Users of Dublin airport in 2019 pay the daa up to €9.65 each time they use the airport’s infrastructure. Flying from Dublin to Stansted and back for example incurs four sets of aircraft charges, as each of the airports’ facilities are used twice.
Last month, the Commission for Aviation Regulation (CAR) proposed as part of its draft determination on Dublin airport charges that the price cap be set at €7.50 per passenger for the next five years (2020-2024). The press statement issued by the CAR stated that the proposed new price cap included all of the airport’s future investment plan, costing some €1.8bn. The CAR invited the views of interested parties by a deadline of 8 July.
The daa’s responding press statement expressed extreme concern at the proposed price cap especially because in the daa’s view the lower average charge would not allow the airport operator to implement its investment programme. On 14 June, the Irish Times reported that the airport CEO, Mr. Dalton Philips, had “stood down” work on new investment at the airport in protest at the proposed reduction in the price cap, seeking instead that the price stay close to €9.65 in the next regulatory period. Mr. Philips also set out the daa view on the Marian Finucane Show last Sunday morning (inter alia claiming the lower price cap would lead to a ‘yellow pack’ airport).
On the face of it, one might easily wonder whether higher (investment) spending could be funded from lower charges. This post is an analysis of that aspect of the proposed airport price cap.
A price cap is a ratio: forecast costs divided by forecast traffic. When traffic (the denominator) increases faster than costs, the result of the calculation is a lower price cap. When costs (the numerator) increase faster than traffic, the result is a higher price cap. Against a background of extremely rapid traffic growth (10% annually in the period 2015 to 2018), a reduced airport price cap is fully compatible with (indeed, unavoidable despite) an increasing investment budget. Otherwise, the airport earns excess profits and passengers overpay for airport infrastructure, the things the price regulatory regime is designed to stop.
In 2009, when passenger traffic fell sharply, the airport price cap rose. The process is working in the reverse direction now.
In simple terms: suppose a price cap is €9 per passenger because it was calculated at a time when costs were expected to be €215 per annum and passengers numbers were predicted to be 25 per annum. The cost base would have included operating costs (€200), depreciation (€87) and a profit allowance (€89), for a total of €378. After subtracting forecast non-aeronautical income (€163), one obtains a net cost base of €215.
Why these quirky numbers? Because they were the actual numbers that appear in the financial model used in 2014 by the CAR to set the price cap for 2019 – once all values are converted to millions. They may be inspected on the CAR website.
Of course, the outturn numbers in 2019 were very, very different! Traffic exploded to more than 31.5 (million) in 2018 – an overshoot of some 30%. Processing of these passengers by the airport added to its operating costs but also raised its non-aeronautical income, as well as requiring more investment spending than initially planned. Had the calculations of 2014 used a 2019 traffic number of even 31 (million) rather than 25 (million), the price cap this year would not be €9 but under €7 (allowing for inflation, etc). It is this dynamic more than anything else that is giving the downward impetus to Dublin airport charges. From one perspective, it is a problem of success.
Although forecasts are uncertain, once the price cap is set, it is generally not reopened. To do so would weaken, or destroy, the incentives for the regulated firm to attract extra traffic and to find cost efficiencies. For the incentives to work, the no-retrospection rule must be symmetric. A regulated firm keeps the additional revenues if traffic exceeds the forecast for the period, but suffers a loss of income if traffic undershoots the forecast. But then, in moving from one regulatory period (2015-2019) to the next (2020-2024), the numerator is rebased. In 2020, this will mean a ‘jump’ from 25 (million) to about 33 (million). Costs are not going to escalate equivalently, so even with a large investment plan, the price cap is certain to be lower. In 2014-19, the daa kept the extra profits from the additional net aeronautical revenues (estimated by the CAR at €150m in 2015-17 alone) but the new traffic forecast will be based on the new traffic level.
Counting in millions of euros, the forecasts for the year 2024 are for operating costs of €290, depreciation of €164 and profit of €124 for a total of €579. After subtracting non-aero income of €296, and dividing by forecast traffic of 38 (million, based on a traffic growth rate of 3% in the next regulatory period) one obtains a 2024 price cap of €7.5.
The daa says it is seeking an “average” price of €9.65 for the next five years. The daa’s regulatory submission shows that in 2020, the daa proposes an airport charge per passenger of €7.82, climbing by about one euro in most of the following four years to reach €11.20 in 2024. If implemented, this would mean the airport would enter the 2024 price review from a starting airport charge above €11.
The Aviation Regulator’s calculations are in the public domain. Scrutiny of these spreadsheets shows that the daa’s proposed future investments (to 2024) of some €1.8 bn are transparently included in the regulatory calculations. The CAR’s numbers allow the daa to earn a profit over the next five years of €500m, on an asset base set to reach €3bn., representing a real rate of return of 4%. One reason the asset base becomes so large is because of the inclusion of the airport’s future capital spending. If the other parameters do not change, but the price cap remains at €9.65, then multiplying the additional charges of €2.15 by the forecast traffic numbers would add a further €380m to daa profits over the next five years. In its next regulatory submission to the CAR, the daa may offer good reasons for a higher price cap. But a justification for such a higher level of profits has not been disclosed to date.
Summary: The CAR proposed price cap of €7.75 includes the planned daa investment of €1.8 bn as well as earning a profit over the five year period of €500m representing a real rate of return of 4% per annum. The reduction in price cap to €7.75 per passenger for the next five years is a function of increased passenger traffic while fully providing for the planned daa investment. Any higher price cap would directly increase daa profits at the expense of the travelling public. The airport regulatory regime is doing what it is designed to do in the context of a monopoly.