The Market in Slots

In April 2012, International Airlines Group SA, the owner of British Airways and Iberia, bought UK airline British Midland International from Lufthansa. This deal was important, not so much because a major UK airline operator bought a loss-making competitor from a European operator desperate to discard it, but because the deal included BMI’s 56 daily slot pairs at Heathrow airport, nine percent of total Heathrow slots.

The reason why the slot factor was critical is that airlines that operate out of congested hub airports with no available slots cannot grow unless they can somehow expand their slot portfolios. Both British Airlines and Virgin Atlantic use Heathrow as a hub and they need slots at Heathrow in order to grow. The only way for them to obtain slots is to buy or rent them from other airlines, or acquire airlines that have slot allocations. This situation led to a bidding war between BA and Virgin Atlantic for the BMI slots.

A slot is the right that is held by an airline or aircraft operator to land at or take-off from a congested airport. It includes right of access to the airport terminal for the airline’s passengers and crew. Slots are usually grouped in pairs, covering both take off and landing at a particular airport at specific times of day.

The current slot system was formalised over previous decades. Slots were originally granted to airlines by national or local air traffic regulators at no charge. The result has been that major airlines now hold large portfolios of slots at congested airports, based on grants of slots to them many years ago, and on their historical use of those slots. These slot holdings give these airlines much leverage over the transportation market at the airports in question, as well as the market power to exclude or limit the activities of competitor airlines at those airports.

Valuing slots

The indispensability of slots for airline operation at busy airports had given rise to the idea that slots are a kind of property that should be valued and included as an asset on an airline’s balance sheet, and that may be bought and sold. While there have been deals involving the purchase and sale of slots, balance sheet valuation has proved problematic.

In the past few airlines that were not involved in buying and selling slots included the value of slots in their financial statements. They reasoned that inclusion was not warranted because the slots had been acquired by grant from aviation authorities, and not by purchase. Where slots have been purchased, however, the cost of the slots or their value has often been included in airline accounts. This practice has been in line with US and international accounting standards requiring slots to be valued and recorded in a balance sheet, when two airlines are combined.

Recently, however, with slots becoming scarcer and apparently more valuable, some airlines that did not feature slots as a balance sheet asset, and encouraged by their accountants, began to think that an asset of significant value was being left off balance sheet and that an opportunity to boost airline value was being missed.

The case of the BMI slots is significant. BMI had incurred losses for several years when Lufthansa decided to sell the airline. One of the main factors in the sale was BMI’s Heathrow slots, because Heathrow has a severe slots shortage as it is operating at full capacity and airport expansion by way of construction of a third runway has been ruled out by the UK aviation authorities.

In 2008, before Lufthansa’s purchase of BMI, the airline valued its Heathrow slot portfolio at £770 million, out of a total book value for the airline of £800 million. In 2009, Lufthansa acquired 80 percent of BMI for £223 million, implying a total value for BMI of £279 million. Lufthansa’s 2010 accounts reported gross assets for BMI of €284 million, consisting mainly of the Heathrow slots and the BMI brand. In 2011 Lufthansa revalued the BMI slots at €239 million, out of a total value of €255 million for BMI’s intangible assets. But of this value, Lufthansa wrote off €150 million as an impairment loss, leaving the Heathrow slots with a book value of a mere €74 million at the time of BMI’s sale to AIG. The AIG sale agreement set the price of BMI at £172.5 million, to be reduced to take account of restructuring costs of BMI that AIG would have to incur. These reductions ultimately resulted in a final purchase price that was negative by €130 million, implying that Lufthansa paid this amount to IAG to take BMI over. The value of the BMI slots appeared to have fallen to zero.

The history of the BMI slots implies that the value of the slots diminished over time, until they were worth little if anything. Lufthansa blamed its inability to extract value from the BMI slot portfolio on the UK air travel market, and capacity limitations at Heathrow. Lufthansa maintained that the Heathrow slots were of great strategic value, but said that the outlook for BMI was difficult because of structural factors in the UK aviation market and at Heathrow. For this reason, said Lufthansa, it had not been possible to realise the full strategic value of BMI’s slots.

EU slots proposals

The European Union has a set of rules governing airport slots, but the slots system is ultimately regulated by individual EU Member States Each state has a slot coordinator who allocates slots at each airport in that state. The system is not unlike that in the USA, where since 1985, the FAA has had the role of assigning slots to airlines on the basis of historical usage and controlling the trading of slots among airlines.

Allocation in the EU is based on historical usage, meaning that an airline that used slots in the past can continue to use them in the future, provided that it adheres to an 80 percent actual usage regime, so that if it operated at least 80 percent of a series of slots in a carriage season, then it has the right to use those slots in the next season. When new slots become available because of more efficient air traffic control or because an airline abandons slots that were allocated to it, these freed up slots a placed in a pool and are allocated on a preferential basis to airlines that are looking to start up operations at the airport concerned.

The European Commission has recently proposed changes to this system. The Commission’s objectives in making these proposals seem praiseworthy. It wants to enable airlines to trade slots with each other at airports anywhere in the EU; to establish conditions for the transparent trading of slots, so that all market competitors will know what slots can be bought and sold; to help new entrants to gain access to markets at congested airports; to allow more airlines to challenge more effectively dominant carriers which have a big presence at busy airports; to make it harder for airlines to demonstrate that they have made enough use of their slots during a carriage season; to increase the slot utilisation threshold from 80 percent to 85 percent. aiming to impose a stricter discipline on airlines by tightening the rules requiring them to demonstrate that they have used their slots sufficiently during a season; to tighten the rules on the independence of slot coordinators and increase the transparency of slots transactions, in order to make the market in slots work better; to improve the information flow between slot coordinators, airports, airlines, national authorities and air traffic control organisations; to improve decision making on airport coordination and to allow the European aviation system to react more effectively to disruptions caused, for example, by severe weather conditions.

The most important of these proposals is the proposal to facilitate the trading of slots between airlines. Existing EU regulations do not provide for trading of slots between airlines, but nor do they specifically ban slot trading. While slot sales have been allowed informally in some EU member states such as the UK, trading has not become formalised and is even prohibited by some EU aviation regulators, such as those in Spain. The result has been that over time, many different practices have evolved across the EU, impeding any real slot market development and limiting the efficiency of the European airline industry.

Is a market in slots feasible?

In theory, some kind of liquid market in slots is probably possible. Significantly, when European airlines and airline associations were surveyed about the EU Commission slot proposals, their response was that they were satisfied with the functioning of the current system, and so most of these companies and organisations said that they did not support the proposals. They felt more concerned about the shortage of airport capacity, which they said the EU proposals did not address. This response does not seem to bode well for the development of an active market in European airport slots.

Moreover, experience with slot deals is that they tend to be complex and highly negotiated, rather than the outcome of a smooth market. This is shown by a recent deal in the US. In December 2011, Delta Airlines exchanged 132 slot pairs at New York’s La Guardia Airport for 42 slot pairs controlled by US Airways at Reagan National Airport in Washington DC, with Delta receiving and additional $66.5 million in cash as well as the right to operate a route between the US and Brazil. The deal was negotiated over a period of many months. Not only did the direct deal have an elaborate structure, but in addition and as a condition for approving the deal, the FAA compelled Delta and US Airways to sell some of their remaining slots at both airports. The result was that JetBlue purchased eight slot pairs at both airports for $72 million, and WestJet bought eight slot pairs at La Guardia for $17.6 million.

Rather than pointing to slots being a standardised product that could be traded in a liquid market, this transaction points to trading of slots being complicated and onerous. Nevertheless, with the right trading mechanism, reduced regulator involvement, industry participant determination and realistic valuations, a market in slots could be a real possibility.

Published in Airline Economics, May-June 2012.