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NowniberXI CFS DISCUSSION PAPERS 101 - Privatization in Tunisia, Jamal Saghir, 1993. 102 - Export Credits: Review and Prospects, Waman S. Tambe, Ning S. Zhu. 1993. 103 - Argentina's PrivatizationProgram, Myrna Alexander, Carlos Corti, 1993. 104 - Eastern EuropeanExperience with Small-Scale Privatization:A CollaborativeStudy with the Central European University PrivatizationProject, 1994. 105 - Japan'sMiain Bank System and the Role of the Banking System in TSEs, Satoshi Sunumura, 1994. 106 - Selling State Companies to Strategic Investors: Trade Sale Privatizations in Poland, Hungary, the Czech Republic, and the Slovak Republic, Volumes 1 and 2, Susan L. Rutledge, 1995. 107 - Japanese National Railways Privatization Study 11: InstitutionalizingMajor Policy Change and Examininlg Economic Implications, Koichiro Fukui, Kiyoshi Nakamura, Tsutomu Ozaki, Hiroshi Sakmaki, Fumitoshi Mizutani, 1994. 108 - Management Contracts: A Review of InternationalExperience, Hafeez Shaikh, Maziar Minovi, 1995. 109 - Commercial Real Estate Market Development in Russia, April L. Harding, 1995. 110 - Exploiting New Market Opportunities in Telecommunications: Lessons for Developing Countries, Veronique Bishop, Ashoka Mody, Mark Schankerman, 1995. 111 - Best Methods of Railway Restructuringand Privatization, Ron Kopicki, Louis S. Thompson, 1995. 112 - Employee Stock Ownership Plans(ESOPs), Objectives, Design Options and InternationalExperience, Jeffrey R. Gates, Jamal Saghir, 1995. 113 - Advanced Infrastructurefor Time Managemenit, The Competitive Edge in East Asia, Ashoka Mody, William Reinfeld. 1995. 114 - Small Scale Privatization in Kazahkstan, Aldo Baietti, 1995.

JOINT DISCUSSION PAPERS Privatization in the Republics of the Former Soviet Union: Framework and Initial Results, Soo J. Im, Robert Jalali, Jamal Saghir; PSD Group, Legal Department and PSD and Privatization Group, CFS - Joint Staff Discussion Paper, 1993. Mobilizing Private Capitalforthe Power Sector: Experience in Asia and Latin America, David Baughman, Matthew Buresch; Joint World Bank-USAID Discussion Paper, 1994.

OTHER CFS PUBLICATIONS JapaneseNational Railways Privatization Study, World Bank Discussion Paper, Number 172, 1992. Nippon Telephone and Telegraph PrivatizationStudy, World Bank Discussion Paper, Number 179, 1993. Beyond Syndicated Loans, World Bank Technical Paper, Number 163, 1992. CFS Link, Quarterly Newsletter. Cofinancing and Financial Advisory Services (Project Financing Group), October 1995

The findings, interpretations, and conclusions expressed herein are entirely those of the authors and should not be attributed in any manner to CFS, the World Bank, or to members of the Board of Executive Directors or the countries they represent. The World Bank does not guarantee the accuracy of the data included in this publication, and accepts no responsibility whatsoever for any consequence of their use. The paper and any part thereof may not be cited or quoted without the author's expressed written consent CFS DISCUSSION PAPER SERIES, N-MBERm lf5 ;.V

Airport Infrastructure: The Emerging Role of the Private Sector

Recent Experiences Based on 10 Case Studies

Ellis J. Juan

WITH CONTRIBUTIONS FROM:

ALBERT AMOS ANIL KAPUR SERGIO MAGNACCA CIRA ROMERO CEZLEY SAMPSON

ASSISTED BY:

EMILY EVERSHED ROXALANA KASSARABA PAUL KIHN VICKI MCGILL HEATHER QUICK MARIE-ANGE SARAKA-YAO JOHN SWEPSTON

For additional copies, please contact the CFS Infonnation Office, Tel: (202) 473-7054, fax (202) 477-3045

TABLE OF CONTENTS

LIST OF ABBREVIATIONS ...... vii

ACKNOWLEDGMENTS ...... X

FOREWORD ...... xi

PRIVATE SECTOR PARTICIPATION IN AIRPORT INFRASTRUCTURE RECENT EXPERIENCES, BASED ON 10 CASE STUDIES ...... 1 I. A Framework for the Analysis of Private Sector Participation in Airport Infrastructure ...... 3 II. Policy Options for Airport Privatization ...... 12 III. Industry Trends Based on Recent Experiences ...... 40 IV. Lessons from Recent Privatization Transactions ...... 46

CASE STUDY 1 AIRPORTS IN BOLIVIA A CASE STUDY OF AIRPORT PRIVATIZATION IN SMALL-SCALE MARKETS ...... 51 I. Ownership and Institutional Framework ...... 54 II. Regulatory Framework ...... 58 III. Restructuring Process and Privatization of the National Airport System ...... 63 IV. Economic Performance ...... 70 V. Key Issues Emerging from the Bolivian Experience (Privatization Program in Process) ...... 75 Annex 1.1 Bolivia: ADP Model for Bolivia's Airport System ...... 80

CASE STUDY 2 AIRPORTS IN CAMEROON A CASE STUDY OF AIRPORT PRIVATIZATION INWEST AFRICAN ECONOMIES ...... 83 I. Ownership and Institutional Framework ...... 85 II. Regulatory Framework ...... 90 III. ADC: Financial Performance ...... 92 IV. Privatization Process ...... 94 V. Key Issues Emerging from the Cameroon Experience ...... 99 Annex 2.1 Feasibility Study Income from Operations ...... 101 Annex 2.2 Feasibility Study Estimated Cash Flow ...... 102

CASE STUDY 3 AIRPORTS IN CANADA A CASE STUDY IN CORPORATIZATION AND JOINT PUBLIC/PRIVATE OWNERSHP STRUCTURES ...... 103 I. Ownership and Institutional Framework ...... 104 II. Regulatory Framework ...... 106 m. Financial Performance ...... 107 IV. Privatization Process ...... 108 V. A6roports de Montreal: A Case Study in Corporatization ...... 111 VI. Lester B. Pearson Airport, Toronto: A Case Study in Joint Public/Private Ownership Structures ...... 120

iii AIRPORT PRIVATIZATION EXPERIENCES

CASE STUDY 4 AIRPORTS IN COLOMBIA A CASE STUDY OF INNOVATIVE INFRASTRUCTURE FINANCING INLATIN AMERICA ...... 131 I. Ownership and Institutional Framework ...... 134 II. Regulatory Framework ...... 137 III. Financial Performance ...... 141 IV. Privatization Process: Second Runway - El Dorado Airport, Bogota ...... 144 V. Key Issues Emerging from the Colombian Experience ...... 154 Annex 4.1 Aircraft Parking and Landing Fee Structure ...... 157 Annex 4.2 Initial Proposed Landing Fee Structure by Consortium Awarded El Dorado Project ...... 160

CASE STUDY 5 AIRPORTS IN EAST ASIA A CASE STUDY OF AIRPORT DEVELOPMENT INFAST-GROWING ECONOMIES ...... 161 I. Ownership and Institutional Framework ...... 164 II. Regulatory Framework ...... 169 lIl. Kai Tak Airport ...... 170 IV. Chek Lap Kok: Airport Development Process ...... 173 V. Privatization Process ...... 180

CASE STUDy 6 AIRPORTS IN JAMAICA A CASE STUDY IN AIRPORT PRIVATIZATION THROUGH A COMBINATION OF PPI MECHANISMS (WRAPAROUND) ...... 193 I. Ownership and Institutional Framework ...... 195 II. Regulatory Framework ...... 197 III. AAJ's Financial Performance ...... 199 IV. Privatization Process ...... 203 V. Key Issues Emerging from the Privatization Experience ...... 214 Annex 6.1 Airports Authority of Jamaica Organizational Structure ...... 217 Annex 6.2 Sangster International Air Terminal Ltd. Available cash flow ...... 218 Annex 6.3 Norman Manley Air Terminal Ltd. Available cash flow ...... 220

CASE STUDY 7 AIRPORTS IN SPAIN A CASE STUDY IN THE EVOLUTION OF STATE OwNERsmP INTHE AIRPORT SECTOR ...... , 223 I. Ownership and Institutional Framework ...... 224 II. Regulatory Framework ...... 227 HI. Financial Performance ...... 231 IV. Privatization Process ...... 234 V. Key Issues Emerging from the Spanish Experience ...... 242 Annex 7.1 Composition of Spanish Airport Traffic ...... 246 Annex 7.2 Organizational Structure of Aena ...... 250 Annex 7.3 Spanish Airport Tariffs - Airside Costs ...... 251 Annex 7.4 Financial Information ...... 254

CASE STuDY 8 AIRPORTS IN THE UNITED KINGDOM -BELFAST INTERNATIONAL AIRPORT A CASE STUDY OF AIRPORT PRIVATIZATION THROUGH A MANAGEMENT-EMPLOYEE BuYouT ...... 255 I. Ownership and Institutional Framework ...... 256 II. Regulatory Framework ...... 260 m. Financial Performance ...... 263 IV. Privatization Process ...... 267 V. Key Issues Emerging from the Belfast Experience ...... 271 Annex 8.1 Airports (NI) Order 1994 ...... 273

iv TABLE OF CONTENTS

CASE STUDY 9 AIRPORTS IN THE UNITED KINGDOM - BAA PLC A CASE STUDY OF 100 PERCENT PRIVATE OWNERSHIP ...... 281 I. Ownership and Institutional Framework ...... 283 II. Regulatory Framework ...... 288 m. Financial Performance ...... 290 IV. Privatization Process ...... 291 V. Key Issues Emerging from the United Kingdom Experience ...... 308 Annex 9.1 Regulatory Regime for Airside Charges ...... 311

CASE STUDY 10 AIRPORTS IN VENEZUELA A CASE STUDY IN DECENTRALIZATION OF AIRPORT OPERATIONS ...... 315 I. Ownership and Institutional Framework ...... 316 II. Regulatory Framework ...... 320 Im. Financial Performance -- IAAIM ...... 322 IV. Privatization Process ...... 323 V. Key Issues Emerging from the Venezuelan Experience ...... 333 Annex 10.1 Venezuela: MTC operated Airports (1993) ...... 335 Annex 10.2 Projected International Passengers by Airport ...... 336 Annex 10.3, 10.4, 10.5 Venezuelan Airport Fees, Taxes and Charges ...... 337 TECHNICAL ANNEX I THE AIRLINE SURVEY ...... 339 I. Airport Ownership ...... 341 II. Airport Pricing ...... 342 m. Institutional and Regulatory Framework ...... 344 IV. Industry Strategic Planning ...... 346 V. Conclusions ...... 347

TECHNICAL ANNEX II AIRPORT ECONOMICS ...... 349 Assumptions of the Model ...... 350 Attachment 11.1 Landing Fees and Related Charges ...... 360

V AIRPORT PRIVATIZATION EXPERIENCES

LIST OF ABBREVIATIONS

AA Airports Authority AAA Air Affaires Afrique AAB Airports Authority of Bolivia AAJ Airports Authority of Jamaica AASANA Administraci6n de Aeropuertos y Servicios Auxiliares de Navegaci6n Aerea AAT Asia Airfreight Terminal Company Limited ACI Airports Council International ACL Airport Coordination Ltd. ACP Airport Core Program ADC Aeroports du Cameroun ADF Airport Development Fund ADM Aeroports de Montreal ADP Aeroports de Paris Aena Aeropuertos Espainoles y Navegaci6n A6rea AJAC Anglo-Japanese Airport Consortium ANA Air Navigation Authority ANFA Average Net Fixed Assets ASA Air Services Agreement ASC Airport Scheduling Committee ASECNA Agence pour la Securite de la Navigation Aerienne en Afrique et a Madagascar ATA Air Transportation Authority ATC Air Traffic Control ATEA Air Transport Engineering Authority ATLA Air Transport Licensing Authority BA British Airways BAA British Airports Authority BAH Booz, Allen and Hamilton BBO Buy-Build-Operate BIA Belfast International Airport BICIC Banque Internationale pour le Commerce et l'Industrie du Cameroun BOO Build-Own-Operate BOOT Build-Own-Operate-Transfer

vi Airport Privatization Experiences

ABBREVIATIONS

BOT Build-Operate-Transfer BTO Build-Transfer-Operate CAA Civil Aviation Authority CAAS Civil Aviation Authority of Singapore CAD Civil Aviation Department CFD Caisse Fran,aise de Developpement CONAER National Aeronautics Council COPRE-Zulia State Reform Commission of Zulia State DFP Department of Finance and Personnel DGAC Direcci6n General de Aviaci6n Civil DGSTA Direcci6n General Sectorial de Transporte Aereo DNP Ministry of Planning DOE(NI) Department of the Environment for Northern Ireland DOT Department of Transportation EEC European Economic Community EIB European Investment Bank EPF Employees Provident Fund EPU Economic Planning Unit ERDF European Regional Development Fund EU European Union FAA Federal Aviation Administration FAC French Ministry of Cooperation FIR Flight Information Region FSA Financial Support Agreement GNP Gross National Product HACTL Hong Kong Air Cargo Terminals Limited HATS Hong Kong Airport Terminal Services Limited IAAIM Maiquetia International Airport Autonomous Institute IATA International Air Transport Association ICAO International Civil Aviation Organization IDA International Development Association IDB Inter-American Development Bank IPB International Public Bidding IRA Irish Republican Army KLIA (Bhd.) Kuala Lumpur International Airport LAA Local Airport Authority LAB Lloyd Aereo Boliviano

vii AIRPORT PRIVATIZATION EXPERIENCES

LATC Lockheed Air Terminal of Canada, Inc. LBP Lester B. Pearson Airport LDO Lease-Develop-Operate MAB Malaysia Airports Berhad MAS Movimiento al Socialismo MDC Mercury Development Capital MEBO Management and Employee Buyout MMC Monopolies and Mergers Commission MTC Ministry of Transportation and Communications MTOW Maximum Take-Off Weight NAPCO New Airport Project Coordination Office NATS National Air Traffic Services NERC New En Route Centre NI Northern Ireland NIAL Northern Ireland Airports Limited NITHCo Northern Ireland Transport Holding Company NMIA Norman Manley International Airport NTA National Transportation Act OAN Organismo Aut6nomo de Aeropuertos OECD Organization for Economic Cooperation and Development OPIC Overseas Private Investment Corporation OUR Office of Utility Regulation PAA Provisional Airport Authority plc Public Limited Company RPI Retail Price Index SAAEZ State of Zulia Autonomous Airport Service SAM Sociedad An6nima Mixta SAR Special Administrative Region SIA Sangster International Airport SOE State-Owned Enterprise SSCA Sub-secretary of Civil Aeronautics Ti Terminal One, Lester B. Pearson Airport T2 Terminal Two, Lester B. Pearson Airport T3 Terninal Three, Lester B. Pearson Airport TAB Transporte Adreo Boliviano TAM Transporte Aereo Militar

viii Airport Privatization Experiences ABBREVIATIONS

TTLP Terminal Three Limited Ownership UDAPE Unidad de Analisis de Politicas Econ6micas UGD Unidad de Gesti6n Diferenciada UNDP United Nations Development Programme YPFB Yacimientos Petroifferos Fiscales Bolivianos ZAA Zulia Airport Authority

ix AIRPORT PRIVATIZATION EXPERIENCES

ACKNOWLEDGMENTS

During the 18-month period taken by us to research, write, and edit the airport privatization cases, we received assistance and support from the different authorities involved in airport operations in the selected countries in the study. We were assisted by high-ranking officers, who provided clear policy orientation and strategic thinking on their privatization cases, as well as by operational personnel who contributed valuable practical insights. In particular we would like to thank the following individuals for their contributions and comments on the various privatization cases: Dr. Rene Blattman (Subsecretary of Aeronautics, Bo- livia) and Javier Burgos (Ministry of Capitalization, Bolivia), Ing. Justin Kono (Director of Civil Aviation, Cameroon), John Cloutier, M.E. Farquhar and Lloyd A. McCoomb (Transport Canada, Airports Division), Lic. Antonio Marulanda Rojas (Secretario Aeroportuario, Aeronautica Civil, Colombia) and Claudia Stevenson (Departamento Nacional de Planeaci6n, Colombia), Albert K.Y. Lam (Airport General Manager, Kai Tak Airport, Hong Kong) and Clinton Leeks (Director of Corporate Development, Provisional Airport Authority, Hong Kong), Pat Morgan (Project Director, Sangster International AMirport Ltd, Jamaica), Khairuddin Ibrahim (Managing Director, Malaysia Airports Berhad, Malaysia) and IR. Lee Chin Wah (Project Manager, K.L. International Airport Berhad), Lic. Fernando Sanchez-Beato Lacasa, Lic. Jose Luis Wagener and Lic. Alfonso de Alfonso (AENA, Espana), Greg Hamill (Finance Director, Belfast Interna- tional Airport, Northern Ireland), Michael Toms and Charles Williams (British Airport Author- ity, U.K.), A.T. Baker (Department of Transport, U.K.), Jhon Banfield (Monopolies and Merger Commission, U.K.), Hugh Ashton (Coopers & Lybrand, U.K.) and Lic. Stephane Gonzalez (CVA, Aeropuerto Internacional Santiago Marinlo, Venezuela). We would also like to thank the following institutions, which provided important information for the development of the privatization cases as well as valuable insights on trends in this sector: Aeroports de Paris (Architecture, Engineering and Consultancy Division), Airports Council International (ACI), International Civil Aviation Organization (ICAO), International Air Transport Association (IATA) and Instituto Autonomo Aeropuerto Internacional de Maiquetia (IAAIM). In addition, we would like to thank the readers and reviewers of various drafts of this report. We benefited greatly from their critical and insightful comments. In particular the contributions from: Harald Fuhr (PSD Specialist, Latin America Country Department II, World Bank), Susan Goldmark (PSD Specialist, Latin America Country Department III, World Bank), Jean-Noel Guillossou (Infrastructure Specialist, Central Africa and Indian Ocean Department, World Bank), Daniel Kern (Director for South America, A.T. Kearney), Moises Naim (Senior Associate, Carnegie Endowment for International Peace), Heidi Mattila (Privatization Specialist, CFSPS, World Bank), Eduardo Quintero (Fellow 1994-95, Harvard University, Center for International Affairs) and Gerver Torres (former Minister of Privatization, Venezuela, 1990-92). We are specially grateful for the support of Kevin Young, Manager of the Private Sector Devel- opment and Privatization Group of Cofinancing and Financial Advisory Services (CFS) of the World Bank, who encouraged us to undertake this study and whose valuable direction was in- strumental in bringing this paper to completion. Alrport Privatization Experiences

FOREWORD

During coming years, air transport infrastructure needs to be expanded and modernized to accommodate the growing demand for international travel and transport of goods and merchan- dise. Developing countries need to invest large amounts of resources in airport related infrastructure in order to connect into the global air transport industry. Increased demands placed on developing country public finances are inducing policy-makers to find alternatives to replace the government's role in the financing and management of airport infrastructure. Recent successes in developed economies in reducing government involvement in this sector have created a more optimistic view of private sector participation in the financing, management, and ownership of airport related activities. This study, Airport Infrastructure: The Emerging Role of the PrivateSector, Recent Experiences Based on 10 Case Studies, is intended for developing country policy makers. Designed to function as a helpful reference work, it provides practical information, context and strategies to foster private sector participation in the airport sector. The study, built on 10 case studies encom- passing diverse continents and national income levels, addresses a large number of issues including privatization mechanisms, regulatory and legal structures, project finance schemes and cross subsidization concerns among different countries. It presents the trends and lessons, derived from existing and on-going privatization cases, relevant to the policy-maker. Our research showed that governments were following diverse patterns and strategies when privatizing their airport operations. Funding needs for upgrades and expansions coupled with budgetary constraints was the consistent common factor identified among the cases. As the private sector increases its participation in the ownership and management of this industry, governments will need to strengthen their institutional capacities to efficiently perform their roles as policy-makers and regulators. This study was prepared as part of the CFS Discussion Paper Series on privatization in developing and transition economies. Other papers in the same series have covered privatization programs in Argentina, the legal and regulatory frameworks in the countries of the former Soviet Union, Japanese National Railways privatization, trade sale privatizations in Poland, Hungary, the Czech Republic, and the Slovak Republic, management contracts, Russian commercial real estate market development, new market opportunities in telecommunications, and most recently a study on Best Methods of Railways Restructuring and Privatization. The Study is a comple- mentary task to the white cover report Airport Infrastructure: The Emerging Role of Private Sector Participationjointly developed by the Latin American Technical Department (LAT), the Transportation, Water & Urban Development Department (TWU), and Cofinancing and Finan- cial Advisory Services Department (CFS) of the World Bank in June 1995. The purpose of the Discussion Paper series is to disseminate current practices and the "lessons" learned in privatization. As a Department that covers all the World Bank's borrowing countries, Cofinancing and Financial Advisory Services (CFS) endeavors to share with outside readers some of its cross-country experience in privatization. We are pleased to present this review of recent experiences in private sector participation in airport infrastructure. Ram Kumar Chopra Kevin Young Director Manager Cofinancing and Financial Advisory Services Private Sector Development (CFS) and Privatization Group (CFSPS)

xi Overview PRIVATE SECTOR PARTICIPATION

PRIVATE SECTOR PARTICIPATION IN AIRPORT INFRASTRUCTURE

RECENT EXPERIENCES, BASED ON 10 CASE STUDIES

In the early 1980s the idea that public airports could be privately owned would have been considered extreme economic liberalism, or ignorance regarding the subject, or both. Today, the U.S. Government has presented Congress with a proposal for the partial privatization of NASA - the transfer to the private sector of the launch and ground processing operations for the space shuttle at Cape Canaveral.' Clearly, the privatization of airports as the last frontier in air transport infrastructure has become old news. Airports are an essential component of the infrastructure needs for air transport activities. As with many other infrastructure developments, airports in the past were almost exclusively under government ownership and management, and capital investment funding was solely government's responsibility. As demands for government spending outpace revenues, competition for funds among society's varied needs is becoming more intense, and governments are increasingly calling for a larger

"NASA's Five-Year Plan," The Washington Post, March 27, 1995. A Tr PRIVATIZATION EXPERIENCES

private sector role in meeting these needs. Economic reforms undertaken by these governments facilitate the involvement of the private sector in the management, financing, and ownership of airport related activities. Consequently, private sector participation has become a rapidly growing worldwide trend. As of early 1994, some form of privatized airport operation existed, was being developed, or was under consideration in some 54 countries. 2 As air transport continues to grow, in both passenger and cargo transport, and as air travel becomes more affordable and accessible to travelers in less developed economies, air transport will increase its participation as a transportation mode.3 The tourism industry is the number one employer and taxpayer in the world. According to the latest figures of the World Travel Tourism Council, the tourism industry employs 10.6 percent of the world's work force (204 million people), generates 10.2 percent of the world's gross national product (GNP), and accounts for 10.9 percent of total consumer spending.4 Global tourism is expected to grow 6.1 percent per year between now and the year 2005. These numbers do not take into account the eventual participation of the Chinese and Eastern European societies in the air travel market once their economies can support the necessary standard of living for their nationals to travel abroad.5 The growth in air transport will also bring about changes in aviation technology, such as aircraft with larger passenger capacities as opposed to aircraft with greater speeds. Airports will need to adapt to the growing tourism demands and the changes in aircraft technology, and will have to be better linked to other means of transportation (i.e., roadways and railways) in order to adequately handle massive additional volumes. Given this trend, air transport infrastructure (airports and air navigation services) will require major investments in upgrading and expansion in the near future. The International Civil Aviation Organization (ICAO) estimates US$250 to US$350 billion as the necessary investment in air transport infrastructure before the year 2010.6 In the United States, the Air-

2 Robert W. Poole, Jr., The Reason Foundation, February 1994. 3The World Bank estimates that for the next 15 years air travel will increase at a rate of 6 percent ("Sustainable Transport: A Sector Policy Review," March 1995). John Naisbitt, "The Global Paradox," March 1994. By the year 2005, 20 million newly wealthier Chinese travelers (up from the current 3 million) plus another 20 million Indian travelers (up from I million at present), will be added to the world's tourists. "The New Age ofTravel," Time Magazine, June 12, 1995. 6 Investment requirements for airport and route facility infrastructure to the year 2010, Circular 236-AT/95. Overview PRIVATE SECTOR PARTICIPATION ports Operators Council International(AOCI) estimated US$50 billion as the amount of investment required by the mid-i 990s to support passenger needs in the year 2001. As the air transport market develops and deregulation continues, related infrastructure investment becomes increasingly necessary. Private sector involvement in the financing, management, and ownership of airport-related activities will become an indispensable part of governments' air transport development strategy. What do the recent attempts to foster private sector participation in airport-related infrastructure have in common? Are there similarities between the successes and failures in this field that are relevant for policymakers? This report deals with these and similar queries by presenting trends and lessons stemming from recent experiences in airport privatization drawn from the cases analyzed in the present study (The Case Studies).

1. A FRAMEWORK FOR THE ANALYSIS OF PRIVATE SECTOR PARTICIPATION IN AIRPORT INFRASTRUCTURE

Private sector participation in airport infrastructure is a very recent phenomenon, and its effects on quality of service, investments, and pricing are yet to be seen, given the relatively small scale of private sector participation in airport ownership today. Available data seem to indicate that, where the private sector has a significant participation in management and ownership, both quality of service and investment commitments have significantly improved. The effect of airport privatization on general pricing policies (i.e., direct airport-related charges and prices for goods and services consumed on the premises) is more difficult to measure, but the evidence at hand from fully privatized airports/terminals suggests the following pattern: la Airside charges (i.e., landing fees, aircraft parking fees, and passenger/terminal fees) are not lower than under the previous public administration, but neither have they increased substantially AIRPORT PRIVATIZATION EXPERIENCES

aI The airside charges pricing mechanism has become more complex (peak hour pricing, volume discounts, etc.) * Airside charges are subject to price-cap economic regulation (i.e., a formula based on general price index adjustments minus X percentage, where X reflects the efficiency gains in the airport operation) * There has been intense development of non-aeronautic commercial airport revenues (i.e., end consumer-oriented concessions, such as duty-free, hotels, shops, frequent traveler services, etc.) at relatively high (premium) prices. Not all current experiences in airport privatizations under development are success stories (e.g., Terminals One and Two at the Lester B. Pearson Airport in Toronto, Canada, and Aeropuerto La Chinita in Maracaibo, Venezuela, in the case studies), although the evidence suggests that in most of these cases failure to accomplish the objectives is associated with poor execution of the privatization strategy and/or changes in the political environment in which the initial decision was taken.

_^¢ A. Privatization Concepts and Definitions to Be Used in the Study

For the purpose of this study the term "privatization of airports" will include all the different approaches through which private sector participation in airport-related activities is being promoted and developed, whether the participation is in ownership, management, or investment programs. An airport authority (the entity that is the subject of privatization) will be divided into the following components: (1) the airsideservices (runways, taxiways, aprons, terminals, etc.), mostly defined as those services considered monopolistic by nature within the airport7; and (2) the landside services (passenger services, food and beverage concessions, duty free, car parking, hotels, etc.), where end-consumers can find a wider variety of suppliers.8 Police and security, customs and immigration, and fire and ambulance services

I The airfield, gates, jetways, and all facilities associated with the movement of the aircraft. Airside facilities are considered to be all the facilities beyond the passenger security areas. (Moody's on Airports, 1992.) The portion of airport facilities devoted to the main terminal complex, ground transportation, and services; facilities associated with the movement of passengers and baggage away from aircraft areas; terminal facilities up to the passenger security areas. (Moody's on Airports, 1992.)

4 Overview PRIVATE SECTOR PARTICIPATION are generally provided by the municipal, regional, or federal government agency in charge of providing that particular service for all purposes (Ministry or Secretary of the Interior, Cus- toms and Immigration Department, etc.). Airport privatization, in the study, will refer to airports that provide services to the general public where governments in both developed and developing countries have a role in the airports' policy and regulatory issues. The study does not consider airports that, by definition, are planned for private users (aeroclubs, aircraft manufacturing airfields, etc.). Privatization of airports, in the context of the study, will not include the air navigation services (air traffic control [ATC], communications services, meteorology, etc.). Privatization of air navigation services, although an important part of air transport infrastructure, will be considered as a separate subject since in most of the cases the institutional framework is separate from that of the airports, and the exploitation of the activities has a stronger externalities component (i.e., national defense and security). 9 That portion of ATC that is related to the approach and landing of the aircraft (the control tower) will be included as part of airport functions under airside services. The airports analyzed in the case studies, and several others, divide their air traffic controlfunction, for the approach and landing of aircraft, into the forms shown in Table 1. Table 1 Aircraft Approach and Landing: Institutional Arrangements

Institution in charge of Institution in charge of Distribution of airport providing the service' runway maintenance charges (i.e., landing fees)2 Examples A CiviiAiahon Civil Aviation 100oCivil Bobvia (AASANA) Aulrhriav ATC Authornty Aviat|n Authority Colombia (DGCA) e Civl Avation Airport Aulhority 1000. A,rport Brmsh Airpons Aulhority (BAA plci AutlhriW ATC Authority 'lenezuela IMaicu6tia) Cameroon (ADC) r COll Aviation Airport Aultonty Revenue shared Toronto (Lester B. Pearson Aulthjriy ATC Detween Airport Airporn) Authority and CAA Jamaica (Montego Bay Airport)

I All of the entities incharge of air navigation services inthe study were under the supervision of the Civil Aviation Authority. 2The airport charge that covers aircraft approach and landing is known as the 'landing fees."

4 Worldwide experience indicates that the first step taken by industrialized countries (the only countries in which ATC activities have been considered for private sector involvement) has been to corporatize air navigation services (New Zealand, Switzer- land, Germany, and South Africa), but with the state still owning a majority of the shares. AIRPORT PRIVATIZATION EXPERIENCES

Total privatization of airports in the most rigid interpretation of the term (100 percent private ownership through purchase of shares or assets) is by no means frequent or widely employed. The only cases of this type found in our research were the British Airports Authority (BAA plc), which today has full private ownership widely distributed among 523,405 private shareholders, and Belfast International Airport, which is owned by the management and employees through a management and employee buyout (MEBO) operation (for reference, see Case Studies 8 and 9). Most other airport privatizations worldwide adopt different models, ranging from partial subscription of shares by the private sector or general public (e.g., airports in Vienna, and Copenhagen) to more complex schemes such as build-own-operate-transfer (BOOT), or similar arrangements (e.g., Terminal Three in Lester B. Pearson Airport at Tor- onto, the planned new airport for Athens, etc.). The term "service concession"10 will be considered a form of privatization of an airport-related activity when the concessionaire is a fully private enterprise. Service concessions have been widely and historically used (except by countries in the communist bloc prior to 1989) in the development of the landside or commercial services, and most service concessions have been to private concessionaires. An airport service concession usually does not carry a large investment commitment and ex- pires in a relatively short period of time (less than five years). When an airport service concession carries an important amount of investment commitment and its maturity tends to be for longer periods, the option becomes a more traditional infrastructure development scheme (i.e., build-operate-own [BOO], build-operate-own-transfer [BOOT], build-operate-transfer [BOT], etc.). With some exceptions, most of the present concessionaires for restaurants, shops, duty-free, car parking, etc., at the terminals are privately owned enterprises or private individuals. More recently, "master concessions" have been used to operate and manage a full range of landside airport services; in these cases the airport authority deals only with one "master concessionaire," which usually has some investment obligations

10 A lease of a defined space or area within the terminal, to exploit a particular conmner- cial activity for a predetermined period of time, and under given financial conditions. It does not consider ownership of the space or area under concession. The ownership of the improvements made to the space or area varies from case to case.

6 Overview PFRIVATE SECTOR PARTICIPATION in terminal upgrading included in the concession contract. An- other use of concessions as a tool to maximize private sector participation in the management of airport-related activities is the multi-concession approach, in which the airport authority gives the private sector, under concession, as many airport-related services as possible (both airside and landside), becoming in effect a concessionaire's administrator with a limited number of employees to perform its functions. In Bucharest, Romania, at the Othopeni Airport Authority, most of the airport-related services have been concessioned to the private sector (i.e., terminal passenger services and ground handling services to a Ger- man-Romanian joint venture,"1 and the rest of the services - shops, restaurants, duty free, car parking, advertising, etc. - to Romanian private enterprises). The Othopeni Airport Author- ity remains in charge of aircraft approach and taxing (airside: runways and aprons management) and internal security, and is developing its capacities as a concessionaire's administrator.12

B. Corporatization of Airports

The term "corporatization," seldom used in the context of restructuring state enterprises or public functions, will be used in this study to mean the step by which an airport is transferred from federal government control to an independent government body through the creation of an autonomous airport authority. The non-corporatized airport, previously subject to federal government laws, becomes subject to civil corporate law like any other private enterprise, with autonomy in its financial budgeting and corporate governance. Although varied from country to country, the status of a corporatized airport authority is similar to that of private corporate governance, allowing for the introduction of certain functions of private enterprise governance (budgeting, accounting principles, productivity programs, salary and staffing, etc.) and even, in some cases, for ownership other than that of the state (e.g., trade organizations, chambers of commerce, etc.). In most of the analyzed cases in the study, shares of airport authorities still under government ownership

I' Lutas, a joint venture among Lufthansa, Tarom (Romanian Airlines), the Airport Authority, and private Romanian investors.

12 In most of the airports around the world (state-owned or with private participation) external security is under the supervision of the armed forces or national police.

7 AIRPORT PRIVATIZATION EXPERIENCES

are most commonly held by the Ministry of Transport, the Min- istry of Defense, or local authorities (municipalities, city councils, etc.). The corporatization of airport activities is a necessary step when the privatization of an existing airport under any form or model is under consideration. Creating an autonomous airport authority with financial and operating independence allows the government to establish the necessary framework for the privatization of airport-related activities. Whether the government is privatizing through the issue of new shares to be placed in the capital markets, concessions arrangements, or long-term leases and BOTs, legal and financial considerations for private sector involvement will be easier under a corporatized entity than under federal government control. (For example, under federal government ownership financial decisions such as capital increases or long-term leases are subject to the general government budget, and in some cases even to parliamentary approval.) It can be argued whether it is absolutely necessary to corporatize an airport prior to its privatization. However, it is significantly more efficient to privatize airport-related activities when the entity subject to privatization is well defined and its assets and liabilities are clearly separated from the federal government's budget, particularly in the case of developing countries. Box 1 provides an illustration of the corporatization and decentralization of airport services in Canada through the creation of Local Airport Authorities (LAAs).

_wqvA C. Assignment of Roles: Airport Infra- structure

For the purpose of allocating responsibilities between the private and public sectors to determine the range of privatization options for the air transport policymakers, the respective roles in airport infrastructure are divided as follows 13:

s Planning/Policymaking. Since market conditions for developing publicly used airports are limited (high cost of entry, long lead planning schedules, limited avail- ability of land, etc.), the government must retain a role in planning investments for airport infrastructure. In

3 C. Kessides, "Institutional Options for the Provision of Infrastructure," The World Bank, September 1993.

8 Overview PRIVATE SECTOR PARTICIPATION

Box 1

CORPORATIZATION OF AIRPORTS: THE CANADIAN MODEL The Canadian Model is based on the transfer of the management of Transport Canada airports to incorporated business entities called Local Airport Authorities (LAAs). first announced as air transport policy in April 1987. The model was developed by an airport transfer task force (headed by Transport Canada) and implemented in July 1992 for the Vancouver, Edmonton, Calgary, and Montreal airports. The LAA is a regional variant of corporatized airport services. It provides the framework and corporate governance of private sector institutions but maintains government ownership of assets. The LAA concept can be defined as the 'privatization of a public sector function." The concept was developed by Transport Canada (i.e., The Federal Department of Transport) as part of the general policy to reduce federal government participation in the provision of air transport services. The LAAs are non- profit corporations with an independent Board of Directors appointed by municipal or regional governments and/or organizations such as the Board of Trade, Chamber of Commerce. etc. As non-profit organizations, the LAAs have no shareholders, and profits are reinvested in the airport operations. The LAAs are not subject to economic regulation and operate and manage the airports under a long-term lease agreement (i.e., 60 years). The federal government mantains ownership of airport-related assets and land. The lease agreement provides the federal government with a base rental payment for each airport business (i.e.. airside, landside, and real estate) plus a participation in the revenue increases. The LAAs enjoy federal income tax exemp- tion and are responsible for airport expansions and capital financing without recourse to federal government funding and/or guarantees. The development and implementation of the LAA concept in Canada, as a model for the corporatization of airport services. has the following strengths and weaknesses: Strengths: Permits airports to better serve local community interests and enhances regional economic development potential. Decentralizes airport management functions, allowing government to concentrate more on aviation sector policy and regulatory issues. Introduces some private sector behavior into the govemance of airport public functions (independent board. nondependence on govemment subsidies, etc.) as well as private sector commercial orientation of the airport operation. Allows the national airport system to operate in a more cost-efficient and commercial manner. The LAAs can access the capital markets for financing purposes on the basis of their future stream of cash flows, without government guarantees.

Continued....

9 AIRPORT PRIVATIZATION EXPERIENCES

Box 1 (concluded)

Weaknesses:

(a) Concerning the structure of the LAAs: A not-for-profit organization will lack some of the necessary incentives for the opti- mization of economic performance and the increase of new investments. If an LAA were to evolve into a for-profit organization, it would require economic regulation (e.g., the case in Britain where BAA pic is a for-profit organization regulated by the Civil Aviation Authority). Since ownership is retained by the federal government, in the event of a default of an LAA, the federal government might possibly be held accountable by the public.

(b) Concerning the rransfer process of the LAAs: Given the way the procedures were initially planned, there was a relatively high degree of discretion in the selection process of the Local Groups (local authorities and private sector organizations) for establishing the LAAs. The process was not open to different interested parties (at the local level) and discussions were held directly with only one Local Group, which gave the federal government limited flexibility in the negotiating process. For a process that does not include pre-qualification of candidates and bidding procedures. the period from April 1987 until July/August 1992 seems to reflect a prolonged and slow execution of the program.

most of the case studies analyzed, this role is performed by a special planning unit under the Civil Aviation Au- thority and/or the Ministry of Transport.

Xm Regulation. Given the monopolistic nature of airport- related services (airside) and the relatively high externalities of its activities, regulatory functions and responsibilities should be separated institutionally from the provision of these services. Government should have a role in the economic regulation of airport user charges, preferably exercised by an independent state body (e.g., the Civil Aviation Authority in the British Airports case), as well as a role in the technical regulation of airport- related activities (runways certification, air safety, air navigation standards, etc.). Airport services that ought to be subject to economic regulation include: (1) airside facilities (i.e., runway, taxiway, apron), and (2) facilities that require access to the airside (terminal, ground handling, fueling, etc.). In most of the case studies ana-

10 Overview PRIVATE SECTOR PARTICIPATION

lyzed, economic and technical regulation was performed by a government body with responsibility for the full range of air transport activities (e.g., a department or departments within a Civil Aviation Authority). Ownership. The holding of shares or assets in airport infrastructure could be in the hands of the state or the private sector. For purposes of the study, the following ownership options are considered: (1) full airport services (both airside and landside); (2) airside services only; and (3) landside/commercial services only. BOOT and BOT schemes that involve long-term leases of real estate and/or existing assets to the private sector on behalf of the state are considered state ownership. How- ever, this is debatable, considering that in economic terms a lease of over 30 years for practical purposes is tantamount to ownership. 14 Land ownership is not analyzed in the context of the study, but in most of the cases land belongs to the local or federal governments. Land ownership has not become an issue in any of the analyzed cases and is usually transferred to the airport operator (private or public) on a semi-perpetual lease (up to 99 years or more). Management (Operationsand General Maintenance). Operations and maintenance of airport activities can be performed by either the state or the private sector. When ownership is retained by the state, management contracts or operational concessions are widely used for the transfer of airport management responsibilities to the private sector. The same options used in the definition of roles under Ownership will be used for management. Investment and Financing. Investments in airport infrastructure for new developments, upgrades, and major maintenance needs have traditionally been a responsibility of the state. As private sector participation in the air transport industry increases, a greater amount of private investment is being channeled into airport-re-

14Ownership of airport-related assets can become an issue for the private sector operator when financial institutions require guarantees or pledges of assets for financing purposes. In such cases some type of collateral is usually required by the financial institutions. AIRPORT PRIVATIZATION EXPERIENCES

lated infrastructure. The same options used in the definition of roles under Ownership will be used in this category.

II. POLICY OPTIONS FOR AIRPORT PRIVATIZATION

Governments confront the decision to privatize their airport system for a host of different reasons. In some cases, mismanage- ment and corruption in airport administration have played a major role in the decision. In countries with a historic heavy military presence, modernization of the political system has driven civil governments to increase the participation of the private sector. However, the single reason common to most case studies was the government's inability to fund and/or obtain adequate financing for airport development (upgrades as well as new airports). Although lack of public funds is common to other infrastructure needs (water and sewerage, electricity, etc.), airports, given their limited use by the public, are even less of a government priority for public investment. As discussed previously, privatization of airport activities can take many different forms (outright sale of shares or assets, concessions, long-term leases, etc.), and can take place for the airport as a whole (e.g., BAA plc), for the airside-related services (e.g., a new runway at El Dorado Airport in Bogota, Colombia), or, as is frequently seen, in most of the landside or commercially related services (e.g., Terminal Three at Lester B. Pearson Airport in Toronto). As noted by the Ameri- can Association of Airport Executives in 1992, "Privatization of airports is not a single theory with a single definition."15 Trying to rigidly structure the different types or options available to policymakers could be misleading. This section attempts to or- ganize the policy options available to a government facing the need to privatize airports, and presents the techniques most commonly used in each case. Each policy option is accompanied by a brief summary of one or two relevant experiences.

15 "An Airport Executive's Guide to Privatization," a Privatization Study by the Ameri- can Association of Airport Executives and the Airport Research and Development Foundation, April 1992.

12 Overview PRIVATE SECTOR PARTICIPATION

As governments embrace economic reform and political modernization, their role in the development of infrastructure evolves from that of owner and operator to that of policymaker and regulator. Although more recent in origins, this is also the trend in air transport infrastructure as private sector participation increases in the sector. In the airline industry today, majority ownership is already private (by late 1994, 70 percent of airlines were private or had a controlling private partnership). The privatization options for the air transport policymaker are illustrated in Table 2(See next page). These options are categorized according to the three roles that the private sector plays and will continue to play in the development of airport infrastructure: (1) ownership; (2) management/operations; and (3) investment/financing. The study assumes that the roles of policy/planner and regulator in airport-related activities will continue to be undertaken by the state. Situations in which the government assumes sole responsibility for all roles are the historical reference to the ways in which airport-related activities were entirely under state control in the past. There are very few exarnples of this type of arrangement in today's airport world. Among the cases considered in the study, there was not one case in which the state had a predominant role in all airport-related activities.'16

16 The following sections present examples drawn from the case studies in this report and other recent airport privatization experiences. Further details on most of the airport transactions discussed in this section can be found in the case studies.

13 AIRPORT PRIVATIZATION EXPERIENCES

Table 2 Private Sector Methods to Increase Participation in the Airports Sector

Roles Option 1' Oplion_ ' Option 3'

State retains Ownership and State retains Ownership ot Ownership Operations, Investment Responsibilities Airport but transfers and Invesiment but transfers Airport Investment as well as Responsibilities are Management and Operations Operations/Management iransterred to to ihe Private Sector Responsibililes to the the Privaie Sector Private Sector

Ownershp State State Private Sector Investment State Private Sector Private Sector Management, Private Sector Private Sector Private Sector Operations i _

* Service Concessions * BOT scheme (BOOT. * Wraparound Additions PPI Options * Contracting-Out BTO, etc I * BOO (comrmrrnly used) * Management Contracts * Long Term Leases tLOO. etc.l * Strategic Buyout a Multiple Concessions a Master Concession (e.g MEBO, etc.) o Capital Markets

* Aeroports du Carrmeroon * Athens International Airport * British Airports Authoritv o Pittsburgh Int'i Airport a Lester B. Pearson, Toronto o Sangster International Recent o Kai Tak Airport. Hong Kong * La Chinita Airporn Airport Jamaica Expenences Maracaibo -Venezuela * Beltast International - Palma de Mallorca, Spain Airport

tPrjvaIe Sector participation trend in airport infrastructuret Legend Private Sector Participation in Infrastructure (PPI) Options

MCs Management Contiacts BOT = Burl3Ooieraie-Transter BOOT= Buila-Own-Operaie-Transler LDO = Lease-Develop-Operate BTO = Build-Transtfer-Operate LT Lease= Long-Term Lease Wraparound= Combination ot BOT lor new lacilitlies with long-term lease or concess,on lor eistirng fac,lifies S.B. =Srategi.- BuVoul by a group or consornum of in'meslors (srares andror assersl MEBOs= Management-Employee Buyouis

Includes alternatives for selected airside activities, selected landside activities, and full airport activities.

14 Overview PRIVATE SECTOR PARTICIPATION

Option 1: State Retains Ownership and Investment Responsibilities but Transfers Airport Management and Operations to Private Sector

This is the most commonly used option for private sector participation in airport-related activities. Evidence suggests that policymakers around the world have concluded that airport commercial activities (landside) with low externalities in relation to the society are better managed by the private sector. Activities such as shops, duty-free, car parking, porters, aircraft catering, and city-airport transport have traditionally been handled by private enterprises. More recently, there have been cases in which the entire airport infrastructure (airside and landside activities) has been transferred to the private sector for management and operation. The investment commitments of the private sector, in this option, are relatively low and are largely associated with the remodeling and redesign of commercial space in the case of landside infrastructure, and with minor repairs in the case of airside infrastructure. The legal configuration or instrument through which this privatization option is implemented can take the following forms: a Service Concession Contract. This is an agreement whereby the private enterprise is awarded the right, by the airport landlord (the airport authority), to exploit a particular service (under, or not under, exclusivity terms, depending on the type of service and the size of the airport) for a given period of time and under certain conditions (quality of service, leasing and or concession fees, minor repairs and maintenance commitments, etc.). In all of the airports analyzed in this study, concession contracts are presently in use in the exploitation of landside/commercial opportunities. Even in the case of fully privately owned airports (such as BAA plc), concession contracts are used as a mechanism for decentralizing management and employing qualified specialists in each field of business, so as to maximize the economic potential of the airport's commercial side. More and more owners perceive airports as offering an opportunity to increase passenger-related revenue by expanding the types of goods and services offered and making the airport an attractive place to shop. This "customer- oriented" movement is emerging at a number of airports, especially in the industrialized countries, since it repre-

15 AIRPORT PRIVATIZATION EXPERIENCES

sents an opportunity to sell goods and services to a cap- tive audience, with available time and an above average income. Terminal Three in Toronto and BAA plc, described in the case studies, are good examples of the use of service concession contracts in modem airports. 17 Contracting-Out.This is an arrangement in which the airport landlord (the airport authority) subcontracts the provision of a particular service with a private enterprise. This type of arrangement is commonly used for maintenance services (cleaning and maintaining infrastructure, repairing and maintaining equipment, over- hauling airport vehicles, etc.). The agreements are usually simpler than those for concessions and are for shorter terms (one year or less). The use of private contractors was frequent in all of the airports analyzed in the study. Contracting-out has the effect of privatizing a function that is being provided by the airport authority at a given time. This type of arrangement has been used to privatize a specific airport service through creation of a commercial company owned by former airport employees who previously performed that service. This mechanism reduces airport staffing and its related costs while simultaneously privatizing the service. (For example, the general maintenance of the airport infrastructure at Othopeni and Baneasa Airports in Buchar- est is in the process of being contracted to a private company recently created by former employees of the airport maintenance department.) Management Contracts. Under this type of agreement the management of all or part of the airport-related activities is contracted by the airport landlord (the airport authority) with a specialized airport operator for a given period of time and under specified conditions (performance criteria, economic incentives, maintenance commitments, etc.). Management contracts can take different forms in the case of airport-related activities, depending on the type of services to be managed, the type of autonomy in the day-to-day administration, and the financial incentives. In some cases the management contracts can even include some equity participation in

" In a recent airport conference in East Asia, an ICAO official indicated, "Airports today could be viewed as large shopping malls with aircraft access gates instead of street exits" (March 1995).

16 Overview PRIVATE SECTOR PARTICIPATION

the airport ownership. The management contractor will generally subcontract, via concession agreements with different specialists in the field, each of the airport commercial services (duty free, shops, car parking, etc.). This option is frequently used when the government wants to maintain ownership of the airport and has already undertaken - or committed itself to - major investments, but does not want to be involved in operation and management responsibilities. It's option is also utilized when the entire airport operation is privatized through the creation of a joint venture enterprise (involving private promoters, real estate developers, and local authorities) and airport expertise is needed to run the operation.

Examples of Option 1: a. FullAirport Services

Cameroon - Aeroports du Cameroun Management ContractforFull Airport Services. A new government-owned airport was opened in Yaound6 (the federal capital) in September 1991. The airport has a capacity of 2 million passengers per year, and total construction costs were approximately US$250 million. Aeroports du Cameroun (ADC), a recently forned (October 1993) joint venture company involving the Government of Cameroon, the national flag carrier (CAMAIR), and Aeroports de Paris (ADP) was created to manage and operate seven airports in Cameroon including Yaound6 International Airport. ADC contracted the management services for all of its airport-related services with ADP for a period of five years. ADP has moved a team of 10 expatriates to Cameroon to run the operations at the privatized airports. As the management contractor, ADP does not have investment commitments in major upgrades and expansions in the airports, and ADC is committed only to reinvest a portion of the profits. Given the relatively low traffic volumes in Cameroon, it is unlikely that major upgrades or expansions in the system will be covered by the joint venture company. The management contract has certain basic performance parameters, and incentives are based on the expected profits from the airport operation. A management contract was used in this case as the main privatization option, given government reluctance to give up ownership in the operating company (ADC) and the government's previous

17 AIRPORT PRIVATIZATION EXPERIENCES

large investment in Yaounde International Airport. In addition to illustrating the use of management contracts, this case por- trays the difficulties faced by governments with regard to cross- subsidies between airports when the operation is transferred to the private sector (only the airports of Douala and Yaounde generate positive cash flows before capital costs), and also points to some of the problems that can arise when the privatization process is not properly designed and the selection process is not adequately promoted. For further information see Case Study 2, "Airports in Cameroon."

Examples of Option 1: b. Landside/Commercial Services

This is the most common type of private sector participation in airport-related activities and usually takes the form of a rental concession for a given period of time. It is also the predominant mode of private sector participation in U.S. airports. Typically, U.S. airports operate on the basis of having one or two master concessionaires with the rights to operate all landside activities. The institutional economic design of the airport system in the United States does not encourage private sector ownership (i.e., the airport system is designed on the basis of direct/residual cost recovery, owing to the historical high influence of the airline industry in the sector). (See Box 2 for further details.) Pittsburgh Airport Authority (PAA) and British Airports Authority plc (BAA plc, operator) Landlord Service Concession for Retail Activities. Pittsburgh International Airport opened a new terminal with a projected capacity of 32 million passengers per year in October 1992. The airport is owned and operated by the local government (the Director of Aviation, Allegheny County, Pennsylva- nia). In 1991 the PAA granted BAA the management and development of all retail, food, and beverages services of the new 75- gate midfield passenger terminal through a 15-year master developer/lessee contract. BAA does not directly operate the concessions but sublets the space to individual operators as if it were the landlord of a shopping mall. BAA's experience in developing commercial revenues in Heathrow and Gatwick, resulted in positive results for PAA. Average spending per passenger climbed from US$2.40 to US$7.30 in the 1991-94 period.18 BAA created a local company (BAA Pittsburgh, Inc.) to

18 Overview PRIVATE SECTOR PARTICIPATION manage concessions at the Terminal Mall (35 shops, 9,200 square meters of space). Infrastructure investment in the Terminal Mall was funded by the local government with assistance from the

Box 2

AIRPORTS IN THE UNITED STATES

The United States is the world's largest domestic air passenger and cargo market and is serviced by approximately 1.400 carriers with a combined fleet of over 6,100 aircraft. There are 5,589 public use airports in the United States. of which 680 have scheduled services by airlines. commuters, andior air taxi operators. In the United States 101 airports have annual traffic flows oaover 1 million passengers. In terms of commercial movements, U.S. airports make up 45 of the worlds top 100 airports. Moreover. U.S. airports handle approximately 48 percent of worldwide passenger and air cargo transport. Almost all U.S. airports are owned and operated by local (state, county. and municipal) governments. Regional and local government ownership has encouraged the use of airports as important growth poles tor local economic development. As extensions of local governments, U.S. airports are considered public utilities and are administered on a not-tor-protit basis. Government linkages allow U.S. airports to obtain funding for infrastructure improvement projects through the issuance of general obligation bonds (which are backed by locai tax receipts) and/or airport revenue bonds. During the 1980s, federal spending on airports was minimal in relaTion to spending on other large infrastructure projects. The low level of federal funding for airports is a reflection of the role of local govemments in airport management and the fact that most large U.S. airports are sell-sustaining entities. The Federal Aviation Administration (FAA I manages the allocation of tederal grants which are used for the renovation and expansion of existing airport facilities (US$t.9 billion in 1994). The FAA does not directly regulate the economic activities ot airports. and this has allowed airports to pursue close economic and strategic partnerships with privately owned airlines. At all large and medium-size airpons in the United States, signatory carriers have negotiated favorable pricing structures tnrough airport use agreements. Many of these agreements also include Majority-in-Interest (Mlli clauses that give airlines veto power over airport financial and development decisions. Furthermore, airlines have vertically integrated operations through the development of new terminals on leased airpon property. These dedicated terminals are either build-operate-transfer (BOT) or wraparound additions that return ownership to the airport authority after a specified time period (e.g.. USAir and Pittsburgh. Delta and Atlanta. American Air- lines and Terminal D in Miami). As a result ot this close relationship with airlines. U.S. airports are directly affected by changes in the airline industry.

Continued ....

IB British Airports Authority, Asian Airports Conference, March 1995.

19 AIRPORT PRIVATIZATION EXPERIENCES

Box 2 (concluded)

The FAA's position on privatization is that airports are natural monopolies with low airside costs which would be abused by private ownership. U.S. carriers also oppose privatization on monopoly pricing grounds and are adamant against the loss of indirect subsidies.' Pnvatization would alter the close relationship that airlines have with airports and lead to the renegotiation of airport use agreements. FAA's position on privatization also stems from its military origins and the post-War view of airports as "strate- i gic national assets.'

Appmzr.ae t42owe'ent.:.IUS. a5 use>Cr 6a1Giror( C:!l I.;rs azj-W..n ,raIrr'..3,1ie, .>)-xld mrbl,Uc,* a. ervm MAthI l f u a I L flinSCrCA.COSISI flu r8n.M'rg tO8p&Cdre 01 U S ai'D(rISuse r:Sdu2I C'jS I'. Ihe 9'.5'TdI uC]u; cow,rNerr.,1 rrw,uC Ir;rC4I.UCOil-ca a-,h dnrgaJ a.r$.'as5 mae'esialu Tha.) elernhals I f s-,re urderprr.9n ad,ei cnan6es thmeUrneoSirne; Cr*.oye:: r.a B'irr i Omice*F.rn.dg US nspor1s 1 Fe,ancSrjLgLaertsS enMe 80 I

federal government (FAA). BAA also plans to offer its services to airports in Denver and New York City (La Guardia). The Pitts- burgh case also reflects a recent globalization trend in airport management. BAA plc, Aeroports de Paris, Aeropuertos Espanioles (Aena), and Vienna Airport are some of the airport corporations that are actively seeking a growing worldwide participation in airport activities. Hong Kong - Kai Tak Airport S Multiple PrivateConcessionaires. Kai Tak is a wholly government-owned airport in which, apart from air traffic control and apron management, the airport activities are operated by the private sector through service concessions (passenger services, ground handling services, car parking, etc.) and BOOT schemes (cargo handling, maintenance facilities, airport hotel, etc.). Kai Tak is extremely profitable (HK$1.0 billion in net profits in the 1993-94 fiscal period, or approximately US$131 million) and provides an interesting example of public/private sector partnership in the exploitation of airport-related services. Kai Tak Airport employs approximately 25,000 workers, only 370 of whom are government workers employed by the Civil Aviation Authority (CAA); the remainder are employed by private airport concessionaires. 19 Because of space constraints,

20 Overview PRIVATE SECTOR PARTICIPATION the airport has only eight gates (fingers) through which it handles 25 million passengers through the use of shuttle links between the aircraft parking areas and the terminal. The operation is run very efficiently; in terms of passengers per gate, Kai Tak has one of the highest ratios in the world. Sixty-five percent of Kai Tak's revenues come from non-aeronautical sources (landside activities), which are relatively high by international standards. This partially explains the stability of the airside charges (landing fees, aircraft parking, and passenger fees), which have not increased in the past four years, and the low level of CAA personnel at the airport (only 1.5 percent of the total work force). In terms of worldwide privatization experiences with airport infrastructure, the Hong Kong case could be labeled "a privately run corporation wholly owned by the government." (For further information, see Case Study 5, "Airports in East Asia.")

Option 2: State Retains Ownership of Airport but Transfers Investment as well as Operations/Manage- ment Responsibilities to Private Sector

As in most transport infrastructure privatizations, a recent worldwide trend in airport infrastructure is some type of arrangement in which the owner/landlord (the government) grants a long- term concession to the private sector for the exploitation of a given service (airside, landside, or both), provided the following conditions are met by the private party: (1) responsibility for funding the required investments in the development or upgrading of the facility; (2) operation and management of the facility; and (3) transfer of the property to the owner/landlord at the end of the concession period (infrastructure built under the arrangement). This is commonly known in financial terms as the build-operate-transfer (BOT) scheme and is widely used for infrastructure development. The following are some of the most common types of long-term leasing arrangements with pre-determined investment commnitments used for airport-related infrastructure.

' Even the internal security services are provided by private security services and funded by a group of private airlines that operating out of Kai Tak Airport.

21 AIRPORT PRIVATIZATION EXPERIENCES

* Build-Operate-Transfer(BOT). Under this scheme, a long-term concession (normally between 20 and 40 years) is given to a private firm for the exploitation of a particular service/facility (a passenger terminal, a cargo terminal, a runway, a complete airport, etc.). The private firm has the responsibility to finance, build, and operate the facility for a given period, after which time the property of the facility is transferred to the government at a symbolic price. The private firm does not take title of the property at any point during the concession. The private firm manages the cash flows from the operation of the facility, accounting for operational costs, capital costs, concession fees, and profits. The scheme allows governments to benefit from private capital market funding at no cost and without project risk (i.e., construction is the responsibility of the private sector) and commercial risk (i.e., the scheme also transfers operational responsibility for the facility to the private sector). Build-own- operate-transfer (BOOT) is a similar scheme in which the private firm takes property title to the facility in the construction period and transfers it back to the government at the end of the long-term concession (e.g., this is used in cases in which loan guarantees or collateral are required). Build-own-operate (BOO) is also a similar scheme, but in this case the property is not transferred back to the government at the end of the concession period. Build-transfer-operate (BTO) is similar to the above scheme but the government takes property title immediately after construction of the facility. ; Buy-Build-Operate (BBO). Underdeveloped or deteriorated facilities are bought from the government by a private firm for a given price and with the right to exploit the service for a given number of years (i.e., a concession). The facilities are upgraded and/or expanded and the property title is owned by the private sector.

X Lease-Develop-Operate (LDO). A long-term concession on an existing facility is given to a private firm. The private firm upgrades and expands the facility and operates it for the given period, managing its cash flows and paying the government a lease canon. The government holds the property rights throughout the concession period.

a Wraparound Addition. An existing government- owned facility is expanded by a private enterprise, which holds title to the addition only.20 The private enterprise operates the

20 "An Airport Executive's Guide to Privatization," American Association of Airport Executives and the Airport Research and Development Foundation, April 1992.

22 Overview PRIVATE SECTOR PARTICIPATION entire facility through a concession contract/operational agreement of the government-owned section (see Figure 1).

Figure 1 ltng -rerm lease or similar Wraparound Addition, Typical Structure

pcite Concessionaireb

fl Builds expans,on of airport lacilite I

ooOperates &maineainsin

Expansgon Airporeo Fcife t

M onteg sionaJmaica,is BOT arrangeduents simirInvesmen.

Theisoption als used in situatins,i,wic assigninlan ini- This option is becoming increasingly prevalent in cases in which an existing passenger terminal needs to be expanded through private sector participation, given that it may not be in the best interests of airport operations if two entities operate the airport -voneoperating the old terminal and the other the expansion. The option is also used in situations in which assigning an initial value to the old tesminal in the privatization transaction would seriously compromise the success of the operation (in view of the prevailing economies of scale). The airport expansion in Montego Bay, Jamaica, is being carried out through the use of a similar scheme.

In most of the BOT schemes used for airport infrastructure development, the private sector participates through joint venture affangements in which there, is usually a partnership among a real estate developer, a financial institution, and an airport operator. In these cases, once the construction of the facility is completed, the BOT scheme is followed by a management contract affangement between the joint venture company and the airport operator. An example is the new passenger terminal at Toronto International Airport, where Terminal Three Limited Partnership (TTLP) (the private consortium to which Transport Canada awarded the construction, development, and operation of Terminal Three) contracted in 1991 with Lockheed

23 AIRPORT PRIVATIZATION EXPERIENCES

Air Terminal of Canada (LATC)21 for the entire operation of the terminal once construction was finished through a management contract arrangement. Contracting out the management of a facility to an airport operator (whether or not the airport operator is included in the private joint venture company awarded the concession contract) has become an important part of successful privatization of airport infrastructure through the use of BOT schemes. In practice, BOT schemes in transport infrastructure for developing economies are becoming a substitute for ownership in cases in which externalities are perceived as politically sensitive, or where governments are in the initial phases of their economic reforms. To revert operations back to government in a long-term concession carries high transaction costs to society (rebuilding of the government's institutional capacities, dilution of public management efforts, etc.). Therefore, the likelihood of the concession's renewal is relatively high (in cases in which the concessionaire defaults on its obligations, a reallocation to another private concessionaire is likely). Under this scenario, ownership becomes an issue only from the financing perspec- tive, when fixed assets guarantees or collateral are required for bank loans. In these cases, lenders will tend to request some type of government guarantee on the conditions of the concession contract.

Examples of Option 2: a. Full Airport Services

Athens, Greece - Spata, the New International Airport BOOT for a Greenfield Airport Project. Since the late 1970s the Government of Greece has been considering the construction of a new airport in Athens. Over the years, government policymakers had nursed the idea of using private sector financing and management for this project, and by June 1991 the private sector was approached regarding the design, financing, construction, and operation of a new airport under a BOOT scheme. The scheme included the following considerations: (1) there would be a 40-year concession on both airside and landside services; (2) the old airport would be closed once the new

21 A subsidiary of Lockheed Corporation.

24 Overview PRIVATE SECTOR PARTICIPATION facilities were fully operational; (3) the government would retain a 40 percent equity participation in the airport operating company (the joint venture to be awarded the BOOT contract); (4) the government would provide part of the funding through an airport development fund (a passenger departure fee was imposed in November 1992 to create the fund), and would provide guarantees for EC and European Investment Bank (EIB) long-term financing; and (5) there would be economic regulation on airside charges (a price cap with an adjusted inflation formula) and a guarantee of open competition (more than two suppliers) in the provision of ground handling concession services. The initial project costs were estimated at US$2.3 billion to be disbursed in a period of 36 months.22 Seven companies expressed their interest, four of these participated in the bidding process from which the German corporation Hochtief AG23 was selected by the government in August 1993. In Sep- tember 1993 the Greek Parliament was dissolved and a new government elected. This government nullified the initial award and initiated a series of investigations regarding complaints by rival builders and mishandling of the bidding process. On July 28, 1995, after several delays and an EC overruling of the complaints, the Greek Cabinet approved the contract with Hochtief AG. Owing to the delays and to the change in government, some of the original conditions have changed, for example: (1) the length of the concession has been shortened to 30 years (instead of 40); (2) private ownership has been limited to 45 percent (the original participation was 60 percent); and (3) the total estimated cost has increased to US$ 2.6 billion (instead of US$ 2.3 billion). Toronto, Canada - Terminal Three at Lester B. Pearson Airport BOOTfor a New PassengerTerminal. The Lester B. Pearson Airport at Toronto (LBP) is one of the facilities owned by Transport Canada. LBP handles a third of Canada's air passenger traffic and 40 percent of the country's air cargo. It is the busiest airport in Canada and is among the top 30 in the world in terms of passenger and cargo traffic. A new terminal, Termi-

22 Coopers & Lybrand, "The BOOT Approach for Airport Development," October 18, 1993. t3 A large German builder, leader of the German consortium interested in developing and operating the new Athens Intemational Airport.

25 AIRPORT PRIVATIZATION EXPERIENCES

nal Three (T3, the Trillium), was opened in 1989, under private sector responsibility concerning of both infrastructure investment and operations management. At the time, this arrangement was one of the most interesting cases of airport privatization. The scheme was to build, own, operate, and transfer (BOOT) a new passenger terminal facility at LBP under a long-term lease contract of 60 years for the use of the land. The project was a greenfield concept to provide LBP with a new passenger terminal that would include the following characteristics: (1) 16 gates; (2) an access road; (3) capacity to handle between 5 and 6 million passengers a year with the potential to expand to up to 12 million passengers a year; and (4) an estimated project cost of Can$250 million. The concession was granted to exploit the airside and landside services in the T3 area.24 The concession contract for T3 was awarded in 1987 to Terminal Three Limited Partnership (TTLP), a consortium of Canadian real estate developers (Huang and Danczkay) and an airport operator (Lockheed Corporation). In 1992 Huang and Danczkay sold their share in TTLP to Claridge Properties Lim- ited (a real estate developer related to the Bronfman investors group, Seagrams). T3 is managed by Lockheed Air Terminal of Canada, Inc. (LATC) under a management contract from TTLP. Total development costs for the project amounted to Can$570 million, and the total time elapsed between the selection of the proposal and the delivery of T3 was three years. The original T3 project of 16 gates and 6 million passengers per year, was expanded to 29 gates (24 and 5 satellite) and a capacity of between 10 and 12 million passengers per year. Terminal One (TI) and Terminal Two (T2) are owned and operated by Transport Canada,25 which has promoted "real" competition for airport services within the same airport premises. Given the lack of economic regulation of airport-related charges in Canada, the terminal fees charged to airlines by T3 are three

24 Aircraft approach and landing, as defined in the study, is shared between Transport Canada (the airport authority) and T3.

25 An effort to privatize Tl and T2 at LBP was launched in 1992. The privatization process used was similar to that for T3. Negotiations were taking place with the "winning" consortium (the same participants involved in T3) late in 1994 before the general elections. After the elections, the new Canadian Govemment (Liberal Party) decided to invalidate the transaction while reconsidering its overall policy with respect to the aviation sector (i.e., restructuring and privatization of airports).

26 Transport Canada argues that if replacement costs (terminal facilities) were to be included in the pricing formula for charges at Ti and T2, the price differential would probably be a ratio of about 1.5 to 1 as opposed to 3.5 to 1.

26 Overviow PRIVATE SECTOR PARTICIPATION

times higher than those charged by TI and T2.26 Airlines are free to choose the terminal from which they will operate and the price mechanism associated with it. The differences in the terminal services (T3 is a new facility as opposed to the older facilities at Ti and T2) and in fees and charges have led to market segmentation at LBPAirport. International and prestige airlines (Lufthansa, British Airways, KLM, etc.) are using T3 services, Air Canada and domestic carriers are using T2, and low fare carriers (U.S. regional carriers, etc.) and charters are using Ti. Operation by the private sector has increased efficiency in the provision of airport services in T3. A Transport Canada official made the following statement during research for this case: "It takes TI and T2 forty-one administrative steps to replace a rug in the passenger service area, while T3 can do it with a phone call from the maintenance manager to the supplier." (For further information, see Case Study 3, "Airports in Canada.")

Examples of Option 2: b. Landside/Commercial Services

Maracaibo, Venezuela - La Chinita Airport LDOfor Existing Landside Facilities.On December 21, 1991, three commercial airports located in the State of Zulia (an oil-producing region located in northwest Venezuela) were transferred from the federal to the local government under a complex legal scheme. The Civil Aviation Authority retained ATC activities (including aircraft approach and landing) as well as the rest of the air navigation services (telecommunications, meteorology, etc.). On June 6, 1992, the three transferred airports (Maracaibo, Oro Negro, and Santa Barbara) were corporatized through the creation of the Zulia Airport Authority (ZAA) (an autonomous entity under the jurisdiction of the governor's office). In October 1992 a general call for bids for the privatization of the three airports under an LDO scheme was announced. The concession agreement included the following key components: (1) a 20-year concession for the exploitation of the landside services and selected airside services (i.e., aircraft parking and some passenger charges); (2) an investment program (to be defined by the bidder); (3) a fee of 5 percent of gross revenues to be paid to the ZAA; (4) a charge of 15 percent of gross revenue to be placed in a local government's trust fund for investment purposes; and (5) the stipulation that economic regulation would be applicable to passenger terminal fees through the ZAA.

27 AIRPORT PRIVATIZATION EXPERIENCES

Bidding took place in early 1993, and the LDO contract was awarded on May 14, 1993, to a consortium of three companies (Consorcio Aeropuertos del Zulia, made up of a U.S.-based consulting firm, a local civil engineering firm, and an international airport equipment supplier). Unfortunately, the performance of the private company, Consorcio Aeropuertos del Zu- lia, as an airport operator was not successful, and the company defaulted on a series of obligations in the concession contract (e.g., investment commitments, financial reporting, maintenance). Changes in the political context within the local government (a new governor was elected in January 1994) exacerbated matters, and the concession contract was voided by the new administration on February 21, 1994. Given the present state of the domestic airline market in Venezuela (in 1994 passenger traffic decreased by 16 percent compared with the previous year) and the political tendencies within the local government, the privatization process is not likely to be restarted. This privatization effort was conducted by a local government (after the decentralization) with little experience in either airport operation or privatization techniques. Although the intentions were positive, the execution of the process lacked consistency and transparency. Lack of adequate institutional capacities in place is one of the risks associated with the decentralization of airport functions in developing countries. (For further details, see Case Study 10, "Airports in Venezuela.") Spain - Palma de Mallorca Airport . BOOTfor New Services Terminal. This project consisted of the construction of a new services terminal to include a hotel complex, an expanded car parking area, and commercial offices. Palma de Mallorca is the second largest airport in Spain. It is an important tourist destination for Europe (13 million passengers in 1993). It is probably the airport with the largest peak traffic difference by world standards (January with an average of 300,000 passengers versus August with an average of 2.0 million passengers). In order to expand Palma de Mallorca's tourist offering to the international business sector the new terminal has been designed to provide the airport with a first class hotel and convention facilities. The total estimated project cost is 10,000 million pesetas (approximately US$80.0 million),27 to be disbursed during a three-year construction period. The project design and plans have been prepared by Aeropuertos Espanioles

27 Based on an average exchange rate of 125 pesetas to US$1 (September 1, 1994).

28 Overview PRIVATE SECTOR PARTICIPATION y Navegaci6n A6rea (Aena), an autonomous public entity with responsibility for the operation of the airport system and the provision of air navigation services. A BOOT scheme will be used for the development of the service terminal through a 40-year land concession to a selected developer (a joint venture between a private promoter and Aena). At the end of the concession period, the existing assets (i.e., service terminal) will be transferred to Aena at a symbolic value. The prices at which the services (hotel, parking, and office rental) will be provided in the new terminal are considered private prices, and therefore not subject to economic regulation. The international public bidding process for the selection of a private promoter to develop and operate the service terminal was launched in early 1993. The promoter was selected in September 1993 and has established a joint venture association with Aena under the predetermined bidding conditions. The joint venture company will develop, own, and operate the new service terminal. Aena's participation in the joint venture could reach a maximum of 31 percent. Project finance for 75 percent of the total project cost is presently being negotiated, and Aena's officials expect construction to start in the third quarter of 1995. (For further details, see Case Study 7, "Airports in Spain.")

Examples of Option 2: c. Airside Services

Bogota, Colombia - El Dorado Airport BOTfor the Constructionof a New Runway. In July 1994 the Civil Aviation Authority (Aeronautica Civil de Co- lombia) launched an international public bidding process for the construction and maintenance of a second runway (3,800 mt) for El Dorado Airport under a BOT scheme. This is one of the first cases world's in which a runway and its related infrastructure are built, financed, and maintained by a private sector consortium.28 The scheme, an innovative mechanism for private sector financing in infrastructure projects, includes the following components: (1) a 20-year concession for the operation and

28 Most of the airside services (aircraft approach and landing) in this case will be provided by a government institution (the Civil Aviation Authority), which is typical given the nature of the provision of air navigation services. The private sector will build the runway and provide the maintenance for both the new runway and existing runway during the concession period.

29 AIRPORT PRIVATIZATION EXPERIENCES

maintenance of the new runway as well as for the existing one (3,800 mt); (2) technical specifications for the construction of the runway, which will determine the development costs (estimated at US$98.8 million); (3) the provision of ATC services, including aircraft approach and landing, by the Civil Aviation Authority; (4) the transfer of landing fees to the concessionaire (a private sector joint venture company) as its source of revenues in the BOT project; and (5) the economic regulation of landing fees by the Civil Aviation Authority - but for the purposes of this project the Government of Colombia is providing a guaranteeto the concessionaire of a minimum level of landing fee revenues (i.e., the minimum level necessary for project implementation). The most important selection criterion in the bidding process is based on the net present value of the 20-year landing fee revenue structure proposed in the offer (including a formula adjusting for inflation and changes in the exchange rate). The proposal with the lowest value will be awarded the contract. Bidding was planned for November 25, 1994, but, given the wide interest of the private sector in this project, the final bidding date was extended to January 25, 1995 (19 private sector companies sent in their expressions of interest and 6 consortia presented final proposals). On May 15, 1995 the project was awarded to a consortium led by the spanish developer Dragados y Construcciones and incorporated as a Columbian Joint Ven- ture Company - CODAD S.A. However, the methods used in structuring transaction raise questions regarding the impact of the pricing strategy used for determining the levels of landing fees, and the use of government guarantees to enhance the project's commercial risks. (For further details, see Case Study 4, "Airports in Colombia.")

Option 3: Ownership, Operations, and Investment Responsibilities Are in the Hands of the Private Sector

This option is the least frequently employed mechanism for private sector participation in airport infrastructure because it en- tails private ownership of the property. However, results from this study suggest that this option will be increasingly used in privatization cases. As previously mentioned, the only cases from the analyzed sample in which 100 percent of both airside and

30 Overview PRIVATE SECTOR PARTICIPATION landside services of a given airport are under private sector ownership are some large airports in Britain (British Airports Au- thority, Liverpool Airport, and Belfast International Airport). Privatization alternatives used in this option range from the issuing of shares to be placed in the capital markets to the outright sale of assets, to a management buyout, as in the case of Belfast International Airport. In most cases the land used for airport operations is not included in the company or assets to be sold, and a perpetual concession (99 years or more) is granted to the new airport owners. Although full private ownership of an entire airport is still uncommon, more and more governments are allowing for 100 percent private ownership in parts of the landside infrastructure (passenger terminal, cargo terminal) as well as in the related infrastructure (hotel, business center, car parking, city transport, etc.). As governments redefine their roles in public services infrastructure, strengthening their capacities as policy planners and regulators, there will be more cases of full private participation. In some cases, for example the Copen- hagen International Airport and the Vienna International Air- port, governments have already taken steps toward the partial privatization of the airport corporations through the use of capital markets. The United States and some countries in Western Europe will probably move more cautiously toward complete private sector ownership of airports, given the influence of their respective airline industries in the air transport sector. (Some countries in Western Europe have not yet privatized their national flag carriers - a first step in the deregulation of the air transport sector).

Examples of Option 3: a. FullAirport Service

London, England - British Airports Authority Full Divestiture through the use of CapitalMarkets (Trade Sale). In 1986 the British Airports Authority, then under state ownership and comprising seven airports,29 was dissolved by the Airports Act and airport assets and liabilities were transferred to seven subsidiary airport companies. The rights and liabilities of all seven companies were transferred to a newly created holding company, BAA plc, for privatization purposes. On

29 Heathrow, Gatwick, Stansted, Southampton, Glasgow, Edinburgh, and Aberdeen.

31 AIRPORT PRIVATIZATION EXPERIENCES

July 16, 1987, 500,000 shares were offered to the general public under the following conditions: (1) the book value was 25 pence per share; (2) the sale value was 245 pence per share; (3) 100 pence was payable on application and the rest by May 1988; and (4) no allocation of shares in excess of 10 percent was to be made to any one person or group. By July 28, 1987, BAA plc was listed on the London Stock Exchange. Of the 500,000 shares 260,000 were offered to the general public and 240,000 were placed with institutional investors. Provisions were also made for shares to be placed privately in Canada, and since July 1988 shares have been quoted on the Toronto Stock Exchange. Cur- rently, BAA has approximately 511 million shares outstanding with approximately 523,405 shareholders (see Table 3).

Table 3 BA's shareholder profile, as of May 22, 1995 Number of Percent of Category Shareholders Total Shareholders Individuals 493,622 94.31 16.99 1 Corporate Investors 29,783 5 69 83.01 rTo 523,405 100.00. 100.00. Size of Holding 1-50C 467,357 89.29 10.08 501-1,000 26,888 5.14 1.96 1,001-5,000 25,240 4 82 4.70 5,001-10,000 1,807 035 1.25 10,001-30.000 787 015 1.33 30,001 and above 1,326 0.25 80.69

Total 523,405 100.00 Io.00 4

Source: BAA pic Annual Report, 1995.

Most of the shares are held by private individuals; however, no individual, with the exception of those granted special written permission from the Secretary of State, is allowed to hold an interest of more than 15 percent of the total shares. The Secre- tary of State holds a golden share which allows for intervention if an action is believed to contravene provisions in the Articles. BAA plc's business goal, as stated in BAA's 1994 An- nual Report, is simple: "To be the world's most successful airport company, and the key is making money through satisfying customers." The case study analysis suggests that BAA plc is

32 Overview PRIVATE SECTOR PARTICIPATION living up to its pledge. The privatization of BAA has led to a good investment opportunity for the private investor. The average rate of return for the 1988-94 period was 17.25 percent, and net assets per share have almost tripled, to £5 per share, in the same period. There has been a steady stream of dividends since the privatization (at an average of 13 pence per share), and the price/earnings ratio of the stock is today one of the highest on the London Stock Exchange (21.4). From the point of view of the general public, the upgrading and expansion of airport facilities in BAA's airport system enables the system to handle 82.0 million passengers a year (domestic and international), compared with 53.0 in 1987, which has made Heathrow the busiest international airport in the world, with 48.4 million passengers handled in the last fiscal year. Indeed, airlines and passengers view Heathrow as the world's hub. In March 1994 the accumulated investment for the post-privatization period amounted to £1,467 million, 40 percent in excess of total profits generated in the same period. The data in Table 4 present an interesting financial comparison between British Airways (the world's top international airline in terms of both revenues and profits) and BAA plc, as of August 1994.

Market Price/Earnings Table 4 Share Price Capitalization Ratio Financial Comparson of (f) (£ millions, British Airways and BAA August 1994) plC Brtish Airways 4.19 4.001 13.1 BAA pic 5.41 5,140 21.4

Sources: BAA Corporate Planning Division; Financial Times, August 15,1994.

Although airlines and airports are different types of businesses, the general view is that airlines are a more lucrative business. However, as of August 15,1994, the price/earnings ratio of BAA was 60 percent higher than that of the world's top financial per- former in the airline sector, and its capital market value was 28 percent higher. Airside charges (i.e., landing, aircraft parking, and passenger fees) are subject to economic regulation by the Civil Aviation Authority. In accordance with the Airport Act of 1986, the Monopolies and Mergers Commission developed the initial five-year price formula for the regulation of airport charges on the basis of unit cost increase recovery. To stimulate cost efficiency and productivity the formula provided for the calcula-

33 AIRPORT PRIVATIZATION EXPERIENCES

tion of maximum charges on the basis of the retail price index (RPI) minus X percentage points. The formula does not directly consider the gains derived from the economies of scale of airport traffic increases. This element, together with the relatively low component of cost efficiency (X= 1 percent) in the first five- year formula (1987-92), has created the perception that profits have been relatively high since BAXs privatization. It is difficult to define just how much of the traffic growth in the BAA airports is driven by non-airport-related factors (population growth, etc.) and how much is due to airport-related factors (capacity, efficiency, location, etc.), but without the investments and the general improvement in operations, traffic levels could not have reached the present 82 million passenger benchmark and thus profits could not have increased to the present £240 million. However, if BAA's profits continue to increase in the coming years (and it is likely that they will, given the air traffic projections for both passenger and cargo traffic), public concern might intensify and cause economic regulation to become more stringent and complex. Since economic regulation of airside charges will likely to limit tariff increases, BAA plc has been increasing its commercial revenue base (duty free, shops, restaurants, car parking, etc.) in order to minimize the impact of future economic regulation and to maximize the company's profit potential. BAA plc has also expanded its business into non-operational airport activities (real estate, hotels, insurance, etc.). More recently BAA plc has expanded its operations to overseas markets, and its Con- sulting Division is presently working on projects in Chile, Ec- uador, Mexico, Jamaica, Australia, and India. BAA plc is considering participating not only as a consultant but also as a joint venture partner. The percentage of total BAA plc revenues originating from commercial airport revenues plus non-operational airport activities was 70 percent in the 1993-94 period - by far the largest such percentage in the airport industry today (the average percentage of commercial revenues in the selected sample cases is about 40 percent). Heathrow Airport has developed strong retail marketing capabilities through an aggressive expansion of the commercial area. Terminal Four can, indeed, be considered a "shopping mall" with aircraft access gates instead of doors. Forty percent of the caviar consumed in Western Europe is purchased at Heathrow; the airport is also the home of

34 Overview PRIVATE SECTOR PARTICIPATION the World's largest Burger King.30 The forthcoming removal of duty-free privileges for EU passengers poses a potential threat to BAA plc's commercial strategy, and the company's management is seeking alternatives to replace anticipated revenue reductions.

Heathrow Airport reached its saturation point in 1994 when close to 50 million passengers went through its four terminals. BAA plc has begun its campaign to build Terminal Five, increasing capacity to 80 million passengers at a cost of US$1.35 billion. BAA plc has become increasingly concerned about losing its position as the world's leading international airport to other European competitors (i.e., Paris' Charles de Gaulle, Amsterdam's Schipol, and Frankfurt and Brussels Airports are all undergoing major expansions). Terminal Five is encounter- ing some resistance in the form of environmental objections, as well as from a public inquiry, ordered by the government in May 1994. (For further details, see Case Study 8, "Airports in the United Kingdom: BAA.") Montego Bay, Jamaica - Sangster International Airport Expansion of the Existing Airport through a Combi- nation of PPIMechanisms (a WraparoundAddition). The Gov- ernment of Jamaica is using a creative approach through which the entire operation of a public airport is being transferred to the private sector through an array of different mechanisms. Own- ership is to be partially transferred. However, if the program is successfully implemented, it would be, for practical purposes, equivalent to complete divestiture, given the role of the private sector in the scheme. The government, through the Airports Au- thority of Jamaica (AAJ), a public corporation in charge of the operation of the airport system, has for the last four years been working on the expansion of the Montego Bay Airport (Sang- ster International Airport) in order to meet projected traffic requirements for the year 2000 and beyond. The funding for the expansion is to come from private sources, and the government has announced its decision to privatize the existing airport operations as well as the proposed project expansion. The project consists of two phases: (1) the construction of a new passenger terminal (2.5 million passenger capacity); and (2) the upgrading and rehabilitation of the old passenger terminal, and its integra-

3 Robert W. Poole, Privatization:The Record to Date, The Reason Foundation, 1992.

35 AIRPORT PRIVATIZATION EXPERIENCES

tion into the new terminal. The total estimated investment for the two phases is US$104 million. A wholly owned subsidiary of AAJ has been created to hold the government's equity participation in the proposed private airport operating enterprise. The government plans to hold a minority position (up to 30 percent of the equity) in the new private airport operations. A BOO privatization scheme is being used for the expansion project. A new company, Sangster International Air Terminal Limited (SIA Ltd.), incorporated in 1993 as a wholly owned subsidiary of AAJ Holdings Ltd., is to build, own, and operate (BOO) the new terminal facilities at Sangster Interna- tional Airport. Once the capital financing structure for the BOO scheme is in place, SIA Ltd. will have the following equity distribution: (1) at least 70 percent will be in the hands of the private sector; (2) up to 30 percent will be owned by the government (through AAJ Ltd.). The articles of association of SIA Ltd. provide for a special share (the golden share concept) to be held by the government, conferring special rights requiring its consent on strategic issues (foreign ownership, dissolution of the company, etc.). AAJ will transfer, via a 49-year lease arrangement, the operation of the existing passenger terminal facility and the remainder of the landside facilities (car parking, duty free, ground handling, shops and restaurants, etc.) to SIA Ltd. Through the use of this mechanism, SIA Ltd. will effectively have ownership and control over the integrated terminal facility. The remaining airside-related services provided under the present arrangements by AAJ (i.e., runways, taxiways, and aprons) will be transferred to SIA Ltd. via a management contract. AAJ will retain ownership of these facilities and will share the airside charges with SIA Ltd. With this arrangement in place, together with the BOO scheme and the long-term lease, the newly created company, SIA Ltd., will have full operational responsibility for the provision of all airport-related services at Sangster International Airport. SIA Ltd. will start operations during 1996 with the construction of the new passenger terminal and the operation of the existing facility. Initially, the operations will be assumed by the AAJ staff to be transferred to SIA Ltd. AAJ is currently holding discussions with international airport operators that have expressed an interest in managing the operations of Sangster In- ternational Airport. (For further details, see Case Study 6, "Air- ports in Jamaica.")

36 Overview PRIVATE SECTOR PARTICIPATION

Best Practices Options

Although experience with successful airport privatization is relatively limited because the trend is recent, the following two options appear as most suitable in fulfilling government objectives in the privatization of airport-related activities.

1. Build-Operate-Transfer (BOTschemes)

When relatively large investments are required (i.e., a greenfield airport project or a large expansion), the BOT schemes (including the different variants, BOOs, BOOTs, BBOs, etc), if appropriately structured, can provide the necessary conditions for the transaction to be successful. In this case a government's main objective is to raise the funding for completion of the project while transferring operational responsibilities to the private sector. Operations will be granted through a Concession Agreement (i.e., a master concession), and responsibility for the funding will be undertaken by the concessionaire according to specific investment commitments outlined in the Agreement. The use of this option maintains government ownership of the facilities and thereby limits political conflict. How- ever, lack of ownership of the facilities under construction could become a financial obstacle for the private sector attempts to raise capital funds for the project. Financial institutions could assign a higher than normal contractual and political risk, thus increasing the project's capital costs.31 This is of particular relevance in the case of developing countries whose governments lack experience in such transactions. The BOT option for airport infrastructure development is best used when: (1) the facility or activity under consideration is independent of the rest of the operations (i.e., a cargo terminal, a new passenger terminal, a fueling facility); (2) the entire airport operation is placed under the BOT scheme; or (3) a greenfield airport project is used. In order to operate airports efficiently it is important to integrate management of the facilities (both existing and new facilities) under a single authority. Where a BOT is being considered for expansion of existing air-

31 Contractual risk is the debt service default resulting from the non-performance of contractual obligations undertaken by the governments or their agencies. Political risk is the debt service default resulting from political force majeure.

37 AIRPORT PRIVATIZATION EXPERIENCES

port facilities, the use of a Wraparound Addition (i.e., a long- term lease of the old facility to the BOT concessionaire) or a similar mechanism would help integrate the management of the complete operation under the authority of the private concessionaire building and operating the expansion. BOT transactions require relatively complex procedures and an array of technical and financial specifications if they are to be successfully implemented. If the government is to promote the use of this type of mechanism for airport privatization, it will need strong institutional capabilities in place, as well as expert advice, before embarking on the project. Figure 2 illustrates a typical BOT scheme.

Figure 2 A Representative BOT Scheme

Project Finance Financial Institultons Capital Markers Equity (promoters)

{ Privatization Process < BOT Concession ' t Revenue Sharingar Cnlaser Plcn Agreement in Concession Fees trategy 8lnnvelnmenis) onairtons o rConcessyon the Debt Services Trar,sactin Design o Invesment Commitments B Dividends + Reinvestments <_Bidcl2ng Procedures F D 1 I Govemment GovernnentaAgency W ) facilFinancial Institutions pressingneed, and private ownershi Provate Concessionair n / ePolicy & Regulation \.

< < ~~~~~~~CentralGove:rnm:en8t

Source: Morgan Stanley Asia Ltd./ World Bank, CFSPS (May 1995).

2. Full Divestiture (Sale of Shares orAssets)

When investment in a new airport facility or expansion is not a pressing need, and private ownership of airport assets is not an important issue in the political debate, full divestiture of the airport assets is the preferred privatization option. In this case, the

38 Overview PRIVATE SECTOR PARTICIPATION

government's main objective is to generate additional revenues for budgetary purposes (i.e., sale of assets or shares) while transferring operational responsibilities to the private sector. Depend- ing on the design of the privatization transaction, divestiture could take place through a trade sale to a strategic investor (a consortium or single enterprise with full majority ownership), or through public offerings via capital markets, or through a combination of both. For an effective stock flotation (a public offering via capital markets), a track record of a minimum threshold level of profits is required, supported by audited financial statements. For cases in developing economies that lack consistent financial reporting and possess relatively small economies of scale, this option might not be suitable in the early stages of the process. However, a combination of a first phase BOT/BOO followed subsequently by a public offering of shares from the operating company, might result in maximized transaction benefits.

Under both options, the government needs to strengthen institutional and regulatory capacities in order to guarantee a level playing field for all participants and to ensure the degree of consistency and transparency necessary for private sector involvement in the provision of public services. Governments promoting the privatization of airport infrastructure should include the following elements in their policy and regulatory agenda: Expand the scope of airport regulations to include a broader spectrum of economic, competitive, and environmental aspects beyond the traditional focus on safety and security 0 Establish independent regulatory agencies (i.e., financial autonomy and corporate structure)

XM Strengthen enforcement capabilities, in particular those derived from concession contracts, and formalize linkages within government agencies involved in air transport activities

X Discourage vertical integration, particularly when it leads to limits on competition • Develop pricing techniques for airport services that are based on economic principles.

39 AIRPORT PRIVATIZATION EXPERIENCES

111. INDUSTRY TRENDS BASED ON RECENT EXPERIENCES

N Governments will need to adapt quickly to the role ofpolicymaker and regulator Private sector participation in the air transport sector will continue to accelerate. As of early 1995, the private sector had a majority participation in the airline industry (70 percent of the airlines are private or have a controlling private sector partnership). This trend has only recently begun in airport-related infrastructure, but as budgetary constraints became more demanding, governments will shift the responsibility of operations and development to the private sector. Governments will need to adapt as rapidly as possible to a new role as efficient policymakers and regulators by strengthening their institutional capacities and developing sound and modem regulatory frameworks that facilitate an orderly development of air transport markets and participants. Lack of public investment increases safety risks and contributes to the deterioration of airport services, thus requiring that governments re- think their traditional role as owners and operators.

X Private ownership of public infrastructurewill in- creasinglybecome a non-issue in the public debate. Ownership will become less of an issue as the financial mechanisms for infrastructure development evolve and as sound economic regulation is in place and government institutions carry out their responsibilities in an effective manner. The concerns about externalities that arise with the private ownership of public infrastructure will be addressed through the legitimate execution of the government's new role. The experiences with private ownership in British public utilities and the recent cases of foreign ownership in most of the Latin American telecommunications utilities have demonstrated that there is no need for governments to retain ownership as a sovereign principle. i Consumerspending at airportfacilitieswill increase markedly and become the predominant revenue source.32 Air- port-related consumer spending will tend to increase in the coming years as a result of (1) higher airport charges to finance upgrades and expansions of the airport infrastructure, and (2) increased profit-oriented private participation. As theprivate sec-

32 Under this definition consumer spending includes the following items: (1) direct airport charges (either paid directly as a departure tax or indirectly through air fares), and (2) expenditures at the airport premises (i.e., duty free, shops, restaurants, hotels, entertainment, etc.).

40 Overview PRIVATE SECTOR PARTICIPATION tor increases its participation the capital costs of investments made in upgrades and expansions will be reflected in airport- related charges (in most of the analyzed cases airports under government administration did not include capital costs in their cost structure). Consumer expenditures at airport premises will also increase as a result of the expanding commercial orientation of the corporatized/privatized airports. In the long run, as traffic increases, commercial revenues (non-aeronautic revenues) will gradually overtake airport-related charges (aeronautic revenues) and these commercial revenues will provide the predominant revenue contribution (see Figure 3). Figure 3 Airport life Cycle Curve

Developing Countries TrafflC | * Increased capacity of the \ airport system Growth Large porMon of revnues \from airstde chargr&s Relatively high m (simple economic High Traffic Growth regulation)

Developed Counries \ Maxrmum revenue base witA Traffic Growth imed passenger growth Matures * Large rton of revenues (complex economic from commecial s _rv regulation) Relatively low Low High Share of Commercial Revenues (out of total revenues)

Source: Morgan Stanley Asia Ltd., World Bank (CFSPS), May 1995.

Airport-related charges will then level off and, in some cases, decrease in real terms. This is already taking place in BAA plc, and although, given the airport size, the experience is not entirely transferable, some indications of future trends can be in- ferred. The commercialization of airports via entertainment expansion is reaching new heights: in 1995 Amsterdam's Schipol Airport will be opening the world's first airport gambling ca- sino - an addition to its existing line of entertainments at the airport site (a computerized golf course, a gym, a sauna, tanning booths, etc.).

41 AIRPORT PRIVATIZATION EXPERIENCES

Price competition will not be a drivingforce in the industry; therefore, well-designed regulation of airport-related charges as well as the necessary institutionalcapabilities will be needed to facilitate the transfer of airport activities to the private sector Given their character as relative natural monopolies, the airports industry will not be driven by price competition. There may be situations in which airlines that want to establish a "hub" operation could be looking at airport pricing as an important variable. Such situations would apply only in the few cases in which there are different well-run airports within a relatively short distance that could compete for those airlines' traffic (airports in the Persian Gulf countries, airports in West- ern Europe for sixth freedom traffic, some airports in the Carib- bean for traffic beyond destination, etc.). However, generally, price competition in the industry will not be a predominant force. Therefore, economic regulation of airport-related charges will have to be carefully designed and institutional capacities will have to be put in place as part of the successful transfer of airport activities to the private sector. Perhaps the most relevant experience with applied economic regulation of airport charges is the British case, from which lessons can be learned to deal with misconceptions on the development of pricing methodology. However, within the airport, competition should be encouraged among the different types of service concessions (landside activities), particularly in ground handling services. Given their impact on an airport's operational performance, ground handling services should not be concessioned on an exclusive basis, to avoid unfair pricing practices and excessive control of the operations.33 Healthy competition in the provision of landside services will improve an airport's performance and consumer satisfaction. However, not all landside services can be economically feasible for more than one concessionaire, and economies of scale should be considered when this decision is made. Box 3 depicts a case for future competition among airports.

33 Iberia, the Spanish government-owned airline, until recently possessed exclusivity in the exploitation of ground handling services at airports in Spain. On November 1994, during labor negotiations between Iberia and the Spanish Government, the ground handling services were part of the airline's slow-down operation affecting airport performance during that period.

42 Overview PRIVATE SECTOR PARTICIPATION

Box 3

A CASE FOR FUTURE COMPETITION AMONG AIRPORTS By 1998, live sizable modern airports will lie within a 75-mile arc radiating from Hong Kong to within mainland China through the Pearl River Delta. Kai Tak (later Chek Lap Kok), Guangzhou, Zhuhai, Shenzen, and Macao Airports will offer a combined capacity of approximately 70 million passengers/year and 1.5 million tons/year. Hong Kong's airport will account for the leading share of traffic (50 percent of passenger traffic and 85 percent of cargo). These five airports will compete for traffic in and out of mainland China once their respective expansions or new constructions become operational. However, if the pace of growth in this part of the world is sustained (i.e., between 15 and 20 percent annual growth) and airport construction experiences common delays. the competition among airports will be reduced by the spillover effect of the facilities that are near saturation. Even if the five airports are completed by 1998, competition among them will be based more on adequate capacity and the ability to handle passengers and cargo than on level of landing fees unless there is an extreme difference regarding airports pricing policies.

CHINA

:-.1. earl River Delta

Kong

Airport efficiency in handlingpassengers and cargo, and the timely expansion of airport capacity, will drive competitiveness in the industry and its impact on economic growth. Airports are driven by the expected demand generated at destination points including the traffic flows of passengers going through a hub connection. In this respect, the airports' ability to foresee the need for timely capacity increase, and their efficiency in handling traffic through facilities, will become the predominant driving force in the industry. Airports are becoming a key component in government's growth strategy targeting the development of the tourism and trade sectors. East Asian airports provide a remarkable example of the contribution of infrastruc-

43 AIRPORT PRIVATIZATION EXPERIENCES

ture projects to economic growth (see Box 4). East Asian airports illustrate two key elements which are particular features of airport development and privatization strategies in fast-growing economies: (1) the government perception of the private sector as ill-suited for airport development management because of a bias toward short-term financial rewards rather than long- term economic growth; and (2) the selection of a privatization

Box 4

CHEK LAP KOK AIRPORT, HONG KONG The Govemment ot Hong Kong has embarked on one of the most ambitious transport infrastructure development programs in the world today. the Airport Core Program (ACP). The total cost of this mega-infrastructure project is estimated at HK$158 billion (approximately US$21 billion), and its main component pivots around a new airport development (i.e., Chek Lap Kok) intended to replace the exisling Kai Tak Airport. The ACP consists of 10 interdependent projects with completion dates interlinked around the airport opening in late 1997. The implementation of the 10 projects is being coordinated by the New Airport Project Coordination Office (NAPCO), which has been set up under the Hong Kong Govem- ment with an integrated team of government and consultant staff to act as project management advisers. In 1989 the Government of Hong Kong created the Provisional Airport Authority (PAA) as a statutory corporation. wholly owned by the government, to build and develop the new airport at Chek Lap Kok. Legislation was prepared and submitted to consultations with the Chinese authorities (i.e., the Sino-British Memorandum of Understanding) for the creation of the Hong Kong Airport Authority, a government authority with the responsibility for operating and administering the airport-related services at Chek Lap Kok. The Airport Authority ordinance was enacted by the Governor of Hong Kong on July 27, 1995. Once the new airport authority is created, the personnel and operations of the PAA will be transferred to the new institution. When construction reaches its peak by the middle of 1996, more than 20.000 workers will be in the airport island. The airport is expected to be open in April 1998. The ACP will be Hong Kong's most important infrastructure development if Hong Kong in helping maintain its competitive edge as a major "commercial hub" of the East Asian region. The project will replace the existing airport, which has reached tull operational capacity (only one runway) and is severely limiting the increase in both passenger and cargo traffic.' The project will integrate intermodal transport facilities (airport, highway, railway, and port) in the Kowloon/New Territories area and will later connect to main transport links with southem China (i.e., the Guangzhou region). Tne ACP is being jointly financed by the Govemment of Hong Kong and the private sector. The government is contributing HK$113.3 billion (approximately US$14.8 billion) in equity investments and public works, and the remainder (HK$44.9 billion, or about US$4.3 billion) is being contributed by the private sector in the form of equity investments. commercial lending. and project finance (i.e., BOOT for the Western Harbor Crossing Project).

Tne CivilAviation Departmeni eslirrales Iat between 30 and 40dai tight peitions h,a.e been rerected during 1994.

44 Overview PRIVATE SECTOR PARTICIPATION mechanism at project completion rather than at project start-up, which results in more rewarding financial proceeds and favors a long-term strategic view in building airport capacity. Airlines will tend not to integrate vertically into airport ownership. As part of the present report, a survey of airline views on airport facilities was conducted in October 1994. Given the importance of airlines as primary airport customers and their influence on government policymakers, it was considered necessary to include their views regarding airport privatization. 34 The impact on airlines of the recent airport privatization trend has not been fully explored. Evidence from the survey suggests that there is growing concern among airlines regarding the impact that airport privatization could have on airport charges, given the profit-oriented nature of a private business. Survey results, together with experiences from the sample cases, appear to indicate that airlines are not eager to expand their roles in airport ownership and management (i.e., airside services and terminals) as part of their future growth strategies. It would appear that keeping up with the pace of technological changes in aircraft- related equipment will consume the lion's share of airline cash resources in the near future. Only in cases where carriers can have access to their own gates and terminal facilities (dedicated terminals) is participation in management and investment of airport infrastructure considered. This is the case, particularly with the United States, given the unique relationship between airlines and government-owned airports (e.g., Delta Airlines invested US$375 million in late 1994 in the construction of a new dedicated terminal facility at Cincinnati/Northern Kentucky Airport to be used as a hub to compete with Chicago).35 For further details on the airline survey, see Technical Annex 1. Efficient airport corporations will become global operators.Air transport is one of the engines of industry globalization, and airport operations are an important component of that engine. Global operators of airport-related activities are beginning to appear as air transport evolves into the next century. Even now, airport operators in Europe and to a lesser extent the United States are starting to transfer airport technology and services to developing economies (examples are BAA plc, Aroports de Paris, Aena, and Lockheed Airport Division). In

I The survey consisted of a written questionnaire mailed to 60 carriers providing worldwide services. Responses were received from 20 airlines.

35 Delta itself issued more than US$500 million in special-facility revenue bonds for this and related projects.

45 AIRPORT PRIVATIZATION EXPERIENCES

the coming years, airport and related services (duty free, cargo handling, ground services, etc.) operators will become more glo- balized, with partnerships in different countries and with more uniform products or services to offer the end-consumer. For example, a subsidiary of Munich Airport Cargo developed and operates a new cargo terminal (60,000 tons capacity) at Shen- zhen Airport Corporation in Southern China, and Aldeasa, a Spanish duty-free operator, operates concessions at Lima's In- ternational Airport in Peru, Santo Domingo Airport in the Do- minican Republic, and Tangier Airport in Morocco.

IV. LESSONS FROM RECENT PRI\VATIZATION

_TRANSACTIONS ___ _

X Corporatizationof airports is a useful first step to improve airportperformance but is not a substitutefor a well- designed privatization. In most of the analyzed cases, the government decision to privatize airport activities was heavily influenced by lack of funding for modernizing facilities and by weak public management capacities for operating airports and their activities. Airports, like other activities in the air transport sector, are dynamic industries in which expedient decisionmaking and implementation are well rewarded through efficiency and market gains. The public sector is ill-prepared to deal with the dynamics of this type of service industry, even more so when airports are operated through central government agencies rather than through autonomous government corporations. Corporati- zation of airports is a positive step in the evolution of government's role in the provision of public services, but is only a first step. The more the role of government can be confmed to regulations and policymaking activities, the more the gains in industry dynamics will benefit airport operations as a whole. i Cross-subsidiesamong airportswill need to be addressed and explicit mechanisms established before the transaction. As previously mentioned, not all airports are financially attractive. There is a threshold of traffic volume that varies according to traffic type, airport size, and investment costs that must be considered when a financial transaction for airport privatization is designed. (For further information, see Box 5.)

46 Overview PRIVATE SECTOR PARTICIPATION

Box 5

AIRPORT ECONOMICS - TRAFFIC THRESHOLD LEVEL Airports are a cash-generating business. After a threshold traffic level sufficient to fully pay capital costs isreached airports can be a lucrative business. Airports resemble a business complex with different sources of revenues (aircraft-related charges, passenger taxes. services charges. consumer expenditures. rentals. concessions, etc.) and three main types of expenses: (1) labor costs, (2) operational costs (maintenance. repairs, services, etc.). and (3) capital costs (financial costs and depreciation). If airport operations are well structured and investments are properly planned and executed, airports beyond a minimum traffic level will make money. However, not all airports are economically viable. Secondary airports catering primarily to domestic trattic have more difficulties reaching their threshold traffic level than do international airports. and there are some cases, particularly in developing countries. where there is a need to maintain domestic airports that will not reach their threshold level for many years. This is one of the key components to be considered in the design of the privatization scheme for a national airport system, where the international airports in the system generally cross-subsidize the other airports. In an attempt to illustrate the * economics of an airport and to provide a profile of the threshold traffic level needed to generate positive cash flows, a financial simulation model was developed in the context of this report. For international airports the traffic threshold level needed to start generating positive cash-flows appears to be between 1 and 2 million WLU per year, For further details on the data and results of Ihe financial model. see Technical Annex 2: Airport Economics.

WLU = Woiking Load Unil laquivalenl Ioone passenger or 100 kg ot cargol.

The following options could be utilized in the privatization of airport systems that include financially unattractive airports: Include (package) profitable and unprofitable airports in the privatization transaction. Government is left only with the roles of regulator and policy maker thereby reducing Government bureaucracy to a minimum. How- ever, the privatization transaction is less attractive from the financial point of view and reduces the amount of investment commitments and potential participants in the bid. _1 Include (package) only the profitable airports in the privatization transaction. Cross-subsidize the rest of the airport system with concession fees from the privatization transaction. Project cash flows, investment commitments, and potential participants in the bid are maximized by this approach. However, Government is left as the operator and manager of the unprofitable airports. Government administers concession fees (bureaucracy).

47 AIRPORT PRIVATIZATION EXPERIENCES

Separate into two privatization transactions: (1) package profitable airports and (2) auction management and operations of unprofitable airports to bidder requesting lowest subsidy. For transaction (1) cash flows, investment, and bidders are maximized while for transaction (2) operation and management responsibilities are transferred to the private sector. However, Government is left with the role of administering subsidy payments to private operators. * The decentralizationofairports should be sequenced in line with the development of local institutionalcapabilities. The decentralization of airport administration is a necessary step in the evolution of the government role in the provision of public services as well as in the process of political reform. How- ever, when the privatization transaction of a national airport system is being designed, careful consideration should be given to the existing institutional capacities at the local/regional government level, so that the privatization process can be successfully completed. Frequently, governments are tempted (for political reasons) to accelerate the decentralization of infrastructure-related services, but if local/regional institutional capacities are not adequate to handle a privatization process, the consequences can be unfortunate. In such cases it is better to implement the privatization process before decentralization and, after that, to initiate the transfer of government responsibilities to the regional/ local authorities. A well-designed privatization will generate private fundingfor airportexpansion. After an economic threshold is reached (traffic volume), airport construction or expansion efforts should be able to access private funds (equity and debt), provided the privatization model (the transaction) is well designed and structured. Key factors deterniining access to private sector funding include: (1) the conditions of the concession (length of time, fees, penalties, etc.); (2) the quality of the airport operator; (3) the definition of management responsibilities (degree of autonomy); (4) a clear and reasonable economic regulation scheme; and (5) an equitable distribution of risks (construction risks, commercial risks, contractual risks, and political risks) between government and the airport operator. The privatization of an airport facility is essentially the sale of a future cash flow; actions to safeguard the future cash flow and enhance its risk perception will help optimize the private funding options of the project. Box 6 provides a summary of the components of an airport privatization program.

48 Overview PRIVATE SECTOR PARTICIPATION

Box 6

AIRPORT PRIVATIZATION PROGRAM - KEY COMPONENTS

There was ro evidence during the course of our research that governments were folloving a similar pahtern when privatizing their airport operations. or that a comrron approach to strategic decisions was shared among them Funding needs for upgrades and expansions coupled with budgetary constraints vias the only consisterit pattern among govemments privatizing or having privatized their airport operations On the basis of our findings regarding the recent airport privatization experiences (completed and inprogressl the following summary is provided of the key components of an airport privatizaton program and the type of expertise required for successful implerrientation.

Key Components Type of Expertise 1 Master Plan. An analysis of trie national airport system includirng. (11 Specialized Consuli,ng financial modeling of the elements in the system fie.. air navigation ser- Firm in the field of air- vices, profitable airports. unproftable airports civil aviation authoritv. etc I port planning (2) traffic forecasts: and i31 investment needs.

I 2. Restructuring Study. Separation of air navigation activities from airport Specialized Consulting activities (if necessary). Definition of airport activities to be privatized (i e., Firm inthe field of sec- airside, landside, or complete operation). Packaging of airports to be priva- ior strategic analysis tized (i.e.. profitable airpons. unprofitable airports. greentield prolectis etc.) and planning Definition of the cross-subsidies mechanism. Future cash-tlow of the system under the proposed privatization arrangement

3. Analysis of the Institutional and Regulatory Framework. Diagnosis of Specialized Consulting the institutional capabilities of government agencies (i.e .civil aviation au- Firms in the field of hority, regulatory agencies. etc.] Adaptation oGexisting regulations Io pri- regulatory anra instlu- vate sector participation in Ihe provision of airport services. Detinitic.n cf tional ecoromics pricing techniques and formulas for sound economic regulation. 4. Design and Implementation of the Privatization Transaction Pnvati- Financial Adviser. In- zation option to be used (ie.. BOT, sale of assets, multiple seRvice conces- vestment Bank wvith sions, management contracts. etc) Financial design ot the transaction li.e . experienice in irfra- airport revenues, prcing tormula. concession fees. level of invesimenis, structure transactions debt capacitl. etc.l. Bidcling process (ie.. sales memorandum, bidding conditions, marketing process. etc.) Completion of the sale (i.e transfer of assets, signing of the concession contracIt etc.)

| Transparentprocesses have a higher payback. As with other infrastructure sectors, the use of transparent and competitive mechanisms (public bidding process, adequate dissemi- nation of information, etc.) to accomplish the privatization of airport-related facilities will tend to increase the economic value of the transaction as well as goodwill for the project. Cases in which, because of previous circumstances, governments have been restricted to negotiating the privatization of airport-related facilities with one partner have not provided the maximum benefits to the society as a whole and often have not contained ap-

49 AIRPORT PRIVATIZATION EXPERIENCES

propriate incentive mechanisms for future investments; thus they have also run the risk of being reversed because of perceptions of unfair practices.

The private sector will become a leading player in financing and operating airport infrastructure during the coming years. Governments, particularly in developing economies, will have to rely increasingly on private sourcing of funds to bring their airport infrastructure up to the market's growing demands as deregulation and globalization affect the air transport sector. Gov- ernments in developing economies will have larger constraints placed on their budget expenditures as social investment needs become more acute. However, for these economies, airport infrastructure development will be crucial to their efforts to become members of the global economy. These governments face the challenge of designing and inplementing creative privatization schemes and innovative financial mechanisms for their infrastructure needs. This will prove crucial in facilitating the flow of private capital and private management to airport operations while economic traffic threshold levels have not yet materialized. The ways in which this challenge is met will determine which economies will hold a competitive edge in the air transport industry.

50 Case Study 1

BOLIVIA

AIRPORTS IN BOLIVIA

A CASE STUDY OF AIRPORT PRIVATIZATION IN SMALL-SCALE MARKETS1

Bolivia, a landlocked country with a large territory equivalent to that of France and an irregular topography, relies heavily on air transportation for internal and external communication links. It is reversing a history of inward-oriented policies with regard to the air transport sector. Given its strategic location with regard to larger air transport markets (i.e., Argentina, Brazil, and Chile), Bolivia has the option of becoming a regional hub provided that an appropriate institutional, legal, and regulatory framework can be established. Prior policies, which contributed to isolating the sector from the rest of the world, assumed a bolivian inability to compete. The new course taken by the Sanchez de Lozada government attacks the root causes of inefficiency by reforming the institutional and regulatory frameworks while encouraging capital inflows. In 1993, as part of its economic reform program, the Government of Bolivia initiated an ambitious program of private sector participation in the nation's infrastructure needs. The Capitalization Program, an integral part of the reform process, involves awarding shares corresponding to equity increases in state-owned enterprises (SOEs) in exchange for contributions

'Research for this case was conducted between October 1994 and June 1995.

51 AIRPORT PRIVATIZATION EXPERIENCES

(i.e., cash, equipment, management services, or a combination). 2 The strategic investor obtains full management prerogatives and equity ownership normally equal to the actual value of the company to be capitalized (up to a maximum of 50 percent). Half of the value of the newly capitalized company becomes the strategic investor's equity share. In accordance with the Capitaliza- tion Law, the shares representing the other half of the company will be distributed on an equal basis to all adult Bolivian citizens. These shares will not be given directly, but will be placed in deferred distribution accounts managed by private pension funds, to be withdrawn at retirement. It is envisioned that the shares will stimulate a new privately run pension system and foster domestic capital market growth. Airports have traditionally played a key role in the development of the regional economy, and in some inaccessible areas they continue to be the only viable transport mode. Con- straining the government's flexibility in reorganizing the system are dozens of small, loss-generating airports that nevertheless serve a vital national purpose. These airports have to be subsidized and are not sufficiently attractive to lure private investment. Three large airports, two of which (La Paz and Santa Cruz) are profitable, raise questions as to what type of cross- subsidization would most effectively balance the interests of the profit-oriented private sector with national political interests. The Government of Bolivia has opted for a build-operate-transfer (BOT) scheme for the development and privatization of the three major airports because of the urgent need for major investment in the La Paz and Cochabamba international airports, as well as ownership considerations in a sensitive sector. The government is considering the creation of an Airport Development Fund (ADF) to manage the concession fees from the BOT that will finance operations of non-profitable airports. Although the Bolivian privatization experience is still in process it is of notable significance for airport privatization in developing countries because it addresses the cross-subsidization issue within a small-scale market context. The airport consulting division of A6roports de Paris (ADP), hired by the government to undertake an analysis of the national airport system, found that the existing capacity had not been managed well by Administraci6n de Aeropuertos y Servicios Auxiliares de Navegaci6n Aerea (AASANA). Furthermore, facilities had de-

2 The eventual capitalization of YPFB (hydrocarbons), ENTEL (telecommunications), ENDE (electricity), ENFE (railways), LAB (airline), and EMV (smelter) is contemplated.

52 Case Study 1 BOLIVIA teriorated and security and safety compromised prior to the privatization decision. In addition, ADP's projections of future air traffic flows (see Figure 1.1) support forecasts and expectations for future constraints on the air transport sector's infrastructure. In view of the need for managerial improvements in the sector (analyzed later in this study) and future requirements for relatively large investments, the government decided to reform the air transport sector, an undertaking it initiated through the capitalization of the national flag carrier and principal passenger service, Lloyd Aereo Boliviano (LAB),3 and aims to follow up with a restructuring involving breaking up AASANA's monopoly on all facets of airport sector policy establishment and implementation.

80 - Figure 1.1

-0 --______- ___-- .-- -- . Bolivia: ProjectedAir Traffic Flows, 1993-2020 g 60 ,, ______i ____

~.o

o*302.0 I E 0.0-;1111 WIL _EI I 1993 2000 2005 2010 2015 2020 Actual Projected Year 13 Domestic Passengers * International Passengers Source: ADP, "Pian Maestro del TransporteAereo de Bolivia: Informe Final," May 1995.

Which should take place in late 1995.

53 AIRPORT PRIVATIZATION EXPERIENCES

ECNI [ 2 !8 ' . - -d A

. 9 XC ~~~~. -*-. BRA2IL -

1.1 a ~~~~I/ 4 -_ P

KBOLIyA

_ '-I<

ACr,i, Y EAP - CENTFRAL cC-tITr AMEFRICA

^-'", - BOLIVIAASANATURAL l1= SOUTHERN CONE HUB

'0 _ E E __7 __ 1 _ AAC-ENT,PA ii -

,~~~~~~~ e. ';rr

* .i. AlN A. * -e__

1. OWNERSHIP AND INSTITUTIONAL FRAMEWORK

A. AASANA

Bolivia's legal framework4 gives AASANA responsibility for all activities concerning air transportation, air administration, and, to a partial degree, formulation of policy and some regulatory activities. AASANA drafts air transportation and airport safety standards. It obtains almost all airport system revenues by charging landing, apron, parking, passenger, and other fees. The 37 public airports are controlled and administered by AASANA. Most countries possessing modern aeronautics legislation divide the airport sector into four broad, institutionally distinct categories based on function: policy formulation, regula-

I The laws of October 16, 1968, D.S. No. 08019 of June 21, 1967, and Decree No. 12965 of October 15, 1975.

54 case study 1 BOLIVIA tion, air navigation services, and airport operations. Bolivia assigns all these functions to AASANA. The latter's large budget and staff make it the most important government agency with respect to the air transport sector. In the regulatory arena, AASANA sets tariffs and provides airport services. From these functions AASANA derives fiscal independence. In the area of air navigation services, AASANA provides air traffic control (ATC), telecommunications, meteorology, and runway approach services. AASANA plans airport infrastructure and investment expenditures. In addition, administration, management, construction, supervision, improvement, and maintenance of the 37 public airports fall within AASANA's domain. AASANA has a highly centralized structure (see Fig- ure 1.2, following page). Through its technical direction it controls and operates the entire airport and air navigation system. Technical direction is divided into four divisions: Operations (i.e., ATC and meteorology) Civil Works (i.e., planning and design, maintenance, architecture, and construction) a Electronics (i.e., telecommunications, radio, etc.) |.1 Airport Services (i.e., operations administration and maintenance of airports). In 1992, in an effort to initiate a decentralization process, the Airport Services Division created four separate departments with responsibility for day-to-day operations of different airports in particular regions: La Paz Cochabamba A Santa Cruz 1.19. Trinidad. The regional departments have very limited financial autonomy.

55 AIRPORT PRIVATIZATION EXPERIENCES

Figure 1.2 Bolivia: AASANA, Organization Chart

Directorate

Execul,ve Counicil

Tecr,nica l (Administration) Secretary Planning & Legal/ Directort 11 8 Finance j General A Information A Auditing

O_perat...vio....s .,,M

E3 <) r ---- ~~.- -,. . -- Airport XElctronics Santa Cruz | La Paz Trinidad Cocha- Set~~ ~Eicoea Regional I Regional I Regioa I bamba Re1gonal

Source: Squire, Sanders and Dempsey, "Regulatory Framework for Bolivia's Aviation Sector," May 1995. AASANA's broad powers and the lack of regulation of its activities result in a sort of "black box" state of affairs. Rev- enues from airport service charges, and government subsidies, after entering AASANA, are not properly accounted for and therefore lend credence to the view that there is a lack of transparency in the entity's financial affairs. This lack of transparency has led to perceptions that AASANA has been misman- aged and has enjoyed a relatively high degree of administrative discretion in the past.5

B. DGAC

The responsibilities of the Direcci6n General de Aviaci6n Civil (DGAC), promulgated in 1947, include the elaboration and control of technical regulation. The DGAC ensures that domestic safety standards comply with International Civil Aviation Orga-

"The AASANA Swindle," The Bolivian Times, November 3, 1993.

56 Case Study 1

BOLIVIA

IDA' TECHNICAL ASSISTANCE PROGRAM FOR THE Box 1.1 REFORM OF THE BOLIVIAN AVIATION SECTOR

A properly organized aviation sector is important to the economic development and integration of Bolivia. Lowering state Intervention. enacting a clear and effective regulatory framework which increases private sector participation, and expanding Bolivia's ties to the rest ot the world through an outward- oriented air transport sector were the government priorities. IDA has provided the technical assistance for the aviation sector reform through IDA credit (Regulatory Reform and Capi- talization Technical Assistance Project). Total technical assistance to the Bolivian aviation sector is in the order of US$3.5 million. The Bank is providing technical assistance for the development of (1) the capitalization ot LAB; (2) the restructuring and privatization ot AASANA; (3) a suitable institutional and regulatory framework; and (4) the restructuring of the smaller domestic airline operations of Transporte Aereo Bo- liviano (TAB) and Transporte Aereo Militar (TAM) (both owned by the Military). LInlmalional DevelopmenlAssr.cialion nization (ICAO) norms. The DGAC's legal charter entrusts it with (1) economic and technical regulation of the air transport sector, and (2) organization of and policy development for the sector. The DGAC also registers the 138 airports, including the 37 controlled by AASANA, in Bolivia and controls and administers the 101 small airports (landing strips). AASANA's control over the remaining 37 airports creates a non-uniform system in terms of air transport security. The DGAC, under the supervision of the Sub-secretary of Civil Aeronautics (SSCA), registers aircraft and issues aircraft permits, pilot licenses, and aircraft operating licenses. Co- ordination and harmonization at the international, continental, and regional levels are of particular relevance in the air transport sector. The DGAC's insufficient economic and human resources impede its ability to carry out the above tasks, and it has had difficulty in ensuring compliance with air transport sector security norms. The U.S. Federal Aviation Administration (FAA), as part of its 1994 safety oversight program, found that the DGAC's inability to fulfill legally mandated functions endan- gered the safety of passengers, pilots, and other participants. AASANA has usurped a number of activities that are legally

57 AIRPORT PRIVATIZATION EXPERIENCES

under the DGAC's purview. Even though it is legally entrusted with overseeing AASANA, the DGAC has little practical authority.

C. CONAER

Supreme Decree No. 23058, issued on February 13, 1992, gave the National Aeronautics Council (CONAER) a large role in formulating, orienting, and defining internal and external air sector policies. CONAER's wide-ranging powers and its composition of high level officials rendered it ineffectual. The need for the entity to be presided over by the President of Bolivia, and in his absence the Minister of Transport, Communications, and Civil Aeronautics (the Ministry of Transport was eliminated by the Law of Ministries), made it more or less impossible to hold meetings. CONAER became a "paper" institution that met only twice: once was for its inauguratory meeting.

11. REGULATORY FRAMEWORK

The current regulatory framework for air transport in Bolivia vests DGAC with the economic and technical regulation responsibilities. In practice, owing to AASANA's ability to raise large revenues from fees (i.e., air traffic and airport-related charges), and the financial constraints faced by DGAC in raising funds other than those transferred through national budget allocations, the former has all the effective authority in the sector. Lack of economic and technical regulation, and of institutional capacities, has given AASANA its unsupervised power.

A. Economic Regulation

Airport and air navigational services in Bolivia are among the most costly in Latin America, affecting Bolivia's competitive advantages and possibility to become a regional hub.6 The cur-

6 A study developed by the Unidad de Andlisis de Polfticas Econ6micas (UDAPE), a government-related economic institue, in 1994.

58 Case Study 1 BOLIVIA rent system of economic regulation is based on the government's traditional role in a state-led economy and not on its new role promoting economic growth, as envisioned in Bolivia's new economic reform program. Current laws do not allow an independent third party to provide services. AASANA has a monopoly on ground handling services. The airlines can provide certain services for themselves as long as they pay AASANA a tariff valued at 40 percent of the total tariff AASANA charges for the service. The current tariff- setting mechanism gives AASANA complete liberty of action and leaves no recourse for airlines to challenge excessive tariffs. AASANA has been criticized, by airlines participating in the Bolivian market, for levying excessive tariffs. In addition to coping with AASANA's imposition of high costs, carriers have historically dealt with high fuel costs. The capitalization of Yacimientos Petroliferos Fiscales Bolivianos (YPFB) within a modem institutional and regulatory framework could ensure competitive fuel costs and prevent a repetition of August 1994, when fuel costs of US$1 per gallon were among the highest in Latin America and approximately twice the Miami FOB price (used as a benchmark for Latin American carriers). An analysis of the various tariff rates demonstrates that for airlines doing business in Bolivia costs are high. The airport use and passenger fee, at US$20 per passenger use, is higher than that of wealthier neighbors with greater traffic volumes, such as Brazil and Argentina. Other Latin American countries with lower tariff structures are at a competitive advantage in luring flights to their airports. For Bolivian airports suffering from lack of use, such as Santa Cruz, which uses only 20 percent of capacity, the tariff structure does little to increase demand. High fees are a product of the inward-oriented air transportation sector policies that have shielded LAB from the market mechanism. Table 1.1 compares airside charges7 of selected Latin American countries.

7Airside charges encompass all services associated with the movements of aircraft: air navigation fees, landing fees, parking fees, and passenger fees.

59 AIRPORT PRIVATIZATION EXPERIENCES

Table 1.1 Selected Airside-Related Charges (per flight) in Latin America - Intemational Flights

Landing+ Air Aircraft Airport Use 11 U=2 Navigation Fee Parking Pass. Fee2 Air Cargo Airside Charges3 Bolivia 630.58 126.12 2,400 00 0.00 3,156.70 Brazil 833.34 262.08 2.160 00 0.00 1 3,255.42 Peru 377 46 37.75 1,800 00 90.00 | 2,305.21 Argentina 428 56 95.84 1,560.00 0.00 I 2,084.40 Chile 347 93 34.79 1,500 00 0.00 I 1,882.72 Uruguay 404.00 20.20 1,320 00 0.00 1,744.20 Paraguay 39.61 547 579 00 0.63 624.45 ' Total passenger fees per aircraft movement (fee times capacity times load factor). 2 Capacity. 3 Based on a Boeing 727 aircraft type. Source: ADP, "Plan Maestro del Transporte Aereo de Bolivia: Informe Final," May 1995.

A policy of low tariffs will only ensure higher total revenues if the market is sufficiently price-elastic to cover the reductions in individual contributions with higher volumes. The privatization of LAB, currently being undertaken by the government, will facilitate the adoption of an outwardly focused air transport sector policy. The Bolivian tariff structure discriminates on two levels: 0 Domestic tariffs are substantially lower than those assessed to international flights: ::a) Domestic landing fees are between 23 and 34 percent lower than those for international flights (depending on maximum takeoff weight) The domestic fee for airport passenger use represents only 11 percent of the international fee.

X Tariffs discriminate among users. LAB has paid substantially lower tariffs than its competitors on both domestic and international flights. On landing fees for international flights LAB pays 28 percent less for a maximum takeoff weight between 0 and 80 tons and 23 per-

60 Case Study t

BOLIVIA

cent less for a maximum takeoff weight over 100 tons. This indirect subsidy designed to shore up LAB's finances could end following the flag carrier's capitalization. While discrimination between national and international fees is commonplace the level of discrimination exhibited in Bolivia has been inordinately high.

B. Technical Regulation

As has been mentioned, AASANA's control of the 37 public airports, and its large budget (combined with the DGAC's neg- ligible one), have created a dual system of technical regulation. Furthermore, the DGAC's lack of resources means that it is unable to fulfill its purpose. At the same time, AASANA's loose management control and lack of institutional capacities means that it too cannot fulfill its functions. For these reasons the system of technical regulation is very weak and is reflected in a relatively high number of smaller aircraft accidents.8 As the civil aviation authority of the largest public market in the world, the U.S. FAA wields considerable power and discretion in enforcing the use of ICAO standards by countries servicing the U.S. market. In September 1994, as part of its safety oversight program, the FAA gave the DGAC a condi- tional approval with the understanding that the Government of Bolivia would make certain changes within the air transport sector. Bolivia was placed in Category 2, which meant that Bo- livian carriers (i.e., LAB) could not expand operations in the

Box 1.2 BOLIVIA: ECONOMIC REGULATION UNDER THE NEW SIRESE LAW' Whereas technical regulation is to be the domain of the newly strengthened DGAC, economic regulation is to be under the aegis of the System of Sectoral Regulation. In light of inter- inslitutional conflicts and the inappropriate nature of the regulatory framework for promoting the air transport sector goals (i.e., increased investment and openness) set forth by the Continued..

For further information on Bolivia's safety problems, see Squire, Sanders and Dempsey, "Regulatory Framework for Bolivia's Aviation Sector, Vol. 1, Final Report," May 1995.

61 AIRPORT PRIVATIZATION EXPERIENCES

Box 1.2 (concluded)

government, the international law firm of Squire. Sanders and Dempsey was hired to draft a new regulatory framework for the Bolivian air transport sector. Their study, which was completed in May 1995, presented a proposal for a new law to govern the air transport sector. It calls for entrusting economic regulation of the sector to SIR ESE. Air transport sector economic regulation. under the SIRESE Law, falls under the jurisdiction of the Superintendency of Transports. The Superintendency's duties are to regulate, control, and supervise air transport sector activities in order to promote, in accordance with the SIRESE Law. competition and efficiency within the sector. The Superintendency's facul- ties include the power to investigate possible anti-competitive, monopolistic, and discriminatory practices of private entities operating within the sector. One of the main objectives of the proposed law. in regard to the air transport sector, is to remove the economic regulatory function from AASANA and award it to the Superintendency. It aims to establish a clearly delineated legal and institutional framework that removes the arbitrariness that has typified AASANAs policies and replaces it with policies designed to encourage competitive practices within the sector. The Law provides that SIRESE's costs and expenses are to be funded by each participating sector.

Sicremra de Regulicion Seci,nriJl rSIRESEi iCrs.-SeciorCl Re ultuion Agenrc- i SIRESE, Organization Chart

- General Supetiinteitdenicy

Superintendency" Superintendency' (Superintendency \ Supenniendency) 'Superintendency) IOf Commuriicar,onjj of Hydrocarbons l! of Transports of Electricity ooff Waters

_ ___ _ ......

Land based [later based Aernauics Transport Transport '-=IritenIntndecycit J ~ltendencyJIr Intenderncy

Source: Squire, Sanders and Dempsey. "Regulatory Framework tor Bolivia's Aviation Sector," May 1995.

62 Case Study 1

BOLIVIA

United States through new routes or through flights of new planes.9 The fact that, if Bolivia were downgraded to Category 3, future measures taken by the FAA could eliminate LAB's direct access to the U.S. market, has had negative repercussions on attempts to capitalize the flag carrier. Since September 1994 the FAA and the Government of Bolivia have been actively en- gaged in talks and training seminars in order to improve the situation. In particular, the FAA has stressed the need for the DGAC to be provided with an independent budget with which to conduct training, hiring, and monitoring of safety inspectors. As of September 1995, several improvements have been made by the DGAC regarding the security and safety program. On July 17, 1995, an agreement was signed between ICAO and the Government of Bolivia to provide the Bolivian authorities with a technical assistance program for the institutional strengthening of the DGAC and the appropriate development of safety and security procedures.

111. RESTRUCTURING PROCESS AND PRIVATIZATION OF THE NATIONAL AIRPORT SYSTEM

Following the conclusions of the ADP and Squire, Sanders and Dempsey studies, the Government of Bolivia developed a specific strategy for restructuring all elements that make up the sector. The reorganization of the sector has as its aim the creation of the proper framework for stimulating private sector participation and encouraging the concomitant investment. This would invigorate a weakening sector while allowing the government to cope with the expanding demand for services and to position itself as a Southern Cone passenger and freight cargo hub. The government's reforms involve (1) restructuring AASANA and distributing its functions within a newly created institutional framework, (2) creating an adequate regulatory oversight mechanism, and (3) fostering private sector participation. The reorganization of the sector will be detailed in a New Law of Civil Aeronautics. The restructured air transport sector com-

9 An exception was made for LAB's recent use of an additional Airbus 320 (June 1995).

63 AIRPORT PRIVATIZATION EXPERIENCES

ponents are summarized below followed by an organization chart of the proposed institutional model for the air transport sector (see Figure 1.4 on page 69).

A. Air Navigation Authority

The reorganization includes the creation through the new law (to be presented to Congress in late 1995) of the Air Navigation Authority (ANA), to provide ATC, communications, meteorology, search and rescue, and fire-fighting services. The entity will be a corporatized state-owned institution, with financial autonomy and independent governance. For this purpose, air navigation-related assets will be transferred from AASANA to the new entity. ANA will be under the supervision of the DGAC and SIRESE. ANA's main sources of revenue will be: (1) an "x," percentage (to be determined) of overflight charges, and (2) an "x2" percentage (to be determined) of landing fees. Funds will be used for operational costs associated with ATC, maintenance, and new investments in air navigation equipment. The corporatization of ANA will ensure that it operates efficiently and within its means, subject to SIRESE's and the DGAC's regulation rather than to AASANA's former practices.

B. Airport Authority of Bolivia (Three Main Airports)

The new Airports Authority would hold title to the assets and administer the concession scheme. It would oversee the operation and management of the more attractive airports by the private sector. The La Paz, Cochabamba, and Santa Cruz Airports handle over 80 percent of total traffic (domestic and international). The government intends to privatize the three main airports via a long-term master concession agreement with investment commitments (i.e., a BOT scheme) (see Box 1.3). For this purpose, airport operation-related assets will be transferred from AASANA to a new entity, the Airports Authority of Bolivia (AAB). The AAB will be incorporated as a joint-stock company, Sociedad An6nima Mixta (SAM), under initial government ownership. The AAB will tender to a private operator, via international public bidding, the master concession for the airport-related operations of the three main airports. The concession will include all airport-related services (i.e., taxing and air-

64 Case Study I BOLIVIA

BOLIVIA: THREE MAIN AIRPORTS (LA PAZ, Box 1.3 COCHABAMBA, AND SANTA CRUZ) - KEY FEATURES OF THE BOT SCHEME (PROPOSED MODEL)

1. Duration = 25 year BOT renewable for periods of 10 years

2. Investment Commitments = US$175.0 million for the period 1996-2020, including US$50.0 million for the period 1996-2000. (Proposed Investment Plan, ADP, May 1995) 3. Sources of Revenues = Airside charges (i.e., 100°b-X% of the landing fees, 1009 of passenger tees and aircraft parking), and landside charges (i.e.,1 00% of all landside charges. such as ground handling and concessions revenues)

4. Uses of Funds = Operational expenses. concession fees to the government (as of total revenues to be paid to the ADF), intrastructure and equipment investments (upgrades, expansions. and modernization of the airport system) 5. Economic Regulation = AdJusted price formula on landing fees and passengers fees overseen by SIRESE. Price discre- ; tion on the rest of airport charges and fees 6. Guarantees Mechanism (Political and Contractual Risks) = Under consideration by the Government of Bolivia

Source Mnistry of Capitalization. Air Transport Group. July 1995.

craft parking, and all of the commercial services) from the mo- ment an aircraft has landed or initiated its final takeoff until passengers have left the airport premises (i.e., landside services and selected airside activities). Specifically, the following activities are to be included: N Operation and maintenance of runways, taxiways, and aprons Operation and maintenance of passenger and cargo terminals Operation and maintenance of commercial areas Operation and maintenance of access infrastructure in the airport perimeter (access routes and car parking). The government felt at this stage that a more conventional trade sale or stock flotation for the privatization of the three main airports was not feasible, given the relatively small size of Bolivia's current air transport market and the lack of consistent financial reporting of airport operations (i.e., audited

65 AIRPORT PRIVATIZATION EXPERIENCES

financial statements). In view of this situation and the relatively large investments needed in the project, the government opted for a BOT type of scheme. The ADP Master Plan Study presents the Bolivian authorities with two distinct development options as concerns the La Paz Airport, which is in dire need of investment to cope with the future demands to be placed on the existing infrastructure at the nation's main gateway to the world (see Table 1.2). The Table 1.2 Bolivia: La Paz Airport Modernization Invest- ment Alternatives, 1994- 2014 (projected; in bolivianos) 1

Investment Allerna3vee 1 110.216.000 55.554.800 82.831.550 60.182.630 308.784 980 (inbolrvianosi Aliernawlie2 218.156.267 53.979.200 78661.630 28.290.880 379.081 977 US$1 =4.386 bolivianos. Source: ADP, 'Plan Maestro del Transporte Aereo Boliviano: Informe Final," May 1995.

first alternative contemplates a gradual and less ambitious investment process to cope with future demand. The second alternative involves a larger and more front-loaded investment, so as to enable La Paz Airport to meet expected demands more quickly and for a longer period of time.

C. Airport Development Fund

The ADF would be a mechanism whereby concession fees from the master concession to be paid by the private operator would be channeled to the unprofitable airports.'° The ADF would be managed by a board, on which the Secretary of Transport will be represented, that will administer the cross-subsidization of the system. Funds received would finance investments and operations of the smaller, more remote airports. The ADF would be a non-operating entity (no personnel and zero operating costs) created for the sole purpose of assuring that AAB's concession fees be used for the operation and maintenance of the rest of the airports in the system. The ADF would be under the supervision of the DGAC.

1' Similar schemes are currently either in use or under preparation in other countries with comparable cross-subsidization problems (Cameroon, Colombia, etc.).

66 Case Study 1 BOLIVIA

D. AASANA and the Other Airports

The remaining AASANA organization (after the transfer of its assets to ANA and the AAB) would be provisionally in charge of the operation of the secondary and minor airports under the supervision of the DGCA. Two years after the sanctioning of the new Civil Aeronautics Law, the DGCA would corporatize Bolivia's smaller airports, and then attempt to transfer the corporatized airports to local authorities and/or privatize them by auctioning their operations to the operators requesting the smallest ADF subsidy. After the airports have been corporatized, transferred, and/or privatized, AASANA will be liquidated. AASANA's main sources of revenues during the transition period will be: (1) the airside and landside charges of the secondary and minor airports, and (2) an allocation from the ADF -a percentage (to be determined) of the concession fees paid by the three main airport operators (BOT scheme). AASANA's main uses of funds will be: (1) the operational expenses of the secondary and minor airports, and (2) their investment expenses in upgrades and modernization.

E. DGAC

Under the new organization, the Secretary of Transport would be in charge of policy setting and planning. A stronger and more effective DGAC, with financial autonomy, would be in charge of technical regulation and would oversee the operations of ANA, AASANA, and the newly created ADF (see Figure 1.3, following page). Technical capacity is being strengthened through a series of assistance programs from international organizations (International Civil Aviation Organization [ICAO], the United Nations Development Programme [UNDPI, etc.). The DGAC's source of funds will not only be budgetary but will also consist of (100-xl) percent of overflight charges and fees from licenses, certifications, penalties, etc. With these funds, together with the clarification of its legal status, the DGAC will have the means to fund agency operational expenses (including training and advisory services) to enable it to: a Formulate regulations on security concerns Oversee airport and airline plans involving safety issues

67 AIRPORT PRIVATIZATION EXPERIENCES

Figure 1.3 Bolivia: DGAC, New Secretary of Organization om .ans . -Comnii-o,calion5 b Civil Aeronaulics

Direclor General of Civil Aeronaulics

Supervisio f Supervision of Supersionof Air Security Air Personnel Inrasiructurep

Radiocommunicat,ons-v- ---

( SupervisionotAirports ATCX

Source: Squire, Sanders and Dempsey, 'Regulatory Framework for Bolivia's Aviation Sector," May 1995.

Create and implement a "Master Plan" involving safety concerns, etc.

Assure observance of ICAO guidelines.

F. SIRESE

As was described earlier, economic regulation is to be the responsibility of SIRESE(see Figure 1.4). The Bolivian Government's commitment to increasing competitiveness and eliminating discriminatory practices in the sector is exemplified by Ministerial Resolution 67, issued by the Ministry of Eco- nomic Development on May 2, 1995, which eliminated policies that had given preferential tariffs to LAB for jet fuel and airside tariffs. The new decree levels the playing field between Aerosur (a private carrier operating domestic flights) and LAB and allows the former to compete on equal terms within the domestic market. It now pays equal tariffs and an equal price for jet fuel which lowers its operating costs and thereby increases its competitiveness. It is SIRESE's task to ensure that future increases in tariffs and jet fuel prices are reasonable and nondiscrimina- tory, but an important first step has been taken in the acknowl- edgment by the Bolivian authorities that "It is the policy of the Supreme Government to give incentives to national industry,

68 Case Study I

BCOLIVIA public and private, and in the present case strengthen transport services provided by air carriers, with the purpose of ensuring that it competes in better conditions with similar corporations, allowing, in such manner, for the consumer to count with improved service."" Figure 1.4 Bolivia: Proposed Model for Restructuring and Privatization Strategy

Secretary of Transportl _Policy&Planning

10% DGAC SIRESE Technical Regulation - t____ Overtlight charges Air Navigati.n Authority * Airport Development Fund I >Ntavigation Air Authorityis3t , : r ,l -

90% (AASANA ll) autonomy) Air Traffic Control Funding of Secondary Airports

Concession fees Funding of operationsl x°/o F - 'investments Airside charges 100- r Private Airport AASANA (V3 years) Landing fees Operators Operat Passenger fees 100%> La Paz (LPZ) Secon eraytr Passengerfees ~ ~ Cochabamba (CBB) (transfer to Local Atoiis Santa Cruz (SCZ) Commercial revenues BOT mechanism 25-30 years Master Concession Legend I Economic regulation _~ =Regulatas U (on L. Fees &P. Fees)

_ = GovemmentInstitutions Freedom on commercial concessions w_Fnanil sty Total= US$170 million (25 years) = Ptvate Sector Total= US$50 million (first Syears)

Note: Under the model, AASANA's debt (US$86 million) isassumed by the Government of Bolivia. Source: Ministry of Capitalization, Air Transport Group, July 1995.

Ministry of Economic Development, Resolution No. 67, May 2, 1995.

69 AIRPORT PRIVATIZATION EXPERIENCES

IV. ECONOMIC PERFORMANCE

A. AASANA

Between September and October 1994, ADP performed an extensive analysis of AASANA's financial situation. Attempting to gauge AASANA's financial situation proves difficult because the accounting results lack the requisite certification by an auditing firm. Furthermore, AASANA does not possess a cost accounting system. However, certain observations did emerge from ADP's analysis.

AASANA's revenues covered operational costs but did not produce the necessary annual surplus to pay for planned capital costs or investments. AASANA's revenues could not finance annual investment needs, estimated at US$240 million for the 1994-2000 period, or debt service for an outstanding debt of US$76.2 million. AASANA claimed that if it had to include debt servicing in tariffs, a landing would cost approximately US$5,600 for a Boeing 727-100. The inability to self- finance operations is normal for an airport system lack- ing in economies of scale; nevertheless, investment needs are urgent since a large part of the equipment, runways, etc., has become obsolete, resulting in safety concerns. Table 1.3 illustrates AASANA's economic performance excluding government transfers. Air navigation charges (landing and overflight fees) provide a surplus that compensates for the airport division losses.'2

0 Some self-financing could occur and the current situation could be improved by cutting down on the loss of passenger airport charges revenues. AASANA's lack of transparency makes it difficult to hazard a guess as to the reason behind the revenue shortfall. According to passenger flow figures, passenger airport charges should result in a revenue of 26.3 million bolivianos, but the

12 For purposes of this analysis, ADP allocated 100 percent of landing fees as part of the air navigation revenues.

70 Case Study I

BOLIVIA

Table 1.3 Bolivia: AASANA's Finances - Inability to Cover Investment (bolivianos OOOs)'

AASANA Air Aeronautical Regions Total Navigation Airports La Paz Cochabamba Santa Cruz Trinidad

Aeronautical Inflows 55.175 32.935 22.780 14,379 6.911 17.033 1.492 Landing Fees 12,803 12 803 0 4,058 1.0276 6,757 705 ight.'lWeevend Exlra Charges 1 612 1.612 0 596 98 913 5 Airciaf Parc,ng 127 0 0 70 48 2 PasserngerFee; 22653 0 22,653 1.271 128 1.431 1 In houSe Navigation Aid 18,520 18.520 0 8|,84 5.606d 7.8,, 9 Ground Handling 2,532 0 2.532 1,218 0 1,314 0 Commercial Revenues 9.402 1,514 7,888 3767 576 4759 257 Vehicle Paiking 1.025 0 1025 317 39 625 4- Cornrr,ffir,1i.I:rl:,vs 5.378 0 5.378 12 446 2,96591 155 Various 7.c444 1514 1485 1638 91 1169 e5 Total Inflows 67,649 34.449 33.200 19,364 7,487 23,106 1,776 Osf I Personnel 41.330 23.223 18.107 12.106 5.895 14.371 3.351 Services &Maintenance 11,834 1442 13,164 3,052 1,115 2,322 1,042 Materials &Supplies 8.214 2.417 5,792 2.815 1,086 2,758 778 State Taxes &Fees 5 1 4| 0 0 0 5 Total Outflows 61,378 27.416 33,962 18,382 8,297 19,925 5,267

Cash flow Operations 6,271 7,033 (-762) 982 (-811) 3,181 (-3492)

' US$1 = 4.70 bolivianos (May 1995). Source: ADP, ""Plan Maestro del Transporte Aereo de Bolivia: Informe Final," May 1995. actual figure is 15 percent lower (see Table 1.4, following page). However, even in the case of full collection of revenues there would still be insufficient funding. AASANA's financial performance is closely linked to that of the airports it administers. ADP found that the most viable way to compare amongst Bolivia's airports was to compare personnel costs in relation to total inflows. Personnel costs account for 64 percent of airport system outflows. An analysis of the airports demonstrates that personnel expenses are covered only by the larger airports. The rest of the airport system does

71 AIRPORT PRIVATIZATION EXPERIENCES

Table 1.4 Bolivia: Theoretical | La Paz 9890 8.384 1,506 versus Actual Revenues from Passenger Fees Cochabamba 3.654 5.606 [1.952] (bolivianos OOOs) Santa Cruz 12,051 7.884 4.167 Trinidad 661 779 [118] Total 26,255 22,65 3.602

'Theoretical revenues are the revenues that should have been perceived inaccordance with the number of passengers that used the airports and were legally obligated to pay the passenger fee. Source: ADP, "Plan Maestro del Transporte Aereo de Bolivia: Informe Final," May 1995. not reach the threshold traffic levels to cover personnel costs. Cross-subsidization would be necessary in Bolivia's case until traffic levels reach an economic threshold"3 (see Table 1.5).

Personnel Airport Use Table 1.5 Airport Costs Inflows Difference Cross-subsidization Al Needs in the Bolivian | La Paz 3.553 9,877 6.324 Airport System Santa Cruz 6,264 11,931 5,668 (bolivianos OOOs) Tarja 265 729 464 Trinidad 186 499 313 Sucre 246 544 299 Cochabamba 2.216 2.326 110 28 loss producers 2,800 349 [2,451] Total 15,629 26 - - . 10126

Source: ADP, "Plan Maestro del Transport Aereo de Bolivia: Informe Final," May 1995.

B. ADP's Financial Model

ADP constructed a financial model for the Bolivian airports case (see Figure 1.5). For the three largest airports the model calculates the outflows and inflows for each airport under the master concession scheme and therefore the amount of autofinancing (inflows minus outflows) before interest and taxes. The model takes into account foreseeable investment for each of the three airports and calculates the internal rate of return for them as a whole.

13 For some airports located in relatively low density areas, cross-subsidies may always be required.

72 Case Study 1 BOLIVIA

Figure 1.5 Bolivia: ADP's Financial Model

Passenger( Related < Operatonal Costs

ADP Model

Cas Ca:h OW ash Flov (MB) (ANA) | ADFI | Rest of

Source: Airport Privatization Study, Case Studies, CFSPS, October 1995.

ADP's simulation tested various economic scenarios for the key variables and found that the internal rate of return is particularly sensitive to (1) changes in the level of concession fees paid to the ADF, (2) the percentage of landing fees shared with ANA, and (3) the level of domestic passenger fees. The model demonstrated that even under various different assumptions the project for the three largest airports had a positive internal rate of return while the medium and smaller airports had a negative internal rate of return. On the basis of market assumptions and the desired level of investment, the model indicates the estimated levels of cross-subsidization in the Bolivian airport system. (See Annex 1.1, Financial Model.) The three large airports (La Paz, Santa Cruz, Cocha- bamba) could interest investors because of their potential profitability. These airports, under all the variable values considered, demonstrate a positive internal rate of return. For this rea-

73 AIRPORT PRIVATIZATION EXPERIENCES

son, these airports could be concessioned off and the revenues could be used to subsidize the operating costs of the other unprofitable airports in the Bolivian Airport System.

C. Cross-subsidies

The Bolivian Government was faced with a situation in which three large airports accounted for 80 percent of total domestic flows and two of them (Santa Cruz and La Paz) accounted for 97 percent of total international air transport system flows. Ob- viously, it is these airports that are attractive in the eyes of prospective investors. However, there is a tangible national interest in developing an air transport system that ensures adequate financing for the smaller airports as well. Once it was understood that cross-subsidization was necessary (at least for the initial project period), the question became the kind of cross-subsidy mechanism that should be selected (see Table 1.6). Table 1.6 Bolivia: Cross- subsidization Options in Airport Privatization

A. Include pack.~get profitable and Govemrnent left only *ith the roles of Privatization transacfion is less attractive unprcftlable a,rpons ,nthe regulator and polcymaker. Govemmenl from the financial point of view. Reduces prvailzai,on ir3n--acrion bureaucracy reduced to minimurri level. the amount of investTenlt commitments. Reducws the number of potenial participants inthe bid. B Inrlude ipa:lAoeel onily the prof Maximizes project cash ftoyls Increases Govemment left wh operator andl manager itable airporls inthe pnvat'zaron the amount of investment commitments. role for unprofitable airporls. Govemrnent ransacrionr, cromssubsidize rest Increases the number ol potential part- has to administer concession fees fbur- of airport stsiem rinrough aor'- ,cipants inthe bid. eaucracyl. cOss,,n fees from rla privat- Zarcin transaction. C Separalte int- t*o diflerenr pr,y- For iransacl,on (1. same as optin B. Governrent isshit left with the role of arllalon rransacrions. (li package For trarsaction 12)transter operation administerrnq subsidy payments to profitable arpcons and 1271auction and management responsibities to private operalors managr-meni arid operations of privaie seclor. unpro.litable airpons lo bidder requue5lrng li:jweireubswVi

Source: Airport Privatization Study, Case Studies, CFSPS, October 1995.

The government chose to package the profitable airports together, privatize them in exchange for concession fees, and cross-subsidize the small and medium-size airports through concession fees. This option was selected in order to maximize the attractiveness of the project by providing the largest cash

74 Case Study 1 BOLIVIA flow, and thereby obtaining the highest number of bids. The concession fees will be collected by the AAB and transferred to the ADF; from there they will be channeled to fund the operations and investments of the smaller airports. It is envisioned that in the future authority over the smaller airports will be given to the local governments. The regional entities would select the operator requesting the smallest subsidy to manage the airports. At that point, the ADF proceeds would be used to fund these subsidies.

V. KEY ISSUES EMERGING FROM THE BOLIVIAN EXPERIENCE (PRIVATIZATION PROGRAM IN PROCESS)

Shift toward Outward Orientation. The case of Bo- livia is that of a nation that over the course of decades found itself increasingly isolated from the global community. The policies undertaken since the 1985 bout with hyperinflation are an attempt to restore Bolivia to the world arena. The reorganization of the air transport sector, which involves the capitalization of LAB and the reorganization of the entire airports system, is a part of this new policy. Bolivia's historical insular development strategy and protection of the air transport sector from foreign competitive pressures led, at least partly, to an inefficient airline, high prices for services, unsafe airports, and debts. Study- ing the results and methodology employed in the Bolivian reorganization will contribute to facilitating future reorganizations of nations with air transport sectors that find themselves in similar situations. AASANA's Black Box. The in-depth investigation of the Bolivian air transport sector, undertaken to ready the sector for an eventual restructuring and privatization of certain functions, confirmed the poor functioning of AASANA. It became clear that AASANA's lack of corporate governance, stemming from its total independence of means and policymaking and its control of numerous functions usually divided among different bureaucratic governmental and private entities, had led it to ac- cumulate large debts while, at the same time, creating a situation rife with security and safety concerns. The lack of transparency combined with the inefficiency of AASANA's affairs prevented it from achieving positive financial results by producing

75 AIRPORT PRIVATIZATION EXPERIENCES

widespread inefficiencies. For developing nations seeking to restructure or modernize their air transport sector, the regulatory, policymaking, airport, and air navigation services functions should be separated, and an appropriate regulatory framework instituted. Government entities such as DGAC must be given financial autonomy. i Institutional Strengthening. The Bolivia case illustrates the negative consequences stemming from a weak institutional structure. Bolivia's weak air transport sector institutional framework led to a deterioration in safety and security (made evident by analyses of airport infrastructure, accidents, training levels, etc.). Unfortunately in today's interrelated world, with its many international regimes, domestic issues can have grave international repercussions. Bolivia's failure to ensure compliance with ICAO-mandated regulations led to problems with the U.S. FAA, which sees its role as ensuring compliance with these standards. This failure, in tum, threatened to derail prospects for privatizing LAB and the national airport system, thus high- lighting not only the interrelated nature of air transport sector policies within nations but also the interrelated aspect of the components that constitute a country's air transport sector.

X Cross-subsidies. One of the characteristics of national airport systems is that only the very large airports tend to obtain the volume of traffic necessary to derive economies of scale and therefore make a profit. Most airports within a country tend to be small and therefore unprofitable. In the case of relatively large (in area) developing countries, maintaining these small but inefficient airports in operation is of great national interest because these airports are often the only links between underdeveloped and developed national areas. In the case of Bolivia, geographical factors make it impossible to link many areas of the nation through railways or highways and therefore the burden of preserving the integrity of the nation-state falls on the air transport sector. Once cross-subsidies are accepted as explicit, the question becomes: what kind of cross subsidy mechanism? When considering whether to package profitable airports together or to combine them with smaller airports with little profitability potential, a government must consider the following: 'A Whether to attach more importance to maximizing the amount of cash flow and bids and making the package more attractive by limiting it to the large, profitable airports

76 Case Study 1

BOLIVIA

j Whether to assign priority to limiting government involvement in administering cross- sub- sidies by privatizing small and large airports together.

The decision about how to package the airports has a large impact on the system's cross-subsidy mechanism. 5 Suitability of BOTArrangements, Design, and Con- tractualGuarantees. Given that a trade sale or a stock flotation did not appear suitable for the Bolivian case under the present circumstances, the use of a BOT was chosen as a more viable and sustainable privatization option. Concerns about ceding ownership in a public service that has high externalities and that is often considered a part of the nation's security apparatus make it politically difficult to attempt a privatization under more conventional forms at the present time. A BOT effectively avoids direct confrontation on the ownership issue. Countries contemplating the use of a BOT to concession off the operation of airports should consider a number of factors which have been of obvious concern to the Bolivian authorities and ensure that the BOT's terms of reference: Specify the amount of investment as well as the required technical specifications to be undertaken by the concessionaire. 'A Elicit the maximum possible response, without sacrificing issues of importance to the national interest, from name-brand airport operators with a serious, reputable track record and with the financial backing necessary for a project of such magnitude. j Specify the economic regulatory environment. This should provide a balance between private and public interest. Contain clearly defined rules with respect to contractual and political risks, specifying the obligations and compensatory procedures to be followed in the event that either party fails to observe the terms of the contract.'4

14 Contractual risk is the debt service default resulting from the non-performance of contractual obligations undertaken by the governments or their agencies. Political risk is the debt service default resulting from politicalforce nmajeure.

77 AIRPORT PRIVATIZATION EXPERIENCES

J Include a reference to the ways in which contractual and political risks will be assessed and covered. This would enhance private sector perceptions regarding the project and therefore would lower the costs associated with risks.

The clearer, more explicit, and specific the terms of reference are, the greater will be the benefit accruing to the parties concerned. M Air Transport Deregulation. The results of opening up the domestic air transport sector to other competitors (i.e., Aerosur)'5 seem to demonstrate that (1) competition brings about positive results in terms of an improved overall service, and (2) the Bolivian domestic market may not derive the necessary economies of scale to make it sufficiently viable for competition between domestic interests to take place. The latter point is illustrated by the financial difficulties that have beset Aerosur, as a result of fierce competition for market share of the domestic air transport market. A solution, endorsed by the ADP study, to problems originating in the limited size of the internal air transport sector market would be to adopt a more widespread "open skies" policy and become part of a larger regional market.'6 The expanded market implicit in a successful insertion of Bolivia into the larger Latin American market (Bolivia s neighbors include Argentina and Brazil) would create economies of scale essential for a sector with large investment needs and long-term financing recoup- ment periods. Furthermore, Bolivia's central position within South America encourages its prospects of becoming a regional hub that could benefit, through increased competition, from flights passing through Bolivia. However, while Bolivia's larger cities would benefit from this arrangement, airline service offerings to the more remote and less densely populated regions remain limited. Airports in these areas will remain unprofitable; the best option might be to auction off the operation of these airports to the bidder requesting the lowest compensation. There-

" Supreme Decree 21060, 1992. 16 Bolivia is already a member of the Andean Pact's "Open Skies" Agreement.

78 Case Study t

BOLIVIA fore, future hopes for a more efficient, and expeditious delivery of air transport services within the domestic market might depend on: -J Enacting a regulatory framework that ensures competitive practices on the part of the local carriers

X Attempting to increase the market's size j Recognizing that certain expenditures or subsidies are inescapable until Bolivia's market experiences long-term economic growth. An important step in such a move is the anticipated capitalization of LAB, which will free the government from what have been, up to now, contradictory goals: (1) to protect LAB's market; and (2) to improve airline service offerings in Bolivia.

79 AIRPORT PRIVATIZATION EXPERIENCES

ANNEX 1.1 BOLIVIA: ADP MODEL FOR BOLIVIA'S AIRPORT SYSTEM (Liberal Context)

TraffiC Debt Service 3_ Annual ADP Traffic Forecast Interest Rale

Pnleis frornal,onepsP- \ / lAircraft Parrina and Finger Fee ernabonal, Pass US£.020 \ / | USS96 00,internanonal Movement D\Drriccri.-Pass\S /020 USi69 O0Domeshc Movement

mrr,a,.n3Ui1ONion| \ nvestmenl Fmnancna DomslcUSi00f1on from Capilal 30°; 15 Olor,rzi Opraior ar> > X

A,rr,>rl l r,arges \ ~~~~~~~~Concess,onFee IPe3uce_Ou,per'farfea FirstYear. 80. 'uritritg ; ;- -1- I 1 Year: O.25l

RESULTS

80 Case Study 1

BOLIVIA HN NE X ES ANNEX 1.1 BOLIVIA: ADP MODEL FOR BOLIVIA'S AIRPORT SYSTEM (concluded) (Liberal Context)

Internal Rate of Retum: 23.88%

RESULTS. 1995-2007

Auto Financing Total 0 9.44 1126 131)7 1932 21 59 2269 2335 25.09 2802 2944 30.52 31 66 LaPaz 0 3 72 448 5.34 765 849 8 94 943 9.94 1169 1226 1277 132i8 SamnaCruz 0 4.15 505 5h8 916 1042 1095 1151 1210 1313 13d82W42 1491 Cc,chabamua 0 1 56 1 7 1 90 250 ;68 2d8 2'92 205 321 3.36 3.51 36' Concesshin Fee 1) 146 171 2 27.9 18 342 368 296 447 4.13 5. 4d7 Cross-SubSPJy cl Irivesimenl C0 473 299 622 1:30 96 1 14 1.14 1.50 521 145 157 1.66 ot Other Airportis CrossjSubs&dy .rtGperai,ons 0 0 44 0)36 u 28 0 22 (t1.1 0.15 0.11 0 u 0 02 0 0 0 of Other Airpors

RESULTS, 2008-2020

AuloFirancingTolal 931 3699 3335 3980 4157 432 4614 47 97 014 52119 54h6 5666 59.10 La3P3z 164 1519 15.81 1646 17 15 1765 1881 1962 2048 Ž116 22.11 23.11 2393

SanraCruZ 15f63 17.6'5 1845 191:16 1995 Ž038 22.30 2309 24 1 25 0 26C0 ?7.54 253d. Cocrabamtba 384 115 4C9 4 2d 142 J68 503 526 549 573 575 601'.2 6.30 Concession Fee 586 6 61 7Q5 751 8 00 e 52 924 9id4 10 48 1115 11P7 12.64 1346 Cross-Subsdyot lnves5ment 191 2e61 218 2?4 255 2 78 317 326 3.53 383 415 460 4d8i of Other Airpo 1s, Cross Subsdv or Operations 0 0 0 0 0 2 1) 0 0 il oaOther Airports

Source: ADP Master Plan, May 1995.

81 AIRPORT PRIVATIZATION EXPERIENCES

82 Case Study 2

CAME ROOD0N

AIRPORTS IN CAMEROON

A CASE STUDY OF AIRPORT PRIVATIZATION INWEST AFRICAN ECONOMIES'

Since the mid-1980s, Cameroon's airports have been characterized by growing air-related services inefficiencies. The problem has been exacerbated by (1) a 40 percent and 64 percent decline in passenger traffic and freight volume, respectively, between 1986 and 1992, in the major international airport at Douala; (2) relative improvements in road transportation between Douala and Yaounde; and (3) the Government of Cameroon's inability, under severe financial distress, to invest in modernizing equipment. The difficulties faced in attempting to modernize the air transport sector infrastructure are exemplified by the Yaounde international airport and the domestic airport at Maroua. The government realized that it did not have the necessary funds to operate and maintain the Yaounde Airport or to finance the necessary equipment for the rehabilitated (through Italian financing) Maroua Airport. With these difficulties in mind, the government in 1991 embarked on a privatization program to improve the efficiency and competitiveness of its 14 airport facilities. In August 1994 the government entered into a concession agreement with Aeroports de Paris (ADP) whereby 7 of the government's 14 airports will be privately managed by the new joint venture Aeroports du Cameroun (ADC). ADC was incorporated in De- cember 1993 as an autonomous company with paid-in capital of

'Research for this case was conducted in July-October 1994.

83 AIRPORT PRIVATIZATION EXPERIENCES

CFAF 177 million.2 The largest portions of shares were allocated to ADP (34 percent); the Government of Cameroon (29 percent); and Agence pour la S6curit6 de la Navigation Aerienne en Afrique et a Madagascar (ASECNA) (20 percent). The remaining shares were distributed among Cameroonian air carriers as follows: Cameroon Airlines (CAMAIR)3 (8 percent), UNITAIR (3 percent), Air Affaires Afrique (AAA) (3 percent), and the domestic Banque Internationale pour le Commerce et l'Industrie du Cameroun (BICIC) (3 percent). ADC's founding mandates were to improve the management and efficiency of airport operations and investments and to generate capital, through autofinancing, for future airport facility maintenance and investment. The government's objectives in transferring airport management control to ADC were the following: The efficient development of air transport services in order to promote Cameroon's tourism sector and to foster economic growth R Private sector financing for upgrades and expansions of airport-related infrastructure to alleviate the demands on Cameroon's public finances. This case illustrates the privatization constraints faced by governments in countries with weak economic performance and a highly subsidized airport system. In this type of situation, the cross-subsidization option (see Table 2.1) selected by the government will drive the privatization strategy to be used in the design of the transaction. ADC's privatization process por- trays a strong government commitment to the completion of the joint venture transaction -- as was demonstrated by the government's downsizing of the airports' labor force prior to the transaction. However, the transaction design was subject to important restrictions (i.e., a ceiling placed on private sector share participation prevented majority ownership in ADC's equity), and lack of clear definitions (i.e., investment commitments, corporate governance of the operating company) caused difficulties in project implementation. An example of such an issue is the deadlock blocking ADC's business development that origi- nated from a disagreement between the Government of Cam- eroon and private sector shareholders regarding the structure and competence of the Board of Directors.

2 CFAF (Central African franc) 291.79 = US$1 (December 1993). National flagship.

84 wase stUay Z CAMEROON

Table 2.1 Cameroon: Cross- subsidization Options in Airport Privatization

a ;- -i '6 .: .6l ' .61 . .6.

A. Include (package) Drortable ar,d Government left only with the roles ot Privatization transaction isless attraclive non-profitable airports inthe regulator and polikymaaWer Govemrnment from the financial point of view. Reduces prwsatzation tiansaction bureaucracy reduced to minimum level. the amount of investment commitments Reduces the number ot potential pan icipanrs In the cd

B tnclude (package) only the prot- Maxirrlizes protect cash flrws. Increases Governmenr left wth operator and manage dable airports in tne privalizatron the amount of investment cormmitments role for unprofitable airports Govemrnment transaction. Cross-subsidie rest Increases the number of potential par t- has rc administer conr.ession fees (bur- of airport systlem trough con- cipants inthe bid eaucracy). cessiron tees from the pnval- ization transac tion

C. Separate into two diffrent piiv- For transaction (1t-same as option B Govemrnment isstill len wir, Ihthrole ol alizairon transactions (II package For transaction 12) lransfer operation adrnirnsterrng subsidy paymens io profitable airports and (21auction and management responsibilities to private operators rnanagement and operations of private sector. unprot,table airports to bidder requesting lowest subsidy.

Source: Airport Privatization Study, Case Studies, CFSPS, October 1995.

1. OWNERSHIP AND INSTITUTIONAL FRAMEWORK

The Ministry of Transport is the principal authority in charge of Cameroonian airport facilities. Before privatization, airport control and management had primarily been the responsibility of two entities, the Civil Aviation Authority (CAA) and ASECNA. Since 1961 ASECNA had been contracted by the Ministry of Transportation, as stipulated in Articles 2 and 10 of the Dakar Convention, to provide air navigation services over Cameroonian territory. ASECNA, created in 1959, is the Afri- can multinational agency in charge of providing air navigational services, including overflight, route control, meteorology, and communications. ASECNA was placed under the tutorship of a committee of regional ministers in charge of civil aviation, as a public entity with complete financial autonomy. The Dakar Con- vention, signed in 1974 by all 16 member states,4 legislates

4 Bdnin, Burkina Faso, Carneroon, Central African Republic, Chad, Congo, Cote d'Ivoire, Equatorial Guinea, France, Gabon, Madagascar, Mali, Mauritania, Niger, Senegal, and Togo.

85 AIRPORT PRIVATIZATION EXPERIENCES

ASECNA's mandates and services. As of January 1994, the total work force employed by ASECNA in Cameroon to provide services specified by the Dakar Convention is 1,231, including 29 engineers and 101 technicians. As a division of the Ministry of Transportation, the CAA promotes, regulates, and controls all Cameroonian civil aviation activities. The CAA's work force consists of a general director assisted by a deputy director, 4 division chiefs with 4 deputy chiefs, 13 engineers, and 15 technicians. Figure 2.1 shows the organization chart for the CAA.

Figure 2.1 Cameroon: CAA Organization Chart m_

Facilities& Air Navigation International Licenstng and Aautic & Air Transport Relations Personnel Serity Services | Services Services i ~~~~~Services

Air Bilateral Airpor Facilites Air WVIvigiOn Agreements Licensing Airport Inspection Transporr | rilernational i Navigation IArpon Inspection Search 8 |' Relations Personnel Radio Rescue Rerltion Peronel Airport Security * ~~~~~Ovedltighl

Source: CAA, L'Aviation Civile au Cameroun, April 1994. The CAA is organized into four main divisions: 1. Air Navigation and Air Transport Services includes regulation of air navigation services, air transport services, and airport services 2. InternationalRelations Services oversees bilateral agreements and international representation (see Figure 2.2) 3. Licensing and Personnel Services provides licensing, permits, and training 4. Aeronautic Security Services inspects and authorizes airports and provides airport security and planning.

86 Case Study 2

CAMEROON

Figure 2.2 _ 31 r_1 1.m- m _ Cameroon: Air Transport Bilateral Germany Israel Agreements

Belgium ___

Holland Burundi Great Britain Ethiopia Switzerland Kenya Former Soviet Union Rwanda o

| Benin TNamibia Ghadnaoir Tanzania Ghana Zimbabwe Liberia O Mali Sierra Leone Senegal Central African Rep. Togo Chad Nigeria Congo

--- Equatorial Guinea I_VAr Gabon Sao Tome & Principe , Algeria J | Zaire

Source: CAA, L'Aviation Civile au Cameroun, April 1994.

Fourteen airports fall under the supervision of both the CAA and ASECNA. Three of them are international: 1. The airport of Douala, the economic center of Carneroon, located in the country's eastern part 2. The airport of Yaound6,5 on the outskirts of the capital city

The new airport is 15 kilometers south of the capital and has a runway of 3,400 meters. It was designed to receive 1.5 million passengers per year with future expansion capabilities of up to I million passengers. At full capacity the airport will accommodate 7 large carriers simultaneously. However, since opening in 1991, Yaounde has operated well under capacity. The financing of the airport (over US$200 million) was structured as follows: 85 percent in the form of soft export credits backed by a German consortium, and 15 percent was front end financing from the Government of Cameroon.

87 AIRPORT PRIVATIZATION EXPERIENCES

3. The airport of Garoua in the northern region: Garoua airport is of particular importance because of poor northern road infrastructure. Since the late 1980s, because of the deepening economic crisis in Cameroon, these larger airports have experienced declining passenger traffic and freight volume. The decline in oil production and the sharp worsening in the international market price for the country's commodity exports eroded the government's export revenues and precipitated an economic crisis that significantly affected transport performance - in particular airport service efficiency. Air transport performance, in terms of both passenger and freight traffic, deteriorated sharply, particularly at Douala Airport (Tables 2.2), beginning in the mid- 1980s. The relative improvement in road transportation between Douala and Yaounde accelerated the decline of the domestic air traffic market.

Table 2.2 00 _ Cameroon: Annual Traffic Flows at Douala .- 24402. 299,820 20,9O7 Airport 1978 20,280 490,788 24,763 1981 34,353 707,765 21,014

20,280 . 733,150 23,327 1986 20,280 58A,550 18,213 1989 20,280 436,293 14,292 1990 20,280 406,088 13,088 1991 13,564 440,228 10,356

W ;' 523 301.134 - .6.56, 1993 10,851 365,264 10,000 Source: CAA, L'Aviation Civile au Cameroun, April 1994.

In the early 1980s rapid growth in gross national product and forecasts for continued economic growth, together with substantial increases in traffic flows, prompted the Cameroonian authorities to study the creation of a new and larger Yaounde International Airport. Financed mainly by German concessional credits and constructed by a German consortium, the airport opened in 1991. Unfortunately, by the time the airport was fully operational Cameroon had entered a period of economic crisis. Air traffic flows to and from, and within, Cameroon diminished greatly and Yaounde International Airport found itself with insufficient revenues to finance operations. Because of the economic downturn Cameroonian officials decided they could not afford the airport's yearly financing requirements.

88 Case Study 2 CAM EROON

Given the economic situation at the time of the decision (second semester of 1993), traffic projections for the ADC project were based on a conservative no-growth scenario. Table 2.3 depicts traffic figures used in ADC's Feasibility Study.

__i~Jp~.rJuIuii[.u,1:pII~IinscJII.mm'u,III.n.pg.].I Table 2.3 Traffic Flows for Seven =Intern_atio_nalw 7 . r 1 I Major Cameroon International i:Airports Douala 351,134 305,033 305,033 10,996 9,570 I Yaounde 138,856 138,856 138,856 666 1,037 1 Garoua 44,657 44.657 44.657 1,313 893 Domestic Bamenda 1,075 1,075 16,224 Bertoua 143 143 16.224 - - I MaroualSaIak 30,997 33,094 32,763 240 168 1 NGaound4rd 17,844 17.844 17.666 64 76 Source: ADP - Consulting Division, estimates from ADC's Feasibility Study, July 1993.

Faced with the above-mentioned inefficiencies and declining airport service performance, compounded by growing pressures on public finances that prevented the state from pur- suing much-needed airport modernization investment, the government decided in 1989 to consider airport privatization. The government's willingness to transfer airport services management to private hands, combined with technical assistance from the French development agency Caisse Fran,aise de Developpement (CFD) (through the financing of a FF760,000 feasibility study), led to the creation, on December 13, 1993, of ADC, with the ownership distribution described at the beginning of this case study.6 ADC, a financially and legally autonomous company, manages five principal airport facilities and services at Douala, Garoua, Yaound&Nsimalien, N'Gaoundere, and Maroua, and ensures minimum service for two secondary airports, Bamenda and Bertoua. ADC has full authority for managing all airport services in all seven airports and for maintaining, upgrading, and replacing equipment and airport installations through a planned investment program of CFAF12 billion. ADC also acts as the executor agency for project development. Prior to start- up, the government must approve projects, with the Board of ADC having the right to refuse any project that jeopardizes the company's financial stability. In most airports, under the priva-

6 The privatization process is described in further detail in section IV.

89 AIRPORT PRIVATIZATION EXPERIENCES

tization scheme, ground handling services exclusivity has been transferred back from CAMAIR to ADC, the airport operator, as is the general practice.7 As of December 1994, ADC has subcontracted air navigation services to ASECNA and ground handling services to CAMAIR for the five major airports.

,._w & II. REGULATORY FRAMEWORK

Since independence, a proper economic regulatory framework has not been developed in Cameroon. Given the considerable state intervention in transport-related services, economic regulation has not been a top priority in the government's agenda. The CAA presents airport and air navigation charges to the Min- istry of Transport and the Prime Minister for approval. Eco- nomic regulation has been based mainly on reserve power practices. Along with managerial and operational control, the government transferred to ADC full authority for setting ground handling and other non-aeronautical charges (parking fees, rentals, leases, concession fees, etc.). ADC is also responsible for establishing air and landside charges after agreement with major airport customers and in line with full production cost recovery. The government retains the final word regarding approval. Aeronautical fees proposals, presented to the Ministry of Transport, should be based on fee levels in the French franc zone countries and members of ASECNA. The CAA retains control over airport policy. However, ADC advises the CAA on policy decisions. Air traffic control and telecommunications remain under the CAA's control through its relation with ASECNA. Proposed changes are subject to government approval. The Government of Cameroon, through ASECNA activities, retains control of the following services at the airports listed below: * Doualaand GarouaAirports: ASECNA collects 2 percent of landing fees at Douala and Garoua. In addition, ASECNA controls air traffic control and meteorologi-

CAMAIR has historically been the exclusive ground handling agent for Cameroon airports, without financial compensation to the CAA.

90 Case Study 2 CAME ROON

cal services, including air traffic in route, approach and landing, the aerodrome weather station, radioelectric equipment to assist air navigation, telecommunications equipment, air navigation visual aids, independent electrical energy production, and fire safety.8 • N'Gaoun6MrJAirport:ASECNA operates and maintains meteorological services • All Airports: ASECNA is responsible for provision of aviation fuel, control of military installations, and acquisition of airport safety equipment. Table 2.4 shows landing and passenger fees as of March 1994. Table 2.4 Cameroon: Landing and Passenger Fees, March 1994 (CFAF)'

International Traffic

lla.l , l .11X 5,744 1,281 2,553 3,606 3.750 3,900 Domestic Traffic _

482 274 1,033 2,068 2.150 2,236 International/ Domestic

66,545 66,545 66,545

Destination _ 500 4,000 6,000 CFAF576 46 = uS$1, as ,.l March 31, 1994 Source: CAA, Decree No. 94/074, March 1994.

It should be noted that at the time of the Dakar Convention agreement in 1974 the airport at Yaounde was not considered an international airport. Since construction of the new international airport in Yaounde, ASECNA has tried to incorporate Yaounde into the list of international airports from which 2 percent of landing fees are collected.

91 AIRPORT PRIVATIZATION EXPERIENCES

.111 ADC: FINANCIAL PERFORMANCE

Owing to data limitations, the financial performance of Cameroon's airports has been evaluated on the basis of estimates provided by ADP's Feasibility Study. The financial statements of the seven privatized airports for the first year of ADC's operation, based on July 1993 actual income statements, forecast an operating profit approximating 39 percent of total revenues. The CFAF304 million difference between operating profits for the three international airports and those for the seven privatized airports reveals the financial burden of cross-subsidization. Under ADC management, labor costs are estimated at 20 percent of total revenues while commercial revenues account for 26 percent of total revenues as comnpared with 74 percent for airside activities. Until now, CAMAIR has provided ground handling services. Historically, the airline has enjoyed the exclusive exploitation of this concession without financially compensating the CAA. To finalize the privatization arrangement, ADP and the government entered into an agreement whereby ground handling revenues, collected by CAMAIR, would be shared with ADC. ADC would subcontract ground handling services to CAMAIR, charging 20 percent of total revenues for the concession. By collecting 20 percent of all ground handling charges, the new company would be able to raise revenues (roughly CFAF400 million per year of operating income) and thereby maintain and upgrade equipment and meet its financial obligations. Ground handling charges alone are expected to total a significant portion (14 percent) of ADC revenues. In addition, ADC is expected to embark on an investment program amounting to CFAF9 billion over a 15-year period to renovate and expand facilities for the five major airports. The investment program is split into two parts, with a CFAF 4.1 billion high priority renovation program financed primarily by CFD and the remainder financed from the fourth year of operation by ADC from internal resources. In the forecasted investment program, half of the financing originates from the CFD as financing linked to the concession agreement contract. Given ADC's heavy reliance on its principal customer, CAMAIR, for revenues, particularly from airside and ground handling services subcontracted to CAMAIR, the financial viability of ADC and the subsequent success of the management contract will depend primarily on CAMAIR's operations and profitability.

92 Case Study 2 CAM EROON

On the basis of proposed investment programs (upgrades and maintenance) and the conditions of the CFD financing facility, the projected income statements and cash flows shown in Tables 2.5 and 2.6 were prepared for the ADC project.

Secondary Seven Table 2.5 Five Major Airports Airports Airports

l l ll l ! ls s , zi l 1-71w_ =_ ~~Statements for ADC, l First Year of Operation Revenues 2,901,359 61,570 50302 51,128 3,064.359 (an illustration of cross- Expenses 1.731,774 207,404 203.946 55,700 *2,198.824 subsidies in the airport Oper. Profit 1.169,585 (1.834) (4,572) 865,535 system) -- -- |(000 CFAF)l Technical A. 80,000 ( Depreciation 50,000 Debt Interest 45,000

CFAF 291.70 = US$1, as of July 31,1993. Source: ADP-Consulting Division, estimates from ADC's Feasibility Study, July 1993. See Annexes 2.1 and 2.2 for further details on ADC's available financial information.

Table 2.6 Cameroon: ADC Forecasts of Cash Flow Statements (000 CFAF)

Net Results 690,535 575.788 457,296 448,812 440,335 Depreciation 50,000 137,000 230,000 230,000 230,000 LT Debt: 900,000 1.500,000 1,500,000 100,000 100,000 Total Inflows 1,640,535 2.212,788 2,187,296 778,812 770,335 Investments 900.000 1.500.000 1,500,000 100,000 100.000 LTDebtto)2 0 0 0 0 0 W Capital 209,058 209,079 208,799 208.521 208,242

m FM, ' ,g*.*,I ' As of July 31, 1993, CFAF 291.70 = US$1. 2The CFD loan is a 15-year obligation at 5 percent interest with a 5-year grace period. The loan amounts to CFAF 4.1 billion, with CFAF 3.45 billion available for investment purposes and the remainder disbursed as technical assistance. I The total cash position reflects the amount of funds available to ADC for necessary maintenance and upgrades of the five major airports (in addition to the investments financed by CFD, Note 2). Source: ADP-Consulting Division, estimates from ADC's Feasibility Study, July 1993.

93 AIRPORT PRIVATIZATION EXPERIENCES

IV. PRIVATIZATION PROCESS

Cameroon's privatization process began in the early 1990s. It was initiated by the Ministry of Transport, which requested a feasibility study concerning privatization of airports. Privatization was considered an avenue for improving the competitiveness of airports through increased efficiency, and for reducing the impact, through lowered fiscal demands, on the government's budget constraints in the near future. In 1991, ADP, at the government's request, conducted a study financed by a FF760,000 technical assistance loan from FAC (the French Min- istry of Cooperation) and ASECNA (headquarters office in Dakar). Five scenarios, differing on number of airports and potential profitability (Table 2.7), were initially considered under the privatization feasibility study. Table 2.7 Cameroon: Airport Privatization Scenarios (CFAF)'

No. of Airports under 14 9 5 9 7 Ptivatization Financial Results (2.5) billion (1.8) billion break-even (100) million (50) million Investment Program n.a. 12 billion n.a. n.a. 9billion Governmenm 1.5 billion 400 million 400 million 500 million 400 million Transfers (Subsidy) Personnel 1o Be 736 262 175 n.a. 492 i Transferred (No. of employees) As of July 31,1993, CFAF 291.70 = US$1. Source: ADP-Consulting Division, estimates from ADC's Feasibility Study, July 1993. The initial recommendation called for privatizing 5 of the country's 14 airports. These 5 airports could become financially viable and relatively efficient. Early in the process, ADP was considered the prospective private airport operator, and no competitive bidding for selecting a private airport operator was undertaken. Additional technical assistance was required to analyze other options, namely, the privatization of 7 or 9 airports with minimum service. Technical assistance was again provided by ADP and financed by FF760,000 from CFD (the French development agency). The privatization of the 5 principal airports,

94 Case Study 2 CAMEROON

Douala, Yaounde, Garoua, Maroua, and N'Gaoundere, again seemed the most efficient scenario since these airports were breaking even (or better) and did not require any subsidy. Ex- tensive discussions in 1992 among the government, ASECNA, donors, and ADP led to the conclusion that privatization of nine airports under a concession agreement contract with a newly created management company was feasible. The key condition for the privatization plan was that, to balance financial accounts, the private operator taking over the management of these 9 airports would charge CAMAIR (the ground handling agent) 20 percent of all ground handling charges. Under this scheme, privatizing 9 airports (5 major airports and 4 secondary airports) would lead to a deficit of CFAF1,800 million that would be offset by an annual government subsidy. However, the continuing economic deterioration in Cameroon in 1993 - reflected in an air traffic decrease at seven major airports, from 584,706 in 1992 to 540,702 in 1993; the financial difficulties of CAMAIR, ADC's main customer; and Cameroon's default on its debt to CFD led ADP to reverse its decision to manage the nine airports. Given the economic out- look and air traffic trends, the government decided to privatize seven airports in three phases. Phase I: the privatization of five airports under a concession agreement and a BOT scheme Phase II: the progressive transfer of two secondary airports, Bamenda and Bertoua Phase III: the closing of the other airports. The structure of the privatization process implemented is given below.

A. Phase 1: Privatization of Five Principal Airports

1. Creation of a New Operating Company (Air- port Operator)

A new private operating company, ADC, was incorporated for the purpose of managing a 15-year master concession agreement for operating seven airport facilities. The new company's shares were distributed among: ADP (the major shareholder)

95 AIRPORT PRIVATIZATION EXPERIENCES

(34 percent); the government (29 percent); ASECNA (20 percent); CAMAIR, (8 percent); and small private airlines and a major bank (9 percent). The company, incorporated under a preferential investment regime for newly created companies, benefits from numerous fiscal exemptions. Under the master concession agreement, ADC has full authority for operations and investments concerning the seven airports. The agreement included a 20 percent charge on ground handling services provided by CAMAIR (as the ground handling concessionaire).

2. Selection of the Strategic Partner, ADP

Even though the World Bank financed a consultant to review the draft concession agreement and to provide advice, and in- sisted that a competitive bidding process be used, the selection of the partner did not result from an open and competitive bidding process but from a series of individual technical consultations held by the government. In that context, alternatives to the privatization scenario have never been explored with other airport specialists and consultants. As the initial consultant in charge of technical assistance for the feasibility study, ADP had the following responsibilities for formulating and starting-up the company: Negotiating with partners (identified by the government) Preparing legal and regulatory clauses for transferring and managing airports

fi Implementing the concession agreement Implementing and administering the charter and bylaws Negotiating subcontracting agreements for meteorological and air traffic control services (air traffic to be subcontracted to ASECNA per government request)

X Developing and implementing standard financial guidelines and procedures (budgets, income forecasts, accounting systems, etc.). Following this study, ADP, the government, and CA- MAIR promoted the creation of ADC, incorporated in Decem- ber 1993. Prior to creating ADC, the government, through the CAA, had signed a technical assistance contract (a type of management contract) with ADP for operating Cameroon's airports. This contract was transferred to ADC, through a master conces-

96 Coae Study 2 CAMEROON sion agreement signed in August 1994. ADP became the operating company's largest single shareholder as well as its management contractor. However, since the Ministry of Transport represents the shareholdings of the government in ASECNA, and CAMAIR (equivalent to 57 percent), the state retains control of key board level decisions.

3. Master ConcessionAgreement

Through this type of concession agreement the government transferred five airports, along with control of airside and landside facilities, to ADC. The company's viability is the government's main concern. The GOC has thrown its full support behind the company. Apart from sub-contracting appropriate services, the newly formed company is completely separated from all national bodies. Regulatory oversight remains the government's responsibility. However, ADC retains advisory status concerning policy formulation directly affecting airport operations. ADC receives all airside and landside charges. Airside charges are set by ADC in agreement with major airport customers and in line with regional pricing. If the government should refuse ADC's request for a new pricing scheme, it would have to compensate ADC unless new services jeopardized air traffic provision and operation. At the Douala and Garoua airports, airside charges are shared with ASECNA according to the Dakar Con- vention of 1974. Charges are on the basis of full-cost recovery. The company remains free to set landside charges. Under the master concession agreement, no performance criteria have been developed. The concession agreement's main articles confer special rights on the government, such as approval rights for all major investments considered by ADC that might bring about a change in the provision of air operations, particularly navigation services, security, and telecommunications.

4. Investment Commitments

Article 6 of the Concession Agreement provides a general description of the investment program for the seven airports under contract. The original investment plan was developed in Octo- ber 1992 and amounted to CFAF5,848 billion.9 This amount

9 As of October 31, 1992, CFAF 251.54 = US$ 1.

97 AIRPORT PRIVATIZATION EXPERIENCES

was revised in Article 6 (February 1994) to CFAF3,450 billion.'0 The description provided in the agreement is vague and lacks the required specifications of an investment plan (i.e., detailed descriptions of the investment projects and their components as well as the cash flow requirements of each). This section of the agreement also establishes guidelines for the financing of the investment plan (Articles 25 and 26). Here, again, the description is vague and is limited to indicating that financing could come from: (1) internal sources (ADC's cash flows), (2) loans and credits from financial institutions to ADC, and (3) the transferring to ADC of grant funds available to the government from the donor ccmmunity.

5. Labor Restructuring Strategy

Following the privatization feasibility study, a technical assessment made by ADP indicated that approximately 492 employees were necessary to support ADC operations. Their distribution was structured as follows: 230 employees for airport operations and 262 for management and administration. Labor restructuring was carried out by means of a competency test designed to select the best employees from the existing work force (approximately 1,230 at the time of the test, in September 1994). In all, 739 employees were laid off. Severance was paid through a CFD loan of CFAF 350 million.

B. Phase II: Operation of Two Secondary Airports

Given the relatively low traffic levels at these two airports at the present time, ADC will manage these airports with reduced personnel and will keep traffic to a minimum. Personnel will be reduced to 10 employees per airport. ADC will operate the airport services and will not subcontract to ASECNA. Under the minimum service scenario, operations in these two airports will lead to a CFAF50 million deficit, to be financed through cross- subsidies from the five profitable airports. The deficit could be bridged by servicing the airports with regular flights. Exploita- tion of these routes could be given to a small airline company such as AAA or UNITAIR.

ID As of February 28, 1994, CFAF 590.10 = US$ 1.

98 Case Study 2 CAME ROON

C. Phase III: Closing of Other Airports

This phase is still under consideration by the Ministry of Trans- port and the CAA.

V. KEY ISSUES EMERGING FROM THE CAMEROON EXPERIENCE

The privatization experience of the Cameroon airports, and the particular scheme used, provide valuable insights for the future privatization of airports in countries with poor economic performance. Five main issues are of particular interest in Cameroon's airport privatization. Government Intervention. Due to the fact that it faces severe economic constraints, the Government of Cameroon has, throughout the last four years, expressed a strong commitment to the completion of the ADC joint venture transaction. Unfortunately, the government's ownership majority in the newly created airport operating company (ADC) and the lack of a clear definition of roles for each participating partner provide obstacles to the development of a successful privatization. Once the privatization decision was taken by the government, its ownership participation in ADC should have been modest (or should have ceased) in order to minimize interference with the day-to-day decisions of a private corporation. Governments in this type of infrastructure operation should concentrate on their roles as efficient policymakers and regulators, leaving the role of owners, operators, and financiers to the private sector. Selection of the Strategic Partner.Lack of competitive bidding in the selection of the technical partner in the private operating company (airport operator) limits the government's choice and its negotiating power in the privatization process. By selecting the strategic partner through individual technical consultations (as opposed to an open public bidding process), the government limited its privatization options and the conditions of the master concession. Cross-subsidy Mechanisms. Cross-subsidy mechanisms should be established prior to transferring airport operations to a private operator. The need to economically sustain

99 AIRPORT PRIVATIZATION ExPERIENCES

the less profitable components of the airport system, particularly when the system as a whole is not financially attractive, remains the most critical issue concerning airport privatization in underdeveloped economies. In the Cameroonian case the authorities did their best to establish a cross-subsidies system through packaging of the airports to be privatized. Given Cameroon's current economic situation, only seven airports were included in the ADC package, with the others awaiting a future decision. The government can no longer finance operations by reallocating resources from profitable airports. Owing to the government's self-imposed restrictions concerning the airport privatization process, alternative mechanisms (e.g., auctioning unattractive airports to the bidder requesting the lowest subsidy) were not considered. The CAA is currently working on a new budget proposal that tries to find ways of dealing with the system's unprofitable airports (a group of seven airports). Investment Commitments. The concession agreement's lack of clarity regarding investment commitments and performance criteria for the private management company could prove critical when investment decisions are made and responsibilities assumed. This issue is even more compelling if one considers that from the government's point of view one objective of privatization is to bring in capital for financing much- needed investment in airport facilities. Ground Handling Service Concession. Exclusivity of the ground handling services concession to the national flag carrier could become a major setback in an airport privatization transaction. In the past, CAMAIR enjoyed exclusive rights for the provision of ground handling services, without paying any kind of financial compensation to the CAA (the airport operator before ADC). Transparency and accountability in airport operations tend to be overlooked when governments own both the airport and the flag carrier. In airport privatization a conflict of interest arises from the government's simultaneous commitments to the privatization effort and the flag carrier. To avoid conflict, airport and airline responsibilities, even in the case of full government ownership, should be clearly defined and the relationship between them established on a commercial basis (i.e., a formal concession agreement with financial compensation). Exclusive ground handling services arrangements should be avoided because of their negative effects on airport operation competitiveness.

100 Case Study 2 CAMEROON Ar J,,XE S ANNEX 2.1 AtROPORTS DU CAMEROUN S.A. FEASIBILITY STUDY Income from Operations' (CFAF 000)

Douala (SecodarvAirport) Garoua Bamenda - Yaounde N Gaoundere Maroua Bertoua

L Revenue Larndin'tees 813,015 41,542 27.964 32.604 915125 Ground lighting 105,419 13.754 11.432 130 605 A;rcrah parking 8.083 80 8 8,176 Passengerlees 745 063 3.676 7 86 16.224 772,8E4 Cargo fees 51352 Q) 0 0 51.352

Total airside charges 59.052 47.300 48 828 1,878 122 Ground handling charges' 400,000 0 0 0 400.000 Dom3nials 41,.168 2,320 3.002 2.300 420 790

Commercial concessions 105.109 54 . - 105,163

Fuel concesslons 70.000 - - 0,000

Other 190.140 144 - - 190.284 Total landsde charges 778,417 2.518 3.002 2,300 7d6.237

TOtal ReVnues 1,718,417 61rS70 50,302 51,128 34354,359 ,. Operating Expenses Opertaons- Labor 587.543 27.866 14.996 47,.100 677 505

Operations .Gther 657,511 42.476 36,730 8,600 745,317 AESCNA peisonnel IATCi 355.180 130 2410 0 65,660 AESCNA personnel IMETl 75 740 0 20 780 0 96.520 OLher 55,800 6.822 1,2d0 0 63.822

Total OperatIng Expenses 1.731.774 207,946 203,948 55.700 2.196,624

1lH.Operatng Profit 1,189,685 -145,834 *153,E44 -4$. 85,535

IV. Net Results Technical assistance 80.000 Deprecation 50,000 Financial charges 12) 45.000

Figures are from July 1993. They have not been updated to include the January 1994 devaluation from 50 to 100 CFAF per FF. As of July 31, 1993, CFAF 291.70 = US$1. Source: ADP-Consulting Division, estimates from ADC's Feasibility Study, July 1993.

101 AIRPORT PRIVATIZATION EXPERIENCES ANNEXES

ANNEX 2.2 AEROPORTS DU CAMEROUN S.A. FEASIBILITY STUDY Estimated Cash Flow'

(CFAF 000, 15 years)

Net results 690.535 575.788 457.296 448,812 440.335

Deprociavion 50.000 137.000 230.000 230,000 230.000 Lonc!-erm aebt ICFD) 900.000 1.500,000 1.500,000 100,000 100.000

Total inflows 1.640.535 2.212.788 2.187.296 778,812 770,335

Investrnenis 900.000 1.500.000 1.500.000 100,000 100.000 Debl repayment 1 1 0 0 0 0 0

Workingcapilal needs 209.058 209.079 208.799 208 521 208,242

Net caSh posiior 531.477 503.709 478.497 470.291 462.093

Net cash poik (a) 3-1.477 1031.1K ' 1

(CEAF 000, 15 years)

-Nel results 612.452 714,952 DeprecaIK'n 230,000 230,JOO Long-lerm debt (CFDI 0 d ITotal inftlowS 842452 944,952 Invesimentis 0 0 Debt repavyment (11 410,000 410,000 Working c-ap,lal needs 207.412 207,412 NJet cash posilion 225,040 327,540

Net (a) _ _ 3.30 . 1 Figures are from July 1993. They have not been updated to include the January 1994 devaluation from 50 to 100 CFAF per FF. As of July 31, 1993, CFAF 291.70 = US$1. Source: ADP-Consulting Division, estimates from ADC's Feasibility Study, July 1993.

102 Case Study 3 CANADA

AIRPORTS IN CANADA

A CASE STUDY IN CORPORATIZATION AND JOINT PUBLIC/PRIVATE OWNERSHIP STRUCTURES1

Within the last 10 years macroeconomic constraints, combined with the overall weak economic performance of Canadian airports, have prompted the limited divestiture of government airport holdings. This process has been uneven, as is reflected in the two distinct ownership structures- (1) corporatization; and (2) joint public/private ownership- within the Canadian airport system. The majority of the 135 airports in Canada are owned or operated by Transport Canada, the national transportation ministry. In 1992, Calgary, Edmonton, Montreal Dorval, Montreal Mirabel, and Vancouver Airports were corporatized and management functions were devolved to four regionally based Lo- cal Airport Authorities (LAAs). In 1994, the newly elected government announced a National Airports Policy which included the intent to corporatize another 19 Transport Canada airports to be completed by the year 2000. Corporatization, in the Cana- dian context, is the transfer of airports by way of long term lease (60 + 20 years) from federal government operation to private sector corporations without shareholders and whose Board of Directors cannot include elected officials or government employees. A unique feature of these LAA corporations is the appointment process for their Board of Directors. Board members are appointed by the LAAs Boards from persons nominated by

Research for this case was conducted in May 1994.

103 AIRPORT PRIVATIZATION EXPERIENCES

local municipal governments, provincial and federal governments as well as organizations such as Chambers of Commerce. The directors' fiduciary responsibility is to the LAA corporation, not to the nominating entity. Private sector participation in Canadian airports also exists within a modified Build-Own- Operate-Transfer (BOOT) scheme that was utilized for the development of Terminal Three (T3) in Toronto. The divestiture of airports has resulted from pressure to change from centralized to local decision making, to make airports more flexible and responsive to local situations, to facilitate a more commercial orientation to these airports and to transfer the financial responsibility for new investments from the taxpayer to the users. The corporatization of the first group of airports took almost four years to bring about because of a national election, several changes of transportation ministers and deputy ministers combined with the fact that the approach was without precedent in Canada. Moreover, limited consensus existed among federal government ministries as to the degree of financial and operational involvement after corporatization. A key step was the reconciliation of conflicting government objectives: deficit reduction versus transportation policy. There was some controversy during the 1993 national elections when the on-going government proceeded to sign agreements which leased two terminals at Canada's major airport to a private sector corporation for a 60 year lease. The incoming government canceled those agreements and is proceeding with corporatizing the airport instead. The process has been further complicated by the involvement of municipal and provincial governments interested in developing airports as economic growth poles.

1. OWNERSHIP AND INSTITUTIONAL FRAMEWORK

In addition to its airport ownership and management functions, Transport Canada (the national transportation ministry) supplies air navigation, air traffic control, safety, security, aircraft certification, pilot licensing, and aviation regulation activities. Table 3.1 summarizes the administration of airport services under the different airport ownership structures in Canada. The two Mon- treal airports (Dorval and Mirabel) illustrate the corporatized experience, and Lester B. Pearson Airport in Toronto illustrates

104 Case Study 3 CANADA

Table 3.1 Canada: Ownership/ Management of Airport Services

Air Traffic Control Transport Canada Transport Canada Transport Canada Police Canadian Mounted Police Canadian Mounted Police Canadian Mounted Police Security Transport Canada Transport Canada Transport Canada Fire/Ambulance Transport Canada ADM' Transport Canada Maintenance Transport Canada ADM Lockheed Air Specific Facilities Transpon Canada ADM Lockheed Air

Traffic Handlmg Aircratt Airlines Airlines Airlines Baggage/Freight Transport Canada ADM Lockheed Air I Passenger Transport Canada ADM Lockheed Air Customs Immigration Canada Immigration Canada Immigration Canada Immigration Immigration Canada Immigration Canada Immigration Canada

Concessions Shopping/Duty Free Private Private Lockheed Air; Private Catering/Restaurants Private Private Lockheed Air; Private Car Parking Private Private LocKheed Air: Private Car Rental Private Private Lockheed Air; Private Other iBanking, Transport Canada; Private Private Lockheed Air Hotel. etc.)

The LAA inMontreal isAeroports de Montreai (ADM), which administers Dorval and Mirabel Airports. Sources: ADM; Transport Canada; Lockheed Air. the joint public/private ownership of facilities. In contrast to a purely private operation, such as British Airports Authority (BAA) in the United Kingdom, the private operators at Lester B. Pearson Airport (i.e., Terminal Three[T3]) do not collect landing fees and related airport taxes.

105 AIRPORT PRIVATIZATION EXPERIENCES

__E;_,,: A. The Current Airport Ownership Structure

Except for T3 at Pearson Airport in Toronto, Transport Canada retains ownership of the assets of the 135 primary airports in Canada. Transport Canada directly administers 76 airports and heavily subsidizes an additional 54. The five corporatized airports are managed by an independent Board of Directors. Be- ginning with Toronto, an additional 19 airports are scheduled to be corporatized within the next few years. T3 (the Trillium Ter- minal) is a BOOT project owned by Claridge Properties Lim- ited (a real estate developer) and Lockheed Air Terminal of Canada, Inc. (LATC), and managed by LATC. The other two terminals were leased to a Toronto consortium but this arrangement was rescinded after the change in governing parties in 1993.

B. Sources of Airport Revenues

The bulk of revenue within the Canadian airport system is generated by the nine largest airports (Calgary, Edmonton Interna- tional, Halifax, Montreal Dorval, Montreal Mirabel, Ottawa, Toronto, Vancouver, and Winnipeg) which comprise 84 percent of total passenger traffic within Canada. On the average, airside charges constitute roughly 50 percent of total revenues at these airports. Revenue generation at the remaining smaller airports is derived almost exclusively from airside activities. Land- ing fees and passenger fees account, respectively, for 30 percent and 19 percent of total revenues. Revenue from landing fees is slightly below the European average of 40 percent and higher than the U.S. average of 23 percent. Revenues from commercial activities comprise roughly 36 percent of total revenues, which is more or less equivalent to the U.S. average. Revenues from land rents remain relatively underdeveloped comprising about 10% of airport revenues.

11. REGULATORY FRAMEWORK

Transport Canada's many transportation activities include the administration and regulation of the Canadian Coast Guard, and of ports, railways, surface roads, aviation, air traffic control, and

106 Case Study 3 CANADA

airports. Civil emergency coordination is also under the aegis of Transport Canada. Cross-subsidies exist between functions since airport and aviation divisions comprise 97.7 percent of Transport Canada's revenues and 41.8 percent of its total budget. The remaining budget shortfall is covered by fiscal appropriations. Like most aviation authorities, Transport Canada provides safety supervision and aircraft certification functions. Transport Canada regulates the economic activities of government-operated airports and airside charges are determined on a cost-recovery basis. No independent economic regulatory agency exists for the five corporatized airport authorities, which have full freedom to establish landing fees and passenger fees (airport use). However, corporatized airports are mandated to be non-profit entities with all profits to be reinvested into airport functions and facilities. This non-profit orientation effectively limits potential abuses in airport pricing schedules.

Ill. FINANCIAL PERFORMANCE

Canadian airports managed by Transport Canada operate on cost- recovery principles that are based on International Civil Avia- tion Organization (ICAO) guidelines. With the exception of the airports in Toronto and Vancouver, most Canadian airports have traditionally been money-losing enterprises. Canadian airports have markedly high operating costs, which represent 54 percent of total costs. In contrast, operating costs at U.S. and European airports comprise 34 percent of total costs. Transport Canada has historically borne the costs of these deficits. In 1991, the last year system-wide information was made available, Trans- port Canada incurred total losses of Can$95.3 million from the operation of the nine largest airports. The corporatization initiative was undertaken in part to improve operational efficiency and reduce government financial involvement in airports. Table 3.2 summarizes the financial performance of the nine largest airports prior to corporatization.

2 Can$1.1457/US$1 in 1991.

107 AIRPORT PRIVATIZATION EXPERIENCES

Table 3.2 Financial Performance of the Nine Largest Canadian Airports, 19911 (Can$ millions) Calgary Edmonton Halifax Dorval& Ottawa Toronto W Mirabel Revenues 38.5 15.8 14.4 103.8 23.0 129.0 73.8 14.6 Costs 53.5 30.9 28.8 142.4 39.6 98.5 71.5 42.7 ProfiVLoss (15.0) (15.1) (14.3) (38.5) (16.6) 30.2 2.3 (28.2)

' The figures include air navigation costs because figures were presented ina cumulafive manner. Sources: ICAO; Transport Canada.

IV. PRIVATIZATION PROCESS

A. Background

Within the Canadian airport system, nine airports have annual traffic levels exceeding 1 million passengers. During 1993, Lester B. Pearson Airport in Toronto and Vancouver Interna- tional were ranked by Airports Council International (ACI) as the twenty-seventh and fifty-eighth largest airports in the world with passenger traffic of 20.0 and 10.1 million passengers, respectively. These two airports account for nearly 40 percent of total passenger traffic in Canada. Air traffic growth within the last 10 years has been largely spurred by airline industry deregulation and restructuring. From 1983 to 1993 total passenger traffic at the nine largest airports grew 2.4 percent annually. However, even this moderate level of growth has been sufficient to strain the existing infrastructure. Transport Canada projects that, in the next 12 years, passenger traffic at these nine airports will increase by 2.1 percent annually. These forecasts, however, do not incorporate the expected increases in passenger traffic from the recently ratified Open Skies Agreement with the United States.3 Private sector capital will be needed if the

3 For example, Mroports de Montreal predicts that passenger traffic will increase by 5.8 percent at Dorval and Mirabel each year as a result of the Open Skies Agreement.

108 Case Study 3

CANADA projected growth in passenger traffic is to be accommodated with additional capacity. Table 3.3 lists historical and projected passenger traffic data at the nine largest airports. Table 3.3 Historical and Projected Passenger Traffic at the Nine Largest Canadian Airports (millions of passengers)

1985 3.9 2.0 1.8 5.5 17 2.3 158 7.0 22 i 494

1990 4.6 20 2.5 64 25 2.7 204 95 2.3 1 59

1993 45 17 23 5.6 2.3 25 19.5 97 20 50.1

1982- 1.2. *1 40% 4 200 0 40. 6 4°o 28% 3 5'o 4 1°o 0.1% j 2 6'. 1993

1990- 3.1%a 2.0V 3.0%0 3 1%. 24%o 3 7eo 3 8% 3.5% .1% 3.1%. 2000'

1 Projected. Source: Transport Canada.

B. Liberalization/Deregulation of the Airline Industry

Canada was one of the first countries to privatize the national carrier and also deregulate the domestic air transport market. Liberalization of the airline industry commenced with the part privatization of Air Canada, the largest national carrier, in 1986. In addition, the National Transportation Act (NTA), which went into effect in 1988, allowed carriers to establish fares without regulatory discretion on most routes. Entry requirements also became less onerous with the elimination of "public convenience and necessity" criteria in favor of financial "fitness" criteria. The ratification of the Open Skies Agreement with the United States had the added effect of improving market access and flight schedules for transborder competitors. In terms of entry, service, and price, Canada has one of the more open air transport markets within the OECD. Air Canada continues to maintain a close and influen- tial relationship with Transport Canada. Airside charges remain artificially low at most government-operated airports, which serves to benefit Air Canada and other airport users. Airport

109 AIRPORT PRIVATIZATION EXPERIENCES

corporatization was undertaken in part to give airport authorities wider latitude over politically sensitive increases in airside charges. Air Canada's influence also extends to the establishment of flight schedules and the distribution of airport space. For example, Air Canada was heavily involved in the decision to refurbish T2 at Pearson.

_w"wAnA C. Emerging Environmental Concerns

Environmental concerns relating to noise mitigation, waste disposal, and water treatment will have an increasing effect on airport operations. Transport Canada has responded to these concerns by requiring mandatory annual environmental audits of Canadian airports. In addition, Transport Canada must provide the necessary funding for Transport Canada operated airports to meet national environmental regulations. For example, the Van- couver LAA was compensated for the destruction of a wildlife habitat during the construction of an additional runway and terminal at Vancouver International Airport because this decision had been made while the airport was still operated by Transport Canada. Funding for noise mitigation has also been provided, and airports situated near residential areas such as Dorval are subject to night restrictions.

D. Upgrading of Air Traffic Control Services

Air traffic control (ATC) navigational services are administered by Transport Canada. ATC functions are financed through a passenger ticket tax (usually 10 percent) that varies depending on the length of the flight. Existing infrastructure is in extremely good condition as Canada is currently installing one of the world's most advanced ATC systems, which is expected to last until the next century. As part of its overall airport divestiture program, Transport Canada is currently reviewing the feasibility of spinning off ATC functions to a private sector corporation. In addition to improving efficiency, corporatization would provide access to private debt markets.

110 Case Study 3 CANADA

E. Limited Sources of Financing

The Canadian Auditor General estimates that Can$329.0 million in capital expenditures will be needed over the next 15 years to renovate existing airport infrastructure and accommodate expected growth in passenger and air cargo traffic. Within the context of extremely high fiscal deficits and other macroeconomic pressures, government funding sources are becoming increasingly scarce. Indeed, airport capital expenditures decreased from Can$244.6 million in 1989 to Can$112.2 million in 1993. Moreover, the poor economic performance of most government- operated airports has made it difficult to generate sufficient funds for airport infrastructure projects. In recent years Transport Canada has begun to consider the private sector for increased funds and to improve airport self-sufficiency. Corporatization and privatization initiatives were undertaken in large part to achieve this financial objective.

F. Two New Ownership Structures in Canadian Airports

The Canadian efforts to divest government airport holdings have had uneven results. Presently, divestiture is reflected in two distinct ownership structures within the Canadian airport system: (1) corporatization of airports ; and (2) joint public/private ownership. Each of these structures is discussed below in case study form (Sections V and VI).

V. AROPORTS DE MONTREAL: A CASE STUDY IN CORPORATIZATION

Seven years and several false starts after the government expressed the need for an airport restructuring program, Transport Canada corporatized five airports in four cities - Calgary, Ed- monton International, Montreal Dorval, Montreal Mirabel, and Vancouver. Most of the delays resulted from the highly politicized context in which the initiative was undertaken and from the fact that the initiative was without precedent. Decision-making was also slowed by the turnover of transportation ministers and the involvement of several federal departments in the trans- AIRPORT PRIVATIZATION EXPERIENCES

fer process. In addition, the final scheme required Cabinet and parliamentary approval as well as the implicit consent of municipal and provincial governments. The corporatization initiative and the introduction of private sector management were driven by the need to reduce government financial involvement, to provide additional sources of funding, to improve the poor economic performance of airports, and to transfer decision making to the local level. The five airports that have been corporatized account for roughly 40 percent of total passenger traffic in Canada.

A. Ownership and Institutional Framework

A6roports de Montreal (ADM) is a primary example of the Ca- nadian airport corporatization experience. Prior to corporatization, Dorval and Mirabel were consistent loss-makers even though they serviced a vital origin and destination market and experienced sufficient traffic levels to be profitable. Both facilities have also suffered from a lack of investment funds. In particular Dorval, the third largest airport in Canada, has long experienced strains on capacity that are heightened by its close proximity to residential areas. The original infrastructure was built in 1941 and needs renovation. In 1992 Dorval handled 95.5 percent of domestic and 49.0 percent of international passenger traffic through Montreal.4 Built in 1975 to alleviate capacity at Dorval, Mirabel is the eighth largest airport in Canada and has some additional capacity for future growth. Passenger traffic at Mirabel is almost exclusively international. Until 1992, Dorval and Mirabel Airports were administered by Transport Canada, and operational and development decisions were centralized in Ottawa. The two Montreal airports were corporatized and management functions were transferred to ADM in April 1992. ADM was formed by members of the local Chamber of Commerce and Board of Trade and the nominating process for the Board was accepted by the Mont- real municipal government, and Transport Canada. Daily and long-term operations are managed by a 15-member independent Board of Directors without interference from Transport Canada. However, local land-use issues are subject to the approval of the local municipal and provincial governments. The

4 Dorval's three runways have a capacity of 77 aircraft movements per hour. With two runways, the maximum capacity at Mirabel is 70 aircraft movements per hour.

112 Case Study 3 CANADA terms of the transfer agreement do not preclude the possibility that ADM can purchase Dorval and Mirabel after five years of operation.

B. Revenue Sources and Regulatory Framework

Formal evidence is unclear as to whether the transfer of management functions depoliticized the airside charges issue. Spe- cific information regarding revenue generation by type of activity was unavailable and was not listed in the most recent annual report. Nonetheless, landside activities have been expanded and overall revenue generation has remained steady. Transport Canada has emulated the compensatory approach used at U.S. airports, in which rents are assessed in proportion to the amount of airport space utilized. Corporatized airports are also free to impose passenger fees without government approval. For example, the Vancouver LAA has assessed a passenger fee in order to expand existing facilities.

C. Financial Performance

Corporatized airports operate under a not-for-profit orientation which requires that excess revenues be reinvested into airport operations, or be used to fund new infrastructure, or be returned to Transport Canada. 5 Formal evidence at this point concerning the still recent transfers of Dorval and Mirabel Airports from Transport Canada to ADM remains unclear. Due to the fact that ADM and Transport Canada have chosen to utilize different accounting practices in depicting their financial situation it would be difficult to compare pre and post-corporatization experiences. Transport Canada accounting practices involve recording and reporting expenditures, both operating and capital on a "cash" basis while ADM uses the generally accepted "accrual" basis whereby profits are reported on an operating basis and depreci- ating capital expenditures expensed over years rather than in the year of disbursement. The practical result of these accounting methods is that ADM's management of the Montreal airports on the surface appears more profitable but in reality proves difficult to gauge. In reality, over the short term results of the

I Profit maximnization would necessitate the introduction of economnic regulation of activities as in the U.K. and Austrian experiences.

113 AIRPORT PRIVATIZATION EXPERIENCES

corporatized airports would not be expected to differ sharply from pre-corporatized results but one would anticipate that in the next five years the positive characteristics of corporatization may lead to better results. At present we can only compare ADM's work force, at 510 employees, which is almost exactly the same as the actual Transport Canada employees that were transferred to ADM, 520 employees. In addition, post-corporatized airports should in the medium term see improved performance attributable in part to the elimination of navigation, ATC and security activities from airport balance sheets. The TC-LAA Ground Lease imposes an obligation to spend a minimum capital amount on airport infrastructure each year on ADM. Therefore, ADM must generate a profit each year roughly equal to its capital spending requirement. In the event that ADM did not spend the minimum capital amount as required by the TC-LAA Ground Lease, ADM would have to re- mit such funds to TC as additional lease payments. Therefore, ADM is currently implementing a 5-year $150 million investment program at both airports to satisfy the terms of the Ground Lease and to minimize the possibility of such funds being remitted to the federal government as additional rent. Lease payments under the TC-LAA Ground Lease agreement totaled Can$1.9 million in 1992 and Can$1.4 million in 1993. How- ever, ADM accepted the option to defer rent obligations to Trans- port Canada until 1997. The amount of deferred rent owed was Can$9.3 million in 1993. Table 3.4 contrasts certain facets of Dorval and Mirabel's economic performance for 1993.

.se.I6..: n:I - -a.:s Table 3.4 Canada: Costs/ Gross Revenues $57.1 $44.8 $101.9 Revenues of ADM Expenses m429 p.3 S7S. 1 Airports, 1993 IReported Profit $14.1 $12.5 26.7 (Can$ million)' Passengers 5 8 2.4 8.2 Onfg.oing capital prolecis Not Available Not Available $33.7 US$ 1is equivalent to Can$1.2901 (1993). Source: ADM.

D. Corporatization Process

1. Growth in Air Traffic Activity

Origin and destination traffic comprises the greater part of the air transport market in Montreal. Consequently, air transport traffic levels are linked to economic growth cycles. Passenger

114 Case Study 3 CANADA traffic at Dorval and Mirabel grew at a steady pace during the 1980s, which was followed by a sharp reduction in the early 1990s owing to the economic downturn in Canada. In recent years, passenger traffic and aircraft movements have rebounded but have not yet reached the levels registered during the previous decade. Mirabel Airport, which relies primarily on international traffic, was less affected by the economic recession. Mirabel is also the primary entry point for air cargo transport to Montreal, which has grown steadily in the last few years. Trans- port Canada forecasts that passenger traffic is expected to grow 3.3 percent annually, and by the year 2005 total passenger traffic through Montreal is projected to reach 12.3 million (8.0 million passengers at Dorval and 4.3 million passengers at Mirabel). Traffic data for the period 1985-93 are summarized in Table 3.5. Table 3.5 Canada: Historical Air Transport Data for Montreal Dorval and Mirabel, 1985-93

Dorval Mirabel Total Dorval Mirabel Total Dorval Mirabel Total 1985 5 5 1 7 7 2 152.1 40.8 192.9 N/A N/A N/A 1a86 5 7 1.9 7.6 160.0 43.2 203.2 NiA NiA N/A 1987 6.0 2.0 8.0 175.4 42.3 217.5 hl,A N/A NMiA 1988 6 5 2.2 8.7 203.1 46.0 249.1 N'A NiA N.A 1989 6 5 2.4 8.9 231.3 49.5 280.8 N/A N/A N/A 1990 6 4 2.5 8 9 197.5 47.8 245.3 N/A N/A N/A 1991 5 6 2 3 7.9 197.4 47.5 244.9 32.3 91.0 123.3 1992 5 6 2.4 8.0 197.5 46.4 243.9 31.5 102.4 133.9 1993 5.8 2.4 8.2 N/A NMA N!A 32.7 109.9 142.6 Sources: ADM; Transport Canada.

2. Limited Sources of Financing

Corporatization was intended to eliminate dependency on government funds and to permit access to private capital, with the restrictions that assets cannot be used as collateral. This prohi- bition relates to the fact that airports are leased assets still owned by the federal government. ADM issued revenue bonds before the devolution of airport management functions. In this way,

115 AIRPORT PRIVATIZATION EXPERIENCES

ADM was able to access starting capital to ease the transition period. Under the specific terms of the ground lease, Transport Canada is not obligated to guarantee debt obligations of the LAAs. Total long-term debt was roughly Can$13 million for 1992 and Can$12 million for 1993. The extensive financial burden of maintaining and expanding two airport facilities led ADM to study the feasibility of consolidating airports. A study undertaken by Aeroports de Paris (ADP) and Transport Canada concluded that closing Mirabel would not be practical because of the existing night restrictions at Dorval. The age of Dorval necessitates several infrastructure improvements. ADM estimates that as much as Can$830 million will be needed for renovations and expansions in both airports. Under the transfer agreement, committed expenditures total approximately Can$150 million (Can$30 million/year), some of which was subsidized by Transport Canada in 1992. In 1993, ADM allocated approximately Can$33 million for investment in airport infrastructure; this was financed in part by debt financing and reserved revenues. ADM must maintain this level of capital spending or it will be required to pay additional rent to Transport Canada.

3. Techniques Used in Corporatization

The most important element of the corporatization process is the ground lease agreement which has a 60-year term. Lease payments forecasts are fixed for the first 16 years and are based on the fair market value of airport property, 20-year traffic projections, and 20-year revenue. Thereafter, lease payments can be restructured only by mutual agreement of both parties. To improve financial viability, Transport Canada gave ADM the option to defer lease payments for the first five years after transfer. ADM and the Edmonton LAA exercised this option and the deferred amount will be paid with interest in years 11 to 15. As part of the ground lease agreement, ADM was required to retain all permanent employees for two years after the transfer. To ensure that airport services were not disrupted by staff reductions, ADM was required by Transport Canada to offer comparable benefits to those provided by Transport Canada. Roughly 98 percent of the employees accepted the transfer toADM.6 Final

6 Overall, 881 out of 1,025 Transport Canada employees (86 percent) transferred to the four LAAs. Another 110 employees refused the transfer and were reassigned to other jobs within the federal government.

116 Case Study 3

CANADA approval of the employee benefits package was given by Trans- port Canada in conjunction with the Treasury Board of Canada. In contrast to the U.S. experience, ADM did not owe the Minis- try of Finance employee benefit liabilities stemming from corporatization. (Figure 3.1 outlines the corporatization process.)

Figure 3.1 Formation of ADM from interested local Canada: Corporatiza- business groups | tion Process, ADM

Montreal CityiQuebec Provincial Government approval: * Designation of single local representative

Determined by Transport Canada: * Base report (revenue and traffic proiections) * Fair market value of Dorval and Mirabel

Negotiated between ADM and Transport Canada: * Bill of sale * ADM operational/organizational plan * Ground lease * Employment agreement * Inspection services agreement * Aviation services and facilities agreement . Agreement to transfer

Ministry of Finance/Treasury Board approval: * ADM employee plan * ADM tax-exermpt status * Agreement to transfer

Transfer of management functions: * Signing of agreement to transfer * 3-6 month transition perod * Transfer of management functions

Sources: Transport Canada; World Bank Staff.

117 AIRPORT PRIVATIZATION EXPERIENCES

The guiding principle behind corporatization was that the government would not be in a worse position as a result of the transfer. However, this approach, combined with the not- for-profit orientation of corporatized airports, has the effect of being an inherent disincentive to incremented revenue generation until certain revenue thresholds are achieved. Revenue generation up to a pre-determined ceiling (based on the 20-year foreca ,sults in higher lease payments to Transport Canada. Revenue ceilings also exist at some U.S. airports but are negotiated with the airlines, not the government. Operational efficiency is encouraged because airlines guarantee break-even revenues. The Canadian arrangement also includes a revenue floor to ensure airports are managed in a commercial manner. Cor- poratized airports in which revenues are below forecasted amounts are eligible to receive a negative lease payment or a subsidy which is limited by the existence of revenue floors. The formula for determining the ground lease payment is as follows: ADM Revenues - (Base Operating Costs + Base Capital Costs) = Lease Payment Actual revenues below revenue projections = decreased lease payments. Actual revenues above revenue projections = increased lease payments (until certain thresholds reached).7 Under the transfer agreement, the four LAAs have committed an equivalent of US$238 million for airport improvement projects over the next 15 years. In particular, ADM has committed an equivalent of US$110 million over five years for renovation and expansion projects at the two airports. To meet these investment levels, ADM must set aside a minimum amount of operational revenues to a capital development fund or return excess revenues to Transport Canada in the form of additional rent. This provision, which mimics economic regulations used in the United Kingdom, was designed as a built-in incentive for airport development. However, this mechanism requires Trans- port Canada to fund committed capital expenditures that exceed the actual revenue streams of the corporatized airports. In 1992 the four LAAs increased capital expenditures by Can$30.9 million but incurred a revenue shortfall of Can$ 13.3 million. Most of this deficit of Can$11.5 million was incurred by ADM. Also

Sources: Transport Canada; ADM; World Bank Staff.

118 Case Study 3 CANADA in 1992, ADM allocated Can$10.2 million or 86 percent of excess revenues to various small-scale infrastructure projects at Dorval and Mirabel. ADM increased total capital expenditures to Can$34 million in 1993. To avoid future shortfalls, ADM must increase revenues, obtain additional private capital, or continue to receive subsidies from Transport Canada.

E. Key Issues Emerging from the Corporatization Experience

The stated objectives behind the airport corporatization initiative were: (1) to ensure that the government was "no worse off from the transfer than if it had continued operating the airports;" (2) to reduce financial involvement in airports; (3) to improve airport sustainability; (4) to de-politicize the airside charges issue; (5) to increase sources of funds; and (6) to increase local involvement and economic growth. To date, Transport Canada has had a relatively satisfactory record in achieving these objectives. Original estimates predicted that after 15 years the government would incur a surplus from the transfer. This amount included a Can$2.0 million shortfall in 1994 and surpluses each year thereafter. Revised estimates predict shortfalls of Can$44.4 million, Can$49.5 million, and Can$52.5 million for 1994,1995, and 1996, respectively.8 The main differences in these estimates are increases in capital expenditures and overhead costs. A projected Can$20.0 million reduction in overhead costs has not yet materialized. Financial involvement in airport operations and development has decreased only marginally. As part of the transfer agreement, Transport Canada absorbed previous airport liabilities. Costs relating to the provision of navigation, ATC, security, and safety services were removed from the balance sheets of the corporatized airports. Furthermore, airports with revenues that are below projections are eligible to receive "negative lease payments" from Transport Canada. Payments are received even when no operating loss is incurred. Two years after the transfer, revenues of the LAAs were below base case projections, and two LAAs - ADM and Edmonton - received negative lease payments. The Canadian Auditor General cited Transport Canada's traffic projections as "overly optimistic."

I According to recent (1995) information from Transport Canada results in 1994 were substantially better than expected.

119 AIRPORT PRIVATIZATION EXPERIENCES

Still, corporatized airports have become more self-sustaining and revenue generation has increased. The Vancouver LAA has been the most proactive with the introduction of a passenger fee which is used to finance airport expansion. This increase is separate from the politically sensitive issue of landing fees, which remains largely unresolved. Additional sources of funds have come from the capital markets, which were unavailable under government administration. Finally, the corporatization initiative has had some success in fostering local economic growth. The LAAs permit the construction of commercial and industrial parks on airport property (an arrangement that is discouraged at some U.S. airports). ADM estimates that in 1992 airport-related activities at Dorval and Mirabel generated Can$2.4 billion and created 48,000 jobs. The Canadian airport corporatization experience was characterized by a relatively high degree of discretion and politicized process. Transport Canada negotiated with only one local group and there were no efforts to advertise that an opportunity existed for corporate investment so no additional groups could have expressed their interest in participating in the LAAs. Political pressures turned the corporatization process into a compromise among federal ministries, provincial and municipal governments, and business groups and took over four years to complete. Potential economic benefits and efficiency concerns were secondary to the negotiation process. In comparison, airport corporatization in the United States took only one year and has been less politicized.

VI. LESTER B. PEARSON AIRPORT, TORONTO: A CASE STUDY IN JOINT PUBLIC/PRIVATE OWNERSHIP STRUCTURES

A. Ownership and Institutional Framework

Lester B. Pearson Airport in Toronto is the largest airport in Canada and accommodated approximately 20 million passengers in 1994. It was the only case in the analyzed sample in which independent public and private ownership of airport facilities shared the same premises. Terminals One and Two (Tl and T2) are owned and operated by Transport Canada, and the

120 Case Study 3 CANADA

newly built Terminal Three (T3) is owned and operated by the private sector. Given the lack of economic regulation in Canada, there is a "real" price competition among the different terminals (i.e., terminal fees charged to airlines by T3 are three times higher than those charged by TI and T2). Because of their differing ownership structures and user preferences, the three passenger terminals at Pearson are in vary- ing states of physical condition. Built in 1962, TI is somewhat deteriorated and in need of renovation. Before the opening of T3, TI handled 10 million passengers each year, which was more than double its intended capacity. Moreover, several foreign- based carriers were crowded into the premises. At present the main users of Ti are low cost U.S. airlines, and a third of total airport's traffic has been diverted to the new T3. The physical infrastructure of T2 is in much better condition than that of Ti as a result of renovation undertaken through ajoint venture with its primary user, Air Canada. However, T2, which was developed in the 1970s, is nearing its maximum capacity. In the five years prior to the development of T3, passenger traffic at Pear- son Airport for Ti and T2 grew at a compounded average annual growth rate of 8.3 percent (Ti was operating at more than double its intended capacity and both terminals were in severe need of renovation). Thus, the initiative to develop a third terminal stemmed from the need to relieve existing capacity. Lim- ited public funds necessitated private sector involvement in the development of the third terminal. The new terminal has a maximum capacity of 12 million passengers per year. Increased funding for the two government-operated terminals has been ham- pered by delays in the bureaucratic process, shifting political objectives, and a tight fiscal environment. The proposed privatization (i.e., long term leasing to private sector operator) of Ti and T2 was canceled owing to the change in governing parties and to conflict of interest concerns. T3 at Pearson Airport was developed as a build-own- operate-transfer (BOOT) project. Equity ownership of T3 is shared by two private entities: Claridge Properties Limited owns 73 percent and LATC owns the remaining 27 percent. Land ownership has been retained by Transport Canada. Through a 60-year lease agreement with Transport Canada (a 20-year lease with two 20-year renewal options), LATC is responsible for the administration and maintenance of T3 facilities, property, and adjacent roadways and receives a 6 percent management fee for its services. Operations are coordinated by Transport Canada.

121 AIRPORT PRIVATIZATION EXPERIENCES

Transport Canada is responsible for providing all air navigation and ATC functions and owns all airport runways and taxiways. Revenues from landing charges, passenger fees, the airline fuel tax, and the ticket tax accrue to Transport Canada. T3 operations are primarily confined to landside activities and begin at apron approach when the aircraft switches from general to T3 tower control.

B. Revenue Sources and Regulatory Framework

The revenue profile of Pearson is comparable with that of other airports operated by Transport Canada. Historically, Pearson has been negatively affected by airside charges that were kept artificially low because of political constraints. Truncated airside revenue streams made it difficult for Transport Canada to finance new and expanded airport infrastructure. The traditional response had been to raise airside charges shortly after each general election. However, pricing according to electoral cycles is no substitute for solid economic criteria. One objective of the airport corporatization initiative was to depoliticize the airside charge issue by devolving the price setting function to the LAAs. In accordance with international principles, airside charges at TI and T2 are purely on a cost-recovery basis. Because of the relative age of the terminals, capital costs are not included in the calculation of airside charges. Moreover, airside charges are much lower at Canadian airports than at the more profitable U.S. airports. Table 3.6 compares the landing fees for a Boeing 747- 200 at Toronto and at Boston, two airports that are comparable in size.

Table 3.6: Comparative Airside Landing 757.34 953 16 Charges for Toronto and Terminal 140.90 596.00 Boston for a B747-2001 Peak Period 51.00 0.00 (US$) Parking (0-4 hours) 67.56 137.00 Loading Bridge 1014 0.00 Total 1,066.94 1,686.16 Landing fees and terminal charges are based on international and/or transborder pricing schedules. Sources: ICAO; Transport Canada.

122 Case Study 3 CANADA

Revenue generation at T3 comes from three sources: (1) airline rents and charges (50 percent); (2) concessions (30 percent); and (3) parking (20 percent). Revenues are split according to the existing ownership breakdown (73/23). The terminal uses a hybrid approach to determine airlines charges which was modeled after the system in use at several U.S. airports. Rents are derived according to the amount of space utilized, with operating and capital costs factored in the rental payments. Operating costs are guaranteed by terminal and aircraft parking charges and can be raised to achieve break-even revenues. To recover security costs, the airlines are assessed a percent per seat charge on each arriving flight. Airlines and concessionaires are also assessed a 5 percent charge that finances maintenance costs. These funds must be utilized or returned to the users. Transport Canada agreed to commit up to the equivalent of $60 million in loans (up to a maximum of $8 million in any one year) if revenues drop by 50 percent during the course of a year. Transport Canada reports that the coordination of activities between the privately owned and publicly owned terminals has been harmonious. Although airside charges at the terminals have been structured on a non-competitive basis, a large disparity exists between the two ownership structures. On average, airside charges at T3 are Can$7.19 per passenger, whereas at T1 and T2 revenue per passenger is Can$2.59. The higher charge at T3 reflects the greater capital costs associated with the development of a new terminal. Airside charges at the government-operated terminals are on a pure cost-recovery basis and do not include capital costs. Market segmentation between the ownership arrangements is another factor. International airlines operate out of T3, whereas domestic and low cost U.S. airlines serve TI and T2, respectively.

C. Financial Performance

In spite of relatively low airside charges, Pearson Airport has remained profitable because of its large passenger flows, which generate higher revenues from landing fees and concessions. In addition, Pearson's operating costs are roughly 3 percent lower than the composite of the largest nine airports in Canada. Table 3.7 outlines the overall financial performance of Ti and T2 at Pearson during the period 1988-92.

123 AIRPORT PRIVATIZATION EXPERIENCES

Table 3.7 Canada: Financial Performance of Ti and T2, Toronto, 1988-92 (Can$ millions, except as noted)

Passengers (millions) 20.7 20.9 21.2 13.4 13.5 Revenues! 148.0 158 4 165.1 129.0 123.1 Revenues/Passenger (Can$) 7 2 7.6 7.8 9.6 9.1 Costs2 69.4 82.6 98 7 98.5 84.6 Costs/Passenger (Can$) 3.3 3.9 4.7 7.4 6.3 Profit/Loss' 78.5 75.9 66.4 30.5 38.4 Cash Holdings 102.0 89 5 88.1 30.6 47.7 Capital Expenditures 46.7 48.9 30.2 18.3 10.3 Average Retum on 36.0 30.0 29.0 13.0 17.0 Investment (%o) Lower revenues 1991-1992 are attributed to U.S./Canada exchange rate differences. US$1=Can$1.1.2307(1988); Can$1.1840(1989); Can$1.1668(1990); Can$1.1457(1991); Can$1 .2087(1992). Lower costs are due to efficiency concems andto the U.SJCanada exchange rate differences. 'The opening of T3 inFebruary 1991 impacted on 1991-1992 profits. Source: Transport Canada.

T3 has much lower staff costs than the government-operated terminals. T3 maintains a third fewer employees than either Ti or T2, and T3's employees are not unionized. More- over, T3 is less burdened by regulatory and administrative procedures, and procurement is more streamlined. To illustrate the efficiency of operations at T3, one official quoted a statement to the effect that to change a carpet in the passenger service area at TI or T2, 41 administrative steps are required, whereas at T3 all that is needed is one phone call from the maintenance manager to the supplier. Although T3 has been profitable, total profits have been less than originally forecast. The decrease in passenger traffic as a result of the Gulf War and the 1991-92 recession had a negative impact on commercial revenue. In addition, two concessionaires contested the financial terms of the retailing agreement, which led to the renegotiation of one contract and the nullification of the other. Detailed information on the financial performance of T3 is precluded by the lack of disclosure by LATC.

124 Case Study 3 CANADA

D. Privatization Process

1. Growth in Air Traffic Activity

Pearson Airport serves the Toronto metropolitan area - the business and financial capital of Canada. In addition to having a strong origin and destination market, Toronto serves as the primary entry point for foreign carriers and provides hub services for Air Canada into domestic markets. Because of these market factors, growth at Pearson Airport is closely linked to changes in national and world macroeconomic conditions. Pas- senger traffic increases in the middle to late 1980s were followed by a reduction in traffic during the Gulf War and the 199 1- 92 recession. Overall, average annual growth rates in passenger and cargo traffic during the period 1985-93 were 3.3 percent and 7.2 percent, respectively. As is seen in Table 3.8, maximum capacity constraints were reached around 1988 and the development of an additional terminal became necessary. Trans- port Canada estimates that air passenger traffic will grow by 2.1 percent annually. Total traffic estimates range from 30 million to 35 million passengers by the year 2005. Table 3.8 lists passenger, cargo, and aircraft movements at Pearson during the period 1985-93. Table 3.8 Canada: Passenger, Cargo, and Aircraft Movements at Pearson, 1985-93

S. * - _ SI ww

T1-2 T3 Total T1-2 T3 Total T1.2 T3 Total 1985 15.8 0.0 15.8 282.6 0.0 282.6 I N/A N/A N/A 1986 171 0.0 17.1 301 2 0.0 301.2 216.7 0.0 216.7 1987 184 00 18.4 313.8 0.0 313.8 241.5 0.0 241.5 1988 20 3 0.0 20.3 347.6 0.0 347.6 273.5 0.0 273.5 1989 20.7 0.0 20.7! 348.3 0.0 348.3 312.2 0.0 312.2 1990 20.4 0.0 20.4 353.8 0.0 353.8 327.6 0.0 327.6 1991 13.4 5.1 18 5 . 214.9 107.4 322.3 209.7 104.8 314.5 1992 13.5 6.5 19.1 218.3 109 2 327.5 216.7 108.3 325.0 '1993 13.7 7.0 20.7 N/A NA N/A N/A N/A N/A Source: Transport Canada.

125 AIRPORT PRIVATIZATION EXPERIENCES

2. Limited Sources of Financing

Federal ownership of Pearson precludes its access to capital market funds. Funding for TI and T2 is obtained exclusively from fiscal appropriations and covers operational costs, navigation, ATC, and security services. Increases for infrastructure improvements have been difficult to obtain within the current macroeconomic context in Canada. In particular, Pearson Air- port requires three new runways which would increase airside capacity by 30 percent and would accommodate projected increases in aircraft movements. This project, which had been under study for four years, was postponed in 1993 because of political concerns and financing constraints. In addition, Ti is in serious need of renovation. Lack of financial resources was the primary reason why T3 was developed by the private sector and the privatization of TI and T2 was undertaken.

3. Techniques Used in Privatization

T3, a 29-gate terminal, was developed to relieve capacity constraints at Pearson Airport. The original developers, Huang and Danczkay (which sold their shares to Claridge Properties in 1992) and LATC had complete autonomy in choosing the design, size, and financing of the new terminal. T3 was constructed in three years at a cost of Can$570 million, an overrun of more than Can$320 million over original estimates. The expansion of the original design from 16 to 24 gates and the development of a 5- gate satellite terminal was the primary cause of the cost overrun. Unlike airport terminals in the United States, developed by airlines to vertically integrate operations and achieve greater economies of scale, this project was intended to be a separate and commercially viable operation. In contrast to the selection process at the corporatized airports, the bidding for the development of T3 was open and transparent. Nine business groups responded to Transport Canada's original request for proposals, which was eventually short-listed to four consortia. The main criterion for differentiating the four bids was the ability to undertake all phases of the development - design, financing, and operations. The maximum rate of return is unregulated by Trans- port Canada. Because of the concern that T1 and T2 would be un- derutilized, Transport Canada has rigidly controlled the entry of airlines at the new terminal. Prior to construction, the develop-

126 Case Study 3 CANADA ers obtained commitments from seven foreign-based airlines to operate at T3. Airline leases have 20-year terms and a review by Transport Canada is required. A demand existed for additional airline transfers to T3, but this was not permitted by Trans- port Canada. Carriers that currently operate out of T3 were un- happy with this decision, as an increase in new entrants would lower rental costs. Transport Canada is not obligated to transfer a new carrier to T3 in the event of drastic service reduction or bankruptcy of the operating airlines. (Box 3.1 gives project highlights for T3.)

TERMINAL THREE (THE TRILLIUM) - PROJECT Box 3.1 HIGHLIGHTS Description of the Project. The privatization concept used in this transaction was a "build - own - operate - transfer' (B1iOTi arrangerment with a long-term lease contract of 60 years icr the use of land irenewable). One of the features of this parlicular transaction w%as that the BOOT included full capita' cost recovery over the life of the lease (including the investor's rate ot return) on the total costs ot the project (ter- iminal access roads. etc.). The project was a greenfield concept iniendea originally to provide Lester B. Pearson Airport with a new passenger terminal with the following characteris- TiCs: l 1t 16 gates; t2) access road: (3) capacity to handle between 5 and 6 million passengers a year with potential for expansion to up to 12 million passenger a year: (4) estimated project cost of CanS250 million. Project Implementation. The BOOT contract for T3 was awar-ded in 1987 to Terminal Three Limited Partnership (TTLP), a consortium integrated by two Canadian developers (Huang and Danczkayl and one airport operator (Lockheed Corpora- tioni. Later in 1992 Huang and Danczkay sold its share in TTLP to Claridge Propenies Limited (a real estate developer related Io the Bronfman investors' group. Seagrams). Termi- nal 3 (T3i is managed by Lockheed Air Terminal of Canada Inc iLATCO under a management contract trom TTLP. The final total development costs for the project amounted to Can $ 570 million. and the total time elapsed from the selection of the proposal until the delivery of the T3 was three years. From the original profect of 16 gates and 6 million passengers per year. T3 ended up with 29 gates t24 + 5 satellite) and a capacity of between 10 and 12 million passengers per year. The total area of the terminal is 130.060 square meters. Structure of Fees and Charges (TTLP). Although financial intormation was not available, given the ownership structure of the private operators i.e.. closely held companies). the following is a description of the key components of the fees and charges at T3: Continued

127 AIRPORT PRIVATIZATION EXPERIENCES

Boxn 3.1 Management Fees. LATC's management fee is 'cost plus" based. The current conditions are set at 6 percent of total expenses. Terminal Fees. Landing fees and air navigation services are charged to airlines by Transport Canada. Charges to airlines tor the use ot T3 start at the apron approach when the carder switches from the general tower control to T3 tower control. TTTLP charges the airlines terminal fees based on a predetermined formula that estimates the total expenses of a given year (i.e.. operational and maintenance expenses plus capital costs). This amount is divided by the estimated number of i offered seats for that year (enplanements and deplanements by type of aircraft) to calculate the terminal fees per offered seat. Secunty Cflarges. TTLP charges the airline a security fee. on a per passenger basis, tor the use of T3. Concessionaires Charges. TTLP charges each one of the commercial concessions with a percentage of gross revenue for the lease of the space (duty-tree. shops, restaurants, etc.). In addition, it charges an initial payment for the right of exploitation (key money). Investment Fund Charges. T3 users (airlines and concessionaires) are charged 5 percent of gross revenues for purposes of upgrades, general maintenance, and new investments tor the terminal. If the amounts in the investment fund are not used within a given period of time, the fund is transferred back to the users. Other Direct Cosl Allocations. Other operational costs are allocated to users (airlines and concessionaires) on the basis of real expenses. These costs are allocated on the basis of space used, according the following distribution: (1) 70 percent to airlines and (2)30 percent to commercial concessionaires including parking (the parking concession is directly exploited by TTLP). Construction Charges. Full recovery of capital investment (including financial costs and investor's rate of return) are included in the pricing lormulas of the different charges

In 1993 the Conservative Administration attempted to privatize TI and T2 through a lease-develop-operate (LDO) scheme. The selected consortium, PAXPORT, agreed to invest in the renovation and expansion of TI and T2. The use of fast- track bidding procedures coupled with a politization of the privatization process resulted in the project becoming controversial. During the 1993 general election, the Liberal Party campaigned

128 Case Study 3 CANADA

against the leasing of T I and T2. With the subsequent change in governing parties, the project was canceled. To date, PAXPORT is seeking financial damages as a result of this cancellation.

E. Key Issues Emerging from the Pearson Airport Experience

E Private Sector Involvement. The privatization experience of the new T3 at Lester B. Pearson Airport has been successful. Pearson airport has three terminals, one of which is completely under private sector management while the other two are under the direct supervision of Transport Canada. The relationship between the two different types of administration has been excellent according to officials from both the Pearson Air- port authority (Transport Canada) and LATC. The difference in prices has segmented the provision of terminal services, providing a market mechanism for carriers' preferences. Capital allocation to the development project was available, given the existing financial conditions in the original arrangement (i.e., 60- year land lease, no economic regulation on charges, user's charges driven by full capital cost recovery requisites). By selecting the option of private sector involvement in the development and operation of T3, Transport Canada provided the community of Toronto with a new terminal facility at no cost to the taxpayer. TransactionDesign. The relative success of the T3 transaction was due to the transparent process and the depoliticized environment. Bid submissions were requested openly, and Transport Canada was able to choose the best out of four proposals. Conflict of interest concerns such as those that affected the privatization of Ti and T2 did not materialize. More- over, the absence of a politicized environment meant that only the main principals involved had a voice in the transaction. The development of T3 was not held hostage to political concerns and did not necessitate the involvement of various federal departments andlor levels of government. Thus, the government was able to concentrate on financial provisions and future operations of the terminal. Moreover, this arrangement precludes future government financial involvement in T3 unless a bankruptcy occurs. Unlike the corporatization experience discussed earlier, in the T3 transaction capital expenditures are the sole responsibility of the developer; in addition, no government funds were involved in the development of the new terminal. The ex-

129 AIRPORT PRIVATIZATION ExPERIENCES

perience with Ti and T2 at Pearson Airport in Toronto illustrates the importance of maintaining transparent and open bidding procedures in the privatization initiative. M PoliticalInfluence. Another significant issue is that the depoliticization of airport operations and development initiatives is absolutely necessary to improve economic efficiency and establish financial autonomy. Political pressure to maintain low airside charges impairs the ability of airport authorities to finance renovations and expansions. At small and medium-size airports, low airside charges in relation to operational costs may impede airport sustainability. Privatization and deregulation of the airline industry is one approach that would depoliticize the airside charge issue and concomitantly reduce the political linkages among aviation enterprises. However, changes in airport ownership structure in conjunction with the establishment of an independent regulatory entity would give airport authorities wider latitude in setting pricing schedules. Management Contract (fees and incentives). T3 is using as a management contractor a private sector operator (Lockheed Air Terminal of Canada Inc.). Given the basis on which the management contract fees are calculated (i.e., cost plus), an argument could be made against real incentives to become cost efficient . This issue will have to be given consideration by Transport Canada on the basis of the "real competition" that could occur in TI and T2 under the present ownership structure (to provide an incentive for lower operational costs). Management fees should not only be linked to total cost figures, but should also include performance results (gross operational profit, revenue increase per passenger, etc.).

130 Case Study 4 COLOMBIA

AIRPORTS IN COLOMBIA

A CASE STUDY OF INNOVATIVE INFRASTRUCTURE FINANCING IN LATIN AMERICA 1

The cielos abiertos (open skies) agreement signed in 1990 by Andean Pact members Colombia, Bolivia, Ecuador, Peru, and Venezuela liberalized air space and, coupled with the economic liberalization taking place in other Latin American nations, stimu- lated air traffic. Sustaining air traffic growth, developing Colombia's position as a regional hub, and satisfying international operative and security standards will require substantial investment in airport and air navigation infrastructure. The Civil Aviation Authority (CAA) (Aerocivil de Colombia) and the Min- istry of Planning (Departamento Nacional de Planeaci6n) forecast investment needs of US$329 million for air navigation and airport-related infrastructure in the near future. In view of the increasing difficulties faced by the Government of Colombia in meeting these investment needs, the CAA embarked in 1993 on a series of far-reaching reforms designed to involve the private sector in the development and provision of air services infrastructure. In early 1993, the CAA commissioned an international consulting firm, Booz, Allen and Hamilton (BAH), to undertake a thorough study, financed by the United Nations Develop-

'Research for this case study was conducted in February 1995.

131 AIRPORT PRIVATIZATION EXPERIENCES

ment Programme (UNDP), for the rationalization of the airport system in Colombia (BAH Study). The study, called "Descentralizaci6n de la Infraestructura Aeroportuaria" (Decen- tralization of the Airport Infrastructure), included a restructuring and privatization strategy for the airport sector, a corporatization strategy for the CAA, and a new pricing policy for airport-related charges (economic regulation). In December 31, 1993 new Transport Law No. 105 was enacted by Congress. Under the new legislation, the government corporatized the CAA, separating airport operations from air navigation activities. At the same time, and as part of a process begun before the enactment of the law, the government undertook the privatization of the second runway at El Dorado International Airport, Bogota, using a build-operate-transfer (BOT) scheme for the construction and maintenance of a new runway (3,800 m) as well as the maintenance of the existing runway (3,800 rn).2 The El Dorado privatization transaction incorporates innovative financing mechanisms in cases of non-conventional airport infrastructure (for private sector participation) such as runways, taxiways, and aprons. If it is successfully implemented (construction is expected to begin at the end of 1995), this type of transaction could become a model for airport infrastructure financing in developing economies. The case also illustrates the importance of using technical experts to design and implement the privatization transaction, as well as a meticulous and pre- cise implementation of bidding procedures for the concession contract. However, the ways in which the transaction was structured raise some issues regarding the impact of the pricing strategy used for determining the levels of landing fees and the use of government guarantees to cover the project's commercial risks. This experience is further analyzed in Section IV of this case study. The privatization process of the Cali International Air- port, after an initial failed attempt owing to security concerns in April 1995, is being reformulated by the CAA in consultation with six interested parties. The transaction is expected to be completed by late 1995. Bidding documents are also being drawn up for the privatizations of the Baranquilla and Cartagena Air-

2 Largely in response to issues of capacity constraint and the desire for a quick resolution of concerns, the government embarked on the partial privatization of the airport facility (runway). In 1993 total time delays reported by airlines at El Dorado airport were equal to 5,200 hours, which, calculated at US$1,350 per hour, equals US$7 million per year.

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x AIRPORT PRIVATIZATION EXPERIENCES

. OWNERSHIP AND INSTITUTIONAL FRAMEWORK

___ e__ A. The CAA through 1993

Colombia's CAA, a government agency under the supervision of the Ministry of Transport, was responsible for overseeing and managing all aspects of air transport policy and airport-related services. With 3,349 employees, the CAA performed three main functions: (1) provision of air navigation services; (2) administration of technical and economic regulation; and (3) airports operation. At the federal level, the CAA was structured into a general division subdivided into three sections:

X An administrative division employed 927 staff who together with the Ministry of Transport oversaw air transport policy. This division established and controlled economic regulation - specifically the determination of airside charges. • An air navigation and technical division, which employed 985 staff, provided air navigation services and, in particular, controlled aircraft movements and provided en route and search and rescue assistance to flights. • An airports division, with 1,437 employees, focused on managing airport-related services and on planning airport investment and maintenance programs in the 74 Colombian airports. Figure 4.1 shows the CAA organization structure. At the regional level, the CAA provided air traffic control services through six air navigation sub-divisions responsible for controlling aircraft movements within Colombian airspace.

B. The CAA after 1993

Given the pressing needs for airport infrastructure development and the tight budgetary constraints, the Government of Colom- bia decided in 1993 to restructure the air transport sector to favor both regional decentralization and increased private sector

134 Case Study 4

COLOMBIA

Figure 4.1 Colombia: CAA Organization Structure (to December 1993)

CAA

I Administrative Division) AirNavigation Services Airports Manageinen)

I Air Tranport Policy) Air Traffic Control Airport Operation

Economic Regulation Safety Regulation )Airport Safty

'Technical Regulatio n) Search' &Rescue ) Cci

Source: CAA, "La Nueva Aerocivil, Estructura y Normas Generales," Janu- ary 1994. participation. Under the December 30, 1993, transport law (Law No. 105) the government overhauled the airport institutional framework. Decree No. 2724, of December 31, 1993, corporatized the CAA: "The CAA is a specialized entity of technical character under the Ministry of Transport with legal character, administrative autonomy, and financial independence."3 Under corporatization, the CAA is subject to civil corporate law like any other private enterprise, with autonomy in its financial budgeting and corporate governance. The CAA's assets and liabilities became clearly separated from the federal government's budget. Undertaking a BOT or a long-term lease concession is easier under a corporatized entity. Corporatization imbued the CAA with the necessary flexibility needed for restructuring the sector. The new CAA, under the jurisdiction of the Ministry of Transport, will focus its activities on: Regulating air transport services. The Administrative Division will focus primarily on economic and technical regulation of the sector.

3 CAA,"La Aerocivil: Estructura y Normas Generales," January 1994.

135 A r)RT PRIVATIZATION EXPERIENCES

Providing air traffic control (ATC) services under the aegis of the Air Navigation Services Division. This reorientation of activities required a corresponding restructuring of personnel. The Administrative Division staff went from 927 to 329 employees, and the Air Navigation Ser- vices Division staff increased from 985 to 1,073. Under the new arrangements, the CAA can transfer responsibility for infrastructure development and airport management to private sector operators. Figure 4.2 shows the post-1993 organization structure of the CAA.

Figure 4.2 Colombia: The New CAA Organization Structure

Policy & Regulation Air Navlption Svvicem

I Air Transport Policy Air Traffic Control

Econornic Regulation )( Safety Regulatlon )

,Technical Regulation ' Search &Rescue

Source: CAA, "La Nueva Aerocivil, Estructura y Normas Generales," Janu- ary 1994.

The aim of the institutional reforms enacted in the air transport sector is to establish a mechanism for decentralizing the administration of transport-related infrastructure while creating a framework that facilitates and promotes private sector participation. The rationalization of Colombia's national airport system is being implemented by the CAA through its operating unit (Secretarfa Aeroportuaria). As private investors enter the sector, the CAA's role in setting air transport policy and regulating the sector will gain in importance (see Box 4.2).

136 Case Study 4 COLOMBIA

OFICOLOMBIA'S Box 4.2 CONTEXT OF COLOMBIA'S RESTRUCTURING AND PRIVATIZATION OF THE AIR TRANSPORT SECTOR In 1994 the Colombian air transport system mobilized 8.0 million domestic passengers, 2.1 million international passengers, 161,000 tons of domestic cargo. and 403.000 tons of intemational cargo. During the period 1990-94 the number of passenger and freight operations grew by an 8 percent annual rate. 1 Most of the increase was concentrated among the larger airports. Forecasts call for continued increases in volumes being handled by the Colombian air transport sector. Investment spending must occur in the light of these projections, for Colombia's airport infrastructure to cope with the increased demands placed on it in future years.

Summary of Passenger Flow Projections (in millions) Airport Year Category 1994 1999 2004 2009 2014 A Large I 6.1 8 9 10.8 13.0 15.7 B Medium' 1.7 2 3 2.8 3.4 4.1 C Sma!l 0.3 0 4 0.4 0.5 0.6

'Reordenamiento Irisinuconal y Plan de Expansion del Sisiema Aeroportuario,. Deparimerit ot National Planning. August 1994. Source Booz. Allen and Hamilton, 'Descenlralizaci6n de la lnfraeslructura Aeroportuaria." Seplember 1994

Il. REGULATORY FRAMEWORK

A. Economic Regulation through 1993

Since its inception the CAA has been responsible for setting and regulating aeronautical charges, which represent 83 percent of revenues. Aeronautical charges in Colombia include air navigation fees, landing fees, aircraft parking fees, and passenger fees. Prior to December 1993, since air navigation services and airport management had been the CAA's sole responsibility, a unitary pricing scheme had been developed whereby air navigation, landing, and aircraft parking fees were not separate fees

137 AIRPORT PRIVATIZATION EXPERIENCES

but were grouped under a single aeronautical charge. Passenger fees, although considered an aeronautical charge, were priced separately while concession and rental fees were set on the basis of market prices (see Figure 4.3).

Figure 4.3 Aircraft Colombia: Unitary Parking Fees Aeronautical Revenues, 17% Including Passenger Fees, 1993 Overflight FeesAipr 8% Passenger Fees 48%

Air Navigation Services Fees 17% Landing Fees 10% Source: CM, "Estados Financierosdel FondoAeronautico Nacional a 31 de Diciembre de 1993."

B. Economic Regulation after 1993

The BAH Study found that, in the context of the liberalized airspace and the pressing need for infrastructure development, changes in the pricing structure of airport services appeared necessary. The BAH Study also emphasized that the present value of future CAA revenues over the next 10 years, using the same pricing structure, revealed an accumulated deficit of US$233 million. If there were no changes, the deficit would continue to drain scarce resources from government coffers (including capital costs). The first step taken was to corporatize the CAA so as to facilitate private investor and regional and local entity participation in the sector. After corporatization, the single aeronautical charge was separated into an air navigation fee, a landing fee, and an aircraft parking fee for El Dorado, because the El Dorado Second Runway privatization scheme was already under consideration; for the remaining airports the single charge was separated into an air navigation fee and a landing fee (with parking fee included). The air navigation, landing, and parking

138 Case Study 4 COLOMBIA fees usually vary depending on flight origin, airport size, and aircraft weight. By separating air navigation charges from landing fees, the government paved the way for the privatization and decentralization of airport services, since ATC and air navigation activities could remain the purview of the CAA while airport services could now be privatized. ATC and air navigation-related services are accepted as the federal government's domain because of their association with defense and safety and because of the need to have one national entity provide these services. The new economic regulation set a passenger fee of US$20 per passenger. Basically, by separating the large aeronautical charge into three smaller charges the CAA increased its flexibility and gave itself options that it had previously lacked, since privatization would have proved more difficult under a unique aeronautical charge. Figure 4.4 presents the aeronautical charge structure before and after 1993. ______Figure 4.4 Colombia: Structure of Aeronautical Charges, before and after 1993

Pre-1993: Single Aeronautical Charge AT,'->Cr,rer ar , l,:n3A,,)Arl

n-ni Facriiit

A,rcra?t ApproaCh Runwiay Ta3.*ay Apron Gates Rermote lAircralt Parking, Parking

_ _ _ …Pgt-1993: Multiple Aeronautical Crares _ _

A,r ja.,qiai,.jn Fe;,LUS2')>51 Lanling FePs ILI5C203 5> A,rcrafi Parking US¶S40J 'fnourl'

I Legend 11 __~~ Al- 'i!l_;'1111 Crl.jre

1 Aircraft parking charges are effective after the first two hours. Note: Data inbrackets are calculated for a B-727 (international flight). Source: CAA, Special Administrative Unit, Decree 2724/93.

139 AIRPORT PRIVATIZATION EXPERIENCES

_ill-l'l-wn C. Pricing Strategy under Consideration for Privatization Purposes

The pricing of airside-related charges for each airport to be privatized under the master concession scheme will be determined on a case-by-case basis, as defined by the govermment on the basis of the results of the BAH Study. The advantage of this arrangement is that it allows the CAA to have flexibility to design the financial structure required by each airport to be privatized (i.e., the financial viability of the transaction). However, this pricing strategy could result in two disadvantages: (1) it could drive up the level of airside charges in the system, which could affect the competitiveness of Colombian airports; and (2) the CAA could find itself regulating a very complex set of airside charges if the differences among airports are significant and/or frequent. Airside charges are to be based on an inflation-adjusted formula, including a minimum salary index for airside charges on domestic flights, and a U.S. inflation index for airside charges on international flights. Table 4.1 shows aeronautical charges as of January 1995.

Table 4.1 Average Weighted Aeronautical Charges' Colombia: Aeronautical Air Navigation2 Landing Fee3 Aircraft Parking4 Charges, January 1995 El Dorado 109,435.12 98,494.13 10.934 97 (in Col$) Large Airports 109,514.99 109.514.99

Medium Airports 107,109.53 107,109.53 4 'Average weighted airport fees. 2 Air navigation fees. For domestic flights, four types of air navigation charges corresponding to fourtypes of Colombian airports apply. For intemational flights, two types of air navigation charges pertain: one for El Dorado and another for other airports. I Landing fees are priced according to aformula based on airport traffic type, aircraft weight, and volume, broadly inline with the formula used for air navigation services. I For El Dorado, aircraft parking fees are distinguished from landing fees, while for other airports aircraft parking fees are included inthe landing fees. Notes: US$1 = Col$831.60 (January 1995). See Annex 1for calculations of average landing fees. Source: CM, Special Administrative Unit, Decree 00724/95.

The final step in the overhaul of the Colombian pricing structure, according to the BAH Study, is to increase Colom- bian charges and bring them more in line with world rates. This will increase the potential profitability of the airports system for the government, and enhance the attractiveness of Colombia's airports for investors. To minimize the potential negative effect of these rate increases on competitiveness, BAH advised gradually bridging the gap between the average international fees and Colombian fees.

140 Case Study 4 COLOMBIA

IlIl. FINANCIAL PERFORMANCER

The CAA's financial statements over the past three years reflect an increase in operational profits resulting from an increase in air traffic, as well as continued recourse to government subsidies and extemal financing (see Figure 4.5). Operating profits as a percentage of revenues rose from 18 percent to 29 percent in 1994.

Govemment Figure 4.5 Government - Colombia: CM Subsidies Revenue Sources, 1994 26%- Airport-Related Services 49%

Air Navigation Services 26%

Source: Booz, Allen and Hamilton, 'Descentralizaci6n de la Infraestructura Aeroportuaria," September 1994.

Whereas airport revenues covered airport operating charges, government subsidies and external financing (non-operational resources) upgraded air navigation equipment and airport facilities. Clearly, if the government agrees that it is no longer able to subsidize investment then it will have to have more private sector involvement. The system's increasing investment needs, stemming from the larger demands placed on it, increase the need for private investor participation in the nation's infrastructure financing. However, it is important to note that total revenues have increased substantially while expenditures have remained constant (see Table 4.2, following page); as a result, an increasing surplus before investment has eased the system's cash needs. Thus, although the operating surplus is not sufficient to cover the sizable investment needs that have accrued over the years, it does demonstrate to prospective investors that the sector is a dynamic one with growth opportunities.

141 AIRPORT PRIVATIZATION EXPERIENCES

Table 4.2 Colombia: CM Financial Performance, 1991 -94 (US$ millions)

roi -venuesR s U48.3 5S53 73.3 77.0 Air Navigation Services 22.6 25.2 19.6 22.3 Airports 16.8 21.5 24 9 20.7 Operational Expenditures 39.4 46.8 44.6 43.0 Debt Service 16.0 18 1 16.0 12.0

.ToIhEJqJdndt 5 -4 64.9 60.6 55.0 Opwrational Resuft - [-7.1 'f-3.31 127 21.9 -I mstrnersls 40.6 50.0 58.8 59.6 FinancingNeeds 47.7 59.3 46.1 37.3

FLunded by. GmrnementTransets 23.2 27.3 2&6 28.3 No-openraton Sources 24.4 32.0 17.5 9.4 I Esfimates for 1994. Source: Department of National Planning, Conpes-2727, August 1994. (From BAH analysis, original source in US$.)

The CAA's ratio of airside to landside charges for 1993, the last year for which data were available, was 83:17 percent.4 The predominance of airside charges as a source of revenue follows a general pattern in developing countries. However, the contribution of airside charges to revenues in Colombia is much higher than in other developing countries. Such a level of contribution indicates a window of opportunity for increased landside revenues to finance upgrading and modernizing of equipment and facilities. The CAA's future financial performance depends on its ability to raise revenues to cover large airport system investment needs. In the context of the continuing liberalization of air transport in Latin American countries (increased traffic flows),

I Airside charges encompass all services associated with the movement of aircraft (air navigation fees, landing fees, parking fees, and passenger fees), while landside charges include all services associated with the movement of passengers (ground handling, airport use fees).

142 Case Study 4 COLOMBIA and in order to meet international operative standards and decrease safety concerns, the CAA needs to invest US$83 million to upgrade air navigation services, mainly in ATC (see Table 4.3) and flight assistance, in the next few years.

. U _ . Table 4.3 Radar 42.7 5 years Colombia: ATC VORDME'ILS 21.7 10 years Investment Plan Communication Equipment 15.5 2 years ( Meteorological Equipment 2.8 3 years Total 82.7

Source: BAH. (From CAA and Department of National Planning, August 1994, original source in US$.)

The CAA forecasts investment plans totaling US$236 million over the next three years for airport infrastructure upgrades (see Table 4.4). Investments will allow airports to meet traffic increases from 8.1 million to 20.4 million passengers in the year 2014, as well as maintenance costs averaging US$7 million per year.

Table 4.4 Runways 78.2 27 8 106.0 Colombia: Airport Aprons 11.8 6.2 56.2 Infrastructure Invest- Terminals 23.5 32.8 18.0 ment Plan, 1995-97 Enclosures 11.8 12.0 23.8 (US$ millions) Security Equipment 1 0 7.4 8.5 Fire Fighting Equipment 4.0 19.7 23.7 Total 130.3 106.0 236.3 ' Data for El Dorado correspond to figures used before the BOT arrangement (second runway). Source: BAH. (From CAAand Department of National Planning, August 1994, original source in US$.)

Under the restructuring program, investment needs for the entire airport system are covered by revenues from profitable airports (cross-subsidies). Introducing private operators into infrastructure financing and management will facilitate explicit resource transfer from one group of airports to the rest of the system. This arrangement will enable the government to concentrate its activities on regulating operators and channeling concession fees to unprofitable airports that cannot achieve the economies of scale necessary to finance large investment costs. Document 2747/94 from the Department of National Planning approved the creation of an Airport Development Fund (Fondo de Compensaci6n Aeroportuaria) to channel funds from con-

143 AIRPORT PRIVATIZATION EXPERIENCES

cession fees revenues (privatization of Category A airports) to unprofitable airports. The government thus can more easily to cope with the conflicting demands of larger airports with considerable political clout and smaller airports with little lobbying power, and transfer funds from the operations of larger airports to the smaller airports.

IV. PRIVATIZATION PROCESS: SECOND RUNWAY - EL DORADO AIRPORT, BOGOTA

Although the construction of El Dorado's second runway was slated for 19885 it was not begun because of the Cabinet's re- fusal to approve the construction under prevailing contractual arrangements. The use of the existing runway had reached saturation levels by 1992, increasing safety hazards and flight delays for airlines. Given the capacity constraint, the government, in 1993, launched an expedient process for building the second runway. (This constraint was limiting the development of Bogotd as a potential "hub" for Andean Pact members.) Fiscal limitations prompted the government to pursue the project through private sector financing and construction. The project can be considered a blueprint exemplifying the government's approach to the privatization of airport infrastructure.

A. Project Description

The project includes (1) building a new runway parallel to the existing one; (2) procuring lighting and instrument landing equipment; (3) maintaining the existing runway; and (4) constructing the related infrastructure (taxiways, aprons, relocation of the Bogota River's western bank, etc.). The technical specifications for the bidding process estimate the total cost to be US$98.8 million (see Box 4.3). The project finance mechanism consists of a BOT scheme involving a 20-year concession for the construction and maintenance of a new runway (3,800 m) as well as maintenance of the existing runway (3,800 m). At the end of the concession period all of the assets needed to provide the service revert to the CAA. ATC services, including approach and land-

5 Master Plan for El Dorado Airport, 1985.

144 Case Study 4

COLOMBEIA

Box 4.3 EL DORADO AIRPORT, BOGOTA: CONSTRUCTION OF THE SECOND RUNWAY (ESTIMATED INVESTMENT COSTS)'

I.Civil Works * Relocatir,n ot the wesiern bank of Bogota River * ConsTructon of the second runwaV i3.8000 m) * Apron tor mil,rary air base Catami * Intermal a:cess road * Waler pump statin ard seiage sistem assoiated wt, the runway

Sub-i $75,893.00 90.00

II. Electrical supplies and visual landing systems $Ks933.00 4 71

Ill. Communication and meterology equipment 989 00 t 0G

IV.Project audit 2424 OU 290

Total 8323900 ge

US$1 = ColIS42.50 iFebrvari 1995s Source CAA. Proyecto de Construcci6n ae la Segunda P,sta ael Aeropuert o E! Dorado de la Ciudad de Santa Fe de Bogota i Resumen ' Ejecutivo) - February 1995. ing, are to be operated by the CAA (services retained by the CAA following the restructuring and privatization process), while maintenance of runways is to be provided by the concessionaire and is estimated to be US$2.8 million annually beginning in 1998, the first year of maintenance. The estimated investment of US$98.8 million is to be financed entirely by the winning bid (the concessionaire). At least 20 percent of the total project cost is to be funded by the concessionaire via equity participation (in the company that operates the concession).

145 00

CL (D c (a .0 w La a) m - - - 0 'A co co CA M 0 E a) > 0) E C Z w (D -0Cn CD :3 co - C X CD 0 0 CD X -6 CL a) 0 -a - (D> L) a) C" W -0 4) cmc xoj ctscc .- 4-:0 0 r E W - a: IJL C X 6- in E m 4- M 0 0 0 -6 c 0 o z .0 C m E CL0 C 0 C-0-r- m c a cis o U) (D CL (D W a) 0 0 U 0 - w E 0 0.0 D..b 2- L2 Q) E 0- E 0 a) x -tn E 0 U) (D a) a -M - CL 0 x a- .- U) CO 70 E to'Co x ci CL -a 4)- r-0) Q) C - C: a) W LU w .= .6 a) 0 0 U cn C CY) - - 0 E (D cy) ai a) 'arts w .;--M Lo m 0 Co C a) o C t: En a) 'D a cn -0 C -- 'a fn in CL m C) LL. u 0 (D w tn r- a) .-o w .1 (b W c) L) a) 0 C CL (D (D E CL u CD CL tn La C u -W V) - 0 CD X - If, a) 0 w C) - CL w 0 h -0 Lc) 0 E E 0 0 oc -C)0 ri tn 0 C- 0 C 0 CL ui C 0 C: -E C o 0 o CL) L) (L) cn v) 0 C,) L) (L) 'a)0 (L) (1).0W 0 L) r- r- 0) C (D c (1) 0 o - 0 CU E E (D CU W a) CL -a CL zr,0 C CL cn z- .2 0 L) :E 2 f E E -o cc')) 0 CL) t! r a)CL (Du LL 0 :p U)n EnCJ 2wtn uE0 E -0 C: m cm ""b Cr,o u0 U En V) 0 0 co , a LUCL 4. D 0 0LO (D o cn 0 'O u L) u 'D (D C C3 CL a) U!) CL ui in C u CL 5 69 U) :3 C2 u 73 .0 > E u wtn -'5u ') E w E d, CL 0 0 0 0 CD 0 -3U) CL D 0 zi CL Ld L) m m -i C3. - CL 0 cn F LA E 7 i m a: L) o Ti 0 LU U) 7 Cl, Zocn - -Z lu.

CC x Case Study 4 COLOMBIA

Landing fee revenues are calculated as the landingfees multi- plied by the expected trafficflows.6 The concessionaire will propose the landing fees structure for the 20-year period (including a formula adjusted for inflation and changes in the exchange rate). Disbursements of landing fee revenues (refunds) from the CAA to the concessionaire will commence when the second runway becomes operational. The construction phase is estimated to take 33 months postdating the contract award. After construction is completed, the maintenance phase will last until the end of the concession.7 Annex 4.2 illustrates the methodology for the submission of proposals for the landing fees structure. The Government of Colombia, through the CAA, is guaranteeing a minimum level of revenues to the concessionaire (floor pricing) in case the landing fees structure and/or the expected traffic volumes cannot support the required revenue stream. The government, through the CAA, will compensate any difference in a given year between "real landing fees revenues" and the required mriinimum level. For this purpose the CAA is establishing, as part of the bidding conditions, a Trust Fund equivalent to 30 percent of the annual landing fee revenues. Landing fees are set by the CAA according to its policies and regulatory framework. The concessionaire will propose the minimum level of landing fee revenues necessary for project implementation (see Figure 4.6).8 The net present value of the re-

AI- > Figure 4.6 Colombia: Minimum Landing Fees Level of Landing Fees Revenues Revenues (Conceptual Scheme)

Minimum Level _ _ (required by bidder)

Time = CAA's compensation to the private concessionaire irom the Trust Fund (commercial risk guarantee) = actual revenues accruing from landing fees Source: Airport Privatization Study, Case Studies, CFSPS October 1995 (based on El Dorado Second Runway Bidding Documents).

6 Depending on the "proposed pricing structure," the cession of landing fee revenues can be partial or total. The maximum tariff increase allowed over the base pricing structure (i.e., Decree 04077, July 1, 1994) is 63 percent. 7 The 20-year concession includes the construction and maintenance phases of the project. I The minimum level of landing fees cannot exceed 100 percent of the expected traffic forecast. Traffic forecasts were included as part of the bidding conditions.

147 AIRPORT PRIVATIZATION EXPERIENCES

quired minimum revenues stream during the maintenance phase will be considered the main criterion for the selection process (15 percent annual rate discounted back to the first day of construction).

C. Bidding Process

Bidding documents were prepared during the first half of 1994 and offered for public access in July 1994.9 Government officials, financial advisers, and interested private parties met to discuss the proposed terms. The elimination of a condition stipu- lating a ceiling limitation on the concessionaire's potential revenues stream increased the project's expected return on investment and investor confidence.10 Presidential elections held in 1994 during the bidding process resulted in a Cabinet change. In September 1994 the newly appointed Minister of Finance increased the income tax level from 30 percent to 37 percent. Potential concessionaires then requested that a clause be added to the bidding documents ensuring compensation for tax changes during the period of the concession. The CAA duly incorporated such a clause (see Box 4.5).

Box 4.5 COMPENSATION FOR TAX POLICY CHANGES (POLICY RISK GUARANTEE)

It a change in the income tax level leads to higher than estimated costs, the CAA will use the following two options to compensate the difference to the concessionaire: 1. An annual payment beginning a year atter the decision to issue an indemnity and continuing throughout the life ot the contract according to the following formula:

C,.- =(MIPCOI + (D *[ ,.- .r

Legend: Cit*n Annual quota equal to difference in costs associated with change of tax. To be compensated in continued.., the year ot operation t+n

'Documents could be obtained at the CAA for the equivalent amount of US$5,000. 10If traffic flows and/or landing fees were much higher than expected during the 20- year period, then the concessionaire would have to reimburse the CAA for excess revenue

148 COLOMBIA

_ Box 4.5 IPCot+n Average value of consumer price index in the year (concluded) t+n IPCt Average value of consumer prce index inthe year t, the year in which the differential in tax payment level is incurred Di Differential in tax payment on rent and complemen- taries and/or industry and commerce in the year in which the quota corresponding to the differential is paid r 1.10 n Number of years remaining in the maintenance period (concession) 2. One lump sum payment of the differential (including interest) within one year (Concurrently, ifa change in the tax policy benefits the concessionaire, the CM will have to compensate it through the use of the procedure described above.) Source~ Bidding Conditions El Dorado Second Runway, Unidad Administrativa Especial Aeronauwica Civil, July 1994.

Bids were presented on January 25, 1995. Six different consortia (most of them including an airport operator, an engineering firm, and a financial institution), representing 18 different firms, presented bids and funding proposals. Participants included firms from Canada, the United States, Mexico, Spain, the Netherlands, France, and Colombia. The technical qualifi- cations of each consortium and the financial viability of its proposed capital finance structure (i.e., funding of the project) were the basis for qualification to continue to the economic evaluation phase. Participants at this initial phase (technical evaluation) were qualified on the basis of yes/no criteria. Two participants failed to pass the technical evaluation while another was disqualified for having conditioned the offer in certain areas and having violated the conditions and terms of the bidding documents. Once bidders were qualified, the selection criteria were based on the economic proposals presented by each participant (see Table 4.5, following page).

149 AIRPORT PRIVATIZATION EXPERIENCES

Table 4.5 Colombia: Economic Evaluation: Qualified Participants, Selection Criteria (US$)

Weiqhted Averaqe Net Present Value Concessionaire Landing Fees Points (minimum level) Points Total Ogdem'DragadosJ 185 12 75 00 90,652.566 33 25.00 100 00 000 Conconcreto 2. Pavirnientos Colombia/ 24326 57.08 98.064 782.01 23.11 80 19 -19.81 Others 3 GaycoGolcorp/Others 266.92 52.01 120.028.,704.79 1888 7090 -29.10 Current Weighted Average Landing Fees (El Dorado) 99 26' 1 Figure used for bidding evaluation purposes by the Govemment of Colombia. Source: CAA, "Economic and Technical Evaluation of Proposals Concerning Construction and Maintenance of Second Runway of El Dorado Airport,' March 1995 (orginal source in US$). The economic evaluation phase (economic proposals) was based on the following formula: * Initial weighted average landing fee in US$ (a function of the type of aircraft and its domestic or international origin)= 75 points * Net present value (discounted at 15 percent @ rate) of the minimum required level of landing fees revenues throughout the concession period, in US$ (i.e., landing fees time estimated traffic volume)= 25 points. On May 15, 1995, the Government of Colombia awarded the El Dorado concession to the Ogden/Dragados/Conconcreto consortium" which was incorporated as a Colombian joint venture company - CODAD S.A. The winning contract stipulates total investments of Col$80,786,000,000 (US$97,157,000 at US$1 = Col$83 1). The contract between CODAD S.A. and the Government of Colombia, which was signed in July 1995, specified that the consortium had eight months from the date of sig- nature to obtain financing. When financing for the project is obtained, construction will begin. As of August 1995, a tenta- tive financing plan was awaiting approval from the Colombian authorities regarding the environmental feasibility of the construction of the second runway (approval was pending on the westward relocation of the Bogota River).

"' Dragados is a leading Spanish builder in several infrastructure sectors, Ogden is a U.S.-based airport operator, and Conconcreto is a Colombian civil engineering firm.

150 Case Study 4 COLOMBIA

D. Project Finance

The government's economic evaluators found the CODAD plan for financing the construction of the second runway aggressive yet realistic. The plan would finance 80 percent of the project cost through the placement of US$107 million in Eurobonds. The financial scheme is supported by the Union of Swiss Banks, which will function as the financial adviser and will place project debt on international capital markets. The Eurobonds will be listed in the Luxembourg and PORTAL Exchanges with a U.S. Securities and Exchange Commission register, under norms and procedures 144A. The financial scheme anticipates an interest rate on the order of 3.5 percent over the U.S. Treasury rate for a period of 10 years and a maturity of 15 years (including a grace period during construction). The project's rate of return is influenced by several factors including construction costs, construction period, and capital costs. The figure in the required investment offered by the CAA during bidding (US$98.8 million) is an indicative figure based on the project's technical specifications and cost estimates. As long as the technical specifications are followed, the concessionaire could attain a more efficient cost structure in the construction phase. Given that the landing fee revenues will not be disbursed by the CAA until the second runway is operational, any gain in time with respect to the 33-month target would improve the projected cash flows.

E. Project Risks

One of the more interesting facets of the Government of Colombia's privatization strategy concerning El Dorado is the government's willingness to partially guarantee commercial risks (i.e., minimum level of landing fee revenues guaranteed by the Trust Fund mechanism). At the same time, the government does not satisfy basic investor concerns regarding issues such as capital repatriation and currency convertibility - transfer risk. Con- struction risk, in terms of both project cost and construction time, is borne 100 percent by the concessionaire, as is the case with most BOT arrangements. Political risks such as those arising from expropriation, strikes, and riots are not specifically mentioned, although Section No. 25.1-5 of the bidding conditions refers toforce majeurewhen defining the compensation mechanism for the minimum level of landing fee revenues.

151 AIRPORT PRIVATIZATION EXPERIENCES

Box 4.6 ( PRIVATIZATION OF THE CALI AIRPORT (ALFONSO BONILLA ARAG6N INTERNATIONAL AIRPORT) Because of continuing demands from the regional govemment in Cali, the Government of Colombia began the privatization process for Category A airports using Cali as the pilot case for the implementation of the strategy developed in the BAH study (i.e., master concession through a public bidding process). Bidding documents were issued in September 1994 and the initial bidding date was set for January 10, 1995. As in the case of the second runway in El Dorado Airport, Bogota. discussions were held with potential concessionaires.1 Although a number of parties expressed interest in the bidding, the Cali Airport was declared deserted in March 1995. Lack of clarity within the bidding conditions on safety and security issues led prospective investors to request additional information. The government. represented by the CAA, has been meeting during recent months with the six previously interested parties to discuss specific security roles and conditions that would be ascribed to the government and the future concessionaire. New bidding conditions are being prepared and the new bidding date is set for late 1995. Following is a brief summary of the main components of the bidding conditions for the airport in Cali: Master Concession Scheme. There will be 15-year concessions (renewable on the government's decision). The concession will include management, maintenance, and operations of both airside and landside activities and will include only a minimum level of investment commitments to general maintenance and upgrade, equivalent to 30 percent of the concession fees. Pricing Scheme. Airside charges are regulated by the CAA. As in the case of the second runway at El Dorado Airport, the concessionaire will propose the complete range of airside charges as part of its economic proposal. These charges will include an inflation-adjusted formula based on: (1) minimum salary index in the case of airside charges on domestic flights. and (2) the U.S. inflation index in the case of airside charges for international flights. Landside charges - provided related services are supplied under market conditions - could be set Independently by the concessionaire. Bidding and Selection Criteria. After technical considerations are evaluated and potential concessionaires qualified, the selection criteria will be based on the highest value of concession fees to be paid to the CAA. The calculation will be based on the net present value of the yearly fee to be paid by the concessionaire (discounted at 15 percent @annual rate). The proposed value of the annual concession fees will have to be higher than a minimum value (floor price) of US$5.5 Continued ... million.

152 Case Study 4 COLOMBIA

- _ >_Box4.6 Use of the Proposed Concession Fee. The proposed tee to Boxc4.6 be paid by the concessionaire will be distributed according to ( the follow,ing scheme: (1) 30 percent will be relained by the concessionaire to be used for inveslment purposes (maintenance and upgrading of airport-related services); (2) 59 percent wvill be paid quarterly to the CAA. as part of the funding for the rest of the airport system (Airport Development Fund): (3) 11 percent will be paid every five years in one lump sum (investments in ATC and safety). Government Guarantees (Commercial and Policy Risks). The C:AA will compensate, through credits from the quarterly concession fee, any difference between the pricing scheme for airside charges proposed by the concessionaire and the pricing scheme authorized by the Ministry of Transport. The CAA will not compensate any difference in the real traffic figures versus the estimated figures in the Airport Restructuring and Privatization Plan. In contrast to the case of the second runway at El Dorado Airport. the commercial risk will not be guaranteed by the CAA in this transaction. The policy risks of changes or adjustments in airside charges will be compensated by the CAA. Existing Concession and/or Leasing Contracts. The different contracts for the exploitation of airport-related services in effect at Cali's airport today will be transferred to the concessionaire. The concessionaire has the rights and responsibilities derived from such contracts until their date of expiration.

,P'tenralconcessionaires v%ere 1i) Surna S.A.-A4roporis ae Paris. ElInvenlir S A. 31 Paimaseca S.A; (41Aena SA. (51C.rporacion Financerad. irVle? and ,61 Corporacon Financiera de ls Andes

V. K'E'\ ISSUES EMERGING FROM THE COLOMBIAN ExPERIEENGE

S Creativity and Innovation in Privatization. The Gov- ernment of Colombia's privatization of El Dorado's second runway is a creative and innovative approach to private sector involvement in providing infrastructure needs. El Dorado is an unusual example of the use of a BOT to finance particular airside infrastructure in a public airport. The case points up the flexibility of BOT mechanisms for infrastructure development: privatization is not necessarily an "all or nothing" arrangement but rather is a lengthy and complex process that can be shaped

153 AIRPORT PRIVATIZATION EXPERIENCES

to fit a particular context. Even the guarantee on commercial revenues, counterproductive or not, is innovative and illustrates a creative approach that provides a challenge to explore ways of improving the methods to increase private sector involvement in the development and operation of public infrastructure. 0 Corporatizationprior to Privatization. The Colom- bian experience confirms that an autonomous government corporation is better prepared to make necessary changes to the operation of airports and to take active steps to privatize. Fol- lowing corporatization, the CAA created a more flexible fee structure that helped the government to enact a BOT scheme for construction of the second runway at El Dorado. However, only a well-designed privatization strategy with clearly delineated responsibilities and risks can ensure the maximum feasibility of successful transfer to the private sector. Therefore, a corporatized government agency could be seen almost as a necessary (but not quite sufficient) condition for privatization. The model for the privatization of Colombian airports does not include the corporatization of individual airports before transfer (airport assets and liabilities are centralized under CAA administration). Given that there is no change in ownership (i.e., the master concession), corporatization of airports that are to be privatized or transferred to local authorities would increase transparency and accountability for the transaction and would simplify administrative procedures for the new management. However, corporatizing and transferring airports to local authorities will not achieve the desired objectives unless proper institutional capacities have been built in at the local level. 0 Design of the Transaction. The project finance arrangement would have been more attractive if the privatization of El Dorado had been packaged with the construction and maintenance of the second runway. A master concession arrangement for the entire airport, associated with a BOT for the construction of the second runway, would have enhanced project cash flows and significantly reduced commercial risk."2 The preliminary design for the restructuring of the national airport system approaches the privatization of the airports on an individual basis (the group of six), and does not include

12 In this case we are referring to the commercial risk associated with the concession of El Dorado Airport to a private operator having no responsibility in the initial setting of airside charges (i.e., landing fees are established in the BOT transaction).

154 Case Study 4 COLOMBIA the possibility of privatizing the airports in groups (i.e., a concession for two or three airports to be bid as a package). Pack- aging in groups would enhance the financial attractiveness of the operation (i.e., the commercial risks would be lower), increase potential investment in airport upgrades and maintenance, and simplify the CAA's oversight function (i.e., there would be fewer operators to regulate). Pricing Policy on Airside Charges. The privatization scheme for the six Category A airports includes a mechanism with built-in incentives for relatively high airside charges. The concessionaire's financial offer is bid on the basis of the highest concession fees to be paid to the CAA, which in turn is based on a proposed airside charges scheme. Landing fees are driven by the government's investment requirements, as reflected in the operators' minimum required level of revenues, not by competitive market forces. The government receives the highest concession fees if the concessionaire imposes the highest landing fees. High landing fees threaten traffic flow volumes. Therefore, the concessionaire's interest in profit and the government's interests need to be balanced. If airports are to be privatized on an individual basis, the CAA could ultimately find large disparities among the airside charges of different airports.' 3 Commercial Risk. The government's absorption of commercial risks casts doubt on the future of landing fees in Colombia, particularly since the El Dorado model will be used as a blueprint for future privatizations. At the same time, the government falls short when addressing policy/regulatory and political risks. However, the case is completely different for the privatization of Cali International Airport, where the government (through the CAA) is providing a guarantee exclusively for the level of landing fees (contractual risk)14 but not for traffic volumes (commercial risk). However, it could be argued whether guaranteeing the total landingfees revenues (the minimum level for project implementation) was an indispensable component of the El Dorado transaction, given the relatively high level of investments involved in the construction of the second runway.

13 Complications could arise if disparities in airside charges were to be transferred to the public via air transport costs (e.g., airlines in the United States are adding a US$40 surcharge on flights into the new Denver Airport, creating a price differential between destinations with similar flying time).

14 Related to the regulation of airside charges.

155 AIRPORT PRIVATIZATION EXPERIENCES

The use of partial risk guarantees promoted by multilateral institutions should be explored as a mechanism for ensuring payment for non-performance of government contractual obligations (the maintenance of an agreed-upon regulatory framework, project delays or interruptions caused by government actions, etc.) or for non-performance owing to political events. The use of such an instrument, by alleviating the perception of investor risks, could provide governments with the confidence to implement a transaction without having to guarantee the project's commercial risk.

156 Case Study 4 COLOMBIA ANNEXES ANNEX 4.1 COLOMBIA: EL DORADO AIRPORT, BOGOTA PROJECT FINANCE FOR THE SECOND RUNWAY Landing Fees Structure (January 31, 1995)

Category Weight (2) Tariff Weighted Component I _ tmax. kg' (Pesos CoCmbis.nos) LUSS P,;R C kv-ooItar' so

0-5.000 12.03 % 3.600.00 4.33 433.08 0.5208 5.001-10.000 10.12%. 7,200.00 8.66 728.64 0.8762 10,001-20.000 14.0300 14A400.00 17.32 2,020 32 2.4294 20,001-30.000 1.94%o 23.900.00 28.74 463.66 0.5576 30.001-50 000 12.81% 38.400.00 46.18 4,919.04 5.9152 50 001-80.000 26.25%o 62.400.00 75.04 16,380.00 19.6970 80,001-110,000 3.33'% 91.200.00 109.67 3,036.96 3.6519 110.001-150.000 0.95'o 124,800.00 150.07 1,185.60 1.4257 150,001-200,000 0.06%o 168.100 00 202.14 100.86 0.1213 > 200 000 (1) 0 02%o 309 425.64 372 08 61.89 0.0744

IWnterntioral Flights . ..

0-10.000 0.19 G 19,200.00 23.09 36 48 0.0439 10 001-20.000 0.14%. 42,700.00 51.35 59.78 0.0719 20 001-30.000 0 15°% 71.100.00 85.50 106.65 0.1282 30,001-50.000 0 31c. 113,900.00 136.96 353.09 0.4246 50,001-80,000 2 44%a 184.900.00 222.34 4,511.56 5.4252 80.001-110,000 6.39%G 270,400.00 325.16 17,278.56 20.7775 110,001-150.000 4.64%c 370.000 00 444 93 17,168.00 20.6445 150.001-200.000 2 07%o 498.100 00 598 97 10.310.67 12.3986 > 200.000 (1' 2.11%c 916 554.30 1,102.16 19.339.30 23.2555

Notes: (1) B-747 =322,050 kg. (2) Weights are based on real traffic movements by aircraft in 1993 (annex 5, bidding conditions). (3) US$1 =Col$831.60 (December 31, 1994). Source: CAA, Resoluci6n No. 00724 (January 31, 1995).

157 AIRPORT PRIVATIZATION EXPERIENCES

ANNEX 4.1 (continued) COLOMBIA: LARGE AIRPORTS (BARRANOUILLA, BUCARAMANGA, CALI, CARTAGENA, CUCUTA, MEDELLIN, SAN ANDRES AND SANTA MARIA) Aircraft Parking and Landing Fee Structure (January 31,1995)

Category Weight (2) Tariff Weighted Component

~~R41s..~ ~ , . .^^ . r -

0-2,500 6.02%o 3,100.00 3.73 186.62 0.2244 2.501-5.000 6 02%-3 4,200.00 5 05 252.84 0.3040 5,001-10,000 10.12%: 7 500 00 9.02 759.00 0.9127 10.001-20,000 14.03°o 17,100.00 20 56 2,399.13 2.8850 20.001-30,000 1.94%.1 26,600.00 31.99 516.04 0.6205 30,001-50,000 12.81%" 43.700.00 52.55 5,597.97 6.7316 50,001-75,000 21.88%6 73.600.00 88.50 16,103.68 19.3647 75.001-100,000 6.57°o 92.80000 111 59 6,096.96 73316 100,001-150,000 2.27°c 141.900.00 170.63 3,221.13 3.8734 150,001-200,000 0.060a 185,700.00 223.30 111.42 0.1340 > 200,000 (1) 0 02°; 343,820.58 413.44 68.76 0.0827

.1 Mrd ar ml.ura F . ' , , 0-10 000 0.19%o 21.400 00 25.73 40.66 0.0489 10,001-20,000 0.14%G 48,100.00 57.84 67 34 0 0810 20,001-30.000 0 15%o 69.500 00 83.57 10425 0 1254 30,001-50.000 0.31°o 117 70000 141 53 36487 0.4388 50,001-80.000 2.440%G 198,000.00 238.10 4,831 20 5.8095 80,001-110.000 6.39%o 267,600.00 321.79 17,099 64 20.5623 110.001-150.000 4 64°o 412,100.00 495.55 19.12144 22 9936 150.001-200.000 207% 535.200 00 643 58 11,078 64 13 3221 >200.000 (1I 2.11°o 1,018.644.15 1,224.92 21,49339 25.8458

Notes: (1) B-747 =322,050 kg. (2) For comparative purposes weights are based on real traffic movements by aircraft at El Dorado in 1993 (annex 5, bidding conditions).(3) US$1 =Col$831.60 (December 31, 1994). Source: CM, Resoluci6n No. 00724 (January 31, 1995).

158 Case Study 4 COLOMBIA

ANNEX 4.1 (concluded) COLOMBIA: MEDIUM AIRPORTS Aircraft Parking and Landing Fee Structure (January 31, 1995)

Category Weight (2) Tariff Weighted Component (max kg) (Pesos Coombcsnos' LUSS) Poess Cc, criuLr:s), Domestic Fight 0-2,500 6.02° 3,100.00 3 73 186.62 0.2244 2.501-5 000 6.02', 4,200 00 5 05 252.84 0.3040 5,001-10.000 10 12%a 5,300.00 6 37 536.36 0 6450 10,001-20,000 14.03%, 16,000.00 19.24 2,244.80 2.6994 20.001-30,000 1 94%o 25,600.00 30.78 496.64 0.5972 30,001-50.000 12.81Oa 42,700.00 51.35 5,469 87 6.5775 50.001-,5 000 21 883., 68,300.00 82.13 14,944.04 17.9702 75 001-100,000 6.57%, 87,500.00 105.22 5,748.75 6.9129 100.001-150.000 2 27% 133,400.00 16041 3,028.18 3.6414

Intemetional Flights ' ' 0-10 000 0 19%0 21.40000 25 73 40.66 0.0489 10,001-20.000 0 14%, 48.100.00 57.84 67 34 0.0810 20001-30000 0.15i% 69.500.00 83.57 10425 0.1254 30,001-50000 031%o 117.700.00 141.53 36487 0.4388 50 001-80.000 2.44co 198,000.00 238.10 4,831.20 5.8095 80,001-110.000 6.39%c 267.600.00 321 79 17,099.64 20.5623 110,001-150.000 4.64% 412,10000 495.55 19,121.44 22.9936 150 001-200 000 2 07° 535 200.00 643 58 11,078.64 13.3221 >200.000d1 2 110 1018.644.15 1,22492 21,493.39 25.8458

Notes: (1) B-747 =322,050 kg. (2) For comparative purposes weights are based on real traffic movements by aircraft at El Dorado in 1993 (annex 5, bidding conditions).(3) US$1=Col$831.60 (December 31, 1994). Source: CAA, Resoluci6n No. 00724 (January 31,1995).

159 AiRPORT PRIVATIZATION EXPERIENCES

ANNEX 4.2 COLOMBIA: INI1TIAI. PROPOSED LANDINGIC FEE STRUCTURE BY CONSORTIUm AWARDED EL DORADO PROJECT (Colombian pesos unless otherwise denoted)

Domestic International Variation from Variation from Category (1) Fee per Category' Actual Fee Weight (2) Category (1) Fee per Category' Actual Fee 'A

in 4.54 90.16%0 12.03`% 1I 27.05 85.02% 0.19% 2n 13.62 90.16%a 10 12%c 2i 81.16 85.009o 0.14% 3n 27.16 90 11%a 14 03 3i 135.27 85.00% 0.15% 4n 45.32 90.13% 1.94%o 4i 216.45 85.00% 0.31 % 5n 72.49 90.15', 12.81 o 5' 351.72 85.00% 2.44% 6n 117.31 90 14%a 26.2503 6i 51406 85.009% 6.39% 7n 172.14 90 14%, 333%o 7i 703.46 85.00%a 4.640' 8n 235.55 90.26%, 0.95%b 81 946.96 85.00% 2.07% 9n 317 11 90.14'o 006%o 91 1,668.71 85.00%0 2.11 % 1On 630.09 90.140.% 0.023 Total IlSSI 55.15 90.15% B1.55% TotallJS$= .. 19S7i O% *

11) Calegones

ln 0-5.000 li 0-1000 2n 5.001-10.000 2i 10001-20000 3n 10.001-20,000 3i 20001-30000 4n 20,001-30,000 4i 30001-50000 5n 30.001-50.0OO 5i 50001-80000 6n 50.001-80,000 6i 80001-110000 7n 80.001-110,000 7i 110001-150000 8n 110.001Q150.000 8' 150001-200000 9n 150.001-200.000 91 >200000 1On >200,000

12; Weighis are based on real iraltic mrcvemenirs by aircraft at El Dorado irn1993

I US$1 =Col$831.60 (December 31, 1994). Source: CM, Financial-Legal Evaluation of Proposals for Construction and Maintenance of Second Runway at El Dorado (March 1995).

160 Case Study 5 EEAST ASIA

AIRPORTS IN EAST ASIA

A CASE STUDY OF AIRPORT DEVELOPMENT IN FAST-GROWING ECONOMIES'

East Asian airports provide a remarkable illustration of the contribution of infrastructure projects to economic growth. East Asian airport development reflects both the unprecedented growth of East Asia as a key economic center and the active support of governments in laying the ground for private entrepreneurial success in infrastructure development projects. The three cases that follow illustrate two key features of airport development and privatization strategies in fast-growing economies: (1) the government perceived the private sector as being ill-suited to manage airport development because of a bias toward short-term financial rewards rather than long-term economic growth; and (2) the government felt that the selection of a privatization mechanism at project completion rather than at start-up would favor more rewarding financial proceeds as well as a long-term strategic view in building airport capacity. The following three cases, Hong Kong, Kuala Lumpur in Malaysia, and Singapore, illustrate the East Asian experience.

Research for this case study was conducted in January 1995.

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45 HONG KONG: KAI TAK AND CHEK LAP KOK AIRPORTS

Air traffic development in Hong Kong reflects both the extraordinary growth of Hong Kong as a key economic center2 in the Pacific Rim area and the active involvement of the Hong Kong Government in keeping the country in the forefront of South Asian economies. The Hong Kong Government views air transport development as essential to the support and promotion of trade and financial and tourism activities and has thus encouraged the development and modernization of Hong Kong's international airport - Kai Tak Airport - into one of the busiest airports in the world, with revenues reaching HK$2.2 billion in 1993.3 Space constraints at Kai Tak (particularly its limited size of 332 hectares) have put pressure on the airport's operators to manage it more effectively. Such constraints currently hinder traffic growth, however, and impede the government's policy of strengthening Hong Kong's economic position in southern Asia vis-a-vis southern China. At full capacity Kai Tak Airport is unable to cope with projected increases in passenger numbers and cargo tonnage. Therefore, the Hong Kong Government embarked in 1989 on the replacement of Kai Tak Airport with Chek Lap Kok Airport. The development of Chek Lap Kok is one of the main components of a mega-infrastructure project, the Airport Core Program (ACP), consisting of 10 interdependent projects worth some US$21 billion.4 Through this project the government intends to maintain Hong Kong's economic lead in the Pacific Rim. The Hong Kong airports provide a good illustration of the contribution that infrastructure projects can make to economic growth. These airports also illustrate the key features of airport development in East Asia as mentioned above, as well as the unique partnership between the government and the private sector, whereby government ownership is combined with private sector management of the entire operation. However, the forthcoming change in the political status of Hong Kong in 1997 (see Box 5.1) poses risks associated with the airport develop-

2 The annual growth of GDP in Hong Kong averaged 6.2 percent in real terms in the past 10 years. The per capita GDP for 1991 was US$14,000.

3From March 1992 to March 1993, US$1 was equal to an average of HK$7.7355. US$1 was equivalent to HK$7.738 on January 1. 1995.

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Box 5.1 POLITICAL STATUS OF HONG KONG

In light of Hong Kong's transfer of sovereignty to China in 1997, China's commitment to the close partnership between the Hong Kong Government and the private sector is a pending issue. The strategic alliance between the Hong Kong Government and the private sector dates back to the beginning of British colonization. The Hong Kong territories were gained by the British Empire during the Opium Wars in the nineteenth century. Shonly afterward Hong Kong became the West's gateway to China. First. Hong Kong became established as a trans-shipment center for trade with China. Much later, when the Korean War and UN embargo cut off most of its trade with China, Hong Kong set itself up as a manufacturing center.

In 1990 Hong Kong ranked as the world's fourth largest financial center after New York. London, and Tokyo. The World Bank's official figure lor Hong Kong's per capita GDP was US$11,490 in 1990 compared with US$370 for China. For a long time, Hong Kong appeared as a symbol of Western capi- talism, pointing up the Chinese Government's difficulties in creating a robust economy. Hong Kong has virtually no restrictions or limitations on legitimate business. The territory has a freely convertible currency and imposes light taxation - 15 percent for individuals. Hong Kong's success to date has been based on the active support of its government. which has acted as a catalyst by displaying foresight in laying the foundations for entrepreneurial success in infrastructure development.

In September 1984 the British and Chinese Governments signed a Joint Declaration in which the British agreed to hand the entire colony back to China on July 1. 1997, on the condition that there would be -one country, two systems" for another 50 years and that the new -Special Administrative Re- gion" (SARI of Hong Kong would be administered by Beijing. Because of the forthcoming change. the British Government, and the Government of China, created the Sino-British Joint Liaison Group to oversee the transition period. Theoretically, the Sino-British Joint Declaration will allow Hong Kong to retain Jts present social, economic. and legal systems for at least 50 years after 1997. However. Hong Kong's Chinese population (96 percent), although they regard 1997 with pride. are also concerned about the new regime The most important question concerns what is likely to happen after 1997. Hong Kong needs China's space and labor, and China needs Hong Kong's capital, expertise, and strategic physical location. Hong Kong's importance as the most efficient service center in the world cannot be emphasized strongly enough. and therefore, in the short term at least. China needs a prosperous Hong Kong. Hong Kong ought to ensure that it becomes a prime gateway to China and an integral part continued ....

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Box 5.1 of China's future economic development. In1991 China gave (concluded) its support to the ACP through a Sin-British Memorandum of Understanding and is being consulted on all aspects of the Chek Lap Kok development through the Airport Com- mittee of the Joint Liaison Group. However, China's reluctance to approve the financing packages for Hong Kong's new airport has already caused some delays in the project development.

ment, its financing scheme and the future business strategy, particularly with regard to the close partnership between the Hong Kong Government and the private sector.

1. OWNERSHIP AND INSTITUTIONAL FRAMEWORK

A. The Civil Aviation Department

The Civil Aviation Department (CAD) is under the supervision of the Secretary of Economic Services, a government authority responsible for overseeing most public utilities activities in Hong Kong. The CAD has a staff of 370 and performs four main functions: (1) the provision of air navigation services (air traffic control, telecommunications, search and rescue); (2) the regulation of the civil aviation sector (excluding licensing, which is the responsibility of the Air Transport Licensing Authority [ATLA]); (3) the administration of air services agreements; and (4) the management of operations and facilities for Kai Tak Air- port. Figure 5.1 depicts CAD's organization chart. CAD's functions are distributed among the following seven divisions. m The Air Services Division. Administers Air Services Agreements (ASAs) after their negotiation by the Air Services Negotiation Unit of the Economic Services Branch. The Air Services Division delivers operating permits to designated airlines so that they can operate scheduled services. Until recently, air traffic rights to, from, and through Hong Kong were covered by ASAs between the United Kingdom and its bilateral partners.

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Direclor Figure 5.1

of _ Hong Kong: CAD - Civil Aviation 3 Organization Chart

Air Services Air Traffic Airport Safet M Division i Manageent aineme nTaJ

Air Sences Air Taffic Ser_ices Agreements ServicesComnea | Ah Fire Akmninsra¶jon Air Nvg3ton Coesncen I Cotge Legis-iaon Servce & ProperV Airwartrnese TwnncalAdmin.

Technical Finance Administratio jPlanning | Division Division

IP annin & _ Forecasting ! relec,rnmuni- Fffam4La1 i Personnl j r1-ont ,Manai,rnent Maragmewnt Elecaricss

In view of Hong Kong's changed status in 1997, the U.K. Government is now establishing separate Hong Kong ASAs. The Air Traffic ManagementDivision. Manages and controls aircraft movements within Hong Kong's airspace. In particular, Air Traffic Services must maintain safe air traffic flows at the busy Kai Tak Airport. Services are provided on a 24-hour basis to all civil and military aircraft. Because of the hilly landscape around Kai Tak Airport, approach and departure flight paths have been restricted to the southeast or western parts of the airport. Thus, aircraft movements are scheduled at a frequency of 28 per hour. To alleviate traffic congestion in Hong Kong, the Air Traffic Management Division has taken measures to provide extra control positions and training, and to improve equipment. As a result, runway capacity has been increased to meet demand. The Air Traffic Management Division has been extremely active and efficient in increasing air traffic control (ATC) capacity by installing additional radar facili-

165 AIRPORT PRIVATIZATION EXPERIENCES

ties at strategic sites. A search-and-rescue coordination center at Kai Tak Airport is linked to an international search-and-rescue assistance satellite system that can rapidly position an aircraft in distress. Finally, to remain competitive and efficient, the CAD has its own school for recruiting and training ATC officers. * The Airport Management Division. Has the day-to-day responsibility for managing Kai Tak Airport, from the operation of the terminal building and the aircraft parking apron to all of the commercial activities. Kai Tak Airport is thus managed directly by the CAD as an operating division. The Airport Management Division employs 270 people, with the objective of providing the best possible service to airport customers, airlines, passengers, and cargo shippers. A very high demand is made on the Division to handle Kai Tak's high volume of passengers, cargo, and aircraft through the single run- way5 and within the very small area of 332 hectares. Since virtually every part of the airport is used to capacity, additional pressure has been felt by the Airport Management Division and its four Sections: Operations; Passenger Services; Commercial Concessions and Prop- erty; and Technical Administration. J The OperationsSection. Supervises airfield and apron activities and all aspects of aircraft operations. The Section plans the allocation of over 200 arriving aircraft per day through a computerized bay allocation system. The Sec- tion is also primarily responsible for airfield safety and aircraft servicing equipment, and also has a bird control unit. The Passenger Services Section. Coordinates passenger flows at the airport through a computerized system called Common Use Termi- nal equipment, whereby any airline can access any desk for passenger check-in. All baggage handling and passenger transfer services are provided by a private concessionaire, Hong Kong Airport Terminal Services Limited (HATS), under a franchise to the Hong Kong Government.

5In 1993, Kai Tak airport handled: 24.5 million passengers; 1,139,000 tons of cargo; and 135,000 aircraft movements.

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"i The Commercial Concessions and Property Section. Responsible for ensuring that high standards of service are provided by airport concessionaires. These concessionaires range from restaurants, bars, and shops to an international bank and a telecommunications post office. The Technical Administration Section. Deals with airport safety regulation and has been responsible for introducing 100 percent hold-baggage X-ray screening, making Kai Tak the first airport in the world to adopt such a system. The Section also supervises airport development. While Chek Lap Kok is under construction, Kai Tak's Technical Administration Section is handling the building of new facilities necessary to meet traffic demands. A HK$2.2 billion (approximately US$288 million) terminal refurbishment program was completed in 1992 together with the reconstruction of the Transport Terminus. Additional passenger space and check-in facilities will be provided shortly. Two new road ramps and a curbside drop-off area have been opened to improve access. HATS has built a new interline baggage handling facility. The Safety Regulation Division. Includes flight safety regulation, the airport fire contingent, and airworthiness. The Technical PlanningDivision. Oversees planning and forecasting, telecommunications, and electronics engineering. The FinanceDivision. Monitors financial performance and produces various financial and accounting statements. The AdministrationDivision. Divided into two sections: personnel management and office organization. In practice, the CAD controls the provision of air navigation services, technical regulation, and the administration of ASAs, and subcontracts most of the airport-related activities to private concessionaires.

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The CAD's work is complemented by specific boards and committees that have advisory status to the Government of Hong Kong. The Aviation Advisory Board advises the government on broad policy matters such as air transport services and transport operations. The Airport Operations Committee, composed of senior members from airline management and the CAD, as well as a representative of the Royal Air Force, provides assistance and counseling to the director of the CAD on operational issues. Lastly, there is the Airport Facilities Committee, which is chaired by the airport general manager, senior staff from the airlines, from HATS, and from the Hong Kong Tourist Association, and by other members involved in passenger-related and cargo-related activities.

B. The Provisional Airport Authority

Along with the decision to build a new airport, the government approved the creation of a commercially independent corporation, the Hong Kong Airport Authority, to operate and manage airport-related services at Chek Lap Kok. Consultations with the Chinese authorities are currently under way regarding legislation for setting up the new Airport Authority. The Airport Corporation Bill (the Airport Authority Ordinance), under revision by the Government of China, was enacted by the Govern- ment of Hong Kong on July 27, 1995. It will incorporate the new Hong Kong Airport Authority as a commercially autonomous government authority(corporation). Airport development assets will be owned by the Airport Authority and airport land will be leased on a long-term contract. As an interim step toward a commercially independent Airport Authority, in 1989 the government set up the Provisional Airport Authority (PAA), under the chairmanship of the Finan- cial Secretary, to supervise the planning, construction, and development of the new airport. The PAA, which in practice functions as a developer, is wholly owned by the government and is funded primarily by advances from the government's Capital Investment Fund. These advances are scheduled to be converted into government equity following the enactment of the Airport Corporation Bill. (Further details on the PAA are provided in Section IV, below.)

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11. REGULATORY FRAMEWORK __

Due to air navigation and airport management services having been the responsibility of a government department (the CAD), economic regulation procedures and methods have not been properly developed. The pricing of airside charges is based on inflation, volume, and time coefficients, which has resulted in higher charges for peak hours. However, owing to traffic congestion at Kai Tak Airport, airside charges have been applied uniformly regardless of peak hours. The formula is based on historical costs with a break-even approach that enables the government to recover the operating cost of the runways. This pricing policy for airside charges is a significant departure from the approach in developing countries and reflects the government's decision to form strategic alliances with the private sector in airport operations. Revenues from private sector commercial concessions provide most of Kai Tak Airport's profits. Most private concessions are regulated through a rate of return formula - the return on average net fixed assets (ANFA). The target ANFA in this profit-controlled scheme ranges from 12 to 15 percent. This scheme is applied to most privately run utilities in Hong Kong. With the forthcoming opening of Chek Lap Kok Air- port and the setting up of a new Airport Authority, economic regulation procedures will have to be developed. Airside charges will probably have to be increased to account for the massive investments in airport infrastructure. Future economic regulation will be formulated in line with International Civil Aviation Organization (ICAO) guidelines. In practice, issues pertaining to economic pricing are still pending, as ICAO guidelines relate more to qualitative aspects, such as the Chicago Convention and non-discriminatory economic treatment, than to quantitative regulation. In this regard, future economic regulation will probably give the PAA the freedom to establish and increase airside charges.

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111. KAi TAK AIRPORT

Kai Tak Airport is owned and operated by the Hong Kong Gov- ernment as an operating division of the CAD. Kai Tak is one of the busiest airports in the world, averaging, in 1993, 24.5 million passengers and 1,140,000 tons of air cargo (see Table 5.1).

Table 5.1 a Hong Kong: Annual Mvt. Type Landings Take-offs Arrivas Departures Transit Unloaded Loaded Traffic Flows at Kai Tak - Airport, 1992-93 Passenger 56624 565533 11.128434 113.Ia7S8 63121 287.782.451 20.0489.s Cargo 4.18 4.361 15.447 767 205 138.55 046 283.484.486

Non-Taffirc 1227 932 | 282 1211 3.071 27M.152 127J36

Trct ilrs, suts"ien 6m t, n.. 4[rMs.ne Source: CAD, 1993 Report. Fifty-five international airlines provide 2,300 scheduled passenger and cargo flights each week out of Kai Tak, with 92 worldwide destinations. In addition, 2,550 non-scheduled passenger and cargo charter flights operate from Kai Tak weekly. In 1993, passenger traffic and air cargo volume at Kai Tak showed, respectively, an 11 percent and a 19 percent growth over the previous year. Kai Tak Airport now ranks fourth in the world in terms of international passenger movements and third in terms of international cargo throughput per annum. The airport is managed and operated by the Airport Management Division of the CAD. Although Kai Tak is a fully government-owned airport, apart from ATC and apron management, its activities (passenger services, ground handling services, car parking, etc.) are operated by the private sector through long-term concessions and build-own-operate-transfer (BOOT) schemes (cargo handling, airport hotel, etc.). The airport is extremely profitable and represents an interesting case of public/private sector partnership in the exploitation of airport-related services. Kai Tak Air- port employs approximately 23,000 workers, only 370 of whom are employed by the CAD; the rest are employed by private concessionaires in the airport.6 Because of space constraints, the airport has only eight gates (fingers) through which it handles 25 million passengers through the use of shuttle-links between the aircraft parking areas and the terminal. The operation is run very efficiently, and in terms of passengers per gate Kai Tak

6 Even the internal security services are paid for by a group of private airlines operating out of Kai Tak Airport and provided by private security services.

170 Case Study 5 EAST ASIA could have one of the highest ratios in the world. Sixty-five percent of Kai Tak's revenues come from non-aeronautical sources (landside activities), which are relatively high by international standards. This partially explains the stability of the airside charges (landing fees, aircraft parking, and passenger fees), which have not increased in the last four years, and the low level of CAD personnel at the airport (only 1.5 percent of the total work force). In terms of the privatization experiences of airport infrastructure around the world, the Hong Kong case could be labeled "a privately run corporation wholly owned by the government." Audited statements as of March 31, 1993 reflect the healthy financial situation of Kai Tak Airport, which has experienced, between 1992 and 1993, a growth of 13.5 percent (12.4 percent in real terms) in total revenues from HK$1,977 million to HK$2,244 million (see Table 5.2). Much of that growth has been accounted for by increases in aircraft landing and parking fees, and in trading concessions. Revenue growth was distributed as follows: trading concessions grew by 7.5 percent; aircraft landing and parking fees, by 19 percent; airport rentals, by 24 percent; and baggage handling, by 15 percent. The growth in airside charges, namely, aircraft landing and parking fees, was attributable to traffic growth rather than unit fee increases.

_3 0 _ .0 = Table 5.2 Airside Operations 587 26 Hong Kong: Revenue Distribution for Kai Tak Landing and Parking Fees 587 26 Airport as of March 31, Landside Operations 165'7 74 1993 Trading Concessions 1.222 54 AirDort Rentals 188 8 Baggage Handling 100 4 Other 147 7

Total Revenues Z244 . 100. 'US$1 isequivalent to HK$7.7355 (average 1992/93 period). Source: CAD, 1993 Report.

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Kai Tak Airport's net operating profits approximated 47 percent and 44 percent of total revenues in 1992 and 1993, respectively (see Table 5.3). This is relatively high compared with industry standards in Europe and the United States. One of the main explanations for this performance is the difference in the labor cost component between Kai Tak and european and american counterparts.

Table 5.3 Hong Kong: Kai Tak TotalRevenues 1,997 2,244 Airport Income State- ments (HK$ millions)' Expenditures Staff 259 266 Depreciation 245 348 Maintenance 199 144 General Expenses 264 286

Total Expenditures 887 1,044 Operating Surplus (before tax) 1.110 1,200

Net Operating Surplus 927 990

'US$1 isequivalent to HK$7.7355 (average 1992/93 period). Source: CAD, 1993 Report.

Kai Tak's financial performance reflects the government's decision to rely on private sector retail concessions for an increasing source of revenue as well as to upgrade airport facilities to meet the growing air transport demand and to favor traffic development. Once Chek Lap Kok Airport becomes operational, the Kai Tak Airport will be closed and converted into a real estate development managed by the government.

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IV. CHEK LAP KOK: AIRPORT DEVELOPMENT PROCESS ..

A. The Airport Core Program

The development of Chek Lap Kok Airport is part of the Airport Core Program (ACP), the mega-infrastructure development program initiated by the government in 1991 and supported by the Chinese authorities through the Sino-British Memorandum of Understanding. To meet the rapid growth in passenger and cargo traffic in the Asia-Pacific region, the Hong Kong Government decided in 1989 to embark on the ACP, which is one of the most ambitious transport development programs in the world today. The ACP includes the creation of a new airport at Chek Lap Kok and of 10 interdependent infrastructure projects. The project will integrate intermodal transport facilities (airport, highway, railway, and port) in the Kowloon/New Territories area and will later connect to main transport links with southern China (i.e., the Guangzhou region).' The implementation of theACP is being coordinated by project management advisers at the New Air- port Project Coordination Office (NAPCO). The total cost of the ACP was estimated at HK$112.2 billion in March 1991 prices or HK$158.2 billion (approximately US$20.7 billion) as of No- vember 1994 (taking into account inflation during the design and construction stages). The ACP is being jointly financed by the Government of Hong Kong and the private sector. The government is contributing HK$113.3 billion (approximately US$14.8 billion) in equity investments and public works, and the rest (HK$44.9 billion, or about US$5.8 billion) is being contributed by the private sector in the form of equity investments, commercial lending, and project finance (i.e., BOOT for the Western Harbour Crossing Project). The ACP will be Hong Kong's most important infrastructure development in its bid to maintain its competitive edge as a major East Asian commercial hub. Table 5.4 depicts the breakdown of costs for the ACP.

I These developments include 34 kilometers of new expressways, an express rail link connecting the airport with Hong Kong's major centers, a highway network, one of the world's largest suspension bridges, a cross-harbor tunnel, land reclamation, and new town building.

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Table 5.4 Hong Kong: Airport Core Program, 10 Different Projects (HK$ billions)" in, ffiffffig"10 Im Description Estimated Cost (HKS billions) 1. New Airport 75 gates, 35 million pass/year 70.7 Transport Links (1st phase 1998)

2. Landau Fixed Crossing 1,377 mt suspension bridge 7.2 3. Airport Railway 34 km local and express service 34.0 4. Western Harbour Crossing 1.36 km cross harbor tunnel 6.5 5. North Landau Expressway 12 km dual 3-lane highway 8.0 6. Route 3 8 km dual 4-lane highway 5 7 7. West Kowloon Expressway 4.2 km dual 3-lane highway (Inc. above) New Land and Town 8. West Kowloon Reclamation 330 ha of new urban land 7.6 9. CentraUWanchai Reclamabon 20 ha of new urban land 3.5 10. Tung Chung new city with population of 200.000 at airport site 15.0

t 1 -ft2' - ^ , ' . . . . 15&2 US$1 is equivalent to HK$7.65 (as of November 31, 1994). Source: PM, 1994 Report.

B. Airport Development

Chek Lap Kok Airport will cover an area of 1,248 hectares8 and will have two runways, 3,800 meters long, and a midfield passenger terminal complex. Chek Lap Kok is an island consisting of 302 hectares, off the northern coast of Landau Island. The airport will be created by leveling Chek Lap Kok and a nearby smaller island, Lam Chau, and by reclaiming 938 hectares of land from the sea. The first runway is scheduled to be completed by June 30, 1997, the scheduled date for the transfer of Hong Kong's sovereignty. The airport is expected to open in April 1998, which allows up to nine months for trial operations and the move from Kai Tak. The capacity at that date will be 35 million passengers and 3.0 million tons of cargo a year, with 65

8 This area is equivalent to more than four times the size of Kai Tak Airport.

174 Case Study 5 EAST ASIA aircraft positions. The total capital cost of the airport project up to the completion of the first phase (1998) is estimated at HK$70.7 billion (approximately US$9.06 billion) as of Novem- ber 1994, including HK$49.8 billion (approximately US$6.4 billion) for PAA costs, HK$15.4 billion (approximately US$2 billion) for private sector franchises, and HK$5.5 billion (approximately US$710 million) for government facilities.9 The second runway will be opened according to air traffic demand. The passenger terminal complex will have one terminal initially and another at a later date. According to the initial opening development plan (being revised at date of publication due to changing traffic forecasts) at the end of its Phase I development in the year 2010, the airport will have an annual capacity of 45 million passengers and 2.5 million tons of cargo. For the second phase, facilities are planned that will increase the airport's capacity to 87 million passengers and 9 million tons of cargo by the year 2040.

C. The PAA

To further stimulate competitiveness in services and efficiency in management, the government has shifted the airport's overall management from a government department to a public corporation. The planning, construction, and ownership of the replacement airport will be placed under a new, commercially independent, airport authority. In the interim, as has been mentioned, the government has set up the PAA, under the chairmanship of the Financial Secretary, as a statutory authority responsible for building and developing the new airport. The PAA was created in 1989 as the corporate entity responsible for planning, designing, and constructing the new airport. It is the PAA's responsibility to ensure that airport development (site formation, key facilities construction, etc.) is carried out in accordance with the Memorandum of Understanding. The PAA's policy is to provide quality services at the airport through competition and private sector participation. Following the enactment of the Airport Corporation Bill, the PAA will be transformed into a full-fledged corporation under its own legislation and will be able to operate the airport independently, to borrow funds, and to initiate investments in facilities to be developed by the private sector. The personnel and the assets and liabilities of the

9 ATC-related equipment and infrastructure.

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PAA will be transferred to the new Airport Authority. The Air- port Authority is expected to focus chiefly on air traffic-related services and apron management, delegating airport-related services to the private sector. The CAD will mainly provide in- route navigation services. The PAA is supervised by a Board with members appointed by the Governor. Executive directors at the PAA are responsible for construction, finance, corporate development, commercial and operations planning, and administrative matters. The PAA employs 1400 persons. The PAA acts principally as project manager, and has four main areas of responsibility:

X Supervision of building operations, including supervision of site formation and construction, and design of the terminal building. Most of the work has been done through contracting the local private sector, with contracts being awarded through a fair and open tendering process. Provision of competitively priced services to all airport users through private sector franchises, to bring in expertise and promote competitive services. The PAA has been mainly involved in commercial and operational planning, including the selection of private operators, the specification of business plans, the drafting of franchise terms, and also negotiations for franchise awards for building and operating airside support businesses such as cargo handling, aircraft maintenance, air catering, and the aviation fuel system. Operational planning has also been oriented toward customer facilities in the terminal building and landside developments. 0 Financial management, including the monitoring of costs and expenditures through financial and management information systems and control procedures, and the structuring of financing for the airport's development. The PAA is responsible for arranging financing, and in that capacity works with the government and the Sino-British Joint Liaison Group's Airport Committee on the overall financing plan. The PAA has continued to prepare for the borrowing program that its successor, the Airport Corporation, would have to undertake to raise capital.

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EAST ASIA et Coordination with the Joint Liaison Group's Airport Committee, including work on the completion of the financing and capital structure agreement for the new airport with the Chinese authorities, on the enactment of the Airport Corporation Bill, and on the land grant for the airport island. The structure and the operational style of the PAA will result in major changes in the provision of civil aviation services in Hong Kong, of which the following are the two main features. f The focus of the PAA's operations will be on designing airport development plans, support systems, and quality, safety, and performance standards for consultants and contractors, and on coordinating with government officials to arrange airport financing structure. *e The total reliance on private sector operators for the implementation of airport development and management translates into a type of greenfield privatization of the new airport with governments owning 100% of the airport corporation and land property. The government's management responsibility will thus be redefined around ATC and meteorological systems. Future airport management will be planned around five management centers: security, airfield safety and operations, passenger terminal customer services, landside services, and maintenance services.

D. Project Finance

Financial arrangements for the new airport were signed on No- vember 4, 1994 by the British and the Chinese in the Joint Liai- son Group's Airport Committee to provide HK$36.6 billion of government equity and a maximum of HK$11.6 billion of private sector debt (see Table 5.5, following page). The private sector will provide HK$15.4 billion in the form of BOOT arrangements for cargo handling, ground handling, catering facilities, and the airport hotel. The CAD will provide an additional HK$5.5 billion in air navigation equipment and related infrastructure.

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Table 5.5 m 0 - HKS Hong Kong: Airport (billions)1 Development (ACP) - Equity Funds 36.6 Financing Structure Debt Funds 11.6

Total Airport Corporation (in process) 48.2 Private Sector 15.4 CAD (air navigation equipment) 5.5 Olhers (to be determined by PAA) 1.0

Total Funding 70.7

US$1 isequivalent to HK$7.8. Source: PM Finance Department, October 1995.

The Government's initial proposal to the Airport Com- mittee had a higher debt: equity structure (almost the inverse of the present 1:3 ratio). The PAA's officials felt confident that, given the project financial figures,'0 the new airport project could easily raise the funds from local capital markets. The Govern- ment of China opposed this proposal on the basis that, as future owner of the new airport development (1997), it was not inclined to accept such a level of debt for a new infrastructure project. It was also reluctant to accept the full coverage of the construction risk, although it finally accepted this in November 1994. The PAA's financial strategy is to raise short-terrn capital through a syndicated loan that will later be converted into a revenue bond issue." The PAA officials believe that the bonds will be placed in the Hong Kong capital market at a rate similar to Government of Hong Kong sovereign debt. Recently (1994), a similar 20-year revenue bond issue from the Mass Transit Rail- way Corporation was placed in the local market with a -AA rating and an 8 percent yield. Construction risk is being undertaken by the government through a FinancialSupport Agree- ment (FSA) between the PAA and the government. In this agreement the government is guaranteeing the total funding for the construction phase of the project (the public sector portion). As usual, the commercial risk will be borne by the project sponsors

'° Once the first phase is in full operation expected revenues are estimated at HK$8.0 billion per year with returns similar to those at Kai Tak Airport. 1"Bonds payable from a specific source of revenue and which do not pledge the full faith and credit of the issuer.

178 Caseo Study 5 EAST ASIA and lenders, but with the following caveat: economic regulation on airside charges will be limited to agreements that comply with international conventions (ICAO).'2 Apart from the risks associated with Hong Kong's change in political status after 1997 (to a Special Administrative Region under the Chinese Central People's Government),'3 policy risks in the new airport development tend to be low, given the arrangements for economic regulation which provide the PAA (and the new Airport Corpo- ration) with a relatively high degree of discretion to establish airside charges. Until now, the PAA has been funded by government advances approved by the Legislative Council's Finance Com- mittee. On July 1, 1994 the Finance Committee approved funds totaling HK$15.18 billion to cover the construction of the passenger terminal and concourse. Further approved funding in January 1995 brought advances from the government's Capital Investment Fund to HK$36.6 billion (i.e., the proposed equity level).'4

E. Private Sector Partnerships

The PAA's objective is to draw on private sector experience and expertise to provide competitive and quality services to all airport users. Therefore, the PAA awards contracts and commercial franchises to private sector firms through an open and non- discriminatory tender process. Companies from all over the world have won major contracts. Japan has received the largest amount (25 percent), followed by Hong Kong (23 percent), the United Kingdom (16 percent), China (7 percent), Netherlands (6 percent), France (6 percent), Belgium (3 percent), New Zealand (3 percent), Australia (2 percent), Spain (2 percent), and others (6 percent). In December 1994 the PAA short-listed four international consortia to tender bills for the contract to build the passenger terminal superstructure at Chek Lap Kok

12The ICAO (Chicago Convention) guidelines and principles on airside charges are very limited and refer mainly to equality of treatment between nations and not to level of pricing.

3 Already largely discounted under the transition period (1984-97).

14 On June 30, 1995, the British and Chinese sides of the Airport Conmiittee reaffirmed support for the construction of the new airport and related projects in reaching an ac- cord over the Financial Support Agreements (FSAs). These contain assurances of government support that will enable the PAA to raise, in a cost-effective manner, the necessary borrowing in accordance with the Agreed Minute (PAA RPE0221, July 1995).

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and three international consortia to tender bids for the terminal building services contract. On January 26, 1995, the PAA awarded the passenger terminal contract (the largest contract in the airport project, at HK$10.1 billion, equivalent to US$1.3 billion) to BCJ Joint Venture.'5 The PAAdecided to award cargo handling franchises to HACTL (capacity on opening 2.6 million tons) and Asian Air Freight Terminals Limited (Hong Kong, Singapore, and Chinese ownership) with capacity of 0.4 million tons.

V. PRIVATE SECTOR DEVELOPMENT

A. Kai TakAirport

Private Sector Development at Kai Tak Airport is characterized by a close partnership between the CAD and private operators. Out of the 23,000 employees at Kai Tak Airport, only 370 are employed by the CAD. This particular process has translated into a very clear division of responsibilities. The CAD is primarily responsible for the provision of air navigation services and apron management. Private concessionaires are primarily responsible for bringing competitiveness and efficiency to the operational management of the airport. In this context, passenger and cargo service operations have been transferred to private operators. The two major franchises in Kai Tak Airport were awarded to Hong Kong Airport Terminal Services Limited (HATS) for passenger and ground handling services and to Hong Kong Air Cargo Terminals Limited (HACTL) for air cargo handling. These concessions were awarded to promote competitively priced and high quality services (charges are regulated through a rate of retem formula known as ANFA). 'J HATS was set up in 1961 as a 50/50 joint venture between Jardine, Matheson & Company Limited and Swire Pacific Limited. It was de-

5 1BCJ Joint Venture comprises: China State Construction Engineering Corporation, of the People's Republic of China; Kumagai Gumi (HK) Ltd., of Hong Kong; Maeda Cor- poration, of Japan; and Amec International Construction Ltd., of the United Kingdom.

180 Case Study 5 EAST ASIA cided at that time that the small area available at the airport would not support the operations of several ground handling agents. Thus, one agent, HATS, was chosen to provide services to all airlines under a six-year renewable franchise agreement. HATS pays royalties to the government and a profit control scheme limits its shareholders returns. HATS employs 1,300 staff, primarily responsible for delivering luggage to and from the aircraft; delivering cargo to and from the aircraft to the HACTL ware- house; delivering air mail; loading and unload- ing aircraft; and providing boarding steps to aircraft. Other HATS responsibilities are ramp transportation, a porterage service, and mail delivery services. HACTL was incorporated in 1971 under a private franchise to handle air cargo services in and out of Hong Kong. The government granted HACTL an exclusive concession to provide consolidated air cargo terminal services to all airlines. HACTL is subject to economic regulation, which is overseen by the CAD through the application of a rate of return formula (return on ANFA). The ANFA rate for HACTL fees and charges has been between 12.5 and 15.0 percent. The decision to grant an exclusive concession was reinforced by space constraints at Kai Tak and by inefficiency in air cargo operations resulting from the fact that airlines were operating their own obsolete warehouses. The ownership of HACTL is distributed among five shareholders, as follows: Jardine, Matheson & Company Limited (30 percent); Swire Aviation Limited (30 percent); The Wharf Limited (15 percent); HK & Whampoa Dock Company Limited (15 percent); and China National Avia- tion Corporation (10 percent). HACTL's shareholders have recently agreed on the acquisition of 10 percent of the company by Cathay Pa- cific Airways. Since 1976, HACTL has been providing cargo handling, storage, buildup, breakdown, and data and documentation processing services on a 24-hour basis to more than

181 AIRPORT PRIVATIZATION EXPERIENCES

70 airlines. HACTL operates two terminals with an annual throughput capacity of 1,500,000 tons. During the period 1992/93, HACTL handled close to 1,000,000 tons."6 To maximize land use, HACTL has exploited vertical space to the extent possible. HACTL's two terminals represent the largest investments in air cargo facilities in the world, amounting to US$256 million. HACTL has been extremely successful in maintaining a high standard of services despite an average compound growth rate of 11 percent per year. The mishandling rate is as low as 1 mishandled consignment out of 20,000. Estimates put the value of tonnage handled by HACTL at 20 percent of Hong Kong's external trade. The average dwell times are 19 hours for exports and 40 hours for imports thanks to the company's efficiency and the free port status of Hong Kong.

_ d------B. Future Private Sector Involvement Process at Chek Lap Kok

Partial placement of the new Airport Authority (the Corpora- tion) equity will take place at the completion of works. It will be supported by subscription of shares to the public via domestic and international capital markets (a percentage of the total equity is to be determined at a later stage). The government decided to partially allow private sector participation in the airport corporation at project completion rather than at its start-up because of the following constraints: i It was considered necessary to develop the airport quickly to meet the rising traffic demand and to complete the airport before the transfer of Hong Kong's sovereignty to China. * The management of the airport's development was undertaken by the government in order to favor a long- term strategic viewpoint in building airport capacity ahead of actual demand.

6 1 HACML ranks among the top the caigo terns in the world today.

182 Case Study 5 EAST ASIA

B The experience and in-depth expertise of the government in such infrastructure project development made it the most suitable candidate for managing the development process quickly and effectively, with financial cost control. * Private sector management of airport development was perceived as being tailored to short-term financial rewards rather than to long-term economic development. Upon the opening of the airport, the private sector will operate five key franchises: aircraft catering, cargo handling, aircraft maintenance, aviation fuel supply, and ground handling services. Business plans for these franchises have been received and evaluation and negotiations are being carried out.'7

KUALA LUMPUR-MALAYSIA: SEPANG AIRPORT

Malaysia has recently corporatized its national airport system through the creation of a state-owned corporation, Malaysia Airports Berhad (MAB). Malaysia, with a total of 36 airports in the system," t is different from the cases of the city-states of Hong Kong and Singapore. In late 1991 the enactment in Parliament of the Civil Aviation Bill separated the existing Civil Aviation Department (CAD) into two entities: (1) the MAB, with responsibility for operation of the national airport system, and (2) the CAD, with responsibility for policy and regulatory functions in air transport. MAB officials have remarked that within the second year of operation the economic performance of the national airport system had changed from that of a subsidized entity to a profit-making concern.

17 Good progress has been made in finalizing the negotiations for these franchises. In a separate Agreed Minute on June 30, 1995, the two sides on the Airport Committee agreed to the terms of the two Franchise Agreements to be entered into by the Airport Authority with HACTL and Asia Airfreight Terminal Company Limited (AAT) for the provision of air cargo services at Chek Lap Kok, confmnring that they will continue to be valid after 1997. The Airport Authority expects to award the franchises as soon as the Airport Authority Ordinance comes into effect (PAA RPE 0221, July 1995). Is Five international airports, 14 domestic airports, and 17 short takeoff and landing (STOL) airports.

183 AIRPORT PRIVATIZATION EXPERIENCES

A. Subang Airport

The existing international airport at Kuala Lumpur, Subang Air- port, has gone through three different expansions and renovations and is now close to capacity limits, handling an average of 12 million passengers per year and 300,000 tons per year in 1994. In 1991 the Government of Malaysia announced plans to build a new international airport in Sepang, 50 kilometers south of Kuala Lumpur. The new airport facility is a mega-project for transport infrastructure in Malaysia and includes railway and highway links to the capital (the first phase of the airport-related infrastructure alone is estimated at RM10 billion, or approximately US$4 billion). The airport project was announced in 1991 in the context of Malaysia's 30-year economic plan (Vi- sion 20/20). The plan's main objective is for Malaysia to achieve developed nation status by the year 2020.

e._ _ B. Sepang, Kuala Lumpur International Airport

The new airport development at Sepang, to be opened in 1998, will have in its first phase the capacity to handle 25 million passengers per year and 1 million tons of cargo per year. Subse- quently, Phase II (2008) and Phase m (2012) will increase the capacity to 35.0 and 45.0 million passengers per year, respectively. In early 1993 the government created a new company, K.L. Intemational Airport (KLIA Bhd.), as a state-owned corporation with full financial autonomy under the supervision of the Ministry of Finance. KLIA Bhd. has responsibility for building and developing the airport facilities according to a master plan developed by the Anglo-Japanese Airport Consortium (AJAC). 19 The concept is to provide the airport development with a high degree of flexibility and autonomy in the construction phase of the facility. Once built, KLIA Bhd. will be incorporated into MAB as a subsidiary for the operation and management of airport-related services. The design concept used is that of "the airport in the forest," which will provide all passenger terminals with built-in surrounding tropical forests, making the facility unique (an 18-hole golf course and an attraction park are planned within the airport compound).

19British Airports Authority (BAA plc) is the "Anglo" component in the consortium.

184 Case Study 6 EAST ASIA

The following are some of the most relevant issues concerning to the new airport project's finances and private sector participation in infrastructure.

1. Private Sector Participation

Of the total projected investment of RM10.0 billion, the private sector is expected to contribute RM2.0 billion (approximately US$0.8 billion). MAB will directly provide the air traffic control, apron management, internal security, and fire and rescue services. The other airport-related services (landside and passenger services) will be provided by the private sector through long-term concessions and BOOT schemes. According to the privatization consultant (Arthur Andersen) working with KLIA's authorities, the following activities will be privatized in the new 'airport development (with total investment funded by the private sector): In Ground handling services I Passenger services (excluding the construction of the passenger terminal) * Car parking and car rental in Aircraft catering * Cargo terminal (apron, terminal, office building, and warehousing) * Aircraft maintenance facilities * Aircraft fueling system *1 Airport hotel

A Golf course/theme park.

185 AIRPORT PRIVATIZATION EXPERIENCES

2. Capital Finance Structure

The remaining RM8.0 billion to be invested by the GOM is structured as shown in Table 5.6.

Sources of Funding RM Malaysia: KLIA Bhd. (billions)' Financing Structure Equity injection (Government of Malaysia) 1.00 Debt: Overseas Economic Cooperation Fund, 1.60 Japan Government (to finance terminal construction) Government Bonds (20 years. Z775%) 1st tranche Employees Provident Fund 1.20 Pensions Funds 0.20 Bank Simpanan 0.15 Social Securty 0.05 2nd tranche (end ot 1995) 1.50 Rest of the Funds Govemrnment bonds from local capital markets. 2.30 terms and conditions to be announced

1 US$1 isequivalent to RM2.56 (January 1,1995). Source: KLIA Bhd. Planning Department, January 1995.

Officials from both the Ministry of Finance and KLIA Bhd. seem confident that most of the financing could come from the local capital markets by means of government bond issues. This is to be expected since the most important bond subscriber, the Employees Provident Fund (EPF), is a government-related institution. The EPF is in charge of managing the funds from the mandatory contributions of employees and employers to pension and social benefits. The EPF has been a major player in the financing of recently privatized infrastructure projects (Norti- South Express Highway, Light Rail Transit, YTL Power Gen- eration Bhd., etc.), and the government is asking it to assume a total of RM4.0 billion in the financing arrangements for the new airport development. The EPF has a mandatory portfolio strategy for the administrators, in which 70 percent of the Fund's assets must be invested in government securities. For all practical purposes most of the project financing needs are being funded by government sources.

186 Case Study 5 EAST ASIA

3. Project Development and Privatization Strategy

Malaysia's Privatization Program, headed by the Economic Plan- ning Unit (EPU) of the Prime Minister's Department, has been widely known as one of the most successful programs worldwide. Several infrastructure projects, with more complicated pricing and revenues issues than those in airport infrastructure, have been carried out successfully in recent years (road infrastructure, ports, power plants, etc.). In the case of the Sepang Airport development, the railway and highway transport links (not included in the RM10.0 billion figure) have also been targeted for full privatization under BOOT schemes. Despite all this, private sector participation in the new airport development is relatively low (20 percent) and airport ownership will remain in the hands of the state, at least in the initial years of the project. During meetings held with officials from EPU, the Ministry of Finance, MAB, and KLIA Bhd., this issue was brought up but did not receive a definite response from the Government. As with Hong Kong, the government prefers to complete the project and then start a privatization process through the placement of shares in local and international capital markets (similar to the BAA case). The following factors must be taken into account in assessing the government's project development and privatization strategy. i The Government of Malaysia feels that if the new airport were to be privatized as a greenfield project, the private sector would probably scale down the size and magnitude of the facility in order to enhance the short- term financial performance. a The new airport development at Sepang is not market driven but supply driven. It is part of the government's strategy to enhance the competitiveness of Malaysia, particularly in relation to Singapore (government officials claimed that they had lost a significant portion of the cargo business to Singapore's Changi Airport). The government appears reluctant to share the responsibility for this type of project investment with the private sector beyond the limits that it has already established. It prefers to assume 100 percent of the risk of over- spending in the short term before compromising the potential of long-term gains in the future. In a certain

187 AIRPORT PRIVATIZATION EXPERIENCES

sense it could be implied that the government believes it can out-perform the market's future expectations with respect to investments in airport infrastructure. a The government is now in a relatively cash-affluent position and can draw most of the project funding from its internal resources. The situation would change somewhat if KLIA Bhd. had to go to international capital markets to seek project finance.

40, SINGAPORE: CHANGI AIRPORT

Today Singapore (with a local population of 3 million) has, in its Changi Airport, the Rolls Royce of the airport industry. This airport is probably the "showcase" of successful transport infrastructure investment as a driving force in economic development. The airport's first phase (a greenfield project) began operations in 1981, with runway, terminal capacity, and related installations clearly exceeding market demand for years ahead. Changi Airport handles 24 million passengers per year and 1 million tons per year of cargo (this represents approximately 10 percent of the worldwide air transport cargo). 20 Terminal 2, a model of airport design in the industry, was opened in 1990 to expand passenger capacity at Changi. Terminal 3 is already in the design phase and is expected to be completed by the year 2000, in order to keep up with airport management's philoso- phy that "airport capacity should always exceed demand." Changi Airport has become, in less than 15 years, the most important commercial hub in Southeast Asia and one of the world's leading airports for international traffic. It has clearly set the standards in terms of operational efficiency and customer service for airports around the world. In 1984 the Government of Singapore decided to corporatize all the air transport-related activities (i.e., airport operations, air traffic control, technical regulation, and the administration of bilateral agreements), creating a new statutory board with full financial autonomy through the enactment of the Civil Aviation Act. The corporation was named the Civil Aviation Au-

LATAI statistics, 1993.

188 Case Study 5 EAST ASIA thority of Singapore (CAAS), and Changi Airport operates as a fully owned asset of the corporation. CAAS is a state-owned corporation under the tutorship of the Public Works Department. It is one the few cases in which both the function of air transport regulations and the administration of bilateral agreements are assigned to a state corporation and not to the federal government. The combining of air transport policy functions (regulations and bilaterals) with operational and management functions (airport and ATC) has had an impact on the business development of the airport. CAAS has aggressively promoted the Changi Airport and Singapore's flag carrier (Singapore Airlines) through the use of a liberal aviation policy (an open skies policy). CAAS believes that having control of both air transport policy and operational functions has been the key to its success in establishing Singapore as a major international gateway. As in the case of Hong Kong, most airport-related activities are operated by the private sector. CAAS is responsible for the provision of air traffic control, apron management, and internal security. ChangiAirport employs approximately 27,000 workers, of which 1,500 are directly employed by CAAS. In 1987 the Government of Singapore short-listed CAAS as one of the candidates for privatization. Privatization studies were contracted out to two international consulting firms, Price Water- house and Arthur D. Little, in 1988 and 1991, respectively. Recommendations from the studies suggested that it would be both desirable and financially attractive to privatize the ownership of the Changi Airport. In 1992 CAAS concluded independently that it was not in the best interests of Singapore to privatize the airport ownership and made a recommendation to the government to exclude the Changi Airport from the privatization list. CAAS claims that its recommendation was totally supported by the government and that presently the government is not considering the privatization of the Changi Airport ownership. CAAS' main concern regarding privatization was that the necessary breakdown of functions within the corporation (the airport would have been privatized as an independent unit without the policy functions) would have weakened the airport's ability to control its own growth. CAAS officials expressed skep- ticism regarding the Western model, wherein policy roles are separated from operational and management roles, particularly concerning Singapore (in which they would need to compete aggressively with neighboring nations to maintain their edge as the region's leading commercial hub).

189 AIRPORT PRIVATIZATION EXPERIENCES

KEY ISSUES EMERGING FROM THE EAST ASIAN EXPERIENCE

* Airport Infrastructure Development. The government efforts in this area appear to be driven by country strategies to enhance competitiveness in the service sector. Airports are not built to meet national demand needs: they are built as extensions of services and exports activities. Cargo facilities for storage and handling play a more important role in the planning and development of airport infrastructure than they do in the standard case of Western economies. Average investment in airport facilities is much higher than in other developing countries. Government supervision of the design and planning process, to ensure long-term economic development, is a key feature of east asian government's airport development strategy. The private sector is perceived as being tailored to short-term financial rewards rather than to long-term economic development goals in the management of large infrastructure projects (i.e., an international airport). However, private corporate governance in the management of project design and construction is the option preferred by both the Hong Kong and Malaysian Governments. Both airport development efforts were led by independent and decentralized government-owned corporations newly created for that purpose. Both the PAA and KLIA Bhd. are cases of corporatization of the airport design and development services, allowing for the necessary level of financial autonomy and corporate governance.

X PrivatizationStrategies. Full privatization of airport ownership is not considered by the governments in these cases to be an initial option for private sector participation in airport infrastructure. The key reason for the deferral of ownership privatization seems to be twofold: (1) the existence of relatively cash- affluent governments with a balanced fiscal situation; and (2) the fact that airport plans and designs are not profit-driven but development-driven, thus governments are inclined to retain control until the facilities are in full operation. An option commonly used is the privatization of the provision of most of the landside and airside airport services, apart from air traffic control and apron management, through long-term concessions and/ or BOT schemes. Both the Hong Kong and the Malaysian Gov-

190 Case Study 5

EAST AsIA emments expressed their intentions to allow partial private sector participation in the ownership at a later date through share subscription.

e VerticalIntegration with National Flag Carriers. In the three analyzed cases, there existed a close "partnership" between the airport authorities and each flag carrier (i.e., Cathay Pacific, Malaysia Airlines, and Singapore Airlines). In most of the cases, flag carriers had some kind of exclusivity rights on the provision of passenger services, ground handling services, or cargo handling services.2" Although this is common in most countries (e.g., in U.S. airports and Western European airports), it raises some questions concerning fair competition and market power, particularly in air transport facilities catering to the international business community.

g ProjectFinance Needs. East Asia's air transport market has been growing in the last three years at an annual rate of between 10 and 15 percent. This is roughly 2.5 times higher than the growth experienced by the rest of the world. Consider- able airport upgrades and expansions are taking place in this area, particularly if one considers the market in China. For many years the Chinese air transport market was dormant, but in the past few years it has experienced impressive growth (there are about 35 domestic air carriers in China today with an annual rate of growth of 20 percent)22 which translates into a massive need for airport and air navigation infrastructure investments in the forthcoming years. Government and the Private Sector ' Unique Part- nership. The development of airport infrastructure in the cases of Hong Kong, Kuala Lumpur, and Singapore illustrates a clear division of responsibilities between the public and private sectors in the provision of air transport services. Government assumes the roles of policymaker, regulator, owner, and developer (including the major portion of the capital financing), transferring the operational responsibilities and management to the private sector.

2 1 In the case of Kai Tak Airport, the parent company of Cathay Pacific (Swire Corpora- tion) owns the exclusive rights to both ground handling and cargo handling. In the case of MAB, Malaysia Airlines owns the exclusive rights to cargo handling and storage. In the case of Chek Lap Kok the ground handling concession will be open to more ample competition.

22 Overseas Economic Cooperation Fund, Asian Airports Conference, Hong Kong, May 1995.

191 AIRPORT PRIVATIZATION EXPERIENCES

192 Case Study S JAMAICA

AIRPORTS IN JAMAICA'

A CASE STUDY IN AIRPORT PRIVATIZATION THROUGH A COMBINATION OF PPI MECHANISMS (WRAPAROUND) 2

The Sangster International Airport (SIA) in Montego Bay is the principal gateway for the Jamaican tourism industry. Passenger traffic at this airport experienced an 8 percent compound growth rate during the period 1980-92, and future traffic is forecast at 5.0 million passengers by the year 2005. The Government of Jamaica realized that by 1990 the present airport system, with a capacity of 2.5 million passengers/year, would have difficulties handling the increased traffic. It was then feared that the lack of capacity would have a negative impact on the country's tourism market. In response, the government initiated the preliminary work for the expansion of the airport facilities. The Government of Jamaica established two basic premises that would govern future airport privatization and expansion programs: (1) airport expansion should be funded primarily by the private sector; and (2) airport operations would be transferred to the private sector. On the basis of these premises, and with private sector involvement, a creative privatization method was devised. The privatization program was centered

1 Research for this case was conducted in September 1994 and January 1995. 2 PPI is Private Sector Participation in Infrastructure. Wraparound is when an existing government-owned facility is expanded by a private enterprise, which only holds title to the addition; the private enterprise operates the entire facility through a concession or lease contract of the government-owned section.

193 AIRPORT PRIVATIZATION EXPERIENCES

on: (1) the use of a deferred privatization mechanism that would maximize privatization revenues by selling up to 70 percent of the shares in the terminal company (SIA Ltd.) that owns the existing terminal buildings, and is responsible for the expansion of landside activities, through a Privatization Trust after project completion; and (2) the design of a capital finance structure that will raise funds on the domestic, regional, and international markets. The government agreed to limit its equity to no more than 30 percent of the overall ownership and to sell a first tranche of SIA Ltd., totaling 10-15 percent of total shareholding, to the private sector with the outstanding shares being placed in a Priva- tization Trust, with an irrevocable commitment to sell these shares at a later date to the private sector. Equity would be sold on the local market or to selected overseas airport investors. While the government was to be entitled to dividends at all times to the extent of its share ownership, its voting rights in the shares in the Trust were to be restricted to 30 percent, which would effectively give control of the expansion and the operation of the terminal to the private sector. The government also concluded that up front privatization would deny the state the opportunity to benefit from the potentially high capital gains anticipated once the expansion was completed. Since the government of Jamaica is not directly providing guarantees to the SIA development plan, the Overseas Pri- vate Investment Corporation, U.S. (OPIC) is guaranteeing the transfer and political risks associated with the Project's Senior Debt. The expansion plans were approved in 1993 and construction is slated to begin in 1996. Due to the relatively complex process of decisionmaking at Jamaica's Cabinet level and the legal and regulatory changes required to allow private participation in the sector, the project's completion has taken longer than expected. As of July 1995, the project has been on hold pending a recommendation from the Attorney General's Office that a vesting legislation is needed to give the government the necessary power to transfer the assets and functions of AAJ to SIA Ltd.3 The government is also considering the rehabilitation and expansion of Norman Manley International Airport (NMIA) at Kingston using the same project concept as in the SIA case (this project is currently being developed by the Airports Au-

' Flotation of the convertible bonds tranche in the domestic market has been postponed pending a decision on the Attorney General's Office recommendation.

194 Case Study 6 JAMAICA thority of Jamaica [AAJ]). The government has also accepted the principle of the privatization of four domestic aerodromes: Boscobel, Tinson Pen, Negril, and Ken Jones.

1. OWNERSHIP AND INSTITUTIONAL FRAMEWORK

The AAJ is an independent corporate body established in 1974, in accordance with the Airport Authority Act, under the supervision of the Ministry of Water and Transport. Its functions are to administer, control, and manage prescribed airports and to provide and maintain such services and facilities, other than navigational services, that are necessary for their efficient operations. The AAJ owns and operates the two international airports at Kingston (NMIA) and Montego Bay (SIA). It is also responsible for, but does not own the assets of, four domestic aerodromes: Tinson Pen, Negril, Boscobel, and Ken Jones. The AAJ is governed by a Board of Directors in which the Chair- man and all the members are appointed by the Minister. In practice the Board functions independently, with a mandate to operate as a viable business entity. The AAJ's current strategic plan has the following objectives: (1) the divestiture of airport terminal operations (landside); (2) the development of new economic regulation framework; (3) the strengthening of its planning and policy development capacities; and (4) the upgrade and modernization of airport related infrastructure (see Annex 6.1 for the organizational structure of the AAJ). The Civil Aviation Department (CAD) (see Figure 6.1, following page) is a division of the Ministry of Public Utilities and Transport in charge of two functions: (1) the provision of air navigation services (air traffic control, communications, meteorology, and search and rescue)4 and (2) the regulation of the civil aviation sector (e.g., air safety, licensing, airport operations), excluding economic regulation activities. The regulatory legislation for Jamaica's aviation sector is contained in the following three documents: the Airports Law of 1959, the Co- lonial Air Navigation Order of 1961, and the Civil Aviation Act

4 Air Traffic Control (ATC) functions as a department of the govermment. A decision was made in 1995 to merge ATC with AAJ. This decision was reversed in 1995 and ATC is to become a part of a proposed Civil Aviation Authority.

195 AIRPORT PRIVATIZATION EXPERIENCES

Figure 6.1 Jamaica: CAD Ministry of Water and Organizational Structure Transport

Director of Civil Aviation

rector DeputyDirector

L hDvigaonSen/ices J 92 e!ion(airopertlon)l

Source: Jamaica Transport Sector Study - Task 8, Teape-Johnston Associ- ates, November 1993.

of 1966. There are other departments/bodies within the Minis- try of Water and Transport that also carry out aviation-related functions in Jamaica: I Air TransportPolicy Committee: Its main responsibilities are to oversee air transport agreements (i.e., bilateral and Caricom) and their associated issues.

X Air TransportLicensing Board: Its responsibilities are to consider and approve requests for air transport licenses and permits as well as pricing issues related to passenger and cargo air transportation (this does not involve airport and air navigation charges). The CAD is not an independent body and does not have financial autonomy. It combines the function of the provision of a public service with the regulatory functions for air transportation. Both of these factors have contributed to the CAD's failure to develop a business/commercial culture and to thereby attain the desired level of economic efficiency in its operations. Given its dependency on central government budgeting, the CAD lacks adequate capital budget allocations and also lacks funding for infrastructure replacement and expansion. The CAD is not up to date in its equipment, technology, and manpower: equipment is

196 Case Study 6

JAMAICA in need of modernization and upgrading, and the organization needs considerable improvement if it is to fulfill its role in the aviation sector.5 Table 6.1 presents CAD annual aircraft operations statistics on movements and overflights for a five-year period.

Table 6.1 Movements Jamaica: Civil Aviation Department, Annual Norman Manley N.A. N.A. 12,470 N.A. 12,961 Aircraft Operations (Kingston) Statistics, 1989-93 Sangster (Number of Movements! i (Montego Bay) 33,642 36,653 36,701 37,991 44,595 Overflights) Overflights Kingston Right Informabon Region (FIR) 34,977 37,494 36,031 54,543 53,981 Source: Civil Aviation Department, September 1994.

11. REGULATORY FRAMEWORK

Given that the operations of both airports and air navigation services have traditionally been under government ownership, economic regulation procedures and methods have not been properly developed. Airport charges are presented by the AAJ to the Minister of Water and Transport for approval, and the same procedure is followed in the case of the CAD for air navigation charges. Under a technical assistance facility from the IDB, the Government of Jamaica is developing an economic regulatory agency for all utilities. The economic regulation of airport related charges is expected to fall within the jurisdiction of the new Office of Utilities and Regulation (OUR). Experts from the U.K. government are scheduled to assist the Govern- ment of Jamaica in the design and development of the new regulatory framework. 6

' From a US$50 million project (funded by IDB/Japanese Exim Bank) for the rehabilitation of Norman Manley airside facilities, US$15 million are earmarked to upgrade the CAD communication system.

6 The study is being financed as part of a US$50.0 million loan from the IDB/Japanese Eximn Bank for phase one of the airport rehabilitation and expansion at Norman Man- ley International. A British finn (Portland Group Ltd.) was retained by the Jamaican Government and conducted the preliminary institutionaUregulatory framework study.

197 AIRPORT PRIVATIZATION EXPERIENCES

Table 6.2 shows AAJ airside and landside charges for 1993/94.

Table 6.2 Jamaica: AAJ Airport (a)Airside Charges (US$) Charges, 1993/941 Landing Fee (per 1.000 Ib) 1.1592 1.6229 Terminal Fee (per arriving passenger) 4.00 5.60 (charged directly to the airlines) Secunty Fee (per arriving passenger) 0.70 1.05 (charged direcly to the airlines)

(b)Landside Charges (J$/m 2) Space Rental Offices 215.28 2.691.00

I Ticket Counter 215.28 2,691.00 Baggage (make-up) 53.82 538.20 Storage 53.82 968.80 Maintenance nil 968.80

'Original source inUS$. Source: Airports Authority of Jamaica, September 1994.

Air navigation charges were also increased recently (May 2, 1994) (see Table 6.3) and airlines have been complain- ing about the magnitude and the timing of the price adjustments (last increase was in 1989). In 1995, in part to remove the air traffic controllers from the Civil Service bargaining unit, the government decided to establish the CAA as a statutory body with financial and regulatory autonomy.7 The CAA was to be responsible for the technical regulation of both the privatized operations and the public facilities. Consideration was given to the corporatization of the air traffic controllers' services, but this was ruled out as an option at this stage.

' Air traffic controllers, though comparatively few in numbers, were able to bargain for higher levels of wage increases than the other public sector groups, and these increases often established a precedent for later negotiations.

198 Case Study 6

JAMAICA

Table 6.3 En R ChUi argeq0 . Jamaica: CAD Air Navigation Charges, (a) Prvate Flights 1994 - aircraft weighing 5.700 kg or less 12.00 - aircraft weighing more than 5,700 kg 24 00 (b) Commercial Flights - 5.700 kg or less 28.00 - more than 5.700 kg 48.00 Th,mlnal Charges (Motego .Buyan-dXts1on)i (a) Pnvate Flights - aircraft weighing 5,700 kg or less 12.00 aircraft weighing more than 5.700 kg 20.00 (b) Commercial Flights - 5,700 kg or less 30.00 - more than 5,700 kg 40.00 Source: CAD, September 1994.

Ill. AkAJ's FINANCIAL PERFORMANCE

The AAJ's March 31, 1993 audited financial statements reflect, as a percentage of total revenues, operating profits of 40 percent and 30 percent, respectively, for 1992 and 1993, and net profits of 22 percent and 13 percent, respectively, for the same period. The return on equity for the year ending March 31, 1993 was 21 percent. Table 6.4 (following page) highlights some of the main financial indicators of the AAJ during the fiscal period 1992/93. Security costs at Jamaican international airports are relatively high compared with world standards (21.5 percent of total airport operating costs in fiscal year 1993). This is due to the fact that in recent years both the FAA and the U.S. customs services have increased the security requirements for Jamaica in response to the growth in illegal drug and arms traffic. Safety and security practices have increased in Jamaican international airports in terms of procedures as well as technology. The ratio of airside to landside revenues is 70:30 percent, which is similar to that in most airports in developing countries. Once both airports in Jamaica are upgraded and modernized, a window of opportunity for increasing the landside revenues (concessions, rentals, etc.) will exist. SIA, with a relatively higher interna-

199 AIRPORT PRIVATIZATION EXPERIENCES

Table 6.4 Jamaica: Financial Airport Revenues 252,699.60 366,006.90 Indicators of AAJ, for the Entire System, 1992/93 Airport Operating Costs 149,023.90 254,470.90 (J$thousands) OpeahigProft

Aerodromes (net cost) 3,882.50 1,190.30 ! Head Office Expenses 15,625.00 46,146.20 Financial Costs 6,724.00 13,030.30 Provision - Doubtful Debts 28,083.50 12,518.80 Other Income-net 6,724.10 7,867.40 (financial and foreign gains)

IM Promi ?~ TotalAssets 418,754.40 667,344.60 Shareholders' Equity 196,483.10 243,000.90

Source: AAJ's audited financial statements, KPMG, July 27, 1994. Note: The equity base of AAJ is not properly reflected. Government advances through the Public Budget and repayment of AAJ Capital Debt are not adequately stated in AAJ books.

tional traffic volume than NMIA, reflects an operating profit of 44 percent, which is high when compared with developing country standards, although there may be some cost allocation procedures that will need to be revised (security costs are higher at NMIA than at SIA, etc.). Table 6.5 shows the economic performance of each international airport during the fiscal period 1992/ 93. Landing and terminal fees at Jamaica's international airports are relatively low by world standards, but when they are compared with those of the relevant airports in the Latin Ameri- can and Caribbean region, the situation changes somewhat. It is a common policy in countries that are developing a tourism market to offer competitive airport rates in order to attract airlines to their facilities. This was certainly the case in Jamaica. But given the need for airport upgrading and expansion (pre- cisely because of tourism development), airport charges could be expected to increase in the future. However, considering that recent increases in airport charges (Table 6.2) are not included in the aforementioned comparison, there appears to be

200 Case Study 6 JAMAICA

Table 6.5 Jamaica: Financial Indicators of AAJ, for Each Airport, 1992/93 (J$thousands) 1992 1993 Norman Manley Sangster Total Norman Manley Sangster Total Airport Revenues Landing fees 35,400.50 47,486.80 82,887.30 46,398.50 69,838.50 116,237.00 Terminal fees 31,705.50 52,799.70 84.505.20 45,003.10 76,369.40 121,372.50 Security fees 5,733.80 9,542.50 15,276.30 8,484.00 13,526.40 22,010.40

Total Airside 72,839.80 109,829.00 182,668.80 _999,885.60 159,734.30 259,619.90 Concessions 31,473.90 27,346.00 58,819.90 49,625.30 43,944.80 93,570.10 iSpace rentals 2,775.20 1,672.80 4,448.00 2,919.90 1,610.10 4,530.00 Utilines 2,931.60 2,038.30 4.969.90 2,934.70 1,847.40 4,782.10 Car parking 1,100.90 388.50 1,489.40 1,548.50 570.50 2,119.00 Miscellaneous 218.70 82.30 301.00 1,303.20 82.30 1,385.50 TotalLandside 38,500.30 31,527.90 70,028.20 58,331.60 48,055.10 106,386.70 Towa 11311v S h l >, _

Airport Expenses Administration 23,999.40 22.220.80 46,220.20 44,411.70 50,869.60 95,281.30 Security 22.372.90 16.415.30 38.788.20 30,491.80 24,093.70 54,585.50 Services 19,035.80 14,127.90 33,163.70 19,002.50 12,579.80 31,582.30 I Electricity n.a. n.a. n.a. 12.192.70 7.083.70 19,276.40 Airfield n.a. na. n.a. 8.611.90 5,563.90 14,175.80 Landscaping n.a. n.a. n.a. 4,656.00 2,174.40 6,830.40 Others 11,457.50 7,952.20 19,410.00 12,193.50 7,731.80 19,925.30 Depreciation 5.043.60 6,398.10 11,441.70n 5,714.50 7,099.40 12,813.90

Total aiAoBM -67A143 A4.% mi%uwmI_

Oper. Profit 29,430.60 74,242.60 103.673.20 20,942.60 90,593.10 111,535.70

I For average exchange rates, see Table 6.4. Source: AAJ's audited financial statements, KPMG, July 27, 1994. little room for further fees increases (from the point of view of the airport investors) if Jamaica is to keep a competitive edge. There is not measurable evidence of the impact of relatively high airport charges on tourism traffic flows in the Caribbean market, but we tend to believe that, all factors considered, landing and terminal fees will not play a major role in popular tour-

201 AIRPORT PRIVATIZATION EXPERIENCES

ist destinations.' This will be an important factor in considering the financing of the upgrading and expansion of Jamaica's international airports, particularly since the government is expect- ing the private sector to finance the projects. Airport Departure Tax in 1995 was set at a level of US$ 11 per passenger. The Government is contemplating the introduction of a passenger facility fee of US$ 5 in early 1996 as part of the revenue stream of airport terminal operating companies (privatization of landside operations). Airlines have expressed reservations about the adoption of a PFC charge. Table 6.6 is a comparison of actual landing and terminal fees for Latin American and Caribbean airports, calculated on the basis of standard aircraft equipment with average configurations. Table 6.6 Comparative Analysis of Landing and Terminal Fees in Latin America and the Caribbean, 1992 (US$)

DC-9 B-707 B-747 DC-9 B-707 B-747 Bahamas (Nassau) 85 282 586 200 400 900 Barbados 119 489 850 697 1.393 3,134 Brazil 235 778 1,686 550 1,100 2,475 Colombia 220 770 1,900 850 1,700 3.825 Cuba 158 522 1,131 250 500 1.125 Ecuador 260 690 1.460 1,250 2,500 5,625 US (Miami) 120 299 682 363 503 1,385 Pueto Rico 116 386 838 127 253 570 Guyana 163 543 1,179 67 133 299 SlfWtff ~~~11,WI. ,) 4..*. vl. Cayman Islands 222 705 1,512 482 964 2.169 Turks and Caicos 196 591 500 1,000 St. Lucia 105 351 709 370 741 1.667 Tnnidad-Tobago 134 443 961 288 575 1.294 Venezuela 135 447 969 366 732 1.637 kg 44.500 148,300 322.050 Seats 75 150 375 Load factor 66.670o 66.67% 60.00% Source: ICAO, 1992 airport and air navigation charges tables.

'We beLieve that in the case of Jamaica more important factors such as tourist safety and security and the real exchange rate will play a more significant role in the future traffic flows of fomgn tourism. Case Study 6

JAMAICA

IV. PRIVATIZATION PROCESS

A. Government Policy Guidelines on Airport Development

During 1993 the Ministry of Water and Transport prepared a nationwide transport sector review under a technical assistance program from the World Bank. The aviation sector studies were carried out by consulting companies from the United States and Jamaica (Wilbur Smith and Associates of the United States, and Teape-Johnston and Associates of Jamaica). The following are the principal Government of Jamaica policy guidelines as described in the Transport Sector Study: a Reduction of public sector involvement in the operation of airports and airlines *i Promotion of aviation infrastructure development through the use of private capital (debt and equity); creation of an adequate economic environment to encourage private sector investments in the sector In Provision of quality services with the appropriate standards of safety and security IN Strengthening of the role of the public sector as a regulator and policy planner of airport-related activities. The Government has taken the first steps in the implementation of its aviation policies. As of October 1, 1994, the Government of Jamaica privatized its national flag carrier, Air Jamaica, by divesting 75 % of its controlling interest to a local private group of investors led by the Sandals Group (one of Jamaica's largest tourism business consortia). Privatization plans for the domestic carrier (Transjamaica) are being carried out by the government's privatization agency (National Investment Bank of Jamaica). The privatization plan for Sangster Interna- tional Airport has been announced, and the new operating company (which is to be privatized later) has been incorporated. Similar privatization plans are being prepared by the AAJ for Norman Manley International Airport. As has been mentioned, the government is considering the corporatization of air navigation services (Civil Aviation Department) and the incorporation of the economic regulatory function into the proposed Office of Utilities and Regulation.

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______B. The Montego Bay Airport Case: The Privatization Process

Through the AAJ, the government has been working during the last four years on the expansion and privatization of the Mont- ego Bay Airport in order to meet the traffic requirements projected for the year 2000 and beyond. A feasibility study undertaken by the U.S. consulting firm Birk Hillman and Zippery analyzed two options: (1) building a new airport (the greenfield project), and (2) building a new passenger terminal on the existing facility (the integrated approach). The initial recommendation of the study was to proceed with the "greenfield project" option given the future limitations of the existing site. Further discussions within the government led to the conclusion that the integrated approach was a better solution from the point of view of cost effectiveness. A minor upgrade and rehabilitation of the existing terminal was made in early 1993, under a concessional terms credit facility from the EEC (US$10 million). Table 6.7 provides traffic statistics for the Montego Bay Airport from 1991 to early 1994.

Table 6.7 Jamaica: Traffic Total TransR Tons Movements' Statistics, Montego Bay : Airport, 1991-94 1991 1 1,665,813 242,653 6,022 33,383 1992 1,862,411 297,908 11.062 34,629 1993 . 1.973,358 300,962 18,008 40,891 199421 1,067,782 128,544 5,013 21,983

Fifty percent of the movements correspond to domestic commuter flights (i.e., Sangster, Tinson Pen, Negrl, Boscobel, and Ken Jones). 2 First semester. Source: AAJ, Airport Traffic Report, 1991-94. Given the new policy guidelines on the aviation sector, the government will privatize the existing airport terminal operations as well as the proposed project expansion. The funding requirements for the project expansion should come from private sources, and the government has expressed its reluctance to provide guarantees for the financing arrangements. The project consists of two phases: (1) the construction of a new passenger terminal (peak hour traffic designs for 2,450 emplanements and 2,700 deplanements), 9 and (2) the upgrading and rehabilitation

9Estimate mnual traffic equivaent to 2.5 milfion passengess.

204 Case Study 6 JAMAICA of the old passenger terminal and its integration into the new construction. The total estimated investment for the two phrases is US$104.0 million.

1. Creation of AAJ Holdings Ltd.

This company was established as a wholly owned subsidiary of the AAJ, created for the purpose of holding the government's equity participation in the proposed private airport operating enterprises (at Montego Bay and Kingston Airports). The government policy calls for a minority position (up to 30 percent of the equity) in each of the private airport operations.

2. BOO Privatization Scheme: Creation of Sang- ster InternationalAir Terminal Limited (SIA Ltd.)

SIA Ltd. was incorporated in 1993 as a wholly owned subsidiary of AAJ Holdings Ltd. SIA Ltd. was created to serve as the vehicle to build, own, and operate (the BOO scheme) the new terminal facilities at Sangster International Airport. Once the capital financing structure for the BOO scheme has been put in place, SIA Ltd. will have the following equity distribution: (1) at least 70 percent will be in the hands of the private sector; and (2) up to 30 percent will be owned by the government (through AAJ Holdings Ltd.). The articles of association of SIA Ltd. provide for a special share (the golden share concept) to be held by the government, conferring special rights to require the holder's consent on the following issues: * Changes in the limitation on each foreign investor's ownership (currently limited to 25 percent equity participation) * Disposal of the whole or the material part of the assets * Dissolution of the company * Decisions which impinge on the sovereign rights of the state.

205 AIRPORT PRIVATIZATION EXPERIENCES

3. Long-Term Lease

AAJ will transfer, via a 49-year lease arrangement, the operation of the existing passenger terminal facility and the landside facilities (car parking, duty free, ground handling, shops and restaurants, etc.) to SIALtd.10 The financial and operational terms of the lease arrangement are still being developed by the Gov- ernment . Through the use of this mechanism, SIA Ltd. will effectively have ownership and control over the integrated terminal facility.

4. Management Contract

The Government is also contemplating the granting of the management contract to SIA Ltd. for the operation of airside-related services provided under the present arrangements by AAJ (i.e., fire security, runways, taxiways, and aprons). AAJ will retain ownership of these facilities and will share the airside charges with SIA Ltd. Criteria for performance and for sharing charges are currently being developed by AAJ. With this arrangement in place, together with the BOO scheme and the long-term lease/ license, SIA Ltd. is expected to have full operational responsibility for the provision of all the airport-related services at Sang- ster International Airport (i.e., the wraparound mechanism).

5. Privatization Process

The government has decided to sell the shares of SIA Ltd. on a phased basis in order to maximize potential gains on its investments. Given Jamaica's capital market limitation and the government's financial objectives, shares will be sold by stages to the local investors. In the first stage a limited amount of shares, 10-15 percent of SIA's equity will be sold to the public via private placement and the rest will be subscribed in the following mode: K A block of shares (up to 30 percent of overall equity) will be subscribed by AAJ Holdings Ltd. on behalf of the Government of Jamaica.

10A 49-year lease of the land of the terminal facilities and related infrastructure, and an exclusive 49-year license to operate the integrated terminal complex will be given to SIA Ltd.

206 Case Study 6

JAMAICA in The remainder (100 percent minus the initial private placement and the government's holdings) will be transferred to a Privatization Trust. * During construction and after, as further equity is required, additional tranches will be sold from the Priva- tization Trust based on market conditions. The phased sale of equity will provide for greater governmental capital gains upon completion of the complex. Government will continue to retain 30 percent shareholding. The Privatization Trust will be held in a Jamaican financial institution (bidding for the selection of the Trustee has already taken place and the Bank of Nova Scotia, with operations in Jamaica, is expected to be appointed as the trustee). This institution will exercise the voting rights of such shares while they are in the Trust. Shares may be transferred (that is, sold) from the Trust only to private persons. A "Deed of Mandatory Priva- tization" has been included in the Trust documents and will grant the Trustee the necessary assurance to execute the sale of the shares to the private sector. In addition, the Trustee's powers will be entrenched in the articles of SIA Ltd. via a second special share which will allow a veto on any proposed modification that could slow or reverse the privatization mandate. The timing and financial mode in which sales of shares from the Trust will take place will be at the government's discretion and will depend on market conditions.

6. Airport Operators

SIA Ltd. will start operations in mid- 1996 on both the construction of the new passenger terminal and the operation of the existing facility. AAJ is currently holding discussions with foreign airport operators that have expressed an interest in invest- ing in the Sangster International Airport operations. The alternative being explored by AAJ with foreign airport operators (one of whom is to be a major investor) is for SIA Ltd. to retain for a given period the management advisory services of an international airport operator to assist it with efficiency improvement, establishment of operational standards and performance criteria, training of personnel, etc. This international airport operator could become the lead investor to take up to 25 percent of equity in the final analysis. Government has limited any one foreign investor to a maximum of 25% of SIA Ltd.'s equity.

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______C. The Montego Bay Airport Case: Capital Financing Structure

In 1992 the Government of Jamaica appointed Citibank as the financial adviser for the capital finance scheme for the Sangster International Airport expansion (estimated at US$104.0 million). The following government premises were given to Citibank in relation to the constraints of the financing strategy to be developed: (1) given that the government has decided to divest itself from airport operations, project financing should be primarily funded by the private sector; and (2) given the economic attractiveness of the project, the government would not be providing government guarantees or assurances of any kind of project financing. Citibank's proposal for the project financing is based on a three tranche structure, with financing to be raised both in the foreign and local capital markets. 1. Tranche (a) Financing from Extemal Markets (up to US$49.0 million)

Senior Debt, 12-year loan with a 2-year construction period, funded in U.S. dollars. OPIC has in principle agreed to provide an insurance coverage for the tranche amount." Risks insured under the Overseas Private Investment Corporation (OPIC) arrangements include the transfer (convertibility) risk, the expropriation risk, and the political violence risk. The estimated cost of the insurance based on OPIC published rates is between 135 and 195 basis points. Citibank is presently rating this tranche with an overseas rating agency in order to facilitate access to foreign investor markets (i.e., New York, Puerto Rico, and Lon- don). Citibank feels confident that with the OPIC insurance facility the rating for the transaction could be at least a triple B, and that they will have no problem raising part of the funding in the foreign capital markets. Additionally for this tranche, conversations with Exim Bank have been held for a long-term project financing facility, and some supplier's credit could also be available under the OPIC insurance umbrella. Citibank estimates the interest rates for this tranche to be 6 months LIBOR plus 400

l' Informal conversations held with Citibank and OPIC during September 1994 indicate that the insurance coverage was given to the project without a government counter- guarantee of any kind.

208 Case Study 6

JAMAICA basis points, depending on market conditions at the time of issuing. This facility will have a first priority lien on the net cash flows from the project.

2. Tranche (b, c, d) Financing from Local Markets Tranche (b) (up to US$ 20.0 million)-SubordinatedDebt Subordinated Debt, 13 year loan with a 2-year construction period, funded in hard currency or a local currency note indexed to U.S. dollars. The investors in this tranche will have a subordinated claim on the net cash flows from the project (a violation of the Senior Debt Coverage ratio will trigger a blockage of payments to the Subordinated Debt). Citibank estimates the interest rates for this tranche to be near LIBOR plus 500 basis points, depending on market conditions at the time of issuing. Citibank believes that most of this tranche will be privately placed in the local markets among investors related to the tourism industry (hotel owners and operators, financial institutions with tourism related assets, real estate developers). The size of this part of the tranche could be up to US$ 20.0 million.

Tranche (c) (up to US $ 15.0 million)-Convertible Bonds Convertible Debt, 13- year private placement of debt convertible to equity after the fifth year, funded in local currency. This facility will be used to finance the local component of the project. Interest on this facility would be cumulative over the first five years of the project (investors will not receive cash interest payments until the project's cash flow is sufficient to meet the coverage of the other facilities). Following the fifth year, investors will have the right to exchange their bonds (including the capitalized unpaid interest) for a given number of shares in SIA Ltd. or have the option to cash out. Because this instrument is providing both debt and an equity return, Citibank believes that it could be placed at below domestic market rates (e.g., 25 percent). The size of this tranche could be up to US$ 15.0 million. Tranche (d) (up to US$10 million) - Initial Equity An initial block of equity of 10% to 15% of the overall equity is to be offered at the time of placing the convertible bonds. A Lead Manager/Underwriter has been selected for the sale of the equity and the convertible bonds based on tender process. There

209 AIRPORT PRIVATIZATION EXPERIENCES

will be a separate equity issue extended to existing employees of Sangster since Employee Share Option Participation forms part of the Government's privatization policy.

3. Tranche (e) Government's Equity Participation (up to US$20.0 million)

This portion of the financing structure will be funded through the increase in domestic departure taxes (collected by AAJ but transferred to the central government) and the creation of a new Passenger Facility Charge (PFC) fee at the Sangster Interna- tional Airport, the airport development fee. Passenger departure taxes have been increased from J$200 to J$500 since May of 1994 (approximately US$ 14.0 equivalent at the present rate of exchange), of which the equivalent of US$5 per passenger is being paid to SIA Ltd. over the period of three years ending March 1997, at which time Government's cash equity of US$20 million will have been reached The new airport development fee has not yet been put into effect.12 Negotiations with the airlines are currently taking place and AAJ's officials estimate that the new charge will be put into effect in early 1996. At present traffic levels on Jamaican international airports, the government's equity portion on SIA Ltd. should be funded in less than two years.

4. Capital Finance Cost

Depending on the initial amount of equity to be raised in the aforementioned financing structure, the capital cost of the Sang- ster International Airport expansion could be simulated on future market conditions, and the bond rating assigned to the transaction (tranche a). Using Citibank interest rates assumptions and estimating the initial equity injection to be 35 percent of the total financing needs (25 percent Government of Jamaica + 10 percent private placements), average capital costs for the project could be approximately 8.75 percent on an annual basis.

12 The Vancouver Airport Authority is also partially financing its international airport expansion through the use of a Can$10 airport improvement passenger fee (January 1994).

210 Case Study 6 JAMAICA

D. The Montego Bay Airport Case: Project Feasibility Study

Table 6.8 contains a summary of the market projections used in the feasibility study for the Montego Bay Airport expansion (the integrated approach).

Table 6.8 Jamaica: Montego Bay Airport Feasibility Study- Market Projections

Enplanements Scheduled Intern. 633.112 693.096 982,500 1,395,100 1,891,300 2,444,500 Charter Intern. 178,142 258,822 260,900 360,500 477,900 606,400 Domestic 30.685 39.065 41.900 54.200 67.900 81.900 1. *W,' 84I as 'im ORNprnoo Movements Intemational 15,092 20,424 23,200 31,200 38,400 45,200 Domestic 15,299 20.467 17.600 19,400 21,200 22,200 *,&.g'f-t;. '., 4.2006.> 0| 3

Sources: (Historical) AAJ; (Projections) Aviation Planning Associates, Inc. During the first semester of 1994 the number of total enplanements (departing passengers) was 524,698, projecting a total of 1,060,000 enplanements for the year. These figures are 9 percent below the estimated projections for 1994 (i.e., 1,160,000). Assuming that the levels of traffic will tend to recover (as some initial indications appear to suggest) the same projected figures will be used for the feasibility study. The feasibility study used for purposes of illustrating this case was carried out in 1992 by Birk Hillman & Zippery in association with Aviation Planning Associates. At that time, the feasibility study was developed for the existing institutional arrangements for airport operation (in other words, for AAJ). No consideration was given to the proposed privatization process and the creation of a new operating company (SIA Ltd.) for the provision of airport-related services at Sangster International Airport. Therefore, the 1992 feasibility study has been adjusted to reflect the proposed institutional arrangements in the privatization process (leasing arrangements for the existing terminal facilities and the management contract for the airside facilities).

211 AIRPORT PRIVATIZATION EXPERIENCES

Estimated costs have been assigned to the proposed lease arrangement (discussed above), and the landing fees, 100 percent of which were allocated to the project's cash flow, have been reduced to 50 percent. (See Annex 6.2, pages 218 and 219, for details on the estimated cash flows of the project [1995-2010] and the assumptions used in the feasibility study.) The internal rate of return (after adjustments) for an investment of US$104.0 million is approximately 16.30 percent, which, when compared with the average cost of capital for the project (8.75 percent), provides an interesting financial return for the equity investors. The internal rate of return is heavily influenced by proposed increases in the passenger facility fees in the years 1999 and 2004. When this factor is discounted (i.e., considering as constant the existing departure tax of US$12), the internal rate of return is only 12.50 percent. The cash flow figures have a high component of fees and charges that are/will be subject to economic regulation and hence the need for a regulatory system which addresses investor confidence. The following fees and charges have a relatively high influence on the determination of the project's cash flows: (1) departure tax, (2) passenger fees, and (3) landing fees - particularly the portion of departure taxes allocated to SIA Ltd., which represents between 35 and 40 percent of the project revenues and is usually considered in most of the countries as a full government-related income.' 3 The allocation of this portion of the revenue to a private airport operator (SIA Ltd.) will have to be supported by a long-term legal agreement among the government, AAJ, and SIA Ltd. The issue of the subsidies required to maintain the operation of the domestic aerodromes in Jamaica has not yet been addressed by AAJ as regards the government's decision to privatize the two international airports.

3 1The departure tax is being made available to this projects to build government equity contribution. Once this is established all departure takes will be transferred to government's consolidated treasury funds.

212 Case Study 6

JAMAICA

E. The Kingston Airport Case: Project Concept1 4

Norman Manley International Airport is to be developed in three phases over the next five years. Phase one will involve government expenditure of approximately US$7.0 Million in 1995/96 to expand the customs hall by 16,000 sq. ft., installation of two additional baggage claim devices, upgrading of the arrival and departure areas and re-configuration of the transportation arrangements to improve traffic flow. Construction is expected to start in November 1995. The second phase consists of improvements mainly to the airside and will involve an expenditure of US$50 million to be financed as follows: US$28 million by the IDB, US$ 15 million by the Japanese Exim bank and the remainder by the Air- ports Authority of Jamaica. Major life-cycle rehabilitation of the runway and taxiway will be carried out. The refueling hy- drant system will be upgraded and the communication and air navigation systems will be modernized. The new Civil Aviation Authority, and the AAJ will effect these improvements on behalf of the Government. The financing negotiations are fairly well advanced and should be concluded by the end of the year, with construction scheduled to commence at the beginning of the second quarter of 1996. As part of phase two, Norman Manley landside facilities are to be prepared for privatization. This will involve divesting assets and functions of the terminal facilities to Norman Manley International Air Terminal Limited, preparing a feasibility study and development plan to significantly upgrade the landside to accommodate the forecasted traffic growth from 616,799 in 1995 to 863,411 million in 2005. It is estimated that the expansion will cost over US$50 million. AAJ is in the process of applying for United States Trade and Development Agency support funds to carry out the development plan and this is estimated to cost US$500,000. Government will be seeking joint venture partners, most likely via tender, to implement the privatization and expansion programme. Table 6.9 shows Norman Manley International Airport traffic projections.

14 Taken from "Capitalizing on New Project Development and Financing Opportunities in Jamaica," Conference at the Waldorf Astoria.

213 AIRPORT PRIVATIZATION EXPERIENCES

Phase three will cover the implementation of the expansion of Norman Manley Terminal and final arrangements for private investors to own and operate the new expanded facility.

Table 6.9 Jamaica: Norman ArRvals 662,000 650,000 720,000 850,000 1,000,000 Manley Intemational Airport, Actual and Departures 552,415 616,799 729,761 863,411 1,201,538 Projected Passenger Transit 114,000 114,000 184,000 243.000 327,000 Traffic, 1990-2010

Passengers per 99 100 105 110 115 Operation Source: Airports Authority of Jamaica

V. KEY ISSUES EMERGING FROM THE PRIVATIZATION ______EXPERIENCE

Given the present status of the project, it is at this point prema- ture to draw conclusions from the Montego Bay case experience. During the course of 1995 and 1996, when the capital finance funding will be raised and the project construction begins, we will be in a better position to analyze the case. Despite this fact, there are relevant issues concerning the privatization process and the capital finance scheme used in this case that need to be highlighted for future developments. These are discussed in this section. PrivatizationProcess. The design and use of a "Priva- tization Trust" with a deed of mandatory privatization to sell the shares of SIA Ltd. at a later date appears to be a creative mechanism for a deferred privatization action. This works well when the underlying reason for the deferred mechanism is the difficulty in selling the shares and/or assets, given the enterprise situation or the existing investment climate. In the Montego Bay Airport case, the reasons for the deferred mechanism are related to the government's profit maximization objectives. Al- though this could be a legitimate reason from the government's point of view, it could lead to the wrong decisions in the development of the project and therefore jeopardize the future profits of the enterprise. Projects of this nature require an experienced

214 Cae* Study S JAMAICA operator to carry out the role of strategic investor (or lead project sponsor). Given the relatively strong interests for private airport operations in emerging markets today, it appears that the government should have no major difficulties in tendering an equity participation with management control to experienced airport operators (British Airports Authority, A6roports de Paris, Lockheed Air Terminal, Aena, etc.). This strategy could enhance the present privatization and financing mechanism in several ways: It would provide additional assurance to institutional investors (a well-known airport operator is a guarantee for the materialization of future cash flows), and thus would make it easier to raise project financing in the local and international capital markets. It would increase the initial portion of equity based capital, thus lowering the average capital cost for the project. It would also reduce the amount of financing to be raised in the capital markets. :,Ji It would provide the project with the necessary technical and management skills in both the construction and the operational phase of the new terminal. Regardless of the current operational capabilities of AAJ's personnel, such a project could benefit from the experience of seasoned managers in the design, construction, and operation of airport facilities. CapitalFinance. The funding structure designed for the airport expansion is creative and relatively cost efficient for projects in developing countries. The use of a major U.S. government-supported insurance agency in a major tranche of the financing (tranche a), and the request for a bond credit rating for the transaction with a specialized British firm, are creative ways of accessing U.S. capital markets and lowering the potentially high interest rate costs. Given present conditions in Jamaica's financial markets, it seems unlikely that the tranche b long-term funding could be raised locally. However, some of the funding in this tranche could come from selective equity local investment (i.e., tourism-related investors), which would reduce the need for debt financing in the local or regional markets. If the placement of the tranche a financing is successful, it would definitively help the "comfort" level of local/regional

215 AIRPORT PRIVATIZATION EXPERIENCES

investors in tranche b. Subordinated long-term debt for a project in Jamaica without guarantees or insurance might not be a "paper" in high demand. 3 Economies of Scale and Thresholdfor FinancialRe- turns. Jamaica provides a good example of economies of scale at airports and of their "attractiveness" for private sector participation. Sangster International Airport, as the principal gateway for the tourism industry, has the necessary traffic volume and the expected cash flows to attract private sector investment in terms of both debt and equity. Norman Manley International Airport, with a lower volume of tourism traffic, does not have as interesting financial returns as Sangster, and therefore may be less attractive to private sector investors. However, Norman Manley is the airport of the nation's capital and is also its main airport, and in the near future both its airside (which is already being upgraded) and its terminal facilities will require expansion and modernization. The government will have to be more creative as regards the privatization mode to be applied to Nor- man Manley Airport, if it wishes to attract private sector capital to the project. Allocating a larger share of landing fees and passenger facility fees, or ear-marked airport development fees could help improve the financial performance of the airport's expansion project. The implicit traffic threshold for attractive financial returns in the Jamaican airport's case appears to be close to 2.5 million passengers per year (departing passengers + arriving passengers). However, the option that would maximize potential investment would be to package the two airports and privatize them as one operating unit. This would increase the potential returns from airport operations to both the private sector and government, and would be likely to attract a larger number of interested investors. The issues of granting exclusivity to a single operator could be addressed through competent economic regulation. For the relative size of its market, the Government of Jamaica will probably gain more from dealing with a single airport operator than with two independent operators, particularly since both Montego Bay and Kingston interlink closely in terms of their traffic type.

216 Case Study 6

JAMAICA

ANNEX 6.1 AIRPORTS AUTHORITY OF JAMAICA ORGANIZATIONAL STRUCTURE

Board oI Directois

Internal Piesideiil I Inspector of I Auditor J I Satety & Security

Vice-president i Vice-president Vice-president Commercial Finance Personnel

Vce President rVice President Eastem Region (Kingston) Western Region (Montego Bay)

Manager Manager Manager i Manager IEngineering| IEninerig &Man.& Main. [AirportI ipr Servicesevcs J|EgneiEngineering & MMain. n. jArptSrvcesJAirpoit Service

Manager Airport Manager Safety & Security Admin & Personnel Safety & Security

Duty ( Aerodrome Duty I Aerodrome Officer Manager Officer Manager

Communications ! Communications OffHicer Officer

Source: AAJ, Personnel Department.

217 AIRPORT PRIVATIZATION EXPERIENCES ANNEXES

ANNEX 6.2 SANGSTER INTERNATIONAL AIR TERMINAL LTD. AVAILABLE CASH FLOW (DEBT SERVICE, TAXES, AND PROFITS) Adjusted Projections

(thousands of constant US$)

i~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~g I Tota Ernplanemenis 1285 1.376 1.474 15.78 7.61 1 8!0 2.137 3.133 ldeparrnin passengers.I

Airside Revenues:

Lanf7ing Fees 4.134 4,395 4,673 4,968 5.283 5.617 7.341 9.144 Passenger Fees 5.595 5,995 6.423 6862 7.373 7.500 10.661 13.729 I Secunry Fe, 1 554 1.665 1.'84 1,912 2.048 2 195 2.962 3.814

Landside Revenues:

Space rentals 671 671 671 671 671 738 812 893 Ioncessi-ni 1093 1170 1 253 1,341 14317 153e 2.072 2,6633 Fuel 1,108 1468 1 539 1.600 1.671 1 746 2.056 2.325 Car Parking 6Z 66 71 76 81 102 131 ! Departure Tax 83 04 9.325 9.991 lu 705 14.747 15.8M0 26.061 39.662

Teial Re.enues 23.27I 2J.'755 26,398 28,,135 33311 35.621 52,067 72.361

Expenses:;

Airpon Overhead 3161 3 290 3.425 3.566 3,713 3.868 4,704 5,663 Airponr SL,rvices 2.212 2 300 2.332 2.488 2,587 2.691 3.2,74 3,983 Ma,nlenance 2.185 2.273 2,363 2.458 2,554 2.650 3,235 3,935 I Fire &Se.7uri7y 2.391 2.443 2.497 2 552 2,608 2 666 2.972 3,314

I Tot3 Erpensest 9919 10.306 10.677 110064 11462 11.875 14,185 16895 meserve br 464 495 520 563 664 712 1.041 1,447 Replacemenl

Aaildabfecashilo,% I2,038 r3.954 15.201 16.508 21.185 23r034 36841 54.019

Adjustments:

Land,ng Fees 2067 2197.5 2336.5 2484 2641.5 2808.5 3670.5 4572 Lease 1old ierminal; 840 840 840 840 B40 840 84e0 40

Atailabel Casn1,1j& 9901 10,976 12,024 13.184 i 7.703 19.335 32,330 48,607 (aher adluslfmenltl Source: Adjusted figures from the 1992 Birk Hillman Zippery Feasibility Study.

218 Case Study 6

JAMAICA

ANNEX 6.2 (CONCLUDED) SANGSTER INTERNATIONAL AIR TERMINAL LTD. AVAILABLE CASH FLOW (DEBT SERVICE, TAXES, AND PROFITS) Assumptions

1.Growth Rate of passenger traffic 6.5%/yearly average 2.Passenger Fee 4.50 US$ 3.Security Fee 125 US$ 4.Fuel Concession Fee 0 03 US$/gallon

5.Departure Tax: 1995-97 1997-99 1999-2005 2005-10 (US$) (USS) (US$) (US$) Gross 12.00 12.00 14 00 18.00 Govemment 7.00 12.00 14.00 18.00 Airport Operator, 5.00 a 0 0

6 Lease Payment for Existing Terminal Facilities Payment to AAJ based on book value of airport-related assets at December 31.1993 (J$464.232) 60°o of the value was assigned to the Montego Bay Airport Leasing fee was calculated at 100o

7.Landing Fees Fee sharing with AAJ tnrough the Management Contract was estimated to be 50°b of the total amount for this concept Until 1997. After 1997 the Airport Operator isallowed to assess apassenger fee of up to US$5.00 to replace loss of departure tax revenue. Source: Adjusted figures from the 1992 Birk Hillman Zippery Feasibility Study.

219 AIRPORT PRIVATIZATION EXPERIENCES ANNEXES

ANNEX 6.3 NORMAN MANLEY AIR TERMINAL LTD. AVAILABLE CASH FLOW (DEBT SERVICE, TAXES, AND PROFITS) Adjusted Projections

(thousands of constant US$)

Total Enplanements 56?7 60 643 68S 939 1.287 (dcepartng passengersi

Airside Revenues: Landing Fees 1.798 1.901 2.011 2.126 2.829 3.755 Passenger Fees 2.471 2.626 2.806 2990 4.108 5.638 Securr, Fee 686 732 779 831 1,141 1.566 Landside Revenues: Space renials 258 257 255 279 313 367 Concessions 482 513 547 582 798 1.094 FueI 589 612 636 661 792 955 Car Parking 27 29 31 33 39 54

DepariureTax 3.844 4097 5.613 5980 10.042 16.287

TbtalRa [Jnues 10,156 7C. 7o9 ?z2f9 13.482 20.062 29.714

Expmses:

Airpon Overhead 1,318 1.365 1,413 1.464 1.812 2.325 Airpori Servces 920 952 985 1.018 1,262 1.636 Mainlenarce 909 941 972 1.003 1,246 1.616 Fire&Security 961 977 993 1,009 1,145 1.361

Total Expenses 4.108 4.235 4,363 4.494 5.466 6,938

Reserve for 520 563 664 712 1,041 1,447 Replacement

Ava dable cash-flow 5.52Z 5,9?1 7.652 8,275 13.555 2f,329

Adjustments:

Landing Fees 899 951 1.005 1,063 1,414 1,877 Lease (old terminal) 560 560 560 560 5E0 560

Availale cash floa 4,0&6 4.460 6,086 6 652 11,581 18.891

(aler ad1usrrnenlts) Source: Adjusted figures from tne 1992 Birk Hiliman Zippery Feasibility Study.

220 Case Study 6

JAMAICA

ANNEX 6.3 (CONCLUDED) NORMAN MANLEY AIR TERMINAL LTD. AVAILABLE CASH FLOW (DEBT SERVICE, TAXES, AND PROFITS) Assumptions

1.Growth Rate of passenger traffic 6.50%/yearly average 2.Passenger Fee 4.50 US$ 3.Security Fee 1.25 US$ 4.Fuel Concession Fee 0.03 US$/gallon

5. Departure Tax: 1995-99 1999-2005 2005-10 (US$) (US$) (USS) Gross 12.00 14.00 18.00 Government 5.00 5.00 5.00 Airport Operator 7.00 9.00 13.00

6.Lease Payment for Old Terminal Facilities Payment to AAJ based on book value of airport related assets at December 31.1993 ,J$ 464,232) 40%o of the value was assigned to the Norman Manley (King- ston) Airport Leasing fee was calculated at 10%O

7. Landing Fees Fee sharng with AAJ through the Management Contract was estimated to be 50%o of the total amount for this concept

Source: Adjusted figures from the 1992 Birk Hillman Zippery Feasibility Study.

221 AIRPORT PRIVATIZATION EXPERIENCES

222 SPAIN

AIRPORTS IN SPAIN

A CASE STUDY IN THE EVOLUTION OF STATE OWNERSHIP IN THE AIRPORT SECTOR1

Airports play a significant role in Spain, given the importance of the tourism industry to the domestic economy (i.e., it is the largest employer and foreign exchange generator). Aeropuertos Espafioles y Navegaci6n A6rea (Aena) is a public entity created by National Law 4/1990 on June 29, 1990 with responsibility for the operation and administration of airports providing public service in Spain (about 40 airports) and for air navigational services. Aena, with some 10,000 employees, handled 89 million passengers and 414,000 tons of cargo in 1993 and generated US$63 million in profits before tax. Air transport in Spain will experience important changes in the near future because of the following factors: (1) the deregulation of the air transport industry in Europe; (2) the increased financial and political autonomy of local governments in Spain; and (3) competition from other means of transport (i.e., the high-speed rail system). To adapt to these changes and to maintain the pace of the investments needed to upgrade and modernize its air transport infrastructure, Aena will continue to become a more commercial, decentralized, and profit-driven institution. Financing through capital markets of new equity-based funds may lead into a partial privatization process. The strides

'Research for this case was conducted in September 1994.

223 AIRPORT PRIVATIZATION EXPERIENCES

Aena has made since its creation facilitate this process of corporate evolution. Aena provides one of the most interesting cases, in recent years, of airport ownership evolution and institutional framework changes. Lessons can be derived from this case that are applicable to developing economies.

1. OWNERSHIP AND INSTITUTIONAL FRAMEWORK

The provision of airport-related services and air navigation activities was the responsibility of the Air Force (i.e., the Air Min- istry) until 1977, the year that the democratic government took office. In 1977 airport and air navigation activities were transferred to the civil government. Airport-related services were placed with a newly created department (Organismo Aut6nomo de Aeropuertos [OAN]), directly under the Civil Aviation Au- thority (CAA) (Direcci6n General de Aviaci6n Civil). Air navigation services were placed within an independent department under the CAA. The CAA was created as a subsecretary of the Ministry of Public Works, Transport and Environment. On June 29, 1990, OAN, the Department of Air Navigation Services, and the Department of Air Transport Infrastructure (i.e., design and construction of airports) were merged into Aena, a public entity covered by Spanish public administrative law and under the tutorship of the Ministry of Public Works, Transport and Environ- ment. "Public entity" is a legal status through which a public service is semi-corporatized and given an autonomous status. A public entity's employees are ruled by the labor law applied to private citizens and not by the public service code (i.e., Ley de Carrera Admninistrativa). A public entity's patrimony is different from that of the state, and most of its administrative actions are ruled by private law. Its annual budget and external financing must be approved by the Council of Ministers and the price of the services it provides is considered a "public price"2 and is subject to government approval and regulation. The next step in the corporatization of a public service in Spanish law is the creation of a "public enterprise," which can be fully or partially owned by the state. A public enterprise does not need the approval of the Council of Ministers for its annual budget and ex-

2 A legal term for the price of a public service under Admninistrative Law in Spain.

224 Case Study 7 SPAIN temal financing, and its prices are considered "private prices" and are not subject to economic regulation. Aena is presently taking the necessary steps to complete this phase in the next few years. Aena is structured into two separate operating bodies (Unidad de Gesti6n Diferenciada [UGD]): the Airports Divi- Table 7.1 sion (Direcci6n General de Aeropuertos) and the Air Naviga- Spain: National Airport tion Services Division (Direcci6n General de Navigaci6n Afrea). System, Traffic Flows, The Airports Division is responsible for managing some 40 air- 2,1993,1994, and ports that provide public services in Spain. These airports are ( (ousandsof passen- subdivided, for Aena's own corporate planning, into the catego- g saper year) nes shown in Table 7.1.

National "hub" airports Madrid-Barajas 18,400 17,570 18,446 34,200 Barcelona-El Prat 10.330 9,998 10,647 18,200 Large tourist airports Palma de Mallorca 11.947 12,526 14,142 16,800 Gran Canaria 6,966 6.992 7,770 13,000 Tenerife- Sur 6,433 7,055 7.562 14.500 Malaga 4,944 4,906 5,545 9,300

Medium-size tourist airports Lanzarote 3,093 3.429 2,723 6,200 Ibiza 2,606 2.776 3,258 4,700 Fuerteventura 1,672 1.952 2,273 4,300 Alicante 2,842 2,923 3.525 4,300 Minorca 1,675 1,752 2,077 3,300

Regional airports Seville' 2,896 1,400 1,385 4,100 Valencia 1,756 1.645 1,605 3,400 Bilbac 1,449 1,315 1,426 2,700 Santiago 913 994 1,027 1,700

Other airports (about 25 minor airports) 6,475 6,446 8,315 11,200 Tot- 84I397 < .eji,L

The 50 percent decrease in traffic flows is due to the start-up of high-speed rail services between Madrid and Seville (April 1992). See Section IV of this case study. Sources: Aena, Strategic Plan 1994-1998, Divisi6n de Operaciones; Aena, Resumen de /a Distribuci6n del Trafico en los Aeropuertos Espanoles 1994 (see Annex 7.1 for additional traffic information).

225 AIRPORT PRIVATIZATION EXPERIENCES

The Air Navigation Services Division provides air traffic control services, telecommunications, and aeronautic information throughout the country, and also maintains air navigation equipment and installations. Spain is part of the Eurocontrol system,3 which acts as a compensatory mechanism for air navigation charges among member institutions (countries) in Eu- rope. In addition to the two independent operating units, Aena has the following administrative staff units at the corporate level: (1) Finance and Administration, (2) Human Resources, (3) Pro- curement, and (4) Corporate Planning (see Figure 7.1). As of August 25, 1995 the total work force consisted of 9,430 employees, divided as follows: Employees Percent * Staff Department 340 4 * Airports Division 6,434 68 • Air Navigation Division 2,656 28 The Airports Unit has its own organization with central staff administrative units, and with each airport reporting directly to the General Airport Director (see Annex 7.2). As of early 1994, airports were being given a greater degree of autonomy, in order to begin a decentralization process intended to

Figure 7.1 Spain: Organizatonal Stucture ot Aena

Finance/ Human !f P f Corporate I Administration Resources rocuremen Planning

Altortpeatiguast >L Air Navigation Services ,

Eurocontrol is a European body entrusted with the safety organization of air navigation in specified airways above Europe. Its objective is to achieve a common policy for standardizing air navigation regulations. Case Study 7 SPAIN lead to a more general regional corporatization. Each airport director is legally considered the authority in the region or area of influence. Currently, directors of national and large airports have financial autonomy for investment decisions of up to 100 million pesetas (about US$80 million) at each airport.

11. REGULATORY FRAMEWORK K __

The CAA is a division of the Ministry of Public Works, Trans- port and Environment and acts as the regulatory body for the aviation sector in Spain. It regulates both operational activities (licensing, aircraft certification, aerodrome and airfield inspection, accident investigation, etc.) and airport and air navigation charges and fees (economic regulation). The economic regulation system for airport-related activities is based on the application of Law 8/1989 on Taxes and Public Prices (Ley de Tasas y Precios Piiblicos), of April 13, 1989. Under this law, airport charges and fees directly charged to private persons on airport public domain premises 4 are considered "public prices," and are subject to economic regulation. Public prices in Spain are by definition established on the basis of full cost recovery. Airport charges and fees charged directly to the public under market conditions and not related to the airport public domain premises, are "private prices" and are not subject to economic regulation.5

A. Charges and Fees ______

Depending on the nature of the charge or fee, the Spanish airport case presents the following types of pricing/economic regulation: Taxes (Tax Regime). Charges and fees within the scope of "public prices" and subject to the approval of the Council of Ministers (previous consideration and en-

According to Aena officials, "public domain premises" is a concept that relates to those types of activities that take place solely because of the existence of the airport. Since airport premises are considered public domain, the pricing of the use of an airport's facilities is considered a "public price." Prices are set on a profit-driven basis.

227 AIRPORT PRIVATIZATION EXPERIENCES

dorsement by the CAA). These types of charges are considered "taxes" under the Spanish Public Laws, and thus part of central government revenues. However, a disposition in Law 4/1990 of the State Budget Program assigns the collection and use of this type of revenue to Aena. The only airport charges that are considered taxes are landing fees. a Public Prices. The remaining airport charges and fees considered public prices and subject only to the approval of the Ministry in charge of Aena's tutorship (previous consideration and endorsement by the CAA). Price setting in this case is more flexible and dynamic with regard to changes in the cost structure of the services provided. The prices considered under this classification are the remaining airside charges (i.e., aircraft parking, passenger fees, and termninal fees) and most of the landside charges (space rental for ticket counters, airline offices, catering services, ground handling services, shops and restaurants, warehousing and aircraft hangars, utilities supplies to concessionaires, etc.). Fe PrivatePrices. Charges and fees not subject to economic regulation. Approval of these charges rests with Aena's Board of Directors. Airport services in this category are: car parking, oil and gas concessions, public telephone and other communications concessions, banking services, and advertising and promotion. For the year 1994 the CAA approved a pricing policy for taxes and public prices based on 1993 prices plus a 3 percent adjustment (inflation in 1993 was 4.75 percent). This formula will adjust prices below the CPI, which is the medium-term strategy of the CAA for the Spanish airport-related charges (CPI minus 2 to 3 percent for the next five years). 6 In order to adapt economic regulatory policy to the dif- ferenttypes of Spanish airports handling different volumes (Aena operates 40 different facilities), the CAA has divided the system into four categories:

X Group A: Alicante, Barcelona, Grand Canary, Ibiza, Lanzarote, Madrid-Barajas, Malaga, Palma de Mallorca, and Tenerife-Sur

6 Aena's Strategic Plan, 1994-98.

228 Case Study 7 SPAIrN

Group B: Bilbao, Fuerteventura, Minorca, Seville, and Valencia a Group C: Almerfa, Asturias, Granada, Jerez, La Corunia, La Palma, Santiago, Vigo, and Zaragoza of Group D: Badajoz, C6rdoba, El Hierro, Gerona, Madrid- CV, Melilla, Murcia, Pamplona, Reus, Sabadell, Salamanca, San Bonet, San Sebastian, Santander, Valladolid, and Vitoria. Each Group has a different pricing level for the regulated airport charges and fees (landing fees, aircraft parking, and most of the space rental charges). Airports in Group A (large volume airports) will have relatively higher airport charges and a higher fee structure than airports in Group D (low volume airports). Under this pricing differentiation, the CAA is attempting to reflect, in airport charges and fees, the relative impact of fixed costs and the size of the investment for each airport. Table 7.2 compares landing fees by Group.

_ Table 7.2 Domestic 224.40 201.90 168.50 168.50 I Spain: NationaiAirport System, Comparison of EEC 264.00 235.15 196.00 196.00 Landing Fees by Group Non-EEC 300.00 270.00 224.40 224.40 (inUS$)

Base: DC-9 (44.5 tons)/less than 50 movements per month. Source: Decree 1268/1994 (Airport Landing Fees), Barcelona Airport fee structure. Landing fees are structured according to the volume of operations, in order to promote the use of the airport facilities by a given airline. Landing fees have a five-tier pricing system depending on the monthly average of the movements of a particular airline. This pricing mechanism could give airlines a discount of up to 35 percent on the landing fees of a particular operation once higher traffic volumes are reached (based on airlines with more than 200 monthly operations). This mechanism could, however, raise issues of price discrimination, particularly with respect to Iberia, given the nature of its ownership (it is state owned). Annex 7.3 provides additional information on the present structure of airside and landside charges for the airports operated by Aena. Air navigation charges are collected and administered through Eurocontrol. At present, Aena only charges overflight fees to airlines using their system. Air navigation approach

229 AIRPORT PRIVATIZATION EXPERIENCES

charges are not collected, and Aena officials estimate the potential revenues lost in 1994 to be close to 12,000 pesetas (approximately US$96 million). This is the primary reason why the air navigation division reflects losses (or cannot fully recover costs).7 Plans to implement approach charges are already under way, and Aena has estimated that revenue collection would begin by early 1995. The air navigation charge (overflight) is based on the following formula: Charge = T (service unit rate)* D (distance of the flight)* P (aircraft weight factor). The applicable service unit rates for Spanish airspace are: (1) ECU 52.14 for the Barcelona Flight Information Re- gion (FIR); (2) ECU 55.56 for the Canaries FIR; and (3) ECU 52.14 for the Madrid FIR.

B. Deregulation of Ground Handling Services

Until 1992, Iberia (the state-owned national flag carrier) had the exclusive right to supply ground handling services to most Spanish airports. In April 1992 Aena created a new system for the concessioning of these services. The new system divided the ground handling function into three groups of services - passenger, ramp, and cargo - eliminating the clause of exclusivity for any particular concessionaire. Passenger and ramp services are usually bid together by the same concessionaire, while cargo service is bid separately. Aena has a calendar for the application of this system, and by 1997 it plans to have at least two handling agents (three in most cases) in all of the relatively important airports (airports with more than 1 million passengers).' Under the new system, airlines are also allowed to do their own handling when it is available (American Airlines, for example, is planning to start

Income statements by cost center (division) were not available for disclosure. s On November 28, 1994 Iberia threatened to strike because of labor disputes stemming from the airline's restructuring plan. Ground handling services were an important component of the threat.

230 Case Study 7 SPAIN its own handling at Barajas Airport, Madrid in the near future). Airports in Grand Canary, Tenerife, and Barcelona are already operating under the new system (October 1994). Ground handling charges are considered "public prices" and as such are subject to economic regulation. Aena has established a "cap price mechanism" (a maximum reference price) for the services offered by the handling agents. Aena collects a 5 percent concession fee from the handling agents (this includes self- handling) on the equivalent invoicing at the maximum reference prices (without taking into consideration discounts or lower pricing policies). The pricing mechanism used by Aena in this type of concession preserves Aena's revenue stream but does not stimulate competitive pricing among handling agents. One of the greatest difficulties that Aena has encountered in implementing the new system has been opposition from Iberia's ground handling workers' union. The elimination of exclusivity rights means an initial reduction in Iberia workers' payroll at the airports. Although it could be argued that work force reduction will be partially compensated by the hiring of personnel by the new concessionaires, the labor conditions (sala- ries and social benefits) will probably not be as attractive. This is another example of how state ownership of flag carriers is slowing the pace of air transport deregulation in Europe. (The Iberia workers' opposition to the new system explains the slower pace of implementation of changes in the various airports in Spain.)

111. FINANCIAL PERFORMANCE

Aena's financial statements reflect a 10 percent profit average (before tax), as a percentage of revenues, for the period 1992- 93. Unlike labor costs of other European airport systems, Aena's labor costs represent a significant portion of total revenues (see Table 7.3) which may reflect the impact of burdensome Span-

ish labor laws as well as cost inefficiencies inherent in a central- _ _ ized operating system. Table 7.3 Spain: Comparison of Aena 45 Labor Costs, Aena and other European British Airports Authority 25 Systems (labor cost as Aeroports de Paris 32 % of total revenues)

231 AIRPORT PRIVATIZATION EXPERIENCES

Commercial revenues represent 35 percent of total airport revenues, indicating a potential area of revenue enhance- ment for Aena when compared with similar airport systems in Europe. Although the available information did not provide the independent financial performance of the operating units (airport and air navigation services), the Airports Division currently generates all the profits in the system. This situation is almost certain to change once Aena's Air Navigation Division begins charging for the approach facilities. The 10 largest airports are profit generators, while the rest of the system, given the centralized nature of operations, is implicitly subsidized. This major obstacle will have to be overcome in future decentralization (regionalization) of the Spanish national airport system. There is a perception among Aena's officials that a higher degree of accountability, and, therefore, economic efficiency, will be possible through increased decentralization of airport-related activities. Aena shows a very strong balance sheet for the period ending December 31, 1993. Total assets were US$4,557 million (85 percent fixed assets) and total liabilities (including provisions) amounted to US$632 million (see Annex 4). This situation provides Aena with a relatively high "leverage potential" that can be used for the 1994-98 investment program. To make efficient use of this "leverage potential," Aena will need a greater degree of financial autonomy. This will increase the need for Aena's corporate evolution into a "public enterprise" as a first step, and, in due course, to a "joint public-private enterprise" as a final step. Table 7.4 gives financial highlights for Aena for the period 1992-93. Most investment in airport upgrades and expansions has been financed by Aena through internal resources, with very limited use of external financing (this explains the strong debt:equity ratio). Healthy operating cash inflows from airport operations (between US$200 million and US$300 million per year) have made this possible in the past, providing Aena with a relatively large degree of autonomy in investment decisions. Figure 7.2 shows Aena's investment program for the period 1994-98. The airport investment program for the period 1994- 98 is estimated at 400,000 million pesetas (approximately US$3,200 million), and the investment program for air navigation services is estimated at 60,000 million pesetas (approximately US$480 million). Aena plans to finance a total of 175,000 million pesetas from external sources. The rest of the financing

232 Case Study 7 SPAIN

Table 7.4 No. of total passengers (millions) 84.40 83.62 Spain: Aena's Financial No of aircraft movements 875,805 869,499 Highlights, 1992-93 Tons (freight) 397,842 379,112 (US$000J' No. of aircraft overflights 1,393,393 1,259,100 Revenues Airport-related (airside activities) 349,056 390,704 Airport related (commercial activities) 196,176 218,096 Air navigation services 245,200 266,480 Total Operating Income 790,432 875,280 Expenses Labor costs 342.696 415,904 Operational costs 167,632 217,050 Net Operating Income 280,104 242.326 Depreciation 160,360 221,848 Net extraordinary expenses/ 38.800 (16,080) (gains, including changes in provisions) Net financial gains 32,864 26,656 Net Profit (b/tax) 113,808 63,214 Calculated at 125 pesetas per dollar. Sources: Aena, Annual Report, 1993-94; Audited financial statements, Coo- pers & Lybrand, June 1994. will come from internal sources and from private sector initiatives in the form of BOOT or similar schemes. Given AENA's ambitious expansion program and the duration of its corporate evolution, private sector participation is the only possible alternative for continuing the pace of Spain's air transport modernization. Airport and air navigation infrastructure has strategic relevance for Spain's economy in view of the importance of the tourism industry.9 The EEC has affected Spain's air transport industry, upgrading and modernizing it to Western European stan-

120 - Figure 7.2 100- Spain: Aena's Invest- ment Program, 1994-98 60 ' ;'%'';'8 .7'.524'[|>V1 f''(millionsr n of pesetas) 406 j 20- : i' 1994 1995 1996 1997 1998 - Air Navigation Airports

Twenty-one percent of total exports in 1992.

233 AIRPORT PRIVATIZATION EXPERIENCES

dards. A clear example is the investments made and/or under consideration for interconnecting the high-speed rail systems with Madrid, Seville, and Barcelona Airports. Aena's activities in the area of expansion into freight transport markets are discussed in Box 7.1.

Box 7.1 AENA'S EXPANSION INTO FREIGHT TRANSPORT MARKETS The forecast expansion of freight relative to passenger cargo (between 7 and 8 percent yearly as compared with a passenger growth of 4 to 5 percent yearly) prompted Aena and Aldeasa to institute a joint venture, the Madrid/Barajas Center for Air Cargo S.A.. with 80 percent Aena participation and 20 percent Aideasa involvement, in order to respond to the increased needs of Ihe dynamic air freight sector. The objective is to create the requisite facilities for the provision of technically modern. competitive, and quality-oriented service. Madrid/ Barajas already absorbs 70 percent of Spain's intemational air freight flows and one-third of total national air freight. In 1993 Maarid/Barajas handled 190,000 tons; the new Air Cargo Center allows tor handling more than 300 firms and projected volumes ot 250.000 tons by 1997. Four years later the air treight handled by Madrid/Barajas will reach 300,000 tons. Aena estimates that the completed facility could eventually handle more than 500.000 tons per year while substantially cutting down on handling time.

-W5 IV. PRIVATIZATION PROCESS

A. Corporate Evolution of Aena

In the near future Aena will probably evolve into a more decentralized organization, with greater private sector participation in operations and a stronger local government presence in ownership structure. The following forces will drive the changes in Aena's corporate structure. Local Government Autonomy. The years of democratic government in Spain have seen a considerable increase in the financial autonomy of local governments

234 Case Study 7 SPAIN

(comunidades auton6micas). Local governments are participating increasingly in the decisionmaking pro- cesses concerning their own finances. Presently, Aena has the discretion to decide where to invest the excess cash flow from operations regarding the upgrading and expansion of airports. The extent to which investment funds can be rationally allocated has created an awareness of distribution inequities at the local government level. This awareness, together with the need for greater participation in local business affairs, will spur the regionalization of airport-related activities. DeregulationofAirport Chargesand Fees. Aena's need for greater financial independence in order to react more swiftly to market changes will drive it toward public enterprise status. Under this status Aena's pricing will be considered "private prices" and thus will not be subject to economic regulation. This is of particular relevance for landside airport activities, where greater ver- satility and autonomy are required. Under public enterprise status, Aena will have more flexibility in incorpo- rating different institutions (local governments, private sector associations, financial entities, etc.) into its ownership structure, as well as in decentralizing ownership of airport infrastructure on a regional basis. Investment Plan (1994-2005). As has been mentioned, Aena's ambitious investment plan for airport and air navigation infrastructure over the next 10 years (estimated at 460,000 million pesetas for the 1994-98 period) will require more than conventional financing sources. In the coming years additional private sector participation through a BOOT or similar scheme will be seen in Spanish airports. To accommodate this private participation, the Spanish airport system will have to modernize its ownership structure to permit a more expedient decisionmaking process and increased integration for local communities. Competitionfrom the High-Speed Rail System. Local and regional competition from the TAV-Renfe (the high- speed rail system) (TAV: transporte de alta velocidad) in specific market locations (i.e., Seville and Barcelona) and market segments (the low end of the business market) will drive Aena to greater pricing flexibility and

235 AIRPORT PRIVATIZATION EXPERIENCES

increased decisionmaking at the regional level. (Box 7.2 describes the TAV's impact on Seville.) In some cases local governments may have to join efforts with both means of transportation for better coordination. During the first year of the TAV-Renfe operation, traffic flows at Seville Airport decreased by 50 percent, seriously affecting the airport's profitibility.10 The Madrid - Barcelona high-speed rail system is expected to start operations by mid-1999 (this market alone presently provides 30 percent of the passengers arriving and departing from Barcelona Airport).

Box 7.2 THE IMPACT OF HIGH-SPEED RAIL ON SEVILLE AIR TRANSPORT MARKETS'

The high-speed rail line between Madrid and Seville connects the downtown sections ot the cities in 2 hours and 20 minutes. Service is provided eight times a day, a frequency similar to that ot airlines. One-way fare prices are 8,400 pesetas for economy class and 11,800 for business class, as opposed to 12.500 pesetas for the equivalent airfare (economy class).2 The high-speed rail punctuality index is running at 96 percent (better than that of domestic airlines), and in a 1993 consumer survey the satisfaction index was 89 percent. Aena's Strate- gic Planning Department estimates that in a 10-year period 48 percent of the air transport market for this route will be served by TAV-Renfe and 52 percent by the airlines.

Data frorr 1994 For a more realistic comrpaison. the cost ot the cty airport transler would have to be added to mte airdare idepending on the means ot Iransportabon used, tfis cosi could be ber*een 500 and 2.500 peselas).

On the basis of discussions held with Aena officials, the probable evolution of air transport activities in Europe, and our own perceptions, it seems most likely that the restructuring and privatization rnodel to be used by the authorities could include the following features: n Conversion of Aena from a "public entity" to a "public enterprise" (i.e., corporatization).

' Not all of the decrease in traffic at Seville Airport is attributable to the TAV-Renfe competition. During 1992, Seville hosted the World Expo, which caused a distortion in the number of tourist passengers for that year.

236 Case Study 7 SPAIN

U Separation of air navigation activities from airport activities; air navigation activities would remain under the central government as a state-owned enterprise. * Creation of regional airport authorities as "public enterprises" with participation in the ownership by: (1) regional/local governments; (2) private sector organizations (chambers of commerce, trade associations, etc.); (3) Aena (as a kind of holding company); and (4) capital markets (equity). s Opening of airside (passenger terminal) and landside activities at airports to private sector participation through the use of BOOT or similar schemes. The model is similar conceptually to what has been the standard in some other countries. However, consideration should be given to the following issues in order to improve the transparency and accountability of the model. Participationof Aena in Regional Airport Authorities. If the airport should serve as a development instrument for a particular region, and if decentralization forms part of government strategy to improve performance, then transfer to regional airport authorities should be complete. Aena's status as a holding company could play a positive role until the proper regulatory framework and regional institutions are developed. m Strengthening of Regulatory Capacities. An independent regulatory body should be in place, together with the development of the restructuring and privatization model, in particular for those aspects dealing with economic regulation. Regulatory activities are undertaken today by the CAA and in some cases directly by Aena. The development of an independent regulatory body (independent from the central government's sphere), will provide the airport system with greater transparency and efficiency, particularly when the number of participants has increased owing to the restructuring and privatization of airport system functions.

237 AIRPORT PRIVATIZATION EXPERIENCES

B. Aena: Privatization Experiences

In recent years Aena has begun to experience some forms of private sector participation in the new developments in airports. As the need for investment in upgrading and expansion increased, Aena explored new sources of private capital finance through BOOT schemes. The following are two examples of private sector participation - in the airports of Palma de Mallorca and Barcelona (cargo terminal).

1. Palma de Mallorca

Palma de Mallorca Airport is an example of an airport with tre- mendous seasonal fluctuations in traffic volume. Airport administrators and facilities cope with over 2.0 million passengers during the peak season (July/August) while taking in only 0.3 million passengers during January. Palma de Mallorca Airport traffic flows are illustrated in Figure 7.3.

Figure 7.3

Spain: Palma de 2. Mallorca Seasonal ,- _ Passenger Traffic, 1994 i (millions of passengers) / /\

- D , .d /: g - >~~~b-

. ,

Source: Aena, 1994 Report, Palma de Mallorca Airport.

The Palma de Mallorca project consists of the construction of a new services terminal to include a hotel complex, and the expansion of the car parking area and commercial offices. Palma de Mallorca is the second largest airport in Spain in terms of traffic volume, given its importance as a tourist destination for Europe (13 million passengers in 1993). The new terminal is designed to provide the airport with a first class hotel and convention facilities, in order to expand Palma de Mallorca's

238 Case Study 7 SPAIN tourist offering to the international business sector. The total estimated cost of the project is 10,000 million pesetas (about US$80 million)," to be disbursed over a three-year construction period. The project design and plans, prepared by Aena, are outlined as follows. U PrivatizationConcept (BOOT). A 40-year land concession will be given to a selected developer (a joint venture company made up of a private promoter and Aena) that will build, own, and operate a service terminal at the Palma de Mallorca Airport under given technical (project design) and operational (concession agreement) specifications. At the end of the concession period, the existing assets (the service terminal) will be transferred to Aena at a symbolic cost. The prices at which the services (hotel, parking, and office rental) will be provided at the new terminal are considered private prices and thus are not subject to economic regulation. • PrivatizationProcess. An international public bidding process will be used to select a private promoter to develop and operate the service terminal. The selected private promoter will establish a joint venture association with Aena (the joint venture company) under predetermined bidding conditions. The joint venture company will develop, own, and operate the new service terminal. Aena's participation in the joint venture company could reach a maximum of 31 percent. Selection Criteria(Technical and Financial).Interested bidders were given, as part of the bidding material, the following information: (1) base design and construction project (the base project), prepared by Aena; (2) land concession conditions (base concession agreement); and (3) bylaws of the proposed joint venture company. Selection of the private promoter was based on both technical and financial criteria.12 Technical criteria included the following aspects of the the base project:

" Based on an average exchange rate of 125 pesetas to the U.S. dollar (September 1, 1994).

12 Financial criteria included the following items: 1. The investment commitments in the project development 2. The expected rate of return of the project 3. The added value of the civil works to be contracted out to third parties 4. The concession fees to be paid to Aena 5. The minimum concession period that the bidder was willing to consider for investment purposes.

239 AIRPORT PRIVATIZATION EXPERIENCES

ii A detailed description of the proposed base project, including changes and improvements to the original project .A The total estimated project costs (construction, equipment, furniture and decoration, service installations, permits and licenses, working capital, etc.)

J A market study (tourism market in Palma de Mallorca, pricing strategy for the services to be provided, operational cost structure of the different activities, cash flow projections, internal rate of return, etc.) The work plan (Gantt chart of the different project and construction activities up until the opening of the new service terminal)."3 • Bidding and Award Process. International bidding for this project took place in July 1993, at Aena's headquarters in Madrid. Participants included: (1) Dragados y Construcciones S.A.; and (2) a consortium composed of Levett & Bailey (British firm), Humiclima S.A. (Spanish firm), and Electrificaciones del Sur S.A. (Span- ish firm). The contract was awarded to Dragados y Construcciones, which teamed up with two companies from the opposing consortium (Levett & Bailey and Humiclima S.A.).

X Capital Finance Structure of the Joint Venture Com- pany. The project funding (based on an estimated US$80 million) has been structured in two phases. PhaseA: Initiationof Project. Initial shareholders' capital of 1,000 million pesetas (about US$8 million), to be subscribed by: (1) Aena, 31 percent (capitalization of base project-related expenses, 360 million pesetas); and (2) the private promoter (cash injection for the rest of the equity subscription).

L-A Phase B: Construction and Completion of Project.Capital increase of 2,000 million pesetas (about US$16 million), to be subscribed by

An evaluation matrix (weights and points) for the technical and financial proposal was not available at the time that this case was prepared.

240 Case Study 7 SPAIN

the two partners according to their initial shares (subscription to be paid in cash). Project finance of 7,000 million pesetas (about US$54 million), to be provided to the joint venture company by the private promoter through commercial bank lending. As of November 1994, this portion of the project finance had still to be raised. Although the Government of Spain is not providing any sort of guarantees, this type of project can make partial use of "Special EEC Funds" for infrastructure development.

2. Barcelona, El Prat de Llobregat

The Barcelona project consists of the construction of a new cargo terminal at the Barcelona Airport. During 1993 the management of the Barcelona Airport contracted with a European consulting firm (Molbay S.A.) for a feasibility study for the development of a new air cargo terminal at Barcelona. The study was completed in April 1994. The main recommendation pointed to a need for an adequate air cargo terminal, to enable the Barcelona Airport to compete with airports in southeastern France (Toulouse, Lyon, etc.) in the increasingly attractive European air cargo market. The feasibility study also indicated that the operation of a new air cargo terminal at the Barcelona Airport should be private, and that user prices should also be considered private, to allow for the flexibility needed to compete in this market. Aena authorized the management of the Barcelona Air- port to begin developing a BOOT project with majority private sector participation for the first phase of the new air cargo terminal (the estimated initial investment is 1,600 million pesetas or approximately US$12.8 million). The project is currently under development, and completion of the first phase is expected in early 1997. The management of Barcelona Airport has been developing its marketing approach for airport activities with a "private business vision." After the passenger terminal facility was expanded in 1992 (for the Summer Olympic Games), the airport management aggressively developed the airport's landside business potential. Commercial revenues have increased by 88 percent since 1992, and according to the airport's marketing director there is still a large percentage of potential revenue that is not being exploited. The Marketing Department at the Barcelona

241 AIRPORT PRIVATIZATION EXPERIENCES

Airport uses a two-tier approach in its product strategy. Airside business developments are marketed to airlines as primary customers, and most of the landside business developments are marketed to passengers (consumers). However, as has been mentioned by the marketing director, "Eighty percent of marketing effort is targeted to the airlines. We conduct market research, we develop marketing products, we create promotional programs, targeted to the increase in the number of commercial and charter airline flights into our airport. Once we have the flights, the consumers will come along."

V. KEY ISSUES EMERGING FROM THE SPANISH EXPERIENCE

2 Governments will need to (1) adapt rapidly to the roles of policymakers and regulators, and (2) give particular attention to laying the groundworkforderegulation. Public ownership of Iberia has slowed the pace of air transport sector deregulation in Spain. Iberia's ground handling workers' union partly obstructed the deregulation of ground handling services. This case study points up the importance of the linkages between the privatization of airport services and the national flag carrier. In addition, the structure of landing fees raises questions about price discrimination and conflicts of interest. Iberia, like Air France, which requested a US$5 billion capitalization, recently asked the European Commission for approval in increasing capital by US$1.5 billion, and it is foreseeable that further expansion could lead to ownership restructuring. Approval for equity issuance is becoming increasingly difficult to obtain because of a negative sentiment within the Commission regarding subsidies, particularly in this highly competitive industry in which 70 percent of airlines are private or have a controlling private sector partnership, and in which private sector involvement is expected to increase.14 The growing competition in the airlines market increases the pressure on the European Com-

14 In May 1995 the European Commission expressed "serious doubts" about the justi- fication for a US$1 billion capital injection into Iberia. The Commission wrote in the European Union's Official Journal: "Fresh evidence must be obtained from the Span- ish authorities to prove that the recovery program for Iberia would meet the criteria of a rational investor operating in a market economy."

242 Case Study 7 SPAIN mission to deny approval, and thereby creates an added incentive (freedom from budgetary strictures) for the remaining state- owned airlines to seek privatization. This implies a need for governments to adapt rapidly to their new roles as policymakers and regulators. Preparing for the deregulation of airport services should include the privatization of the national flag carrier."5 Full corporatization of airports will increase efficiency. If Aena is to become even more competitive and market driven it must continue to move toward full corporatization as a public enterprise. Currently, most airside and landside charges are subject to the approval of the Ministry of Public Works, Trans- port and Environment, which hinders Aena's ability to respond to market stimuli. Aena's status as a public entity constrains financial autonomy and restricts efficient use of its capital structure. Aena's corporate evolution into a public enterprise would provide increased price flexibility and would maximize "leverage potential." Price flexibility is particularly important to Spain's air transport sector since it would enable the country's airports to compete more effectively with Portuguese, French, and other European airports for the tourist dollar. Public enterprise status would increase private sector participation by creating a public corporation that, in effect, behaved like a private counterpart. A corporatized ownership structure would augment growth beyond the respectable results currently achieved by Aena by providing it with the necessary instruments to act in the corporate interest. The more rapid the move to the changed ownership structure is, the less the cost will be. Private capital markets can be a potentialsource of funds. In its present institutional state, characterized by private corporate governance, Aena has become increasingly competitive (10 percent earnings growth in the past three years). 16 Over the next few years Aena will face budgetary restrictions. An outgrowth of the need for increased private participation will be Aena's move toward public enterprise status. Airlines and the air transport sector will follow the same general pattern. The need for greater competitiveness, additional investment, and

" In 1994 the German Government, at the cabinet level, decided to privatize Lufthansa. It allowed the government stake in the airline to fall from 51.42 to 40 percent by forgo- ing rights to newly issued shares. The Lufthansa Chairman emphasized that the increased competitiveness deriving from privatization would enable the airline to restructure and to prepare for futther industrywide rationalization and competition.

16 It might have achieved even better results under a different corporate structure.

243 AIRPORT PRIVATIZATION EXPERIENCES

increased competition for public funds may result in the need for financing from capital markets (equity) - the first step in the evolution toward privatization.

X The airportdecentralization process should be adequately implemented. The country's current movement toward political decentralization, as it concerns local governments, holds important ramifications for the future of airports. The nature of air navigation services implies a need for centralized leader- ship, while airport services, both landside and airside, can be provided in a decentralized form. Therefore, airport services could be placed under the regulatory aegis of local authorities, which would make theiT own arrangements with the private sector, while air navigation services could continue to be provided by a central or regional body. However, since these services have the character of natural monopolies not driven by price competition, well-designed regulation and institutional capacity must be in place before any transfer takes place. While political decentralization provides an added incentive, in the form of political stimuli, for airport service deregulation, in cases where local regulatory/institutional capacities are underdeveloped, it is pref- erable to undertake privatization before decentralization regardless of short-term payoffs. Effcient operators become global operators.Aena's private corporate governance led it to internationalize its operations. The results include Aena's rapid expansion (through Aldeasa) into the Latin American and North African duty free markets, entry into the airport operator market niche, and an expanded presence in the international cargo rnarket. In Latin America, in particular, shaTed cultural, historical, and language traditions could aid Aena (as was the case with the state owned telecommunications enterprise, Telef6nica) in becoming the pre- eminent supplier of technical assistance, special airport management services, and investments. In operating like its private counterparts, Aena has become extremely profit driven and its involvement in international markets is projected to intensify. Aena's outward expansion, an outgrowth of its increased efficiency, points to the fact that in today's global economy the efficient operator views domestic and foreign markets with the same business eye.

E The challenge of high-speed rail points up the importance of air transport linkages with other transportmodes. The development of high-speed rail has had important consequences for traffic volumes between Seville and Madrid. Air-

244 Case Study 7 SPAIN port administrators must cooperate rather than compete with surface modes. At the same time, service delivery between railways and airlines must be coordinated. In the future, airlines will concentrate on carrying people and cargo over distances of at least 300 to 400 miles while leaving short hauls between major population centers to the railways. The implications for Span- ish airports are important, since most business air routes in Eu- rope are short and in the next century will be serviced by such trains as the French TGV or the Spanish TAV-Renfe. Expansion projects in Spain need to take into account the ramifications of expanding high-speed rail routes both in and outside of the country. With the challenge of high-speed rail, and a more competitive European air transport sector, Aena will need to become more market driven. The Spain case study illustrates the importance of providing linkages between different modes of transport in the planning of air transport sector policies and regulations.

245 AIRPORT PRIVATIZATION EXPERIENCES

ANNEX 7.1 COMPOSITION OF SPANISH AIRPORT TRAFFIC Table A 7.1.1: Passengers

;. - L S..L 3. Sa.Aj .. .* Commercial Domestic 36,257.262 37,598,802 40.99 3.70 International 45,152.213 51,931,050 56.62 15.01 Transh 1,707,582 1,952,993 2.13 14.37 Other 246.944 242.758 0.26 -1.70 83,364,001 91,725,603 100.00 10.031 Regular Domestic 30,546,682 33,108,002 36.09 8.38 International 15,506,863 18,012,071 19.64 16.16 1il. 48,053,545 51,120,093 55.73 11.00.- Charter Domeslic 5,710.580 4.490.780 4.90 -21.36 International 29,645.350 33.918,979 36 98 14.42 35,355.930 38,409,759 41.87 &.4:

Table A 7.1.2: Movements

: ...... J;. .* .*. Commercial Domestic 459.819 499,183 41.61 8.56 International 400.680 439.219 36 61 9.62 Other 279.689 261.400 21.79 -6.54 .Total 1,140,188 1,199.802 100.00 .&23.)- Regular Domestic 384.947 411,917 34.33 7.00 International 199.235 210.927 17.58 5.87 ..lbt£al' 584,182 622.84 51.91 .627 Charter Domestic 74.872 87,266 7.27 16.55 International 201.445 228.292 19.03 13.33 276,317 315,58 25.30. 1142,6 Passengers per plane 96 97 1.11

246 Case Study 7 SPAIN ANNEXES Table A 7.1.3: Freight and Mail

Freight(kg) Domeslic 188,800.390 194,762.817 46.91 3.16 International 190.311,642 220,393,538 53.09 15.81 Total 379.112,032 415,156,355 100.00 9.51 Mailtkg) Domestic 37,917.843 35,095.897 70.26 -7.44 International 15,910.352 14,854,717 29.74 -6.63 Total 53,828L195 49,950,614 100.00 -7.20

Table A 7.1.4: Monthly Peaks

Passengers 1993 maximum August 9.632.656 11.52 1993 minimum February 4.904.265 5.86 1994 maximum July 10,178,445 11 10 1.06 1994 minimum February 5.259,850 5 73 1.07 Airplanes 1993 maximum July 117 .587 10.27 1993 minimum February 75.556 6.60 1994 maximum July 120,658 10.06 1 03 1994 minimum February 79.186 6.60 1.05 Freight/all 1993 maximum December 41.867.292 9.64 1993 minimum August 31,396.537 7.23 1994 maximum December 44.899,361 9.65 1 07 1994 minimum January 32,811.797 7.05 1.05

247 AIRPORT PRIVATIZATION EXPERIENCES Table A 7.1.5: Seasonality

I. esB I. j'4 L*; I*I*

June-September 35,108,185 41.98 38,655,283 42.14 Apri, May, Oct., & Nov. 27,207,170 32.54 29,795,099 32.48 Rest of Year 21,306,291 25.48 23.275,221 25.37

June-September 443,557 38.76 461,055 38.43 Aprf, May. Oct., & Nov. 400,664 35.01 393,276 32.78 Rest of Year 300,211 26.23 345,471 28.79

June-September 137,066,870 31.57 151,865.217 32.65 April, May, Oct., & Nov. 148.499,955 34.21 158,881,142 34.16 Rest of Year 148,536,892 34.22 154,360,610 33.19

248 Case Study 7 SPAIN

ANNEXES Table A 7.1.6: Traffic by Airport Passengers Airport Aircraft Arrivals & Transit Total Freight Traffic Departures Units

Aait@ -~ t . < 24,086 2.863.932 51,288 2,915,220 4,514.236 2.909.074 Alm6rfa- . 5.244 513.336 12,550 525.886 406.003 517.396 Aasunas j, 5.558 455.675 6,201 461,876 370.647 459.381

Sada*z . .. 1,127 14.830 0 14,830 0 14.830 133 542 9.654.140 338,278 9.992,418 57.478,133 10.228,921 tao- , . 16523 1.291.926 23,783 1,315,709 3307540 1.325.001 175280 1.345 0 1.345 0 1,345 eFuedev ua 17,552 1 772.850 131,677 1,9041.527 2.910,465 1.801,955 ;kona ' >2.150 256 057 3,740 259.797 97,136 257.028 GranGanajia .69,403 6.763.602 215,880 6.979.482 33,676.274 7.100.365 4,229 325.520 10,704 336.224 221.290 327,733 EIefoHO 2.146 104.785 0 104.785 302.277 107.808

Ibin :. . . . 24.135 2.734.814 31.085 2,765,899 4.034.270 2.775.157 'Jerez 5048 280.797 5.488 286.285 299 750 283.794 LaOoRdA 3.531 272.902 0 272,902 279 498 275,697 LaPalrna 10,582 642.589 10,410 652.999 2.051.992 663.109 29.118 3 000 392 216,994 3.217.386 6.285.445 3.063,246 Mladrl4/Ba~as 186.706 17.342.157 208,096 17.550,253 194.802,508 19.290.182 Mdnd/uatro'Vwentos 237 393 0 393 0 393 Mata . , .45.277,4.869,038 29,239 4,898,327 5.885.607 4.927,944 MehlE: :- .- 6.488 223.416 0 223,416 569.244 229.108 M tp;ctt..,. 16.835 1.725.468 24,394 1,749.862 3.908,446 1.764.552 MviciaSnJavler . 2372 88.843 0 88,843 397.414 91.817 Pakadeakloral 92.679 12.429.486 84,356 12.513.842 13.840.697 12.567.893 .PamplOne 2.186 132.684 23 132.,707 73.666 133.421 794 103.136 2,71 9 105.855 0 103,136 Sabile . -. * . 78 132 0 132 0 132 '$alainpca . -'--- : 344 29 282 4 29,286 1.066 29.293 .SanSeolsau'y . 1.822 123.444 0 123,444 349.476 126.939 Santinder. 3,135 186.401 658 187.059 86,879 187270 Samniag 11 992 963.326 30,157 993.483 3288.000 996.206 Sev.a. 16950 1.334.198 63,106 1,397,304 3.534.408 1.369,542 TmerN te . 25,274 1 404,557 647 1.405,204 7.813.864 1.482,696 .faneri?o'&x -, . . ' 51.184 6.940.614 113,756 7,054.370 14,345.395 7.084,089 V~ila ' -- 23,111 1.577.872 56,052 1,633.924 5.454,100 1.632,413 2.749 148.717 8,105 156 822 65.286 149,370 %,gtVIgc~. -> ,. *4.880 375.587 469 376.056 868.726 384,274

Ni>'tdi 7' '4' '' 3,114 242.826 9.283 252,109 403220 246,858 8.078 218.356 18,649 237.005 7,289.074 291.247

249 AIRPORT PRIVATIZATION EXPERIENCES

ANNEX 7.2 ORGANIZATIONAL STRUCTURE OF AENA Figure A 7.2.1: UGD Airport Unit

Admilnistration &

TehncalSuppoj Poet&Wrks j s

Opealon8 Cmmrcial Services

Figure A 7.2.2: UGD Air Navigation Services Unit

Administration & 1

[Systems & Regional Ai

Instal5a0ions Navigation U

250 CssG Study 7

SPAIN

- ES ANNEX 7.3 SPANISH AIRPORT TARIFFS - AIRSIDE COSTS Table A 7.3.1: Landing Fees (Barcelona)

Aircraft Portion olt veight __U **.is (less than 10 MT) (10 - 100 MTt -) Monihiy Opcrations PtasiMT USS.MT Ptas,MT USSIMTi Domestic F69hts Less Than 50 566 4 53 649 519 ,L:. 51 to 100 517 4.14 592 4 7.1 ,i: 101 to 150 467 374 535 425 151 to 200 417 340 478 3 82 ,,2 Over 200 368 294 422 338 Intr-European UniGn Flights Less tilan 50 660 5.28 756 6 u5 51 to '00 602 4.82 690 5 52 101 tc. 150 545 4 36 624 4 99 151 Ic 200 487 3.90 558 4.1f .4F. Over 200 429 3.43 491 39i3 Noi-Europesn Union Flights Less tnan 57 i55 604 865 692 51oI 100 689 5 51 789 6.31 101t;o150 622 498 714 571 151 to 200 557 446 638 5-10 73 Over 2oo 491 3.39 562 45-0 .

Note: MT = metric ton. Table A 7.3.2: Parking Fees (Barcelona) (tariff is charged in exchange for airport parking zone use)

Aircraft Weight Pesatas Less than 10 metric tons 824 flat rate

10 - 100 metric tons 96 per metric Ion 0.,7 ce.&n ; r, Over 100 metric tons 106 per metric ton C1.85 r, e,nrtFC

251 AIRPORT PRIVATIZATION EXPERIENCES

Table A 7.3.3: Airport and Infrastructure Use Fee, per Passenger'

Destination Origin Peninsula Balearics Canaries Melilla

Peninsula 300 300 300 100 Balearics 300 100 300 100 Canaries 300 300 100 100 Melilla 100 100 100 E E.S.' Nations 798 798 798 798 Non-E.E.S. Nations 927 927 927 927

(n.- XhS - - - - 4 Peninsula 2 40 2.40 2.40 0.80 Balearics 2.40 0.80 2.40 0.80 Canaries 2.40 2.40 0.80 0.80 MelilIa 0.80 0.80 0.80 E.E.S. Nations 6.38 6.38 6.38 6.38 Non-E.E.S. Nations 7.41 7.41 7.41 7.41

1 This tariff is applicable to those who make use of airport terminal zones not accessible to visitors. Those persons who are not members of the airplane crew or are being transported as a result of a contract shall be held liable for this tariff. Passengers on a direct flight that makes a stop in a Spanish airport, but who remain on the plane, shall not be obligated to make this payment. How- ever, passengers undertaking a flight from a Spanish airport shall be held liable for payment independent of prior immediate stages that said flight may have undertaken and independent of the flights destination.

2 E.E.S. = European Economic Space. Table A 7.3.4: Use of Airport Finger Fee' Normal Tariff Reduced Tariff Service per Plane (Pesetas) (USS) (Pesetas) (USS) Firsthourorfraction 13,840 1.110.72 6,295 50.36 Every additional quaner hour 4.150 33.20 1.885 15.08 or fraction ' This involves the use of public domain airport space and the use of airport installations to facilitate the boarding and exiting of aircraft. The reduced tariff is applied between 22:00 and 7:00 local Spanish time. After the first three hours, the prior tariffs will be applied with an additional charge of 50 by 100.

252 Case Study 7 SPAIN ANNEXES ANNEX 7.4 FINANCIAL INFORMATION Table A 7.4.1: Aena Balance Sheet (as of December 31. 1993)

Pesetas USS Assets (million) (million) Fixed Assets 510.984 3,813.31 Intangible 9,352 69.79 R&D 3,796 28.33 Software Applicaiions 9,313 69.50 Depreciation (3.757) (28.04) Tangible 499,882 3,730.46 Land & Buildings 386.712 2,885.91 Technical Facilities and Machinery 87,577 653.56 Other Facilities and Macninery 58.612 437.40 Fixed Assets Under Construction 34,196 255.19 Other Fixed Assets 7,847 58.56 Depreciation (75,061) (560.161 Financial 1,750 13.06 Investments in Associated Companies 1,750 13.06

Current Assets 95.675 714.00 Inventories 3.964 29.58 Debtors 40.640 303.28 Trade Debtors 53.675 400.56 Associated Companies 435 3.62 Sundry Debtors 12 0.09 Personnel 108 0.81 Stale Bodies 7,960 59.40 Provisions (21.550t (160.82) Short-Term Investments 46,184 344.66 Short-Term Securities Poiffolio 45.900 342.54 Other Loans 199 1.49 Snori-Term Deposits andl Guarentees 85 0.63 Cash &Bankes 4.794 35.78

¶ US$1=134.0 Pesetas.

253 A nRT PRFvATIZATION EXPERIENCES

ANNEX 7.4 (concluded) FINANCIAL INFORMATION Table A 7.4.1: Aena Balance Sheet (as of December 31, 1993)

Pesetas USS ______(milliorl) (m illion) EqUitY ; 535,236 EqLII.yM 512,519 3,824.77 lclelEECrnin!1,s ,99O8,991 67.10 olaiulory Rsrs,n;s 13,726 102.43 Inflows to Disiribute In Various Exercises 1,939.. 14A7 Capitai 1,939 14.47 Provision for Long-term Contingencies and Expenses :' 17S2,; '1 - Provisions ftO; Acquired Personnel Commitments 2,632 19.64 Provisi,ns l:lr Taxe- 3,262 24.34 Provisions iQCrThir-.Parry Liabilities 11,432 85.31

Long-term Deart 26,214 195.63 Other Crec;:,s 11,214 83.69 Uncallec ,n-.e 0 ayrnertis Payable 0 0 Other rEb S 15,000 111 .94

Short-aria et:. 24,212 15OAt < Trade ?Edi;':r: 5.365 40.04 Other 2r^tioa:{O216 1.61 PuDiIc Es.I.S 2.037 15.20 Other J,:IS 14.871 110.98 Acc iLe':' KiY1.itJvSaiCnIS Payable 1,529 11 41 Sho,-Teirr Cij r&rae arind Deposil Held 194 1.45 Provision fr ShWt-term Contingencies and Expenses 11,M 875- _ _ ' _ . Is .

US$1=134.0 pesetas. Source: For all annexes the source is Aena.

254 Case Study 8 UNITED KINGDOM: BELFAST

AIRPORTS IN THE UNITED KINGDOM- BELFAST INTERNATIONAL AIRPORT

A CASE STUDY OF AIRPORT PRIVATIZATION THROUGH A MANAGEMENT-EMPLOYEE BUYOUT'

Belfast International Airport (BIA), Northern Ireland's principal airport, has been in operation for over 30 years. It is the only airport in Northern Ireland offering scheduled international flights and accounts for 78 percent of the Province's total air traffic. Given its location in politically sensitive Belfast, BIA security has always been in the forefront of government concerns. This issue made the divestiture of BIA's ownership (100 percent transfer to the private sector) a highly publicized event with nationalsecurity concerns acting to constrain the transfer's completion. 2 BIA's privatization illustrates the complexity of dealing with national security matters in a geopolitically sensitive context, and also highlights the government's creativity and determination to solve these problems in an adequate manner.

Research for this case was conducted in October 1994.

2 Initial plans for BIA's privatization began in 1986 (feasibility study), but it was not until 1990 that the government was able to take the decision to sell the facilitities.

255 AIRPORT PRIVATIZATION EXPERIENCES

A complex government ownership structure required simplifi- cation, airport security had to be assured, and the use of an air base by the Ministry of Defence had to be clarified in order to make the transaction possible. The BIA privatization process could become the blueprint for airport privatization in countries with similar security conditions and a highly-charged political context. Before privatization BIA was the only civilian airport in the United Kingdom owned by the central government. Most other sizable U.K. airports are publicly owned, albeit by local authorities, and are held via separate companies. In May 1993 the Department of the Environment for Northern Ireland (DOE[NI]) drafted legislation for the privatization of Northern Ireland Airports Limited (NIAL), the company operating BIA. (Northern Ireland Airports Order, 1993). A pre-qualification memorandum was sent to 200 potential candidates worldwide. Ten interested bidders were pre-qualified for the sale, of which four were short-listed (all of these included Northern Irish participation). The winning bid went to a management and employee buyout team (MEBO Co.) for a total of £47.9 million (approximately US$72 million), and the airport contract was awarded on July 20, 1994. The transaction was funded by Mer- cury Development Capital (MDC) and the Bank of Scotland.3 With the exception of a Special Share of £1, 100 percent of the share capital was transferred to the private sector. DOE(NI) retains ownership of the Special Share (the"golden share concept") in order to exercise power in particular instances related to matters of security and the public interest.

I. OWNERSHIP AND INSTITUTIONAL FRAMEWORK

Prior to the sale, BIA was owned by the central government through the Northern Ireland Transport Holding Company (NITHCo). The executive management team included 6 senior managers and 14 managers, most of whom were members of the management buyout team that purchased BIA. NIAL has approximately 260 full-time employees, with another 35 employees at the car parking facility. The airport also recruits tem-

"How to Sell an Airport," Airports International,October 1994.

256 Case Study 8 UNITED KINGDOM: BELFAST porary and part-time employees during the seasonal peaks, generally from May to September. Full-time employees and managers are grouped into the following departments: Managing Director's Office 3 Marketing and Sales 17 Financial 19 Airport Operations and Technical Services 103 Security and Safety 118 Sub-total 260 Car Parking Facility 4 35 Total 295 Given the location and strategic importance of BIA, security is a major concern. Consequently the airport runs its own airport constabulary which takes care of internal policing.5 Passenger search, luggage X-ray, and other security tasks are contracted out to Securicor plc (see Box 8.1, Section II, Regula- tory Framework, below).

A. Areas of Operation

In 1992, throughput at BIA consisted of 2.24 million passengers, 22,000 tons of cargo, and 6,400 tons of mail. The airport is the fourth largest in the United Kingdom in terms of domestic passenger numbers and the third largest in terms of freight tonnage excluding mail. A new terminal and apron were built in 1963 and the airport has since upgraded its facilities; major investments have improved runways and accommodated heavier passenger aircraft, refurbished retail and catering facilities, and upgraded freight handling and car parking facilities.

I Car parking employees are directly employed by NIAL's subsidiary, Aldergrove Carparks Limited. I The airport operator is required to maintain a police presence at the airport. This follows from the currently assessed level of terrorist threat. Since 1971, NIAL has been authorized to appoint its own constabulary who have the usual policing powers and carry out day-to-day policng functions for the airport property. This authority is continued in the 1993 Airports Order. (BIA Information Memorandum, Touche Ross, March 31, 1994)

257 AIRPORT PRIVATIZATION EXPERIENCES

1. Aircraft-relatedActivities

Aircraft-related activities include passenger services, cargo, test and training, military flights, and private charters. Domestic flights account for 78 percent of passenger throughput, reflecting the airport's significance as a link between Northern Ireland and the rest of the United Kingdom. Domestic passenger volume in 1992 was 1.73 million, compared with an international volume of 501,000 passengers. International passenger volume has grown 8.2 percent per annum over the last decade and grew 37 percent in 1992/93, following the adverse effects of the Gulf War and the recession in the United Kingdom. As opposed to domestic routes, the majority of international flights are char- tered; these flights account for 92 percent of total international passenger income. Moreover, BIA is Northern Ireland's main provider of international flights and the only airport in the region to offer scheduled international flights (Paris, Amsterdam, and New York destinations). In terms of cargo, BIA has one of the largest air cargo centers in the United Kingdom outside of London and also benefits from freedom from noise abatement constraints and unrestricted 24-hour freight operation.

2. Commercial Activities

Commercial activities include concessions, rental of terminal and cargo space, car parking, and related activities. Such activities have grown in importance in relation to BIA's total revenues, increasing from 10.5 percent of total revenues in 1984 to 24.4 percent in 1993. Concessions include retail services, in- flight catering and terminal catering, car rentals, and advertising. Rentals include terminal space and warehousing rented to airlines, handling agents, and freight forwarders. The other category includes the Business Centre, the Executive Jet Centre, and an interest in the Novotel Belfast International Airport Ho- tel, which opened in 1993. The Business Centre has never generated substantial revenues and alternative uses for the premises have been considered.

258 Case Study 8 UNITED KINGDOM: BELFAST

B. Competition

BIA directly competes with Belfast City Airport, on all domestic scheduled routes, for both business and leisure travelers. BIA's share of total passenger volume has declined as Belfast City Airport's share has increased (see Table 8.1). Nonethe- less, BIA accounts for more than three-quarters of the passenger throughput and practically all of the air freight volume. BIA's advantages over Belfast City include: (1) a much higher standard of facilities for both airlines and passengers; (2) the ability to handle aircraft of all types and sizes; (3) a greater capacity for passenger and freight volume; (4) more frequent services on the key Heathrow route; (5) 24-hour all-weather operation free from noise constraints; (6) extensive car parking facilities and easy access to the Province's road network; and (7) a greater range of international holiday destinations. Belfast City Airport's primary advantages include its convenient location close to the city center and the presence of low-cost operators offering a range of scheduled flights. The main disadvantages of Belfast City include the operating restrictions of noise constraints and the implications of heavy traffic volumes, which are such that substantial investment in infrastructure will be required.

jN Table 8.1 Passenger Volumes (000s) U.K.: Northern Ireland Airports, Passenger Beltast International 2.294 2,168 2.241 1 Volumes and Market Belfast City 548 537 612 Share City of Derry (formerly Eglinton) 41 37 28 Total Notherm Ireland Market 2.883 2,742 2Z881 Market Share (°J) Belfast International 79.6 79.1 77.8 Belfast City 19.0 19.6 21.2 City of Derry dtormerly Eglinton) 1.4 1.3 1.0 100.0 100.0 100.0 Source: Civil Aviation Authority (CM).

259 AIRPORT PRIVATIZATION EXPERIENCES

C. Asset Ownership

Before BIA's privatization, the land on which the airport operated was owned by its holding company (NYTHCo); yet, according to group policy, land assets were included in the financial statements of NIAL. Following BIA's privatization, all the land was leased to NIAL 2 (the privatized airport operating company) under a 999-year lease at a nominal rate. Follow- ing the buyout (led by three BIA managers), MEBO Co. holds 50 percent of the ordinary equity shares while institutional investors hold the remaining 50 percent, with the exception of the Special Share retained by the government. MDC, which provided the majority of institutional financing, has since sold a portion of its shares to four other financial institutions.

11. REGULATORY FRAMEWORK

The Civil Aviation Authority (CAA) regulates all airports in the United Kingdom. The CAA is an independent statutory body that issues operating licenses for airports and air routes, maintains safety standards within the air transport industry, addresses consumer concerns, and advises the government on civil aviation matters. Under the 1986 Airports Act, the CAA is also an economic regulator of airports in that it oversees trading practices and airport charges. CAA provisions for economic regulation do not apply to Northern Ireland. However, the Airports (Northern Ireland) Order of 1994 (see Annex 8.1), which became effective in April 1994 as part of the privatization process, provides for an administrative system equivalent to that of the 1986 Airports Act of the United Kingdom. BIA has not been "designated" as an airport that requires more stringent controls over pricing policy (i.e., economic regulation), as are Heath- row, Gatwick, Stansted, and Manchester Airports. Had Belfast City Airport, BIA's primary competitor, participated in the bidding and consequently purchased BIA, the government would probably have considered designating the airport and instituting some form of pricing controls. The Department of Transportation (DOT), through the National Aviation Security Programme, regulates security matters for all airlines and airports operating in the United King- dom. The Programme's realm in terms of enforcing standards

260 Case Study 8 UNITED KINGDOM: BELFAST and procedures is limited to civil aviation and applies mainly to a particular group of airports, including BIA, known as the "Re- stricted Zone." In addition, DOT's role involves setting mandates and making recommendations to circulars, as well as per- forming routine and ad hoc inspections, tests, and audits. DOT recently conducted a survey of security standards at BIA and as a result the airport is undergoing various required improvements. The security regulations enforced by DOT also apply to the newly privatized airport. The Aviation Security Act of 1982 and the Aviation and Maritime Security Act of 1990 provide DOT with such regulatory powers. The government has identified BIA as a "Key Point," or security sensitive site that requires particular protection against terrorism. Given this status, BIA is subject to security surveys by the Royal Ulster Constabulary. The Con- stabulary has completed a survey that sets the basis for counter- terrorist security standards at BIA and other Key Point airports (see Box 8.1).

SECURITY AND SAFETY AT BIA' Box 8.1 I. Current Framework

The principal security mechanisms that operate at BIA are as follows:

National Aviation Security Programme. Through the National Aviation Security Programme, the Department of Transportation (DOT) imposes security standards on all airlines and airports operating public transport operations in the United Kingdom. The scope of the standards and procedures is limited to civil aviation matters and. in the main, currently applies only within a specified area or areas of airports known as the -Restricted Zone' and to matters affecting Restricted Zones. The current standards and procedures required by DOT will continue to apply to NIAL 2.

Key Point Survey. Along with other security sensitive sites in the Province, the government has designated the airport as a Key Point. requiring particular protection against terrorism. As a result of this designation, the airport is subject to security surveys by the Royal Ulster Constabulary. The surveys establish security standards which extend to areas outside the Restricted Zone and complement the standards imposed by the National Aviation Security Programme.

BIA Information Memorandum. Touche Ross. March 31, 1994.

__ -- Continued..

261 AIRPORT PRIVATIZATION EXPERIENCES

Box 8.1 II. Post-privatization Security Controls (concluded} In view of BiA's strategic significance, a security regime will be created on privatization comprising the following:

The Special Share. DOE(NI) will own the Special Share. The primary purpose of this share will be to enable the government to exercise control over subsequent changes of ownership of the airport, to prevent a change of control of the airport without the government's prior consent. It will also give the government powers to assume day-to-day control of the airport in the event that NIAL 2 does not provide key operating facilities to the Ministry of Defence. as required pursuant to the Operating Agreement.

Leasehold Control. A 999-year lease will be granted to NIAL (and subsequently vested in NIAL 2 pursuant to the transfer scheme) in relation to most of the land at the airport. Under the provisions of the lease. the consent of the lessor will be required for assignment of the lease and, in the event of a breach of the obligation in the Operating Agreement to provide key operating facilities to the Ministry of Defence, the lessor (together with Ministry personnel) will have the right to enter the airport land.

Given the strategic importance of BIA (from a military and political point of view), a security regime was planned for post-privatization, consisting of (1) the Special Share and (2) Leasehold Control. The Special Share is held by DOE(NI) to maintain government control over subsequent changes of ownership. It also enables the government to assume control of the airport if the new company does not adhere to regulations (i.e., the obligation to provide facilities to the Ministry of Defence). Leasehold Control establishes a 999-year lease with DOE(NI) for the majority of the land at the airport. Under lease provisions, in the event of a breach of the obligation to provide facilities to the Ministry of Defence, the lessor and the Ministry of Defence are authorized to enter airport land. The passage of the necessary legislation for the sale of BIA was complicated by the need to use the "Order in Council" procedure, relating to the emergency situation affecting North- ern Ireland since 1973, arising from acts of terrorism (see An- nex 8.1). A noteworthy component of the sale and the required legislation was the role of the Ministry of Defence following privatization, as the Ministry has a major base next to the airport and frequently uses its facilities. Two years of negotiations between the Ministry and BIA were needed to affirm provisions of security, priority, and facilities as requested by the Ministry.

262 Case Study 8 UNITED KINGDOM: BELFAST

Annex 8.1 provides a summary of the major aspects of the Air- ports Order (the airport legislation used in the privatization of BIA, April 1994).

111. FINANCIAL PERFORMANACE

Total airport revenues reached £23 million (US$34.5 million) in 1993, an increase of 9.6 percent over the previous year. Air- craft-related activities generate the bulk of revenues (76 percent) for BIA. These revenue charges are based on the maximum takeoff weight of an aircraft and the number of passengers aboard. Aircraft- related revenues consist of the items shown in Table 8.2.

Table 8.2 Domestic flights 11.797 67.8 U.K., Belfast: NIAL Aircraft-related Rev- International flights 3.985 22.9 March Rev- Freight 836 4.8 Ministry ol Detence 653 3.8 Private charter 34 0.2 Test and training 17 0.1 Other 72 0.4 Total 17.394 1Xoo

£1=US$1.50 (March 1993). Source: NIAL, Annual Report, 1993.

Commercial activities have become considerably more important in generating revenues, and have increased from 10.5 percent of total revenues in 1984 to 24.4 percent in 1993. Con- cessions income makes up 37.4 percent of commercial revenue, rentals 34.1 percent, and other activities 28.5 percent, most of which includes car parking revenues. The breakdown of concession income is shown in Table 8.3.

263 AIRPORT PRIVATIZATION EXPERIENCES

Table 8.3 U.K, Belfast: NIAL Retail concessions 881 41.8 Concession-related Flight catering and bonded store 325 15.5 Income. 1992/9-3 Terminale,na cateringcaeig283 231. 13.5 Care hire 251 11.9 Advertising 154 7.3 Other 212 10.0 Total e.i - , w .

Source: NIAL, Annual Report, 1993.

In terms of domestic and international destinations, the passenger numbers and corresponding revenues are specified in Table 8.4. The range of routes and operators often changes from Table 8.4 U.K., Belfast: NIAL Passenger Traffic and Revenues by Destina- tion, 1992/93

As % of Passenger Total Domestic/Int'l. Nu'mbers Revenue Flight Revenues g . ,~~~~ ~ ~~OOOsl)(f0001' Domestic |

London Heathtow 1,191 8,050- .:i.;:. ;** * k Luton 147 887 7.5 Manchester 128 821 7.0 Birmingham 107 796 6.7 East Midlands 67 419 3.6 Glasgow 63 348 3.0 Jersey 21 132 1.1 Leeds/Bradford 8 59 0.5 Other INole) 15 285 2.4

Total 1,747 11.797 ' ,s .;*k. International Paris 24 115 2.9 Arnsterdam 23 190 4.8 Charter 454 3,680 92.3

Total 501 3,985 - £1=US$1.50 (March 1993). Note: The disproportionate revenues generated by these passengers result from the charging basis whereby, on intemational charters arriving via another U.K. airport, the passengers are counted as international passengers but the flight and associated revenues are dassified as domestic. Source: NIAL, Annual Report, 1993.

264 Case Study 8 UNITED KINGDOM: BELFAST year to year - some being discontinued and others being added. Roughly 50 operators serve BIA, 8 of which generate 94.4 percent of aircraft revenues. The bulk of the revenue comes from British Airways (35.2 percent) and British Midlands (33.8 percent), reflecting the significance of the London Heathrow route.

A. Revenues and Profits

BIA has achieved an average compound turnover growth rate of 13.5 percent per annum, marking 10 consecutive years of turnover growth since 1983/84. This revenue growth was maintained despite the recession in the United Kingdom and growing competition from Belfast City Airport. As previously mentioned, the proportion of commercial activities revenues has grown from 10.5 percent of the total to 24.4 percent. BIA has also been consistently profitable over this period, with an average compound growth in operating profit of 16.5 percent before interest and taxes. However, from 1989 to 1992 profits before interest and taxes declined. Reasons for this decline included the impacts of the U.K. recession and the Gulf War on air travel as well as increased capital expenditures totaling £17.7 million. The management team introduced measures to reverse the declining profitability and increase efficiency, notably by making significant cutbacks in the labor force, which reduced the number of employees from 384 in 1992 to 295 in 1994 (a 23 percent reduction). Given such measures and the growth in revenues, the 1992/93 operating profit increased by 71 percent to £4.5 million. Owing to higher passenger volumes during the summer a greater proportion of BIA's revenues is generated in the period from April to September. In 1992/93, 58 percent of revenues was generated during this period. Costs, however, are less seasonal than income. While labor costs are generally higher during the seasonal peak (as additional staff are recruited), higher fuel and power costs in the winter offset labor costs in the peak season. In 1992/93, 49.8 percent of total costs were incurred during the peak season. A large degree of costs, notably depreciation and air traffic control (ATC), contains a fixed element. The results for 1992/93, before interest and taxes, are summarized in Table 8.5.

265 AIRPORT PRIVATIZATION EXPERIENCES

Table 8.5 U.K., Belfast: BIA Profit I Revenue and Loss Account, I Excluding Exceptional Aircraft operations? 16.041 17,394 Items, Net Interest Concession3 2,621 2,107 Receivable, and Rental 1,847 1,917 Taxation for the Two Years Ended March 31 Olmer3 502 1,605 1 (000) Total re venue - 2 Costs

Staff costs 7,695 7,803 Net depreciation 1.611 1,570 Rates 1,691 1,432 Air traffic control 3,237 3.398 Securicor 1,231 1,200 Other 2,926 3,140

Total costs: Operating profi 4 2,620 4,480

£1= US$1.77 (March 1992) and US$1.50 (March 1993). 2 The increase inaviation revenue isprimarily aresult of substantially increased intemational flight revenues, up 41 percent, intine with a37 percent increase inpassenger numbers. I The fall inconcession revenue isdue to the transfer of car parking faciliies from aconces- sionaire basis to a subsidiary company as of April 1,1992. The income generated by the car parks isnow included inother revenue. 4Operating profits are before exceptional items, which in1992/93 totaled US$3.8 million (comprising US$2.6 million owing to the write-off of design costs of an aborted check-in development). Source: NIAL, Annual Report, 1993.

B. Assets and Liabilities

The consolidated balance sheet for the 1992/93 period and the unaudited situation as of September 1993 are shown in Table 8.6.

266 Case Study B UNITED KINGDOM: BELFAST

3193/1993 IS 31 Table 8.6 (audited) U.K., Belfast: BIA Consolidated Balance Fixed assetS2 40,852 40.684 Sheets, 1992/93 Net current assets3 9.503 13,329 (£OOO)1 Total assets less current liabilities 50.355 54.193 Deferred income and taxese 19,198 19,747 Nt asset- 31,157 3446

1 El=US$1.50 (March 1993). 2 Fixed assets consist primarily of land, airport buildings, and runways and taxiways. Net current assets in1993 include US$15.2 million of cash. 4Deferred income refers to govemment grants with respect to fixed asset expenditure which is deferred and released to the profit and loss account over the expected useful lives of the related assets. Source: NIAL, Annual Report, 1993.

'With the exception of certain property assets (which are subject to a lease) and of cash, all assets and liabilities were transferred upon privatization to NIAL 2. However, there are some specific changes which will be reflected in the new balance sheet, as well as additional changes or revaluations that management may effect. Such changes include the impact of the deal's financing structure (for example., new loans of £19.5 million and a revised capital structure) and the change resulting from the removal of £15.15 million from NIAL's cash to fund the transaction costs.

C. Capital Expenditures

NIAL has invested steadily over the past decade, modernizing and upgrading BIA facilities to meet international standards. The airport has received grants from both the European Regional Development Fund (ERDF) and the U.K. Government for a range of projects. Investments between 1983 and 1993 included:

Xi Construction of the international pier in 1983 s Expansion of the car parking capacity to 3,800 spaces in 1987 East Terminal Extension, costing over £6 million in 1989/90 Construction of the cargo area, costing about £7 million, completed in 1991

267 AIRPORT PRIVATIZATION EXPERIENCES

* Several terminal refurbishment projects beginning in 1993.

WA -4- IV. PRIVATIZATION PROCESS

_ t A. Background

Privatization of BIA was first considered in 1986, when the government conducted a feasibility study to analyze the possibility of selling the entire Belfast public transport infrastructure. Not until 1990 did the government decide to sell BIA. The government's main objectives were to maximize sale proceeds, maintain service and security standards, and retain a large degree of Northern Irish interest. DOE(NI), in cooperation with the Treasury and Department of Finance and Personnel, was responsible for the sale. The first obstacle was enacting legislation for the sale, which took over two years. Because of the state of emergency existing in Northern Ireland since 1973, the "Order in Council" procedure was required; such legislation is not required for other U.K. airport privatizations. In May 1993, DOE(NI) drafted legislation for the privatization of NLAL (the company operating BIA), calling for the formation of a new company, NLAL 2, which would retain all the assets and liabilities of the former company with the exception of a Special Share of £1. DOE(NI) would retain ownership of the Special Share in order to exercise power in security related affairs. In addition, the land used by BIA for operational purposes, largely owned by NIAL's holding company, NlTHCo, was intended either to be vested in NIAL 2 with freehold title or to be leased under a 999-year lease at a nominal rent. As it turned out, following privatization all land was leased to NIAL 2 under a 999-year lease, and remaining assets and liabilities (with the exception of £15.5 million in cash reserves and the Special Share) were transferred to NIAL 2. While the sale legislation was debated in Parliament, the firm Touche Ross was appointed by the govemment as lead advisers to the privatization and the firm Denton Hall was appointed as its solicitors to arrange for the sale. First, a consensus was reached as to (1) using privatization via trade sale rather than flotation (it was felt at the time that the level of NIAL's

268 Case Study 8 UNITED KINGDOM: BELFAST

total profits was relatively low for a flotation scheme), and (2) selling the airport as a whole rather than selling non-core assets or land for development separately. Next, Touche Ross proceeded with the valuation of BIA. Valuation was determined by analyzing the earnings stream and by identifying comparable company sales. Since East Midlands Airport was the only direct U.K. comparison, Touche Ross also linked the privatizations of Toronto Terminal 3 and Vienna Airport. To prepare NIAL for privatization, Touche Ross conducted an operational and financial review of the company. In addition, a steering committee comprised of representatives of DOE(NI), the Trea- sury, Touche Ross, and Denton Hall served as a transitional watchdog and a catalyst to advance privatization initiatives. In mid-1992, BIA management contacted Price Waterhouse, appointing the firm as lead adviser in August 1993. Price Water- house first decided to form a management-employee buyout team as opposed to a management buyout, in order to bring airport employees into the buyout and gain their support. Price Water- house then helped management devise a business plan to gain financial backing for a MEBO scheme to participate in BIA's privatization.

B. Bidding Process

The entire privatization process from issue of the Pre-qualification Memorandum to sale completion took about nine months. The Pre-qualification Memorandum was sent to 200 international companies, including potentially interested parties as well as the obvious U.K. prospects. No organization was prohibited from participating in the process. Short Brothers plc, the owners of Belfast City Airport, declined to participate in the bidding for BIA and issued a public statement to that effect. Ten interested bidders, including non-U.K. companies, were pre-qualified for the sale, of which four were short-listed. All four candidates had Northern Irish representation. The timetable for the sale of the airport was planned as follows: - Issue of Pre-qualification November 1993 Memorandum * Submission of pre-qualification December 1, 1993 applications

269 AIRPORT PRIVATIZATION EXPERIENCES

F Assessment and screening of applicants December 1993- January 1, 1994 0 Issue of Information Memorandum to February 1994 pre-qualified prospective bidders k Visits to BIA (airport facilities) April 2 - 22, 1994 * Deadline for submitting tenders May 6,1994 Notification to short-listed tenderers By May 20, 1994 * Data room and management May 23 - June17, 1994 presentations IN Target date for exchange of contracts July 8, 1994. The sale completion took place as soon as was practi- cable after the exchange of contracts, on July 20, 1994, on which date the sale was announced. Table 8.7 shows the participants in the bidding process.

Table 8.7 _ _ U.K., Belfast: BIA !, Management: Employee Management/Employee Pnvatizafton Process -- Buyout Team (MEBO!.? Buyout Team (MEBO) Co. Pivate Sector Participa- 2. Legal & GeneraV tion in Sabe Nash Sells 3. TBF Thompson/ Northern Bank 4. Ulster Investment Bank/3i

All four bids were close in range. The MEBO Co. bid of £47.9 million (US$72.0 million) was the highest; the MEBO team did not have previous access to the bids of the other three companies. The three other bidders were consortia led by Legal & General and Nash Sells; TBF Thompson and the Northern Bank; and the Ulster Investment Bank and 3i. The first two of these bidding teams were backed by high-profile chairmen of two local development agencies.

mm 1 96 MA C. Financing

As a result of the privatization process, MEBO Co. acquired the entire share capital of NIAL 2 (later transformed into Belfast International Airport Limited), with the exception of the Spe- cial Rights share held by DOE(NI) for a total price of £47.9 million. The offering price included £32.75 million (equivalent to US$49 million) from MEBO Co.'s cash funds and £15.15 million (equivalent to US$23 million) from NIAL's cash reserves

270 Case Study 8 UNITED KINGDOM: BELFAST

(cash out debenture)..6 MEBO Co.'s cash funds were financed by the London-based MDC and the Bank of Scotland. The Bank of Scotland, one of four U.K. banks interested in the MEBO bid, provided a £19.5 million (US$29 million) 12-year term loan facility, and the rest of the cash funds were raised through the issuing of new shares and deep discount secured loan stock (MDC). In addition, the Bank of Scotland agreed to provide a revolving debt facility to be used as a safety net in the event of unanticipated capital expenses, and a standard overdraft of £3.0 million (equivalent to US$4.5 million) for working capital needs. From the equity standpoint, BIA was attractive to venture capi- talists because over the past five years the airport had made substantial infrastructure investments. Moreover, the airport had inadequate marketing, especially in comparison with its main competitor, Belfast City Airport, and thus was viewed as having untapped potential. This particular deal was complex in that the seller was the central government, and the airport had particular operational requirements and security concerns. The privatized airport aims to expand international routes and to market itself more aggressively and effectively.

V. KEY ISSUES EMERGING FROM THE BELFAST EXPERIENCE

X MEBO Option. NIAL was in a unique position with a management team that had taken difficult decisions prior to privatization (i.e., labor force reduction). The management team had a stake in the outcome and a proven track record en- abling it to raise the necessary funds for the offer. The structuring of a MEBO had several positive effects on the transaction: (1) it helped to bolster support for the privatization, since in this case the employees "bought into the idea," during a politically difficult period for privatization in the United Kingdom; (2) a crucial point was that managers assumed significant responsibility in the equity investment which inspired confidence and

6 US$23.0 million was taken out of the company under acquisition (NIAL 2). This meant that the bidders had the possibility of using the assets of the enterprise to be acquired as a means of payment to the original owner, which was DOE(NI), through NITHCo.

271 AIRPORT PRIVATIZATION EXPERIENCES

which effectively led the work force; (3) the MEBO offered a smooth transition for the new company from the start. In addition, the technical assistance sought by the MEBO ensured that a credible and realistic proposal was prepared from the outset. To date, this is one of the few privatization transactions in the airports sector involving a full management-employee buyout (The authors did not find any similar experience in the research for this study. There are, however, MEBO experiences in selected airport-related services. See Box 8.2).

Box 8.2 MEBOS FOR SELECTED AIRPORT-

RELATED SERVICES

As part of the normal evolution of airport services ownership. there seems to be a trend in some developing countries to commercialize selected airport-related services through a type ot MEBO scheme. Employees of a particular department or division (i.e., ground handling. maintenance, porters) are declared redundant and removed from the airport authority payroll. Proceeds of the termination benefits are used to create a commercial company and to tund its working capital requirements. The airport authority grants a long-term concession on the particular service being provided by the employees to the newly created commercial company. Examples of this type of MEBO scheme are being implemented at Othopeni Airport Authority, in Bucharest, Romania. Aeropuerto Internacional de las Americas, in Santo Domingo. Aeropuerto Intemacional Jorge Chavez. in Uma, Peru. and other airports.

i Security Concerns. On several occasions, legitimate security and defense concerns have been accepted by governments as important obstacles to the privatization of public services. The privatization of BIA in the summer of 1994 (before the peace agreements between the Irish Republican Army, [IRA] and the British Government) illustrates that even under particular security conditions the provision of public services by the private sector is possible if an adequate regulatory scheme is in place (see Box 8.1, Section II, Regulatory Framework).

X Strong Regulatory Framework. An adequate modern regulatory framework needs to be established for pricing structure (i.e., economic regulation). Without a strong regulatory framework, BIA management may not have a strong enough incentive for maximizing strategic routes, developing its cargo network, lowering costs substantially, and/or expanding commercial revenues. Although BIA has been profitable for some

272 Case Study a UNITED KINGDOM: BELFAST time, aircraft-related income still accounts for 75 percent of revenues. The proper incentives need to be maintained to promote the growth of the commercial side of the airport business while reducing in real terms the aeronautical charges. This will stimulate air traffic growth and new business development.

273 AIRPORT PRIVATIZATION EXPERIENCES

ANNEX 8.1 AIRPORTS (NI) ORDER 1994

The Airports (Northern Ireland) Order, which became effective in April 1994, affects the activities of airports in Northern Ire- land, including Belfast International Airport (BIA), Belfast City Airport, and smaller airports. The main provisions of the Order concern (1) the modification of existing airports legislation in Northern Ireland to reflect applicable legislation in the United Kingdom; (2) the regulation of airport charges at certain airports; and (3) the privatization of Northern Ireland Airports Lim- ited (NIAL) which operates BIA and is a wholly owned subsidiary of the Northern Ireland Transport Holding Company (NITHCo). I

1. Modification of Existing Legislation

The Order modifies the rights and responsibilities of airport operators and the Government for Northern Ireland (NI) airports. It replaces legislation contained in the Aerodromes Act (NI) 1971, which was enacted to promote the development of airports in order to meet the air transport needs of Northern Ire- land. Airports policy in the United Kingdom has changed significantly since 1971, and in conjunction with these changes, the Order modifies existing legislation as follows: Repeal duty of the Departmentofthe Environment (NI). It is no longer considered policy that the Department of the Environment (hereinafter, the "Department") be responsible for promoting, developing and maintaining airports nor providing for the privatization of NIAL. a Harmonizationwith U.K. legislation. The rights of and regulations regarding airport operators in NI are to be consistent with those existing for the benefit of airport operators in the UK. Exceptions are to be made where local conditions so require.2

NITHCo is a government controlled holding company for transport undertakings in Northern Ireland.

2 For example, exceptions have been made to take account for differences in land law and of the different Town and Country Planning regimes which operates in Northern Ireland.

274 Case Study 8 UNITED KINGDOM: BELFAST ANNEXES X Improved administrativeprocedures. The Order contains provisions for improved procedures for: (1) the compulsory acquisition of land; (2) the authority to give directions; (3) compensation payable by airport operators; and (4) the creation and enforcement of bylaws and sub- ordinate legislation.

2. Land and Related Provisions

Provisions for land usage account for some of the major changes in the harmonization with U.K. legislation. These provisions include the following: Compulsory acquisition. Only airports subject to the regulation of airport charges or managed by a district council or by the Civil Aviation Authority (CAA) have rights to acquire land compulsorily and to stop-up or divert roads.3 Other small airports will lose rights granted under the Aerodromes Act. Airports with rights to acquire land compulsorily may also obtain easements or other rights, such as the right to install and maintain structures or to enter land for survey purposes. Adjacent property. Rights to control adjacent property in the interests of aircraft safety will be restricted to operators of airports licensed under the Air Navigation Order 1989. Such rights which were available to unli- censed operators under the Aerodromes Act, though never exercised, are no longer available to them. Security of airportproperty. The Secretary of State is authorized to direct the operator of any licensed airport, or persons holding a property interest or carrying on business at the airport, to take measures to preserve the security of airport property, not subject to measures to protect aviation security. This power, however, does not exist in equivalent U.K. legislation. a Compensation. The Order describes the extent of compensation payable by airport operators for damaged property, disturbance, land devaluation, or expenditure incurred as a result of action taken by the airport opera-

Airport operators can acquire land compulsorily by applying to the Department for a vesting order concerning of land in any way related to the performance of their functions.

275 AIRPORT PRIVATIZATION EXPERIENCES

tor under the Order. The Department may obtain repayment or compensation from airport operators for which the Department was required to pay under local planning legislation for a planning decision made in the interest of the airport, and for any subsequent developments.

3. Management of Airports

The Order enables district councils to develop and maintain airports and ancillary services subject to the Department's consent. It also specifies the type of airport where the operator is permitted to make airport bylaws and defines the scope of such bylaws. Airport operators are empowered to detain and sell aircraft, and any equipment and stores on board, to recover unpaid airport charges. This power is subject to the High Court's prior concent and any regulations that the Department may issue. The Secretary of State may authorize the operator of any licensed airport to appoint constables who will exercise their function under the exclusive control of the airport operator. The employment protection rights of Industrial Relations legislation will be extended to the office of airport constable. The Secre- tary of State may also require disclosure on directions on security and commercial grounds. The Department, with the approval of the Department of Finance and Personnel (DFP) can make grants or loans to an airport operator for capital expenditure schemes approved by the Department. Provisions for the control of noise have not been amended from those contained in the Aerodromes Act; such provisions are re-established in the Order. As such, the Depart- ment may require the airport operator to take measures to limit airport noise.

276 Case Study 8 UNITED KINGDOM: BELFAST ANNEXES 4. Economic Regulation of Airports

The Order's provisions for economic regulation are derived primarily from the Airports Act 1986, which aimed to ensure fair competition between U.K. airports and fair trading within them. The Order introduces an identical system of economic regulation to airports in Northern Ireland. Accordingly, new responsibilities for the CAA and the Monopolies and Mergers Commis- sion (MMC) have been established. In the event that the principal airports in Northern Ire- land fall under the same ownership, or competition between them is otherwise restricted, the Department may designate specific airports where conditions can be imposed by the CAA to ensure the transparency of accounts and may regulate the maximum level of airport charges. The Department may also assume the CAA regulatory functions where appropriate.

1. CAA Conditions

Since airports are known to have certain monopolistic characteristics in providing services to their local areas, any airport with a turnover of more than £1 million in at least two out of three consecutive years - in practice, BIA and Belfast City Airport - will be subject to economic regulations and as such, will be required to apply to the CAA for permission to levy airport charges. The £1 million limit may be modified by the Department with the consent of the DFP. The CAA may impose conditions on airport operators in order to ensure transparency of accounts and to regulate the maximum level of airport charges over five-year periods. The CAA may require airport operators to provide financial information in order to identify any subsidy element of charging policy. The Order provides for third parties to seek compensation through the courts for loss or damage as a result of non- compliance by airport operators regarding conditions imposed by the CAA.

277 AIRPORT PRIVATIZATION EXPERIENCES

The CAA will not determine charges but will be empowered to investigate complaints about charging policy or predatory pricing and to enforce appropriate remedial measures. The Monopolies and Mergers Commission will hear appeals against CAA decisions.

2. Monopolies and Mergers Commission

The Monopolies and Mergers Commission (MMC) is empowered under certain circumstances to investigate and report on CAA limits on airport charges and discretionary conditions. The Order specifies the degree of assistance which the CAA must provide to the MMC in relation to a reference and the procedures with which the MMC conducts investigations. It also describes the details which the MMC must include in its reports and the action which the CAA must take to impose or modify conditions as a result of an MMC report, subject to direction by the Department. The Department may regulate annual charges to be payable by airport operators to the CAA in respect of certain MMC expenses incurred under the Order. The CAA in turn remits these charges to the Secretary of State for payment into the Con- solidated Fund.

_l'ol-_JML~ 5. Privatization of NIAL

The Order provides for a scheme for the transfer of specified assets and liabilities of NIAL from Government ownership to the private sector in a manner similar to other privatizations. The provisions for privatization are modeled after the Electric- ity (NI) Order 1992 rather than the Airports Act 1986 which gave effect to the privatization of the British Airports Authority. Some modifications to the Electricity Order have been made as appropriate, including the following: (1) NIAL will not be divided into separate functions as part of any reorganization prior to privatization; (2) privatization will involve only one successor company; and (3) the successor company will be sold by trade sale and not by a public flotation of shares.

278 Case Study 8 UNITED KINGDOM: BELFAST ANNEXES The Department, with the consent of the DFP, is empowered to structure the framework within which the finances of the successor company under Crown ownership are conducted, including the authority to: (1) make directions regarding statutory reserves; (2) place temporary restrictions on borrowings and raising capital for reasons of public interest; (3) make loans from the Consolidated Fund; (4) guarantee loans made to the successor company; (5) convert loans to securities (by direction); and (6) discharge loans.

1. Reorganization Scheme

The Order enables the Department to direct NITHCo to develop a reorganization scheme under which NIAL's estate in specified land will be transferred to NITHCo, and NITHCo will grant a land lease to NIAL. The purpose of this scheme is to provide for the rearrangement of property rights at the airport prior to their transfer and in such a manner as to avoid adverse tax consequences. If NITHCo fails to develop a reorganization scheme by a specified date or if the Department does not approve of the scheme submitted, the Department may develop the scheme itself. The Department also specifies the date on which the reorganization will take place.

2. Transfer of Assets and Liabilities

The Order also requires NITHCo to develop a "transfer scheme" for the transfer of specified assets and liabilities of NITHCo and NIAL to the successor company on a date set by the Depart- ment. The Order also describes the Department's functions concerning the approval, modification, and development of the transfer scheme (in consultation with NITHCo) and directs NITHCo and NIAL to assist the Department as necessary. The Department may hold, manage, and dispose of any assets transferred to it under the Order and discharge any liabilities so transferred. Likewise, NITHCo may hold, manage, and dispose of any airport assets which are not transferred under the Order and discharge any airport liabilities which are not so transferred.

279 AIRPORT PRIVATIZATION EXPERIENCES

The Department or the DFP may at any time acquire and dispose of securities of the successor company or rights to subscribe for such securities; the purpose of this right is to enable the sale of the successor company and its assets into the private sector.

3. Finances

The Order enables the successor company to create a reserve to be used solely for paying out unissued shares of that company to be allotted to members of the company as fully paid bonus shares. The purpose of this reserve is to facilitate the financial structuring of the successor company. The Order provides for continuity in accounting by maintaining that the commencement date for the statutory accounts of the successor company be the last complete financial year of NIAL prior to the transfer date. The Department (with the consent of the DFP) may make loans, in an aggregate amount of £10 million, to the successor company while it remains publicly owned and may guarantee the repayment of such loans.

280 Case Study 9 UNITED KINGDOM: BRITISH AIRPORTS AUTHORITY

AIRPORTS IN THE UNITED KINGDOM- BAA PLC

A CASE STUDY OF 100 PERCENT PRIVATE OWNERSHIP'

The United Kingdom has been in the forefront in increasing autonomy for airports and encouraging private sector involvement in airports. The establishment in 1965 of the British Air- ports Authority (BAA) as an independent commercial enterprise under government ownership marked the country's first experience with airport corporatization. Four airports - Heathrow, Gatwick, Stansted, and Prestwick - were incorporated under the BAA structure. In the 1970s BAA acquired Aberdeen and Edinburgh Airports from the U.K. Government and obtained Glasgow Airport from the Glasgow Airport Corporation. As part of the 1986 Airports Act, BAA was privatized and its 500 million shares were sold on the London Stock Exchange (BAA plc). This sale represented the first airport privatization experi-

I Research for this case was conducted in August 1994 (financial information updated in July 1995).

281 AIRPORT PRIVATIZATION EXPERIENCES

ence of significance. After privatization, BAA purchased Southampton Airport and sold Prestwick to a consortium of local interests. 2 BAA handles approximately 71 percent of passengers and 81 percent of air cargo passing through U.K. airports. In 1994, 87.7 million passengers passed through BAA's seven airports. With 52.1 million passengers, London Heathrow is the largest international airport and the fourth largest airport in the world.3 London Gatwick is the twenty-eighth busiest airport in the world. BAA's large traffic flows and extensively developed landside (commercial) activities have made it an extremely profitable enterprise. Private ownership has allowed BAA to improve the efficiency of its airside operations and to further develop commercial activities. In addition, BAA has lent its expertise through management contracts and joint ventures, becoming involved in several non-airport activities. These ventures include a £300 million4 joint venture with British Rail to develop a high-speed rail link between Heathrow and central London, as well as involvement in real estate and hotel enterprises. These commercial activities facilitate the diversification of revenues, as airside (traffic related) tarrifs and charges at London Heathrow, London Gatwick, and London Stansted are tightly regulated by the Civil Aviation Authority (CAA) and are linked to retail prices index formulae.5 The 1986 Airports Act also applied economic regulation to all airports with annual revenues of over £1 million (the Airports Act did not require airports to be turned into companies, but it did require them to keep accounts, and made them subject to economic regulation). Airport management functions were transferred to 16 public limited companies all initially owned by municipal governments, but operated at arm's length. The largest of these companies administers Manchester Airport which, with 12.5 million annual passengers, is the third largest airport in the United Kingdom after Heathrow and Gatwick. The traffic volume at Manchester Airport led to it being included

2 Until 1990, transatlantic flights into Scotland could go only through Prestwick. The U.K. Govemment prohibited transatlantic carriers from servicing Glasgow and Edinburgh Airports. As a result of legal action, this policy was rescinded and air traffic plummeted at Prestwick from 322,000 to 35,600 passengers. Prestwick Airport now operates almost exclusively as a cargo airport. BAA plc Annual Report, 1995. The average exchange rate for fiscal year 1995 was £1=US$1.56. Airside Tariffs and charges under economic regulation are landing, aircraft parking, and passenger fees.

282 Case Study 9 UNITED KINGDOM: BRITIshi AIRPORTS AUTHORITY amongst the airports designated by the British Government for price control by the CAA, but the airport is reviewed separately from BAA. Corporatization led to the privatization of some British airports. In 1990, 76 percent of the equity shares of Liverpool Airport were sold to British Aerospace. Cardiff-Wales has been sold to a local company while a stake in Birmingham Airport is being acquired by a consortium including the Irish airport operator Air Rianta. East Midlands Airport was recently sold to National Express. However, the proposed privatization of Lon- don Luton Airport was precluded by the decline in the U.K. stock market and by changes in the composition of the local government. The government has encountered strong resistance from municipalities over the privatization of corporatized airports. While the government could force the issue by withholding approval for public sector funds, political conditions have precluded this strategy. 6 Most of the 16 corporatized airport companies are profitable and would have little difficulty obtaining private sector funds if they were privatized. BAA was the first completely private ownership transaction (100 percent ownership) carried out in the airports sector by any government. Since then, several other large international airports (e.g., Copenhagen, Vienna, etc.) have followed the same pattern but with the governments still holding an equity participation. Only in the case of Belfast International Airport has the government been fully divested of its ownership (100 percent).

I. OWNERSHIP AND INSTITUTIONAL FRAMEWORK

The National Air Traffic Services (NATS), a CAA subsidiary, provides air traffic control (ATC) services to most airports in the United Kingdom. At some non-BAA airports, ATC functions are performed by airport authorities and private contractors. As in the United States, the national government is responsible for customs and immigration services while the airlines manage passenger, ground handling, and maintenance ac-

6 In fact, at the date of publication the government was withholding funds.

283 AIRPORT PRIVATIZATION EXPERIENCES

tivities. Commercial activities are generally carried out by commercial retailers who return a percentage of their revenues to BAA. Approximately 90 percent of the 74,000 employees at BAA airports (as of July 1994) are hired directly by the private operators, airlines, or airline subcontractors that provide ground handling, traffic handling, and retail services.7 The contracting out of airport services is common in the United Kingdom but is less common in other European countries, where some airport authorities (in Vienna, for example) perform traffic handling activities. Table 9.1 presents the administration of functional activities at both BAA and non-BAA airports.

Table 9.1 I ! :.. U.K., BAA: Manage- Operational ment of Airport Services at U.K. Airports Air Tratfic Control NATS NATS Airport Authority Private Contractors Police Local Police Local Police Security BAA Airport Authonty Airlines Airlines Fire BAA Airport AuThority MainTenance Airlines Airlines Traffic Handling Aircraft AirlinesilHC' Airlines Baggage.Freight AirlinesilHC Airlines Passenger AirlinesIIHC Airines Custon,s U K Government U.K. Govemment Immigration U.K. Government U.K. Government Concessions Shopping.; Private Private Duty-Free Cateringi Private Pnvate Restaurants Car Parking Pnvate Pnvate Car Rental Private Pnvate Other- Banking. Private Private Hotel, etc IHC=Independent Handling Companies Source: BAA plc Annual Report, 1994, and World Bank staff.

7Meeting with Corporate Planning Departnent, July 1994.

284 Case Study 9 UNITED KINGDOM: BRITISH AIRPORTS AUTHORITY

A. The Current Airport Ownership/Manage- A ment Structure

In 1987 BAA was privatized and its shares were sold on the London Stock Exchange. BAA owns and operates seven airports - four in England (Heathrow, Gatwick, Southampton, and Stansted) and three in Scotland (Aberdeen, Edinburgh, and Glasgow). The English airports are managed as non-competing subsidiaries, and the three Scottish airports are managed by Scot- tish Airports Limited, an intermediate subsidiary divided into three smaller airport companies. 8 The BAA subsidiaries retain property and assets directly related to airport operations. Non- operational assets are held by BAA, which can best be described an as airport holding company. BAA's international division provides airport management, engineering, planning, and commercial expertise around the world. Figure 9.1 outlines the corporate structure of BAA.

Figure 9.1 U.K., BAA: Corporate Structure of BAA

BAA pic 1

Heathrow Gatwick Stansted Southampton Scottish |Airport |jAirpot Airport Airport Atrpots Umited Limited Limited Limited Limnted

Edinburgh I Glasgow Aberdeen Airport Airpor Airpor Limited Limited Limited

Source: BAA pic.

R The U.K. Government considered the alternative privatization strategy of forming individual competing airport companies, but concluded that the sale price of an airport conglomerate would be greater than the amount generated by the sale of individual companies.

285 AIRPORT PRIVATIZATION EXPERIENCES

BAA is governed by a Board of Directors with seven executive and five non-executive directors. The Board of Di- rectors meets nine times a year to establish long-term policy and provide overall financial and organizational direction. The day-to-day operations are managed by a Chief Executive and a Management Committee comprised of 13 senior directors (4 of whom manage BAA airport subsidiaries). Non-executive directors serve in an advisory capacity and make up the following Board committees: (1) Audit Committee (reviews quarterly financial statements); (2) Remuneration Committee (reviews the appointment and remuneration of executives and senior staff); and (3) Safety and Security Committee (oversees safety supervision). There is also the Charitable Donations Committee, which is comprised of executive and non-executive directors. Figure 9.2 outlines BAA's management structure. Figure 9.2 U.K., BAA: Management Structure of BAA

Board of Directors

ExawtSw Dketors | Chanitable1 Donations Nof-Executive Commiffee Dimetors

CEO Safetu and Management [ Audit Remuneration Sfc Comm,ttee t Comminee Comminee Committee

Source: BAA pic.

286 Cnase tuay 9 UNITED KINGDOM: BRITISH AIRPORTS AUTHORITY

B. Sources of Airport Revenues

BAA derives 33.9 percent of its operational revenues from airside activities (airport related charges). This figure represents the impact of regulation of airside charges at the South-East Air- ports9 and the subsequent need to further diversify revenue streams.'0 Aircraft landing/parking fees and passenger fees constitute, respectively, an estimated 40 percent and 60 percent of airside revenues."' BAA's airside charge schedule structure is among the most comprehensive in the world and includes peak passenger fees during daily peak and seasonal peak periods at the South-East airports (outside this period charges are levied at off-peak rates). As is the case with U.S. airports, BAA derives a significant percentage of total revenues from landside activities (66.1 percent). The trend toward expanding commercial activities at BAA airports began before privatization and was facilitated with the advent of economic regulation. In 1983, commercial activities constituted 46.8 percent of total revenues. In four years this increased to 51.7 percent and has since grown to the above- mentioned 66.1 percent. Retail prices at BAA stores are comparable to those of downtown shops and even lower in the case of duty-free outlets. Commercial activities at Heathrow alone generated £443 million in fiscal year 1995. BAA reports that "25 percent of all the books in the United Kingdom and 40 percent of all the caviar in Western Europe are purchased at London's Heathrow Airport."'2 Table 9.2 summarizes the development of commercial activities at six BAA airports. Table 9.2 U.K., BAA: Development of Commercial Activities at BAA Airports' Airport Aberdeen Edinburgh Gatwick Glasgow Heathrow Stansted Total

Number of ShopS 10 15 116 27 167 20 355

'C,rr,rr,9rcrI i acio,es aysoutrampion remain relatwely unadeveIoped and therefore are nol listed Source: BAA, World Class Shopping at BAA Airports, 1993.

9 Heathrow, Gatwick, and Stansted.

1° BAA plc Annual Report, 1995. Based on weighted averages for landing fees, parking charges, and passenger fees at all seven airports.

12 Robert W. Poole, Airport Privatization: The Record to Date, Reason Foundation, 1992.

287 AIRPORT PRIVATIZATION EXPERIENCES

Commercial activities are not subject to CAA economic regulation but can be controlled by general trading laws, and European Union (EU) actions governing commercial activities in member countries. As part of the common market pact implemented on January 1, 1993, intra-EU passengers will no longer be able to purchase duty-free products at member country airports after July 1, 1999. BAA, which generates 15.8 percent of total revenues (£183 million in fiscal year 1995) from duty-free shopping activities, could experience a strong impact from this ruling. For this reason the EU has granted European airports a five-year transition period (1992-97) to comply with this provision. Table 9.3 summarizes the economic performance of all seven BAA airports.

Table 9.3 . .. - *i5 ; E U.K., BAA: Revenues at (milbons) ICmillions) (£millions) E BAA Airports' Heathrow 52.1 689.4 278.3 13.23 (year Ended March 31, Gatwick 21.2 244.6 60.9 11.54 1995) Stansted 3.4 44.4 (.14.3) 13.06 - ''X'""'~ Southampton 0.5 6.2 1.4 12.40 Glasgow 5.5 73.8 21.9 13.42 Edinburgh 3.0 30.6 9.8 10.20 Aberdeen 2.2 23.3 6.6 10.59

roti - 7.1 "1-t;L0t' -''7h,',; I 1$JO

1£= US$1.56. Source: BAA PIc Annual Report,1995.

In fiscal year 1995, BAA generated £2.0 million from airport management services and £61.5 million from other activities. Revenues from other activities include: (1) non-operational airport activities in the United Kingdom and United States (£16.9 million); (2) non-airport property activities (£29.1 million); and (3) corporate and other activities (£15.5 million).'3 These include the development and management of the AirMall at Pittsburgh International Airport and the drafting of designs for the new airports in Kuala Lumpur, Malaysia, and Hong Kong. BAA did not disclose the economic performance of its hotels, but in the past BAA's hotel ventures were loss-making enterprises."

'3 BAAplc Annual Report (1995). 14 BAA opened six hotels at its London airports in 1990-91 and one hotel in Ghent, Belgium, in 1990.

288 Case Study 9 UNITED KINGDOM: BRITISH AIRPORTS AUTHORITY

11. REGULATORY FRAMEWORK 4 _

The peak pricing system was developed by the British Airports Authority in consultation with airlines and the British government, and the CAAinstituted it at Heathrow, Gatwick, and Stan- sted to relieve capacity constraints and to reflect the opportunity cost of scarce runways.'5 Passenger surcharges are assessed according to daily seasonal rates, and landing fees charged as a fixed fee per aircraft when runways are fully utilized but are weight related in off-peak periods. This system generates increased revenues from larger aircraft that carry high volumes of passengers. (Section IV-F has a more detailed discussion of CAA's pricing mechanisms). Seasonal peak period rates are in effect between April 1 and October 31. There are also some peak changes in winter. Free aircraft parking periods have been eliminated during peak times to encourage the rapid turnover of parking stands. There are no free parking periods at all at Heath- row or Gatwick (except overnight). Outside the United King- dom peak period surcharges are much less common. Table 9.4 delineates the airside pricing structure at Heathrow Airport. Table 9.4 U.K., BM: Airport Charges at Heathrow Airport, 1995-96

Landing' 0-16 tons Ego £390 (0700-0959, 16-50 tons E162 E390 17DD t359; >50 tons 12B4 E390 Regular Season r2harges apply at all other times) Parking £3.25 per fl4 'our t 3 x the surrharge applied (0700-1229) 5 pence per ton per 1/4 hour during regular season. (i e . 1 mn. = 3 min.) Base clarges apply to lel aircraft meeling the mequiremenis of Chapter 3 aircrah. Base charge is stbject to a 20%.L surcharge tof Chapter 2 aicrah and a 550. surcharge for let aircraft not meetng Chapter 2 noise certdfation staridardls. PAWlN0IMMATLED(osucsbfsiwllrtef~w 3;iii~it~ Domestic £4.00 (M-F 0800-0929, £6.55 (M-F 0700X129 (1930-2059) 1830.1959) £2.55 (All other times) E2.55 (All other times) Intemational £300 (All times) £12.82 (0900-1529) £3.00 (All other times) Source: BAA plc, July 1995.

i5 Stansted Airport was regulated in order to avoid schedules that were preferential compared with those of its competitors during its development.

289 AIRPORT PRIVATIZATION EXPERIENCES

Even with peak period pricing, some economists maintain that BAA's pricing schedule does not adequately reflect market conditions and utilization of scarce resources. Airside charges at BAA airports are relatively low compared with those at airports of comparable size. For example, Heathrow is ranked as the fourth largest airport but has an airside charge schedule rated twenty-first among the 25 largest airports.16 In relative terms, this figure is approximately one-quarter of that of the next busiest airport, Tokyo Narita Airport. For the market to be cleared, the CAA estimates that airside charges need to increase by 130 percent and 70 percent at Heathrow and Gatwick, respectively. These increases could potentially double BAA's total profits. By extension, price increases would necessitate a drastic revision or elimination of RPI-Xprice controls. The elimination of price controls is likely to lead to tariff differentials between charter, cargo, and foreign aircraft, which would run contrary to international standards and bilateral agreements. However, the implementation or use of separate regulatory controls could prevent the existence of price differentials. Instead of allowing the demand price for crowded airport services to meet the supply, the Department of Transport has at times opted to restrict supply (i.e., 1978). The Department of Transport imposed restraints on new international, domestic, charter, and cargo services at Heathrow. These restrictions were eliminated in 1991 because of the constraints on the economic efficiency of long-haul services and the violation of international norms. However, the ban on cargo and general aviation flights at Heath- row and Gatwick during peak hours remains.

111. FINANCIAL PERFORMANCE

With the exception of Stansted, six of the seven airports within the BAA system are profitable. The strong financial performance of Heathrow Airport, which turned operating profit of £273.2 million in fiscal year 1995, is particularly noteworthy. Profits accrued from the six profitable airports were used to cross- subsidize the loss-making activities at Stansted while the latter remains developed as an alternative to Heathrow and Gatwick. BAA, at the present time, is not immune from cross-subsidizing

16 MMC 1991 Report on BAA's airport charges prepared by TM Economics (an economic consulting firm associated with Avmark).

290 Case Study O UNITED KINGDOM: BRITISH AIRPORTS AUTHORITY activities. In fiscal year 1995, Gatwick Airport offset a £20.5 million loss in airside functions with profits of £79.6 million in landside activities.' 7 The airside activities loss at Gatwick can be attributed partly to economic regulation. Overall, BAA is an extremely profitable corporation. On the cost side, BAA has achieved a 27 percent increase in staff productivity since privatization. BAA reduced its staff in 1993 by over 1,900 employees, or 20 percent of total staff. In fiscal year 1995, BAA incurred interest costs of £35 million and dividend obligations of £104 million. BAA, like municipally owned airports, is not exempt from local and federal taxes and is taxed at the U.K. corporate tax rate of 33 percent. However, deferments for capital allowances and capitalized interest reduce the effective tax rate to 26 percent of total profits. In fiscal year 1995, BAA generated £175 million in retained profits."8 Table 9.5 summarizes BAA's overall economic performance.

Total Revenue 1,159 Table 9.5 Operating Costs (758) U.K., BAA: Economic Operating Income 401 Interest Expense (35) Performance of BAA Profits before Taxes and Dividends 366 (Year ended March 31, Taxes (87) 1995) Dividends (104 (£ millions)

'£1 = US$1.56. Source: BAA plc Annual Report, 1995.

IV. PRIVATIZATION PROCESS _

A. Background

In the past 20 years, air traffic in the United Kingdom has increased by an annual compounded average of 6 percent.'9 BAA predicts that the number of passengers using its airports will double in the next 15 to 20 years. In fiscal year 1995, Heathrow and Gatwick handled passenger traffic of 52 million and 21

7 BAA plc Annual Report. 1995.

18 BAA plc Annual Report 1995.

19 "U.K. Airports AreTaking Advantage of Liberalization," Airport Forum, January 1992, p. 27.

291 AIRPORT PRIVATIZATION EXPERIENCES

million, respectively. Both are important origin/destination airports and Heathrow is a vital gateway hub into Europe. High traffic volumes have created capacity constraints at these two airports. One solution has been the development of Stansted Airport as a viable alternative. A new terminal (capacity: 8 million passengers per year) was built in 1991 but growth has been slow owing to the unwillingness of airlines to cede their slots at Heathrow and Gatwick. At Heathrow a fourth terninal was built in 1986 and a proposed fifth terminal is currently under review by a Public Inquiry. As a separate entity, the proposed terminal, with an estimated capacity of 30 million passengers per year, could develop into one of the world's largest airports. To relieve capacity pressures at Gatwick Airport, a new terminal with a capacity of 10 million passengers was built in 1988. To relieve traffic flows into the London airports, there has been increased emphasis on developing regional airports such as Birmingham, Manchester, and Glasgow,2 0 perhaps through private sector participation. It has been government policy to corporatize regional airports with the expectation that these airports would eventually obtain private capital through some form of privatization initiative. Since corporatization, regional airports have grown steadily; however, private participation has been uneven. Without private sector participation, Manchester Airport recently completed construction of a second terminal, with the goal of becoming the second largest hub in the United Kingdom. Liverpool Airport was the first regional airport to be privatized, with 76 percent of equity sold to British Aerospace. British Airways opened a new terminal and established hub operations at Birmingham Airport through a build, operate, transfer (BOT) arrangement. 21 In addition, the sale of East Midlands Airport to local private interests was recently completed Fi- nally, BAA has sought to develop Southampton, and Stansted Airports in an attempt to reduce congestion at Heathrow and Gatwick. Glasgow Airport is being developed to meet growing Scottish demands and this could also serve to reduce congestion at Heathrow and Gatwick.

20 Passenger traffic at Glasgow Airport increased dramatically after Prestwick Airport lost its monopoly over transatlantic flights.

21 The terminal is owned by: Birmingham International plc (25 percent); British Air- ways (21.4 percent); National Car Parks Ltd. (21.4 percent); John Laing Ltd. (11.9 percent); and Forte Ltd. (6 percent). The remaining equity is held by the seven municipal governments that own Birmingham Airport (14.3 percent).

292 Case Study 9 UNITED KINGDOM: BRITISH AIRPORTs AUTHORITY

B. Liberalization/Deregulation of the Airlines

Prior to deregulation, the CAA (and its predecessors) had actively discouraged direct competition on airline routes to ensure the profitability of domestic airlines. Following the lead of the United States, Parliament passed the Civil Aviation Act of 1982 which led to the liberalization of the airline industry in the United Kingdom. The effects of this legislation were: (1) to deregulate air transport services in order to satisfy all substantial categories of public demand; (2) to codify the 1944 Chicago Conven- tion which set aside the international rules for the non-discrimination of charter, cargo, and foreign aircraft; (3) to create the legal framework for regulating airport charges; and (4) to create the legal framework for the exclusion of aircraft from U.K. air space.22 The Civil Aviation Act and subsequent policy decisions gradually permitted carriers to compete directly on a price basis and also introduced hub services. The primary effects of deregulation were to increase discount fare offers, destinations served, and flight frequency, all of which contributed to the rapid growth of the scheduled airlines, particularly British Midland. As part of the drive to liberalize the airline industry, British Airways (BA), the dominant domestic carrier, was privatized in 1987. Deregulation decreased BA's dominance of the domestic market, reduced its market share, and led to the discontinuation of some unprofitable routes. BA's dependency on previously regulated routes to ensure profitability was dras- tically reduced. Privatization facilitated improvements in efficiency and led to a dramatic reduction in costs. Privatization also increased BAs profits, improved its sources of financing, and streamlined its management and employment. One of BAXs initial actions as a privatized entity was to acquire British Caledonian Airlines, the second largest domestic airline. The merger increased BA's charter and international services and provided extensive financial savings through the consolidation of activities.23 In recent years BA has also obtained a 24.6 percent share in USAir, a stake in Qantas, and a minority share in

22 This latter provision provided the legal underpinnings of the Traffic Distribution Rules instituted (and later repealed) at Heathrow and Gatwick.

23 In exchange for the approval of the Monopolies and Mergers Comnission, BAagreed: (I) to surrender British Caledonian's licenses to operate on certain international routes; (2) to accept the licensing of new entrants; and (3) to cede 10,500 slots at Gatwick.

293 AIRPORT PRIVATIZATION EXPERIENCES

the French airline TAT. In this manner, BA has followed a more strategic approach which has led to an increase in hub service and the rationalization of the airline's international routes. The EU has begun to liberalize the airline industry within its member states. Historically, European airlines, many of which were state owned, were shielded from foreign competition by restricting access to new entrants. The Common Market initiative has attempted to limit airline grandfather rights, to encourage new entrants, and to increase competition for routes by granting priority to new entrants for new airport slots at congested airports. Inter-community air fares have been deregulated as well, and airlines have been given some flexibility to provide services outside of their domestic market. The expectation is that member states will abolish the remaining access restrictions by January 1, 1997. However, it appears that this process will be difficult to implement. Several member countries have actively prevented foreign carriers from providing service at domestic airports. A prominent example of this was the controversy over landing rights for BA at Paris' Orly Airport. The recent decision granting BA landing rights in Paris is only the first step toward improved reciprocity and liberalization.

C. Emerging Environmental Concerns

The Civil Aviation Act of 1982 also conferred the authority on the Secretary of State for Transport andlor the CAA to impose restrictions to mitigate noise pollution. This authority has been used to prescribe specified flight paths and the reduction of night operations at the three South-East airports. At BAA airports, older, noisier aircraft are assessed a 35 percent surcharge on landing fees, whereas newer and quieter aircraft receive a re- bate on landing fees. A new system in place since 1993 imposes charges of up to £1000 for departures infringing specified noise levels. Proceeds go to local community finances. In order to minimize potential noise pollution effects BAA has purchased a limited number of properties near Heathrow and Gatwick. Through the Air Navigation Orders of 1986 and 1990, the CAA incorporated EC restrictions pertaining to noise pollution. These regulations preclude the certification of, and thus effectively ban, all aircraft that do not meet the first level of noise pollution standards of the International Civil Aviation

294 Case Study 9 UNITED KINGDOM: BRITISH AIRPORTS AUTHORITY

Organization (ICAO).24 Unless they are hush-kitted, most Boe- ing 707 and McDonnell Douglas DC-8 aircraft are affected by this provision. The 1990 Order adopted EC regulations that disallow the certification of new aircraft that are in non-compliance with ICAO's second level of noise pollution. The intent of this provision is to phase out all subsonic jet aircraft and certain categories of propeller-driven airplanes depending on weight and date of certification (for example, Boeing 727s, 737-100s, and 737-200s, and McDonnell Douglas DC-8s and DC-9s). Air- craft used by a carrier prior to November 1, 1989 are exempt from this legislation and airlines can replace any of these aircraft on a one-to-one basis if they are accidentally destroyed. More recently, the EU has considered the operationalban of all aircraft not meeting ICAO's second level standards on noise pollution. However, a decision on this provision has yet to be taken by the member states. The Regulation of Aircraft Emissions was instituted by the Air Navigation Order of 1986.25 This provision requires certification to meet fuel venting and smoke emissions standards. Aircraft certification can be undertaken through the CAA or through any aviation regulatory entity of ICAO signatory countries. The aircraft affected by these regulations are (1) those that are powered by gas turbine engines whose date of manufacture was on or after May 1, 1986, and/or (2) those that utilize a turbojet or turbofan engine whose date of manufacture was on or after May 1, 1986. U.K. emissions standards do not include control of emission of carbon monoxide and nitrous oxides. However, stricter controls can be instituted under the 1990 En- vironmental Protection Act. Implementation of aircraft emissions standards is not uniform among EU members.

24 These regulations are based on ICAO standards established on April 2, 1971 and listed in Volume 1 -Aircraft Noise, of Annex 16 on Environmental Protection. These standards are more commonly known as "Chapter 2," which outlines the first level of noise pollution, and "Chapter 3," which establishes the second level of noise pollution.

25 This regulation is based on ICAO standards listed in Volume 2 - Aircraft Engine Emissions, of Annex 16.

295 AIRPORT PRIVATIZATION EXPERIENCES

D. Upgrading Air Traffic Control Services

NATS, the CAA subsidiary, provides ATC services to most of the large airports in the United Kingdom. In route services run on a not-for-profit basis (required under Eurocontrol rules) with the overpayment of fees discounted against future charges. ATC Services are required to make a return of 8% on revalued assets. The Scottish Highlands and Islands Airports Ltd. (operated by Department of Transport), individual airports, and independent contractors also provide ATC services in the United Kingdom. Because safety supervision and regulatory functions are also under its domain, the CAA has the unique distinction of regulating its ATC competitors. For this reason, the U.K. Government is studying the feasibility of splitting ATC and safety services into two discrete entities. Safety supervision and economic regulatory functions would remain under government control and NATS would be divested to private ownership. Privatization would reduce dependency on public sector funds and would eliminate public sector borrowing constraints that limit the total amount of private funds that can be obtained each year. The need for alternative sources of funding has grown in importance because capital spending by NATS has increased from the pound sterling equivalent of US$50 million to approximately US$250 million annually.26 These funds have been used to finance the construction of a New En Route Center (NERC) in Britain and to improve linkages between ATC operations at Heathrow and Gatwick and a centralized unit. As part of its privatization initiative, the CAA is expected to announce the official tendering of bids for the development and management of the pound equivalent of a US$300 million ATC center in Scot- land.27 However, the drive toward privatization has recently slowed down owing to strong resistance on the part of domestic airlines and air traffic controllers. Resistance to the privatization of ATC services in the United Kingdom has also come from the EU. The EU contends that privatization would derail plans to harmonize ATC services in Europe. The need for harmonization is highly relevant. Cur- rently, there are roughly 54 centers using 31 different computerized traffic control systems made by 18 manufacturers. ATC computers use 22 operating systems and over 70 programming

26 CAA, Annual Report, 1994.

7 CAA estimates.

296 Case Study 9 UNITED KINGDOM: BRITISH AIRPORTS AUTHORITY languages. The costs to airlines caused by delays is estimated to be between the pound equivalent of US$4 billion and US$5 billion per year.28 In early 1994 the first computer links to neighboring ATC centers using the EU standard system, Eurocontrol, were instituted.

E. Limited Sources of Traditional Financing

Prior to privatization, BAA's capital expenditures were circum- scribed by tight fiscal policy and regulations that limited the total amount of private sector funds that municipally owned entities could borrow. New projects were financed primarily through operational revenues. Privatization enabled BAA to obtain funds from both the debt and equity markets. In the first year under private sector ownership, BAA was able to obtain: (1) a £200 million multi-year facility from a 35-bank consortium; (2) a commercial paper program valued at £100 million; and (3) £150 mnillion from the European Investment Bank (Em). In 1990 BAA's commitment to the EI grew to £350 million which was used to finance new terminals at Gatwick and Stansted. BAA's total debt obligations are currently approximately £1.4 billion.29 Moreover, privatization eliminated the restriction on profit maximization and facilitated the development of commner- cial activities. In fiscal year 1995 BAA generated £766.3 million in commercial and other activities, which comprise 66.1 percent of total revenues. This amount includes earnings from BAA's seven hotels, a real estate development company,30two cargo companies, 3' and airport management contracts. Because roughly two-thirds of its retained earnings are used to finance new infrastructure projects, BAA's commercial activities have become an extremely important source of funding.

2S CAA estimates.

29 BAA plc Annual Report, 1995. 3 Lynton Property and Reversionary plc was purchased in 1988.

31 In 1989 BAA purchased Scottish Express Ltd., a rapidly growing freight forwarder, and another cargo company, both of which operate at Heathrow and Gatwick.

297 AIRPORT PRIVATIZATION EXPERIENCES

F. Comparison of Airport Regulatory Structures

In contrast to its U.S. counterpart, the Federal Aviation Admin- istration (FAA), whose regulatory activities are limited to aviation safety/navigational matters, the CAA is responsible as well for the economic regulation of airports. The CAA confers the ability to impose airside charges and has the legal purview to impose price controls on airside activities in order to prevent abuses of the natural monopoly position of airports. These potential abuses include: (1) Exploitation of monopoly; (2) predatory pricing; and (3) price discrimination. The CAA is also authorized to impose limits on categories, time periods, and maximum airside revenues. Compliance is secured through impos- ing mandatory reductions, rescinding the ability to impose airside charges, and/or fining airport operators. The CAA reviews airport pricing structures every five years and is assisted by the Monopolies and Mergers Commission (MMC).32 However, the Secretary of State for Transport has the final authority to re- scind CAA price controls in order to meet the U.K. international obligations stemming from U.S./U.K. bilateral agreements, EU membership, and/or the terms of the Chicago Convention of 1944. After an initial CAA pre-review, the MMC undertakes a comprehensive examination of BANs (airport activities) economic performance over the previous five year review period, and five-year forecasts. On the basis of this information, the MMC recommends a level of price restraints to the CAA.33 After the MMC review, the CAA has the option of following MMC recommendations or establishing its own price controls. The MMC has the legal purview to recommend policy changes and penalties and can also investigate reported abuses. Formal MMC complaints can be initiated by aircraft/airport operators through the CAA or by the CAA itself. The CAA (or the Secretary of State for Transport) has the authority to impose penalties based on the MMC's non-binding recommendations which typically cover the cost of the investigation. The CAA decisions can be appealed through the judicial system.

32 CAA has price control powers only at Heathrow, Gatwick, Standsted and Manchester.

33 For other regulated industries, the MMC does not have the automatic authority to review pricing structures and serves primarily as the final arbiter.

298 Case Study 9 UNITED KINGDOM: BRITISH AIRPORTS AUTHORITY

In accordance with the terms of the 1986 Airports Act, the Department of Transport established the Rate Plus Inflation Rule (implementented by CAA), which limited the maximum amount assessed per passenger through aircraft landing fees, aircraft parking fees, and passenger fees. The Rate Plus Infla- tion Rule followed the example set in telecoms and gas privatizations. Price ceilings are calculated by limiting airside charges (i.e., landing, aircraft parking, and passenger fees) to a fixed percentage below the U.K. retail price index (RPI) or RPI-X. This fortnula applies only to the four airports designated by the Secretary of State for Transport - Gatwick, Heathrow, Stan- sted, and Manchester. Airside charges are determined under the "single till" approach in which estimates of total airport revenues (including revenues from concessions) and total costs are forecast and airside charges are set to meet a specified level of profits.34 Thus, landing and parking charges are treated as a residual. Under the single till approach, airports with thriving commercial activities can cross-subsidize airside activities and remain profitable. The U.K. system is similar to the experience at several U.S. airports, especially those that have revenue sharing agreements with servicing airlines. 35 The CAA and the MMC, in consultation with BAA, airline executives, the Inter- national Air Transport Association (IATA), airport managers, and executives from other transportation modalities, review BAA's airside pricing structure every five years. The most recent review took place in 1991 and the next one will occur in 1996. The determiination of the percentage below the RPI, or the "X factor," has generated considerable controversy. From 1986 to 1991, the revenue ceiling was RPI- I percent which was based on projected traffic flows and financial forecasts. In addition, BAA could recover up to 75 percent of additional security costs caused by changes in government security requirements. The pricing schedule for airside charges for the period 1992-97 at BAA's London Airports is: (I) RPI-8 percent for the period April 1992 to March 1994; (2) RPI-4 percent for the pe-

I BAA's revenue structure is currently divided at about 60:40 in favor of its landside activities. Therefore, a 2.5 percent change in airside revenues is needed to achieve a I percent change in total revenues.

35 U.S. airports that have residual agreements in which the airlines guarantee break- even revenues also operate under the single till approach. With a residual agreement, commercial revenues are shared with the airlines. U.S. airports with compensatory agreements are not guaranteed break-even revenues and are not obligated to share con- cessionary revenues with their airline customers. Airside and commercial revenues are differentiated under a double till approach.

299 AIRPORT PRIVATIZATION EXPERIENCES

riod April 1994 to March 1995; and (3) RPI-1 percent for the period April 1995 to March 1997.36 BAA's revenue ceiling is lower than most other privatized enterprises (not lower than telecoms or gas) because the CAA projects that air traffic will continue to grow.37 The CAA staggered the RPI-X formula in order to increase efficiency in the first two years and to create an incentive for BAA to undertake new capital infrastructure projects in the medium term.38 In particular, the RPI- I formula represented a compromise in which the CAA adopted a higher revenue ceiling in exchange for the development of a fifth terminal at Heathrow. (For a more technical explanation of the pricing formula used to regulate airport pricing structures in the United Kingdom, see Annex 9.1). Figure 9.3 outlines the regulatory structure for the determination of BAA airside rates and summarizes the means for resolving complaints against purported abuses in the BAA!s monopoly position. Figure 9.3 U.K., BAA: The U.K. Airport Regulatory Structure

MMC '~~~~~~~~~~Sec.of State) CAC AAjudicial Revie (

Pnmary Comprehen- Final Appeals, Final Re.,ew sive RF,eew & Peniew Enlorcement Approval Recommenda- 1,ins lonly when necessary)

Dorres)c Ior Intemational or European Uron n \~~~~~~~~ or CAA Bilateral Treaties European Cormrrissirn MMC Infernational Courts Judicia! Reviei Sources: BAA; CAA; Center for the Study of Regulated Industries; MMC; U.K. Parliament.

36 From 1988 to 1993 the formula for Manchester Airport was RPI-1; from 1993 to 1998 the formula is RPI-3.

37 For the period 1992-97, the MMC recommended RPI-4 (and RPI-I for Heathrow). The staggered pricing structure also represents a compromise between the CAA and the MMC. In its conclusions, the CAA stated that the importance of London as a gateway hub to Europe will encourage steady growth in air traffic. The CAA also predicted that the Channel Tunnel will have a minimal effect on air traffic in the United Kingdom.

38 With hindsight, the CAA admits that a regulatory structure with investment incentives should have been implemented after the 1986 review.

300 Case Study 9 UNITED KINGDOM: BRITISH AIRPORTS AUTHORITY

In theory, complaints against purported abuses of monopoly position can be taken to the MMC or the High Court of England. However, the MMC's role as the final arbiter of airport regulatory activities in the United Kingdom has been su- perseded by international institutions and treaties. Two prominent cases illustrate this supposition. The first case involves a complaint by London Luton Airport, which accused BAA of setting artificially low airside charges at Stansted to capture market share away from Luton. The CAA examined this complaint and agreed that airside charges at Stansted caused Luton material harm because of their low level. Nevertheless, the CAA concluded that BAA was acting in a "loss-minimizing" as opposed to a "predatory" manner. The CAA also ruled that BAA was following the government's long-standing pre-privatization policy of developing Stansted as the third largest London airport. Luton took the case to the European Commission where it is presently in the early stages of consideration because it was not entitled to appeal to the MMC or ask for judicial review which only covers procedural failure (cannot review decisions). The second complaint was raised by U.S. airlines, which charged that airside fees at Heathrow are "unjust and unreason- able" and in violation of a bilateral agreement guaranteeing non- discrimination of aircraft. 39 An international tribunal ruled that airside charges at Heathrow were not excessive but that the calculation of airside charges at Gatwick and Stansted could be construed as discriminatory.40 As a result of this ruling, the bilateral Bermuda II Treaty was redrafted to factor in the impact of regulation. These cases have led to a reexamination of the roles of the CAA and the MMC. This could also include the elimination of the MMC's role in reviewing airport pricing schedules. The CAA is also responsible for overseeing the distribution of airport flight slots in the United Kingdom. Slots are allocated through market mechanisms (for example, peak period rates) or, more commonly, through administrative (non- market) procedures. At BAA airports administrative allocation is carried out every six months by an in-house coordinator employed by Airport Coordination Ltd. (ACL), an association of

"I Part of this complaint centered on the fundamental disapproval on the part of the U.S. airlines of the RPI-X formula and on the different airport pricing systems utilized by U.S. and U.K. airports.

40 BAA, the CAA, and the MMC had argued that the three airports should be operated as a system and that the lower profitability of Gatwick and Stansted should be offset against the higher profitability of Heathrow.

301 AIRPORT PRIVATIZATION EXPERIENCES

the eight largest domestic airlines. In contrast in the United States, Airline Scheduling Committees (ASCs) play more of an advisory role and are not charged with the allocation of slots. If at any time discriminatory practices are revealed, the CAA has the authority to relieve ACL of its duties and to manage slot allocation itself. At present, slot allocation is governed by the following rules (in descending order): (1) GrandfatherRights - previous users receive preference; (2) Use It or Lose It - infrequent users lose slot privileges; (3) Priorityfor Regular Services - priority is given to the carrier that plans to use the slots more frequently; and (4) DiscretionaryPriority - priority is given to carriers trying to accommodate differences in day- light saving regimes or to larger aircraft. Grandfather rights is by far the most dominant rule (95 percent of runway traffic is allocated on this basis), which can make the market impenetrable to new entrants. To increase competition, the EC has mandated that 50 percent of new or unused slots must be allocated to new entrants.

G. BAA's Privatization Process

The 1986 Airports Act dissolved the corporatized BAA and transferred its assets, rights, and liabilities to seven subsidiary companies held by BAA plc. The Secretary of State retained ownership of BAA's 500 million shares up to the time of the listing on the London Stock Exchange and the concomitant sale to investors. For this sale, 260 million ordinary shares were offered to the general public and 240 million were tendered to institutional investors. (Box 9.1 describes the privatization process). The

Box 9.1 PRIVATIZATION OF BAA PLC: DESIGN OF THE TRANSACTION Structure of Offer 1. An offer of 500 million shares was made by the investment banks, County Nat West and J. Henry Schroder Wagg & Co. Limited, on behalf of the Secretary of State. The shares were offered for a fixed price ot 245 pence per share. A total of 125 million shares was reserved for tender; however, offers had to be at or above the fixed price. The offer was structured in the following way: (i) 260 million Ordinary shares, at the tixed price. were of- Continued.... fered to the general public.

302 Case Study 9 UNITED KINGDOM: BRITISH AIRPORTS AUTHORITY

(ii) 240 million Ordinary shares were placed with institutional Box 9.1 investors. Of the 240 million shares. 115 were offered at the (concluded) fixed price and 125 million will be reserved for tender offers. for which the general public may submit applications.

Allocation of Shares 2. Priority in the allocation of shares of up to 25 million was given to directors, employees, and pensioners of BAA. structured in the following way:

(i) 'Free Offer - 41 Ordinary shares per individual were offered, free of charge. to eligible employees. (ii) "Matching Offer"- Eligible employees were offered the right to purchase 82 Ordinary shares, at the fixed price. The government would then match two shares for each share purchased, free of charge. (iii) "Priority Otter"- Eligible directors, employees. and pensioners can file an application tor Ordinary shares at the fixed price. The application will receive pnority. However. it is limited to 4.082 shares 3. No one individual can obtain shares in excess ot 10 percent ot the total shares offered initially. The Secretary of State has the option to use the "Golden Share" to ensure that no one individual obtains more than 15 percent of the total shares in the future. Payment 4. Payment for the shares was made In two instalments: (i) For Ordinary shares 100 pence was payable upon application and the remaining 145 pence was payable 10 months later, on May 18, 1988. (ii) For tender shares the amount minus 145 p was payable upon application with the remainder due on May 18, 1988. Employee Provisions 5. There were no special employee provisions made prior to privatization. Employees were not liquidated or restructured. After privatization it was the responsibility of the individual companies to structure an employee program. Investment Provisions 6. There were no investment requirements in place at the time of privatization. Investors were not required to make any structured investments into the company.

303 AIRPORT PRIVATIZATION EXPERIENCES

depth of the domestic financial market permitted the government to float shares, which produced a more diversified shareholder base and allowed for relative ease in trading shares. In the initial offering, sales of the shares were limited to domestic investors. Foreign shareholders now hold 9 percent of BAA's total equity shares. For private investors, the acquisition of BAA shares has proved a good investment. From 1988 to 1994, the internal rate of return to investors has been 17.25 percent and the value of net assets per share has almost tripled. Moreover, the priceleamnings ratio of BAA's stock is one of the highest listings on the London Stock Exchange (19.6). Table 9.6 summarizes BAA's current stock ownership profile.

Table 9.6 BA's Shareholder Profile (as of May 22, 1995)

Number of % of Total Number of Category Shareholders Shareholders Shares Capital

Type ot Holding Private Individual 493,622 94.31 174,752,931 16.99 Pension Funds 668 0.13 305.848,915 29.74 InsuranceCompanies 132 0.03 185,301.548 18.02 Overseas Holders 404 0.08 94,219,229 9.16 Private/Investment Trusts 36 0.01 13,697,239 1.33 Unit Trusts 47 0 01 7,253,419 0 71 Other Corporate Holders 28.496 5.44 247 227,575 24.04

*^ Xdsci;S4< .:"lw \r">>> ;2f:S>$; 405 - 100.00- -:1,028 8W5- 100600;

Size of Holding 1 - 500 467,357 89.29 103,606,082 10.08 501 - 1,000 26,888 5.14 20,106.323 1.96 1,001 - 5,000 25,240 4.82 48.326.666 4.70 5,001 - 10,000 1,807 0.35 12,852,433 1.25 10,001 - 30,000 787 0.15 13,705,164 1.33 30,001 and abave 1.326 0.25 829,704,188 80.69

'.Va vs.> - ~ ;S: *XZ. ; .$,0.100:Z 0s 30t 61 . _100 Source: BAA pic Annual Report, 1995.

304 Case Study 9 UNITED KINGDOM: BRITISHi AIRPORTS AUTHORITY

As a disincentive to speculation and also to encourage the stable holding of shares, the government instituted a share bonus program.4' In order to avoid concentrated ownership and takeover battles, individual share holding is limited to 15 percent of BAA's total shares. Up to 5 percent of BAA shares was reserved for employee stock programs. The government retained a "Golden Share" which gives it a voice over proposed additions/divestitures of airports, and the dissolution of BAA subsidiaries, and also gives it the right to regulate economic activities. Otherwise, the government has little influence over operational decisions. The 1986 Airports Act also established the legal framework for the economic regulation of privatized and corporatized airports. As with other privatized state-owned enterprises (SOEs) in the United Kingdom, the BAA's pricing structure was indexed by the Department of Transport (through CAA) to inflation.42 In contrast to other privatized SOEs, BAA's review by the MMC is mandatory every five years but the MMC's role is advisory and non-binding. The CAA eschewed the public utility approach taken in the United States which guarantees a fixed long-run rate of return because of the lack of incentives for improving productivity or developing other sources of income. In addition, a fixed long-run rate of return creates a bias toward capital-intensive operations. For this reason the Airports Act instituted price controls that vary over the medium run and are reviewed every five years.

1. Objectives Achieved through Privatization

With the objectives of reducing public debt burdens and increasing entrepreneurial activities, the Thatcher Government launched an extensive series of privatizations which included the sale of British Telecom, British Gas, British Aerospace, British Airways, and BAA. The economic objectives of privatizing BAA were: (1) to ensure that airports operate as commercial enterprises; (2) to impose efficiency improvements; and (3) to increase access to private capital. In the seven years after privatization, these objectives have largely been achieved. BAA has been extremely

41 Only individuals were eligible to receive bonus shares.

42 Similar pricing structures were instituted for the privatized gas, water, telecommunications, and petroleum industries.

305 AIRPORT PRIVATIZATION EXPERIENCES

profitable and commercial activities constitute the majority of BAA's revenues. Moreover, BAA has been able to diversify and offer its expertise to other airports. In addition to enhancing revenue generation opportunities, privatization has led to the introduction of significant efficiency gains in airport operations. Since privatization there has been a 27 percent increase in staff productivity and a 20 percent decrease in total staff. The goal of improved access to capital market funds was also achieved. Immediately after privatization, the BAA obtained £650 million from the capital markets. Of even greater significance, BAXs earnings per share grew by an average of 14 percent per year.43 Improvements in revenue generation and productivity have led to an almost five-fold increase in BAA's stock price, between 1987 and 1994.44 By comparison, the stock price of other privatized transport and utilities companies in the United Kingdom increased by an average of 54 percent. BAA's stock price also vastly outperformed the FT All-Share, a composite of U.K. companies which grew by nearly 60 percent during the same period.45

2. Financial Performance after Privatization

BAA plc is one of the few cases of full private ownership in the airport industry. Its shares are listed on both the London and Toronto Stock Exchanges. BAA plc has been very profitable in recent years, particularly in fiscal year 1995 when it reached record profits before dividends of £279 million (see Table 9.7). Its total net worth is equivalent to £2,845 million with fixed assets totaling £4,009 million. Total employment during this period was 8,170 workers.46 Profit ratios as a percentage of revenues have remained practically unchanged in the period before and after privatization, but from an individual investor point of view the profitability of investments (capital gains + dividends) increased substantially after privatization. The market value of the share (Lon-

" BAA plc Annual Report, 1995.

44 The initial share offer price was 245 pence per share. This increased to 541 pence per share as ofAugust 16,1994 (equal to 1082 pence in old shares precedinga2 for I swap). I BAA plc Annual Report, 1995; FinancialTimes, Stock Market Publication and Offers on Calculations, 1995.

46 BAA plc Annual Report, 1995.

306 Case Study 9 UNITED KINGDOM: BRITIS-II AIRPORTS AUTHORITY

Table 9.7 U.K., BAA: BAA's Financial Highlights, 1986-95 (year ended March 31)

Passengers 53.4 55.3 63 7 68.0 71.3 72 0 72.0 77.7 82.0 877 (millions) Movemenis (OOOs) 619 626 680 715 766 791 815 847 871 895

Financial Highlights (f milhons) Revenues 396 439 523 630 746 834 903 952 1,098 1.159 Profits betore Ta. 119 122 166 198 255 247 191 285 322 366 Profits afterTax 83 78 105 137 185 189 153 211 240 279

Profit Margin (%) 21.0 17.8 20.1 21 7 24.8 22.7 169 22 2 21.9 241

Per Share DataI

DividendVShare (p) - - 3 6 4 5 58 6.5 7.3 80 9.0 10 1 Earning.'Share ip) 8.3 7 8 10.5 137 185 189 15.2 209 23.5 273 Net AssetsIShare If) 0.55 0.70 090 1 41 1.89 1 87 1.87 01 249 2.77

I Comparative per share data have been adjusted for the one-for-one capitalization issue in July 1994. Note: Exchange rate data are as follows: 1986: £1=US$1.47; 1987: £1=US$1.64; 1988: £1=US$1.78; 1989: £1=US$1.64; 1990: £1=1.79; 1991: £1=US$1.77; 1992: £1=US$1.77; 1993: £1=US$1.50; 1994: £1=US$1.53; FY1995: £1=US$1.56. Source: BAA plc Annual Report,1995. don Stock exchange) was £5.41 on August 16, 1994. For shares bought in the initial offering, the internal rate of return for the period was 17.25 percent.

Since privatization,4 7 BAA plc has consistently invested in airport-related assets (excluding investments in other businesses such as real estate companies) in excess of the total amount of the net profits generated by the group, and in some cases in excess of the cash flow generated by the operation. This means that BAA plc has borrowed in the financial markets to maintain the pace of the investment demands on its airport system. Table 9.8 shows, for fiscal years 1989 to 1995, the total capital expenditure program in relation to the profits and cash flow generated by the operation.

I Analysis of the capital expenditure program before privatization was not possible because of lack of information at the time the research was conducted.

307 AIRPORT PRIVATIZATION EXPERIENCES

Table 9.8 U.K., BAA: BAA's Capital Expenditure Program, 1989-95 (year ended March 31) (f millions)

-MII e I*NN 1OW r e Capital Expenditures 182 191 269 384 196 245 411 Profts after Tax 137 185 189 153 211 240 279 Funds from Operations 193 172 180 175 99 390 345 (less dividends) Capital/Profits Ratio 1.33 1.03 1.42 2.51 0.93 1.02 1.47 Capital/Funds Ratio 0.94 1.11 1.49 2.19 1.98 0.63 1.19 Note: Exchange rate data are as follows: 1989: £1=US$1.64; 1990: £1=US$1.79; 1991: £1=US$1.77; 1992: £1=US$1.77; 1993: £1=US$1.50; 1994: £1=US$1.53; FY1995: £1=US$1 .56. Sources: MMC, 1991 Economic Regulation Report; BAA pic Annual Report, 1995. In the three-year period from 1994 to 1997, BAA plc plans to invest £1.4 billion in airport-related assets. The major projects considered within this program are: (1) Heathrow Ex- press, a joint venture with British Rail that will provide surface rail transportation between central London and Heathrow (£300 million); (2) the development of Terminal 5 at Heathrow (over £100 million to date); (3) Heathrow's Flight Connections Cen- tre, which will make connections easier at Heathrow (£100 million); and (4) the development of new facilities at Gatwick's North and South Terminals (£67.2 million).48

48 BAA plc Annual Report, 1995.

308 ~...... y S UNITED KINGDOM: BRITISH AIRPORTS AUTHORITY

V. KEY ISSUES EMERGING FROM THE UNITED KINGDOM EXPERIENCE

The privatization experience of BAA provides several important lessons that can be useful to future airport privatization pro- cesses. * BAA attained and improved profitability under a corporatized structure before privatization. Obtaining profitability is vital to attracting private sector funds in airport privatization projects. Moreover, BAA's nearly 21-year tenure as a corporatized entity provided it with the experience needed to improve operational efficiency, to increase and improve the level of commercial services, and to develop successful long- term growth strategies. Other countries have learned from the BAA experience and have shortened the period between corporatization and privatization. 49 * An adequate regulatory structure must be established in order to prevent abuses of the naturalmonopoly position of airports. The difficulty in establishing the proper economnic regulation reflects the need to balance profitability, productivity, and investment incentives with potential price-goug- ing considerations. In this respect, the U.K. model is still a work in progress. In 1991 the CAA restructured the previous regulatory framework in order to incorporate new economic realities and add efficiency incentives. The five-year review cycle permits the regulatory framework to be flexible over the long term. Another important element of the regulatory structure is the continued vigilance over BAA's activities. A recurrent problem in the developing country context is not the lack of a regulatory structure but the lack of supervision and of the concomitant ability to enforce penalties. However, the regulatory framework implemented in the United Kingdom has an important disadvantage in that supply/demand functions are performed by the same agency. Not only is the CAA the main supplier of ATC activities but it is also in a unique position to regulate its competitors. This arrangement holds potential conflict of interest implications. Moreover, the CAA also regulates both airport safety and economic activities, which could lead to inappropri-

49 Vienna took 15 years to privatize its airports. Australia is reviewing privatization after 1 year. Argentina is looking to privatize its airports without the intermediate step of corporatization.

309 AIRPORT PRIVATIZATION EXPERIENCES

ate policy directives. The fact that the government is considering privatizing ATC services and restructuring the CAA demonstrates a partial awareness of the problem. The BAA experience has demonstratedthe extremely lucrativepotentialfor developing airportcommercial activities. BAA's commercial activities have reduced BAA's dependence on airside charges and have made it into an extremely profitable enterprise. Over 60 percent of BAA's revenues are derived from non-aeronautical activities. BAA airports that are loss-makers in their airside activities (such as Gatwick) are profitable because their commercial revenues offset these losses. In most developing countries, airport revenue profiles tend to be the opposite of that of BAA (airside 60 percent, landside 40 percent), and airports are typically unprofitable enterprises. In- creasing development of commercial activities can improve the profitability of airports in developing countries. 0 Privatization has allowed BAA to engage in non- airportactivities, albeit with mixed results. The primary advantage of diversification is reduced dependency on airside revenues, which increases resiliency to decreases in passenger flows and other economic shocks. The main drawback of diversification is that it can also lead to the conscious decision of airport operators to supersede operational objectives by purely commercial ventures.50 Another potential disadvantage is that airport activities could subsidize operational losses in non-airport enterprises. 5" Although the RPI-X formula limits the cross-subsidization of airports, the lack of a similar regulatory mechanism in the developing country context could worsen the economic perforrnance of airports. Moreover, in BAA's case, commercial activities remained unregulated and the potential for price discrimination has not been eliminated. After privatization BAA developed a reputation for being a "aggressive monopolist"5 2 owing to its implementation of taxi stand, bus-pickup, and car parking fees. In 1990 BAA agreed to index increases in car parking fees to inflation and the Office of Fair Trading (implementing Fair Trading Act) withdrew its threat. Nonetheless, this incident highlights the need for regulation of selected landside activities (those under monopolistic supply) of privatized airports.

50 One example is the development of a disco instead of a new arrivals area. Another is speculation in real estate rather than use of funds to renovate an old terminal.

51 The New York Port Authority, which owns New York's La Guardia and JFK Airports and is also involved in rail, bridges, and real estate, is a prominent example. 32 52 Rigas Doganis, The AirportBusiness, Routledge: London and New York, 1991, p. .

310 Case Study 9 UNITED KINGDOM: BRITISH AIRPORTS AUTHORITY ANNEXES ANNEX 9.1 REGULATORY REGIME FOR AIRSIDE CHARGES

The 1986 Airports Act gave the CAA the responsibility for monitoring airport charges. The CAA uses a price ceiling mechanism' to limit the maximum amount assessed per passenger through aircraft landing fees, aircraft parking fees, and passenger fees.2 These airside charges are limited to a fixed number of percentage points (X) below the U.K. retail price index (RPI), which results in a fall in real prices. The X number of percentage points is set to reflect a variety of factors including productivity and efficiency gains, the effects of technical changes, expected changes in real costs, and an implicit allowable rate of return. This formula provides strong incentives for the operator to pursue greater operational and cost efficiencies, since all of the associated financial rewards beyond those anticipated by the regulator by the X factor accrue to the operator. In addition, the CAA takes into account changes in security requirements that the U.K. Government places on airport operators. The CAA sets price ceilings for five-year periods in order to provide enough time so that BAA has the incentive to seek efficiencies without fearing that any profit gains will be lost through annual rate-setting exercises. For the first five- year period subsequent to BAA's privatization (April 1987 - March 1992), the Department of Transport used the following simplified formula to control prices which was implemented by the CAA: RPI - 1% + S S = 75 percent of any additionalsecurity costs arisingfrom higher security standards imposed by the Government (after a delay of two years). In four of those five years, BAA achieved a return on revenues (after tax) of over 20 percent, as BAA benefited from (1) a steady increase in passengers leading to increased revenues; (2) excep-

' Another popular form of regulation of utilities is rate of retum regulation. This method, however, provides no incentive for the operator to pursue cost reductions, as all profit benefits are captured.

2 This method of limiting the revenues from airport charges per passenger handled is called the "revenue yield" method.

311 AIRPORT PRIVATIZATION EXPERIENCES

tional growth in revenues from commercial activities; and (3) its ability to achieve cost efficiencies (partly attributable to scale economies). For the period April 1992 - March 1997, the CAA revised its price ceilings to the following formulae: Years I & 2 RPI-8% +S Year 3 RPI-4% + S Years 4 & 5 RPI - 1% + S S = 95 percent of any additional security costs arisingfrom higher security standardsimposed by the government. The staggered pricing formula reflects the CAAs belief that more efficiencies can be gained in the earlier years, while it recognizes the need for BAA to earn an adequate return on new investment that will be needed when it begins Terminal 5 at Heathrow Airport in the latter part of the period 1992-97. The CAA also increased the allowable recovery of security costs to 95 percent because of new security restrictions in the late 1980s. The above formulae have been simplified to reflect the key concepts of the CAA's price ceiling mechanism. In practice, the CAA uses a combination of three equations to take into account the time lag in determining revenue yields and inflation rates. The first equation deals directly with the price cap and specifies the maximum average revenue yield per passenger for year t (M,). Equation I

Ml 1+ 100 ) K where

RPI, = the percentage change in the RPI between year t and the immediately preceding year

X = the specified X factor for BAA Y,, = the base yield, as specified below in Equation 2 K, = the correction per passenger to be made in year t, as specified below in Equation 3

312 Case Study 9 UNITED KINGDOM: BRITISH AIRPORTS AUTHORITY ANNEXES The second equation specifies the yield base to which RPI-X is applied, since at the time charges are set, data from the previous year are not yet available. This equation takes the yield from two years previously and uprates it by RPI-X for the previous period, adding to it any additional security costs from two years previously, to derive the "specified average revenue yield per passenger" (Y,): Equation 2

I =t (l + RPIt - i- X XYt-2] + St-2 [( 100 ) ] where

S12 = allowable additional security cost per passenger using the airport in year t-2. The final equation specifies a correction factor that depends on the difference between actual revenue and allowable revenue two years previously, and reflects the time lag between the current rate setting proposal and the latest year for which revenue yield data are available. The difference is uprated by an interest rate (the T-bill rate expressed as an annual percentage) in year t- 1. Equation 3

K.=Tt- 2 -(Qt - 2Mt - 2) (1 Lt- 2)2 Kt Qt - 2 +100 where

Tr2 = total revenue from airport charges in year t-2

Qt 2 = passengers using airport in year t-2

't-2 = interest rate in year t-2 (+3 percent if over-recovery). The correction factor can be positive or negative, depending on whether BAA over- or under-recovered in year t-2. When BAA over-recovers, a 3 percent interest rate penalty is applied. Equation 1, which incorporates Equations 2 and 3, therefore takes into account changes in allowable security costs from two years previously and correction factors for whether the yield of two years previously exceeded or fell short of actual revenue yield.

313 AIRPORT PRIVATIZATION EXPERIENCES

Box A9.1 THE "REVENUE YIELD" METHOD'S CONTRIBUTIONS

TO CONGESTION, NOISE, AND ENVIRONMENTAL WORRIES The following is based on the article "Why Heathrow is Hell" that appeared in The Economist. August 26, 1995: Recently, the "single till" approach has been criticized for fur- thering problems with BA's management of the three Lon- don airports (Heathrow. Gatwick, and Stansted). Heathrow is so congested that a new terminal is being considered for construction (Terminal 5) in order to meet an expected excess demand ot 24 million passengers within 10 years. At the same time, Stansted. with a capacity of 15 million passengers (ex- pandable to 30 million by The year 2005). handles 3.5 million passengers. However, it costs 30 percent less to land a Boe- ing 747 at Heathrow than at Stansted! Although other charges make Heathrow more expensive in relation to Stansted, it remains one of the world's cheapest airports (airport charges are barely one-third of those at Narita-Tokyo). Critics of London's airport system argue that the system of price regulation determined by the RPI minus an x factor only worsens matters because in assessing the value of the x factor the CM takes into account profits earned from Heathrow's various unregulated businesses (duty-free sales, car parking, restaurants, etc.) whereby the higher these profits are the lower the regulated airport charges are. Theoretically 'single-tillr price regulation could result in airlines being paid to land at Heathrow. The pricing regime creates a situation that makes Heathrow even more attractive than the other London airports, thus leading to additional excess demand, noise pollution, and environmental concerns. Meanwhile. across town Stansted barely has enough traffic to stay afloat and cannot count on the lucrative unregulated businesses at Heathrow to drive down landing fees and make it attractive to airlines already hesitant to fly there.

314 Case Study 10 VENEZUELA

AIRPORTS IN VENEZUELA

A CASE STUDY IN DECENTRALIZATION OF AIRPORT OPERATIONS'

In 1989 the Government of Venezuela began taking steps toward political and economic reform. For the first time, regional governors were elected rather than appointed by the President. A decentralization policy was adopted to allow for the transfer of operational responsibilities of ports, toll roads, and airports to regional governments. This decentralization program was a tool through which governors could gain greater autonomy for their regions. In provinces with aggressive governors, transference of operational duties was rapidly sought. For example, in the State of Zulia, where the decentralization policy was first implemented in June 1992, the governor not only aggressively pursued the decentralization of the airports in his state but also pushed for their privatization. The reasons given for embarking on a privatization effort included the need to (1) minimize the effects of political ups and downs at the state government level (state elections are held every three years), and (2) create a better environment for a long-term airport development process. However, in some regions, including the State of Zulia, the transfer of responsibilities began before sufficient institutional capacity was in place. Three airports (two domestic and one international) were transferred and privatized in this envi-

' Research for this case study was conducted between September and November of 1994.

315 AIRPORT PRIVATIZATiON EXPERIENCES

ronment. Shortly after the privatization of operational responsibilities, regional elections were held and a new govemor was elected. Given that the airport privatization process was not adequately implemented, the new government found cause to ter- minate the concession agreement and return operational responsibility to the regional airport authority. As of June 1995 there have been no further attempts at airport privatization within the province. The State of Zulia's airports privatization attempt, and the reasons for its failure, are discussed in detail in this case study. Although completed only recently (February 1994), the decentralization and subsequent privatization of the Santiago Marifio International Airport, on the Island of Margarita, has had a positive outcome. Passenger traffic and aircraft movements have increased significantly since the transfer of the airport's operational responsibilities to a private company (a local consortium, Consorcios CVA, with a technical assistance agreement with Hughes Aircraft Co., Airports Management Division). Re- gional government (State of Nueva Esparta) airport revenues from the concession are much higher than before the privatization, and the new operator will begin expanding the intemational passenger terminal in early 1996 (estimated investment of Bs 11.2 billion, equivalent to US$100 million at February 1994 exchange rates). With two such different experiences, Venezuela's debate on privatization still remains open. Positions on privatization vary from the belief that the state should divest itself from the production of goods and services and become an efficient policymaker and regulator, to positions justifying the return of the economy to state control.

I. OWNERSHIP AND INSTITUTIONAL FRAMEWORK

Venezuela's airport system is comprised of 36 commercial airports. Of these, 25 serve domestic routes and 9 serve both domestic and international routes. Two airports are civilian/military hybrid airfields servicing commercial flights on a regular basis. About 13.8 million passengers, 79 percent domestic and 21 percent international, used the system in 1993. Owing to its geographic position, Sim6n Bolfvar International Airport in

316 Case Study 10 VENEZUELA

Maiquetfa has developed into the hub airport for the Caribbean, and for South and Central America. Most of Venezuela's 2.9 million international passengers travel through this hub. By the year 2000, over 4 million international passengers are projected to travel through Venezuelan airports. The Ministry of Transportation and Communications (MTC) holds jurisdictional authority over Venezuelan aviation activities. Within the MTC, the General Air Transportation Sec- tor Authority (Direcci6n General Sectorial de Transporte Areo [DGSTA]), which reports directly to the Vice-Minister for Trans- portation and Communications, is responsible for all aviation sector regulatory and administrative duties. DGSTA also directly operates 21 of the nation's domestic airports with an estimated traffic flow of approximately 1.5 million passengers per year (see Annex 10.1 for the list of airports operated by the MTC). Maiquetfa International Airport Autonomous Institute (IAAIM) is the sole managing body for seven intemational airports it administers (see Table 10.1). The IAAIM is under the tutorship of the MTC.

Passengers/Year Table 10.1 State Domestic Venezuela: Traffic at * Slmn Bolivar International Federal 4,644,822 2.460,726 IAAIM Operated District Airports, 1993

Barcelona, J.A. Anzoategui Anzoategui 701.266 47,826

Puerto Ordaz, Gral. M. Piar Bolivar 541.249 1,474

Barquisimeto, Jacinto Lara Lara 477,110 12,503

SSan Antonio del Tichira Tachira 260.264 N/A

Marturin, Jose T. Monagas Monagas 250,045 N/A

Cumana,Antonio J. de Sucre Sucre 172,330 N/A #V4* , .

Source: MTC, Annual Report, 1993.

During 1992, six regional airports were transferred to the local authorities under the Decentralization Law of Decem- ber 28, 1989. Table 10.2 provides information on the six decentralized airports (including two international airports).

317 AIRPORT PRIVATIZATION EXPERIENCES

Table 10.2 Passengers/Year Venezuela: Decentral- State Domestic l ized Airports under I Arturo Michelena, Valencia Carabobo 219,359 30,829 Regional Government Ora. S. Salom. Pto. Cabello Carabobo N/A WA Administration, 1993 a _ Santiago Marifio. Margarita N. Espana 1,328,690 120,662 La Chinita, Maracaibo Zulia 858,972 103,066 Oro Negro Zulia N/A N/A Santa 5arbara Zulia NIA N/A Total 2,407,021 254.557 N/A =not available (airports with traffic below 100,000 passengers per year). Source: MTC, Annual Report, 1993.

DGSTA and IAAIM have administrative freedom in the management of their respective airports including the financial management. Both agencies collect revenues from airport operations into a central budget from which they allocate budgeted amounts to individual airports. However, DGSTA is very much entrenched in the bureaucratic maze, which blurs the lines of responsibility and creates a difficult environment for formulating a viable business culture. In addition, DGSTA, and the MTC as a whole, lack the trained personnel (air transport specialists) needed to operate airports as a business. Although IAAIM is not entirely free from the bureaucratic problems that beset DGSTA, partly because it has not been fully corporatized, it is in a significantly better position to create clear and efficient lines of direction, management, and authority. LAAINJ's status as a semi-corporatized agency allows it some discretion over operational divisions. Figure 10.1 shows the institutional organization of the airport sector in Venezuela. DGSTA is responsible for (1) the provision of air navigation services (air traffic control [ATC], telecommunications, etc.); (2) the regulation of the civil aviation sector (including air safety, licensing, admninistrative overseeing of all airports, etc.); and (3) the management of operations and facilities for 21 domestic airports. DGSTA's functions are carried out through four divisions. 1. The Airports Division (AD), whose responsibilities include: interpreting and applying regulations issued by the International Civil Aviation Organization (ICAO); and developing and planning airport policies.

318 Case Study 10 VENEZUELA

,C Regional ' Figure 10.1 MTC - - - -- Governmtents ) Venezuela: Airport - _- # s Sector Organization Chart IAAIM

DGJSTA .i i TA , I Decentralized International Decentralized

_ | Decentralized Dnmestic r i Airports

Source: World Bank, CFSPS, November 1994.

2. The Civil Aviation Division (CAD), whose powers include: (1) planning, developing, and operating air traffic services under the relevant ICAO regulations; (2) regulating and managing all air traffic services, which range from air space control surrounding terminal areas to overseeing and authorizing the operation of aircraft and related equipment; and (3) establishing the pricing policies for air navigational charges and airport-related charges under DGSTA's administration. 3. The Air TransportationDivision (ATD), which has been vested with the power to draft, execute, and implement policies and terms of bilateral and multilateral national and international agreements. 4. The Air TransportationEngineering Division (ATED), whose responsibilities are to plan, develop, protect, and maintain air navigation support systems, including equipment, maintenance, and facilities. Venezuela's commercial airport system allows for additional ownership and/or management schemes. Three airports are municipal property, although MTC-operated, and two are jointly operated by the MTC and the Ministry of Defense (military air bases). Private ownership exists only in airports intended for smaller aircraft use (i.e., aeroclubs).

319 AIRPORT PRIVATIZATION EXPERIENCES

Box 10.1 summarizes Venezuela's decentralization program.

BOX 10.1 11 Box 10.1 DECENTRALIZATION PROGRAM Venezuela has been undergoing a political and administrative decentralization process since the early 1990s. For the first time regional govemors are elected rather than appointed by the President. Under this process, operational responsibilities for ports, toll roads, and airports were transferred to regional authorities. Since all responsibilities had previously been managed by the central government, the regions had to create local institutional capacities. The degree and speed with which the local govemments assumed these operational activities depended on the aggressiveness of the local govemments. Consequently. there were no uniform transfers, and institutional capacities did not always match the initiatives undertaken. A factor constraining a complete decentralization process was that only operational responsibilities were transferred to local authorities; all duties pertaining to ownership remained the responsibility of the central govemment.

See seciicn IV for funthr iniormalon on the prcess.

II. REGULATORY FRAMEWORK

DGSTA-ascribed airportsreceive their operating budgets from revenues generated by airport activities and from DGSTA budgetary allocations where necessary. At the present time a passenger airport tax has not been established at DGSTA-managed airports. The staff in these airports is wholly appointed by the central government. IAAIM-ascribed airports receive their budgets from IAAIM's own centralized budget, which allocates mninor amounts to be directly managed by each airport and appoints the corresponding officials. By 1991, IAAIM's budget income was distributed asfollows: (1) 91 percent generated by airport fees and charges (i.e., airside revenues), and (2) 9 percent generated by the commercial concessions (i.e., landside revenues). It may be assumed that income allocation remains proportionately the same. IAAIM is fully empowered to set landside charges at the airports it manages, as well as airport taxes paid by passengers

320 Case Study 10 VENEZUELA

(see Table 10.3). IAAIM has full discretion to negotiate leases and concessions for commercial areas as well as sole discretion in property valuation, on the basis of property size. In addition, IAAIM acts as a collection agent for DGSTA-set airport taxes and airside service fees, including air navigational fees. How- ever, the Government of Venezuela retains full ownership of all assets of the nine international airports.

Table 10.3 Day landing rates Night landing rates Venezuela: Airport- International Traffic Related Charges at Bs per ton 765.00 935.00 IAAIM-Managed Airports Minimum fee 2,210.00 3,400.00 (Bs) ' I Domestic Traffic Bsperton 11.99 40.00 Minimum fee 120.00 120.00

International Domestic Each hourifraction 127.50 2.01 Minimum fee 3.400.00 99.99

Intemational Domestic Bs per passenger 800.02 40.00 Bs170 - US$1 (October 31,1994). Source: MTC, October 1994. For further details of fees, see Annex 10.3.

Landing and aircraft parking fees, as well as passenger airport tax rates, etc., are determined by the corresponding local entity of ascription. The MTC, through DGSTA, sets airport- related charges for all facilities under its management while IAAIM sets those for the seven international airports that it holds (see Annexes 10.2-10.5). Finally, regional governments and military air bases autonomously set their corresponding airport-related charges. The commercial activities provided at both domestic and international airports include office and counter space rental; the negotiation of these agreements is the responsibility of each individual airport. Services such as transportation to and from the main terminal, ground handling services, jet fuel, catering, and others are provided by third parties through concessions. The Central Administration Law (Ley de Administracion Cen- tral) vests the MTC with the powers to provide air transport- related services. However, the MTC is empowered to grant the provision of such services to private firms under concession

321 AIRPORT PRIVATIZATION EXPERIENCES

schemes. The MTC, through DGSTA, performs a multiple role of owner, regulator, policymaker, and operator in Venezuela's airport system.

Ill. FINANCIAL PERFORMANCE -- IAAIM2

IAAIM generates its own revenues from service and other commercial operations fees. As was mentioned above, IAAIM airports receive budget allocations from the institute's central budget. However, this dependency on central budgeting led to a lack of adequate capital budget allocation and also to a lack of funding for infrastructure maintenance and replacement. As of July 31, 1994, IAAIM held debts of approximately Bs800 mil- lion3 for telephone, power, and water services. It is believed that airports under IAAIM management have not received necessary maintenance work for some 20 years. Consequently, the current budgeted sum for major maintenance projects is approximately Bs4,080 million.4 At present, IAAIM would not be able to fund these maintenance costs. Efforts were made to research the financial performance of IAAIM, but lack of information resulted in a partial portrayal of IAAM's financial situation (see Table 10.4).

Table 10.4 Venezuela: IMIM - Budget Allocation Operating Income (Bs millions) ' Percent of Percent of 1992 total revenues 1993 total revenues Revenues 2.606.84 100.00 3,257.96 100.00 Operational Costs 2,269.10 87.04 2.970.01 91.16 O$gt3IlngbIcas -337.74 12.96 287.14 684

' Bs/US$ average exchange rate in 1992 = 68.4, and in1993 = 91.5 Bs to the US$ (Central Bank). Source: MTC, Annual Report, 1993.

2 Financial infornation for DGSTA-operated airports was not available. At Bs170 = US$1 (October 1994). At Bsl70 = US$1 (October 1994).

322 Case Study 10 VENEZUELA

In addition, IAAIM is vested with responsibility for expansion projects. Its board is currently considering the feasibility of drafting a concession project for constructing a hotel, expanding the main terminal building, and building a new runway at the Sim6n Bolfvar International Airport at Maiquetfa. Regarding IAAIM's 2,700 workers at the national level, the terms of the collective labor contract are the same for all workers. Through a broad interpretation of a management soli- darity principle established under Venezuela's labor legislation, the same benefits granted to IAAIM workers are also granted to some 2,500 workers at the national level who are on the pay- rolls of the IAAIM contracting firms.

IV. PRIVATIZATION PROCESS _ _

A. Administrative Decentralization Policy

Venezuela is currently undergoing a process of political and administrative decentralization of national responsibilities, including airport operation and management. These responsibilities are being categorized as exclusive or concurrent. Exclusive obligations are those that intrinsically pertain to the central government and are therefore "non- transferable." a Concurrent obligations are jointly held by local and national governments through a formal and specific legal delineation that universally establishes which functions are the responsibility of the central government and which are the responsibility of local governments. This decentralization policy was implemented on De- cember 28, 1989, with the approval of the Organic Law on De- centralization and Transfer of Public Sector Responsibilities (Ley Orgdnicade Transferenciade Competenciasdel Sector Publico). This policy effectively separates operating responsibilities from concurrent obligations between the central government, and state and local authorities. It specifically establishes provisions for transferring obligations of various governmental responsibilities, including "the management and maintenance of commer-

323 AIRPORT PRIVATIZATION EXPERIENCES

cially used public ports and airports."5 However, the Law only establishes the possibility of transferring the administration of airports, not the ownership and/or the ability to dispose of assets. The transfer of operating and management duties is not automatic and in fact depends on the approval of a Special Law by a state's legislative assembly, under which law it assumes the new specific powers. The decentralization policy was part of an overall political shift toward greater regional autonomy. Prior to Decem- ber 1989, state governors were directly appointed by the Presi- dent. In December 1989, when governors were first elected through suffrage, they were motivated to assume some central government responsibilities in order to strengthen their state's autonomy. However, the Decentralization Law implies transferring management and minor maintenance duties, while ownership (air navigability services, routes, air traffic, ATC, and direct operating authority at airfields) remains under the exclusive authority of the MTC. Under the legal framework currently in force, the MTC is the sole governing, decisionmaking, and executing entity in these matters. As opposed to the initial pace experienced in the early 1990s, the decentralization process in Venezuela seems to be currently undergoing a general slowdown. Given the existing political situation, the government seems more concerned with holding control at the central level than with a further deepening of the process started in 1989.

B. Case Study: La Chinita, Oro Negro, and Santa Barbara Airports

The decentralization policy was first implemented in the State of Zulia in June 1992, when the local state government assumed, through a Special Law,6 the power to manage all airports located within the state: La Chinita (Maracaibo), Oro Negro, and Santa Barbara. According to the Governor of Zulia, the following were the motivating factors for assuming responsibility for the airports: (1) to promote improved service quality to users (which lacked appropriate and permanent services of water supply, public telephones, air conditioning, rest rooms, etc.); and

5 Decentralization Law. 6 Ley Parala Administraci6n de Puertos y Aeropuertos del Estado Zulia, Legislative Assembly, January 9, 1992.

324 Case Study 10

VENEZUELA

(2) to promote and improve the image of the State of Zulia. One of the incentives for privatizing was the need to minimize the effects of political ups and downs at the state government level and to create a more favorable environment for a long-term airport development process. Since airport and port management fell under central government control, local governments had to set up local entities vested with control over operating and managing the transferred obligations. Consequently, on the basis of the Decentrali- zation Law, the State of Zulia established the State Reform Com- mission of the State of Zulia (COPRE-Zulia). This move initiated the transfer of management of Zulia's three airports to the local government. Along with the Zulia State Legislative Re- form Advisory Committee, COPRE-Zulia drafted a framework for taking over the management of ports and airports within the state. The framework was later adopted into a law (Manage- ment and Maintenance Law for Public Ports and Airports within Zulia) that recognized concessions as a feasible instrument for airport management. The law added that concessions were to be awarded only through an open, public bidding process.

1. Institutional Framework: Zulia Airport Authority

To assume operational responsibility for the airports within the State of Zulia the regional government had to establish local administrative bodies. A local airport commission, headed by the Aeronautical Commissioner as Zulia's authority in airport- related matters, was created. The commissioner was responsible for drafting a comprehensive program outlining activities to be assumed by the local authority, including operations, maintenance, administration, financial management, security, public relations, legal issues, commercialization, data processing, and infrastructure maintenance and expansion. On June 6, 1992, the Zulia Airport Authority (ZAA) (Direcci6n General de Aeropuertos del Estado Zulia) was created by the Governor to undertake administration of the regional airports. The ZAA was created as a regional government entity ascribed to the Governor's Office without financial autonomy. The ZAA is responsible for granting and administering concessions. A Regional Transportation Council was established to

325 AIRPORT PRIVATIZATION EXPERIENCES

oversee and regulate all state obligations pertaining to ports and airports. Figure 10.2 shows the organizational structure of the Zulia regional decentralized airports.

Figure 10.2 Ofieo-h Venezuela: Zulia Office ol the Regional Organization Governor Regional Chart, Decentralized - / | Transportation | Council i Airports

S | ~~~Cormmissioner A _r-pu-ri-- Airport

Source: World Bank, CFSPS, November 1994.

2. Transfer Process

On June 6, 1992 a formal agreement among the MTC, IAAIM, and the Zulia Government completed the transfer of the three public commercial airports: La Chinita, Oro Negro, and Santa Barbara. As an international airport, La Chinita was ascribed to IAAIM. 7 This agreement outlined the specific duties to be transferred to local control from the IAAIM to the ZAA: (1) use of all facilities, equipment, and other assets used in daily airport operations; and (2) all services under IAAIM control, including management, operation, exploitation, and maintenance of La Chinita. IAAIM also transferred to the Zulia Government the right to use the assets that make up airport infrastructure, including terminal buildings, offices, hangars, runways, and other buildings and facilities, as well as airport perimeter land and its surroundings. However, the Government of Venezuela would retain full ownership of these assets. The MTC retained responsibility for air traffic services, including all regulation and operation of air traffic control, and also kept its current staff. This staff includes air traffic controllers, aeronautical telecommunications operators, aeronautical data processing technicians, aeronautical radio communications

7 La Chinita is the airport servicing the City of Maracaibo, Venezuela's second largest city. In 1993 its traffic was close to I rnillion passengers.

326 Case Study 10 VENEZUELA technicians, SAR officials, and pilots ascribed to the Ministry. In addition, airport chiefs and deputies continued to be employed by the MTC. The ZAA assumed responsibility for all employees on the payroll at the time of transfer, and also the mandated responsibility of appointing an Airport Director with airport management experience.

3. Regulatory Framework for the Decentralized Airports

The MTC continued to set and regulate all airside charges; however, the ZAA has the authority to set all landside charges. The ZAA assumed all previously held IAAIN4 obligations pertaining to leasing contracts and concessions. All revenues generated from these fees and contracts are directly remitted to the local government (ZAA). The ZAA can allocate these funds for maintenance, expansion, development of new works, or investments. However, the capital needs for such projects are likely to exceed revenues. Therefore, the Government of Venezuela has allowed for a mechanism to supplement airport funds for such projects: local governments can request, from the nation's Ex- ecutive Branch, budgetary allocations for forthcoming fiscal years. Within the new institutional framework (i.e., decentralization) the following responsibilities are to be undertaken by the local airports authority: • Provision of selected airside services and the full range of landside services: passenger services, ground handling services, commercial concessions, aircraft maintenance, catering, etc. • Creation of the airport safety and security committee. This committee will act as the regional arm of the air navigation authority, DGSTA, and will oversee the implementation of safety procedures and security standards. • Assessment of traffic flow developments and capacity planning for air transport infrastructure in the region. As mentioned by an MTC officer during research for this case study, the division of responsibility between the MTC and the newly created decentralized airport authority is determined by the operational condition of the aircraft engines. While

327 AIRPORT PRIVATIZATION EXPERIENCES

the aircraft engines are on, the aircraft is under the responsibility of the MTC (DGSTA) and when the aircraft engines are off, the aircraft is under the responsibility of the Airport Authority.

4. The Privatization Scheme

In October 27, 1992, the Regional Government of Zulia publicly announced the bidding conditions for the privatization of the three public commercial airports. The privatization scheme was based on a 20-year concession for the management and operation of the three airports under a lease-develop-operate (LDO) arrangement. Airport activities enumerated in the concession, although not entirely specified in the bidding conditions and/or contract, included the functions defined above in section IV.B.3. Bidders were only required, as part of the pre- qualification conditions, to demonstrate that their paid-in capital was at least Bs1O million8 and to submit audited financial statements for the last three years. Each financial proposal included: (1) an airport revenue allocation scheme (maintenance, investments, operational costs, etc.), (2) concession fees to be paid to the regional government through ZAA, and (3) the investment plan. On January 18, 1993, the regional government received bids from eight interested parties. Three of the participants were allowed to join together after bids were submitted and formed a consortium (Consorcio Aeropuertos del Zulia).

5. Concession Agreement

On May 21, 1993, the concession was awarded to Consorcio Aeropuertos del Zulia, C.A. headed by Jerry Thompson y Asociados (JTA - Venezuela) and including CAINCA, Divisi6n Aeropuertos (a local engineering firm) and Airport Technology Systems, C.A. (an international airport equipment supplier). Under the terms of their bid the consortium planned to invest up to Bs8,000 million in service-related works and was prepared, if necessary, to invest an additional Bs2O,000 million for new

Equivalent to US$141,000, at the prevailing exchange rate of October 1992. Equivalent to US$100 million and US$250 million, respectively, at the prevailing exchange rates in January 1993. For an international airport the size of La Chinita (I million passengers, 1993), these amounts should be more than enough to cover a 15- year expansion (under normal market circumstances).

328 Case Study 10 VENEZUELA developments.9 Such investments and developments would need to be approved by the ZAA. All debts assumed by the concessionaire would have to be repaid by the agreement's expiration date. The revenue allocation structure outlined in the concession agreement is shown in Table 10.5.

Table 10.5 allocation Use of Funds Venezuela: Zulia 40 * Creation of an Operating Trust Fund in which Airports Concession 409. ogrsrvnefoprAgreement, Revenue 40%O of gross revenues trom previous month Allocation Scheme for will be deposited by the concessionaire Airport-Related * 7i9 (31%o) will be earmarked for General Revenues Maintenance * 2/9 (9%O) will be earmarkded for Promotion and Public Relations 5 Concession Fees to Zulia Airport Authority 15 . Creation of an Investment Trust Fund in which 15%o of gross revenues from previous month will be deposited by the concessionaire * Investments in Airport upgrades and expansions, previously authorized by the ZAA. will be funded by this mechanism 40 Airport Concessionaire operating costs and return on investment 0

On June 11, 1993 the government formally transferred the three airports to the consortium.

6. Post-Privatization Developments

In December 1993 gubernatorial elections were held in the State of Zulia. The incumbent governor lost the election and was re- placed by the candidate for the rival party, Movimiento al Socialismo (MAS). The new governor appointed new members to local posts including positions at the ZAA. By February 21, 1994, the ZAA voided the concession agreement on the premise that the concessionaire was in violation of contract clauses and legal and regulatory norms. The ZAA cited specific administrative infringements to support the above claim, including inadequate oversight of billing and collection of user fees, inadequate accounting records (which made it difficult for the concessionaire to monitor the financial situation of the airports), and failure to prepare quarterly financial reports. In addition to these

329 AIRPORT PRIVATIZATION EXPERIENCES

administrative infringements, the ZAA cited the consortium's failure to pursue outside sources of financing for airport development. The above "defaults" were able to occur for several reasons: I The consortium, poorly structured from the outset, lacked an airport operator with experience £ Lack of experience manifested itself in lack of financial and investment plans 3 No financial sources backed the consortium, making it more difficult and costly to raise the needed financing. On March 29, 1994, the State of ZuliaAutonomous Air- port Service (SAAEZ) was created and vested with the responsibilities previously transferred to the consortium. SAAEZ is a government corporation owned by the State of Zulia. In view of the significant implications of the government's decision, and since there is evidence of substantial defaulting on the part of the concessionaire, an assessment of some of the process elements is given below.

A The bidding process was extremely localized with results published in one local and one national news- paper.

A No technical assistance was sought. 3 Generalized bidding requirements ensured that virtually any party with sufficient funds could take part, regardless of whether it had airport management experience. 3 A detailed investment program or a set of specific investment obligations was never required or drafted by the interested party. Rather, each party proposed what it believed was the best possible course of action, to the best of its knowledge and understanding. 3 The concession contract did not expressly establish an investment program. It merely mentioned that the concessionaire expected to invest approximately Bs 8,000 million (US$100 million) in service-related works and facilities, plus up to Bs 20,000 million (US$250 million) in new developments. The contract did not set a preliminary program or a specific yearly investment schedule. In any case, the level of investment commitments seems disproportionate with respect to the existing traffic demands (between 1.0 and 1.5 million passengers).

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P4 As a consequence of not establishing objective criteria and requirements for interested parties, the bidding process committee subjectively "felt" that no individual bidder fulfilled its expectations, and thus reached a decision to allow bidders to associate with other bidders. Allowing for associations of bidders that individually did not qualify as solid airport operators, while reflecting flexibility and commitment to privatization, does not address the lack of technical capacity. Since the concession agreement did not specifically set a detailed investment program, and as one of the arguments for voiding the contract was concessionaire default, the concessionaire appealed the administrative measure before the courts. A decision on this case is pending before the jurisdictional courts. Since the decentralization process for state airports followed the political values of Zulia's official party at the time, the state government promoted a public opinion information process to support both decentralization and privatization. The decisions to void the concession and to create an SAAEZ were not noted in any public information program - hence the public has not reacted to these decisions either favorably or negatively. After the development of La Chinita Airport in Maracaibo, the regional Government of the State of Nueva Esparta completed what appears to be a successful case of regional airport privatization (see Box 10.2).

Box 10.2 THE OTHER SIDE OF THE COIN: PRIVATIZATION OF THE SANTIAGO MARINO AIRPORT

On February 1 1994 the CVA consortium look over the management main- } tenance. operation, and development of the Santiago Manho International Airport through a master concession agreement. Santiago Marino is the international airport servicing the Islarid of Margarita (State of Nueva Esparta) Venezuela's main tourisic desiination. The contract specitied that the lengin of the concession would be 20 years, renewable tor an additional 20 years. As inthe case ot La Chrinia, the concession includes the operation of passenger terminals Idomesiic and international). parking areas, and adjacent real estate Air trafic control, communications. air navigation aid, and military installations remain trie purview of DGSTA and ihe Air Force

Continued

331 AIRPORT PRIVATIZATION EXPERIENCES

Box 10.2 The CVA consortium agreed to invest Bsl 1.2 billion (approximately equiva- (concluded) lent to US$100 million at February 1994 rates) during the length of the concession on enlarging and re-equipping the intemational terminal and constructing a new domestic terminal CVA will elaborate plans for the construction of an entirely new intemational terminal, to commence in 1999. CVA agreed to pay a concession fee to the regional government of the State of Nueva Esparta equivalent to 15 percent of gross revenues obtained from operating the Sanbago Mario Airport.

Selection cnteria used in the bidding process Included the following key i components, among others:

Amount ro be invested by each group in airport upgrades and expansions Amount of concession fees to be paid to the Govemment of the State of Nueva Esparta Previous experience and a serious track record in infrastructure investments Technical assistance support from a specialized firm In the airport ! operations field. CVA s economic proposal included: (1)an investment commitment of Bs 112 billion (as opposed to Bs3.0 billion in the second best offer), and (2) fees equivalent to 15 percent of gross revenues for the 20-year concesson payable at the end of each month to the regional government (as opposed to a 10 percent concession tees proposal from the second best offer). In addi- I tion. CVAs proposal irduded technical assistance from the airport operation specialist Hughes Aircraft System. The contract with Hughes, open for yearly renewal. isfor 2 years and provides technical assistance inthe areas of design. development, maintenance. and airport administration. The results of the pnvatizaiion ot Santiago Manio in the first 1B months of its operation under the CVA consortiurn have been positive. Internatonal passenger trahic experienced an 18 percent rise in 1994 from the previous year while the first five months of 1995 saw a 45 percent increase compared to the same period in 1994 Pnor to granting the concession, the airport had an operating deficit of Bs39 million and a labor force of 220. Relations between the State of Nueva Esparta and the airport's work force had been strained and threatened to paralyze the airport. The empioyees were then compensated by the regional govemment and passed into retirement so that the new operator could begin operations with a clean slate. CVA's contibution to Nueva Esparta in terms of concession fees is estimated as on the order of Bs 150 million for 1995 (as opposed to a previous deficit). Although it is too early to judge. the concession agreement between CVA and the regional govemment would appear to be on the rght track to becoming asucessful case. The regional govemment has removed iTself from the management of the airport, including labor relations, and from financing operations through subsidies. CVA, with the help of the Hughes group, has turned an operation that was in deficit into a profit maker and has contributed a significant amounT of funds to the regional government.

332 c;as- *Xuay IU VENEZUELA

V. KEY ISSUES EMERGING FROM THE VENEZUELAN EXPERIENCE

Venezuela's privatization experience provides several lessons that could be useful in other airport privatizations. N Decentralizationversus Institutional Capacity. The decentralization process in Venezuela did not take into account the necessity for a strong institutional framework to be in place before transference of responsibilities. The attempt at instituting political and economic reform simultaneously hastened the process without creating clear lines of authority and responsibility. The process was further complicated by the partial transference of activities. Specifically, ownership title was still retained by the MTC along with some revenue-generating activities. This partial transference, combined with the region's lack of institutional capacity for the responsibilities that it did adopt, created a difficult environment for a successful privatization.

a Lack of Technical Assistance in Developing a Sound Program. Owing to the political pressures of decentralization combined with an aggressive local governor, the program was undertaken hastily. Additionally, the tender offering omitted such critical elements as a Master Plan, which compromised the privatization scheme from the outset. Had the expertise of an airport specialist been used, many of the pitfalls, such as the lack of a concrete regulatory framework, could have been addressed early in the process. In addition, a financial adviser would have helped to structure the transaction, including all the necessary investment and development plans.

a Investment Commitments. A BOOT (build-own-operate-transfer) or BOT (build-operate-transfer) scheme would have required the concessionaire to develop an investment commitment which outlined a clearer role for concessionaire responsibilities. The inclusion of such an investment commitment less- ens the ease with which the new government overturns the concession. The development of a Master Plan prior to privatization would have forced the government to realize the investment needs from the start. Furthermore, the prospective concessionaire would have had to outline its approach to the Plan, thereby putting the govemment in a stronger position to evaluate the concessionaire's long-term commitment to the airport's development. - Airport Operator. The tender offering was limited to domestic investors. The lack of intemational bidding did not attract operators with crucial international experience. Had the

333 AIRPORT PRIVATIZATION EXPERIENCES

government focused on attracting such operators, it could have benefited from the operators' experience and their ability to raise needed financing. One of the common themes of successful privatization cases in other countries has always been the presence of a qualified airport operator. Corporatization.The semi-corporatization of IAAIM hinders it from functioning with private sector objectivity. Once the government makes the decision to privatize, the complete corporatization of IAAIM is necessary. This would assist in the day-to-day management of the airports under IAAIM's jurisdiction and would alleviate some of the concerns that investors might have. Since the completion of the privatization of the Santiago Mariflo Intemational Airport is quite recent, lessons drawn from that case were not included in this section. However, when compar- ing Santiago Mariiio's case with the process followed in the State of Zulia airport case, two differences are noted: (1) the privatization scheme in the Santiago Marifio case included a world class airport operator providing technical assistance to the local consortium (Hughes Aircraft Co., Airport Management Divi- sion), and (2) clear investment commitments were included as part of the bidding conditions (US$100 million during the 20- year concession period). Box 10.3 illustrates an attempted privatization at Venezuela's largest international airport, Sim6n Bolivar Airport.

Box 10.3 ATTEMPTED PRIVATILATION OF SIMON BOLfVAR INTERNATIONAL AIRPORT

In October 1993. the MTC issued a tender for an experienced international operator to assume day-to-day responsibility of Sim6n Bolivar International Airport in Maiquetia (the airport servicing the City ol Caracas. The responsibilities transferred were to include management and administration of landside operations including maintenance of the existing facilities and future expansions. However, the MTC would retain ownership title to the airport. The MTC pul forward a well-siructured tender and evaluaTion scheme, which included management and administrative experience in airport landside operations, proposed expansionidevelopment plans, and financing and investment plans. However, the bidding was never completed. The MTC canceled the tender owing to strong labor opposition. No further attempts have been made to privatize Sim6n Bolivar International Airport.

334 Case Study 10 VENEZUELA ANNEXES ANNEX 10.1 VENEZUELA: _ MTC OPERATED AIRPORTS (1993)

State Passenqers per year Puerto Ayacucho, Cacique Aramare Amazonas 90,241 San Tome Anzoategui 73,720 Guiria Anzoategui N/A San Femando de Apure, Apure 39,772 Las Flecheras Municipal de Barinas Barinas 84,726 Municipal de Bolivar Bolivar 136,001 Santa Elena de Uairen Bolivar 4,014 Caicara del Orinoco Bolivar 697 San Rafael de Tucupita Delta Amacuro N/A Calabozc Guarico N/A Jacinto Lara, Barquisimeto Lara 477,110 Alberto Carnevalli Merida 281,250 El Vigia, J.P. Perez Alfonzo Merida N/A Guanare Portuguesa N/A Acarigua. Gral. Oswaldo Guevara 40,962 Mujica Carupano, Gral. J.F. Bermudez Sucre 100,972 La Fra, Ramon J. Velasquez Tachira N/A Valera, C.Nicolas Briceiio Trujillo 94.548 Coro J. Leonardo Chirinos Falcon 58,605 Valle de IaPascua Guarico 414 San Felipe, Subte. Arias Yaracuy N/A Total 1,482,335 Source: MTC, Annual Report, 1993.

335 AIRPORT PRIVATIZATION EXPERIENCES

ANNEX 10.2 PROJECTED INTERNATIONAL PASSENGERS BY AIRPORT (thousands)

Maiquetia 2.598 2,922 3.192 3,466 3.746 3,906 4,104 Valencia 23 26 29 31 34 36 37 I Las Piedras 52 56 62 68 75 78 82 Maracaibo 70 77 84 92 96 101 105 Barcelona 80 88 97 105 107 112 117 Margarita 135 168 210 262 327 360 364 i Total 2,985 3,337 3,674 4,024 4,385 4,593 4,809 Source: Special Intemational Consultation, 1993.

ANNEX 10.3 AIRPORT PRICING MECHANISM AIRCRAFT SERVICE FEES - GATE ACCESS FEE (USE OF FINGERS) IAAIM-APPLIED RATES'

Aircraft weight Fee per every hour or fraction (USS)

0 to 60,000 13.00 60,001 to 100,000 18.00 100,001 to 160,000 26.00 160,001 to 200,000 36.00 200,001 to 280,000 46.00 280,001 and heavier 52.00

0 to 40,000 150.00 40,001 to 60.000 182.00 60,001 to 100,000 240.00 100,001 to 160,000 312.00 160,000 to 200,000 455.00 200,001 and heavier 598.00

'Basis: maximum take-off weight. Source: MTC, October 1994.

336 Case Study 10

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ANNEXES ANNEX 10.4 AIRPORT PRICING MECHANISM

AIRPORT TAX RATES - LANDING FEES - FEES CHARGED AT IAAIM-ASCRIBED AIRPORTS1

Da=$S WNight landing (US 5)

Fee per ton or ton fraction 4.50 5.00 Minimum fee 13.00 20.00

Fee per ton or ton fraction 0.0705 0.2353 Minimum fee 0.7059 0.7059

Surctiarges: $23.53/hour From the last business hour up until all special landings have been completed ' Base: Maximum take-off weight, as stated inair operability certificates. 2 All dollar-denominated fees are collected inboifvars (Bs). 3Fee based on bolivars and then converted into US$. Source: MTC, October 1994.

ANNEX 10.5 AIRPORT PRICING MECHANISM AIRPORT TAX - PARKING FEES - RATES APPLIED AT IAAIM- ASCRIBED INTERNATIONAL AIRPORTS'

On the Tarmac at Passenqer International Domestic' and Cargo Terminals (USS) (Bs) 3 Everyhourorfraction 0.75 0.0118 Minimum 20.00 0.5882 Private commercial aircraft are charged US$5.9 for every 12 hours or fraction Basis: maximum take-off weight, as stated inair operability certificates. The first 120 minutes following landing are free of charge. Rates are on a per ton or ton fraction basis. 2 dollar-denominated fees are collected inbolivars. Fee-based on bolfvars and then converted into US$. Source: MTC, October 1994.

337 AIRPORT PRIVATIZATION EXPERIENCES

338 iecnnicai Annex 1 TI IE AIRLINE SURVEY

TECHNICALANNEX I

THE AIRLINE SURVEY

Throughout the course of the research for the case studies in the Airport Privatization Study, the question of who is the primary customer of an airport - the passenger or the airline - was in the forefront of the discussions. Although airports must market to both passengers and airlines, it is nevertheless the airlines that drive the decision making process for airports. The primary concern of airport management is to attract the greatest possible number of airlines and flights and to establish the best possible working relationship with these airlines. According to a director of a large airport in Mediterranean Europe, once passengers are at the airport, the marketing effort will focus on their general satisfaction and their per capita spending; however, in order for passengers to arrive, marketing should focus primarily on attracting the airlines. Accordingly, of the total marketing expenditures at that particular airport, 75 percent were airline- driven. Given the airlines' role as the primary customers of airports, and their influence on government policymakers, it was considered necessary to include airline views in this study. There- fore, a survey of airline views on airport facilities was conducted in October 1994 by Aviation Planning Associates, Inc. (a Par- sons Brinckerhoff company), Cincinnati, Ohio. I The survey con-

' This survey serves as the source for the information within this technical annex unless otherwise noted.

339 AIRPORT PRIVATIZATION EXPERIENCES

sisted of a written questionnaire mailed to the head of the Cor- porate Planning Unit at 60 carriers providing worldwide services; responses were received from 19 airlines. Most of the respondents were airlines based in either Western Europe or North America. In addition, the majority of respondents were scheduled passenger airlines as opposed to charter or cargo airlines (see Figure TA1.1 for a more detailed composition of the survey respondents).

Figure TA1.1s Western Composition of Survey Europe Respondents by Region . .2 North America 5. C) Asia m Australia/New <, Zealanud _ _ .. .C .- Middle East 1

South America 1

0 2 4 6 8 Number of Survey Respondents

Figure TA1.1lb Composition of Survey Scheduled Respondents by Type Passenger - of Carrier

*2 Charter 4 X Passenger

Cf Dedicated F Cargo

0 5 10 15 Number of Survey Respondents

340 THE AIRLINE SURVEY

1. AIRPORT OWNERSHIP

Survey results, together with experiences from the samples cases, seem to indicate that airlines are not eager to expand their roles to include airport ownership and management of airside services and terminals as part of their future growth strategies. With regard to termninal facilities, less than 12 percent of airlines considered full ownership of terminal buildings, although when joint ventures with either airports or other airlines were included, this figure increased to 35 percent (see Figure TA1.2).

( Figure TA1.2 Preferred Method of Joint-Venture Accessing Terminal Ownership with Buildings g ~~~~~~~Airport Full Ownership 59% Rent from 11.8% ./CS Private Entity 29.4%

Joint-Venture Ownership with :=------Airlines 17.6%

Rent from Airport 35.3%

There appears to be some support for private ownership of terminal facilities, since 29 percent of airlines wanted to rent these facilities from a private entity. Financial constraints appear to be part of the reason why airlines are reluctant to move into ownership of facilities. Keep- ing up with technological changes in aircraft-related equipment will consume a large proportion of airlines' cash resources in the near future. Thus, carriers consider participation in management and investment of airport infrastructure only in cases in which they can have access to their own dedicated gates and terminal facilities such as in the U.S.-based carriers' long-term leasing arrangements with U.S. airport authorities. For example,

341 AIRPORT PRIVATIZATION EXPERIENCES

in December of 1994, Delta Airlines invested US$375 million in the construction of a dedicated new terminal facility at Cin- cinnati/Northern Kentucky Airport, which it will use as a hub to compete with Chicago; Delta issued more than US$500 million in special-facility revenue bonds to fund this and other related projects.

11. AIRPORT PRICING

On average, approximately 8 percent of total airline operating costs are due to direct airport charges including landing fees, terminal fees, aircraft parking, etc. This figure increases to 17 percent when other related costs are included, such as ground handling, airport-stationed personnel, etc. Of the airlines surveyed, 64 percent estimated that direct airport costs would tend to increase in the future, while the rest estimated that costs would remain the same. None of the airlines estimated that direct airport costs would decrease in the foreseeable future. Over 72 percent of the airlines surveyed favored appro- priating aircraft slots at airports through self-allocation or allocation by an airline committee (see Figure TA1.3).

Figure TA1.3 Preferred Methods of Allocation by Aircraft Slot Allocation at GovernmentI AirportE Airports 11.1%

Auction 16.7%

Self-Allocation by Airline Committee 72.2%

342 THE AiRLiNE SURVEY

Under these systems, slots are usually awarded on the basis of grandfather clauses, or to airlines that were already using the slots previously, based on seniority.2 Only 16.7 percent of airlines surveyed favored using auctions to determine the allocation of aircraft slots.3 Auctions would force airlines to assign market values to slots at airports and ensure that those airlines that attached maximum value to the slots would receive access to them. Using this market-based mechanism would theoretically improve the economic efficiency of the distribution of scarce slots. It could be expected that the market clearing prices at peak times for congested airports would be higher than the prices paid via self-allocation or allocation by a committee, thereby increasing the operating expenses for those airlines that currently have slots. Over half of the respondents (53 percent) believed that rates and charges at airports should be established by a reserve power mechanism as opposed to price cap or rate of return devices (see Figure TA1.4). The airlines felt that a case-by-case method had the greatest potential for offering more stability in rates and charges.

Figure TA1.4 Preferred Mechanism Profit Driven for Regulation of Airline 10.5% Rates and Charges

Per Case Basis (Reserve Power) Price Driven 52.7% 36.8%

2 Grandfather clauses create exemptions to rules based on previously existing circumstances. Airlines that already have access to slots could continue to keep the slots. I There are currently only a few examples of slot allocations determined via auction. In the United States there are four airports with a formal market for slots in domestic flights - Chicago O'Hare, New York La Guardia, New York Kennedy, and Washing- ton National. ("The Economics of Airport Slots," Nera, January 1993.)

343 AIRPORT PRIVATIZATION EXPERIENCES

III. INSTITUTIONAL AND REGULATORY FRAMEWORK

Presently, 66 percent of the airlines surveyed operate in an environment in which economic regulation is the responsibility of the federal government. However, only 39 percent of those surveyed believed that the federal government should continue to maintain this responsibility (see Figure TA1.5).

Figure TA1.5 Economic Regulation of Current Situation Airside and Landside Private Entity Facilities Facilities1 ~~~~2.%Airport ~~~~~~~~2.6%Independent Authority _ , E w - ~~~~~~~~~~~~~~~21.1%

0 | ~~~~~~~ ~ ~ ~~~~~~~Airlines

- .: -x:-xLocall Govemment tE | , 7.9 % |~~~~~~~~.9

i Federal Govemment Agency 65.8%

Preferred Situation

Private Entity ffi ~~~~13.0% Independent Airport Authority 37.0%

Federal Govemment Agency - - I 39.1%Alne Local 4.3% Govemment 6.5%

344 THE AiRLINE SURVEY

Instead, 37 percent and 13 percent of respondents believed that this should be the responsibility of an independent airport authority or a private entity, respectively. Currently, 50 percent of the airlines surveyed operate in an environment in which the federal government is responsible for the financing, planning, design, operation, and maintenance of airside and terminal facilities. There is support for shifting more of this responsibility to an independent airport authority; airlines also preferred private entities to the federal government for administering these functions (see Figure TA1.6).

[Current Situation Finance,Fgr Planning,A. Private Entity Design, Operation, and 2.6% Maintenance of Airside Independent and Terminal Facilities

Airport Authority A ; A ffi E _ ~~~~~~~~31.6%/

Federal Govemment Agency 50.0%

Lor,al Govemment 10.5% Preferred Situation

Private Entity § ~~~~21.7'

Independent Federal Airport Authority l GovemmentAgency 50.0% 13.0%

§ Locai \ _Lo I Governmeni 4.3% Airlines 10.9%

345 AIRPORT PRIVATIZATION EXPERIENCES

Currently, 100 percent of airlines surveyed indicated that the federal government or a federal agency is responsible for the financing, planning, design, and regulation of Air Traffic Control (ATC) facilities. An overwhelming number of respondents (79 percent) believed that these entities should continue to serve the regulatory function of ATC facilities. However, only 30 percent believed that the federal government or a federal agency should maintain ATC financing, planning, or designing functions. The majority of respondents believed that either a private entity or an independent airport authority should hold this responsibility.

woo IV. INDUSTRY STRATEGIC PLANNING

The airlines surveyed noted that the most important operating criterion in the choice of an airport for potential new service is the size and demand of the local market; this is followed by the airlines' opportunity to access new markets and expand potential passenger connections. Such airport attributes as condition of airport terminal and terminal efficiency are of secondary relevance. The airlines estimated growth in passenger traffic and cargo traffic to be approximately 6 percent and 9 percent, respectively, over the next 10 years. With this type of traffic growth, airport capacity limitations will continue to be a key issue for future planning for airlines. Accordingly, airlines define airport capacity as the greatest constraint to the future growth of the air transport industry (see Box TA1.1).

Box TA1.1 CONSTRAINTS TO AIRLINE GROWTH 1. Airport Capacity 2. Airline Capital Spending Requirements 3. Government Control and Involvement 4. Labor Costs 5. Environmental Constraints 6 Bilateral Agreements 7. Technological Advances in Air Traffic Control 8. Costs of Operaling Hub Airports 9. Fuel Costs 10. Competition 11. Limitations in Aircraft Size 12. Technological Advances iri Navigational Aids

346 THE AIRLUNE SURVEY

Airline capital spending requirements were listed as the second greatest constraint to the industry's growth. Meeting these financial challenges is likely to lead to an increased reliance on private investment in the industry as a whole. This has been reflected in the responses of surveyed airlines that favor a slight increase in private entity participation in airport operations.

V. CONCLUSIONS

Although some airlines still favor some government involvement in various areas of airport operations and regulations, government control and involvement was listed as the third most significant constraint to growth. Many airlines believe that the federal government is not an impartial body or that it is not able to manage some airports efficiently enough. It is this belief that has led many of the airlines surveyed to favor a shift in the responsibilities the federal government has held to an independent airport authority or a private entity. In the short term, privatization of airport infrastructure will tend to be viewed cautiously by airlines because of the potential impact on airport-related charges, given the inherent profit-oriented nature of private companies. However, as airport operations improve under the management of private operators, airlines should recognize these advantages and favor private sector involvement. In addition, airlines will need to enter into more strategic relationships with the airports as airport capacity problems and financial challenges continue to grow, and it is likely that the airlines will endorse greater private sector participation in airport operations. Unlike other types of industries, airlines will not tend to integrate vertically into airport ownership, since, contrary to typical vertical integrations, this will not yield an economic advantage (e.g., reduced airside charges). One exception would be with regard to obtaining rights to a dedicated terminal. Guar- anteed access to slots has thus far been the only situation in which airlines have been willing to invest their own capital into improving airport infrastructure.

347 AIRPORT PRIVATIZATION EXPERIENCES

348 Technical Annex i1 AIRPORT ECONOMICS

TECHNICAL ANNEX 11

AIRPORT ECONOMICS: FINANCIAL SIMULATION MODEL

Airports are complex commercially driven business units that are becoming more profit-oriented as the private sector increases its participation. After a threshold traffic level sufficient to fully pay capital costs is reached, airports can be a lucrative business. Airports resemble a business complex with different sources of revenue (fees, taxes, service charges, consumer expenditures, rentals, concessions, etc.) and with three main types of expenses: (1) labor costs, (2) operational costs (maintenance, repairs, services, etc.), and (3) capital costs (financial costs and depreciation). If airport operations are well structured and investments are properly planned and executed, airports, beyond a minimum traffic level, will make money. However, not all airports are economically viable. Secondary airports that cater primarily to domestic traffic have a higher threshold traffic level than do intemational airports, and there are some cases, particularly in developing countries, where there is a need to maintain domestic airports, that will not reach their threshold level for many years, in operation. This is one of the key issues to be considered in designing a privatization scheme for a national airport system in which the international airports cross-subsidize the other airports.

349 AIRPORT PRIVATIZATION ERIENCES

To portray the economics of an airport and to provide a profile of the threshold traffic level needed to make the operation financially attractive, the authors have developed a Finan- cial Simulation Model. This model was developed for a predetermined airport type (i.e., size, traffic type, ownership structure), and is included in this study to illustrate the traffic levels needed to support a cash-generating operation as well as capital cost repayment (principal and interest). This financial simulation does not attempt to establish a technique for determining whether a particular airport would be profitable, given that airports could be exploited under different ownership structures and operational schemes. The Airport Corporationwill define the entity in charge of airport management and operations as well as the project sponsor (in charge of the investment/financing of the airport-related infrastructure). The output of the simulation model will be the Airport Corporation'scash flows. Air navigation services in the model will be provided by the Civil Aviation Authority (CAA).

ASSUMPTIOP!S OF THE MODEL

A. Airport Type:

Airside Services: Runway and apron management operated by the Airport Corporation (aircraft approach operated by the Air Navigation Services Division of the CAA). Passenger and cargo terminals operated by private concessionaires. Landside Services: 100 percent operated by private concessionaires. Security: provided by a federal agency and paid by the users (airlines/concessionaires) through a special security fee. Fire and Rescue : provided by the Airport Corporation. Type of Traffic : international passengers (100 percent of traffic).

350 Tachnical Annex 11

AIRPORT ECONOMICS a Airport Capacity (Passengers): 5 million passengers/ year. Airport Capacity (Cargo): 25,000 tons/year.

B. Airside Revenues

1. Landing Fees

On the basis of a selected airport sample from the 1992 ICAO statistics, a world average US$ fee was calculated for the purpose of estimating the landing fee revenues in this exercise (see Table TA2.1 Table TA 2.1 and Attachment 11.1). Landing Fees

US$ per MTOW (ton) 6.44 6.44 8 57 6.57 6.57 6.60 US$ per Passenger (WLU)' 5.73 4.83 374 5.47 6.57 9.45 Aircraft Mix (average 10O 25"% V;c 20% 2c0l 25%' fee for the model)

WLU =Working Load Unit.

Landing fees will be divided between the air navigation services entity (aircraft approach) (10 percent) and the Airport Corporation (90 percent).

2. Passenger-related Charges

Passenger-related charges for the use of terminal facilities are charged directly to airlines in most cases. On the basis of a selected airport sample from the 1992 ICAO statistics, a world average US$ fee was calculated for the purpose of estimating Table TA2.2 the airside revenues in this exercise (see Table TA 2.2 and At- Passenger-related tachment 11.1). Charges

US$ per MTOW (Ton) 13.10 13 10 7 72 7.52 7 52 7 67 US$ per Passenger (WLU)' 11.66 9.82 111 6.27 752 10.98 Aircraft Mix (average 100% 25% 0% 29o L'I 20%io 25,c! fee for the model)

WLU =Working Load Unit.

351 AIRPORT PRIVATIZATION EXPERIENCES

A"111ISM&W C. Landside Revenues

1. Concessions and/or Rentals Related to Airline Services

Concessions and/or rentals related to airline services (i.e., ground handling, catering, office space, cargo warehouses, ticket counters) will be treated as follows: of Ground handling (basic services)/US$ per passenger. On the basis of information from the case studies, ground handling rates are normally charged per type of aircraft. When these rates were adjusted per number of passengers, they ranged from US$7.50 to US$26.00. For this exercise, a figure of US$14.00 per passenger will be used. Net revenue to the Airport Corporation (in the model this service is provided by outside concessionaires) will be equivalent to 10 percent of the total ground handling revenues. Other concession revenues. The remaining concession revenues (to the Airport Corporation) will be estimated as a percentage of total airport revenues (i.e., ticket counter, office space, warehousing, cargo, catering). The percentage used in this exercise will be equivalent to 8 percent of the total airport revenues.

2. Concessions and/or Rentals Related to Consumer Services

Concessions and/or rentals related to consumer services(i.e., duty free, shops, restaurants, hotels, car parking, bookstores, car rentals) will be treated as follows: Estimates for these revenues are based on a percentage of consumer per capita expenditures at this type of airport facility. Information from the case studies suggests that average expenditure (gross revenues to concessionaires) is as follows: 'J For departingpassengers. Average expenditure is between US$25.00 and US$45.00 per passenger (approximately 70 percent of this amount is represented by duty-free purchases).

352 Technical Annex 11 AIRPORT ECONOMICS

2 For arriving passengers. There is no evidence on the amount spent by arriving passengers other than that it is substantially less than that spent by departing passengers. This trend might change in the near future as more airports open duty-free concessions for incoming passengers. An estimate of 10 percent of the amount spent by departing passengers will be used for purposes of this exercise. a The net income from consumer services concessions to the Airport Corporation will be estimated at 10 percent of gross concessions revenues.

3. Fuel Concessions

For purposes of this model, fuel concessions will take the following forms.

* Average consumption of jet fuel per passenger = 60.0 US gallons (mid range - long haul flights) Average jet fuel price (Spot) = 48.4 US cents per gallon (January 1995) Fueling at airport facility = /2 the needs of each inbound/ outbound flight * Concession fee (to Airport Corporation) = 12 percent.

D. Operational Costs

1. Labor Costs

Annual labor costs, given in Table TA2.3, are based on labor cost structures taken from the airport case studies in this report, and are adjusted for airport size.

353 AIRPORT PRIVATIZATION EXPERIENCES

Table TA2.3 Average Total Annual Labor Costs' Number Salary Salary

irside Operalions - 15 40,000 600,000 Runway/Apron Management Terminal Operations 125 25,000 3,125,000 IEngineering - Maintenance 100 25,000 2,500,000 i Fire & Rescue 60 17,500 1.050,000 Administration 50 25.000 1,250,000 Senior Management 06 54,000 324,000 -! Totai381 23,225 8,849,000

'Case Studies, 1993-94.

2. Other Operational Costs

These costs include maintenance and repairs, services contracted, and related expenses. They do not include any type of ownership costs (i.e., depreciation, leases, capital costs) (see Table TA2.4).

S- ,e - - Table TA2.4 Operational Costs as Hong Kong - Kai Tak 18 > US$250.0 million Percent of Revenues' Singapore - Changi 22 > US$250.0 million

Washington - National 26 50.0 - 100.0 US$ million Washington - Dulles 26 50.0 - 100.0 US$ million British Airports Authority 24 > US$250 0 million A&roports de Paris 38 > US$250.0 million Aeropuertos Espanoles 25 > US$250.0 million Cameroon. ADC 24 c US$50.0 million

Case Studies, 1993-94, ADP, Metropolitan Washington Airport Authority.

354 Technical Annex 11 AIRPORT ECONOMICS

E. Airport Departure Tax c_ *

This is a special airport development tax to be charged during construction and during the first 10 years of the concession, as follows: E Passenger airport development tax = US$10.00 To be shared in the following manner: Airport Corpora- tion, 60 percent, and government, 40 percent.

F. Investment Costs

Investment costs for purposes of this model are the following: E Passenger Terminal = US$15 million per gate (each gate could handle approximately 312,500 passengers/year)' Runway, taxiway, and apron (including lighting equipment) = US$90 million (based on the latest cost calculations for the second runway at El Dorado Airport, Co- lombia) Total estimated costs (for purposes of the model) = US$330 million.

G. Financial Results

For the simulated airport type, the project can begin accounting for full capital costs only after it has reached a threshold level of approximately 2.3 million passengers/year. The project should begin to generate attractive cash flows (after accounting for the improvement and replacement of assets) at the 3.5 to 4.0 million passengers/year threshold level. Under a 6 percent annual growth, once the facility reaches 3.5 million passengers, terminal expansion would have to begin in order to avoid reaching

' Airports Council International estimates (September 1993, high end costs for an international passenger terminal).

355 AiRPORT PRIVATIZATION .- :ERlENCES

saturation levels.2 Investment costs for the expansion would tend to be lower than the initial construction costs, particulary if the initial airport design was modular (see Tables TA2.5 through TA2.8).

Table TA2.5 Airport Economics Financial Simulation Model' (US$ thousands)

Cash Flow after Available Cash Flow Labor and for Improvements Operational Costs - Capital Cost and Profits

,l'L Li million.s US5330 million rZt *'fpa~serg¢rs I 12%. 2Oiedlsl

2.100,000 '2.0 36.679.14 44,180.00 (7.500.85| 22,475,000 i 2.3 44.181.54 44,180.00 1.54 2,650.000,, 2.5 47.452 45 44,180.00 3.272.46 3.200,000 3 0 58.225.77 44.180.00 14 045.77

3.750.000 f 3.5 68,999.06 44,180.00 24,819.09 4.250,000 4 0 78,793.01 44,180.00 34,613.01

' Airport type =5.0 million passengers/year. 2 WLU = Working Load Unit (equivalent to one passenger or 100 kg of cargo). IPrincipal interest and interest come under the following financial conditions: (1)annual interest rate of 12 percent; (2)20-year term; and (3)payment at the beginning of each period.

2 At a 6 percent annual growth rate, it will take a terminal facility with a traffic volume of 3.5 million passenger/year approximately three years to reach a traffic level of 4.0 million passengers (at 80 percent capacity the facility will start to reach saturation levels). It takes approximately three years to have a terminal ready for operation after the initial design has been approved.

356 Technical Annex II

AIRPORT ECONOMICS

I Airport Type: Table TA2.6 I Airport Economics - Capacity: 5 million passengers/year - 25.000 tons'year Financial Simulation Eslimated Investment Costs: US$330 million Model Landside Services: 1000 operated by concessionaires International Traffic ______.- (Figures in US$ thousands)

Passengers 2 Off.000 00 2 00.300 00 2.200,000.00 2,300,000.00 2.400,000.00 Cargo kionsi 10,000.00 12 503.00 15,000.00 17,500.00 20,000.00 Total WLU 2.1 00.000.rjo 2.25.00)00 2.350,000.00 2,475.000 00 2,60o.0o00rD , T,ial aircian 15.527 16451 17375' 18255 19.224 I Retenues Airside LancngFees 13.75500 1l.t573.75 15,39250 1621125 17,030 00 Termnal Fees 19152.00 20.2N2.00 21,432.00 22,572.00 23,7 1200 Sub-Icra! 32.90700 34,865.75 36,824.50 38,783.25 40,742 00 Landside 4jrlrne Sen ices Ground Handling 2 940.00 3.115.00 3,290.00 3,465.00 3,640 00 Con&ession Revrenues 4.882.48 5 173 11 5,463 73 5.754 35 6,044 98 Fuel Concessions 3.659 04 3.876.4 4.094 64 4.31244 4,530.21 Passenger Sen,.es |Concessions ldutj-tree, | shops?cararkinqietcj 4.042'50 4.283 13 4.52375 4.764.38 50005.00 Sub-total 15,524.02 1644 807 17,372 12 18,Ž96.17 19,20 22 Airport Departure TaL 12.60000 13.3.5000 14,10000 14.85000 15,60000 (devtelopment ree!

Total Revenue 61.031.02 64.663.82 68,296.62 71 29.4Ž 75,562 22

Operational Costs Labor Costs 8 85Q00 9.059.27 9,268 54 9,477.81 9,687.08 |QrherOperai,onalCos I i 1.i.50188 16.42461 17,34734 18'7007 19,IQ28 )1 Total Operational Costs 24.351,38 25.48388 26,615 83 27,747.88 28,879 '8

Coniritu:cn Rc .:aplai cstis Irilere;1s*capilil) and protits 3567914 39 17994 41,680.74 44.181 54 16,682.33

USt30millon ~12 . 20,rs f 44.180.001 t14W.tI 44.180.Oi (44.180 001 (4- 180001

A-ea,lable Cash Flow fc,r Airpon ,improLements and profits (7,500.86) (5,000.06) (2.499.26) 1.54 2.502.34

357 AIRPORT PRIVATIZATION EXPERIENCES

Table TA2.7 Airport Type: Airport Economics - Financial Simulation Capacity: 5 million passengers/year -25.000 tons/year Model Estimated Investment Costs. US$330 million Lands'de Services. 100r operated by concessionaires International Trafflic (Figures in US$ thousands)

Pa3sengef4 2,000.000)00 2,500,00Xi t00 3,000.000.00 .15 Cri00000 4 ,X000 0000 C31',gJ ttonsi 10,000.00 '5,00.00 20.000 00 25.00000 25000.00 T..,lal WLUi 2 100,000.00 2.650.003) O0 3,200.000 00 37i .L00 00 4 250-.1.00000 Toialauicraft 15.527 19.593 23.1560 27,726 31,423 Revenues Airside Landino Fees 13,755.00 17,35750S Ž20.960.00 24.562 50 27.837 50 Tenrmnal Fees 19, 525 00 24,168 00 9 184 00 *4 2N0 00 3f7 60 O0 -ubtotal 32,907.00 41,S2550 50 1440 5.3.762 50 66.597 50 Landside i4rimneSen ices Ground Handling 2.94000 ,.710 00 4.4800& 5.25000 5 950 0r :cnr-s.on PCe,eoues 4,89248 6 161 23 7,439.97 3.71872 9.881 21 Fuel Concez s,ons 3,659.04 4 617 36 5.575 68 6.534 00 7.405 20 Passenger Seroice; Conce 3ion,s lduty free. sfiopscar parking,etc 1 4,042 50 .101.25 6.16d.00 7.218 7 6.111 25S Sub-total 15,524.02 I9.'MI984 23.655 65 27,721 47 31.417 66 Arporn Deparlure Tax 12,60000 15.900.00 19202'01.00 22.500.00 25 500.00 ideveloprlenl leel

Total Revenue 61.031.02 77,015.34 92.999 65 108.983 97 123.515 16

Operational Cosrs Lator -osE 8,850 '20 niC)iO 99 11151.97 Ž302.96 1334931 Otrer Operationai Cosls lii 15,501 88 I19.61I 90 3621.91 2-.681 93 31 3'2 85 Total Operational Costs 24.351,88 29.562238 34 773 88 39.984.86 4-.722 16

Corinbution io capnaI Cols mInleres+c:aprtall and pilils 36.6.9 14 47 452 46 5,225 77 68.99903 78.793,01

44 Us$33r1 miliont. 1Ž2,I20,, s J4-150rS,DOI :4.1t80 O ( ,180.00Ix 44180I 0CI I 44,130 00

Avaulable Cash Flo.w ior Aiipnrt improvements and piclis (7.500 86) 3.272 46 14,045.77 24,819.09 34,613 01

358 Technical Annex 11

A-%IRPORT ECONOMICS

Airport Type: Table TA2.8

Capacity. 5 million passengers.Iyear -25,000 tons/year Airport Economics - Estimated Investment Costs: USS330 million Model Landsidje Services: 100%c. operated by concessionaires Il-iernational Traffic (Figures in US$ thousands)

500.0000Od 600dO0000 700.000 80d00 00 gdG900.00000 i Cargo IIcn S.Q5000r00, 6000 r) 700000 8 Qdu 00 9.G0.00 Total VWLLJ 550 000 co 660,000 05 770.00000, 8dd80 oi Qrj 990.0000)0 Tola' 3icr411 4 067 4 820 5,6.72 1.5)06 7.320 I Revenues Aiiside LLani'1) Fe." 3 602 50; 4 323.00 5.043 50! 5r7-4.00 6.4'S4 '0 Teqrnm,3i FEes 5.01 600 6 01920| 7.02240; 8d025 60 9022850 Sbuumlidl| 17i710ldi34220 1206590 13,78&.60 15.51 J3.7j LBondside A,ri,n,rSeri res ','vjni,d Hardi'n .U00 92400 1.078(0I 12 32( IC 1.386 00 ronr --iC.nRevenuec 127875 1 54J9 1790.24 2 015 99 2,.301 74 Fuei 'oncecsrons; 9I58, 32; 1 49 98 1.3-41t5 151' 31 1 724 93

IPassen7er Secocas

srr:p Ler parirgeicrc | 1,058 75 1 270 50 1.4,32 2c5 1&34 00 1.905.75 Sub-total 4o05d82 4;8789' .692 14 b5S[30 7 s047 I Airp.n D0p3rlure T3. 3,30000 :1.w'(I 4 62000 r 5 280 00 5.940.00

Total Reoerue 15 9834'2 19.181 18 22 378 04 2'j 574 90 28 77I 7

,peraflonal Costs LarOOCcsi; 8;80'0l 8 85D00G0 8.85000CIO 8.f(00C0 3.8500[I! ,her C errinLraiCc*is 1I, 8 ?QM73 7 C-2 47 8.95 22 10.22.996 1 5C3

total Operational Costs I 5,24, 3 16.5224. 17.801!22 14917996 ,35 71 Curirburn, Ic car.w. :31cc is 'fll.3'EUt 2l40I'ii and proir 7-4S59 2,658 71 4 57662 6.494 4 6.1IvE6

IJii833'10 millin . 12' 20 Ir4. 180l ic.i 144 160) OOi 144 18') OOj (44.180 do00 44 80 OCII

A,crprn irpr,crsSerrienls arit p,r,lts t43.439.41 (41.521.29) i39,603.17) (37.685.05: (35.766.941

359 AIRPORT PRIVATIZATION EXPERIENCES

ATTACHMENT 11.1

LANDING FEES AND RELATED CHARGES World average (based on a selected airport sample) (US$)

DC-9 8-77 B--747 DC-9 B- 7 .747

North Amerca

Cnicago 22200 489.00 1,331.00 62400 1 243 00 2808.00 Dallas 176 00 589.00 1.278 00 Los Angeles 58.00 128 00 350.00 Miami 120 00 299 00 682.00 363 00 503 00 1.385 00 Ijeiw'.on' KennedV 32500 852.00 1733.00 1.340 00 1.8750i0 3 213.00 Washirigion-Duiles 196 00 4.31.00 1,173.00 5030') 1.0050ry) 2.26t 0u) TorCnio 145 00 664 00 1439 00 179.00 291 00 773 0r0 MonIreal-Mirabal 152.00 699G00 1.51500 35100 463 00 944 00 Varc,ouver 141 OC' 644.00 1,395G5 221G0 333.00 81400

4i§raJF 1' . 56 5127 8 1 210 6 51157 81686 1.742.57

Latin America

Mex,io 147 00 45500 1,052 00 648.00 1,164.00 2.455.0Q Vernezuela 135 00 447 00 3r69GO ,6O00 73200 1 6,3700 I Brazil 23500 778.00 1,686 00 55000 1.10000 2.4' 5.00 Bolivia 4i900 1,88800 4,212.00 750.00 1500.00 3.37500 Chile 119 00 672'00 1.457.00 625 C0 1.250 00 2.81 00 Colombia 220.00 770 0 1.900.00 550 00 1 700.00 3 825.00 Ecuador 240.00 690.00 1,460 00 1.250 00 2.500.0y) 5 6,2500 Jamaira 11400 37900 82400 34300 68700 1,545.00 Aroenlina 238 00 967.00 2.322.00 ,44 00 1.287 0' 2,896 00 Panama 110.00 280Q00 840 ',O 1,55000 3.050.00 6.800.00

4veraoe 203 70 ,4 56t,0 1 62Ž0 757. 60 149.00 3.344.60

Europe

Fr3nnkurlAirpon 569.00 1,885W0 4.027 00 37000 741.0) 1 667.00 Heathrov, London: 776 0j 7 00 7760 0 1.290.00 2.581 00 5.807 oo IDG.Paris 246 00 1 112 i0 2.798.00 587.00 1,7,3r0n 2,64000 IBaralas M.1adrid 414 00 2 049 00 3.555 0O 393 00 -85 00 1 -66 00 I Schipol.Amsrresram 380 00 1.398.0G 3,10000 484.00 968.00 2.1Z,'.00 Zurich Airport 465.00 1,604.00 3.450 00 417.00 833.00) 1 875.00 Fiumicirrn. Rome 244O 27900 1,941.00 517.00 1 033.00 2.325.00 Brussels Airport 15000 498.00 1.080.00 545.00 1 0)48 00 2.3)6.00 Moscw Airporl 708.00 2.344 00 5.081.00 550 00 1.1 00W 2.475 00 /WarsawAirport 765 00 2.533.00 5,491 00 500.00 1.00 000 2 25G 00

I Aerage 471.Z?61.&8 O 31359 .565.30 1.126 20 2.528.31

Continued ...

360 Technical Annex i1 AIRPORT ECONOMICS

ATTACHMENT 11.1 (continued)

_~~~~~~~~~~~~~

- l D3@-9 58227 E 7 .' DJ*9 B-p-0!' B-7' Middle EasU Africa

Atu Dhab' 1211 CI 4E6 0tu 1.(540 -CI Sa,u'i0Arabia 5r0I GJ 1.0560' 1.984 00 200 8 no '7 7rj Jordan ~ J;rd3n SO30 tlO00 3o1321.00 rMtl -5205~~~~~~~~~~~-75Ž00 7303 0t0 14t16CO Gd '2820 Od Egypt 72 00 3S 0') 8 220i 9500 1,,001 4.275 CC' | Pakistan 370 0f) 1 225 50 2 655 00 7,r04 I 1.408 no 3. 168 00 I Cameroci 24 00I 1.46000 3.494.00 1.07l 00 2 5500 48-3900 COleI B 7e77 00 1.413I87iJ4.00 75401) 1,5>09W 3,395.C0

4aernoe c4229 .~.2.3@ 21C1'92'J 590'4 1 !590'99 6 28'

South East Asia

India '51 00 6E.'5901 1 442.n00 193 00 386 0,0' 869.00 Sii.japore l n920 753dO 1 77000 40700 768.00 7OO1.00 4 NaI&sai s111.00I 41.0 1 0.5GIIo 0 91 l00 5 G100 1 Jo.00 HCngK:nrg 2130C10 562 C 10 964.00 1,9280,01 4.338CC' Priii,l,in-s 14 (0I' 64600 I1 460 CC 236 00 7, 300 1 C'64 00o Tna,land 14900 55,00 1 26A 00 391.00 781 00 1,7 |600 Inaonesia 195 0'j ,44 0') 1 729 I3 ,5.00 88700 1 94600C1 China 360 C' 1192 0i0 2,584.00 '3C00 36600 82300 r,rea 1650t) 835800 1 860t{( 464.00 929 00 2.010C0i

4Leraqei 3935 153E3r , 1.-.4.' 39600, 788 ', 4;1

Far East -Oceania

lapannKansai 81! 00 68U00 i-3' 0C0 901.00 1.,b-52 Cn 3.52i9 00

Ausfralia 211 ii') 69900) 1516 00 - 7 ealal-i 287 00 956'0 2 07700l 437 00 874 00 I 97 00

A.eraae J ,ij33 1 44j 6' 316-' -67 C't- 12-630E0 2 -48 GOD

t_f _. t__. _ _ t . . . _ _ _ _ _. _ _ _ ._ _ft _ _ . _ _

TaKE-oltvvGeghtitorins 4- 501 148 30 322 10 6000 'IC,0000 150 00 tNumber oi snals 750) 1I50 00 37500 12000 18(CO 222500 | Loading 1:31:1or t69 , 67 ; 6', ii7 67':57! I tNumter . Ssenqeri 6300 10'3('0 22 '30 8000 10j JO 15)300

Continued ...

361 AIRPORT PRIVATIZATION EXPERIENCES

ATTACHMENT 11.1 (concluded)

Landing Fees Cosi (US$1 per TOW., ion e.44 6 57 6 t0 I Landing Fees Crost US$) per passenger (WLUI 5.73 9 7 9 45 Relaied Crarges (USSi per TOW.' ton 13 10 7 p 7 ! Relared Charges IUS'i per passenger (L'WLUI 1166 11.15 10.98

|e stmalCo based on tAT.JW capacity I

Landing Fees Cost IUS$) per TOW, ion 6 44 6 57 6 F7 Landing Fe-s Cost (USSi per passenger iWLu) 4 83 5 47 6 57 Relaled Cnarges iUS$ per TOW' trn 131 7C,52 7 52 Related Criarges IWS$' per passenger IWLLUii 'a 662.7 52

Related charges passenger-related services associated with the use of gates and terminals, most of the cases added to the landing fees (e.g., use of air bridges, use of apron, use of terminal, etc.). 2 Heathrow = tariffs correspond to peak pricing -landing fees. Source: ICAO - Document 7100 (1992).

362 -rOu wORI I) B \\K

Ills \l)QI \IRII LRS 18I 11 S iiu i. N.W. NV.\usvi(lO\. D.C. 2043 3. U.S.A. Tu:[i- iH\ r: (202) 477-1 234 F \cmii .1: t'(202) 477-(6*') I Trl1.\: MCI 64145 WORLDB.j..\\K NICI 248423 WVoi.)B \\NK C.\iBI. .-\A1)4ss: 1\ I B \f R \D NV\SIlIiN 1o\1

Et ROPI'\N O-1-I(Ix 66. A\ [NiFI DiN,\ 75116 P.\I{Is. FR \NTE TFEl.EPHiO\N-E: (I) 40.69.30.0() FACSIMILE: (1) 40.69.30.66 TELEX: 842-64W65 I

ToK()Y( OFFICEF KOKL s.-\I BL IL.DIN\G I -I. NIKL \()L HI-(H -HO\IF CH{IYODL)\;. ToK)tO 1000. J xP-\\ TELFINIONE: (3) 3214-5001 F\(simII j.: (3) 32 14-3657 Ti,, A: 78 1-26838

Uo\ci Bean_ict, St[o, I lie \lv'oi Id Bjnk

~~- ' -