Select Committee on Transport, Local Government and the Regions Eighteenth Report


16. NATS proposes to recover its financial position by implementing a financial restructuring package and a new business plan. There are four elements to the company's financial package:

    —an injection of additional investment, shared between a new investor and the Government of up to £130 million in permanent capital;[38]

    —"some subordination of Airline Group's interests";[39]

    —variation in the terms of NATS' loans, including some reduction in debt availability fees; and[40]

    —an increase in the charges to its customers.[41]

The business plan incorporates "a programme of carefully targeted cost savings and very active management of our cash".[42] NATS argues that if it cannot raise new finance and restructure its banking facilities, "domestic and international users' interests would be seriously damaged both in the short and longer terms".[43] NATS is required under its licence to make substantial investments in its services. That investment is dependent on its relationship with its bankers and access to debt markets.[44]

NATS' charges

17. Under the Transport Act 2000, which laid down the principles of the PPP, NATS' en-route business is subject to "RPI minus X" economic regulation, the standard model for monopoly regulation in the United Kingdom. The PPP was intended to lead to more competitive charges. Initially NATS did reduce its charges.[45] Following advice from the CAA, the Government set the original 'X' value, for CP 1 at 2.2 for 2001, 3.0 for 2002, 4.0 for 2003, and 5.0 for each of 2004 and 2005.[46]


18. NATS' licence for its en-route business stipulated that its charges should reduce during the first control period. Following 11 September, it revised its demand forecasts and calculated that it would need to increase prices.[47] In February 2002, it applied to the CAA to raise the charge cap, starting in January 2003, to help recover the shortfall in its income.[48] The proposed revised charge cap was RPI plus 4 in 2003, plus 3 in 2004, and plus 2 in 2005.[49]

19. In May 2002, the CAA published a consultation document in which it set out its analysis and preliminary conclusions on NATS' request.[50] The document highlighted its three principal concerns:

    —NATS' current highly geared financial structure may not be robust enough to withstand future shocks;

    —the banks financing NATS may be reluctant to make available NATS' loan facility for capital expenditure if they believed that NATS' financial performance might not be adequate in the next control period. The CAA note that a key issue is whether users, through the price cap, should provide an injection of cash flow in the face of such a possibility;

    —an extended period of hard financing constraint could lead to uncertainty over the leadership and management of NATS.[51]

20. The CAA concluded that it was "unconvinced that a price cap adjustment is appropriate to address those concerns". It argued that an increase in the price cap would send a signal to NATS' debt holders that "excessive gearing can be expected to deliver benefits for investors thereby raising the likelihood of high gearing persisting in future, and reducing the incentives on NATS' investors to opt for a stronger financial structure".[52]

21. The CAA estimated that, if NATS' application were accepted and its revised traffic forecast was borne out, it would earn additional revenues of £174 million in present value terms.[53] The CAA's projections of NATS' future revenue suggest that the current licence charge will allow NATS to earn revenues in excess of those required to earn a 7.75 per cent pre-tax real return on the Regulatory Asset Base. The CAA concluded that "despite the demand shock, NATS is now expected to be better off in cash flow terms up to the next review than either the CAA or the Airline Group originally anticipated." However it warned that serious cash flow problems would arise after 2005, when "a default event may occur due to a tightening of NATS' financial position".[54] It also warned that NATS' precarious finances could lead to its banks declining further draw downs on the capital loan facility, in which case "capital expenditure would need to be met out of operating cash flows ... which would be unlikely to be sufficient to fund the full planned programme.[55] In such circumstances the CAA concluded that "There would be a risk of undesirable uncertainty over the leadership and management of NATS and, in the extreme administration for NATS could result".[56]

22. The CAA accepts that NATS faces significantly lower projected demand than was anticipated at the time of the PPP, but it is "not convinced" that that amounts to a case for revising the price cap.[57] Although it recognises the importance of creating a sustainable and stable financial structure for NATS, it does not believe increasing NATS' charges to be justified to secure that objective.[58] The consultation document suggests that NATS could seek additional revenue by increasing non-regulated terminal navigation charges. NATS rejected this as unrealistic in the short-term, although it welcomed developing with the CAA "a unified and most cost reflective terminal approach charge".[59]

Comparison with previous downturns and forecasts

23. Critical to the decision to re-open the charge cap is the assessment of whether the events of 11 September constitute an "exceptional circumstance" for the purposes of Condition 25 of NERL's [NATS En-route service] licence.[60] The CAA's analysis used six traffic forecasts to determine the "expected outlook for demand over 2002-2005 given that 11 September occurred", and to examine how that demand compare with previous shocks to demand, such as the Gulf War.[61] Figure 1 shows the current percentage Chargeable Service Unit (CSU) growth against previous events.[62]

24. NATS considers the current downturn to be unprecedented, and it expects a slower recovery than occurred after the Gulf War.[63] Mr Gibson-Smith, chairman of NATS, told the Sub-Committee that he did not believe the company should have been designed to withstand such an event, which was "too unusual and too exceptional".[64] He believed the proposed new financial structure would have a greater resilience to downside demand shocks.[65]

25. The CAA identified an inconsistency in NATS' central argument:

    "On the one hand it is argued that the demand shock could not have been reasonably anticipated because the post-11 September outlook is worse than the CAA's 'low case' forecasts from August 2000. But the amount by which NATS wants the price cap to be increased compensates it for the whole of the difference, not just the difference between its current expectation and the CAA's low case projection".[66]

Nor did the CAA accept NATS' arguments that there were qualitative differences between a one-off unexpected shock and more general downside risk. It considered such a distinction to be artificial because "demand volatility is inherently subject to small and large shocks, all unforecastable with certainty by definition".[67]

26. NATS' financial structure left it extremely vulnerable to a reduction in demand. The air transport industry has a history of cyclical levels of demand and sensitivity to external events. The terrorist attacks of 11 September were unprecedented, and the consequential downturn in air traffic was more severe than those following previous downside demand shocks. The reduction in demand was not outside the bounds that NATS should have been able to withstand and should have been considered within its contingency planning.[68] The impact of a 'downside demand shock' should have been assessed as part of the due diligence during the PPP sale process.

NATS' revised proposals

27. NATS' response to the CAA's consultation exercise lists several points of agreement between it and the CAA. Those points include agreement that: there has been a significant downside demand shock; NATS is not expected to bear the volume risk when "exceptional circumstances" arise; a breach of banking covenants could result in NATS becoming insolvent and forced into administration; and the possibility of financial distress may entail risks to users.[69] If the CAA does not allow a revision of the price cap, NATS states that the CAA would have failed to take full account of NATS' current financial position.[70]

28. NATS' response to the consultation proposes a more detailed solution. The regulatory aspect of that solution includes the recalculation of the charge cap to RPI plus 2 for the remainder of CP 1, and plus 3.5 for CP 2.[71] In addition to the revision in the price cap, it proposes several additional elements to a composite regulatory settlement:

    —an increase in the Regulatory Asset Base to "smooth" transition to CP 2;

    —a traffic floor set at NATS' current low case traffic forecast for CP 1;

    —a rolling incentive mechanism based on the operating cost forecasts in NATS business plan;

    —a commitment to an investment grade credit rating;

    —a commitment on regulatory depreciation.[72]

29. The details available suggest that the proposed composite regulatory settlement would lead to a significant reapportionment of risk. A traffic floor would insulate the company for the worst effects of a deeper decline in air traffic. Presumably NATS charges would increase correspondingly so that its income was assured, shifting the risk of a downside demand shock from NATS to its customers. Increasing the Regulatory Asset Base would reduce the company's gearing ratio, which would shift risk from the company to its lenders. A rolling incentive mechanism would allow NATS to benefit from increased charges on the basis of promised operational costs savings estimated to be worth £72 million. Similar mechanisms have been used in other regulated industries, but in those cases the benefit is achieved once the cost-savings targets have been reached.

30. Responses to the CAA's consultation show the extent of concern about NATS' proposed changes, particularly among non-Airline Group airlines, which rejected an increase.[73] JMC Airlines Ltd states that NATS has not made:

    "a sustainable argument of support for such a radical revision of its revenue stream. Furthermore, the current operational performance of the business is so abysmal that carriers who have other [air traffic control] options are seeking to re-route to avoid NATS controlled airspace, further compounding their revenue problems."[74]

JMC and other airlines also question why NATS' performance has declined given the reduction in the level of traffic.[75] Swiss International Airlines makes the point that the charge increase proposal "seems to be primarily bank-driven to reduce their risk".[76] NATS charges were supposed to reduce, not increase, under the PPP. The arguments advanced so far will probably do little to persuade the CAA that an increase in charges is warranted.


31. NATS en-route charges have fallen in comparison with other European air traffic control providers.[77] The United Kingdom still has the third-highest en-route charges and the highest costs per kilometre in Europe.[78] NATS claims that meaningful comparisons with Europe are impossible.[79] In particular, it notes that it has a smaller proportion of overflights (see Figure 2), which yield the most revenue for the least workload, than most other European providers.[80]

Figure 2: Comparison of en-route and terminal charges for major European ATC providers

euro million
Terminal Airport
euro million
euro million
Percentage charged
to En-route
Cost per flight
% of total

Source: PRC Benchmarking Report July 2002, using data for 2000.[81]

New equity partner

32. NATS plans to find a new investor that is suitable "in terms of safety impact; financial robustness of the equity investor; and strategic alignment with NATS' goals".[82] Any new investment needs to be in place by the end of September, when the short-term loan facility expires. Mr Gibson-Smith confirmed that BAA was likely to be the new investor.[83] Heads of terms had been concluded, and the parties were moving towards finalising a firm contract for the investment.[84] The Government intends to match the new investment at the same time in order to ensure that it maintains its 49 per cent shareholding, although no binding undertaking has been made.[85] The new investor has at least an expectation, if not a requirement, for the Government to make a matching investment, and for a positive settlement of application for a revision of the price cap.[86]

33. NATS is convinced that without BAA's investment it would be unable to make up the shortfall in its finances.[87] NATS confirms that the investment from BAA would be between £50 million to £65 million, some of which will be equity and some debt.[88] The debt proportion would be subordinated debt, used to pay some of the senior debt, and will not have a repayment profile.[89] The gearing ratio would remain slightly less than 100 per cent.[90]

34. According to the CAA, financial restructuring is essential if NATS is to have a sustainable financial structure in future. In the absence of that restructuring, a cash injection alone would not provide NATS with a financial solution.[91] The CAA also believes that it is in the interests of airlines to increase the price cap if NATS' finances were restructured.[92] We have received no clear evidence about how the new investor would be incorporated into the financial structure of the company. The Government must provide greater detail about the implications of BAA becoming an investor in NATS alongside the Airline Group. None of our witnesses was able to offer an informative opinion on those implications. It was not clear whether the additional investment would significantly improve NATS' financial position.

35. The Committee was assured that no quid pro quo had been discussed in relation to BAA's investment.[93] However, BAA has a central role in the aviation industry. The Government is currently preparing a white paper on aviation. BAA has a view on how that policy will develop and, particularly the required increase in capacity in the south east of England.[94] The Government must ensure that BAA's involvement in NATS is, and is seen to be, transparent, especially if charges of a quid pro quo for BAA's capacity expansion plans in return for investing in NATS are to be avoided.

36. At the time of the PPP, the Airline Group was acceptable as a bidder for NATS ownership only because of its inherent aviation interests. The Government should ensure that any further attempts to secure capital do not dilute the aviation expertise and stake in NATS.

38   NATS' Response, para 1.13. Back

39   IbidBack

40   Ibid, Ev. p 77. Back

41   NATS' Response, para 1.13. Back

42   Q 1. Back

43   NATS' Response, paras 1.14-1.15. Back

44   Ibid, paras 4.7-4.9. Back

45   QQ 104, 64. Back

46   QQ 108, 379; Ev. p 48; HC Deb, 18 June 2002, col 184w. Back

47   Ev. p 45. Back

48   Ev. pp 45, 77. Condition 25 of the Air Traffic Services Licence for NATS (En-route) Limited refers to "Exceptional Circumstances" as a condition under which the Charge Control Conditions could be suspended or modified. See Back

49   Ev. pp 45, 77. Back

50   Ev. pp 45, 48. NATS' Application to Re-open the Eurocontrol Charge Control: Consultation on CAA's Preliminary Conclusions, Civil Aviation Authority, May 2002, hereinafter, CAA ConsultationBack

51   CAA Consultation, para 1.19 Back

52   Ibid, para 1.20; Q 346. Back

53   CAA Consultation, para 2.3. Back

54   Ibid, paras 1.18, 3.64-3.65, 4.12. Back

55   Ibid, para 4.15 Back

56   IbidBack

57   Ibid, para 1.20; Ev. p 77. Back

58   IbidBack

59   NATS' Response, para 4.15-4.18. Back

60   NATS bankers' (Abbey National Treasury Services plc, Barclays, Banc of America Securities and Halifax) response to the CAA Consultation on NATS' Application to Reopen Eurocontrol Charge Control, June 2002. Back

61   CAA Consultation, para 3.25. The CAAs consultation document makes reference to six different sets of forecasts, its own 'base case' and 'low case' forecasts of August 2000, and its 2002 forecast, NATS 2002 'base case', and 1999 'low case' forecasts, and the 2002 'base case' forecast by NERA economics consultancy.  Back

62   Ev. pp 62, 73. A 'CSU' is a chargeable service unit, which is the basic unit of charging for en-route air traffic services agreed with in Eurocontrol. It takes account of both aircraft weight and distance flown. A flight of 100 km by a 50 tonne, e.g. Boeing 737, aircraft approximates to one CSU. Back

63   Q 26; Ev. p 51. Back

64   QQ 1, 23, 28. Back

65   QQ 24, 27. Back

66   CAA Consultation, para 3.32. Back

67   Ibid, para 3.34 Back

68   QQ 445-448, Ev. pp 62-72. Back

69   NATS' Response, para 1.21; CAA Consultation, paras 3.15, 3.70, 4.30, 1.6 and 3.29, 3.51 and 3.52, 1.16, 4.31, 4.10, 1.22. Back

70   NATS' Response, para 2.2. Back

71   Ibid, para 6.11. Back

72   Ibid, para 6.15; see CAA Consultation, paras 7.1-7.18. Back

73   The International Air Transport Association, British European, European Regions Airline Association, Swiss International Airlines, JMC Airlines Limited, and Lufthansa are against an increase; bmi British Midland, Virgin Atlantic, and Britannia Airways Limited are in favour of an increase. Non-Airline Group airlines provide about three quarters of NATS' income, Q 256. Back

74   JMC Airlines Ltd's response to the CAA Consultation on NATS' Application to Reopen Eurocontrol Charge Control, June 2002. Back

75   JMC Airlines Ltd's and Swiss International Air Lines' responses to the CAA Consultation on NATS' Application to Reopen Eurocontrol Charge Control, June 2002. Back

76   Swiss International Air Lines' response to the CAA Consultation on NATS' Application to Reopen Eurocontrol Charge Control, June 2002. Back

77   Q 58, 168, 416, Ev. pp 79-80. Back

78   QQ 59-65, 94, Ev. pp 74, 79-80. Back

79   Ev. p 79. Back

80   Ev. pp 79-80. Back

81   Ev. p 80. Back

82   QQ 72-74. Back

83   Q 246. Back

84   Q 247. Back

85   QQ 251, 254, 274-276, 299, 393, 400, 424, 466; Ev. p 81; HC Deb, 10 June 2002, col 759w; HL Deb, 17 April 2002, col 943. Back

86   QQ 260, 406, 410-411; Ev. pp 55-56, 81. Back

87   Q 268. Back

88   QQ 246-247, 303-307, Ev. p 81. Back

89   QQ 303-304, 391. The senior debt owing to the lending banks arising from the original deal is £730 million. Back

90   Q 305. Back

91   QQ 339, 373. Back

92   Q 341. Back

93   QQ 279-280. Back

94   Q 437. Back

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