Auckland Airport facing profit clampdown

By BRIAN FALLOW

The Commerce Commission has found that Auckland International Airport is extracting about $4 million a year in monopoly profits from airlines and has recommended some form of regulatory control be imposed.

Underpinning the decision, the upshot of a four-year inquiry, is a view that specialised assets such as runways should be valued for charge-setting purposes on their historic cost, not their replacement cost, and also that the airport company is not entitled to a return on land held for a future second runway until its construction begins.

The commissioners split 3:2 on the question of the valuation of improvements such as runways. The dissenters, Donal Curtin and Peter Taylor, preferred the optimised depreciated replacement cost method, which is also used in other natural monopoly industries, for instance electricity distribution.

On that basis Auckland Airport's excess profits are about half what they are by the commission's reckoning, and too low to justify the costs of imposing regulatory control

The Commerce Minister (at present Paul Swain) will decide before Christmas whether to impose price control, or possibly some other form of control such as rate-of-return, on the airport.

If the minister opted for price control the commission would have the task of devising a regime, which it would hope to complete within a year, said chairman John Belgrave.

An alternative outcome is that landing charges may be renegotiated between the airport and the airlines, where the commission's report and the pricing principles it contains would strengthen the airlines' position.

Brendan Fitzgerald, president of the Board of Airline Representatives, said that the price increases agreed last year were without prejudice to any recommendations the commission might make, so the airlines would seek to resume discussions with the airport company.

Auckland Airport earns about 25 per cent of its profit from the airfield services that are the subject of the commission's inquiry.

Taking the commission's estimate of an appropriate after-tax weighted average cost of capital of 8.4 per cent, it stands to make an excess profit of $3.9 million a year on average until 2007 when the present landing charge agreement expires.

That has to be seen in the context of the company's stated expectation that it will report a net profit of around $70 million for the June year just ended.

Auckland Airport shares ended 11c lower yesterday at $4.05.

The commission's valuation methodology, which continues to be strongly disputed by airport owners, wipes $121 million or 39 per cent from Auckland's airfield valuation and $40 million or 42 per cent from Wellington International Airport. The commission has not recommended control be imposed on Wellington or Christchurch airports.

But it gave a warning to Wellington Airport, which is two-thirds owned by listed investor Infratil, that if it imposed a significant increase in charges after its present consultation with the airlines it would risk a recommendation of control.

The decision gives an insight into the commission's (divided) view on how the assets of natural monopolies should be valued. The issue is crucial because whereas in competitive industries the prices the market is expected to deliver determine the value of the assets, with natural monopolies it is the other way round: the valuation drives the prices able to be charged.

Auckland Airport responded that the commission's historic cost approach to the valuation of specialised assets could have significant consequences on other infrastructure companies and the regulatory framework in which they operate.

"No doubt such organisations will also be interested in making comments to the minister on this issue."

Asked whether this decision should be seen as a precedent for other industries, Belgrave said: "We arrived at the asset valuation decision based on the commission's view of the circumstances of airports, as against other network industries."

The minority view of Curtin and Taylor is that in the case of specialised assets such as runways current costs are more relevant than historic costs. They call the commission's approach of mixing historic costs (in the case of specialised assets) and current costs (in its use of the opportunity cost for other assets) "an uncomfortable hybrid".

Tim Brown of Infratil said it was "nutty" to contend, as the commission did, that airport land was only worth its "scrap value - what it would fetch it it was flogged off for houses".

Auckland Airport said that the commission's method of valuing airport land effectively represented its value if it exited the business, that is, ceased operating as an airport.

"The company believes, from a competition perspective, that the appropriate value would be what a new entrant would pay to enter the business and to create the same facility."

Brown said that on equity grounds any radical change in the valuation needed to be based on some overwhelming justification, given that investors had acquired these assets in good faith.

But Fitzgerald said that considerations of fairness applied to airports' customers as well as their owners. "We have always been seeking a reasonable stance by the airport companies ... [Sometimes] that has not been the case."