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Sydney Airport: performance and potential competition from a second airport

Sydney Airport: performance and potential competition from a second airport

Advice on legislation or legal policy issues contained in this paper is provided for use in parliamentary debate and for related parliamentary purposes. This paper is not professional legal opinion.
Briefing Paper No. 2/2014 by Andrew Haylen
On the 3rd April 2014, the Australian Competition and Consumer Commission (ACCC) published their latest airport monitoring data which showed that Sydney Airport had again underperformed across a number of key investment and service indicators in 2012-13 when compared to Australia’s other major airports. Yet it continues to obtain the highest revenue per passenger for its aeronautical services, while maintaining the negative growth in its operating costs. The result of which has been further growth in operating margins, or ‘profits’.

The ACCC and the Productivity Commission have both concluded that Sydney Airport possesses considerable market power for its domestic and international aeronautical services. However, the ACCC has not determined conclusively that Sydney Airport has misused its market power; nor has this been suggested by the Productivity Commission.

After many years of planning and indecision, on Tuesday 15th April 2014 Badgerys Creek was approved by cabinet and confirmed by Prime Minister Tony Abbott as the location of Sydney’s second airport.

In 2002 as part of the privatisation agreement with the federal government, the current owners of Sydney Airport acquired the first right of refusal to build and operate any second major airport within 100 kilometres of the Sydney Central Business District. This option is yet to be formally taken up by Sydney Airport Corporation Limited.

While the economic and employment benefits from a second airport are significant and have been well documented, an aspect of the debate that has yet to be considered in detail is that of airport competition.

The development of a second Sydney airport at Badgerys Creek, with both domestic and international facilities, will not only ease aeronautical capacity constraints in the Sydney region, but provide a viable alternative for airlines that have had to rely solely on Kingsford Smith for aeronautical access into Sydney.

A second airport at Badgerys Creek, in the long run and under separate ownership, has the potential to curb the market power of Kingsford Smith Airport and create a more competitive airport market in the Sydney region. The end result of this may be more efficient aeronautical pricing and service quality outcomes at Kingsford Smith Airport.

Airport Privatisation and Market Power

The Productivity Commission (2007) found that Brisbane, Melbourne, Perth and Sydney airports possess substantial market power, mostly because of the lack of substitutability between airport services. Sydney Airport in particular, which is capacity constrained and is a major hub for connecting traffic, has virtually no competition from other airports in the region and there are no comparable land-based transportation options. [2.2.1]

The Productivity Commission (2002) also concluded that in the absence of any effective constraints or regulation, major airports (which are monopolists without any direct competition) will generally have an incentive to exercise their market power to maximise profits.

To achieve persistently higher profits, an unregulated monopoly airport, over the long run, might be expected to set prices for aeronautical services above the full cost of their provision (including normal profits); it might also allow quality to fall over time through cost-saving measures and by delaying investment. It should be noted that Australian airports are subject to limited regulation in the form of price and service quality monitoring by the ACCC; a process periodically subject to review by the Productivity Commission. [2.2.2]

ACCC Airport Monitoring Reports

According to the ACCC (2010), Sydney Airport possesses a high degree of market power in domestic markets; and as the main international gateway airport, it is likely to have even greater market power than other Australian airports for international traffic.

In comparing the expected price and service quality outcomes against the monitoring results for each of the other airports, the ACCC (2010) considered that Sydney Airport might be earning monopoly rents from its aeronautical services. The ACCC (2011) also concluded that Sydney Airport’s insufficient investment in aeronautical infrastructure, while undertaking significant investment in non-aeronautical services, is consistent with the airport exercising its market power.

In subsequent reports the ACCC has not demonstrated a misuse of market power by Sydney Airport, citing data and information limitations as reasons preventing a comprehensive assessment of market power. [3.4]

The Productivity Commission (2011) did make some broad assessments of the misuse of market power at Australian airports with respect to a range of pricing, investment and service quality indicators. Across each of these individual indicators alone, the Productivity Commission did not find that the Australian airports had misused their market power.

Despite a lack of conclusiveness around the misuse of market power at Sydney Airport, its price, investment and service quality monitoring results remain relatively weak when compared to the other monitored Australian airports and have, for the most part, not improved since the Productivity Commission report was published in 2011. [3.4, 3.5]

Economics of airport competition

Normally the expectation is that an increase in competition would be economically beneficial through improved price and service quality outcomes. This is not always the case in the airport market and is dependent on various structural and locational characteristics of the respective airports.

However, if a secondary airport is established and takes traffic away from a primary airport which is facing excess demand, its entry will lead to a more efficient allocation of flights to airports in the region. For Sydney airport, which was forecast (by the Joint Study on Aviation Capacity for the Sydney region) to have excess demand in the coming years, this is likely to be the case.

When a second airport enters into the market, it may be able to offer lower charges than the primary airport because it is either more efficient or flexible to the requirements of the low cost airlines. The monopoly status of primary airports may have meant that they were not previously minimising their costs and there is scope to reduce the overall level of aeronautical service charges to airlines.

The threat of an airline switching airports also provides a direct and powerful competitive constraint for airports. If an airport loses an airline customer to a competitor, it can incur both a loss of aeronautical and non-aeronautical revenue, as fewer passengers visit the shops and other retail facilities or use car parks at the airport. Consequently, aeronautical revenue losses will translate disproportionately into reduced profitability. [4.1]

Forsyth (2013) suggests that the introduction of a second Sydney airport with separate owners will create competition for Kingsford Smith Airport but it is inconclusive whether the gains from having a duopoly will be that substantial. It should be reiterated that Sydney Airport have the first right of refusal to build and operate an airport at Badgerys Creek; the proposition and extent of airport competition in the Sydney region is dependent on whether Sydney Airport Corporation Limited formally take up that option. [4.2]

Forsyth (2006) also believes that strong competition between airports can be a good substitute for economic regulation; this proposition is also supported by other theoretical and empirical studies. [4.3]

Empirical Analysis and International Case Studies

While the breadth of research into the specific issue of airport competition remains limited, a number of key areas of consensus can be highlighted from recent empirical and theoretical studies.

The most important of which is the finding that airport competition has the ability to improve various forms of pricing (including landing fees and airfares) at primary and secondary airports. This was shown by Van Dender (2007) and Brueckner et al. (2014) to be the case in the United States; and by Bel and Fageda (2009) to be the case in Europe. Haskel et al. (2013) also showed this by developing a theoretical model of airport competition.

A considerable number of empirical studies also showed that competition had the ability to improve airport productivity and efficiency across multiple jurisdictions. Yan and Winston (2014) showed this for airports in the San Francisco Bay area of the United States; while D’Alfonso et al. (2013), Merkert & Mangia (2014), Adler & Liebert (2014) illustrated this for European airports. Chi-Lok & Zhang (2014) were also able to show, from a sample of Chinese airports, that airports with more competition are more efficient than their counterparts

While studies (Haskel et al. (2013) and Yan & Winston (2014)) did show that competition had the ability to improve pricing and efficiency at airports, the benefits obtained from such improvements were largely absorbed by the airlines and not by the passengers. Brueckner et al. (2014) did however show positive spill over effects from competition in terms of airfares.

A number of other studies (Hancioglu (2008); Bel & Fageda (2009); and Adler & Liebert (2014)) were able to show that airport competition, under certain circumstances, was an effective substitute for economic regulation.

Many of the studies, however, concluded that the nature and extent of these price, efficiency and regulatory benefits varied according to various locational and structural factors in an individual airport catchment. [5.1, 5.2, 5.3]

Note that the focus of this paper is on the issue of competition and the literature relating to it. It is acknowledged that the second airport question might also be considered from the perspective of the potential benefits of common ownership. [4] ​