Economic Regulation - IATA

04 - Economic Regulation 31
By contrast, airports in Australia and New Zealand have
attempted to use a more light-handed regulatory system
to artificially increase their asset base in relation to the
higher opportunity cost of the land they hold (see Box 3
for more details).
The resulting overvaluation of the asset base is unjustified,
unfair and inefficient. It merely creates unearned returns
(i.e. windfall gains) for airports, with no link or incentive for
improved efficiency or service quality. In addition, much of
the aeronautical land is either designated for aviation use
or impractical for other uses.
When there is no feasible alternative use, the opportunity
cost valuation has no clear basis.
It terms of calculating the RAB, land should be treated
as a store of value for airports, unlike depreciating assets
such as terminal buildings.
This investment value can be realised if the assets are
sold, but changes in its value do not reflect changes in
airport quality or efficiency. Therefore, the asset base
(and, therefore, user charges) should only be adjusted
where an additional cost is incurred in purchasing new
land to expand or improve services, and this land is in
operational use 13 .
CALCULATING THE ALLOWABLE RETURN
ON THE REGULATED ASSET BASE
A regulator also needs to determine an allowable rate of
return on the regulated asset base of the company. This
total return (i.e. rate of return multiplied by the regulated
asset base) is the “profit” element for the regulated firm,
and is added to operational expenditure to determine the
total allowable revenue for the regulatory period.
The return that is allowed to be earned on a regulated
asset base is typically based on the calculation of a
weighted average cost of capital (WACC). The WACC is
the level of expected return required by financial markets
to provide capital to a firm for a given level of risk. The
calculation of the WACC is often complicated, producing
a range of possible values from which the regulator
makes a determination of the actual value. However, it
is an extremely important part of the regulatory model.
Small changes in the WACC can have a major impact on
the level of the price cap that is set.
The basic calculation for the WACC is:
WACC =
(Share of Debt x Cost of Debt)
+
(Share of Equity x Cost of Equity)
However, the final WACC determined by a regulator can
vary, depending on whether it is calculated on the basis of
pre or post-tax levels and whether it is in real or nominal
terms. For example:
WACC (pre-tax) =
[g x Rd] + [(1 – g) x Re]
WACC (pOST-TAX) =
[(1 – t) x g x Rd] + [(1 – t) x (1 – g) x Rd]
NB. Where: g is the gearing level; t is the rate of corporation tax;
Rd is the pre-tax cost of debt; Re is the pre-tax cost of equity.
13
The purchase or leasing of additional land should be set out in a long-term strategic development plan that has been discussed and agreed to
by all stakeholders, including airline users and governments.