Select Committee on Transport, Local Government and the Regions Minutes of Evidence


Examination of Witnesses (Questions 225 - 239)

WEDNESDAY 9 JANUARY 2002

SIR ROY MCNULTY MP, MR BOB COTTERILL, CAPTAIN MICHAEL A VIVIAN AND MR CHRIS TARRY

  Chairman: May I firstly apologise to you, sorry to have kept you waiting. I have one or two housekeeping jobs to do first, if I may. Firstly, I must wish all our witnesses and all members of the general public a Happy New Year and a very prosperous one. Thank you for coming. May I have declarations from those Members of the Committee who have interests to declare?

  Mr Stevenson: Member of the Transport and General Workers' Union.

  Chairman: Mr George Stevenson, member of the Transport and General Workers' Union.

  Mr Donohoe: Member of the Transport and General Workers' Union.

  Chairman: Mr Donohoe, member of the Transport and General Workers' Union.

  Miss McIntosh: Anne McIntosh, not a member of the RMT but I have minor shares in BA and BAA and my husband works for an American Airline.

Chairman

  225. Anne McIntosh, a number of involvements in specific companies. Gwyneth Dunwoody, member of the Rail Maritime Transport trade union. Sir Roy, may I ask you firstly if you would like to introduce your colleagues and yourself?
  (Sir Roy McNulty) Certainly. I am Roy McNulty, the Chairman of the Civil Aviation Authority. I should apologise in advance that I have a very bad cold but I will do my best to meet your normal standards of voice production. On this side is Captain Mike Vivian, who is Head of the Flight Operations Inspectorate in the Safety Regulation Group, and on this side is Bob Cotterill, who is the Director of Economic Policy and Regulation.

  226. Thank you.
  (Mr Tarry) I am Chris Tarry. I am the Head of Transport Research at Commerzbank Securities and have followed the aviation industry professionally since 1986.

  227. Thank you very much. Mr Tarry, you may not know our ground rules. Where you agree with what is said by anyone else perhaps you would not repeat it, but if you wish to catch my eye at any point I hope that you will do so. The other witnesses are aware of how we normally operate. Sir Roy, do you have something you want to say to kick off?
  (Sir Roy McNulty) Just very briefly, Chairman. We submitted a written memorandum explaining our perspective on what we see as the very serious difficulties affecting the airline industry particularly since 11 September. We set out our analysis of how that affects the different parts of the industry and the ways in which we, as the industry regulator, have been responding to that. I just wanted to say that was written about a month and a half to two months ago. Very little has changed in the intervening period to change our analysis, I think we still see it as a very severe set of problems affecting the airline industry and a set of problems that both the airlines and a lot of the other people involved will have to respond to quite urgently over the coming months.

  228. Mr Tarry, you also gave us some written evidence. Do you want to say anything in commencement?
  (Mr Tarry) I do not have too much more to add than Sir Roy. I think out of adversity we have an opportunity for the airline industry to address not just the issues from the period after 11 September but there are a number of fundamental issues and problems confronting the industry of a structural nature which have to be resolved as well. The events of 11 September unfortunately are the catalyst, perhaps, for that action to be taken, some of which was beginning to be taken, other of which needs to be accelerated.

  229. That gives me a starting point because this is quite important. How much of the problems that we are now facing are due to 11 September and how many of the problems were being forecast before that date?
  (Sir Roy McNulty) I will invite Bob Cotterill in a moment to give a more detailed analysis than I am capable of. I think it is clear that most of the airlines were having a somewhat difficult time during the earlier part of last year. That is evident from their financial results, from the fact that the growth that had been there in earlier years was no longer so evident. What obviously happened was that the 11 September incidents accentuated what was already a problem. If I may say, it is the transition from having a cold to having pneumonia. I think that is what we are seeing. We have seen the demise of SABENA. They were already in trouble but now are virtually dead. We have seen Swissair, who were struggling, get into very severe difficulties and maybe will not come out of them. A number of the other airlines which were in difficulty moved from there to being in severe difficulty. Bob has a much more detailed understanding of these things.
  (Mr Cotterill) I think before 11 September clearly the economy had been slowing both in the UK and in some of the other major economies. As a result of that traffic was clearly either growing slower in many areas or in some, such as the North Atlantic, had already begun to decline, and in a more extreme case, say Japan, had begun to decline quite substantially. That said, I think there is a clear step down, as Sir Roy said, in traffic of a very severe nature, particularly on North Atlantic routes, where for the European major airlines in general in October, if we move past September where there was a mixed effect, there was a 34/35 per cent decline in traffic and that was similarly mirrored on British Airways. That clearly was something very different happening and very much worse. Since that there are some signs of traffic coming back, even on the North Atlantic, but still we are talking about traffic very much down on what it would have been if it had not been for the terrible events of 11 September.
  (Mr Tarry) I would like to say I agree entirely with my colleagues on this side of the table. The issue I think was that we had seen a disconnect between the traditional relationship between GDP and air travel. There were a number of other fundamental problems, we could see the cyclical issues that were very much increasing through the early part of 2001. I think there has been a structural problem with this industry for a good number of years. The reality is that there has been too much capacity. We can look at all of the models and we can say that traffic has grown faster than capacity, but the reality is that if you look at a measure, perhaps a fundamental demand, if you look at it over a period of time then there is a excess capacity which has been built up which has translated into economic returns and financial returns for the airlines that have become increasingly bad.

  230. Had the plans they had in place before 11 September addressed that in a sufficiently radical way?
  (Mr Tarry) No, I do not think they had. We have seen a reversal in some parts of the world in the latter part of 2000 and the early part of 2001, particularly where we have seen some significant wage increases. The whole structure of cost has changed and put greater pressure on the industry. What we are also seeing, and it is not just the structural change in the macro picture of what I call excess capacity, but particularly in the United Kingdom, is a structural change with the lower costs airlines coming in, backed up by a change on the demand side, where there is an increasing and important difference between the customer and the traveller, particularly on the corporate side.

  231. The customer and the—?
  (Mr Tarry)—The traveller. By that I mean if I am travelling on a personal basis I am both the customer and the traveller, but most of my travelling is done as an employee of Commerzbank, who pay the bill, and there is an increasing focus to get best value for money, to the extent that we see a move from the business class cabin to the economy class cabin. That, again, will move as carriers such as easyJet offer additional services, say from Gatwick. We will see a migration and the segmentation in the market will become more pronounced.

  232. Which was more important, the over capacity or reduction in yield?
  (Mr Tarry) Long term we have seen too much capacity, which is fundamentally linked to the reduction in yield. We have had a situation with structural excess supply which has shown through in the yield. In the year 2000, in one year, we had a better balance between fundamental demand and supply. We can see the way the airlines were able to push their prices up to recover some of the increase in the fuel bill. We have had an imbalance and we can see it since 11 September. The fundamental issue that all airlines have to focus on is getting liquidity and ensuring their cash and liquidity position is secure. You will remember there were a lot of concerns over BA which were then removed when British Airways announced it had £1.9 billion of liquidity and was using cash of two million a day. Beyond that, yes, of course, the stimulation of the market we have seen over the last quarter is important because it gives airlines cash. The important thing now is that the airlines go through, address the cost basis and the capacity issues so that the industry emerges in a stronger position.

  233. Do you agree with that position?
  (Sir Roy McNulty) I agree with the broad analysis that the airlines were struggling with a situation of over capacity and they were struggling with the yield changing. It is impossible to know to date whether they would have managed their way through that successfully or not. What is for sure is that when 11 September and the aftermath came on top of that it created an extraordinarily difficult position.

  Miss McIntosh: Can I ask Sir Roy, first of all, we took evidence last week that a number of airlines have gone bankrupt, the first one in the United Kingdom was the end of September, Gill Air. Because it had recently come out of receivership I wonder how closely the CAA had cause to track this and, perhaps, the true financial position of the company was not as transparent as might have been the case? The fact that it went bankrupt as quickly as it did meant the pilots were left in a difficult situation, many of them had invested in the company and lost everything. Is that a marker that we should put down as monitoring potential airlines?

  234. Are you keeping your eye on the airlines, are they as transparent as you think they are?
  (Sir Roy McNulty) We are keeping our eye on these airlines. This is, as you well know, a liberalised market and therefore it is possible for people to come in and it is possible for people to fail. That is the way this market is set up. As to whether the figures we were getting and seeing from Gill Air were as transparent as they might or might not have been I really cannot comment. I think it has been well known in the industry for many years that Gill Air has hovered in and out of difficulties and never got far away from them.

Miss McIntosh

  235. Can I ask both Sir Roy and Mr Tarry what the implications are for slots at Heathrow and of any potential link up between BA and American airlines and the fact that BA are obviously giving up slots at Gatwick without giving slots at Heathrow and whether you have a view on that?
  (Mr Cotterill) I think it is entirely unsurprising with the present slot allocation system that British Airways is giving up slots at Gatwick and moving services to Heathrow. They are going to make more money at Heathrow than at Gatwick. As to the British Airways/American alliance, that at the moment is being examined by the competition authorities in the United Kingdom, the Office of Fair Trading. The possibility of slots as part of the condition of any such alliance were very central to the OFT's and European Commission's considerations last time. The situation has changed somewhat since then. It is a matter of careful analysis as to whether it warrants the same sort of conditions that were being proposed last time. It may not. That is something that is still with the Office of Fair Trading. I think we are awaiting with interest to see their conclusions.
  (Mr Tarry) I wrote in early September that I believe that BA should not be required to give up slots as a precondition for a licence to be approved because I believe that the relevant focus of competition is Europe to the US. Against the background of the airline alliances that exists there is an opportunity cost to be borne by the other airline partners to cede slots to their transatlantic partners if they want to run long haul services or transatlantic services from London to the United States. We put some research out having examined the issues. I am not trying to promote my research, we wrote a piece in September which went through all of these issues and looked at it from the point of view of networks, because it is one alliance competing with another alliance and against that background then there is an opportunity cost which other alliance partners, perhaps, should bear in ceding slots to other transatlantic champions in the grouping.

  236. Could I ask both Sir Roy and Mr Tarry why they think in particular the freight figures immediately following the tragic events of 11 September dived as radically as they did and how you would both account for the success of the no frills, low cost airlines? Perhaps they have not been so heavily dependent on freight?
  (Sir Roy McNulty) We have, to the best of my knowledge, done no work on the drop in freight figures, I really cannot contribute on that. As far as the low cost airlines are concerned, it is quite clear they are addressing a different market segment from the major international carriers. The drop on the North Atlantic, which has been the most pronounced drop, barely affects them. They are also in a phase where they are bringing on new capacity, prepared to offer very attractive deals, and clearly they are experiencing growth, which is not the case with the major international people.
  (Mr Tarry) I too have done no work on the cargo side but in terms of the low cost carriers I would add one point about Ryanair in that we see in Ryanair in particular, although it is obviously not a UK registered carrier, the flexibility it has with new route openings. So it is not going into a mature market or a market that is already served, it is bringing new opportunity to grow a market from a zero base.

Mr O'Brien

  237. Mr Tarry, what is your estimate of the over-capacity before 11 September and since September 11?
  (Mr Tarry) We have done a degree of fundamental modelling and taking the rule of thumb that GDP drives traffic at a rate of about two times, so the multiplier of traffic to GDP is two, if we take an assumption that over 20 years real GDP has grown at about two per cent we can see that the average underlying rate of growth driven by economic activity for a given structure of fares is in the order of four per cent. If we overlay that in the same period with the actual capacity growth and the actual traffic growth on a global basis we can see that there is almost 30 per cent over that period cumulatively, there is a buffer of 30 per cent too much capacity. Another way to look at it is to look at the average operating margins as we move through each cycle and the average operating margin at the peak of the last cycle was lower than it was seven to ten years earlier.

  238. So you are saying that on 10 September there was a 30 per cent over-capacity?
  (Mr Tarry) You can argue that case. What we have seen since is obviously the step down.

  239. I do not want to argue the case, I am just asking for information.
  (Mr Tarry) Using the assumptions which I believe to be reasonable, I think it is a valid conclusion.


 
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