Airports differ from natural monopoly network utilities, such as energy and water networks, and yet have historically been regulated using similar approaches, relying on price caps designed to recover historical costs incurred. However, airports can – and do – compete with each other and, following the recent decision by the UK Competition Commission to require BAA to sell three of its seven airports, this inter-airport competition looks set to intensify.

This paper explores the issues that should be considered when regulation sits alongside competition. It describes how the investment incentives created by the application of ‘RPI-X’ style price cap regulation can be similar to the incentives typically associated with ‘rate of return’ regulation; namely the existence of ‘gold plating’ incentives, through the Averch-Johnson effect.

However, these distortions to incentives also affect non-regulated airports. A model is presented that illustrates the potential for perverse incentives on non-regulated airports and distortions to their investment decisions. Finally, this paper considers the case of the regulation of Stansted Airport, which illustrates that these incentive effects can occur in practice. The paper also describes the Civil Aviation Authority’s approach to regulating Stansted against the background of these incentive effects.