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Airports, Commercial Value and how to Split Hairs

In the not too distant past, major UK airports were public assets. In many parts of the world, they still are. But here, for some good and some not so good economic reasons, we privatised ours. So now we need to ask whether private investors want to own them, and especially whether they want to construct new ones.

An economics consultancy, Oxera, has recently concluded that no private investor would pay for all the infrastructure and construction costs, plus compensation, of a new airport in the Thames Estuary to replace Heathrow. Being an economist, I have known for a long while we can be clever fools, but this takes the biscuit. Any sane person knows, without the benefit of a report, that a private investor will prefer to invest in an existing successful venture and its expansion (i.e. Heathrow) than an alternative, technically more demanding, in a new location. Doh, as Homer Simpson would say.

The good reason for thinking about what a private investor would do is to think about where and how payback happens. The bad reason is to envisage that only the private sector can invest effectively and the public sector has no money. This is a bad joke. In comparison with what money is spent on welfare, health, education and so on, what we spend on infrastructure is chicken feed. But of course, this is not to deny that infrastructure must create value.

It must raise incomes, create trading opportunities, release constraints on value creation as well as improve the quality of life.

So what are the key things we should look at in considering the viability of a new airport in the Thames Estuary or indeed anywhere else? It is rather sad that in this report Oxera have been asked to answer a much more limited question. They do not address which costs and revenues are relevant to the private or public sectors. They do not address the fundamental purpose of investing in aviation. Instead, they set out a set of scenarios which produce some limited and indeed odd conclusions.

Oxera conclude that doubling the size of Heathrow adds approximately £2-3bn to its current value. This is because most of the increase in discounted away. This is the first conclusion to challenge. An asset which carries 70 million passengers per year is worth £13bn, but doubling it only adds £2bn, because the increase happens slowly. If London airports maintained their market share, even of DfT’s constrained demand total, it would add a potential 92 million passengers per year to the existing base, while such a market share of an unconstrained base adds 104 million. The valuations look rather pessimistic.

Oxera’s cost assumptions are drawn from published material and taken at 2012 prices. So costs are incurred today, while revenues start only 20 years later. In fact costs will also have an extended time frame and should also be discounted. If compensation of £20bn has to be paid in 2026 at the opening of a new airport, this is less than £5bn at the commercial discount rate chosen here. Oxera’s high cost scenario assumes that costs are under-estimated, but their base case appears to over-estimate them.

Clearly if the value of airport expansion is small, any cost will be hard to bear.  Indeed, on Oxera’s estimates, since the 3rd runway at Heathrow is projected to cost £8-9bn, it is not worth doing either, and will reduce the value of the asset.  No expansion of airport capacity is justified as a private sector investment.  Heathrow Ltd is obviously barking mad in wanting to expand.

Rightly Oxera distinguishes between the costs of the airport and the associated infrastructure which makes it possible for people to get in and out. The costs of the Heathrow expansion make no allowance for this. Indeed this was an important element in the Judicial Review challenge to the 3rd runway policy, which was upheld. Doubling the numbers using Heathrow (if it can even be done with a half length runway) will need substantial additional access in a crowded and expensive area. No private sector investor will pay for a new Piccadilly Line.

They have produced an analysis which suggests that no private investor will want to abandon an existing vested interest. Indeed they conclude that even expansion will damage the asset. In fact, it is not at all obvious that there could not be alternative profitable uses of the Heathrow acres, so that compensation could be recouped, while an efficient modern airport could capture both UK growth in demand and claw back transfer traffic from other European airports from which has been lost.

They do not ask whether this is possible.

Although they make a distinction between airport investment and supporting infrastructure, they do not ask about the fares and charges for such infrastructure.

You only get a sensible answer if you ask a sensible question. Unfortunately, this paper does not ask a sensible question.

Bridget Rosewell

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