SUBMISSION
TO
Australian Competition and Consumer Commission
Issues Paper
on
AIRSERVICES AUSTRALIA’S
FIVE YEAR DRAFT PRICING PROPOSAL
11 May 2011
Executive Summary
The Qantas Group (comprised of Qantas, Jetstar and QantasLink) operates in all of the major
commercial airline markets in Australia, providing international, domestic, regional, freight and
charter services. We are therefore well positioned to understand the drivers and issues in each
of these markets throughout Australia. The Group understands the challenges that Airservices
Australia (AsA) faces in determining costs and proposing prices which are acceptable to the
Minister, the industry and that are endorsed by the Australian Competition and Consumer
Commission (ACCC).
The proposed Long Term Pricing Agreement (LTPA) and associated ‘Services Charter’
improves commitment to customer service and this approach is most welcome. The Group
understands the challenges and the great efforts that AsA have gone through to establish a
balanced approach and the difficulty associated with trying to “future proof” a dynamic industry
that has many variables. As such it is not surprising that the LTPA has not seen a significant
departure from the existing AsA price structure and methodology.
The Qantas Group is of the view that increasing charges does not happen in isolation, the
proposed LTPA if implemented in its current form disadvantages regional services, in particular
it will significantly disadvantage the continued growth and development of air services to many
destinations in regional Australia. The proposal discourages airlines from increasing capacity in
regional markets and focus instead on major gateways. As a result there is potential for
detriment to associated tourism and economic benefits to regional markets. The proposed
pricing proposal may result in increasing average airfares and dampening travel demand on
many city pair routes to and from regional markets.
Furthermore it should also be noted that from an economic perspective it is the Qantas Group’s
view that the LTPA may not achieve AsA’s three pricing objectives, notably to set prices that
will:
4 provide pricing certainty and support aviation industry investments;
4 enable the right investment at the right time; and
4 improve the efficiency of service delivery by AsA and the industry.
The Qantas Group has arrived at this view because we believe that there are a number of
considerations that are either overlooked by the AsA, or acknowledged but not used in a
quantitative sense in the computation of charges. The Qantas Group also believes that this
review provides a critical opportunity to challenge a number of the assumptions and theories
that underpin the current charging methodology and to seek improvements in the equity and
utility of the charges to airlines. The Qantas Group’s key concerns apply to all AsA proposed
charges: Terminal Navigation (TN), Enroute (EN) and Airfield Rescue and Fire Fighting Service
(ARFF) charges.
Page 1
Introduction
The Qantas Group recognises the challenges faced by AsA in setting prices for five years.
There is incentive for AsA to include all costs for potential projects or services in the capital
expenditure profile to avoid an ACCC review during the term of the pricing agreement.
Significant over recovery or capex under spend is rebated in the following year. The risk with
this approach is that it results in high upfront prices for airlines which can affect demand
through higher airfares or reduced route viability and flights. The current AsA pricing approach
impacts the overall economic welfare of the travelling public and the broader Australian
economy.
The costs for many locations increase dramatically in the first 2 years of the LTPA. For example
TN charges increase by 5% in the first year then a further 3.5% in the second year. ARFFS
charges increase by 10% year on year for the first 2 years and 13% year on year for categories
9/10. The Qantas Group estimates that the overall impact of this structural over-recovery for
projects that may not proceed translates to an increase of $85m over the 5 year price period of
the LTPA without the compounding affect of activity growth or aircraft fleet changes.
The level of transparency and detail of data provided during the consultation period was
insufficient to make informed comment on many important aspects contributing to the overall
cost of services which AsA provides.
The Qantas Group believes that the LTPA charging should only take into account projects that
have been fully reviewed, costed and approved. There should be a separate mechanism
developed that would allow consultation on new projects to be discussed with airlines and
included during the term of the LTPA at which time an adjustment of the charges would be
appropriate. This approach would avoid the structure of over-charging found currently in the
LTPA, which leads to unnecessarily high charges and the dampening of demand.
The following are responses to the questions posed in the ACCC Airservices Australia draft
price notification Issues paper published in April 2011. The Qantas Group welcomes the
opportunity to make this submission.
1. Long term price proposal
The ACCC seeks comment on the appropriateness of the period covered by Airservices’ price
proposal. In particular, the extent to which the long term approach to pricing provides:
• industry stakeholders with the appropriate level of pricing certainty
• Airservices with appropriate incentives to achieve greater cost reductions.
The period of five years is sufficient to provide industry with an appropriate level of price
certainty. Five years is the generally accepted industry long term pricing agreement period
particularly given the time and expense involved in consultation and an ACCC review.
There is little evidence to show that the length of period provides incentives for greater cost
reduction or efficiencies, due to the perceived risk of under recovery of costs. There is incentive
for AsA to include all costs for potential projects or services in the capital expenditure profile
or/and a contingency buffer for costs. There is also an incentive for AsA to take a conservative
approach with the activity forecast. This is evidenced in recent years by the continual annual
receipt of rebates for activity as well as the under spend and non delivery of capital projects in
the previous pricing period.
Page 2
The ACCC seeks comment on the effectiveness of Airservices’ consultation processes in its
development of its price proposal. In particular, the extent to which:
• Airservices has provided industry with sufficient information in the course of its
consultations
• interested parties have been provided with, and taken up, the opportunity for
Airservices to provide briefings about the detail of individual projects
• the need for new or increased services has been consulted on with the relevant
regulatory bodies, such as CASA, as well as Airservices’ users. Also, the extent to
which these consultations consider the type, cost and price for those services.
AsA has improved their provision of information over the past decade with increased regularity
of consultation meetings from annual meetings prior to 2007 to the current practice of quarterly
industry meetings. While we recognise the steps taken to improve the provision of information
we are concerned that the data provided at these meetings remains at a summarised high level
and the details of the building block calculations or models have not been provided to be
scrutinised as part of the consultation process.
The data provided as part of the LTPA was not sufficiently comprehensive or provided in
sufficient time to enable assessment with due diligence. This is concerning to the Qantas
Group considering the annual revenue for AsA is nearing $1bn. A more detailed package of
cost and pricing data was provided as part of the consultation process in 2004. During the
current pricing consultation significant focus was given to the pricing structure of TN services.
This was done as a prelude to the main consultation of costs and prices in December 2010 and
detracted from meaningful consultation on the actual costs for each of the services and return
on assets.
The consultation provided by AsA on projects has improved to some extent but there is room
for improvement in order to be completely comprehensive. Qantas has been briefed in relation
to projects with a cost greater than $1m. The information provided is still at quite a high level
and requires the airlines to pursue more details when it should be provided upfront as is
expected for any major capital projects. This is a major area of concern.
The Qantas Group is involved in regular technical consultation meetings and there are some
areas of significant collaboration. Notwithstanding this collaboration there are a number of
projects of a non operational nature, which we are not generally consulted on in any detail.
Qantas is concerned about the level of governance surrounding these major expense items.
Qantas has requested further evidence of cost benefit analysis for projects material in cost,
benefits or operational expenditure and shall track progress through the service charter and the
quarterly industry meetings.
The start up costs for new services and associated infrastructure are significant and the step
change in costs is very significant. These lumpy infrastructure costs should be allocated such
that early users of the services are not unfairly paying for the asset and that pricing still
encourages activity growth.
For example the cost to build the new tower and ARFF building in Broome was $20m and has
resulted in a cost increase for TN to the maximum level of $13.32 per MTOW and upward
impact on all networked ARFF prices. The activity just exceeds the threshold and the high costs
are spread over a relatively low activity level so the step change in the cost base is very
significant. Without details of the building block model used to attribute the costs an informed
commentary on a more equitable model for pricing over the life of the asset cannot be made.
AsA is encouraged to engage the airline industry in a more timely manner when planning the
introduction of new ATC/ARFF services (or related infrastructure).
Page 3
2. Activity forecasts
The ACCC seeks comment on the reasonableness of Airservices’ activity estimates.
IATA’s international average air passenger forecast growth rate of 5.8% is in line with historical
averages and therefore is reasonable. The Group believes that IATA’s domestic and regional
forecasts are too low, with predictions of domestic passenger kilometres growing at an average
rate of 4.9% between FY11 and FY16 and regional passenger kilometres to grow at 5.1% over
the same time period.
Domestic
The average historical growth rate for domestic revenue passenger kilometres (RPKs) depends
on the time horizon chosen and the method used to generate those growth rates. Using 25, 10
and 6 year horizons and three different computational techniques 1 the average historical
growth rate in domestic RPKs ranges between 0% and 8.3%. Relative to these historical growth
rates, IATA’s average growth rate is unusually low. A six year growth rate of 4.9% or less would
have occurred on only three occasions over the past 20 years.
It is the Qantas Group’s view that using the real airfare as a driver variable of forecasts is
flawed and the forecast decline in real airfares that is used to generate these results is
excessive and very unlikely over a six year horizon. The Qantas Group believes that a
theoretically and empirically superior technique for generating forecasts of aviation passenger
volumes is to take advantage of the strong correlation between passenger volumes and airline
capacity. There is a very strong connectivity between domestic available seat kilometres
(ASKs) and RPKs. By accurately forecasting airline capacity it is possible to generate accurate
forecasts of passenger volumes.
Qantas forecasts that ASK growth will average 7.0% between FY11 and FY16, rising steadily
for the first three years peaking in FY14 at 9.7% before falling for the subsequent 2 years.
These ASK growth forecasts imply that average RPK growth over the next 6 years will be 7.2%,
with a time profile similar to that of forecast ASK growth. This average growth rate is more
aligned with historical averages and is 2.3pp above that forecast by IATA.
The Qantas Group believes that a domestic air passenger forecast of 7.2% over the next 6
years can be more rigorously defended than a forecast of 4.9% and as such should be used for
the purpose of determining charges.
Regional
IATA forecasts that regional RPKs will grow on average by 5.1% pa over the next 6 years. This
compares to historical average growth rates that range between 2.8% and 12.1%.
IATA’s forecasts are based on placing all weight on the historical growth rate observed
following the collapse of Ansett (2001), and placing no weight on the pre-collapse period which
saw average growth that was over twice this pace. IATA’s forecasts are built by assuming a
passenger volume to GDP elasticity of 1.6 for which no rationale is presented. The Qantas
Group believes that IATA‘s modelling approach and forecast outcome are inaccurate. While
there was a supply-side structural change in early 2000, this does not mean that the 15 year
information set prior to the change should be abandoned. If this 15 year information set is used,
we see that ASK growth explains around 94% of the variation in RPKs. Like Domestic RPKs, it
is necessary to understand airline ASK decisions going forward if we are to understand future
RPKs in the regional space.
The model developed by the Qantas Group estimates that average ASK growth in the regional
sector over the next 6 years will average 11%. This in turn generates an RPK forecast that
averages 12.1% over the same time period.
1
The 3 methods used are a simple arithmetic average of annual growth rates, the median of those growth rates and a
regression-based CAGR approach.
Page 4
From an economics perspective, the Qantas Group believes that this very strong regional
forecast is supported by expectations of strong commodity prices over the next 6 years and
beyond, which in turn drives strong mining investment and production.
International
The Group believes that the IATA international average air passenger forecast growth rate of
5.8% is in line with historical averages and therefore is reasonable.
It needs to be acknowledged that AsA did revise some activity data as a result of the January
submissions by the industry parties.
3. Building block model
The ACCC seeks comment on the efficiency with which Airservices provides its services,
including:
• the level of estimated operating costs reflected in Airservices’ proposal
• Airservices’ incentives for, and effectiveness in, containing and reducing its operating
costs
• the efficiency with which Airservices conducts its recruitment and training.
The Qantas Group’s experience with Airport building block models indicates that the
construction and application of these models vary broadly. AsA has not provided a working
example of their building block model for industry to scrutinise as is the practice by the major
airports. In theory the building block model revenue target comprises:
•
Depreciation;
•
Return on assets;
•
Operating costs; and
•
Tax expense.
The choice of model variation, depreciation schedule/ type, operational expenditure, the time
period for recovery, timing of capital expenditure and effects of smoothing all have a significant
impact on the recoverable revenue for a given year. It is assumed that the ACCC will have
access to this data and be able to make comment on the application of the building block model
used. The ACCC is in a better position to determine if the calculations for the return of and on
assets are efficient and equitable for users over the total life of the assets not just over the five
year pricing period.
Charging for new infrastructure based on traditional depreciation methods, whether pre-funded
or not results in incumbent airlines subsidising future new market entrants. New market
entrants do not contribute during the construction or the early years of life of the asset, whereas
incumbent firms do.
Using a stylised example, the impact of pre-funding on changing market share is illustrated.
The example is based on an airline market comprising two airlines and assuming a 50-year
asset. Airline 1 commences with an 80 per cent market share and halfway through the asset’s
life, its market share drops to 20 per cent. Conversely, Airline B’s market share is 20 per cent in
the first 25 years and increases to 80 per cent in the second 25 years. This scenario assumes
that the usage of the asset over its lifecycle is the same across the two airlines. Figure 1 shows
the charges over the asset’s life between the two airlines.
Page 5
Figure 1
The differences in the charges paid by Airlines 1 and 2 are significant and demonstrate the
potential inequities associated with the construction of new assets with significant excess
capacity. On an undiscounted basis, the total charges paid by Airline 1 over the asset’s life are
40% more compared with Airline 2. The average annual charge per passenger (on an
undiscounted basis) is 3.4 times higher for Airline 1 than for Airline 2. The implication of this
stylised example is that there is a significant difference in the total charges paid by the two
airlines, even though each has equal market share positions over the life of the asset. Early
users of the asset are penalised by being forced to pay for excess capacity built to
accommodate future users. Therefore, there is clearly an inequitable contribution to the cost of
the asset between two airlines (and for that matter between two customers) which is solely
dependent upon the timing.
The Qantas Group has some concerns over the use of the building block model particularly the
circularity of the building block model. The LTPA uses an ACCC endorsed Building Block model
that calculates the allowable revenue to be recovered in one year. The total allowable revenue
is then allocated by service or location then divided by the activity driver to determine a unit
rate.
Under the building block approach, prices are determined using the following formula:
Building Block Price =
Allowable Revenue
Activity Driver
The circularity argument says the following: an increase in charges increases the unit cost to
airlines, which is potentially passed-through into higher average airfares where possible given
the different market characteristics on each route. Higher average airfares dampen demand or
the activity driver. The activity driver, however, is in the denominator of the equation that is
used to compute the unit charge, and so if the charge increases it follows that an increase in
the unit charge actually causes an increase in that charge.
To circuit-break this circularity, a more complex methodology that incorporates an estimate of
both the airfare elasticity of demand and the extent to which an increase in unit costs is passedthrough into higher airfares is required. Without consideration of these parameters and the use
of an appropriate pricing formula it is unlikely that the charges proposed by AsA will fully
recover costs.
The Qantas Group considers that the LTPA Building Block methodology places regional
communities at a disadvantage in comparison to their major city counterparts. The Qantas
Group believes there is an alternative pricing model that, if adopted, would provide a more
equitable allocation of resources across the Australian population.
Page 6
The consultation process has not provided sufficient clarity on the operational costs of AsA.
High level forecast accounts for total operational expenditure was provided for all TN and ARFF
ports. Insufficient detail has been provided of existing operational costs for TN, ARFF or any
Enroute services, corporate or major project operational expenditure as part of the consultation
process. As a result the Qantas Group is not able to make informed comment with respect to
evidence of efficiency or to benchmark operational costs.
Insufficient details with respect to recruitment and training have been provided in order to make
meaningful comment regarding the efficiency or effective recruitment and training of staff.
Further details need to be disclosed to determine if AsA’s training and recruitment strategy is
effectual in meeting the challenge of an ageing workforce, the retirement of experienced
personnel, an ambitious capital project plan and the need for new services in regional locations.
These are major challenges for AsA and there is scepticism within the industry that AsA will be
able to meet capital project targets as costed in the LTPA.
The ACCC is interested in stakeholder views on whether Airservices has adequately
addressed the ACCC’s views in relation to formal efficiency targets in the price proposal.
AsA have tightened the risk management capital expenditure rebate triggers and developed the
Services Charter. The Qantas Group is supportive of the progress that has been made towards
driving appropriate behaviours within the organisation. There are no clear efficiency targets
within either the Services Charter or the proposed pricing, nor is there any mechanism to
penalise AsA if they do not achieve targets. No determination can be made from the
operational expenses without further disclosure of detailed data. The ACCC may be in a better
position to determine if their targets are satisfied by the price proposal.
It is the Qantas Group’s understanding that AsA executed a Depreciated Optimised
Replacement Cost (DORC) revaluation of assets in 2004 and in principle Qantas believes it is
inappropriate to calculate prices off such a revalued asset.
It is debatable whether the AsA practice of charging for the replacement of an asset is
appropriate if the assets were re-valued at DORC and they have been receiving a higher return
of (depreciation) on those assets. The debate of pricing off revalued assets was resolved to
some degree for the five major airports with the “line in the sand” determination for 30 June,
2005 and subsequent prohibition of such practices. Revaluation of assets using the DORC
methodology in effect provides a windfall gain as asset values are increased without actual
expenditure.
It is not clear which assets and projects drive the change in asset values from the previous
model. Only high level figures were presented and since the charges where held over for 2
years from 2009 and there is not sufficient detail available to assess these matters. AsA have
also not disclosed any disposal of assets, therefore it is not possible to see if any assets have
been removed from the asset base as they are replaced or fully depreciated.
The ACCC seeks comment on the efficiency of Airservices’ proposed capital expenditure
program, including:
•
•
•
•
•
•
the adequacy of Airservices’ capital expenditure to date in meeting the needs of
users, including whether sufficient capacity has been provided
the efficacy of Airservices’ capital expenditure as demonstrated by increases in
capacity, reliability, safety and quality of services
the appropriateness of the capital projects included within the proposal
the appropriateness of the estimated costs associated with the capital projects
included within the proposal
the appropriateness and effectiveness of the decision-making process undertaken by
Airservices in determining the capital projects to be undertaken over the period
covered by the proposal
the extent to which Airservices’ capital expenditure is driven by regulatory
requirements, such as requirements by CASA or international policies.
Page 7
The $960m five year capital expenditure program includes a number of projects that lack
sufficient transparency to validate the costs, benefits or specific aeronautical nature. This is
unacceptable when passengers and airlines are asked to pay for these services without the
ability to determine if they represent appropriate and prudent expenditure. Specifically, the
capital expenditure program includes $90m in medium and minor projects that need additional
information to justify their inclusion. The Qantas Group would suggest that a separate ACCC
approved pricing mechanism should be used to address such uncertain projects and services
and that these costs should be excluded until the projects have been properly assessed, costed
and agreed by all industry stakeholders. This sort of mechanism is in practice in some airports
in Australia.
There are a number of concerns surrounding some projects. The timing of the capital plan is
ambitious, the costs expensive and potentially speculative for projects planned for the latter
years. Some projects result in duplicating services with old and new technology. For most
projects material in nature AsA has not disclosed sufficient cost benefit analysis or shown
evidence that the appropriate decision process that has been undertaken. Of concern is the
infrastructure upgrades, many are very costly in nature. The $20m refurbishment of the
Canberra office building including a café and childcare centre is a particular case in point.
Capital projects require more comprehensive industry collaboration and review before being
implemented. The duplication of services is inefficient and without the appropriate due diligence
being in evidence. The capital plan includes some projects which are currently only in the
research and development or options phase. Having these projects listed assumes a level of
agreement with that nominated option even though it may not be the best technological or
economical option when the time of implementation. We are concerned the pricing path
includes all of these project costs with little option for recovery of those costs if the project does
not materialise except via a rebate after the event only if the overall capital under spend
reaches those trigger points.
As a means to address a number of project concerns the Qantas Group has requested
monitoring of spend and progress of projects material in capital cost, benefits and or
operational expenditure on a quarterly basis. Through this process it is hoped that more rigor
and accountability for delivery is introduced.
Since providing its submission to AsA in January, Qantas has engaged with AsA for them to
provide the required transparency of the listed projects. Qantas is waiting for this further
information for demonstration of justification of each project and that the associated costs are
appropriate. Whilst AsA provides some high level information of key projects underway in its
2
“Capital Works Program 2012-2016” report it only has line descriptions of each project and it
does not have any supporting business cases (including cost-benefit analysis) that
demonstrates the benefits that the project would offer to the industry. There must be a clear
demonstration for each project, regardless of its nature or driver(s), of why it is needed and why
its scope and timing is appropriate.
Since providing its submission to AsA in January, Qantas has engaged with the organisation to
provide the required transparency of the listed projects. Qantas is waiting for further information
to justify each project and provide assurance that the associated costs are appropriate.
The ACCC seeks comment on the appropriateness of Airservices’ proposed rate of return on
capital.
Does the proposed return on capital reflect an appropriate benchmark given the risks borne
by Airservices?
Regarding the Weighted Average Cost of Capital (WACC) – The Qantas Group believes a debt
margin of 237 basis points (bp) is unacceptably high. AsA is rated at “AAA/Stable/A-1+” by
Standard and Poor’s (S&P) and the appropriate funding rate for an AAA+ business should be
between 40-50bp.
2
Source: Capital Works Program 2012-2016, Airservices Australia, version for ACCC 2 March 2011
Page 8
As a regulated monopoly AsA has a 'Critical Role' in providing civil and military air traffic
control, which is of strategic importance to Australia's economy, public safety and defence
capability. AsA has a legislated monopoly position for Australia's air-traffic control and aviation
rescue and fire fighting (ARFF). S&P have the view that it is 'almost certain' that the Australian
Government would provide timely and sufficient extraordinary support to AsA in the event of
financial distress, in accordance with the S&P criteria for government-related entities 3 .
S&P view AsA's role as falling within the 'Critical' rather than 'Very Important' category. In
addition, the view is based on AsA's 'Integral Link' to its sole owner, given the importance of the
AsA's operational role (including the politically visible nature of its public safety role), the strong
degree of Government oversight (including the authority's strategic direction) and the
Government's aviation policy (which indicates that services relating to control tower and ARFF
will not be contestable). S&P also note that neither the current Government nor the Federal
Opposition has a policy to privatise AsA.
The proposed AsA debt margin of 237bp above the risk free rate is unacceptably high. It is
based on a stand alone rating of AA and recent regulatory decisions for other unrelated
industries such as Australia Post with contestable services. The previous ACCC decision for
AsA in 2004 was for AAA+ and 55bp, on this basis the debt margin should be reviewed. The
Qantas Group strongly believes that a better proxy would be the Australian Government credit
default swap pricing which is currently at around 40-50bp for five years.
The Qantas Group would also challenge on a similar basis that the Asset Beta of 0.55 is too
high. Airways NZ has set their Asset Beta at 0.45. The inherent risk of AsA not recovering their
revenue targets is low. Over the past 7 years activity growth has remained high despite the
numerous shocks to the industry and the economy. Demand is closely linked to the available
seat capacity and airlines use other levers to stimulate demand to keep their aircraft assets
flying. It was also noted in the ACCC 09/10 price monitoring report that airlines buffer economic
impacts to demand by reducing airfares. In the face of such evidence it is hard to see that AsA
contains such a high level of risk, one that is higher than New Zealand with a significantly
smaller population and economy.
The ACCC seeks comment on the appropriateness of the risk sharing arrangements
embodied in Airservices’ price proposal, particularly relating to the trigger mechanisms for
review of pricing.
The ACCC is also interested in understanding the extent to which the risk sharing
arrangements may result in an increase or decrease in the risks borne by Airservices and its
users.
Risk sharing mechanisms in the LTPA need to be reviewed further, whilst the triggers for a
capital expenditure rebate has reduced from 50% to 20% under spend in 1 year and from 25%
to 10% under spend cumulatively, this could still be improved and is still ineffective at
preventing prefunding and sharing risk. The risk sharing trigger point for activity has not shifted
from +/- 5%. The Qantas Group believes that the risk sharing arrangements proposed in the
LTPA are somewhat one sided and do not effectively share the risk for activity and capital
expenditure. They may also drive undesirable conservative cost and activity forecasts.
Currently there is only one general mechanism with triggers for traffic under/over recovery and
underspend of capex budget to share the risk. This comes in the form of a rebate paid to
airlines six months after the financial year to which it refers has ended. This time frame should
be reduced.
This current structure provides little incentive for AsA to tightly control capital expenditure as the
under spend has to be considerable before the trigger point for a rebate is reached. The current
structure and $960m capital plan means airlines and passengers could potentially prefund
3
(GREs; see "Enhanced Methodology and Assumptions For Rating Government-Related
Entities," published to Ratings Direct on June 29, 2009).
Page 9
significant sums each year. The current risk sharing arrangement also provides little
disincentive for warehousing of assets in order to reach capital spend targets. In simple terms,
this means AsA may have an incentive to spend on infrastructure assets (rather than provide a
refund to airlines) that effectively sit in a warehouse unused until a project is ready to progress.
This is another form of prefunding for which customers receive little or no benefit.
Many of the capital projects included in the five year capital works program are indicative in
terms of scope, timing and requirement. Due to the uncertainty that surrounds these projects
the risk incurred by airlines is higher than is necessary with the current pricing mechanism. For
material projects where the costs are largely estimated Qantas would rather that these projects
received special attention so that the charges associated were adjusted as the particular
project’s timing and costs become certain.
An example of a major project that should receive such special treatment is the Air Traffic
Management (ATM) Future System project. The total capital costs for this project is estimated
4
at $300 million over five years (2014-2018) which is based on a modular style system rather
than the costs of total system replacement which are expected to cost more than this. AsA are
currently scoping the options and expected to engage the airlines later this year.
Understandably the estimated costs have been inserted into the pricing models as a
placeholder for an asset replacement at the point of the end of the useful life of the existing
ATM system as an interim measure until the actual costs are known.
Given so much uncertainty surrounding this project, which isn’t due to commence for another
three years, it would be more appropriate for a risk sharing mechanism to be put in place that
allows for the adjustment to the affected charges at a point in time closer to the commencement
of the project (such as awarding of contract). For such a change in approach to work it would
require the commercial relationship between AsA and the airlines to become more mature than
it currently is. Qantas would need sufficient comfort that it would receive the necessary
transparency of the project throughout its entire lifecycle to ensure that the optimal system is
delivered for the industry.
The current mechanism for activity sharing of 5% is still ineffective at fostering the appropriate
sharing of activity risk and incentivises a conservative activity forecast. A 5% trigger is too high
and should be lowered to 2%. The downside should not be covered by airlines but with lower
activity AsA should adjust operational and capital expenditure as is the practice by most
commercial businesses. Every year over the past seven years airlines have received a rebate
of millions of dollars. Each year activity has exceeded the forecast by more than 5% in every
year. It is the Qantas Group’s understanding of the rebate calculation is that it is the revenue
above that 5% which is rebated and AsA retains the first 5% excess estimated at ($40m) pa in
excess of its revenue target.
Despite the major events that have impacted the aviation industry over the past 7 years AsA
have not suffered financially unlike the airline industry. Details of the total over recovery and the
calculation for the rebate are not provided for commercial reasons so we are unable to validate
the rebate.
Rather than the current rebate structure, it would be preferable for passengers and airlines to
have a lower unit cost from the outset of the agreement. The Qantas Group also considers that
there is merit in examining risk-sharing arrangements between AsA and the airlines at
individual locations. In particular, it may allow for price reductions or rebates to the individual
airlines contributing to strong growth at a particular location.
4
Airservices advised that $180 million in 2014-2016 plus approximately $120 million in 2017-2108.
Page 10
4. Pricing and structure of prices
The ACCC seeks comment on the expected impact of the current proposed price path on
demand for each of the regulated services.
In particular, the ACCC is interested in stakeholder views on:
• whether full cost recovery for all services is achievable
• whether full cost recovery for all services is a desirable outcome for interested parties
• whether the timing and magnitude of the proposed price changes for each of the
services is appropriate
• how an inability to recover shortfalls from en route services would affect Airservices’
incentive to invest at loss making locations
• any alternative ways to structure prices or recover costs, taking into account the likely
efficiency and equity outcomes of those alternatives.
Terminal Navigation
The TN LTPA risks a significant negative impact on regional markets and destinations in
Australia. The structure of the LTPA could potentially lead to a wealth transfer (we estimate in
the order of magnitude of approximately $70M) from regional airport users to major capital city
airport users. This in turn impacts negatively on price sensitive regional markets and has overall
negative impacts for the Australian economy.
TN charges were subject to a review in mid 2010 where seven options were proposed by AsA
ranging between location specific and network charges. The current pricing is mostly location
specific with some pooling of costs where basins exist. Qantas proposed a two part pricing
option which would maximise the welfare benefit. The AsA proposed TN prices differ only
marginally from the current location specific approach.
As the terminal navigation charges proposed by AsA may result in higher charges at relatively
small airports, there could be a stronger reduction in demand at smaller airports than at larger
ones. The Qantas Group recommends that the structure and total costs of the TN charges be
reviewed to maximise the economic benefit to the industry and the Australian economy.
Enroute Charges
The Qantas Group acknowledges that in previous years EN charges have assisted in
subsidising TN and ARFF charges at regional airports. It is a concern that the removal of cross
subsidisations effectively increases regional charges. Qantas is concerned it may negatively
affect activity demand and welfare in regional areas and reducing recovered revenue gets to a
point of exceeding the original subsidisation.
The Qantas Group further acknowledges the consideration made in the LTPA regarding
capping of the TN charge at a number of regional airports and subsidising capped airports via
EN charges. The Qantas Group believes this should continue as many EN services are also
services that benefit from the regional class D towers currently costed under the location
specific TN charges.
ARFF charges
In the LTPA, ARFFS charges increase by 10% year on year for the first 2 to 5 years for most
locations and costs for Cat 9/10 increases by 13% in the first year then 10% per annum. The
major drivers of these cost increases from July 2011 are new services and buildings. AsA has
priced in two possible new services and estimate up to four new services will be required due to
the forecast activity in each of Coffs Harbour, Port Hedland, Ballina and Gladstone.
The Qantas Group considers that the rate of increase is very significant and will affect the
demand and recovery of costs in a number of locations. The steep increase in the first two
years should be moderated and services reviewed to ensure that demand is not affected by
higher prices. The costs for new ARFF services should not be introduced prior to their actual
implementation. This amounts to a prefunding of these services from which neither passengers
nor airlines derive a benefit.
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The Qantas Group is unable to determine if the choice of building block model type, the number
of years and depreciation approach means that disproportionate costs are being recovered
from users in the early years of the new asset life and airlines are paying for excess capacity. It
is also unclear if efficiency gains are being made and maintenance is reduced with the new
assets.
Potential new TN and ARFF services
The inclusion of costs in the LTPA for potential and unconfirmed services such as ARFF
category 10 in Brisbane & Perth and TN or ARFF services in Coffs Harbour, Port Hedland,
Ballina and Gladstone is not acceptable. Currently there are no confirmed plans for category 10
aircraft services at Brisbane or Perth. Whilst forecasts tip the other four locations to achieve
activity requiring ARFF or TN services sometime in the next five years, the cost increase could
in turn reduce the demand. The Qantas Group objects to paying for services prior to a
confirmed and sustained requirement. We appreciate that AsA has shifted the timing for these
new services as a result of industry submissions in January 2011.
The ACCC seeks comment on:
• the appropriateness and efficiency of the application of a capital city ‘basin’ approach
to charging for TN services
• whether any subsidy accurately reflects positive spillovers or externalities generated
by the basin airports
• the expected impact of removing the basin pricing approach on users of both
secondary airports and the major capital city airports.
The Qantas Group believes that, as a result of demand switching from smaller aerodromes to
larger aerodromes, Sunshine Coast and Gold Coast airports should be considered to be in the
same basin for pricing as Brisbane airport. Avalon airport should also be considered to be in
the same basin as Tullamarine. If these aerodromes are not considered to be in the same
basin, then relatively low TN charges at Brisbane and Tullamarine airports will lead to demand
switching from Sunshine Coast and Gold Coast into Brisbane and from Avalon into Tullamarine.
A second operational reason for believing that Sunshine Coast and the Gold Coast should be
part of a Brisbane (or South East Queensland) basin and that Avalon should be part of a
Melbourne basin is that they share common costs; in particular, they share common AsA
services. Specifically, flights into and out of Gold Coast and Sunshine Coast frequently use
Brisbane radar and class D tower services and vice-versa, while flights into and out of Avalon
frequently use Melbourne radar and class D tower services.
The ACCC seeks comment on whether the proposed method of allocating direct costs is
appropriate. In particular, the ACCC is interested in stakeholder views as to whether
Airservices’ stated method of standardisation (using the standard costing method) provides a
reasonable indication of the direct costs of providing services.
In calculating the building block costs, AsA have indicated that standard costings have been
applied. Where standardisation of costs for similar cost inputs, smoothing any cost anomalies
that are not location driven, aimed at providing a cost base that better reflects the level of
service and types of assets employed at a particular location.
Apparently the effect of standard costing is twofold:
• to smooth variation in standard cost inputs across locations; and
• to smooth variation in standard cost inputs across time.
Without specific details or models to compare what the pricing or location costs would have
been without standardisation it is not possible to comment whether this is an appropriate
treatment of costs. It is unclear if this method would drive efficiencies or hide inefficiencies.
Costing an asset over its lifetime and determining a price based on the activity over its lifetime
ensures that return on and of assets is equitable for all users. However, it is not clear without
more detail if this is the approach that has been taken by AsA.
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The use of a standardised approach for salary costs and some operational costs which differs
from actual costs in theory may have some merits specifically where some location costs could
be inappropriately skewed based on the length of tenure of the employee and could change
dramatically with minor staff changes.
The ACCC seeks comment on whether the proposed method of allocation of fixed and
common costs is appropriate.
In particular, the ACCC is interested in stakeholder views regarding the advantages and
disadvantages of this approach, and alternatives to the proposed method of cost allocation
that achieve the desired efficiency, equity and price stability outcomes.
The Qantas Group, in the response to the March 2010 AsA TN options review, proposed a two
part tariff where the variable costs are recovered under a location specific model and the fixed
costs are networked across the segments. The variable cost component satisfies the user pay
and thus equity principles, to finance the costs that are directly associated with their supply
decisions and drives efficiencies. Applying a network model for fixed TN costs recognises the
lumpy infrastructure costs and overheads that are part of a complete national service
simultaneously minimising the adverse impact on consumption of TN charges at smaller
aerodromes. The activity driver was also shifted from being in direct proportion MTOW in
acknowledgement of the movement costs component of services.
The Qantas Group’s preferred pricing option is a two part tariff, the two part tariff that is
proposed by the Qantas Group can be summarised in the following way.
Part 1 of the tariff involves setting a charge that is specific to particular aerodromes that permits
the recovery of variable costs. It can be described by the following formula in the case of the ith
aerodrome:
Tariff 1 Aerodrome i =
Variable Costs Aerodrome i
Terminal Activity Driver Aerodrome i
(1)
Part 2 of the tariff is set in order to recover the fixed costs of the total TN network (including the
summation of class C and D aerodrome fixed costs). The second tariff can be described by the
following formula, which is for the ith aerodrome once again:
Total Network Fixed Costs × Terminal Activity Driver Aerodrome i
Tariff 2 Aerodrome i =
N
∑ (Terminal Activity Driver Aerodrome i )
2
(2)
i =1
Equation (2) is the solution to a constrained optimisation problem that asks the following
question posed in the TN options review:
What set of terminal navigation charges per aerodrome will maximise the welfare of
aerodrome users at the same time as finance all of the costs incurred by Air Services
Australia in the provision of terminal navigation charges?
In relation to the first part of the two-part tariff, the justification for this component is that
aerodromes must be directly responsible, under user pay and thus equity principles, to finance
the costs that are directly associated with their supply decisions. Put simply, aerodromes must
pay for their variable costs. If aerodromes do not face these costs then their profit maximising
supply decisions will be distorted by the fact that the marginal costs they face are lower than
their true marginal costs. It is also the case in business, generally, that if entities are unable to
at least cover their variable costs then they should strongly consider whether their business
models are sustainable.
In relation to the second part of the two-part tariff, this is based on a well recognised theorem,
developed for allocating fixed costs across several demand segments, referred to as the
Ramsey-Boiteux approach (hereafter simply the Ramsey approach). The intuitive justification
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for this approach is that it generates a set of prices that recovers fixed terminal navigation costs
at the same time as minimising the adverse impact on consumption of TN charges.
The parameter to which the Ramsey approach most relies is the price elasticity of demand.
Specifically, the approach says that prices should be set highest for those demand segments
that have the least elastic demand. Conceptually the Ramsey approach is the right approach to
recovering fixed costs from different demand segments; the difficulty the approach faces is in its
implementation.
The primary problem in applying the Ramsey approach is that the information burden required
for its implementation is significant. This follows from the fact that it requires information about
price elasticities of demand for every demand segment in the network (in our case every
aerodrome in the network). Formula (2) is derived from some simplifying assumptions applied
to the elasticity across every route in the pursuit of a method that is simple, transparent and
easy to administer – yet at the same time retaining some very desirable properties that permit
more equitable and efficient allocation of fixed costs across aerodromes.
The ACCC is seeking stakeholder views on both the existing system of weight based charges
for each of the service lines, and the proposed changes (i.e., application of average MTOW
and the weight cap).
In particular, the ACCC is interested in stakeholder views on:
•
•
•
the extent to which costs vary as a result of weight
whether the basis for charging, and the specific settings are appropriate
whether there are alternatives to the basis of charges that would more accurately reflect
capacity consumed.
In theory the preferred activity driver is that which is most closely aligned with the service since
this will allow pricing that is more aligned with costs. In order to choose the driver we must
therefore have an appreciation of the key costs.
There are two broad types of costs – tangible and intangible. The tangible costs represent the
money that is spent on physical infrastructure, such as the Air Service towers, radars, IT, ARFF
stations, equipment, and navigation aids, the maintenance of that infrastructure, and air service
staff. It also comprises the costs associated with financing capital expenditure. While there are
both variable and fixed elements to these costs the activity driver that appears most closely
aligned to these tangible costs are movements since this determines the need for separation
and traffic information, and thus air services, both on approach and on the ground at the
aerodrome.
The intangible costs represent those that would be generated if there were a breakdown in
safety standards at aerodromes, and this gave rise to aircraft and aerodrome damage, injury or
loss of life. There are strong arguments, on the basis of cost alignment, for both movement
based and MTOW based charges. Continuation of a MTOW based charge is therefore the
Qantas Group’s preferred basis for setting charges with a cap or discount for the heavier
aircraft as an acknowledgment of the movement based arguments that services provided are
not proportional to the weight of the aircraft.
The Qantas Group also supports the application of average MTOW by AsA across the fleet.
Airlines operate aircraft with different MTOW’s or have aircraft that can operate at different
multi-weights. In practice the Qantas Group believes that the application of MTOW’s across a
fleet type simplifies the administration and invoicing process, minimised the number of mistakes
and reduces workload for all parties.
The introduction of the weight cap of 500 tonnes only affects the A380 aircraft at this stage. The
Qantas Group’s view is that the weight cap is appropriate and consideration that services
provided to heavier fleet aircraft are not proportionally more based on weight. This cap could be
lowered or a % discount applied to aircraft above a particular weight.
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The ACCC seeks comment on:
• the impact of Airservices’ basis of charging for en route services on airlines’ incentives
for investment
• whether Airservices’ projected timeline for establishing structure of en route pricing is
appropriate.
The Qantas Group would support a shift towards EN charges based on the level of airspace
and the services provided in that airspace. We understand this will require significant
technological advances and mandates for the use of Global Navigation Satellite System
(GNSS) and Automatic Dependant Surveillance Broadcast (ADS-B) technology, particularly in
upper airspace as opposed to the infrastructure and cost intensive radar system and legacy
navigation system. Duplication of technology is costly to the airline industry and an inefficient
use of resources.
The ACCC seeks comment on the appropriateness of the proposed call out fee for nonaviation call outs, and the refunding of these fees to customers.
The Qantas Group believes this proposal is appropriate and desirable. Airlines and passengers
should not be cross subsidising non aeronautical businesses. The plan to introduce a call out
fee for non aeronautical services is supported where it is competitive for the market to use
ARFFS and to the extent that it does not disrupt the availability of the airfield. The Group also
supports the proposal to rebate the revenue from these call-outs to airlines.
The Qantas Group would like to see more initiatives where fire fighting staff are utilised to
improve the efficiency and functionality of the AsA. For example, fire fighting staff could become
multi skilled and perform complementary Airport, AsA or community functions which are flexible
enough to not compromise CASA and airfield requirements. These could include functions such
as conducting training courses for occupational health and safety, first aid, fire fighting,
performing safety inspections, audits, security or office based project work. This in effect would
further minimise cost and achieve efficiencies in the provision of these services.
The ACCC seeks comment on the appropriateness of the proposed changes for general
aviation pricing.
In particular, what are the expected impacts of any issues, problems or benefits you
envisage?
Could any alternative strategies better achieve Airservices’ aim to reduce administrative
costs?
On the information available it is not possible to assess whether airlines are subsidising low
frequency GA. If this is the case, such cross subsidies are not desirable or reasonable. The
populous that own and operate GA aircraft are generally wealthy individuals and it is
inappropriate that the general flying public subsidise this segment of the aviation community.
Whilst it is clear that a significant number of customers generate an inordinate number of
invoices it needs to be shown that the costs to provide services to GA are being recovered by
that segment of the industry by charges more reflective of the costs to provide services to them.
The ACCC is seeking comment regarding;
• what Airservices seeks to achieve through any prefunding of capital projects
• how any prefunded capital projects are accounted for
• alternative methods of funding capital projects that would achieve Airservices’ stated aim
of providing price certainty for users, and address any transparency and ‘equity over time’
issues that users may have in funding projects before they have been completed.
The LTPA contains approximately $200m of specifically identified prefunded works. Prefunding
also occurs when projects are delayed or assets are pre purchased. Prefunding is not a
generally accepted method of project funding and results in passengers and airlines paying a
return on and a return of assets that they are not currently receiving any immediate benefit
from.
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Prefunding of assets allows AsA to undertake major capital investments by charging during
construction. However, such a practice raises several issues around equity for airlines and
passengers. Large scale investments can take years from commencement to completion.
Prefunding arrangements require airlines and passengers to pay for a return (based on WACC)
on an asset during construction for which no access to an asset or service is received. When
construction times are particularly lengthy this results in airlines and passengers paying for a
period in which they receive no benefit for years. In addition, new infrastructure may cause
disruptions during the construction phase. For example airlines may experience increased flight
delays, or be limited in growth plans. Further it can result in a situation where incumbent users
effectively provide a significant subsidy to future users.
This issue is critical as airlines, like AsA, are extremely capital intensive businesses. Due to the
competitive nature of the airline business it is not possible for airlines to ask passengers to
prefund future aircraft purchases. These aircraft must be purchased out of ordinary revenues
and are usually debt or equity funded.
At the levels of investment currently facing Australia’s airlines for new fleet, maintenance,
catering and associated facilities it is untenable for airlines to also be called upon to prefund the
capital intensive projects.
Gaining user agreement regarding significant investments is of particular importance in the
context of prefunding. To construct an asset that users do not require, and enforce charges
upon them, suggests that projects are not always undertaken at optimal times, and may result
in inefficient resource allocation decisions. It is also important to note that ICAO considers that
both aeronautical and non aeronautical revenues should contribute in circumstances of
prefunded infrastructure.
The prefunding proposals of some airports also result in existing airlines and their customers
contributing a disproportionately high amount to the total cost of new assets, without receiving
any future benefit. This results in a cross-subsidisation from current users to future users.
The ACCC is seeking comment on whether Airservices’ estimated impacts are an accurate
reflection of the likely impact of the price changes on your organisation. The ACCC is
interested in stakeholder views on the expected impacts of Airservices’ proposed prices and
price structure, to the extent that they differ from those estimated in the price proposal.
Given that the Qantas Group operates in the major commercial airline markets in Australia,
providing international, domestic, regional, freight and charter services the overall impact to the
Qantas Group is in line with the overall weighted average impact stated by AsA. Pricing and
costing however is not done on an overall basis and is conducted at a port or route level. This
is where the proposed pricing has the most impact.
The new TN service costs in Karratha and Broome will increase costs in total by $3m or $10
and $15 per passenger respectively. Darwin experiences an $8 per passenger increase, Alice
Springs $15 per passenger landing, a number of other regional ports will experience an
increase of between $3 and $6 per passenger landing. These are material impacts which may
impact the level of airfares, availability of seats and viability of routes.
The Qantas Group is by far the highest contributor of revenue to AsA and as such is the most
significantly affected. The cost impact of this pricing proposal over 5 years is about $85m based
on FY11 activity. It is a material cost component of a flight.
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5. Dynamic efficiency
Performance measurement
The ACCC is interested in stakeholder views regarding the appropriateness of the elements of
the performance measurement system (i.e. key performance indicators, methodology and
targets).
Adoption of technology
The ACCC seeks comment on whether:
• Airservices’ adoption of technology is appropriate
• Airservices has adequate incentives to introduce more efficient processes or to invest
in efficiency-increasing technologies over time
• Airservices’ adoption of technology is appropriate in comparison to other air
navigation and emergency services operators overseas.
Cost accountability and efficiency of project delivery – The LTPA currently lacks a mechanism
to ensure that there is accountability for the cost, progress and efficient delivery of projects.
Such a mechanism should be included to ensure that there is commercial accountability and
rigour underpinning the capital expenditure program.
Qantas supports the Service Charter and looks forward to further developing the measures and
systems within the charter to drive improved business behaviours and performance. The
Qantas Group believes that the appropriate way to manage this issue would be to manage and
monitor expenditure collaboratively at PCC meetings. Qantas has recently engaged with AsA
to develop a detailed monitoring report that it is proposed will be provided to airlines ahead of
each PCC meeting that will allow informed decisions to be made at the meeting in evaluating
capital projects and their financial milestones, including operational expenditure.
The Qantas Group appreciates that there are considerable capital expenses associated with
the provision of a safe and modern system of air traffic management services. Capital
expenditure projects are often determined by regulations and legislation as well as on the basis
of safety risk assessments. However, the LTPA contains a significant number of projects about
which the Qantas Group is unsure in relation to their benefit or relevance to aeronautical
services or that have not been explained in sufficient detail to allow proper assessment and
endorsement. Considering the quantum of capital in the LTPA, it is critical that airlines are
provided with detailed information about the cost, timing and benefits of each project to ensure
that this expenditure is reasonable.
It is envisaged that any existing and new proposals would be costed in full from end to end and
coupled with a complete business case that demonstrates the benefit to industry. This should
apply to all projects within the term of the LTPA. One clear example requiring significant
additional information is ‘The Advanced Australian Air Traffic System’ (TAAATS). This project
will cost almost $200 million during the LTPA. However, based on the historical cost of
TAAATS, it is unclear if there may be another several hundred million dollars required to
complete the project. Clearly this is a significant project requiring a significant sum of money.
The Qantas Group would need considerable information and strong reasons to support this
level of expenditure.
The Qantas Group also believes that a number of items in years 2013 to 2016 of the LTPA
should be reviewed during the term of the LTPA to ensure that they are still relevant. There is
risk associated with a five year agreement that once capital plans are agreed they become an
expected outcome even if they may no longer relevant. With the pace of technology change, in
three or four years time projects may no longer be the best available choice for the industry. In
line with the Services Charter, this pace of change highlights the need for a dynamic process to
support a mechanism to adjust the LTPA during its term.
AsA projects also should shift towards industry solutions, where collectively industry can set the
architecture and participate in software solutions; otherwise the industry will inefficiently
continue to duplicate expenditure.
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Conclusion
The Qantas Group believes there are significant reasons to review the charges using:
• an economically sound methodology for the calculation of TN charges (as
proposed in June 2010) to achieve AsA’s pricing objectives;
• TN basin including Gold Coast and Sunshine Coast in Brisbane and Avalon in
Melbourne;
• continued cross subsidisation by EN and allocation of TN costs that are used by
Enroute operations;
• activity Forecasts based on longer term trends and ASKs;
• building Block models with fair distribution of costs of the life of the assets;
• efficiency target for operational costs;
• Non circular Building Block models for all charges;
• WACC commensurate to a AAA+ rating;
• Asset Beta reduced to be comparable to Airways NZ;
• Excluded capex for unconfirmed or prefunded projects or services; and
• A reduction in the steep increase in prices in the first years of the LTPA and
smoothed price path.
The Qantas Group also requests the ACCC to review the risk sharing mechanisms, encourage
AsA to use an ACCC approved mechanism to price isolated projects or services and for ASA to
further develop the Services Charter to incorporate capital and operational expenditure review
with an accountability mechanism.
At this stage, the Qantas Group cannot determine the reasonableness of the overall
recoverable cost or the specific charges and it objects to the significant increases in charges for
FY12 and FY13. There is little evidence of efficiency gains. The level of transparency and detail
of data provided during the consultation period was insufficient to make informed comment on
many important aspects contributing to the overall cost of services which AsA provides.
Further detail and collaboration is needed to ensure the most appropriate technology and
infrastructure are utilised. The Qantas Group looks forward to further dialogue and a response
from AsA on the items set out above in order to translate the contents of this and other
submissions into an appropriate pricing proposal.
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