scarce resource. The total price paid by the consumer would not necessarily increase since airlines currently receive the scarcity rent associated with the slot through the yield premium it charges passengers. Ultimately, market demand will determine prices – if passengers value the convenience of Heathrow, they will be prepared to pay for it.

The idea of auctions, backed up by a secondary trading market in slots, is gaining support. The European Commission has asked NERA, a firm of economic consultants, to quantify and identify the respective costs and benefits associated with various possible slot allocation systems, including primary auctions and secondary trading. Its report will be submitted in July.

NERA’s report is likely to build on work already undertaken by the Civil Aviation Authority, which advocated market based solutions in a paper, The Implementation of Secondary Slot Trading, published just over a year ago, as well as some detailed analysis of slot auctions carried out by DotEcon Ltd, another firm of economic consultants, on behalf of HM Treasury and DETR in 2001.

Gordon Brown’s Treasury is a driving force behind the idea of adopting auctions, because it realises that switching to an auction-based system might prove a useful income earner for the Exchequer through the imposition of a levy on auction revenues collected by the monopoly provider of runways in the south-east, BAA plc.

Airlines with valuable slots at congested airports are likely to lobby vigorously in defence of the status quo since this protects them from unwelcome competition. But a market based system of slot allocation would be more equitable, because it gives all airlines an opportunity to bid for slots. It would be more efficient, since slots would be used by carriers who are confident that they can fill their aircraft. It could offer a better deal for those who live near airports.

Adopting an auction-based system of slot allocation would allow airport operators to compensate residents badly affected by aircraft noise and activity. In the context of new runway construction, if slot income was channelled into financial compensation for those adversely affected by additional air transport movements, residents who wanted to sell might receive up to 50 per cent more than the current value of their homes. This should help redress the vehement opposition to any new runway proposals among those who live close to existing airports.

In order to introduce a much needed element of competition, the introduction of market mechanisms for slot allocation could also be accompanied by the break-up of BAA’s monopoly in the south-east. Significantly, no new runways have been constructed since the company was privatised in 1987. If BAA was fragmented in the interests of greater competition, each of the constituent parts would have a real incentive to develop additional capacity, for example, through the development of feeder-relievers at Northolt airport near Heathrow, and the expansion of Redhill, five miles north of Gatwick.