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Southern Water’s Draft Price & Service Plan 2012-2015: Response from Nekon Pty Ltd, 30 September 2011

Southern Water’s Draft Price & Service Plan 2012-2015: Response from Nekon Pty Ltd, 30 September 2011

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114427 submission from_nekon_pty_ltd_re_pricing_investigation_principles_and_approach_111012 114427 submission from_nekon_pty_ltd_re_pricing_investigation_principles_and_approach_111012 Document Transcript

  • Price & Service Plan 2012 – 2015Southern WaterResponse from Nekon Pty Ltdensuring sustainable, responsible and affordable water delivery for TasmaniansPrepared 30 September 2011
  • Price & Service Plan 2012 – 2015, Southern Water Response from Nekon Pty Ltdensuring sustainable, responsible and affordable water delivery for TasmaniansTable of ContentsExecutive Summary............................................................................................................. 1Background ........................................................................................................................ 2The Situation ................................................................................................................... 2The Reforms .................................................................................................................... 3Southern Water................................................................................................................ 5The Pricing Issue ................................................................................................................. 6Background...................................................................................................................... 6Economic Considerations ................................................................................................... 6A Proposed Solution............................................................................................................. 8The Theoretical Model ....................................................................................................... 8Alternative Solutions ......................................................................................................... 9The Practical Solution...................................................................................................... 10Tariff Implications........................................................................................................... 11Bibliography & References .................................................................................................. 15
  • Price & Service Plan 2012 – 2015, Southern Water Response from Nekon Pty Ltdensuring sustainable, responsible and affordable water delivery for Tasmanians Page 1Executive SummaryIn formulating this response to the proposed water pricing changes to be implementedwithin the areas serviced by Southern Water, a number of issues were considered. Anexamination of both the global and national water situation provided the context for aheightened need to efficiently price water. Effective pricing signals facilitate better waterconsumption (demand) and operating (supply) decisions.The first best economic model of pure marginal cost pricing was also considered. Whilstimpractical to implement within the context of the current Australian and Tasmanian urbanwater industry structure, it does provide directional focus. Second best alternatives wereexamined with our preference being a move towards taking a long run marginal costapproach.Choosing the most appropriate pricing model is complex for a number of reasons includingeconomic, commercial, social and political issues and priorities, which must be considered atboth regional and national levels. For the immediate future, this submission supports themove to a two-part pricing mechanism where economic efficiency is maintained through anemphasis on the variable component, and a minimal fixed charge component. Economicefficiency is maintained in principle and a nationally aligned pricing system is introduced.In this light, this submission proposes that the fixed, network access charge be minimisedto: Support the allocative efficiency benefits gained through marginal cost pricing (thevariable usage charge), Set reasonably tight operational efficiency targets, Ensure competitively geared cost management processes are established andmaintained, and Achieve pricing alignment at a national level.The resulting comparatively higher volumetric charge would have a number of positiveeffects including the: Signalling of the long run consequences of consumer consumption decisions in termsof infrastructure needs. A higher volumetric charge would provide a greater incentiveto alter water consumption patterns, possibly reducing the need for capacityexpansion. Provision of some of the necessary financing for capital expenditure and distributionof the related costs of this according to consumption.It is understood that full cost transparency is yet to be achieved, and is a fundamentalrequirement for an effective marginal cost pricing model. Similarly, a more informedresponse to the Draft Price and Service Plan requires the availability of more data andaccess to Southern Water’s operating costs, consumption patterns and other relatedinformation. This submission has raised at least two pricing model alternatives, andrequests Southern Water and the Office of the Tasmanian Economic Regulator to seekfurther responses on the proposed pricing model whilst making the following information,and any other information necessary to make an informed decision, available for thedeliberations: More detailed explanation of the numbers driving Southern Water’s Draft Price andService Plan The provision of serious alternatives from which to select Wherever possible, access to the supporting data, calculations and assumptions Provision of data and assumptions set upon which to test and propose viablealternatives.In the absence of more detailed consumer profile data and a more in-depth understandingof the scale of consumers requiring transitional tariff arrangements, a commercially viablealternative is difficult to propose.
  • Price & Service Plan 2012 – 2015, Southern Water Response from Nekon Pty Ltdensuring sustainable, responsible and affordable water delivery for Tasmanians Page 2By 2050 water forecasters are expecting global water shortages or a‘gap’ between the supply and demand for water, driven, in a macrosense, by the increase in population.Science Alert, Global Water Availability to 2050,Future Directions International, Thursday 20 January 2011BackgroundThe SituationUltimately, the global water ‘gap’ will be driven by our increased demand for food, includingmilk, meat and other high water-usage agricultural products. Within 40 years, the ‘gap’ isexpected to be about 3,000 cubic kilometres of water per annum; equivalent to the annualflow of three Nile Rivers. Others predict the gap to be around 6,000 cubic kilometres. Whilstthis global water gap will vary regionally, Australia has been identified as having a highwater-stress level.1While two thirds (2/3) of people on Earth use less than 60 litres of water a day, during2008/09 Australian household water consumption per capita was 81 KL or 222 litres perday.2The graph below shows water consumption per capita for each of the AustralianStates/Territories. In 2008-09 Tasmanian householders consumed just under 140 KL percapita per annum – assuming 2.7 persons per household3, this equates to 378 KL perhousehold. The Office of the Tasmanian Economic Regulator recently reported (September2011) in its Water and Sewerage State of the Industry Report 2009-10 that the averageconsumption per connection within Southern Water’s region was 458 KL. However, a lack ofmetering in Tasmania’s southern region prevents accurate measurement of consumption inthe area.Graph 1: Australian Household Water Consumption by State, 2008-09Source: ABS, 4610.0 - Water Account, Australia, 2008-091Maplecroft, global assessment, November 2010, as reported in Science Alert, Global WaterAvailability to 2050, Thursday 20 January 20112ABS, 4610.0 - Water Account, Australia, 2008-09,http://www.abs.gov.au/AUSSTATS/abs@.nsf/DetailsPage/4610.02008-09?OpenDocument3Australian Bureau of Statistics, Census 2006, average household size for Tasmania’ssouthern region statistical division 610 & Greater Hobart 605, 2011
  • Price & Service Plan 2012 – 2015, Southern Water Response from Nekon Pty Ltdensuring sustainable, responsible and affordable water delivery for Tasmanians Page 3Tasmanian householders are the third highest water consumers in Australia. It is alsointeresting to note that lower household consumption is evident within the States currentlyoperating under a two-part pricing scheme, where the variable component is designed tosend the most efficient pricing signals to both suppliers and consumers.The rising cost of water in Australia is significant. From a national perspective, the ABSreported a near doubling of the average price of water in 2008-09 with the average pricepaid by households being $1.93/kL4. Water increases for 2011-12 are also evident with theSouth Australian government approving a 26.3% average increase for consumers ofdrinking water5, and similar increases have been announced for Barwon Water (Vic),Sydney Water, (NSW), Brisbane Water (Qld), Hunter Water (NSW), and South East Water(Vic).Regulatory bodies, utilities, irrigators and consumers alike are pushing for reform tomoderate these price increases. Development of a coherent set of national objectives iscritical for Australias water sector - from the National Water Initiative and beyond. A pushfor competitive pricing and pricing regimes that are competitive at a national level arewarranted for a number of reasons including, but not limited to: Many businesses and householders span multiple states and territories in theirinvestments and operations (including property investments, holidays and travel,living parts of the year in different states due to weather and family considerations,and the increasing number of grey nomads traversing the nation) Water data is becoming more available for the average person Competitive pricing at national levels will help ensure monopolistic profit taking andinefficient cost management practices at an individual utility level are self-regulatedand minimised.Australia, and specifically Tasmania, is often cited by global water authorities as a leader ininnovation6, and is the focus of many international studies. However, this recognition is dueto the introduction of a competitive pricing model in the agricultural sector via the watertrading system. On the urban water supply and delivery side, Tasmania is struggling tomeet quality standards, and the pricing system is inherently inefficient. Whilst some regionswithin Southern Water’s service area have introduced usage charges, others have not; withthe Hobart metropolitan area currently basing its water charges on property values. TheTasmanian Water and Sewerage Industry’s 2011-12 Price Determination Investigation andits Draft Price and Service Plan Guideline, are set to potentially improve the pricing regimethrough standardisation, more economically efficient pricing, transparency and fairness.The ReformsReforms are in place to move to a more economically effective, consistent and equitablepricing model. Guidelines have been provided by Tasmania’s Water and Sewerage IndustryAct 2008, Interim Price Order. Section 68 of the Industry Act includes the following pricingprinciples for regulated water and sewerage services:“…the price is to provide for efficient pricing through a two-part pricing for waterservices based on the recovery of fixed costs and variable costs…”,“…the price is to provide effective incentives to promote economic efficiency,reduce costs or otherwise improve productivity with respect to a regulatedservice…”, and4Australia Bureau of Statistics, Water consumption down, water prices up, 4610.0 - WaterAccount Australia, 2008-09 Media Release, 20105South Australian Government Regulatory Statement - 2011-12 Drinking Water andSewerage Prices, 20116London Economics, Economic Brief: Reform in the Australian urban water sector; theProductivity Commission Inquiry, April 2011
  • Price & Service Plan 2012 – 2015, Southern Water Response from Nekon Pty Ltdensuring sustainable, responsible and affordable water delivery for Tasmanians Page 4“…the price charged to a particular customer or class of customers is to reflectthe costs that are directly attributable to the provision of the regulated service tothat customer or class of customers.”.For Tasmania, urban water reform was the outcome of a review of the challenges facing theindustry; namely, concerns over service levels and asset management coinciding with aneed for major capital investment and predicted price increases. An innovative model wasdeveloped: consolidating 32 local government businesses into three independent watercorporations considered to have sufficient scale to advance performance (shown in Figure 2below).Figure 1: Tasmanian water industrySource: Comparison of Victorian and Tasmanian Urban Water Reform InstitutionalModels - Northern Tasmanian Water and Sewerage Reform ProgramThe upside to reform is significant – it provides a wealth of benefits, stemming from theconsolidation of smaller entities. Duplicated overheads across businesses are eliminatedwhile the new, large water businesses achieve both economies of scale and attract industry-leading delivery partners.The new models rationalise and align tariffs, bringing greater equity to consumers, as wellas central responsibility for price planning for the future. Tariff regulation will help ensureprices are linked to justifiable costs and are supported by the principle of “user pays”.Additional benefits to the consumer will include a higher, more transparent level of service –driven by regulatory frameworks which promote investment into justifiable serviceoutcomes and reduce the long-term risk of price shock and service interruption.For any major, wide-ranging reform process there is a trade-off between detailed planningand execution to ensure an effective change, and achieving this change within a reasonablecost and timescale.Hindering the success of the change program in Tasmania has been the management of thecost impact of reform on consumers and the reluctant relinquishing of individual Councilpowers with respective to water and sewerage. The process of asset valuation and transferhas also exposed a legacy of underinvestment and inadequate system design by some localgovernments in their infrastructure, with corresponding upgrade programs needed to bringthe asset base to a sustainable standard.
  • Price & Service Plan 2012 – 2015, Southern Water Response from Nekon Pty Ltdensuring sustainable, responsible and affordable water delivery for Tasmanians Page 5The clear benefits of industry reform are underpinned by transparency, businessconsolidation and tariff rationalisation. Timely and effective planning is crucial to avoid‘crisis response’ situations – and attempts to unpick a partially completed reform couldprove to be very costly in the long term.Southern WaterSouthern Water was established on 1 July 2009 to deliver water andwastewater services to the 200,000 residents and businesses ofsouthern Tasmania. It operates throughout 12 council areas,including Hobart, Clarence and Glenorchy, Brighton, CentralHighlands, Glamorgan-Spring Bay, Huon Valley, Kingborough,Derwent Valley, Sorell, Southern Midlands and Tasman. SouthernWater’s vision is to create lasting value for our communities byproviding sustainable water and wastewater solutions. This is beingachieved by improving the economic, environmental and public healthoutcomes for all of Southern Water’s customers.
  • Price & Service Plan 2012 – 2015, Southern Water Response from Nekon Pty Ltdensuring sustainable, responsible and affordable water delivery for Tasmanians Page 6Getting the price for water “right” is increasingly seen as animportant tool for overcoming these problems, and for channellingthe management of this key natural resource in a more sustainabledirection.The OECD Environment Program 1999-2000The Price of Water: Trends in OECD CountriesThe Pricing IssueBackgroundThere is widespread international concern that poor water management will be one of themajor limiting factors on sustainability in the new millennium. Water shortages, degradingwater quality and the lack of competitiveness of water-intensive economic production are allpushing water management issues higher on the international agenda.Natural monopolies arise in industries such as water supply because the relatively highcapital investment required creates natural barriers to entry. Further, the entrenched owneris able to capitalise on economies of scale and scope, producing at a lower cost thanpotential new entrants. Thus larger, single operators are theoretically more profitable andefficient than multiple smaller operators.Originally, utilities, such as water, were privately operated. Concerns arose when it wasdeemed that monopolistic profit taking by the private sector undermined our constitutionalright to water. Section 100 of the Australian Constitution guarantees the right to water byall Australians, where the Commonwealth shall not give preference,“…nor abridge right to use waterThe Commonwealth shall not, by any law or regulation of trade or commerce,abridge the right of a State or of the residents therein to the reasonable useof the waters of rivers for conservation or irrigation.”Nationalisation of key industry assets, such as electricity, gas, and airlines began afterWorld War Two. However, this was short lived, as concerns quickly arose around publicownership inefficiencies resulting in price distortions and deteriorating assets. Privateindustry was, and is currently considered, ultimately better positioned to deliver costefficiencies, service improvements and investment.Economic ConsiderationsIn a democratic and market economy such as Australia’s, the creation of a fair and equitablepricing regime, is best achieved through the application of economic principles andcompetitive markets. It is important to note that economic efficiency does not just extendto the costs of delivering water services, but is inherently dependent upon the correctsignals being given to consumers through efficient pricing mechanisms. Prices signal thecost of providing the services, and allow consumers to evaluate consumption decisions.Where prices do not reflect the true cost of water services, decisions regarding consumptionare distorted and resources will more than likely be inefficiently allocated – creating asimilar situation to that which Tasmania is currently experiencing.Choosing the most appropriate pricing model is complex for a number of reasons: A theoretically perfect pricing model is inherently doomed due to the current, andforecast worsening of, the water ‘gap’ – where Demand exceeds Supply at a globallevel. The economic basis of water pricing is that the supplier must be able to recover all ofits costs including operations, maintenance, investment, opportunity costs such as
  • Price & Service Plan 2012 – 2015, Southern Water Response from Nekon Pty Ltdensuring sustainable, responsible and affordable water delivery for Tasmanians Page 7greenhouse gas emissions and water scarcity, and benefits such as improved healthand standards of living due to higher quality potable water. Economic efficiency demands that prices are set at marginal cost. Under marginalcost pricing, price is set to recover the cost of supplying an extra unit of water for agiven level of infrastructure. In capital intensive industries such as water storage andsupply, the utility will not generate sufficient revenue to cover costs. True costs of supply and delivery are not known, or not transparently communicated.Nor are they effectively separated throughout the industry’s vertically integratedsupply chain. The Tasmanian water industry is suffering from historical under-investment whichrequires capital intensive works programs to bring the assets up to Australianstandards. In Australia, urban water pricing considerations also include sewerage and drainagecosts (horizontal integration). Water storage and supply has limited capacity with very lumpy capacity expansionpatterns. The regulator must ensure the presence of pricing equity; balancing the needs of lowincome groups against those of the financial sustainability of the supplier. Marginal costs are typically not stable in the short run, experiencing significantfluctuations in price depending upon available capacity and supply. A sawtooth, orfactory roof pattern is often used to describe this characteristic. Short run marginalcosts fall to zero following each extension of capacity and then rise to full cost ascapacity becomes exhausted, new investment is installed and short run marginalcosts fall to zero fall to zero once again. Alternatively, prices are pushed upwardswhen supply is cut short such as during a drought, and may fall to zero during floods(assuming capacity is not exhausted). Any change initiative requires significant effort to gain support amongst thecommunity. There will be winners and losers in any scenario, and these people alsosignificantly impact our political environment, and thus the industry regulators.How then, is an appropriate pricing model for a water business selected? Criteria designedto assist in the evaluation of an appropriate pricing model are: Allocative efficiency – society gets the greatest return form its scarce resources byputting those resources to their most productive use in the economy. This isachieved when consumption and production decisions are based on prices that reflectthe opportunity cost of the available resources, and consists of both Demand andSupply efficiencies.o Demand efficiency when users are charged no more or no less than it costs toproduce the unit of service to themo Supply efficiency (revenue adequacy)when producers are able to recoversufficient cost to sustain the provision of the services required Productive or technical efficiency – where goods and services are produced atminimum cost given the available technology. Dynamic efficiency – optimising the allocation of resources over time, includinggenerating additional resources, to maximise overall benefits to society. An exampleis finding better ways to produce or deliver goods and services. Based on a solid theoretical foundation. Fair and objective. Price stability should be supported. Transparent and reliable. Practical and understandable. Flexible – can be applied to different circumstances and yield different outcomes fordifferent groups.
  • Price & Service Plan 2012 – 2015, Southern Water Response from Nekon Pty Ltdensuring sustainable, responsible and affordable water delivery for Tasmanians Page 8A Proposed SolutionThe Theoretical ModelAccording to standard economic theory, prices should be set at marginal cost (MC) since, inthe absence of externalities, this maximises economic welfare. This is because such pricesreflect the costs involved in providing an additional amount of output. Where the uservalues an extra unit more than it would cost to produce it, it is economically efficient toproduce that unit, and vice versa. Setting prices equal to marginal cost means that userswill continue purchasing extra units until it is no longer economically efficient to producethem at that price. Marginal cost based pricing therefore send signals to consumers andproducers encouraging them to balance the benefits obtained by consuming a good orservice with the costs of providing it.Under a strict Marginal Cost pricing model, the price of water is its short-run marginaloperating cost. This assumes that capacity (supply, storage or water availability) is inexcess of demand and that distribution (supply delivery) is available, as and whendemanded. Price may equal zero when the existing supply ‘safely’ exceeds demand. Pricewill rise as supply is reduced to meet a rising level of demand. The applicable marginal costsconsist of those additional costs incurred in operating and distributing the amount of waterdemanded. Once demand increases to the point of capacity, price will increase verticallyuntil demand is reduced, or consumers are willing to pay for the additional investmentrequired to increase capacity. This situation is shown in Graph 3 (as adapted from EfficientUrban Water Pricing, by Professor Hugh Sibly, School of Economics and Finance, Universityof Tasmania, The Australian Economic Review, vol 39, no 2, pp227-237).Graph 2: Adding Extra Capacity, Marginal Cost Pricing ModelS1 = current supply asconstrained by capacity.Where Supply (S1) exceedsDemand (D1), the efficientmarket price is pe.Price pc is the price wherecapacity is reached. Atcapacity, any increases indemand will significantlyincrease price.Once capacity is added (refergreen S2 line), an efficientmarket is again restored withsupply exceeding demand(D2), and price retreatingback to p3.Several issues arise when applying this perfect theoretical model to practical urban utilities,including: The fact that on a global basis demand exceeds supply and Australia is considered tohave a relatively high water stress level (primarily due to the fact that we produce93% of our own food, export food to other countries, population growth, continuedurbanisation, and lack of effective water consumption education and pricing signals). The true cost of utility operations and delivery is unknown or not publicly available. In Tasmania, urban water pricing includes sewerage, with drainage remaining withthe Councils. Equity and fairness must be maintained for social and political purposes.S1 S2D1pe
  • Price & Service Plan 2012 – 2015, Southern Water Response from Nekon Pty Ltdensuring sustainable, responsible and affordable water delivery for Tasmanians Page 9 Equity and fairness should be considered at a national level, thereby promotingcompetition at a national level amongst the regional utilities. Monopolistic pricing must not be seen to be exerted. Tasmania’s current water industry has been under capitalised. Tasmania has a ready supply of fresh water, relinquishing the high cost need fordesalination, yet still requiring suitable harvesting and reticulation systems.Whilst the ‘first best’ solution is to set price equal to marginal cost to achieve allocativeefficiency, when dealing with a natural monopoly or networked/reticulated business such aswater, the utility will not make sufficient revenue to recover its fixed costs (because averagecost is below marginal cost). Ultimately, efficient pricing signals are not being provided toconsumers and utilities may not be sustainably compensated for operating and deliverycosts; issues achieving both allocative efficiency and revenue adequacy arise.Alternative SolutionsAdaptions made to the theoretical model have been proposed to overcome the abovementioned shortcomings. It is worth noting, that there is no ideal, and the best move at thispoint in time is to take some action towards implementing an efficient market model andadjusting it as required.In situations where Marginal Cost is less than Average Cost and the utility needs to recoupits operating costs via a sustainable pricing mechanism, Sibly (2006) advocates the use of afixed charge related to property values (as a proxy for the consumer’s ability to pay).However, this is not to say that water charges should reflect property values in theirentirety; rather it is a suggested second best solution to recovering operating costs via afixed charge when the ideally efficient Marginal Cost priced variable charge will not.The introduction of a fixed or lump sum charge has been suggested to compensate thewater utilities for the difference between their Average Cost and Marginal Cost, therebyensuring they are financially sustainable. Rather than subsidies and taxation, which Coase(1946 as quoted by Altmann, 2007, p9) considers distortionary, a fixed charge covering thecost of the network connection is recommended. A volumetric charge set at marginal costmaintains economic efficiency with the fixed charge filling the shortfall.Australia’s economic regulators tend to support Coase’s two part pricing proposition. Movingforward, the Tasmanian legislation stipulates a, “…two-part pricing for water services basedon the recovery of fixed costs and variable costs…”7.It has been further suggested that both volume consumed and distribution were variablecosts: volume according to usage, and distribution by network distance.8Another alternative is to use Long Run Marginal Cost, which effectively brings forwardinvestment (capital works programs) by ‘budgeting’ for it now. Long run marginal costpricing includes costs related to scarcity, negative and positive externalities, and plannedsupply investment requirements. Turvey (quoted in Altmann, 2007) defines long runmarginal cost of water supply as the sum of marginal capacity costs, marginal operatingcosts, marginal distribution costs and per connection overhead costs. Whilst includingmarginal capacity costs differs from conventional economic theory, it was argued thatcommitments to expand capacity are made years in advance to their implementation. Hencethe variable is not the incremental expenditure, but rather the timing. It was shown that aone year change in commissioning new capacity can have a significant marginal costimpact. The UK Office of Water and the Essential Services Commission in Victoria have bothemployed this concept of marginal cost pricing in their business models.7Section 68: Pricing principles, Water and Sewerage Industry Act 2008,Tasmania, 20118Vickrey, W.S. Some implications of marginal cost pricing for public utilities. AmericanEconomic Review, 45(5): 605-620, 1955.
  • Price & Service Plan 2012 – 2015, Southern Water Response from Nekon Pty Ltdensuring sustainable, responsible and affordable water delivery for Tasmanians Page 10A mix of both Long Run (LRMC) and Short Run Marginal Cost (SRMC) pricing has also beensuggested where price is set at the higher of either the LRMC or SRMC. Effectively, whensupply exceeds demand and capacity is at safe limits, SRMC is used; in times of drought orwhen capacity limits are reached, LRMC is applied. Whilst such a proposition supportsrevenue adequacy, it requires a relatively high degree of administrative flexibility andcommunity communication. Given the current economic climate, price increases and pricestability are sensitive issues for water users.North American water suppliers use the Average Incremental Cost approach in price setting.This is the additional cost per unit of additional consumption when both additional annualcosts and consumption are expressed as the present value of their flows. The benefit ofaveraging costs is the achievement of price stability. Again, this is a volumetric pricingmodel, but less attractive in allocative terms than marginal cost approaches and is highlydependent on the underlying discount rates applied.The Practical SolutionSelecting an appropriate pricing mechanism for water utilities is complex and requires thequantification and balancing of many variables including tariff price, fixed and variablecosts, network and infrastructure costs, supply and demand constraints, political agendas,social goals, community expectations, regulatory frameworks, and asset quality. ForSouthern Water, this is further complicated by the need to achieve operating efficiencies,equitable pricing and improved transparency from the recent merging of the wateroperations of 11 different Council areas. All this, in the absence of a competitive watermarket, could result in a game of blind’s man bluff.From a purest perspective, economic efficiency within the water industry is unattainable inthe current environment. We need to work with a ‘first best’ or ‘second best’ solution.The ‘first best’ model is one based on marginal cost pricing, as it is this that best achievesallocative efficiency and supports movement towards productive and dynamic efficiencygains. It is also based in sound economic theory, provides the basis for transparent and fairpricing, and facilitates price flexibility. The difficulties arise in price stability andunderstanding the true costs that need to be included. Another key difficulty is ensuringallocative efficiency within a monopolistic networked environment that is highly regulatedand vertically and horizontally integrated.Given the current state of the State’s water assets and relatively significant quality issues,there is an immediate need to invest in capacity building and examine ways to betterimprove our dynamic and productive efficiency levels. By raising the marginal cost toinclude long run variables, capacity building is expedited whilst maintaining economicefficiency. Recognising the potential shortfall in recouping operating costs, it isacknowledged that a fixed charge – or network access charge – may be required. Thissubmission proposes that this fixed, network access charge be minimised to: Support the allocative efficiency benefits gained through marginal cost pricing (thevariable usage charge), Set reasonably tight operational efficiency targets, Ensure competitively geared cost management processes are established andmaintained, and Achieve pricing alignment at a national level.The resulting comparatively higher volumetric charge would have a number of positiveeffects including the: Signalling of the long run consequences of consumer consumption decisions in termsof infrastructure needs. A higher volumetric charge would provide a greater incentiveto alter water consumption patterns, possibly reducing the need for capacityexpansion. Provision of some of the necessary financing for capital expenditure and distributionof the related costs of this according to consumption.
  • Price & Service Plan 2012 – 2015, Southern Water Response from Nekon Pty Ltdensuring sustainable, responsible and affordable water delivery for Tasmanians Page 11Ultimately, higher volumetric charges (with lower fixed charges) allow households and otherconsumers to better manage their water bills through conscious decisions regarding thevolume of water consumed. A single or two person household – such as a retiree – whomight typically only consume approximately 60 to 100 KL water per annum, will no longerbe charged the same as a 4 to 5 person household which may consume at least twice asmuch water as the retiree. Similarly, water conscious family households have a greaterability to reduce their water bills through changing consumption habits.In the medium term, continued research and development into water industry technologies,and supply and delivery alternatives is strongly supported. Longer term, an unbundling ofprice signals for new water sources from the cost of delivery, and retailing, infrastructure isalso supported.For the immediate future, this submission supports the move to a two-part pricingmechanism where economic efficiency is maintained through an emphasis on the variablecomponent, and a minimal fixed charge component. Economic efficiency is maintained inprinciple and a nationally aligned pricing system is introduced.Tariff ImplicationsIt is understood that full cost transparency is yet to be achieved, and is a fundamentalrequirement for an effective marginal cost pricing model. Similarly, a more informedresponse to the Draft Price and Service Plan requires the availability of more data andaccess to Southern Water’s operating costs, consumption patterns and other relatedinformation. An alternative to consider is based on average estimation with guidelines anddata sourced from: Tasmanian Water and Sewerage Industry, Pricing Principles Tasmanian Water and Sewerage Industry, 2011-12 Price DeterminationInvestigation, Draft Price and Service Plan Guideline Tasmanian Water & Sewerage State of the Industry Report 2009-10 Southern Water’s Price and Service Plan Summary 2012-2015 Southern Water’s Annual Report 2009-2010 National Water Commission’s Review of Pricing Reform in the Australian WaterSector 2011 Australian Bureau of Statistics’ Census data and Water Accounts Pricing strategies of selected Australian water industry participants:o Hunter Water, New South Wales,o Sydney Water, New South Wales,o South East Water, Victoria,o Barwon Water Victoria,o SA Water, South Australia, ando Brisbane Water, Queensland.Table 1 shows a comparison of pricing strategies across the selected water utilities forstandard users.Table 1: Water Utility Pricing ComparisonSource: various utility pricing fact sheets 2010-2011Urban Water Pricing ComparisonsResidential Non-Resi Resi 1Business Resi Non-Resi Resi 2Non-Resi2ResiNon-ResiResi 3Non-Resi3Resi Non-ResiFixed Service Charge, $Fixed Water per 20mm 272.32 272.32 18.84 18.84 144.82 144.82 82.44 82.44 150.63 150.63 234.60 273.00 167.16 167.16Fixed Water 100mm 6,808.00 6,808.00 471.12 3,619.82 3,619.82Fixed Sewerage diameter 20 mm (or 1 tenement) 488.71 488.71 521.25 1,042.50 539.54 539.54 335.68 398.64 499.59 302.64 325.00 325.00 475.92 475.92Fixed Sewerage diameter 100mm (or 5 tenements) 2,443.55 2,443.55 26,062.50 13,488.50 13,488.50VolumetricVariable Sewerage per KL 0.65 1.71 1.71 1.53 1.69$ / KL 0.90 0.90 1.90 1.90 2.10 2.10 1.75 2.13 1.98 1.98 1.93 2.13 0.67 0.79Plan FY13 Water Charges, 2010-2011SA Water (SA)Brisbane Water(QLD)Hunter Water(NSW)Sydney Water (NSW)South East Water(Vic)Barwon Water(Vic)Sthn Water
  • Price & Service Plan 2012 – 2015, Southern Water Response from Nekon Pty Ltdensuring sustainable, responsible and affordable water delivery for Tasmanians Page 12Table 1 shows that Southern Water’s pricing plan, as compared to other industryparticipants, is relatively highly geared towards maximising the Fixed Costs with a minimalVariable Usage charge. National alignment and a higher variable component to thatproposed by Southern Water is achieved through the application of an average approach tothe pricing structure.Table 2 offers an alternative consideration where the variable water usage rate is increasedfrom $0.90KL to $1.72 or $1.84KL and the fixed water charge if reduced (for a 20mmconnection) from $272.32 to $133.08. In the absence of key underlying data from SouthernWater, both economic theory and the pricing strategies of other Australian water utilitiessuggest more efficient pricing signals will be given to both consumers and the utility (underthis alternative pricing model).Table 2: Alternative Pricing Model for Consideration - Average TariffsSource: Southern Water’s Draft Price and Service Plan 2012-2015 Summary,averages derived from pricing information sheets published by the selectedutilitiesApplying these figures to Southern Water reveals that revenue requirements are alsomaintained.Table 3: Revenue Requirements, Southern WaterSource: base data from Southern Water Annual Report 2009-2010Based on Southern Water’s 2009-10 total revenue of $101,879,000 a forecast requiredrevenue for 2012-13 assuming 3% annual growth over the 3 years to 2012-13 yields arequired revenue of approximately $111,326,000. Separating this into Water and SewerageUrban Water Pricing ComparisonsResidential Non-Resi Residential Non-ResiFixed Service Charge, $Fixed Water per 20mm 272.32 272.32 133.08 139.48Fixed Water 100mm 6,808.00 6,808.00Fixed Sewerage diameter 20 mm (or 1 tenement) 488.71 488.71 449.50 514.04Fixed Sewerage diameter 100mm (or 5 tenements) 2,443.55 2,443.55VolumetricVariable Sewerage per KL 1.35$ / KL 0.90 0.90 1.72 1.84Plan FY13AVERAGESthn WaterSouthern Waters RequirementsConnectionsNumber(2009-10)Revenue(2009-10)avge rev perconnex(2009-10)RevenueRequired(2009-10) % RevenueSalesRevenueforecast20012-13(3% growthpa)ConnectionsNumber(2012-13)avge rev /connex(2012-13)TOTAL 101,879,000 111,325,934Water 98,385 51,933,000 527.85 51,933,000 51% 56,748,591 98,385 576.80Sewerage 90,241 44,974,000 498.38 44,974,000 44% 49,144,304 90,241 544.59Other (Irrigation, Regates, Fees) 4,972,000 5%expected water supplied, ML 43,600Water Revenue, Residential 75% based on revenue breakbrown for Hunter Water 42,561,443 89,597 475.03Water Revenue, Non residential 25% NB: Frontier economics Resi=60 to 70%, Industrial = 10%, 14,187,148 8,788 1,614.38Number of households (ABS data 2006) commercial = 20 to 30% 89,597
  • Price & Service Plan 2012 – 2015, Southern Water Response from Nekon Pty Ltdensuring sustainable, responsible and affordable water delivery for Tasmanians Page 13revenues and dividing by the number of connections gives an average revenue per waterconnection of $576.80 and $544.59 for sewerage for 2012-13.Applying a 75% split for Residential and 25% for Non-residential water consumption, resultsin an average revenue per connection of $475.03 for residential and $1,614.38 for non-residential.Applying the ratio of 60% fixed and 40% variable as detailed in Southern Water’s AnnualReport 2009-2010 to the proposed ‘average’ tariff structure of Fixed Water Charge = $135and Variable Charge = $1.84 KL, shows that Southern Water’s revenue requirement isexceeded (Table 4). So as not to unduly exceed revenue requirements, the fixed chargecould be reduced even more. At the very least, further investigation and modelling arerequired to identify a more “ideal” pricing scheme or selection of pricing alternatives.Table 4: Proposed Pricing Impact, per Residential & Non-Residential UserResidential Non-ResidentialRequired Proposed Avge Required Proposed AvgeWater only TOTAL $475.03 $546.18 $1,614.38 $2,505.89$KL $1.84 $1.84Fixed, $ $135 $540A figure of 60% Fixed and 40% Variable has been communicated as an estimation of thesplit within Southern Water’s pricing model. However, another view of the available datasuggests this may be more along the lines of 47% Fixed and 53% Variable; again it isrecognised that figures are derived from averages and slightly misaligned time periods. Thiswas derived by taking the average revenue per water connection for 2012-13 of $576.80less $272.32 (47%) for a standard fixed charge, yielding $304.48 (53%) for variablecharges.Further dividing the variable component of $304.48 by the $0.90 charge per KL suggests anaverage consumption rate of 338 KL per annum. This average differs from that proposed inSouthern Water’s Draft Price and Service Plan 2012-2015 Summary, Example 1 of 200 KLper annum for standard residential customers and, Example 4 suggests a medium sizednon-residential customer consumes 800KL per annum. The recently released State of theIndustry report suggests another average consumption figure of “…458 KL for the southernregion”9. Again, averages could be taken and further assumptions made.A meaningful response to the proposed pricing strategy demands more than these relativelyhigh level assumptions and averages.It is acknowledged that residential water consumption prices will increase. However, bygiving greater emphasis to the volumetric charge than currently allowed, consumers – mostparticularly, householders – are given some degree of control over the extent to which theywill be affected since they can alter their water consumption patterns. Tables 5a-b showthat an alternative pricing scheme with a lower fixed charge and higher volumetric chargewill deliver Southern Water’s revenue requirement of $613 per household (based on anaverage household consumption of 378 KL per annum10).9The Office of the Tasmanian Economic Regulator, Tasmanian Water and Sewerage State ofthe Industry Report 2009-10, p 39, 201110ABS, 4610.0 Water Account, Australia, 2008-09 & Census Data (2006) profiles forStatistical Divisions 605 & 610, 2011
  • Price & Service Plan 2012 – 2015, Southern Water Response from Nekon Pty Ltdensuring sustainable, responsible and affordable water delivery for Tasmanians Page 14Table 5a: Constant Revenue to Southern Water (water only)Table 5b: Pricing Assumptions (water only)Table 5b shows the Fixed Charge as being reverse engineered down from $272.32 to $84(similar to that charged by South East Water, Victoria) and the variable charge increasedfrom $0.90 to $1.40 per KL. Southern Water’s revenue of $613 is maintained. Thisalternative model, better supports economic efficiency and consumers’ freedom in decidingthe quantity of water they consume.It is recognised that Table 5b provides yet another alternative to the “average” modelpresented earlier in Tables 2 and 4. In the absence of more detailed consumer profile dataand a more in-depth understanding of the scale of consumers requiring transitional tariffarrangements, a commercially viable alternative is difficult to propose. In formulating asensible response, Southern Water and the Office of the Tasmanian Economic Regulator isrequested to seek further responses on the proposed pricing model whilst making thefollowing information, and any other information necessary to make an informed decision,available for the deliberations: More detailed explanation of the numbers driving Southern Water’s Draft Price andService Plan The provision of serious alternatives from which to select Wherever possible, access to the supporting data, calculations and assumptions Provision of data and assumptions set upon which to test and propose viablealternatives.SWs DraftPricing PlanProposedAlternativeType of Household average averageHousehold consumption, KL 378 378Variable Charge 340$ 529$Fixed Charge 272$ 84$TOTAL WATER (ex sewerage) 613$ 613$SW DraftPricing Plan2012/13ProposedAlternativeFixed Water, 20 mm connection ($) 272.32 84.00Volumetric Charge, Water ($KL) 0.90 1.40Fixed Sewerage, per 1 ET($) 488.71 481.77
  • Price & Service Plan 2012 – 2015, Southern Water Response from Nekon Pty Ltdensuring sustainable, responsible and affordable water delivery for Tasmanians Page 15Bibliography & ReferencesAnnual Reports for Sydney Water, Hunter Water, Barwon Water, South East Water, SAWater and Brisbane WaterAustralian Bureau of Statistics, various National Regional Profiles (1379.0.55.001), 2011Australian Bureau of Statistics, Water consumption down, water prices up, 4610.0 - WaterAccount Australia, 2008-09 Media Release, 2010Australian Bureau of Statistics, Water Account (4610.0), 2011Australian Government, Urban water in Australia: Future directions, National WaterCommission, 2011Allen’s Arthur Robinson, Summary of Productivity Commission reports on Australia’s urbanwater sector, url:www.aar.com.au/pubs/water/fowmay11.thm, 2011Altmann, D. Marinal cost water pricing: Welfare effects and policy implications usingminimum cost and benchmarking models with case studies from Australia and Asia, Doctorof Philosophy Thesis submission, University of Adelaide, School of Economics, 2007.Coase, R. The marginal cost controversy, Economica, 13(8): 169-189, 1946.Deloitte/AWA, State of the water sector 2010-15: Preliminary report, 2010Economic regulation of the South Australian Water Industry, Statement of Issues, TheEssential Services Commission of South Australia, 2010.Ernst & Young, Spotlight on water,Frontier Economics, Approaches to urban water pricing, Waterlines Occasional Paper, no.7,2008Hughes, N., Hafi, A., Goesch, T., Brownlowe, N. Urban water management: Optimal priceand investment policy under uncertainty, Australian Bureau of Agricultural and ResourceEconomics Canberra Conference, 2008London Economics, Economic Brief: Reform in the Australian urban water sector; theProductivity Commission Inquiry, April 2011OECD, The price of water: Trends in OECD countries, The OECD Environment Program1999-2000,PriceWaterhouseCoopers, Infrastructure Australia: Review of urban water securitystrategies, 2010Pricing fact sheets and publications for Sydney Water, Hunter Water, Barwon Water, SouthEast Water, SA Water and Brisbane WaterRoberts, R., Mitchell, N., Douglas, J. Water and Australia’s economic growth,Sibly, H. Efficient urban water pricing, The Australian Economic Review, 39(2):227-237,2006Sibly, H. Urban water pricing, Agenda, 13(1):17-30, 2006.South Australian Government Regulatory Statement - 2011-12 Drinking Water andSewerage Prices, 2011
  • Price & Service Plan 2012 – 2015, Southern Water Response from Nekon Pty Ltdensuring sustainable, responsible and affordable water delivery for Tasmanians Page 16Office of the Tasmanian Economic Regulator, Water and Sewerage State of the IndustryReport 2009-10, 2011Office of the Tasmania Economic Regulator, Tasmanian Water and Sewerage Industry 2011-12 Price Determination Investigation Draft Price and Service Plan Guideline, 2011Southern Water, Draft Price and Service Plan 2012-15 Summary, 2011The Allen Consulting Group, Urban water: A vision and roadmap for national progress, GapForum on Urban Water, 2009Turvey, R. Analysing the marginal cost of water supply, Land Economics,158-168, 197652(2):Vickrey, W.S. Some implications of marginal cost pricing for public utilities. AmericanEconomic Review, 45(5): 605-620, 1955.Water and Sewerage Industry Act, Section 68: Pricing principles, 2008. url:http://www.thelaw.tas.gov.au/tocview/index.w3p;cond=;doc_id=13%2B%2B2008%2BAT%40EN%2B20090623150000;histon=;prompt=;rec=;term=