List of Abbreviations
4 Airports
4.6 Enlarging a runway
airport that did the overinvesting would experience inferior profitability and would eventually be driven out of business.
Aviation Organisation (ICAO) Code-D aircraft.18 As a consequence, the long-haul passengers have to fly to one of three hub airports located one hour's flight away and connect on to intercontinental flights from there.
An airline approaches the airport with a traffic study suggesting that direct flights to the most popular intercontinental destinations could attract 50 per cent of the 2,000 daily long-haul passenger movements currently connecting through one of the nearby hubs, allowing the airport to convert those pas-senger movements from short-haul to long-haul traffic. For the other 1,000 passengers per day the viable direct flights would not constitute a viable travel alternative. To accommodate the long-haul passenger movements, it will be necessary to enlarge the runway to accommodate Code-D operations. A presentation to the airport executives convinces them of the traffic potential and they decide to conduct an appraisal of the investment to check whether it makes financial sense.
For the long-haul passengers originating or ending their trip at the airport, avoiding the connection at any of the three closest hubs would save three hours from the average intercontinental trip. At an average value of time of EUR15 per hour, saving those three hours would reduce the average behavioural generalised cost per one-way trip from EUR720 to EUR675. This means that in addition to the 1,000 passengers per day diverted from short-haul connecting flights to long-haul direct flights at a generalised cost elasticity of demand of
−1.2, the lower generalised cost could generate a 7.5 per cent increase in traffic, or new trips that would not have taken place without the project.
This generated traffic would account for the main financial gain of the airport. This is because any revenues from the additional charges to the new intercontinental flights would be at the expense of revenues from charges to short-haul connecting flights.19 On the costs side, the airport would have to invest in lengthening and widening the runway, widening some sections of the existing taxiway (no full parallel taxiway is deemed necessary), and modifying the baggage claim area at the terminal. The capital investment cost at the airport site would be EUR90 million. In addition, the longer runway would mean that aircraft operations would exceed noise limits for nearby residents, requiring the installation of double glazing in many houses. This would add another EUR20 million to the cost, bringing the total investment cost of the project to EUR110 million.
Table 4.8 shows the estimation of project returns, focusing only on the long-haul traffic of the airport that would be affected by the project, initially 1,000 passengers per day, or 365,000 passengers per year. The difference in passenger throughput with and without the project (rows 1 and 2) constitutes traffic generated by the project by reducing the generalised cost of travelling long-haul through the airport. This traffic difference also accounts for the difference between operating cash flows with and without the project (row 5), as the unit costs and unit revenues (or passenger yield) of the airport are the same in both scenarios. The resulting financial return for the airport is strongly negative, with a project NPV of a negative EUR89.4 million.
Table 4.8 Financial and economic returns of a runway enlargement project with no change in aeronautical charges PV\Year 1 2 3 4 10 15 20 25 28 FINANCIAL RETURNS Passengers (1) with project (thousand) 365.0 383.3 402.4 452.7 606.7 774.3 988.2 1,261.2 1,460.0 (2) without project (thousand) 365.0 383.3 402.4 422.5 566.2 722.7 922.3 1,177.2 1,362.7 Operating cahflow (3) with project (EUR m) 155.3 5.5 5.7 6.0 6.8 9.1 11.6 14.8 18.9 21.9 (4) without project (EUR m) 146.0 5.5 5.7 6.0 6.3 8.5 10.8 13.8 17.7 20.4 (5) = (3) - (4) net benefit (EUR m) 9.3 0.0 0.0 0.0 0.5 0.6 0.8 1.0 1.3 1.5 (6) Capital investment (EUR m) 81.0 20.0 35.0 35.0 (7) Intern. of external costs (EUR m) 17.7 0.0 10.0 10.0 (8) = (5) - (6)-(7) Operator financial flows (EUR m) -89.4 -20.0 -45.0 -45.0 0.5 0.6 0.8 1.0 1.3 1.5 Operator FRR N/A ECONOMIC RETURNS Time benefits (9) = (4) × time costs to diverted pax (EUR m) 35.4 0.0 0.0 0.0 1.3 2.0 2.9 4.0 5.7 7.0 (10) = 0.5 × ((3) - (4)) × time costs to generated pax (EUR m) 1.3 0.0 0.0 0.0 0.0 0.1 0.1 0.1 0.2 0.2 Lower ticket prices (11) to diverted pax (EUR m) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (12) to generated pax (EUR m) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (13) = (9) + (10) + (11) + (12) Total gain to passengers (EUR m) 36.7 0.0 0.0 0.0 1.4 2.1 3.0 4.2 5.9 7.2 (14) Profit gain to airline (EUR m) 465.6 0.0 0.0 0.0 22.6 30.3 38.7 49.4 63.1 73.0 (15) = (8) + (13) + (14) Economic flows (EUR m) 412.8 -20.0 -45.0 -45.0 24.5 33.0 42.5 54.6 70.2 81.7 Project ERR 23.5%
In addition to airport cash flows, an economic appraisal of the investment would also measure non-monetised benefits to passengers, as well as benefits to the airline(s). At the assumed value of time of EUR15 per hour, project benefits to diverted passengers would have a present value of EUR35.4 mil-lion (row 9). Traffic generated by the project would enjoy a consumer surplus of EUR1.3 million (row 10).
These gains in consumer surplus to passengers assume that the airline at hand would offer the same ticket price for direct and connecting long-haul flights. However, the airline will experience substantial savings by operating direct long-haul flights, as it will be saving the costs of flying passengers to the connecting hub. Conversations between the airline and the airport reveal that the airline expects such savings to amount to about EUR50 per pas-senger. The savings would apply to both diverted and generated traffic and would therefore amount to a very substantial EUR466.6 million (row 14).
This signals that the project generates a lot of value that is not being reflected in the aeronautical revenues of the airport. The project has an economic value of EUR412.8 million and an economic return of 23.5 per cent. Again, it is assumed that all externalities are internalised. In the event that they were not, the economic return of the project would be higher, as the main project benefits consist of airline operating costs savings by reducing the need for connecting flights to the hub, and airline externalities are directly related to airline output.
The appraisal shows that the airport does not have an incentive to carry out the project, whereas the airline has a strong interest in the project. Clearly, the airline will have an incentive to contribute some of the expected savings of EUR50 per passenger in order to incentivise the airport to carry out the project. Therefore, the airport suggests to the airline that in order to achieve the 7.1 per cent regulated rate of return on investment, they would need to introduce an increase in landing charges to Code-D aircraft – those benefiting from the project – of EUR12.8 per passenger, leaving savings in operating costs to airlines at EUR37.2 per passenger instead of EUR50.
The implications for project return are shown in Table 4.9. Whereas the increase in charges for Code-D aircraft reduces the benefit to the airline, the project still yields substantial benefits to the airline, amounting to EUR346.4 million in savings (row 14). This increase in charges is not passed on to pas-sengers and does not change resource use, consisting merely of a transfer from the airline to the airport. Hence, whereas the financial value of the project to the airport is now a positive EUR29.8 million (row 8) and the return on investment is 7.1 per cent, the economic value and economic return remain unchanged after the increase in charges at EUR412.8 million and 23.5 per cent, respectively.
Strictly speaking, such a scenario would apply to a context of a mono-polistic airline market. However, the airline business is competitive and there will be reactions from other airlines. It is not even necessary to assume that other carriers will enter the direct long-haul route, as the market may be too
Table 4.9 Returns on a runway enlargement project with change in aeronautical charges and limited airline competition PV\Year 1 2 3 4 10 15 20 25 28 FINANCIAL RETURNS Passengers (1) with project (thousand) 365.0 383.3 402.4 452.7 606.7 774.3 988.2 1,261.2 1,460.0 (2) without project (thousand) 365.0 383.3 402.4 422.5 566.2 722.7 922.3 1,177.2 1,362.7 Operating cahflow (3) with project (EUR m) 274.5 5.5 5.7 6.0 12.6 16.9 21.5 27.5 35.1 40.6 (4) without project (EUR m) 146.0 5.5 5.7 6.0 6.3 8.5 10.8 13.8 17.7 20.4 (5) = (3)-(4) net benefit (EUR m) 128.5 0.0 0.0 0.0 6.2 8.4 10.7 13.6 17.4 20.1 (6) Capital investment (EUR m) 81.0 20.0 35.0 35.0 (7) Intern. of external costs (EUR m) 17.7 0.0 10.0 10.0 (8) = (5) - (6)-(7) Operator financial flows (EUR m) 29.8 -20.0 -45.0 -45.0 6.2 8.4 10.7 13.6 17.4 20.1 Operator FRR 7.1% ECONOMIC RETURNS Time benefits (9) = (4) × time costs to diverted pax (EUR m) 35.4 0.0 0.0 0.0 1.3 2.0 2.9 4.0 5.7 7.0 (10) = 0.5 × ((3)-(4)) × time costs to generated pax (EUR m) 1.3 0.0 0.0 0.0 0.0 0.1 0.1 0.1 0.2 0.2 Lower ticket prices (11) to diverted pax (EUR m) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (12) to generated pax (EUR m) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (13) = (9) + (10) + (11) + (12) Total gain to passengers (EUR m) 36.7 0.0 0.0 0.0 1.4 2.1 3.0 4.2 5.9 7.2 (14) Profit gain to airline (EUR m) 346.4 0.0 0.0 0.0 16.8 22.6 28.8 36.8 46.9 54.3 (15) = (8) + (13) + (14) Economic flows (EUR m) 412.8 -20.0 -45.0 -45.0 24.5 33.0 42.5 54.6 70.2 81.7 Project ERR 23.5%
thin to make room for more than one long-haul operator from the airport.
But airlines from other competing hubs would lower their prices in order to minimise the loss of business. The airline that approached the airport may also then be forced to lower the price of its air tickets to retain travellers. But the lower time cost to the passenger enabled by the direct service should still make the airline operating the direct service the preferred choice for many passengers. All in all, a plausible final outcome of the project is shown in Table 4.10. The airline passes, say, EUR20 of its EUR50 savings in unit costs to passengers, corresponding to a EUR40 cut on the average return airline ticket price. This generates further traffic, which in turn allows the airport to reduce its required contribution from the airline via higher aircraft charges from EUR12.8 per passenger to EUR12, while keeping its 7.1 per cent regulated return on investment. The airline ends up with a net gain of EUR172.6 million (row 14), down considerably from the EUR364.4 mil-lion that it would have made if the airline industry were not so competitive.
Such competition is good for consumers though. Because of the generated traffic from the fare cut, the overall return of the project has increased slightly from 23.5 per cent to 23.8 per cent.
Under an alternative context of political economy, the airline may try to push for the increase in aeronautical charges necessary to finance the project to be spread across all passengers (and airlines) using the airport, irrespective of whether they benefit from the project or not. The airline may claim that the larger runway benefits the local economy by making the region more accessible to the world at large. Lobbyists from the local hotel sector may buy into this argument and support the airline, and politicians may perceive the project as potentially popular. Moreover, the airport operator, rather than limit itself to increasing its regulatory asset base by just EUR90 million, may take advantage of the political momentum in favour of an investment project and propose an even larger runway expansion project, one suitable for Code- E aircraft, larger than the Code-D needed by the airline, and possibly adding a full-length parallel taxiway. The airline may quietly object to the un-necessary higher cost of upgrading capacity to Code-E rather than the suf-ficient Code-D, but may decide not to antagonise the airport, to profit from the policy momentum, and to accept the higher cost as the price to pay for spreading the charges among all passengers. The final result is that the in-vestment cost will be higher than necessary, the airport operator will make more money by inflating its regulatory asset base (the Averch–Johnson effect, see section 4.6), and the airline will end up paying a slightly higher charge than necessary, although it will not bear the marginal cost of the project, which will be spread across all travellers using the airport. In effect, both the airport and the airline are capturing some of the consumer surplus of all of the passengers using the airport, including those that do not use the long- haul flights prompting the runway extension. As far as society as a whole is concerned, there will be some resource misallocation in the form of a larger runway than would be efficient, as signalled by a fall in the economic return
Table 4.10 Returns on a runway enlargement project with change in aeronautical charges and competitive airline market PV\Year 1 2 3 4 10 15 20 25 28 FINANCIAL RETURNS Passengers (1) with project (thousand) 365.0 383.3 402.4 466.1 624.7 797.2 1,017.5 1,298.6 1,503.3 (2) without project (thousand) 365.0 383.3 402.4 422.5 566.2 722.7 922.3 1,177.2 1,362.7 Operating cahflow (3) with project (EUR m) 274.5 5.5 5.7 6.0 12.6 16.9 21.5 27.5 35.1 40.6 (4) without project (EUR m) 146.0 5.5 5.7 6.0 6.3 8.5 10.8 13.8 17.7 20.4 (5) = (3) - (4) net benefit (EUR m) 128.5 0.0 0.0 0.0 6.2 8.4 10.7 13.6 17.4 20.1 (6) Capital investment (EUR m) 81.0 20.0 35.0 35.0 (7) Intern. of external costs (EUR m) 17.7 0.0 10.0 10.0 (8) = (5) - (6) - (7) Operator financial flows (EUR m) 29.8 -20.0 -45.0 -45.0 6.2 8.4 10.7 13.6 17.4 20.1 Operator FRR 7.1% ECONOMIC RETURNS Time benefits (9) = (4) × time costs to diverted pax (EUR m) 35.4 0.0 0.0 0.0 1.3 2.0 2.9 4.0 5.7 7.0 (10) = 0.5 × ((3)-(4)) × time costs to generated pax (EUR m) 1.8 0.0 0.0 0.0 0.1 0.1 0.1 0.2 0.3 0.4 Lower ticket prices (11) to diverted pax (EUR m) 173.8 0.0 0.0 0.0 8.5 11.3 14.5 18.4 23.5 27.3 (12) to generated pax (EUR m) 9.0 0.0 0.0 0.0 0.4 0.6 0.7 1.0 1.2 1.4 (13) = (9) + (10)+(11) + (12) Total gain to passengers (EUR m) 220.1 0.0 0.0 0.0 10.3 14.0 18.2 23.6 30.7 36.0 (14) Profit gain to airline (EUR m) 172.6 0.0 0.0 0.0 8.4 11.2 14.4 18.3 23.4 27.1 (15) = (8) + (13) + (14) Economic flows (EUR m) 422.4 -20.0 -45.0 -45.0 24.9 33.7 43.2 55.6 71.5 83.2 Project ERR 23.8%
from the project. Such a scenario could only be prevented by effective regulation, including independent oversight of investment plans.