4.4 Physical model
5.1.4 Convergence analysis
The terms of reference for the Inquiry state that as a minimum, the government expects water supply and sewerage service providers to be financially self sufficient.
Similarly, the Minister for Water has stated that any new model must achieve:
1. Sustainable pricing mechanisms with independent review;
2. Existing revenue streams maintained or enhanced; and 3. Capital expenditure funding maintained or enhanced.
This chapter explains how pricing is currently governed in NSW, and how it could be improved in order to achieve sustainable and affordable prices for water and sewerage services for non-metropolitan NSW.
Chapter 7 of this report indicated that some local water utilities are not delivering sustainable water supply and sewerage services under the current regulatory regime. This extends to local water utility pricing practices and a thorough review of the pricing regulation system is a necessary facet of any reform of the industry in non-metropolitan NSW.
The pricing regulation regime likely to produce the most effective outcome will depend on a number of factors. The form of pricing regulation adopted must be consistent with the general and operational regulation of the industry. Whether the industry is more robustly constrained within a revised best-practice management framework, or are issued with operating licences, will set the framework for the appropriate price regulation regime.
Moreover, the number of utilities operating within the industry will also have an influence on price regulation. The regulatory costs and benefits will be significantly different depending on how many utilities are to be regulated.
These issues are explored in more detail in this chapter.
CURRENT PRICING SYSTEM GOVERNING WATER SUPPLY AND SEWERAGE PRICING IN NSW
Water supply and sewerage utilities are natural monopolies and have the ability and market power, if unregulated, to set their prices without regard to efficiency, reasonable financial performance or levels of service.
Appropriate pricing is vital in order to ensure that services are delivered safely, efficiently and sustainably and that customers are not over or under-charged. Following the introduction of National Competition Policy and its associated CoAG Framework for Urban Water Reform in the mid 1990s, Australia’s water supply and sewerage utilities have increasingly moved to an independently regulated price regime. Almost every metropolitan utility in Australia now has its maximum price set by a state-based regulator. The aim of such regulation is to ensure that utilities’ prices reflect reasonable costs - both explicit (operating and capital costs) and implicit (opportunity cost of capital/return on investment).
In NSW, the five largest utilities (the State owned Sydney Catchment Authority, Sydney Water Corporation and Hunter Water Corporation and the Council-owned Gosford and Wyong Water Supply Authorities) have maximum water supply and sewerage prices set by the NSW Independent Pricing and Regulatory Tribunal (IPART). IPART also is the
operational regulator for Sydney Water and Hunter Water, both of which are issued with an operating licence.
The regulation of water supply and sewerage prices in NSW falls into three broad categories:
1. Utilities which have their prices regulated by IPART:
Sydney Catchment Authority Sydney Water Corporation Hunter Water Corporation
Gosford City Council (subject to Minister’s approval) Wyong Shire Council (subject to Minister’s approval)
Fish River Water Supply (bulk water supplier, subject to Minister’s approval) 2. Utilities which require the Minister for Water to approve their prices;
Country Energy (Broken Hill)
Cobar Water Board (bulk water supplier) Fish River Water Supply (bulk water supplier) Sydney Olympic Park Authority
3. Utilities which have no direct regulation on their prices All other 101 local water utilities
While there is no direct legislative or regulatory restriction of prices for local water utilities, the Department of Water and Energy closely monitors the costs, revenue and prices levied by local water utilities.
As a part of the Best-Practice Management of Water Supply and Sewerage Guidelines, a local water utility is required to prepare a sound strategic business plan and an associated financial plan which sets out in detail all the operating, capital and financial costs of delivering services into the future. The required revenue and associated tariffs are determined
accordingly.
Although this process is fundamentally sound, there is at present no legislative or regulatory instrument that compels or directs local water utilities to undertake this process. Furthermore, the Guidelines only require local water utilities to undertake the strategic and financial
planning - not to actually implement those plans. As such there is a potential disconnect between the planning and implementation of prices, although the prices are disclosed in the annual Action Plan which is required to be prepared by each utility following analysis of its triple bottom line Performance Report for each of water supply and sewerage.
In 2002, the Department issued the Water Supply, Sewerage and Trade Waste Guidelines in line with the CoAG Strategic Framework for Urban Water Reform, National Competition Policy and Pricing Principles for Local Water Authorities. The pricing guidelines set out the elements of best-practice pricing.
In May 2004, the NSW Government issued the Best-Practice Management of Water Supply and Sewerage Guidelines which further specified the tariff structure of water supply and sewerage tariffs set by local water utilities. Any council wishing to draw a dividend from its water supply or sewerage business or that was seeking a grant under the Country Towns Water Supply and Sewerage Program had to demonstrate substantial compliance with the guidelines, including pricing.
The Department of Water and Energy monitors and publishes the performance of all Local Water Utilities annually. The NSW Water Supply and Sewerage Performance Monitoring Report and the more comprehensive NSW Water Supply and Sewerage Benchmarking Report sets out and discloses the costs, revenue, financial performance and prices of all local water utilities in NSW.
The Department also directly assists local water utilities to improve their financial performance and to set appropriate prices for their services. As a result, all local water utilities have now abolished free water allowances and most are achieving full recovery of all explicit operating and capital costs. From a financial performance perspective, while almost all local water utilities are achieving full cost-recovery, most do not generate a commercial rate of return on their investment (or achieve ‘upper bound pricing’). That is, most utilities ensure that all operating and capital costs are covered but do not make a profit that a private entrant would consider reasonable.
The government strives to ensure that local water utilities set reasonable prices for water supply and sewerage that are affordable to the community (whilst not jeopardising financial sustainability). As such, having a return on investment which is below the market rate is, for many councils, no bad thing in terms of service affordability.
NATIONAL WATER INITIATIVE
NSW has committed, through being a signatory to the National Water Initiative, to the following (at clause 64):
64. The Parties agree to implement water pricing and institutional arrangements which:
i) promote economically efficient and sustainable use of:
a) water resources;
b) water infrastructure assets; and
c) government resources devoted to the management of water;
ii) ensure sufficient revenue streams to allow efficient delivery of the required services;
iii) facilitate the efficient functioning of water markets, including inter-jurisdictional water markets, and in both rural and urban settings;
iv) give effect to the principles of user-pays and achieve pricing transparency in respect of water storage and delivery in irrigation systems and cost recovery for water planning and management;
v) avoid perverse or unintended pricing outcomes; and
vi) provide appropriate mechanisms for the release of unallocated water.
The outcomes above are to be achieved through the actions at clause 65:
65. In accordance with National Competition Policy commitments, the States and Territories agree to bring into effect pricing policies for water storage and delivery in rural and urban systems that facilitate efficient water use and trade in water
entitlements, including through the use of:
i) consumption based pricing;
ii) full cost recovery for water services to ensure business viability and avoid
monopoly rents, including recovery of environmental externalities, where feasible and practical; and
iii) consistency in pricing policies across sectors and jurisdictions where entitlements are able to be traded.
INDUSTRY SUBMISSIONS TO THE INQUIRY
The majority of submissions to the Inquiry by councils and local water utilities expressed a strong preference for retaining the current light-handed price regulation scheme.
In its submission to the Inquiry the NSW Water Directorate wrote, in part:
“In terms of pricing regulation the Water Directorate notes recent statements by the current Minister that consideration is to be given to IPART having an increased role in price determinations across the whole of NSW. We reject this approach as neither desirable nor sensible for several reasons: It is extremely doubtful that IPART’s existing heavy workload could possibly allow it to deal with 50 or 100 different additional determinations across the entire breadth of the State within the timeframe set for Councils by the Local Government Act (1993) for advertising and adopting their Annual Revenue Policies.
IPART could not possibly understand or be empathetic to the needs and wishes of each LGA like their own elected Council would be. If the State Government is seeking to ensure sufficient accountability in water price setting it need look no further than the current system of Council Management Plans that are approved by elected Councillors. Councillors are more in touch with their local community than a Sydney-based Tribunal because they receive feedback on a daily basis [that] is direct and immediate.
The current system of price setting relies on a well-tested, light-handed style of regulation by the Department of Water and Energy via their gazetted Best Practice Pricing Policies. These are written by the Department of Water and Energy with IPART and National Water Initiative principles firmly in mind, and gazettal under the Local Government Act (1993) ensures they have the force of statutory law behind them as far as local water utilities are concerned.
The current system of price setting is transparent and cost-efficient. We believe that the introduction of an IPART process where 100 individual utilities are obliged to develop 100 individual cases for consideration within a timeframe of months would be both impractical and highly cost-inefficient.
The Water Directorate therefore recommends most strongly that IPART not be introduced into regional NSW as the regulatory authority for water supply and sewerage pricing.”
These views are widely shared by local water utilities. As representing a fairly typical response from Councils, Singleton Shire Council stated in its submission that:
“Singleton is ready to cooperate with the development of reasonable pricing
oversight. Bearing in mind the size of this task for regional New South Wales, and the greatly varying local conditions, it is suggested that pricing principles, as opposed to compulsory oversight and approval would be far more resource efficient, whilst producing a satisfactory outcome.”
The Total Environment Centre (TEC) wrote in favour of more rigorous, independently regulated prices:
“TEC sees no reason why determination of prices for services provided by local water utilities should not be subject to the same level of rigour and public participation as those applying to metropolitan water utilities. We strongly urge the Inquiry to recommend that responsibility for price setting be transferred to IPART with determinations to be made following a rigorous process of investigation and public participation. A key strength of this arrangement would be the requirement for utilities
to submit pricing proposals to an independent public forum and justify costs and revenue requirements.
Current arrangements for council based water utilities also result in the inevitable politicisation of decisions regarding water resource planning and pricing. TEC
strongly believes that these decisions should be divorced from political considerations and based on sound economic, environmental and planning principles.”
Country Energy largely supported this view and recommended IPART be given responsibility for determining prices in non-metropolitan NSW.
A more moderate role for IPART was advocated by Upper Hunter Shire Council in its submission to the Inquiry:
“Local Government is an open and transparent level of government, and any assistance that a body such as IPART can provide would be welcomed. IPART already plays a role in developing best-practice revenue policies for Councils operating Water and Sewerage services under the Local Government Act.”
Several Councils expressed concerns regarding the capacity of non-metropolitan utilities to increase revenue or achieve full cost-recovery. For example, in the opinion of Cowra Shire Council, Cowra’s:
“…rural community does not have the capacity to meet increased water charges that will inevitably result as a consequence of restructure [of the industry].”
In a similar vein, Jerilderie Shire Council stated:
“Sustainable pricing arrangements must also recognise that water and sewer are essential services and that in rural markets sustainable pricing cannot mean full cost recovery”.
On the issue of uniform pricing and geographic cross-subsidisation, Kyogle Council suggested:
“A possible solution to the issues of sustainability and affordability is for the pricing of water supply and sewerage services to be set at a state level in such a way as to ensure the availability of funds to all local water utilities. In this regard all communities would pay the same price for the same service, with those in areas where economies of scale allowed systems to be operated at lower cost subsidising those in areas where the systems operate at a higher cost per connection. This would ensure equity between metropolitan and non-metropolitan areas, affordability to all communities, and long term financial sustainability.”
PRICING OPTIONS AND ANALYSIS
There are essentially three potential options available for regulation of water supply and sewerage prices in local water utilities, namely:
1. Pricing regulator;
2. Mandatory best-practice pricing principles; and
3. No enforcement of best-practice pricing principles (status quo).
1. Pricing Regulator (Direct Independent Price Regulation)
This option entails the direct setting of maximum water supply and sewerage prices by an independent regulator such as IPART. Currently, IPART sets maximum prices for Sydney
Catchment Authority, Sydney Water, Hunter Water, Gosford City Council and Wyong Shire Council. These utilities cannot levy fees and charges above the level determined by IPART.
Independent price regulation involves detailed analysis of the reasonable level of a utility’s costs. In other words, the price regulator determines what costs the utility should reasonably be expected to face if it was operating efficiently and effectively. Included in the cost is the opportunity cost of capital invested in the business – and a reasonable return on that investment.
Independent price regulation has the advantage of assessing a utility’s reasonable costs in detail, and hence can drive efficiency. It also eliminates monopolistic pricing behaviour through unreasonably high charges and profits. Current and future capital and operating costs can be analysed in detail and a fair and reasonable price be set to reflect those costs.
However, it is a resource intensive process. It takes considerable time and resources to analyse a utility’s reasonable costs. As such, it is a process which is likely to be cost prohibitive where there are a large number of utilities to regulate.
2. Mandatory Best-Practice Pricing Principles
At present, the elements of best-practice water supply and sewerage pricing are set out in the Best-Practice Management of Water Supply and Sewerage Guidelines. However, the adoption of these practices is not mandatory for local water utilities. While Councils who wish to draw a dividend from their water supply or sewerage businesses, or to be eligible for a grant under the Country Towns Water Supply and Sewerage Program must demonstrate compliance with the guidelines, all utilities cannot be compelled to introduce best-practice pricing.
The strengthening of legislation/regulation to compel utilities to introduce best-practice pricing will enhance the government’s power to ensure tariff structures and, to some extent, business revenues are:
set to reflect reasonable costs; and
implemented accordingly.
For this regulatory framework to be most effective, there would ideally be some scrutiny of each utility’s costs and an assessment of whether those costs are reasonable. Under the current Best-Practice Management of Water Supply and Sewerage Guidelines, local water utilities are strongly encouraged to undertake a 30 year strategic business plan and an accompanying financial plan. If undertaken in accordance with the Guidelines, this 30 year plan sets out in detail the operating costs, capital and financial costs of delivering services into the future to achieve the best possible social, environmental and financial balance.
An output of the financial plan is the utility’s revenue requirements needed to achieve full cost recovery. The associated customer bills and prices are then set out in accordance with the revenue required. This process is a very effective, sound and transparent way for utilities to ensure that services are fully sustainable while giving customers a degree of surety regarding both current and future prices.
The above notwithstanding, the effectiveness of this particular regulatory framework hinges on three important factors:
a) That the strategic business plan and financial plan represent the most efficient strategy for delivering services (operating and capital costs are appropriate given the levels of service and overall performance);
b) That the utility actually adopts the prices set out in the plan; and c) The Guidelines continue to reflect best-practice.
a) Efficient planning
The first of these issues can be addressed through the oversight and analysis of each utility’s strategic plans. This would involve a regulator, be it independent or departmental, analysing the content and structure of each strategic business plan and granting its approval. Utilities currently submit strategic business plans to the Department of Water and Energy for review.
However, the Department of Water and Energy has no direct legislative or regulatory power to compel utilities to amend their plans or to complete or submit them.
Regulatory requirements that compel utilities to complete, submit and periodically update strategic plans would significantly strengthen the process of promoting efficiency within utilities and hence the prices at which services are delivered.
Moreover, it would allow the regulator and government to have a better understanding of the risks, demand growth and future costs of services to every customer in NSW.
A vital aspect of effective regulation under this framework is that utilities actually implement what is set out in their strategic business plans. The implications of this are self-evident and pivotal. For a regulatory framework which hinges on the completion and then implementation of a strategic business plan, the integrity of this system demands that the prices set out in that plan be implemented. If the plans are reviewed and approved by the regulator, the prices set out in those plans must be adopted. Failure to take this step renders the process
toothless and, largely, irrelevant.
b) Requirement to implement plans
At present, there is no instrument which the Government can use to compel local water utilities to implement prices set out in their strategic business plans.
Under this proposed regulatory framework, it is likely that the regulator (be it independent or departmental) would have the power to direct non-metropolitan utilities to set prices in
Under this proposed regulatory framework, it is likely that the regulator (be it independent or departmental) would have the power to direct non-metropolitan utilities to set prices in