sample essay of MGX5440 (3)

this is the second assignment of MGX 5440

Abstract

Historically, airports around the world were owned and operated by governments. Since the mid-1980s, however, significant changes have occurred in the way airports are owned, managed, and operated. In the report, it first states the five types of airport privatisation. Then it states the cases from UK, Canada and Colombia to demonstrate these types of privatisation in details. After that, two previous studies conducted by different researchers are shown. They find that the benefits of privatisation are not as clear as some documents stated. Finally, the conclusion is the governments should think thoroughly before they decide to involve the private sector in the provision of public infrastructure and related services.

Introduction

Currently, for some reasons, the governments would like involving the private sector in the provision of public infrastructure and related services. According to Northern Territory Treasury (2010), the greatest attraction in privatisation is the impetus it gives to the pursuit of dynamic efficiencies. Dynamic efficiency involves the degree to which the minimum level of inputs is being used to produce a given level of a particular output. This requires the assets or business in question being put in the hands of owners with enough of a stake to benefit from improved performance and with the power to achieve results. Privatisation also has the attraction that it can basically eliminate the administrative and monitoring burdens on the government of having to oversight the risks and returns of the businesses in question. The government can then concentrate on activities more suited or appropriate to government ownership. A final benefit of privatisation is the budgetary gains possible from any privatisation, and the associated additional financial flexibility that results. Such gains depend upon whether investors are prepared to pay a premium for the control of the government business. In this report, it will describe privatisation in a specific industry-airport. First, it will show the types of airport privatisation. Then it will describe the airport privatisation in UK, Canada and Colombia in details. After that, some previous studies' results will be analysed. At the end of this report, a conclusion will be given.

Types of airport privatisation

 According to Dr Anne Graham (2010), there are five types of privatization.

1.      Share flotation or IPOs

Shares sold on stock exchange and all risks passed to shareholders. Airport needs to perform well to be sold in this way. Management maintains controls as small/ passive investors.

Examples: BAA, Vienna, Rome, Auckland, Fraport

2.      Trade Sales

All or some of airport sold to single investors or consortium. It usually brings expertise as well as finance.

Examples: Australia, UK regional airports, Brussels, Dusseldorf

3.      Concession

Private company/ consortium has concession to operate all or some assets for fixed period (usually 20-30 years). At end of concession in theory airport is handed back to government. Annual fee is usually paid to government and there may be a guaranteed level of investment or service quality. It is favoured by many governments as they keep ownership of the airport.

Examples: Columbia, Bolivia, Argentina, Mexico, Luton, Peru, Delhi, Mumbai

4.      Project Finance/BOT

It is used when a new airport or new facilities are needed. Operator finances, builds and operates new facility then in theory hand back to government. There may be a special type of concession agreement with the operator paying an annual fee to the government.

Examples: Athens, Istanbul, Hyderabad, Bangalore, Antalya, Amman, Cyprus.

5.      Management Contract

It has more limited privatisation as government maintains ownership, makes strategic decisions, sets aeronautical charges etc. Operator runs airport (or part of airport) on a day-to-day basis usually for 5-10 years. Government pays a contract fee (or operator pays government some revenues). It is often used in areas of high risk or where other privatisation models are not possible.

Examples: total contract- Indianapolis. Retail contract- Boston, Pittsburgh, Baltimore

UK

BAA (British Airport Authority) was privatised under the Airports Act 1986 and is the largest UK airports manager, operating seven airports in England and Scotland. In addition to the London airports of Hethrow, Gatwick, and Stansted, BAA owns airports at Glasgow, Edinburgh, Aberdeen and Southampton. Although there are 41 airports in the UK handling passengers and/ or cargo and levying airport charges, the market is highly regionalised. In particular, BAA's London airports have almost a localised monopoly in the economically important south-east of City and Southend. Luton has developed its business in recent years but still remains largely concerned with chartered flights for holiday makers. Most airlines and passengers, and especially those in the lucrative business market, prefer to use Heathrow. In total, BAA accounts for 72 per cent of UK air passenger traffic and 82 per cent of cargo shipped by air (Parker, 1996).

At the time of privatisation, all of BAA's issued share capital was sold by the government, except for a retained special ("golden") preference share, which still exists. The state corporation was privatised without restructuring on the grounds that a unified company would have the financial resources to fund future investment needs. In addition, there appears to have been recognition that the hiving-off of either or both of Gatwich or Stansted to another company would not necessarily produce effective completion for Heathrow. The main impact of privatisation was not, therefore, in the product market, but in the capital market. BAA became subject to pressure from commercial investors and, in particular, was no longer completely sheltered from the threat of takeover by another company that indentified possible efficiency gains. At the same time, the continued existence of the government's golden share in BAA may have reduced the takeover threat (the special share held by government can block takeover bids. The government chose not to invoke its powers in the case of the Ford purchase of Jaguar, but did so in the case of a more recent bid in the electricity industry. The government's attitude to a takeover bid for BAA remains unclear) (Parker, 1996).  

Before privatisation BAA was regulated directly by government in conjunction with the CAA (Civil Aviation Authority) in a manner that was implicitly cost-plus. The cost of airport operation was forecast, and to this was added a target minimum rate of return. This approach to price setting was typical of the economic regulation of UK state enterprises. However, under the regulatory system for designated airports introduced at the time of the Airports Act, charges are controlled through a form of RPI-X price cap. The price cap is of a revenue yield per passenger form applied to runway charges, aircraft parking charges, and the passenger charge, all of which are levied on airlines. The price cap therefore covers around 35 per cent of BAA's total revenues. Commercial activities inkling duty free sales and airport facilities are not governed by the cap; but when setting X account is taken of all revenues under what is called "the single-till principle." This principle derives from international agreements that establish the rule of a reasonable rate of return on airport investment, irrespective of the precise source of the revenues. By linking X explicitly to the rate of return, a cursory appraisal might suggest that the price cap is a form of profit regulation with associated efficiency disincentives. In the case of the UK airports, however, Xis set ex ante, therefore efficiency incentives remain for the airport management to exceed the expected profit. There have been two price reviews since privatisation, in 1991 and 1996 (Parker, 1996).

BAA has been encouraged by the price control on aeronautical charges to seek out revenues elsewhere. Although BAA remains primarily an airport operator in the UK, it does have business overseas and in recent years has expanded its real estate, retail and other commercial ventures (Skapinker, 1996). For example, it is responsible for retail management at Greater Pittsburgh International Airport in the USA, and has undertaken consultancy work in countries such as Malaysia, Macau, and Hong Kong. In 1988 BAA acquired Lynton Property and Reversionary plc to diversify into property development. This proved to be mistimed, given the property slump. In more recent years the company has adopted a strategy of concentrating on its core airport operations, including its retail skills; for example in 1993 it sold the electrical distribution system at its south-east airports to London Electricity. The company now earns over 40 per cent of its revenue from retail activities, mainly at its airports (Parker, 1996).

Canada

Toronto's Lester B. Pearson Airport is a rare case both of joint public-private ownership of facilities on shared premises and of competitive provision of airport infrastructure services. Terminals one and two are owned and operated by Transport Canada, the government transport authority, and terminal three, operating since 1991, is owned by the Terminal Three Limited Partnership (TTLP). Terminal three is operated under a management contract by Lockheed Air Terminal of Canada Inc. (LATC), and it was developed under a build-own-operate-transfer (BOOT) arrangement that includes a sixty-year renewable land lease contract. The development cost for the terminal, which has capacity for 10 million to 12 million passengers, was about Can$570 million. Transport Canada coordinates activities between Lester B. Pearson's privately and publicly owned terminals. It also provides air navigation services, owns all runways and taxiways, and receives all revenues from landing fees, passenger fees, airline fuel taxes, and ticket taxes. LATC controls the landside activities for terminal three, which begin when aircraft switch from general to terminal three tower control. While airside charges for terminals one and two are purely on a cost-recovery basis, terminal three generates revenues through airline rents and charges (aircraft taxiing and parking, and terminal fees), concessions, and parking to cover not only higher operating costs and capital costs but also profits. The market is segmented: the average per passenger airside charges at terminal three are twice as high as those at terminals one and two, and the more prestigious international carriers tend to use terminal three, while lower cost regional or local carriers use the others (Juan, 1996).

Colombia

At the end of 1993, the government of Colombia corporatized its Civil Aviation Authority (CAA), separating airport operations from air navigation activities. At the same time, it undertook the development of a second runway at El Dorado International Airport in Bogotá, using a BOT scheme for construction and maintenance of the new runway and maintenance of the existing runway. In May 1995, the government awarded the BOT concession, stipulating investments of US$97 million, to the consortium of Ogden, Dragados, and Conconcreto. The concessionaire's investment and operating costs, financing expenses, and profits will be covered by the landing fee revenues, which the CAA will cede during the twenty-year concession. Once bidders had fulfilled the technical requirements, bids were evaluated on the basis of the net present value of the minimum landing fee revenue the bidder would require throughout the concession period (landing fees multiplied by estimated traffic volume) and the weighted average landing fee in U.S. dollars. The government has guaranteed a minimum level of revenues (floor pricing), in a rare case of a government's accepting commercial risk. If the landing fee structure or traffic volume, or both, cannot support the required revenue stream, the government would compensate the concessionaire from a trust fund equivalent to 30 percent of the annual landing fee revenue. The El Dorado transaction demonstrates the flexibility of BOT schemes and is becoming a model for private sector participation in developing such airside airport infrastructure as runways, taxiways, and aprons (Juan, 1996).

Privatisation or not

Numbers of studies were conducted by different researchers based on various data. Parker's (1996) study has been concerned with technical efficiency at BAA's airports, and found out no evidence was found that performance improved because of privatisation. And a similar study conducted by Oum, Adler and Yu (2006) shows that 100% public (single government owned) airports are more efficient than the PPP (Public Private Partnership) airports, where a government retains majority ownership and control. Furthermore, airports with majority private ownership (including 100% private ownership) do not achieve significantly higher efficiency than the 100% government-owned airports, such as those in the U.S. their date were collected in 116 airports in several countries. From these two studies, it indicates that privatisation is not as good as it described.

Conclusion

As mentioned above, there are five types of privatisation relation to airport industry- share flotation, trade sale, concession, project finance and management contract. Different airports in different countries used different methods. Then three cases from UK, Canada and Colombia are provided to demonstrate these types of privatisation in details. Although in some documents they state there are some benefits of privatisation, through some previous studies, the benefits of privatisation are not very clear. So, when the governments decide involving the private sector in the provision of public infrastructure and related services, they should consider it thoroughly as the benefits of privatisation are hard to achieve.

 References

Graham, A. (2010) Fundamentals for Airport Privatization and Concession Policies, University of Westminster, London

Juan, E. (1996) Privatising Airports- Options and Case Studies, Public Policy For The Private Sector, The World Bank, Note No. 82

Northern Territory Treasury (2010) Privatisation and Outsourcing, Retrieved 25^th September 2010, from www.nt.gov.au/ntt/financial/9899bps/bp3/ch_8.pdf,

Oum, T. Adler, N. and Yu, C. (2006) Privatization, Corporatization, Ownership Forms and their Effects on the Performance of the World's Major Airports Retrieved 25^th September 2010, from http://linkinghub.elsevier.com/retrieve/pii/S0969699705001006

Parker, D. (1996) The Performance of BAA Before and After Privatisation, Journal of Transport Economics, Volume 33, Part 2, pp133-46

Skapinek, M. (1996) BAA Hopes to Elude Labour Windfall Tax, Financial Times, 12^th November, page 22