Slots Allocation Schemes

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<p>January 2004 STUDY TO ASSESS THE EFFECTS OF DIFFERENT SLOT ALLOCATION SCHEMES A Report for the European Commission, DG TREN Project Team: Ian Jones, Stuart Holder, Jan Peter van der Veer, Emily Bulman, Neil Chesters, Simon Maunder, Dr Philip Kalmus, Dr Soren Sorensen, Federica Maiorano, Dr Pablo Mendes de Leon, Professor Piet-Jan Slot, Peter Somers</p> <p></p> <p>ABOUT NERANERA Economic Consulting is an international firm of economists who understand how markets work. Our clients include corporations, governments, law firms, regulatory agencies, trade associations and international agencies. Our global team of 500 professionals operates in 16 offices across North and South America, Europe, Asia and Australia. NERA economists devise practical solutions to highly complex business and legal issues arising from competition, regulation, public policy, strategy, finance and litigation. Our more than 40 years of practical experience creating strategies, studies, reports, expert testimony and policy recommendations reflects our specialisation in industrial and financial economics. Because of our commitment to deliver unbiased findings, we are widely recognized for our independence. Our clients come to us expecting integrity; they understand this sometimes calls for their willingness to listen to unexpected or even unwelcome news. NERAs Transport Practice is comprised of economics and industry experts who help transport industries around the world develop and implement economically sound policies. We advise transport operators, regulators and policy makers on issues of industry structure, competition, regulation, pricing, efficiency and environmental assessment. NERA Economic Consulting (, founded in 1961 as National Economic Research Associates, is a Marsh &amp; McLennan company (MMC). MMC is a global professional services firm with annual revenues exceeding $11 billion. It is the parent company of Marsh Inc., the worlds leading risk and insurance services firm; Putnam Investments, one of the largest investment management companies in the United States; and Mercer Inc., a major global provider of consulting services. Approximately 60,000 employees provide analysis, advice and transactional capabilities to clients in over 100 countries.</p> <p>TABLE OF CONTENTSEXECUTIVE SUMMARY 1. 2.2.1. 2.2. 2.3. 2.4. 2.5.</p> <p>i 1 55 5 9 11 18</p> <p>INTRODUCTION THE EXISTING FRAMEWORKIntroduction The Existing Slots Regulation Proposed Amendments to Regulation 95/93 Regulatory and Policy Context The Current Scheduling Process</p> <p>3.3.1. 3.2. 3.3. 3.4. 3.5. 3.6. 3.7. 3.8. 3.9.</p> <p>IMPACT OF THE EXISTING FRAMEWORKIntroduction Current Levels of Use of EU Category 1 Airports The Structure of Airport Charging The Extent of Excess Demand for Slots Variations in Traffic Mix Between Airports Variations in Aircraft Size and Loadings The Operational Patterns of Network Carriers and the Effect on Traffic Peaks Slot Holdings of Major Network Carriers Forecast of Changes in Excess Demand at Airports Between 2002 and 2007</p> <p>2121 21 23 23 30 32 35 41 43</p> <p>4.4.1. 4.2. 4.3. 4.4. 4.5. 4.6.</p> <p>INEFFICIENCIES IN THE CURRENT FRAMEWORKIntroduction The Causes of Inefficiency Slots Utilisation Indicators of Inefficient Use of Slots Slot Mobility Peak and Off Peak Use of Airport Capacity</p> <p>4949 49 53 56 61 62</p> <p>5.5.1. 5.2. 5.3. 5.4. 5.5.</p> <p>POTENTIAL MARKET MECHANISMSIntroduction Primary and Secondary Trading Mechanisms Use of Market Mechanisms in Other Sectors Use of Market Mechanisms to Allocate Airport Slots Specific Options Examined</p> <p>6565 66 69 72 76</p> <p>6.6.1. 6.2. 6.3. 6.4. 6.5. 6.6. 6.7.</p> <p>POTENTIAL IMPACT OF MARKET MECHANISMSIntroduction Potential Impact: Airports with Severe Excess Demand throughout the Day Potential Impact: Airports with Limited Excess Demand Impact on the Use of Airport Capacity Overall Impact Impact on Airline Competition The Implications of Market Mechanisms for EU Policy on Airline Mergers</p> <p>8181 82 87 92 100 101 112</p> <p>6.8. 6.9. 6.10.</p> <p>Impact on Fares and Service Levels Impact on the Environment Impact on Accessibility of the Regions</p> <p>117 121 124</p> <p>7.7.1. 7.2. 7.3. 7.4.</p> <p>SECONDARY TRADINGIntroduction Description of Approach Practical Issues Impact Assessment</p> <p>127127 127 129 135</p> <p>8.8.1. 8.2. 8.3. 8.4.</p> <p>HIGHER POSTED PRICESIntroduction Description of Approach Practical Issues Impact Assessment</p> <p>147147 148 151 159</p> <p>9.9.1. 9.2. 9.3.</p> <p>APPLYING AUCTIONS TO AIRPORT SLOTSIntroduction Description of Approach Practical Issues</p> <p>173173 173 177</p> <p>10.10.1. 10.2. 10.3. 10.4.</p> <p>AUCTIONS OF POOL SLOTSIntroduction Description of Approach Practical Issues Impact Assessment</p> <p>185185 186 187 189</p> <p>11.11.1. 11.2. 11.3. 11.4.</p> <p>AUCTIONS OF TEN PER CENT OF ALL SLOTSIntroduction Description of Approach Practical Issues Impact Assessment</p> <p>199199 199 201 203</p> <p>12.</p> <p>CONCLUDING COMMENTS</p> <p>213</p> <p>APPENDIX A. APPENDIX B. APPENDIX C.</p> <p>INFORMATION GATHERING LEGAL APPENDIX US EXPERIENCE OF SLOT TRADING</p> <p>219 223 271 279</p> <p>APPENDIX D. THEORY AND PRACTICE OF AUCTION DESIGN APPENDIX E.</p> <p>APPROACH TO QUANTITATIVE ASSESSMENT OF IMPACTS 331 EXAMPLE CALCULATION 379</p> <p>APPENDIX F.</p> <p>Executive Summary</p> <p>EXECUTIVE SUMMARYBackground This report, by National Economic Research Associates (NERA) in conjunction with the Faculty of Law at the University of Leiden and Consultair Associates, examines the feasibility and likely impact of using market mechanisms to allocate slots at congested EU airports. There is significant excess demand for slots at a number of EU airports. Among the 30 or so EU Category 1 airports:</p> <p>seven airports experience excess demand for slots throughout the day these are Dsseldorf, Frankfurt, London Gatwick, London Heathrow, Madrid, Milan Linate and Paris Orly. In some cases, this situation is partly due to environmental restrictions or air traffic distribution rules; a further 14 airports experience excess demand for slots at certain times of the day.</p> <p>While planned investments may ease the situation somewhat at Dsseldorf, Frankfurt and Madrid, these airports will still have excess demand at certain times of the day. For Category 1 airports as a whole, moreover, the general extent of excess demand is expected to increase over the next five years. Despite this excess demand, the effect of the current EU slot regulation (95/93) is that existing users of these airports enjoy grandfather rights in relation to their current slot holdings. While the regulation provides for 50 per cent of any slots not subject to grandfather rights to be allocated to new entrants, and the remainder allocated according to administrative criteria, there are usually very few slots available from this pool. It is therefore difficult for airlines to obtain slots in order to introduce new or more frequent services. The fact that existing airport charges fail to reflect the scarcity value of slots means that they may be allocated to services that are barely profitable at the current level of airport charges. Airlines that might be able to use these slots more efficiently (for example, because their services would carry more passengers or generate more profits), and would therefore be willing to pay considerably more than the current level of charges, may nevertheless be unable to get hold of any slots. In addition, the fact that airlines only pay charges based on their actual use of slots means that they have poor incentives to use slots efficiently. Some slots therefore remain unused, even at congested airports - either because they are returned late to airport coordinators (and cannot be reallocated) or because airlines simply fail to use their full allocation of slots. i</p> <p>Executive Summary</p> <p>The Role of Market Mechanisms Market mechanisms have the potential to address these inefficiencies by confronting airlines with the cost of occupying scarce capacity. This occurs in one of two ways:</p> <p>under primary trading mechanisms, such as auctions or higher posted prices, airlines have to pay for their slots. Both mechanisms aim to ensure that slots are allocated to the airlines that value them most, and they seek to achieve this by setting prices sufficiently high that other airlines are no longer interested in those slots; under secondary trading, airlines are able to buy and sell slots. Though existing slot holders do not have to pay for their slots, they nevertheless face an opportunity cost in the form of the revenues they forego if they carry on using a slot that could be sold instead to another airline.</p> <p>If market mechanisms were introduced at congested EU airports, we believe that higher passenger volumes would use existing airport facilities for the following reasons:</p> <p>a shift in the mix of services using congested airports, notably an increase in the proportion of long haul services, which, compared to short haul services, generally use larger aircraft, carrying a higher number of passengers, and often at higher load factors; within each category of service, a general shift to services with higher load factors. Within short haul services, for example, some regional services and services operated by full service carriers other than the hub carrier will be withdrawn, and more services will be operated by low cost carriers. Some of the least profitable long haul services will also be withdrawn; where possible, airlines will shift services to off-peak times or to uncongested airports. This is most likely to affect charter services and perhaps some long haul services, and will free up peak capacity for other services. For many services, however, shifting to off-peak times or uncongested airports will not be a realistic option; slot utilisation will also improve, as the increased fixed costs (including opportunity costs) of holding slots will encourage a more intensive use of slots by reducing the incidence of late slot returns and cancellations. In addition, the increased cost of slots at congested airports is likely to discourage airlines from holding onto more slots than they need (which they can do at present, provided they do not breach the 80-20 rule).</p> <p>Taking account of both the shift in traffic patterns and the improved utilisation of slots, our illustrative calculations suggest that these factors could increase passenger numbers ii</p> <p>Executive Summary</p> <p>at Category 1 airports by approximately 7 per cent. But for the reasons set out below, it is unlikely that any specific market mechanism will deliver all of this increase. While service levels on some routes will be cut, other routes may gain both from increased service levels and also from stronger and more effective competition (either from entrants on long haul routes or from low cost carriers on short haul routes). The cases where service levels are increased will more than offset those where services are reduced, and consumers will benefit from the increased volume of flights and from higher levels of service. This increase in services, combined with stronger competition on some routes, is likely to put downward pressure on airfares. These impacts are unlikely to be offset by the effect of higher slot costs, as these are mainly fixed costs and will not therefore affect the long run profit maximising fares structure for airlines. We therefore expect market mechanisms to lead to lower fares on average. Potential Mechanisms We have examined the potential ability of specific market mechanisms to deliver these improvements, and also the implementation costs and other effects of each mechanism. Secondary trading Under secondary trading, airlines have the ability to buy and sell slots from each other. As a secondary mechanism, it operates only after an initial (or primary) allocation has been established. It can also be applied, therefore, alongside the primary allocation mechanisms discussed below. But in the absence of a primary mechanism, any new slots will continue to be allocated on the basis of administrative criteria. We envisage that trading would take place as a result of bilateral negotiations between potential buyers and sellers. There might be a risk that deals would not take place, either because buyers and sellers could not identify each other or because airlines were reluctant to sell slots to their competitors. The first of these problems might be reduced in several ways, including the potential for independent agents to act as facilitators and to remain aware of each airlines willingness to buy or sell slots. And the second is less likely to occur in practice, as we would expect most of the potential slot sellers to be airlines that do not have such concerns. Secondary trading is likely to have low implementation costs and is unlikely to interfere with existing slot allocation and scheduling procedures. But because airlines are confronted only with an opportunity cost, rather than a cash outflow, the response in some cases might be delayed, or might not occur at all. Secondary trading might also be slightly less successful than primary trading mechanisms in promoting a more efficient use of slots. iii</p> <p>Executive Summary</p> <p>Higher posted prices Slot prices could be increased in order to reduce the extent of excess demand and ensure that sought-after slots are not allocated to low value services. The main difficulty, however, is that airport operators would have to forecast demand one year in advance, and might have little or no information about the way that airlines would be likely to respond to higher prices, at least during the early stages of adjusting from current charges towards market clearing levels. Higher posted prices would be set as a rate per slot per season (or shorter period for seasonal services), to provide incentives for airlines to use slots efficiently. To reduce the risk of setting prices too high and slots remaining unsold, we would expect prices to be set deliberately on the low side. But this means that prices might still fail to clear the market and therefore there would still be excess demand for some slots. The benefits of this approach might also be delayed, as we assume that prices would be raised only gradually. This mechanism would be relatively straightforward to implement, and would also provide incentives for airlines to use slots efficiently. But there is a risk that higher prices could lead to disputes, challenges and possible retaliation by non-EU states. Higher posted prices and secondary trading There could be additional benefits from applying secondary trading alongside higher posted prices. The ability to buy and sell slots might help to address remaining inefficiencies that result if higher posted prices fail to clear the market. But secondary trading is most effective when there are large differences between the buyers and the sellers valuation of a slot, and it may therefore only be partially successful in fine tuning the allocation of slots among those airlines willing to pay high posted prices. Both mech...</p>