Air transport industry - Government response to Select Committee report CM 5623

Introduction

The events of 11 September 2001 severely exacerbated the already difficult trading conditions in which much of the global aviation industry found itself at that time. The UK air transport industry was not immune to these effects, and parts of it were substantially adversely affected, so the Select Committee's inquiry into the state of the UK industry was timely. The Government welcomes the Committee's generally supportive stance towards its policy response to the downturn currently being experienced in parts of the aviation industry.

In the following paragraphs we set out the Government's response to each of the Committee's specific recommendations.

(a) We expect to see firm proposals for the future of aviation in the forthcoming Aviation White Paper, which is due to be published in the autumn of 2002. We are concerned that the timetable for the White Paper has already slipped.

The Government remains fully committed to producing an air transport White Paper setting out a clear policy framework for airports and aviation in the UK over the next 30 years. The White Paper will be informed by the outcome of the detailed consultation exercise on airport development options, launched in July, for which the period for responses runs until the end of November. Consequently, the White Paper will not now be published before 2003. We are keen to publish as quickly as we can, whilst ensuring that responses to the consultation receive careful consideration and that final decisions are well founded.

(b) The air transport industry is cyclical and susceptible to downturns in the economy. Since 2000, there have been signs of a general slowdown in the global economy that led to fewer passengers and less money for investment in the industry. Many sectors of the United Kingdom's air transport industry were, therefore, already experiencing a significant reduction in business even before the terrorist attacks in the United States. There has been a marked contrast in reaction by the various industry sectors in responding to that reduction in business. The low-cost sector appears to have been the most successful in generating traffic and improving profitability by exploiting new markets and, in some cases, use of secondary airports while restraining costs.

It is now clear that the aviation industry was suffering a downturn in demand before 11 September, and it is difficult to quantify the exact impact of the terrorist attacks or to isolate their effects from the problems which were already in evidence. The low cost sector has generally maintained and even increased its profitability during the last year, but it has been helped in this by the ability to offer low fares on the basis of a tightly controlled cost base. Some major carriers have responded by changing their fare structures to compete more vigorously with the scheduled low cost carriers on shorthaul routes, but this has most likely been bought at the price of a reduction in their yields. The longer term sustainability of this strategy will depend greatly on whether the major carriers can reduce their own cost bases sufficiently to adjust to the new conditions.

(c) We do not support long-term public assistance for the additional security costs incurred by the air transport industry as a result of 11 September.

In consultation with the air transport industry, the Government sets out security requirements for UK airports and the aircraft operators using these airports. Government policy is that the industry should meet the costs incurred, as it does for safety, and should decide whether these costs should be passed on to the user. This has been a long-standing policy, and the Government welcomes the Committee's support for it.

(d) We condemn the hasty manner in which the insurance industry withdrew cover for aviation following the terrorist attacks and welcome the Government's prompt and appropriate action in implementing short-term measures to ensure continuity of essential insurance cover. The Department should provide a report on progress towards a return to a wholly commercial insurance market, and an indication of its view on long-term solutions to providing war risk and terrorism liability insurance cover for the air transport industry. We recommend that the Treasury publish figures on the amount of money it has received from the industry by way of premia and explain what it intends to do with the money.

The insurance industry withdrew almost all cover for third-party war and terrorism risks in September 2001. A number of companies now offer this type of cover, but at a higher price and with a significant restriction compared with that on offer before the terrorist attacks. In order to limit their exposure, insurers have restricted their cover to an aggregate limit rather than offering a per-occurrence basis.

Since the inception of the Government-backed insurance scheme, Troika, HM Treasury has made clear in press announcements that the aim of Government was to intervene in the insurance market only as long as necessary. Treasury has progressively raised the price and/or the threshold at which cover would apply in order to encourage airlines and others to return to the commercial market.

The Government is currently analysing possible long term options. A number of international mutual insurance schemes have been proposed (one global, one for Europe, and one for USA), each relying on government support in the early years until sufficient funds have accrued to make them self sufficient. There have also been suggestions of a new international convention on air carrier third-party liability, and the International Civil Aviation Organisation has included this in its work plan over the next few years. It is possible that a proposed convention could include a cap on liability arising from war and terrorism which, depending on the limit agreed, could help to stabilise the insurance market.

Taking into account the costs incurred in setting up Troika, Treasury has to date collected a little over £17 million in premia from airlines, airports, ground service providers and other policyholders. Unless needed to meet claims, this money will be transferred to the Consolidated Fund.

(e) The immediate impact on airlines of the 11 September attacks was severe, particularly for those providing premium services to the United States. But there is no compelling evidence to suggest that there will be a medium to long-term reduction in passenger confidence in aircraft safety and security. In the past, passengers have adjusted to the imposition of more stringent security regulations and are unlikely to find difficulty in doing so again. We do not anticipate that the latest security requirements will have an adverse impact on the market for air travel.

The Government sees no grounds in the aftermath of 11 September to change its long-standing policy that the costs of aviation security should be paid for by the users of aviation services.

(f) There is no doubt that, even though passenger confidence is recovering, times are tough for the air transport industry. We do not consider it appropriate to increase either the regulatory burden or the costs to any sector of the air transport industry now. We recommend that the CAA seek to postpone the introduction of any proposed increases in charges at regulated airports that may result from its recent review.

The Government notes the Committee's recommendation. The CAA will doubtless take note of the Committee's view when completing its review of charges at the regulated airports.

(g) The events of 11 September had implications throughout the air transport industry, including general aviation and ground service providers. We recommend that the Government bring forward firm proposals to guard against the permanent loss of highly skilled jobs and personnel in the industry.

The Government does not believe that specific proposals are called for to preserve skilled jobs and personnel in the aviation industry. While there has been some impact on the London airports of Gatwick and Heathrow due to retrenchment by some of the major carriers, the effect at regional airports has been much less. Indeed, at some regional airports the impact has been minimal with buoyant charter traffic and rapid expansion by the low cost scheduled airlines such as Ryanair, easyJet and Go. As recovery in the industry takes hold, there is evidence that employment patterns are returning to pre-11 September norms.

Despite high profile announcements of redundancies by airlines such as British Airways, Virgin Atlantic and bmi British Midland in the immediate aftermath of 11 September, in general these airlines have been content to manage their job losses in-house and have looked at reducing numbers and costs by introducing alternatives to redundancy such as unpaid special leave, temporary lay off and short time working.

Since Christmas the situation has steadily stabilised. Redundancies from airlines, airport support services and the aerospace industry have slowed considerably. Vacancy levels for airport support personnel such as security and baggage handlers have returned to normal levels for the time of year. Additionally new airlines such as Astraeus, DAT and GB Airways are looking to follow easyJet in filling vacant slots at Gatwick. Longer term, the development of Terminal 5 at Heathrow will provide a welcome boost to the jobs market in West London and the surrounding area.

(h) Without prejudice to the findings of our separate inquiry into NATS finances, we find it remarkable that the Department had not prepared a contingency plan for NATS going into administration or receivership.

There are provisions in the Transport Act 2000 for handling the financial or other failure of a company which holds a licence to provide air traffic services. NATS is the current holder of this licence. The measures include a special form of administration regime. There are also contractual provisions under the Public Private Partnership deal for NATS which enable the Government and the banks to step in and take necessary measures to sort out the company's problems. The Government is committed to ensuring continuity of service, for the benefit of airlines and their passengers and in discharge of its international obligations under the Chicago Convention.

(i) The evidence that we received at the beginning of this inquiry about the duration of the current downturn seems to have been pessimistic. We welcome signs of recovery that suggest that in the absence of another incident traffic levels could recover within the two years forecast by the more pessimistic analysts, although we do recognise that the recovery in traffic may have been achieved with some dilution of revenue.

The Government agrees that the more pessimistic predictions about the duration of the downturn have not occurred. Nonetheless, traffic carried by major European airlines remained over 10% down in the first six months of this year compared with the corresponding period last year, with the North Atlantic market still some 16% lower than a year ago. An encouraging sign is that load factors are very close to those of 2001, which indicates that airlines have responded to the downturn by adjusting capacity rather than by relying wholly on unsustainable fare reductions. Financial recovery normally lags behind recovery in traffic levels, and it is still too early to say with confidence when this will be achieved. The volume of air freight carried is currently higher than in 2001, and even on the North American sector freight levels have almost returned to pre-11 September levels.

(j) Although we accept the rationale for waiving the 'use it or lose it' rule, the Government should firmly resist implementing any further European Union directives on slot allocation that are inappropriate to the United Kingdom's needs and circumstances.

In normal times, the Government would welcome an increased turnover of airport slots. However, recognising the difficult circumstances under which airlines were operating post 11 September, a Commission-sponsored amendment to Council Regulation 95/93 on slot allocation to suspend the "use-it-or-lose-it" rule for the Summer 2001 and Winter 2001-2 seasons was agreed and subsequently adopted. The UK Government supported the amendment as incumbent airlines might otherwise have continued to operate solely in order to maintain their slots, exacerbating the problem of excess capacity in the short term. The UK Government would not support renewing this suspension. The Commission have confirmed that there is no intention of proposing any extension.

Department for Transport officials are currently seeking to negotiate more substantive amendments to Council Regulation 95/93 based on a proposal issued by the European Commission in June 2001. The UK welcomes this review of the slot allocation system, but will not support any amendments which could reduce flexibility for the re-timing of slots and slot transfers. Given that the UK has some of the most congested airports within the EU, the importance of retaining this flexibility is continually being underlined during negotiations.

The UK Government favours a more market-based system than the existing regime to allocate slots, but recognises that the problems of slot allocation vary across Member States.

(k) The Committee considers the United States compensation package to have provided an unfair advantage to US carriers. It is imperative that the United Kingdom Government ensure that the competitive balance between US and UK carriers is restored.

We understand the reasons why the US Government was persuaded to make a significant amount of compensation available to their airlines. The entire US domestic industry, which serves the largest air services market in the world, was forced to cease operations as a result of the closure of US airspace following the terrorist attacks and, in certain cases, for some time afterwards. The US Government has however also made available loan guarantees, and funded additional security measures, which in the UK ultimately fall to the consumer. In addition, heavily indebted airlines can seek protection through the Chapter 11 bankruptcy process. These latter provisions have more potential to distort the competitive balance than the compensation for closure of airspace. But the UK Government will continue to monitor the situation.

(l) The Government must ensure that any future international aviation agreements maintain the competitive position of United Kingdom carriers. However, the Government should not make concessions to United States airlines in receipt of US State Aid, merely to hasten the signing of a new US UK bilateral on open skies.

In negotiating bilateral Air Services Agreements we always seek a balanced outcome. The UK Government made proposals in August to introduce further competition under the UK-US Air Services Agreement "Bermuda II". We continue to explore whether we can reach an agreement with the United States.

(m) This Committee believes that the bilateral agreements on open skies must include progress on the critical issues of open skies, cabotage, wet leasing and ownership. As we concluded in our July 2000 Report into Air Service Agreements between the United Kingdom and the United States , it is imperative that the Government maintain its efforts to agree beneficial aviation bilateral agreements with the United States.

The Government has sought real progress on these issues for many years and will continue to seek balanced liberalisation of the UK-US market that offers benefits for consumers and airlines alike.

(n) We remain to be convinced by arguments in favour of changes to the rules of ownership or that consolidation will bring benefits to the industry or consumers. The Government should be cautious about changes to the rules of ownership that would allow unfettered consolidation within the industry. We recommend that the relevant competition authorities give rigorous scrutiny to any further moves towards consolidation of the United Kingdom airline industry.

The Government believes strongly that liberalisation of air services, including the removal of special ownership and control rules, will produce benefits for consumers through more flights, lower fares and, generally, greater consumer choice. That airline consolidation has not occurred more widely within Europe is no doubt due in large part to the fact that, under Member States' bilateral agreements, third countries would in many cases be entitled to reject the designation of a carrier not owned and controlled by nationals of the designating country. Any cross-border acquisition or merger between airlines from more than one Member State would therefore place at risk the combined entity's ability to exploit traffic rights to third countries. The Government intends to continue to seek ways in which these limitations on the ability of European airlines to act in a commercially rational manner can be removed. But we agree with the Committee that liberalisation must be accompanied by the consistent and rigorous application of competition law.

(o) The present situation has strengthened arguments in favour of Public Service Obligations to ensure the continuity of vital regional links with Heathrow and Gatwick. We recommend that the Government ensure that slot allocation at the main London airports be consistent with its aims of ensuring access to the United Kingdom's peripheral regions as regional air services are "socially and economically vital to the regions". Prior to the availability of any additional runways in the south east, we believe the Government must adopt Public Service Obligation protection for the most vital links to the United Kingdom regions. This is a widely established policy within the European Union. We do not see or anticipate any European regulatory impediment to securing such slot protection. We are aware that some airlines and airport operators may be against the use of such designation at congested hub airports but the needs of the United Kingdom regions should have priority.

The Government recognises the importance to the regions of having air services to London.

Mechanisms for the protection of regional air services within the European Union are governed by the strict criteria set out in European Regulations (2408/92 and 95/93). Member States may allocate Public Service Obligations (PSOs) and ring-fence slots only if these criteria are met. The Government would consider any PSO application from the relevant authorities for a regional route to London carefully in accordance with the Regulations.

Most other EU Member States do not suffer from the severe slot constraints experienced in the UK. The lack of infrastructure at Heathrow and Gatwick presents a variety of problems associated with the ring-fencing of slots such as issues of confiscation and compensation. In addition, the highly competitive nature of the UK aviation industry would make any decision to impose PSOs or ring-fence slots more liable to challenge than might be the case in other EU states.

Other options available for the protection of regional air access to London are currently being considered.

(p) The Sub-Committee intends to consider aviation infrastructure and capacity requirements when it conducts its inquiry into the Aviation White Paper.

The Government notes the Committee's intention. (q) The Committee is concerned that the Air Travel Reserve Fund should be maintained at a sufficient level and calls on the Minister to bring forward legislation providing for that at the earliest opportunity. The Government shares the concern expressed by the Committee that the Air Travel Trust Fund should be maintained at a sufficient level and will introduce proposals to secure new levy-making powers when a suitable legislative opportunity arises. In the meantime the Government continues to stand behind the ATTF and to guarantee the bank overdraft, enabling the Fund to pay for the repatriation of stranded passengers and the reimbursement of others in the event of a travel organiser failure where the bond proves insufficient.