Longitudinal improvement in comprehensibility

Project Recommendation 5: For multi-stage projects there may be a benefit derived from including a financial assessment each stage in the business case, in order to determine what impact the non-implementation of later stages would have.

Project Recommendation 6: Only reuse schemes for customers with steady demands are justified in using maximum usage volumes in their indirect benefit calculations. Agricultural reuse schemes should use a realistic long term average volume in their calculations.

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Valuing indirect benefits

The water industry has spent a lot of time considering the best ways to calculate indirect benefits from reuse schemes. The considered case studies show that there are relatively simple methods for doing this, but also that there can be large variations in terms of values applied.

Three of the case studies, Coldstream (B3), Coburg (B6) and Kalkallo (B7), attempted to value benefits to the wider stormwater system. Interestingly Toolern (B5) did not attempt this even though it would likely have provided further justification of the project. As shown in Table 6, taken from the Coldstream case study, the monetary value of removing stormwater from waterways can be

calculated in a variety of ways, differing by a factor of up to 1000 (from $40k benefits to $40M benefits for volumes associated with Coldstream).

Table 6 – Variation in indirect benefits calculation methods (taken from Coldstream B3) LRMC of treatment

at WTP

Current stormwater offset contribution

Cost $430.46/tonne $7,236/kg/year

Annual or one off Annual One off

Load 5600 kg/year 5600 kg/year

Total funding justified

$38,155

(NPV 25 year) $40,521,600

Altona (B2) and Kalkallo (B7) also calculated indirect benefits from the deferral of infrastructure augmentations. Altona calculated the benefit of deferring the next major city-scale potable water headworks augmentation by assuming that all water saved would be accrued with Melbourne’s dams and therefore the next augmentation could be delayed by a certain number of years. Kalkallo did a similar thing but only for local scale transfer and storage infrastructure. They then multiplied the total expenditure by the deferral period and their discount rate to calculate savings.

In all cases it is shown that there are relatively simple ways of calculating indirect benefits, but that these methods can vary substantially. This means that the most important thing is that various projects use a consistent indirect benefit valuation methodology so they can be fairly compared against each other.

Accounting for external funding in financial assessments

The case studies are interesting in terms of how internal funds are considered in comparison to external funds. The Coburg (B6) and Kalkallo (B7) projects both sought to receive 50% subsidies from government grants, which they did not include in their financial assessment, instead only seeking to justify internal funds. In essence the spending of government money was considered inconsequential.

Also the Altona (B2) project had an assumption that Melbourne Water would not lose money when providing feedwater, which may require further investigation if the project is to proceed. This can be referred to as “financial ring-fencing”.

Project Recommendation 7: There are relatively simple ways of calculating indirect benefits from IUWM projects, however these methods require some level of consistency in order to allow fair comparison of projects.

Project Recommendation 8: Wherever possible it is preferable to carefully consider project finances on both a total community cost perspective, and an organisational perspective.

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2.2.3 Considering risk and uncertainty in decision making

When conducting option selection and deciding whether a project should be recommended for implementation or not there are many uncertainties and therefore substantial risks that need to be considered. It is found that (i) development growth predictions are often overly optimistic; (ii) there is serious risk involved in planning potable reuse schemes for Greenfield areas because planners cannot consult with an existing community; and (iii) decision making processes should place greater importance on potential risks, especially in complex and NPV negative schemes.

Urban development and growth projections

Three of the considered project case studies utilised urban development growth estimates in their business cases: Toolern (B5), Coburg (B6) and Kalkallo (B7). Actual development in all three has been slower than expected. In particular the Kalkallo development has been severely delayed, causing the constructed treatment plant to remain idle for a number of years. It appears that development estimates are generally higher than actual growth rates. Using these over-optimistic estimates can cause business cases to appear more viable than they actually are.

Risks associated with potable reuse schemes in Greenfield areas

As well as risks around growth estimates, another risk in Greenfield areas is not being able to

determine community sentiment towards a project, because the community does not yet exist. One of the considered case studies, Kalkallo, intends to eventually operate as a stormwater to potable reuse scheme. There are a number of uncertainties associated with whether or not the community and regulators will accept this. The two main risks which are difficult to mitigate are (1) the future community may not want to drink treated stormwater, and (2) that the Department of Health (DoH) may never approve potable use. A number of other stormwater to potable schemes are currently being considered in Melbourne, so it is important that the planners involved in these projects be proactive in determining the current sentiment of Melbourne residents and the DoH in relation to such a concept.

Incorporating risk considerations into decision making

Throughout the project case study there was a tendency to accurately identify and assess risks, but not attach significant importance to these risks in final decisions. For example Toolern (B5) identified a number of risks that could not be mitigated, the project continued and then most of the risks

identified in the business case eventuated, stopping the project. While risks were effectively identified in this case study, decision makers did not take these risks fully into account. The authors believe that conclusions in business cases should genuinely acknowledge potential risks.

Project Recommendation 9: Development estimates should be “taken with a grain of salt” and where possible project implementation should be triggered by urban development milestones.

Project Recommendation 10: A number of other stormwater to potable schemes are currently being planned and so it is important that the planners involved be proactive in determining the sentiment of the community and the DoH.

Project Recommendation 11: Risks should be taken seriously in option selection, and decision making processes. It may be appropriate to discontinue the planning of projects which have multiple likely risks which cannot be mitigated.

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2.2.4 Funding sources

Even if a project is assessed to have a nett community benefit, the project still needs to have realistic funding avenues. All except one of the considered case studies would not have been viable without an external funding grant. These case studies reveal that (i) government grants were required in most IUWM projects, but utilities will have to move to a beneficiary-pays model; (ii) grant funding

agreements require time-flexibility; (iii) take-or-pay contracts are essential for agricultural schemes due to extreme usage variations; and (iv) there are no clear funding application avenues for privately-led IUWM projects.

External funding – moving from government grants to beneficiary-pays

Table 3, which summarises the funding processes in the case studies, shows that almost all of the case studies required external funding to proceed; with four of the seven requiring a 50% subsidy, one 30%, one 15% and one 0%. Most of these were funded by the Federal Government. The practice of giving Federal grants to fund local water infrastructure projects in financially stable water sectors only existed for a short time window following Australia’s millennium drought. In 2011 the Australian Government’s Productivity Commission recommended that the Federal government cease this practice.

This means that the water industry will have to move to a beneficiary-pays model if these types of reuse projects are going to continue into the future.

Funding avenues for privately-led schemes

One of the considered case studies, Coldstream was a private scheme which is not financially self-sufficient and was planned to benefit growers rather than run at a profit. It requires (at least) $2M in external funding to proceed, and has investigated various avenues for this including through stormwater benefits to Melbourne Water, and regional economic benefits through the Victorian Government. The Coldstream project had serious difficulty exploring these avenues because there is no standard process and they have no experience dealing with such agencies. There are more examples of private reuse schemes operating in Victoria, New South Wales and South Australia and so the question of how private schemes should be funded in pertinent.

Time flexibility in external funding agreements

Government grants generally specify a short time period within which funding can be used. For the purposes of IUWM projects this can cause problems with timing. The Kalkallo (B7) project was built prior to surrounding development because of time constraints placed on the funding agreement, this meant that the treatment plant is currently unused three years after construction and has had a negative impact on the project financials. It was noted in the Toolern case study that planners took notice of what occurred in Kalkallo, and so were able to include increased time-flexibility in their funding agreement.

Project Recommendation 12: Government grants for reuse projects are likely to become less common in the future, so if reuse projects are to continue the water industry needs to shift towards a combination of a beneficiary-pays and polluter-pays models.

Project Recommendation 13: Allow private schemes to apply for consideration and funding as part of a beneficiary-pays approach.

Project Recommendation 14: If government grants for reuse projects in urban development areas are to continue then they should be designed to have as much time-flexibility as possible.

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Take-or-pay contracts for irrigation use schemes

Demands profiles for outdoor use schemes are highly variable and affected by rainfall patterns. For such a scheme, including Coldstream (B3) and Boneo (B4), it is important to utilise take-or-pay contracts which ensure that customers pay for their water entitlement whether they use it or not.

Without this, agricultural reuse schemes are financially unviable, although as explained earlier the use of take-or-pay contracts does not solve the problem of overestimating usage in indirect benefit

valuations.

2.2.5 Regulation, approvals and governance findings

After financial evaluation, risk considerations and funding sourcing is completed, a certain individual or group has authority to both “pull the trigger” to implement a project, and also sometimes “pull the pin”, and cancel it. From the case studies it is found that: (i) it is very important to have effective communication channels between planners and regulators; (ii) it is constructive that funding bodies have the ability to cancel funding if project circumstances alter; and (iii) in Victoria there is no clear regulatory process for private reuse schemes.

Communication between regulators and planners

All case studies have highlighted the importance of effective communication between regulators and planners. In the case of Kalkallo (B7) effective communication with the Department of Health was required to attempt to implement stormwater to potable. Altona (B2) is an example of when

communication is required with financial regulators such as the Essential Services Commission. One example of well managed communication process is that of the Boneo scheme (B4), in which South East Water gave an in-person presentation to the Department of Treasury and Finance and was therefore able to deal with any issues.

Withdrawal of funding and project cancellation

Two of the considered case studies originally achieved funding but then were not implemented. In the case of Toolern, Federal funding was initially awarded and then later withdrawn when it became clear that an agreement could not be reached over the proposed water exchange mechanism. In the case of Coburg, there were some cost increases which made the project unviable, and Yarra Valley Water made the decision to cancel it.

The authors believe this to be a positive attribute of the funding agreements. It is important to have the flexibility to discontinue a project if circumstances change and the project becomes unviable or no longer the best solution.

Regulation for private reuse schemes

In Victoria there is currently no regulator tasked with the financial regulation of private reuse schemes.

In the Coldstream case study it is clear that there is a risk that the private enterprise will experience financial problems due to under-budgeting. If this happens then either Yarra Valley Water or some

Project Recommendation 15: It is important to continue to utilise take-or-pay contracts in irrigation reuse schemes.

Project Recommendation 16: It is important that relationships and communication channels between water authorities and regulators are maximised in order to achieve positive results.

Project Recommendation 17: It is important to continue the practice of discontinuing projects when project circumstances become more negative.

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Project Recommendation 18: There should be an entity in Victoria tasked with regulating private water schemes to ensure they are financially sustainable. In NSW the pricing regulator IPART fulfils this function under the Water Industry Competition Act.

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