Examination of Witnesses (Questions 225
WEDNESDAY 9 JANUARY 2002
MP, MR BOB
MICHAEL A VIVIAN
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
Chairman: Mr George Stevenson, member of the
Transport and General Workers' Union.
Mr Donohoe: Member of the Transport and General
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.
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
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
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
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
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.
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
(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
(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.
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.