Finding the right price for the right to fly

Article in the Financial Times by Keith Boyfield

Finding the right price for the right to fly

Faced with crippling congestion on access roads to Heathrow, the BAA is reported to be discussing with London's mayor and the government the idea of imposing charges for “slots” on the approach roads to Britain's main hub. If the pricing mechanism can be introduced for surface access, why not extend the principle to runways?

The price paid to land or take off an aircraft at Heathrow, Europe's busiest airport, remains entirely divorced from the normal rules of demand and supply. The airport operator, BAA, is prevented from charging a market rate by a rigorously applied regulatory regime. Despite the latest protestations by the airlines over the Civil Aviation Authority’s decision to raise landing charges, they remain well below the levels carriers would voluntarily pay if an auction system were introduced.

This arbitrary and irrational system of allocating scarce slots leads to pent-up demand for slots at Heathrow (as well as Gatwick and, to an increasing extent, Stansted), and pressure on existing terminals. The four terminals at Heathrow were designed to accommodate a maximum of 50m passengers, yet today handle over 60m. Traditionally, slots have been allocated on a grandfathering basis: an airline that holds and used a slot in the previous year is automatically entitled to use it or exchange it for another in the next year. Airlines do not pay anything for the slots they are allocated. While new entrants have a limited opportunity to acquire less popular slots through a pool system, access at slot-congested airports such as Heathrow is effectively crowded-out by incumbent carriers.

Slots can be worth a lot of money. It is estimated that British Airways paid more than £2m to KLM for each of the Heathrow slots it acquired in the mid-1990s. Accordingly, carriers that have built up a considerable share of available slots, notably BA at Heathrow, zealously defend what they regard as their assets. Indeed, BA now places a value for its slots on its balance sheet.

This antiquated system of administrative allocation should be overhauled in favour of a market-based system that will align demand closer to available supply. New legislation is needed to define property rights relating to slots. This should define the nature of the slots, the rights and obligations that go with holding them, and the rules relating to a new system of primary and secondary trading.

Markets have a valuable role to fulfil in providing transparency and flexibility. Airports, as the creators of the slot capacity in the first place, should be allowed to establish auctions as the principal means of allocating slots. For reasons of flexibility, there will also be a role for a secondary trading market that enables carriers to exchange slots.

An auction-based system would need to be phased in over time. Each year, a random batch of 10 per cent of the available slots at London's three main airports should be offered on 10- to 15-year franchises. Over 10 years all the available slots would come up for auction and would presumably be acquired by those carriers who find them most valuable.

All three principal airports in the south-east are operated by BAA, which enjoys a dominat monopoly. Critics will object that it should not be entitled to extract a monopoly rent for scarce slots. This objection can be addressed in a number of ways.

First, the government could impose a levy on BAA's windfall profits and channel this money into addressing the environmental problems associated with airline noise and surface access. Second, new capacity could be provided by competitors, whether this relates to major new sites such as Cliffe on the Hoo peninsula in north Kent, or shorter, feeder-reliever runways such as the Redhill proposal.

Third, BAA could be fragmented in a move to encourage greater competition. Competing airport operators are far more likely to support new initiatives, such as the development of feeder-reliever airports at under-utilised aerodromes, no