Treasury Committee House of Commons, Committee Office, 14 Tothill Street, London SWlH 9NB Tel 020 7219 5769 Fax 020 7219 2069 Email treascom@parliament.uk Website www.parliament.uk/treascom

Rt Hon Philip Hammond MP Chancellor of the Exchequer HM Treasury 1 Horse Guards Road London SWlA 2HQ

Copy: Rt Hon. Chris Grayling MP, Secretary of State for Transport

8 December 2016

The economic case for airport expansion

Thank you for your letter of 12 October regarding the economic case for airport expansion.

Twelve months ago I tabled questions in Parliament, asking for information crucial to an

assessment of the relative merits of each proposal in the Davies report to be re-produced.

Some of these questions have been addressed in a document intended to inform the

announcement of the Government's decision to endorse expansion of Heathrow - published

on 25 October. 1 These include an assessment of the extent to which the cost of each scheme

would be passed to passengers in higher fares, and the percentage changes required for the

net present values of each of the three shortlisted schemes to equal zero. This is not before

time.

The Government's decision to endorse Heathrow initiates consultation, prior to a vote to

approve it by Parliament. It is crucial that this process is transparent and accountable.

The cost benefit analysis presented in the Davies Report has been restructured by the

Government in several ways. This leaves some of the questions in my letter to you

1 The background and rationale for the Government's support of Heathrow's north-west runway as the preferred option for south-east airport expansion can be found at https://www.gov.uk/government/collections/heathrow-airport-expansion. 'Further Review and Sensitivities Report: Airport Capacity in the South East' addresses some of the points previously raised by the Committee.

unanswered. It also raises a new one. Accordingly, the Committee would welcome your

response to the following:

Outstanding questions

The economic case under 'different scenarios'

In a document intended to inform. the announcement of the Government's decision to

endorse expansion of Heathrow - 'Further Review and Sensitivities Report' - it is stated that

'the direct passenger benefits are particularly sensitive to the different global demand

scenarios', and that 'the Net Present Values (NPVs) for some of the options could potentially

be negative under some demand scenarios'.2 However, in its reassessment of the

commission's economic case, summarised in Table ES.2 of this document, the Government

has only considered one scenario: 'assessment of need, carbon traded'.

I would be grateful if you could reproduce Table ES.2 of the 'Further Review and Sensitivities

Report' under the four alternative growth scenarios determined by the Airports Commission:

(a) global growth, b) relative decline of Europe, c) low-cost is king and d) global

fragmentation.

Appraisal Periods

The Government's guidance on demand and revenue forecasting states:

When forecasting demand, it is important that, to ensure consistency between

appraisals, a demand cap is used. In the majority of cases, demand growth should be

capped after a 20 year period from the year the appraisal is undertaken ( e.g. an

appraisal carried out in 2013/14 would be on the basis of demand capped in 2033/34).

Sensitivities of 10 and 30 years of growth should be presented. Under exceptional

circumstances, such as with long-term infrastructure projects, it may be appropriate

2 'Further Review and Sensitivities Report: Airport Capacity in the South East', Department for Transport, p.41

to use a different demand cap. In these cases advice should be sought from Off. (TAG

UnitAS.3)3

The Airports Commission has not capped demand growth after 20 years, instead allowing it

to continue but at a slower rate other than in a single sensitivity test. This is not in line with

the guidance issued by the Department for Transport. I would be grateful if you could:

• reproduce ES.2 of the 'Further Review and Sensitivities Report', capping demand after

a period of a) 10 b) 20 and c) 30 years; and

• reproduce ES.2 of the 'Further Review and Sensitivities Report' using an appraisal

period of a) 10 b) 20 and c) 30 years.

I would also be grateful for an assessment of the likely effect on the overall economic case of

the changes made above.

Agglomeration benefits

I would be grateful if you could make an assessment of the effect on the conclusions of the

Airports Commission's Final Report of the Commission's decision not to take account of

high value-added international sectors in measuring the agglomeration benefits of the three

shortlisted projects.

Choice of investment measure

The Government has made a number of changes to the cost-benefit analysis to make the

Airports Commission's assessment of costs and wider economic impacts more consistent

with its appraisal guidance for transport projects, WebTAG. This has had the effect of

reducing the difference in NPV between the three shortlisted schemes that the Airports

Commission argued clearly favoured the economic case for expansion of a third runway at

Heathrow.

3 TAG UNIT AS.3 .3 Rail Appraisal, Department for Transport, December 2015, p.2

The results illustrate the difficulty of reaching a clear decision on the basis of the economic

case alone. As the 'Further Review and Sensitivities Report' states, 'there is little difference in

the NPV s of the schemes when considered over a 60 year appraisal period' and 'the net

differences are small, with LGW Second Runway delivering the highest NPV at the lower end

of the range, and LHR Northwest Runway delivering the highest NPV at the upper end of the

range in the central case'.4

I would be grateful for your response to the following questions:

• When considering the economic case, what interpretation and weight is put on each

of the investment measures - net present value, net public value, net social benefit and

total benefits - presente~ in Table ES.2 of the 'Further Review and Sensitivities

Report' in informing your decision about the value for money represented by each

proposal?

• The report indicates that the net public value investment measure was included as a

result of a request from the Treasury. Why did the Treasury propose net public value

as a measure for consideration in this review? Can you provide any examples where

net public value has previously been used as a measure to assess the cost-benefit case

for major infrastructure projects?

I will be putting this letter, and your response, in the public domain.

RT HON ANDREW TYRIE MP CHAIRMAN OF THE TREASURY COMMITTEE

4 'Further Review and Sensitivities Report: Airport Capacity in the South East', Department for Transport, p.40