Phase 2 Review of Sunwater Administration Costs

Queensland Competition Authority SunWater Administration Cost Review Phase 2 25 August 2011 Deloitte Touche Tohmatsu ABN 74 490 121 060 550 Bourke Street Melbourne VIC 3000 Tel: +61 (0) 3 9671 7000 Fax: +61 (0) 3 9671 7700 www.deloitte.com.au John Hall The Chief Executive Officer Queensland Competition Authority GPO Box 2257 Brisbane QLD 4001 25 August 2011 Dear Mr Hall RE: SunWater Admin Costs – Phase2 Review Deloitte is pleased to submit this final report to the Queensland Competition Authority as part of the SunWater Irrigator Price Review process. Please do not hesitate to contact me directly should you wish to discuss. Yours sincerely Kumar Padisetti Partner Energy and Infrastructure Advisory 1 Contents Statement of Responsibility 3 1 Executive Summary 5 2 Introduction 7 2.1 Background to the Price Setting Review 7 2.2 Terms of Reference and Approach 7 3 SunWater‘s Administrative Costs 9 3.1 SunWater‘s Services 9 3.2 Provision of Services 12 3.3 Adminstrative Costs Summary 15 3.4 Assessment of SunWater‘s Administrative Costs 17 3.5 Local benchmarking 36 3.6 Cost Escalation 40 3.7 Insurance 42 3.8 Identified Efficiency Opportunities 44 4 Cost Allocation Methodology 45 4.1 SunWater‘s proposed CAM 46 4.2 Assessment of SunWater‘s Proposed Methodology 51 5 Conclusion 80 5.1 General Comments 80 5.2 Reasonableness and Prudency of Administrative Costs 80 5.3 Appropriateness of Cost Allocation Methodology 81 Appendix A – Case Studies 83 Appendix B – Worked examples of cost allocation to schemes 89 Appendix C – Worked examples of cost allocation to customer groups 98 Appendix D – Allocation of admin costs to Irrigator Service Contracts and Deloitte modelling results 104 Appendix E – MAE detailed analysis 110 2 Statement of Responsibility This report was prepared for the Queensland Competition Authority as part of the 2012-17 irrigation price review, for the purpose of assessing the efficiency of SunWater‘s proposed administration costs and the appropriateness of the allocation methodology used to apportion administration costs to irrigation customers. In preparing this report we have relied on the accuracy and completeness of the information provided to us by the Queensland Competition Authority and SunWater and from publicly available sources. We have not audited or otherwise verified the accuracy or completeness of the information. We have not contemplated the requirements or circumstances of anyone other than the Queensland Competition Authority. The information contained in this report is general in nature and is not intended to be applied to anyone‘s particular circumstances. This report may not be sufficient or appropriate for your purposes. It may not address or reflect matters in which you may be interested or which may be material to you. Events may have occurred since we prepared this report which may impact on it and its conclusions. We do not accept or assume any responsibility to anyone other than Queensland Competition Authority in respect of our work or this report. 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For more information, please visit Deloitte‘s web site at www.deloitte.com.au. 4 1 Executive Summary The Queensland Competition Authority (‗Authority‘) has been directed by the Queensland Premier and the Treasurer (‗Ministers‘) to establish irrigation prices to apply to 22 of SunWater‘s Bulk Water Supply Schemes and 8 Distribution Supply Schemes (‗WSS‘) from 1 July 2012 to 30 June 2017. The Ministerial Notice requires that bulk water supply and irrigation channel prices be set so that it allows SunWater to recover: its efficient operational, maintenance and administrative costs; prudent and efficient expenditure on renewing and rehabilitation existing assets, through a renewals annuity; and a commercial return of and on prudent capital expenditure for augmentation commissioned on or after 30 September 2011 The Authority has sought external, expert advice from Deloitte Touche Tohmatsu (‗Deloitte‘) in response to the Minister‘s Notice. In particular, independent expert advice was sought to carry out an assessment of the prudency and efficiency of SunWater‘s proposed administration costs and the reasonableness of the allocation of administration costs to WSS and to medium and high priority customers. This report represents our analysis and findings to date including: 1. An assessment of the reasonableness and prudency of SunWater‘s cost base through a benchmarking and case study exercise. In addition we have undertaken a bottom-up ‗needs based‘ assessment of the services provided and associated labour effort to help establish the benchmarking exercise and identify where labour is being spent 2. An assessment of the allocation of administrative costs to scheme and customer level. We reviewed SunWater‘s proposed allocation methodology and completed an assessment of the appropriate drivers for each administrative function. Overall SunWater‘s cost structure was found to be within expected global benchmark ranges. Our MAE (missions, activities and end-products) analysis did not identify any major structural issues with the delivery of services. Our final analysis indicates there is an opportunity to reduce FTEs by 2.3 – 2.9 % (of the 178.4 FTE‘s we assessed). The main opportunities identified are within the Finance, HR, ICT and Health Safety, Environment and Quality (HSEQ) functions. Based on a median SunWater salary of $98,582 (for the forecast year 2012), this translates to a potential saving of $409,115 to $507,697. As this saving includes the statutory on-costs associated with employees, such as superannuation payments, it represents a comprehensive view of the potential efficiency opportunities faced by SunWater. We have identified a number of areas of SunWater‘s proposed CAM that could be improved. In particular, to allocate the costs of some functions using direct costed labour may result in the apportionment of costs to customers that do not necessarily bear the most responsibility for their causation. Taking into account the activities carried out by SunWater staff across key functions and the impact of using alternative cost allocation bases (CABs) quantified through a modelling exercise, we have recommended alternative CAB(s) for the following functions: 5 Finance Procurement Infrastructure Management – Regions Infrastructure Management – Asset Management Infrastructure Management – Water Accounts Infrastructure Management – General Manager and Service Delivery Infrastructure Development. We note that our analysis has been undertaken from an economic perspective. In making a final decision the QCA may wish to take into account other considerations such as the size of the impact on individual customer groups or equity considerations. A key finding of the review was that SunWater defines its overhead and indirect costs in a unique way. Typically a business will define overhead costs as those costs occurring in head office functions that are not able to be directly charged. While SunWater does consider these costs as overheads, SunWater also considers non-utilised time of field staff (approximately 20 per cent of their time) as an overhead cost. In most businesses, this would be considered an operational expense. The impact of SunWater‘s unique definition is that the total overhead amount appears large. In looking at an alternative allocation methodology, we have recommended that costs associated with non-utilised employee costs be allocated only to the Service Contracts those employees service, rather than being spread across the entire business. In regard to the allocation of costs to customer groups within Service Contracts, we recommend that a weighted factor, such as SunWater‘s HUF, is used to allocate both capital and O&M costs. This is because in the

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