221. Let's not get involved with lawyers. Is it fair to regard NATS as a utility like water. Surely it is inherently riskier and therefore unsuitable for RPI-X or minus regulation? It is inherently riskier, is it not?
(Ms Lomax) It looks that way. How risky it is depends on how the regulator himself behaves. I think it is difficult to say how risky a utility is in the absence of clearly stated regulatory policy and that is only now being agreed.
222. Let us get back to this question of paragraph 3.27. If you turn to that on page 39 it deals with figure 21 on which there was debate earlier. You will see at the end of paragraph 3.27 it says, "given a reduction in traffic on the scale experienced in both of the oil shocks, each of which lasted several years, we found that NATS would have been unable to reach its debt service obligations." It shows, does it not, that a own turn as bad as either of the oil shocks would have left NATS unable to meet its debt service commitment? It does show that, does it not? Paragraph 3.27 says that.
(Ms Lomax) We have not seen that.
223. It does say that. Did your Department realize this and decide to ignore it or did your Department fail to realise that NATS' finances would not berobust? Which of those two did you do? Did you ignore the information that was given to you or did you realise NATS' finances would not be robust? Did your Department realise this?
(Ms Lomax) Can I approach the question from a different end and explain why I succeeded in confusing everybody, because I did not mean to quarrel with the NAO Report and I got led into it by simply assuming that the figures in Table 21 were the same as the figures in Table 23, or whatever it was, which was flights. The confusion arises because it is a fact that chargeable service units are not available on a consistent basis before 1983. I want to get into why I confused you, I will come to it in the end. The material that you have got in Table 21, chargeable service units-
224. Do not go too quickly. (Ms Lomax)-where we got into confusion is the table which shows different scenarios. What the NAO says is, look at these scenarios, they did not test them and when we tested them they showed that the bid was financially flawed. When I said that while we might not have tested exactly these, enormously extensive stress testing was done which showed that the bid was robust, we got into great confusion and you said, did you or did you not do these and I said these are on a different basis. Let me go back. Table 21 I had assumed, was flights because everything else is in terms of flights. The reason I assumed that it was flights is because I know that before 1983 chargeable service units are not available on the same basis as post 1983. What has happened, I have now had advice from behind me, is that NAO extrapolated these figures from flight data and basically recreated a series for chargeable service units before 1983. This was a subject for some unhappiness while the Report was being prepared. But I should not have mentioned it because we basically decided not to push it.
225. Jeremy, will you help me on this, will you try and explain to the Committee what is going on?
(Mr Colman) I agree with every word Ms Lomax has just said. There was discussion, the scenarios in grey in Figure 21 are scenarios that we constructed extrapolating from data regarding flights. Our point is that these were scenarios that were markedly worse than those that are in blue, however they are measured. We asked the Department whether they had tested the robustness of the model against those scenarios. We did our own modelling, which is what 3.27 is about, which suggests that either of the oil shocks, were they to have been repeated with the NATS' financial structure in place, would have caused difficulties. 3.27 is reporting NAO's analysis.
(Ms Lomax) Not shared with the Department or CSFB. My answer is what you say is interesting and I fully accept that we did not challenge this, and I must say I walked into this debate by mistake. The point I was trying to make is, it is a highly technical business testing these bids, they were tested extensively against a wide range of scenarios, volumes and volumes of scenarios were tested.
Mr Davidson
226. Surely that is what your advisers got £40 million for?
(Ms Lomax) That is exactly what they were for and that is what they were doing to earn this huge amount of money. They did not specifically test a repeat of 1973 and 1979, but they did test-
Chairman
227. Why did they not do that, after all we had had 1973 and 1979?
(Ms Lomax) Why did they not? I have had two answers to this. They did test scenarios which they regarded as severe but more relevant, a sustained period of low growth for 10 years and a sudden shock to CSUs in the scale of the Gulf War. In both cases the Airline Group bid was robust, NATS did not run out of money. They also asked themselves a different question, which is not discussed here, how severe a shock would there have to be to cause this real trouble to this financial model? The answer they got was one which was regarded as so extreme as not to be worth pursuing. The real issues that I was trying to explain is the problem is that peoples' imagination of the situation in May did not embrace a situation as severe as actually happened. You can do an awful lot of arithmetic if you like but if you think the world is a safer place than it was-it is complicated, but very, very many scenarios were tested. The point that is being made, the general point that the NAO is making, which I am taking issue with, is that the Department did not do due diligence on these bids. I am challenging that. The Department took good advice and did extensive testing of all of the bids which people at the time thought was relevant. Did they do enough? In the light of what has happened they did not. Basically the world turned out to be altogether capable of more savage downturns than we had realised before.20
228. That is not the point. We are not on the point of more savage downturns. I must come back to the NAO here, what you are telling us, the NAO, is that if there had been a study done on what might happen on the same scale as the oil shocks this deal would not have been robust?
(Mr Colman) That is what our modelling suggested. Paragraph 3.28 shows the results of our discussion with the Department's advisers CSFB. Their view was that it would be inefficient to leave capital lying round in NATS, as it were, waiting for such a shock. It is clearly possible to have a debate about whether that is sound or not. The consequence is if you do not leave the capital in and shock occurs you have to do something about it.
(Ms Lomax) Can I suggest that is a different point, that it is not worth looking at these downside shocks, there are other mechanisms to cope with them and therefore we should not put in reserves or whatever you are suggesting in your recommendations. If you did the modelling we have not seen it.
Mr Williams
229. That makes it worse because they did not take into account the basic point which has been asked on several occasions, that anything that affected or created a down turn for NATS would create a down turn for the shareholders, for the seven air companies and therefore it was incompetent to give the advice they gave but it was better for the shareholders to respond to the company's needs as risk transpired because the sort of risk we are talking about would affect them all equally or approximately equally.
(Ms Lomax) That is another point and I would like to respond to it. We established a regulatory system which can respond to exceptional events. There is a clause in the NATS' licence which specifically permits an exceptional user contribution if something happens which impairs the ability of both the shareholders and NATS to respond in the way that you are worrying about. We did think about that particular scenario. That is why it has got that clause in the licence. Also at the moment the PPP is coping with such a situation without falling apart. The CAA is negotiating with NATS on a composite solution where the burden will be shared between users, shareholders, investors and the company.
(Mr Everitt) And the company.
(Ms Lomax) And the company. The company is having to make adjustments which if it had remained in the public sector it would not have had to make.
230. Surely that leaves all the risk with one shareholder, the Government?
(Ms Lomax) No, it does not.
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20 Note by witness: My answer appears to imply that a specific test was done to establish how severe a shock would have been required for the company to have been unable to meet its debt obligations. As I explain in my supplementary memorandum to the Committee, it is more accurate to say that, given the assumptions used for the testing, the set of events would have had to be so severe that it was not worth establishing the precise point at which failure would have occurred. See Ev 24.