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Between a lame duck and a white elephant: the runway business case

airport longer runway

by Keith Johnson
I was sort of retained as an economist by the Guardians of the Bays ginger group that has been formed to contest the Wellington Airport runway extension project – with our tiger-lady organizer Sea Rotmann setting me to tackle the Notorious Business Case that has been developed by the consulting group Sapere.

I quail before the competencies and activism of Sea and her talented team of volunteers. Is there anything that I can add to what they’re already tabling?

Yes – I think there is. I’ll try to be more technical and focussed in my critique of assumptions and methods regarding the Sapere Report – mounting an economist-to-economist ‘Keep the Bastards Honest’ critique.

In this article, I’ll concentrate on a simple question: ‘Why can’t Wellington International Airport Ltd [WIAL] pay for the proposed extension itself?’ This question is the central issue that should be addressed by the Sapere Business Case.

I have to start by saying that Cost-Benefit Analysis in New Zealand is a swamp, with a distinct lack of consensus in approaches. Moreover, hardly any of the micro-economists working in the field in NZ have had any hands-on business experience or any practical exposure to real-life project planning and development.

I even find the Treasury’s Better Business Case guidelines to be confusing and over-complicated. As such, they provide plenty of cover under which poor practice can be hidden. Moreover, they relate directly to the evaluation of central government programmes and projects to support departmental applications for new spending within budget rounds. They do not relate directly to applications for public funding to support private project investments like the Runway Extension proposed by WIAL.

And if the BBCs are somewhat convoluted and partial in their approach, any applications for public funds to support private projects are even more prone to BBBC [‘Bullshit but beautifully cooked’].

So we need to go back to basics and as you won’t necessarily believe me without corroboration, I’ll cite the UK Treasury’s ‘Short Plan English Guide’.

This makes two main points:

There is a Project Sequence over which assessments are progressively and iteratively focussed, developed and refined;
There are a number of different types of assessment which are differentiated according to purpose and by the viewpoint taken.

Let’s concentrate on the second point and note that the Guide differentiates:

the Strategic Case [A robust Case for Change and ‘doing the right things’]
the Economic Case [Getting Value for Money and ‘doing things right or effectively’]
the Commercial Case [Is the project commercially viable – will it provide the best positive net returns to the promoter for the resources allocated?]
the Financial Case [Is the project financially affordable with the funding sources available?]
the Management Case [Can the project be delivered successfully in terms of organization, manpower and technology?]

I’ll cite a little case study here to illustrate the differences. We used this when I was a Lecturer at the Project Planning Centre in the University of Bradford. The ‘project’ was the construction of a brewery [in Banjul, in the West African country of The Gambia] partially funded by the World Bank.

The Economic Case revolved around substituting local produced beer for imported beer. The cost of imported beer – less the excise charge by the Government as a tariff on the imported beer – provided the price datum against which the economic efficiency of local production could be evaluated. As the brewery generated employment and saved foreign exchange, it was economically viable.

The Commercial Case stripped out any premium for saving foreign exchange and evaluated the business proposition in terms of local currency and the actual wages paid to workers [likely inflated as they were by union activism]. Again, the analysis gave a positive result. The Financial Case was also positive, given the guaranteed availability of World Bank funding at concessional rates. The Management Case depended on the degree of institutional support and technology transfer made available by a joint venture with a European Brewing conglomerate – again it was positive.

Now there was a problem for the Government in all this and here we have to add a seventh form of analysis – Fiscal Analysis. It turned out that the revenue raised from the excise on imported beer was important to the Government’s budgetary balance. The loss of the tariff revenue turned out to be a big unforeseen blow.

Finally, although the brewery was built, it quickly closed. It closed because the Libyan Government promised to equip the City of Banjul with new buses as long as it closed what Moslems might regard as an affront to their faith. This then was the Strategic Dimension – the project didn’t do the right thing, all things considered, in terms of public opinion and the wider public policy framework.

Anyhow, you get the point. Cost-Benefit Analysis and Business Case Analysis are both fundamentally about asking the right questions and analysing options and outcomes clearly and logically.

Who benefits – who loses – and what will the consequences be – from different viewpoints?

The right question in the case of the Wellington Airport runway extension is: why can’t Wellington International Airport Ltd pay?

Wellington International Airport Limited (WIAL) was privatised in 1998 and is now 66% owned by Infratil and 34% owned by the Wellington City Council. It is an independent commercial company that happens to have inherited a sleeping partnership with its host city as a result of local politics.

It follows that we are not dealing with a public investment project – we are dealing with a Private Investment Project [except insofar as Infratil can persuade external parties to subsidise its operations by contributing zero cost funding].

We should then be primarily dealing with a Commercial Business Case – with alternative funding mechanisms being made explicit.

Infratil itself is an owner and operator of businesses in the energy (mainly renewable), transport and social infrastructure sectors. Its energy operations are predominantly in New Zealand and Australia. As well as Wellington Airport, the company owns public transport services in Auckland and Wellington.

Infratil has assets of nearly $2.5 billion. It has strong cash flows and relatively low levels of debt. Over the last five years Infratil has returned 18.9% per annum and since listing on 1 April 1994 18.4% per annum. Someone who invested $1,000 in Infratil shares on 31 March 1994 and subsequently reinvested all dividends and the value of rights issues, etc. (i.e. who neither took money out nor put money in) would, as at 31 March 2015, own 10,840 shares worth $34,474.

The latest 2015 Interim Report notes that its consolidated cash flow was $452 million [forecast for 2016 is $500 – $530 million] and that net debt fell to $308 million from $761 million over the prior year. [That is it reduced the value of its debts last year to the tune of the entire value of the proposed Runway Extension Project].

So has Infratil previously applied for or received assistance from either Wellington City Council or Central Government for its capital investments? The answer ‘No’.

The Airport has undertaken a relatively substantial investment programme over the last 10 years which includes:

Construction of a 90 metre southern runway end safety area [RESA], including a road underpass – costing $23.5 million in total
Construction of a 90 metre northern RESA– costing $7.5 million
Upgrading of the international terminal at a cost of $25.4 million.

WIAL undertook to fund the above improvements from its own resources and planned for cost recovery through user charges.

Why then should the proposed Runway Extension Project be any different?

Interestingly, it was a little too successful in its previous cost recovery attempts and there was a formal complaint by users to the Commerce Commission concerning excessive charging and abuse of monopoly power. The 2015 decision found the airport was targeting super-profits and mandated a moderation of charges.

Reporting on the outcome the Commission estimated that “consumers would now be $33 million better off over a three year period as a result of this process.” This is very interesting for 2 reasons:

It shows that a very minor adjustment in charging and profit levels could raise the $90 million requested from Wellington City Council for the proposed Runway Extension – in less than 9 years

It shows that usage does not react strongly to price increases [i.e. that demand is relatively inelastic with respect to price].

WHAT DOES THE SAPERE REPORT SAY?

I’ll start by looking at the section of the Sapere Report that sort of attempts to deal with the issue of Who Should Pay. This is ‘Section 6: Alternative approaches to funding’. You should read the whole thing. It is designed to deliberately obfuscate and confirms yet again that microeconomics in New Zealand is the pits.

Frankly it is BBBC [Bullshit But Bloody Badly Cooked].

Basically it conflates bits of ‘theory’ concerning the Deadweight Cost of Taxes with bits of theory concerning Externalities. You can read up about these two issues on Wikipedia which has some reasonably readable explanations.

Let’s quote Sapere on the issue of why user charges are NOT the best way to go:

‘An alternative approach to estimating the economic costs and benefits of the proposal would be to assume it were funded by an increase in user charges. If this increase in fees were paid by existing users of Wellington Airport, it would necessarily mean a charge which exceeds the economic cost of supplying those services (assuming current charges reflect the full economic cost of the existing service).

However, there is no guarantee that WIAL’s existing system of user charges would be capable of raising the revenue required to fund the additional capital costs of the project at a lower cost to the nation as a whole than would New Zealand’s tax system’.

Well, as the Commerce Commission inquiry proved, the revenue is indeed there if you are ready to charge for the additional traffic. As for user charging being a less efficient way of raising revenue than general taxation, this should be seen for what it is – a totally specious argument – by even the most economically illiterate. Clearly, we would all like our financial responsibilities to be shouldered by Government.

And again:

‘All else equal, higher airport charges would reduce demand for airport services at Wellington to a level below that which would otherwise have prevailed in the absence of those higher charges (i.e., if the capital costs of the project had been funded from general taxation revenue instead).

Overall, to increase the net benefits that the nation as a whole derives from an extension of the runway at Wellington Airport, the “deadweight costs” associated with using the revenue from airport user charges to fund the capital costs of that extension would have to be sufficiently lower to offset the extent to which the lower aircraft and passenger number using Wellington Airport would reduce the net benefits from the project.’

Although most of what is said above is gobbledegook, the arguments that the disgracefully unprincipled economic hacks at Sapere are trying to mount are described below [see Wikipedia]:

demand and supply

The argument is that there is a ‘Social Demand’ for airport services which is much higher than the Private Demand because all sorts of secondary / multiplier effects will arise among user businesses from the improvements in accessibility and mobility made possible by the Runway Extension.

So a subsidy from Local or Central Government is necessary to reduce what would have been the level of user charges necessary for cost recovery, to levels that stimulate / generate / trigger the responses from downstream businesses in the Wellington Region.

If I tell you that the diagram above originally related to the merits of governments subsidizing child vaccination programmes [because the social benefits of complete coverage are infinitely higher than the benefits of incomplete coverage from parents who are willing to pay], it will give you some idea as to how stretched [and indeed immoral] the Sapere arguments are.

I guess if you are following me this far, you are onto it – and if you are not following me this far, there is not much point in saying more.

Except to add once again that we are dealing with a commercial situation – so that, if the kinds of ‘positive externalities’ from the Runway Extension were to actually arise, a good economist’s immediate prescription would be that they should be ‘internalized’.

This means that ways should be found to recover the required revenue from the user businesses which benefit [tourism operators, retailers, hospitality service providers, businesses with overseas operations etc.].

I would be happy with that. And the fact that this is not being proposed proves beyond all shadow of a doubt in my mind that the project is somewhere between a Lemon Lame Duck and a White Elephant with Knobs On.

Keith Johnson is an economist who lives in Island Bay. Read more from him on his blog here.

3 comments:

  1. Esjay, 1. December 2015, 17:20

    Fascinating Keith. As I see it, WIAL is endeavouring to establish the need to the public without going down the road of trying to sell the “cost”. By utilising this approach it’s easy to sway those who have little or no knowledge of investment returns. It’s far easier to accept a conclusion that is a “good idea” rather than face up to financial juggling which is a path where angels fear to tread.

     
  2. Rosamund, 2. December 2015, 11:31

    Congrats. Keith on producing such a coherent and comprehensive article. We will end up funding this project and then also funding its support AND opposition in our Alice-in-Wonderland world. It is clear to me that WIAL will only go ahead IF the runway is subsidised.
    In the early 90’s the same proposal was made and the costs for excavation, infilling, re-engineering and construction plus the opportunity costs of transport disruptions etc came, I seem to recall, to $1bn. The only way the $300million is explicable is that it separates the various cost centres, an old game to keep to a budget and then crow that everything was done “on time and within budget” requiring great economy of truth. It should be noted that one of the principals of Sapere is apparently that arch neo-liberal and former head of Treasury, Graham Scott.

     
  3. Trish, 2. December 2015, 20:59

    What a brilliant scheme. They are clearly geniuses. I think I should buy some Infratil shares ASAP.