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Focus: ERA releases WA water regulation reports

16 September 2008

In brief: In July 2008, the Economic Regulation Authority of Western Australia has released its final reports from two recent inquiries into water regulation in the state. Senior Associate Robyn Glindemann and Law Graduate Robert French examine the major findings and recommendations of the Inquiry into Developer Contributions to the Water Corporation and the Inquiry on Competition in the Water and Wastewater Services Sector.

How does it affect you?

  • The Economic Regulation Authority of Western Australia (the ERA) has recommended a range of reforms which, if implemented, will significantly modify the structure and operation of Western Australia's water and wastewater service industries.
  • The ERA has also commenced an inquiry into the pricing of recycled water and expects to release a draft report in October 2008.
  • Each of these inquiries can have a significant impact on the security and cost of water in Western Australia. It is important to be aware how such changes might affect your business.
  • With the election of the new Liberal minority government, however, it is unclear how such reports will be addressed. Some issues in the reports reflect the national approach to competition in the water sector and so one would expect the new government's response to have an eye on the national position.

Inquiry into Developer Contributions to the Water Corporation

Background

In October 2007, the ERA was asked to develop a set of principles for the setting of 'developer contributions' to the Water Corporation (the Corporation). The ERA released a draft report from its inquiry in April 2008, and the final report largely reaffirms the ERA's preliminary conclusions.

Developer contributions may take the form of cash payments (often called 'developer charges') to help the Corporation recover part of the infrastructure costs associated with new land development, as well as charges for bringing forward new land developments ahead of schedule ('out of sequence charges').

Role and guiding objectives of the inquiry

Because regulated utilities such as the Corporation are typically monopolies, it is the regulator's role to ensure that the utility's total revenue from all sources, including developer contributions, covers the utility's costs. In examining the way developer contributions are set, the ERA's inquiry was guided by three broad objectives:

  • Economic efficiency, which involves setting charges in a way that appropriately influences developers' decisions to invest;
  • Equity, which relates to considerations such as the affordability to the purchaser of the developed land, and avoiding sudden price rises; and
  • Good regulatory practice, which requires that developer contributions be based on a stable, predictable and easily understood methodology and be contestable through an appropriate appeals mechanism.

The ERA's report sets out 18 principles and findings under these three headings for setting developer charges. In reaching these findings, the ERA examined approaches to developer contributions in other jurisdictions, such as New South Wales, Victoria, and England and Wales, and in other industries such as electricity and gas.

The Corporation's standard headworks charges

Having laid down the principles to follow, the ERA then examined two broad alternatives to the Corporation's current practice of charging standard headworks charges for water, wastewater and drainage services across Western Australia. At the moment, the Corporation charges a state-wide standard headworks contribution based on recovering 40 per cent of the average state-wide cost of providing headworks infrastructure to a typical residence on an average residential lot. The remaining 60 per cent is recovered through annual usage and fixed charges and Community Service Obligation payments from the government (where applicable). Under this approach, non-standard and out-of-sequence charges are levied where appropriate.

The first alternative proposed by the Corporation was a uniform state-wide charge to be calculated based on the existing state-wide distribution assets for water and wastewater services.

The second alternative was scheme-specific headworks charges to be calculated based on the total cost of each scheme's distribution assets. There are 216 country town schemes in Western Australia provided with water services, and in some cases, wastewater services are provided as well. Under this approach, the Perth metropolitan region would be treated as a single scheme. The ERA favoured this approach on economic efficiency grounds, because it provided scope for setting headworks charges that reflect development costs at individual locations.

The ERA ultimately recommended a modified version of the scheme-specific approach proposed by the Corporation. The ERA proposed that a modified scheme would take into account existing spare capacity in limited circumstances and also reflect permanent savings made in the distribution costs of new developments by the use of Water Sensitive Urban Design principles. Further, according to the ERA, no caps should be placed on developer charges because this would distort price signals sent by location-based developer charges and would have no social welfare advantages.

The ERA proposed the establishment of an implementation committee to determine developer charges for each scheme, ongoing stakeholder consultation and an independent regulatory review mechanism. Finally, an appeal mechanism should be provided for the location-based developer charges.

Inquiry on Competition in the Water and Wastewater Services Sector

The ERA was asked in July 2007 to investigate possible competitive enhancements for the delivery of water and wastewater services in Western Australia.

The ERA noted in the introduction to its final report that, unlike in other business sectors, the water and wastewater service industry has certain characteristics which limit competition. The ERA stressed the importance of regulatory intervention in the industry, noting that competition can prove counterproductive in certain respects. For example, unrestricted consumption can lead to over-utilisation of resources, and environmental and public health risks mean that business decisions in the industry impact on third parties.

Against this background, the ERA sought to examine how security of supply could be maintained at the lowest cost.

Independent Procurement Entity

The ERA confirmed the preference it expressed in previous reports for the establishment of an Independent Procurement Entity (IPE), which would oversee the procurement of bulk water supplies.

The IPE would be an independent statutory authority funded by customers via water tariffs, with oversight by the ERA. It would be the sole agency responsible for managing water supply and demand functions within the Integrated Water Supply Scheme, which supplies Perth and much of the southern part of Western Australia.

The IPE's core task would be to identify and manage future possible supply shortfalls. Upon identifying a shortfall, the IPE would seek proposals from the Corporation and the private sector. If it concluded that an additional source or demand management option was necessary, the IPE would seek private sector bids on these proposals and select the project with the greatest net benefit to the community. Technical and operational negotiations would then take place between the Corporation and the selected bidder(s) for developing the source.

The IPE would also take over responsibility from the Department of Water and the Corporation for funding and approving existing demand management programs, such as restrictions and rebates.

The ERA concluded that an IPE could offer significant savings to customers by investigating all possible procurement options and ensuring the development of the lowest-cost combination of sources. It would allow for streamlining and the removal of the duplication that currently exists in bulk water procurement in Western Australia. The ERA further found that, compared with the Corporation's proposed procurement model, the IPE would encourage private sector innovation in developing supply options.

Third-party access

The ERA recommended a new third-party access regime be implemented in Western Australia, to allow for easier access to water and wastewater infrastructure than is currently available under the Trade Practices Act 1974 (Cth).

The ERA favoured a state-based access regime similar to the one recently introduced in New South Wales (although it advised delaying finalisation of the Western Australian regime until any issues with the New South Wales system are resolved). Under this regime, there would be two ways in which third-party access agreements could be reached between a service provider and an access seeker:

  • through an access undertaking, proposed by the service provider and agreed to by the access seeker, setting out the terms and conditions of access; or
  • through a Ministerial declaration of infrastructure to be covered by an access agreement.

Under the framework, if access terms cannot be agreed upon by the parties, the regulator can make an access determination setting out the arrangements to apply between the parties. In the event of a dispute, either party can apply to the regulator for arbitration.

Service providers would be also be able to apply to the regulator for a binding 'non-coverage declaration' for infrastructure that is yet to be built, or which is not currently used to provide water or wastewater services.

On pricing, the ERA recommended a 'retail-minus' approach, which takes the retail price as the starting point and subtracts from that an estimate of the costs avoided by the incumbent (the service provider granting access) as a result of the access seeker taking on some of its services. The ERA rejected a cost-based approach, under which prices would be calculated on the basis of determining the cost incurred by the incumbent in providing access. The ERA noted concerns that under this approach, access seekers might be able to 'cherry pick' customers in areas which are less expensive to serve, leaving the incumbent with the highest-cost customers and at risk of revenue loss.

Other issues
Water trading mechanisms

According to the ERA, water trading facilitates the transfer of water from lower value to higher value uses. Water access entitlements are traded voluntarily and on either a temporary or permanent basis. The ERA concluded that an effective water trading regime must be established 'as a matter of urgency'. The ERA also noted that Western Australia is required to develop an effective trading scheme under the National Water Initiative.

The ERA considered that, where feasible, barriers should be removed to allow water trading to occur where there are benefits in doing so. To ensure the effective operation of a water trading scheme, the ERA recommended that neutral auctioning be used in the reservation of water for future public suppliers, and that equal treatment be give to all entitlement holders. It also suggested neutral market mechanisms be used in issuing water licences.

Community Service Obligations

A Community Service Obligation (CSO) arises where a government requires a public enterprise to carry out activities at prices that would not otherwise be commercially viable. In the Western Australian water and waste water services sector, CSO payments are used to ensure service provision in regional and remote areas of the state.

The ERA recommended that the Department of Treasury and Finance (which is responsible for the payment of CSOs) develop a policy to allow CSO payments to be made to non-government entities.

Alternative industry structures

The ERA investigated the likely benefits and cost implications of creating a multi-utility responsible for the provision of electricity, water and wastewater services in regional Western Australia. The model considered was a synergy between the Corporation and Horizon Power, which is currently responsible for generating or procuring, distributing and selling electricity in the Pilbara, Kimberley, Gascoyne, Mid-West and southern Goldfields. The ERA, while suggesting a multi-utility did not currently appear to be commercially preferable, recommended that a comprehensive business case be developed to explore the possibility further.

The ERA also investigated alternative configurations of water and wastewater provision in the Bunbury and Busselton regions, concluding that a single entity might reduce the cost of services currently provided by the Bunbury and Busselton water boards. Once again, the ERA recommended the development of a comprehensive business case for this proposal.

Next steps

In response to the ERA's reports, the previous State Government indicated it would develop 'a whole-of-government response' to both reports and had established a working party, chaired by the Department of Premier and Cabinet, to consider the recommendations of the Inquiry on Competition in the Water and Wastewater Services Sector. It was expected that the government would take three to six months to formulate its response.

With the election of the Liberal minority government (with the support of the WA National Party), it is unclear how these reports will be addressed. Both reports have ramifications for regional Western Australia and so the position of the Nationals on the issues raised in the reports will be key considerations in the formal government response.

In early August, the ERA also released an issues paper as part of its inquiry into the pricing of recycled water in Western Australia. The ERA has been asked to consider the circumstances in which recycled water prices should be regulated and the recommended approach to any required regulation, having regard to the pricing recommendations of the State Water Recycling Strategy and other factors that the ERA considers relevant to the adoption of recycled water and other alternative water supplies.

A draft report is expected to be made available in October 2008 ahead of a final report to the Treasurer by 6 February 2009.

We will keep you informed of developments in this area as they arise.

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