Airports Profitability Assessments Introduction and Welcome - - PDF document

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February 2019

Airports Profitability Assessments Introduction and Welcome

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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)

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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

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

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Workshop purpose

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February 2019

Airports Profitability Assessments Regulatory Framework

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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?

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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

Purpose of information disclosure

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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

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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

Purpose of Part 4 Other considerations

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• 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
• f information disclosure
• Optional v mandatory requirements – what better promotes

the purpose of information disclosure

• Are there any other matters that should be considered?

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IM review

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The 2016 input methodologies review resulted in a change to the approach for assessing profitability in our forward- looking ID requirements for airport services

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

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February 2019

Airports Profitability Assessments IRR Disclosures

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Agenda

• Standard IRR calculation
• Comparisons
• Time series
• Pricing asset base and RAB

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Standard IRR Calculation

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*Calculation has been simplified for demonstration purposes

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%

Airport Profitability Assessment

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Standard IRR Calculation

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*Calculation has been simplified for demonstration purposes

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%

Airport Profitability Assessment

Opening negative cash flow Closing positive cash flow Revenue = 148 days Expenditure = 182 days Timing Assumptions

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Comparisons

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Comparing Rates of Return

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• 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

Year 1 Year 2 Year 3 Year 4 Year 5 IRR 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%

Compare to pricing decision forecast

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Actual Forecast Variance

Opening RAB 110 110 Opening carry forward 20 20 Opening investment value 130 130 plus Revenue 45 45 less Assets commissioned 20 20 less Operational expenditure 20 20 Closing RAB 115 115 Closing carry forward 20 20 Closing investment value 135 135 IRR 7.61% 7.61% 0%

Airport Profitability Assessment

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Time series - current year and pricing period to date

21 Variance Actual Forecast Opening RAB 110 110 Opening carry forward 20 20 Opening investment value 130 130 plus Revenue 45 45 less Assets commissioned 20 20 less Operational expenditure 20 20 Closing RAB 115 115 Closing carry forward 20 20 Closing investment value 135 135 7.61% 7.61% 0.00% Airport Profitablity Assessment Pricing period YTD Variance

Actual Forecast Opening RAB 110 110 Opening carry forward 20 20 Opening investment value 130 130 plus Revenue 50 45 5 less Assets commissioned 20 20 less Operational expenditure 20 20 Closing RAB 115 115 Closing carry forward 15 20

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Closing investment value 130 135

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7.73% 7.61% 0.12% RAB Assets Profitability Current year

Example: Reporting variances to forecast

Airport demand over the period is higher than expected which increases revenue by $5 more than forecast

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Variance

Actual Forecast Opening RAB 110 110 Opening carry forward 20 20 Opening investment value 130 130 plus Revenue 50 45 5 less Assets commissioned 20 20 less Operational expenditure 20 20 Closing RAB 115 115 Closing carry forward 20 20 Closing investment value 135 135 11.59% 7.61% 3.98%

RAB Assets Profitability Current year

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Example: Risk sharing

Airports have agreed to return the extra revenue to airlines through a risk sharing arrangement agreed during the price setting event

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Variance

Actual Forecast Opening RAB 110 110 Opening carry forward 20 20 Opening investment value 130 130 plus Revenue 50 45 5 less Assets commissioned 20 20 less Operational expenditure 20 20 Closing RAB 115 115 Closing carry forward 15 20

• 5

Closing investment value 130 135

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7.73% 7.61% 0.12%

RAB Assets Profitability Current year

Example: Risk sharing

Airports have agreed to return the extra revenue to airlines through a risk sharing arrangement agreed during the price setting event

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Note: Small variance in actual IRR due to time value

• f money
• assumption. To

discuss later in workshop

Variance

Actual Forecast Opening RAB 110 110 Opening carry forward 20 20 Opening investment value 130 130 plus Revenue 50 45 5 less Assets commissioned 20 20 less Operational expenditure 20 20 Closing RAB 115 115 Closing carry forward 15 20

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Closing investment value 130 135

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7.73% 7.61% 0.12%

RAB Assets Profitability Current year

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• 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

Pricing Asset Base Profitability

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• 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

Pricing Asset Base - Challenges

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Pricing Asset Base IRR Disclosures - Options

Compulsory disclosure consistent with RAB IRR Airports voluntarily disclose as supporting information Compulsory disclosure of partial information

Reasons?

Optional / Flexible Mandatory / prescriptive February 2019

Airports Profitability Assessments Forecast annual IRR

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• Context
• What is needed

Agenda

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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

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Context

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Annual forecast of

 Revenues  Expenses  Taxes  Opening and closing RAB × Opening and closing carry forward  Cash flow timing assumptions × = Annual IRR

What is needed to determine annual forecast IRR

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February 2019

Airports Profitability Assessments Rolling forward the Carry forward balance

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• Purpose of carry forward balance
• Carry forward balance requirements

Agenda

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• Accounts for agreed future value transfers between airports

and their consumers

• Used in the determination of internal rates of return (IRR)

calculations – annual and pricing period

Purpose of carry forward balance

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Accounts for

• default revaluation gain/loss adjustment
• risk allocation adjustments
• return of value through prices

Is there value in

• Separately identifying individual elements of the carry

forward balance

• Anything else?

Carry forward balance requirements

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February 2019

Airports Profitability Assessments Cash flow timing assumptions and time value of money

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Cash flow timing assumptions

Forecast assumptions Backward-looking assumption - preliminary Revenue 148 days or airport assumption Consistent with price setting event Assets commissioned 182 days or airport assumption Refer preceding slide Cash flow from asset disposals 182 days or airport assumption Refer preceding slide Operating expenditure 182 days or airport assumption Consistent with price setting event Unlevered tax 182 days or airport assumption Consistent with price setting event

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• Current profitability calculation takes into account monthly

commissioning (Schedule 1b(ii))

• Forward-looking profitability assessments 182 day cash flow

assumption for asset commissioning

• Current approach is consistent with other regulated sectors

with lumpy commissioning profiles e.g. Transpower

• Works under construction assumes at least monthly

capitalisation of interest

• Should monthly cash flow timing assumption also be applied

to regulatory divestments?

Cash flow timing – assets commissioned

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The concept that having money available at the present time is worth more than having the identical sum available in the future due to its potential earning capacity

Time value of money - concept

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• Schedule 6c provides for the estimated present value of

proposed risk allocation adjustments

• Schedule 18(ii) ‘Opening carry forward adjustments from

current pricing setting event’ includes a ‘Risk allocation adjustment’ amount

• What are the appropriate time value of money assumptions

that should applied in to the risk allocation adjustment?

Time value of money – adjustments to carry forward balance

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• Risk allocation adjustments to the carry forward balance

should include time value of money assumption in the period the adjustment relates to (refer slide Example: risk sharing)

• As the carry forward balance is implicit in the IRR calculation

– a time value of money consideration is not required in the annual roll forward of carry forward balances

Time value of money – adjustments to carry forward balance (2)

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February 2019

Airports Profitability Assessments Other amendments

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The purpose of this session is to discuss other consequential updates to the backward-looking disclosures that support the profitability assessment

Purpose

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• Assets held for future use
• Works under construction
• Current transitional provisions

Agenda

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Assets held for future use

4b(viii): Assets Held for Future Use

* Corresponds to values in RAB roll forward calculation.

Base Value Holding Costs Net Revenues Tracking Revaluations Total Assets held for future use—previous disclosure year – plus Assets held for future use—additions¹ – less Transfer to works under construction – less Assets held for future use—disposals – Assets held for future use² – – – – – Highest rate of finance applied (%)

¹ Holding Costs, Net Revenues, and Tracking Revaluations entries in the 'Assets held for future use—additions' line relate to the value incurred during the disclosure year. ² Each category value shown in the 'Assets held for future use' line (Base Value, Holding Costs, Net Revenues, and Tracking Revaluations) is carried forward into the following year's disclosure as 'Assets held for future use—previous disclosure year' .

18(ix): Assets held for future use cost and base value

Assets held for future use opening cost—previous year – plus Forecast holding costs less Forecast assets held for future use net revenue plus Forecast assets held for future use additions less Forecast assets held for future use disposals less Forecast transfers to works under construction Assets held for future use closing cost – – Initial base value plus Opening tracking revaluations Opening base value – – plus Forecast assets held for future use revaluations plus Forecast assets held for future use additions – – less Forecast assets held for future use disposals – – less Forecast transfers to works under construction – – Closing base value – – Tracking revaluations – –

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Works under construction

18(viii): Forecast Works Under Construction

Works under construction—previous year plus Capital expenditure less Assets commissioned Works under construction – – 4b(v): Works Under Construction

Works under construction—previous disclosure year plus Capital expenditure – less Asset commissioned – – less Offsetting revenue plus Adjustment resulting from cost allocation – Works under construction – Unallocated works under construction Allocated works under construction 48

• Clause 2.10(1) and Schedule 24 are now redundant
• Clause 2.10(2) and (3) remain relevant until WIAL make their

annual disclosure in August 2019

Current transitional provisions

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Amendments to be considered

• Items relevant to the backward-looking assessment of

profitability

• Correction of minor errors in our forward-looking ID

templates Amendments that require policy decisions that don’t relate to the backward-looking profitability assessment are outside scope

Any other items

February 2019

Airports Profitability Assessments Airports set prices as they see fit

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Price setting events

• Airports have the ability to set prices as they see fit
• The IMs and forward-looking profitability disclosures

provide for flexibility in the price setting process

• This session is to recap on the flexibility provided –

including a discussion on staff’s current thinking on potential backward-looking disclosures

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Airport ID flexibility

Key Variable Forecast disclosure Backward-looking Operational expenditure

• Forecast operational expenditure to

be incurred (IM clause 1.4)

• Actual operational expenditure

incurred (IM clause 1.4)

Capital expenditure

• General requirement to apply GAAP

(IM clause 3.9)

• General requirement to apply GAAP

(IM clause 3.9)

Regulatory tax allowance

• Determined by applying the tax

rules and corporate tax rate to regulatory profit (IM clause 4.1)

• Determined by applying the tax

rules and corporate tax rate to regulatory profit (IM clause 4.1)

RAB - Depreciation

• Standard methodology with the

ability to apply non-standard methodology (IM clause 3.4(5))

• Methodology required to be

consistent with price setting event (IM clause 3.4(5)(c))

RAB - Revaluations

• Choice of CPI-indexation or an un-

indexed approach (IM clause 3.7(7))

• Methodology required to be

consistent with price setting event (IM clause 3.7(6))

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* To be considered as part of this consultation process

Airport ID flexibility cont.

Key Variable Forecast Backward-looking Carry forward balance

• Airports have ability to supplement

the IRR with a carry forward mechanism (ID clause 2.5(1)(d)and(e))

• Airports to include adjustments

agreed during price setting event (ID clause 1.4)

• Airports ability to make

adjustments for other items (ID clause 1.4)

Default cash flow timing assumption

• Default assumptions with the

ability for airports to apply alternative assumptions (ID clause 2.5(1)(f))

• Assumptions to be consistent with

price setting event disclosures*

Alternative methodologies

• Airports can, in a range of

instances, apply alternative methodologies with equivalent effect (IM clause 3.13)

• Methodology required to be

consistent with price setting event (IM clause 3.13)

Any other? February 2019

Airports Profitability Assessments Summary and Analysis

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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

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Interested persons assessment – matters to consider

• Difference between actual outcomes and target
• Resulting profitability (IRR) – current year and pricing

period to date

• Outcomes of risk sharing arrangements
• Other adjustments to carry forward balance
• Magnitude of carry forward balance
• Deviations from standard assumptions and disclosure

methodologies

• Anything else?

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February 2019

Airports Profitability Assessments Transiting to the new requirements

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Indicative final decision timing

Today Workshop March 2019 Draft decision April 2019 Submission period May 2019 Final decision

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Upcoming disclosures

Regulated entity Year end Pricing period (years ending) Discussion AIAL 30 June 2018-22 Pricing period 2nd annual disclosure due Nov 19 CIAL 30 June 2018-22 Pricing period 2nd annual disclosure due Nov 19 WIAL 31 March 2015-19 Pricing period 5th annual disclosure due Aug 19

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Transitional Provisions Questions

• If we amended our backward looking profitability disclosure

requirements during the current disclosure year, would there be sufficient time for AIAL and CIAL to prepare their 2nd annual disclosures for the current pricing period using the new disclosure requirements?

• Is there value in requiring AIAL and CIAL to redisclose their 1st

annual disclosures for the current pricing period?

• Should the new disclosure obligations only apply to WIAL

under their new pricing period?

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February 2019

Airports Profitability Assessments Closing comments