CAA price control proposals for NATS (en route) plc (NERL)

These CAA price control proposals (240 pages, PDF) set out the proposed price controls on the UK's air traffic services (NERL) from 1 January 2011 to 31 December 2014 for the Eurocontrol and Oceanic services.

The CAA proposes an extension to the London approach element of the price control (part of the Eurocontrol service), so that it includes London City Airport and London Luton Airport. In addition, there is a proposal for a separate revenue pot for the London approach which will be deducted from the calculation of the allowed revenue for the Eurocontrol en route charge.

Cap on gearing

The CAA proposes a cap on the gearing level in order to ensure the financial resilience of NERL in carrying out its air traffic services to users. The cap would have two elements:

There is also a proposal to provide a tax clawback mechanism. This will reduce the incentive to increase gearing in order to benefit from the debt interest tax shield. It is calculated as the difference between the corporation tax costs estimated in the cost of capital determinations and the estimated corporation tax costs incurred at the higher level of gearing. The clawback will lower the regulatory asset base. This option was chosen by the CAA over the option to increase the target credit rating for NERL. This option was rejected on the grounds that the financial resilience of NERL to carry out its duties was not aligned with the ability of NERL to finance its debts.

Allowed rate of return

The CAA proposes a real pre-tax WACC of 7.5 per cent, largely based on a report for the CAA by Europe Economics (70 pages, PDF). The CAA has departed from the recommendations set out by Europe Economics in some cases. For example, the CAA have proposed an equity risk premium (ERP) of 5.5 per cent compared to 5.25 per cent from the Europe Economics report. The CAA does not provide any real justification for this departure, simply stating that there is continued uncertainty within financial markets and increased concerns over sovereign risk. The 5.25 per cent estimate from Europe Economics was calculated on the basis of an equity risk premium of 5 per cent with an extra allowance of 20 per cent for the financial crisis (therefore corresponding to a equity risk premium of 6 per cent), which was estimated to affect one quarter of the next regulatory period.

The CAA also proposes setting the same WACC for the two branches of NERL's business, despite the Oceanic service being exposed to a higher level of systematic risk due to its lack of traffic risk sharing arrangements. The brief reasoning given for this is that to set different WACCs would require a level of accuracy that is within the margin of error of the WACC estimate and that it would merely reapportion the revenue allowance, rather than change the overall allowance.

For further information or advice please contact Richard May.

Filed under CAA, Price controls.

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