Heathrow charges to fall by almost 20% in 2024

The CAA airport charges decision is finally published

The long-running saga over Heathrow’s charges reached a new milestone when the airport’s regulator, the CAA, finally released its “Final Decision” about charges for the next three years. The decision was to cut prices in real terms for the 2024 to 2027 period by 19.3% compared to 2023, an outcome that prompted the predictable apoplectic response from the airport:

“The CAA has chosen to cut airport charges to their lowest real terms level in a decade at a time when airlines are making massive profits and Heathrow remains loss-making because of fewer passengers and higher financing costs. This makes no sense and will do nothing for consumers at a time when the CAA should be incentivising investment to rebuild service. We will now take some time to carefully consider our next steps.”

Although it seems like a victory for the airlines, it sounds better than it really is. 2023 charges were set at a historically high level of £31.32, 37% higher than the 2019 charges of £22.91. Compared to that pre-pandemic level, the new charges will still be about 11% higher. And further inflation adjustments will be applied in 2024 and beyond. The CAA’s forecast for outturn charges in 2024 was £25.43, which I believe assumes a CPI increase of only 0.6% for 2024, based on official government forecasts for inflation. It could clearly be worse than that.

Part of the reason that the interim charges for 2023 were set as high as they were was the passenger volume assumptions that were used. A lot of an airport’s costs are fixed, so the higher the passenger volumes assumed, the lower the charges and vice versa. I wrote at length about how this played out with volume forecasts for 2022 in a previous post. The TL;DR of that post was that Heathrow always puts forward stupidly low volume forecasts, the airlines counter with a somewhat optimistic forecast and the CAA splits the difference comes to its own considered opinion. However, whatever the process that the CAA uses to prepare its forecasts, in recent years it has consistently produced numbers that seem obviously too low to me.

We got some new passenger volume forecasts for 2023 and beyond as part of today’s announcement. Are there any signs that the situation has improved at all?

Passenger volumes for 2023 - 2026

Here are the passenger volume forecasts published today by the CAA.

Source: CAA

To get us warmed up, let me start with the figures for 2022.

2022 passenger volumes

The CAA figure for 2022 of 61.6m is the actual outcome. The airline forecast made half way through the year was 7% too high. Assuming the airlines had the July actual figures at the time, that meant that they overestimated the August - December numbers by 11.6%. That does look like a deliberate over-estimate to me and I think would have damaged their credibility with the CAA. As I documented in my earlier articles, my own forecast for the year stayed in the 60-61m range from the end of December 2021 onwards. I can’t believe the airlines really believed that 65m was a reasonable forecast.

But that behaviour pales into insignificance compared to Heathrow’s. In June 2022 the airport was forecasting only 54.4m passengers, a figure that the CAA basically accepted as the basis for setting interim charges for 2023. That forecast underestimated volumes for the June-December period by 17%. Assuming Heathrow knew the November actual numbers when they produced their December 2022 forecast, they under-estimated volumes for the month they were actually in the middle of by 15.3%. I think that the fact that they submitted such a forecast to their regulator shows the level of contempt they had for the CAA and the process.

2023 passenger volumes

OK, let us move onto 2023. Heathrow has already increased its forecast slightly from 66.6m to 67.2m, a figure it announced as recently as February 23, when the company released its results for 2022. It said this was the central forecast and the possible range was between 58m and 73m. Stated in terms of a percentage of 2019 levels, the central forecast is 83% and the range is 72-90%. The airline figure quoted above by the CAA would represent 99% of 2019 volumes. The CAA has gone for a figure almost exactly half way between the two of 73m, which would represent 90% of 2019 volume.

Back in mid January, after Heathrow released their final passenger number figures for 2022 of 61.6m passengers, I wrote about what I was expecting for 2023. I said that a "credible range" for passengers was 73-77m (90-95% of 2019) and that I expected the outturn to be 75m (92.7%) or better. At least Heathrow, the CAA and I finally agree on one thing, which is that 73m passengers is a possible outcome for 2023. But for me, it is a "worst case" scenario, for the CAA it is a "mid case" scenario and for Heathrow it is a "best case" scenario. You couldn't make this up.

We now have a bit more data than we did in January. We have actual traffic stats for January and the published capacity statistics have had time to settle down as airlines have finalised their summer schedules. Passenger volumes for January came in at 92.5% of 2019, so better than Heathrow's "best case" scenario (which they published after having already seen those figures). Capacity in January was at 94% of 2019, so load factors were marginally down. Published capacity for the whole of 2023 now stands at 98% of 2019, unchanged from a couple of months ago. Here’s the data for seats, flights and passengers as a % of 2019:

Source: Heathrow published statistics, airline published schedule data

You can see that the capacity recovery continues month by month, as you would expect. As well as the seat capacity figures, which give you the passenger volumes if you assume a load factor, I’ve also shown the flight numbers as a % of 2019. Given that airlines need to use their slots, or lose them, there are lots of reasons to believe that flight numbers will be close to 2019 levels. The figures in November/December 2023 will probably fall back a bit as tactical cancellations are made by airlines closer to the day of operation, but summer schedules should now be solid, barring operational disruption. Heathrow’s largest operator, British Airways, has given guidance to its investors that it expects to get back to 2019 levels of capacity by the end of 2023.

For the January - September period, published capacity is 97% of 2019. The final quarter is less certain but will probably at least match that. So even allowing for load factors being slightly down, I think a passenger forecast of 95% of 2019 levels now looks quite conservative to me. That would give you 76.9m passengers, right at the top of my 75-77m range from the earlier article. Whilst I don't think we'll hit the airline forecast of over 80m, it could get quite close to that magic figure.

So once again, I think the CAA’s split the difference approach sophisticated forecasting model seems to be clearly underestimating passenger volume forecasts for 2023. Which means that despite the reductions, the charges are higher than they should be.

Passenger volumes for 2024 - 2026

It is obviously a lot harder to forecast volumes for the last three years. A lot can happen in that time. But if you accept my arguments that the 2023 outturn will be around 77m or better, the CAA’s forecast of 78.9m for 2024 also looks remarkably “conservative”, representing a growth rate of less than 2.5% for an industry that is still in recovery mode. Under the CAA forecasts, it takes until the final year of 2026 for Heathrow to regain its 2019 volume levels. That ignores a whole bunch of what to me are obvious structural shifts. Virgin Atlantic has consolidated its operations at Heathrow, using slots sourced from its partners such as Air France. It is operating much bigger aircraft on those slots than Air France did. In 2023, Virgin’s Heathrow seat capacity will be over 30% higher than in 2019. Flybe has gone bust again. The BA slots it was using under the EU remedy provisions (related to IAG’s takeover of bmi) will most likely be operated in future by bigger aircraft, whether by BA or other carriers. In the face of rising emissions costs, airlines are shifting to larger aircraft sizes to drive down their per seat costs. In my opinion, Heathrow will get back to 2019 volume levels very soon. The only question is how far above those levels can be achieved, given the runway constraints.

Of course, there could be another downturn in the industry which puts a dent in volumes. You don’t need me to list all the economic and other risks. But overall, I would say that the CAA passenger forecasts, on which it has based its charging decision, look too low to me.

Other assumptions

There are lots of other “building blocks” which make up the overall CAA decision on charges. In the interests of getting this post out in a timely way, I won’t go into them here. Maybe I will find the time to look at some of those in a later post.

Financeability

At the heart of the question of whether the charges that the CAA has set for Heathrow are too low or too high is the question of “financeability”. Can the airport cover its costs and finance the investment that users of the airport wish to see?

As we saw earlier, the airport complains that with the charges at the level set by the CAA, it will not be able to simultaneously invest, support its debt and pay dividends to its shareholders. It threatens that it is the investment side of this that will have to be cut. Whilst I have been a little critical of the CAA in relation to the passenger volume forecasts, I did completely agree with this statement that they included in today’s decision, which I thought was the perfect response.

“As we have noted above our assessment of financeability has been carried out on the basis of a notional company with a level of gearing of 60%. In 2022, the gearing of Heathrow Funding Limited was higher than this and it is for HAL’s management and shareholders to manage the consequences for HAL’s financing of higher levels of gearing. We note that during the pandemic, HAL’s ultimate owners have not supported the group with additional equity finance, in contrast to the shareholders of many aviation businesses.”