Post-COVID airport regulation: a clear path?
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Advancing economics in business March 2021 Post-COVID airportalgorithms The risks of using regulation: a inclear path?demystifying AI business:
Post-COVID airport regulation: a clear path?
issues loom. Perhaps more than many other • What should happen to capital
Contact sectors of the economy, the aviation industry investment plans?
will have to play its role in tackling climate
Christopher Davis
change and contributing to decarbonisation. • Do investors and regulators need
Senior Consultant
Climate-change events are likely to have to take a fresh view of the degree of
Michele Granatstein direct impacts on aviation going forward, financial resilience that should be built
Partner such as extreme weather events affecting into airport capital structures?
traffic and rising sea levels affecting coastal
airports, and due to shifts in travelling habits • How would price increases impact
because of a greater awareness of the impact the airline market and the recovery of
of flying. passenger traffic?
In April 2020, as governments around
the world imposed travel restrictions, The focus on such issues has already led These questions are largely the same as
we asked what the long-term effects to cancelled or delayed investments at those that have been discussed since the
would be for the aviation sector, airports—such as a third runway at Heathrow start of the pandemic, and which were
with a focus on the implications for and the building of a new terminal at raised in our article a year ago.5 In most
economic regulation.1 One year on, Aéroports de Paris—and the introduction of instances, regulatory processes have
many restrictions remain. In this article, carbon-pricing policies for airlines. In addition, been delayed to allow more time to let
we ask: what has happened since? the support provided to some airlines during the pandemic play out, in anticipation
What are the key challenges for airport the pandemic (e.g. to Air France) has (or hope) that the outlook would become
regulators and industry stakeholders? required environmental commitments. At clearer. Consequently, there remains little
And what might the future hold? the same time, some government policies clarity over how regulators will address
aimed at helping the sector recover from these challenges. There have, however,
the pandemic (for example, potential cuts in been some developments of note in the
One year on from the introduction of domestic Air Passenger Duty in the UK) may last year.
lockdown measures across Europe and conflict with climate commitments.
around the world, COVID-19 remains the First, discussions have started over
biggest issue currently facing the aviation When taken together, these factors mean whether there should be explicit
sector. Over the course of the last year, there is greater uncertainty around short-, adjustments to the future value of
governments worldwide have introduced a medium- and long-run passenger volumes, regulatory asset bases (RABs) to offset the
variety of travel restrictions, ranging from investment requirements, and the risks COVID-related revenue losses. Heathrow
complete travel bans to bans on entry of faced by airports. It is therefore important to has positioned such an adjustment in
non-citizens, quarantining (in hotels or at consider how regulation may need to adapt to terms of a ‘depreciation holiday’. Its
home), and testing. address such challenges. proposal is that given that passenger
numbers are well below forecast levels,
While the pace of vaccine development the RAB should not be reduced by the full
has provided some positive news, it will
Short-term regulatory amount of forecast regulatory depreciation
take many months, and in some cases challenges in 2020 and 2021. The result would be a
potentially years, for vaccines to be rolled higher RAB value in 2022 than envisaged
out to the entire adult population. There is In July 2020, Global Competition Review under the existing price control. The
also increasing concern regarding variants In the aftermath of COVID-19, operators theoretical basis for this proposition
of COVID-19, which could reduce, or in the and regulators of airports across Europe appears to be sound—the airport will not
worst case completely undermine, vaccine are largely facing the same set of issues. earn sufficient revenues in these years
efficacy.2 The revenue shortfalls arising from the to cover regulatory depreciation, and
drop-off in traffic have created a relatively utilisation of the asset base has been
Consequently, travel restrictions could unusual challenge of regulating loss- much lower than usual (e.g. terminal
remain in place for some time. making businesses. It is not obvious that the buildings are closed and runways and
standard regulatory toolkit—geared towards equipment are less frequently used). The
preventing airports from earning excessive question, however, is whether an ex post
Costs and COVID-19 profits—is well suited to helping loss-making adjustment of this kind is in the consumer’s
businesses return to profitability, particularly (passenger’s) interest.
These restrictions can be costly—for
when the downstream (airline) market is
example, the PCR tests required as pre-
also under financial pressure and unable to The UK CAA is currently consulting on
departure tests for entry into most countries
absorb price increases. Heathrow’s proposal and has yet to
cost €69 at Frankfurt Airport 3 and £99
commit to, or rule out, a RAB adjustment.6
at Heathrow Airport.4 There may also be
The issues are broad and will not be The considerations it has set out are
indirect costs in terms of lost work days if
straightforward to address. likely to have wider applicability to other
people have to quarantine and cannot work
airports proposing similar adjustments. In
from home. Perhaps most importantly,
• How should regulators treat revenue particular:
the constantly changing nature of these
shortfalls? Should airports bear the full
restrictions, and differences between
effects, or should they be able to recover • balancing the certainty of higher future
countries, create uncertainty for travellers,
some of this ‘lost’ revenue? prices if a RAB adjustment is made
potentially hindering the recovery of
against the less certain impact on
demand. These factors, combined with
• How can regulators reset prices in light prices if there is no RAB adjustment
lower output in the economy (GDP) even
of the considerable uncertainty around but a consequent increase in the cost
once travel restrictions are removed, may
passenger volumes? How should this of capital;
mean that the path to recovery for the
uncertainty be dealt with in forecasts?
aviation sector is a long one.
• promoting affordable charges,
• How should risks around traffic recovery particularly in supporting recovery
While these challenges are occupying
be allocated between airports and of the aviation sector following the
much of the sector’s attention at the
airlines? pandemic;
moment, potentially larger long-term
March 2021 1
Post-COVID airport regulation: a clear path?
• ensuring that equity investors are taking (e.g. financial penalties relating to service The key unknowns are the speed of
their fair share of the financial burden quality performance), as they were based recovery of traffic given uncertainty
arising from the pandemic. on outdated targets and could providye around vaccination programmes, travel
perverse incentives. CAR also noted that it restrictions, macroeconomic conditions and
Elsewhere, other regulators have initiated expects a further interim review of the 2019 whether there will be structural changes in
interim review processes. For instance, in Determination to be required as the situation demand (e.g. reduced business travel) in
June 2020, just as the appeals from the last develops over the coming years. future years.
price review were being decided, Ireland’s
Commission for Aviation Regulation At other airports there have been Critically, the range of possible outcomes
(CAR) launched a consultation on the renegotiations of the terms of concession in terms of traffic is very wide. There is
regulatory response to COVID-19 for Dublin agreements, as well as the consideration evidence to suggest that this is affecting
Airport. CAR noted that ‘the assumptions of whether the airports should receive any how both debt and equity investors view
underpinning the 2019 Determination are compensation for the loss of passengers the sector. On the debt side, Moody’s
not reflective of the current situation, and that resulted from government restrictions has given the European airports sector
it does not appear that this will change at on international travel. In our article a negative outlook, stating that this
least in the short term’.7 It suggested that a year ago, we posed the question of ‘reflects [their] expectation that the path to
there were a number of possible responses, whether market-based solutions, such recovery in passenger traffic remains very
including: as commercial agreements between uncertain’.12 On the equity side, there has
airports and airlines, would be preferable been a marked increase in asset betas of
• no interim review; to regulator-driven processes. It is notable listed airport operators over the last year,
that Copenhagen Airport, which operates indicating that this uncertainty has also
• an interim review to address immediate under a commercial negotiations-based affected equity investors’ assessment of the
issues for 2020 and 2021; regime (with a fall-back regulatory price cap risk profile of airports relative to the market
if agreement cannot be reached), has been as a whole.
• a full interim review addressing all able to reach agreement with its airlines
issues; on a set of prices and incentives through to This effect on the equity market can be
December 2023.11 This agreement has been observed clearly when comparing the betas
• both an interim review to address approved by the Danish Civil Aviation and of listed airports to those of other sectors.
immediate issues and a full review at a Railway Authority. Airports have generally been considered
later stage. higher risk (higher beta) than utilities
In all of these cases, regulators are making (given greater elasticity of demand and
CAR also noted that:8 important trade-offs and trying to balance exposure to volume risk), but the difference
the financeability of airports on their path has historically been relatively small. In
To date we have used the building blocks back to profitability with the affordability for contrast, current market evidence shows
approach to RAB based regulation to airlines and passengers that have also been a clear divergence between the betas of
arrive at the price cap. This is not the only impacted by COVID-19. airports and utilities in light of COVID-19
possible methodology and we are open (see Figure 1).
to representations on innovations to this
approach, or alternative methodologies
Higher risk, higher returns? As regulators come to reset price controls,
which may be more suitable to the they will need to decide how much weight
A related question that regulators are
current circumstances. to place on the pronounced movement
tackling is whether these issues have
in betas over the last year. At the heart of
affected the cost of capital for airport
After consulting with stakeholders, CAR this lies the question of whether the higher
operators, and, if so, the extent to which this
published its Decision in December.9 It level of risk exposure will continue. If it
will be a lasting effect.
determined that an interim review was is considered that it will, the impact on
needed to ‘address immediate unintended regulatory cost of capital allowances could
Current market evidence indicates that
consequences for the 2019 Determination be marked.
investors believe the airports sector
that the pandemic has created’.10 It therefore
is subject to higher levels of risk and
removed all triggers and adjustments As far as we are aware, there have not yet
uncertainty following the pandemic.
relating to the price caps for 2020 and 2021 been any regulatory determinations on
Figure 1 Utilities and airports: divergence in asset betas
Source: Oxera analysis based on Bloomberg and Datastream data.
March 2021 2
Post-COVID airport regulation: a clear path?
the cost of capital for a European airport the approach to allocating volume risk are It is clear from the route map that the
since the start of the COVID-19 pandemic likely to have a direct impact on the cost of majority of the required reductions in
(i.e. March 2020). However, the early signs capital. Heathrow has taken this position emissions are expected to come from
are that airports will (unsurprisingly) be in its Revised Business Plan—presenting improvements in engine technology,
requesting material increases on allowed separate WACC proposals depending on sustainable fuels, air traffic management
rates of return, and in particular the cost of whether the CAA makes a RAB adjustment. and emissions pricing schemes rather
equity. than directly from airport operations or
infrastructure. However, airports will
• Heathrow’s latest H7 business plan
A regulatory framework fit have to make their own investments
incorporates an ‘ask’ of 8% for the for the future? in decarbonisation and will play a
real, pre-tax weighted average cost significant role in facilitating the required
of capital (WACC)—with a real cost While the current regulatory framework transformation of other stakeholders—for
of equity in excess of 13.5%.13 This may need to be adapted in the short term example, by providing the supporting
is a significant increase on the level to deal with the impact of COVID-19, there infrastructure for hydrogen-powered or
requested in its initial plan and the is a risk that this unprecedented shock, and electric aircraft.
allowance in the previous period (Q6), the subsequent focus on the recovery path,
as shown in Table 1. The main driver of leads to inaction in addressing the longer- It is therefore relevant to ask whether
this change is a significant increase in term challenges facing the sector, and current economic regulatory frameworks
the equity beta assumption. notably the climate crisis. provide the right incentives and
appropriately aid the achievement of
• Aena, the Spanish airports operator, This is clearly a critical issue for all parts of the net-zero ambition. Will a fixed and
is proposing a nominal, pre-tax WACC the aviation value chain, and EU leaders prescriptive five-year regulatory settlement
of 7.68% for the second DORA.14 This are being encouraged to join an EU Pact for provide sufficient flexibility and agility to
compares to an allowed rate of return Sustainable Aviation by the end of 2021, with meet evolving requirements? Will current
of 6.98% (nominal, pre-tax) for the first a view to securing a net-zero aviation sector approaches to appraisal, driven primarily
DORA. by 2050. Leading industry associations of by the commercial imperatives of airports
airports (ACI Europe), airlines (A4E and and airlines, lead to the right investments
It is worth noting that regulatory decisions the European Regions Airline Association), and appropriately capture external costs
may themselves affect the cost of capital. air traffic controllers (CANSO) and aircraft (such as for carbon)? Are the relationships
In particular, the level of commitment that manufacturers (ASD) recently joined forces between airports and other industry players
regulators are willing to give around airports’ to set out a pathway to net zero for the entire (airlines, aircraft manufacturers, air traffic
ability to recover the capital in the RAB and sector.15 controllers) sufficiently strong to coordinate
Table 1 Heathrow Airport’s WACC proposals
Source: Civil Aviation Authority (2014), ‘Estimating the cost of capital: technical appendix for the economic regulation of Heathrow and
Gatwick from April 2014: Notices granting the licences’, CAP1155, February, p. 44, https://bit.ly/3ccEIeT; Heathrow (2020), ‘H7 Revised
Business Plan’, December, pp. 403 and 420, https://bit.ly/3ccjaz2.
March 2021 3Post-COVID airport regulation: a clear path?
1
See Oxera (2020), ‘Flying through the storm: airport regulation in
the wake of COVID-19’, April, https://bit.ly/3vRNIOp.
2
World Health Organization (2021), ‘The effects of virus variants
on COVID-19 vaccines’, 1 March, https://bit.ly/2ORLNc8.
3
See Centogene (2021), ‘COVID-19: test centers: Frankfurt
Airport’, https://bit.ly/3rexdrW.
4
See Heathrow (2021), ‘COVID-19 Test for Travel’,
https://bit.ly/3r7Wfco.
5
Oxera (2020), ‘Flying through the storm: airport regulation in the
wake of COVID-19’, April, https://bit.ly/3vPbWst.
6
Civil Aviation Authority (2021), ‘Economic regulation of Heathrow
Airport Limited: response to its request for a covid-19 related RAB
adjustment’, CAP 2098, February, https://bit.ly/3cbC5Kg.
7
CAR (2020), ‘CP3/2020 COVID-19 Price Regulation Response
Airport Charges – Dublin Airport’, Commission Paper 3/2020, 30
June, p. 2, https://bit.ly/3tP8kVQ.
8
Ibid.
9
CAR (2020), ‘Decision on an Interim Review of the 2019
Determination in relation to 2020 and 2021’, Commission Paper
12/2020, 22 December.
10
Ibid., p. 2.
11
Copenhagen Airport (2021), ‘CPH and airlines team up to restart
traffic’, 18 March, press release, https://bit.ly/31cGcj3.
12
Moody’s (2020), ‘Airports—Europe: 2021 outlook negative on
high degree of traffic uncertainty’, 25 November, p. 2,
https://bit.ly/3sdQxaj.
13
Heathrow (2020), ‘H7 Revised Business Plan’, December,
https://bit.ly/3r7Xpog.
14
Aena (2021), ‘Disclosure of other relevant information’, 9 March.
Table 2 How might airport regulatory frameworks evolve? 15
NLR and SEO Economics (2021), ‘Destination 2050: A route to
net zero European aviation’, February, https://bit.ly/3r7XUyE.
Source: Oxera.
16
For example, the CAA has a secondary duty to the environment.
and collaborate effectively? And perhaps regulatory framework may need to adapt It states that the CAA needs to ensure that a licence holder (i.e. a
regulated airport) ‘is able to take reasonable measures to reduce,
most fundamentally, is it still appropriate for in the short term to deal with these losses control or mitigate the adverse environmental effects of the airport
airports to have high-powered incentives are important. But it is essential to have one to which the licence relates, facilities used or intended to be used
in connection with that airport (“associated facilities”) and aircraft
around traffic growth? eye on the long-term strategic challenges using that airport’.
that the industry will need to address, and
In order to ensure that regulatory consider how the regulatory framework may
frameworks are fit for purpose in helping need to adapt in the longer term as a result.
with these challenges, regulators Addressing the climate emergency is likely to
themselves must have environmental issues become a central issue in airport regulation
at the top of their agenda. However, there over the next few years.
are very few European airport regulators
with duties to consider environmental Contact
issues, and where these duties exist, they
tend not to be primary ones.16 What is
christopher.davis@oxera.com
clear is that without any changes, current
regulatory frameworks are unlikely to Christopher Davis
provide the right platform and incentives for
the long-term planning, sustainability-driven
michele.granatstein@oxera.com
investment prioritisation, and cross-industry
collaboration needed to deliver the sector’s Michele Granatstein
environmental ambitions (see Table 2).
Where next?
Naturally, much of the airport sector’s
current focus is on COVID-19 and the
recovery profile. This is unsurprising given
the scale of the pandemic’s impact on
the sector. Considerations about how the
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