Our Ref.: Let.2103 2 September 2015 Paul Logan Acting Chief Financial Officer Airservices Australia PO Box 367 Canberra ACT 2600 Dear Paul, Airservices Australia s Pricing Proposal 2016-21 The Board of Airline Representatives of Australia (BARA) has reviewed Airservices Australia s (Airservices) Pricing Proposal 2016 2021 (2016 Pricing Proposal). BARA supports Airservices first seeking input from interested parties before lodging its proposal with the Australian Competition and Consumer Commission (ACCC) for assessment. In this letter BARA outlines the amendments it is seeking to the 2016 Pricing Proposal to make it more amenable to support from its member airlines. It also describes the additional information Airservices needs to provide so that BARA, other interested parties, and ultimately the ACCC, can properly assess Airservices proposals. BARA is open to working with Airservices to develop the necessary amendments and information before it lodges the proposal with the ACCC. Summary of BARA s position BARA is seeking a pricing and service delivery agreement with Airservices that would achieve the following key outcomes: 1. greater accountability over the delivery of services for the prices paid by international airlines 2. justification of efficient operating and capital costs 3. a long-term solution to pricing services at regional locations. Consistent with these desired outcomes, BARA s Vision and outcomes for international aviation in Australia, published in September 2013, set the broad expectations of its member airlines over the ongoing provision of safe and efficient air navigation services. They included demonstrated value and efficient and customer-driven investment decisions. BARA has also published commercial principles for Australian airports in its policy paper, Timely and reasonably priced airport infrastructure. The core principle of an outcome-focused agreement, which formed the basis of the recently completed negotiations with Sydney Airport, is equally applicable to Airservices. The 2016 Pricing Proposal effectively represents a roll forward of the long term pricing agreement (LTPA) arrangements implemented back in 2011 (current LTPA). BARA notes how since this time external bodies, including the Commission of Audit, Productivity Commission, Rural and Regional Affairs and Transport Legislation Committee and Harper Review, have raised concerns over the efficiency of Airservices capital investment program, operating efficiency and pricing structures. These issues are not new, and formed part of the ACCC s assessment of Airservices in 2011. As such, BARA had expected the 2016 Pricing Proposal would have contained a framework that directly responded to the issues raised by external bodies. GPO Box 198 Sydney NSW 2001 T (02) 9299 9919 E: barry.abrams@bara.org.au W: bara.org.au
2 While the 2016 Pricing Proposal contains forecast costs, activity volumes and some high-level descriptions of outcomes, there are no binding commitments on Airservices to delivering anticipated improvements in service capabilities to airlines. This is particularly problematic given the proposed expenditures associated with the OneSKY project. Further, it does not provide enough detail for BARA, other stakeholders, or the ACCC, to properly assess the efficiency of Airservices cost base. The arrangements therefore need to evolve, establishing a new basis for promoting the ongoing efficient delivery of services to international airlines. With this in mind, the 2016 Pricing Proposal needs to incorporate the following three initiatives: 1. Establish a clear link between price increases and the delivery of outcomes to airlines. BARA envisages Airservices developing an agreed checklist of tangible and measurable deliverables, especially for the OneSKY project. Annual price increases for en route and terminal navigation (TN) services (with an option of smoothed price paths) should depend on meeting the agreed deliverables. 2. Airservices commission an independent third party to assess its operating and capital efficiency. The independent reviewer and its terms of reference should be mutually agreed by Airservices, the ACCC and major users, and be financed by Airservices. The review should devise a set of improvement initiatives, which can be incorporated into Airservices proposed operating and capital expenditures. There should also be formal reporting against the improvement initiatives. 3. Incorporate all new incremental capital expenditure into the prices charged at the location where the service is provided. This is consistent with promoting dynamic efficiency and would encourage better investment decisions at regional locations. There is still enough time for Airservices to amend its proposal, and incorporate the specific outcomes and information BARA seeks. It would, however, require a substantial commitment on the part of Airservices, especially developing tangible and measurable outcomes. An important shift in the commercial arrangements would mean Airservices assuming greater accountability over the delivery outcomes to airlines. BARA s detailed comments provided below are as follows: BARA s understanding of the issues the 2016 Pricing Proposal needs to address specific outcomes BARA is seeking to achieve, as listed earlier forecast activity volumes. Given the threshold issues to be addressed, in this letter BARA has not commented on the weighted average cost of capital and a number of other issues, but may do so at a later date. What issues does the 2016 Pricing Proposal need to address? The 2016 Pricing Proposal needs to directly respond to the requirements of the ACCC s 2011 assessment and the recommendations of subsequent reviews into Airservices capital efficiency and pricing structures. The specific issues BARA would like to see the 2016 Pricing Proposal address are briefly described below. ACCC 2011 assessment: capital efficiency The ACCC s 2011 assessment set Airservices a number of important requirements for the ongoing development and implementation of its capital investment program. In particular, the ACCC stated that:
[It] considers that there is scope for Airservices to improve its consultation processes to allow stakeholders to provide more informed input on the benefits and costs of specific projects. 1 And: 3 For future LTPAs, the ACCC expects that Airservices will provide a detailed reconciliation of its proposed opening value of assets in the first instance. In particular, the ACCC expects that Airservices will be able to demonstrate how actual capital expenditure (and associated depreciation) compares to that projected in this LTPA. Further, the ACCC notes that the ability of Airservices to demonstrate its actual costs incurred does not provide it with an automatic right to include it in the rolling forward of its asset base for future LTPAs. The ACCC will also need to be satisfied that those costs have been incurred prudently and efficiently. 2 Despite not providing the full reconciliation the ACCC expected, BARA acknowledges Airservices efforts to consult over its capital expenditure, while noting concerns remain over the level of spend on new and replacement fire stations. BARA s main concern relates to the lack of well-defined deliverables associated with the OneSKY project, including when airlines can expect improvements in capabilities. ACCC 2011 assessment: operating efficiency Airservices total costs are dominated by its annual operating expenditures. The ACCC s 2011 assessment also contained specific requirements for Airservices efforts to implement and demonstrate ongoing improvements in its level of operating efficiency: The ACCC has reviewed this information and is satisfied that Airservices has in place a performance management framework for employees, which is supported by a system of financial rewards and accountabilities for performance. In addition, the ACCC is satisfied that Airservices has appropriate budget processes and decision-making processes in place for capital investment decisions. The ACCC considers these to be appropriate formal checks and balances to have in place within the organisation. However, the ACCC notes that it has relied on the advice of Airservices staff in relation to how robustly those formal processes are implemented. The ACCC notes stakeholders concerns regarding their inability to make an assessment of the efficiency of Airservices cost base, and efficiency of operating costs. As noted above, the ACCC has in past decisions considered that Airservices could go further to develop formal incentives for efficiency. These could be in the form of internal benchmarking and explicit efficiency targets. 3 Airservices has not shown it has firmly implemented its performance management framework, which is discussed later in this letter. The 2016 Pricing Proposal also contains little information about Airservices plan to improve its operating efficiency over the term of the new agreement. Recent reviews of Airservices Since 2011, the reviews the Australian Government has commissioned have expressed concerns over the efficiency of Airservices capital expenditure and its pricing structure. These more recent observations suggest the measures Airservices undertook to put in place since 2011 have either not been fully implemented, have not been effective, or both. Both the Commission of Audit and Productivity Commission have expressed reservations over the efficiency of Airservices capital investment. The Commission of Audit: an independent review [should] be undertaken of Airservices Australia with a particular focus on the scope of its activities as well as its planned capital expenditure programme. 4 1 ACCC (2011a), Airservices Australia draft price notification: Preliminary view, July, p vii 2 ACCC (2011b), Airservices Australia Price Notification: Final Decision, September, p. 23 3 ACCC (2011a), p. 22. 4 Commission of Audit (2014), Commission of Audit Final Report Phase 2, p. 95.
And the Productivity Commission: 4 The Australian Government should conduct scoping studies to investigate the efficiency gains and other merits of privatising some or all of the business activities of the Australian Rail Track Corporation and Airservices Australia. The study into Airservices Australia should include a review of the efficiency of its capital expenditure program, as recommended by the National Commission of Audit. 5 It is also appears Airservices has repeatedly not complied with its obligations under the Public Works Act 1969 (Cth) to report its capital expenditure activities to the Joint Parliamentary Committee on Public Works. In its report of March 2015 in relation to the replacement of the fire station at Hamilton Island Airport, the Committee noted: On its own, the project does not exceed the $15 million threshold for referral to the Committee. However, following numerous instances over the last two years of Airservices s non-compliance with the requirements to notify the Committee of medium works (ie works with an estimated cost of between $2 million and $15 million), the Committee sought to have this project referred for full inquiry. 6 BARA also notes that the Rural and Regional Affairs and Transport Legislation Committee has recently raised concerns over procurement issues associated with the OneSKY project. 7 It will be important that these procurement issues are understood and resolved where necessary so that stakeholders have confidence over the robustness of the OneSKY procurement process. In addition to concerns over its capital efficiency, the review into Australia s Competition Policies (Harper Review) examined the issue of Airservices pricing structures, noting the pricing structure for services provided by Airservices Australia should be a focus of further reform efforts in the sector. 8 The Pricing Discussion Paper Airservices issued in March 2015 sought industry comment from interested parties on its pricing structure. The 2016 Pricing Proposal, however, effectively represents a continuation of the current LTPA pricing structures. Greater accountability over the delivery of services for the prices paid by airlines Many of the problems highlighted can be addressed through Airservices taking greater accountability for the delivery of outcomes to airlines over the term of the new agreement. The 2016 Pricing Proposal provides no assurances over the delivery of improved capability and capacity, while airlines may be expected to bear the risk of cost overruns through the capital expenditure provisions. This is particularly problematic given the significance of the OneSKY project in both potential deliverables to airlines and total overall cost (capital and operating). Airservices needs to assume more accountability if it is to establish a level of confidence with stakeholders about delivering the OneSKY project over the next six years. An outcome-focused and commercially balanced set of arrangements with Airservices assuming greater accountability for the delivery of outcomes would involve Airservices: 1. agreeing with the airlines a tangible and measurable set of deliverables associated with the OneSKY and associated projects, including the timing of these deliverables, and 2. being prepared to link the pricing of en route and TN services each financial year to the agreed deliverables (i.e. price increases are permitted based on actual delivery). 5 Productivity Commission (2014), Public Infrastructure, Inquiry Report, July, p 91 6 Joint Parliamentary Committee on Public Works (March 2015), Report on Referrals made December 2014, p.5 7 Rural and Regional Affairs and Transport Legislation Committee (18 August 2015), Performance of Airservices Australia. 8 Competition Policy Review (March 2015), Final Report, p. 206
5 BARA notes that 2016 Pricing Proposal is currently front loaded, with the majority of the price increases occurring on 1 July 2016. To better link price increases with the delivery of outcomes, one option would be for Airservices to determine smoothed price paths for en route and individual TN services (i.e equal price increases each financial year by service). This would also address potential prefunding issues associated with the largest price increases occurring on 1 July 2016. This proposal is consistent with the expectations buyers can reasonably expect from other infrastructure and technology service providers to international airlines. As noted earlier, BARA has sought to negotiate more outcome-focused agreements with Australia s major international airports. If such outcomes can be achieved with the airports under the light-handed economic regulation (such as recently occurred with Sydney Airport), then it should also be possible for Airservices under the ACCC s prices notification processes. BARA would expect that there is a mapping between the outcomes agreed with airlines and the contracts Airservices has with the project providers. That is, the risk of delivery should primarily reside with the project providers themselves. BARA notes Airservices has provided some initial tentative commitments and information towards articulating some deliverable metrics associated with its proposed $600 million OneSKY project as part of the CMATS Industry Working Group. However, airlines do not have a clear understanding of the deliverables, and their timing, under the OneSKY project. As well as providing industry with tangible information about the OneSKY project deliverables, the measurements developed through the CMATS Industry Working Group could also underpin the commercial arrangements between Airservices and the airlines. BARA envisages a checklist of deliverables each financial year. Price increases from 1 July 2016 onwards would depend on Airservices being able to show it had achieved the deliverables set for the previous financial year (noting expenditure on OneSKY is already occurring). Performance measures for international aviation The current Services Charter is promoting ongoing consultation between Airservices and the industry. It is important the charter is flexible enough to allow the measures and outcomes examined to adapt through time to meet changing industry needs. Many of the performance measures now collected relate to efficiency outcomes for domestic aviation, such as flight times and delays between the major airports. BARA would see merit in expanding the measures to monitor the effectiveness of services provided to international aviation. A small working group convened with representatives from Airservices and international airlines could establish these measures. BARA therefore requests that Airservices commit to establishing and measuring some performance indicators for international aviation; these could include average flight times between key overseas airports, and airborne and ground delays for international aircraft. Justification of efficient operating and capital costs It will be important the 2016 Pricing Proposal adequately justifies the efficiency of the existing cost base and that the forecast costs represent Airservices efforts to operate reasonably efficiently. As discussed below, BARA is not convinced Airservices has fully complied with the requirements the ACCC set out back in 2011. BARA proposes Airservices commission an independent third party, mutually agreed between Airservices, the ACCC and major users, to review its operating and capital efficiency. The review should articulate a set of improvement initiatives, which can be incorporated into Airservices proposed
6 operating and capital expenditures. There should also be formal reporting against the improvement initiatives. Opening asset base There are some indicators of efficiency in Airservices capital program to date the Public Works Committee did not seem to find any problems with the new fire station at Hamilton Island Airport, and for the first three years of the current LTPA for which audited accounts are available, actual capital spend is very close to what was forecast. However, BARA does not believe these are enough to demonstrate past capital efficiency; nor does the 2016 Pricing Proposal address the concerns of a range of credible commentators, including the ACCC, discussed earlier. In particular, the 2016 Pricing Proposal does not provide: project-by-project reconciliation against the current LTPA data for the financial year ending 30 June 2015, and an estimate for the year ending 30 June 2016, so that Airservices claimed opening asset base can be tested and reconciled benefits realisation information for each project undertaking during the current LTPA, which Airservices committed to providing to stakeholders 9. Moreover, the out-turn capex costs being close to those forecast, as was the case for the first three years of the current LTPA, does not of itself indicate efficiency it may simply indicate an understanding of inefficient practices that makes outcomes easy to forecast. In BARA s view, Airservices needs to demonstrate what initiatives it has successfully pursued to ensure it has achieved capital efficiency. 2016 Pricing Proposal capital expenditure forecast The Capital Works and Services Improvements Program document on Airservices website is a particularly useful place to start discussing Airservices capital works program. However, it would be helpful for Airservices to indicate what costs are associated with individual projects and outcomes. It is also not clear upon what basis the cost estimates have been made. The information provided to stakeholders should include the basis for establishing contingencies and allowance for risk, and internal and external labour that will be capitalised. In relation to risk and contingencies, BARA would like to understand Airservices methodology for making these estimates. BARA understands the cost of the OneSKY project will be shared with the Department of Defence. It is critical that Airservices advise users how the current estimate costs are to be shared and also what arrangements are in place to deal with sharing costs due to changes in scope and cost overruns. Finally, BARA questions Airservices ability to undertake the amount of investment contemplated in the initial years of the new pricing agreement. It may be prudent to re-distribute some of the proposed investment in 2016-17 and 2017-18 into the financial years 2018-19 to 2020-21. Operating costs BARA is disappointed Airservices has not provided disaggregated data relating to operating costs, particularly as these costs account for over three-quarters of its total allowable revenue. BARA is concerned with deficiencies in the transparency and efficiency of Airservices operating cost base for a range of reasons, including: based on data contained in Airservices Annual Reports, in the first three years of the current LTPA operating costs (excluding depreciation) exceeded forecast by 5.4%, 6.2% and 14.9%, 9 ACCC (2011b) p15
7 respectively. While some of this expenditure may be explained by the new fire stations, the growing actual above forecast raises concerns over Airservices efforts to operate efficiently no information is provided on supplier costs there has been significant public controversy about executive pay Airservices employee numbers have grown more strongly than expected, yet no information is provided about current and future employment in different parts of the business Airservices has not demonstrated that it has effectively implemented the internal efficiency measures the ACCC relied upon in 2011. Airservices current enterprise bargaining agreements (EBAs) see annual nominal wage increases of more than 4%. This compares with the general Commonwealth public service offer of about 1.5% a year. 10 There is a commonly held view, supported by empirical evidence, that where strong unions negotiate with the management of a monopoly who is able to pass cost increases through to consumers, the incentives are weaker for management to ensure real wage growth is underpinned by productivity growth. 11 In justifying the prices contained in the 2016 Pricing Proposal, BARA considers it necessary Airservices demonstrates the: 1. real wage increases contained in its EBAs have/will continue to be funded by productivity improvements, and the policies it has in place to ensure these are achieved, and 2. increases in staff associated with the OneSKY project and its aging workforce are indeed temporary and the minimum necessary to achieve the required outcomes efficiently. BARA is also particularly keen to understand the labour component in the OneSKY project, and the extent to which that labour should be capitalised into the project cost rather than treated as operating expenditures. A long-term solution to the pricing of services at regional locations BARA s views on the appropriate structure of Airservices prices are well known and documented. 12 The existing structure of prices Airservices charges for its services is encouraging an inefficient aviation industry to develop and distorting the competitive playing field both between regional airports and with other modes of transport. BARA s advocacy for location-specific pricing is consistent with promoting the long-run efficient delivery of services by Airservices and use by airlines. BARA is particularly concerned about applying uniform pricing to delivering new services, especially aviation rescue and firefighting (ARFF) services at regional airports Airservices proposed standing policy on assets exacerbates this problem. BARA does not consider that it was the ACCC s intention to apply these pricing arrangements to new services. Rather the arrangements were put in place given concerns about the use of existing assets and services. Stakeholders also have greatly reduced incentives to adequately evaluate the merits of Airservices capital expenditure at regional locations under the current pricing structures. This is because most costs 10 T Abbott (Prime Minister) and N Andrews (Minister for Defence), Joint press conference: Joint Operations Command Centre, Carwoola, transcript, 4 March 2015; Australian Government, Mid-Year Economic and Fiscal Outlook 2014 15, p. 26. 11 Vickers, J. and Yarrow, G. (1989) Privatisation: An economic analysis, pp 108-159 12 See for example, BARA s submissions to Airservices Pricing Discussion Paper and the Harper Review.
8 are ultimately borne by airlines operating at the major international airports. Such an outcome is not consistent with promoting customer-valued investment decisions. BARA s proposal is to incorporate all new capital expenditure into the prices charged at the location they are provided. While this outcome does not represent location-specific pricing (LSP), it would at least create some incentive for the users of services at regional locations to take a more active interest in the merits of the expenditures Airservices proposes. Forecast activity volumes It is difficult for BARA to make a serious contribution to Airservices proposed traffic volumes given the lack of detail about how the forecasts have been derived. In addition, the forecast for 2015 16 is equally relevant as it forms the basis for forecast traffic levels from 1 July 2016. Airservices appears to have adjusted down the International Air Transport Association s (IATA) en route growth forecasts but not TN and ARFF. This suggests Airservices has made a downward revision to the average distance flown by aircraft compared with IATA s assumed distances. BARA would need to first understand the adjustments Airservices has made before being in a position to comment on whether they are reasonable compared with IATA s assumptions. It is also unclear as to what base level of activity these forecast growth rates are being applied to set prices. BARA would assume the 2014 15 financial year can now be updated with actual outcomes instead of relying on the forecasts developed when the analysis was first done. It would be useful for Airservices to prepare tables that show how the level of traffic volumes were derived each year by both it and IATA for the different traffic types (domestic, international and regional), including: passengers numbers load factors total flights (en route) and landings (TN and ARFF) average aircraft weight average distance flown (en route). With this information BARA would be able to provide a considered view of the activity forecasts. Such information was provided to airlines as part of Airservices 2004 pricing submission. Proceeding with the commercial arrangements BARA appreciates the opportunity to comment on Airservices 2016 Pricing Proposal. BARA is keen to work with Airservices to ensure that, as much as possible, it will be in a position to support Airservices application to the ACCC. BARA is available to meet with representatives from Airservices to discuss the issues and initiatives raised in this letter. Yours sincerely, Barry Abrams Executive Director