Civil Aviation Authority

Ltd

Q6 Capex Review Heathrow Airport

Final Report

November 2013

Contents Executive Summary 1. Introduction

1.1 Background 1.2 Q6 price control process 1.3 HAL’s FBP, RBP and ABP

2. Review of cross-cutting issues 2.1 Background 2.2 Constructive Engagement 2.3 Project costing

2.3.1 Definition of cost 2.3.2 Estimating procedures 2.3.3 Base and project specific costs 2.3.4 Project on-costs 2.3.5 Risk allowances

2.4 Benchmarking 2.4.1 Principles 2.4.2 Benchmarking for the regulatory settlement 2.4.3 Benchmarking in practice 2.4.4 Summary

2.5 HAL’s Gateway process 2.6 Procurement

2.7 Development and core capex 2.8 Independent Fund Surveyor 2.9 Integrated Baseline Reviews

2.10 Post-project reviews

3. Assessment of Q6 capex programme 3.1 Methodological approach 3.2 Q6 joint priorities 3.3 Airline affordability 3.4 Historic and current QSM scores 3.5 Proposed HAL project portfolios – RBP and ABP 3.6 LACC/AOC capital plan 3.7 Individual airline views 3.8 Review of selected projects 3.8.1 T2A Phase 2 and T2C 3.8.2 T3 refurbishment and enhancement 3.8.3 T4 infrastructure Improvements 3.8.4 T5 security capacity 3.8.5 Northern Perimeter 3.8.6 Enabling the new generation of wide-bodied aircraft 3.8.7 Airfield efficiency and resilience 3.8.8 Commercial IT and telecoms 3.8.9 Automation of the passenger journey 3.8.10 De-icing facilities 3.8.11 Additional fuel infrastructure 3.8.12 T3IB (roll-over) 3.9 Timing and profile of expenditure 3.10 Differences between HAL and airline priorities

3.10.1 Current position 3.10.2 Q5/Q5+1 roll-over projects 3.10.3 Airfield/resilience projects 3.10.4 T1 & T2 projects 3.10.5 T3 projects 3.10.6 T4 projects 3.10.7 T5 projects 3.10.8 Terminal (non-specific) projects 3.10.9 Baggage projects 3.10.10 IT projects 3.10.11 Surface access projects 3.10.12 Other projects

3.11 Conclusions

Appendices Appendix A: Comparison of preliminary HAL and LACC/AOC Q6 capex plans

Appendix B: HAL’s RBP/ABP – Project Gateway status (as at 19 July 2013)

Appendix C: Airfield map (effective July 2013)

Appendix D: Glossary

Appendix E: Terms of Reference

Executive Summary

1) This Final Report has been prepared by Alan Stratford and Associates Limited (ASA) on behalf of the UK Civil Aviation Authority (CAA). It provides an assessment of Heathrow Airport Limited (HAL)’s proposed capital expenditure (capex) programme for the quinquennial period from 1st April 2014 to 31st March 2019 (designated as Q6). The review forms part of the CAA’s statutory requirement to establish the potential level of any price cap at regulated airports.

2) HAL has prepared three capital plans for Q6. A Full Business Plan (FBP) with

a capital project portfolio amounting to £3 billion over the five year period was submitted to the CAA in January 2013. HAL regarded the level of the WACC (weighted cost of capital) shown in the CAA’s Initial Proposals for Q6 as unacceptable to its shareholders and subsequently prepared a Revised Business Plan (RBP) with a reduced capital portfolio amounting to £2 billion. At the request of the CAA, HAL has also prepared a third business plan, its Alternative Business Plan (ABP), representing an update of its earlier £3 billion FBP, but has limited the projects it is progressing through its Gateway approval procedure to those in the RBP.

3) Our assessment excludes all asset replacement projects during Q5, which are

evaluated in a separate study for the CAA. The total portfolio of non-asset replacement projects in the FBP amounts to £1.5 billion, the RBP to £0.7 billion and the ABP to £1.6 billion

4) We recognise that there has been an extensive two year period of Constructive

Engagement for Q6, in which many of the project preparation and delivery processes were jointly agreed with the airlines and the priorities and objectives for Q6 were set. This has been well-documented in the Q6 Capital Efficiency handbook. Despite a broad level of agreement over the capital delivery procedures for Q6, there are still substantial differences in the scale of the capital investment, with HAL now opting for a £2.0 billion plan and the LACC/AOC preferring a £3.1 billion plan

5) There has been some refinement of the project cost estimating process for Q6,

although this is largely dependent on HAL’s estimating cost database, which comprises some 400 facilities costs, broken down by differing degrees of granularity. Of these 160 facilities relate to Heathrow, with the others those of other airport or non-airport facilities. In general, however, there is a strong influence of Heathrow (and other BAA or ex-BAA) facilities within this database which could distort the estimates if, for example, there was a Heathrow factor within the costs. HAL has also advised that their cost consultants and suppliers provide a further source of cost information

6) We note that HAL has set target reductions of between 1.6% - 2.7% in its add-

on percentage for project on-costs. These on-costs include the allocation of the staff costs of HAL’s Capital Solutions division. We note that the Q6 capital budget is likely to be significantly less than that in Q5, so a considerable reduction in staff numbers will be needed. We also note that project on-costs include early design costs and we would recommend that these should be allocated directly against project cost rather than in an on-cost ‘pot’

7) HAL’s estimating cost database provides the main source of information supporting their benchmarking process, although occasionally an external benchmarking report on a specific project is commissioned. Since this database was established HAL have firmed up their definition of project cost. They have not, however, reviewed data generated prior to this (and held in the database) so that structural and cost allocation adjustments can be made. It is considered, that for certain project types, this process is undertaken to ensure that benchmarking data can be used in a more meaningful, proactive way. HAL has responded to this by stating that adjustments to historic data did not justify the significant amount of work required. The labelling of data in the database also needs to be reviewed along with identified scope of works to ensure that relevant data is selected for use in benchmarking. It is understood that the Works Breakdown Structure and Data Collection templates have been reviewed and reissued to address this issue.

8) HAL undertake benchmarking in order to generate confidence in their estimates. The process appears to be used as a means of validation of bottom line cost. The data and process could however be used to much greater effect to drive through value. It is considered that a more dynamic approach could be adopted without too much impact/inconvenience on workload.

9) All project cost estimates take account of risk (and opportunity) costs through an appraisal of the key risk elements, their likely probabilities and their cost impacts. In Q6, HAL intend to cost projects on a P80 basis during the development phase (ie up to Gateway 3). Once projects transition through Gateway 3, they will be recosted on a P50 basis. This is expected to result in a build-up of surplus funds at the development phase which could be re-allocated to projects by mutual agreement with the airlines.

10) The introduction of and Independent Fund Surveyor (IFS) role is a new concept

for Q6. The IFS (or IFSs) will be appointed jointly by HAL and Heathrow AOC Limited and will provide an independent monitoring role for all key project expenditure during Q6. The funding for the IFS will be provided through HAL’s capital budget for Q6. We regard the IFS as a positive step in ensuring capital efficiency, although we note that in their RBP HAL has significantly reduced the budget (to £3.0 million). This reduction is strongly rejected by the LACC/AOC

11) HAL recognise that the reduced capital programme in the RBP would mean it

would be unable to fulfil its vision and priorities for Q6 as agreed with the airlines during Constructive Engagement and set out in the FBP. The focus in the RBP is to maintain its current position in terms of the passenger experience, resilience and hub capacity rather than endeavour to improve these to develop Heathrow as ‘Europe’s hub of choice’ as set out in the FBP. The LACC/AOC have indicated that they totally reject these new priorities which were not agreed with them

12) In terms of phasing, a higher proportion of expenditure in both the RBP and the

ABP is theoretically incurred in the first two years, rather than the following three years of the quinquennium. It should be noted that, at present, many Q6 projects are in their infancy, so it would be a challenge for HAL to meet this timetable

13) We have prepared a detailed review of 12 major projects in Q6. These

represent some 53% of all non-asset replacement capital expenditure in the RBP and 57% in the ABP

14) The Terminal 2 project commenced in Q5 with the partial construction of the main T2A building and completion of the satellite pier, T2B. In Q6, two projects are proposed - completion of T2A Phase 1 (ie the roll-over costs) and T2A Phase 2 / T2C

15) In the case of the T2A Phase 1 roll-over costs, there are differences in the

project scope between the ABP (£159.7m) and the RBP (£55.1m). In the latter case, it is proposed not to complete two stands (Stands 234 / 235) or provide a through taxiway (Kilo taxiway) linking T2A and T2B until T7. This will result in a loss of pier service and increased taxiing times. The LACC/AOC opposes this and we concur that it is not sensible to build new rectilinear terminals and satellites and not to connect these properly.

16) There is also a substantial difference between the T3A Phase 2 / T2C costs in

the ABP (£219.8m) and the RBP (£5.0m). The project scope in the ABP covers the preliminary works (tunnelling etc) necessary for the next stage of the T2 project. In the RBP, the cost covers just the necessary planning permissions etc required for the next stage of work. The reduced project scope would delay the overall T2 programme by about two years, which HAL acknowledge would impact pier service levels in Q7/Q8, although they have not quantified this. It is our view, however, that the work could be delayed until Q7.

17) HAL has allocated a budget of £36.7m for a new transfer security facility in T3

in both the RBP and ABP. The ABP also includes a further £41.0m for other improvements to this terminal. With an expected future life of some 20-25 years, it is recognised that Q6 is the last opportunity for significant investment in T3. The LACC/AOC plan includes these improvements together with some £11.0m expenditure on new facades in the South Wing and Arrivals areas.

18) A budget of £52.8m has been included in the RBP for infrastructure

improvements to T4. This rises to £72.0m in the ABP. Both the RBP and the ABP cover the upgrading of two stands to Code F (A380) capability together, the joining of Reclaim Belts 6 &7 to cater for A380 operations and an upgrade of the LV system. The A380 requirements are based on known future A380 operations by T4 carriers and the LV upgrade is required for safety reasons – so these items are clearly essential. The ABP also includes a new coaching gate (1B), the refurbishment of the Arrivals Hall and Forecourt and new HV infrastructure. The LACC/AOC plan includes further expenditure on the short stay car parks and the Immigration Hall. We understand that the proposed increase in the capacity of T4’s short stay car park would also be used for any overspill resulting from a shortage of capacity in the long-stay car park. On balance, we believe that this additional expenditure is justified – and we note that HAL endorsed expenditure on improved T4 car parking in their initial Q6 business plan..

19) A project to improve transfers security in T5 has been significantly refined since

the FBP and is included at £23.0m in both the RBP and ABP. HAL has some further £8.0m expenditure allocated to T5 in the ABP (£5.0m for expansion of the CIP lounges and £3m for baggage reclaim improvements for A380 flights). The LACC/AOC has a significantly higher budget (£210m) for T5 improvements including a further £65m for the CIP lounges and £70m for an extension to the T5C satellite pier. Much of this expenditure, however, is dependent on the BA’s future A380 fleet operations – particularly whether it exercises its options for a further seven aircraft. Given these uncertainties, we remain unconvinced that the full £210m budget is justified.

20) A £10m project to provide additional car parking space along the Northern Perimeter road is shown in both the RBP and ABP and is accepted by the airline community. The ABP also includes a £20.2m project to extend the PRT (Passenger Rapid Transit) system from the business car parks to the CTA (Central Terminal Area). The airlines, however, feel that this would not represent value for money as it is not an effective means of transporting passengers. In our view, this project might perhaps be commercially viability – but the case is difficult to prove – and, in view of the budget constraints should be excluded,

21) The project ‘Enabling wide-bodied growth’ is a mix of airfield works including

taxiway widening for A30 aircraft, runway RETs (Rapid Exit Taxiways), a runway RAT (Rapid Exit Taxiway) and new remote stands. £86.8m is budgeted in the RBP and £182.7m in the ABP. The LACC/AOC is not in favour of the reduced scheme as the lack of remote stands would impact pier service in T2, the lack of the RETs would impact punctuality and congestion, whilst the RAT is an enabler for the ending of the Cranford Agreement and would improve departure rates on Runway 09L

22) The ‘Airfield efficiency and resilience’ project is a collection of IT and modelling

initiatives by HAL in conjunction with NATS designed to improve airfield efficiency. A budget of £70.7m is allocated in the ABP and £29.0m in the RBP reflecting a reduced selection of initiatives. The LACC/AOC feels that the full £70.7m budget is required. We concur with this, with the proviso that suitable commercial agreements with NSL and NCRL can be reached

23) The project ‘Automation of the passenger journey’ covers replacement of the

existing CUSS (Common User Self Check-in) machines and the introduction of self bag drop, self boarding gates and information kiosks at the airport. The budget in the ABP is £60.0m to cover partial introduction of these technologies and £8.5m in the RBP for CUSS replacement only. The LACC/AOC attaches considerable importance to this project and has allocated a budget of £120m. In our view this is justified, apart from the self-boarding gates which have a low passenger priority and relatively small opex savings. We believe a budget of £80.0m - £90.0m would be more appropriate.

24) A project for remote de-icer pads at the runway holds has been under

consideration for some time following the Begg Report on winter resilience at Heathrow, but was not included in the FBP or RBP. A budget of £48.0m is now shown in the ABP. The project would appear to be justified – although there is concern that a suitable commercial arrangement for their operation has not been agreed with the airlines

25) A commercial project to provide a common 4G IT infrastructure and

improvements in LAN/WLAN connection speeds across all Heathrow’s terminals is budgeted at £14.0m in both the RBP and ABP. It is expected to deliver a total EBITDA of £13.7m in Q6 and is included in the LACC/AOC separate ‘C’ list of commercial projects with a full payback in Q6

26) A £28.6m project to cover the enabling works for new fuel storage

infrastructure was shown in the FBP but was subsequently removed from the RBP and ABP. In reverse to the existing business model, HAL now contend that the enabling works should be borne by the fuel companies themselves and then passed through to the airlines in the fuel price. The LACC/AOC has included the full cost of the infrastructure (£130m) in their capital plan. We can

see no reason, however, why the existing business model should no longer apply and we therefore support this project on this basis (ie with a budget of £28.6m). We recognise, however, that further commercial negotiations with HAFCO are required to bring this project to fruition.

27) We have undertaken a preliminary review of the roll-over costs of T3IB

(Terminal 3 Integrated Baggage Facility), which is costed at £35.0m in the RBP and ABP. These roll-over costs are derived from a recent £75.0m cost estimate increase, bringing the total estimate cost of the project to £435.0m. The airline community has made strong representations to the CAA about this (and previous) cost increases for the T3IB project. Our preliminary assessment suggests that some £41.5m of the £75.0m cost increase is not substantiated and that therefore there is a prima facie case for the CAA to reject these roll-over costs from the Q6 capital budget. It should be noted, however, that some of this £41.5m unsubstantiated cost has or will occur in Q5+1, with the remainder in Q6.

28) In terms of the forthcoming Q6 settlement, we feel that If HAL and the airlines

were to agree that a capex budget of around £3 billion were acceptable within the overall framework of Q6, there could be agreement on the project portfolio itself, although there remain important differences between the ABP and the Airline Plan. It should be noted, however, that many of the proposed projects are relatively immature (ie at Gateway 2 or earlier), so changes in project scope and/or costs may still occur through mutual consent.

29) We also believe that there may be some scope for a reduction in a £3 billion

budget if this proves necessary, although given the immaturity of many of the Q6 business cases it may prove difficult to make these judgements at this stage. There is some scope to delay the second phase of the T2A/T2C to Q7, although we feel that HAL needs to further assess this. In our view, the business cases for certain projects in HAL’s ABP (eg Back Office IT or additional baggage enhancements) look less convincing than others and could be rejected. The resulting costs savings from such adjustments might amount to between £200m-£250m Further cost reductions might also be achieved for asset replacement in Q6 although we have not assessed this.

30) There is also a question mark as to the appropriate extent of HAL’s contribution

to the Crossrail project (beyond any work required within the airport site). This issue is beyond the scope of our report.

31) In summary therefore, we believe that, whilst a project portfolio of around £3.0

billion would provide the most long-term benefits, this might be reduced to between £2.7 - £2.8 billion (excluding any reduction to the asset replacement programme) without any major impact to the passenger experience or operational performance. Whilst this could provide an overall budget ceiling, we note that nearly all the Q6 projects / business cases are relatively immature (at Gateway 1 or 2) and are therefore subject to agreed changes in scope, the selection of appropriate options and refinement of the cost estimates before they can proceed.

1. Introduction

1.1 Background This Final Report has been prepared by Alan Stratford and Associates Limited (ASA) on behalf of the UK Civil Aviation Authority (CAA). It provides an assessment of Heathrow Airport Limited (HAL)’s proposed capital expenditure (capex) programme for the quinquennial period from 1st April 2014 to 31st March 2019 (designated as Q6). The review forms part of the CAA’s statutory requirement to establish the potential level of any price cap at regulated airports. This Report follows an earlier Interim Report on the then-proposed £3 billion capital programme as outlined in HAL’s Full Business Plan (FBP) submitted to the CAA in January 2013. The Interim Report covered the cross-cutting issues involved in capital planning and delivery and made some preliminary assessment of the overall programme and selected projects1. The report also took account of the views of the airlines including the Heathrow LAAC/AOC2 on this £3 billion programme. Following the publication of the CAA’s Initial Proposals for Q6, HAL reconsidered its position and prepared a Revised Business Plan (RBP) which incorporated a reduced £2 billion capital investment programme over the five years. The reduction in the programme was made in response to the CAA’s proposals on the Q6 WAAC (Weighting Average Cost of Capital), which HAL felt was unacceptable to its shareholders. Following this, Heathrow’s airlines made further submissions to the CAA to disapprove of this reduced £2 billion plan and the CAA asked HAL to prepare an updated Alternative Business Plan (ABP) based on a £3 billion budget. HAL has indicated that, in terms of progressing the Q6 capital programme through the Gateway process, they are engaging only on projects as they stand in the RBP. As requested by the CAA, this report provides an assessment of the £3 blllion ABP – although we take account of any differences with the earlier £3 billion FBP, the £2 billion RBP and the views of the airlines. The report also includes some further analysis on the cross-cutting issues, notably on cost estimation and on-costs, and gives an update on the status of some 11 projects including one further project (‘Additional fuel infrastructure’) which was initially included in the FBP but has subsequently been dropped from the RBP and ABP. It should be noted that the assessment excludes asset replacement projects, which are evaluated in a separate study for the CAA undertaken by Steer Davis Gleave (SDG). This study has been undertaken by a review of the relevant business cases and supporting documentation prepared by HAL’s Capital Solutions Group. A number of meetings have been held with HAL’s staff and AOC/airline representatives and any questions raised to HAL have been formally answered through a written response under the IRS scheme.

1 For the purposes of this report, the term ‘project’ is used for the various business cases in HAL’s and

the LACC/AOC’s Q6 capital plans. Strictly speaking, the business cases will be converted into

projects at Gateway 3. 2 LACC/AOC – London Airport Consultative Committee / Airline Operators Committee. For the

purposes of this report, the AOC’s views are considered identical to those of its parent body, the

LACC.

The original Terms of Reference for our assignment for the CAA are provided in Appendix E.

1.2 Q6 price control process Airport charges at Heathrow are regulated by the CAA using a Regulated Asset Base (RAB) based single till. The capital expenditure programme represents one of the key ‘building blocks’ for the regulatory settlement. These ‘building blocks’ need to be defined and assessed using a ‘bottom-up’ approach – bearing in mind the nature of the inter-relationships between them. In this way, the traffic forecasts can, for example, define the level of investment in new infrastructure capacity or investment in new commercial facilities can increase revenue under a single till. This evaluation is made on a ‘bottom-up’ basis by assessing individual projects in the overall Q6 capex programme. For the purposes of this second stage of the project, we have added a further six projects to the seven initially assessed in the Interim Report. (One project, ‘Baggage Standard 3 HBS’ has been dropped as it is now regarded as asset replacement). We also report on the current views of the airlines in the context of the two current proposals (the £2 billion RBP and the £3 billion ABP). The LACC/AOC and individual airlines/alliances have indicated that that they believe that the general level of capital investment required in Q6 is about £3 billion, although this is subject to an acceptable level of airport charges in Q6 (and projected for Q7). There are, however, still differences between the airlines’ preferred project portfolio and HAL’s current £3 billion plan (ABP).

1.3 HAL’s FBP, RBP and ABP As indicated above, there are significant differences between the initial £3 billion FBP, the revised £2 billion RBP and the subsequent £3 billion ABP. The overall priorities and targets for each plan are given in more detail in Section 2.2. In terms of the allocation of funding, the total budgeted for asset replacement against non-asset replacement is given in Figure 1.1 below: Figure 1.1 FBP, RBP and ABP by Asset Replacement v Non-Asset Replacement £mill FBP % of total RBP % of total ABP % of total

Asset Replacement 1,531.2 51.0% 1,318.4 66.1%

1,458.8 48.4%

Non-Asset Replacement 1,473.8 49.0% 674.8 33.9%

1,555.1 51.6%

Total 3,005.0 100.0% 1,993.2 100.0%

3,013.9 100.0%

These figures indicate that the level of asset replacement is broadly similar under all three plans – but, in the RBP, its proportion of the total capex budget is substantially higher than in the FBP or ABP. The asset replacement projects include some £254.9m for Baggage Standard 3 Hold Baggage Screening machines which is strictly a compliance (or early asset replacement) project. The business cases have been defined in seven programmes representing the main themes for the capex portfolio. HAL defines a programme as ‘a temporary organisation’ created to direct and oversee the implementation of a set of related projects and activities in order to achieve certain outcomes and benefits that help

deliver our strategic objectives. In practice, these programmes will alter as business cases are translated into defined projects at the delivery stage. As indicated in Section 2.7.1, it is proposed that, for the purposes of project delivery, the business cases are grouped into programmes of related projects.. Figure 1.2 HAL’s FBP, RBP and ABP by Programme £million FBP RBP ABP

Passenger Experience 321.5 187.4 358.4 Terminal 2 400.1 60.1 401.5 Surface Access 222.3 57.0 214.3

Airfield Resilience 445.0 233.5 422.4 Baggage 532.4 486.1 538.3 Asset Replacement 904.9 828.2 864.7 Business Systems & Technology 166.7 135.9 152.3

Others 12.1 5.0 60.1 Total 3,005.0 1,993.2 3,013.9

It should be noted that some projects that could be defined as ‘Asset Replacement’ are included under other categories.

2. Review of cross-cutting issues

2.1 Background This section provides a critique of the cross-cutting issues involved in the identification and delivery of capital projects at Heathrow. It includes an overview of the Construction Engagement process for consultation between Heathrow and its airline users which, for Q6, commenced in summer 2011 and underpins the collectively agreed proposals for the setting of the price cap for this qunquennium. The review focusses on key factors relating to the potential capital efficiency of the overall Q6 capex programme and its projects. These are as follows:

• The nature of HAL’s project costing process

• The cost estimating and cost tracking process

• The nature of and level of project on-costs

• The nature of and level of risk and opportunity allowances

• The use of project cost benchmarking

• The nature of HAL’s Gateway process for project approval, which was updated in Q5

• The nature of HAL’s project preparation and delivery process, which has also been revised in Q6

• The current proposals for an inflation allowance for the Q6 settlement

• The nature of the proposed split between development and core capex and the implications for project efficiency

• The proposals for an Independent Funds Surveyor (IFS) to provide on-going quality assurance for capex spend in Q6

• The nature of HAL’s Integrated Baseline Reviews of the capex programme which commenced in Q5 and will continue in Q6

• The nature of the proposed post project reviews and their implications in terms of capital efficiency and value for money

The study does not consider project procurement procedures apart from a brief comment on their current status. Whilst we recognise that this is a key issue in procurement procedures for Q6 are currently under discussion with the CAA as part of the new licencing arrangements. In an amendment to the original Terms of Reference, the study does not review the inflation allowance in Q6 as this is now covered in a separate CAA study.

2.2 Constructive Engagement 2.1 Background The Constructive Engagement (CE) process for Q6 commenced in summer 2011 and followed a consultation document ‘Setting the Scene for Q6’ published by the CAA in July 2011. The process evolved from the CE procedures in Q5 and involved both a top-down approach led through a governance body, the Joint Steering Team (JST) and a bottom-up approach through a number of specialist workstreams reporting to the JST. These included both a ‘Capital Efficiency’ and a ‘Capital and Solutions’ working group. Q6 CE was based on several key assumptions including continuation of the 480,000 ATM cap and that the capital programme should be based on the 2 Runway Masterplan which, in the longer-term, rationalises passenger processing capacity into two buildings (T2 and T5) from that originally in T1,T2, T3 and T5. The speed of development of the masterplan is dependent on traffic growth, the investment programme and future Government policy. Whilst projects in Q6 have been defined around this masterplan, consideration has been given where appropriate to the implications of a possible future 3 Runway Masterplan. In late 2011, HAL tabled three potential scenarios for capital expenditure in Q6. These were Scenario (a) ‘Minimal Capital Expenditure’ with a budget of £2.0 billion, Scenario (b) ‘Step towards the Masterplan’ with a budget of £3.0 billion and Scenario (c) ‘Masterplan Priority’ with a budget of £4.0 billion. In the FBP submitted to the CAA, HAL put forward a capex plan based on Scenario (b) - £3.0 billion. In their initial submissions to the CAA, the LACC/AOC and the airlines made it clear that their position on this capex budget was subject to their assessment of affordability of airport charges in Q6 (and beyond) once the full set of ‘building blocks’ for the regulatory settlement are established. The overall strategic framework for the FBP was based on an emerging programme of Q6 joint priorities and a set of Q6 programmes. The programmes represent groups of related projects to deliver each priority. A small number of projects are shown as ‘others.’ Following the CAA’s initial proposals for Q6, HAL prepared a Revised Business Plan (RBP) based on a £2 billion budget, which was effectively Scenario (a) above. As indicated earlier, HAL stated that this proposed reduced budget was due to the high WACC (Weighted Average Cost of Capital) put forward by the CAA which they indicated was unacceptable to their shareholders. HAL were subsequently asked by the CAA to put forward a new £3 blllion capital budget (the ABP) based on their latest assessment of the potential projects. They have however stressed that they are now only progressing projects as they stand in the RBP which is their current preferred option.

The Constructive Engagement process formally ended on 3rd December 2012. Whilst the FBP was not officially an output of CE, many of the capital delivery processes in Q6 were agreed jointly with the airlines over this period. It is our view and that of HAL and the LACC/AOC that considerable progress was been made in reaching consensual agreement, particularly in the area of capital delivery, to the

credit of all parties concerned. Nevertheless there are still areas of disagreement on some areas of capital efficiency, on the size of the overall capital programme and on the nature and costs of some individual projects.

2.3 Project costing 2.3.1 Definition of costs

A project costing or estimate has a number of constituent elements, all of which will have a different calculation methodology. In the case of Heathrow Airports Limited (HAL), the individual elements used are as follows:

• Base costs:

• Project specific costs:

• On-costs:

• Risk allowance

The methodology to derive these elements of total project cost are set out below:

2.3.2 Estimating procedures

The EC Harris paper – Guidance on Estimation at Concept and Strategic Level (2)3 includes significant detail of the component costs which comprise these elements together with methodology of how the estimates will be prepared.

This methodology, is intended to be the standard used by EC Harris in the support they provide. This has been fully adopted by HAL. Discussions with EC Harris confirm that they expect to provide significant input into the independent cost estimates, completing between 40% and 50% directly.

Like many process related points, although it is acknowledged that HAL is seeking to improve and standardise their processes, it appears that their adoption has been relatively recent or in some instances, is still being developed. As such the quality of their implementation will continue to be improved as these processes are fine-tuned. As a result, the expected increased accuracy of estimates and control of costs is likely to lag behind implementation. Consequently, the success of the new arrangements is likely to become clear over the period of Q6 as outturn costs are realised. It is recommended that sufficient and specific time be devoted within the post project review process, to understand the degree of adoption of the new processes and the benefits that have accrued as a result (making time to understand and implements any lessons learned).

The current form of this document, which was published in May 2013, is an amendment used since 1

st

January 2012 to reflect nuances needed for Gateway 2 which has only recently been approached by Q6

business cases.

The following flowchart has been distilled from the guidance document:

HAL’s Cost Estimating Process

The salient points of the specific methodology are further discussed in the following sections:

2.3.3 Base and project specific costs

A key source of information supporting provision of a Single Point Estimate (SPE) is the Data Collection Analysis (DCA) library. This is a data warehouse of cost information which is understood to have been established and is periodically added to with information based on scheme costs (at estimate, contract or outturn stage).

The DCA is considered in greater detail in Section 2.4; however the following points are noted:

• Given that capital projects are relatively unique it may not have wide coverage or significant depth of appropriate information;

• Evidence provided by HAL indicates that information for some schemes is held at a granular level and for others held for large units of cost (for example: carousels);

• It is understood that HAL’s specific taxonomy/work breakdown structure used to categorise costs will also be used to capture contracts priced submissions.

The DCA is used to derive base and project specific costs. Further specific comments on the DCA are set out in the section on “Benchmarking” with comments on how the SPE’s are used in the section on “Risk” below.

The EC Harris guidance suggests that SPE’s should be built up through the information held at a granular level in the first instance and if this is not available, that more aggregated data be used to produce the estimate. In addition to the DCA information (or instead of, if no information exists), the existence of other benchmarks

Complete and

Validate CPS

Estimating Procedure

Produce SPE

Base CostsProject Specific Costs

On-costs

Agreed 3PE

Commercial

Manager Produces

Initial 3PE

Workshop to

Validate 3PE

Should there be insufficient clarity the process will either be

abandoned or a SPE only process (right hand side) will be followed.

Assuming there is reasonable development of the scope etc, the full

3PE route (left hand side) will be followed.

Distributed Project

Outcomes

Risk Manager via

Primavera

Risk Manager via

Primavera

Establish “P”

Values

Review and Report

Outcomes

The SPE will be put together by a variety of means

reflective of the information available – they are (in

order of max information available), 1) Database

elemental values, 2) Database project values or other

available values/projects.

Where relevant, a 3PE will be produced and validated

to show (based on industry experience and analysis)

what an optimistic and pessimistic estimate may be

based on an understanding and assessment of the

opportunities and risks respectively.

Specific software will be used to produce

a distribution of probabilistic outcomes

after running multiple iterations

(10,000) in order to create a distribution

bell curve.

From the distribution curve it is possible to “read off” the relevant “P” values be

they the P50 (50% confidence), P80 (80%) or (P95) which are used at different

parts of the projects development depending on the level of development and

certainty of the technical solution and underlying costs.

This is the basic process used

throughout a projects development

(give or take). As projects crystallise,

and the “ranges” of the 3PE narrow,

at a point, the “P” value will change

from 80 to 50, this combined with

the narrower range will reflect the

greater certainty of costs.Outputs will be subjected to review and benchmarking against other estimation

methods. Once satisfied, the output will be captured in the relevant

template/business case and reported.

and projects will be examined to validate or produce the SPE. How the SPE is manipulated from this point is discussed in the section on “Risk” below.

2.3.4 Project on-costs

Breakdown of project on-costs

On-costs are recovered on the aggregate of base and projects specific costs (and by implication risk). They are based on a percentage calculation to recover a number of costs controlled by HAL and in particular the MSP unit. These are based on a sample of Q5 projects which represent 60% of the Q5 spend, which along with the relative turnover, generate the on-cost percentage. In terms of Q6, the Q5 on-cost percentages have been referenced in order to identify targeted improvements.

HAL On-costs by contributing element

These costs are recovered against projects based on calculated percentages with some variation for the known greater or lesser requirement of certain project types. The following table shows the project “archetypes” together with the original on-cost recovery percentage and stretch target:

HAL – Original and stretch on-cost recovery percentages by archetype Q6 Target (%) Q6 Stretch Target (%) Target Reduction (%) Terminals 18 17.5 2.7 Piers and Satellites 15-19 14.5-18.5 2.7 Car Parks 16 15.6 2.2 Pavement & Infrastructure 16-17 15.7-16.7 1.6

As can be seen, depending on the project archetype, target and stretch target on-costs for Q6 range between 15% - 19% and 14.5% - 18.5% respectively.

Meaningful benchmarks are not readily available, however, it is understood that HAL do periodically benchmark this information. They have supplied the following rates received for similar based industries with large infrastructure programmes:

Sector On-cost range Water 11%-20% Rail 12%-25%

Utilities 17%-24% Environment Agency 12%-18%

Should these on-cost figures be comparable in terms of their constituent components, HAL’s rates could be considered competitive. For Q6, on-cost percentages are considered to be representative of “the market” and should therefore hold good for the foreseeable future. However, it is worth noting that the risk of under or over recoverability rests with the airlines and the extent that budgeted costs are greater (or lesser) than that recovered through the established percentages will reduce (or increase) the budget available for works. There are a number of risks with this assumption:

The analysis provided shows a number of heads of expenditure which comprise the sum recoverable from capital projects (see below). Examining the list it is clear that (all else being equal), there will be greater certainty in some costs than others. For example, “Design Consultants” and “Specialist Support” which account for 34% (22% and 12% respectively) are likely to vary considerably depending on the uniqueness and complexity of the scheme and are consequently more volatile. Indeed, we are surprised that the cost of early design work for projects is not allocated directly against the projects themselves rather than within an overall on-cost ‘pot’, which is then redistributed to the projects. This can potentially distort the true project cost and both we and the LACC/AOC recommend that HAL, in conjunction with EC Harris, reappraisal this procedure.

Staffing numbers

HAL’s internal costs make up nearly 30% of the total cost of on-costs. It is understood that this cost is based on the current Capital Solutions division within HAL which has some 288 staff..

We understand that current expectations are to make an appropriate reduction in the headcount based on the agreed level of capital spend in Q6 settlement – together with an assessment of the workload for project preparation and delivery. Clearly a significant reduction will be– given that the capital budget in Q6 is likely to be less than one half that in Q5 and the stretch on-cost targets are more stringent.

It is noted that expenditure further declines over the term of Q6. As a result, to minimise disruption and potential future severance costs, HAL will need to plan and take action as soon as possible in order to accommodate future headcount reductions.

In order to manage this transition, a Q6 Development Steering Group chaired by the Development Director has been established. This group has set a target to commence a formal consultation process with staff in January 2014 ahead of the commencement of the Q6 budget period.

The required reduction in staffing is significant; this will need to be carefully managed and monitored to ensure that:

• The reductions are made in good time;

• The required reductions are achieved, and

• That there is not significant reduction in the interim and therefore adverse service impact can be avoided.

It is considered, even if managed well, that it is likely that (due to the loss of economies of scale) there will be a negative effect on on-cost rates.

Our review of selected projects in Q6 suggests that the cost estimates prepared to date include on-costs at the stretch target rates – although it is possible that further adjustment may be required once a more refined cost estimate in produced at Gateway 3 (see Section 2.6)

2.3.5 Risk allowances

Risk in project budgeting is incorporated in the estimating process in a number of distinct ways:

• At an initial estimating stage:

As part of the build-up of the SPE which, as noted previously, is the first step in determining an estimate. Risk is captured via a workshop attended by technical and commercial staff in order to consider the risks inherent in the project (corporate risks affecting all projects are captured elsewhere) which is then quantified with the assistance of HAL’s risk manager;

• For immature projects (Up to Gateway 3 for Q6):

On a P80 basis – the risk being equal to the difference between the P80 value and the “most likely” estimate (the most likely estimate contains an element of risk itself), and

• More mature projects (post Gateway 3 for Q6):

On a P50 basis adjusted for specific risks. As discussed, the estimating process employed by HAL utilises 3PEs, the initial version of which will be produced by the Commercial Manager prior to being validated by others in a specific workshop. Once agreed, the 3PEs are analysed on a Monte Carlo basis via “Primavera”, a third party risk analysis tool, in order to provide a distribution of potential project cost estimates at varying degrees of confidence.

Based on an assessment of the likely risk (and opportunity4) items, their potential probabilities of occurrence and the cost impact of occurrence, a Monte Carlo simulation analysis can be run to derived an S-curve of the distribution of overall estimated project cost. Based on the distribution, the P50 value is the cost estimate with a 50% probability that it will not be exceeded. The P80 value is the cost estimate with an 80% probability that it will not be exceeded.

At Gateway 3, it is expected that the technical solution and the estimates (SPE and 3PE) will have evolved to a level that would give the project team increased confidence. This would be manifested in pricing on the basis of the P50 risk value. At this trigger point any excess funds would be returned to the portfolio for reallocation rather than being carried forward to be managed at a programme level – see below).

4 An opportunity is the reverse of a cost risk item (ie a possibility of a cost-saving)

These risk premia and cost increases generally appear to be managed at a programme level. To the extent that a project needs funds over and above that allocated, an application will be made to the programme who will manage any increases/decreases within an overall control total (should it be the case that the programme will overspend, an application can be made to the portfolio holder).

It is noted that the process for risk in the form discussed, has been adopted by others bodies with high infrastructure costs such as the Ministry of Defence and the Nuclear sector. However, it needs to be followed through in substance and with the right tools and information. As previously noted, it appears that although there is the will to improve processes, they are, in their current form, relatively new and their success cannot yet be effectively assessed

The success of the new arrangements will only become clear in due course and it is recommended that sufficient and specific time be devoted, as part of the post project review process, to understand their application and impact as part of the general (and specific to process in its own right) post project reviews. We do not know whether HAL has ever undertaken a post-hoc review of the extent to which the risks on projects materialise (ie to gauge the probabilities and cost impacts for future cost estimates.

Depending on the project it is likely that there will be a marked movement between P80 and P50 risk adjusted values and as a result, a reduction in expected spend. As set out above, this excess development capital expenditure will be returned to the portfolio for reallocation at Gateway 3. Depending on the project and the frequency of the Gateways, this could create a situation of perpetual underspending and give the portfolio very little opportunity to bring forward projects or take action to maintain momentum. To help address this it is considered that either:

• A process could be put in place to give “earlier warning” of issues (either formally or informally, and/or

• In year budgets could be “over programmed” on the assumption of reduced budgets/slippage (accepting that this brings other risks).

This point is especially relevant at the current stage of the portfolio’s development as almost all of the Q6 projects are in their infancy and therefore currently costed on a P80 basis.

2.4 Benchmarking 2.4.1 Principles HAL’s consultant, EC Harris, notes that cost benchmarks are considered to ‘provide a high level of indication of the likely cost of a similar product if replicated at a given time and location’5 It is important to expand upon this recognising that benchmark data can be used to inform risk, to drive through value and to support continuous improvement. To this end benchmarking is more dynamic; not just an indicator of cost but operating as a tool performing a variety of functions.

5 EC Harris Facility Benchmarking paper, September 2012

In order for the benchmarking process to return accurate and useable data it is essential that there is consistency in the way that historic supporting data is dealt with. Primarily there should be consistency in structure and scope of works should be sufficiently detailed so that decisions can be made about whether or not the data is appropriate to support the benchmarking purpose. HAL has advised that the status of data (ie whether it is based on competitively tendered sums, final accouint data etc) is included in the database and on the detailed analysis, Where possible, abnormals and project speciifics are identified separately; however, in some cases ie contractors’ final accounts, these costs cannot be specifically identified.

2.4.2 Benchmarking for the regulatory settlement HAL’s approach to estimating for Q5 was primarily focused on single point estimates informed by benchmarking data generated from 70 facility benchmark rates.6

Their costing methodology for Q6 (as set out in the Capital Efficiency Handbook) proposes a three-point estimate considering time, cost and risk. The intent of this approach is to more comprehensively inform HAL of impact on capital expenditure. Cost ranges of minimum, most likely and maximum cost are identified with confidence generated through Monte Carlo simulation (see Section 2.3.2). Estimates for Q6 are then informed through internal and external estimating rates and benchmark data.7 The benchmark results (in the Handbook these are based on data contained in documents 1 – 4 overleaf) are used to identify an average total cost/m² GIA or per unit with an efficiency target then identified of between 2% and 4%. The benchmarking data is rebased using the BCIS All in Tender Price Index (All in TPI) at Q1 2012 and HAL proposed that this will be updated for the regulatory settlement using the index at Q2 2013 (this is an error and should be Q3 2013). The Q6 benchmark targets are noted as:

• New build terminals;

• Piers;

• Multi-storey car parks;

• Taxiways; • Stands; and

• Toilet refurbishments.

A review of HAL’s benchmarking processes and reports has been carried out with reference to the following documents:

1. Facility Benchmarking paper September 2012 (EC Harris) 2. Q6 Key Facility Benchmark Targets – Baggage (July 2012) 3. Q6 Facility Benchmark Targets – Toilet Refurbishments 4. Q6 External unnamed terminals 5. HAL Capital Efficiency Handbook, FBP Part D, Revision 14, dated 22 January

2013 From this review it is apparent that:

6 IRS 84.01 Estimating and On-Costs presentation, 30 July 2013

7 HAL Capital Efficiency Handbook, FBP, Part D, Revision 14, dated 22 January 2013, page 54

• Adjustments made to raw benchmarking data for abnormal (project specific) and on-costs are not transparent. Now that these elements have been set by HAL (see Section 2.3.1) the definitions need applied in a logical, coherent manner for these benchmarking exercises regardless of whether data is generated internally or externally;

• A number of the projects used for benchmarking have been adjusted to normalise their location. The BCIS All in TPI has been used for UK projects but no detailed index series is provided for adjustment of international project data. It is suggested that HAL clarify the updating process for international data for these exercises;

• Most of the benchmarking data is focussed on total cost figures and the results have been used to identify average prices against which efficiency adjustments have been set. Because the facilities benchmarked are airport specific, comparative project data is not available in terms of volume, quality or typical structure. Many of these are other projects at Heathrow or the former BAA airports, Gatwick and Stansted. This limits the benefit of the benchmark exercise (at present it appears to be a means of validation against the norm) and the results need to be considered accordingly so that targets represent value improvement and are achievable. Where structured data is available then it would assist if percentage distribution of cost is analysed and further targets set against the results. This will drill into what constitutes balanced design, balanced cost and delivery of value;

• References to the TPI in all the documents analysed have been inconsistent and in some instances incorrect regardless.

2.4.3 Benchmarking in practice HAL’s Estimating Rate Database is the primary source of benchmarking data with additional data obtained from external consultants. It currently contains data for just over 400 facilities. 160 of these are Heathrow facilities. The remainder are a mix of other airport facilities and non-airport facilities. 69 per cent are new build with 31 per cent refurbishment. HAL have been asked to split this data which has returned varying totals suggesting that it may not be sufficiently categorised. HAL note that data is structured according to their ‘Estimating and Cost Planning Definitions’ Programme Controls which is aligned to industry best practice (ref footnote 8). The intent is that this provides for consistent comparison against both internal and external benchmarks. Data is captured at four levels:

• Project analysis;

• Facility analysis; • Elemental analysis;

• System analysis. HAL have confirmed that the elemental analysis follows best practice guidance which is then extended to capture HAL specific elements and costs. Analysis of data

submitted by HAL (IRS 112) does not however support this in that the elemental structure does not reflect that set out by BCIS (inclusion of envelope for example). It is possible then that external data will have to be restructured to reflect HAL’s structure. HAL have now defined project specific costs and on-costs but some of the data held in their database was generated prior to agreement of these definitions. HAL have been asked what their intent is for this existing data and their response is: ‘…The analysis sheets have been provided in accordance with the requirements at the time. Adjustment would involve re-allocation of some on-costs…[HAL] do not consider that retrospectively adjusting the data to suit current definitions would have a material enough impact on the base data to warrant the considerable effort involved’9 The sample data submitted identifies that benchmarking is carried out using base cost data. The consequence of HAL’s response to retrospective adjustment is that this will render the base cost data potentially unsound which may skew the benchmarking results. HAL have released a detailed benchmarking exercise for multi-storey car parks (MSCP) with supporting analyses. The principle behind updating historic UK costs is sound. The BCIS All in Tender Price index (TPI) has been used, which HAL have adopted as best practice. If HAL produce their own inflation index (see 2.4.3.3) then it is suggested that this is used to rebase historical data. The UK data in the database is updated quarterly based on the latest TPI release. HAL is aware that there are more frequent updates to the TPI (often at intervals as short as two weeks) but consider a quarterly update is sufficient. It is however suggested that since updates can include amendment to recently historic indices HAL should ensure that (if they continue to reference the TPI) their updates are run to coincide with BCIS TPI releases. International data (the volume/value of this has been queried but not established) is reported in its local currency and users of the data are required to make adjustments for location/inflation based on their current knowledge. Reference is made to the Turner & Townsend International Cost Survey as a source of international cost data. This has limitations in that the survey is conducted annually (and is therefore quickly out of date) and is based on a limited number of countries and construction types. In the absence of industry recognised international indices this approach is not considered inappropriate providing the guidance is applied with intelligence and in mind of project specific features/functionality/criteria. It is also suggested that international data is clearly categorised, it sits outside or in a separate section of HAL’s database and that it is used for reference only (i.e. not as a key informer). Further observations on the MSCP exercise are as follows:

• There are instances where the project data is duplicated.. It is recommended that only a single instance of a project is used and that nature of the cost (construction decision cost, final account cost etc) is clearly reference on all

9 IRS-112 070813

data collection and analysis (DCA) sheets and benchmarking summaries (this is not evident in the data provided in IRS-112 070813) ;

• Benchmarking is carried out on total base cost only. There is no indication that HAL benchmark elemental costs or elemental distribution of cost. This immediately limits the usefulness of the process, with it becoming a bottom line validation tool as opposed to anything dynamic to drive through efficiency and value in design;

• The benchmarking is carried out using project data and not facility data (facility and elemental data is held in the DCA). This can significantly skew the output. Removing facility base cost data from the MSCP exercise reduces the range cost per car park space and as a consequence significantly reduces the average cost per space; replacing project data with relevant facility data would not be of any negative consequence because of the base cost approach;

• The scope of work is not adequately described and this makes selection of

appropriate cost data for benchmarking purposes difficult, unless the project is known by the user,

• The elemental costs are not necessarily supported by robust systems costs with much of the breakdown being based on cost/m² gross internal area or element area rates (HAL have subsequently advised that this is being addressed through quality checks on DCAs and the requirements for more information to be included);

• Build up figures do not always transpose directly into element figures,

suggesting an informal, unrecorded means of adjustment between the two (or an error in transposing);

• There is no evidence that detailed analysis is carried out on the impact of data being for a Heathrow project, an airport project or a non-airport project. Data is mixed in the benchmarking overview and it therefore can’t be established if the base cost of a Heathrow project or an airport project carries a premium. It is important to understand this in consideration of procurement management, inflation and the ability to secure competitive construction prices.

Whilst the benchmarking exercise considers base cost only the MSCP project analyses suggest that other on costs plus risk, opportunities and inflation costs are calculated as a standard percentage. It is not clear if this percentage is calculated at project level and then dispersed through to facility level or if HAL apply standard percentages generally. It is suggested that, where it is possible to split project cost into facility costs, costs associated with these elements are calculated on a per facility basis in view of each project’s particular profile. This would then allow benchmarking of these costs which would assist HAL in understanding the effectiveness of procurement routes and related design development. It is also suggested that these on-costs are benchmarked to ensure continuing efficiency.

It is also noted that although HAL’s estimating methodology is based on three point estimating there is no apparent analysis of construction duration and risk aligned to cost in the benchmarking process.

2.4.4 Summary The basis of a sound benchmarking system is in place but its application could be improved and the following is suggested:

• The analysis data needs to be consistently labelled according to agreed terminology. This will allow data to be easily categorised and more accurately applied;

• Collection and analysis of data at both contract commitment and out-turn stage of a project will further allow HAL to objectively measure what has happened to a project whilst it has been on site against what was anticipated to happen as defined by the contract documents. This will support the drive for value in future projects to a greater degree. Using contract data for benchmarking purposes, without consideration of what materialised for individual projects, is likely to lead to a benchmarking profile that is not achievable and/or does not represent a value improvement;

• Avoid use of estimated data – consider contract or out-turn costs, avoid multiple instances of the same project in the benchmarking process;

• Historic data that is used frequently for benchmarking is restructured so that it reflects industry best practice. This could be done over time on a project by project basis so that it is efficient and focussed;

• Project and facility scope is adequately defined;

• If the TPI remains the means of basing and rebasing data, the database should be updated in line with TPI releases to capture changes to historic indices;

• Analyse the difference between Heathrow projects, airport projects and non-airport projects to identify if there is a Heathrow or airport premium;

• Benchmark elemental cost to drive through value and efficiency in design;

• Benchmark risk and time aspects of projects so that these impact of these on cost can be better understood;

• The inclusion of project/facility data is reviewed with the benchmarking results to ensure that only appropriate data is included and the results aren’t skewed;

• Benchmarking data is applied effectively to drive through efficiency and value as opposed to it being base cost validation

It is concluded that use of benchmarking as a dynamic tool to test estimates, measure project risk and set improvement targets should be implemented as standard procedure for Q6. However benchmarking needs to be supported by a robust cost database with parameters around the cost transparent and understood. Greater use of independent benchmarking consultants as suggested in the Q5 report may also assist in generating more comparative data for both UK and international

airports. In addition there should be consistency in the measure of inflation and how this is applied to normalise and then forecast cost. The application of benchmarking as a means of cost validation (as set out in the Handbook and implied through the MSCP exercise) only partly exposes its potential to effectively support projects and to derive value from them.

2.5 Gateway process HAL has a new “Heathrow Gateway Process” covering stages G0 to D8 inclusive which was developed during Q5 and implemented in 2012. HAL’s project governance process has been developed to align with industry best practice through the application of principles of the Association of Project Management (APM) and Office of Government Commerce (OGC), now Major Projects Authority. It has been developed around a Gateway assurance model. Projects are reviewed at key points (Gateways) throughout their life to ensure that the project is still on track and has the appropriate project management systems in place to ensure delivery. There are seven stages in the project lifecycle. Before proceeding to the next stage each project must carry out a stage Gateway review which ensures that current stage works have been completed and that the project is ready to proceed into the next stage. Governance and assurance of the project lifecycle is built around the stage gateway process and has two key components:

• At each gateway, specific ‘Exit’ criteria need to be met (has the project done what it should have done to date?); as well as 'Entry' criteria (does the project have all the plans in place to maximise the chance of success of the next stage?); and a review of the project business case must be held to ensure its continuing validity.

• The utilisation a Project Complexity Assessment model at the outset of the gateway process to ensure that the governance & assurance requirements of a particular project are tailored, within the overall mandated framework, to respond efficiently to the particular complexities and attributes of that project rather than adopting a 'one size fits all' approach dependent purely on EAC.

The Project Sponsor is accountable for ensuring that an appropriate Assurance Plan is in place and being executed.

The gateway process is, in part, web enabled and contained on the Heathrow Hub giving accessibility to and acting as a reference point for all project teams. The hub includes and sets out the process, procedures, templates and sign-offs required at each of the Gateways G0 to D8. The Gateway Process utilises five key project documents:

• Brief

• Business case

• Project management plan

• Sanction request

• Acquisition strategy

Further specialist documents are also needed at individual gateways The main gateways are defined at the end of each key process as follows:

• G0 - Strategy

• G1 - Initiate

• G2 - Options

• G3 - Solutions development

• G4 - Definition • G5 - Implementation

• G6 - Transition

• G7 – Close down

• D8 - Operation At present nearly all Q6 projects in HAL’s RBP and ABP (except Q5 roll-over) are at G0 or G1 – with more projects expected to transition to G2 in the current year (ie Q5+1) or in the first year of Q6. A list of all projects showing their Gateway status as at 19 July 2013 is given in Appendix B. The relationship between the current Gateway process and that used for the majority of Q5 (DGS/IGS 2004) is shown in the diagram below. ……….

In addition to the changes to the Gateway progress, HAL is planning a new project delivery procedures in Q6 in which business cases that transition through G3 are combined into a project delivery package (or packages) for implementation. It is expected that these packages will be largely defined on a geographic basis.

2.6 Procurement HAL’s procurement procedures were independently evaluated in the post-hoc review of Q5 capex expenditure and capital efficiency. This report raised a number of concerns about HAL’s procurement procedures in place at this time – including the selection process for and the allocation of contracts within CBI (Complex Build Integrator) Framework contracts. In particular, the report recommended that, for

maximum capital efficiency and ‘value for money’, all contracts should be awarded through a competitive tender process. In the case of the CBI framework contracts, it was recommended that there should be a second stage tender amongst the selected framework contractors for individual project contracts. A further concern was the type of contracts awarded. A significant number of contracts during Q5 had been awarded as NEC Option E (cost reimbursable) contracts, which it was felt should only be used if the project scope was inadequately defined. The airlines also indicated that, in Q5, they had no input or involvement in the procurement process. Whilst we recognise that this is ultimately the responsibility of HAL, we would hope that, in Q6, the IFS will be able to provide some oversight of the procurement process. HAL have advised that its procedures in Q6 (including the award of Framework Contracts for Complex Build Integrators-CBIs) are currently under review. HAL are also in discussions with the CAA over the procurement process in Q6. In view of this, we have not addressed the future procurement procedures in Q6 in this report although we acknowledge that this is an important element of capital efficiency.

2.7 Development and core capex During the course of the Constructive Engagement process, HAL and the airlines agreed (in conjunction with the CAA) to designate capital expenditure in Q6 as either development or core capex. This enables the development of less mature project scope to meet the time schedule required for the delivery of benefits and provides an element of flexibility to meet evolving stakeholder requirements. Core capex is defined as projects where the scope, costs, risk and time schedule is well defined. It will normally include all projects which have passed G3 representing construction or implementation decision. Core capex will be costed using a P50 risk approach, thereby providing a sound target for efficient project management. Under the Constructive Engagement proposals, development capex will have a lower definition of scope, cost, risk and time schedule for delivery. It is expected that the majority of projects in Q6 (except for Q5 and Q5+1 roll-over) will be considered as development capex at the start of the quinquennium. Development capex will be costed using a P80 risk approach. Once development capex projects transition through Gateway 3, they will be recategorised as core capex and recosted using P50 risk allowances. The majority of a project’s expenditure will therefore be incurred as core capex, although a proportion (eg for project design, preliminary works etc) may occur as development capex. The allowed return (WACC) is expected to be identical for both development and core capex. Given that the overall Q6 capex budget is based on P80 costs, it is expected that a surplus fund will accumulate as projects transition to core capex. It is not known exactly how much will accumulate in this way. In principle, this will be the difference between the P80 and P50 project costings (as at the CAA settlement). It is obviously possible that, for some projects, the latest P80 and P50 costings may have increased by G3 (eg due to under-scoping or changes in labour or materials costs) – although conversely some may have reduced. We suspect that, in practice, project costings are more likely to increase between the CAA settlement and G3 (eg through agreed scope changes through Change Control) – although this should not be a justification for a lack of definition in earlier costings.

We have not been provided with a full list of projects costed on a P50 basis, although looking at a selection of costings provided to us, we believe that the P50 costs are approximately 5.5% - 6.5% lower than P80 costs – this would suggest that around 6% of the budget should theoretically accumulate as a surplus (less any changes to the costings as shown above). The budget surplus would be monitored by the IFS and would theoretically available for further project scope or a rebate on airport charges provided this not needed to fund any budget overspend during Q6. We can see advantages in this approach in that it theoretically gives some flexibility for additional as yet undefined project scope or alternatively provide a rebate on airport charges during what may be a difficult financial period for many airlines. We do have, however, have some caveats. We do not feel that P80 budgets should be used as a buffer for possible increases in project costings between budgets at the CAA settlement and those at G3. Furthermore, given that P50 costings represent the most effective benchmark for cost control, we believe that all project expenditure (including design work etc) is best managed against P50 rather than P80 costs (whilst still retaining the difference between the P80 and P50 costs at a programme level. We understand from HAL that this is their intention, although there would need to be a strong justification for the use of the cost differential. Indeed, there is an argument that project managers might be given more stringent targets eg P20 to attempt to add greater control over project costs. The IFS will need to play a key role in monitoring these costs and advising all parties as to what level of budget surplus should be anticipated on the basis of efficient capital budget and expenditure throughout the Q6 period. The progression from development to core capex through the Gateway process is illustrated in the diagram below.

2.8 Independent Fund Surveyor The introduction of and Independent Fund Surveyor (IFS) role is a new concept for Q6. The objective of the IFS role is set out in the HAL Q6 Capital Efficiency Handbook at Section 610, the first paragraph of which states:

The objective of the introduction of an Independent Fund Surveyor is to provide an on-going assessment of the reasonableness of all key decisions made on key projects and, in undertaking Development projects the capital is being used effectively to deliver the outcomes determined by the business case.

The second paragraph sets out the principle and timing of engagement of the IFS and aligns the IFS role to identified projects ie those which are defined and consulted upon:

The principle of an Independent Fund Surveyor is aligned to identified projects; as such there is a presumption that at the time of appointment the nature, scope, benefits and business case have been defined and agreed by HAL and consulted with the Airline Community. The role relates to monitoring the delivery of the same.

The precise details of the IFS appointment are still to be determined, although it is understood that this will be a Framework Agreement with several companies, each focussing on individual projects or project groups. Fee levels for the IFS are stated as capped at 0.5% of the EAC (Estimated Cost at Completion) of the selected projects which will be defined as “Key Projects” as provided in the CAA’s Heathrow Consultation and Information Protocol (revised Annex G) dated November 2011. The precise list of key projects in Q6 still needs to be defined, although it is likely that these will be largely (but not exclusively) non-asset replacement projects. It is difficult to judge the overall input needed from the IFS(s) during Q6. This may vary from project to project dependent on their complexity and possibly on whether certain issues emerge (as, for example, has been the case for T3IB). In the ABP (and in the initial FBP), HAL has set aside a Q6 budget for the IFS role of £9.5million. This equates to some 0.33% of the overall capex plan. In the RBP HAL has significantly reduced the IFS budget to £3.0 million (0.15% of the overall capex plan). This reduction is strongly rejected by the LACC/AOC. The timetable for the appointment of the IFS has slipped (due in part to a pause period required by HAL so that they could fully understand the implication of CAS proposals) but HAL have now confirmed that frameworks are scheduled to be awarded on 1 November 2013. It may take a little time to ‘bed down’ the precise contribution of the IFS in view of the ‘learning curve’ required. The staff resources available, particularly within the airline community, for the on-going assessment and monitoring of projects is limited. There

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inclusive

is no doubt, therefore, that an independent IFS will play a key role in ensuring that capital is being used efficiently during Q6.

2.9 Integrated Baseline Reviews HAL undertook Integrated Baseline Reviews (IBRs) on T5 in Q4 then throughout Q5 on the Q5 CIP. They intend to continue with these reviews during Q6. The outline approach to carrying out IBRs is set out in the HAL Q6 Capital Efficiency Handbook at Section 1311. The fundamental difference between Q5 and Q6 is that the portfolio will commence with a baseline. This was not in place at the commencement of Q5 as the HAL approach, in managing the projects/programme/portfolio, was revised during Q5 and the IBR approach introduced. The key aspects of the IBRs during Q6 are that:

• They will be carried out at least annually.

• They will test and challenge each project and programme. • The IBR outputs presented to the Development Executive and Airlines.

• Their coverage will include: acquisition, cost, schedule, risk and change. HAL should clarify whether its intention is to baseline review “each project and programme” or “focus primarily on Development’s “Key Projects””. We consider the former is a better approach. HAL should consider drafting a simple procedure to support the IBR review process and involving one of the IFS providers as an integral part of the HAL team which carries out each of the IBR reviews. We expect the IBR approach, implemented in a robust manner, will provide positive benefits, in terms of delivery cost certainty and schedule confidence, throughout Q6.

2.10 Post-project reviews For most key projects, HAL undertake post-project reviews (PPRs) in which they examine whether projects have been achieved within budget and their planned time schedule and whether the expected benefits have been achieved.

Whilst we recognise that such post-projects were undertaken in Q5 and that, in most cases, the expected benefits (eg improved service times or target increases in QSM scores etc) appear to have been achieved. We feel, however, that with the assistance of an IFS, these could be improved through a more formal process. We have been advised by HAL that, in Q6, the PPRs will concentrate on the time, cost and quality of the outputs delivered by the projects. Benefits realisation reviews will be conducted by programmes and aligned to programme gateways. It is recognised that the assessment of the financial and other benefits will be a challenge. The business cases (particularly as they stand at Gateway 1 or 2) will evolve into deliverable project packages after Gateway 4, which are expected to be largely defined on a geographic basis. It is important not to lose sight of the derived benefits within these project packages. It may also be difficult to precisely identify how target reductions in opex or increases in commercial revenue have been achieved as this may be due to a variety of factors, not just the particular capital

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project reviewed. Similar considerations will also apply for improvement in QSM scores etc.

3. Initial assessment of Q6 capex programme

3.1 Methodological approach In our initial assessment of the Q6 capex programme given in our Interim Report we provided an overview of the £3 billion programme proposed in the FBP, an preliminary appraisal of the business cases for seven selected projects and a summary of the main differences with the airlines on this particular project plan. The projects chosen for this initial evaluation were selected jointly by ourselves, HAL and the airlines and were as follows: The costs shown are as per the FBP. BC No Project FBP-£m

B005 Baggage Standard 3 Hold Baggage Screening £254.9m B009 Northern Perimeter £43.0m

B012 Airfield Efficiency and Resilience £70.7m B017 T4 Infrastructure Improvement £82.9m B020 Commercial IT and telecoms £14.0m B029 Automation of the passenger journey £30.0m

B054 T2 Phase 2 and T2C £219.8m

`1 The seven projects total some £715.3m, representing approximately 41% of the proposed Q6 FBP programme (excluding asset replacement). In our subsequent assessment of RBP and ABP, we have extended this to an appraisal of 12 projects following discussions with the CAA. Project B005 has been dropped as this is now regarded as asset replacement. Two further terminal projects, an airfield project, a roll-over project from Q4 (T3IB) and project for de-icing facilities have been added for more detailed appraisal. We also examine a further possible project for additional fuel infrastructure which was included in HAL’s FBP but subsequently excluded from the RBP and ABP. The full list of projects now reviewed is as follows: BC No Project RBP-£m ABP-£m

B054 T2A Phase 2 and T2C £5.0m £219.8m B016 T3 refurbishment and enhancement £36.7m £77.7m B017 T4 infrastructure Improvements £53.8m £72.0m

B018 T5 security capacity £23.0m £23.0m

B051 T3IB roll-over £82.1m £82.1m B009/B088 Northern Perimeter £10.6m £30.8m

B011 Enabling the new generation of wide-bodied aircraft £86.8m £182.7m B012 Airfield efficiency and resilience £29.0m £70.7m B020 Commercial IT and telecoms £14.0m £14.0m

B029 Automation of the passenger journey £8.5m £60.0m

B035 De-icing facilities - £48.0m B033 Additional fuel infrastructure - -

Our evaluation of B054 (T2A Phase 2 and T2C) includes some comment on B050 (T2A Phase 1 completion) and the implications of the use of the T1 transfer baggage sorter for the early phase of T2.

The reviewed projects total some £349.5m in the RBP (representing some 52% of all non-replacement capex) and £880.7m in the ABP (57% of non-replacement capex). In addition to our review of these 12 projects, we provide a summary of the main differences between the HAL and the LACC/AOC capital plans and give some brief comments on this where appropriate. This summary is shown in Section 3.9.

3.2 Q6 agreed joint priorities Q6 priorities were jointly defined by HAL and Heathrow’s airlines through the Constructive Engagement process which commenced in summer 2011. This confirmed the agreed vision for Heathrow as: ’the UK’s direct connection to the world and Europe’s hub of choice by making every journey better’. Building on this vision and based on certain key assumptions including continuation of the current 480,000 ATM cap, the R2 masterplan and the current single till RAB based regulatory process, a strategic framework was jointly developed showing the joint priorities and service propositions throughout Q6. This framework, which was not contingent on any particular level of capex spend, is presented in the figure below. HAL’s FBP – Q6 Strategic Framework

This strategic framework was used to underpin HAL’s Full Business Plan with a £3 billion capital budget which was submitted to the CAA in January 2013. HAL referenced all Q6 projects against these joint priorities and service propositions in their business cases. Following publication of the CAA’s Initial Proposals for Q6, HAL subsequently amended its capital programme in a Revised Business Plan with a reduced £2 billion budget. This programme was based on a revised set of priorities and targets, although these were not agreed with the airlines. The key differences in these between the FBP and RBP are shown in the table below.

Comparison of Priorities and Targets in HAL’s RBP and FBP

.

As such, the RBP is expected to sustain existing levels of passenger experience, and hub capacity whilst reducing the underlying operating cost by some 9.4% in comparison to a saving of some 6.8% in the FBP. Certain other assumptions are inherent in the RBP including continuation of the Cranford Agreement. Implementation of the RBP will have some impact on the overall T2 programme and service levels during Q6 and Q7

As HAL point out on p21 of the RBP, with the proposed £2 billion capital programme in Q6, ‘(Heathrow) will enter Q7 with passenger experience at lower levels than other European hub airports, with punctuality under pressure and some further capacity constraints’. We have not assessed these overall impacts under the FBP, RBP and ABP except insofar as we look at the expected benefits of certain projects. It should be noted that, at no point has the LACC/AOC or the airlines endorsed this revised set of service propositions or the concept of reduced £2 billion capex budget in RBP. In July 2013, HAL were requested by the CAA to prepare an Alternative Business Plan (ABP) with a £3 billion capex budget (effectively an update of the earlier FBP). The strategy framework for this and operational assumptions are the same as in the FBP. At present, HAL are only taking forward projects in the RBP through the Gateway process although some analysis on other projects in the ABP is being undertaken at the request of the airlines.

3.3 Airline affordability The airline position on the overall level of the Q6 capex programme is that it will ultimately depend on affordability. At present, the LACC/AOC have totally rejected HAL’s £2.0 billion RBP and has significant reservations about several projects in their £3.0 billion ABP. It has prepared its own plan based on a £3.0 billion portfolio, with a further list of some eight commercial projects totalling £97m, which are in HAL’s ABP but pay back to HAL during Q6. These would be included in the RAB – so therefore the LACC/AOC capex plan for Q6 amounts to some £3.1 billion. The LACC/AOC recognise, however, that the level of capex in Q6 will ultimately depend on airline affordability of the proposed airport charges in Q6 (and projected in Q7).

3.4 Historic and current QSM scores A key purpose of capital investment is to improve the passenger experience at Heathrow. HAL measures this through a number of quantitative and qualitative methods, including ASQ (airport service quality) statistics for individual facilities and QSM (quality service monitor) survey data from passengers. For the purposes of our report, we reproduce the trends in the QSM scores since July 2009, shown on a moving 12 month average basis. Heathrow QSM scores (MAA basis on scale 1-5)

T1 Dep T1 Arr T3 Dep T3 Arr T4 Dep T4 Arr T5 Dep T5 Arr Jul-10 4.02 4.01 4.07 4.00 4.13 4.09 4.22 4.24 Jul-11 4.08 4.05 4.07 4.01 4.11 4.06 4.18 4.20 Jul-12 4.09 4.09 4.13 4.04 4.18 4.10 4.25 4.22 Jul-13 4.14 4.14 4.19 4.12 4.19 4.22 4.23 4.22

These figures illustrate the difference between the experience of passengers using T5 and those using other terminals at Heathrow. There has been some closing of the gap over the past 12 months, particularly in T4, although the experience of arrival passengers in T3 is still significantly below that of T5. This may however be largely due to border control issues rather than the airport facilities in these areas. . .

3.5 Phasing over Q6 HAL has provided the phasing of capital programme in the FBP, RBP and ABP, which is shown in the table below. In general terms, a higher proportion of expenditure is theoretically incurred in the first two years, rather than the following three years of the quinquennium.. HAL argue, however, that the delay in not progressing those projects in the ABP but not in the RBP through the Gateway system has shifted the phasing of the ABP later in the quinquennium in comparison to that in the FBP. HAL’s Proposed Q6 Capital Programme (FBP, RBP & ABP)

£milliion 2014/15 2015/16 2016/17 2017/18 2018/19 Total FBP 660 697 591 591 464 3,003

% of total 22.0% 23.2% 19.7% 19.7% 15.5% 100.0% RBP 505 552 424 307 206 1,993

% of total 25.3% 27.7% 21.3% 15.4% 10.3% 100.0% ABP 614 705 638 516 541 3,014 % of total 20.4% 23.4% 21.2% 17.1% 17.9% 100.0%

It should be noted that, at present, many Q6 projects are in their infancy, so we believe it would be a challenge for HAL to meet this timetable. HAL has stated that the phasing has been developed to balance off the competing demands of delivery of benefits (ie opex reduction, capacity increase etc) against a sensible construction schedule. The phasing shown is approximate as it is largely based on the project P80 cost estimates – rather than the P50 figure which is a more ‘realistic’ estimate of actual expenditure. We would also expect some savings in the transition to the P50 estimate and it is unclear when these savings would themselves be spent (if at all).

3.6 LACC/AOC capital plan On behalf of the airline community at Heathrow, the LACC/AOC has prepared its own alternative capex plan, which comprises three lists of projects: (a) A list of 44 projects assuming a £500m provision for T2 Phase 2 including early

work on the T2 baggage system

(b) A list of additional projects to be included if T2 Phase 2 is costed at £220m (ie the preliminary works as identified in the RBP). This amounts to some 12 further projects totalling £287m

(c) A list of a further eight commercial projects totalling £97m which are expected

to pay back during Q7. These projects are included in both HAL’s RBP and ABP.

The LACC/AOC plan is shown in Section 3.8 and Appendix A, although for the purposes of our study and reconciliation with HAL’s FBP and RBP, we have used different project categories.

.3.7 Individual airline views Whilst in general terms the airlines at Heathrow concur with the collective view of the LACC/AOC, several of the main airlines and airline alliances at Heathrow have submitted separate representations to the CAA which include their personal views on the capex programme for Q6. We have seen certain early representations from British Airways and Virgin Atlantic which were submitted to the CAA prior to their initial proposals – but we have not seen any (draft) final representations subsequently submitted. In the case of the early representations, British Airways presented its case for further development of T5 and its views on the capital inefficiency of the T3IB project. Virgin Atlantic strongly supported the development and refurbishment of T3, its home terminal, although its representation was made prior to the decision to base the new Virgin domestic operation, Little Red, in T2. It should be noted that, whilst we comment on the roll-over costs of T3IB, we have not investigated any historic cost over-runs in Q5 or Q5+1 in this particular study12.

12

T3IB cost over-runs in Q5 (but not Q5+1) were evaluated in an earlier CAA study – ‘Q5 Capex and

Consultation Review – Heathrow Airport’, Alan Stratford and Associates Ltd, April 2013

3.8.1 Terminal 2 - (T2 Phase 1 roll-over and T2A Phase 2 / T2C)

Summary

BC050 T2A Phase 1 roll-over

Project value (Q6) Summary of scope

FBP (£3 blllion) £160.4m All outstanding T2 roll-over items

RBP (£2 billion) £55.1m As above excluding Stands 234/235 and through Kilo taxiway

ABP (£3 billion) £159.7m All outstanding T2 roll-over items

BC054 T2A Phase 2/T2C

Project value (Q6) Summary of scope

FBP (£3 blllion) £219.8m Design and enabling works for T2A Phase 2 / T2C

RBP (£2 billion) £5.0m Planning consent work only

ABP (£3 billion) £219.8m Design and enabling works for T2A Phase 2 / T2C

Project scope

The construction of Terminal 2 (T2) represents a major step in the development of Heathrow as a future two terminal airport under the R2 masterplan. This review covers the current position re-roll-over expenditure in Q6 relating to the first stage of T2 (T2A Phase 1), which started in Q5 and further expenditure in Q6 on the next phases of T2 (T2A Phase 2 and T2C). T2A Phase 1 roll-over The first phase of T2, which comprised the first stage of the main T2 terminal (T2A Phase 1 and the first satellite terminal T2B) was the largest individual component of Q5 expenditure. T2B opened in December 2009 and is currently used on a temporary basis as additional pier capacity for T1 through access via T1’s Europier. T2A Phase 1 and the connection to T2B are scheduled to open on a ‘soft’ basis (ie through the phased introduction of airlines) in June 2014. T2A Phase 1 and T2B have been allocated to the Star Alliance airlines, Aer Lingus and Virgin domestic services. (Virgin acquired various services from Bmi following its take-over by British Airways. These services have now been assigned to T2A following a terminal occupancy review undertaken by HAL in early 2013). The total EAC of the T2 project is difficult to track due to substantial changes in the programme in Q5. The current (July 2013) EAC of the main T2A Phase 1 building is £1,153m, which represents an increase of £30.7m in comparison to the EAC estimate in August 2012 (£1,122m). HAL has advised that some £15.9m represented cost savings (including inflation gains) in Q5, which were offset against increased expenditure of £47.4m in Q5+1. The expected EAC over Q6 has reduced by £0.9m between these two estimates. It is understood that the increased expenditure in Q5+1 was due to programme change and was endorsed at the CIPWG. It should be noted that the T2A Phase 1 roll-over costs (ie Business Case 05) now technically includes not only outstanding T2A Phase 1 items but also certain other T2 items in Q6 including the completion costs for the associated multi-storey car park (MSCP) and T2B Phase 2. In the ABP, these roll-over costs amount to £159.7m.

The £104.9m reduction in the roll-over cost in the RBP is due to the omission of the proposed Stands 234 and 235 serving T2B and the lack of completion of a through taxiway (Kilo) between T2A and T2B and safeguarding of tunnels under this taxiway. The location of these works is shown in the diagrams below. HAL has indicated that the lack of completion of stands 234 and 235 (as in the RBP) will reduce pier service standards for T2 carriers from 97% to 95%, although this would still be within initial T2 targets. The LACC/AOC argue, however, that there would be differences between the T2A and T2B carriers. They state that pier service for United and Air Canada in T2B would reduce from 99% to 93% (below the target level). HAL also maintain that the retention of the two existing Europier stands (139 and 141) for the remaining life of T1 in Q6 will de-risk the airline move sequence prior to closure of this terminal. Following the closure of T1, the two stands would be retained for remote parking.

Proposed status of T2A Phase 1 roll-over works in the RBP

Proposed status of T2A Phase 1 roll-over works in the ABP

The impact of the lack of a through taxiway (ie the use of two cul-de-sac taxiways) will result in longer taxiing times. Some TAAM modelling work has been carried out on this which indicates that on westerly operations, some arrivals traffic will require at least two minutes additional taxiing time, whilst on easterly operations both arrivals and departures traffic will require at least two minutes additional taxiing time. HAL has indicated that further TAAM modelling work is required on this. T2A Phase 2 / T2C The completion of the T2 project (T2A Phase 2 / T2C) is designed to provide capacity for a mid 2020 traffic scenario and is expected to be fully delivered by 2026 (ie two years into Q8). The key elements include:

• T2A Phase 2 (including demolition of T1, FCC and MSCP1, the extension of the T2A building, associated new stands and operational readiness

• Fully integrated baggage system (T2A, T2B and T2C including inter-terminal connectivity and T3—1 tunnel fit-out)

• Tracked Transit System (TTS) serving T2A, T2B and T2C

• Enabling works for T2C

• T2C satellite and associated stands

Under the FBP and the subsequent ABP, the project expenditure in Q6 (£219.8m) is expected to be largely design, enabling works etc – with expenditure focussed on the end of the five year period. A provisional breakdown of this expenditure is as follows: Component Q6 cost

T2A Phase 2 including the design and development requirements to Gateway 4 (Definition) and the demolition of MSCP1, Eurolounge & Pier 3

£130m

T2C design and development to Gateway 3 (Solutions Development) £17m Infrastructure services £13m

Airfield works - dependent on the options for the Eastern Maintenance Base (EMB)

£60m

Under the schedule proposed in the FBP and ABP, the project is expected to be fully delivered by 2026 (ie two years into Q8). Under the RBP the project expenditure is just £5.0m to cover the relevant planning approvals etc for the next phase of T2. HAL accept, however, that the reduction in T2A Phase 2 / T2C expenditure as budgeted in the RBP could delay completion of the full T2 project by about two years. HAL acknowledge that there would be some loss of pier service as a result of any delay – together with increased risks of continuation with the T1 baggage system. In practice, however, the timing of T2A Phase 2 / T2C may depend on the outcome of the Airports Commission and its implications for Heathrow. T2 Phase 1 baggage system Due to the proximity of LUL’s Piccadilly line under the first phase of the T2A building, it was not possible to build a basement to house the main departure baggage system in Phase 1 of T2. Although other options were explored, it was agreed that T2 Phase

1 baggage would be handled via the existing T1 baggage system until the second stage of T2, when a baggage basement would be constructed under the extension to the T2A building in Phase 2. Although the T1 terminal is planned to close by the end of 2016, the existing baggage system will be retained until around 2023/24 – with all T2 Phase 2 construction taking place alongside the live T1 baggage link. Two Q5 projects (T1 baggage system transitions and T1 baggage systems prolongation) have upgraded the system for the additional capacity needed for its combined use for T1 and T2 until 2018 – and for any further requirements to serve T2. However, given the system’s overall age and its recent failure history, there has been some concern, particularly amongst the airline community, as to the risks of retaining the system for the next 10 years. HAL have advised us that they have been working on possible contingency plans for dealing with a prolonged outage of T1 baggage system in a T2A/T1 scenario for several months. However, In view of the concern expressed, HAL and the airlines jointly commissioned a study from Suisseport A.G. to assess the likely risk of failure of failure of one or more components of the system and possible contingency measures that might be applied. The Suisseport A.G. study indicates that the actual departures component of the T1 system (excluding transfer processing) has sufficient capacity to handle combined T1/T2A traffic levels and that there is 100% potential redundancy in the system for the failure of any single component. This conclusion does however depend on strict adherence to the manufacturer’s maintenance standards and on-going support from the supplier being available. Beumer Crisplant, the supplier, has pledged to provide support for the system until at least 2023. We understand that an Inspection Report in 2009 highlighted instances of poor maintenance by Babcock, the T1 O&M contractor. HAL has advised us that Babcock has confirmed that the deficiencies that we identified have been addressed. The main area of concern is the T1 transfer sorter. This performs three principal functions:

• Transfer break and sort

• Hold baggage screening

• Link to departure sortation In the event of failure of the sorter, bags that are already sorted (ie from T3, T4 and T5) can enter the baggage system through one of three inputs and can then be processed through the HBS and the departure part of the system – albeit with some loss of capacity. This capacity is expected to be sufficient to meet demand until the new T2 baggage system is operational. In the case of intra-T1 or T2A bags, however, there is no capacity for transfer break and sort due to the lack of input docks. The transfer sorter is a single point of failure of the T2 baggage system – with an average of about 2.5 outages of one hour or more experienced every year. (Outages of less than one hour are regarded as less important as there is sufficient buffer within Minimum Connect Times to avoid a significant level of missed bags).

A graph showing the history of T1 transfer sorter stoppages per month, including stoppages of one hour or more and their associated average downtime is shown in the graph below:

Source: Suisseport study – June 2013

Suisseport conclude that, whilst the average number of stoppages of one hour or more has remained fairly constant, average length of downtime seems to have increased. The analysis, however, excludes stoppages after 1st July 2013 HAL advise that, whilst they maintain records of system outages, no formal records are kept on the number of missed bags as a result of the T1 transfer sorter failures as this information would need to come from the airlines and the handlers. The evidence however suggests that, in the vast majority of cases, this is less than 50 missed bags per failure. We would recommend that all parties should collaborate to compile such data in the future. There are currently contingency measures in place for manual break and sort of all transfer bags on inbound aircraft at T1 using Building 139 (see diagram below). This facility currently used for T3 transfer sortation and processes around 12,000 bags per day. In the event of a T1 transfer sortation failure, the throughput increases to around 14,000 bags per day – but the facility is capacity constrained at peak times due to the limited number of input docks. Some T3 carriers will move to T2 when the new terminal opens, so the net impact of the additional T2 bags would be similar. Once T3IB opens all T3’s transfer product will leave Building 139 – leaving an average throughput of some 6,000 bags per day. Whilst there is (or will be) sufficient capacity for the use of Building 139 as a contingency measure, bags will need to be driven by tug and dolly from either T1 or T2 and then back to the T1 or HBS screening and flight make up. The additional impact of this on the total processing time has not been measured or modelled by HAL. HAL has undertaken some high-level assessment of the impact of adding an illustrative 20 minutes to the processing times of intra-T1 and T2 bags. They estimate that, due to short Minimum Connect Times, about 3% of bags would miss their outbound flights. Over a full day this would represent some 2,500 x 3% = 75 bags – although, based on an average stoppage of four hours, this would equate to around 17 bags. We would however, wish to see more analysis of these figures, particularly

in view of the knock-on effects (eg on arrivals unloading operations) due to shortages of handler resources as staff are re-assigned under the new contingency operations. We would also ideally wish to assess the situation based on current missed bag statistics when the T1 transfer sorter fails, assuming that these can be obtained from the relevant airlines and handlers. As an alternative to Building 139, HAL has identified another area, the T1 domestic arrivals dock (see figure below ), which could be used for contingency transfer and sort operation once the bulk of T1 domestic flights are transferred to T2. This is considerably closer to T1 and would reduce the additional 20 minutes required for the processing of intra-T2 and T1 bags. The precise layout of this area and the system requirements are yet to be determined, although HAL anticipate that the fit-out cost would be unlikely to exceed £5m-£10m. In any event, the costs of these alternative contingency arrangements would need to be assessed against the expected benefits (ie the comparative reduction in the number of missed bags). Proposed location of T1 transfer sorter contingency arrangements

The Suisseport A.G. study also evaluates the risk of failure of related facilities (eg T1 or T2A check-in, the arrivals baggage system etc) although no statistical analysis is provided. In any event, we understand that HAL and the airlines are currently satisfied that appropriate contingency measures for such failures are, or will be in place. Costings The Q6 cost of £219.8m represents just 5.7% of the overall cost of the project (=£3.8 billion). Risk (at P80) is 11.6% and on-costs are 12.2% of total cost. Comparable figures (at construction decision) for T2B Phase 1 are risk (at P50) at 7.3% and on-costs at 13.1% of total cost. Airline views

The LACC/AOC capital plan includes the full budget allocation for T2A Phase ! roll-over and T2A Phase 2 / T2C as shown in the ABP. A further contingency of £225m is also provisionally included for a possible ‘T2 baggage solution’ in Q6.

Our discussions with HAL and with the airline community suggest, however, that HAL’s proposed use of the T1 domestic arrivals dock in the event for the failure of the T1 transfer sorter is likely to be acceptable. In any event, it is unclear how any contingency reserve might be spent as a new T2 baggage system cannot be built without the main T2A Phase 2 programme – and indeed can only be installed on completion of the main terminal building. Our views

We agree with HAL that the proposed contingency arrangements for the T1 transfer sorter appear to the best option and that no further contingency budget could practicably be spent in Q6 to mitigate this risk. (The contingency shown in the LACC/AOC capital plan is designed to bring forward a new T3 baggage system, although in practice this could not be delivered until the construction of the T2A Phase 2 terminal building). In terms of the T2A Phase 1 roll-over costs, we not believe that it is sensible to delay the construction of Stands 234/235 or the development of a through Kilo taxiway to Q7 and we are not convinced that the original agreed targets for T2 (eg for pier service) would be met. We do however suggest that there may be some scope to delay the second phase of T2A/T2C to Q7, although we feel that HAL needs to further assess this. We acknowledge, however, that the LACC/AOC does not share this view. In any event, we suspect that the project will become more urgent if the Airports Commission (and the Government) rule in favour of new runway capacity at Heathrow. If this is the case, then a reappraisal of the Q6 (or an early Q7) settlement will be necessary. If it does not, then a delay in the T2A Phase 2/T2C project is likely to be more appropriate.

3.8.2 T3 refurbishment and enhancement Summary BC 016/116 T3 security and other infrastructure improvements

Project value (Q6) Summary of scope

FBP (£3 blllion) £25.0m Allowance for Passenger Facing Works

RBP (£2 billion) £36.7m New Transfers Security Facility

ABP (£3 billion) £77.7m New Transfers Security Facility New Façade Arrivals Forecourt Premium Drop-off Facility International Departure Lounge improvements

Project scope Based on the QSM scores for T3, it is recognised that several facilities in this comparatively old terminal require improvement to meet appropriate passenger experience standards. In particular, the forecasted increase in connecting passengers (eg based on a Summer 2020 schedule) suggests that the existing transfers security facility will be inadequate during or shortly after Q6. Given the expected life span of T3 (approx. 10-12 years), Q6 will effectively be the last opportunity for any significant infrastructure improvements. In the FBP an allowance of £25.0m was made for various passenger facing works in T3. This did not specifically include the transfer passenger security although an allowance for additional security lanes was included as part of a separate business case (B068 – Security SQR harmonisation). In the RBP the project was redefined as a new transfer passenger security area to be built on a specially constructed mezzanine floor above the baggage reclaim area. This would increase the total number of transfer security lanes and is costed at £36.7m. The space made vacant in the existing transfer security area could potentially be redeveloped as a new airline reticketing facility – whilst the existing airline ticketing facility could be converted into additional departure lounge space with additional seating/retail space. This would alleviate congestion in these areas, particularly at peak times. There is, however, no budget within the RBP for this additional redevelopment. In the ABP, HAL has allocated a total of £77.1m for the connections security project and further infrastructure improvements. A list of HAL’s proposed improvements in priority order and their indicative costs, together with the LACC/AOC’s proposals for this project (not in any priority order) are shown in the table below. Priority Facility HAL ABP LACC/AOC Proposed

1 Transfers security £35.1m £37.0m

2 New façade (B-G) £20.8m £21.0m 3 Arrivals forecourt £10.5m £10.5m

4 Passenger drop-off £2.8m £3.0m 5 IDL works (SGR 4.0) £8.5m £8.5m Total proposed in ABP £77.1m -

6 Arrivals concourse refit £4.5m £4.5m 7 Arrivals façade (Zone A) £5.9m £6.0m 9 Southwing façade £4.7m £5.0m 10 IDL works (SQR 3.8) - -

Total evaluated £92.2m £95.5m

Benefits As indicated above, the project will provide faster throughput in transfers security and, in the case of the ABP, reduced crowding in the IDL and an overall improved passenger experience (eg from the new facades). It should however be noted that the current (2013) QSM passenger experience scores for T3 departure passengers is 4.16 (out of a maximum of 5.0) and 4.10 for T3 arrivals, representing a substantial improvement over previous years – although these scores are lower than those for T4 and T5. There are no specified benefits included in the financial analysis – although one option for the renovated IDL includes some additional retail space and the other some loss of retail space. Any additional (or loss of) retail revenue is likely to be minor. Options The options for reconfiguration of T3 are limited as it is not possible to expand the footprint of the main T3 building, The recommended option for the new transfer security facility (the mezzanine floor) will require some new load-bearing columns within a baggage conveyor. There may be some minor disruption to baggage reclaim operations during construction. Two options have been presented for the reconfiguration of the IDL. Option A provides an additional 304 seats and 370 sq m of retail space. Option B provides a further 400 seats but involves a net loss of 83 sq m of retail space. This project is currently at Gateway 1 (Initiate). Costings The costings in the RBP and ABP have been prepared by EC Harris on a P80 basis. Further costings have made as three-point estimates. EC Harris state that elemental benchmarking has been undertaken against Heathrow T2A, T5A, T5B and T5C new build terminals, Dublin T2 new build, Gatwick South Terminal Extension and Stansted Terminal Extension. These, however, all represent substantially different types of project. Airline views The LACC/AOC consider that a full spend of some £95.5m is required for this project reflecting their strong priority for terminal upgrade projects in Q6. Whilst we concur generally that some infrastructure upgrading is certainly required in T3, some of the improvements, particularly to the facades, might be regarded as cosmetic in the context of a limited budget in Q6.

3.8.3 T4 infrastructure improvements Summary

BC 017/117 T4 infrastructure improvements

Project value (Q6) Summary of scope

FBP (£3 blllion) £82.9m Upgrade stands for two A380s Coaching gate !B Reclaim belt 6/7 Arrivals hall and forecourt refurb LV upgrade HV infrastructure Car park enhancements Sierra taxiway

RBP (£2 billion) £53.8m Upgrade stands for two A380s Reclaim belt 6/7 LV upgrade

ABP (£3 billion) £72.0m Upgrade stands for two A380s Coaching gate !B Reclaim belt 6/7 Arrivals hall and forecourt refurb LV upgrade HV infrastructure

Project scope T4 currently caters for 39 airlines at Heathrow, including those in the Skyteam alliance. The traffic pattern displays morning and evening peaks and there is a growing requirement to cater for A380 operations. The initial project scope as defined in BC017 in the FBP involved improvements to the terminal, stand and taxiway infrastructure as follows:

• Stands - Upgrading of two Code E to Code F (A380) stands - Conversion of one Code E to Code C stand - Conversion of Stand 463 to an equipment storage area - Refurbishment of Gate 1b as a coaching point

• Third A380 baggage reclaim belt (created by joining Belts 6 and 7)

• Arrivals hall and forecourt refurbishment – reconfiguration of existing space

• Short-stay car park (SSCP) - provision of additional capacity through at grade car parking linked to the existing car park. Modifications to the road layout are also required

• Upgrade of HV/LV system to comply with the latest safety standards

• The upgrading of Sierra taxiway

The required scope was based on HAL’s traffic forecasts (and terminal occupancy assumptions) as at October/November 2012. These forecasts assumed that there will be no increase in passenger demand at peak periods due to airline relocations (eg MH will transfer with Oneworld to the CTA, UA consolidates operations in T2 and IL relocates to T5).

In the RBP, the project scope was reduced to cover the upgrading of the stands to hold two A380 aircraft, the third A380 reclaim belt and an LV upgrade. The scope in the ABP is as per the RBP, plus the coaching gate 1b, the arrivals hall and forecourt refurbishment and the introduction of HV infrastructure. In both the RBP and the ABP, the cost for the upgrading of Sierra Taxiway has been transferred to B011 (‘Enabling the new generation of wide bodied aircraft’). Benefits Terminal 4 is now 27 years old and many of its facilities no longer meet current and future airline and passenger requirements. The key project benefits are the provision of necessary capacity for wide-bodied (including A380) growth, the upgrading of the LV infrastructure, which is life expired and represents a significant business risk and, in the case of the project as defined in the ABP, improvements to the T4 building improve the overall passenger experience The business cases do not quantify any specific financial benefits from the project. Options It is understood that a number of project options for the A380 stands will be reviewed including a reduction in the overall number required (x4 not x5 as proposed in the currently preferred option). It should be noted that Arups have undertaken a strategic options study for T4 which was completed in May 2012. This covered the full development of T4 in Q6 and beyond. Arups identified that the long-term development costs could range from approx £275m-£325m under a ‘do minimum’ option to approx. £1,050m-£1,100m in a maximum investment option. Arups and Atkins have already undertaken some preliminary design work on the project, although the project is still at Gateway 1. Costings The P80 cost of the project scope as defined in the RBP are estimated at £53.8m and in the ABP at £72.0m. These costings have been prepared by EC Harris in conjunction with HAL and are calculated on a Three Point Estimate basis. A high proportion of the cost relates to the A380 stands (£35.0m) and baggage belt (£4.0m) and is expected to be delivered in Year 1 of Q6 (2014/15). Airline views In their capital plan, the LACC/AOC have allocated a total budget of £57.0m for this project, covering the A360 stands (£35.0m), the baggage belt (£4.0m), the Immigration Hall (£3.0m), the Arrivals Hall (£5.0m) and both the long and short stay car parks (£10.0m). An LV upgrade (£19m) is included in their Engineering Asset Replacement project – giving a total proposed T4 expenditure of £76m, which is broadly in line with HAL’s ABP. It should be noted that whilst the T4 building needs long-term facility upgrades, the QSM scores for arrivals passengers, in particular, have improved significantly over the past four years (see Section 3.4) and are now comparable to those in T5.

3.8.4 T5 Security Capacity

BC 018/118 T5 Security Capacity

Project value (Q6) Summary of scope

FBP (£3 blllion) £75.0m Provision of new 36 lane central security search area behind BA bag drop in current landside area

RBP (£2 billion) £23.0m Creation of new escalator transfers arrival route plus five additional search lanes

ABP (£3 billion) £23.0m As per RBP

Project Scope T5 security facilities are currently problematic; the central search area is at capacity – primarily at the northern search cone where public transport routes point the passenger towards – and congestion is caused when peak transfer passengers arrive. The problem is primarily in the northern component where transfers feed into and there is little scope to push O/D (origin/destination) traffic through the southern area. The facilities overall have lacked resilience to market moves such as BA purchase of bmi and up gauging to larger aircraft. The project scope from the FBP has changed considerably and the focus will now be on the revised project with business case dated July 2013 rather than the £75m project in the FBP which involved a landside single security area and attendant operational disruption and high capital costs. Following stakeholder meetings with BA, a more tactical project has been devised, involving the creation of a new transfers route by means of an additional escalator from the arrivals and a routing to the existing southern security area. The latter would have five new lanes added to it. Benefits/Costs A solution to the problem would reduce Heathrow’s security waiting times both for O/D and transfers and also improve the airport’s QSM scores for these areas. It would also help Heathrow maintain its upper quartile position in the ASQ scores and improve terminal connection times. The new project still has retail impacts as an airside area next to the southern cone has to used; this leads to a revenue loss of just under £3m per annum. As the buggy route is removed some £270k is lost on extra PRM costs to compensate. There are also additional security staffing costs to man the five additional lanes which total about £570k per annum. Options As mentioned above the initial scheme in the FCP was rejected and was never fully designed. Following structural and MEP feasibility studies at least 8 options were examined and a scheme with two escalators passing down two levels but avoiding mid floor beams was chosen. There was a T5 CIP lounge component to this project which is now dealt with elsewhere in the capital plan.

Costings The usual EC Harris three point estimates were completed; enabling works, gate seating changes, reconfiguring arrivals and departures levels and installing escalators costing £16.1m including £1.5m on-costs and £2,5m risk. Another £6.8m has been allowed for CSA and connections security works. The current scheme is only fixed conceptually with many more options on detailed routings and operational processes to be completed. Gateway 2 is due for September 2013 and Gateway 3 in October next year. Airline views Airline views would appear to be supportive of this project and the current solution in particular.

3.8.5 Northern Perimeter Summary

BC 009/109 Northern Perimeter

Project value (Q6) Summary of scope

FBP (£3 blllion) £43.0m Additional car parking spaces (2460) Consolidation of car hire PRT into CTA

RBP (£2 billion) £10.6m Additional car parking spaces (750)

ABP (£3 billion) £10.6m + £20.2m (PRT)

Additional car parking spaces (750) PRT into CRT shown as a separate business case

Project scope This project, as originally conceived in the FBP, was designed to improve the car parking for CTA and T5 passengers provided along the Northern Perimeter road. The scope covered: (a) Increasing car parking capacity by 6.4% by providing an additional 1,585 deck

and 875 surface spaces

(b) Consolidation of all existing passenger, staff and car rental car parks to single sites

(c) Improvement of the Northside road network and wayfinding

(d) Provision of PRT connectivity from the car parks to the CTA (e) Increased commercial returns from increased car parking usage and yields (eg

as a result of capacity improvements, the PRT etc) (f) Reduced opex savings eg through consolidated bussing operations etc Subsequent meetings with stakeholders indicated that there was no ‘buy-in’ from the car rental companies and that there were no benefits from consolidation of other car parks. As a result, the focus of the project in the RBP and ABP changed to the provision of extra car parking capacity for T5 in the business and long stay car parks. The project brief was to provide between 750 to 1300 additional car parking spaces as close to T5 as possible, with a minimum requirement of 250 T5 Business parking spaces. Certain adjustments to other car parks, wayfinding etc would also be necessary to facilitate the above. A wide range of options have been explored (see below) through joint workshops, meetings etc with stakeholders. Three possible options (Strategy A, B and D) have now been identified – one of which has been recommended (Strategy A) at the G2 Gateway.. Strategy A involves a new single storey deck in the T5 business park increasing the total number of spaces from 1,250 to 1,500 (ie an additional 250 spaces) and a redesign of the N2 area to provide 1,000 T5 long stay spaces together with consolidated bussing operations. A further option (Strategy D) provides 360 more business parking spaces but would require land acquisition (the Beach). At this

stage (Gateway G2) the possibility of such land acquisition is continuing to be explored. The business case for this project is identical in both the RBP and ABP – although the PRT component originally in the scope of the project in the FBP is now shown as a separate project in the ABP (B088) and is budgeted at £20.2m. The objective of the PRT is to improve the passenger experience in terms of their ‘first and last’ impressions of Heathrow and to provide incremental car parking and sponsorship revenue. Extension of the system to the CTA business car parks would provide equivalence with T5 users. HAL has indicated that the T5 PRT has a very high QSM satisfaction rating (4.7 out of 5.0) representing the highest score of all facilities at the airport. They estimate that the PRT to the CTA would carry approximately 1,200 passengers per day. The precise routing of the system within the CTA has not been finalised and at present there are two options (high and low cost) for the location of the stations. Benefits The business case for the proposed new T5 car parking is estimated to provide total benefits of £22.2m in Q6 and Q7 (primarily from increased car parking revenue) which is offset by £8.4m in additional opex (ie a net gain of £13.8m). This must be assessed against the capital costs of £10.6m. This is based on an assumption of a 0.25% increase in modal split (ie towards the use of T5 car parking) growing to a maximum increase of 0.75%. We have not analysed these financial benefits in detail. We would, however, contend that these seem high, particularly as additional revenue is only generated when the extra capacity is utilised, although HAL maintain that they have taken account of demand variation across the year. We understand that the HAL is proposing to re-assess the financial benefits following the selection of the preferred option at G2. HAL also contend that the project has some sustainability benefits, notably a reduction in CO2 and NOx emissions and reduced noise – largely as a result of a reduction in kiss and ride traffic. HAL has prepared a summary of the costs and benefits of the PRT (Business Case 088), which is shown below:

This analysis suggests that the net annual financial benefits from the project will be some £3.1m pa, representing approximately £7.00 per passenger journey. Based on HAL’s figures, the project would pay back in mid-Q7. It should be noted that the airlines have strong reservations about the benefits of this project and we have some concerns that the increase in car parking revenue may not be achieved. Options Some 14 options for additional T5 parking (plus a ‘Do Nothing’ scenario) were evaluated during the G2 stage. Of these, one option (development of the existing T5 Business Parking had four sub-options) Seven of these identified options were rejected without detailed assessment as they supported a need to relocate contractor parking which through internal consultation was established as no longer being required. From these, three preferred options were selected (Strategy A offering 1,250 additional spaces, Strategy B 900 additional spaces and Strategy D 1,370 additional spaces – with Strategy A (see above) nominated as the recommended option (with continuation of discussions for land acquisition (‘the Beach’) for Strategy D.. The PRT project has two possible options: a low cost option with CTA stations at the coach park and MSCP2 (representing a total track length of 650m) and an ‘aspirational’ high cost option with stations in the forecourt and in front of T2 (with a total track length of 840m) Costings Although a budget of £10.6m is shown within the business case, the detailed costings for the three preferred Strategies are less than this. Strategy A is costed at £7.0m, Strategy B at £8.0-£9.0m and Strategy D at £6.8m excluding land acquisition costs (all on a P80 basis). Some benchmarking against decked car parking projects at Gatwick has been undertaken by Arup, who are HAL’s consultants for this project. This would suggest that the decked car parking component of Strategy A is line with these projects. No other benchmarking of airport (or non-airport) car parks has been undertaken. The PRT project has been benchmarked against the T5 PRT system. Interestingly, HAL’s figures suggest that the capital cost for the T5 system (which was the first to be introduced) had a higher capital cost (£32m) but has less users (approx. 1,000 passengers per day) in comparison to the CTA PRT with a capital cost of £20.2m and a forecasted 1,200 passengers per day. Airline views There has been good shareholder consultation throughout the development of this project through joint working group sessions, the Surface Access Portfolio Stakeholder Board and the Landside Shareholder Engagement. The LACC/AOC support the Northern Perimeter project as defined in the RBP and ABP – although thy have included it on their ‘commercial payback’ project list rather than their main £3 billion portfolio. They totally reject BC008 (PRT to the CTA).

3.8.6 Enabling the new generation of wide-bodied aircraft

Summary

BC 011/111 Enabling the new generation of wide-bodied aircraft

Project value (Q6) Summary of scope

FBP (£3 blllion) £158.5m Bravo North Taxiway and Sierra A and C works PLUS Pier 4A remote stands, RETs and RAT and FEGP for new aircraft types

RBP (£2 billion) £86.8m Bravo North Taxiway and Sierra A and C works only

ABP (£3 billion) £182.7m As per FBP but with taxiway Sierra C works transferred from T4 Infrastructure and a new noise wall.

Project Scope This project originally (ie in FBP) excluded Sierra C works which were then part of the T4 Infrastructure project. As a result the FBP total was £158.5m total, whereas the ABP is some £182.7m. The RBP has reduced scope with only Bravo North Taxiway and Sierra A and C works included – ie a project just carrying out taxiway widening for Code F aircraft and costing £86.8m. The RBP excludes any works on Pier 4A remote stands, RETs and RAT and FEGP for new aircraft types which are included in the ABP/FBP. The ABP also now includes scope for a noise wall.

For the purposes of this report we will focus on the ABP version of B011. A380 departures are forecast to be running at about 35 a day by 2018 with almost 45 forecast by 2030; this aircraft in particular causes problems because of its wingspan, but airlines will also be investing in other new generation wide bodied aircraft such as the B787 and A350. Benefits/Costs Currrent sub optimal A380 taxi routes to and from T4 add around 7 minutes to their taxi times leading to £5m additional operating costs for airlines at Heathrow due to £1m extra fuel burn and £0.5m delay costs by A380s directly, and another £1m extra fuel burn and £2.3m delay costs for all departing and arriving aircraft due to knock-on extended taxi times. This in turn leads to 6.3k tonnes of increased CO2 emissions. These increased taxi and runway hold times are also bound to increase block times and adversely impact on overall punctuality and delays to passengers. The Sierra taxiway improvements would allow A380s using T4 to operate on the souithern runway, thereby avoiding the problem of runway crossings from T4 using the current Code F clearance taxiway. Such crossings would reduce reliability of operations and potentially reduce runway capacity and resilience. In addition without these aircraft it is unlikely that HAL will meet its passenger forecasts. The above benefits would be enjoyed for both the ABP and RBP schemes. In addition the provision of RETs would reduce missed approaches and help meet minimum separation distances which would improve the resilience of the operation

and reduce delays. A RAT for runway 09L would reduce departure delays and improve resilience as well as helping improve Heathrow’s noise footprint on easterlies. The development of pier 4A wide body stands would enable long stay aircraft to be towed off pier served stands and thus improve pier service in T3 and enable up-gauging of aircraft generally. Provision of FEGP for B787s would avoid use of APUs and GPUs improving operational performance and reducing emissions. There are also some small reductions in operating costs – only £24k per annum from 2016/17 onwards – resulting from the use of LED lights. Options This is really a programme of different airfield projects most of which has been subject to optioneering. Fast time runway and airfield simulation has been used to generate the best options for taxiways, RETs and RATs. The current configuration for the taxiways for the northern runway relies on a complex sequence of airfield construction and operational protocols whereby A380s initially use Alpha taxiway whilst Bravo is being constructed which is itself a temporary solution; Sierra taxiway sections A and C also have a complex development strategy with a road relocated and 4 stands reconfigured (latest thinking). Different options for building remote stands on the area occupied by Pier 4A have been identified but this work has ceased. Similarly options work on RETs has been stopped – three preferred options having been identified. Costings The usual EC Harris three point estimates were completed; for Bravo taxiway enabling works (demolition of Pier 4A), the taxiway works and prelims cost £35.3m with £2.5m project specifics, £5.7m on-costs and £6.6m risk bringing the total to £50m or £57.6m at P80 level. For Sierra C, enabling works and relocating roads and stands cost £10.3m with £3.2m project specifics, £2.7m on-costs and £3m risk bringing the total to £19m or £21.6m at P80 level. The breakdown by individual component is as follows; Bravo North taxiway and partial demolition of pier 4, £57.6m: provision of 4 Pier 4A Code E remote stands, £60.5m: Northern runway RETS (x4) £27.9m: FEGP upgrades £6.9m: 09L RAT and noise wall £10m: Sierra taxiway changes £19.7m. The project has relatively well defined benefits and has passed Gateway 2 with Gateway 3 scheduled for February 2014 for the reduced RBP scheme. Airline views The full ABP scheme has a lot of airline support; they are not in favour of the reduced scheme due to:

The exclusion of the Code E Remotes. This will increase towing distances and, in the opinion of the airlines (but not HAL), impact on pier service levels in T2

• The exclusion of the RETs for the northern runway from the HAL RBP would mean no improvement in arriving flights ability to exit the runway, and therefore no improvement in congestion or punctuality

• The 09L RAT and noise wall is an enabler for the ending of the Cranford Agreement. It would allow more efficient use of 09L by enabling easterly alternation which HAL does not currently do. This would result in balanced runway usage, whether on easterly or westerly operations.

In our opinion, these points are reasonable.

3.8.7 Airfield efficiency and resilience Summary

BC 012/112 Airfield efficiency and resilience

Project value (Q6) Summary of scope

FBP (£3 blllion) £70.7m As RBP but with datalink comms, automated stand allocation, turnround management, vehicle tracking, airbridge links, Ops freedom works, Cat 2/3 GBAS, plus reduction in scope for SMAN (an integrated AMAN/DMAN), runway incursion protection options

RBP (£2 billion) £29.0m Time Based separation, Airspace changes, RTA/Queue management, Surface Management, GBAS

ABP (£3 billion) £70.7m See FBP

Project scope This project is a collection of IT and modelling initiatives by HAL in conjunction with NATS designed to improve airfield efficiency. The scope of the project is entirely driven by the rise in proportion of A380 and Code F aircraft generally in the fleet mix at Heathrow which because of wake vortex issues will lead to increases in arrivals delay of around 35 minutes in 2019 compared to the under ten minutes scheduled for today. This in turn leads to model forecasts of only 59% flights being punctual but subsequent rotational delay and off schedule congestion would mean much higher levels of delay in reality. The aim is therefore to deliver wide body growth (and hence increased passenger numbers) within the 480k ATM cap and at acceptable levels of delay/punctuality. Benefits/Costs Benefits for this project would be significant and many as follows:

• Delays significantly detract from the passenger experience and are probably the key performance indicator for passengers

• Enables passenger growth which brings revenue growth for airlines and HAL

• Also reduces the level of cancellations and disrupted days with airline airport and passenger benefits

• Improves minimum connect times and reduced missed bags

• Improves noise performance by reducing ground and airborne holding and less night flights

• Reduces airline fuel burn

• Lower carbon and NOx emissions from lower fuel burn

• Reduces airline operating costs by more efficient use of crew, aircraft and handling operations

It is estimated that doing nothing would lead to additional airline operating costs of over £500m over Q6 and the project would deliver capability improvements of £178m over Q6. Both these together would deliver annual cost savings of over £300m by the end of Q6. In terms of metrics the following targets have been adopted

• Reduced air holding from 7.4 to 5 mins per flight

• Reduced ATFM delay from 2.8 to 1 minutes per flight

• More reliable schedule – 80% punctuality for arrivals and departures • Reduction in disrupted days from 38 to 29

• Reduced unscheduled night flying from 554 flights to 496

• Reduced ground holding from 20.5 minutes to 18

• Reduced taxi-in times from 7.5 mins to 6.5 It is estimated that some £71m capital and an additional £7.8m of operating costs will be involved in Q6. Options HAL considered only limited options for this project – do nothing, reducing the growth of code F aircraft or reducing the number of slots. Clearly none of these alternatives would be acceptable to HAL or its stakeholders. However, in reality this programme is really a collection of projects each of which has its own risks and opportunities many of which are not well understood at present. These projects are as follows:

• Approach efficiency; a series of initiatives such as serve by schedule protocol, independent parallel approaches, arrivals datalink protocols, GBAS landing aids, time based separation on arrivals (used primarily in hind winds)

• Departures efficiency; another suite of solutions such as optimised airbourne departure routes, departures datalink protocols, and full DMAN procedures

• Enabling Mixed Mode operations; implementing mixed mode for use on a tactical or planned basis according to Government policy

.

• Ground movements of aircraft; again a collection of solutions such as real time monitoring of runway occupancy, automated taxi guidance systems, stand allocation and runway incursion systems, vehicle tracking and access controls for airbridge operations.

• Airfield Management; improved airfield capacity modelling and the integration of AMAN and DMAN tools.

These solutions require significant collaboration between a wide group of stakeholders (HAL, NSL, NERL, airlines and ground handlers) with DfT and CAA SRG approval required for many projects. The projects will also form key parts of the UK Future Airspace Strategy and the EU’s SESAR R&D programme. Costings The total estimated P80 cost is £70.7m. The project is relatively mature and has passed through project gateway 1 with G2 scheduled for October. The departures efficiency and airfield management phases have expenditure scheduled for the first two years only.

Key assumptions behind the costings include aircraft demand based on a 2019 forecast schedule, delay costs as calculated by the University of Westminster, and the renegotiation of the current NATS contract expiring in April 2014.

There is a detailed programme of 21 workstreams each with their own business

driver, capital and operating costs and outline schedule. Assurance by C&C has

been provided for almost all workstreams, though the impact on the NATS contract financial terms is unknown. A Monte Carlo analysis of the IT items was carried out giving a P80 value of £53.6m. Risks would appear to be moderate and based around lack of available specialists, the need for complex stakeholder discussions on process, and safety/policy approvals.

The RBP costings have been calculated as follows (compared to the same elements

in the FBP): £million FBP RBP

Time-based separation £8.0m £5.0m Airspace changes £10.0m £6.0m RTA/Queue management £1.2m £4.0m

Surface management £6.7m £10.0m GBAS £4.85m £4.0m

Total £30.75m £29.0m

This means that there are excluded works of some £31m but with savings of £7.4m

through budget absorption. The excluded works comprise datalink comms, automated stand allocation, turnround management, vehicle tracking, airbridge links, Ops freedom works, Cat 2/3 GBAS, plus reduction in scope for SMAN (an integrated AMAN/DMAN), runway incursion protection options and all risk allocation.

HAL expects to be able to sustain current levels of punctuality with this reduced

scope as the wide bodied fleet increases. By implication more punctual schedule than today will not be delivered nor will at least some of the airline cost savings which were forecast to be over £100m per annum by the end of Q6.

Airline views

. Airlines are generally a big supporter of this project; they are however wary of the complexity of the NSL and NERL interfaces and concerned about value issues when negotiating with another monopoly supplier. There is a wide variety of stakeholder involvement required to deliver new concepts, operating procedures and safety sign-off. Consequently, the full scope of the project is unknown. The airlines are, however, against the RBP scope reduction for the following reasons

• The enhanced surface management being excluded will mean that landing and departure flight phases will be less well integrated

• The excluded New Stand Allocation System would have provided more dynamic updates and better use of infrastructure

• The projects being excluded will lead to lower punctuality and resilience

• There will be a loss of SESAR functionality as part of the Single European Sky project – no introduction of emerging results or promising results from the validation of common projects currently being underway across Europe

We believe that the airlines views are valid.

3.8.8 Commercial IT and telecoms Summary BC Commercial IT and telecoms

Project value (Q6) Summary of scope

FBP (£3 blllion) £14.0m 4G common infrastructure, Improving WAN connection speeds, Commercial deployment, NRC infrastructure

RBP (£2 billion) £14.0m As above

ABP (£3 billion) £14.0m As above

Project scope HAL currently offers two streams of commercial IT/Telecoms; one it provides itself direct to consumers (B2C) and one it provides B2B via the outsource contract with CAP Gemini but operated by SITA. It believes that there is not a consistent comprehensive product available due to the lack of a coherent plan with suite of offerings. This project provides investment to enable such a plan to be realised involving the right products and technology adoption. It is included in the Revised Capital Plan. Benefits/Costs Benefits for passengers would comprise access to Wi-Fi and Internet services comparable to those available elsewhere, especially with the advent of 4G. ASQ would be used to measure satisfaction For the airline community improved technology offerings would be available with lower cost and better service IT. These would either be in competitive markets or via the Other Regulated Charges mechanism. CAP Gemini’s quarterly customer satisfaction survey would be used to track progress in the areas of price, SQ, product and technology adaption. Capex totals almost £14m but is front end loaded in Q6 due to the advent of 4G. It is assumed that revenue will increase by £17m over Q6 (£9m from 4G and £8m from B2B via the SITA contract) and by £28m over Q7 with additional operating costs of £3.6m over Q6. The project is therefore forecast to deliver EBITDA of £13.7m so is almost cash neutral but likely to lead to a modest reduction in airport charges over Q6. Capital spend has been identified in four areas:

• Provision of a 4G common infrastructure offering for Heathrow terminals -

£6m

• Improving WAN connection speeds over the Heathrow campus by new

ports/routers; this is important for the NRCs - £1m

• Commercial deployment - £2m

• NRC infrastructure – mostly moves, adds and changes - £4m

Options HAL considered only limited options for this project – do nothing, or just some of the areas identified above. The airport feels it needs to invest in both the public and airline community products both from a customer service perspective and from the need to take advantage of new revenue sources. The investment in the Heathrow common IT infrastructure for operational purposes would make little sense if these commercial add-ons were not taken advantage of. Costings The total estimated P80 cost is £14.0m. For IT capex a three point estimate is provided for each line item by the assurance supplier C&C. A Monte Carlo analysis is then completed leading to an overall P80 value for the project. For BC020 the estimates were a mixture of allowances and benchmarks. The 4G costs were benchmarked using 3G expenditure, WAN connection was an allowance and the other two items were mixtures of allowances and benchmarks. The costings can only be regarded as very high level estimates, little more than allocations, given that 4G licencing has not been completed, the market is still untested and that other products may arrive in Q6 which are currently unknown. However, risks are relatively low and are mostly around avoiding operational disruption and ensuring third party buy-in. This project is included in full in the ABP and the RBP. The latter is unsurprising given the positive contribution it would make to HAL’s commercial revenues. The project is relatively immature and has not passed through any project gateways. Airline views

. As this project has a payback within Q6 the airlines are generally supportive of it. However, there was a specific query about whether the business case contains all the relevant costs and revenues (especially NRCs) and a reminder that such forecasts should be part of the overall regulatory forecasts. The project is included in the airlines “C” list – ie to be included whatever level of capex is agreed provided the project fully pays back in Q6.

3.8.9 Automation of the passenger journey Summary

BC029/129 Automation of the passenger journey

Project value (Q6) Summary of scope

FBP (£3 blllion) £30.0m Allowance for: - Check-in product development - Self-bag drop - Self-service kiosks - Info kiosks & PRM assistance points

RBP (£2 billion) £8.5m Check-in product development only (Replacement of CUSS IT assets at end of life

ABP (£3 billion) £60.0m Increased allowance for: - Check-in product development - Self-bag drop - Self-service kiosks - Info kiosks & PRM assistance points

Project scope This project provides a portfolio of new technologies to improve the passenger journey and provide financial and other operational benefits to Heathrow’s airlines. The project scope in the FBP and ABP potentially covers

• Check-in product development (CUSS check-in and self tagging)

• Self bag drop

• Self-service kiosks for check-in / Flight rebooking kiosks in Connections and baggage recovery kiosks in Reclaim

• Information kiosks and PRM assistance points In addition to these items, a further technology, self-boarding gates, has been identified in the ‘aspirational’ scope for the overall business case, but these would not be implemented until Q7. In the RBP, the project scope is limited to the replacement of the existing CUSS check-in terminals only. These terminals would be integrated with the CUPPS (Common Use Passenger Processing Systems) which links to airline check-in and DCS (Departure Control) systems. The CUPPS systems at Heathrow are paid for by the airlines. Some work has been undertaken by IATA to assess how this might be achieved at Heathrow; however here is some debate with the airlines as to whether this is necessary at this point due to evolving technologies and the growth of mobile check-in. In view of this, HAL believe it will be necessary to replace the existing CUSS terminals (or fully refurbish them) in Q6. The ‘aspirational’ scope for this project involving full implementation of these technologies across all terminals is estimated at between £120m-£130m. In the FBP, the budget allocated was £30m. This, however, only covered a limited number of self bag drop units (x50) in T5 and T2. The budget in the ASP has been increased to £60m.

An initial breakdown of the likely costs of each component is given in the table below. It should be noted that the ‘Aspirational scope’ cost covers all items requested by the airlines. It is costed as a most likely estimate – so the P80 costs are likely to be higher. B029/129 Automation of the Passenger Journey - Breakdown of Budgeted Expenditure FBP RBP ABP Aspirational

scope Self Bag Drops £12m - Not shown £73m Self Boarding Gates - - Not shown £28m CUSS Asset Replacement £9m £9m Not shown £9m

Self Service/Info Kiosks £9m - Not shown £9m Total Budget £30m £9m £60m £119m

In terms of the technologies involved, the self bag operation is a two step process involving the self tagging of bags and entry into the self bag drop unit without any interaction with an airline member of staff. The units cater for common airline use for both international and domestic flights. Further technologies proposed include mechanical barriers at boarding gates and barriers at Flight Connections to validate passenger tickets. HAL has been working with IATA (eg the Passenger Experience Management Group – Fast Travel Programme), the Border Agency and interested airlines at Heathrow to develop these initiatives. There have already been some trials (eg bag drop facilities in T3 (BA) and in T1 (Star Alliance). HAL have undertaken some market research amongst passengers to identify the size of the need for each type of automated process and their likely usage / expected behaviour. Of the different types, e-passport gates achieved the most positive overall score, followed by automatic ticket presentation, CUSS, gate barriers, self boarding, self bag drop and self bag tagging. Baggage recovery kiosks, information kiosks and wayfinding technologies achieved the lowest overall scores. HAL have also prioritised the different technologies with BA, OneWorld, Star Alliance and Virgin). Automation of the Passenger Journey – Priority and Benefits Matrix

HAL has also assessed the extent of introduction of these technologies at other major international airports, which is shown in the table below:

Self Bag Drop Self Boarding Biometrics

Frankfurt (FRA) Trial/Impl Trial/Impl - Munich (MUC) Trail/Impl Trial/Impl - Paris (CDG) Planned Trial/Impl - Amsterdam (AMS) Trial/Impl - - Copenhagen (CPH) Trial/Impl Trial/Impl Trial/Impl London Gatwick (LGW) Planned Planned Planned Manchester (MAN) - - Trial/Impl

Sydney (SYD) Trial/Impl - - Houston (HOU) Planned Planned - Vancouver (YVR) Trial/Impl - -

Benefits HAL have identified the key benefits to be savings in airline opex (eg from self bag drop), capacity increases (eg in the check-in concourse as a result of reduced passenger processing and queuing times), improved passenger experience (as measured by ASQ scores) and a reduction in human errors for border control activities (eg at the pier gates).. . HAL estimate that the airline opex savings from self-bag drop (based on one host for four self-bag drop units) to potentially be as follows:

• 10% usage by LHR passengers - £2.3m pa

• 25% usage by LHR passengers - £5.8m pa

• 50% usage by LHR passengers - £11.6m pa The likely usage during the course of Q6 is difficult to estimate and there will undoubtedly be a proportion of passengers who will continue to use standard check-in desk procedures. The airline opex savings from self-boarding gates are estimated at £2.5m pa for implementation in T2 and T5 and £4.8m for full implementation across all terminals. On the negative side, there are some HAL operational, maintenance and additional IT costs – although these are significantly outweighed by the airline cost savings. It should, however, be noted that the airline cost savings are HAL estimates only and have yet to be validated by the airlines. Options In the FBP, a ‘minimum investment’ scenario was proposed, with a total budget of £30.0m in Q6. This involved:

• Self bag drop – Replacement of 20% of check-in desks with self bag drop in T2 & T5. None in T1, T3 or T4

• Self boarding – None

• CUPPS – Replacement of all existing CUSS units

• Information kiosks and PRM (Passenger Reduced Mobility) The airline community felt that this level of investment was inadequate and that there should be no discrimination between terminals. The LACC/AOC has allocated a

figure of £120m in its £3.0 billion budget for full cross-airport implementation of the project in Q6. In the ABP, the budget for this project has been increased to £60.0m although the business case does not provide a breakdown of the funding by the individual technology or by terminal. Whilst the budget now has more flexibility, the LACC/AOC still believe that it is insufficient. In the RBP, the budget is reduced to just £8.5m to cover the CUSSP equipment only. Again, this is rejected by the airlines, who feel that replacement could, in any case, be delayed and would prefer ‘to sweat the assets’. Costings All cost estimates to date have been prepared on a P80 basis, with allowances of. 7.7% for project specifics, 8.0% for on-costs and 15.4% for risk. We note that in the costings prepared to date (eg for the FBP), the equipment and IT costs amount to about one-third of the overall project cost – with the remainder comprising the necessary building and reconfiguration works and the allowances. In our view, the risk allowance appears excessive, despite the uncertainties around the reconfiguration requirements (eg for the check-in areas).. The self bag drop equipment cost projections have been based on the equipment used in the T3 and T1 trials. It is understood that this has Triple A (Accounting and Authorising of Hold Baggage for Carriage By Air) compliance in line with DfT requirements. However, it is expected that unit costs will decrease as the market expands in the next 3-4 years and on the basis of the number of units ordered. Airline views As indicated above, the project is strongly supported by the airlines and has the direct involvement of IATA and the DfT in trials of the technologies. The trials of the self bag drop, self boarding gates and information kiosks have proved successful and a biometric process trial at CUSS terminals was also carried out in T5 in November 2012. A study on passenger risk assessment using these technologies has been proposed, which would be jointly funded by HAL and the DfT.

Our views We are generally supportive of this project, although we note that there are still uncertainties over the Triple A certification of the equipment and pro-active engagement with the DfT and the Home Office is needed to bring this project to fruition. We also feel that further input could be provided by the airlines on the likely benefits. (There would appear to be some disagreement with the airlines as to the extent of the airline operational cost data provided to HAL). Whilst we are in favour of self bag drop, the CUSS replacement and the information kiosks, we recognise that self boarding gates rank low in the list of passenger priorities and have a relatively low opex saving to the airlines (and none to HAL). If the Q6 capital budget is limited (ie less than £3.0 billion), we feel therefore that this component of the project might be delayed until Q7 pending further trials and passenger and airline experience at other international airports where this has been introduced. We acknowledge, however, that the LACC/AOC do not share this view.

3.8.10 De-icing facilities BC De-icing facilities

Project value (Q6) Summary of scope

FBP (£3 blllion) - Not included

RBP (£2 billion) - Not included

ABP (£3 billion) £60.0m 4 Code F de-icing pads on both 09R and 27L thresholds and 2 Code F pads on the 09L and 27R thresholds with an extra single Code F pad for southside access to 09R and 27L.

Project Scope This is a new project not previously included in the FBP or the RBP but is now in the ABP. It originates from the Heathrow Winter Resilience Enquiry (the Begg report), in particular recommendation 2: ‘ ‘….that BAA work with airlines, NATS and other relevant stakeholders to review and invest in the aircraft de-icing processes and infrastructure to ensure the airport can maintain its flow rate in inclement weather’. Although no specific recommendations were made on infrastructure, the evidence submitted by BALPA highlighted the problems with on-stand de-icing and advocated remote facilities. In 2012 work was undertaken to look at the impact of de-icing on efficiency and airfield performance; it concluded that there was £22m inefficiency with further costs from excess taxiing and aircraft holding. On a worst case single day over £4m inefficiency was observed. Benefits/Costs It should be highlighted however that these quoted costs of overall inefficiencies in de-icing did not just refer to having on-stand versus remote de-icing or poor infrastructure generally. The causes of the above inefficiencies were a variety of factors including lack of stand capacity, fragmented service provision, lack of co-ordination, inconsistent processes and standards, and poor training and lack of modern equipment. A Steering Group was set up which supported the concept of off-gate de-icing and single service provision, and a model developed which identified the optimum pad size (7 code F bays) and location (runway holds) to support a resilient and punctual operation. Options Based on initial design and costings, £48m could facilitate four Code F pads on both 09R and 27L thresholds and two Code F pads on the 09L and 27R thresholds with an extra single Code F pad for southside access to 09R and 27L.The infrastructure would incorporate glycol recovery and recycling facilities as well as an electronic message board and control system. De-icing rigs would incorporate blending of glycol and air to minimise cost and environmental impact.

Costings A full business case for this project has not yet been produced so the £48m should be viewed as a high level estimate of a particular type of investment. Operating costs of the new facility are excluded. The business case is highly immature and it is unclear which Gateways (if any) have been passed. There does not appear to be any delivery timescale given the continuing discussions on project scope and implementation. Airline Views After a series of Steering Group meetings and working groups, the LACC/AOC has now proposed the a jointly commissioned study is undertaken into the relative performance of aircraft de-icing at Heathrow. They have expressed reservations about the detail of the operational processes behind the suggested concept as well as about having a single supplier of the de-icing service.

3.8.11 Additional fuel infrastructure BC Additional fuel infrastructure

Project value (Q6) Summary of scope

FBP (£3 blllion) £28.6m Groundworks and infrastructure for the site for 6 additional tanks on site GA 17A

RBP (£2 billion) - Without any HAFCO agreement the project is effectively deferred indefinitely

ABP (£3 billion) - As above

Project Scope This project was conceived in Q5, underwent project governance in that quinquennium and was treated as a rollover project into Q6 with £28.3m allowed in the FBP as a resilience item. This would have covered enabling scope including site clearance plus the provision of HV power and fire water and drainage services, with HAFCO, the Heathrow Fuel Consortium undertaking the infrastructure construction itself including six storage tanks, pipelines and associated tunnel. The project would have been jointly delivered by 2017. Since this time the project has been removed from the ABP and RBP completely with the statement: :’Heathrow has only provided funding in the past for basic enabling works. Fuel companies fund the actual storage infrastructure. Heathrow still supports the project including the provision of land, but it is suggested that enabling costs should be incorporated into the existing funding model airlines have with fuel companies’. . The Q5 activity was essentially concentrated on finding a suitable new site for fuel storage which was completed with airline endorsement in 2011 when Grass Area 17A was identified (next to the 470 stands near T4). The activity then concentrated on reaching acceptable Heads of Terms with HAFCO, but negotiations have reached an impasse with HAFCO reputedly refusing to take on liability for construction and on-going operations. Benefits/Costs The main rationale for the project is the current very low level of storage capacity of a maximum of 2.2 days compared to 4.2 at Gatwick, 9 at Amsterdam, and 11 at Paris CDG. This means that the risk of supply of fuel interruption is high despite having three supply pipelines and limited road and rail delivery capability; this was the basis of the recommendation for six extra tanks made by the 2009 study jointly commissioned by HAL, the airlines and HAFCO. The contingency of road tankering fuel into the airport, as was required post the Buncefield explosion in 2005, causes significant departure delays and cancellations particularly as the super cooling of the tankered fuel can cause aircraft wing surfaces to ice up and require de-icing. HAL now also appear to be casting doubt on the fuel forecasts carried out under the 2009 study; in particular they cite monthly and daily fuel uptake in 2013 and believe that annual daily demand will not rise above 21.5m litres – much less than figures around 25m forecast by DfT and BA for 2018.

Given that the lack of current progress with HAFCO discussions and discussions over a suitable business model it could be some time before this project re-commences despite HAL and airlines both seemingly still supporting it in principle. The timescales for delivery are therefore uncertain but presumably the infrastructure could be in place by 2018 assuming an acceptable business model and HAFCO Heads of Terms can be agreed in the next six months. Options Seven airport locations were examined up to 2009 with GA 17A being the only option suitable. It is not proposed to revisit this as HAL and airlines agree on the site. Costings Governance for initial site costings were completed in Q5 up to Gateway 2 and again it is not proposed to review these. Airline Views The views of the airline community are that the resilience risks of the existing infrastructure remain significant with a one day drop in fuel supplies in December 2012 almost invoking the emergency contingency plan. The airlines want the existing project pushed forward but prefer another business model whereby HAL contract HAFCO to construct the storage facilities and take on the assets into the RAB (to the value of £130m). Their belief is that this will give them an improved commercial position though their main priority really is that this project needs to be completed urgently and that HAL should inject more effort into doing this. It is understood that the Commission for Aviation Regulation in Ireland is considering a fully RAB based fuel storage solution for Dublin Airport. HAL Paper to CAA HAL have recently (20 August) provided a paper on this topic to CAA which summarises the infrastructure, roles and responsibilities and fuel demand picture, although we understand that the LACC/AOC has not received a copy of this.. The paper also assesses the business delivery options of the traditional route (HAL enabling works and HAFCO doing fuel infrastructure), HAFCO doing all the works, and HAL doing all the works and broadly finds that the traditional model works best which is at variance with the statement made above for RBP/ABP purposes. The paper repeats that without any agreement with HAFCO this project cannot go ahead but feels that adequate resilience exists with the existing infrastructure. Our views We have the following thoughts on this project:

• The physical assets required and their location would appear to be agreed and the debate is around timing and the business model

• We have requested data on the number of warnings on fuel at Heathrow and were told that there has been one red warning (contingency plan imminent or underway) in October 2012 and one amber (risk of contingency plan being implemented at short notice) since then. However generally we feel that the airlines are best placed to analyse risk as it is they who will have to live with the consequences. If the airlines believe that 6 extra tanks are required as per the

2009 study, and are prepared to pay for them then HAL should facilitate this. The bases of some of the forecasts are in any case uncertain.

• The business model of the airport providing enabling works and the consortium building the rest is long established and was used for the T5 Perry Oaks facility; we know of many circumstances where this is used at other airports. We agree with HAL’s conclusion that there does not appear good reason to change the business model.

• The sticking point would appear to be HAFCO refusing to accept liability for construction and operation. We do not understand this as surely they are the best party to undertake this; our suspicion is that this stance is purely a negotiating position and needs to be robustly tested, perhaps with CAA’s assistance.

• HAL should use the existing business model and ensure that charges to airlines are transparent and the basis of calculation is understood, is reasonable and can be independently verified

• HAL should seek to progress the project along these lines as quickly as possible though of course subject to good commercial sense.

3.8.12 T3IB roll-over

Introduction

This project is treated differently than others in our review as it commenced in Q5. We therefore comment on the additional roll-over costs of £35m projected in Q6 and included in HAL’s RBP and ABP.

T3IB (Terminal 3 Integrated Baggage) is a three storey baggage facility adjacent to T3, incorporating the T3 departure baggage system, arriving bag capacity, an early bag store and HBS, with interfaces for transfer bags through the T3-T5 baggage tunnel and the eastern campus via the WIB (Western Interface Building). It was initially estimated to cost £257m in out-turn prices

This project has had a well-documented series of difficulties during construction with a number of cost increases and project delays. As part of the Q5 capital expenditure review undertaken by ASA for the CAA, an extensive a deep dive forensic was conducted on the project and £30m of inefficiencies was identified. HAL has advised that they have previously written to the CAA rebutting these inefficiencies.

At the time of publishing our Q5 review (April 2012) the project’s Estimated Final cost was £360m. By June 2013 this has increased to £435m but with no change to the timescale and minimal impact on project deliverables.

Based on information supplied by HAL this overspend of £75m is split between £40m in Q5 (almost all in Q5+1) and £35m in Q6. The latter is therefore an additional rollover item of capital expenditure for Q6.

We have been asked to report on this issue to CAA, although this was not strictly speaking part of our brief and we have not had the time to conduct another forensic investigation as per Q5 at the same time as investigating the capex issues and projects included in our terms of reference for Q6.

This assessment is therefore only able to come to some initial prima facie views and suggest a way forward for CAA to consider.

Airline Views

The AOC and BA have made separate submissions on this issue calling for any overspend on the project (the existing £75m and any subsequent increases) to be disallowed from the RAB, and for the £35m Q6 rollover in HAL’s capital programme to be ignored. Their main contention is that had they known that the project was going to cost this much they may well have chosen a different option or project which would have provided them with better value.

Cost Overrun

HAL split the £75m overspend into the following areas:

• Main building works contract with Ferrovial Agroman UK - £20.7m, all in Q5+1

• Baggage Installation contract with Vanderlande Industries - £22.8m with £5.1m

in Q6

• Existing Baggage Hall works (cut-ins) with Mace and VI - £17.6m, all but

£0.75m in Q6

• Project Delivery (all other items including on-costs)

Investigation of the Main Building Works Contract

We have undertaken some initial analysis on documentation provided to us by HAL (‘T3IB programme update on EAC increase to Alan Stratford and Associates’ – IRS 87). Our preliminary conclusions are as follows:

• The statement in the introduction that ‘most of the £75m increase is an estimate for future spend …’ is therefore not correct as a significant proportion of it relates the FAUK contract and this is due to substantially complete in October 2013. In addition HAL have reached agreement with FAUK that there will be no further exposure to consequential cost claims (see Appendix C of HAL’s document).

• Of the £20.72m, £9.11M represents the implication of programme change and the impact of ‘inclement weather’ plus embargos around the Olympics and Immigration industrial action. For weather to be considered a compensation event under the NEC contract it needs to be clearly demonstrated, using weather data, that the conditions experienced occur less frequently than once in ten years. This is relatively straight forward to demonstrate using data provided by the Met Office. The NEC contract also requires the issue of a comprehensive project programme. In compiling this FAUK should have given due regard to anticipated weather conditions and (assuming FAUK knew that the Olympics were scheduled to happen at the time of entering into contract (!)) made reasonable allowances for the impact of the Olympics. If weather data proves that weather should be considered a compensation event then, providing FAUK have followed the contractual requirements for submission of programme data, then the impact of this and other programme events should be capable of calculation. If the Olympics and Immigration issues were not foreseen then there should be evidence of notification from FAUK and/or instruction from HAL clarifying the impact on the project works. Getting to the bottom of this aspect (set out in 2.1) is essential as it either paves or blocks the way for the other programme related issues. Please note that it is not a given that costs should be paid because of delay to the works.

• Of the £20.72m, £3m relates to increase in scope of works. To better understand this we would need to see the original scope, would need to clarify FAUK’s design responsibility and also establish what extent of the scope is driven by regulatory requirements (e.g. thermal insulation).

• £2.1m is for additional resources required for health and safety. Again it is difficult to see why H&S implications weren’t clear at the outset and why FAUK didn’t properly price for them.

• £5.21m is for provisional sums and it is implied in the IRS that this is the total extra cost relating to provisional sums. This needs clarifying along with the scope, value and quantity of provisional sums originally captured in the contract works.

• £3.50m is for subcontractor contract entitlements. Details of this would need to be known in order to comment further

The programme update contained in Appendix C refers to design errors resulting in rework and this needs further exploration. It also refers to a contract conversion from

cost plus to target cost with a 60/40 pain/gain share (HAL/FAUK). The impact of this arrangement is not evident with no visible operation of a pain/gain approach in the information supplied. A saving has been achieved by reducing FAUK’s fee and excluding costs caused by problems in FAUK’s design and integration. These excluded costs must have transferred into another pot so this generates a potentially misleading picture (as opposed to a saving), although the extent of this is not known. In summary, the information provided does not validate the increase in costs. However, works procured under the NEC contract should have been effectively administered and consequently there should be an audit trail to allow further detailed investigation if needed.

Baggage Installation contract with Vanderlande Industries (VI)

The following observations can also be made about this contract

• Withdrawal of discount due to non integration with the WIB (£5.7m) and non realisation of savings (£1.9m). It is unclear why these discounts/savings have not been realised.

• Test bags and handlers during system testing plus O&M training support (two items totalling £2.65m). It is unclear why these costs were not allowed for originally.

• A lot of additional costs – eg work area re-sequencing, disruption, mitigation of disruption, mezzanine sundry works, interface resources – totalling £2.56m; it is unclear why these were not included in original estimates or why they are true additional costs.

• There is also a last section titled Disruption Impacts claimed by BI which HAL

say are still under negotiation – these total £8.9m. Presumably at least some of these claims will be disallowed

. • We also believe HAL are still looking for further efficiencies across the works in

view of the cost increases experienced. This could represent £3-4m savings.

Existing Baggage Hall Works

There is more of a reasonable claim by HAL for cost over-runs in this area as the design works have had to follow the main works to allow the change of the Transfer Docks location to be incorporated following airline agreement. There has also been some peripheral changes in scope with the need for an interim OOG facility and a storage area for ULDs.

However there is still a need to analyse the £18m cost increase to ascertain that these additional costs could not reasonably have been anticipated when the original £27m cost estimate was produced.

Project Delivery

Given that there is a high proportion of on-costs contained in this section it follows that any disallowable costs from the preceding sections will have corresponding additional disallowable costs under project delivery. Under the circumstances we

believe HAL charges and additional risks (totalling £6.77m) should in any case be borne by HAL.

Interim Conclusions

The extent of the possible disallowable costs can thus be estimated as follows;

• FAUK – possible 50% of £20.7m i.e. £10.35m

• VI – possible 50% of items cited above totalling £12.8m i.e. £6.4m

• VI – possible 100% of £8.9m item cited above

• VI – reduction in fees - £3.5m

• Cut-ins – 25% reduction of £17.6m i.e. £4.4m

• Project Delivery - £8m This totals some £41.5m so we believe there is enough prima facie evidence for CAA to disallow the £35m Q6 rollover. That is not to say that all the disallowable monies arise in Q6 – some do arise in Q5+1.

However, further more detailed analysis would be required to come to come to a more properly costed disallowable sum.

3.9 Timing and profile of capex We understand the agreed capex plan will be phased over the five year period and submitted to the CAA on a P80 basis for all projects (except roll-over). An outline phasing of the FBP, RBP and ABP is given in Section 3.5. It is expected that an agreed plan will be refined as the timing of the project gateways are themselves defined in more detail.

3.10 Differences between HAL and airline priorities 3.10.1 Summary of current position The LACC/AOC has prepared its own capital plan for Q6, which is based on a main list of 42 projects totalling £3 billion and incorporates a £280m contingency allowance for early commencement of T2 Phase 2 with more focus on baggage. As they are still considering as to whether this will be necessary, they have identified a further 11 projects totalling £287m to be included in the plan if this contingency is regarded as not required. It is our understanding that, whilst no formal decision has been taken, the LACC/AOC and the airline community are likely to accept that the £280m contingency allowance will not be necessary. The LACC/AOC project lists exclude eight projects totalling £97m in HAL’s RBP and ABP which have a full commercial payback in Q7. In comparative terms, therefore, the LACC/AOC’s preferred capital plan amounts to £3,097m. This section summarises the key differences between this plan and HAL’s £2 billion RBP and £3 billion ABP. These differences are also highlighted in LACC/AOC’s submission to the CAA although we have queried a number of their points with HAL. A full listing of projects in the RBP and ABP and the LACC/AOC capital plan is given in Appendix A. The LACC/AOC has stressed that any agreement on the capital plan is dependent on the impact on airport charges, which itself is dependent on the ‘building blocks’ of the regulatory settlement including the WACC and the airport operating cost. Given the current uncertainty over these issues, the LACC/AOC reserve their position on their £3.1 billion plan, which is subject to a ‘satisfactory’ agreement on the resulting airport charges. Equally HAL has made its position clear that, unless an acceptable level of WACC is included in the CAA settlement, they will be forced to adopt the £2 billion RBP. LACC/AOC’s stance is that they totally reject the £2 billion RBP which does not provide the necessary level of investment to meet the agreed joint objective of Q6 to make Heathrow ‘Europe’s hub of choice’. HAL argue that fulfilment of this objective would merely be delayed, although clearly this would depend on the settlement in Q7 having an appropriate level of investment, WACC and airport charging regime. There are substantial differences between HAL’s RBP and the LACC/AOC’s own plan. These differences cover all types of (non-asset replacement) project – but particularly terminal-related improvements. Most of the other types of project (airfield, resilience etc) are included in both the RBP and the LACC/AOC lists although there are significant reductions in the scope and cost budgets in the RBP.

There are still considerable differences between HAL’s ABP and the LACC/AOC’s list although we feel that it should be possible for the two parties to agree a mutually acceptable plan, if an overall budget of around £3 billion is feasible in the context of the settlement. In line with our Terms of Reference, we have reviewed in detail some 12 key projects in Section 3.5 and we have highlighted any differences between HAL and the LACC/AOC in terms of their scope and budget. This section considers the overall plan and key areas of disagreement in the context of both the RBP and ABP. For the purposes of categorisation, we have split all possible projects (excluding asset replacement) into 11 groups as shown below:

£ millions RBP ABP LACC/AOC Main list

LACC/AOC Additional

LACC/AOC Commercial

Q5/Q5+1 roll-over 187.2 291.8 251.0 - -

Airfield/resilience 149.5 389.0 394.0 67.0 11.0

Terminal 1&2 35.1 249.9 248.0 - -

Terminal 3 36.7 77.7 87.0 8.5 -

Terminal 4 61.8 80.0 57.0 6.0 -

Terminal 5 30.7 35.7 116.0 94.0 8.0

Terminal (non-specific) 91.7 104.7 60.5 55.0 30.0

Baggage - 35.5 280.0 57.0 -

IT 67.7 124.2 120.0 - 35.0

Surface access 7.0 152.0 7.0 - -

Other 7.4 14.7 6.1 - -

Total (Non-Asset Replacement) 674.8 1,555.1 1,626.6 287.5 84.0

Total (Asset Replacement) 1,318.4 1,458.8 1,373.5 - 13.0

Total 1,993.2 3,013.9 3,000.1 287.5 97.0

It should be noted that several projects are ‘cross-category’ and our definitions (including the distinction between asset and non-asset replacement) may differ from those of HAL and the LACC/AOC. Nevertheless, we have reconciled our total budget figures to theirs. Our comments on the key areas of difference in each project category are shown below.

3.10.2 Q5/Q5+1 roll-over projects

£ millions BC No RBP ABP LACC/AOC Main list

LACC/AOC Additional

LACC/AOC Commercial

Terminal 2 Phase 1 Completion B050 55.1 159.7 159.0 - -

T3IB Q5 Rollover B051 82.1 82.1 47.0 - - Additional Rollover B089 50.0 50.0 45.0 - - Sub-total 187.2 291.8 251.0 - -

The LACC/AOC’s £3.1 billion plan assumes that Stands 234/235 and Kilo taxiway are included in the T2A Phase 1 roll-over costs. They do not accept the recent £75.0m cost increase in T3IB – so their plan excludes the additional amount accruing in Q6 (=£35.1m).

3.10.3 Airfield/Resilience projects

£ millions BC No RBP ABP LACC/AOC Main list

LACC/AOC Additional

LACC/AOC Commercial

Northern Perimeter B009 10.6 10.6 - - 11.0

PRT B088 - 20.2 - - - CTA redevelopment (Lead Plan version) B010 - 15.0 - - - Enabling New Generation of Wide Bodied aircraft - Airfield B011

86.8

182.7 179.0 - -

Airfield Efficiency and Resilience B012

29.0

70.7 70.0 - -

Ops Efficiency and Continuous Improvement B038

5.7 5.7 - - -

Security Fixed Post Modernisation B026

10.3

10.3 10.0 - -

Additional Fuel Infrastructure B033 - 130.0 - - Deicing B035 - 48.0 - 50.0 - APOC B043 2.2 2.2 - 2.0 - Cargo Centre Southside B062 - 13.8 - 15.0 -

Air Quality -vehicle charging B073 - 5.0 - - -

Waste Management Infrastructure B055

5.0

5.0 5.0 - -

Sub-total 149.5 389.0 394.0 67.0 11.0

There are significant differences in the budgets for airfield and resilience projects between HAL’s RBP and ABP. As described in Sections 3.8.6 and 3.8.7, the budget in the RBP for projects ‘Enabling the New Generation of Wide Bodied Aircraft’ (B011) and ‘Airfield Efficiency and Resilience’ (B012) are both less than 50% of those in the ABP, with resulting impacts on future pier service, punctuality and resilience. As shown in Section 3.8.11, the LACC/AOC plan includes an allocation of £130m for additional fuel infrastructure but excludes a budget of £20.2m for extension of the PRT to the CTA, which is included in HAL’s ABP but not in the RBP.

3.10.4 Terminals 1 & 2 projects

£ millions BC No RBP ABP LACC/AOC Main list

LACC/AOC Additional

LACC/AOC Commercial

Terminal 1 T1 Closure B030 8.1 8.1 8.0 - -

Airline Moves B037 22.0 22.0 20.0 - - Terminal 2 T2A Phase 2 and T2C B054 5.0 219.8 220.0 - - Subtotal 35.1 249.9 248.0 - -

The key difference between HAL’s RBP and ABP is the T2A Phase 2 / T2C project, which we comment on in Section 3.8.1. The LACC/AOC’s plan has included the full amount in the ABP. As indicated in this earlier section, we have some reservations as to whether the full budget for the T2A Phase 2 / T2C project needs to be included in the current Q6 settlement.

3.10.5 Terminal 3 projects

£ millions BC No RBP ABP LACC/AOC Main list

LACC/AOC Additional

LACC/AOC Commercial

T3 Refurbishment and Enhancement

B016 36.7 77.7 - - -

T3 Transfers - - 37.0 - -

T3 Façade (B-G) - - 21.0 - - T3 South Wing Façade - - 5.0 - -

T3 Arrivals Forecourt & Concourse - - 15.0 - -

T3 Arrivals Façade - - 6.0 - - T3 Premium drop off - - 3.0 - - T3 IDL Works (Seating) - - - 8.5 -

Subtotal 36.7 77.7 87.0 8.5 -

In the RBP, HAL’s capex expenditure on T3 infrastructure is limited to improvement of the transfer security area only (see Section 3.8.2). The LACC/AOC regard this as inadequate for the terminal to be competitive against other terminals (at Heathrow and elsewhere) over its expected future life (20-25 years). HAL’s budget in the ABP (£77.7m) also includes a new façade in the main check in area to provide additional circulation space, a premium drop area in line with Heathrow’s other terminals and an arrivals forecourt and additional IDL seating. The LACC/AOC plan includes all these items (with a further allowance of £4.5m for a refit in the arrivals forecourt pending further information from HAL), together with new façades in the Southwing and in the Arrivals areas.

3.10.6 Terminal 4 projects

£ millions BC No RBP ABP LACC/AOC Main list

LACC/AOC Additional

LACC/AOC Commercial

T4 Infrastructure Improvement B017 53.8 72.0 - - - T4 IDL Masterplan Phase 4 and enhancements B081 8.0

8.0 - - -

T4 A380 stands - - 35.0 - - T4 A380 baggage belts - - 4.0 - -

T4 Immigration Hall - - 3.0 - - T4 Arrivals Hall - - 5.0 - - T4 Long and short-stay car park - - 10.0 - - T4 HV Upgrade - - - 6.0 - Subtotal 61.8 80.0 57.0 6.0 -

The £18.2m difference between HAL’s RBP and ABP relate to the HV upgrade and continuation of the work in the Arrivals Hall which commenced in Q5. Additional items in the LACC/AOC’s plan include improvement to both the long and short stay car parks and the Immigration Hall. Some further T4 improvements (eg the T4 A380 baggage belt and TBF) are included in a separate baggage project (‘Improved Baggage Capacity and Resilience’ – see Section 3.8.8 below)..

3.10.7 Terminal 5 projects

£ millions BC No RBP ABP LACC/AOC Main list

LACC/AOC Additional

LACC/AOC Commercial

T5 Concessions B022 7.7 7.7 - - 8.0 T5 Security Capacity B018 23.0 23.0 23.0 - - T5 CIP expansion B082 - 5.0 70.0 - -

T5 Additional Baggage Reclaim

- - 3.0 - -

T5 B & C Additional MUPs - - 15.0 - -

T5A Direct Lounge Access & Landside Offices - - 5.0 - - T5 Additional Stand 574 - - - 9.0 -

T5 PRM & UM Facilities - - - 5.0 - T5 South Extension - - - 70.0 -

T5 Code F stands to A380 capability - - - 10.0 - Subtotal 30.7 35.7 116.0 94.0 8.0

HAL’s RBP and ABP includes an allowance for improvements to T5 security (see Section 3.8.4), reconfiguration of the concessions and, in the case of the ABP, an allowance for expansion of the CIP lounges (eg to cover the additional flights handed by BA following its take-over of bmi and future A30 operations). The LACC/AOC plan includes substantially higher capital expenditure for T5, with a further £174.3m allocated for improvements on both its main and additional project lists. These included a further £65m for CIP expansion (particularly in the T5A North Gallery), £70m for a T5C South Extension to improve pier services and a new narrow-bodied stand (£9m) for remote towing operations to provide increased flexibility. Further expenditure is also allocated to provide extra resilience for A380 operations – although it should be noted that BA’s fleet plan for Q6 (including the exercise of its options for additional A380 aircraft) has not yet been finalised.

3.10.8 Terminal (non-specific) projects

£ millions BC No RBP ABP LACC/AOC Main list

LACC/AOC Additional

LACC/AOC Commercial

Enhanced Terminal Facilities for Passengers B045

19.5

19.5 - - -

Commercial Advertising and Sponsorship B024

31.8

31.8 32.0 - -

Wayfinding B014 - 10.0 - - - UKBF Accommodation B092 4.8 4.8 - 5.0 -

Security SQR Harmonisation B068 3.5 3.5 3.5 - -

Commercial BAU fund B041 30.1 30.1 - - 30.0 PCA Additional Infrastructure B034 2.0 5.0 25.0 - -

Commercial Projects - Positive - No payback in Q - - - 50.0 - Subtotal 91.7 104.7 60.5 55.0 30.0

The main difference between HAL’s RBP and ABP is an allocation of £10m for a wayfinding project. The LACC/AOC plan includes an extra £20m for the PCA (Pre Conditioned Air) project as they regard HAL’s budget of £5m as insufficient.

3.10.9 Baggage projects

£ millions BC No RBP ABP LACC/AOC Main list

LACC/AOC Additional

LACC/AOC Commercial

Improved baggage capacity and resilience B006 -

35.5 -

57.0 -

T2 Baggage Contingency - - 280.0 - - Subtotal - 35.5 280.0 57.0 -

HAL has a budget of £35.5m in the ABP only for additional expenditure to improve baggage capacity and resilience. This includes an allowance of £21m for baggage IT works. It is rather unclear as to what is included in this or indeed in the LACC/AOC’s budget of £57m as there would appear to be considerable overlap with other projects. As indicated in Section 3.8.2, the LACC/AOC has earmarked a contingency of £280m for early T2 baggage works – although their current plan (ie the inclusion of the ‘additional’ project list seems to suggest that this will not be required).

3.10.10 IT projects

£ millions BC No RBP ABP LACC/AOC Main list

LACC/AOC Additional

LACC/AOC Commercial

Automation of the Passenger Journey B029 8.5 60.0 120.0 - - Commercial IT and telecomms B020 14.0 14.0 - - 14.0 Ebusiness development for Heathrow B023

7.6 7.6 - - 8.0

Premium Passenger Products & Services B025

6.0

6.0 - - 10.0

Commercial systems replacement and upgrades B044

2.6

2.6 - - 3.0

Innovation, Reseach and Trials B058 - 5.0 - - -

Back Office IT B064 29.0 29.0 - - - Subtotal 67.7 124.2 120.0 - 35.0

A significant difference between all three capex plans is the budget allocated for the ‘Automation of the passenger journey’ project (see Section 3.8.9). Two projects (‘Innovation, Research and Trials’ and ‘Back Office IT’) are excluded from the LACC/AOC plan as they believe that they should be self-funding and that any costs associated with the first should be incorporated in individual projects that require such activity..

3.10.11 Surface access projects

£ millions BC No RBP ABP LACC/AOC Main list

LACC/AOC Additional

LACC/AOC Commercial

Crossrail B008 5.0 5.0 5.0 - - Surface Access Development Fund B056

2.0

10.0 -

- -

T2 Access to Heathrow Express B072 - - 2.0 -

Crossrail Contribution B094 - 137.0 - - - Subtotal 7.0 152.0 7.0 - -

HAL’s ABP includes a contribution of £137m towards Crossrail, although further appraisal of this is needed by the CAA. Both the RBP and ABP also include allowances for a surface access development fund. Both items are omitted from the LACC/AOC’s plan – although this does include an allowance for cosmetic improvement to the proposed route between T2 and Heathrow Express. (An earlier £50m project in HAL’s FBP has now been cancelled as the potential reduction in the length of the route would be minimal).

3.10.12 Other projects

£ millions BC No RBP ABP LACC/AOC Main list

LACC/AOC Additional

LACC/AOC Commercial

Visitor Centre B059 - 0.2 - - -

Noise Compliance B039 2.4 2.4 - - - Funds for Independent Funds Surveyor B076

3.0

9.5 9.5 - -

Hillingdon Community Trust B077 2.0 2.0 2.0 - - LACC Project Manager B078 - 0.6 0.6 - -

VIP lounge - - 19.0 - -

Design Allowance - - -25.0 - - Subtotal 7.4 14.7 6.1 - -

The £7.3m difference between HAL’s RBP and ABP for this group of projects is largely due to a reduction in the budget for the IFS (see Section 2.9) and that for the LACC Project Manager, which historically has been funded under HAL’s capex budget. These reductions are strongly contested by the LACC/AOC. Their plan also includes £19m for an additional VIP lounge (particularly for the Middle East carriers) and an offset item of £25m for design costs that they understand will be completed in Q5+1 (not Q6).

3.11 Conclusions Our review of the HAL’s capital project preparation and delivery processes for Q6 suggests that there has been some refinement since Q5 in line with best industry practices – although we have made certain recommendations as to how this might be improved to increase overall capital efficiency. We have not, however, evaluated the new proposed procurement procedures for Q6, which will represent a key determinant of this efficiency. The context of the level of capital spend is that it must be ‘acceptable’ to HAL and its shareholders and ‘affordable’ to the airlines within the Q6 settlement. Our assessment indicates that there are still substantial differences between HAL and the airline community on the level and composition of the Q6 capital budget. There is little doubt that a reduced capital budget of £2 billion would jeopardise Heathrow’s competitive position as a leading European hub, particularly in terms of its punctuality performance, resilience and the introduction of automated passenger processing. If HAL and the airlines were to agree that a capex budget of around £3 billion were acceptable within the overall framework of Q6, then we broadly feel that there could be agreement on the project portfolio itself. It should be noted, however, that many of the proposed projects are relatively immature (ie at Gateway 2 or earlier), so changes in project scope and/or costs may still occur through mutual consent. The main areas of disagreement between HAL’s and the LACC/AOC’s £3 billion plan are the budget allocations to passenger processing automation, for improvements in T5

and for new fuel farm infrastructure – which the LACC/AOC regard as insufficient. Conversely HAL has included allowances for a contribution to Crossrail and for additional roll-over costs, notably for T3IB. We do feel that there may be some scope for a reduction in a £3 billion budget if this proves necessary, although given the immaturity of many of the Q6 business cases it may prove difficult to make these judgements at this stage. As indicated in Section 3.8.1, there may be some scope to delay the second phase of the T2A/T2C to Q7. We feel that HAL needs to further assess this, although we acknowledge that the LACC/AOC do not share our view. In any event, we suspect that the project will become more urgent if the Airports Commission (and the Government) rule in favour of new runway capacity at Heathrow13. If this is the case, then a reappraisal of the Q6 (or an Q7) settlement could be necessary. If it does not, then a delay in the T2A Phase 2/T2C project is likely to be more appropriate. In our view, the business cases for certain projects in HAL’s ABP (eg Back Office IT or additional baggage enhancements) look less convincing than others – although we concur with the LACC/AOC that a £60m spend on passenger processing automation might prove to be inadequate (although further work needs to be undertaken on the precise airline requirements and the likely future costs). The resulting costs savings from such adjustments might amount to between £200m-£250m Further cost reductions might also be achieved for asset replacement in Q6 although we have not assessed this. There is also a question mark as to the appropriate extent of HAL’s contribution to the Crossrail project (beyond any work required within the airport site). This issue is beyond the scope of our report.

In summary therefore, we believe that, whilst a project portfolio of around £3.0 billion would provide the most long-term benefits, this might be reduced to between £2.7 - £2.8 billion (excluding any reduction to the asset replacement programme) without any major impact to the passenger experience or operational performance. Whilst this could provide an overall budget ceiling, we note that nearly all the Q6 projects / business cases are relatively immature (at Gateway 1 or 2) and are therefore subject to agreed changes in scope, the selection of appropriate options and refinement of the cost estimates before they can proceed.

13

The Airports Commission is due to publish its final report in summer 2015.

Appendix A

Comparison of HAL and LACC/AOC Q6 capex plans

COMPARISON OF HAL FBP, RBP & ABP & LACC/AOC Q6 CAPITAL PLANS

£000s FBP RBP ABP LACC/AOC LACC/AOC LACC/AOC

Main List Additional Commercial

Q5/Q5+1 roll-over

B050 Terminal 2 Phase 1 Completion 160,375 55,111 159,688 159,000 - -

B051 T3IB Q5 Rollover 51,102 82,097 82,097 47,000 - -

B089 Additional Rollover - 50,000 50,000 45,000 - -

Subtotal 211,477 187,208 291,785 251,000 - -

Airport-wide/resilience

B009 Northern Perimeter 43,032 10,600 10,600 - - 11,000

B088 PRT - - 20,156 - - -

B010 CTA redevelopment (Lead Plan version) 15,000 - 15,000 - - -

B011 Enabling New Generation of Wide Bodied aircraft - Airfield 158,529 86,842 182,700 179,000 - -

B012 Airfield Efficiency and Resilience 70,699 28,993 70,699 70,000 - -

B038 Ops Efficiency and Continuous Improvement 5,664 5,664 5,664 - -

B026 Security Fixed Post Modernisation 10,250 10,250 10,250 10,000 - -

B033 Additional Fuel Infrastructure 28,266 - - 130,000 - -

B035 Deicing - - 48,000 - 50,000 -

B043 APOC 5,425 2,200 2,200 - 2,000 -

B062 Cargo Centre Southside 13,768 - 13,768 - 15,000 -

B073 Air Quality -vehicle charging 5,000 - 5,000 - - -

B055 Waste Management Infrastructure 9,127 5,000 5,000 5,000 - -

Sub-total 364,760 149,549 389,037 394,000 67,000 11,000

Terminal 1 & 2

B030 T1 Closure 17,547 8,147 8,147 8,000 - -

B037 Airline Moves 20,000 22,000 22,000 20,000 - -

B054 T2A Phase 2 and T2C 219,773 5,000 219,773 220,000 - -

Subtotal 257,320 35,147 249,920 248,000 - -

COMPARISON OF HAL FBP, RBP & ABP & LACC/AOC Q6 CAPITAL PLANS

£000s FBP RBP ABP LACC/AOC LACC/AOC LACC/AOC

Main List Additional Commercial

Terminal 3

B016 T3 Refurbishment and Enhancement 25,000 36,675 77,700 - - -

T3 Transfers - - - 37,000 - -

T3 Façade (B-G) - - - 21,000 - -

T3 South Wing Façade - - - 5,000 - -

T3 Arrivals Forecourt & Concourse - - - 15,000 - -

T3 Arrivals Façade - - - 6,000 - -

T3 Premium drop off - - - 3,000 - -

T3 IDL Works (Seating) - - - - 8,500 -

Subtotal 25,000 36,675 77,700 87,000 8,500 -

Terminal 4

B017 T4 Infrastructure Improvement 82,858 53,800 72,000 - - -

B081 T4 IDL Masterplan Phase 4 and enhancements - 8,000 8,000 - - -

T4 A380 stands - - - 35,000 - -

T4 A380 baggage belts - - - 4,000 - -

T4 Immigration Hall - - - 3,000 - -

T4 Arrivals Hall - - - 5,000 - -

T4 Long and short-stay car park - - - 10,000 - -

T4 HV Upgrade - 6,000

Subtotal 82,858 61,800 80,000 57,000 6,000 -

Terminal 5

B022 T5 Concessions 7,657 7,657 7,657 - - 8,000

B018 T5 Security Capacity 75,485 23,005 23,005 23,000 - -

B082 T5 CIP expansion - - 5,000 70,000 - -

T5 Additional Baggage Reclaim - - - 3,000 - -

T5 B & C Additional MUPs - - - 15,000 - -

T5A Direct Lounge Access & Landside Offices - - - 5,000 - -

T5 Additional Stand 574 - - - - 9,000 -

COMPARISON OF HAL FBP, RBP & ABP & LACC/AOC Q6 CAPITAL PLANS

£000s FBP RBP ABP LACC/AOC LACC/AOC LACC/AOC

Main List Additional Commercial

Terminal 5 (cont)

T5 PRM & UM Facilities - - - - 5,000 -

T5 South Extension - - - - 70,000 -

T5 Code F stands to A380 capability - - - - 10,000 -

Sub-total 83,142 30,662 35,662 116,000 94,000 8,000

Terminal (non-specific)

B045 Enhanced Terminal Facilities for Passengers 19,520 19,520 19,520 - - -

B024 Commercial Advertising and Sponsorship 31,796 31,796 31,796 32,000 - -

B014 Wayfinding 10,000 - 10,000 - - -

B092 UKBF Accommodation - 4,768 4,768 - 5,000 -

B068 Security SQR Harmonisation 31,600 3,500 3,500 3,500 - -

B041 Commercial BAU fund 30,099 30,099 30,099 - - 30,000

B034 PCA Additional Infrastructure 5,000 2,000 5,000 25,000 - -

Commercial Projects - Positive - No payback in Q - - - - 50,000 -

Sub-total 128,015 91,683 104,683 60,500 55,000 30,000

Baggage

B006 Improved baggage capacity and resilience 33,980 - 35,500 - 57,000 -

T2 Baggage Contingency - - - 280,000 - -

Sub-total 33,980 - 35,500 280,000 57,000 -

IT

B029 Automation of the Passenger Journey 30,000 8,500 60,000 120,000 - -

B020 Commercial IT and telecomms 13,980 13,980 13,980 - - 14,000

B023 Ebusiness development for Heathrow 7,576 7,576 7,576 - - 8,000

B025 Premium Passenger Products & Services 10,000 6,000 6,000 - - 10,000

B044 Commercial systems replacement and upgrades 2,572 2,572 2,572 - - 3,000

B058 Innovation, Reseach and Trials 10,000 - 5,000 - - -

COMPARISON OF HAL FBP, RBP & ABP & LACC/AOC Q6 CAPITAL PLANS

£000s FBP RBP ABP LACC/AOC LACC/AOC LACC/AOC

Main List Additional Commercial

IT (cont)

B064 Back Office IT 38,484 29,036 29,036 - - -

Sub-total 112,612 67,664 124,164 120,000 - 35,000

Surface Access

B008 Crossrail 100,000 5,000 5,000 5,000 - -

B056 Surface Access Development Fund 10,000 2,000 10,000

B072 T2 Access to Heathrow Express 50,000 - - 2,000 - -

B094 Crossrail Contribution - - 137,000

Sub-total 160,000 7,000 152,000 7,000 - -

Other

B059 Visitor Centre 190 - 190 - - -

B039 Noise Compliance 2,428 2,428 2,428 - - -

B076 Funds for Independent Funds Surveyor 9,500 3,000 9,500 9,500 - -

B077 Hillingdon Community Trust 2,000 2,000 2,000 2,000 - -

B078 LACC Project Manager 550 - 550 550 - -

VIP lounge - - - 19,000 - -

Design Allowance - - - 25,000- - -

Sub-total 14,668 7,428 14,668 6,050 - -

Total (Non-Asset Replacement) 1,473,832 674,816 1,555,119 1,626,550 287,500 84,000

Total (Asset Replacement) 1,531,151 1,318,394 1,458,764 1,373,500 - 13,000

TOTAL 3,004,983 1,993,210 3,013,883 3,000,050 287,500 97,000

Appendix B

HAL’s RBP/ABP – Project Gateway status (as at 19 July 2013)

List of business cases and gateway status as at 19th Jul 2013

Prepared 23/08/13, based on info from PSB presentations 12/6 & 17/7

Business Case Ref £'000 Prior Gateway Ref £'000 Prior GatewayEngineering Asset Replacement B101 575,000 Wave 1 & 2 G1 B001 600,000 Wave 1 & 2 G1 *

Rail Asset Replacement B102 50,000 B002 62,300

IT Asset Replacement B103 75,140 B003 100,000

Baggage Asset Replacement B104 149,155 G1 B004 165,893 G1 *

Baggage Standard 3 Hold Baggage Screening B005 254,858 G1 B005 254,858 G1

Improved baggage capacity and resilience - - B006 35,500

Crossrail B008 5,000 B008 5,000

Northern Perimeter B009 10,600 G1 B009 10,600 G1

CTA redevelopment (Lead Plan version) - - B010 15,000

Enabling New Generation of Wide Body Aircraft - Airfield B111 86,842 G2 B011 182,700 G2 *

Airfield Efficiency and Resilience B112 28,993 G1 B012 70,699 G1 *

Wayfinding - - B014 10,000

Operational Systems Critical Asset Replacement B015 20,800 B015 20,800

T3 Refurbishment and Enhancement B116 36,675 G1 B016 77,700 G1 *

T4 Infrastructure Improvement B117 53,800 G1 B017 72,000 G1 *

T5 Security Capacity B018 23,005 G1 B018 23,005 G1

Commercial IT and telecoms B020 13,980 B020 13,980

T5 Concessions B022 7,657 G1 B022 7,657 G1

Ebusiness development for Heathrow B023 7,576 B023 7,576

Commercial Advertising and Sponsorship B024 31,796 G1 B024 31,796 G1

Premium Passenger Products & Services B025 6,000 B025 6,000

Security Fixed Post Modernisation B026 10,250 G1 B026 10,250 G1

Surface Water Management Infrastructure B127 15,200 G1 B027 21,700 G1*

Metering & Energy Demand Management B028 13,000 B028 13,000

Automation of the Passenger Journey B129 8,500 B029 60,000

T1 Closure B030 8,147 G2 B030 8,147 G2

CTA & Cargo Tunnels B131 115,000 Q5 G3 B131 130,000 Q5 G3

PCA Additional Infrastructure B134 2,000 B034 5,000

Deicing - - B035 48,000

VIP Strategy - Commercial and facility - - B036 6,615

Airline Moves B037 22,000 B037 22,000

Ops Efficiency and Continuous Improvement B038 5,664 B038 5,664

Noise Compliance B039 2,428 G1 B039 2,428 G1

Commercial BAU fund B041 30,099 B041 30,099

APOC B043 2,200 Q5 G2 B043 2,200 Q5 G2

Commercial systems replacement and upgrades B044 2,572 B044 2,572

Enhanced Terminal Facilities for Passengers B045 19,520 G1 B045 19,520 G1

Consolidated HAL landside Ops/Eng facility - - B047 15,357

Terminal 2 Phase 1 Completion B150 55,111 Q5 G4/G5 B050 159,688

Q5 G4/G5

Kilo 234/5 excl

T3IB Q5 Rollover B051 82,097 Q5 main works G4 B051 82,097 Q5 main works G4

Other Q5 Rollover B052 28,739 Various Q5 stages B052 28,739 Various Q5 stages

T2A Phase 2 and T2C B154 5,000 B054 219,773

Surface Access Development Fund B156 2,000 B056 10,000

Innovation, Research and Trials - - B058 5,000

Visitor Centre - - B059 190

Cargo Centre Southside - - B062 13,768

Back Office IT B164 29,036 B164 29,036

Waste Management Infrastructure B165 5,000 B165 5,000

Energy and Utilities Management - Supply B066 19,502 G1 B066 19,502 G1

Security SQR Harmonisation B068 3,500 B068 3,500

Asset Management Programme B169 2,000 B069 20,000

Air Quality - vehicle charging - - B073 5,000

Funds for Independent Funds Surveyor B176 3,000 B076 9,500

Hillingdon Community Trust B077 2,000 B077 2,000

LACC Project Manager - - B078 550

T4 IDL Masterplan Phase 4 and enhancements B081 8,000 B081 8,000

T5 CIP expansion - - B082 5,000

PRT - - B088 20,156

Additional rollover B089 50,000 B089 50,000

UKBF Holding Rooms B092 4,768 B092 4,768

Crossrail Contribution - - B094 137,000

1,993,210 3,013,883

Key

* indicates that only the RBP elements of the business case are being progressed

RBP ABP

Appendix C

Airfield map (effective July 2013)

Appendix D

Glossary

GLOSSARY

09L/27R Northern runway

09R/27L Southern runway

ABP (HAL's) Alternative Business Plan

AMAN Arrivals Manager (ATC Planning System)

AOC (Heathrow's) Airline Operators Committee

APM Association of Project Managers

ASQ Airport Service Quality (Statistical Measure)

ATFM Air Traffic Flow Management

ATM Air Transport Movement

CAA Civil Aviation Authority

CAA SRG Civil Aviation Authority Safety Regulation Group

CBI Complex Build Integrator

CE Constructive Engagement

CIP Commercially Important Passenger

Code F Code F stands (for A380 aircraft)

COPI BIS (Dept for Business, Innovation & Skills) Construction Output Price Index

CPI Consumer Price Index

CTA Central Terminal Area

CUSS Common User Self Service (Check-in kiosks)

CUSSP Common User Self Service (Check-in kiosks) - Plug-in Applications

DCS Departure Control System

DfT Department for Transport

DMAN Departures Manager (ATC Planning System)

EBITDA Earnings before Interest, Tax, Depreciation & Amortisation

ECH EC Harris

FBP Full Business Plan

FEGP Fixed Electrical Ground Power

GBAS Ground-based Augmentation System (Aircraft Landing)

HAFCO Heathrow Airport Fuel Company Consortium

HAL Heathrow Airport Limited

HBI Heathrow Blended Index

HV High Voltage

IATA International Air Transport Association

IDL International Departure Lounge

IFS Independent Funds Surveyor

JST Joint Steering Team

LACC London Airport Consultative Committee

LUL London Underground Limited

LV Low Voltage

MSCP Multi-storey Car Park

MUPs (Baggage) Make-up Positions

NATS National Air Traffic Services

NEC New Engineering Contract (sponsored by the Inst of Civil Engineers)

NERL NATS En-route plc

NSL NATS Services Limited

OGC Office of Government Commerce (now the Major Projects Authority)

P50 Cost estimate with a 50% probability that its value will not be exceeded

P80 Cost estimate with an 80% probability that its value will not be exceeded

PRM Passengers with Reduced Mobility

PRT Personal Rapid Transport (System)

Q5 Quinquennium 5 (April 2008-March 2013)

Q5+1 Quinquennium 5+1 (April 2013-March 2014)

Q6 Quinquennium 6 (April 2014-March 2019)

QSM (HAL's) Quality Service Monitor

R2 masterplan (HAL's) 2 runway masterplan

R3 masterplan (HAL'a) 3 runway masterplan

RAB Regulated Asset Base

RAT Rapid Access Taxiway

RBP (HAL's) Revised Business Plan

RET Rapid Exit Taxiway

RPI Retail Price Index

RPIJ Retail Price Index using Jevons (geometric mean) calculation

SESAR Single European Sky ATM research programme

SMAN Sequencing Manager (ATC Planning System)

SQR Service Quality Rebate

SSCP Short-stay Car Park

T3IB Terminal 3 Integrated Baggage (Facility)

TPI BCIS (British Chartered Institute of Surveyors) All-in Tender Price Index

TTS Tracked Transit System

UM Unaccompanied Minors

WACC Weighted Average Cost of Capital

WAN Wide Area Network

Appendix E Terms of Reference

Ref. 1778 (Services Order 02) – 16 December 2012 Q6 Capex Review: Heathrow and Gatwick Airports

SPECIFICATION

Terms of Reference

Q6 Capex Review: Heathrow and Gatwick Airports

Context

The CAA is currently considering the most appropriate regulatory arrangements to put in

place at each of the three airports subject to economic regulation: Heathrow, Gatwick and

Stansted. The present price controls expire in March 2014. As part of this work the CAA is

establishing the potential level of any price cap under a RAB based framework. The CAA is

also undertaking work on alternative forms of regulation such as price monitoring, long run

incremental costs and pegging prices to charges at comparator airports.

One of the key building blocks of a RAB-based price control is capital expenditure (capex).

Capital expenditure can be thought of as made up of three elements:

Capex renewals, where existing assets are renewed or replaced with assets

generating similar outputs;

Compliance, where capex is required to meet health and safety standards or

government regulations; and

Capex Enhancements, where capex provides increased outputs, for example

improved service quality or greater reliance.

In its initial business plan Heathrow forecast capex assumed a capex strawman of £3bn1.

Annex A sets out the potential projects included in the strawman. Of the £3bn capex,

around £1bn relates to capex renewals, £0.3bn to compliance and £1.7bn to capex

enhancements.

In its initial business plan Gatwick identified potential projects assumed £1.2bn of capex2.

Annex B sets out the projects included in the business plan. Of the £1.2bn capex, around

£0.4bn relates to assets renewals, less than £0.1bn to compliance and £0.8bn to capex

enhancements.

1 Q6 Initial Business Plan, Heathrow Airport Limited, August 2012. This document can be accessed at:

http://www.heathrowairport.com/static/Heathrow/Downloads/PDF/Q6_Heathrow_Initial_Business_Plan.pdf

2 Initial Business Plan to 2020, Gatwick Airport Limited, April 2012. This document can be accessed at:

http://www.gatwickairport.com/Documents/business_and_community/Public%20Regulation%20Pages/Econo

mic%20regulation/2012/Beyond%20Q5%20business%20plan%20(public%20version)%20-

%20issued%2019%20April%202012.pdf

Ref. 1778 (Services Order 02) – 16 December 2012 Q6 Capex Review: Heathrow and Gatwick Airports

One of the potential innovations being considered by the CAA for Q6 is a two-tier approach

to capex, where capex is split into:

core capex: projects that are well defined which are likely to be subject to capex

triggers3; and

development capex: projects that are less well defined, which could be included in

the initial price cap, or included in the price cap during the control period following

consultation/agreement from airlines.

The Q6 policy update document provides further details of the core and development capex

approach4.

Requirement

This request for advice is split into two parts:

A review and projection of Heathrow’s Q6 capex allowance for Q6; and

A review and projection of Gatwick’s Q6 capex allowance for Q6.

Tenderers can bid for the work at Heathrow or Gatwick or Heathrow and Gatwick combined.

Where tenderers are bidding for work at both airports, separate prices should be provided for

each airport.

This review is limited to an assessment of capex relating to enhancements and compliance.

Capex relating to renewals is being considered as part of a separate consultancy study

which is examining maintenance and renewals expenditure.

The review is split into three phases:

Phase one: review of cross project issues;

Phase two: initial assessment of enhancement and compliance project allowances;

Phase three: full assessment of enhancement and compliance project allowances.

The assessment of project allowances should include an evidenced assessment of the scale

of capex efficiency.

The assessment should draw on the following existing and on-going studies:

Mid Q5 review of capex at Heathrow and Gatwick Airport, Currie and Brown5;

Heathrow Q5 capex review, Alan Stratford and associates, completion end

December 2012;

Gatwick Q5 capex review, URS, completion end December 2012;

3 Capex triggers remove the capital expenditure allowance for a project if the outputs are not delivered on

time.

4 Q6 policy update, CAA, May 2012. This document can be accessed at:

http://www.caa.co.uk/docs/5/Q6PolicyUpdate.pdf

5 These reports can be accessed at: http://www.caa.co.uk/docs/5/ergdocs/HeathrowCapexReport.pdf and

http://www.caa.co.uk/docs/5/ergdocs/GatwickCapexReport.pdf

Ref. 1778 (Services Order 02) – 16 December 2012 Q6 Capex Review: Heathrow and Gatwick Airports

Review of maintenance and renewal expenditure, SDG, Interim report January 2013,

draft final report March 2013, update report August 2013;

Deliverables from constructive engagement at each of the airports, Heathrow report

completed 3 December, Gatwick and Stansted reports due end of December 2012.

These deliverables may include airline prioritization for Q6, although airlines views on

the overall capex programme may be subject to affordability constraints.

The work should also draw on the work undertaken by the airports themselves, particularly

on benchmarking expenditure..

Phase One: Review of the cross project issues

This part of the research should consider the cross cutting issues that can impact on the

costs across projects. This consideration should include:

Benchmarking of project costs, where available the Contractor should assess the

benchmarking of unit costs to identify the efficient costs of capital schemes going

forwards. This should draw on the work undertaken by the airport and include an

assessment of whether appropriate benchmarks and adjustments have been used

(for example in relation to risk) and comparisons with other benchmarks available to

the contractor.

On-costs, whether the adjustment for on costs is appropriate, for example in relation

to other airports and other sectors;

Contingency and risk, whether the allowances for risk and contingency is appropriate

given the stage in the projects development and the relationship between project and

portfolio risk adjustments,

[is the allowance for input price inflation appropriate, for example given the historic

relationship between construction and retail prices and the outlook for the economy

going forwards.

The output of Phase 1 should be an interim report setting out the analysis and assessment

for each of the topics list above (and any other issues the contractor considers relevant).

Phase Two: Initial assessment of enhancement and compliance capex expenditure

Based on the analysis undertaken as part of Phase One, the review of existing and on-going

studies and the contractors own assessment of the overall capex programme and a sample

of Q6 projects, the contractor should provide an initial assessment of the capex allowance

for Heathrow and/or Gatwick airports (as appropriate).

The assessment should be based on the Airport’s Full Business Plan, published at the end

of January 2013, and the outputs of constructive engagement.

This should involve:

An assessment of whether individual projects are justified given the needs of current

and future airlines and their customers and, where appropriate, the promotion of

competition;

Ref. 1778 (Services Order 02) – 16 December 2012 Q6 Capex Review: Heathrow and Gatwick Airports

An assessment of the efficiency of the Q6 capex programme. This should draw on

the Q5 capex review (including proposed procurement approach), phase 1 of the

study and other information the consultant considers relevant;

An assessment of the efficient timing of capex and profile of expenditure;

An evidenced initial assessment of the Q6 capex allowance.

It should be noted that at the time of the full business plan, a number of projects are likely to

be at early stages of development and this should be taken into account in the initial

assessment.

Phase Three: Full assessment of enhancement and compliance capex expenditure

Based on Phase Two of the study, any updated business plan submitted by the airports by

20 July 2013, and further work undertaken by the contractor. The Contractor should provide:

For each project that is proposed for the core capex program (where appropriate), an

assessment of:

o Whether the project is justified given the needs of current and future airlines

and their customers, and where appropriate the promotion of competition;

o the appropriate cost allowance for Q6 (and year within Q6) (and for the

project overall where it spans more than one control period);

For the development program, whether the overall allowance for development

expenditure is appropriate given the range and nature of projects proposed by the

airport.

Given the nature of the development of the capex program, the main focus of the study is

likely to be in Phase Three and, to a lesser extent, Phase One of the study.

Timescales

The CAA anticipates that the draft report for Phase one of the study will submitted by 31st

January 2012, Phase two by 8th March 2013 and Phase three by 17th August 2013. A final

published report is expected after Phase two and Phase three of the study. Airport

commercial confidentiality should be taken into account when considering the form of the

final report.

Action Date

Issue of ITT 15 December 2012

Return of tenders 4 January 2012 (12 noon)

Appointment of Contractor w/c 7 January 2012

Kick off meeting w/c 7 January 2012

Draft interim (phase one) report 31 January 2013

Draft final (phase two) report 8 March 2013

Ref. 1778 (Services Order 02) – 16 December 2012 Q6 Capex Review: Heathrow and Gatwick Airports

Draft final (phase three) report 17 August 2013

Final report One week after comments

Output

The final report (s) will take the form of long form report. The draft final report will be shared

with stakeholders before publication. All supporting analysis and spreadsheets should be

supplied on request to the CAA. If required by confidentiality issues separate reports, or

separate report sections, should be produced for each airport.

Stakeholder engagement and the CAA’s process.

The contractor is expected to work closely with the CAA and stakeholders to maximise the

potential buy-in with the reports’ findings. The Contractor should assume regular meetings

with the CAA on at least a three to four weekly basis. The Contractor should also assume

significant engagement with each of the airports to understand their cost base and the

airlines to understand their views. Proposals should make clear how tenderers intend to

manage the consultation process between airports and airlines and clearly state the

involvement they expect from the CAA.

Cooperation

Protection must be given to confidential information that is released in the course of this

review. The terms of reference includes confidential information and should not be released

to third parties. This includes the release of information about the detailed capex plans of

one airport to other airports. The CAA reserves the right to use its formal powers to request

information.

Request for proposals

The CAA requests receipt of proposals for meeting these terms of reference by 12 noon

Friday 4 January 2013. The CAA expects to appoint the adviser in w/c 7 January 2012.

The proposal shall include:

An understanding of the issues raised in the terms of reference;

The proposed approach to be taken on the study. This should encompass the key issues that are likely to arise in the study and how the contractor intends to address these;

Potential data requirements, data sources and likely availably. The CAA is likely to place particular weight on tenderers who have ready access to the required benchmarking data;

Any potential conflicts of interest envisaged by the tenderer and how these might be addressed;

The key outputs expected from each task and the study overall;

A workplan setting out the time input by task and individual;

The relevant experience of the tenderer and named individuals to undertake the study and their roles on the project. All experience should be related to a member of the proposed study team

The key risks in undertaking the study and how these will be mitigated; and

Ref. 1778 (Services Order 02) – 16 December 2012 Q6 Capex Review: Heathrow and Gatwick Airports

Unit prices (hourly / daily rates) and the total fixed price for the Phases one and two of the study. Phase three of the study should be separately priced. The unit rates should be assumed for any follow-on work in the subsequent year to update the work.

The tenderer may submit a proposal for the work at either Gatwick airport or Heathrow

airport or for both Airports. Where a bid is submitted for both airports, each airport should be

individually priced.

The CAA will give the following weights to proposals: price (30%) and quality and value

added (70%).

Ref. 1778 (Services Order 02) – 16 December 2012 Q6 Capex Review: Heathrow and Gatwick Airports

Annex A: Heathrow initial Q6 capex projections

Title £m Heathrow categorisation of spend

Engineering Asset Replacement Asset replacement and compliance

IT asset replacement Asset replacement and compliance

Baggage Asset Replacement Asset replacement and compliance

Rail Asset Replacement Asset replacement and compliance

Baggage Standard 3 Asset replacement and compliance

Surface Water Management Infrastructure Asset replacement and compliance

Energy and Utilities Management Asset replacement and compliance

Air Quality Compliance Asset replacement and compliance

Energy and Utilities Management - Supply Asset replacement and compliance

Waste Management Infrastructure Asset replacement and compliance

Asset replacement total 1,320 Asset replacement and compliance

Commercial systems replacement and upgrades

Competitive cost of operation

Security Fixed Post Modernisation Competitive cost of operation

New commercial products and services Competitive cost of operation

Commercial advertising and sponsorship Competitive cost of operation

Commercial BAU Funds Competitive cost of operation

Automation of passenger journey – bag drop Competitive cost of operation

T5 concessions Competitive cost of operation

Deck T5 Business Parking Competitive cost of operation

Additional Car Park Capacity & Staff / Public Swap

Competitive cost of operation

Cargo Centre Southside Competitive cost of operation

VIP - refresh Enhance passenger experience

T5 Reconfigure Domestic Gates - and integrate CTA

Enhance passenger experience

T5 Transfers Security Enhance passenger experience

Enhanced terminal facilities for passengers - T3 & T4

Enhance passenger experience

Wayfinding Enhance passenger experience

T4 Gate Room Reconfiguration Enhance passenger experience

T4 Landside Arrivals & Forecourt Refresh Enhance passenger experience

T3 Check-in and Arrivals Minor Enhancements Enhance passenger experience

CTA redevelopment Enhance passenger experience

Additional PRT on Northern Perimeter Enhance passenger experience

T3IB Q5 Rollover Hub capacity and resilience

Other Q5 Rollover Hub capacity and resilience

Additional fuel infrastructure Hub capacity and resilience

CTA tunnel Hub capacity and resilience

Cargo tunnel Hub capacity and resilience

NCTA Bravo Taxiway Realignment (incl Pier 4 Hub capacity and resilience

Ref. 1778 (Services Order 02) – 16 December 2012 Q6 Capex Review: Heathrow and Gatwick Airports

Title £m Heathrow categorisation of spend

demolition)

Additional 4 RET's on Northern Runway Hub capacity and resilience

Code E remote stands over Pier 4a (incl Pier 4a demolition)

Hub capacity and resilience

Efficient & Resilient Airfield Hub capacity and resilience

T5 Reclaim Reconfiguration - extend 4 existing belts

Hub capacity and resilience

T4 - One additional Code F stand (total of 3) Hub capacity and resilience

Sierra Taxiway Enhancement including pavement work

Hub capacity and resilience

T4 LV / HV Electrical Capacity Hub capacity and resilience

T4 Additional Reclaim Capacity Hub capacity and resilience

Real Time Heathrow Integration Hub capacity and resilience

Additional FEGP for B787's Hub capacity and resilience

T5 B&C Additional MUPs & Bag Check Units Hub capacity and resilience

Baggage IT Improvements Hub capacity and resilience

Consolidated HAL landside Ops/Eng facility Hub capacity and resilience

Business Support systems Hub capacity and resilience

Ops Efficiency and Continuous Improvement Hub capacity and resilience

Commercial IT and telecoms Hub capacity and resilience

Pier 7 re-lifing Hub capacity and resilience

APOC Other

09L RAT Other

E Business Other

Asset Management Programme Other

Consolidated Car Rental Facility Other

Innovation and Trials Other

Visitor Centre Other

Q6 Contingency Other

Crossrail Surface Access

Surf Access Development Fund Surface Access

Terminal 2 Phase 1 Completion Terminal 2 related

T1 closure - mothball Terminal 2 related

Airline Moves Terminal 2 related

T2A Phase 2 and T2C Design & Enabling Terminal 2 related

T2 access to Heathrow Express Terminal 2 related

TOTAL 3,008

Ref. 1778 (Services Order 02) – 16 December 2012 Q6 Capex Review: Heathrow and Gatwick Airports

Annex B: Gatwick initial Q6 capex projections

Title £m Heathrow categorisation of spend

Airfield asset stewardship 68 Asset stewardship

Facilities asset stewardship 183 Asset stewardship

Commercial asset stewardship 43 Asset stewardship

Compliance and risk 14 Asset stewardship

IT asset stewardship 57 Asset stewardship

Additional long stay capacity 29 Surface access

Long stay car parking 14 Surface access

NT short stay car park 20 Surface access

PTI and surface access 39 Surface access

Early bag store 24 Check-in concourse

ST baggage and Pier 1 69 Check-in concourse

Upgrade check-in and bag drop and NT ceilings and floors

42 Check-in concourse

NT security 28 Security

CIP departures 2 Departure lounge

NT IDL reconfiguration and expansion 105 Departure lounge

ST IDL capacity 79 Departure lounge

ST IDL reconfiguration (phase 3 & 4 food court) 25 Departure lounge

Delivery of 95% pier service (North Terminal) 158 Piers

Pier 3 modernisation 60 Piers

Pier 5 1 Piers

Arrivals border zones 20 Arrivals border zones

NT baggage reclaim 3 Reclaim

ST baggage reclaim 12 Reclaim

CIP arrivals 2 Onward travel and arrivals

Car rental 5 Other passenger facing products

Digital media – return 5 Other passenger facing products

Passenger service improvements through IT 14 Other passenger facing products

Additional staff car park capacity 4 Non passenger facing products

Consolidated motor transport facility 4 Non passenger facing products

Future capital planning post 2019 10 Non passenger facing products

Hanger facilities 6 Non passenger facing products

NT energy centre 6 Non passenger facing products

Runway safeguarding 4 Non passenger facing products

TOTAL 1,154

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