NO.032

Productivity Commission Report – Review of Price Regulation of Airport Services

The Treasurer and the Deputy Prime Minister and Minister for Transport and Regional Services today announced the Australian Government’s response to the Productivity Commission inquiry report entitled Review of Price Regulation of Airport Services, released on Friday.

The Government has decided to continue the current approach to regulation of aeronautical prices at the major airports and has accepted the Commission’s recommendation that Sydney, Melbourne, Brisbane, Perth and Adelaide airports continue to be subject to price monitoring for a further six years. Canberra and Darwin Airports will not be subject to the formal price monitoring arrangements to take effect from 1July 2007, however, the Government will continue to keep an eye on developments at all of its leased airports and, if any concerns arise, will consider whether further investigation is required.

Mr Vaile said, “The Government’s response to the Commission’s recommendations has taken into account the interests of airports, airport users and the travelling public.”

“Importantly the Commission has found that the light handed pricing regulatory approach has had positive outcomes including making it easier to undertake the infrastructure investment needed to enable airport services to meet the growth in demand for air travel in Australia. However, the Commission did find there is a need to give greater clarity in the Government’s pricing principles to guide the commercial negotiations”, Mr Vaile said.

He noted that the Government’s revised Aeronautical Pricing Principles (see response to the Commission’s recommendation 4.4 below) underpinning the new pricing oversight regime at the five monitored airports would provide better guidance on expected pricing negotiation outcomes and should also serve as a guide for pricing of aeronautical services at the non-monitored capital city and larger regional airports.

Mr Costello noted that the new regime allows for airports and their customers to further develop commercial relationships while ensuring that regulatory oversight of airports with significant market power continues. “The regime encourages parties to work together to secure access to airport services without harming incentives for investment, innovation and productivity improvement,” Mr Costello said.

The key Government initiatives to improve the regime and facilitate effective commercial negotiations include:

• amending Part IIIA of the Trade Practices Act 1974 (the Act) to address uncertainty regarding its interpretation following the October 2006 Federal Court decision in relation to Sydney Airport;
• establishing a starting aeronautical asset base for monitoring airport pricing behaviour;
• setting clear expectations for effective commercial negotiations, including commercial resolution of disputes through processes such as independent commercial mediation/binding arbitration;
• slightly expanding the scope of the definition of aeronautical services to cover all aeronautical services for which airports are likely to have significant market power; and
• introducing a “show cause” process whereby price monitored airports may be required to demonstrate why their conduct should not be subject to more detailed scrutiny such as a formal price inquiry under the Act.

The Ministers said that an independent review will be carried out in 2012, or earlier if there is clear evidence of unjustifiable price increases or other misuse of market power across the price monitored airports. The Government reserves the right to re-impose price controls if airport operators are found to be misusing their market power by unjustifiably raising prices and/or imposing non-price conditions on access to aeronautical services and facilities in a manner inconsistent with the Government’s Aeronautical Pricing Principles.

Mr Vaile said that “The Government will also be asking the Australian Competition and Consumer Commission to monitor car parking prices at the major airports separately from the aeronautical price monitoring regime, given it is an area of ongoing public interest.”

Mr Vaile noted that the new price monitoring arrangements do not change the current price controls protecting NSW regional airlines operating to and from Sydney Airport.

The Ministers thanked the Productivity Commission and all those who provided submissions, presentations and other assistance to the review. The Government’s response to the Productivity Commission’s recommendations is available at the DOTARS (http://www.dotars.gov.au) and Treasury (http://www.treasurer.gov.au) websites.

CANBERRA

30 April 2007

Contact:

Renae Stoikos	Treasurer’s Office	02 6277 7340
Tim Langmead	Deputy Prime Minister’s Office	02 6277 7680

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GOVERNMENT RESPONSE TO THE PRODUCTIVITY COMMISSION INQUIRY REPORT – REVIEW OF PRICE REGULATION OF AIRPORT SERVICES

Introduction

The Australian Government (‘the Government’) is committed to fostering a competitive aviation industry and ensuring the needs of the travelling public are met by implementing a regime for the price regulation of airport services that enables airport operators to achieve a fair return and provides incentives for operators and their customers to invest in and use airport infrastructure efficiently. Consistent with its overall policy aims, the Government moved to a light-handed price monitoring approach in July 2002 following consideration of the recommendations of a Productivity Commission (‘the Commission’) inquiry in early 2002.

The move to a light-handed approach was intended to facilitate investment and innovation by airports – while retaining a constraint on misuse of market power in their dealings with airlines and other customers. By providing greater opportunities for the parties to negotiate and build commercial relationships, the ultimate objective was that the provision of aeronautical services would be determined through commercial negotiations.

The Government decided at that time that there would be an independent review towards the end of the five-year period of price monitoring to ascertain the need for future airport price regulation. The Commission undertook this review in 2006.

The Commission concluded in the final report of its Review of Price Regulation of Airport Services (‘the Review’) that five years of price monitoring, as part of a light handed regulatory approach, has delivered some important benefits, namely:

i. it has been easier to undertake the investment necessary to sustain and enhance airport services in the face of growing demand for air travel;

ii. the airports’ productivity performance has been high by international standards;

iii. service quality of airport services provided to aeronautical customers has been satisfactory to good;

iv. for the larger monitored airports in particular, compliance costs have been quite modest; and

v. at most of the monitored airports, commercial relationships between the parties have been developing – though some particular issues have impeded progress in this area.

While the light-handed approach has delivered some significant benefits, and price levels do not appear to be excessive, the review also found that:

i. some of the market constraints on airports’ behaviour (e.g. the countervailing power of airlines) have not been as strong as was initially envisaged;

ii. some non-price terms and conditions outcomes (which cover matters such as the allocation of gate and aircraft parking positions, and the right of an airport to vary its conditions of use) have been less satisfactory than price outcomes;

iii. commercial relationships between certain airports and their customers have been strained; and

iv. some ‘systemic’ shortcomings have detracted from the effectiveness of price monitoring and the light-handed approach as a whole, and in particular:

• lack of policy guidance on how assets should be valued for pricing purposes;
• no clarity on when further investigation of an airport’s conduct is required; and
• no process for initiating such investigation of an airport’s conduct.

The Commission’s final report concluded that these systemic shortcomings can be addressed without sacrificing the benefits of a light-handed approach and that a further period of price monitoring would be preferable to a reversion to stricter price controls (such as the price capping regime that applied from 1997 until June 2002), with all of its attendant costs.

Within this context, and consistent with the Government’s obligation to table the Commission’s final report of its Review in each House of Federal Parliament pursuant to s.12 of the Productivity Commission Act 1998, following is the Government’s response to each of the Commission’s recommendations.

Recommendation 3.1: To ensure that the operation of the Part IIIA national access regime leaves open the option of using price monitoring and other light-handed approaches for regulating major infrastructure provision (including at airports), the Government should consider amending Part IIIA to restore the prevailing interpretation of s 44H(4)(a) prior to the Federal Court decision upholding the declaration of the domestic airside service at Sydney Airport.

Response: The Government supports this recommendation.

The Government intends to amend subsection 44H(4)(a) of the Trade Practices Act 1974 to reinstate its interpretation to that which prevailed prior to the decision of the Full Court of the Federal Court in Sydney Airport Corporation Limited v Australian Competition Tribunal [2006] FCAFC 146. We consider that this amendment will address uncertainty that has arisen following the Federal Court’s decision and is consistent with the objective of Part IIIA, which is to promote efficient investment in, and use of, major infrastructure.

Recommendation 3.2: There should be a further period of price monitoring at Australia’s major airports (see Recommendation 5.5) when the current arrangements end in June 2007. However, if it becomes apparent that Part IIIA has become the operative regulatory instrument governing charges and terms and conditions at major airports, and no corrective action is considered appropriate before the scheduled review of Part IIIA in 2011, then price monitoring should be discontinued. In that event, the possible reintroduction of monitoring should be considered in the light of the outcomes of the review of Part IIIA.

Response: The Government supports a further six-year period of price monitoring at Australia’s major airports when the current arrangements end in June 2007.

The Government considers that the new regime, which will include a number of amendments designed to improve the current regulatory framework, will continue regulatory oversight of those airports with significant market power while providing an environment that enables commercial relationships between the major airports and their customers to be further developed and maintains incentives for facilitating investment, innovation and productivity improvement.

The key initiatives that the Government will implement to address some systemic deficiencies in the current price monitoring arrangements include:

(i) emphasising the importance of commercial negotiation and articulating pricing principles which more clearly establish the Government’s expectations regarding effective commercial negotiations and reasonable access outcomes (see response to Recommendation 4.4);

(ii) applying a credible threat of re-regulation incorporating a ‘show cause’ mechanism that may lead to more detailed scrutiny such as a pricing inquiry under Part VIIA of the Trade Practices Act 1974 or another appropriate investigative mechanism (see response to Recommendation 4.1);

(iii) setting a starting aeronautical asset base at each of the monitored airports (see Recommendations 4.2 and 4.3); and

(iv) applying a clearer and more robust definition of aeronautical services and facilities (see response to Recommendation 5.2).

The Government also intends to amend subsection 44H(4)(a) in Part IIIA of the Trade Practices Act 1974 (see response to Recommendation 3.1).

An independent review of the regulatory regime will be undertaken in 2012 to ascertain the need for future airport price regulation. However, the Government reserves the right to bring forward the review if there is persuasive and clear evidence of unjustifiable price increases (see response to recommendation 5.5). The Government has also introduced a ‘show cause’ mechanism that allows it to impose greater scrutiny of an individual airport if it considers the airport has unjustifiably increased its prices – which may, after consideration of the issues involved, lead to the imposition of more heavy-handed regulation (see response to Recommendation 4.1).

Recommendation 4.1: Under the new price monitoring regime, the Minister for Transport and Regional Services, having regard to monitoring reports and other relevant information, should each year be required to publicly indicate either that:

• no further scrutiny of the conduct of the monitored airports is necessary; or
• that one or more airports will be asked to ‘show cause’ why their conduct should not be subject to more detailed scrutiny through a Part VIIA price inquiry, or other appropriate investigative mechanism.

Response: The Government supports this recommendation.

Following the release of the Australian Competition and Consumer Commission’s (‘ACCC’) annual report on price and service quality outcomes (see Recommendation 5.4), but also having regard to other relevant information, the Minister, following consultation with the Treasurer, will issue a statement indicating whether the Government will be asking any of the monitored airports to ‘show cause’ as to why their conduct should not be subject to more detailed scrutiny.

On receipt of the ‘show cause’ response(s), the Government would then determine whether more detailed scrutiny is required. Such scrutiny may be in the form of a formal price inquiry under Part VIIA of the Trade Practices Act 1974, or another appropriate investigative mechanism. In coming to a view on whether more detailed scrutiny is required the Government will have regard to, amongst other things:

• the extent to which the airport(s) and where appropriate its customers have acted in a manner consistent with the Government’s Aeronautical Pricing Principles; and
• whether the airport operator company(ies) has fully complied with the provisions of Parts 7 and 8 of both the Airports Act 1996 and the Airports Regulations 1997, and with the new Direction made pursuant to s. 27A of the Trade Practices Act 1974 for price monitoring purposes.

The ‘show cause’ mechanism is intended to provide clarity as to when the Government considers further scrutiny of an airport’s conduct is necessary and, in doing so, ensures that the threat of re-regulation is both measured and credible.

Recommendation 4.2: Under the new price monitoring regime, the value of an airport’s asset base for monitoring purposes should be:

• The value of tangible (non-current) aeronautical assets reported to the Australian Competition and Consumer Commission as at 30 June 2005, adjusted as necessary to reflect the proposed service coverage of the new regime (recommendation 5.2);
• plus new investment;
• less depreciation and disposals.

Response: The Government supports this recommendation.

The Government recognises that the valuation of some airports’ asset bases for the purpose of negotiating aeronautical charges has acted as a significant impediment to developing sound commercial relationships between these airport operators and their customers.

The Government will ask the ACCC to determine an aeronautical asset base value as at 30 June 2005 at each of the monitored airports. The values determined by the ACCC will be used to assist with monitoring trends in rates of return – thereby better informing the Government on whether pricing outcomes going forward reflect the Government’s expectations regarding aeronautical pricing. The Government will ask the ACCC to have regard to the sensitivities associated with adopting this ‘line in the sand’ approach when annually reporting on price outcomes.

The Government will also ask the ACCC to provide guidance to the monitored airports on a range of related asset valuation issues that were raised in submissions to the inquiry and/or at the inquiry’s public hearings, some of which are global in nature and some specific to individual airports.

Recommendation 4.3: In giving effect to this basis for valuation, the Australian Competition and Consumer Commission should consult with airports and airlines on how best to accommodate differences in statutory and regulatory reporting requirements within the new price monitoring regime.

Response: The Government supports this recommendation which will be implemented as described in the response to Recommendation 4.2 above.

Recommendation 4.4: Assessments of airport behaviour during the next period of price monitoring should be governed by an overarching set of principles. All of the current ‘Review Principles’ should be retained. In addition, there should be three new principles specifying that:

• further asset revaluations should not generally provide a basis for higher charges for monitored aeronautical services;
• the parties should negotiate in ‘good faith’ to achieve outcomes consistent with the principles, including through the negotiation of processes for resolving disputes in a commercial manner; and
• there should be a reasonable sharing of risks and returns between airports and their customers (including those relating to productivity improvements and changes in passenger traffic).

Response: The Government supports this recommendation although the wording of some of the current ‘Review Principles’ and in the Commission’s recommended new principles will be refined to provide greater clarity and to better integrate their meaning and application, given recent developments within the industry and the establishment of PartIIIA pricing principles for infrastructure of national significance.

The Government’s updated Aeronautical Pricing Principles provided below, which build on the Part IIIA pricing principles, specify the Government’s expectations on the pricing behaviour and outcomes that should apply to aeronautical services and facilities that are subject to significant market power.

For example, principle c) reflects the Government’s strong view that effective commercial negotiations are the foundation of a light-handed approach to pricing regulation (consistent with the responses to Recommendations 3.2 and 4.1). It also reflects the Government’s view that a ‘take it or leave it’ approach (eg. varying existing prices and/or terms and conditions of access without prior agreement) is inconsistent with commercial negotiations undertaken in good faith between an airport operator and its customers.

The Government will give regard to these Pricing Principles when assessing the behaviour of the monitored airports. A persistent failure to produce results consistent with these Principles could lead to more detailed scrutiny of an airport(s) under the ‘show cause’ mechanism (see the response to Recommendation 4.1) and potentially the imposition of more heavy-handed regulation.

The Government also considers that these Pricing Principles should act as a guide for the conduct of all airports, whether price monitored or not.

Aeronautical Pricing Principles

The pricing principles relating to prices for aeronautical services and facilities (as defined in Part 7 of the Airports Regulations 1997) provided by airports are:

a) that prices should:

(i) be set so as to generate expected revenue for a service or services that is at least sufficient to meet the efficient costs¹ of providing the service or services; and

(ii) include a return on investment in tangible (non-current) aeronautical assets, commensurate with the regulatory and commercial risks involved and in accordance with these Pricing Principles;

b) that pricing regimes should provide incentives to reduce costs or otherwise improve productivity;

c) that prices (including service level specifications and any associated terms and conditions of access to aeronautical services) should:

(i) be established through commercial negotiations undertaken in good faith, with open and transparent information exchange between the airports and their customers and utilising processes for resolving disputes in a commercial manner (for example, independent commercial mediation/binding arbitration); and

(ii) reflect a reasonable sharing of risks and returns, as agreed between airports and their customers (including risks and returns relating to changes in passenger traffic or productivity improvements resulting in over or under recovery of agreed allowable aeronautical revenue);

d) that price structures should:

(i) allow multi-part pricing and price discrimination when it aids efficiency (including the efficient development of aeronautical services); and

(ii) notwithstanding the cross-ownership restrictions in the Airports Act 1996, not allow a vertically integrated service provider to set terms and conditions that discriminate in favour of its downstream operations, except to the extent that the cost of providing access to other operators is higher;

e) that service-level outcomes for aeronautical services provided by the airport operators should be consistent with users’ reasonable expectations;

f) that aeronautical asset revaluations by airports should not generally provide a basis for higher aeronautical prices, unless customers agree; and

g) that at airports with significant capacity constraints, peak period pricing is allowed where necessary to efficiently manage demand and promote efficient investment in and use of airport infrastructure, consistent with all of the above Principles.

Recommendation 4.5: Neither an airport-specific arbitration regime, nor mandatory information disclosure requirements for airports, should be introduced at this time.

Response: The Government supports this recommendation.

The Government expects the price monitored airports and their customers to operate in a commercial manner consistent with the Aeronautical Pricing Principles. This includes utilising commercial processes, such as independent commercial mediation/binding arbitration, for resolving disputes.

The Government notes that some stakeholders argued strongly to the Commission for an airport-specific arbitration mechanism, but agrees with the Commission’s conclusion that such a mechanism would undermine incentives for parties to commercially negotiate outcomes and could effectively become the default option for airport customers. The Government also agrees with the Commission’s conclusion that mandatory information disclosure is not warranted at this time as it expects open and transparent information exchange in commercial negotiations.

Recommendation 5.1: The new price monitoring regime should apply to Adelaide, Brisbane, Melbourne, Perth and Sydney Airports. Darwin and Canberra Airports should not be subject to monitoring once the current arrangements end.

Response: The Government supports this recommendation.

The Government accepts the Commission’s assessment of market power at those airports subject to price monitoring under the current regime.

From 1 July 2007, the new price monitoring regime will apply to Adelaide, Brisbane, Melbourne, Perth and Sydney airports. The new regime will not apply to Canberra and Darwin airports, and these airports will also not be required to report financial and quality of service information under Parts 7 and 8 of the Airports Act 1996. However, Canberra and Darwin airports will remain subject to the general provisions of the TradePractices Act 1974 (TPA), as do all incorporated airports in Australia.

The Government expects that all airports and their customers will develop and mature commercial relationships in a manner consistent with the operation of well-functioning markets. The Government also considers that expectations regarding pricing conduct encapsulated in the Aeronautical Pricing Principles should be a guide for all airports, whether price monitored or not.

The Government will keep abreast of pricing practices at the larger regional and general aviation airports and, if any concerns arise, will consider whether further investigation is required.

Recommendation 5.2: Price monitoring should apply to all of those services for which airports have significant market power. Consistent with this, the service coverage of the new monitoring regime should be that specified in the current proposal from the Department of Transport and Regional Services to align the

relevant parts of the Airports Act and the directions pursuant to the Trade Practices Act giving effect to airport price monitoring, subject to the exclusion of:

• office space used by airline staff; and
• telecommunications infrastructure.

Also, the definition of terminal space and related facilities in the Departmental proposal should be clarified to explicitly exclude dedicated terminal space, under long-term lease to airlines.

Response: The Government supports this recommendation with one exception.

The new definition will cover those aeronautical services and facilities recommended by the Commission, but will be amended to also include “space and facilities (whether in terminals or airside) essential to efficient airline operations” – see (b)(x) of the ‘Definition of Aeronautical Services and Facilities’ on the next page.

The Government considers that airports have significant market power over the provision of this category of service which is essential for the handling of arriving and departing aircraft, and should therefore be covered under the new price monitoring regime. The Government expects that the monitored airports and their customers will reach agreement on which spaces and facilities are included in this category.

To ensure that the new Definition of Aeronautical Services and Facilities appropriately addresses issues of significant market power and efficient aeronautical operations during the monitoring period, the Government will monitor developments regarding the nature of aeronautical services and consider whether further amendment of the Definition is necessary.

The Government will align the definition of aeronautical services and facilities in the Airports Act 1996 and in the new direction issued pursuant to Part VIIA of the Trade Practices Act 1974 that will give effect to the new price monitoring regime.

Definition of Aeronautical Services and Facilities
Preamble2 Aeronautical services and facilities are services and facilities provided at airports for the purposes of operating and/or maintaining civil aviation services at the airport including, but not limited to, the items listed below. As the nature of services change, it may be necessary to amend the list of specified items. Aeronautical costs and revenues are costs and revenues resulting from the provision and use of aeronautical services and facilities and which are recovered by airport operators either directly or indirectly (eg. through third party suppliers, such as fuel throughput levies) from airlines.
Sub-heading (a) Aircraft-related services and facilities, including the provision, maintenance and repair of:		Sub-heading (b) Passenger-related services and facilities3, including the provision, maintenance and repair of:
(a)(i) runways, taxiways, aprons, airside roads and airside grounds		(b)(i) ) public areas in terminals, public amenities, lifts, escalators and moving walkways
(a)(ii) airfield and airside lighting		(b)(ii) departure and holding lounges, and related facilities (excluding club/business lounges)
(a)(iii) aircraft parking sites and facilities		(b)(iii) aerobridges (including nose-in guidance systems) and airside buses
(a)(iv) ground handling services and facilities (including equipment storage and refuelling)		(b)(iv) flight information and public-address systems
(a)(v) aircraft refuelling services and facilities (including pipelines to and from the JUHI)		(b)(v) facilities to enable the processing of passengers through customs, immigration and quarantine
(a)(vi) airside freight handling and long/short term staging areas essential for aircraft loading and unloading		(b)(vi) check-in counters and related facilities (including associated queuing areas)
(a)(vii) airfield navigation services and facilities (including visual navigation aids)		(b)(vii) landside terminal access roads and facilities (including lighting and covered walkways)
(a)( viii) airside safety and security services and facilities (including rescue and fire-fighting services and perimeter fencing)		(b)(viii) security systems and services (including closed circuit surveillance systems)
(a)(ix) environmental hazard control services and facilities		(b)(ix) baggage make-up, handling and reclaim facilities
(a)(x) services and facilities to ensure compliance with environmental laws		(b)(x) space and facilities, in terminals or airside, essential to efficient airline operations for the handling of arriving and departing aircraft (eg. airline crew-rooms and airline operations centres)
(a)(xi) aircraft light and emergency maintenance sites and buildings

Recommendation 5.3: In examining opportunities to improve and streamline quality monitoring, the Australian Competition and Consumer Commission should give particular attention to:

• whether it remains necessary to report survey responses from the Australian Customs Service;
• how best to eliminate overlap between the airline and passenger satisfaction surveys, and between these surveys and other quantitative indicators; and
• whether greater emphasis should be placed on comparative passenger satisfaction results contained in authoritative international benchmarking exercises.

Response: The Government supports this recommendation.

The Government accepts the Commission’s finding that the risk of significant misuse of market power by airports to degrade service quality is low. Consistent with the Government’s commitment to reduce the regulatory burden on business, wherever practicable, quality of service reporting under the new price monitoring regime will be streamlined and designed to provide more meaningful information that takes into account the practicalities, complexities and evolving nature of service delivery. In developing and implementing the quality of service reporting framework, regard will be given to the issues identified in this recommendation.

Recommendation 5.4: Under the new price monitoring regime, price and service quality outcomes should be presented in a single report, published annually.

Response: The Government supports this recommendation.

Under the new price monitoring regime, price and quality of service outcomes will be published annually in a single report. The Government considers that publishing price and service quality outcomes in a single report will enable better analysis of the link between quality of service and the pricing and investment cycles.

Recommendation 5.5: Unless ‘supplanted’ at an earlier date by Part IIIA (see recommendation 3.2), the new price monitoring regime should operate for six years ending on 30 June 2013. The new regime should be reviewed in 2012, with that review having regard to the outcomes of the scheduled 2011 review of the national access regime.

Response: The Government supports this recommendation.

The price monitoring regime will operate for six years from 1 July 2007, ending on 30 June 2013. The Government considers this will provide sufficient time to assess the behaviour of the monitored airports and their customers under a regime which encourages the development of commercial relationships and maintains incentives for facilitating investment, innovation and productivity improvement.

A major independent review of the light-handed regulatory regime will be undertaken during 2012. The review will assess the effectiveness of the regime and ascertain the need for future airport price regulation, including advising on any changes to the regulatory regime. However, the Government reserves the right to undertake such a review earlier if there is persuasive and clear evidence of unjustifiable price increases, or other misuse of market power, at the price monitored airports.

¹ For the purpose of determining aeronautical prices through commercial negotiations, these should be long-run costs unless another basis is acceptable to the airports and their customers.

² The Definition of Aeronautical Services and Facilities is intended to include all services and facilities at airports that are necessary for efficient civil aviation operations at the airport. Commercial arrangements for the purpose of providing a ‘premium’ service to a particular subset of airline customers, and commercial property transactions that are unnecessary for efficient aeronautical operations, are excluded.

³ Excludes those original Domestic Terminal Leases that remain on-foot.