01 August, 2016 | Water
In June 2016 a number of regulatory pricing reviews in the water sector were finalised. This includes: Hunter Water, Sydney Water and Water NSW (IPART), Melbourne Water and Goulburn Murray Water (ESC); and SA Water (ESCOSA).
Just prior to these determinations the ESC released a Position Paper on A New Model for Pricing Water Services in Victoria’s Water Sector, which flags a more fundamental change in approach. This note will briefly review the key themes emerging from these recent decisions and what it might mean for the sector.
The key themes are:
We also compare the Weighted Average Cost of Capital (WACC) outcomes.
Not surprisingly, and consistent with most other regulated sectors, there is a strong focus on driving efficiencies and reducing prices. IPART has introduced an Efficiency Carryover Mechanism, which will allow the businesses to retain permanent opex savings for four years regardless of when the saving is made, to remove any incentive to delay these savings into the beginning of the next regulatory period.
The ESC approved several proposals from Melbourne Water to revise its tariff structures, including: a shift from a fixed and variable water headworks tariff to a fully fixed tariff for water retail businesses; separate sewerage system charges to send clearer price signals based on underlying cost differences; and significant changes to non-residential waterways and drainage tariffs to increase cost-reflectivity.
IPART will also allow Sydney and Hunter Water to enter into unregulated pricing agreements with large non-residential customers for water and sewerage services, which allows them to agree to ‘opt out’ of the prices set by IPART. In the Hunter Water decision IPART also approved changes that reallocate costs and restructure price elements to make tariffs more cost-reflective. In effect, this will see residential and small business prices increasing, while tariffs to medium and large businesses will decrease. It also approved a gradual increase in sewerage charges for apartments to be in line with households.
IPART reiterated that it will continue to consider and develop performance benchmarking in consultation with businesses and stakeholders, including: cost driver and activity benchmarking; productivity index analysis; and efficiency frontier analysis.
ESCOSA’s decision for SA Water includes two mechanisms designed to achieve increased alignment between revenue and the costs, being: (1) a demand variation adjustment mechanism to ensure there are no windfall gains or losses arising from material variations between forecast and actual demand; and (2) a pass through mechanism enabling revenue caps to be adjusted during the regulatory period where there is a significant change in legal obligations or an extraordinary event that is unavoidable and beyond SA Water’s direct control, and has a material impact on SA Water’s costs.
IPART has also committed to consider an adjustment to revenues at the end of the regulatory period for any material under- or over-recovery of revenue due to differences between actual and forecast water sales, where ‘material’ is defined as plus or minus 5% over the period.
Both Melbourne Water and SA Water proposed estimating their cost of debt using the ‘trailing average’ approach. The key issue, which is also one of the matters that has been subject to appeal under the national energy framework, is whether a transition to this new approach should be required. ESCOSA accepted this approach for SA Water with no transition (as it assessed the difference between transition and no transition as immaterial). The ESC accepted this approach for Melbourne Water subject to the exclusion of the years following the GFC where debt margins spiked (2008-09 to 2012-13).
In establishing forecasts of efficient operating expenditure for SA Water, ESCOSA has considered the operation of the Adelaide Desalination Plant as part of an overall optimised water supply portfolio. The determination provides for (but does not require) the operation of that plant over the coming four years in a ‘minimum production’ mode of no more than 8 GL per annum (out of a maximum capacity of 100 GL/a). In relation to Melbourne Water’s desalination costs, the ESC’s final determination approved the proposed capitalisation of $30 million of Melbourne Water’s annual desalination security payments on the basis that this will better align the benefits that customers receive from the desalination security service with the payments made by customers.
IPART approved Sydney Water’s proposal to make a pass-through of the variable costs of operating the Sydney Desalination Plant more transparent, uplifting the water usage charge by $0.12 per kL if the plant is operating. IPART deferred considering a cost pass-through mechanism for Hunter Water’s drought-response measures until the next pricing review.
We note that ESCOSA’s decision results in a materially higher return on debt compared to the return on equity in the first year of the regulatory period (with the return on debt then varying each year under the trailing average approach). This anomaly is not acknowledged by ESCOSA.
The ESC’s new pricing model for water services will be one of the most significant developments to monitor in the regulatory landscape. Apart from this, the ongoing quest for efficiency gains, the appropriate sharing of those gains, as well as the potential application of economic benchmarking will be key issues for regulated water networks.
01 August, 2016 | Water
