The challenges facing regional water equality | by Tracy Ong

The challenges facing regional water equality

By Tracy Ong

In July 2010, the united Nations amended the universal declaration of human rights to include access to clean, safe water as a fundamental right. You would think then that all people in Australia would enjoy access to safe, secure water and wastewater services, right?

For most Australians, particularly those in metropolitan areas, this isn’t a problem. In New South Wales, Sydney and Hunter Water customers enjoy water with 100 per cent compliance with the Australian Drinking Water Guidelines (ADWG).

But for many of those living in rural and regional parts of the state, accessing safe, secure and efficiently priced water and sewerage services is much less straightforward.

For one, the majority of regional water consumers are paying more for their water and sewerage compared with those in metropolitan areas of the state. Based on a uniform household consumption rate of 200kL per annum, close to 65 per cent of the state’s local water utilities have higher ‘typical residential water bills’ than the metropolitan average.

We are concerned that customers in regional and rural areas are not receiving adequate service and are exposed to water quality risks, particularly in New South Wales and Queensland.

The challenges facing regional water equality

Many of New South Wales’ rural and regional residents are also at heightened risk of drinking water contamination. In 2008–09, 12 local water utilities failed to meet minimum microbiological water quality standards. Between them, these utilities serviced over 25,000 connected properties.

Put simply, higher prices coupled with a heightened contamination risk mean that large numbers of rural and regional consumers are paying more than their city counterparts, but cannot expect the same quality standards. This could not be any better illustrated than by the fact that half of the 12 utilities that failed to meet minimum quality standards in 2008–09 had above average water prices, including three whose prices were close to 20 per cent above the average price across the state.

These facts are certainly concerning, but they are by no means surprising – having been extensively documented in recent years.

An AECOM report, prepared for Infrastructure Australia (IA) earlier this year, found that some regional communities – particularly in New South Wales and Queensland – are ‘exposed to a greater risk of illness from pathogens, algal toxins and other physical and chemical contaminants,’ with ‘sections of the community with weakened immune systems particularly at risk’ (AECOM, 2011). Similar concerns have also been raised in recent months by the National Water Commission and the Productivity Commission.

Yet despite this strength of evidence on the challenges facing the state’s regional water sector, a clear pathway for effective and lasting reform has successfully evaded government, at both the state and local levels.

A new report by Infrastructure Partnerships Australia (IPA) and Castalia Strategic Advisors seeks to buck this culture of inaction and to restore price and standard equality for regional water consumers.

The report, Regional water equality in New South Wales, brings a fresh perspective to the key challenges facing the sector, as well as their underlying causes.

The report finds that weak governance frameworks and a lack of functional separation, corporate accountability and commercial incentive are all key contributors to the sector’s underperformance.

By outlining an alternative and practical pathway for lasting and effective reform of the state’s regional water sector, the report also builds on the existing range of reform options.

Reform advocates, to date, have focused almost exclusively on the forced amalgamation of local councils into county councils, regional water corporations or voluntary alliances. Undeniably, such amalgamations will ensure much-needed scale as well as other flow-on economic benefits.

Amalgamations also go to the very heart of the problem; that there are considerably more utilities operating in regional New South Wales – with the vast majority of these run by general purpose local councils – compared with other states (see Figure 1).

LeFT: Regional water supplies run a higher risk than urban supplies of containing contaminants like green algae.

The challenges facing regional water equality

Figure 1 – water utilities by state or territory

State or territory Number of water utilities

New South Wales 109 (including 106 local councils and three metro utilities) Queensland 72 local councils and regional water utilities Australian Capital Territory Single state-wide utility Victoria 16 (including three metro utilities and 13 regional utilities) Tasmania Three regional water utilities

South Australia Single state-wide utility

Northern Australia

Western Australia Single state-wide utility Five (including one single state-wide utility and four small local utilities)

(Source: AECOM, 2011) * Includes Sydney Water, Hunter Water and Sydney Catchment Authority

However, as effective as they would be, forced amalgamations will ultimately have to be imposed on unwilling councils and, as such, are both politically and operationally difficult. A failure to appreciate these difficulties and to look at alternative options for generating scale and other operating efficiencies is, according to the report, a key reason for the lack of reform progress in New South Wales to date.

The report concludes that in the absence of forced amalgamations, the next most effective and lasting reform pathway is to better ‘incentivise’ local councils to change their operating structure, while better ‘supporting’ them through the change process.

Underpinning this approach is a fundamental understanding that while structural change must be implemented by the local councils themselves, the ‘incentive’ for change must ultimately be shaped and driven by the State Government.

According to the report, effectively incentivising local councils to adopt a more efficient operating structure, above all, requires a strengthened regulatory framework.

The current regulatory framework, articulated in the Best-Practice Management of Water Supply and Sewerage Guidelines, is found by the report to be ‘light handed’ at best and fundamentally incapable of bridging the gap with respect to water quality and pricing. The fact that less than 30 per cent of local utilities are achieving 100 per cent compliance with the Best-Practice Guidelines is a clear illustration of this.

This ‘light handed’ approach also extends to pricing. In contrast to metropolitan utilities, and the private sector operating under the Water Industry Competition Act 2006, local utilities are free to set

The challenges facing regional water equality

their water and sewerage prices independently of regulation. The report finds that this absence of pricing oversight has stifled the incentive for efficiency gains, innovation and continuous improvement, contributing to greater price rises in regional areas, relative to the cities.

To counter this weak governance and lack of accountability on the part of utilities the report recommends, as a minimum, mandating compliance with all relevant plans, guidelines and standards contained in the State Government’s Best-Practice Management of Water Supply and Sewerage Guidelines, including the health-critical elements of the ADWG. The paper also calls for greater oversight of pricing decisions, including bringing local utilities under the authority of the Independent Pricing and Regulatory Tribunal of New South Wales (IPART).

Ultimately, these changes would establish a legal obligation on utilities to meet minimum standards, rather than simply a recommendation to do so.

Hand-in-hand with a weak regulatory framework is, according to the report, the failure to effectively link local utility performance with state financial support.

Decades of poor financial performance by regional water utilities has entrenched a culture of reliance on State Government subsidies. Reflecting this, funding commitments for the Country Towns Assistance Scheme – the principal state funding program for local utilities – now exceed $1.1 billion.

Successive governments have failed to drive improvements by directly linking these subsidies to utility performance, creating a situation whereby local utilities not only have no legal obligation to meet the Best-Practice Guidelines, but also no meaningful financial incentive to do so.

According to the New South Wales Office for Water, local utilities must comply with all 19 requirements – including 10 for water and nine for sewerage – of the Best-Practice Guidelines in order to qualify for state subsidies. However, a utility is deemed to have complied if it ‘has made significant progress towards these requirements and has a plan and clear target in place to meet all the requirements’.

The report finds the current requirement for utilities to comply with Best Practice Guidelines in order to be eligible to deduct a dividend to be similarly ineffective.

The State Minister for Water can – under the Local Government Act 1993 – disallow a local council from deducting a dividend if it has not substantially complied with Best-Practice Guidelines, and can also ‘direct a council to comply with any particular aspect of the Guidelines before making any further deduction’.

LeFT: The Prospect Filtration Plant provides 85 per cent of Sydney Water’s drinking supplies, and was privately financed, constructed and operated.

The challenges facing regional water equality

The reality, however, is that the vast majority of utilities simply do not have the capacity to pay a dividend, and therefore have little incentive to comply. In 2008–09, only three per cent of utilities proposed to pay a dividend from the surplus of their water supply or sewerage businesses.

The report identifies stronger linkages between CTAS funding and compliance with Best-Practice Guidelines, as well as additional funding specifically linked to marked performance improvements, to be key components of an incentive-driven approach.

Importantly, the report argues that any additional state funding will only be necessary in the short to medium term, with performance improvements eventually enabling savings for government as demand for CTAS funding eases.

A further key conclusion of the report is that a large number of regional utilities stand to gain considerable benefits from the outsourcing of water and wastewater investment and operations to a single private provider.

This would involve a number of local councils, perhaps structured along catchment boundaries, collectively outsourcing their water and wastewater investment and operations to a single private service provider, under a PPP or other concession.

With several notable exceptions, private sector engagement in the regional water sector has been largely non-existent. In contrast, the state’s metropolitan utilities – and their customers – have realised considerable benefits from private sector

Given the potentially severe consequences for public health of a breach of drinking water quality standards, compliance with the health-critical elements of the ADWG should be mandatory for all utilities.

engagement. As just one example, the privately financed, constructed and operated Prospect Filtration Plant provides 85 per cent of Sydney Water’s drinking supplies – equating to 3000 megalitres a day.

The report finds that outsourcing to a large private sector operator will instil necessary degrees of commercial incentive and corporate accountability in the delivery of water and sewerage, enabling local councils to: l protect and grow their revenue bases; l allow for a high degree of local control and autonomy, including the retention of water and sewerage assets in council ownership; l facilitate greater commercial efficiency and long run viability, as well as essential managerial and technical expertise; and l improve the sector’s ability to better coordinate integrated water cycle management across whole catchments and areas.

The benefits of outsourcing will, according to the report, ultimately flow through to regional consumers and ratepayers in the form of more stable and sustainable water supplies and pricing that more accurately reflects the reasonably efficient cost of supply, as well as reduced health risks.

Above all, the report finds that joint outsourcing of water and wastewater investment and operations would, through the realisation of economies of scale, private sector efficiencies and technological innovation, address the poor financial performance of a number of local utilities. Crucially, this would in turn enable utilities to address the current under-investment in regional water and sewerage infrastructure.

Latest available figures suggest that close to 40 per cent of the state’s 106 local water utilities are unable to generate an adequate return for their capital investment, and are presently operating at a loss.

This poor financial performance is mirrored in the performance of the regional water sector as a whole. In 2008-09, the sector recorded a net loss after tax of $27 million, as well as an Economic Real Rate of Return (ERRR) of just 0.6 per cent. In stark contrast, the two metropolitan utilities, Sydney Water and Hunter Water, reported combined profits in 2008–09 of $220 million, and an ERRR of close to 1.7 per cent.

The challenges facing regional water equality

According to the report, it is this poor financial performance on the part of a number of utilities that underpins their inability to meet minimum quality and pricing standards, as they are simply unable to invest enough to increase the efficiency and effectiveness of their infrastructure.

The report estimates the sector’s annual capital expenditure requirements to be in the order of $790 million in 2008–09, or around four per cent of the total sector-wide asset replacement value of $19.9 billion.

Actual capital expenditure in 2008–09 was around 3.4 per cent of total replacement value, suggesting that while local utilities are, on average, spending enough to cover replacement costs and growth, they are not investing enough to increase the efficiency and effectiveness of their water or sewerage infrastructure.

State Government subsidies delivered through the CTAS, while assisting to contain this shortfall in recent years, have been unable to plug the gap and, as a result, a growing infrastructure investment shortfall has arisen.

IPA’s report has estimated this investment shortfall to be in the order of $150 million per annum (in real dollars).

A comparison of investment levels across the regional water sector with the state’s metropolitan utilities further illustrates the extent of this investment gap. Even when discounting the Sydney Desalination Plant, the paper finds that regional utilities are, on average, spending about half the amount being spent by Sydney and Hunter Water (see Figure 2).

The report also compares capital expenditure levels of utilities in other states and territories (see Figure 3 on the following page).

Moreover, the report finds that annual capital expenditure of around four per cent of total asset replacement value is only adequate if asset replacement is in a long-run steady state. In practice, assets such as water distribution pipes are likely to have been originally constructed in waves corresponding to population growth spurts as well as increasing access to reticulated water between the 1950s and 1970s. Given their low profitability, the capacity of utilities to undertake sizeable capital works programmes in order to cover these ‘lumpy’ costs is, according to the report, simply not there.

Outsourcing would enable local councils to reverse this growing shortfall, whilst at the same time enabling the State Government to reduce the reliance on its CTAS. Longer term, this will allow scarce State Government funds to be re-allocated to other infrastructure sectors facing chronic under-investment, such as local roads and rail.

The report finds that a handful of councils have already taken proactive steps in respect to outsourcing, including Bega Valley Shire Council.

Due to an influx of sea-changers combined with holiday makers descending on towns in the summer holidays, the capacity of Bega Valley Shire Council to provide sewerage services was being severely stretched.

Under an alliance agreement with Tenix, Bega Council has been able to significantly upgrade its existing wastewater systems, whilst at the same time increasing efficiencies and reducing costs. This included upgrading five existing wastewater treatment plants, as well as building five new plants to service smaller villages.

The alliance has also enabled Bega Council to reduce its capital and operational expenditure through the introduction of innovative Membrane Bio Reactor (MBR) technology.

Rather than relying on a traditional gravity sewerage system, the deal introduced a pressure sewerage system that has meant the council is able to reduce its pump stations from 25 to one,

Figure 2 – State regional water sector and metropolitan comparison – annual capital expenditure (as a percentage of total fixed asset value)

(Source: Castalia analysis, 2011)

The challenges facing regional water equality

Figure 3 – Annual capital expenditure of water utilities (as a percentage of total fixed asset value) – state and territory averages

(Source: IPA analysis based on the WSAA 2008-09 National Performance Report, and NSW Office for Water’s 2008-09 Performance Benchmarking Report)

as well as introduce MBR technology, which allows it to recycle high-quality effluent for irrigators, taking pressure off potable water supplies.

Tenix will operate the plants – which remain under council ownership – until the end of the contract in 2017, with an option to extend the contract for an additional five years.

The $75 million project means that the council can lock in its operation and maintenance costs over the life of the 10-year contract, while building capacity for further growth.

However, on the whole, proactive reform on the part of local councils has been lacking. As a result, while Sydney Water and Hunter Water continue to raise the bar for water utilities in other states, particularly in respect to innovative re-use and private outsourcing, the state’s regional water sector trails further and further behind.

In a positive sign for the industry, the new State Coalition Government has revived an inquiry started by the previous government on regional water reform, with the state Office of Water recently announcing it will come up with recommendations on sustainable water and sewerage treatment services.

Given the extent of the longer-term challenges facing the sector, particularly in respect to its growing infrastructure shortfall, it is highly unlikely that government will recommend the status quo.

Equally, however, while forced amalgamations would provide much-needed scale and associated economic efficiencies, these benefits are likely to be outweighed by political difficulties, making this approach equally as unlikely.

Accordingly, an incentive-driven approach may provide the only viable pathway for restoring pricing and quality standards parity for the state’s regional water consumers. Importantly, this pathway could also provide the only means for local councils to manage their mounting obligations to ratepayers, consumers and the environment.

But for this incentive-driven approach to be successful, the report argues, councils must also be appropriately ‘supported’, particularly in managing any financial and operational impacts associated with a change in their operating structure.

A key component of this support will be assisting local councils to engage meaningfully with private sector operators. In this regard, the report cites the considerable potential for an ‘advisory’ body that could assist local utilities to achieve best quality and value in collective outsourcing and in its broader negotiations with the private sector.

The report also cites the benefits that an advisory body could bring in assisting local councils to evaluate and deliver other largescale infrastructure projects – beyond water and wastewater – in a cost-effective and efficient manner.

Queensland’s Local Government Infrastructure Service (LGIS) is cited as a possible example in this regard. The LGIS, a joint initiative between the Local Government Association and the Queensland Treasury Corporation, assists local government in the procurement and delivery of cost-effective infrastructure.

Within the water sector, the LGIS offers local councils assistance in all areas of delivery of both water provision and sewerage services, including construction, operation and retail. LGIS also investigates the potential for collaboration between local councils, which could facilitate economies of scale, supported by centralised maintenance programmes.

IPA will be publicly releasing its report in coming weeks.

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