A mix of slightly larger and even smaller numbers

Yesterday I posted as follows

From The Evening Standard:

"Flybe owns about 6% of Gatwick's slots. Selling off some or all of these — to operators which could include easyJet, British Airways or Norwegian — could bring in, according to Liberum Capital's estimates, as much as £12.5 million."

I have no idea whether Flybe owns the best slot or the worst slots, but assuming a mix of both, that means the total value of the landing/take-off monopoly rights at Gatwick (after taxes etc) is around £200 million.

There was another interesting snippet in this morning's Metro:

Flybe is to sell all 25 of its runway slots at Gatwick airport to raise up to £20 million. The struggling regional airline saw its shares rise by 20 per cent on the new yesterday on hopes a deal can be found.

The only way to make sense of that is to assume that Flybe is making a loss from those slots but that analysts think that other airlines think that they will be able to use those slots profitably. Which might be e.g. because Flybe doesn't own tasty slots at the "other end".

The £20 million figure is a bit higher than the £12.5 million mentioned yesterday, fair enough. So the assumption is that those slots are worth between £500,000 and £800,000 each to an airline that can use them profitably.

Also worth noting is that one "slot" means the right to land and take off again at a fairly specified time each and every day of the year, i.e. 25 slots = 6% of all Gatwick slots, meaning that there are about 400 slots at Gatwick, call it one landing/take-off every minute and half for ten hours a day (or whatever).

We might as well turn that £500,000 - £800,000 per slot into an annualised value of £100,000 - £160,000 and divide it by 360 flights a year, which tells us that the anticipated super-profit (monopoly or rental income) per flight is only £300 or £400, call it £1 or £2 per passenger (the figure is depressed by APD). Or you could double the value of the slots for the "other end" and double the number of flights to arrive at the same figure, i.e. to fly from A to B and back again you need to control a slot at A and a slot at B.

Surprisingly small numbers

From The Evening Standard:

Flybe owns about 6% of Gatwick’s slots. Selling off some or all of these — to operators which could include easyJet, British Airways or Norwegian — could bring in, according to Liberum Capital’s estimates, as much as £12.5 million.

I have no idea whether Flybe owns the best slot or the worst slots, but assuming a mix of both, that means the total value of the landing/take-off monopoly rights at Gatwick (after taxes etc) is around £200 million.

From the BBC, late 2011:

British Airways owner IAG has agreed a binding deal to buy BMI from Lufthansa for £172.5m, but has warned the deal could lead to job losses. IAG, which also owns Spanish airline Iberia, will gain 56 more slots at Heathrow airport in the deal...

BMI, which is based in Castle Donington in Leicestershire, operates flights to Europe, the Middle East and Africa. It has 8.5% of the landing slots at Heathrow, the UK's busiest airport, which are seen as the main attraction of a purchase.

Again, I don't know what sort of mix BMI had, but dividing £172.5 million by 8.5% gives us a total value of the landing/take-off monopoly rights at Heathrow (after taxes etc) of around £2,000 million (£2 billion).

Heathrow appears to have double the capacity of Gatwick (Wiki) so presumably the extra £1,600 million is explained by where the other ends of all Heathrow's slots are?

Half a free market is better than none.

In case you were ever thinking about starting up an airline in the UK, presumably the first thing you'd do is get hold of the accounts for other UK airlines and look at the profit and loss account. Then you divide the profits you could make by the amount of money you'd have to invest in aeroplanes, and that gives you your return on capital. If that's more than, say, ten per cent, then you are on to a winner, yes?

Nope. There are two kinds of airlines in the UK - those who were granted take-off and landing slots for free when they were privatised in the 1980s (i.e. British Airways); and those who had to buy landing slots for their market value 'second hand' (most of the others). The accounts for the former will neither show the value of the landing slots (which is enormous, they are worth more than the aeroplanes) nor the associated amortisation*; the accounts for the latter will show the cost of the landing slots; the associated liability (or share capital) and the amortisation.

So before you can go into business, you need to buy some slots (and now might be a very good time to buy, the air travel industry being at rock bottom). How do you work out the value of the slots? Well, you work out your cash profit per flight and then deduct from that the required return on the money invested in aeroplanes; what is left over is a balancing figure - you then take a random figure as an "earnings multiple" and that's what you offer. Another airline with slots to spare does the same calculation, and provided your estimate is higher than theirs, they'll sell you it.

If you overestimate the value, then you are doomed, of course - you are committed to the corresponding loan and interest repayments for ever more, but the value of the slots can plummet (let's imagine that Eyeful o'yokel never stops erupting, for example). Or their value might rocket if the NIMBYs get their way and airports are never allowed to expand.

Anyways, getting back to the point in hand, Nick Drew looked at the Lib-Con Energy policy, and under "Good", he listed replacing Air Passenger Duty with per-flight duty. I commented thusly:

Per flight taxes are better than per passenger, but the best way of doing it is auctioning off the landing/take-off slots. The value of these is merely a balancing figure between revenues and costs; so however much the airlines voluntarily pay for the balancing figure does not change anything - it's a non-distortionary tax, because you cannot pass on a balancing figure.

In other words, instead of having to hand over a vast amount to another airline, every year or two, you would do your own calculations and turn up at the next auction and bid for the number of slots you think you need; and if yours is the winning bid, you buy an aeroplane or two to match (airlines who lose enough bids will no doubt have one or two spare), paint it in your colours and away you go. If you overbid for a slot for a year or two, you will go out of business, but at least the amount of money you have lost is much less than if you had overbid for buying up slots in perpetuity from another airline.

Nick D didn't seem to get the point, and replied:

I'd be cautious about price-setting distortions (market power) under your auction system, MW - auctions have been tried in many areas of the energy industry and have thrown up all manner of problems.

I specifically was not talking about auctions in the energy industry, which is all much trickier (because raw material costs fluctuate so wildly). Ah well. Here endeth today's.

* Applying normal accounting standards, BA only accounts for landing slots which is has acquired from third parties, which are stated as having cost £212 million in its 2009 accounts, the cost is amortised at £8m a year. Back in late 2008, BMI which owns 11% of Heathrow landing slots, valued them at £770 million (the value has fallen since), BA owns 41% of Heathrow landing slots (plus heck knows how many at Gatwick etc) so their total value a year or two ago must have been about £5 billion, about as much as all its aeroplanes put together.

Lib Dem Fun (2)

So, having established that the top level statements are pretty vacuous, let's look in more detail at their proposal to increase the personal allowance for income tax from the current level of £6,475 to £10,000:

Cutting taxes for people on low and middle incomes. There will be no income tax on the first £10,000 you earn – meaning 3.6 million working people and low income pensioners will no longer have to pay any income tax at all, while millions more will have an income tax cut of £700. Pensioners will get up to £100 extra.

The change will be paid for by introducing a mansion tax, closing loopholes that benefit the wealthy and making sure airlines pay for the pollution they cause.

Two fundamental errors there.

1. It is true that increasing the personal allowance by £3,525 would reduce people's income tax bills by up to £705, and that this would, in relative terms, benefit lower earners more than higher earners (so it's a very good place to start), but they quite clearly overlook the other tax on income that employees have to pay, being Employee's National Insurance contributions ('NIC'), which is 11% of your income above the 'threshold' of £5,720 per annum (let's ignore Employer's NIC for now).

If we are to level the playing field even a little bit, then they ought to increase the NIC threshold to £10,000 per annum as well, which would mean a tax saving of up to £705 for people with mainly interest or rental income and a saving of up to £1,375 for employees.

2. If thirty million taxpayers get a tax cut of £700 each, the total 'cost' would be in the order of £21 billion.

a) Vince Cable's mansion tax (I thought they'd shelved this idea anyway), was set at 1% on the amount by which the value of a home exceeds £1 million. There are currently about 200,000 such houses, so let's assume a tax take from each of £5,000, that would raise £1 billion, but then minus off the Inheritance Tax that won't be collected and that gets it down to £600 million.

b) What loopholes that benefit the wealthy? The only one that springs to mind is the fact that very high earners could claim tax relief on pension contributions of £255,000 per year, but Alistair Darlling's weird new rules have probably wiped out a lot of the value of that tax break, so let's call the possible saving £5 billion or something.

c) I'm all in favour of airlines paying for the value of landing slots they use, and have done fag packet workings that say total revenues would be £5 billion per annum. You could, in theory, raise the same amount by increasing taxes on airline fuel, but it comes to much the same thing and sets an upper limit of £5 billion.

OK, that gets us halfway to raising the required £21 billion. If the Lib Dems want to be taken seriously, would they mind telling us how they will raise the rest? Or would they like to explain what government spending they'd cut, which would be a much simpler and better way of freeing up money for tax cuts?

Fun Online Polls: Commute times & British Airways

Thanks to everybody who took part in last week's Fun Online Poll. The responses to the question "How long does your journey to work take in the morning?" were as follows:

less than 15 minutes - 32%
15 to 30 minutes - 22%
30 to 60 minutes - 29%
60 to 120 minutes - 15%
more than 120 minutes - 3%

I foolishly forgot to include the option "I work from home", which (judging by the comments) would be about a third of the 32% who reported a journey time of less than 15 minutes.

There is no particular back story to this poll - I was just genuinely interested whether my assumption that the majority of people are prepared to tolerate a commute of 'about half an hour' was correct and what the spread about the mean (37 minutes) is.
--------------------------------------
Staying with the travel theme, the British Airways versus Unite (the trade union) industrial dispute seems to me like one of those cases where you want both sides to lose.

As a privatised former public entity, BA was given enormously valuable landing slots at UK airports for free but inherited a hefty final salary pension scheme which it never bothered to fund properly. Even though it was privatised a quarter of a century ago, it never really shook off the public sector mentality - even now, salaries for BA staff are nearly twice what they are at other airlines (if they had taken lower salaries then the difference would have gone into the pension fund and all would be sweet and dandy).

The trade union is being completely daft - in economic terms (if you consolidate the airline and its pension fund into one entity), the employees already own about ninety per cent of their employer (or at least older members of the final salary pension scheme do). I am surprised that the union doesn't have an economist to quietly point this out.

Luckily, there is a way in which both sides can lose. All it needs is for passengers to stop booking with BA for a few weeks and the whole thing will simply collapse. All their slots can be auctioned off properly by the government (preferably on a leasehold rather than a freehold basis) and smaller competitors and new entrants can snap up the aircraft, infrastructure and most of the employees.

So that's this week's Fun Online Poll: "Would you be bothered if British Airways goes bankrupt and is split up between smaller competitors?"

Vote here or use the widget in the sidebar.

Worker-owned co-operatives

Many of the recent articles about the British Airways - whether about the Iberia merger, the proposed strike or the ensuing court case or - mention the BA pension funds deficit of £3.7 billion.

Relatively few articles mention the pension fund assets, which appear to be about £12 billion. Most of this is invested in shares in other plc's, and some will be invested in UK government bonds - which is a neat trick of the UK government to create a captive market for its bonds: "If you want the pension fund tax breaks, you have to invest x% in UK government bonds" - but I digress.

In round figures (they are to some extent plucked out of the air by actuaries and stock markets), the pension funds have assets of £12 billion and liabilities of £16 billion, net deficit £4 billion, which BA 'owes' them.

If we add BA's pension fund deficit of £4 billion to its current market capitalisation of £2 billion that gives BA an enterprise value of £6 billion. (To digress yet again, a large part of that enterprise value consists of the landing slots it was given for free and for which it should be paying a fair market price to avoid there being barriers to entry).

If we consider BA and its pension funds to be one economic unit, we end up with total assets of £18 billion and total liabilities to pension scheme members, i.e. employees, of £16 billion. If we didn't have these silly rules brought in after the Robert Maxwell shenanigans, BA could simply issue two new shares to its pension funds for every share in issue to settle the pension fund deficit.

That would probably focus the minds of the trade unions and employees on the fact that the BA economic unit is in fact a worker-owned investment fund with a majority stake in an airline - call it a co-operative if you will. They'd accept, in the short term, that people have to be laid off - but their redundancy pay is, to a large extent, being paid by the continuing employees, not some mythical group of shareholders, who are always seen as fair game for being plundered.

Why you shouldn't base a business-model on bubble values (part 94)

From The Times:

British Midland (bmi) may struggle to raise the £95 million in funding it needs to keep flying because potential buyers for its Heathrow landing slots have become thin on the ground...

In the airline’s most recent accounts, its directors warned that uncertainty over the slot sale cast doubt on the company’s ability to continue as a going concern next year. This has sparked fears about the future of the UK’s third-largest airline and Heathrow’s second-largest operator...

Bmi’s most valuable asset has been its 11 per cent of Heathrow landing slots. The airport has been so congested in the past that slots traded for huge sums of money. Continental Airlines paid $209 million for four pairs of slots two years ago, but today recession-hit carriers are cutting back rather than seeking to expand.

Until UK airports and British Airways were privatised about twenty years ago, nobody paid much attention to the inherent value of landing slots. The government of the time just handed over most of the slots to British Airways, rather than parcelling them up with the airports or the sensible option, retaining them as part of the state's assets.

Commonsense, and real life, tells us that the value of the slots is a balancing figure, i.e. the money an airline can earn from each flight minus its normal operating costs. The normal operating costs can be competed away so are a fairly stable figure but total ticket sales fluctuate a lot depending on current economic conditions (and/or fear of terrorist attacks), so the value of the slots fluctuates disproportionately.

What exacerbates the fluctuations is that slots are a semi-artifically rationed monopoly right (the only way to increase supply is to buil more airports, and the NIMBYs aren't having that, of course), which enhances their value even more. And the net present value is inversely proportional to prevailing borrowing rates. In other words, the value of the slots is a function of the super-profits that airlines can earn, and then some.

These value fluctuations don't affect those airlines who originally got the slots for free (and haven't used them as security for loans), but airlines who borrowed money to buy them are now in big trouble.

Would it not have been better for the state to take the sensible option, retain the slots and auction them off each year or every six months? The airlines would never bid anymore than next year's super-profits, so would never have been able to get into such debts; in bad years, the price will be bid down, so in the bad years airlines save money and still remain profitable.

The auction proceeds could be used to pay for the external costs of air travel in places round airports, i.e. noise pollution, extra congestion on roads and railway etc. Or to put it crudely, bribe local NIMBYs into accepting that collectively, we are better off with airports than without them.

What's not to like?

Valuing landing slots at Heathrow

Continuing my occasional series, the FT reported that Lufthansa had been tricked into paying £800 million for the 49% of BMI that they didn't already own, however "The value in BMI lies with its coveted take-off and landing slots at Heathrow, about a seventh of the total. Earlier this year, BMI put a balance sheet value on these slots at £770m."

The Times reckoned that BMI owned 11% of Heathrow's landing slots, so let's call it one-eighth in round figures. There are 471,000 aircraft movements at Heathrow each year, so that's 235,500 'pairs' (one to land, one to take-off) and BMI 'own' the right to land/take-off 30,000 times a year. £770 million ÷ 30,000 = £26,000 for the right to land/take-off once a year, in perpetuity.

Assuming that this right could be reasonably amortised over ten years, that's a notional cost of £2,600 per pair if you own them, and a real cost of £2,600 per pair if you have to buy them (cost of finance + uncertainty premium). In other words, if the local councils around Heathrow were allowed to auction off land slots, airlines would and could pay an average of £2,600 and still be profitable. Times that back up by 235,000 pairs gives local councils potential income of £611,000 million.

And the value of those landing slots is depressed by Air Passenger Duty. If we scrapped that crude tax as well, the annual 'rental' value of the slots would go up by another £673 million (67.3 million passengers at an average of £10 APD), bringing the total local revenues to a nice round £1.3 billion (rather less than my earlier estimate, I admit).

And in difficult times like these, the auction price would drop of course - in extremis to £nil in the short term. Great, that means that airlines can drop ticket prices by several per cent, which will hopefully keep things ticking over, minimise job losses and ensure that they recover much more quickly again in future (so the auction receipts quickly revive again, and so on and so forth).

"Planes fly empty to keep slots at Heathrow"

The Times devoted half of today's front page to this rather fascinating story, cont. page 8. This is well worth reading in full, if you have the time, but to sum up the salient facts:

Cost of running a flight from Heathrow to Edinburgh: £60,000
Take offs and landings on an average day at Heathrow: 1,303
Value of a peaktime Heathrow slot: £30 million
Average value of BMI's Heathrow slots: £5 million

Heathrow also have a rule that an airline that 'owns' a slot must use it at least 80% of the time or it forfeits it, which is why "It is, therefore, better for a carrier such as bmi to lose £20,000 per flight than to give up a £30 million slot. For bmi this is particularly important as it is trying to keep its value up for a potential sale this year. British Airways, Virgin Atlantic and Lufthansa are all interested in buying bmi, and the biggest attraction is the airline’s 11 per cent of Heathrow slots - the second-largest holding behind BA."

Of course, in a truly free market economy with no planning restrictions, supply and demand would even out and more airports would be built, so a landing slot would have negligible value. Indeed, if 'enough' airports were built in The Good Times, there would be a huge overcapacity in The Bad Times (fear of terrorist attacks, recession, high oil prices etc) and landing slots would have negative value - airports would have to pay airlines to land there (to skim off money from passengers at the airport shops etc). And it would, to be frank, be a bit of a waste of concrete and radar equipment to build airports that sometimes stand empty for year on end.

However the NIMBYs and Greenies are in charge, which is why we have chronic airport undercapacity - which is why the slots have such a colossal scarcity value - and it surely can't have been the intention of the NIMBYs and Greenies to generate windfall gains for BMI shareholders or to encourage a system whereby airlines fly empty planes, can it?* OTOH, air travel does have external costs - it causes noise and passengers use other local transport links to and from the nearest city.

Here's the interesting bit: "... some aviation analysts believe that there are no legal grounds for these carriers to own the slots, and advocate that they should belong to the State and be leased to the highest bidder. High prices for rented slots would encourage only profitable flights, which would almost certainly mean full flights."

I gave this a few hours thought a couple of months ago and came to exactly the same conclusion. The gimmick being that such an auction process only works if there is undercapacity.

The other possibility of course is that BAA just start charging much more for slots, but as they are Spanish-owned, why would anybody advocate this?

* That would be a good Conspiracy Theory - NIMBYs and Greenies are in fact all shareholders in smaller airlines.

Auctioning landing slots at Heathrow

Further to my recent post about local councils (those affected by the airport) charging for landing slots, I can now put some numbers on it.

In yesterday's City AM, it was mentioned that Continental had paid £100 million for four take-off and landing slots. Seeing as you need a 'pair' (one to take off and one to land), that's £25 million per pair that airlines are happy to pay. Assuming that Continental amortise this over ten years at the longest, that's £2.5 million per slot per year, divided by 365 days = £7,000 per take off.

The figures are all over the place; peak slots and slots to New York are of course worth more than early or late slots to Manchester, other figures quoted are 'Up to £20 million per pair'; '£30 million for seven or eight more daily flights'; £20 million or £30 million per slot pair. So let's go low, say £10 million for an average slot, amortised over 10 years divided by 365 days is about £3,000 per flight. Add on £30 per passenger average Air Passenger Duty x 300 passengers = £9,000, £3,000 plus £9,000 = £12,000.

We can ignore landings and assume that the charge is just for taking off. Airlines would still be profitable even if they were charged an average of £12,000* for each take off (Air Passenger Duty would be scrapped of course). Those airlines that have paid through the nose for slots would be spitting feathers, of course, but that's just tough. As the amount of noise and air pollution and strain on local infrastructure round the airport is much the same whether an aeroplane is flying to Manhattan or Manchester is neither here not there.

Heathrow has 471,000 aircraft movements a year, so call it 235,000 take-offs**. 235,000 x £12,000 = nearly £3 billion*** in totally non-distortionary tax each and every year to be spent on public transport, local infrastructure, sound insulation etc.

* Obviously, the exact rate would be set by auction. Airlines would submit sealed bids for how much they offer for how many slots, they would then be allocated in order of who offered most. Some airlines will collude, of course, but on the whole airlines hate each other, so there will always be some outsider prepared to offer that little bit more, just to rub BA's nose in it, if nothing else.

** Check: one take-off per minute, twelve hours a day for 365 days a year = 262,800, so seems about right.

*** Check: total APD receipts 2007-08 £2 bn, maybe £3bn is a tad on the high side for just our largest airport, but it can't be miles off.