For Information


INTRODUCTION

1. This paper is to brief members on the Authority's obligations and position. It also summarises the background against which the Authority's Scheme of Airport Charges was set, discusses the airlines' concerns and describes the efforts and measures adopted by the Authority.

STATUTORY OBLIGATIONS

2. Under the Airport Authority Ordinance, the Authority is required to among other things:

• provide, operate, develop, and maintain the new airport with the objective of maintaining Hong Kong's status as a centre of international and regional aviation;
  
  
• conduct its business in accordance with prudent commercial principles; and
  
  
• arrange its finances to ensure that, as far as practicable, its revenue covers its expenditure on a year-on-year basis.

In addition, the Authority is empowered to determine the scheme of airport charges subject to the approval of the Chief Executive in Council. According to the Airport Authority Ordinance, the scheme shall be approved unless the Chief Executive in Council believes implementation of the scheme as proposed would, or would be likely to, result in a breach of an international obligation relating to civil aviation or hindrance of the implementation of such an obligation. Such international obligations include the requirements that the charges imposed on aircraft of any other contracting State of the relevant international conventions shall not be higher than those that would be paid by aircraft of the Hong Kong Special Administrative Region engaged in similar operations or services, and that the charges shall be just and reasonable.

BACKGROUND

3. The current Scheme of Airport Charges, gazetted in January 1998, was drawn up in October 1997 after 8 rounds of consultation meetings from 28 February 1996 to 8 October 1997 with the Hong Kong User Charges Board of the International Air Transport Association (IATA). At the conclusion of the consultation process, the Authority and IATA agreed to meet once a year to review the level of airport charges. The understanding was to commence the review meetings after the Authority's financial year-end when the necessary information (audited accounts for the previous year and revenue and cost estimates for the current year) would be available, i.e., in July each year.

4. The Authority adopts the residual charging method or the single till method, based on a 50-year cash flow projection, to determine the amount of airport charges required to balance total expenditure and total revenue. (Please refer to Appendix 1 for a detailed description of the residual charging method.)

5. At the last consultation meeting in October 1997, the level of airport charges was reduced by 25% to 40% from those originally proposed in early 1997. These reductions were possible because of higher-than-expected retail tender results at that time. Under the residual charging method, the airlines were, in late 1997, given the benefit of these higher anticipated revenues, which unfortunately have not been realised.

6. Based on the traffic and revenue forecasts conducted in September 1997, the current level of airport charges was targetted to generate a real rate of return of 5% on the total capital employed by the Authority over the period to 2047, while enabling the Authority to plan its finances, under the Financial Support Agreement, with the objective of repaying its phase 1a debt by 2001 and paying a dividend to its shareholder no later than September 2001.

7. The Scheme of Airport Charges was developed in compliance with relevant guidelines issued by the International Civil Aviation Organisation ("ICAO") particularly in respect of:

• non-discrimination;
  
  
• pay for use;
  
  
• cost-relatedness; and
  
  
• non-proliferation of charges.

8. The three components of the current Scheme of Airport Charges are: Landing Charge, Parking Charge, and Terminal Building Charge ("TBC") (at $39 per departing passenger, excluding transit passengers). As an illustration, the charges for a B747-400 aircraft are as follows:

	Charges (HK$)
Landing Charge	30,350
Parking Charge (assuming 4 hour turnaround)	2,928
Terminal Building Charge (assuming a load factor of 67%)	10,922
Total	44,200

RECENT DEVELOPMENT

Financial Crisis/Recession

9. Airlines serving Hong Kong and other destinations in the Asia Pacific region have been adversely affected in various degrees by the regional economic crisis which first became apparent in mid-1997, and worsened significantly during 1998.

10. The prolonged Asian financial crisis and devaluation of most the Asian currencies have weakened the purchasing power of the travelling public, resulting in a drop in the number of passengers and thus a lower load factor to the airlines. The shift of passengers from first and business class to economy class further reduced airlines' yield.

Over-Capacity

11. Over the past 2 years, growth in industry capacity outpaced growth in market demand. With the tough competition amongst airlines, extensive discounts in airfares were offered, resulting in lower yields for the majority of their routes.

12. All of the above factors have adversely impacted airlines' financial position. For instance, Cathay Pacific Airways Limited recently recorded its first full-year loss of $542 million in 35 years, and it has been reported that the Mainland airlines suffered a combined loss of more than 2 billion yuan last year.

13. In December 1998, a few months after the opening of the new airport at Chek Lap Kok ("CLK"), the Board of Airline Representatives ("BAR") and IATA wrote to the Authority requesting a meeting to discuss possible reductions in airport charges. The Authority maintained that, as agreed with IATA in October 1997, it should not start the review process until its first financial year's audited accounts became available in July 1999.

AIRLINES' CLAIMS

"Hong Kong's airport charges are the 3rd highest in the world"

14. The airlines alleged that airport charges at CLK was the 3rd highest in the world after Narita and Kansai, and that these "high" charges were undermining Hong Kong's competitive position as an aviation hub. They apparently chose to compare airports on the basis of the amount of airport charges paid by them, whereas the Authority carried out benchmarking on 3 different dimensions, namely:

• the total amount received by the airport operator;
  
  
• the net amount paid by airlines; and
  
  
• the total amount paid by passengers.

15. The main difference between airport charges paid by airlines and that received by the airport operator is the passenger charge, which may be partially or fully recovered from passengers. The inclusion of passenger charges in calculating total airport charges received by the airport operator conforms with common practice among leading aviation consultations such as SH&E, TM Economics, Avmark International, Symonds Travers Morgan, and Cranfield University. Please refer to Appendix 2 for passenger charges imposed by other international airports.

16. Based on the latest IATA Airport and En Route Aviation Charges Manual dated 22 February 1999 and exchange rates on 20 April 1999, the ranking of CLK among 20 comparable international airports is as follows:

Airport Charges	B747-400	B737-300
Received by Airport Operator	11th	13th
Net Paid by Airlines	6th	6th
Paid by Passengers	15th	15th

Please refer to Appendix 3 for details on the comparison of airport charges for a typical B747-400 movement at the 20 international airports.

17. The Authority believes that the airlines' allegation that CLK is the 3rd most expensive airport is probably derived by:

• not deducting the $20 per passenger security charge collected by airlines from passengers on the air ticket. As passenger charges similarly collected by airlines at other airport are deducted from airlines' comparison, their comparison is therefore not made on a like with like basis;
  
  
• excluding Osaka Otami airport from their benchmarking; and
  
  
• assuming non-peak landing and parking charges at Heathrow airport. (Please note that peak hour landing charge is around 40% higher and parking charge is some 3 times higher than non-peak hour. During the summer and winter months, 10 hours and 5 hours of the day respectively are defined as peak hours at Heathrow. The bulk of aircraft movements at Heathrow are operated during these "peak hours".)

However, on the basis of the IATA data and a uniform set of comparable figures as illustrated in paragraph 16 above, the Authority does not believe that the airlines are justified in making such an allegation.

"High airport charges are driving airlines away, damaging Hong Kong's competitiveness and its place as Asia's premier aviation hub"

18. According to statistics published by ICAO, airport charges amounted to only 4.3% of total airline operating expenditure for the period 1995 to 1998, compared with 15.7% for ticketing, sales and promotion, and 11.2% for fuel and oil (as shown in Appendix 4). Since at least 2 airports are involved in each flight, charges at CLK would account for about half of the 4.3%. In fact, the impact of airport charges of a particular airport on an airline's total operating cost is not significant. Reductions in airport charges do not necessarily lead to an increase in the number of flights and tourists and subsequently their spending in Hong Kong. As in other commercial environments, market demand is the most important driver.

19. As a matter of fact, there has been a net increase of 32 departures per week at the airport (68 additions and 36 cancellations) since airport opening up to 27 March 1999. The net increase of 32 departures included 9 cargo flights. Details of the flight changes are shown in Appendix 5.

20. Approximately half of the Authority's total revenue is derived from airport charges. If the Authority reduces the level of airport charges by 50%, its total revenue will be reduced by roughly 25%, which is equivalent to an annual amount of $1.25 billion. However, this 50% reduction in airport charges will only generate savings of 1% to 1.5% in the airlines' total operating expenditures.

21. A survey of 30 international airlines conducted by the British Airport Authority on airport selection criteria identified that the most important consideration is traffic volume and that landing fees (which account for the majority of airport charges) only ranked 8th out of a total of 16 criteria, indicating that the airport charges factor is only a moderate issue of concern to airlines. (Please refer to Appendix 6 for other details.)

"Charges at CLK are 64% higher than those at Kai Tak"

22. The airlines have alleged that the charges at CLK are 64% higher than those at Kai Tak. This comparison was again not made on a like with like basis. During the Kai Tak days, airlines collected $20 from each departing passenger on tickets as security service charge. This practice continues at CLK. However, the airlines include this amount in calculating the total charges at CLK but exclude it in calculating the charges at Kai Tak. Such a comparison is not equitable.

23. According to the Authority's calculations, which take into account all relevant elements of charges at both Kai Tak and CLK, the charges at CLK are 15% to 34% higher than those at Kai Tak, depending on the type of aircraft. Considering the brand new facilities and the bigger scale of operation at CLK, such increases are not unreasonable.

THE AUTHORITY'S EFFORTS AND MEASURES

24. The Authority has a statutory obligation to conduct its business according to "prudent commercial principles" and to ensure that its revenue is at least sufficient to meet its expenditure. In order to maintain the current level of airport charges, the Authority has been absorbing the loss which resulted from reduced traffic and commercial revenue. It is expected that a loss will be incurred in the Authority's first financial year which ended on 31 March 1999. It should be noted that, by using the residual charging method agreed with IATA, the Authority could have actually increased the level of airport charges to cover its losses.

25. Various measures have been implemented to build up the financial position of the Authority. They include but are not limited to:

• exploring new or incremental commercial revenue sources;
  
  
• a vigorous review of internal operating costs;
  
  
• an independent review of employee compensation and benefits;
  
  
• streamlining the Authority's organisation structure to enhance efficiency; and
  
  
• negotiations with service providers with a view to reduce expenditure.

Through various cost cutting measures, the Authority expects some 10-12% savings in its operating costs in 1999/2000.

26. Government charges for the provision of the aerodrome licence, air traffic control, fire and rescue, and meteorological services, is the largest single element of the Authority's operating expenditure accounting for 29% ^(Note) or some $935 million per year (Appendix 7 shows the breakdown of the latest estimated operating expenditure for 1999/2000). As part of its effort to cut down operating costs, the Authority has initiated discussion with the Government to explore possibility of lowering these Government charges.

CONCLUSION

27. Based on the latest IATA Airport and En Route Aviation Charges Manual dated 22 February 1999 and exchange rates on 20 April 1999, CLK ranks 11th in terms of airport charges received by airport operators and 6th in terms of net airport charges paid by airlines for a typical B747-400 movement (i.e., CLK is not the most expensive in the world).

28. CLK offers world-class facilities to airlines and passengers. The Category III Instrument Landing System on the North Runway enables airlines to operate under poor weather conditions. With 24-hour operations at the airport, airlines can increase operating efficiency by improving aircraft utilisation. With the opening of the second runway (during peak hours in from 26 May and full time from August), the two-runway system will provide more scheduling flexibility, especially during peak hours, and reduce delays, diversions, and cancellations.

29. The Authority is aware of the importance of keeping the airport charges as competitive as possible. The Authority will review the charges together with airlines in July 1999 as scheduled taking into account all factors including the latest financial position of the Authority.


Airport Authority
May 1999

Appendix 1

Under the residual charging method, the airlines pay sufficient airport charges to the Authority to ensure a minimum return criterion or break-even operation. In other words, the difference between total annual expenditure (including operating expenses, government charges and financial requirements) and all other anticipated revenues (i.e., revenue from terminal commercial and airside support services, etc.) is balanced by the airport charges as shown in Diagram 1 below. All non-airline revenues are credited against total airport costs to determine the (net) revenue requirement to be paid by the airlines.

Appendix 2

Airport	Passenger Charge per international departing passenger *		Payment Method	Total value for a typical 747-400 movement @ (USD)
	Local Currency	USD equivalent #
Kansai	JPY 2,650	22.4	Paid by departing passenger.	6,241
Sydney	AUD 30	19.5	Paid by passenger on ticket.	5,451
Tokyo	JPY 2,040	17.2	Paid by passenger on ticket.	4,804
Macau	MOP 130	15.9	Paid by departing passenger.	4,452
Bangkok	THB 500	13.4	Paid by passenger.Collected by airline at check-in.	3,734
Manila	PHP 500	12.7	Paid by departing passenger.	3,559
Frankfurt	DEM 20.5	11.2	Payable by airline.Collected from passenger on ticket	3,114
Mainland of China	CNY 90	10.7	Paid by departing passenger.	2,989
Kuala Lumpur	MYR 40	10.6	Paid by passenger on ticket.	2,947
Heathrow	GBP 6.5	10.5	Paid by airline.	2,928
Amsterdam	NLG 21.65	10.4	Payable by airline.Collected from passenger on ticket	2,916
Vancouver	CAD 15	10.1	Paid by passenger at airport.	2,814
Taipei	TWD 300	9.2	Paid by departing passenger.	2,556
Singapore	SGD 15	8.8	Paid by passenger on ticket.	2,450
Seoul	KRW 9,000	7.3	Paid by departing passenger.	2,045
Jakarta	IDR 50,000	5.5	Paid by departing passenger.	1,531
CLK	HKD 39	5.0	Paid by airline in respect of departing passengers ($20 of which are collected from passengers on tickets)	1,405

* Source : IATA Airport & En Route Aviation Charges Manual, 22 February 1999 (Exchange rates as of 20 April 1999).

# Rounded to the nearest decimal point.

@ Based on seat capacity of 418 and a load factor of 66.8% (i.e. about 279 passengers).

Appendix 5

Scheduled Addition and Cancellation from Airport Opening to 27 March 1999
(Figures as at 9 April 1999)
(Source: HK Schedule Co-ordinator)

Airline	Addition		Cancellation		Net Increase / Decrease
	Route	Weekly frequency #	Route	Weekly frequency #
Air China	Beijing / HK	5			5
China Airlines			Jakarta / HK / Taipei	3	-3
Continental Mic			Guam / HK	1	-1
Cargolux	Luxembourg / Abu Dhabi / HK *	1			1
Cathay Pacific	HK / Istanbul HK / Singapore HK / Hanoi HK / San Francisco HK/ Manila	2 3 2 7 3	HK / Sapporo HK / Jakarta HK / Surabaya HK / Ho Chi Minh HK / Los Angeles	2 4 1 1 4	5
China Southern	Sanya / HK Wuyishan / HK	1 2			3
Federal Express	USA / HK *	5			5
Japan Air System	Kansai / HK Tokyo / HK	1 2			3
Dragonair	HK / Beijing HK / Kunming HK / Chongqing HK / Shanghai HK / Xian	1 1 1 8 1			12
KLM	Amsterdam / HK			1	1
Kampuchea			Phnom Penh / HK	2	-2
EL AL Israel	Tel Aviv / Tashkent / HK *	1			1
China Eastern	Yantai / HK Shanghai / HK	1 11			12
Northwest			Minneapolis / HK	3	-3
Qantas Airways			Bangkok / HK	7	-7
Varig Brasil			Rio De Janeiro / Bangkok / HK	2	-2
SAS			Copenhagen / HK	4	-4
Singapore Airline	Singapore / HK	2			2
Swissair	HK / Manila Delhi / Mumbai / HK *	1 2			3
China Southwest	Chengdu / HK Chongqing / HK	1 1			2
Vietnam Airlines	Ho Chi Minh / HK	1	Hanoi / HK	2	-1
		68		36	32

# Equivalent to number of departures per week.

* Cargo flights







Source : British Airport Authority

(Note) According to the Civil Aviation Department, charges for the provision of air traffic control, fire and rescue, and meteorological services accounted for some 50% of the operating expenditure at Kai Tak Airport. However, any comparison between the costs of the two airports should be made with caution given their different scale and cost base.