Airports Profitability Assessments Introduction and Welcome February 2019 Introduction • Commerce Commission • Air New Zealand • Auckland International Airport (AIAL) • Board of Airline Representatives New Zealand (BARNZ) • Christchurch International Airport (CIAL) • New Zealand Airports • Wellington International Airport (WIAL) 2 1
Agenda • Workshop purpose • Regulatory framework • IRR Disclosures • Forecast annual IRR • Rolling forward the carry forward balance • Cash flow timing assumptions and time value of money • Other amendments • Airports to set prices as they see fit • Summary and analysis • Transitioning to the new requirements 3 Workshop purpose To seek stakeholder views on how the backward-looking profitability disclosure requirements might be amended • Workshop participants views will inform our draft decision Formal views on the draft decision will be sought from stakeholders as part of • the submission process • Minutes will be taken outlining points of preliminary agreement between participants • Any views expressed in these slides or at the workshop are those of Commission staff only 4 2
Airports Profitability Assessments Regulatory Framework February 2019 Contents • Purpose of information disclosure • Summary and analysis • Purpose of Part 4 • Other considerations • IM review • What we already have • Success – what does it look like? 6 3
Purpose of information disclosure To ensure sufficient information is readily available to interested persons to assess whether the purpose of Part 4 is being met s 53A of the Commerce Act 1986 7 Summary and Analysis We must publish a summary and analysis of information publicly disclosed for the purpose of promoting greater understanding of the performance of individual regulated suppliers, their performance, and the changes in performance over time s 53B(2)(b) of the Commerce Act 1986 8 4
Purpose of Part 4 To promote the long-term benefit of consumers … by promoting outcomes that are consistent with outcomes produced in competitive markets such that suppliers of regulated services….. a) have incentives to innovate and invest …; b) have incentives to improve efficiency and provide services at a quality that reflects consumer demands; c) share with consumers the benefits of efficiency gains …; and d) are limited in their ability to extract excessive profits s 52A(1) of the Commerce Act 1986 9 Other considerations • Price setting – airport services are not subject to price- quality regulation and can set prices as they see fit • Transparency – • required to address information asymmetry • provides clarity of decisions made and reasons • Flexibility v prescription – what better promotes the purpose of information disclosure • Optional v mandatory requirements – what better promotes the purpose of information disclosure • Are there any other matters that should be considered? 10 5
IM review The 2016 input methodologies review resulted in a change to the approach for assessing profitability in our forward- looking ID requirements for airport services 11 What we already have Internal Rate of Return (IRR) calculation consistently applied in Part 4 regulation Airport businesses that can set prices as they see fit Approach for assessing airports targeted profitability Targeted profitability – set at the beginning of each pricing period × Backward-looking disclosure requirements aligned to IRR calculation and targeted profitability disclosures 12 6
1 2 3 4 5 6 13 Airports Profitability Assessments IRR Disclosures February 2019 7
Agenda • Standard IRR calculation • Comparisons • Time series • Pricing asset base and RAB 15 Standard IRR Calculation Airport Profitability Assessment Actual Opening RAB 110 Opening carry forward 20 Opening investment value 130 plus Revenue 45 less Assets commissioned 20 less Operational expenditure 20 Closing RAB 115 Closing carry forward 20 Closing investment value 135 IRR 7.61% *Calculation has been simplified for demonstration purposes 16 8
Standard IRR Calculation Timing Assumptions Airport Profitability Assessment Actual Opening RAB 110 Opening negative Opening carry forward 20 cash flow Opening investment value 130 Revenue = 148 plus Revenue 45 days less Assets commissioned 20 Expenditure = less Operational expenditure 20 182 days Closing RAB 115 Closing positive Closing carry forward 20 cash flow Closing investment value 135 IRR 7.61% *Calculation has been simplified for demonstration purposes 17 Comparisons 18 9
Comparing Rates of Return IRR 5 Year 1 Year 2 Year 3 Year 4 Year 5 year period Actual Annual Return 9.0% 8.7% 5 year WACC 7.5% Forecast Return 9.2% 8.5% 7.5% 6.5% 5.8% 7.5% • Pricing decisions based on 5 year WACC • Revenue smoothing can result in uneven returns across the period • Actual annual returns are therefore better compared to annual forecast returns 19 Compare to pricing decision forecast Airport Profitability Assessment Actual Forecast Variance Opening RAB 110 110 0 Opening carry forward 20 20 0 Opening investment value 130 130 0 plus Revenue 45 45 0 less Assets commissioned 20 20 0 less Operational expenditure 20 20 0 Closing RAB 115 115 0 Closing carry forward 20 20 0 Closing investment value 135 135 0 IRR 7.61% 7.61% 0% 20 10
Time series - current year and pricing period to date RAB Assets Profitability Current year Variance Actual Forecast Opening RAB 110 110 0 Opening carry forward 20 20 0 Opening investment value 130 130 0 plus Revenue 50 45 5 less Assets commissioned 20 20 0 less Operational expenditure 20 20 0 Closing RAB 115 115 0 Closing carry forward 15 20 -5 Closing investment value 130 135 -5 7.73% 7.61% 0.12% Airport Profitablity Assessment Pricing period YTD Variance Actual Forecast Opening RAB 110 110 0 Opening carry forward 20 20 0 Opening investment value 130 130 0 plus Revenue 45 45 0 less Assets commissioned 20 20 0 less Operational expenditure 20 20 0 Closing RAB 115 115 0 Closing carry forward 20 20 0 Closing investment value 135 135 0 7.61% 7.61% 0.00% 21 Example: Reporting variances to forecast Airport demand over the period is higher than expected which increases revenue by $5 more than forecast RAB Assets Profitability Current year Variance Actual Forecast Opening RAB 110 110 0 Opening carry forward 20 20 0 Opening investment value 130 130 0 plus Revenue 50 45 5 less Assets commissioned 20 20 0 less Operational expenditure 20 20 0 Closing RAB 115 115 0 Closing carry forward 20 20 0 Closing investment value 135 135 0 11.59% 7.61% 3.98% 22 11
Example: Risk sharing Airports have agreed to return the extra revenue to airlines through a risk sharing arrangement agreed during the price setting event RAB Assets Profitability Current year Variance Actual Forecast Opening RAB 110 110 0 Opening carry forward 20 20 0 Opening investment value 130 130 0 plus Revenue 50 45 5 less Assets commissioned 20 20 0 less Operational expenditure 20 20 0 Closing RAB 115 115 0 Closing carry forward 15 20 -5 Closing investment value 130 135 -5 7.73% 7.61% 0.12% 23 Example: Risk sharing Airports have agreed to return the extra revenue to airlines through a risk sharing arrangement agreed during the price setting event RAB Assets Profitability Current year Note: Variance Small variance Actual Forecast Opening RAB 110 110 0 in actual IRR Opening carry forward 20 20 0 due to time value Opening investment value 130 130 0 of money plus Revenue 50 45 5 assumption. To less Assets commissioned 20 20 0 less Operational expenditure 20 20 0 discuss later in workshop Closing RAB 115 115 0 Closing carry forward 15 20 -5 Closing investment value 130 135 -5 7.73% 7.61% 0.12% 24 12
Pricing Asset Base Profitability • The forward-looking profitability disclosures allow for assessment of RAB profitability and pricing asset base profitability • We seek participants views and reasons for potentially requiring backward-looking disclosures of pricing asset base profitability • We will consider views as part of the draft decision process 25 Pricing Asset Base - Challenges • Backward-looking pricing asset base profitability disclosures would require duplicate disclosures of information included in: Schedule 1 – Return on investment • Schedule 2 – Regulatory profit • Schedule 3 – Regulatory tax allowance • Schedule 4 – RAB roll forward • Schedule 6 – Actual to forecast expenditure • 26 13
Pricing Asset Base IRR Disclosures - Options Airports Compulsory Compulsory voluntarily disclosure disclosure of disclose as consistent partial supporting with RAB IRR information information Optional / Mandatory / Flexible prescriptive Reasons? 27 Airports Profitability Assessments Forecast annual IRR February 2019 14
Agenda • Context • What is needed 29 Context • Pricing decision disclosures require disclosure of a 5 year IRR • Annual closing asset base and carry forward balance are required to determine forecast annual IRRs 30 15
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