Final Report
SEQ Grid Service Charges 2011-12
July 2011
Level 19, 12 Creek Street Brisbane Queensland 4000 GPO Box 2257 Brisbane Qld 4001 Telephone (07) 3222 0555 Facsimile (07) 3222 0599
[email protected] www.qca.org.au Authority staff who contributed to this report include:
Will Copeman, Peter Halligan, Michelle Kelly, Einar Oddsson, George Passmore, Rick Stankiewicz
© Queensland Competition Authority 2011
The Queensland Competition Authority supports and encourages the dissemination and exchange of information. However, copyright protects this document. The Queensland Competition Authority has no objection to this material being reproduced, made available online or electronically but only if it is recognised as the owner of the copyright and this material remains unaltered.
Queensland Competition Authority Preamble
PREAMBLE
The Authority has recommended Grid Service Charges (GSCs) for the Grid Service Providers (Seqwater, WaterSecure and LinkWater) to apply in 2011-12.
Consistent with the Minister’s Direction Notice, the Authority’s regulatory scrutiny is limited to a review of the prudency and efficiency of non-drought capital expenditure and post-completion drought capital expenditure, and fixed and variable operating costs. It does not address capital charges related to existing assets (return on capital and depreciation), capital expenditure or depreciation on drought assets, or the QWC levy. As a result, only some 33% of the total recommended GSCs have been eligible for regulatory review.
The Authority’s final recommendations for the 2011-12 GSCs are included in the table below, compared to the approved 2010-11 GSCs.
Grid Service Provider Approved 2010-11 QCA Recommended 2011-12 $m $m
Seqwater 370.0 398.8
WaterSecure 317.7 306.5
LinkWater 192.5 205.7
Total Grid Service Charges 880.2 911.0
On the basis of the volume forecast provided by the South East Queensland Water Grid Manager (WGM), the total GSCs across all GSPs average $3,299/ML. This compares to an average of $2,642/ML in 2010-11. The 25% increase in $/ML costs is largely due to a decline in expected volume of 17% in 2011-12 in association with a cost base that is largely fixed. While the GSCs have increased on a per ML basis, the bulk water price payable by the Distributor/Retailers has not been affected.
At $3,299/ML, the GSCs compare to the bulk water prices charged by the WGM to Distributor/Retailers which have a weighted average of $1,736/ML. In other words, in respect of bulk water sold to Distributor/Retailers, the WGM is forecast to recover only 53% of the GSCs paid to the GSPs.
The Authority has also recommended a process for adjusting the GSCs which provides incentives for the entities to invest, innovate and pursue efficiency improvements.
i Queensland Competition Authority Table of Contents
TABLE OF CONTENTS
PAGE
PREAMBLE I
GLOSSARY IV
EXECUTIVE SUMMARY VI Direction Notice vi Grid Service Providers (GSPs) vi Seqwater vii WaterSecure ix LinkWater xi Summary of GSCs xii Review Thresholds xiv
1. MINISTER’S DIRECTION 1 1.1 SEQ Water Market Rules 1 1.2 Direction Notice 1 1.3 Investigation Plan 1 1.4 QWC Manual 2 1.5 Draft Report 2 1.6 Conduct of the Investigation 2 1.7 Future Investigations 3
2. BACKGROUND 4 2.1 The SEQ Water Grid 4 2.2 Drought Assets 6 2.3 Bulk Water Prices 6
3. APPROACH TO THE INVESTIGATION 7 3.1 Regulatory Objectives 7 3.2 Grid Service Charges 7 3.3 Seqwater-WaterSecure merger 8 3.4 Capital Charges 8 3.5 Fixed Operating Charge 15 3.6 Variable Operating Charge 16 3.7 Allowable Costs 17 3.8 Other Services 20
4. SEQWATER 22 4.1 Background 22 4.2 Capital Charge 22 4.3 Fixed Operating Charge 49 4.4 Variable Operating Charge 65 4.5 Allowable Costs 70 4.6 Revenue Offsets 75
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4.7 Summary of GSC 76
5. WATERSECURE 78 5.1 Background 78 5.2 Capital Charge 78 5.3 Fixed Operating Charge 90 5.4 Variable Operating Charge 100 5.5 Allowable Costs 104 5.6 Summary of GSCs 107
6. LINKWATER 109 6.1 Background 109 6.2 Capital Charge 110 6.3 Fixed Operating Charge 124 6.4 Variable Operating Charge 132 6.5 Allowable Costs 138 6.6 Summary of GSCs for 2011-12 142
7. REVIEW THRESHOLDS 144 7.1 Background 144 7.2 Framework and Approach 145 7.3 Cost Impacts of Changes in Law, Government Policy and Emergency Events 148 7.4 Changes in Forecast Demand or Water Sources 150 7.5 Adjustments for RAB and Cost of Debt 152 7.6 Adjustments for Under- or Over-Spend of Capital and Operating Costs 153 7.7 Procedures for Reviewing GSCs and Review Thresholds 158 7.8 Summary of Review Thresholds 158
REFERENCES 160
DEFINITIONS 161
iii Queensland Competition Authority Glossary
GLOSSARY
Term Definition
ADWG Australian Drinking Water Guidelines
AWTP Advanced Water Treatment Plant
Capex Capital Expenditure
CNF Competitive Neutrality Fee
CSO Community Service Obligation
DERM Department of Environment and Resource Management
DR Distributor-Retailer
IT Information Technology
Investment State Water Authorities Investment Guidelines Guidelines kWh Kilowatt hour
FAMP Facilities Asset Management Plan
FTE Full-time Equivalent
GIS Geographic Information System
GSC Grid Service Charge
GSP Grid Service Provider
HR Human Resources
LinkWater The Queensland Bulk Water Transport Authority
OH&S Occupational Health & Safety
O&M Operations and Maintenance
Opex Operating Expenditure
Market Rules The South East Queensland Water Market Rules
ML Megalitre
NPV Net Present Value
NRW (the former Queensland Department of) Natural Resources and Water
RAB Regulated Asset Base
RBA Reserve Bank of Australia
R&D Research and Development
R&M Repairs and Maintenance
iv Queensland Competition Authority Glossary
QCA Queensland Competition Authority
QTC Queensland Treasury Corporation
QWC Queensland Water Commission
SCADA Supervisory Control And Data Acquisition
SEQ South East Queensland
Seqwater The Queensland Bulk Water Supply Authority
SEQwater Trading name of the former South East Queensland Water Corporation Limited
SKM Sinclair Knight Mertz
SOP SEQ System Operating Plan
WACC Weighted Average Cost of Capital
WAE Water Access Entitlements
WCRW Western Corridor Recycled Water
WGM South East Queensland Water Grid Manager
WTP Water Treatment Plant
WaterSecure The Queensland Manufactured Water Authority
v Queensland Competition Authority Executive Summary
EXECUTIVE SUMMARY
Direction Notice
Pursuant to a Direction Notice issued by the Minister for Energy and Water Utilities (the Minister1) on 9 February 2011, the Authority is required to investigate and recommend Grid Service Charges (GSCs) for the Grid Service Providers (GSPs) to apply in 2011-12, and to recommend a process for adjustments of the GSCs including Review Thresholds.
Grid Service Providers (GSPs)
The GSPs are state-owned statutory authorities and comprise the:
(a) Queensland Bulk Water Supply Authority (trading as Seqwater). Seqwater supplies bulk water from dams, weirs and treatment plants to the SEQ Water Grid Manager (WGM) and some rural customers;
(a) Queensland Manufactured Water Authority (trading as WaterSecure). WaterSecure supplies water from the Gold Coast Desalination Plant and the Western Corridor Recycled Water Project to the WGM, who supplies to power stations and Wivenhoe Dam; and
(b) Queensland Bulk Water Transport Authority (trading as LinkWater). LinkWater provides water transport services to the WGM involving the transfer of water from dams and other water resources through bulk pipeline networks to Council owned water distributor-retailers.
While Seqwater and WaterSecure were merged into one entity as from 1 July 2011, the Authority has continued to treat them separately for the purpose of recommending GSCs for 2011-12. This is consistent with the SEQ Water Market Rules prevailing at the time the Direction Notice was issued. The Authority also proposes to do so until the cost implications of the merger are assessed. To do otherwise could be interpreted as the Authority having considered merger cost implications which it has not.
Limitations on the Authority’s Discretion
The Direction Notice (which incorporates a Manual containing further requirements related to the estimation of GSCs) outlines key principles for risk allocation. These principles include the following:
(a) GSPs are to be fully immunised from interest rate exposures, through recovery of the actual cost of debt;
(b) GSPs are not to be subject to volume or source risk either in total or across production or dispatch points over the regulatory period; and
(c) the regulated asset base (RAB) is to be as advised by the Queensland Water Commission (QWC) and not to be subject to optimisation. Expenditure on drought assets are to be incorporated in the RAB at project cost.
The Authority is required to accept that:
(a) the rate of return on drought assets is limited to the actual cost of debt provided by Queensland Treasury Corporation (QTC); and
1 At the time of the referral, the Minister for Energy and Water Utilities was designated the Minister for Natural Resources, Mines and Energy and the Minister for Trade.
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(b) the rate of return on non-drought assets must be set using parameters advised by the QWC, with the risk-free rate and actual cost of debt advised by the QTC.
Review of Prudency and Efficiency
The Authority engaged Sinclair Knight Mertz (SKM) to review the prudency and efficiency of proposed new non-drought and post-commissioning drought capex as well as fixed and variable operating costs. SKM used a sampling approach in conducting its analysis.
Seqwater
The QWC advised that Seqwater’s opening RAB for 1 July 2011 was $2,609.9 million and comprised 25% drought assets and 75% non-drought assets.
Major adjustments to the RAB during 2011-12 include the completion of Wyaralong Dam at a value of $373 million ($10 million less than indicated in the Draft Report), final completion works on Hinze Dam of $30 million ($4.5 million higher than in the Draft Report) and non-drought capital expenditure of $44 million ($3.1 million higher than in the Draft Report). As required by the Direction Notice, drought assets such as Wyaralong and Hinze Dams are to be included in the RAB at project cost at the time of commissioning.
The overall capex estimates included in this Final Report are therefore a net $2.4 million lower than in the Draft Report due to revised estimates from Seqwater and revisions arising as a result of SKM’s analysis.
SKM reviewed a sample of Seqwater’s proposed non-drought capex items and concluded that all items were prudent and efficient, with the exception of the Kilcoy WTP project. SKM considered that insufficient information had been provided to satisfy its concerns regarding the specification of the WTP or the queries regarding the prudency of the Kilcoy WTP raised by the WGM.
The Authority accepts SKM’s recommendation, and encourages Seqwater to instigate further discussions with the WGM regarding the prudency of the Kilcoy WTP project. The Authority notes that the Kilcoy WTP is not to be commissioned until 2013-14 and therefore has no immediate impact on the recommendation of 2011-12 GSCs. The Authority has included all of Seqwater’s capital expenditure to be commissioned in 2011-12 in its recommended GSCs.
Seqwater’s rate of return on non-drought assets and post-commissioning drought capex, based on parameters provided in the Direction Notice, is 9.91% (pre-tax nominal). This compares with 9.94% in 2010-11 and 9.95% in 2009/10. Seqwater’s drought assets earn a rate of return equal to the cost of debt which averages 6.30%.
SKM also reviewed a sample of Seqwater’s proposed fixed operating costs and concluded that all costs were prudent and efficient except for a number of research projects proposed by Seqwater. SKM considered that the need for the research programs had not been sufficiently justified by Seqwater. As a result of SKM’s conclusions, the Authority has excluded four research programs from the recommended GSCs. The total value of these exclusions is $238,906 or 0.2% of Seqwater’s proposed fixed opex.
SKM also reviewed a sample of Seqwater’s proposed variable operating costs and concluded that these costs were prudent and efficient. Seqwater’s variable costs have declined on a $/ML basis as Seqwater has achieved electricity cost savings through a competitive tendering process.
Other costs (termed allowable costs) proposed to be included in 2011-12 include working capital, the QWC levy and the QCA regulatory fee.
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Seqwater proposed to include $11.2 million in Stage 1 capex for Wyaralong Water Treatment Plant (WTP) as an allowable cost, but the Authority considered this should be included in the RAB when the WTP is commissioned. Seqwater also proposed $11.2 million in land and property tax provisions, but this was excluded until Seqwater’s land tax eligibility is determined by Government. The Authority has also reduced Seqwater’s estimate of working capital by $1.4 million on the basis of improved working capital management assumptions.
The Authority recommends GSCs for Seqwater in 2011-12 of $399 million. This is higher than approved in 2010-11, largely due to increases in capital charges because of the commissioning of Wyaralong Dam and upgrade of the Hinze Dam.
Capital charges of $230 million comprise more than half of Seqwater’s 2011-12 GSC.
A summary of Seqwater’s recommended GSC is provided in Table 1 below while Figure 1 shows the proportions of each component of the GSC.
Table 1: Seqwater’s Recommended GSC ($m)
Revenue Component Approved 2010-11 Seqwater QCA Draft Report QCA Proposed 2011-12 2011-12 Recommended 2011-12
Capital Charges 194.2 n/a 229.1 229.8
Fixed Operating Costs 139.7 147.0 142.8 146.8
Variable Operating Costs 21.9 16.9 16.9 16.9
Allowable Costs 14.2 36.5 13.5 9.2
Revenue Offset - (4.0) (4.0) (4.0)
Total GSC 370.0 n/a 398.3 398.8
Note: these figures may not add due to rounding.
Relative to the Draft Report, the changes to the recommended GSCs for Seqwater result from revised drought capex estimates (down $5.5 million), the identification of $54 million of land in capex which it is not proposed to depreciate (identified in principle in the Draft Report but now quantified), SKM’s review of additional information from Seqwater which has resulted in more capex and opex being deemed to be prudent and efficient and a reduction of $1.3 million in allowable costs arising from removal of head office relocation costs and a reduction of $2.9 million in the QWC levy for Seqwater.
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Figure 1: Seqwater’s Recommended GSC for 2011-12
4% 2%
Capital Charge Fixed Operating Charge 36% Variable Operating Charge 58% Allowable Costs
WaterSecure
The QWC advised that WaterSecure’s opening RAB as at 1 July 2011 was $3,055.5 million and was comprised almost entirely (99.9%) of drought assets.
WaterSecure proposed capital expenditure totalling $5.8 million in 2011-12 (all non-drought). The largest items were upgrades to the Bundamba Advanced Water Treatment Plant (AWTP) ($1.9 million) and upgrades to the Purified Recycled Water (PRW) Network ($1.9 million).
SKM reviewed a sample of capex items (totalling $5.3 million or approximately 90% of WaterSecure’s proposed capex) and found that the Bundamba SCADA Integration Program, the Bundamba AWTP Chemical Area Storage Cover for Stage 1A, the Swanbank Cross Connection Pipeline, the HV Switchroom Fire Alert System and the Bundamba AWTP Renewals Sump Pumps to be both prudent and efficient.
The remaining sample items (totalling $1.4 million) were deemed not prudent and/or efficient. The Authority accepted SKM’s recommendations and therefore included $4.4 million of capital expenditure in WaterSecure’s Capital Charge for 2011-12. This represents an increase of $1.5 million over the capex included in the Draft Report as prudent and efficient due to improved information from WaterSecure.
WaterSecure’s rate of return on non-drought assets and post-commissioning drought capex, based on parameters provided in the Direction Notice, is 9.91% (pre-tax nominal). This compares with 9.63% in 2010-11. WaterSecure’s drought assets earn a cost of debt rate of return of 6.52%.
WaterSecure submitted fixed and variable operating costs based on initial budgets from scheme operators. Based on SKM’s analysis, $72.7 million of WaterSecure’s proposed $72.8 million in fixed operating costs were included in the Fixed Operating Charge. The difference of $0.1 million relates to WaterSecure’s revised cost estimates for the mothballing of the Gibson Island AWTP, which SKM considered to be both prudent and efficient. Compared to the Draft Report, fixed operating costs include an additional $8.2 million of which $6.3 million relates to repairs and maintenance at the Tugun desalination plant and the PRW Network. Furthermore, fixed operating costs remain subject to WaterSecure’s review and approval of the scheme operators’ budgets and, as such, should be regarded as preliminary.
ix Queensland Competition Authority Executive Summary
SKM also reviewed a sample of WaterSecure’s proposed variable operating costs, and concluded that these costs were prudent and efficient. The WGM provided a volume forecast for Tugun Desalination Plant and a range of throughput forecasts for the Western Corridor Recycled Water scheme. Based on these forecasts, variable operating costs are forecast to range from $8.9 million to $13.1 million.
Other costs (allowable costs) proposed to be included in 2011-12 comprise working capital, the QWC levy and a QCA regulatory fee. Since the Draft Report, the QWC levy has been reduced from $8.1 million to $5.2 million for WaterSecure.
The Authority recommended a GSC for WaterSecure of between $306.5 million and $310.8 million for 2011-12, for low and high volume scenarios. This is lower than the approved 2010-11 GSC of $317.7 million. In this regard a higher capital charge in 2011-12, due to the increased RAB, is offset by lower fixed and variable operating costs arising from reduced water volumes (resulting in the mothballing of some facilities).
Capital charges of $216.2 million account for 70% WaterSecure’s 2011-12 GSCs.
A summary of WaterSecure’s recommended GSC is provided in Table 2 and Figure 2 below. Figure 2 is based on the lower estimate of volumes.
Table 2: WaterSecure's Recommended GSC ($m)
Revenue Component Approved 2010- WaterSecure QCA Draft Report QCA Recommended 11 Proposed 2011-12 2011-12 2011-12
Capital Charges 201.3 n/a 216.2 216.2
Fixed Operating Costs 82.0 72.8 64.5 72.7
Variable Operating 23.9 13.5 8.9 to 13.1 8.9 to 13.1 Costs
Allowable Costs 10.5 10.2 11.7 8.7
Total GSC 317.7 n/a 301.3 to 305.5 306.5 to 310.8
Note: these figures may not add due to rounding.
Relative to the Draft Report, the GSC is some $5.2 million higher. This is mainly due to an $8.2 million increase in fixed operating costs accepted by SKM, including the $6.3 million cost of repairs and maintenance at the Tugun desalination plant and the PRW Network, partially offset by a $2.9 million reduction in the QWC levy for WaterSecure.
x Queensland Competition Authority Executive Summary
Figure 2: WaterSecure’s Recommended GSC for 2011-12
3% 3%
24% Capital Charge Fixed Operating Charge Variable Operating Charge Allowable Costs
70%
LinkWater
The QWC advised that LinkWater’s opening RAB as at 1 July 2011 was $2,041.4 million and comprised 71% drought assets and 29% non-drought assets.
LinkWater advised that $522 million for the Northern Pipeline Interconnector Stage 2 will be rolled into the RAB in April 2012 as drought assets. Under the Direction Notice, drought assets are to be rolled in at project cost. LinkWater proposed a further $24.4 million in non-drought capex. SKM reviewed a sample of LinkWater’s proposed capex items and concluded that all were prudent and efficient.
LinkWater’s rate of return on non-drought assets and post-commissioning drought capex, based on parameters provided in the Direction Notice, is 9.90% (pre-tax nominal). This compares with 9.99% in 2010-11 and 10.03% in 2009/10. LinkWater’s drought assets earn a cost of debt rate of return which averages 6.60%.
SKM reviewed a sample of LinkWater’s proposed fixed operating costs representing 51% of total fixed operating costs and found all to be prudent and efficient.
SKM also reviewed a sample of LinkWater’s variable operating costs and found all to be prudent and efficient.
Other costs (allowable costs) proposed to be included in 2011-12 comprise working capital, the QWC levy and the QCA fee. Since the Draft Report, the QWC levy for LinkWater has increased from $8.1 to $10.3 million.
The Authority recommends a GSC for LinkWater in 2011-12 of $205.7 million, compared to LinkWater’s proposed $210.8 million.
The main reason for the difference was that LinkWater proposed an adjustment to asset appreciation to the value of $14.7 million, to address concerns that the inflationary gain on assets exceeded depreciation and restricted cash flow. However, this proposal was not accepted by the Authority. This reduction was offset to some degree because the Authority’s estimated return on assets was higher than LinkWater’s due to the inclusion of the Northern Pipeline Interconnector Stage 2 in the RAB, which was not initially proposed by LinkWater.
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Capital charges of $147 million account for over 70% LinkWater’s 2011-12 GSC.
A summary of LinkWater’s recommended GSC is provided in Table 3 and Figure 3 below.
Table 3: LinkWater's Recommended GSC ($m)
Revenue Component Approved 2010-11 LinkWater QCA Draft QCA Proposed 2011-12 Report 2011- Recommended 12 2011-12
Capital Charge 139.4 156.2 147.0 147.0
Fixed Operating Costs 38.8 42.6 43.0 43.0
Variable Operating Costs 4.5 2.9 2.5 2.5
Allowable Costs 9.8 9.1 11.0 13.2
Total GSC 192.5 210.8 203.5 205.7
Note: these figures may not add due to rounding.
Relative to the Draft Report estimated GSC, the final recommended GSC is some $2.2 million higher. This is entirely due to an increase in the QWC levy allocated to LinkWater.
Figure 3: LinkWater’s Recommended GSC for 2011-12
6% 1%
21% Capital Charge Fixed Operating Charge Variable Operating Charge Allowable Costs
72%
Summary of GSCs
As a result of the limitations on the Authority’s discretion outlined above, the Authority’s review of the capital charge component of GSCs is limited to assessing the prudency and efficiency of non-drought capital expenditure and post-completion drought expenditure. As a consequence, the Authority has only been able to review 42% of Seqwater’s recommended total GSCs, 28% of WaterSecure’s and 24% of LinkWater’s. Only 33% of the $911.0 million total recommended GSC has been eligible for regulatory review by the Authority.
xii Queensland Competition Authority Executive Summary
A summary of the GSCs for the three GSPs for 2010-11 and 2011-12 is provided in Figure 4 below. As noted above, compared to 2010-11, GSCs increase for Seqwater and LinkWater, but decrease for WaterSecure.
Figure 4: Recommended GSCs for 2010-11 and 2011-12 ($m)
450 400 350 300 250 200 Allowable Costs 150 Variable Operating Charge 100 Fixed Operating Charge 50 0 Capital Charge 2010/11 2011/12 2010/11 2011/12 2010/11 2011/12
Seqwater WaterSecure LinkWater
The total RAB of the three GSPs is forecast to increase from $7,707 million at 1 July 2011 to $8,713 million at 1 July 2012.
On the basis of the 2011-12 volume forecast provided by the WGM (261,591ML from Seqwater and a minimum 14,562 ML from WaterSecure), the total GSCs across all GSPs average $3,299/ML (Table 4). This compares to an average of $2,642/ML in 2010-11. The 25% increase in $/ML costs is largely due to a decline in expected volume of 17% in 2011-12 as the fixed cost components, which make up 97% of the total GSCs, do not reduce as volume declines.
While the GSC has increased on a per ML basis largely due to reduced volumes, the bulk water price to the Distributor/Retailers set by the Government is unaffected.
Table 4: 2011-12 Grid Service Charges per ML
GSCs ($m) Volume (ML) $/ML
Seqwater $398.8 261,591 $1,524
WaterSecure $306.5 14,562 $21,049
LinkWater $205.7 223,944 $919
Total $911.0 276,153 $3,299 Note: Total volume excludes LinkWater’s transport volumes as they do not add to total water supplied
At $3,299/ML, the GSCs compare to the bulk water price charged by the WGM to Distributor/Retailers which has a weighted average of $1,736/ML. In other words, in respect of bulk water sold to Distributor/Retailers, the WGM is forecast to recover only 53% of the GSC cost of $3,299/ML.
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Review Thresholds
The Direction Notice also instructed the Authority to develop a process, and appropriate Review Thresholds, for reviewing the 2011-12 GSCs. Table 5 below summarises the review thresholds proposed by the Authority.
Table 5: Summary of Proposed Review Thresholds
Trigger/Event Eligible Cost Review Threshold category
Change in law or policy, or All Zero, with assessment to be undertaken at end of Government specified emergency regulatory period unless cost impact (in event combination with impact of other Events) is 5% of GSC in which case assessment will commence on the date of the GSC’s request.
Change in Demand or Supply Source Variable Operating As above (applications by GSPs). Charge
Change in Demand or Supply Source Variable Operating As above (applications by WGM) Charge
Change in Cost of Debt Capital Charge As above
Change in RAB Capital Charge As above
Change in actual capex from that Capital Charge As above initially estimated
Consistent with the requirements of the Direction Notice for the Authority to provide incentives for the entities to invest, innovate and pursue efficiency improvements, the Authority recommends that an incentive structure be implemented to encourage GSPs to achieve efficiency gains. Under such an arrangement, GSPs will be permitted to retain 50% of any efficiency gains achieved in 2011-12 in 2012-13 GSCs. However, the efficiency gains must be the result of specific initiatives put in place by the GSPs, and should be submitted for consideration as part of the 2012-13 review.
It is also recommended that any other variations in operating costs in 2011-12 will be borne by, or to the benefit of, the relevant GSP. Nevertheless, the Authority notes the limited time available for this initial review has not enabled a detailed review of fixed operating costs. Therefore, should a subsequent review indicate greater efficiencies to be possible, these would be excluded from future charges. This is particularly relevant in the absence of detailed analysis of the merger of WaterSecure and Seqwater.
xiv Queensland Competition Authority Chapter 1: Minister’s Direction
1. MINISTER’S DIRECTION
1.1 SEQ Water Market Rules
Pursuant to section 10(m) of the Queensland Competition Authority Act 1997 (the QCA Act), the Authority can be required to perform functions provided to the Authority under an (other) Act or to exercise a power delegated to it under an (other) Act.
The SEQ Water Market Rules (Market Rules) require that the Authority investigate and recommend Grid Service Charges (GSCs) to apply to the Grid Service Providers (GSPs) in 2011-12 and to provide a report to the Price Regulator supporting those recommendations. The Price Regulator is the State of Queensland or its nominated agent, in this case, the Minister for Energy and Water Utilities (the Minister).
The GSCs are charges paid under Grid Contract Documents by the South East Queensland (SEQ) Water Grid Manager (WGM) to GSPs for the provision of Declared Water Services (water services declared by the Minister under the Water Act 2000).
Subsequent to the release of the Authority’s Draft Report, the Market Rules were amended (and took effect from 1 July 2011). The amendments to the Market Rules do not affect the GSCs themselves.
1.2 Direction Notice
Under the Market Rules (s8.3), the Price Regulator may issue a Direction Notice to provide further instructions to the Authority.
The Authority received a Direction Notice from the Minister2 dated 9 February 2011. A copy is available on the Authority’s website.
The Direction Notice requires the Authority to recommend GSCs for the GSPs on the basis of the Authority’s Investigation Plan for SEQ Bulk Water Grid Service Charges for 2011-12 and the QWC’s Manual for Setting 2011-12 Grid Service Charges.
The Authority is directed to:
(a) follow the process, adopt the assumptions and apply data from the sources identified and in the manner specified in the QWC’s Manual for setting the 2011-12 Grid Service Charges;
(b) provide a Report to the Price Regulator setting out its recommendations regarding the GSCs; and
(c) develop a process, and appropriate Review Thresholds, for reviewing the 2011-12 GSCs.
1.3 Investigation Plan
The Authority provided an Investigation Plan to the Price Regulator prior to 30 October 2010. A copy is available on the Authority’s website.
2 At the time of the referral, the Minister for Energy and Water Utilities was designated the Minister for Natural Resources, Mines and Energy and the Minister for Trade.
1 Queensland Competition Authority Chapter 1: Minister’s Direction
1.4 QWC Manual
The QWC’s Manual provides guidelines to the Authority regarding the methodology that is to be applied in investigating and recommending the GSCs to apply for 2011-12. A copy is available on the Authority’s website.
The QWC’s Manual sets out:
(a) the policy objectives which must be achieved by the Authority in providing its recommendations regarding the 2011-12 GSCs (see section 3.1);
(b) the approach and methodology to be followed by the Authority when investigating the 2011-12 GSCs (chapter 3);
(c) the stakeholders that must be consulted (see 1.5 below);
(d) the sources of information to be used when calculating the 2011-12 GSCs, including:
(i) the RAB (to be sourced from the QWC);
(ii) costs of debt and the risk-free rate (to be provided by the QTC); and
(iii) production forecasts (to be provided by the WGM); and
(e) additional information to be taken into consideration in relation to Seqwater’s capital and operating costs. These include the nature of recreation facilities, and cost allocation between the irrigation and Grid activities.
1.5 Draft Report
As required by the Direction Notice, the Authority provided a Draft Report to the Price Regulator on 30 May 2011. The Draft Report contained the Authority’s draft recommended GSCs for each of the GSPs for 2011-12. A copy is available on the Authority’s website.
Copies of the Draft report were also provided to relevant stakeholders.
1.6 Conduct of the Investigation
Under the Direction Notice, the Authority must consult with relevant parties, including the QWC, the GSPs and the WGM, and consider all submissions within the applicable timetable for the investigation.
GSPs must be allowed sufficient time to comment on the GSCs before a recommendation is provided to the Price Regulator. An appropriate period should also be provided for the WGM to comment on the initial GSCs consistent with that provided to the GSPs.
The QWC noted in the Manual that a consultation period of 45 days was provided for the GSPs to comment on the initial (draft) 2010-11 GSCs.
The timeframe available to the Authority did not permit a consultation period of 45 days to comment upon the draft GSCs for 2011-12, having regard to the need to finalise estimates and the due date for the Final Report. However, the Authority maintained an ongoing transparent process of engagement with the GSPs throughout the investigation process.
2 Queensland Competition Authority Chapter 1: Minister’s Direction
1.7 Future Investigations
The Authority notes that the amended Market Rules require the Authority to also recommend GSCs for 2012-13, with a Final Report due by 21 May 2012, which represents a substantially earlier date than for 2011-12. This will require earlier submissions from GSPs than for the current review. Furthermore, the Authority intends to conduct a more detailed review of fixed operating costs as part of that investigation.
The Authority intends to continue to work closely with GSPs and other stakeholders to increase the effectiveness of its regulatory oversight.
3 Queensland Competition Authority Chapter 2: Background
2. BACKGROUND
2.1 The SEQ Water Grid
The SEQ urban water and wastewater sector has recently undergone extensive reform which has involved, among other things, the establishment of the SEQ Water Grid. The Water Grid integrates the existing water sources, storages and treatment plants across the SEQ region (from Noosa to Coolangatta and out to the Lockyer Valley) with new climate resilient water supplies, such as desalination and purified recycled water.
In addition, 22 separate entities were amalgamated to establish the WGM, three state-owned GSPs and three council-owned distributor/retailers entities (DRs).
Grid Operation and Planning
The QWC provides advice to the Government on the SEQ Water Strategy3 (the Strategy), which sets out the medium to long term strategic planning framework for the Grid. The Strategy defines the Level of Service objectives of the Grid and role of the System Operating Plan4 (SOP) in setting the operating rules necessary for key Grid infrastructure such as the Tugun desalination plant to achieve the Levels of Service. The Strategy also details the process that the QWC will follow when providing advice to the Minister regarding when the next regionally significant supply is required.
To date, drought response has been directed by the Water Regulation 20025 and the SEQ Regional Water Security Program6 which have mandated the construction or upgrade of bulk water assets such as the Tugun Desalination Plant and the Western Corridor Recycled Water Scheme. It is expected that the QWC’s drought response plan will contain levels of combined storage of the Grid that will trigger further government-mandated construction of new water supplies.
The WGM oversees the operation of the Grid and is responsible for providing potable and purified water to the three DRs and power stations. To meet the DRs’ demand for water, the WGM contracts the services of the GSPs and pays for these services by the GSCs.
Subject to the constraints of the SOP, the WGM uses Grid Instructions to direct the GSPs, including setting the level of demand and determining which assets to employ by setting the operational mode of the Grid. In this way, the WGM directs the short-term operation of the Grid. In the medium-term, the WGM’s Operating Strategy outlines demand forecasts and the WGM’s approach to meeting SOP requirements of security and Grid efficiency.
The WGM is required to provide guidance to the responsible Ministers in regard to new and replacement capital expenditure on infrastructure or information technology projects of $2 million or more from 2011-12. The WGM is to assess whether there is a clear and appropriate need for the proposed expenditure and that a full range of options has been considered. In particular, any increase in capacity should match projected increases in demand.
Capital expenditure projects are also subject to guidance through processes administered by the Department of Environment and Resource Management (DERM), including Strategic Asset Management Plans (SAMPs), Dam Safety Guidelines and Drinking Water Quality Management Plans (DWQMPs).
3 http://www.qwc.qld.gov.au/planning/seqwaterstrategy.html 4 http://www.qwc.qld.gov.au/planning/operatingplan.html 5 http://www.qwc.qlg.gov.au/planning/seqwaterstrategy.html 6 http://www.derm.qld.gov.au/water/strategy/seq_water_security.html
4 Queensland Competition Authority Chapter 2: Background
Compared to regulated water entities in other jurisdictions, typical responsibilities such as demand forecasting, large capital expenditure planning and asset deployment are significantly beyond the GSPs’ control.
Seqwater
The Queensland Bulk Water Supply Authority (trading as Seqwater) was established in November 2007 under the South East Queensland Water (Restructuring) Act 2007 and reports to two Ministers, the Treasurer and the Minister for Energy and Water Utilities. Seqwater is considered a GSP under the Water Act 2000.
Seqwater is responsible for the supply of bulk water in Queensland, and owns a number of assets that provide Declared Water Services. Seqwater’s major assets include dams, weirs and water treatment plants (WTPs) and include bulk supply assets transferred from local governments and public water boards under the South East Queensland Water (Restructuring) Act 2007 and recently constructed drought assets (see section 2.2), such as the Hinze Dam raising.
Seqwater provides potable water by treating the water captured in its water storages and operates assets that are connected to the SEQ Water Grid as well as standalone water supply schemes in SEQ. Seqwater is also responsible for management of a substantial catchment area and natural assets.
Seqwater was merged with WaterSecure, the former Manufactured Water Supplier, on 1 July 2011.
WaterSecure was responsible for two recently constructed drought assets that manufacture water in SEQ. The Tugun desalination plant produces drinking water from seawater, while the Western Corridor Recycled Water (WCRW) Scheme is a network of advanced water treatment plants (AWTPs) that produce purified recycled water (PRW) from treated water. An existing Project Alliance Agreement is in place with Veolia Water and John Holland for the Gold Coast Desalination Plant and an Operations and Maintenance Agreement is in place between Seqwater (the current owner) and Veolia Water (the operator) on the WCRW scheme. WaterSecure was also responsible for 200km of pipelines, 9 tanks, 12 pump stations and other associated network infrastructure.
LinkWater
LinkWater owns and operates the bulk transport assets that transport potable water around the South East Queensland Water Grid. LinkWater’s assets comprise bulk pipelines, pumping stations and reservoirs, including drought projects such as the South Regional Water Pipeline and assets transferred from local governments and public water boards under the South East Queensland Water (Restructuring) Act 2007.
LinkWater Projects (LWP) is the trading name of the Southern Regional Water Pipeline Company. LWP is a government-owned and incorporated company established as a Special Purpose Vehicle in January 2006 for the design and construction of bulk water pipelines in SEQ.
While LinkWater and LWP are separate businesses, they are governed by the same Board and Chief Executive Officer.
5 Queensland Competition Authority Chapter 2: Background
2.2 Drought Assets
Drought assets are major capital investments determined by the Queensland Government for the purposes of regional water security and constructed under the Water Regulation 2002, as amended by Part 8 of the Water Amendment Regulation (No 6) 2006, and Table 1 of the Regional Water Security Program7.
As directed by the Market Rules (s8.11), the Authority must accept that all drought assets are to be included in the RAB at their project construction cost including any capitalised interest amounts and earn a rate of return equal to the cost of debt.
2.3 Bulk Water Prices
The GSCs are distinct from the Bulk Water Prices, which have been set by the Government until 2017-18 and are paid to the WGM by the DRs.
The 10-year Bulk Water Price Path prevents retail water bills from immediately reflecting the entire cost of the Government’s $7 billion of investment in bulk water infrastructure. The WGM’s 2009-10 Annual Report8 shows that the revenue shortfall between GSCs paid and Bulk Water Prices received has been largely capitalised as debt.
The Bulk Water Price Path is not to be reviewed by the Authority. However, the GSCs are an important input into determining the level of debt held by the WGM.
7 http://www.derm.qld.gov.au/water/strategy/seq_water_security.html 8http://www.seqwgm.qld.gov.au/News-and-publications/Annual-reports/2008%E2%80%9309-Annual- Report.aspx.
6 Queensland Competition Authority Chapter 3: Approach to the Investigation
3. APPROACH TO THE INVESTIGATION
The Authority’s approach to the investigation is largely determined by the Market Rules, the Direction Notice and accompanying QWC Manual.
3.1 Regulatory Objectives
Pursuant to the Market Rules, the Price Regulator may from time to time direct the Authority in writing about the manner in which it is to perform its functions and matters to consider. Accordingly, the Direction Notice and Manual provide some guidance as to the key objectives in recommending GSCs for 2011-12. The GSCs should be consistent with:
(a) allowing the GSPs to recover a sustainable revenue stream from the provision of Declared Water Services determined on the basis of efficient and prudent expenditure forecasts;
(b) ensuring that incentives remain for GSPs to invest, innovate and pursue efficiency improvements consistent with their roles and responsibilities, and to maintain service standards; and
(c) the available information and stage of development of the GSPs.
The Authority is also to have regard for the costs of regulation itself, appropriate consultation processes, and minimising uncertainty for the GSPs.
The Authority’s role does not extend to the price of water charged to the distributor/retailers (and thus the public), as the bulk water price path has already been established by the Government.
The Market Rules, Direction Notice and Manual also set out a range of policy objectives which must be met within the broader regulatory framework in setting GSCs for 2011-12. These are identified in the following sections.
3.2 Grid Service Charges
Under the Market Rules (s8.8), the components of the GSCs are:
(a) Capital Charges (return of and return on capital);
(b) Fixed Operating Charges;
(c) Variable Operating Charges; and
(d) Allowable Costs.
The Direction Notice and QWC Manual also provide key principles for risk allocation. These principles include the following:
(a) GSPs are to be fully immunised from interest rate exposures, through recovery of the actual cost of debt;
(b) GSPs are not subject to volume or source risk either in total or across production or dispatch points over the regulatory period;
(c) assets constructed under the Water Regulation 2002 (drought assets) are to achieve returns equal to the actual cost of debt for each asset; and
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(d) the regulated asset base and capital expenditure commenced in the previous period are not to be subject to optimisation.
At the same time, the GSPs are exposed to risks related to capital expenditure and operating expenditure. This is evident in references requiring the Price Regulator to take account of (only) prudent and efficient capital expenditure (s 8.11(e)), and to permit GSPs to recover (only) prudent and efficient fixed and variable operating costs and corporate costs (s 8.12-8.13).
In effect, the Direction Notice and Manual require the Authority to assess the prudency and efficiency of capital expenditure incurred post commissioning on drought assets, new non-drought capital expenditure and operating expenditure other than where these relate to volume or supply source issues.
Under the Market Rules, the GSCs may be reviewed if the Price Regulator is aware of changes sufficiently material to justify an additional review of Grid Service Charges (s 8.7). The Minister’s Direction Notice requires the Authority to develop a process, and appropriate Review Thresholds, for reviews of the 2011-12 GSCs. The Authority’s analysis and determinations in regard to Review Thresholds are outlined in Chapter 7.
3.3 Seqwater-WaterSecure merger
While Seqwater and WaterSecure were merged into one entity as from 1 July 2011, the Authority has continued to treat them separately for the purpose of recommending GSCs for 2011-12. This is consistent with the SEQ Water Market Rules prevailing at the time the Direction Notice was issued. The Authority also proposes to do so until the cost implications of the merger are assessed. To do otherwise could be interpreted as the Authority having considered merger cost implications which it has not.
3.4 Capital Charges
Opening Regulated Asset Base
The opening RAB of the GSPs includes former local government, SunWater and water board assets – these assets were transferred to GSPs under the South East Queensland Water (Restructuring) Act 2007 and included in the GSPs’ RAB on the transfer date (mostly 1 July 2008). The value and life of assets transferred to the GSPs from local governments were determined by Government.
Under the Direction Notice, the Authority is required to accept the opening values and asset lives as at 1 July 2011 provided by the QWC. In addition, the Authority:
(a) must give effect to any RAB adjustments notified by the QWC to take into account adjustments for actual capital expenditure during the 2010-11 year;
(b) must not optimise the RAB; and
(c) may disaggregate the RAB with the agreement of the GSPs provided the total value of the disaggregated asset base does not exceed the RAB provided by the QWC. The weighted average asset life of the disaggregated assets cannot differ from the aggregated asset life provided by QWC.
The QWC noted that the 2010-11 closing RAB is currently based on capital expenditure forecasts provided by the GSPs, and the QWC does not expect to have a final opening RAB for 2011-12 until October 2011.
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Draft Report
The Authority derived Capital Charges based on the RAB estimates provided by QWC.
In particular, the Authority:
(a) disaggregated the asset registers as much as possible for modelling purposes. The Authority identified differences between individual items in the RAB provided by the QWC and those provided by each GSP, but adopted the RAB provided by the QWC as required by the Direction Notice;
(b) identified that land assets have been included in the RAB. Where possible to do so, they have been identified separately, to avoid depreciating these assets. If land assets have been inadvertently depreciated in previous periods, the Authority ceased depreciation and retained the land in the RAB at the value as provided by QWC; and
(c) found that some negative asset values, although insignificant, were included in the RAB. The Authority has netted these negative values from higher value related assets with a similar life. This will leave the overall RAB unchanged.
Stakeholder Submissions on the Draft Report
No comments were received from stakeholders regarding the Authority’s approach to determining the opening RAB.
Authority’s Final Decision
The Authority proposes no change to the Draft Report recommendation.
Capital Expenditure
The Direction Notice requires that the Authority accept that:
(a) expenditure on non-drought and post-commissioning drought capital projects approved under the Market Rules but not necessarily fully expended as at 30 June 2011, should be recognised as being prudent in scope, but is subject to review for efficiency where expenditure is incurred after 1 July 2011; and
(b) major (regionally significant) capital investment for grid capacity augmentation will be determined by the Government as part of the SEQ Water Strategy and Regional Water Security Program (drought capex). Any such capital expenditure is to be rolled into the relevant entity’s RAB at the project cost upon the date of commissioning, and is not to be subject to prudency or efficiency review by the Authority.
For the 2011-12 GSCs, the QWC’s Manual provides further guidance, as follows:
(a) prices should provide incentives for water businesses to promote productive efficiency, reduce costs or otherwise improve productivity;
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(b) GSPs need to demonstrate that appropriate processes and approvals as specified in the ‘State Water Authorities Investment Guidelines’9 have been applied and appropriate internal capital expenditure governance arrangements were in place to justify the expenditure;
(c) where capital expenditure is related to a project that has commenced in a previous regulatory period, the Authority is to accept that the capital expenditure is prudent. (Such expenditure is still subject to efficiency review); and
(d) capital expenditure incurred on projects including commissioning costs, capitalised corporate costs and capitalised interest costs are to be rolled into the relevant entity's RAB at the date of commissioning. Where discrete parts of projects are completed and provide the requisite service potential in a particular year, that expenditure is considered to be commissioned within that year.
Draft Report
Prudency and Efficiency
As indicated above, the Authority is required to assess the prudency and efficiency of new non-drought capex and post-commissioning drought capex and any such capex continuing from the previous period is to be accepted as prudent in scope but is to be subject to review of efficiency. Drought capex continuing from a previous period is to be accepted as prudent and efficient.
As noted in the Investigation Plan, the Authority’s Draft Report adopted the definitions of prudency and efficiency consistent with those approved by Ministers for the purposes of the interim price monitoring of SEQ retail/distribution.
Capital expenditure is prudent if:
(a) it is required as a result of a legal obligation, growth in demand or renewal of existing infrastructure that is currently used and useful; or
(b) it achieves an increase in the reliability or the quality of supply that is explicitly endorsed or desired by the relevant agency (for example, the WGM).
Capital expenditure is efficient if:
(a) the scope of the works is appropriate having regard to the desired outcomes and the options available, including the substitution possibilities between capital expenditure and operating expenditure and non-network alternatives such as demand management;
(b) the standard of the works conforms with technical, design and construction requirements in legislation, industry and other standards, codes and manuals. Compatibility with existing and adjacent infrastructure is relevant as is consideration of modern engineering equivalents and technologies; and
9 The State Water Authorities Guidelines establish principles to guide GSPs in new capital expenditure, asset replacement and major contracts. Such investments are subject to Minister notification and approval requirements, must be approved by the responsible Minister based on commercial merit, and if directed by Government, will be supported by CSO arrangements agreed with the Minister. GSPs must ensure risk sharing arrangements are commensurate with their own financial contribution and must restrict investments to their core business activities.
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(c) the cost of the defined scope and standard of works is consistent with conditions prevailing in the markets for engineering, equipment supply and construction.
The Authority engaged SKM to assist with reviewing the prudency and efficiency of capital expenditure and a sampling approach was adopted.
To assist with assessing capital expenditure, the GSPs provided details of forecast capital expenditure against four investment drivers:
(a) maintaining service – projects to address an anticipated inability to meet performance obligations, or to prevent ongoing non-compliance with a performance obligation and to improve the quality of service to meet regulatory or community needs;
(b) renewals – projects directed towards replacement and/or enhancement of assets that currently meet performance standards but face an unacceptable risk of future non-compliance. The renewal will maintain existing levels of service over the life cycle of the asset;
(c) business efficiency – a project to improve operational efficiency and reduce ongoing costs; and
(d) growth – a project to increase the capability to maintain performance obligations in response to increased demand growth.
In some cases, GSPs were not able to provide sufficient information to enable SKM to reach a conclusion in regard to the prudency or efficiency of specific items. For the Draft Report, the Authority did not include items for which SKM did not have sufficient information to assess prudency. Where insufficient information was provided to assess efficiency, the Authority has also excluded the items in the GSCs. In this regard, the Authority recommended that GSPs seek to provide further information prior to the Final Report.
New Multi-Period Capital Expenditure
The Market Rules specify a one-year regulatory period for 2011-12, limiting the ability of the Authority to provide any undertakings or assurances about the future treatment of capital expenditure commencing in the 2011-12 year but to be commissioned in later years.
The Authority noted that the approach undertaken by the QWC in previous years was to roll non-drought capital expenditure into the RAB as it was incurred rather than as it was commissioned. However, the requirement of the Direction Notice to roll capital expenditure into the RAB on the commissioning date precludes this option.
This presents some risk to the GSPs, as any assessment by the Authority that capital expenditure was imprudent could occur after several years of incurring capital expenditure.
In the Draft Report, the Authority noted that there are mitigating factors that would reduce the risk to the GSPs. These included:
(a) capital expenditure projects are generally required by regulation or service standards, and therefore prudency should be easily assessed by the GSP; and
(b) growth and renewals capital expenditure projects over $2 million are to be assessed by the WGM to confirm that the increase in capacity matches an expected increase in demand. As the sole customer of the GSPs, the Authority considered that an endorsement from the WGM would provide compelling evidence of prudency to the Authority.
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Capital expenditure that is most at risk is large, non-drought, multi-year renewal capital expenditure that is expected to commence in 2011-12. This is currently a small component of total GSP capital expenditure.
The Authority invited GSPs to identify such projects in their submissions to the Authority.
As the capital expenditure will not be rolled into the RAB until it is commissioned, the Authority’s assessment of the prudency of multi-period projects may not be relevant in the event that the Authority is not involved in recommendations of GSCs beyond 2012-13. To assist, the Authority nevertheless provided an assessment of the proposed capital expenditure (wherever possible), and will be bound by its own findings (if it is involved in the future), subject to an ex post assessment of the actual expenditure incurred.
Other Capital Expenditure Issues
In the process of the investigation, a number of issues relating to capital expenditure warranted further attention:
(a) in some cases, capital expenditure was identified for 2011-12 that duplicated capital expenditure already included in the 1 July 2011 RAB. The Authority excluded these projects as these had already been included in the value of the assets in a previous period;
(b) capital expenditure for new assets that are part of final completion of a drought asset were included at project cost. An example is the access road for Wyaralong Dam; and
(c) GSPs have lost assets in the January 2011 floods which are to be replaced during 2011- 12. Any relevant capital expenditure was incorporated into the RAB at its estimated efficient cost. Adjustments will need to be made for any future insurance revenues. The existing asset also remained in the RAB.
Stakeholder Submissions on the Draft Report
Seqwater sought clarification regarding the Authority’s assessment of the prudency of capital expenditure. Seqwater interpreted the Authority’s Draft Report to mean that all capital projects included in its submission had been accepted by the Authority as prudent. Further, Seqwater interpreted that this acceptance of prudency extended beyond the capex project sample reviewed by SKM and includes both 2011-12 capex and multi-period capex.
The WGM proposed minor rewording of the criteria for determining whether capital expenditure is prudent, to make it clear that growth in demand and the need for renewals is informed by customer needs through service contracts. In particular, the WGM suggested that part (a) of the criteria for establishing whether capital expenditure was prudent should state “it is required as a result of the legal obligation, growth in demand or renewal of existing infrastructure that is currently used and required by service contracts.”
Further, the WGM stated that in response to part (b) of the criteria for determining whether capital expenditure is prudent, there was no evidence showing where the WGM has been consulted in regards to reliability or water quality specification in relation to new capital projects. As a result, the WGM expected that SKM would not have been able to assess part (b) as the information had not been provided.
Authority’s Final Decision
The Authority is not able to review all capex projects for prudency and efficiency because of, inter alia, time limitations. It therefore adopts a sampling approach. As a result, non-sampled
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2011-12 capital expenditure will be added to the RAB and recovered by GSPs – however, this does not equate to the Authority’s endorsement of the prudency of the projects.
In relation to multi-period capex, the Authority’s comments on prudency in the Draft Report were intended to provide some regulatory certainty to the GSPs in relation to large multi-period capex, despite the fact that they had no bearing on the 2011-12 GSCs. However, it was not intended to be a comprehensive review of all multi-period capex and the Authority reserves the right to review expenditure on multi-period projects for prudency in the years in which the expenditure is incurred.
The Authority accepts the WGM’s suggested minor amendment to the criteria for determining whether capital expenditure is prudent. However, the change does not affect the Authority’s Draft Report review of prudency and efficiency as SKM’s analysis included the contractual requirements of the GSPs.
In relation to the criterion of prudency that relates to an increase in the reliability or the quality of supply that is explicitly endorsed by the WGM, this driver of capex was not claimed by any of the GSPs in 2011-12. As a result, the Authority agrees with the WGM that SKM was not able to review capex against this criterion, but notes that it was not necessary to do so.
However, the Authority recommends that this criterion be retained, despite not being invoked during the investigation. Future requirements from the WGM in relation to water degradation or whole-of-Grid disinfection, for example, may require a capital response.
Under the revised definition, capital expenditure is prudent if:
(a) it is required as a result of a legal obligation, growth in demand or renewal of existing infrastructure that is currently used and required by service contracts; or
(b) it achieves an increase in the reliability or the quality of supply that is explicitly endorsed or required by the WGM.
Return on Capital
The Minister’s Direction Notice requires that:
(a) for drought assets constructed under the Water Regulation 2002 (amended 2006) and Table 1 of the Regional Water Security Program, the rate of return should be the actual cost of debt inclusive of administration and capital markets charges but exclusive of a Competitive Neutrality Fee (CNF) as advised by QTC;
(b) for non-drought assets and renewal expenditure on drought assets, a commercial rate of return equal to the Weighted Average Cost of Capital (WACC) is to be achieved. The cost of debt component of the WACC is to be equal to each GSP’s actual cost of debt including administration and capital market charges and the CNF as advised by QTC; and
(c) all GSPs must be fully immunised from interest rate exposures through the full recovery of the actual cost of debt.
Draft Report
Seqwater and LinkWater had a slightly different WACC applying to non-drought assets and different costs of debt applying to drought assets, reflecting differences in the underlying debt pools managed by QTC that are applicable to their assets.
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WaterSecure did not have any non-drought assets but, with new capital expenditure for 2011- 12, will have some assets subject to the commercial WACC. The Authority recommended that, given that WaterSecure was merged with Seqwater from 1 July 2011, the WACC applicable to Seqwater should apply to WaterSecure’s non-drought assets.
At the end of the period, the Price Regulator will need to adjust the returns to ensure that the returns equal the actual cost of debt as provided by QTC. The process for these adjustments is considered in Chapter 7.
Stakeholder Submissions on the Draft Report
No comments were received from stakeholders regarding the Authority’s approach to determining return on capital.
Authority’s Final Decision
The Authority proposes no change to the Draft Report recommendation.
Return of Capital
Depreciation applied by the QWC was calculated on a straight-line basis over the estimated useful asset life. The aggregation of assets in the RAB meant that land assets were depreciated as part of a broader asset grouping (except in the case of WaterSecure where they were separately identified), and that the asset lives were often calculated as a weighted average of the component parts.
Depreciation was calculated and applied monthly. In some cases, negative asset values appeared in the QWC RAB where capital expenditure was less than forecast, leading to distortions in depreciation estimates.
The Minister has directed that the return of capital component will be provided through a depreciation allowance. The QWC’s Manual requires that:
(a) this is based on the written down value of the assets and is calculated using a straight line regulatory depreciation based on each asset’s estimated useful life; and
(b) estimated useful lives along with the written down asset values will be provided by the QWC.
Draft Report
The Authority separately identified land assets and will not depreciate them from 1 July 2011 onwards. Negative asset values have been offset against relevant positive values.
For new assets, the Authority reviewed the asset lives proposed by GSPs for consistency with asset lives for similar assets in the RAB, and with asset lives used in other regulatory reviews.
Stakeholder Submissions on the Draft Report
No comments were received from stakeholders regarding the Authority’s approach to determining return of capital.
Authority’s Final Decision
The Authority proposes no change to the Draft Report recommendation.
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Indexation
The Market Rules, Direction Notice and Manual are silent in regard to the method of indexation of asset values throughout the regulatory period.
QWC applied a 2.5% annual indexation rate to all assets for the purposes of asset appreciation and for determining closing RAB in setting 2010-11 GSCs.
Draft Report
The Authority noted that in recent investigations (e.g. Gladstone Area Water Board (GAWB), QR Network) it also applied a 2.5% indexation factor on the basis that this represents the mid-point of the Reserve Bank of Australia’s (RBA’s) target inflation band and that there is a reasonable expectation that the RBA will be able to maintain inflation within this band over time.
The Authority therefore recommended an annual indexation rate of 2.5% to apply for 2011-12.
Stakeholder Submissions on the Draft Report
No comments were received from stakeholders regarding the Authority’s approach to determining indexation.
Authority’s Final Decision
The Authority proposes no change to the Draft Report recommendation.
3.5 Fixed Operating Charge
The QWC Manual states that, in determining the Fixed Operating Charge, the following principles apply:
(a) the Fixed Operating Charge is to recover:
(i) all reasonable fixed operating costs associated with the operation and maintenance of each asset for Declared Water Services; and
(ii) all reasonable corporate or related costs which have been clearly identified by GSPs;
(b) fixed operating costs will be provided by GSPs with sufficient information available to allow identification and assessment of costs for each asset; and
(c) all fixed costs proposed by GSPs are to be reviewed for prudency and efficiency.
Draft Report
In the Draft Report, the Authority recommended the prudency and efficiency tests consistent with those approved by Ministers for the purposes of the interim price monitoring of SEQ retail/distribution.
Under these tests, operating expenditure is prudent if it is required to meet the GSP’s requirements relating to:
(a) its Grid Contract;
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(b) the SEQ System Operating Plan;
(c) the forecast required supply under the WGM’s Operating Strategy; or
(d) its standard of service.
Operating expenditure is efficient if it is undertaken in a least-cost manner over the life of the relevant assets and is consistent with relevant benchmarks. In assessing efficiency, it is necessary to take account of the conditions prevailing in relevant markets, historical trends in operating expenditure and the potential for efficiency gains or economies of scale.
For the Draft Report, the Authority did not include items for which SKM did not have sufficient information to assess prudency. Where insufficient information was provided to assess efficiency, the Authority excluded the items from the GSCs. In this regard, the Authority recommended that GSPs seek to provide further information prior to the Final Report.
Stakeholder Submissions on the Draft Report
The WGM suggested that the Authority include definitions for each of the fixed operating cost categories to clarify what is included at the asset level. The WGM submitted that this information was required in order for the WGM to make informed decisions about operating the grid.
Authority’s Final Decision
The Authority notes the WGM’s suggestion and will endeavour to provide more detailed definitions of each of the fixed operating cost categories for the 2012-13 investigation of GSCs. For this review, the Authority’s cost categories are as outlined in its Information Requirements which are now available on its website.
3.6 Variable Operating Charge
The Market Rules (s8.13) require the Price Regulator to permit GSPs to recover efficient variable operating costs relating to the Relevant Assets apportioned on an appropriate basis between the provision of Declared Water Services and other services.
The Direction Notice requires the Authority to accept production forecasts for the regulatory period consistent with the WGM’s Operating Strategy.
All operating costs proposed by the GSPs are to be reviewed for prudency and efficiency.
Draft Report
The Authority recommended the prudency and efficiency tests consistent with those approved by Ministers for the purposes of the interim price monitoring of SEQ Retail/Distribution.
In this regard, operating expenditure is prudent if it is required to meet the GSP’s requirements relating to:
(a) its Grid Contract;
(b) the SEQ System Operating Plan;
(c) the forecast required supply under the WGM’s Operating Strategy; or
(d) its required standard of service.
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Operating expenditure is efficient if it is undertaken in a least-cost manner over the life of the relevant assets and is consistent with relevant benchmarks. In assessing efficiency, account is taken of the conditions prevailing in relevant markets, historical trends in operating expenditure and the potential for efficiency gains or economies of scale.
In setting 2010-11 GSCs, the QWC determined the Variable Operating Charge as fixed monthly amounts based on production forecasts, with quarterly ‘true-up’ adjustments to account for variations in production or throughput (but not changes in unit rates per ML).
The Authority considered that the Variable Operating Charge should be defined as a form of volumetric charge expressed as a $/ML amount at relevant supply and distribution points, with the charges determined on monthly volumes in arrears. Effectively, the Fixed Operating Charge and Variable Operating Charge form a two-part tariff.
In the Draft Report, the Authority recommended volumetric ($/ML) charges for the GSPs’ nominated supply and distribution points, some of which were aggregated. For reporting purposes, the Authority also recommended a forecast Variable Operating Charge for 2011-12 based on the WGM’s production forecasts for the full year.
Stakeholder Submissions on the Draft Report
The WGM submitted that the Authority should make it clear that variable costs will be charged on actual volumes from each source (i.e. by asset) at budget cost/ML.
Authority’s Final Decision
The Authority reaffirms the WGM’s submission. The Authority recommends that GSC invoices are prepared by the GSPs using approved $/ML variable costs by asset and actual volumes by asset. These $/ML costs by asset are further identified below.
3.7 Allowable Costs
The QWC’s Manual notes that Allowable Costs are costs that are incurred by the GSPs which are not recovered through the Capital Charge, Fixed Operating Charge or Variable Operating Charge but may be recovered under the GSC. Allowable Costs may include the following:
(a) working capital allowance to account for the timing difference between receivables and payables. The working capital allowance for 2011-12 is to be calculated as follows:
(Annual Accounts Receivable x Average Debtor days/366 - Annual Accounts Payable x Average Creditor days/366) x WACC;
(b) QWC levy. Under sections 24(8) and 24(C) of the Water Amendment Regulation (No.3) 2010, each GSP is required to pay the QWC funding levy;
(c) QCA regulatory fees. The Authority notified all GSPs that it will be recovering the full cost of providing regulatory services from all GSPs from 1 July 2010. The 2010-11 GSCs have included the Authority's regulatory fees as an Allowable Cost under section 8.14 of the Market Rules; and
(d) business integration costs. The 2008-09 and 2009-10 GSCs included an allowance for costs associated with business integration. Although it was noted in the 2009-10 GSCs Determination that integration costs are only relevant to the transitional water reform period, Seqwater's 2010-11 GSCs contained an allowance for legal and due diligence expenses arising from asset transition legacy issues.
17 Queensland Competition Authority Chapter 3: Approach to the Investigation
It is likely that there will continue to be a range of land access and tenure arrangements requiring finalisation in 2010-11 for the GSPs, as part of business integration. Under the Direction Notice, the costs associated with these activities are allowable costs with a full pass through.
Draft Report
In the Draft Report, the Authority noted that the QWC estimated working capital on the basis of 60 debtor days and 25 creditor days for Seqwater, and 30 debtor days and 30 creditor days for LinkWater and WaterSecure.
Debtor Days
The Authority requested information from the WGM on the transactional history of GSC invoices. The WGM provided a list of all available invoices received and paid for all GSPs during 2010-11.
This information shows that, on average, Seqwater took eight days to issue an invoice after the end of the month, and that the WGM took a further 21 days to pay it, for a total of 29 calendar days. Similarly, WaterSecure averaged 30 calendar days. However, LinkWater was able to achieve invoice issuance and payment in 22 calendar days, due to more prompt invoice issuance.
The Authority noted that the billing terms in the Grid Contracts are standard across the GSPs, and therefore considered that Seqwater should be able to match LinkWater’s performance in terms of billing efficiency. In other words, bills should be able to be issued within one day of month end.
At the same time, the WGM advised that its payments procedures had recently been amended to pay GSC invoices on the due date (20 business days after receipt) rather than on the Tuesday preceding the due date (as was previously the practice). On this basis, a maximum of 21 business days seems reasonable for the issuance and payment of bills. This equates to about 30 calendar days.
In addition, the Authority considered that 15 days is appropriate for when the service was delivered, relative to when the invoice is raised, on the assumption that the service is delivered, on average, in the middle of the month.
Therefore, accounting for the WGM’s payment procedures, the Authority recommended a debtor days benchmark of 45 days, comprising:
(a) 15 calendar days from service delivery to month end; and
(b) 30 calendar days for invoice payment by the WGM.
Creditor Days
Unlike Debtor days, which are dominated by the WGM’s payment terms, creditor days will comprise of a variety of payment arrangements that GSPs have with suppliers. As a consequence, the Authority recommended adopting a benchmark creditor days value of 30 days. This is consistent with the approach recommended by the QWC in previous years for WaterSecure and LinkWater, and proposed by WaterSecure and LinkWater for 2011-12. Although Seqwater proposed to adopt 25 creditor days in 2011-12, the Authority did not consider that a preferential treatment of Seqwater’s creditor days relative to the other GSPs had been justified.
18 Queensland Competition Authority Chapter 3: Approach to the Investigation
Working Capital Allowance
Based on the analysis of billing and payment schedules between the WGM and the GSPs, and between the GSPs and creditors, the working capital allowance was determined assuming 45 debtor days and 30 creditor days for each GSP. This was applied for all GSPs.
The working capital allowance also included critical spares where identified by the GSPs and considered warranted.
QWC Levy and QCA Fee
In the Draft Report the Authority, on the QWC’s advice, applied the 2010-11 QWC levy of $8.11 million including GST for each GSP for 2011-12. The 2011-12 QCA fee is $710,600 including GST for each GSP.
Other Costs
The Authority recommended that merger costs associated with the Seqwater/WaterSecure merger also be considered as an allowable cost. These were not available for the Draft Report.
Stakeholder Submissions on the Draft Report
Subsequent to the Draft Report, the QWC submitted a 2011-12 levy for all service providers that totalled $20.658 million (excluding GST). This compares with a preliminary estimate of $24.3 million (which included GST) in the Draft Report. Further, the QWC advised that, following the merger of WaterSecure and Seqwater, the total levy is to be shared evenly between LinkWater and the newly merged entity, rather than three levies of one-third each, as outlined in the Authority’s Draft Report.
Authority’s Final Decision
The Authority accepts the QWC’s updated levy for the GSPs which are summarised below in Table 3.1.
Table 3.1: QWC Levy for 2011-12 ($m)
GSP Proportion of Total QWC Levy QWC Levy
Seqwater 25% 5.2
WaterSecure 25% 5.2
LinkWater 50% 10.3
Total 100% 20.7
Note: these figures may not add due to rounding.
As the merger of Seqwater and WaterSecure is not expected to materially reduce the cost to the Authority of investigating and recommending GSCs for the newly merged entity, the Authority proposes to retain the three fees of one-third each, as recommended in the Draft Report.
Since the Draft Report, the Authority has confirmed that, as GST is rebated to the GSPs, all costs should exclude GST. As a result, a QCA levy of $646,000 (excluding GST) for each of the three GSPs has been included in the calculation of GSCs.
19 Queensland Competition Authority Chapter 3: Approach to the Investigation
3.8 Other Services
In recommending the Capital Charge to apply to GSPs, the Market Rules (s8.11) require the Authority to take into account an appropriate apportionment of the RAB between the provision of Declared Water Services and other services.
The QWC Manual requires the Authority to accept as prudent, the current scope of Seqwater’s recreation activities as reflected in the current GSCs and catchment management activities previously approved by the QWC (although these can be subject to efficiency review). The Authority is also to accept the QWC approach for allocating capital expenditure and revenues between the WGM and the irrigation sector in the case of Seqwater. Under this direction:
(a) any capital expenditure for joint schemes (those that use grid assets), other than capital expenditure funded from a renewals annuity, should be treated as normal capital expenditure and included in the RAB for grid-related regulated services; and
(b) ongoing capital expenditure for irrigator only schemes should not be included in the RAB and therefore be funded by Seqwater.
The Manual also requires the Authority to continue to pass through the operating costs and revenues (including community service obligations (CSOs) received for Lockyer schemes) relating to irrigation services to the WGM.
The allocation of administrative, corporate and other common costs to non-Grid activities including the irrigation sector is to be deferred until such time as it is directed to review the allocation of common costs as part of a broader review of irrigation pricing.
Draft Report
In the Draft Report, the Authority noted that, in regard to Seqwater’s irrigation schemes, the Direction requires that operating expenditure be included in the GSC but that capital expenditure that can be identified as directly linked to irrigation should not be included in the RAB for GSCs. The QWC proposed this approach as an interim measure.
The Direction also requires that irrigation revenue be taken into account. Any revenue received from irrigation activities is to be offset against the GSCs. The Authority has offset these revenues from its recommended GSCs.
The Authority noted, however, that irrigation revenue should be first adjusted to exclude the renewals annuity contribution made by irrigators with this revenue held in escrow pending a future review of irrigation prices. Renewals revenue is considered to be revenue reserved on behalf of irrigators to cover the costs of future asset refurbishment and replacement. Seqwater has previously excluded this revenue.
In relation to other non-grid activities, the Authority identified the following potential non-regulated revenues:
(a) mini-hydro generators at Wivenhoe and Somerset Dams. In previous years, the Price Regulator treated the mini-hydro assets as non-regulated non-Grid assets, and excluded all costs and revenues from the determination of GSCs. Seqwater submitted that the revenue earned from non-regulated assets is minor. As a result, the Authority recommended that the Price Regulator’s approach be continued for the interim regulatory period; and
(b) revenue earned from the leasing of water assets such as reservoirs for placement of third-party telecommunication equipment. The Authority did not recognise revenue from
20 Queensland Competition Authority Chapter 3: Approach to the Investigation
telecommunications facilities in its 2010-11 SEQ Interim Price Monitoring Report on the basis that this was non-regulated revenue. On this basis, and given that the revenues are not significant, the Authority did not take account of these revenues in 2011-12.
The Authority recommended that a more comprehensive consideration of non-regulated revenues be undertaken next year.
Stakeholder Submissions on the Draft Report
No comments were received from stakeholders regarding the Authority’s approach to other services.
Authority’s Final Decision
The Authority proposes no change to the Draft Report recommendation.
21 Queensland Competition Authority Chapter 4: Seqwater
4. SEQWATER
4.1 Background
Seqwater owns and manages a range of water storage assets, WTPs and groundwater assets. These include:
(a) 26 dams and weirs across SEQ, including Wivenhoe, Somerset and North Pine Dams, Hinze Dam on the Gold Coast and Baroon Pocket Dam on the Sunshine Coast. Seqwater also owns the land inundated by the dams up to the flood margin, although at some storages such as Wivenhoe and Somerset Dams, it owns land beyond the flood margin;
(b) 46 operational WTPs, the largest of which are Mt Crosby, Molendinar, Mudgeeraba, North Pine and Landers Shute. Of these, eight are interconnected to the Grid’s bulk transport pipelines, while another 31 provide water directly to the distribution network, including standalone WTPs serving regional towns. Seqwater also owns seven minor treatment plants at recreation areas, 46 pump stations and 26 associated pipelines; and
(c) six bores and bore fields, most of which were constructed in response to the drought and transferred to Seqwater.
The WGM is the major customer and holds the water access entitlements (WAE) that provide the rights to water. However, in four schemes, the Warrill Valley, Central Brisbane, Logan and Upper Mary Schemes, irrigators and other users hold a significant proportion of the entitlements. Seqwater refers to these as joint schemes.
In two other irrigation schemes (Central and Lower Lockyer) transferred from SunWater, the WGM does not hold any WAE. These schemes are not Declared Water Services.
Seqwater also owns a small hydro-electric plant at Somerset Dam, and a larger plant at Wivenhoe. The Wivenhoe Dam plant is operated by Stanwell Corporation under a Build-Own- Operate-Transfer arrangement, with eventual transfer to Seqwater.
4.2 Capital Charge
Opening RAB
Under the Direction Notice, the Authority is required to accept the opening RAB for Seqwater as at 1 July 2011, as provided by the QWC.
The opening RAB includes actual ongoing non-drought capital expenditure from 2009-10 and 2010-11, reflecting QWC’s approach of adding actual non-drought expenditure into the RAB as it occurs rather than waiting until projects are commissioned as required of the Authority in the Direction Notice.
Since the Authority is required to accept the opening RAB provided by the QWC, any amounts to be included in the RAB upon commissioning of these assets should only include the incremental capital expenditure relating to these multi-period projects.
The QWC will also provide adjustments to the RAB after the 2011-12 GSCs have been recommended to the Price Regulator to take account of actual capital expenditure for 2010-11.
Draft Report
The QWC’s opening RAB is provided in Table 4.1 below, compared to Seqwater’s submission. For the purpose of transparency, remaining asset lives have been included.
22 Queensland Competition Authority Chapter 4: Seqwater
Table 4.1: Seqwater’s RAB at 1 July 2011
Seqwater QWC
Value Remaining Value Remaining Asset ($m) Life (years) ($m) Life (years)
Non- SEQWater assets 488.0 488.0 Drought 59.6 59.6
Aquagen Assets 123.0 59.7 123.0 59.7
Local Government Assets 1,060.0 60.0 1,060.0 60.0
SunWater/NRW Assets 79.9 60.0 79.9 60.0
Lake Manchester 82.3 47.6 82.3 47.6
Redlands transfers 0.5 60.4 0.5 60.4
Ewen Maddock WTP Upgrades (CAPEX post 28.5 28.5 0.3 0.3 completion)1
Sth Maclean WTP transfer 2.4 29.0 2.4 29.1
Actual CAPEX 2008-09 38.7 14.5 38.7 14.5
Actual CAPEX - ongoing 2009-10 37.1 21.5 37.1 21.0
Ongoing 2010-11 CAPEX forecast 34.2 22.5 34.2 22.0
Sub-total 1,946.3 57.0 1,946.5 57.0
Drought Brisbane Aquifer Project 49.3 17.2 49.3 17.2
Bribie Island Groundwater 40.0 17.3 40.0 17.3
Enoggera Dam WTP Upgrades 11.6 28.5 11.6 28.5
Ewen Maddock WTP Upgrades 43.0 27.9 43.0 27.9
Cedar Grove Weir 26.1 98.0 26.1 98.0
Bromelton Offstream Storage 45.9 28.0 45.9 28.0
Esk-Wivenhoe pipeline transfer from WCRW 6.7 68.6 6.7 68.6
Coominya pipeline transfer from WCRW 6.7 68.2 6.7 68.2
Enoggera Project pain/gain liability - - 0.3 28.9
Hinze Dam Upgrade 421.1 149.6 433.8 149.7
Wyaralong WTP 8.8 30.0 - -
Sub-total 659.4 107.8 663.3 109.7
Total 2,605.7 69.9 2,609.9 70.4
1Seqwater classified this asset as Drought. These figures may not add due to rounding. Asset life totals are weighted averages.
23 Queensland Competition Authority Chapter 4: Seqwater
Seqwater submitted an opening RAB of $2,606 million, comprising $1,946 million in non-drought assets and $659 million in drought assets.
Seqwater noted that it is possible under the Market Rules for the Authority to recommend an apportionment of Seqwater’s RAB to services other than water supply (specifically flood mitigation). Seqwater submitted that it does not consider that the allocation of RAB values to flood mitigation is consistent with the Direction Notice. Seqwater submitted that the QWC did not do so, and that the Direction Notice requires the Authority to adopt the QWC’s approach to recommending 2010-11 GSCs.
Seqwater also raised the issue of the regulatory treatment of proceeds from the potential disposal of its building at 240 Margaret Street as part of the State’s announced relocation of the GSPs to Ipswich in 2012. As part of the bulk water reform program, the building was valued by the State at $22 million on 1 July 2008. To date, Seqwater has included the building’s imputed rent in its operating costs invoiced to the WGM, but not owner-related building costs such as rates, maintenance or lighting. Seqwater did not include the building in its RAB.
Seqwater submitted that the water assets transferred to Seqwater in 2008 were mostly accompanied with very limited information, particularly in relation to historic costs, condition and maintenance. In conjunction with the transferred assets, Seqwater inherited multiple asset registers and information systems.
Further, Seqwater submitted that its asset base does not include any donated or contributed assets.
In the Draft Report, the Authority noted that Seqwater provided RAB values in its submission which differ slightly from those provided by QWC (a total of $2,606 million compared to $2,610 million or 0.15% lower than the QWC’s RAB). However, within these values, there are two relatively significant differences, which largely offset each other:
(a) Seqwater reported a value of $421.1 million for Hinze Dam Stage 3 compared to QWC’s $433.8 million, a difference of $12.7 million; and
(b) Seqwater included the Wyaralong WTP Stage 1 at a value of $8.8 million ($8.5 million plus capitalised interest), while the QWC did not include this asset in the opening RAB.
As required by the Direction Notice, the Authority adopted the RAB provided by the QWC for the purposes of recommending GSCs. Any difference to the values provided by Seqwater is a matter for the QWC.
With regard to the allocation of Seqwater’s dam asset values to flood mitigation, the Authority’s Statement of Regulatory Pricing Principles for the Water Sector (2000) noted that, in the absence of specific pricing arrangements relating to flood mitigation works, the Authority would include all water assets in the RAB for pricing purposes.
The Authority noted that the GSCs and the Bulk Water Prices charged by the WGM to the DRs do not currently allow for an effective differentiation between the beneficiaries of flood mitigation and water supply. As a consequence, the Authority did not allocate any portion of Seqwater’s RAB to flood mitigation.
With regard to the Seqwater building at 240 Margaret Street, the Authority understands that the building is occupied by Seqwater, and the Seqwater staff accommodated in the building perform roles that contribute to the provision of declared water services. Consistent with the approach adopted in the Authority’s SEQ Retail/Distribution Price Monitoring investigation proceeds
24 Queensland Competition Authority Chapter 4: Seqwater
from the sale of an asset that is used to provide Declared Water Services should be deducted from the RAB.
However, Seqwater provided the signed Transfer Notice made under the SEQ Water (Restructuring) Act 2007 that lists the assets and corresponding values that were transferred from Seqwater’s predecessor (SEQWater) to Seqwater. The Transfer Notice indicates that the building was not included in Seqwater RAB. Accordingly, the Authority did not intend to subtract the value of the 240 Margaret Street from the RAB upon its potential sale.
Stakeholder Submissions on the Draft Report
Seqwater queried the extent to which the Authority disaggregated the opening RAB for modelling purposes, as referred to in section 3.3. Seqwater noted that the Direction Notice only allows the Authority to disaggregate the RAB with the agreement of Seqwater. Seqwater has specifically requested a clear statement that the Authority did not separate land in Seqwater’s RAB.
Authority’s Final Decision
In response to the Seqwater’s concerns regarding disaggregation of the RAB, the Authority did not disaggregate the opening RAB to separate land from other assets. The Authority notes that the value of assets transferred from local government and previous supply entities reflected a whole of business valuation methodology from which it would not be appropriate to distinguish the value of individual components. Table 4.1 outlines the degree of disaggregation (as provided by the QWC).
However, in relation to 2011-12 capex, land and non-land costs have been separated as the information exists to make this distinction possible.
Capital Expenditure
The Direction Notice requires that the Authority assess the prudency and efficiency of non-drought capex and post-commissioning drought capex, and assess the efficiency of forecast capex on non-drought projects commenced in a previous regulatory period.
Capex incurred on projects, including capitalised costs, are to be rolled into the RAB at the date of commissioning.
Draft Report
In its initial submission, Seqwater identified a total $473.8 million of capital expenditure to be expended (rather than commissioned) in 2011-12, as shown in Table 4.2.
25 Queensland Competition Authority Chapter 4: Seqwater
Table 4.2: Seqwater’s Proposed Capex For 2011-12 ($m)
Capex Type 2011-12 Value
Drought Projects 409.7
Non-Drought projects 53.8
Non-infrastructure 7.8
Total Grid capex 471.3
Non-grid 2.5
Total Capex 473.8
Note: these figures may not add due to rounding.
Seqwater’s proposed drought capital expenditure is summarised in Table 4.3 and accounts for 86% of total forecast 2011-12 capital expenditure.
Seqwater submitted that drought projects are undertaken as a result of a directive by the Queensland Government, and that prudency or efficiency of the investments is not in question. A substantial proportion of this expenditure relates to the commissioning of the Wyaralong Dam and final construction costs for Hinze Dam Stage 3.
Seqwater submitted that the transfer cost for Wyaralong Dam is $383.5 million, plus an additional $0.4 million in owner’s transactions costs.
Table 4.3: Seqwater’s Proposed Drought Capex – to be Commissioned in 2011-12
Capital expenditure item Value Expected Asset life commissioning date ($m) (years)
Wyaralong Dam Transfer from 383.5 1/07/2011 100 QWI1
Hinze Dam Stage 3 15.7 31/08/2011 150 (Construction)2
Hinze Dam (Defects Liability)3 10.0 31/10/2012 150
Wyaralong Dam Transfer 0.4 31/12/2011 100 (Owner input and Advice)
Ewen Maddock WTP Upgrade 0.1 31/07/2011 30 (Defects Liability)
Total 409.7
Notes: 1QWI – Queensland Water Infrastructure Pty Ltd – a State Government company created to deliver the design and construction of drought assets 2 The Hinze Dam Stage 3 construction cost was originally submitted by Seqwater at a cost of $20.3 million, but was subsequently revised to $15.7 million. 3Defects Liability – refers to costs incurred by the constructing authority soon after the commissioning of an asset that relate to rectification of defects.
Seqwater initially submitted $20.3 million of expenditure relating to the final construction of Hinze Dam Stage 3. In support of its submission, Seqwater subsequently provided a five-year
26 Queensland Competition Authority Chapter 4: Seqwater
works budget for Hinze Dam, totalling a revised $15.7 million in 2011-12 with $0.7 million in subsequent years. Major components of the expenditure in 2011-12 include a Compensatory Habitat Strategy and pain-share costs.
Seqwater submitted that $10.0 million of estimated expenditure in 2011-12 on Hinze Dam related to defects liability, with a further $5.1 million estimated in 2012-13. In support of its submission, Seqwater subsequently provided the alliance construction contract which confirms that Seqwater is liable for costs incurred during the Defects Rectification period which extends for 2-5 years from the commissioning date.
In initial submissions, Seqwater submitted that $8.8 million of capex and capitalised interest relating to Wyaralong WTP Stage 1 should be included in the opening RAB, while an additional $0.5 million in capex on the WTP was forecast for 2011-12, with completion by December 2011. Seqwater was advised by the QWC that the Wyaralong WTP is to be treated as a drought asset.
Seqwater noted that, in recommending 2010-11 GSCs, the QWC rolled non-drought capex into the GSPs’ RABs as it was expended, whereas the Authority has been directed to roll-in capex at the commissioning date of the asset. Seqwater submitted that, if the additional $0.5 million to be spent in 2011-12 is not included in the RAB, it should be an Allowable Cost rather than capex.
The QWC did not include any value in the opening RAB for the Wyaralong WTP. Seqwater advised that the capex incurred to 30 June 2011 is $10.5 million including expenditure in 2009- 10 and capitalised interest. A further $0.5 million is to be spent in 2011-12, to produce a total of $11.237 million including capitalised interest at the commissioning date of 17 December 2011. This cost includes $1.24 million of land assets.
Seqwater submitted that the timing of the actual construction (Stage 2) of the Wyaralong WTP has yet to be determined and therefore a commissioning date is not yet identified. Instead of continuing to capitalise interest on an uncommissioned asset for an indefinite period, Seqwater submitted that it recover all $11.237 million of forecast capex as an allowable cost in 2011-12.
Seqwater’s non-drought capex consists of a number of distinct capex projects as well as a large number of relatively minor WTP and Dam renewals programs that are forecast to incur costs on an ongoing basis over a number of years. Seqwater proposed a mid-year commissioning date of 1 January 2012 for capex expended as part of the renewals programs.
Seqwater indicated that there remains a high level of uncertainty relating to damage sustained and estimated repair cost as a result of flooding during 2010-11. Seqwater did not expect to have reasonable information relating to flood damage until June 2011. Furthermore, the extent to which insurance proceeds cover the cost of repairing or replacing assets remains unknown.
Seqwater proposed that it make a further submission to the Authority in regard to flood damage costs and suggested that they be included in the allowable costs section. Seqwater had initially estimated $6.6 million to meet the costs of pre-January 2011 flood impacts, but did not include this amount in its submission. Seqwater advised that it was still evaluating the impacts of the January 2011 floods.
Seqwater also identified $912,000 of critical spares for 2011-12, with an asset life of 15 years. Seqwater noted that critical spares inventory costs would normally be included in a working capital allowance, but noted that the definition of working capital in the Direction Notice did not include critical spares.
27 Queensland Competition Authority Chapter 4: Seqwater
Seqwater’s proposed non-drought capital expenditure that is expected to be commissioned during 2011-12 is summarised in Table 4.4.
Table 4.4: Seqwater’s Proposed Non-Drought Capital Expenditure – to be Commissioned in 2011-12
Capital Expenditure Item Value Expected Asset Life Commissioning Date ($m) (years)
Power Supply Review 5.2 1/01/2012 20
Mt Crosby Eastbank WTP - Raw 2.4 1/01/2012 60 Water Infrastructure upgrade
Information and Communication 1.8 1/01/2012 5 Technology (ICT) Asset Replacement Program
North Pine WTP Filter Upgrade 1.8 31/12/2011 20
Supervisory Control and Data 1.5 1/01/2012 15 Acquisition (SCADA) Remote Access
Holts / Cameron’s Hills Sites 1.2 1/01/2012 30 Renewal
On-Line Instrumentation 1.2 30/06/2012 10 Improvement Program - Stage 3
SCADA Strategy Planning - 1.2 30/06/2012 15 Specifications & Scope of works
Office Facilities - furniture and 1.0 1/01/2012 10 fittings/equipment
Mt Crosby WTPs Upgrade Water 1.0 31/12/2011 20 Quality Improvements
Critical Spares 0.9 1/01/2012 15
Other (80) 26.4 n/a 32
Total 45.6 n/a 57
Note: these figures may not add due to rounding. Asset life totals are weighted averages.
Seqwater identified various multi-period non-drought capital expenditure items that will incur expenditure in the 2011-12 year but be commissioned after the 2011-12 year. These are detailed in Table 4.5, ranked according to total value of projects.
28 Queensland Competition Authority Chapter 4: Seqwater
Table 4.5: Seqwater's Proposed Multi-Period Capital Expenditure
Capital Drought/Non- 2011-12 Value Total Value1 Expected Asset Life Expenditure Item Drought Commissioning Date (years)
Lake McDonald Non-drought 0.3 26.8 TBA 80 Dam Spillway Upgrade
Maroon Dam Non-drought 0.3 25.0 TBA 80 Spillway Upgrade
Moogerah Dam Non-drought 0.3 24.1 TBA 80 Spillway Upgrade
Capalaba WTP Non-drought 0.6 15.6 TBA 30 Upgrade
Kilcoy WTP Non-drought 6.6 10.8 30/09/2013 34
Image Flat WTP Non-drought 0.6 10.2 TBA 80 Upgrade
Ewen Maddock Non-drought 1.7 3.0 TBA 60 Dam – piping
Other (12) Non-drought 5.8 33.5 n/a 29
Total 16.0 149.0 n.a 26
1Excludes any expenditure during 2010-11 Note: figures may not add due to rounding. Asset life totals are weighted averages.
Seqwater indicated that total non-drought capital expenditure is largely made up of renewals (47%), compliance (maintaining service) projects (42%), and business improvement projects (11%). Seqwater noted that this is because:
(a) assets are still being brought up to consistent standards to meet ongoing supply requirements;
(b) major growth and water security projects have recently been completed (for example Hinze and Wyaralong Dams); and
(c) regional planning, outside of a drought context, is in a state of development.
Of the non-drought capital expenditure, Seqwater identified $21 million in flood resilience projects. These projects are designed to ensure ongoing plant operations in the event of a flood, and include, for example, moving high voltage equipment to higher ground. Seqwater allocated these costs to renewals ($2.4 million or 12%), compliance (maintaining service) ($16.9 million or 80%), and business improvement projects ($1.7 million or 8%).
Seqwater submitted details of $7.8 million of non-infrastructure capex, including buildings, furniture, motor vehicles, equipment and software.
In the Draft Report, the Authority noted that under the Direction Notice, the Authority is to roll drought assets commenced before 1 July 2011 into the RAB at project cost, and therefore did
29 Queensland Competition Authority Chapter 4: Seqwater
not review Seqwater’s forecast drought capital expenditure. Accordingly, $409.7 million in drought capex, including $383.5 million relating to Wyaralong Dam, was added to the RAB.
In relation to the Wyaralong WTP, the Authority did not consider that Seqwater’s proposal to treat the Stage 1 expenditure as an Allowable Cost is consistent with the Direction Notice which requires capital expenditure to be included in the RAB at commissioning date. Seqwater’s expectation that capex incurred in 2010-11 would have been included in the opening RAB is a matter for the QWC.
The Authority recommended that the Wyaralong WTP should be included in the RAB when it is commissioned, as per the Market Rules. The Authority noted that the timing of the construction phase of the project was yet to be determined. In the event that the WTP project was to be formally abandoned or delayed indefinitely, the Authority would seek to include the costs incurred to date in the RAB, and to investigate depreciating the asset over an accelerated timeframe.
However, while the construction of the WTP in coming years remains a possibility, the Authority recommended that recovering the design costs as an Allowable Cost or through inclusion in the RAB would be contrary to the Market Rules.
The Authority reviewed non-drought capital expenditure for prudency and efficiency.
(a) Prudency and Efficiency Review
The Authority engaged SKM to review the prudency and efficiency of Seqwater’s non-drought capital expenditure. SKM reviewed the cost drivers of the capex in detail and the need for, and scope and standard of works when doing so.
For capex to be included in the RAB, it is required to be prudent (demonstrated need for the expenditure) and efficient (cost effective in scope and standard, using market benchmarks).
SKM undertook a sampling process for reviewing Seqwater’s proposed capex. SKM reviewed a sample of six proposed capital expenditure items, accounting for 30% of total non-drought capex to be expended in 2011-12.
Of these, two (the Kilcoy WTP and the Capalaba WTP upgrade) related to multi-period capital expenditure. All other reviewed projects are to be commissioned in 2011-12.
The sampled capital expenditure projects are listed in Table 4.6 below.
(i) Power Supply Review – flood resilience project - $5.16 million
SKM noted that the Power Supply Review encompasses 30 separate WTP sites. The January 2011 flood event demonstrated vulnerabilities with regards to power supply across Seqwater’s assets. Seqwater proposed undertaking a review of power supply reliability across all facilities, in order to identify reliability enhancements required commensurate with site criticality. Components of the project include providing power supply backup through provision of mobile power generation equipment and replacement of the existing backup generator at Landers Shute WTP.
SKM concluded that the majority of the project is both prudent and efficient, as it is required to ensure continuity of supply during adverse conditions.
However, SKM recommended that the upgrade of Lander’s Shute WTP generator ($1.44 million) cannot be considered efficient due to a lack of supporting documentation. SKM
30 Queensland Competition Authority Chapter 4: Seqwater
recommended that Seqwater provide further information before the Authority consider this portion of the project efficient.
The Authority accepted SKM’s finding that $3.72 million of the proposed capex is both prudent and efficient, but that the remaining $1.44 million relating to the replacement of the Lander’s Shute WTP generator could not be assessed for efficiency until further information is provided.
(ii) Mt Crosby Eastbank WTP - Raw Water Infrastructure upgrade – flood resilience capex - $2.42 million
SKM noted that the upgrade to the raw water pumping station at Mt Crosby Eastbank is required to prevent intrusion of flood waters into wells, which would result in failure of raw water supply. Due to Mt Crosby WTP’s status as a major supplier of treated water to the Grid, any significant failure is considered an unacceptable risk.
SKM concluded that the project is prudent and of critical importance to supply continuity. However, SKM indicated that insufficient details have been provided to conclude that the project is efficient. SKM recommended that Seqwater provide further details of the scope of works before the Authority recommend that the project is efficient.
The Authority accepted SKM’s recommendation that the project is prudent, but could not be considered efficient at that stage. The Authority did not include any capex relating to this project in the recommendation of GSCs.
(iii) Information & Communication Technology (ICT) Asset Replacement Program - $1.8 million
SKM noted that the ICT Asset Replacement Program delivers a range of capital items, and includes a minor element of opex. SKM considered the three largest capital components:
(a) major ICT Equipment Renewals ($0.5 million);
(b) minor ICT Equipment Renewals ($0.3 million); and
(c) improvements to system integration, upgrades and support for business improvement ($0.3 million).
SKM concluded that, although the prudency of the Major and Minor ICT Equipment Renewals was not well supported in Seqwater’s submission, this type of expenditure is generally necessary for maintaining corporate systems. Similarly, SKM considered that the cost of the Renewals are efficient, based on Seqwater’s stated procurement process.
However, SKM concluded that the $0.3 million for improvements to system integration could not be considered prudent or efficient due to a lack of supporting information on the scope of works and the project need.
The Authority accepted SKM’s finding that $0.3 million of the project could not be considered prudent or efficient without further substantiating information. The Authority recommended the inclusion of $1.528 million relating to ICT Asset Replacement Program in the 2011-12 GSCs.
(iv) North Pine WTP Filter Upgrade - $1.8 million
SKM noted that the filtration system at North Pine WTP had been assessed as requiring an upgrade due to the decreasing reliability of the existing ageing assets. SKM noted that the previous owner, Brisbane City Council, identified the requirement prior to the transfer of the asset to Seqwater.
31 Queensland Competition Authority Chapter 4: Seqwater
SKM concluded that the project is prudent due to requirements for water supply reliability. SKM also concluded that the project is efficient, as the current scope of works is the best means of achieving the desired outcomes.
The Authority accepted SKM’s recommendation that the project is both prudent and efficient, and recommended the inclusion of $1.8 million of capex in calculation of GSCs.
(v) Kilcoy WTP - $6.6 million
SKM noted that the project involves the replacement of the Kilcoy WTP as the existing plant is in poor condition and major components of the plant are beyond their useful life, such that either a major upgrade or total replacement was required. Increasing water demand in the area will soon exceed the current raw water allocation from Kilcoy Creek.
SKM’s assessment of the Kilcoy WTP project concluded that the project was prudent due to the requirement for the WGM to meet contractual agreements with Queensland Urban Utilities (QUU). SKM also concluded that the project is efficient due to the estimated design and construction costs comparing well against typical market expectations and SKM’s in-house knowledge.
The Authority accepted SKM’s assessment that the Kilcoy WTP project is prudent and efficient.
(vi) Capalaba WTP Upgrade - $0.6 million
SKM noted that the Capalaba WTP is currently inadequate to meet Seqwater’s contractual obligations for water quality. For example, recent quality monitoring indicates that the limits for Aluminium and Trihalomethanes have been breached. The plant is operating at below capacity due to age/condition factors.
With the introduction of the Grid, other options have become available that may provide a more cost effective means of improving the water supply to the Capalaba area. Accordingly, Seqwater decided to commission a study to examine and develop options for addressing the water quality (and related capacity) issues at the Capalaba WTP.
SKM concluded that the overall project budget of the Capalaba WTP Upgrade was not prudent or efficient, as no final project scope had been defined. However, SKM considered that the $600,000 budgeted to be expended during 2011-12 was both prudent and efficient and will allow Seqwater to establish the most appropriate course of action.
The Authority accepted SKM’s assessment that the expenditure to be incurred by Seqwater in 2011-12 relating to the Capalaba WTP Upgrade was both prudent and efficient. However, the Authority recommended that expenditure from 2012-13 onwards cannot be deemed prudent or efficient until the final project scope has been defined.
(b) Summary of SKM Review
Table 4.6 provides a summary of SKM reviewed capital expenditure items.
32 Queensland Competition Authority Chapter 4: Seqwater
Table 4.6: Summary of SKM Reviewed Capital Expenditure for the Draft Report ($m)
Project Title Cost Driver Cost Estimate SKM Recommended
Power Supply Review Maintaining Service 5.2 3.7 (Flood resilience)
Mt Crosby Eastbank WTP Raw Business 2.4 0 Water Infrastructure Improvement (Flood resilience)
ICT Asset Replacement Program Renewals 1.8 1.5
North Pine WTP Filter Upgrade Renewals 1.8 1.8
Kilcoy WTP1 Maintaining Service 6.6 6.6
Capalaba WTP upgrade1 Business 0.6 0.6 Improvement
Total Sample 18.4 14.2
Total Capex (Non drought) 61.6
Total Sample/Total Capex (%) 30% 1These projects are due for completion after 2011-12. The cost estimate presented above relates to costs incurred in 2011-12 only, not total project costs. These figures may not add due to rounding
(c) Other Capital Expenditure Projects
In the Draft Report, the Authority recommended that flood damage response capital expenditure be considered non-drought capex rather than an Allowable Cost. Notwithstanding the severity of the January 2011 floods, the Authority considered that capital expenditure requirements as a response to weather events is a normal part of Seqwater’s business. Under the Market Rules, Allowable Costs are costs that are not recoverable as Capital Charges or Fixed or Variable Operating Charges. An adjustment for capital expenditure can be made under the Authority’s recommended framework for adjustments (Chapter 7).
The Authority agreed with Seqwater that critical spares should be included in working capital (see section 4.5) and has excluded them from capital expenditure. As a result, the Authority also excluded the critical spares from its calculation of depreciation.
The Authority also reviewed other multi-period capital expenditure items:
(a) Maroon and Moogerah Dams spillway projects – Seqwater submitted that Dam spillway upgrades are required by the Water Supply (Safety and Reliability) Act, administered by DERM, in order to meet Acceptable Flood Capacity requirements. Seqwater submitted that the Maroon and Moogerah dam spillway upgrades were reviewed by QWC in 2010- 11 for prudency and deemed justifiable. The Authority accepted Seqwater’s proposal that the spillway upgrade projects on Moogerah and Maroon Dams are prudent;
(b) Ewen Maddock Spillway Upgrade – A further project was approved by the Price Regulator in 2010-11 relating to spillway upgrade of Ewen Maddock dam. Seqwater submitted that an assessment by GHD concluded that the Dam upgrade can be staged with the installation of pressure relief wells within the next two years and the embankment raise and spillway work completed by 2025. Seqwater advised that it expected a staged program to be more efficient, and was therefore proposing to proceed with the installation of pressure relief wells. This project has therefore been redefined as
33 Queensland Competition Authority Chapter 4: Seqwater
‘Ewen Maddock Dam – piping’. The Authority accepted Seqwater’s proposal that the upgrade of piping at Ewen Maddock Dam was prudent. Seqwater provided cost estimates used in the preparation of project budget which reflect the more expensive of two possible project scopes, and include a 50% contingency factor. The Authority recommended that the project be reviewed for efficiency during the period it is to be included in the RAB (2012-13);
(c) Lake MacDonald Dam – Seqwater provided the results of an assessment conducted by URS of the safety, risk and options for upgrading Lake McDonald Dam. The Authority understands that this is sufficient under DERM’s guidelines to require an upgrade of Lake McDonald Dam. As a result, the Authority recommended that the Lake McDonald Dam Spillway upgrade project be considered prudent; and
(d) Boonah Kalbar WTP Upgrade – Seqwater’s capex program includes $8.8 million over three years for an upgrade of the Boonah Kalbar WTP, for which the primary capex driver is growth. Seqwater submitted that this project is still in the planning phase, and a formal study is about to be commissioned. A business case, which would usually be used as the basis of consultation with WGM, had yet to be finalised. As such, the project was not yet at a stage where the WGM had been asked to provide endorsement. Until WGM endorsement is received, the Authority was not in a position to consider this capex prudent.
However, as these assets are not commissioned in 2011-12, they do not affect GSCs for 2011- 12.
(d) Summary of Capital Expenditure
In the Draft Report, the Authority recommended the proposed non-drought capital expenditure to be commissioned in 2011-12 as detailed by Seqwater (Table 4.4) be accepted with the exception of:
(a) $1.44 million of the Power Supply Review;
(b) $2.42 million of Mt Crosby Eastbank WTP Business Improvement;
(c) $0.3 million of ICT Asset Replacement Program; and
(d) $0.91 million of critical spares (included in working capital).
The Authority noted that the excluded items are subject to further review following the provision of more information by Seqwater.
Further, the Authority noted that capital expenditure to be commissioned in future years does not have any impact on the recommendation of 2011-12 GSCs. SKM’s and the Authority’s assessment of these projects provide guidance to Seqwater and informs future regulatory reviews. The Authority accepted capital expenditure, to be commissioned in 2011-12, as summarised in Table 4.7.
34 Queensland Competition Authority Chapter 4: Seqwater
Table 4.7: Forecast Capital Expenditure 2011-12 ($m)
Seqwater Proposed Authority Draft Recommendation
Drought 409.7 409.7
Non-Drought 45.6 40.5
Total 455.3 450.2
Note: these figures may not add due to rounding.
Stakeholder Submissions on the Draft Report
(a) Wyaralong WTP
In response to the Authority’s Draft Report, the QWC advised that construction of Wyaralong WTP is now not expected to begin until 2013-14 at the very earliest. The QWC indicated that the design phase of the WTP is a distinct project from the construction phase, and was recognised as a distinct project in the approved 2010-11 GSCs. As a result, the QWC requested that the full costs associated with the design of Wyaralong WTP be rolled into the RAB at the completion of the design phase.
Seqwater’s submission on the Draft Report reiterated the expectation that expenditure on the WTP to 30 June 2011 would be included in the opening RAB advised to the Authority by the QWC. Seqwater submitted that it will continue to discuss this issue with the QWC.
(b) Hinze Dam Stage 3 (Construction) Costs
Subsequent to the finalisation of the Draft Report, Seqwater provided an updated budget of the expected Hinze Dam Stage 3 (construction) costs for 2011-12, which totalled $20.2 million. The updated budget included a detailed breakdown of the expected cost components (Table 4.8 below), and compares to the $15.7 million included listed in Table 4.3 above. The additional costs relate to items that Seqwater had identified, but not quantified in its initial submission.
Table 4.8: Hinze Dam Stage 3 (Construction) costs ($m)
Cost Category Value
Land 9.0
Pain Share 3.0
Gold Coast City Council Management costs 2.7
Seqwater office costs and project management 1.5
Asset Upgrade Program 0.8
Vegetation Management 0.7
Other 2.5
Total 20.2
Note: these figures may not add due to rounding.
35 Queensland Competition Authority Chapter 4: Seqwater
(c) Wyaralong Dam
Subsequent to the finalisation of the Draft Report, Seqwater provided an advice on the transfer of Wyaralong Dam from QWI and associated costs. The updated budget fell from $383.5 million to $373.4 million as a result of the exclusion of a $10.0 million contingency. Seqwater also advised that the total cost included $45.1 million of land assets.
(d) Power Supply Review
In response to the Authority’s Draft Report, Seqwater submitted a quote of the estimated cost of the back-up generator at Lander’s Shute WTP, which accounted for $1.44 million of the original $5.16 million total cost.
Subsequent to the Authority’s Draft Report, Seqwater progressed the project specification and decided that the amount of backup power required can be reduced by including the Lander’s Shute hydro in the power requirement assessment. As a result, only a 500kVA generator is now planned and will fit in the existing generator building with minimal modifications. Being able to incorporate the replacement generator in the existing generator building substantially reduces the expected cost from $1.44 million to $0.16 million.
(e) Mt Crosby Eastbank WTP Raw Water Infrastructure upgrade
Seqwater submitted that the Raw Water Infrastructure upgrade consists of two components:
(a) flow measurement – installation of flow meters for improved raw water pumping control; and
(b) flood immunity – installation of submersible bilge pumps to improve flood resilience.
In relation to flow measurement, Seqwater provided the options analysis for meter type selection for the Mt Crosby Westbank Flow Meter Project which is currently underway. This project is very similar in nature to the Eastbank project and it is expected that the findings of this options analysis will translate to the installation at Mt Crosby Eastbank. Within this report several options are considered including the installation of mag-flow meters, ultrasonic flow meters and strap on meters. The recommended option for the Westbank project was a mag-flow meter.
Seqwater submitted that the cost of the mag-flow meters themselves comprises only a small amount of the overall project cost. The two largest costs are for civil works ($250,000) and mechanical works ($250,000).
Seqwater also provided third party quotes relating to the procurement of bilge pumps for the flood immunity portion of the project.
(f) ICT asset replacement program
Seqwater submitted that the system integration cost excluded from Draft GSCs relate to the final stage of an ICT program largely completed in previous years. The remaining $300,000 is expected costs during 2011-12 consisting of:
(a) $120,000 in increased licensing costs due to a need to increase the number of licenses for former WaterSecure employees; and
(b) $180,000 of contractor resources to deliver the final components of the planned corporate information system implementation.
36 Queensland Competition Authority Chapter 4: Seqwater
(g) North Pine WTP
In relation to the North Pine WTP, the WGM submitted that it has advised Seqwater that it endorses the need for project. In relation to the scope of the proposed upgrade, the WGM sought advice as to whether significant costs could be saved should it specify that only part of the capacity of the WTP needed to be available in the short term. The WGM was subsequently advised by Seqwater that significant cost savings would not be achieved, but no supporting information was provided to the WGM.
(h) Kilcoy WTP
Seqwater provided further details on the Kilcoy WTP, including a letter advising that the project was to commence, an updated budget estimate and business case.
The forecast total cost of the WTP project has increased by more than 50% since the Draft Report, from $11.5 million to $17.8 million. The 2011-12 portion of expenditure has increased from $6.6 million (as included in Table 4.5 above) to $12.0 million.
Seqwater submitted that the causes of the increase in costs include:
(a) additional project works valued at $3.3 million necessary to deliver the project in accordance with its objectives. This includes:
(i) additional WTP equipment required $0.6 million;
(ii) upgrade to the access road $1.7 million;
(iii) lime/CO2 dosing facility $0.6 million;
(iv) raw water and treated water pipeline duplications $0.4 million;
(v) electricity supply increase $0.1 million;
(vi) increase in the Clear Water Storage volume $0.1 million; and
(b) a market [cost] escalation of approximately $1.6 million.
Seqwater also provided a letter from the WGM regarding the Kilcoy WTP. The WGM’s letter confirmed that the WGM had endorsed the original $11.5 million project, but raised several concerns about the revised project scope:
(a) that the project cost appears high compared to benchmark rates for similar WTPs;
(b) that the WTP project specification was more stringent than required under Seqwater’s Grid Contract; and
(c) that the increase in forecast project cost warrants a more fulsome assessment of an alternative supply option, namely a pipeline connection to the Grid.
Seqwater, in its submission, considers that deferral of the Kilcoy WTP project is not feasible for the following reasons:
(a) postponing the project is likely to result in a departure from Seqwater’s flood safety commitments, and therefore a breach of its Grid Contract;
37 Queensland Competition Authority Chapter 4: Seqwater
(b) the existing Kilcoy WTP has an increasing level of risk resulting in 20 hour/day operations, voluntary demand reductions by industrial customers and operation of the existing contingency WTP; and
(c) postponing the project will warrant a re-tender, representing a reputational and price risk to Seqwater.
Seqwater submitted that the treated water quality limits set for the Kilcoy WTP are based on Australian good industry practice and at levels that are typical (and achievable) for modern conventional WTPs. The limits specified are generally more conservative than those specified in the ADWG because the ADWG values apply at the consumer tap and it is likely for many of the parameters (e.g. disinfection by-products, manganese, turbidity) the quality of water will degrade within the distribution system.
In setting these limits, Seqwater gave consideration to the water quality notification triggers set for treated water entering the Kilcoy distribution system managed by Queensland Urban Utilities (the downstream Distribution Retail Entity). Consideration was also given to the trend in health based targets set in Australian and international guidance/regulation around safe drinking water. Seqwater submitted that they are consistent with the objectives of Seqwater’s Water Quality Policy and approved Drinking Water Quality Management Plan.
In its submission to the Authority, the WGM noted that it endorses the need for improvements to the Kilcoy water supply. The WGM also advised that it had no objection to the proposed WTP at the estimated project cost contained in the [initial] Business Case. Seqwater has since advised the WGM that the project cost had increased significantly, through the tender process. At this higher cost, the WGM considers that the project would benefit from value engineering to ensure that the project scope is efficient and aligned to the service specification.
(i) Mt Crosby WTP Upgrade Water Quality Improvements
In relation to the Mt Crosby WTP Upgrade Water Quality Improvements, the WGM submitted that it has advised Seqwater that it considers that there is a clear need for the project. This project has since been expanded to include polymer dosing facilities, the need for which the WGM also endorses.
(j) SEQ Water Grid Manager Capability Assessment Report
The WGM submitted that it has advised Seqwater that it supports detailed planning investigations into the other nominated projects. However, the WGM has not yet provided advice regarding the need for the projects or the options to them. Such advice will be informed by the Seqwater investigations and by the WGM’s assessment of Grid capability. Seqwater has committed to involve the WGM in key stages of these planning investigations.
The WGM submitted that its recent SEQ Water Grid Manager Capability Assessment Report highlighted potential capability gaps at a number of these locations, including at Capalaba. However, as outlined in that report, WTP upgrades or replacements are only one of the options being considered.
(k) Spillway upgrade projects
In relation to the spillway upgrade projects, the WGM submitted that the need for these projects is set by regulation. In relation to options, the WGM will work with Seqwater to determine whether any of these upgrades could be reduced or avoided through the operation of the storage in normal conditions.
38 Queensland Competition Authority Chapter 4: Seqwater
Authority’s Final Decision
The Authority has reviewed the issues raised in submissions, with referral to SKM where necessary for further assessment of prudency and efficiency.
(a) Wyaralong WTP
In response to issues raised by QWC, the Authority notes that none of the information available at the time of preparing the Draft Report (including the Regional Water Security Program, Seqwater’s 2011-12 GSC submission and the QWC’s report on Seqwater’s 2010-11 GSCs) identified the design phase as a distinct project. Furthermore, Seqwater has not identified the WTP as a separate project in its submission on the Authority’s Draft Report, and instead proposes to pursue the inclusion of the 2010-11 expenditure in the opening RAB.
Design costs have been included in the total project value of other drought assets rolled into the RAB by the QWC in previous periods. As a result, the Authority does not consider the QWC’s request, without validation that design costs were formally approved as a separate project by the Price Regulator, is sufficient to alter the recommendation in the Draft Report.
Consistent with the Draft Report, the Authority recommends that the total project cost, including design costs, be included in Seqwater’s RAB at the commissioning date, as required by the Direction Notice.
(b) Hinze Dam Stage 3 (Construction) Costs
As the Hinze Dam is a drought asset, the Authority accepts Seqwater’s revised project costs.
The additional cost details provided by Seqwater allow the Authority to separately identify $9.0 million of land assets. These land asset values have therefore not been depreciated (see also Return of Capital further below).
(c) Wyaralong Dam
As Wyaralong Dam is a drought asset, the Authority accepts Seqwater’s revised project costs.
The additional cost details provided by Seqwater allow the Authority to separately identify $45.1 million of land assets. These land asset values have therefore not been depreciated.
(d) Power Supply Review
SKM reconsidered the Power Supply Review project in light of new information provided by Seqwater, and found it to be prudent because it is necessary to meet compliance requirements.
SKM recommends a reduction in project costs due to the decline in cost for the Lander's Shute WTP generator upgrade. SKM reviewed third party quotes for the replacement generator and the corresponding contingency allowed by Seqwater, and considered them reasonable. As a result, SKM recommended that, taking account of revisions to contingencies, a revised project budget of $4.08 million is efficient.
The Authority accepts SKM’s recommendations and recommends the inclusion of a revised $4.08 million of capex in calculation of GSCs. This compares with an initial estimate by Seqwater of $5.2 million and an initial recommendation by SKM of $3.7 million.
39 Queensland Competition Authority Chapter 4: Seqwater
(e) Mt Crosby Eastbank WTP Raw Water Infrastructure upgrade
In relation to flow measurement costs, based on recent project experience, SKM recommended that the costs for the construction of a flow meter pit and works to cut out the pipe and install the meter are of the right order of magnitude and therefore efficient.
However, SKM recommended that an assessment of the suitability of alternative meters that would result in significant project cost reductions should be evaluated against the meters’ required accuracy. SKM recommended that any reduction in project costs arising from this review should subsequently be captured in the end of year reconciliation with the QCA.
In relation to flood immunity costs, SKM recommended that the quotation for the bilge pumps, which total 75% of the total project costs, is reasonable. SKM also considered these costs to be efficient.
The Authority accepts SKM’s recommendations and recommends the inclusion of previously excluded $2.42 million of capex in calculation of GSCs.
(f) ICT Asset replacement program
SKM considered that the ICT asset replacement works are required to complete the implementation of final components of the planned corporate information system integration of modules and to meet the increased licensing needs. SKM noted that the upcoming merger has been considered within these activities. SKM recommended that the project is prudent.
SKM noted that these works have been awarded via a competitive procurement process. SKM considered that the rates used and assumptions regarding growth are reasonable, and therefore recommends that the project is efficient.
The Authority accepts SKM’s recommendation and recommends the inclusion of the full $1.8 million of capex, in place of the Draft Report approved amount of $1.528 million.
(g) North Pine WTP Filter Upgrade
The Authority notes the WGM’s submission on North Pine WTP. The project was reviewed by SKM prior to the preparation of the Authority’s Draft Report. Although the WGM submission notes that Seqwater’s response to WGM queries were not accompanied by supporting information, Seqwater did provide sufficient detail to SKM to assess the project’s prudency and efficiency. As a result, the Authority does not consider it necessary to re-open SKM’s prior investigation.
Consistent with the Draft Report, the Authority recommends that the North Pine WTP Filter Upgrade be considered prudent and efficient.
(h) Kilcoy WTP
Under the Direction Notice, the Authority is required to accept projects approved in 2010-11, but not necessarily fully expended by 30 June 2011, as prudent in scope. The Authority notes that the WTP project was approved by the Price Regulator as part of the 2010-11 Grid Service Charges at its original budgeted cost of $8.4 million. Under the Ministerial Direction, the Authority is obliged to accept the approved scope as being prudent.
However, the scope (and cost) has been revised and the WGM has not endorsed the revised Kilcoy WTP project due to concerns about the specification of alternate supply options, and the high level of technical specification of Seqwater’s preferred WTP option. The WGM has submitted that an alternate pipeline option requires further consideration.
40 Queensland Competition Authority Chapter 4: Seqwater
The Authority considers that new information submitted by Seqwater and the WGM constitutes a material change in project scope from 2010-11 which has not been considered or approved by the Price Regulator. As a consequence, the Authority considers it within its purview to review both the prudency and efficiency of the revised WTP project. The Authority engaged SKM for this purpose.
SKM noted that the WGM had raised a concern that the cost of the competing pipeline option may have been overestimated, questioning the assumptions regarding length, diameter, configuration and material of the pipeline. The WGM also suggested that the cost of renewals required for Woodford WTP may have been overlooked, which would be avoided under the pipeline option.
SKM noted that insufficient information had been provided by Seqwater to either prove or dismiss the WGM’s submission. SKM recommended that Seqwater works with the WGM to establish feasible alternative pipeline options. However, SKM noted that such an investigation is likely to result in a number of risks involving the continued use of the Kilcoy WTP, including a potential breach of its Grid Contract. During discussions with the WGM, SKM understands that the WGM is willing to accept this risk. SKM strongly recommended that Seqwater meet with the WGM to discuss and clarify this arrangement, including whether a non compliance with Seqwater’s Grid Contract (the primary driver for this project) is acceptable and on what terms.
In relation to the $3.3 million additional project works added to the specification, SKM noted that insufficient information was provided in a timely manner to allow SKM to complete its assessment of the prudency of the additional works. In particular, SKM retained unanswered concerns regarding the flood immunity specification of the access road and the prudency of the proposed pipeline duplication.
SKM also noted the WGM’s concerns regarding the treated water quality targets adopted by Seqwater within the project specification for the Kilcoy WTP. In particular, the following was noted as being particularly stringent or overly conservative:
(a) turbidity – 0.1 NTU 95th percentile and 0.3 NTU limit; and
(b) achievement of above specifications with a raw water turbidity of up to 500 NTU while operating at full capacity (4 ML/d).
SKM noted that a more relaxed specification for the plant of 0.3NTU (95th percentile) and 0.5NTU (limit) is more consistent with current guidelines. SKM recommended that Seqwater produces documentation which directly links the results of its risk assessment to a justification of the plant specifications.
In addition, SKM recommended that the process design for the Kilcoy WTP is reviewed following any relaxing of the plant specification to determine whether there are any resulting changes to the process design, in particular whether there are any changes to the additional scope identified during the design period.
In summary, SKM recommended that there was insufficient information to conclude that the Kilcoy WTP project was prudent.
Given SKM’s concerns about the project, and the lack of timely information available for SKM review, the Authority cannot consider the project prudent at this stage. The Authority notes that the Kilcoy WTP is not due for commissioning until 2013-14, and that its recommendation relating to prudency has no immediate effect on Seqwater’s GSCs.
41 Queensland Competition Authority Chapter 4: Seqwater
(i) Mt Crosby WTP Upgrade – Water Quality Improvements
This project was not sampled as part of the Draft Report SKM review. The Authority notes that the WGM endorses both the need for and recent expansion of the scope of this project.
(j) SEQ Water Grid Manager Capability Assessment Report
The Authority notes that a number of Seqwater’s WTPs are identified in the WGM Capability Assessment as under investigation for potential augmentation or renewal. The Authority will consider the outcomes of these assessments as they become available.
(k) Spillway upgrade projects
The Authority notes the WGM’s submission that it will continue to work with Seqwater to determine whether any of these projects costs could be reduced or avoided.
(l) Conclusion
In summary, the Authority has revised its recommendations of prudency and efficiency from the Draft Report for capital expenditure items shown in Table 4.9 below.
Table 4.9: Summary of amendments to Draft recommended Capital Expenditure in 2011- 12 ($m)
Project Title Seqwater Initial QCA Draft Seqwater Revised QCA Final Submission Recommendation Submission Recommendation
Power Supply Review 5.2 3.7 4.1 4.1
Mt Crosby Eastbank WTP 2.4 0.0 2.4 2.4 Raw Water Infrastructure
ICT Asset Replacement 1.8 1.5 1.8 1.8 Program
Hinze Dam Stage 3 15.7 15.7 20.2 20.2 (construction) costs
Wyaralong Dam 383.5 383.5 373.4 373.4
Kilcoy WTP1 6.6 6.6 12.0 0.0 1This project is due for completion after 2011-12. The cost estimate presented above relates to costs incurred in 2011-12 only, not total project costs. These figures may not add due to rounding
The net effect of the revisions to the Draft Report is to reduce Seqwater recommended capital expenditure by $2.4 million. The final recommended 2011-12 capital expenditure is shown in Table 4.10.
42 Queensland Competition Authority Chapter 4: Seqwater
Table 4.10: Forecast Capital Expenditure 2011-12 ($m)
Seqwater Initial QCA Draft Seqwater Revised QCA Final Submission Recommendation Submission Recommendation
Drought 409.7 409.7 404.2 404.2
Non-Drought 45.6 40.5 43.6 43.6
Total 455.3 450.2 447.8 447.8
Note: these figures may not add due to rounding.
Return on Capital
Under the Direction Notice, the return on drought assets is to be set at the actual cost of debt incurred by Seqwater for its drought assets.
The cost of debt for drought assets is the book interest rate forecast by QTC for 2011-12 for each asset plus administration and capital market charge. The Authority is required to adopt the QTC rates.
Draft Report
The QTC submitted the cost of debt for Seqwater’s drought assets as shown in Table 4.11. QTC advised that the differences in interest rates represent differences in market interest rates when the borrowings were made and when the Water Infrastructure Debt Pool (WIDP) was rebalanced. The WIDP has a mix of fixed and floating rate debt instruments and is adjusted each quarter.
Table 4.11: Cost of Debt Rates for Drought Assets
Asset 2011-12 Forecast Cost of debt
Brisbane Aquifer 6.44%
Bribie Island Aquifer 6.21%
Enoggera WTP 6.38%
Ewen Maddock WTP Upgrades 6.38%
Cedar Grove Weir 6.73%
Bromelton Off-Stream Storage 6.73%
Esk-Wivenhoe Pipeline 6.58%
Coominya Pipeline 6.58%
Hinze Dam Upgrade 6.20%
Wyaralong Dam 6.13%
Wyaralong WTP 6.06%
43 Queensland Competition Authority Chapter 4: Seqwater
For non-drought assets, the Authority must determine a pre-tax nominal WACC for non-drought assets based on parameters detailed in the Manual. The cost of debt used in the WACC is the book interest rate forecast by the QTC for each asset plus an administration and capital market charge and a Competitive Neutrality Fee. The Direction Notice and Manual prescribe all parameters to be used in determining WACC.
Table 4.12: QTC Input Parameters for Calculation of Seqwater’s WACC
Parameter Value
Cost of debt (Weighted Average) 8.01%
Risk Free rate 5.96%
In the Draft Report, the Authority stated that based on the parameters directed by the Price Regulator and the inputs provided by the QTC as in Table 4.12, the WACC to apply to Seqwater’s non-drought RAB and post-commissioning non-drought and drought capital expenditure was calculated at 9.91%.
This compares to a pre-tax nominal WACC of 9.94% applied by the Price Regulator for 2010- 11 and 9.95% for 2009/10.
Stakeholder Submissions on the Draft Report
No comments were received from stakeholders regarding Seqwater’s return on capital.
Authority’s Final Decision
The Authority proposes no change to the Draft Report recommendation.
Return of Capital
Under the Direction Notice, the Authority is to determine the return of capital based on the written down value of the assets and using a straight line regulatory depreciation based on each asset’s estimated useful life. Estimated useful lives along with the written down asset values have been provided by the QWC. However, the Authority may review proposed asset lives for new assets.
Draft Report
In its initial submission, Seqwater submitted that the asset life for the transferred Wyaralong Dam should be 100 years, but noted that in recent regulatory reviews, dam lives have varied between 100 and 200 years. Seqwater also noted that the ATO has applied a life of 100 years for the purposes of depreciating dams and weirs. Seqwater acknowledged that the physical life of a dam wall is potentially infinite and that any assignment of life is largely arbitrary. It chose a 100 year life on the basis of a cautionary approach, given that demand can change dramatically over a 100 to 200 year period given changes in technology and population.
Seqwater did not provide an estimate of depreciation in its submission.
In the Draft Report, the Authority adopted the QWC’s opening RAB values, and applied a straight line depreciation approach to each of Seqwater’s assets and 2011-12 capex items in order to derive the total depreciation allowance for 2011-12.
44 Queensland Competition Authority Chapter 4: Seqwater
In relation to Wyaralong Dam, the Authority accepted that the establishment of a dam life can be quite arbitrary. However, it is noted that a life of 150 years was applied for existing dam assets, including by the QWC in 2010-11 for the newly commissioned Hinze Dam raising. The Authority noted that it has also previously applied a 150-year life to Awoonga Dam in its GAWB investigation.
As a matter of consistency, the Authority recommended a 150-year life for the Wyaralong Dam.
Stakeholder Submissions on the Draft Report
In relation to Wyaralong Dam, Seqwater submitted that the land component should be depreciated. Without the revenue earned from depreciation, Seqwater submitted that it will be unable to extinguish the debt associated with the acquisition of the dam as the charges relating to the land component will only recover the cost of debt itself, and not the principal. Seqwater noted the component of the Direction Notice that requires the Authority to adopt a consistent approach to that adopted by the QWC in previous regulatory periods. Seqwater submitted that the land component of assets was depreciated in previous regulatory periods.
Seqwater also provided updated capital expenditure estimates for Wyaralong Dam. This included the removal of a project contingency of $10.0 million, to reduce the overall project cost from $383.5 million to $373.4 million. Seqwater also submitted a total project cost that allowed for the separate identification of $45.1 million of land assets which were not identified at the time of the Authority’s Draft Report.
As noted above, subsequent to the finalisation of the Draft Report, Seqwater provided updated capital expenditure estimates for the Hinze Dam Stage 3 (Construction) project. This included a $5.5 million increase in project cost, but allowed for the identification of $9.0 million of land assets.
Authority’s Final Decision
In relation to Wyaralong Dam, the Authority maintains its position that depreciation of land is contrary to standard regulatory practice. The Authority acknowledges that the return of assets component of capital charges recommended by the QWC in 2010-11 was likely to include some depreciation of land. However, the QWC did not separately identify any Seqwater land assets and the Authority has not been able to establish the land value to be excluded from depreciation.
However, where there is sufficient information, for new assets, which allows for the disaggregation of land, this land asset has not been depreciated. The Authority notes that land assets that were separately identified in 2010-11 for other GSPs were not depreciated by the QWC.
The Authority will continue to require GSPs to separately identify land assets in their capex submissions, particularly for projects that are likely to include a large land component, such as the construction of a new dam.
The Authority accepts Seqwater revised project costs for Wyaralong Dam and removed $45.1 million of land assets from the calculation of return of capital.
In relation to Hinze Dam Stage 3 (Construction), the Authority has revised the return of capital to include the additional project costs. The Authority has also removed the $9.0 million of land assets from the calculation of return of capital.
Finally, the Authority has revised depreciation on 2011-12 capital expenditure to correct for an asset life transposition error. This error understated Seqwater’s return of capital revenue recorded in the Draft Report by approximately $935,000.
45 Queensland Competition Authority Chapter 4: Seqwater
In total, Seqwater’s return of capital revenue has increased from the Draft Report level of $51.9 million to $52.4 million. The updated capital charge is shown below in Table 4.13.
Table 4.13: Depreciation Summary ($m)
Asset Approved 2010-11 QCA Draft QCA Final Recommendation Recommendation
RAB – Drought Depreciation 10.1 12.1 12.1
RAB – Non-Drought Depreciation 36.3 37.0 37.0
New Capex Depreciation - 2.8 3.3
Total Depreciation 46.4 51.9 52.4
Note: these figures may not add due to rounding.
The higher depreciation allowance for 2011-12, relative to 2010-11, is mainly due to the inclusion of Wyaralong Dam as a new drought asset in 2011-12 and the addition to the RAB of the Hinze Dam raising at the end of the 2010-11 regulatory period.
Summary of Capital Charge
Draft Report
In its initial submission, Seqwater submitted that when it becomes merged with WaterSecure, its total asset base will be mostly comprised of drought assets, for which the rate of return is limited to the cost of debt. Seqwater reiterated concerns also submitted by LinkWater that the implications of using the nominal building blocks model will have implications for its financial position. In particular, high gearing of 90%, straight line depreciation with a high weighted average remaining asset life and the regulatory removal of asset appreciation gains from GSCs will constrain Seqwater’s free cash flows.
In order to generate an operating surplus, Seqwater proposed an alternative application of the nominal building block model for determining the Capital Charge which involves:
(a) the removal of inflationary gains from annual revenues attributable to drought assets only up to a value equal to the nominal depreciation allowance for drought assets;
(b) the annual difference between the actual inflationary gain and the value removed from annual revenues to be deducted from the value of the drought asset base; and
(c) continuation of this approach until the annual depreciation allowance equals the annual inflationary gain for drought assets at which point the calculation of annual revenue would revert back to the conventional nominal building block methodology.
However, Seqwater did not provide a proposed adjustment amount in its submission.
In the Draft Report, the Authority noted that Seqwater’s concern arises as a result of its merger with WaterSecure, but details relating to the financial implications for the merged entity were not yet available.
The Authority’s modelling indicated that for Seqwater’s current asset base (excluding WaterSecure), the revenues from Capital Charges should provide free cash flows of around $31 million in 2011-12.
46 Queensland Competition Authority Chapter 4: Seqwater
The Authority also noted that it is not unusual for water businesses that have invested in long term spare capacity to experience a number of years of negative net operating cash flows. The QWC, in recommending the 2010-11 GSCs, did not make any adjustments to account for short term negative cash flows.
Further, the Authority considered that an adjustment of the type proposed by Seqwater is not consistent with the Direction Notice. The forecast operating losses are largely a result of government policy, which the Authority has been directed to accept. Further, despite being presented as an adjustment to asset appreciation, Seqwater’s proposal is, effectively, the adoption of a higher depreciation allowance than the straight-line depreciation mandated by the Manual.
While Seqwater justifies its position also in regard to ensuring that it is immunised against interest rate exposure, the Authority considered that entities are ‘immunised’ when capital charges are adjusted in response to changes in actual costs of debt. A change to the treatment of asset appreciation or depreciation is not relevant to immunisation against interest rate changes.
The Authority concluded that the matter raised by Seqwater is best addressed by the Queensland Government which, as the owner of Seqwater, is free to adjust its policies in response to any concerns about Seqwater’s financial sustainability.
The Authority would require an amendment of its Direction to undertake the nature of the adjustments proposed by Seqwater. The Authority noted that it had not received any communication or submission regarding Seqwater’s financial sustainability from either Seqwater’s owner (the Queensland Government) or Seqwater’s debt provider (Queensland Treasury Corporation). The Authority also stated that it had no information that could lead it to conclude that Seqwater is at danger of default or insolvency.
The Authority recommended that Seqwater’s proposal regarding adjustments to asset appreciation not be adopted. The Authority recommended that the RAB be rolled forward on the basis of capital expenditure and depreciation as reviewed above, with indexation for inflation as conventionally applied in a nominal building block model (Chapter 3).
Capital Charges calculated by the Authority are shown in Table 4.15 and compared to the QWC 2010-11 Capital Charges approved by the Price Regulator. The Authority has not included any adjustments from the 2010-11 Capital Charges, pending further advice from the QWC. These adjustments will be taken into account when available and will include adjustments to take account of the actual cost of debt and changes to 2010-11 capital expenditure.
The estimates of depreciation and asset appreciation vary between Tables 4.13 and 4.14 as the former are expressed as year-end numbers, and the latter as mid-year numbers. The use of year- end numbers in the calculation of Maximum Allowable Revenue would represent an implicit assumption that revenues are received at the end of the year. However, the GSPs generally raise their revenue each month over the course of the year given monthly invoicing. If left unadjusted, this would mean that the net present value of the actual flow of revenues recovered over the course of a year will exceed that of the Maximum Allowable Revenue determined by the Regulator.
To address the issue, the Authority discounted the building block components to a mid-year value using the appropriate WACC or cost of debt return. This approach gives an approximate estimate of the revenue required assuming constant revenue over the year. The adjusted components are: return on assets, return of assets (depreciation), and indexation.
The Authority’s external consultant NERA confirmed that the mid-year adjustment had been appropriately applied in calculating the 2011-12 GSCs. NERA also confirmed that the mid-year
47 Queensland Competition Authority Chapter 4: Seqwater
discounting adjustment accurately estimates the required revenue under the current invoicing arrangements that exist for the GSPs.
Stakeholder Submissions on the Draft Report
Subsequent to the finalisation of the Draft Report, Seqwater provided updated capital expenditure estimates for the Hinze Dam Stage 3 (Construction) project. This included a $5.5 million increase in project cost and allowed for the identification of $9.0 million of land assets.
Seqwater also provided updated estimates for Wyaralong Dam, including a $10.0 million decrease in costs, and the identification of $45.1 million of land assets.
Authority’s Final Decision
The total RAB, upon which the Capital Charges have been based, is summarised in Table 4.14 below. This includes the revised capital expenditure forecasts for Hinze Dam Stage 3 and Wyaralong Dam, both of which are drought assets.
Table 4.14: RAB Roll-forward ($m)
Drought Non-drought Total
Opening RAB (1 July 2011) 663.3 1,946.5 2,609.9
plus Capital Expenditure 404.2 43.6 447.8
plus Asset Appreciation 26.3 49.4 75.6
less Depreciation (14.8) (39.9) (54.7)
Closing RAB (30 June 2012) 1,079.0 1,999.6 3078.6
Note: these figures may not add due to rounding.
Seqwater’s final recommended capital charge is shown in Table 4.15 below. The increase in Capital Charges since 2010-11 largely reflects the inclusion of newly commissioned Wyaralong Dam and final construction costs for the Hinze Dam upgrade.
Table 4.15: Capital Charge Summary ($m)
Drought Non-drought Total
Return on Assets 64.1 185.9 250.0
plus Depreciation 14.3 38.0 52.4
less Asset Appreciation (25.7) (46.9) (72.6)
Final Recommended Capital Charge 2011-12 52.8 177.1 229.8
Draft Recommended Capital Charge 2011-12 53.1 176.0 229.1
Approved Capital Charge 2010-11 24.3 171.6 194.2
Note: these figures may not add due to rounding.
48 Queensland Competition Authority Chapter 4: Seqwater
4.3 Fixed Operating Charge
The Direction Notice requires that the Authority assess the prudency and efficiency of all fixed operating costs proposed by the GSPs.
Draft Report
In its initial submission, Seqwater submitted that fixed operating costs are forecast to increase from that approved for 2010-11 GSCs by about $15.6 million (in 2012 dollars). Seqwater attributed the increases to:
(a) a 4% increase in salary costs;
(b) increased maintenance costs arising from flood damage;
(c) increased maintenance expenditure in order to comply with obligations to the WGM, particularly in regard to addressing backlog maintenance at WTPs. This followed detailed condition assessments and asset management plans completed during 2010-11;
(d) new trade waste charges externally imposed on Seqwater; and
(e) additional costs arising from new assets transferred.
Details as submitted by Seqwater are provided in Table 4.16.
Table 4.16: Seqwater Fixed Operating Costs ($m)
Item Actual (forecast) Approved 2010-11 Revised 2010-11 Seqwater Proposed 2010-11 2011-12
Dam 31.1 32.8 32.8 38.8
Treatment Plants 43.4 32.7 41.5 46.9
Business Overheads 21.9 26.4
Corporate Overheads 32.0 34.9
Total Entity 53.9 65.4 53.9 61.3 Overheads (Sub-total)
Total (nominal) 128.4 130.9 128.2 147.0
Total (2012$) 131.6 134.2 131.4 147.0
Note: the revised 2010-11 amount excludes $11.2 million for land tax and $0.3 million for Ipswich relocation costs from entity overheads and includes $8.8 million in unplanned maintenance for treatment plants previously allocated to variable operating costs. These figures may not add due to rounding.
In relation to dam fixed operating expenditure, Seqwater identified particular increases, including:
(a) additional costs arising from the transfer of Wyaralong Dam and raising of Hinze Dam;
(b) additional maintenance costs for compliance conditions for Wyaralong and Hinze Dams relating to fishways and monitoring equipment ($1.6 million); and
49 Queensland Competition Authority Chapter 4: Seqwater
(c) restoration of natural assets in the Lockyer, Somerset and Wivenhoe areas following recent flooding to comply with catchment management and water quality obligations ($3.2 million).
Dam fixed operating costs are summarised in Table 4.17.
Table 4.17: Seqwater’s Proposed Dam Fixed Operating Expenditure ($‘000)
Dam Catchment Recreation Fixed Unplanned Planned Asset Other Total Management Management Labour maintenance Maintenance Overheads and water Quality Monitoring
Baroon 126 40 174 31 194 96 661 Pocket
Hinze 426 176 846 129 623 396 2,595
North 543 155 754 44 222 640 2,358 Pine
Somerset 520 142 372 95 367 514 2,010
Wivenhoe 929 140 2,048 13 793 3,406 7,329
Lake 211 80 207 83 2 188 771 Mcdonald
Ewen 371 238 592 115 33 43 1,393 Maddock
Other 2,707 878 4,999 916 1,359 3,255 4,514 18,628 dams
Total 5,833 1,849 9,992 1,426 3,593 8,538 4,514 35,745 Note: Other Cost category includes R&D and irrigators’ costs. These figures may not add due to rounding.
Table 4.17 does not include unallocated overheads for dams of $3.05 million. Total dam costs are therefore $38.8 million.
The allocation of fixed operating costs between dams is also shown in Figure 4.1.
Figure 4.1: Fixed Operating Costs for Seqwater Dams
Baroon Pocket Hinze Dam Dam 7% North Pine Dam 2% 7% Somerset Dam 6%
Other Wivenhoe 51% Dam Lake 21% Mcdonald Ewen Maddock Dam Dam 2% 4%
50 Queensland Competition Authority Chapter 4: Seqwater
In regard to treatment plants, Seqwater identified increases in costs due to trade waste levies by Allconnex for discharges into the sewer system from Molendinar and Mudgeeraba treatment plants. Seqwater also identified increases in costs due to 26 additional fluoridation plants, and additional costs for raw water mains owned by Seqwater. Water treatment plant costs are summarised in Table 4.18.
Table 4.18: Seqwater’s Proposed WTP Fixed Operating Expenditure ($’000)
WTP Water Quality Fixed Labour Unplanned Planned Asset Total Monitoring Maintenance Maintenance Overheads
Landers 273 670 1,259 1,737 523 4,461 Shute
Noosa 27 1,508 1,535
Molendinar 273 1,690 124 625 1,059 3,771
Mudgeeraba 27 548 240 298 1,929 3,041
North Pine 36 1,014 678 1,981 431 4,140
Mt Crosby 237 3,301 327 1,016 1,296 6,177 Eastbank
Mt Crosby 42 631 352 834 429 2,289 Westbank
Others 857 6,175 3,114 4,438 2,609 17,193
Total 1,772 14,030 6,094 10,928 9,783 42,607
Note: these figures may not add due to rounding.
Table 4.18 does not include unallocated WTP overheads of $4.25 million, giving a total WTP fixed operating cost of $46.9 million. Seqwater allocated direct costs to assets, but had not allocated corporate overheads. Further, Seqwater identified overhead costs relating to Dams and WTPs, but that are not directly attributable to a specific asset. These WTP Overheads and Dam Overheads are distinct from the Asset Overhead costs attributed to individual WTPs and Dams (Table 4.19).
Table 4.19: Seqwater’s Proposed Overhead Operating Expenditure ($m)
Employee expenses Supplies and Other overheads Total Services
Dam unallocated Overheads 1.68 1.36 0.02 3.05
WTP unallocated Overheads 1.90 2.34 - 4.25
Business Overheads 10.87 8.23 7.35 26.46
Corporate Overheads 15.59 16.17 3.17 34.93
Total 30.04 28.11 10.54 68.69
Note: these figures may not add due to rounding.
51 Queensland Competition Authority Chapter 4: Seqwater
Seqwater submitted that it only had two full years of historical cost data which to rely upon for informing future cost estimates. Since establishment, Seqwater has been developing a greater understanding of the assets and functions it acquired and how these assets can be optimally managed within the context of the Grid. This work is ongoing.
Seqwater also identified changes to its operating environment as having an impact on providing year-on-year forecasts, including new drinking water quality regulation, legislative requirement for fluoridation, integration of newly acquired drought assets and more recently managing significant increases in water availability and implementing flood operations at dams.
In the Draft Report, the Authority recognised that Seqwater is required to manage significant changes in its operations that could have implications for the quality of information provided. Compared to its predecessor (SEQWater), Seqwater has assumed responsibility for all dams and WTPs in SEQ.
The Authority sought comment from SKM in regard to information availability and data adequacy. SKM noted that Seqwater has not separately identified cost information relating to its pipeline assets, as they are included in costs related to WTPs. SKM recommended that Seqwater continue to develop its systems to capture both capital and operating costs for larger pipeline assets and that the Authority review its requirement for Seqwater to disaggregate information into pipelines below a certain cost in future reviews.
Consistent with the Direction Notice, the Authority took into account available information and the stage of development of the entities.
At the same time, the Authority considered that the general level of information disaggregation by GSPs should be improved over future regulatory reviews. For Seqwater, this should include separately identifying variable costs for more than seven dams and seven WTPs, and further disaggregation of costs between pipeline and WTP assets.
Prudency and Efficiency Review
The Authority engaged SKM to review the prudency and efficiency of Seqwater’s fixed operating costs.
For opex to be included the GSCs, it is required to be prudent (demonstrated need for the expenditure) and efficient (least cost and consistent with relevant benchmarks, having regard to prevailing market conditions, historical trends and the potential for efficiency gains or economies of scale).
SKM undertook a sampling process for reviewing Seqwater’s proposed fixed operating costs. The sample of 17 cost categories accounts for 34% of Seqwater’s proposed fixed operating costs. The sample used in the Draft Report is listed in Table 4.20 below.
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Table 4.20: Fixed Operating Costs Reviewed by SKM ($m)
Cost Cost Category Seqwater Proposed 2011-12 Cost
Hinze Dam Planned maintenance Water Storage 0.62
North Pine Dam labour Water Harvesting and Water Storage 0.75
Somerset Dam catchment Water Harvesting 0.52 management
Wivenhoe Dam labour Water Harvesting and Water Storage 2.05
Residual storages planning and R&D Water Harvesting 3.91
Landers Shute WTP planned Water Treatment 1.74 maintenance
Noosa WTP overheads Treatment Plant Overheads 1.51
Molendinar WTP labour Water Treatment 1.69
Mudgeeraba WTP overhead supplies Treatment Plant Overheads 1.64 and services
North Pine WTP planned Water Treatment 1.98 maintenance
Mt Crosby WTP planned Water Treatment 1.85 maintenance
Residual WTP labour Water Treatment 6.18
Engineering Supplies and Services Overhead 5.52
Information Services – Supplies and Overhead 5.39 Services
Asset Service Management – Overhead 4.20 Supplies and Services
Engineering – Employee Costs Overhead 5.37
Asset Service Management – Overhead 5.28 Employee Costs
Total Sample 50.18
Total Fixed Operating Costs 147.04
Total Sample/Total Fixed 34 Operating Costs (%)
Note: these figures may not add due to rounding.
These items are reviewed below, with SKM’s conclusions and the Authority’s Draft recommendations for each item.
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(a) Hinze Dam Planned Maintenance - $0.62 million
The planned maintenance for Hinze Dam of $0.62 million compares with an amount of $26,754 in 2010-11. Two categories of maintenance are included – scheduled maintenance for works identified by plant operators, and strategic maintenance to improve efficiency, often including larger refurbishment works.
SKM reviewed scheduled maintenance activities including civil, electrical, mechanical, and telemetry maintenance. These account for $0.2 million. Catchment maintenance included catchment and landcare costs of $200,000 and erosion remediation projects also costing $200,000.
Based on an assessment of individual items, SKM considered that the scheduled maintenance portion is prudent and efficient. In regard to strategic asset management, SKM sought additional information from Seqwater, but did not receive any documentation relating to the estimation of costs for strategic asset maintenance projects totalling $123,500. As a result, SKM concluded that insufficient information was available to conclude that strategic asset maintenance expenditure was efficient.
The Authority accepted SKM’s recommendation.
(b) North Pine Dam Labour - $0.75 million
Labour costs for North Pine Dam comprise $0.48 million for water harvesting and $0.27 million for water storage activities. SKM noted that the projected cost of $0.75 million was lower than the $1.18 million expended in 2010-11, due to a decrease in the fixed labour cost for the water storage component of the dam. SKM was unable to define the reasons for the reduction.
The costs provide for 6.97 FTEs, with 2 FTEs for dam operations, 1 FTE for water quality, 1.32 FTEs for catchment management maintenance and 2.65 FTEs for recreation management and maintenance. SKM advised that benchmarks of employee costs relating to catchment management are not widely available. However, SKM considered that Seqwater’s proposed dam and catchment management program is representative of good practice and that the staffing levels are reasonable for the work undertaken.
SKM considered the expenditure to be prudent and efficient.
The Authority accepted SKM’s recommendation.
(c) Somerset Dam Catchment Management - $0.52 million
Maintenance of the catchment area improves the water quality in the dam and provides for a number of public recreation areas.
The Somerset Dam catchment management costs include contractors for weed control, vegetation management, fire management services, ground maintenance, water sampling and routine testing. SKM noted that the costs are substantially higher than the $254,000 allowed for in 2010-11, due to restoration of natural assets following the 2011 floods, increased use of recreational facilities, seasonal changes requiring a higher level of vegetation management and need to improve public safety.
SKM took a pragmatic approach to Seqwater’s proposals and considered the expenditure to be prudent. SKM’s review of the largest item, $180,000 for water sampling and routine testing, found that the extent of water quality monitoring identified by Seqwater was justified. SKM concluded that the expenditure was efficient.
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The Authority accepted SKM’s recommendation.
(d) Wivenhoe Dam Labour - $2.05 million
SKM noted that the projected cost of $2.05 million was lower than the $4.6 million expended in 2010-11, due to a decrease in the fixed labour cost for the water storage component of the dam. SKM was unable to define the reasons for the reduction. Labour costs comprise $0.57 million for water harvesting activities and $1.48 million for water storage activities.
The costs provide for 17.71 FTEs, with 11.1 FTEs for dam operations, 3.16 FTEs for catchment management maintenance and 3.45 FTEs for recreation management and maintenance. SKM considered that Seqwater’s proposed dam and catchment management program is representative of good practice and that the staffing levels are reasonable for the work undertaken. SKM considered that dam operations are a core function that should be undertaken internally, rather than by external contractors.
SKM considered the expenditure to be prudent and efficient.
The Authority accepted SKM’s recommendation.
(e) Residual Storages Planning Research and Development (R&D) - $3.91 million
These costs relate to R&D programs and planning across all the residual dams. Seqwater advised SKM that the costs are preliminary and yet to be confirmed.
In providing further information, Seqwater provided the following breakdown:
(a) Water Quality and Reliability – $1.03 million; (b) Optimising Multi-Barrier Treatment – $1.51 million; (c) Water and Energy Policy Formulation – $0.47 million; (d) Performance and Technologies – $0.30 million; (e) Environmental Obligations and Performance – $0.72 million; and (f) Other – $0.34 million.
SKM noted that the total value of the detailed R&D budget provided by Seqwater ($4.38 million) does not match Seqwater’s submission ($3.91 million).
Through discussions with Seqwater, SKM established that the basis for research and development is to facilitate multi-barrier protection and to seek operating cost efficiencies. Multi-barrier protection is specified in the Australian Drinking Water Guidelines, which itself is identified as the water quality specification. SKM concluded that research and development expenditure for the development of multi-barrier protection is prudent.
However, SKM noted that Seqwater did not provide any information relating to the likely cost efficiencies that may result from research and development. As a result, SKM concluded that there is insufficient information to conclude that the research and development expenditure for the purpose of cost efficiencies improvements is prudent.
SKM concluded that the establishment of a Research Panel of consultants represents the least- cost method for delivery of this service. SKM considered that it is not practicable for Seqwater to develop this research capability internally and through the competitive tender process the cost for the delivery of these services will be reflective of current market rates and conditions. SKM concluded that the expenditure is efficient.
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The Authority accepted SKM’s conclusions, and recommended the inclusion of only $1.51 million of capital expenditure relating to Optimising Multi-Barrier Treatment in the calculation of GSCs.
(f) Landers Shute Treatment Plant – Planned Maintenance - $1.74 million
The planned maintenance for Landers Shute WTP of $1.74 million compares with an amount of $0.46 million in 2010-11. Two categories of maintenance are included – scheduled maintenance for works identified by plant operators, and strategic maintenance to improve efficiency, often including larger refurbishment works.
SKM reviewed scheduled maintenance activities including civil, electrical, mechanical, and telemetry maintenance. These account for $0.7 million. The single largest item of strategic asset maintenance is the replacement of filter media to biological activated carbon filters, costing $0.68 million.
SKM considered that the maintenance activities are representative of practices necessary to meet Seqwater’s Grid Contract obligations and are therefore prudent. However, SKM noted that planned maintenance costs were 31.3% of total operating costs for Landers Shute plant compared to 13.4% for North Pine WTP. While the costs were higher than expected norms, SKM noted that larger strategic asset maintenance activities are required from time to time and benchmarking may not give the relevant guidance.
Based on an assessment of individual items, SKM considered that the scheduled maintenance portion is prudent and efficient. In regard to strategic asset management, SKM sought additional information from Seqwater but did not receive any documentation relating to the estimation of costs for strategic asset maintenance projects totalling $1.0 million. As a result, SKM concluded that insufficient information was available to conclude that strategic asset maintenance expenditure was efficient.
The Authority accepted SKM’s recommendation.
(g) Noosa WTP Overheads – $1.51 million
The Noosa WTP is managed by Veolia on the basis of an agreement established prior to Seqwater acquiring the assets and due to expire in June 2013. The payments to Veolia are indexed to several cost indices.
SKM found that the overall operating cost for Noosa WTP were higher than the other large WTPs operated by Seqwater ($402/ML compared to, for example, $221/ML at Landers Shute, $133/ML for Molendinar and $200/ML for Mudgeeraba). SKM noted that this is in part due to a higher requirement for quality of water produced at Noosa WTP and the contractual arrangements with Veolia involving the transfer of risk to Veolia.
SKM concluded that the expenditure was prudent, but would not represent the least cost method of delivering the service. Seqwater is a large enough organisation to manage the risk and should not need to shed the risk to a contractor. SKM considered the expenditure to be not efficient.
The Authority noted SKM’s conclusions, but also noted that the contractual constraint is a legacy issue arising from the transfer of assets and associated contractual obligations. Seqwater therefore had no immediate ability to address any perceived inefficiencies.
The Authority recommended that the operating expenditure be retained for 2011-12, but that it should be addressed once the contract expires in 2013.
56 Queensland Competition Authority Chapter 4: Seqwater
(h) Molendinar WTP – Labour - $1.69 million
The labour cost for Molendinar WTP includes staff associated with the plant operations as well as employees from the water quality and infrastructure management teams, and include overtime costs.
SKM noted that there were 13.1 FTEs attributable to Molendinar WTP, with the total cost of $1.69 million equivalent to about $38/ML. While this was 30% higher than the next most similarly sized plant, North Pine, it was comparable with other WTPs including Mt Crosby Eastbank ($40/ML). SKM considered that the use of an internal labour force rather than an external contract should be seen as the least cost method.
SKM considered the expenditure to be prudent and efficient.
The Authority accepted SKM’s recommendation.
(i) Mudgeeraba WTP Overheads Supplies and Services - $1.64 million
Mudgeeraba overhead supplies and services relate to the costs of disposal of waste product from the treatment process and for minor maintenance activities not included elsewhere. These costs comprise $1.64 million of the total WTP overheads of $1.93 million.
The largest component of this expenditure relates to disposal of waste into Allconnex’s distribution network and the charges imposed by Allconnex Water. Rather than undertake benchmarking, SKM considered alternative options including trucking the waste to an adjacent water utility for disposal or constructing dewatering facilities with disposal of waste to landfill. SKM considered these options would be more expensive than the current approach of using Allconnex’s waste distribution system.
SKM noted that the waste stream from Mudgeeraba WTP is mostly sediment and not high in chemical oxygen demand which is a critical parameter in wastewater treatment processes. SKM considered that the chemicals being disposed of by Seqwater are similar to those used in wastewater treatment, and that the waste from Mudgeeraba WTP could actually enhance Allconnex’s wastewater treatment process.
SKM recommended negotiating with Allconnex to achieve a discount to published rates. However, as current disposal charges are not at the discretion of Seqwater, SKM considered this component of expenditure to be prudent and efficient.
SKM also queried Seqwater’s inclusion of $0.12 million in costs relating to catchment management and building demolition. Following review of subsequent information provided by Seqwater, SKM concluded that these activities were prudent and efficient.
Overall, SKM considered the expenditure to be prudent and efficient. The Authority accepted SKM’s recommendation.
(j) North Pine WTP Planned maintenance - $1.98 million
SKM identified a coding error, whereby $1.2 million for decommissioning of Woorim, Aratula, and other small WTPs were included in this category. The costs were adjusted to $0.78 million. The cost of $1.2 million should be attributed to ‘other’ WTPs. The cost of $0.78 million compared to a cost of $0.89 million in 2010-11.
SKM identified $0.54 million in scheduled civil, electrical, mechanical and telemetry maintenance. Strategic maintenance activities included $75,000 for joint sealing of sedimentation basins and $165,000 for cleaning and resealing of roof joints of reservoirs.
57 Queensland Competition Authority Chapter 4: Seqwater
SKM noted that strategic asset maintenance budgets for each of Seqwater’s assets are developed under Facilities Asset Management Plans (FAMPs) for each facility. These detail 10-year renewals programs to enhance efficiency without materially modifying the facilities.
SKM assessed the planned maintenance costs to be 13.4% of total operating costs, in line with the average for planned maintenance at Seqwater’s plants. As a general benchmark, on the basis of its experience with other water utilities, SKM considered that planned maintenance costs should be less than 15% of overall maintenance. However, large strategic asset maintenance activities may be required from time to time.
Overall, SKM concluded that the expenditure is prudent and efficient.
The Authority accepted SKM’s recommendation and included $0.78 million in this cost category. The miscoded cost of $1.2 million was not reviewed and was included in residual WTPs Planned Maintenance.
(k) Mt Crosby WTP Planned Maintenance - $1.85 million
The cost of $1.85 million is spread across Mt Crosby Eastbank ($1.02 million) and Westbank ($0.83 million). It compares to a total cost of $2.05 million in 2010-11.
SKM reviewed scheduled maintenance activities including civil, electrical, mechanical, and telemetry maintenance. Strategic maintenance includes 25-year crane inspections, refurbishment of raw water pumps and valves and condition assessment of internal pipework.
SKM noted that strategic asset maintenance budgets for each of Seqwater’s assets are developed under FAMPs for each facility. These detail 10-year renewals programs to enhance efficiency without materially modifying the facilities.
Benchmarking analysis indicated that planned maintenance costs are 12.5% of total operating costs, in line with the average for planned maintenance at Seqwater’s plants. As a general benchmark, on the basis of its experience with other water utilities, SKM considered that planned maintenance costs should be less than 15% of overall maintenance. However, large strategic asset maintenance activities may be required from time to time.
In regard to strategic asset management, SKM unsuccessfully sought additional information from Seqwater relating to the estimation of costs for strategic asset maintenance projects totalling $0.7 million. As a result, SKM concluded that insufficient information was available to conclude that strategic asset maintenance expenditure was efficient.
The Authority accepted SKM’s recommendations.
(l) Residual WTP labour - $6.18 million
This cost item relates to the labour cost budget for the 32 residual WTPs, the most significant being Image Flat (13.4% of total), Ewen Maddock (10.9%), Capalaba (9.9%), Petrie (7.5%) and Beaudesert (6.5%). Seqwater advised that eight of the WTPs are currently not operational, but still require labour input of around 2 FTEs. SKM considered that engagement of labour is required to fulfil Seqwater’s obligations under the Grid Contract and is prudent.
SKM noted that the projected cost was a significant increase on the $4.7 million provided for in the 2010-11 period, and that there was no explanation for the increase. SKM indicated that the cost covered 55.3 FTEs across the WTPs, including eight FTEs for infrastructure maintenance and one FTE for water quality management. The cost was equivalent to $166/ML or about four times that of the highest cost of the largest six WTPs.
58 Queensland Competition Authority Chapter 4: Seqwater
SKM acknowledged the average cost per ML is not directly comparable with those of single larger plants. SKM considered that in treatment operations there is a minimum level of effort required to competently operate, provide assurance, due diligence and reliability that all product water meets the water quality standards.
Seqwater advised that shortly after it began operating all of the WTPs in SEQ, it commissioned an independent third party to review staffing levels in the operations group with the view of establishing an appropriate standard. SKM was satisfied that Seqwater’s labour costs for residual WTPs are comparable to like sized industry peers. As such SKM considered the expenditure to be efficient.
The Authority accepted SKM’s recommendation.
(m) Engineering – Supplies and services - $5.52 million
SKM noted that the proposed $5.5 million of engineering supplies and services relate to the development of Facilities Asset Management Plans, Asset Portfolio Master Plan, Capital improvement plans and Business cases and planning reports.
This cost category has increased markedly relative to 2010-11, largely due to an internal cost reclassification of asset strategy and policy costs being reclassified as engineering. The cost item was only $0.4 million in 2010-11.
SKM concluded that the expenditure is prudent as it is required to fulfil Seqwater’s obligations under the Grid Contract. SKM also concluded that the expenditure is efficient, as external consultants are engaged where specialist advice is required, and the proportion of engineering supplies and services is less than 3% of the combined opex and capex program.
The Authority accepted SKM’s recommendation.
(n) Information Services – Supplies and Services - $5.4 million
SKM noted that the proposed $5.4 million expenditure includes records storage and maintenance, hardware and software maintenance, software licensing costs, telecommunications costs; and specialist staff and consultants. This cost category has increased significantly relative to 2010-11 due to an additional $1.0 million for providing support and maintenance to new financial and other ICT systems.
SKM considered this expenditure is required by Seqwater to enable the continuity of its business, primarily to comply with the Grid Contract. This expenditure is also required to maintain Seqwater’s financial reporting systems to comply with corporate and legal obligations. As a result, SKM concluded that this expenditure is efficient.
SKM reviewed the underlying costs for Information Services and considered these to be reflective of market conditions. Furthermore, SKM’s comparison of costs with like-sized organisations showed costs on a per FTE basis to be reasonable. As a result, SKM concluded that the expenditure for Information Services Supplies and Services is efficient.
The Authority accepted SKM’s recommendation.
(o) Asset Service management – supplies and services - $4.2 million
SKM noted that the two main functions that comprise this expenditure are:
59 Queensland Competition Authority Chapter 4: Seqwater
(a) Infrastructure Maintenance – activities required to maintain Seqwater’s infrastructure for all aspects of its business operations. This includes developing maintenance schedules and managing and delivering maintenance activities; and (b) Property and Facilities Team – to manage assets including property, fleet and facilities.
The actual expenditure for 2010-11 is $5,660,956, compared to the forecast 2011-12 budget of $4,196,726. Seqwater submitted that the decrease was due to a reorganisation of groups within Seqwater with some functions residing in a separate budget area.. SKM concluded that this expenditure is required to enable Seqwater to meet its obligations under its Grid Contract and the Market Rules and is therefore prudent.
SKM reviewed the underlying costs for Asset Service Management and considered these to be reflective of market conditions. SKM compared Seqwater’s costs with like-sized organisations and concluded that costs for the value of assets under Seqwater’s management are reasonable. SKM concluded that this expenditure is efficient.
The Authority accepted SKM’s recommendation.
(p) Engineering Employee Costs - $5.4 million
SKM noted that Seqwater forecast to incur $5.4 million for engineering employee costs of 43.4 FTE staff in Strategic Maintenance, Project Delivery and Integrated Asset Planning teams.
SKM concluded that the costs are prudent, as they are required to remain compliant with the Grid Contract. SKM also concluded that retaining a core technical group in house is commensurate with good industry practice and representative of the least cost method for delivery. SKM did not consider the staffing levels to be excessive for the range and value of assets under Seqwater’s management. As a result, SKM considered Seqwater’s proposed Engineering Employee costs to be efficient.
The Authority accepted SKM’s recommendation.
(q) Asset Service Management Employee Costs - $5.3 million
SKM noted that this $5.3 million cost category includes 36.5 FTEs in asset policy and strategy, facilities management, group support, infrastructure maintenance, property and facilities and program management teams.
SKM concluded that the costs are prudent, as they are representative of good industry practice. SKM also concluded that retaining a core technical group in house is commensurate with good industry practice and representative of the least cost method for delivery. SKM did not consider the staffing levels to be excessive for the range and value of assets under Seqwater’s management. As a result, SKM considered Seqwater’s proposed Asset Service Management Employee costs to be efficient.
The Authority accepted SKM’s recommendation.
Summary of Fixed Operating Charge
As a result of SKM’s conclusions, in the Draft Report, the Authority partially excluded some expenditure from four opex categories from the recommended GSCs. The total value of these exclusions was $4.3 million or 3% of Seqwater’s proposed fixed opex. These exclusions were to be reconsidered if Seqwater provided evidence that convinces the Authority of their prudency and efficiency.
The SKM reviewed fixed operating costs are summarised in Table 4.21.
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Table 4.21: Summary of SKM Reviewed 2011-12 Fixed Operating Costs ($m)
Cost Seqwater Prudency Efficiency QCA Draft proposed Recommendation
Hinze Dam Planned 0.62 Prudent Insufficient 0.50 maintenance information to conclude that all expenditure is efficient
North Pine Dam labour 0.75 Prudent Efficient 0.75 Somerset Dam 0.52 Prudent Efficient 0.52 catchment management
Wivenhoe Dam labour 2.05 Prudent Efficient 2.05 Residual storages 3.91 Insufficient Efficient 1.51 planning and R&D information to conclude that all expenditure is prudent
Landers Shute WTP 1.74 Prudent Insufficient 0.70 planned maintenance information to conclude that all expenditure is efficient
Noosa WTP overheads 1.51 Prudent Not efficient, but 1.51 accepted by Authority
Molendinar WTP 1.69 Prudent Efficient 1.69 labour
Mudgeeraba WTP 1.64 Prudent Efficient 1.64 overheads
North Pine WTP 1.98 Prudent Efficient 0.781 planned maintenance
Mt Crosby WTP 1.85 Prudent Insufficient 1.15 planned maintenance information to conclude that all expenditure is efficient
Residual WTP labour 6.18 Prudent Efficient 6.18 Engineering Supplies 5.52 Prudent Efficient 5.52 and Services
Information Services – 5.39 Prudent Efficient 5.39 Supplies and Services
Asset Service 4.20 Prudent Efficient 4.20 Management – Supplies and Services
Engineering – 5.37 Prudent Efficient 5.37 Employee Costs
Asset Service 5.28 Prudent Efficient 5.28 Management – Employee Costs 1. An amount of $1.2 million reallocated to Residual WTP planned maintenance costs.
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The total fixed operating charge is provided in Table 4.22.
Table 4.22: Summary of Fixed Operating Charge - Seqwater 2011-12 ($m)
$
Seqwater Proposed 2011-12 147.0
QCA Recommended 2011-12 142.8
Approved 2010-11 (Nominal) 130.9
Revised 2010-11 (Nominal) 128.2 Note: the revised 2010-11 amount excludes $11.2 million for land tax and $0.3 million for Ipswich relocation costs from entity overheads and includes $8.8 million in unplanned maintenance for treatment plants previously allocated to variable operating costs. These figures may not add due to rounding.
Stakeholder Submissions on the Draft Report
The WGM submitted a preference for detailed cost information for all individual WTPs, rather than only the six largest.
Seqwater submitted further information relating to operating costs that were excluded from the Authority’s Draft GSCs recommendation.
(a) Hinze Dam Planned maintenance
Seqwater provided supporting information for the Hinze Dam strategic asset maintenance works component of planned maintenance that was excluded from the Draft GSCs recommendation. This included condition assessments, project justifications and a breakdown of cost estimates. Vendor quotations were also provided to establish the unit cost for the inspection and replacement of air valves.
(b) Residual storages planning and R&D
In response to the Authority’s Draft Report, Seqwater provided further information and R&D expenditure including business cases that detailed needs analysis, contextual analysis, preferred option evaluation and recommendation for each of the research programs.
Seqwater also noted that ‘R&D’ is a fixed category in the cost drivers template developed by QWC. However, the section and functions are titled ‘Research, Science and Technology’ (RST) within Seqwater. Seqwater submitted that it does not undertake development of commercial products as part of its research program.
The Authority excluded some RST expenditure from its Draft GSC recommendation on the basis of insufficient information relating to the expected efficiencies to be achieved by the program. However, Seqwater submitted that the primary driver of its RST expenditure is compliance rather than cost efficiency. Seqwater submitted that, while cost efficiencies are likely to be derived as a by-product of the investments in RST, the 2011-12 program is designed to meet regulatory and contractual compliance requirements across the business.
Seqwater identified a number of regulatory instruments, including the ADWG, Drinking Water Quality Management Plan, the Environmental Protection and Biodiversity Conservation Act 1999 and the Fisheries Act 1994 that required compliance in the form of R&D expenditure.
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(c) Landers Shute WTP planned maintenance
Seqwater provided supporting information for the Lander’s Shute WTP strategic asset maintenance works component of planned maintenance that was excluded from the Draft GSCs recommendation. This includes supporting information for the strategic asset maintenance works including condition assessments, project justifications and a breakdown of cost estimates. Vendor quotations were also provided for the filter press cloth replacement.
(d) Mt Crosby WTP planned maintenance
Seqwater provided supporting information for the Mt Crosby WTP strategic asset maintenance works component of planned maintenance that was excluded from the Draft GSCs recommendation. This included condition assessments, project justifications and a breakdown of cost estimates. Vendor quotations were also provided to support the estimated costs for the crane inspection, East Bank pipework condition assessment, roadway repair and raw water pump/valve refurbishment.
Authority’s Final Decision
The Authority notes the WGM’s preference to individually list more WTPs and also notes that SKM recommended an increase in the number of WTP for which individual costs are detailed. The Authority proposes to address these issues as part of the 2012-13 investigation.
In relation to issues raised by Seqwater relating to prudency and efficiency of selected opex items, the Authority sought further advice from SKM.
(a) Hinze Dam Planned maintenance
SKM notes that costs for scheduled maintenance (electrical, civil, and mechanical) have been developed from historical expenditure. SKM considers that, as this maintenance is of a recurring nature, this approach is appropriate. SKM reviewed the additional documentation and recommended that Seqwater’s approach and cost estimates to be representative of the least cost manner of expenditure and therefore efficient.
The Authority accepts SKM’s recommendation and recommends that $0.62 million of expenditure be included in calculation of GSCs.
(b) Residual storages planning and R&D
SKM noted that Seqwater identified regulatory and contractual compliance as the drivers for the RST program on the basis that ADWG is specified in the Grid Contract.
SKM noted that ADWG provides a framework for a water authority to undertake research and development, but does not establish the need for the research and development alone nor the justification for expenditure on research in itself. As such, SKM considered that linking the requirement to undertake the RST program to other documentation such as the Drinking Water Quality Management Plan which provides justification for or supporting information in respect to a need for a particular project was also important.
SKM also considered it was important to establish that a knowledge gap exists and considered that this was not always apparent in the documentation provided by Seqwater. SKM considered that some of the issues identified by Seqwater may be common to other water authorities in Australia and potentially worldwide.
SKM recommended that in future Research Science and Technology business cases, Seqwater provides clear statements to the effect that a literature review (or similar) has been completed
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and that a knowledge gap exists, thereby supporting the need for Seqwater to undertake a research project.
SKM reviewed the documentation provided by Seqwater and considered the proposed RST projects to be prudent, with the following exceptions:
(a) Developing diatoms as a biological indicator of reservoir health ($66,406). The need for a biological water quality indicator had not been established. In SKM’s opinion it was unlikely that assessment of water quality through biological indicators would be acceptable (by the WGM or Queensland Office of Water) as a substitute for conventional water quality sampling. SKM noted that no information supporting the requirement for monitoring of reservoir health through anything other than traditional sampling had been provided by Seqwater;
(b) Sludge management options ($50,000). Research and investigations for the reuse and recycling of treatment sludge has previously been conducted (and implemented) worldwide. SKM considered that the business case provided by Seqwater did not sufficiently establish why existing research cannot be applied to Seqwater water treatment operations;
(c) Frog acoustic monitoring ($48,000). SKM recommended that the need for a biological water quality indicator had not been established. SKM considered that it was unlikely that assessment of water quality through biological indicators would be acceptable (by the WGM or Queensland Office of Water) as a substitute for conventional water quality sampling. SKM noted that no information supporting the requirement for monitoring of reservoir health through anything other than traditional sampling had been provided by Seqwater; and
(d) Aquatic pest management ($74,500). Management and eradication of aquatic pests is a common issue with reservoir managers. SKM considered that Seqwater had not established that research and development undertaken by other entities as to the best practice from aquatic pest management cannot be directly applied to Seqwater reservoirs.
The Authority accepts SKM’s recommendations, and has excluded a total of $238,906 from Seqwater proposed R&D expenditure from the calculation of recommended GSCs.
(c) Landers Shute WTP planned maintenance
SKM noted that costs for scheduled maintenance (electrical, civil, and mechanical) have been developed from historical expenditure. SKM considered that, as this maintenance is of a recurring nature, this approach is appropriate. SKM reviewed this information and recommend that Seqwater’s approach and cost estimates to be representative of the least cost manner of expenditure and therefore efficient.
The Authority accepts SKM’s recommendation.
(d) Mt Crosby WTP planned maintenance
SKM noted that costs for scheduled maintenance (electrical, civil, and mechanical) were developed from historical expenditure. SKM considered that, as this maintenance is of a recurring nature and is not able to be tightly scoped at this stage, this approach is appropriate. SKM reviewed the additional documentation and recommend that Seqwater’s approach and cost estimates to be representative of the least cost manner of expenditure and therefore efficient.
The Authority accepts SKM’s recommendation.
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(e) Summary
The amendments to the Authority’s Draft recommendations are summarised in Table 4.23 below.
Table 4.23: Amendments to Draft recommended Fixed Operating Expenditure ($m)
Project Title Seqwater Submission QCA Draft QCA Final Recommendation Recommendation
Hinze Dam Planned maintenance 0.62 0.50 0.62
Residual storages planning and R&D 3.91 1.51 3.67
Landers Shute WTP planned 1.74 0.70 1.74 maintenance
Mt Crosby WTP planned maintenance 1.85 1.15 1.85
Note: these figures may not add due to rounding.
The net effect of the amendments to the Draft Report is to increase Seqwater’s recommended fixed operating expenditure from $142.8 million to $146.8 million.
4.4 Variable Operating Charge
The Market Rules require that variable operating costs be determined on a $/ML basis for each GSP.
The Direction Notice requires the Authority to adopt production forecasts for the regulatory period consistent with the WGM’s Operating Strategy.
Draft Report
In its initial submission, Seqwater identified two variable costs, chemical costs relating to solids removal and chemical treatment, and energy costs relating to pumping.
Despite proposing an information template that identified additional variable costs relating to pre-treatment, filtration or post-treatment stabilisation activities at WTPs, Seqwater’s initial submission does not include these costs.
Seqwater’s initial submission included variable costs relating to the six largest WTPs, with the remaining WTPs grouped as residual. Seqwater subsequently provided its variable operating costs relating to each of its WTPs, which have been included in full in Table 4.24.
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Table 4.24: Seqwater’s Proposed Variable Operating Costs ($/ML)
WTP Energy Treatment Chemicals Total
Mt Crosby 24 42 66 Molendinar 11 37 48 North Pine 9 39 49 Landers Shute 3 40 43 Mudgeeraba 16 46 62 North Stradbroke Island 50 25 75 Petrie 24 43 67 Noosa - - 1441 Image Flat 4 43 46 Capalaba 45 53 98 Ewen Maddock 82 72 155 Lowood 78 22 100 Caboolture 77 64 141 Banksia Beach 182 67 249 South Maclean 91 84 175 Woodford 137 64 201 Kalbar (Boonah) 63 74 137 Beaudesert 82 61 143 Kilcoy 165 91 256 Enoggera - 37 37 Point Lookout 95 16 111 Esk 159 71 230 Kooralbyn 153 70 222 Dunwich 119 16 135 Dayboro 89 37 126 Amity Point 86 16 102 Canungra 108 60 168 Kenilworth 88 99 188 Rathdowney 111 71 182 Somerset Dam Township 241 87 328 Linville 72 51 123 Jimna 105 52 156 Total, Average 21 40 65 1: Noosa WTP operates under a Design-Build-Operate contract with Veolia Water that was transferred to Seqwater along with the WTP from the former Noosa Regional Council. The contract terms specify a fixed capacity fee and a variable treatment fee. The variable treatment fee is set by a pre-determined formula relating to various chemical costs, electricity tariffs and source surcharges. For simplicity, it is presented in this report as a single variable cost.
Seqwater noted that its energy usage costs vary significantly between WTPs, as shown by Figure 4.2.
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Figure 4.2: Seqwater’s Energy Usage by WTP
Seqwater attributed the variation in energy costs to:
(a) whether the water supply to the WTP and water delivery from the WTP is gravity-fed or pumped;
(b) whether the WTP has an energy recovery system in place (such as hydro);
(c) economies of scale; and
(d) the energy intensity of different treatment process such as ozone generation.
Seqwater proposed the following variable costs relative to the approved 2010-11 charges for the six largest WTPs (Table 4.25).
Table 4.25: Seqwater’s Total Variable Operating Costs by WTP ($/ML)
WTP Approved 2010-11 Proposed 2011-12
Mt Crosby (East & West Bank) 73.82 66.03
Molendinar 47.34 47.94
North Pine 66.61 48.51
Landers Shute 45.72 43.34
Mudgeeraba 68.01 61.66
Noosa 112.08 143.58
Other 116.30 97.56
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Seqwater attributed the reduction in unit costs largely to reductions in the cost of energy following Seqwater’s recent energy procurement process.
For comparison, energy costs for 2010-11 and 2011-12 are shown in Table 4.26.
Table 4.26: Comparison of Energy (Pumping) Costs 2010-11 and 2011-12 ($/ML)
WTP 2010-11 2011-12
Mt Crosby (East & West Bank) 30.65 24.14
Molendinar 12.80 10.63
North Pine 9.71 9.20
Landers Shute 3.40 3.20
Mudgeeraba 29.14 15.50
Noosa 0 0
Other 75.31 52.46
Total Average 28.60 21.32
Prudency and Efficiency Review
As noted above, for opex to be included in prices, it is required to be prudent (demonstrated need for the expenditure) and efficient (least cost and consistent with relevant benchmarks, having regard to prevailing market conditions, historical trends and the potential for efficiency gains or economies of scale).
In the limited time available for review, SKM concentrated its review on Solids Removal costs at the Mt Crosby WTP which account for 24% of total proposed variable operating expenditure.
SKM concluded that the expenditure was prudent as it was required to meet the terms of Seqwater’s Grid Contract. SKM also concluded that the unit rates for procuring chemicals used in the solids removal process were below market rates, and therefore efficient. SKM also noted that Seqwater had recently changed from multiple chemical suppliers to a single supplier for chemicals.
In the Draft Report, the Authority accepted SKM’s conclusion that solids removal costs at Mt Crosby WTP are both prudent and efficient. The Authority noted that Seqwater’s use of a single chemical supplier means that SKM’s conclusion of efficient chemical procurement costs is broadly applicable to all Seqwater WTPs.
The Authority also noted that, for electricity costs, Seqwater’s recent energy procurement process has led to substantial electricity cost reductions across all Seqwater WTPs.
Assessment of Total Variable Operating Costs
As required by the Direction Notice, the WGM has provided the approved March 2011 Operating Strategy to the Authority with details of the forecast volume to be produced at each WTP in the Grid. The WGM’s forecast as at March 2011 differ by 1.5% from those provided by Seqwater in December 2010 and Seqwater has since adopted the WGM’s volume forecasts, summarised in Table 4.27 below.
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Table 4.27: Forecast Water Production for 2011-12 (ML)
WTP WGM Forecast volume
Mt Crosby (East & West Bank) 97,787
Molendinar 43,088
North Pine 28,897
Landers Shute 27,187
Mudgeeraba 21,684
North Stradbroke Island 8,693
Petrie 6,258
Noosa 5,947
Other 22,050
Total 261,591
As required by the Direction Notice, the Authority accepted the demand forecasts provided by the WGM in its March 2011 Operating Strategy. These volumes have been applied to Seqwater’s forecast Variable Operating costs to present an expected Variable Operating Charge.
Table 4.28: Recommended Variable Operating Charge
WTP Volume Variable Operating Forecast Variable Cost Charge (ML) ($m) ($/ML)
Mt Crosby (East & West 97,787 66.03 6.46 Bank)
Molendinar 43,088 47.94 2.07
North Pine 28,897 48.51 1.40
Landers Shute 27,187 43.34 1.18
Mudgeeraba 21,684 61.66 1.34
Noosa 5,947 143.58 0.85
Other 37,001 97.56 3.61
Total Recommended 261,591 64.62 16.90 2011-12
Total Proposed by 261,591 64.62 16.90 Seqwater
Approved 2010-11 300,317 72.93 21.9
Note: these figures may not add due to rounding.
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The total expected variable cost is lower than allowed by the Price Regulator for 2010-11. This is due to a lower volume forecast and reductions in the cost of electricity following Seqwater’s revised energy procurement process.
Stakeholder Submissions on the Draft Report
No submissions were received from stakeholders regarding Seqwater’s variable operating charge.
Authority’s Final Decision
The Authority proposes no change to the Draft Report recommendation.
4.5 Allowable Costs
Allowable operating costs are intended to capture legitimate business costs not reflected in fixed and variable operating costs.
Draft Report
In its initial submission, Seqwater submitted a number of Allowable Cost items. As a general principle, Seqwater proposed to pass the actual cost through to the WGM for each of its proposed allowable costs, rather than the forecast cost.
In the Draft Report, the Authority accepted Seqwater’s proposal in principle, but was concerned that a literal interpretation of it would require Seqwater waiting until actual costs are known before seeking to recover them from the WGM. The Authority recommended that the GSCs invoiced to the WGM should be based on forecast costs, with, any variation between forecast and actual costs to be dealt with under the Review Thresholds mechanism (see Chapter 7).
Working Capital
Seqwater submitted that it should be allowed 60 debtor days and 25 creditor days as input into the working capital assumption. Seqwater noted that this is consistent with the approach allowed by Price Regulator in previous years. Seqwater suggested that the 60 debtor day period consists of:
(a) 15 calendar days from when the service was delivered relative to when the invoice is raised, on the assumption that the service is delivered, on average, in the middle of the month;
(b) invoices must be issued within 15 business days of the calendar month; and
(c) invoices must be paid by the WGM within 20 business days of the date of receipt of the invoice.
After converting business days to calendar days, Seqwater suggested that 60 calendar days is an appropriate benchmark.
On this basis, Seqwater identified a net working capital balance of $49 million, for a cost of $4.86 million at the non-drought WACC of 9.91%.
Seqwater included an amount of $912,000 in critical spares as capital expenditure, noting that the Manual’s formula for working capital does not provide for critical spares or inventory.
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As outlined in Chapter 3, the Authority considered in the Draft Report, that the working capital allowance should be based on 45 debtor days and 30 creditor days.
Based on this analysis, the working capital allowance is summarised in Table 4.29.
Table 4.29: Seqwater's Working Capital Requirements ($m)
Working Capital Requirement Approved 2010-11 Seqwater Proposed Draft Recommendation 2011-12 2011-12
Average Accounts Receivable 58.8 69.3 49.1
Average Accounts Payable 13.6 20.3 14.0
Average Debtor Days 60 60 45
Average Creditor Days 25 25 30
Net Working Capital 45.2 49.0 35.2
Critical Spares and Inventories - - 0.9
Total Working Capital - - 36.1 Requirement
Return on Working Capital 4.5 4.8 3.4
Note: these figures may not add due to rounding.
An additional allowance of $912,000 was included in working capital for critical spares, for a cost of $90,000 per year at a WACC of 9.91%.
Working capital relates to the funds that an entity requires simply to fund its operations, and is a capital cost that is incurred by all businesses. As such, the Authority recommended that the Price Regulator consider including working capital as a component of the Capital Charge, rather than an Allowable Cost, in future regulatory periods.
QWC Levy
The QWC imposes a levy under section 360F of the Water Act 2000, which provides that the QWC is to be funded by an annual levy payable by each water service provider.
Seqwater forecast a QWC levy of $7.4 million for 2011-12. However, the QWC advised the Authority that the levy for 2010-11 should be continued, pending a final estimate from QWC. In the Draft Report, the Authority therefore recommended an amount of $8.11 million (including GST) be included.
QCA Fees
The Authority’s Investigation Plan, as submitted to the Minister, identified the self-funding levy charged by the Authority to regulated entities as an Allowable Cost. Seqwater forecast the fee as $0.65 million for 2011-12.
The Authority confirmed Seqwater’s forecasts, but recommended that an additional allowance for GST is added to Seqwater’s estimate. In the Draft Report, the Authority recommended including $710,600 of allowable costs relating to QCA fees.
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Integration Costs
Seqwater advised that the business integration tasks associated with establishing Seqwater have now been completed and no provision is required for 2011-12. However, the merger with WaterSecure will give rise to one-off transitional costs. While these may be offset by efficiency gains, Seqwater will seek to recover any integration costs in 2011-12. Seqwater had not yet provided an estimate of these costs.
The Authority accepted that net business integration costs should be considered an Allowable Cost for 2011-12, and should be included once they are determined.
Relocation Costs
As announced by the Premier in 2008, Seqwater is preparing to relocate to Ipswich. While the relocation will not occur until after 2011-12, Seqwater forecast relocation costs of $1.25 million in 2011-12.
The Authority accepted Seqwater’s submitted relocation costs of $1.25 million.
Queensland Floods Commission of Inquiry
Seqwater noted that it expects to incur costs relating to the Queensland Floods Commission of Inquiry, which will make an interim report into the January 2011 floods in August 2011. Seqwater had not included any costs relating to the Queensland Floods Commission of Inquiry in its submission, but proposed to treat these costs as an Allowable Cost when they become known.
The Authority accepted Seqwater’s proposal to treat the Inquiry costs as an Allowable Cost as these relate to Government policy matters beyond Seqwater’s control.
Land and Property Taxes
In its initial submission, Seqwater submitted that it is awaiting advice from the Government as to the application of land tax to certain landholdings. Seqwater advised that it had included $11.24 million in estimated costs in the 2010-11 Fixed Operating Charge and that this had been approved by the Price Regulator. Seqwater expected that this amount will be returned through an adjustment once these are reviewed by the QWC.
For 2011-12, Seqwater submitted that, if government policy determines that Land Tax is payable, that this cost be treated an Allowable Cost. Seqwater submitted that the Government may decide to apply the tax retrospectively, and that tax relating to previous years be recovered as an Allowable Cost in 2011-12. The amount of $11.24 million was considered an indicative estimate only. Seqwater’s proposal for 2011-12 is to not recover any land tax unless a ruling is received that Seqwater is liable.
In considering Seqwater’s proposal to potentially recover past tax liabilities in the 2011-12 year, the Authority noted in the Draft Report, the varying regulatory treatments of land tax in previous periods. Seqwater commenced recovering potential land tax expenses through GSCs in 2009-10 of approximately $10 million, but this amount was rebated to the WGM when Seqwater’s tax status became uncertain. Seqwater then recovered $11.2 million during 2010-11 relating to land tax, an amount which Seqwater has retained.
The Authority considered that a decision relating to Seqwater’s liability for land tax would qualify as a change in Government Policy for the purpose of the Review Threshold and should address revenues received and expenses incurred relating to Land Tax over the period since Seqwater’s formation.
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While Seqwater indicated that it proposed not to include the provision in 2011-12 GSCs, the amount was in fact included in the information templates as an Allowable Cost. The Authority recommended excluding the amount pending a policy decision from Government.
Once the issue of Land Tax eligibility has been resolved, the Authority recommended that ongoing Land Tax costs are incorporated in the Fixed Operating Charge rather than in Allowable Costs.
Partnerships Contributions
In its initial submission, Seqwater submitted that it is an active contributor and beneficiary of partnerships. Seqwater receives research services from partnerships with University of Queensland and Griffith University as part of a sourcing strategy.
Seqwater submitted that financial and in-kind contributions to partnerships are subject to change without advance notice, particularly following events such as extreme flooding. Seqwater submitted that any increase in the cost of partnership contributions should be treated as an Allowable Cost to be passed through as they arise during the regulatory period. Seqwater did not submit a forecast amount for 2011-12.
In the Draft Report, the Authority did not consider that Seqwater had provided sufficient justification for treatment of any increase in partnership contributions as an Allowable Cost. The Authority noted that Seqwater’s fixed operating expenditure includes $3.9 million relating to R&D. It is recommended that any material divergence between this forecast and actual is addressed through Review Thresholds (see Chapter 7).
Wyaralong WTP
In its initial submission, Seqwater submitted that it expects to complete Stage 1 of the Wyaralong WTP (design and investigation work) during 2011-12. The timing of the construction of the WTP (Stage 2) has yet to be determined. Seqwater was concerned that the Authority would not include this additional expenditure in the RAB until the asset is itself commissioned.
While Seqwater submitted that it intends to address this issue with QWC, Seqwater’s submission proposed to treat the Wyaralong WTP costs as an Allowable Cost.
In the Draft Report, the Authority recommended that costs incurred to complete a stage of capital expenditure should not be included as an Allowable Cost, but should be incorporated in capital expenditure. The Authority considered that capital expenditure should be only included in the RAB when it is commissioned as per the Market Rules. The Authority addressed this issue in regard to capex above (see section 4.2).
Flood Damage
In relation to the January 2011 flood, Seqwater submitted that it did not expect to have reasonable information about the extent and cost of flood damage until June 2011, at the earliest. Moreover, Seqwater did not expect it will know the proceeds from insurance claims until during the 2011-12 year, at the earliest.
Due to the uncertainties of these costs, Seqwater submitted that capital expenditure relating to the rectification of damage caused by the January 2011 floods be treated as an allowable cost.
In the Draft Report, the Authority recommended flood damage rectification is treated as capital expenditure rather than an Allowable Cost. The Authority addressed this issue in section 3.3.
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The Authority also recommended a review process for differences between forecast and actual capital expenditure (see section 7.6).
Summary of Allowable Costs
The Authority’s Draft Report recommended allowable costs are summarised in Table 4.30 below.
Stakeholder Submissions on the Draft Report
In response to the Draft Report, Seqwater noted that it has reviewed the partnerships requests for additional funding, but has elected not to increase its base funding contribution at this time. As such, Seqwater withdrew its initial request for consideration of treatment of partnership contributions as an allowable cost.
Seqwater submitted that the Minister had decided not to progress with the relocation to Ipswich at this time. Seqwater accepted the Authority’s Draft Report recommendation on treating flood damage capex as capex rather than an allowable cost.
Since the release of the Draft Report, the QWC have advised the Authority that the QWC levy in 2011-12 for Seqwater is $5.2 million exclusive of GST.
Authority’s Final Decision
No submissions were received from stakeholders regarding Seqwater’s working capital allowance. Therefore, the Authority proposes no change to the Draft Report recommended approach to determining the working capital allowance for Seqwater for 2011-12.
With minor changes to capital charges and fixed operating costs, the average Accounts Receivable increased from $49.1 million to $49.2 million and the average Accounts Payable decreased from $14 million to $13.9 million. The net working capital allowance remains unchanged for the Final Report (Table 4.30).
Table 4.30: Seqwater's Working Capital Requirements ($m)
Working Capital Requirement Seqwater Proposed Draft Recommendation Final Recommendation 2011-12 2011-12 2011-12
Average Accounts Receivable 69.3 49.1 49.2
Average Accounts Payable 20.3 14.0 13.9
Average Debtor Days 60 45 45
Average Creditor Days 25 30 30
Net Working Capital 49.0 35.2 35.2
Critical Spares and Inventories - 0.9 0.9
Total Working Capital Requirement - 36.1 36.1
Return on Working Capital 4.8 3.4 3.4
Note: these figures may not add due to rounding.
The Authority accepts Seqwater’s withdrawal of its request to treat partnerships contributions as an allowable cost. As no amount was included in Draft GSCs, this results in no change.
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The Authority notes the cancellation of Seqwater’s relocation to Ipswich, and has removed the relocation costs from the recommended allowable costs.
The Authority accepts the QWC’s updated levy.
The Authority has also confirmed that as GST is rebated to the GSPs all costs should exclude GST. As a result, the QCA levy for 2011-12 is $646,000.
The amended Allowable Costs are summarised in Table 4.31 below.
Table 4.31: Summary of Allowable Costs ($m)
Approved Seqwater QCA Draft QCA Final 2010-11 Proposed 2011- Recommendation Recommendation 12 2011-12 2011-12
Working Capital including 4.49 4.8 3.4 3.4 critical spares
QWC Levy 8.11 7.37 8.1 5.2
QCA fee 0.67 0.65 0.7 0.6
Integration Costs 0.93 TBA TBA TBA
Relocation Costs 1.25 1.3 0
Floods Commission of Enquiry TBA TBA TBA
Land and Property Tax 11.24 TBA TBA
Partnerships Contributions TBA 0 0
Wyaralong Dam WTP 11.24 0 0
Flood Damage capex TBA 0 0
Total 14.2 36.5 13.5 9.2
Note: these figures may not add due to rounding.
The estimated allowable costs remain subject to adjustment for additional costs arising from the Flood Commission of Enquiry, Seqwater/WaterSecure merger costs, and any adjustments to land and property taxes.
4.6 Revenue Offsets
The Direction Notice requires that the Authority continue the current approach for passing through operating costs and revenues (including community service obligation payments) relating to irrigation services and other non-Grid activities to the WGM.
Draft Report
In its initial submission, Seqwater identified $4.0 million of revenue received from non-Grid sources. This included:
(a) $2.755 million relating to irrigation revenue, comprising $1.92 million in water charge revenue plus $1.33 million in CSOs, less $0.5 million provided by irrigators for a
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renewals annuity which is held by Seqwater in escrow pending a review of irrigation prices in the future;
(b) $0.575 million of non-irrigator, non-Grid revenue from irrigation schemes; and
(c) $0.647 million of rental, permit and lease income. Seqwater leases flood margin land and also rents some houses and other premises. The revenues from these activities are forecast at $0.647 million for 2011-12, comprising:
(i) rental income – $0.102 million;
(ii) permit income - $0.262 million; and
(iii) land leases – $0.283 million.
Seqwater proposed that these revenues be applied to offset operating costs given the costs and administrative effort involved in separately identifying or allocating costs to these activities. Moreover, the lease of flood margin land is common practice for storage owners and involves a range of other benefits (e.g. managing trespass, assigning responsibility for pest and weed control) to storage operations.
In the Draft Report, the Authority noted that the revenue offset amounts are relatively small compared to the GSC. In the case of the irrigation sector, revenues fall short of lower bound cost recovery, but the difference is made up by a CSO contribution. Lower bound costs have been carried over from SunWater but are likely to change to take account of a share of Seqwater’s corporate and other common costs. However, the Direction Notice requires the Authority to defer any investigation into common costs.
Given the constraints of the Direction Notice, the Authority has not undertaken any investigation of irrigation scheme costs and the levels of revenue offsets. The Authority accepted Seqwater’s proposal for a $4 million revenue offset against total GSCs.
Stakeholder Submissions on the Draft Report
No comments were received from stakeholders regarding Seqwater’s revenue offsets.
Authority’s Final Decision
The Authority proposes no change to the Draft Report recommendation.
4.7 Summary of GSC
The Authority’s recommended GSC for Seqwater for 2011-12 is shown in Table 4.32.
The total GSC is higher in 2011-12 mainly due to the inclusion of new drought assets. The Fixed Operating Charge in 2011-12 is broadly similar to that for 2010-11, while the Variable Operating Charge is lower due to lower volumes and lower unit costs in electricity.
Relative to the Draft Report, the major changes to Seqwater’s recommended GSCs result from revised drought capex forecasts, the identification of $54 million of land in capex which it is not proposed to depreciate and, SKM’s review of additional information from Seqwater which has resulted in more capex and opex being deemed to be prudent and efficient.
Increases in fixed operating costs due to additional items being accepted by SKM are offset by a reduction in allowable costs arising from removal of head office relocation costs and a reduction to the QWC levy for Seqwater.
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Table 4.32: Seqwater's Revenue Requirements
Revenue Component Approved 2010- Seqwater QCA Draft QCA Final 11 Proposed 2011-12 Recommendation Recommendation 2011-12 2011-12
Return on Drought RAB 23,542,998 - 64,181,941 64,064,304
Return on Non-Drought 182,881,293 - 185,789,347 185,930,737 RAB
Depreciation 46,373,733 - 51,850,775 52,393,461
Asset Appreciation (56,848,698) - (72,695,602) (72,576,836)
Historic Adjustments (1,779,984) - TBA -
Capital Charge 194,169,342 N/A 229,126,461 229,811,666
Fixed Operating Costs 139,712,800 147,040,075 142,778,598 146,801,169
Variable Operating Costs 72.90 64.62 64.62 64.62 $/ML
Variable Operating Costs 21,901,269 16,903,182 16,903,182 16,903,182 total
Allowable Costs 14,201,061 36,510,000 13,481,140 9,218,980
Revenue Offset (3,977,000) (3,977,000) (3,977,000)
Total Maximum 369,984,472 N/A 398,312,382 398,757,997 Allowable Revenue
Note: these figures may not add due to rounding. Approved 2010-11 Fixed Operating Costs include $11.24 million in land taxes, $0.3 million in relocation costs and $8.8 million in WTP unplanned maintenance costs. Approved 2010-11 Allowable Costs include $8.11 million for the QWC levy and $0.67 million for the QCA regulatory fee.
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5. WATERSECURE
5.1 Background
The Queensland Manufactured Water Authority (trading as WaterSecure) is a Queensland Government statutory authority established on 2 May 2008 under the South East Queensland Water (Restructuring) Act 2007. WaterSecure produces and supplies purified, recycled and desalinated water to the SEQ Water Grid.
WaterSecure’s assets include a reverse osmosis desalination plant at Tugun, more than 200 kilometres of large-diameter underground pipeline, three advanced water treatment plants (AWTPs) located at Bundamba, Luggage Point and Gibson Island, and other associated infrastructure. As of 1 July 2011, WaterSecure’s assets were valued at $3.1 billion.
The combined production capacity of WaterSecure’s assets is up to 365 megalitres (ML) a day, of which 232 ML a day is sourced from the Western Corridor Recycled Water (WCRW) scheme, and 133 ML a day from the Tugun desalination plant.
Purified recycled water from the Western corridor scheme supplies water to the Tarong and Swanbank power stations. The WGM plans to expand the supply of purified recycled water to other industrial and agricultural users, as well as provide a backup mechanism for SEQ’s dams should they fall below a combined capacity of 40%.
The desalination plant feeds directly into the SEQ Water Grid. The Queensland Government announced in December 2010 that the desalination plant would operate on a “hot standby” mode. This entails production being scaled back to the minimum level required to ensure the plant could come on line at 100% capacity within 72 hours and 33% within 24 hours. This mode of operation allows the WGM to have water capacity on standby to react to water quality incidents, grid asset failures, or planned maintenance.
WaterSecure outsources the operation of both the WCRW scheme and the Tugun desalination plant. Veolia Water Australia is the appointed operator for the Western corridor scheme, while the Tugun desalination plant is operated by the GCD Alliance (consisted of Veolia Water Australia, John Holland Australia, and the owner WaterSecure).
On 1 July 2011, Seqwater and WaterSecure were merged into one entity. The Authority has continued to treat them separately for the purpose of recommending GSCs, consistent with the SEQ Water Market Rules prevailing at the time of the issuance of the Direction Notice, and proposes to do so until the cost implications of the merger are assessed.
5.2 Capital Charge
Opening RAB
Under the Direction Notice, the Authority is required to accept the opening RAB for WaterSecure as at 1 July 2011, as provided by the QWC. The opening RAB includes actual capital expenditure from 2009-10 and 2010-11, reflecting QWC’s approach of adding actual expenditure into the RAB as it occurs rather than waiting until projects are commissioned (as required of the Authority in the Direction Notice).
The QWC will also provide adjustments to the RAB after the 2011-12 GSCs have been set to take account of actual capital expenditure for 2010-11.
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Draft Report
The QWC’s opening RAB is provided in Table 5.1 below, compared to WaterSecure’s own estimate. The asset remaining lives are also included for transparency.
Table 5.1: WaterSecure’s Opening RAB at 1 July 2011
WaterSecure’s QWC Difference Remaining Remaining Opening RAB Value ($m) Life (years – Life (years – Asset ($m) ($m) QWC) WaterSecure)
Drought Western Corridor 2,087.2 1,936.8 150.4 42.5 39.7 Recycled Water (WCRW)
Land Allocation 7.7 7.7 0 0 0 Cost WCRW – Southern Regional Water Pipeline (SRWP)
Land Allocation 0.3 0.3 0 0 0 Cost - WCRW Purified Recycled Water (PRW) Wivenhoe Release
Land PRW - WCRW 35.8 96.9 -61.1 0 0
Tugun desalination 826.8 813.6 13.2 23.2 23.6 plant (Interim Operating Phase)
Land for Tugun 3.5 3.5 0 0 0
Tugun desalination 149.8 194.4 -44.6 23.3 34.0 plant (Final Assets)
Sub-Total 3,111.1 3,053.1 57.9
Non- Office Furniture & 0.0 0.8 -0.8 4.0 4.0 drought Fittings
IT Equipment 0.0 0.7 -0.7 4.3 4.3
WCRW Ongoing 0.0 0.5 -0.5 4.5 4.5 CAPEX 2010-11
Tugun Ongoing 0.0 0.1 -0.1 4.5 4.5 CAPEX 2010-11
Plant & Equipment 1.9 0.1 1.8 4.5 4.5
Sub-Total 1.9 2.3 -0.4
Total 3,113.0 3,055.5 57.5
Note: these figures may not add due to rounding.
In its initial submission, WaterSecure submitted an opening RAB of $3,113 million, comprising $3,111 million in drought assets and $1.9 million in non-drought assets.
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WaterSecure identified a further $53.5 million in WCRW land and network easements to be incorporated into the RAB during 2011. This provided a total of $3,164.6 million in drought assets.
In the Draft Report, the Authority noted that WaterSecure provided RAB values in its submission which differ from those provided by QWC (a total of $3,113 million compared to $3,055 million or 1.9% higher than the QWC’s RAB). If WCRW land is included, WaterSecure’s opening RAB is 3.5% higher. Within these values there are three relatively significant differences, which somewhat offset each other:
(a) WaterSecure values the WCRW scheme (not including land) at $150 million more than QWC’s estimate at 1 July 2011;
(b) the QWC values the land component of the WCRW scheme at $61 million less than WaterSecure. However, this is largely accounted for by the addition by WaterSecure of a further $53.5 million in WCRW land assets in 2011-12; and
(c) the QWC values the final assets of the Tugun desalination plant $45 million less than WaterSecure.
As required by the Direction Notice, the Authority adopted the RAB provided by the QWC for the purposes of recommending GSCs. It is not the Authority’s role to settle valuation differences between WaterSecure and the QWC.
Stakeholder Submissions on the Draft Report
No comments were received from stakeholders regarding WaterSecure’s opening RAB.
Authority’s Final Decision
The Authority proposes no change to the Draft Report recommendation.
Capital Expenditure
The Direction Notice requires that the Authority assess the prudency and efficiency of non- drought capex and post-commissioning drought capex, and assess the efficiency of forecast capex on non-drought projects commenced in a previous regulatory period.
Capex incurred on projects, including capitalised costs, are to be rolled into the RAB at the date of commissioning.
Draft Report
In its initial submission, WaterSecure stated that capital expenditure is aligned with the approved SAMPs for the WCRW and the desalination plant. However, WaterSecure indicated that it is developing a new SAMP in conjunction with Veolia Water for the asset management of the entire business, expected to be completed in June 2011.
WaterSecure identified $36.2 million in drought capex for the WCRW, but advised that this amount was already incorporated into the opening RAB. In its initial submission, WaterSecure identified a total of $3.9 million in new capex on growth and service capital and renewals for the WCRW and $1.9 million for non-infrastructure support functions, including $1.5 million for a Supervisory Control and Data Acquisition (SCADA) integration system at Bundamba.
Table 5.2 below outlines WaterSecure’s proposed 2011-12 post-commissioning capex, which totals $5.8 million.
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Table 5.2: WaterSecure’s Proposed Capital Expenditure for 2011-12
Capital Expenditure Item Value ($m) Expected Completion Asset Life (Years) Date
Bundamba AWTP 1.9 2016 10
Network PRW 1.9 2012 10
Environmental washdown bays 0.22 2012 10
Office equipment, furniture 0.2 2016 5 and fittings
Replacement of motor vehicles 0.18 2012 5
Supervisory Control and Data 1.5 2012 10 Acquisition (SCADA) integration system
Total 5.8
Note: these figures may not add due to rounding.
WaterSecure identified capex according to drivers as shown in Table 5.3.
Table 5.3: WaterSecure’s Proposed 2011-12 Capex by Driver ($m)
Capital Expenditure Driver Number Value
Compliance 3 0.4
Efficiency 6 4.6
Renewal 8 0.6
Service 2 0.2
Total 19 5.8
Note: these figures may not add due to rounding.
In the Draft Report, the Authority noted that WaterSecure’s submission to the Authority included two capital expenditure items which have been excluded from this analysis. They were a $30.1 million allocation for land for the WCRW scheme and $6.1 million for the Gibson Island Advanced Water Treatment Plant (AWTP) (a total of $36.2 million). WaterSecure informed the Authority that both capital expenditure items were already part of the RAB at 1 July 2011, but the funds were still due to be expended in the 2011-12 budget. Accordingly, the Authority excluded them from the capital expenditure.
The Authority noted that these items relate to final completion of drought assets that must be rolled into the RAB at project cost.
(a) Prudency and Efficiency Review
The Authority engaged SKM to review the prudency and efficiency of WaterSecure’s non- drought capital expenditure. SKM reviewed the cost drivers of the capex in detail and the need for, and scope and standard of, works when doing so.
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For capex to be included in the RAB, it is required to be prudent (demonstrated need for the expenditure) and efficient (cost effective in scope and standard, using market benchmarks).
SKM undertook a sampling process for reviewing WaterSecure’s proposed capex. The sample of three projects comprised 50% of total capex. The sample is listed in Table 5.4 below.
Table 5.4: Capex Projects Reviewed by SKM for the Draft Report ($m)
Project Title Project Category Cost Estimate 2011-12
SCADA Integration System Non-infrastructure 1.5
Bundamba AWTP – Chemical Growth 0.8 Storage Area Covers
Bundamba AWTP – Network Growth 0.6 Storage Shed
Total Sample 2.9
Note: these figures may not add due to rounding.
(i) SCADA Integration System - $1.5 million
The objective of this project is to standardise the control systems between the Bundamba 1A and 1B AWTPs, therefore providing consistency and visibility in the way in which the two plants run. WaterSecure submitted that the original business case was prepared with inputs from both WaterSecure and Veolia Water, and is $0.3 million less than the original project budget of $1.8 million.
However, based on additional information from WaterSecure since the submission to the Authority, the project cost for 2011- 12 had been revised upwards to $2.75 million. The increased costs reflected a misalignment of project expectations between WaterSecure and Veolia Water.
SKM reviewed WaterSecure’s memoranda which indicated that five options were considered involving complete or partial implementation by Veolia or complete implementation by a third party. WaterSecure elected to proceed with using Veolia rather than risk using another contractor. SKM was not provided with enough information to justify the proposed cost variation.
The benefits of the SCADA system are that it enables a switch from 24/7 manning to 8/5 operations, with WaterSecure indicating a saving $438,000 in labour costs per year. However, SKM was unable to collect enough information to verify this estimate of savings. SKM also noted that the proposed mothballing of part of the Bundamba plant was not taken into account.
Based on the current lack of information provided in WaterSecure’s submission, the need for the variation, and whether the scope of work adequately takes into account the mothballing of 1B, SKM found this project not to be prudent at this stage.
Based on the lack of certainty of the scope of works, SKM concluded that the expenditure on this project is not efficient. SKM recommended that the scope of this project be reviewed following confirmation of the mothballing procedure at Bundamba to eliminate any elements of the scope that are no longer required.
In the Draft Report, the Authority accepted SKM’s recommendation that there was insufficient information to assess whether WaterSecure’s proposed expenditure for a SCADA Integration
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System is prudent or efficient. The Authority recommended excluding this capex item from the Capital Charges, pending further review prior to the Final Report.
(ii) Bundamba AWTP – Chemical Storage Area Covers - $0.8 million
Stage 1A and 1B of the Bundamba AWTP each have outdoor uncovered chemical storage areas. This exposes the chemical storage equipment to harsh weather conditions including changes in temperature, storms and wind. This affects the asset integrity and life of the asset, as well as the quality of the chemicals stored.
SKM found that the business case for this project has not taken into account the decision to mothball Bundamba 1B AWTP. Further information is required to support the need for the covering of the chemical area for Stage 1B given that this plant will not be used in the foreseeable future. On the basis that the covering of the chemical area for stage 1A works will not be affected by the mothballing of Stage 1B, the Stage 1A works were considered to be prudent.
SKM also found that the covering of the chemical area for 1B is not efficient given that this plant will not be used in the foreseeable future. Also, insufficient information was provided to allow SKM to assess whether the costs associated with covering the chemical area for Stage 1A are efficient.
The Authority accepted SKM’s recommendation that WaterSecure’s proposed expenditure for Chemical Storage Area Covers are not prudent or efficient for Bundamba 1B, and that the proposed expenditure for 1A is prudent. However, insufficient information was available for SKM to determine whether the cover for Stage 1A was efficient. WaterSecure informed the Authority that this project was under review, and that it was yet to determine whether to undertake a cost benefit analysis and the preparation of a detailed business case.
Based on SKM’s analysis, the Authority recommended excluding this capital expenditure item, pending further review prior to the Final Report.
(iii) Bundamba AWTP – Network Storage Shed - $0.6 million
This project is for the construction of a storage yard to facilitate the network maintenance function. This facility will be used to store spare pipe lengths and other network spares such as pit lids, pipe fittings and valves as well as emergency response equipment. It will ensure stock and equipment are managed effectively and efficiently.
SKM was only able to identify a cost breakdown accounting for $0.27 million of the proposed $0.58 million.
SKM found the project not to be prudent due to the lack of evidence suggesting consideration had been given to alternative storage on site following mothballing of one of the plants. Also, inadequate information was provided regarding the scope of work.
SKM found the project not to be efficient on the grounds that the costs submitted to it are less than 50% of the cost submitted to the Authority for this project. WaterSecure was not able to explain the difference in costs.
The Authority accepted SKM’s recommendation that WaterSecure’s proposed expenditure for a Network Storage Shed is not prudent or efficient.
WaterSecure informed the Authority that this project was under review, and that it was yet to determine whether to undertake a cost benefit analysis and the preparation of a detailed business
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case. The Authority recommended excluding this capex item from the Draft Capital Charges, pending further review prior to the Final Report.
(b) Summary of Capital Expenditure
SKM concluded that insufficient information was available to enable it to assess whether any of the three capital expenditure projects reviewed were prudent or efficient.
The Authority therefore recommended excluding the reviewed projects to a value of $2.88 million (as submitted). The Authority advised in its Draft Report that if WaterSecure could provide the necessary information required to support expenditure on the excluded projects, it will review its assessment prior to the Final Report.
Stakeholder Submissions on the Draft Report
In response to the Draft Report, WaterSecure stated that in May 2010, Veolia provided a proposal to address the issues associated with the two different SCADA systems in Bundamba 1A and 1B. The key issues raised at the time of the proposal were:
(a) even though they are situated together, 1A and 1B are controlled as two separate plants;
(b) while having two plants provides redundancy should one fail, this redundancy cannot be coordinated by one or the other plants; and
(c) a single interface will harmonise the various systems so that an operator can navigate seamlessly from the AWTP to the Raw Water and Reverse Osmosis Concentrate systems.
Further, WaterSecure stated that the Bundamba AWTP Chemical Storage Area Covers project remains in the early stages of project definition and scoping, and are yet to undergo WaterSecure’s business case proposal and approval process. WaterSecure also stated that the impending merger with Seqwater has further delayed this process.
WaterSecure submitted that the Network Storage Shed is for the entire network, not solely for Bundamba. Therefore, to avoid confusion, the project should be referred to as the Network Storage Shed. In addition, WaterSecure provided clarification regarding the costing for the Network Storage Shed. WaterSecure noted that the original budget estimate was $575,000. However, refinement and re-scoping of the project resulted in a lower than expected direct cost estimate of $370,000.
The WGM submitted that it had not reviewed the need for, or options to, proposed capital expenditure by WaterSecure due to the estimated cost of those projects being below $2 million.
Authority’s Final Decision
The Authority re-engaged SKM to assist the Authority with responding to new information it received in response to the Draft Report, specifically regarding the prudency and efficiency of capital and operating expenditure.
Based on the additional information supplied by WaterSecure for the three previously reviewed capital expenditure projects, SKM’s findings were:
(a) SCADA Integration System ($1.5 million) the project is required to reduce the amount of operating support required and the associated costs. SKM also found that the project is required to provide a more reliable plant with reduced potential safety, environmental and equipment damages incidences. Therefore, SKM concluded that the project is prudent.
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Based on the proposed resourcing schedule and the provided costs, SKM found the hourly rates to be reasonable and therefore concluded that the project is efficient;
(b) Bundamba AWTP – Chemical Storage Area Covers ($0.8 million) – on the basis that the covering of the chemical area for Stage 1A of the plant will not be affected by the mothballing of Stage 1B, SKM considered these works to be prudent. However, SKM recommended that the scope of works for Stage 1A be reviewed in view of the mothballing of Stage 1B to ascertain the exact requirements for chemical storage for Stage 1A. SKM considered that the scope of works for the chemical storage area for Stage 1B is not prudent, based on the recent decision to mothball Stage 1B of the plant. SKM benchmarked the proposed costs of the chemical storage covers for both Stages 1A and 1B and concluded that the proposed costs were efficient. SKM advised that the efficient cost associated with the chemical cover for Stage 1A was $457,876; and
(c) Network Storage Shed ($0.6 million) the project is again considered not prudent due to the lack of evidence of cost avoidance to support the project justification. SKM noted that one of WaterSecure’s drivers for the project was the improved ability to control stock and avoid over ordering spares. However, SKM considered this not to be a relevant driver for the project. In addition, inadequate information was provided regarding the scope of works. SKM also noted that WaterSecure’s revised cost estimate was still lower than the value submitted to the Authority. SKM therefore, found the project not to be efficient.
Given the concerns about the projects that were reviewed in the Draft Report, the Authority reviewed the majority of the remaining capex projects for prudency and efficiency prior to the issuance of the final GSCs. In total, the Authority has reviewed 91% of WaterSecure’s capex. The remaining 9% included several small items less than $100,000 in value. SKM’s recommendations on the additional reviewed projects are as follows:
(a) Swanbank cross-connection pipeline ($1.5 million) – the WGM sent WaterSecure a letter detailing the requirement for this Bundamba AWTP cross connection as part of the package of de-mobilising the Gibson Island AWTP and Stage 1 of the Bundamba AWTP. Therefore, SKM concluded that the project was prudent as it constituted compliance with the instruction from the WGM. However, SKM also recommended that WaterSecure proceed with detailed design to verify whether the preferred option for the cross connection is technically feasible. SKM found that the costs for the current scope of works are of the correct order of magnitude and are therefore efficient;
(b) HV fire alert at Bundamba AWTP ($0.3 million) – SKM considered that it is good industry practice to install this type of system for high voltage switchboards. Therefore, SKM concluded that the capital expenditure for the high voltage switchroom fire alarm and suppression system was prudent. Based on industry knowledge of fire protection systems, SKM found that the scope of works was deemed suitable for the existing plant, and the costs were based upon competitive tender rates. Therefore, SKM considered the costs were efficient;
(c) environmental weed hygiene wash down bays ($0.22 million) – insufficient information was provided to enable SKM to assess the prudency and efficiency of this project;
(d) Karawatha Forest access track ($0.2 million) - insufficient information was provided to enable SKM to assess the prudency and efficiency of this project; and
(e) Bundamba AWTP renewals expenditure ($0.17 million) - the capital expenditure for the sump pumps are considered to be prudent. However, the capital expenditure associated with the chemical mixers is not considered to be prudent, as the replacement of the
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chemical mixers is based on an assumed asset condition, rather than a proven asset condition. SKM recommended that WaterSecure undertake condition assessments of these four mixers to determine the condition of the linings. Further, SKM found the costs associated with the sump pumps for the Bundamba renewals to be efficient. However, insufficient information has been provided on the mixers to allow an assessment of efficiency.
The Authority accepts SKM’s conclusions regarding WaterSecure’s proposed capital expenditure. In particular, the Authority notes that it has only accepted the project costs associated with the chemical storage covers associated with Stage 1A (i.e. not Stage 1B). Further, with regards to WaterSecure’s Bundamba AWTP renewals expenditure, the Authority has included the costs associated with the sump pumps that SKM deemed to be prudent and efficient, but excluded the costs associated with the chemical mixers as SKM considered these costs were neither prudent nor efficient.
A summary is provided in Table 5.5 below.
Table 5.5: Summary of SKM’s Further Review of WaterSecure's Capital Expenditure for 2011-12 ($m)
Capital Expenditure WaterSecure’s Assessment of Assessment of QCA’s Final Project Proposed Cost for Prudency Efficiency Recommendation 2011-12 for 2011-12
SCADA Integration 1.5 Prudent Efficient 1.5 System
Bundamba AWTP – 0.8 Stage 1A cover is Efficient 0.5 Chemical Storage prudent. Stage 1B Area Covers cover not prudent.
Network Storage 0.6 Insufficient Insufficient 0 Shed information provided information provided
Swanbank Cross- 1.5 Prudent Efficient 1.5 Connection Pipeline
HV Fire Alerts for 0.3 Prudent Efficient 0.3 Bundamba AWTP
Environmental Weed 0.2 Insufficient Insufficient 0 Hygiene Wash information provided information provided Down Bays
Karawatha Forrest 0.2 Insufficient Insufficient 0 Access Track information provided information provided
Bundamba AWTP 0.17 Sump pumps are Sump pumps are 0.1 Renewals (sump prudent. Mixers are efficient. Insufficient pumps and chemical not prudent information provided mixers) regarding the costs of the mixers
Total 5.3 3.9
Note: these figures may not add due to rounding.
The Authority has assessed approximately 90% of WaterSecure’s proposed capital expenditure for 2011-12 in the Final Report. As noted in Table 5.5 above, the Authority therefore recommends excluding the reviewed projects to a value of $1.4 million (as submitted). As a
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result, the Authority’s final recommendation regarding WaterSecure’s capital expenditure for 2011-12 is $4.4 million, as illustrated in Table 5.6 below. The difference between $4.4 million and the $3.9 million referred above reflects projects not assessed.
Table 5.6: WaterSecure’s Capital Expenditure for 2011-12 ($m)
Value
WaterSecure Proposed 5.8
QCA Draft Recommendation 2.9
QCA Final Recommendation 4.4
Note: these figures may not add due to rounding.
Return on Capital
Under the Direction Notice, the return on drought assets is to be set to the forecast actual cost of debt incurred by WaterSecure for its drought assets.
For non-drought assets, the Authority must determine a pre-tax nominal WACC for non-drought assets based on parameters detailed in the Manual. The cost of debt used in the WACC is the book interest rate forecast by the QTC for each asset plus an administration and capital market charge and a Competitive Neutrality fee. The Direction Notice prescribed all parameters to be used in determining WACC.
Draft Report
Under the Direction Notice, the return on drought assets is to be set at the actual cost of debt incurred by WaterSecure for its drought assets.
The cost of debt for drought assets is the book interest rate forecast by QTC for 2011-12 for each asset plus administration and capital market charge. The Authority is required to adopt the QTC rates.
QTC submitted the cost of debt parameters for each of WaterSecure’s drought assets for 2011- 12 to be 6.52%.
QTC did not provide borrowing rates for non-drought (or post-commissioning drought) assets for WaterSecure. However, a non-drought WACC is required to be applied to new capex items identified above.
Given the forthcoming merger with Seqwater, the Authority recommended applying the same WACC as applied for Seqwater to WaterSecure’s post-commissioning drought assets.
For the non-drought WACC, the QTC provided key parameters as shown in Table 5.7.
Table 5.7: QTC Input Parameters for Calculation of WaterSecure’s WACC
Parameter Value
Cost of debt 8.01%
Risk-free rate 5.96%
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Based on the parameters directed by the Minister and the inputs provided by the QTC as in Table 5.7, the WACC to apply to WaterSecure’s non-drought RAB and post-commissioning non-drought and drought capital expenditure was calculated at 9.91%.
This WACC compares with a pre-tax nominal WACC for 2010-11 of 9.63%. The 2010-11 WACC was based on a risk-free rate of 5.66% and an actual cost of debt of 7.80%.
Stakeholder Submissions on the Draft Report
No comments were received from stakeholders regarding WaterSecure’s return on capital.
Authority’s Final Decision
The Authority proposes no change to the Draft Report recommendation.
Return of Capital
Under the Direction Notice, the Authority is to determine the return of capital based on the written down value of the assets and using a straight line regulatory depreciation based on each asset’s estimated useful life. Estimated useful lives along with the written down asset values have been provided by the QWC. However, the Authority may review proposed asset lives for new assets.
Draft Report
In its initial submission, WaterSecure stated that it applied a straight line method of depreciation and average remaining asset lives. WaterSecure forecast a depreciation allowance of $110.6 million on its drought RAB.
In terms of the depreciation of WaterSecure’s proposed capex for 2011-12, applying asset lives consistent with industry standards provides for a depreciation allowance of $0.3 million over the 2011-12 regulatory period.
Table 5.8 below provides a summary of WaterSecure’s proposed depreciation for the 2011-12 regulatory period.
WaterSecure did not provide a rolled-forward RAB in its submission.
In the Draft Report, the Authority stated that it adopted the QWC’s asset values, and applied a straight line depreciation approach to each of WaterSecure’s assets in order to derive the total depreciation allowance for 2011-12. The figures are presented in Table 5.8.
The Authority’s estimated depreciation is lower than that proposed by WaterSecure. This reflects the differences in WaterSecure’s opening RAB for 1 July 2011 compared to the QWC’s opening RAB for 1 July 2011, which the Authority has been directed to accept.
Stakeholder Submissions on the Draft Report
No comments were received from stakeholders regarding WaterSecure’s return of capital.
Authority’s Final Decision
The Authority proposes no change to the Draft Report recommendation regarding the methodology for determining WaterSecure’s return of capital.
As noted above, the Authority’s recommendation in relation to WaterSecure’s capital expenditure has changed from the Draft to the Final Report. This has marginally altered the
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Authority’s recommended depreciation, but has not resulted in a discernible change to depreciation in table 5.8 below.
Table 5.8: Depreciation Summary ($m)
Asset Approved WaterSecure QCA Draft QCA Final 2010-11 Proposed Recommended Recommendation 2011-12 2011-12 2011-12
WCRW (Drought) 47.8 70.7 53.1 53.1
Tugun Desalination (Drought) 41.0 39.9 43.2 43.2
RAB Non-Drought Depreciation - - 0.5 0.5
Capex Depreciation - - 0.2 0.2
Total 88.7 110.6 97.0 97.0
Note: these figures may not add due to rounding.
Summary of Capital Charge
WaterSecure’s initial submission did not include a proposed Capital Charge estimate.
The Authority’s analysis of the asset roll-forward is summarised in Table 5.9.
Table 5.9: RAB Roll-forward ($m)
Drought Non-drought Total
Opening RAB (1 July 2011) 3,053.1 2.3 3,055.5
plus Capital Expenditure - 4.4 4.4
plus Asset Appreciation 76.3 0.1 76.4
less Depreciation 99.4 0.8 100.1
Closing RAB (30 June 2012) 3,030.1 6.1 3,036.2
Note: these figures may not add due to rounding.
The Capital Charges are shown in Table 5.10.
The estimates of depreciation and asset appreciation vary between Tables 5.9 and 5.10 as the former are expressed as year-end numbers, and the latter as mid-year numbers. The use of year end numbers in the calculation of Maximum Allowable Revenue (MAR) would represent an implicit assumption that revenues are received at the end of the year. However, the GSPs generally raise their revenue each month over the course of the year given monthly invoicing. If left unadjusted, this would mean that the net present value of the actual flow of revenues recovered over the course of a year will exceed that of the MAR determined by the Regulator.
To address the issue, the Authority discounted the building block components to a mid-year value using the appropriate WACC or cost of debt return. This approach gives an approximate estimate of the revenue required assuming constant revenue over the year. The adjusted components are: return on assets, return of assets (depreciation), and indexation.
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The Authority’s external consultant NERA confirmed that the mid-year adjustment was appropriately applied in calculating the 2011-12 GSCs. NERA also confirmed that the mid-year discounting adjustment accurately estimated the required revenue under the current invoicing arrangements that exist for the GSPs.
Table 5.10: Capital Charge Summary ($m)
Drought Non-drought Total
Return on Assets 192.9 0.4 193.2
plus Depreciation 96.3 0.7 97.0
less Asset Appreciation (74.0) (0.1) (74.0)
Total Recommended Capital Charge 2011-12 215.2 1.0 216.2
WaterSecure Proposed Capital Charge 2011-12 N/A N/A N/A
Draft Recommended Capital Charge 2011-12 215.2 1.0 216.2
Approved Total Capital Charge 2010-11 - - 201.3
Note: these figures may not add due to rounding.
The Authority’s recommended Capital Charge is higher than that for 2010-11 due to the inclusion of additional capital expenditure in the RAB during 2010-11. The RAB increased from $2.23 billion at 1 July 2010 to $3.06 billion at 1 July 2011.
WaterSecure’s Capital Charge has not changed to a discernible extent from the Draft Report.
5.3 Fixed Operating Charge
The Direction Notice requires that the Authority assess the prudency and efficiency of all fixed operating costs proposed by the Grid Service Providers.
Draft Report
In its initial submission, WaterSecure submitted information templates that included different cost categories compared with the forecast cost estimates provided in its submission. The Authority adopted the template estimates with updates where appropriate to take account of revised forecasts.
For the WCRW scheme, WaterSecure advised that its forecast fixed operating costs have been prepared with the assistance of its plant operator, Veolia Water. It is a contractual requirement that the draft Target Operating Cost (TOC) budget be submitted to WaterSecure by 31 March 2011. WaterSecure has 60 business days to review the draft budget and make adjustments and agree on a final budget.
The Alliance (Veolia, John Holland and WaterSecure) that operates the Tugun desalination plant are not required to prepare annual budgets. The Alliance contractor is assisting the owner in preparing a budget for 2011-12. The timeframe for completion is aligned with the WCRW 60 business day review period.
WaterSecure proposed draft fixed operating costs for 2011-12 of $72.8 million. Table 5.11 below summarises the components which comprises WaterSecure’s expected fixed operating
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charges for the regulatory period, along with a comparison of the same charges for 2010-11. The Authority was unable to identify Fixed Operating Charges for prior years.
The fixed operating charges proposed by WaterSecure incorporate the decommissioning of the Gibson Island plant, the decommissioning of half of the Bundamba plant, and the ‘hot standby’ mode of operation for the Tugun desalination plant.
Table 5.11: WaterSecure's 2010-11 and Proposed 2011-12 Fixed Operating Costs ($m)
Category Operating Cost Component 2010-111 2011-12 Proposed
Fixed Operating Employee Direct & Indirect Costs 9.4 8.1
External Consultant Costs 1.3 1.3
Water Analysis & Lab Consumables 1.2 2.1
Planned Maintenance 7.2 7.7
Unplanned Maintenance 0.5 0.9
Spare Parts 1.0 1.5
Plant Consumables 0.5 0.6
Rentals 0.3 0.2
Fixed Energy 1.7 2.9
Office and IT Related Costs 0.8 0.9
Motor Vehicle Expenses 0.3 0.7
Other Fixed Costs 1.3 1.4
Operational Project Management 9.4 8.5
Owner Costs Insurance 1.1 1.5
Property Rates and Utilities 1.1 1.3
Plant Defect Maintenance 4.2 11.3
Other, including Plant Mothballing 0 2.0
Audits 0.8 0
Overheads Fixed Overheads 18.0 20.1
Total Fixed Operating Costs 60.0 72.8
Note: these figures may not add due to rounding. 1: 2010-11 costs provided by WaterSecure for equivalent cost items. Total approved by QWC for 2010-11 was $82 million.
The comparison with 2010-11 showed that the greatest increases in fixed operating costs are Plant Defect Maintenance ($7.1 million), Fixed Overheads ($2.1 million), Fixed Energy ($1.2 million), and Water Analysis and Lab Consumables ($0.9 million). Employee Direct and
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Indirect costs decreased by $1.3 million between the periods, as do Operational Project Management ($0.9 million) and Rentals ($0.1 million).
WaterSecure also submitted a further breakdown of its Corporate Costs which are provided in Table 5.12 below.
Table 5.12: WaterSecure’s Proposed Entity Overhead Costs for 2011-12 ($m)
Fixed Overheads Value
Business Services 8.1
Technical Services 1.8
Executive Services 0.4
Operational Services 5.2
Corporate Services 3.5
Office Management 1.1
Total 20.1
Note: these figures may not add due to rounding.
In its submission to the Authority for the 2011-12 GSC investigation, WaterSecure categorised a number of fixed operating cost items (Insurance, Property rates and utilities, Plant defect maintenance, Plant Mothball, and Audits) as ‘Owner Costs’.
In the Draft Report, the Authority recommended that WaterSecure bring forward Veolia’s draft budget submission date so that in future regulatory periods, the operating budget data supplied to the Regulator is finalised. However, since WaterSecure and Veolia are party to a long- standing (more than 15 years) operations and maintenance contract, the Authority understands that this recommendation may be difficult to implement.
The Authority engaged SKM to review the adequacy of the data provided by WaterSecure and the prudency and efficiency of the proposed fixed operating costs.
Prudency and Efficiency Review
For opex to be included in prices, it is required to be prudent (demonstrated need for the expenditure to meet its requirements) and efficient (least cost and consistent with relevant benchmarks, having regard to prevailing market conditions, historical trends and the potential for efficiency gains or economies of scale).
For the Draft Report, SKM undertook a sampling process for reviewing the prudency and efficiency of WaterSecure’s fixed operating costs. SKM reviewed a sample of 7 proposed fixed operating expenditure items (13 if disaggregated according to facilities), accounting for 49% of total fixed operating expenditure.
The sample is listed in Table 5.13 below.
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Table 5.13: Fixed Operational Costs Reviewed by SKM ($m)
Item Category Cost Estimate 2011-12
Operational Project Management Bundamba, Luggage Point, Gibson 6.6 Island, Network
Employee Costs Bundamba, Luggage Point, Gibson 4.4 Island
Luggage Point Plant Defects Luggage Point 3.2
Gibson Island Mothballing Costs Fixed Gibson Island 1.6
Repairs and Maintenance Network, Desalination 6.3
Business Services Overheads 8.1
Operational Services Overheads 5.2
Total Sample 35.4
Total Fixed Operating Costs 72.8
Total Sample/Total Fixed 49% Operating Costs
Note: these figures may not add due to rounding.
These items are reviewed below, with SKM’s conclusions and the Authority’s recommendations.
(a) Operational Project Management Costs – $6.6 million
This sample included the Operational Project Management Costs for the Bundamba ($2.48 million), Luggage Point ($2.04 million) and Gibson Island AWTPs ($0.37 million), as well as pipelines assets ($1.75 million).
This cost category relates to the profit and overhead margin that Veolia charge, as per the contractual arrangement, to WaterSecure to operate these assets. It also includes the allocation of costs for the Veolia office in the city, and any research and development costs associated with each asset.
SKM found that the expected operating expenditure for Operational Project Management is prudent. SKM concluded that whilst Research and Development is not a requirement of the grid contract, SEQ System Operating Plan, SEQ Water Grid Operating Strategy or Standards of Service identified by WaterSecure, it plays an important role in helping WaterSecure meet the water quality requirements of the end users in a cost effective manner.
SKM also found that the proposed Operational Project Management Cost expenditure is efficient. A comparison of the relative proportion of operational project management costs with internal benchmarks shows the costs to be comparable with other utilities of similar size.
In the Draft Report, the Authority accepted SKM’s recommendation that WaterSecure’s proposed expenditure for Operational Project Management Costs is prudent and efficient.
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(b) Employee costs - $4.4 million
This sample included the Employee Costs for the Bundamba ($2.14 million), Luggage Point ($1.86 million) and Gibson Island AWTPs ($0.35 million).
This category represents the employment costs for personnel directly relating to the operation of the AWTPs. All of these personnel are employed by Veolia Water. The costs comprise of direct costs (salaries and wages, bonuses) and indirect costs (allowances, fringe benefit taxes, payroll tax, staff clothing etc.).
On the basis that labour is required to both operate and maintain the AWTPs, SKM found the expenditure for employee costs to be prudent. Since there is little published benchmarking data available to verify staffing requirements, SKM had difficulty in determining whether the employee costs were efficient. On the weight of evidence however, SKM was satisfied that the proposed employee costs for Bundamba and Luggage Point are in keeping with a least cost method of delivery.
SKM could not confirm that the Gibson Island proposed expenditure is efficient because verification of the maintenance strategy for the mothballed plant by a third party has not been completed, and also because WaterSecure’s budget process lacks a consideration of options to demobilise or partially demobilise plants.
The Authority accepted SKM’s recommendation that WaterSecure’s proposed expenditure for Employee Costs (for the Bundamba, Luggage Point and Gibson Island AWTPs) is prudent, but only partially efficient. The Authority therefore recommended that the $0.347 million allocated for the employee costs of the Gibson Island mothballing project be excluded from the recoverable component of WaterSecure’s Fixed Operating Charge.
(c) Luggage Point Plant Defects - $3.2 million
SKM’s sample included Plant Defect costs for the Luggage Point AWTP. SKM found that the plant construction agreements did not include allowances for the defects which need to be rectified, and where warranties on equipment are available that these have been utilised. On the basis that the repair of minor defects is required to ensure the efficient and safe operation of the Luggage Point AWTP, SKM found this proposed expenditure to be prudent.
SKM also concluded that the expenditure for Plant Defects at Luggage Point is efficient on the basis that the construction contract did not allow for rectification of defects of this nature to be recovered under a defects liability period. SKM reviewed the unit rates used in the estimate of known repair items and considered these to be in line with market rates.
The Authority accepted SKM’s recommendation that WaterSecure’s proposed expenditure for Plant Defects is prudent and efficient.
(d) Gibson Island Mothballing Costs - $1.6 million
Based on an announcement by the Queensland Government in December 2010, WaterSecure proposed a cost of $1.6 million to mothball the Gibson Island AWTP. The combined savings from mothballing the two AWTPs is estimated to be approximately $5 million in the first year. Provided that the plant has achieved practical completion, it is due to be handed over for mothballing on 1 July 2011.
SKM found that the proposed expenditure for the mothballing of the Gibson Island AWTP is prudent based on the decision by the Queensland Government in 2010. However, SKM could not confirm this expenditure to be efficient given that:
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(a) evaluation of options is not yet complete; and
(b) an independent verification of all aspects of the mothballing process has not yet been undertaken.
The Authority accepted SKM’s recommendation that WaterSecure’s proposed expenditure for Mothballing is prudent, but not efficient. However, it is noted that mothballing is a requirement imposed on WaterSecure by the Government and that some costs will be incurred.
The Authority therefore recommended excluding this amount from calculation of the Fixed Operating Charge, pending further review prior to the Final Report.
(e) Repairs and Maintenance - $6.3 million
This sample included the Repairs and Maintenance costs for WaterSecure’s PRW Network ($1.68 million) and Tugun Desalination assets ($4.66 million).
Repairs and Maintenance are undertaken on WaterSecure’s Network and include civil, electrical, mechanical and land maintenance activities. These works are undertaken by Veolia Water as part of its operation and maintenance agreement with WaterSecure and includes:
(a) planned maintenance;
(b) repairs and maintenance projects;
(c) unplanned maintenance in the case of break downs; and
(d) provision of critical spare parts.
SKM considered that the scope of works proposed for the Repairs and Maintenance program are required to fulfil WaterSecure’s obligations under the Grid contract, and hence this expenditure is prudent. Whilst SKM considered that the unit rates and frequency of repairs are reasonable, they do not consider the current Operation and Maintenance Agreement to reflect the least cost method of delivery. SKM concluded that they had insufficient information to assess whether the costs were efficient.
The Authority noted that WaterSecure is bound by an agreement with the scheme operator made at a time when the scheme was expected to be operating at 100% capacity. However, the Authority accepted SKM’s recommendation that WaterSecure’s proposed expenditure did not represent least cost service delivery.
The Authority therefore recommended excluding this amount from calculation of the Fixed Operating Charge, pending further review prior to the Final Report. It is expected that more information should be made available once WaterSecure has completed its negotiations with Veolia in June 2011.
(f) Business Services - $8.1 million
Business Services are defined by WaterSecure as the costs built up from the following areas of the budget:
(a) Chief Financial Officer;
(b) accounting;
(c) human resources;
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(d) commercial; and
(e) information technology.
Except for an amount of $40,000 for transition merger costs (not material), SKM found that the expenditure for Business Services is prudent. Apart from the transition merger costs, all of the Business Services activities are necessary for WaterSecure to fulfil its obligations in the Grid Contract, as well as regulatory and legal obligations.
SKM also found that the expenditure for Business Services is efficient. The benchmarking that had been undertaken indicated that the proposed expenditure is comparable with organisations of a similar size to WaterSecure.
The Authority accepted SKM’s recommendation that WaterSecure’s proposed expenditure for Business Services is both prudent and efficient.
(g) Operational Services - $ 5.2 million
Operational Services are defined by WaterSecure as the cost built up from the following areas of the budget:
(a) Operations Office;
(b) Operations Management;
(c) Operations PRW;
(d) Operations Desalination;
(e) Land Management;
(f) Environment;
(g) Asset Management; and
(h) Transition Management.
SKM found the expenditure for Operational Services to be prudent. Operational Services provide oversight for the plant’s operations that have been contracted out. SKM considered that the provision of such oversight is required to both administer the contracts and to ensure compliance with the Grid Contract and other legal obligations.
SKM also found this expenditure to be efficient. The bulk of activities are undertaken by in- house labour, with consultants engaged only where specialist knowledge is required or for short term peaks in workload. SKM considered that this represents the least cost method for delivering Operational Services.
The Authority accepted SKM’s recommendation that operational services expenditure is efficient.
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Summary of Fixed Operating Charge
The results of SKM’s review are summarised in Table 5.14 below.
Table 5.14: Summary of SKM Reviewed Fixed Operating Costs ($m)
Cost Proposed 2011-12 Prudency Efficiency QCA Draft Cost Recommendation 2011-12 Cost
Operational Project 6.6 Prudent Efficient 6.6 Management (Bundamba, Luggage Point, Gibson Island AWTPs and Network)
Employee Costs 4.4 Prudent, excluding Efficient, 4.0 (Bundamba, Luggage Gibson Island AWTP excluding Gibson Point, Gibson Island Island AWTP AWTPs)
Plant Defects (Luggage 3.2 Prudent Efficient 3.2 Point AWTP)
Mothballing (Gibson 1.6 Prudent Not efficient 0 Island AWTP)
Repairs and 6.3 Prudent Not efficient 0 Maintenance (Network, Tugun Desal)
Business Services 8.1 Prudent Efficient 8.1
Operational Services 5.2 Prudent Efficient 5.2
Note: these figures may not add due to rounding.
SKM excluded $8.3 million on the basis that insufficient information was available to ascertain whether or not the expenditure was efficient. This has the effect of reducing WaterSecure’s proposed fixed operating costs from $72.8 million for 2011-12 to $64.5 million.
In the Draft Report, the Authority acknowledged that WaterSecure’s forecast Fixed Operating Charge will require further consideration prior to the Final Report to take account of updated information from its Veolia contracts. WaterSecure advised that additional information from Veolia is being collated in response to SKM’s analysis, but this is not available in time for the Draft Report.
The total Fixed Operating Charge is provided in Table 5.15.
Table 5.15: Summary Fixed Operating Charge ($m)
$
WaterSecure Proposed 2011-12 72.8
QCA Draft Recommendation 2011-12 64.5
Approved 2010-11 82.0
Note: these figures may not add due to rounding.
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Stakeholder Submissions on the Draft Report
In response to the finding by SKM that the Gibson Island Employee and Mothballing costs were found to be both prudent but not efficient, WaterSecure provided additional comment.
Employee Costs – Gibson Island AWTP
WaterSecure submitted that for the period January to June 2012, a budget allowing for 1.9 FTEs on site at the Gibson Island AWTP will maintain and preserve the asset to an appropriate state.
WaterSecure has investigated the decommissioning of a water re-use facility in Arizona and reviewed the methodologies, practices and processes used to decommission and preserve that plant. By way of comparison, the mothballed plant at Yuma, Arizona, currently employs 60 staff (while acknowledging that the plant’s capacity is nearly eight times greater than Gibson Island AWTP).
Gibson Island Mothballing Costs
WaterSecure submitted that the decision by the Minister (in late November 2010) to decommission the Gibson Island plant was driven by the desire to achieve estimated cost savings of around $5 million per annum. WaterSecure acknowledged that further evaluation of alternative options was required in order to derive a more accurate budget proposal.
WaterSecure advised that planning for the optimal mothballing scenario was protracted because of the need to work through the options and risks in order to achieve the correct outcomes between asset protection, asset readiness and operational / capital expenditure across both short and long term time frames.
Since the initial submission to the Authority in March 2011, WaterSecure has undertaken further planning and analysis to ensure that the Gibson Island plant is shutdown and preserved in a safe and efficient manner. WaterSecure supplied further information to the Authority, including the outcomes of this planning and analysis:
(a) Gibson Island AWTP Draft Maintenance Strategy – details the ongoing maintenance required to deliver an optimum whole of life cost for the assets;
(b) Gibson Island AWTP Condition Assessment and Monitoring Plan – provides an assessment of asset condition and performance of Gibson Island for the effective management of the asset life and maintenance;
(c) Gibson Island AWTP 2011 De-Commissioning Plan – details the steps involved in the condition monitoring, staged shutdown, decommissioning and preservation of the Gibson Island asset; and
(d) Financial Analysis of alternative options for treatment of the RO membranes – three options are under evaluations, being either straight disposal, removal from plant and storage offsite, or storage at the plant. Assessment of the risks and benefits are currently under review including NPV calculations over a five and 10 year timeframe.
Repairs and Maintenance
WaterSecure submitted that SKM’s finding in relation to the Repairs and Maintenance budget that the unit rates and frequency of repairs are reasonable yet not reflective of the least cost method of delivery, is contradictory. WaterSecure stated that Veolia’s maintenance strategy is premised on the equipment suppliers’ recommendations for servicing and maintenance, and in some cases Veolia is obliged to follow maintenance regimes in order to comply with warranties.
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WaterSecure, in conjunction with Seqwater’s senior Maintenance personnel, reviewed the rates and frequency of the proposed Repairs and Maintenance plan. Seqwater found that the proposed rates and frequency were competitive and adequate, respectively. Seqwater also recommended that a number of servicing costs be reduced based on their benchmarks.
Authority’s Final Decision
The Authority re-engaged SKM to review the three opex projects which were found to be either not prudent or efficient and were excluded from the calculation of WaterSecure’s Grid Service Charge in the Draft Report. SKM also responded to WaterSecure’s comments and took account of new information provided by WaterSecure. SKM found that:
(a) employee costs: Gibson Island AWTP ($0.347 million) – WaterSecure has clear obligations under the Grid Contract to produce and supply purified recycled water to meet specified demands. SKM concluded that expenditure for employee costs was prudent, as labour is required to both operate and maintain the AWTPs. SKM also concluded that the proposed staffing levels for the plants in their new mode of operation were reasonable, and that the salaries, benefits and other allowable costs are commensurate with current industry conditions. SKM therefore considered this expenditure to be efficient;
(b) mothballing: Gibson Island AWTP ($1.6 million) – the SEQ Grid Operating Strategy places a clear obligation on WaterSecure to de-mobilise the Gibson Island AWTP. Therefore, SKM concluded that the expenditure for mothballing was prudent. SKM noted that WaterSecure is currently undertaking an option analysis to determine the most effective way to mothball the Gibson Island AWTP. While the review was not yet completed, WaterSecure had indicated that for a short mothballing period (i.e. less than five years) preserving the RO membranes is preferable (costing $1.53 million). However, for a mothballing period of five to 10 years, WaterSecure noted that disposal of the RO membranes is preferable (costing $1.48 million). SKM considered that the process being undertaken is both exhaustive and representative of good practice, considering the lack of industry information available worldwide. SKM concluded that the efficient expenditure for mothballing the Gibson Island AWTP would not exceed $1.53 million; and
(c) repairs and maintenance: PRW Network and Tugun Desalination ($6.3 million) – WaterSecure has obligations in its Grid Contract to supply purified recycled water at the required quantities and quality. Therefore, SKM concluded that the expenditure for repairs and maintenance is prudent. SKM considered that the unit rates and frequency of repairs were reasonable. However, SKM considered that the budget setting process as defined in the current maintenance and operation agreements and hence efficient outturn in overall operating costs under the agreements was highly dependent on both parties having the knowledge and experience to accurately determine reasonable and realistic budget operating costs. SKM noted that there was an established procedure for WaterSecure to review and agree the draft budget developed by Veolia Water over a 60- working day review period (in relation to the WCRW scheme). In addition to the pain share/gain share mechanism, this provides a degree of protections and safeguards to ensure that the final budget costs are efficient. Therefore, SKM considered the costs for repairs and maintenance on the WCRW scheme was efficient.
The Authority accepts SKM’s finding that WaterSecure’s proposed fixed operating expenditure is both prudent and efficient. A summary of the fixed operating costs reviewed by SKM for the Final Report and the Authority’s final recommendation are provided in Table 5.16 below.
99 Queensland Competition Authority Chapter 5: WaterSecure
Table 5.16: Summary of SKM Reviewed Fixed Operating Costs ($m)
Cost WaterSecure Prudency Efficiency QCA Draft QCA Final Proposed Recommendation Recommendation 2011-12 Cost
Employee Costs 4.4 Prudent Efficient 4.0 4.4 (Bundamba, Luggage Point, Gibson Island AWTPs)
Mothballing (Gibson 1.6 Prudent Efficient 0 1.5 Island AWTP)
Repairs and 6.3 Prudent Efficient 0 6.3 Maintenance (Network, Tugun Desal)
Note: these figures may not add due to rounding.
The total recommended Fixed Operating Charge for 2011-12 is provided in Table 5.17 below. The Authority notes that the difference between WaterSecure’s proposed fixed operating expenditure and the Authority’s recommended fixed operating costs reflects the slight difference in efficient mothballing costs associated with the Gibson Island AWTP. WaterSecure proposed $1.6 million while SKM concluded the efficient costs reflected $1.5 million.
Table 5.17: Summary Fixed Operating Charge ($m)
$
WaterSecure Proposed 2011-12 72.8
QCA Draft Recommendation 2011-12 64.5
QCA Final Recommendation 2011-12 72.7
Approved 2010-11 82.0
Note: these figures may not add due to rounding.
5.4 Variable Operating Charge
The Market Rules require that variable operating costs be determined on a $/ML basis for each GSP.
The Direction Notice requires the Authority to adopt production forecasts for the regulatory period consistent with the WGM’s Operating Strategy.
Draft Report
In its initial submission, WaterSecure proposed variable operating costs for 2011-12 of $13.5 million, which is less than the $15.5 million cost in 2010-11 due to the planned closure and mothballing of one and a half AWTPs, and ‘hot standby’ of the Tugun Desalination plant (Table 5.18). The 2011-12 costs comprise $8.6 million for energy costs associated with the Tugun desalination plant and the WCRW scheme and the water pumping, $3.6 million associated with chemical treatment to ensure the quality of water delivered meets safe drinking standards, $0.2 million for cleaning chemicals, and $1.1 million for sludge and waste disposal.
100 Queensland Competition Authority Chapter 5: WaterSecure
Table 5.18: WaterSecure’s 2010-11 and Proposed 2011-12 Variable Operating Costs ($m)
Variable Operating Costs Approved 2010-11 2010-11 Actual/Forecast 2011-12
Variable Energy 16.4 10.1 8.6
Treatment Chemicals 5.8 4.7 3.6
Cleaning Chemicals 0.2 0.2
Sludge and Waste Disposal 1.6 0.5 1.1
Total Variable Operating Costs 23.8 15.5 13.5
Note: these figures may not add due to rounding.
Table 5.19 below details the proposed average variable cost per megalitre for the two WCRW plants expected to be operating in 2011-12, the network assets, and the Tugun desalination plant. Due to the higher water pressures used in the desalination reverse osmosis process, and the Government mandated purchase of carbon offsets, energy costs for the Tugun desalination plant are higher than the two AWTPs.
Table 5.19: WaterSecure’s Proposed Variable Operating Cost by Plant 2011-12 ($/ML)
AWTP Bundamba AWTP Luggage Point Network Desalination
Variable Energy 138.90 142.60 112.88 539.23
Treatment Chemical 151.92 197.81 0 110.67
Cleaning Chemical 14.79 10.55 0 1.77
Sludge and Waste Disposal 60.68 60.68 0 25.84
Total Variable Costs 366.30 411.64 112.88 677.57
Note: Gibson Island AWTP is mothballed in 2011-12. The costs exclude the plant operator margin.
The Authority engaged SKM to review the adequacy of the data provided by WaterSecure and the prudency and efficiency of the proposed variable operating costs. SKM reviewed the calculation of costs, benchmarking of costs, delivery of service, and efficiency gains and synergies for the operating expenditure items in detail.
Prudency and Efficiency Review
As noted above, for opex to be included in prices, it is required to be prudent (demonstrated need for the expenditure to meet its requirements) and efficient (least cost and consistent with relevant benchmarks, having regard to prevailing market conditions, historical trends and the potential for efficiency gains or economies of scale).
In the limited time available for review, SKM undertook a sampling process for reviewing WaterSecure’s proposed variable operating costs. SKM reviewed one variable cost item accounting for 36% of total proposed variable operating expenditure.
This item is reviewed below, with SKM’s conclusions and the Authority’s recommendations.
101 Queensland Competition Authority Chapter 5: WaterSecure
(a) Electricity Costs - $4.9 million
This category represents the variable electricity costs associated with the Tugun desalination plant. The proposed 2011-12 expenditure of $4.9 million is made up of $3.5 million of ‘black power’, and $1.5 million of associated ‘green power’ costs. The black power component is an agreed variable charge cost based on tariff charges through the electricity provider, while the green power component is the purchase of renewable energy certificates to offsets the CO2 emissions of the desalination plant. This purchase of CO2 offsets was announced by the Queensland Government during the construction of the plant in order to reduce its carbon footprint.
SKM considered WaterSecure’s electricity costs to be prudent given that this expenditure is essential for achieving the obligations set by the WGM, as well as the Water Quality performance requirements as per these agreements. SKM also considered the costs to be efficient given the current operating environment and uncertainty around the forecast demand volumes.
The Authority accepted SKM’s recommendation that WaterSecure’s proposed expenditure for electricity costs was both prudent and efficient.
(b) Assessment of Total Variable Operating Costs
The Direction Notice requires the Authority to accept production forecasts for the regulatory period consistent with the WGM’s Operating Strategy.
It is important to note that output from the AWTPs is currently provided for the Swanbank and Tarong power stations. Section 8.3 of the SEQ System Operating Plan (SOP) stated that the Western Corridor Recycled Water Scheme is the primary supplier of water to Swanbank and Tarong power stations. According to the SOP, the supply of water from the Gold Coast Desalination Plant is to be maximised when the total volume of water stored by key water grid storages falls below 60%.
Table 5.20 below outlines the anticipated production of recycled and desalinated water for 2011-12 as forecast by the WGM. The recycled water forecasts are based on expected demand by power stations in 2011-12, while the desalinated water demand is based on a ‘hot standby’ mode of operation with contingencies to cover water quality and Seqwater plant issues.
Table 5.20: Western Corridor Recycled Water Scheme Demand Forecast 2011-12
Plant WaterSecure Forecast 2011-12 Forecast average ML per year to be produced (WGM)
Bundamba AWTP 7,300 2,773 to 6,982 (range)
Luggage Point AWTP 7,300 2,773 to 6,982 (range)
Gibson Island 0 0
WCRW Scheme (Network) 14,600 5,545 to 13,963 (range)
Tugun Desalination Plant 9,054 9,017
Note: the above numbers are sourced from the SEQ Water Grid Operating Strategy, Attachment 10.
Pursuant to the Direction Notice, the Authority accepted production and throughput forecasts for the regulatory period that are consistent with the WGM’s Operating Strategy. However, the
102 Queensland Competition Authority Chapter 5: WaterSecure
Authority noted that the WGM had provided a range for volumes attributable to the Bundamba and Luggage Point and Network Assets.
Table 5.21 below presents the total forecast variable operating costs for WaterSecure’s main assets. It is important to note that the difference between the water volumes forecast by WaterSecure (38,254 ML) and the WGM (20,107 ML) can be mostly accounted for by lower water production by the WCRW scheme. The WGM forecast a WCRW low demand scenario of 5,545 ML for 2011-12, compared to a forecast volume of 14,600 ML by WaterSecure. WaterSecure’s variable operating costs shown in Table 5.18 are based on its assumed throughput. The Authority applied these unit rates in determining the total Variable Operating Charge.
The Authority recommended a range for the Variable Operating Charge on the basis of the low and high volume scenarios provided by the WGM. The unit rates provided by WaterSecure have been used to determine the low and high estimates for the Variable Operating Charge.
The recommended forecast operating cost is $4.6 million less than the proposed forecast operating cost for 2011-12 at the lowest volume of throughput.
Table 5.21: WaterSecure’s Proposed and Recommended Variable Costs
Volume (ML) (WGM) Variable Operating Forecast Operating Cost Charge ($/ML) ($m)
Bundamba AWTP 2,773 to 6,982 (range) 366.30 1.02 to 2.56
Luggage Point AWTP 2,773 to 6,982 (range) 411.64 1.14 to 2.87
Gibson Island AWTP 0 - -
WCRW Network 5,545 to 13,963 (range) 112.88 0.63 to 1.58
Tugun Desalination Plan 9,017 677.57 6.11
Total Recommended 14,562 610.65 8.89 2011-12 (Minimum)
Total Recommended 22,980 570.80 13.12 2011-12 (Maximum)
Total Proposed by 23,654 569.10 13.46 WaterSecure
Approved 2010-11 32,896 727.60 23.94
Note: these figures may not add due to rounding.
The difference between the Authority’s recommended total Variable Operating Charge and that proposed by WaterSecure can be accounted for by the variation in forecast demand as sourced from the WGM.
The Authority noted that average unit costs for 2011-12 are projected to be lower than for 2010- 11.
Stakeholder Submissions on the Draft Report
No comments were received from stakeholders regarding WaterSecure’s variable operating expenditure for 2011-12.
103 Queensland Competition Authority Chapter 5: WaterSecure
Authority’s Final Decision
The Authority proposes no change to the Draft Report recommendation.
5.5 Allowable Costs
Allowable operating costs are intended to capture legitimate business costs not reflected in fixed and variable operating costs.
Draft Report
WaterSecure’s proposed allowable costs are summarised in Table 5.22.
Table 5.22: WaterSecure's Proposed Allowable Costs ($m)
Item Cost 2011-12
Working Capital Allowance 1.29
Queensland Water Commission Levy 8.0
Queensland Competition Authority Levy 0.9
Total 10.2
Note: these figures may not add due to rounding.
In its submission to the Authority, WaterSecure claimed $2 million as an Allowable Cost for the mothballing of the Gibson Island and Bundamba 1B AWTPs. WaterSecure also proposed a $3.8 million allowance for flood damage costs across the WCRW scheme. In order to avoid double counting, and to also align with the actual 2011-12 data template (Appendix 1 to the WaterSecure submission) from WaterSecure, the Authority did not recommend including these items as Allowable Costs. The costs of mothballing are already included in the Fixed Operating Charge. Flood damage costs can be incorporated in GSCs once the final amounts are ascertained under the review arrangements (Chapter 7).
Working Capital
Consistent with the Direction Notice, WaterSecure proposed a working capital allowance determined as accounts receivable less accounts payable.
Based on a cost of debt of 6.52%, WaterSecure estimated the working capital allowance required for 2011-12 is $1.3 million, which accounts for 0.4% of the operational revenue budget.
WaterSecure submitted that it applied an average debtor and creditor days of 30, as applied by QWC in previous GSC decisions. However, based on analysis of billing and payment schedules, in the Draft Report the Authority recommended that working capital be based on 45 debtor days and 30 creditor days (Chapter 3).
The working capital allowance is summarised in Table 5.23.
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Table 5.23: WaterSecure's Working Capital Requirements ($m)
Working Capital Approved 2010-11 WaterSecure Proposed 2011-12 QCA Draft Requirement 2011-12 Recommendation
Average Accounts Receivable 26.2 26.6 37.7
Average Accounts Payable 8.5 6.9 7.1
Average Debtor Days 30 30 45
Average Creditor Days 30 30 30
Net Working Capital 17.7 19.8 30.6
Critical Spares and Inventories 0 0 0
Total Working Capital 17.7 19.8 30.6 Requirement
Return on Working Capital 1.7 1.3 2.9 - WACC
Note: these figures may not add due to rounding.
The Authority recommended that the Price Regulator consider including working capital as a component of the capital charge, rather than an allowable cost, in future regulatory periods.
The Authority also stated that WaterSecure should include critical spares in the working capital component of its costs in future regulatory submissions. However, WaterSecure advised that critical spares are held by Veolia Water and the costs are included in charges to WaterSecure. Hence, for the 2011-12 submission, WaterSecure included critical spares in the Fixed Operating Cost category.
QWC Levy
WaterSecure forecast a QWC levy of $8.0 million for 2011-12. However, the QWC advised the Authority that the levy for 2010-11 should be continued, pending a final estimate from QWC. The Authority therefore recommended an amount of $8.11 million be included.
QCA Fees
The Authority’s Investigation Plan, as submitted to the Minister, identified the self-funding levy charged by the Authority to regulated entities as an Allowable cost. WaterSecure forecast the fee as $900,000 for 2011-12.
In the Draft Report, the Authority recommended including $710,600 of allowable costs relating to QCA fees, including GST.
Merger Costs
The Queensland Government announced that WaterSecure and Seqwater would merge to form a single bulk supply entity. This merged entity would operate from 1 July 2011. WaterSecure stated in its submission that the expected efficiency gains (with the exception of the removal of board and management costs) have not been factored into the 2011-12 budget.
105 Queensland Competition Authority Chapter 5: WaterSecure
Summary of Allowable Costs
The Draft Report recommended Allowable Costs are summarised in Table 5.24.
Table 5.24: Summary of Allowable Costs for 2011-12 ($m) – for the Draft Report
WaterSecure Proposed QCA Draft Recommendation
Working Capital (excluding critical 1.3 2.9 spares)
QWC Levy 8.0 8.11
QCA fee 0.9 0.72
Merger costs TBA TBA
Total 10.2 11.7
Note: these figures may not add due to rounding.
Stakeholder Submissions on the Draft Report
Since the release of the Draft Report, the QWC has advised the Authority that the QWC levy in 2011-12 for WaterSecure has decreased from $8.11 million (including GST) to $5.2 million (excluding GST). Further, as a result of the Seqwater/WaterSecure merger, WaterSecure’s share of the total QWC levy has decreased from 33% to 25%.
Authority’s Final Decision
No submissions were received from stakeholders regarding WaterSecure’s working capital allowance. As a result of the Capital Charge, the QWC levy and the QCA fee being amended since the Draft Report, WaterSecure’s working capital requirement has changed. The updated working capital allowance for WaterSecure in 2011-12 is summarised in Table 5.25 below.
Table 5.25: WaterSecure's Working Capital Requirements for 2011-12 ($m)
Working Capital Requirement WaterSecure QCA Draft QCA Final Proposed Recommendation Recommendation
Average Accounts Receivable 26.6 37.7 37.7
Average Accounts Payable 6.9 7.1 7.2
Average Debtor Days 30 45 45
Average Creditor Days 30 30 30
Net Working Capital 19.8 30.6 30.5
Critical Spares and Inventories 0 0 0
Total Working Capital Requirement 19.8 30.6 30.5
Return on Working Capital - WACC 1.3 2.9 2.9
Note: these figures may not add due to rounding.
106 Queensland Competition Authority Chapter 5: WaterSecure
The Authority accepts the QWC’s updated levy.
The Authority has also confirmed that as GST is rebated to the GSPs, all costs should exclude GST. As a result, the QCA fee for 2011-12 is $646,000.
The updated Allowable Costs are summarised in Table 5.26 below.
Table 5.26: WaterSecure's Total Allowable Costs 2011-12 ($m)
WaterSecure QCA Draft QCA Final Proposed Recommendation Recommendation
Working Capital (excluding critical spares) 1.3 2.9 2.9
QWC Levy 8.0 8.11 5.2
QCA Fee 0.9 0.72 0.6
Total 10.2 11.7 8.7
Note: these figures may not add due to rounding.
5.6 Summary of GSCs
WaterSecure’s GSCs for 2011-12 are recommended by the Authority as shown in Table 5.27.
WaterSecure did not propose a complete GSC for comparison to the Authority’s recommendation. However, compared to the 2010-11 GSCs, the recommended GSC is slightly lower. Increases in the Capital Charge due to the inclusion of new assets are offset by reductions in the Fixed Operating Charge and Variable Operating Charge.
The reduction in the Fixed Operating Charge is due to WaterSecure’s lower proposed fixed opex compared to what was approved in 2010-11. The total Variable Operating Charge is lower because of lower throughput volumes and lower unit costs.
Relative to the Draft Report, the GSC is some $5.2 million higher. This is mainly due to an increase in the cost of repairs and maintenance at the Tugun desalination plant considered to be prudent and efficient, partially offset by a reduction in the QWC levy for WaterSecure.
107 Queensland Competition Authority Chapter 5: WaterSecure
Table 5.27: WaterSecure's Revenue Requirements ($)
Revenue Component Approved WaterSecure QCA Draft QCA Final 2010-11 Proposed 2011- Recommendation Recommendation 12 2011-12 2011-12
Return on Drought RAB 182,532,050 N/A 192,875,902 192,875,902
Return on Non-Drought RAB N/A 358,255 364,940
Depreciation 88,746,247 110,600,000 97,009,763 97,010,801
Asset Appreciation (70,475,677) N/A (74,046,261) (74,048,063)
Ex post Adjustments 538,595
Asset Appreciation Adjustment
Capital Charge 201,341,214 N/A 216,197,659 216,203,579
Fixed Operating Costs 81,977,060 72,800,000 64,502,717 72,723,364
Variable Operating Costs 23,936,734 13,461,708 8,892,411 to 8,892,411 to 13,116,990 13,116,990
Allowable Costs 10,488,104 10,188,581 11,694,099 to 8,696,557 to 11,710,710 8,713,122
Total GSC - Maximum 317,743,112 N/A $301,286,887 to 306,515,911 to Allowable Revenue $305,528,076 310,757,055
Note: these figures may not add due to rounding.
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6. LINKWATER
6.1 Background
LinkWater is a Statutory Authority, owned by the State Government and governed by an independent Board.
Since its inception in November 2007, LinkWater submitted that it has acquired assets with a regulatory value of more than $2,042 million (as at 1 July 2011). Of these assets, $575 million relate to assets acquired from the former council water businesses, while $1,467 million represent assets constructed under the State Government’s Water Security Program.
LinkWater’s assets, as at 1 July 2011 broadly comprise:
(a) the bulk water transport facilities and pipelines previously owned by various local councils in SEQ comprising the Brisbane City Council, Gold Coast City Council, Redland City Council, Logan City Council, and Moreton Bay Regional Council; and
(b) drought assets forming part of the State Government Water Strategy Program, including: (i) the Southern Regional Water Pipeline (SRWP) – connects the Cameron’s Hill Reservoir with the Molendinar WTP. The 95km pipeline provides a two-way flow system that is capable of delivering water from Brisbane to the Gold Coast or from the Gold Coast to Brisbane; (ii) the Network Integration Pipeline (NIP) – links the SEQ Desalination Facility (SEQDF) at Tugun with the Mudgeeraba and Molendinar WTPs; (iii) the Eastern Pipeline Interconnector (EPI) – is a two-way flow connection between Heinemann Road Reservoir in Redlands to Kimberley Park Reservoir, with a pump station and Water Quality Facility (WQF) at Gramzow Road, Mt Cotton; and (iv) Stage 1 of the Northern Pipeline Interconnector (NPI Stage 1) – which connects Landers Shute WTP within Sunshine Coast Regional Council to North Pine WTP.
Overall, LinkWater’s assets include 534 kilometres of pipelines, 28 reservoirs, 22 pump stations and seven water quality treatment facilities (see Table 6.1).
Table 6.1: LinkWater's Assets (as at 1 July 2011)
Asset Type Pipeline Reservoirs Pump Water Quality Length km (Number) Stations Facilities (Number) (Number)
Inherited Assets 350 23 15 2
Southern Regional Water Pipeline 94 4 5 2
Eastern Pipeline Interconnector 8.4 0 1 1
Northern Pipeline Interconnector Stage One 47 0 0 1
Network Integration Pipeline 35 1 1 1
Total 534.4 28 22 7
109 Queensland Competition Authority Chapter 6: LinkWater
LinkWater submitted that following the completion of Stage 2 of the Northern Interconnector Pipeline its asset base will expand further, as LinkWater will assume ownership of an additional 48 kilometres of bulk water pipelines, at an expected value of $522 million from an expected commissioning date of 1 April 2012.
6.2 Capital Charge
Opening RAB
Under the Direction Notice, the Authority is required to accept the opening RAB for LinkWater as at 1 July 2011, as provided by the QWC.
The opening RAB includes actual ongoing capital expenditure from 2009-10 and 2010-11, reflecting QWC’s approach of adding actual non-drought capital expenditure into the RAB as it occurs rather than waiting until projects are commissioned (as required of the Authority in the Direction Notice).
The QWC will also provide adjustments to the RAB after the 2011-12 GSCs have been recommended to the Price Regulator to take account of actual capital expenditure for 2010-11.
Draft Report
The QWC’s opening RAB is provided in Table 6.2 below, and is compared to LinkWater’s estimates.
Table 6.2: LinkWater's RAB at 1 July 2011 ($m)
Asset LinkWater’s QWC’s Opening QWC’s Remaining Opening RAB RAB Life (Years)
Southern Regional Water Pipeline (SRWP) 872.4 866.3 63
Eastern Pipeline Interconnector (EPI) 41.0 40.3 57
Network Integration Pipeline (NIP) 220.4 219.5 61
Northern Pipeline Interconnector (NPI) Stage 1 332.9 329.4 61
Total Drought 1,466.7 1,455.4 62
Non-Drought 574.9 586.0 43
Total 2,041.6 2,041.4 56
Note: these figures may not add due to rounding. Asset life totals are weighted averages.
In its initial submission, LinkWater proposed an opening RAB as at 1 July 2011 of $1,467 million for drought assets and an opening RAB for non-drought assets of $575 million.
LinkWater stated that it has used asset values that were utilised for the purposes of calculating previous year’s proposed GSCs.
However, LinkWater recognised that the final RAB to be applied in the determination of its regulatory revenue for 2011-12 will be advised by the QWC and may differ from its interim values.
110 Queensland Competition Authority Chapter 6: LinkWater
In the Draft Report, the Authority noted that LinkWater’s estimated opening RAB for 1 July 2011 is $273,986 or 0.01% higher than the QWC’s opening RAB. LinkWater’s estimate for non-drought assets is slightly lower than the QWC’s opening RAB, while LinkWater’s estimate regarding its drought assets is slightly higher than QWC’s opening values. These differences largely offset each other. The Authority noted that the differences are not materially significant.
The Authority adopted the RAB provided by the QWC for the purposes of recommending GSCs for the 2011-12 regulatory period as required under the Direction Notice.
Stakeholder Submissions on the Draft Report
No comments were received from stakeholders regarding LinkWater’s opening RAB.
Authority’s Final Decision
The Authority proposes no change to the Draft Report recommendation.
Capital Expenditure
The Direction Notice requires that the Authority assess the prudency and efficiency of non-drought capex and post-commissioning drought capex, and assess the efficiency of forecast capex on non-drought projects commenced in a previous regulatory period.
Capex incurred on projects, including capitalised costs, are to be rolled into the RAB at the date of commissioning.
Draft Report
LinkWater submitted that its forecast capital expenditure was prepared in accordance with the requirements of the Market Rules. Further, LinkWater stated that its forecast was based on the WGM’s proposed forecast demand volumes and a costed program of work a prudent operator would invest to meet the requirements of its performance obligations.
In relation to drought capex, LinkWater submitted that consistent with the Water Security Program, Stage 2 of the Northern Pipeline Interconnector was under construction (and was estimated to cost $522 million). Once completed LinkWater will assume ownership. LinkWater submitted that this asset be rolled into LinkWater’s RAB at the project cost upon the expected date of commissioning (April 2012), consistent with the Direction Notice.
The Authority noted that in its submission, LinkWater identified a number of drought and non-drought capital expenditure items for 2011-12. However, LinkWater subsequently advised that its proposed capex for 2011-12, except for NPI Stage 2, comprises only non-drought or post-commissioning drought capex (which attracts the same commercial WACC). LinkWater proposed non-drought capital expenditure of approximately $24.4 million for the 2011-12 regulatory period. This represented a decrease of 5.8%, compared to LinkWater’s approved capital expenditure of $25.9 million for 2010-11.
The expenditure according to key asset types is summarised in Table 6.3.
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Table 6.3: LinkWater's Forecast 2011-12 Non-drought Capital Expenditure ($m)
Asset Type Asset Lives Value
Pump Stations 45 1.5
Reservoirs 55 3.0
Trunk Mains 75 10.6
Water Quality 50 0.3
Land 0 2.0
Supervisory Control and Data 7 3.5 Acquisition (SCADA)
Buildings 50 0.5
Non-Infrastructure Capex 3 2.9
Total 24.4
Note: these figures may not add due to rounding.
LinkWater identified the capital expenditure according to drivers as shown in Table 6.4.
Table 6.4: LinkWater's Proposed Non-Drought Capital Expenditure Program for 2011-12 ($m)
Capital Expenditure by Cost Driver 2011-12
Maintaining Service 16.5
Renewals 7.6
Business Efficiency 0.3
Growth 0.04
Total Capital Expenditure 24.4
Note: these figures may not add due to rounding.
LinkWater submitted that:
(a) 70 projects comprise its maintaining service capital expenditure (projects to ensure compliance with service obligations) totalling $16.5 million. This program represents 68% of LinkWater’s total non-drought capital expenditure budget, and includes the SCADA project ($3.2 million), the Tenure Gaps Pilot Land Acquisition Project ($2 million) and the barrel joints program ($1.7 million);
(b) its renewals program consists of 21 projects totalling $7.6 million. The two largest projects account for 30% of the total renewals program and 9% of LinkWater’s total non-drought capital expenditure budget. These two projects were the above ground pipe recoating programme ($1.5 million) and the Ipswich Central (Karana Downs) Pipeline replacement ($1.1 million);
112 Queensland Competition Authority Chapter 6: LinkWater
(c) it has proposed eight business efficiency capex projects totalling $0.3 million; and
(d) one growth driven capital project for 2011-12 is costed at $44,884. LinkWater stated that the lack of investment driven by growth reflected the current capacity of its drought assets to meet current and medium term forecast demand.
LinkWater also proposed non-infrastructure capital expenditure of $2.9 million for projects to support the operational activities of the business, including office equipment, fleet and IT equipment. The majority of the non-infrastructure capital expenditure addresses legacy issues relating to IT systems and asset data inherited by LinkWater from the local governments.
LinkWater reiterated that it has two distinct asset bases, comprising the relatively aged non-drought assets inherited from the former council water businesses and the newly constructed drought assets that form part of the Water Security Program.
LinkWater submitted that the inherited assets attract the majority of non-drought capex over the short-to-medium term despite representing only 28% of LinkWater’s total assets by regulatory value.
In the Draft Report, the Authority noted that the Stage 2 NPI is drought capex and is to be rolled into the RAB at the project cost. LinkWater initially proposed not to include this item in its capex for the purposes of determining Capital Charges for 2011-12. However, following further consultations with LinkWater, and to be consistent with the Direction Notice, LinkWater submitted that all drought assets be included upon commissioning. Essentially, this increases the proposed RAB by $522 million for the Stage 2 NPI for the purposes of determining the Capital Charge.
The Authority noted that should the project cost be different from that forecast, an adjustment can be made to GSCs (see Chapter 7).
(a) Prudency and Efficiency Review
The Authority engaged SKM to review the prudency and efficiency of LinkWater’s non-drought capital expenditure. SKM reviewed the cost drivers of the capex in detail and the need for, and scope and standard of works when doing so.
For capex to be included in the RAB, it is required to be prudent (demonstrated need for the expenditure) and efficient (cost effective in scope and standard, using market benchmarks).
In the limited time available for review, SKM undertook a sampling process for reviewing LinkWater’s proposed capex. The sample of six projects comprises 43% of total capex. The sample is listed in Table 6.5 below.
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Table 6.5: Capex Projects Reviewed by SKM for 2011-12 ($m)
Project Title Cost Driver Cost Estimate 2011-12
NU SCADA Project Maintaining Service 3.2
Tenure Gaps Pilot Land Acquisition Project Maintaining Service 2.0
Continuation of Barrel Joints Program (2011-12) Maintaining Service 1.7
Above Ground Pipe Recoating Program Renewal 1.5
Ipswich Central (Karana Downs) Pipeline Replacement Renewal 1.1
Valves and Chambers Evaluation and Rehabilitation Renewal 1.0 Program
Total Sample 10.6
Total Capex 24.4
Total Sample/Total Capex 43%
Note: these figures may not add due to rounding.
(i) SCADA Consolidation - $3.2 million
LinkWater submitted that its SCADA10 project will deliver a single uniform and efficient SCADA environment that improves upon the numerous systems inherited from the previous owners and Alliances. The implemented system will provide interfaces to corporate systems (where security can be assured) and enable improved productivity and security.
LinkWater noted that the risks associated with not undertaking this project include:
(a) continued non-standardisation across all levels of system architecture with the attendant operational and strategic risks and inefficiencies;
(b) avoidable SCADA system failures will continue to be costly, time consuming and disruptive due to multiple interfaces and multiple vendor products;
(c) continued high risk of security breaches occurring;
(d) business needs for data sharing will not be met;
(e) minimising the risks of non-continuity of supply; and
(f) maintenance and support costs for SCADA will continue to be high due to the multiple Service Level Agreements.
LinkWater stated that the SCADA Project will reduce reliance on proprietary SCADA systems for data management, processing, routing and warehousing, and provides greatly improved ability to interface/exchange information with other business systems (e.g. GIS, SAP and energy management).
10 SCADA refers to a system that collects data from various sensors at a factory, plant or in other remote locations and then sends this data to a central computer which then manages and controls the data. A SCADA system usually includes signal hardware (input and output), controllers, networks, user interface (HMI), communications equipment and software. All together, the term SCADA refers to the entire central system.
114 Queensland Competition Authority Chapter 6: LinkWater
LinkWater also stated that the next stage of this project allows for detailed design, site implementation and integration for much of the new system. It is planned that a provider will be selected in June 2011. The $3.2 million reflects forecast expenditure for 2011-12 only. This multi-year project is expected to total approximately $10.5 million over three years.
Following its assessment, SKM concluded that due to the operational and maintenance issues identified by LinkWater, the project is prudent. SKM also concluded that the project is considered to be efficient because the selected option was identified in a robust and comprehensive manner.
The Authority accepted SKM’s recommendation that LinkWater’s SCADA Consolidation Project to be commissioned in 2011-12 is both prudent and efficient.
(ii) Tenure Gaps Pilot Land Acquisition - $2.0 million
LinkWater stated that this project is intended to address the significant portions of the network that do not have well defined or secure tenure in favour of LinkWater such as freehold land or other registered easements. LinkWater submitted that substantial tenure gaps exist at more than 400 properties. The pilot project is to be commissioned in 2011-12.
LinkWater argued that securing suitable tenure (e.g. easements) will provide enhanced access for efficient operational activities, provide a safe contiguous corridor and minimise risk or threat from third parties activities and reduce potential risks to public safety.
Further, LinkWater noted that addressing this issue will require a significant multi-year commitment and this provision is essentially a pilot for the larger project.
Following its analysis, SKM concluded that the pilot project is prudent as the protection of LinkWater’s infrastructure is a vital factor in its ability to deliver quality water. Formal tenure over the land is a critical component of protection and maintenance measures to ensure that network integrity is guaranteed. Investigations undertaken in recent months have identified that formal tenure does not exist across all pipelines.
SKM also concluded that the project is efficient. SKM noted that whilst the scope of works lacks definition, this is to be expected with pilot studies. Justification was provided for the project costs, including roles and responsibility definitions. Based on the information provided for the project costs, SKM was satisfied that there is a requirement for these separate roles during this initial phase. SKM also recommended that the process for obtaining future easements is documented within the project plan, and that the need for the resources is reviewed as part of the project plan for future years.
The Authority accepted SKM’s recommendation that the Tenure Gaps Pilot Land Acquisition Project to be commissioned in 2011-12 is both prudent and efficient.
(iii) Continuation of the BUJ Replacement Program - $1.7 million
LinkWater noted that the barrel union joints (BUJ) replacement program is a continuation of a program which was endorsed by the Minister for Natural Resources, Mines and Energy and Minister for Trade, following the Anstead failure. It involves a progressive commissioning of new barrel joints throughout the system.
This program was subsequently approved by the QWC and a total allowance of $4.0 million was approved for the progressive replacement of BUJ with a thickness less than 6 mm. An allowance of $2.0 million was approved by the Price Regulator for inclusion in LinkWater’s 2010-11 capex program.
115 Queensland Competition Authority Chapter 6: LinkWater
LinkWater submitted that the proposed $1.7 million for 2011-12 is a continuation of this previously approved program of work.
Following its assessment, SKM concluded that the project is prudent due to the criticality of the assets affected by the BUJs and the risk involved in not replacing them.
SKM also concluded that the capital expenditure for the project is efficient as the costs LinkWater used to estimate the 2011-12 budget are reasonable when compared against the 2010-11 BUJ replacement program.
The Authority accepted SKM’s recommendation that the continuation of the BUJ Replacement Program to be commissioned in 2011-12 is both prudent and efficient.
(iv) Above Ground Pipe Recoating - $1.5 million
LinkWater submitted that the above ground pipe recoating is a continuation of the program previously approved by the QWC and is intended to ensure that the above ground steel pipes utilised by LinkWater are effectively protected from the elements and can achieve their intended effective lives.
There are 25km of above ground pipelines on LinkWater’s trunk main network representing 4.6% of LinkWater’s total bulk supply network. Each section of above ground pipe represents a critical node on LinkWater’s bulk supply network as it is exposed to the elements, the environment and the public. It involves progressive commissioning of a series of projects, with 13 sites to be commissioned in 2011-12.
LinkWater submitted that a failure in a section of above ground pipe would represent a significant incident resulting in risks of property damage to surrounding areas, hazards to the public and reduce LinkWater’s capabilities to operate the bulk supply network.
Further, condition assessments have identified that the majority of the above ground pipelines are in an acceptable condition. However, there are sections of above ground pipeline where the protective coating is damaged or in poor condition. These sections require repair and/or rehabilitation in order to maintain the integrity of the protective coating system to minimise the likelihood of future critical failures.
The objectives of this project are to repair sections of above ground pipeline where the existing protective coatings are damaged or in poor condition.
Following its assessment, SKM concluded that the project is prudent as there is an apparent need to act on the poor state of sections of above ground pipeline, as indicated by investigations and the impacts of a failure on LinkWater’s ability to fulfil its obligations under the Grid Contract.
Further, SKM concluded the project is efficient as the scope of work meets the project need and is in line with industry costs.
The Authority accepted SKM’s recommendation that the Above Ground Pipe Recoating Project to be commissioned in 2011-12 is both prudent and efficient.
(v) Ipswich Central (Karana Downs) Pipe Replacement - $1.1 million
LinkWater submitted that the Mt Crosby central pipeline is a 500 mm diameter cast iron concrete lined (CICL) water main transporting water from the Mt Crosby water treatment plant to the central region of Ipswich. The major function of the pipeline is to supply water to the Blackstone reservoir owned by QUU and is a significant source of supply to the Ipswich region.
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The consequence of a pipeline failure would be the risk of limited supply of water to the Ipswich region.
LinkWater also stated that a secondary function of the central pipeline is to provide redundancy for the EPI. This redundancy is of particular importance to ensure security of supply to one of QUU’s major customers (an abattoir). Under normal operation, the central pipeline transfers an average of approximately 5.5 ML/d of water, the majority of which is used to fill the Blackstone reservoir.
LinkWater submitted that in May 2009, a failure occurred on a section of the central pipeline prompting investigation into the cause of failure and risk of further failures in the future. Examination of the pipeline at the location of failure revealed that this section of pipeline is in poor condition and further failures are likely to occur.
Further, LinkWater noted that the options assessment report conducted subsequent to the Karana Downs pipe failure recommended decommissioning the central pipeline and replacing it with a feed from the SRWP.
Following its assessment, SKM concluded that the project is prudent. SKM noted that this conclusion was based on the condition assessment of the existing asset by MWH, as well as the criticality of the asset to LinkWater’s ability to fulfil its operating requirements. SKM also stated that the project was considered prudent in terms of scope of work and standards of service.
SKM also concluded that the project costs are reasonable when compared to published values and their previous project experience.
The Authority accepted SKM’s recommendation that the Karana Downs Pipeline Replacement Project to be commissioned in 2011-12 is both prudent and efficient.
(vi) Valves and Chambers Evaluation and Rehabilitation Program - $1.0 million
SKM noted that the main objectives of this project are to resolve the operational concerns with valves and chambers in LinkWater’s network through developing a program for condition assessment and rehabilitation and/or repair of trunk valves and chambers. The scope for this project has not yet been fully defined. The program is intended to be the beginning of an ongoing program of inspection and maintenance.
Following its analysis, SKM concluded that the project is prudent. SKM stated that this was due to the criticality of the assets affected by the issue of uncertain capacity to perform to the required standard.
SKM also stated that as the precise specifications of the infrastructure to be replaced are not specified, it is not possible to conclude that the allowance for major rehabilitation works, $25,000 per site, is an efficient value. However, on the basis that the construction of a new valve chamber is expected to be in the region of $20,000 (excluding any mechanical or electrical works) the rehabilitation/repair works of an existing chamber is likely to be cost efficient.
In addition, SKM stated that LinkWater’s Project Justification Report noted that in the event that additional budget is made available (i.e. in the event of an underspend on one site), LinkWater intends to apply any excess capital budget to the rehabilitation of the next asset in order of risk. On this basis, SKM concluded that the project is efficient.
The Authority accepted SKM’s recommendation that the Valves and Chambers Evaluation and Rehabilitation Program to be commissioned in 2011-12 is both prudent and efficient.
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(b) Summary of Capital Expenditure
SKM concluded that all six of the sample capital expenditure items were found to be prudent and efficient.
In the Draft Report, the Authority accepted SKM’s recommendation and included all of LinkWater’s proposed capital expenditure, as summarised in Tables 6.3 and 6.4, in the RAB.
Stakeholder Submissions on the Draft Report
The WGM submitted that it has reviewed the need for, and the options to, LinkWater’s SCADA project. Based on the information provided, the WGM considers that the project is needed and that there are no alternative options to it from the whole of Grid perspective. The WGM also noted that it had not reviewed options for delivering the project, as these are a matter for LinkWater and the Authority.
Further, the WGM stated that it had not reviewed LinkWater’s other proposed capital expenditure as the remaining projects are costed at below $2 million.
Authority’s Final Decision
The Authority notes that in its Draft Report, LinkWater’s SCADA project was considered prudent and efficient. The Authority therefore accepts the WGM’s conclusion that the SCADA project was prudent and proposes no change to the Draft Report recommendation.
Return on Capital
Under the Direction Notice, the return on drought assets is to be set to the forecast actual cost of debt incurred by LinkWater for its drought assets.
The cost of debt for drought assets is the book interest rate forecast by QTC for 2011-12 for each asset plus administration and capital market charge. The Authority is required to adopt the QTC rates.
Draft Report
QTC submitted the cost of debt for LinkWater’s drought assets as shown in Table 6.6. QTC advised that the differences in interest rates represent differences in market interest rates when the borrowings were made and when the Water Infrastructure Debt Pool (WIDP) was rebalanced. The WIDP has a mix of fixed and floating rate debt instruments and is adjusted each quarter.
Table 6.6: Cost of Debt Rates for LinkWater's Drought Assets
Asset Forecast Cost of Debt 2011-12
EPI 6.62%
NIP 6.59%
SRWP 6.62%
NPI – Stage 1 6.57%
NPI – Stage 2 6.09%
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For non-drought assets, the Authority must determine a pre-tax nominal WACC for non-drought assets based on parameters detailed in the Manual. The cost of debt used in the WACC is the book interest rate forecast by the QTC for each asset plus an administration and capital market charge and a Competitive Neutrality fee. The Direction Notice prescribed all other parameters to be used in determining the WACC.
For the non-drought WACC, the QTC provided key parameters as shown in Table 6.7.
Table 6.7: QTC Input Parameters for Calculation of LinkWater’s WACC
Parameter Value
Cost of debt 8.00%
Risk-free rate 5.95%
In its initial submission, LinkWater proposed a weighted cost of debt for drought assets of 6.61%. The pre-tax nominal WACC for other assets was estimated at 9.71% based on a risk-free rate of 5.61%.
Based on the parameters directed by the Price Regulator and inputs provided by the QTC as in Table 6.7, the WACC to apply to LinkWater’s non-drought RAB and post-commissioning non-drought and drought capital expenditure was calculated at 9.90%.
This compares to a pre-tax nominal WACC of 9.99% applied by the Price Regulator for 2010- 11 and 10.03% in 2009-10. The Authority noted that in 2010-11 the risk-free rate was 5.99% compared to 5.95% in 2011-12. In addition the cost of debt was 8.13% in 2010-11 compared to 8.00% in 2011-12.
Stakeholder Submissions on the Draft Report
No comments were received from stakeholders regarding LinkWater’s return on capital.
Authority’s Final Decision
The Authority proposes no change to the Draft Report recommendation.
Return of Capital
Under the Direction Notice, the Authority is to determine the return of capital based on the written down value of the assets and using a straight line regulatory depreciation based on each asset’s estimated useful life. Estimated useful lives along with the written down asset values was provided by the QWC. However, the Authority may review proposed asset lives for new assets.
Draft Report
In its initial submission, LinkWater stated that it applied a straight line method of depreciation to its average remaining asset lives. LinkWater forecasted a depreciation allowance of $21.5 million on its drought RAB and an allowance of $15.7 million on its non-drought RAB.
In terms of the depreciation of LinkWater’s proposed new commissioned capex for 2011-12, applying asset lives consistent with industry standards provides for a depreciation allowance of $1.8 million over the 2011-12 regulatory period.
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Table 6.8 below provides a summary of LinkWater’s proposed depreciation for the 2011-12 regulatory period.
However, LinkWater noted that the useful lives along with the written down asset values to be applied in the determination of its regulatory revenue for 2011-12 have been advised by the QWC.
In the Draft Report, the Authority adopted the QWC’s opening RAB values, and applied a straight line depreciation approach to each of LinkWater’s assets and 2011-12 capex items in order to derive the total depreciation allowance for 2011-12.
Estimated depreciation is summarised in Table 6.8.
Table 6.8: Depreciation Summary ($m)
Asset Approved 2010-11 LinkWater Proposed QCA Recommended 2011-12 2011-12
RAB – Drought Depreciation 23.4 21.5 21.9
RAB – Non-Drought 17.2 15.7 17.9 Depreciation
Capex Depreciation - 1.8 2.8
Total Depreciation 40.6 39.0 42.6
Note: these figures may not add due to rounding.
The Authority’s estimated depreciation is slightly higher than proposed by LinkWater due to longer asset lives assumed by LinkWater as compared to QWC. The net impact of these differences exceeds the impact of:
(a) QWC’s lower opening RAB for 1 July 2011, which the Authority has been directed to accept;
(b) the Authority not depreciating land values, some of which were previously being depreciated in the QWC’s financial model; and
(c) the Authority’s exclusion of negative non-drought asset values that were included in the RAB. According to the QWC, these reflected underspend on prior capital expenditure items. The Authority has netted these negative non drought asset values off against LinkWater’s drought assets. This will leave the overall RAB unchanged.
Stakeholder Submissions on the Draft Report
No comments were received from stakeholders regarding LinkWater’s return of capital.
Authority’s Final Decision
The Authority proposes no change to the Draft Report recommendation.
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Summary of Capital Charge
Draft Report
In its initial submission, LinkWater noted that the current interim regulatory arrangements require that the Authority should allow LinkWater to recover a sustainable revenue stream over time.
However, LinkWater submitted that it is forecasting net operating losses over the next 10 years. Linkwater stated that this is the combined result of:
(a) the cost of debt rate of return on drought assets;
(b) LinkWater’s high debt gearing ratio of 91%;
(c) straight line depreciation with a high weighted average remaining asset life; and
(d) the regulatory removal of asset appreciation gains from LinkWater’s GSCs.
In order to generate an operating surplus, LinkWater proposed an alternative application of the nominal building block model which involves:
(a) the removal of inflationary gains from annual revenues attributable to drought assets only up to a value equal to the nominal depreciation allowance for drought assets;
(b) the annual difference between the actual inflationary gain and the value removed from annual revenues to be deducted from the value of the drought asset base; and
(c) continuation of this approach until the annual depreciation allowance equals the annual inflationary gain for drought assets at which point the calculation of annual revenue would revert back to the conventional nominal building block methodology.
LinkWater submitted that this outcome would result in:
(a) an increase of approximately $14.66 million to revenue in 2011-12, which would remove the requirement for LinkWater to seek additional within year debt funding;
(b) consistency with the Government policy that LinkWater does not earn more than its cost of debt on drought assets; and
(c) preservation of net present value (NPV) neutrality with the outcome from application of the conventional nominal building block methodology.
LinkWater provided an analysis by Marsden Jacob Associates (MJA) to support its proposals. MJA estimated that the proposed approach of ‘sculpting’ the inflationary gain adjustment would increase revenue to LinkWater from the WGM over the period to 2023-24 by a total of $98 million or $73 million in present value terms.
LinkWater noted that its proposed approach would enable compliance with the Direction Notice which stated that all GSPs must be fully immunised from interest rate exposures through the full recovery of the actual cost of debt and would ensure a sustainable revenue stream over this regulatory period and the remainder of the interim regulatory arrangements.
In the Draft Report, the Authority stated that its modelling indicated that for LinkWater’s current asset base, the revenues from Capital Charges should provide free cash flows of around $12 million in 2011-12.
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The Authority noted that it is not unusual for water businesses that have invested in long term spare capacity to experience a number of years of negative net operating cash flows. The Price Regulator, in setting the 2010-11 GSCs, did not make any adjustments to account for short term negative cash flows.
Further, the Authority considered that an adjustment of the type proposed by LinkWater is not consistent with the Direction Notice. The forecast operating losses are largely a result of government policy, which the Authority has been directed to accept. Further, despite being presented as an adjustment to asset appreciation, LinkWater’s proposal could be considered as equivalent to a higher depreciation allowance, and therefore not consistent with the requirement to adopt straight-line depreciation.
While LinkWater justified its position also in regard to ensuring that it is immunised against interest rate exposure, the Authority considered that entities are ‘immunised’ when capital charges are adjusted in response to changes in actual costs of debt. A change to the treatment of asset appreciation or depreciation is not relevant to immunisation against interest rate changes.
The Authority concluded that the matter raised by LinkWater is best addressed by the Queensland Government which, as the owner of LinkWater, is free to adjust its policies in response to any concerns about LinkWater’s financial sustainability.
The Authority would require amendment of its Direction to undertake the nature of the adjustments proposed by LinkWater. The Authority has not received any communication or submission regarding LinkWater’s financial sustainability from either LinkWater’s owner (the Queensland Government) or LinkWater’s debt provider (Queensland Treasury Corporation). The Authority also has no information that leads it to conclude that LinkWater is at danger of default or insolvency.
In the Draft Report, the Authority recommended that LinkWater’s proposal regarding adjustments to asset appreciation not be adopted. The Authority also recommended that the RAB be rolled forward on the basis of capital expenditure and depreciation as reviewed above, with indexation for inflation as conventionally applied in a nominal building block model (see Chapter 3).
The total RAB, upon which the Capital Charges have been based, is summarised in Table 6.9.
Table 6.9: RAB Roll-forward ($m)
Drought Non-drought Total
Opening RAB (1 July 2011) 1,455.4 586.0 2,041.4
plus Capital Expenditure 522.2 24.4 546.6
plus Asset Appreciation 39.6 15.0 54.6
less Depreciation (24.6) (19.6) (44.2)
Closing RAB (30 June 2012) 1,992.6 605.7 2,598.3
Note: these figures may not add due to rounding. The Capital Charges were calculated as shown in Table 6.10.
LinkWater’s Capital Charge included the proposed $14.66 million asset appreciation adjustment and this accounts for the majority of the difference between LinkWater’s estimated Capital Charge and the Authority’s recommended Capital Charge. When this adjustment was removed,
122 Queensland Competition Authority Chapter 6: LinkWater
the Authority’s Capital Charge remained about $1 million higher than that proposed by LinkWater. This mainly reflects the slightly higher non-drought WACC applied by the Authority.
The estimation of depreciation and asset appreciation estimates vary between Tables 6.9 and 6.10 as the former are expressed as year-end numbers, and the latter as mid-year numbers. The use of year-end numbers in the calculation of MAR would represent an implicit assumption that revenues are received at the end of the year. However, the GSPs generally raise their revenue each month over the course of the year given monthly invoicing. If left unadjusted, this would mean that the net present value of the actual flow of revenues recovered over the course of a year will exceed that of the MAR determined by the Regulator.
To address the issue, the Authority discounted the building block components to a mid-year value using the appropriate WACC or cost of debt return. This approach gives an approximate estimate of the revenue required assuming constant revenue over the year. The adjusted components are: return on assets, return of assets (depreciation), and indexation.
The Authority’s external consultant NERA confirmed that the mid-year adjustment was appropriately applied in calculating the 2011-12 GSCs. NERA also confirmed that the mid-year discounting adjustment accurately estimates the required revenue under the current invoicing arrangements that exist for the GSPs.
The Authority did not include any adjustments from the 2010-11 Capital Charges, pending further advice from the QWC. These adjustments will be taken into account when available.
Table 6.10: Capital Charge Summary ($m)
Drought Non-drought Total
Return on Assets 100.6 56.5 157.1
plus Depreciation 21.9 20.7 42.6
less Asset (35.2) (17.4) (52.6) Appreciation
Total 87.2 59.8 147.0 Recommended Capital Charge 2011-12
LinkWater - - 156.2 Proposed Capital Charge 2011-12
Approved Capital 81.1 57.7 139.4 Charge 2010-11
Note: these figures may not add due to rounding. The Price Regulator’s Final Capital Charge for 2010-11 also includes a number of Adjustments. The Authority noted that the total recommended Capital Charge for 2011-12 is higher than the Price Regulator’s 2010-11 Capital Charge, mainly due to the addition of the Northern Pipeline Interconnector Stage 2 to the RAB in April 2012.
Stakeholder Submissions on the Draft Report
No comments were received from stakeholders in response to LinkWater’s Capital Charge for 2011-12.
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Authority’s Final Decision
In the Draft Report, the capital expenditure for the NPI Stage 2 was categorised as Non-Drought in the Capital Charge Summary, as per Table 6.10 above. For the Final Report, this has been amended to appropriately reflect the NPI Stage 2 capital expenditure as Drought expenditure. The Authority notes that the total NPI Stage 2 capital expenditure value and the total recommended Capital Charge for 2011-12 have not changed from the Draft Report.
The updated values are provided in Table 6.11 below.
Table 6.11: Capital Charge Summary ($m)
Drought Non-drought Total
Return on Assets 100.6 56.5 157.1
plus Depreciation 23.9 18.7 42.6
less Asset Appreciation (38.4) (14.3) (52.6)
Total Recommended Capital Charge 2011-12 86.1 60.9 147.0
Note: these figures may not add due to rounding.
6.3 Fixed Operating Charge
The Direction Notice requires that the Authority assess the prudency and efficiency of all fixed operating costs proposed by the Grid Service Providers.
Draft Report
In its initial submission, LinkWater proposed fixed operating costs for 2011-12 of $42.6 million, comprising of:
(a) corporate costs - $14.2 million;
(b) network operational management - $10.0 million;
(c) asset maintenance - $17.0 million; and
(d) water quality testing - $1.5 million.
LinkWater stated that it derived all costs through a bottom-up approach where labour, consultancy, contractor and specific non-capital costs were determined for each activity within the fixed operating cost components.
LinkWater submitted that its proposed fixed operating costs for 2011-12 are broadly consistent with those previously approved by the Price Regulator in 2010-11; are reasonably stable over time; and are broadly consistent with a sample of other regulated businesses.
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Table 6.12: LinkWater's Fixed Operating Costs ($m)
Fixed Operating Cost Component 2008-09 2009-10 2010-11 Proposed 2011-12
Corporate Costs - - 15.2 14.2
Network Operational Management - - 5.4 10.0
Asset Maintenance - - 17.0 17.0
Water Quality Testing - - 1.2 1.5
Total Fixed Operating Costs 37.1 40.5 38.8 42.6
Note: these figures may not add due to rounding.
LinkWater also submitted a further breakdown of its Corporate Costs which are provided in Table 6.13 below.
Table 6.13: LinkWater's Proposed Corporate Costs for 2011-12 ($m)
Corporate Costs Value
CEO and Board 1.1
Legal Services 1.4
Business Services 3.7
Corporate Services 2.9
IT and Knowledge Management 2.5
Project Support 1.1
Property Leasing 1.4
Total 14.2
Note: these figures may not add due to rounding.
LinkWater stated that a comparison of the year-on-year movement in fixed operating cost components is difficult due to inconsistencies in the manner in which data was reported in the QWC’s data templates in previous years. In particular, LinkWater noted that a number of costs were reported as ‘overhead’ costs and allocated across different cost components and as a result are difficult to track and report on a consistent basis.
However, LinkWater has noted that there was a 9.8% increase in costs for 2011-12 relative to 2010-11. LinkWater submitted that the increase was due to wage growth and a minor increase in overall full time equivalent employees.
Further, LinkWater submitted that it had identified initiatives that aim to provide efficiencies through operational improvements and synchronisation of processes. These initiatives include:
(a) a reduction in project management costs through reduced contractors and increased in- house capability; and
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(b) an increased IT system capability through improvements in GIS, SAP and SCADA systems to automate LinkWater’s work order and asset management processes therefore reducing manual procedures.
LinkWater submitted that it expects these initiatives will realise productivity improvements which will result in a reduction in labour costs associated with its project management or minor capital works function of 0.4% over 2011-12, increasing to 1.2% as these initiatives become fully operational from 2012-13 onwards.
Overall, LinkWater stated that it considered its proposed costs are reasonable and necessary to ensure it can discharge its operational requirements.
Prudency and Efficiency Review
For the Draft Report, the Authority engaged SKM to review the adequacy of the data provided by LinkWater and the prudency and efficiency of the proposed fixed operating costs.
For opex to be included in prices, it is required to be prudent (demonstrated need for the expenditure to meet its requirements) and efficient (least cost and consistent with relevant benchmarks, having regard to prevailing market conditions, historical trends and the potential for efficiency gains or economies of scale).
SKM undertook a sampling process for reviewing LinkWater’s proposed fixed operating costs. The sample of nine projects was drawn from the corporate costs, network operational management and asset maintenance cost driver categories, which account for 51% of total fixed operating costs. The sample is listed in Table 6.14 below.
Table 6.14: Fixed Operational Costs Reviewed by SKM ($m)
Item Category Cost Estimate 2011-12
Business Services Corporate Costs 3.7
Corporate Services Corporate Costs 1.9
Water Quality and Compliance Network Operational Management 1.5
Asset Insurance Network Operational Management 1.5
Network Operations Network Operational Management 1.1
Asset Management Network Operational Management 1.1
Planned Water Quality Asset Maintenance 3.5
Planned Pump Station Asset Maintenance 2.9
Unplanned Asset Maintenance 4.3
Total Sample 21.6
Total Fixed Operating Costs 42.6
Total Sample/Total Fixed 51% Operating Costs
Note: these figures may not add due to rounding.
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(a) Business Services - $3.7 million
LinkWater submitted that its business services comprise the following support functions: treasury; tax; budgeting; general financial accounting; general management accounting; payroll; performance reporting and financial services such as general accounts payable and receivable; and economic regulation.
Following its review, SKM concluded that LinkWater’s expenditure for business services is prudent. SKM stated that all of the business service activities are necessary for LinkWater to fulfil its obligations in the Grid Contract, as well as regulatory compliance and legal obligations.
SKM also concluded that the expenditure for business services is efficient. SKM noted that the benchmarking that was undertaken points to the proposed expenditure being comparable with organisations of similar size to LinkWater. Further, SKM noted that the bulk of activities are undertaken by in-house labour, with consultants only engaged where specialist knowledge is required or for short-term peaks in workload.
In the Draft Report, the Authority accepted SKM’s recommendation that LinkWater’s proposed business services expenditure is both prudent and efficient.
(b) Corporate Services - $1.9 million
LinkWater submitted that the expenditure for corporate services comprises government relations; community and stakeholder management; annual reporting; employee communications; risk management; health and safety; and environment and human resources.
Following its assessment, SKM concluded that expenditure for corporate services is prudent. SKM noted that all of the corporate service activities are necessary for LinkWater to fulfil its obligations in the Grid Contract, as well as legislation.
SKM also concluded that expenditure for corporate services is efficient. SKM noted that the benchmarking that was undertaken points to the proposed expenditure being comparable with organisations of similar size to LinkWater (based on analysis by KPMG for LinkWater and SKM’s own internal sources). Further, SKM noted that the bulk of activities are undertaken by in-house labour, with consultants only engaged where specialist knowledge is required.
The Authority accepted SKM’s recommendation that LinkWater’s proposed expenditure for corporate services is both prudent and efficient.
(c) Water Quality and Compliance - $1.5 million
Pursuant to the Water Supply (Safety and Reliability) Act 2008, LinkWater stated that it is required to maintain an approved Drinking Water Quality Management Plan (DWQMP).
In addition, the Market Rules require LinkWater to make available at bulk water supply points with the Distributor-Retailers water which meets the water quality specifications set out in its DWQMP, any applicable Grid Contract Document and operating protocol.
LinkWater submitted that a significant consideration in water quality management is the difference in water requirements of the different Distributor-Retail entities. As a result, LinkWater operates two different disinfection systems across its network, chlorine and monochlorine, which have considerable operational implications.
The water quality and compliance activities captured within network operational management are associated with the implementation and maintenance of a best-practice water quality
127 Queensland Competition Authority Chapter 6: LinkWater
management system which is appropriately accredited. The chemical costs associated with dosing and the ongoing testing of water is discussed below.
Following its assessment, SKM stated that LinkWater’s expenditure for water quality and compliance is prudent. SKM noted that all of the water quality and compliance activities are necessary for LinkWater to fulfil its obligations in the Grid Contract, as well as legislation, specifically in regards to the DWQMP.
SKM also concluded that the expenditure for water quality and compliance is efficient. SKM stated that its analysis indicated that LinkWater’s proposed expenditure is in line with market rates and LinkWater’s peers. SKM also stated that it was satisfied that LinkWater is delivering this service in a least cost manner.
The Authority accepted SKM’s recommendation that LinkWater’s proposed expenditure for water quality and compliance is both prudent and efficient.
(d) Asset Insurance - $1.5 million
LinkWater submitted that it has elected not to self insure and has acquired asset insurance coverage through an insurance broker. LinkWater stated that its insurance portfolio is $1.5 million and includes a wide range of coverage of LinkWater’s activities including but not limited to business interruption insurance in the event of operational failure of key infrastructure assets as well as public liability cover.
Following its assessment, SKM concluded that the expenditure for asset insurance is prudent as it is necessary to meet a clear obligation in the Grid Contract.
SKM also concluded that the expenditure for asset insurance is efficient. SKM stated that while the Grid Contract does not specify the level of insurance required, SKM compared LinkWater’s levels of insurance with peer organisations and concluded that it is comparable with market trends. Further, SKM considered that through LinkWater’s procurement policies and the use of Insurance Brokerage firms the service was being delivered in the least cost manner.
The Authority accepted SKM’s recommendation that LinkWater’s proposed expenditure for asset insurance is both prudent and efficient.
(e) Network Operations – $1.1 million
LinkWater stated that network operations are focussed on the day-to-day physical operation of the network to ensure that LinkWater meets is water quality assurance and volume requirements under a Grid Contract Document, the DWQMP and the WGM Grid Instructions. In particular, network operations are responsible for:
(a) creating and reviewing maintenance plans;
(b) conducting security assessments of LinkWater’s assets;
(c) preparing and maintaining service manuals for reservoir, pumping stations and water quality facilities; and
(d) assessing asset criticality audits.
LinkWater submitted that to maintain its network, it operates a fully manned 365 day 24-hour continuous real-time control room. The control room has the capacity to monitor the entire network and remotely control certain functions of both inherited and new assets.
128 Queensland Competition Authority Chapter 6: LinkWater
LinkWater stated that maintaining a control room is an essential business requirement necessary to enable LinkWater to discharge is obligations under its Grid Contract Document and the Market Rules.
Following its assessment, SKM concluded that the expenditure for network operations is prudent. SKM noted that transporting water is one of LinkWater’s core functions and the operation of a control room to oversee transportation operations is important to ensuring that obligations under the Grid Contract for both quality and quantity of water are met.
SKM also concluded that the expenditure for network operations is efficient. SKM stated that it reviewed the staffing levels and benefits and considered these to be comparable with LinkWater’s peer organisations. In addition, SKM considered that the delivery of this activity by in-house labour is representative of the least cost method.
The Authority accepted SKM’s recommendation that LinkWater’s proposed expenditure for network operations is both prudent and efficient.
(f) Asset Management - $1.1 million
LinkWater submitted that asset management is essentially focussed on ensuring LinkWater’s network is capable of delivering the required level of service (LOS) while optimising the whole of life costs of its assets. The whole of life approach encompasses planning, creation, operation, maintenance, refurbishment and replacement for long-lived assets.
LinkWater submitted that key tasks within the asset management function are:
(a) asset condition management, refurbishment and renewals planning – which focuses on assessing the condition and rate of deterioration of LinkWater’s assets and implementing appropriate works to maximise the live of the assets. Minimising corrosion of the mainly metallic pipelines used by LinkWater is a particular focus. Without such tracking and protection, the assets would suffer premature failure leading to losses of service and increased costs. This function also addresses the risk of pipeline workers arising from electrical faults being conveyed by the metallic pipes;
(b) leakage management – while a level of leakage is inevitable, the minimisation of leakages to an appropriate level is an important consideration and an useful indicator of overall system condition and integrity. Pursuant to the Water Supply (Safety and Reliability) Act 2008, LinkWater is required to develop a leakage management plan by May 2012; and
(c) metering management – given that only 32 of the 435 connection points between LinkWater and the Distribution-Retailers are metered, LinkWater provides information to the WGM in accordance with the alternative methodology published by the Rules Administrator. In addition, the Market Rules require LinkWater to prepare a metering transition plan identifying bulk supply points that are un-metered and to propose a timeline and estimated cost for the installation of meters which is consistent with the Metering Standard. This information was provided to the QWC in March 2009. LinkWater submitted an estimated cost of $34.3 million for the installation of meters.
Following its assessment, SKM concluded that the expenditure for asset management is prudent. SKM noted that all of the strategic asset management activities are necessary for LinkWater to fulfil its obligations in the Grid Contract. Further, SKM stated that these activities can be considered best practice for asset management.
SKM also concluded that the expenditure for asset management is efficient. SKM stated that the LinkWater’s proposed expenditure is in line with market rates and is delivered in a least cost manner.
129 Queensland Competition Authority Chapter 6: LinkWater
The Authority accepted SKM’s recommendation that LinkWater’s proposed expenditure for asset management is both prudent and efficient.
(g) Planned Water Quality Maintenance - $3.5 million
SKM noted that LinkWater’s planned water quality maintenance involves the routine inspection and maintenance of water quality facilities. Costs have been allocated across mechanical, electrical, structural and operational areas of operation and maintenance.
Following its review, SKM concluded that the expenditure for planned water quality maintenance is prudent. SKM noted that LinkWater has clear obligations in the Grid Contract to ensure that water transported in its assets meet specific water quality levels. Further, SKM considered that the maintenance of water quality facilities as an essential part of meeting water quality specifications.
SKM also concluded that the expenditure for planned water quality maintenance is efficient. SKM noted that whilst detailed benchmarking data is not available, SKM examined LinkWater’s proposed expenditure and considered this to be reasonable for the number of water quality assets, the extent of the network and the importance placed on water quality in the Grid Contract.
The Authority accepted SKM’s recommendation that LinkWater’s proposed expenditure for planned water quality maintenance is both prudent and efficient.
(h) Planned Pump Station Maintenance - $2.9 million
SKM noted that LinkWater’s planned pump station maintenance expenditure includes routine maintenance and inspection works associated with pump station assets. The work is to be carried out by a service contractor according to the LinkWater’s strategic asset management plan.
Following its review, SKM concluded that the expenditure for planned pump station maintenance is prudent. SKM noted that LinkWater has clear obligations in the Grid Contract to transport water from treatment plants to the retail/distribution networks. Further, SKM stated that providing a comprehensive and planned maintenance program for water pumping facilities is an essential part of meeting this obligation.
SKM also concluded that the expenditure for planned pump station maintenance is efficient. SKM noted that whilst detailed benchmarking data is not available, SKM examined LinkWater’s proposed expenditure and considered this to be reasonable for the number and size of pumping stations. In addition, SKM noted that LinkWater had identified limitations with its former Alliance maintenance and operational agreement and have established a new contract with its former alliance partners. SKM considered this a positive move, giving LinkWater increased control and knowledge of how best to maintain its assets, creating opportunities for further cost efficiencies in the future.
The Authority accepted SKM’s recommendation that LinkWater’s proposed expenditure for planned pump station maintenance is both prudent and efficient.
(i) Unplanned Maintenance - $4.3 million
SKM noted that in addition to the routine inspections and maintenance captured with the fixed fee, the LinkWater Operations and Maintenance Deed provides for additional services under a variable fee arrangement. The largest drivers of additional services are reactive works resulting from routine inspections.
130 Queensland Competition Authority Chapter 6: LinkWater
Following its review, SKM concluded that the expenditure for unplanned maintenance is prudent. SKM noted that the expenditure for unforeseen requirements (such as breakdowns) is required to enable LinkWater to re-establish its operations and meet obligations in the Grid Contract.
SKM also concluded that the expenditure for unplanned maintenance is efficient. SKM noted that whilst detailed benchmarking data is not available, SKM examined LinkWater’s proposed expenditure and considered this to be reasonable for the range of assets being maintained. In addition, SKM noted that LinkWater had identified limitations with its former Alliance maintenance and operational agreement and have established a new contract with its former alliance partners. SKM considered this a positive move, giving LinkWater increased control and knowledge of how best to maintain its assets, creating opportunities for further cost efficiencies in the future. Unplanned maintenance costs are reduced from the previous financial year due to improved operating conditions as a result of previous capital expenditure.
The Authority accepted SKM’s recommendation that LinkWater’s proposed expenditure for unplanned maintenance is both prudent and efficient.
Summary of Fixed Operating Charge
The Authority accepted SKM’s recommendation that LinkWater’s proposed fixed operating expenditure is both prudent and efficient.
The Authority’s analysis of Variable Operating Charge (see below) indicated that $0.4 million of pumping energy costs are fixed connection charges that do not vary according to the amount of electricity used. These costs were more appropriately incorporated into Fixed Operating Charges. On this basis, the Authority recommended a minor adjustment to LinkWater’s proposed Fixed Operating Charge as noted in Table 6.15.
Table 6.15: Summary of Fixed Operating Charge ($m)
Value
LinkWater Proposed 2011-12 42.6
LinkWater Proposed Fixed Electricity Charge 0.4
QCA Recommended 2011-12 43.0
Approved 2010-11 (Nominal) 38.8
Note: these figures may not add due to rounding.
Stakeholder Submissions on the Draft Report
LinkWater provided a late submission to the Authority stating that the insurance costs included in its initial submission were based on preliminary estimates from its insurance provider and that its final insurance cost (as at 30 June 2011) was slightly higher, as a result of recent natural disasters.
LinkWater requested that the Authority accept the updated insurance costs of approximately $1.7 million, compared to the initial estimate of approximately $1.45 million.
131 Queensland Competition Authority Chapter 6: LinkWater
Authority’s Final Decision
The Authority notes that LinkWater’s submission was received well after the deadline for submissions on the Draft Report and too late for the matter to be referred to SKM.
Therefore, the Authority proposes no change to the Draft Report recommendation.
6.4 Variable Operating Charge
The Market Rules require that variable operating costs be determined on a $/ML basis for each GSP.
The Direction Notice requires the Authority to adopt production forecasts for the regulatory period consistent with the WGM’s Operating Strategy.
Draft Report
In its initial submission, LinkWater proposed variable operating costs for 2011-12 of $2.9 million, comprising $2.6 million for energy costs associated with water pumping facilities to meet forecast demand and $0.3 million associated with chemical dosing to ensure the quality of water delivered meets safe drinking standards.
LinkWater submitted that its variable operating costs are largely driven by which assets are defined in the Grid Instructions to transport water to meet demand. Specifically, when the Water Grid is operating in drought mode there is a greater reliance on LinkWater’s interconnecting pipes which require greater pumping capacity to transport water from one region to another.
However, when the Water Grid is operating in non-drought mode, the reliance is on regional water supply which does not require the same degree of pumping.
LinkWater stated that prior to 2010, the water grid operated in drought mode. For this reason, LinkWater’s historic variable operating costs have been high relative to the costs proposed for 2011-12.
Table 6.16: LinkWater's Historic Approved Variable Operating Costs ($m)
Cost Category 2008-09 2009-10 2010-11 2011-12
Energy N/A 6.0 4.0 2.6
Dosing N/A 1.1 0.4 0.3
Other N/A N/A 0.1 0
Total 4.4 7.1 4.5 2.9
Note: these figures may not add due to rounding.
LinkWater stated that it applied forecasts included in the WGM’s draft SEQ Water Grid Operating Strategy Version 3, provided to LinkWater by the WGM on 21 March 2011. The WGM has advised these forecasts will inform its April 2011 Operating Strategy.
LinkWater submitted that outside of the requirement to transport defined volumes through its regional interconnector pipelines, LinkWater seeks to meet demand as far as practicable by transporting water via gravity feed. This approach minimises electricity costs generated by the
132 Queensland Competition Authority Chapter 6: LinkWater
use of water pumping capability. However, demand cannot always be addressed via gravity feed due to the hydraulics of the network and demand in terms of volume, flow and pressure. In these instances, it is necessary for LinkWater to use pumping capability to ensure delivered water meets delivery specifications as per Grid Instructions.
LinkWater stated that in meeting certain delivery obligations, it is necessary to engage multiple pumping stations on a single pipeline to ensure delivery. For this reason, there is not a direct relationship between the volume of water released from water supply sources and the volume of water pumped.
Furthermore, the volume of water chemically treated will not be equal to the water released from supply sources and water transported through pumping stations as this volume is largely determined by the requirement for different standards of water quality (i.e. chlorinated versus chloraminated) by the Distributor-Retail entities at the different demand zones as well as the distance of the demand zone location from a water dosing facility.
The forecast volumes for pumping and dosing, with forecast volumetric costs are summarised in Table 6.17. Linkwater advised that its total energy costs also include $0.4 million in fixed connection charges to make the total $2.9 million. As noted above, the Authority included the $0.4 million fixed connection charge in the Fixed Operating Charge as per Table 6.15.
Table 6.17: Summary of LinkWater’s Volumetric Charges Forecast 2011-12 ($m)
Volume (ML) $/ML Total
Pumping (Energy Costs) 118,404 18.53 2.2
Chemical Dosing 38,688 8.45 0.3
Total 2.5
Note: these figures may not add due to rounding.
Prudency and Efficiency Review
The Authority engaged SKM to review the adequacy of the data provided by LinkWater and the prudency and efficiency of the proposed variable operating costs.
As noted above, for opex to be included in prices, it is required to be prudent (demonstrated need for the expenditure to meet its requirements) and efficient (least cost and consistent with relevant benchmarks, having regard to prevailing market conditions, historical trends and the potential for efficiency gains or economies of scale).
SKM undertook a sampling process for reviewing LinkWater’s proposed variable operating costs. The sample of two projects was drawn from the electricity costs and chemical dosing categories, which account for 95% of total variable operating costs. The sample is listed in Table 6.18 below.
133 Queensland Competition Authority Chapter 6: LinkWater
Table 6.18: Variable Operational Costs Reviewed by SKM ($m)
Item Category Cost Estimate 2011-12
Pumping Stations Electricity Costs 2.6
Chambers Flat Chemical Dosing 0.2
Total Sample 2.8
Total Variable Costs 2.9
Total Sample/Total Variable Costs 95%
Note: these figures may not add due to rounding.
(a) Pumping Stations Electricity Costs - $2.6 million
LinkWater stated that based on the WGM’s proposed forecast volumes, LinkWater has forecast the average water volumes it expects to pump during peak and off-peak electricity tariff periods on a pump station basis.
LinkWater stated that pumping requirements are concentrated at LinkWater’s inherited assets reflecting the WGM’s forecast demand to be supplied from localised supply rather than through the interconnector pipelines.
LinkWater expects to pump on average 9,865 ML per month at an energy cost of $2.2 million. However, LinkWater submitted that these costs do not include the annual connection charge which is a fixed cost regardless of the amount of electricity used. LinkWater’s annual fixed connection costs with respect to its pumping stations are $0.4 million. Therefore, total forecast energy costs relating to the transportation of water for 2011-12 are $2.6 million.
In terms of the reasonableness of these costs, LinkWater submitted that it is a non-market electricity customer. On the basis that LinkWater’s tariff is the fixed gazetted tariff and the use of pumping functionality is non-discretionary (it is set to meet Grid Instructions), the issue of reasonableness must be judged according to the efficient operation of the respective pumps. LinkWater provided pump operating flow and operating power for each of its pump stations.
LinkWater considered that when assessed collectively its fixed tariff, nondiscretionary demand and pump efficiency support the reasonableness of its proposed $2.6 million in energy costs for 2011-12.
Furthermore, LinkWater stated that it has commenced investigations into the benefits of becoming a contestable electricity customer. Forecast energy costs at each pumping station are as shown in Table 6.19.
134 Queensland Competition Authority Chapter 6: LinkWater
Table 6.19: LinkWater’s Forecast Water Volumes and Energy Costs
Major Asset Pumping Station Forecast % % Operating Pump Energy Annual Pumped Pumped Flow (L/s) Operating Cost per ML at Peak at Off- Power annum $ Pumped Tariff Peak (kW) Tariff
SRWP Bundamba 0 100 0 1,990 2,230 2,167
Chamber’s Flat 13,716 30 70 1,570 2,594 374,527
Coomera 0 30 70 1,570 415 1,076
Molendinar 13,716 30 70 650 619 554,349
Swanbank 0 100 0 1,440 1,525 1,506
EPI Gramzow Road 1,464 60 40 200 185 77,588
NPI Caloundra St 10,524 50 50 25 34,560
NIP Tarrant Drive 456 80 20 1,000 138 4,314
Non- Alexander Hills 672 60 40 135 54 15,581 drought
Aspley 11,688 40 60 1,400 312 140,564
Byrnes Road 0 100 0 400 355 1,261
Cameron’s Hill 0 100 0 5,000 1,653 470
Daisy Hill 2,244 70 30 450 280 89,361
Eprapah Creek 0 100 0
Heinemann Rd 1,800 60 40 130 95 75,656
Kimberley Park 2,244 70 30 600 172 41,181
Learoyd Road 0 100 0 1,800 1,078 852
Lloyd Street 5,784 60 40 600 122 67,631
Mudgeeraba 0 100 0 600 569 1,348
North Pine 31,488 50 50 1,150 647 506,173
Stones Road 19,200 60 40 1,200 177 162,785
Trinder Park 3,408 70 30 750 142 40,539
Wellers Hill 0 100 0 2,000 543 386
Total 118,404 2,193,874
135 Queensland Competition Authority Chapter 6: LinkWater
Following its assessment, SKM concluded that the expenditure for electricity is prudent as it is required for LinkWater to meet is requirements under the Grid Contract.
SKM also concluded that the electricity expenditure is efficient, for the following reasons:
(a) as the provision of energy is yet to be market tested, it is likely that the rates applied in the calculation of the 2011-12 budget are not the lowest available. However, LinkWater demonstrated that it is currently preparing to seek out a competitive price, after consideration of the risks involved;
(b) LinkWater stated that it seeks to reduce energy costs where possible through gravity supply of water, as well as the use of off-peak rates; and
(c) the stated efficiencies of LinkWater’s pumps are reasonable.
In the Draft Report, the Authority accepted SKM’s recommendation that LinkWater’s proposed expenditure for electricity is both prudent and efficient.
(b) Chambers Flat Chemical Dosing Costs - $0.2 million
LinkWater submitted that its Grid Contract Document require the ability to deliver different water quality configurations (i.e. chlorinated versus chloraminated) to the different demand zones.
LinkWater stated that water dosing volumes are impacted by the distance of the demand zone location from the water dosing facility given that the chlorine/chloraminate levels decline over time and distance transported. That is, water may require re-dosing to top up chlorine/chloraminate levels during transit to the final demand delivery zone.
In developing its forecast costs, LinkWater determined the type and level of dosing required from each water supply source to satisfy the different water quality standards at each Distributor-Retail entity demand zone.
LinkWater stated that the costs are consistent with those approved for 2010-11. Further, LinkWater stated that the chemicals used in dosing are procured through a competitive tender process consistent with LinkWater’s procurement practices.
SKM noted that the chemical dosing expenses projected to be incurred at the Chambers Flat water quality facility are largely driven by the volume of water to be pumped and the differences in water quality requirements of the supplier and the final recipient of the water.
Following its assessment, SKM concluded that expenditure for chemical dosing at Chambers Flat water quality facility is prudent, as it is necessary to meet statutory obligations to provide safe drinking water.
SKM also concluded that the unit price obtained by LinkWater for the supply of chemicals for the dosing of water at the Chambers Flat water treatment facility is efficient. SKM stated that the rates for purchase of chemicals are reasonable for market conditions and dosage rates are seen to be suitable based on water quality compliance.
The Authority accepted SKM’s recommendation that LinkWater’s proposed expenditure for chemical dosing is both prudent and efficient.
136 Queensland Competition Authority Chapter 6: LinkWater
Assessment of Total Variable Operating Costs
As required by the Direction Notice, the WGM has provided the approved March 2011 Operating Strategy to the Authority with details of the forecast volumes at pump stations and chemical dosing points in the Water Grid. The WGM’s forecasts as at March 2011 are provided below in Table 6.20.
Table 6.20: LinkWater’s WTP Volumes to Transfer
Water Treatment Plant Owner Forecast average ML per month to be released
Landers Shute Seqwater 877
Molendinar Seqwater 3,591*
Mudgeeraba Seqwater 1,807
Tugun Desalination WaterSecure 751
Mt Crosby Seqwater 8,149
North Pine Seqwater 2,408
Capalaba Seqwater 354
North Stradbroke Island Seqwater 724
Total 18,662
Note: the above numbers are sourced from the SEQ Water Grid Operating Strategy, Attachment 10. The forecast average monthly volumes for the Molendinar WTP reflect the forecast volumes from LinkWater’s submission, as per the explanation below.
In the Draft Report, the Authority noted that the forecast average monthly volumes for the Molendinar WTP in the WGM’s Water Grid Operating Strategy were different to the volumes provided in LinkWater’s submission.
LinkWater subsequently advised that historically supply from Molendinar has been distributed to both LinkWater and Southport in the Gold Coast region via two separate water treatment points. However, recently the two treatments points have been consolidated to one treatment point (LinkWater’s). As a result, all dispatch now enters LinkWater’s network, albeit only to get treated, before entering Southport. The length of transportation is probably all of 50 metres, however, to demonstrate a balance between dispatch and delivery the water delivered to Southport it needs to be recognised in LinkWater’s supply.
The WGM has acknowledged the error and agrees with LinkWater that since re-valving was done at the site, all production from Molendinar WTP passes through LinkWater assets. The WGM also indicated that it will update the Molendinar volumes to reflect the re-valving.
Pursuant to the Direction Notice, the Authority accepted production and throughput forecasts for the regulatory period that are consistent with the WGM’s Operating Strategy. However, the Authority accepted LinkWater’s demand forecast for the Molendinar WTP. This relates to a total release volume of 223,944 ML for 2011-12.
LinkWater’s pumped volume of 118,404 ML per year represents an estimate of the proportion of total releases that require assisted pumping rather than gravity feed. The proportion that
137 Queensland Competition Authority Chapter 6: LinkWater
requires pumping can vary significantly from year to year depending on the operation of the Grid. The volume requiring chemical dosing is forecast at 38,688ML for 2011-12.
In the Draft Report, the Authority recommended that the Variable Operating Charge be defined as shown in Table 6.21.
Table 6.21: Summary of Volumetric Charges 2011-12 ($m)
Volume (ML) $/ML Total
Pumping (Energy Costs) 118,404 18.53 2.2
Chemical Dosing 38,688 8.45 0.3
Total 2.5
Note: these figures may not add due to rounding.
The Authority noted that fixed energy charges of $0.4 million should be incorporated in the Fixed Operating Charge. With this amount allocated to the Fixed Operating Charge, the Variable Operating Charge for LinkWater is forecast at $2.5 million, based on WGM forecasts.
However, the Authority recommended that Linkwater invoice the WGM for volumes in arrears consistent with the $/ML charges noted in Table 6.21, or on a facility basis where practical.
Stakeholder Submissions on the Draft Report
No comments were received from stakeholders regarding LinkWater’s proposed variable operating costs for 2011-12.
Authority’s Final Decision
The Authority proposes no change to the Draft Report recommendation.
6.5 Allowable Costs
Allowable operating costs are intended to capture legitimate business costs not reflected in fixed and variable operating costs.
Draft Report
In its initial submission, LinkWater submitted that its allowable operating costs for 2011-12 comprise a working capital provision of $0.9 million and regulatory levies (imposed by both the QWC and the Authority) of $8.2 million (Table 6.22).
138 Queensland Competition Authority Chapter 6: LinkWater
Table 6.22: LinkWater's Proposed Allowable Costs ($m)
Regulatory Agency/Cost Recoverable Levy 2011-12
Working Capital Allowance 0.9
Queensland Water Commission Levy 7.6
Queensland Competition Authority Levy 0.7
Total 9.1
Note: these figures may not add due to rounding.
Working Capital
LinkWater stated that three major components should drive the value of working capital for regulatory purposes:
(a) inventories which reflect the stores required to be held by a water business in order to operate their network including a holding of critical spares which are necessary to correct critical failures;
(b) accounts receivable associated with collection of regulated revenue; and
(c) accounts payable related to the amounts paid for operating costs and capital expenditure.
Consistent with the Direction Notice, LinkWater proposed a working capital allowance determined as accounts receivable less accounts payable. Consistent with the approach taken by Authority in its recent GAWB decision, LinkWater also included inventories.
LinkWater submitted that it has applied an average debtor and creditor days of 30 as applied by the Price Regulator in previous GSC decisions. However, based on analysis of billing and payment schedules, the Authority recommended that working capital be based on 45 debtor days and 30 creditor days (Chapter 3).
The working capital allowance is summarised in Table 6.23.
139 Queensland Competition Authority Chapter 6: LinkWater
Table 6.23: LinkWater's Working Capital Requirements ($m)
Working Capital Requirement Approved 2010-11 LinkWater QCA Draft Proposed 2011-12 Recommendation 2011-12
Average Accounts Receivable 16.3 13.7 25.0
Average Accounts Payable 8.8 7.2 4.5
Average Debtor Days 30 30 45
Average Creditor Days 30 30 30
Net Working Capital 7.5 6.5 20.6
Critical Spares and Inventories - 2.4 2.4
Total Working Capital Requirement - 8.9 23.0
Return on Working Capital - WACC 0.8 0.9 2.2
Note: these figures may not add due to rounding.
Working capital relates to the funds that an entity requires simply to fund its operations, and is a capital cost that is incurred by all businesses. As such, the Authority recommended in the Draft Report that the Price Regulator consider including working capital as a component of the Capital Charge, rather than an Allowable Cost, in future regulatory periods.
QWC Levy
The QWC imposed a levy under section 360F of the Water Act 2000, which provides that the QWC is to be funded by an annual levy payable by each water service provider.
LinkWater stated that on 2 July 2010, the QWC advised LinkWater that the quarterly levy is $1.8 million (excluding GST). In the absence of advice from the QWC regarding the levy to apply in 2011-12, LinkWater escalated the $1.8 million by 2.50% as a proxy for inflation. Therefore, LinkWater forecasted that the QWC levy will be $7.6 million for 2011-12.
However, the QWC advised the Authority, that the Authority should assume a QWC levy for 2011-12 of $8.11 million (including GST).
QCA Levy
LinkWater stated that on 13 October 2010, the Authority advised LinkWater that pursuant to the provisions of the Queensland Competition Authority Regulation 2007, it would be imposing a levy of $658,000 for 2010-11 and this levy would be indexed annually by 5.8%.
The Authority’s Investigation Plan, as submitted to the Minister, identified the self-funding levy charged by the Authority to regulated entities as an Allowable cost.
The Authority confirmed LinkWater’s forecasts, but recommended that an additional allowance for GST is added to LinkWater’s estimate. The Authority recommended including $710,600 of allowable costs relating to QCA fees (including GST).
Summary of Allowable Costs
Allowable costs are summarised in Table 6.24.
140 Queensland Competition Authority Chapter 6: LinkWater
Table 6.24: LinkWater's Total Allowable Costs 2011-12 ($m)
LinkWater Proposed QCA Draft Recommendation
Working Capital 0.9 2.2
QWC Levy 7.6 8.1
QCA Levy 0.7 0.7
Total 9.1 11.0
Note: these figures may not add due to rounding.
Stakeholder Submissions on the Draft Report
Since the release of the Draft Report, the QWC have advised the Authority that the QWC levy in 2011-12 for LinkWater has increased from $8.11 million (including GST) to $10.329 million (excluding GST).
Authority’s Final Decision
The Authority notes that no submissions were received from stakeholders regarding LinkWater’s working capital allowance.
The Authority accepts the QWC’s revised levy.
The Authority has also confirmed that as GST is rebated to the GSPs all costs should exclude GST. As a result, the QCA levy for 2011-12 is $646,000.
As a result of both the QWC levy and the QCA levy being amended since the Draft Report, LinkWater’s working capital requirements have subsequently changed marginally. In particular, the average accounts receivable; average accounts payable; the net working capital; and the total working capital requirement have all increased since the Draft Report. The updated working capital allowance for LinkWater in 2011-12 is summarised in Table 6.25 below.
141 Queensland Competition Authority Chapter 6: LinkWater
Table 6.25: LinkWater's Working Capital Requirements for 2011-12 ($m)
Working Capital Requirement LinkWater Proposed QCA Draft Report QCA Final Report Recommendation Recommendation
Average Accounts Receivable 13.7 25.0 25.3
Average Accounts payable 7.2 4.5 4.6
Average Debtor Days 30 45 45
Average Creditor Days 30 30 30
Net Working Capital 6.5 20.6 20.7
Critical Spares and Inventories 2.4 2.4 2.4
Total Working Capital Requirement 8.9 23.0 23.1
Return on Working Capital - WACC 0.9 2.2 2.2
Note: these figures may not add due to rounding.
The updated Allowable Costs are summarised in Table 6.26 below.
Table 6.26: LinkWater's Total Allowable Costs 2011-12 ($m)
LinkWater Proposed QCA Draft QCA Final Recommendation Recommendation
Working Capital 0.9 2.2 2.2
QWC Levy 7.6 8.1 10.3
QCA Levy 0.7 0.7 0.6
Total 9.1 11.0 13.2
Note: these figures may not add due to rounding.
6.6 Summary of GSCs for 2011-12
LinkWater’s proposed notional building block revenue requirement for 2011-12 is shown in Table 6.27.
In the Draft Report, the Authority’s recommended GSC was $203.5 million, compared to LinkWater’s proposed $210.8 million. The key difference was due to LinkWater’s proposal to include an adjustment to asset appreciation to the value of $14.66 million, which was not accepted by the Authority.
As noted above, LinkWater’s Allowable Cost has been updated since the Draft Report as a result of changes to both the QWC levy and the QCA fee.
The Authority recommends that LinkWater’s Grid Service Charge for 2011-12 is $205,698,598.
Relative to the Draft Report estimated GSC, the final recommended GSC is some $2.2 million higher. This is entirely due to an increase in the QWC levy allocated to LinkWater as required by the QWC.
142 Queensland Competition Authority Chapter 6: LinkWater
LinkWater’s Revenue Requirement for 2011-12 is summarised in Table 6.27 below.
Table 6.27: LinkWater's Revenue Requirements ($)
Revenue Approved 2010-11 LinkWater QCA Draft QCA Final Component Proposed 2011-12 Recommendation Recommendation 2011-12 2011-12
Return on Drought $94,167,995 $96,951,351 $100,599,218 $100,599,218 RAB
Return on Non- $54,620,581 $56,928,627 $56,475,071 $56,475,071 Drought RAB
Depreciation $40,565,026 $38,977,175 $42,564,186 $42,564,186
Asset Appreciation ($50,011,124) ($51,349,023) ($52,624,338) ($52,624,338)
Ex post Adjustments $66,631 0 0 0
Asset Appreciation 0 $14,664,767 0 0 Adjustment
Capital Charge $139,409,109 $156,172,897 $147,014,137 $147,014,137
Fixed Operating $38,820,154 $42,621,495 $43,007,592 $43,007,592 Costs
Variable Operating $4,513,978 $2,906,974 $2,520,866 $2,520,866 Costs
Allowable Costs $9,776,744 $9,063,510 $10,993,164 $13,156,002
Total GSC - $192,519,985 $210,764,876 $203,535,759 $205,698,598 Maximum Allowable Revenue
Note: the allowable costs for 2010-11 includes working capital ($751,979), critical spares ($242,665), the QWC levy ($8,110,000 GST inclusive) and the QCA fee ($672,100 GST inclusive).
143 Queensland Competition Authority Chapter 7: Review Thresholds
7. REVIEW THRESHOLDS
7.1 Background
Market Rules
The Authority notes that, since the Draft Report, amended Market Rules were issued in July 2011. The current Market Rules have been used as the basis for the Final Report.
Review of GSCs
Section 8.7 of the Market Rules states that the Price Regulator may review GSCs at any time if:
(a) the Price Regulator is made aware of any change that is sufficiently material to justify an additional review of GSCs; or
(b) a GSP or the WGM makes an application to the Price Regulator for a review in accordance with section 8.15.
Review Events
Under section 8.15, a GSP may from time to time apply by notice in writing to the Authority for a review of a component or components of the GSCs which apply to it if it incurs or is reasonably expected to incur expenditure which exceeds the relevant Review Threshold.
Upon receipt of an application for review under section 8.15(c), the Authority:
(a) may request information that is required to determine GSCs (s8.9);
(b) shall apply such of the principles and procedures in section 8.9 – 8.14 as it shall consider relevant in determining the merits of such application; and
(c) shall, upon completion of its investigation, make a recommendation to the Price Regulator as to whether any revisions to the GSCs should be allowed.
Procedural Requirements
Section 8.9 and 8.15 of the Market Rules outline the procedural requirements for determining review thresholds. These arrangements are that:
(a) the Authority may (and must, if so directed by the Price Regulator), from time to time, having regard to the matters set out in section 8.5 of the Market Rules, determine, vary and notify the Review Threshold for all or some of the components of GSCs;
(b) prior to notifying a Review Threshold, the Price Regulator must:
(i) circulate a draft of the proposed Review Threshold; and
(ii) allow GSPs and the Water Grid Manager an opportunity to comment on the proposed Review Threshold; and
(c) the Authority may, in its sole discretion, accept or reject some or all of the comments made by GSPs or the Water Grid Manager or initiate its own amendments when issuing a final Review Threshold.
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Direction Notice and Manual
The Price Regulator’s Direction Notice of February 2011, issued pursuant to the Market Rules, instructs the Authority to develop a process, and appropriate Review Thresholds, for reviewing the 2011-12 GSCs.
The Manual requires the Authority to develop an appropriate process for adjusting the 2011-12 GSCs to ensure that:
(a) assets constructed under the Water Regulation 2002 (drought assets) achieve returns equal to the actual cost of debt for each asset;
(b) GSPs are immunised from interest rate exposures, through the full recovery of the actual cost of debt; and
(c) the GSPs are not to be subject to volume or source risk whether in total or across production or dispatch points over the regulatory period.
The Manual also identifies a number of parameters that will require adjustment during or after the regulatory period:
(a) the QWC is required to provide the opening RAB for 2011-12 for the Authority. However, the final estimate of the RAB is not expected to be available until October 2011; and
(b) the cost of debt used in the WACC is to reflect the actual cost of debt including an administration fee, Capital Market Charge and, in the case of non-drought assets, a Competitive Neutrality Fee. At the end of the regulatory period, the Authority is to adjust the returns to ensure that the returns equal the actual cost of debt provided by the QTC.
The Manual also requires that the Authority must consider the process for adjusting GSCs for under or over spend of capital and operating costs. The Direction Notice requires the Authority to provide incentives for the entities to invest, innovate and pursue efficiency improvements consistent with their roles and responsibilities.
The Market Rules [section 8.5(a)] also require that the Price Regulator and the Authority recognise the need to minimise the economic cost of regulatory actions and uncertainty.
The Authority’s Role
On the basis of the Market Rules, Direction Notice and Manual the Authority is required to recommend:
(a) the appropriate Review Thresholds for reviewing the 2011-12 GSCs; and
(b) the procedural requirements for determining, varying and notifying the Review Thresholds and GSCs.
7.2 Framework and Approach
Draft Report
In considering the appropriate framework for the review, the Authority considered the requirements of the Market Rules, Direction Notice and Manual.
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In particular, the Authority had regard for the fact that:
(a) in the absence of a review following a change of circumstances, the GSCs are calculated annually using the latest available estimates of efficient costs. This differs from most regulated entities which have their efficient costs reviewed every three to five years;
(b) the GSPs do not bear a number of risks normally borne by regulated entities. In this regard:
(i) the GSPs are not to bear any volume or source risk;
(ii) drought assets are to achieve returns equal to the actual cost of debt for each asset; and
(iii) the GSPs are to be immunised from interest rate exposures, through the full recovery of the actual cost of debt in both the rate of interest payable in respect of drought assets and the interest rate incorporated in the WACC applicable to non-drought assets;
(c) the opening RAB is not to be optimised and must be adjusted for any changes as advised by QWC; and
(d) the Authority must include estimates of efficient capex and operating costs in the GSCs and establish a process for handling under or over expenditure of such costs.
As such, the GSPs’ major risks relate to:
(a) any under- or over-expenditure of operating costs in 2011-12 that is not addressed in the calculation of 2012-13 GSCs. In this regard, variable operating costs range from about 2% to 5% of total GSCs;
(b) the costs in 2011-12 of any variations from the estimate of capital, operating costs and water/source volumes incorporated in 2011-12 GSCs. Revised estimates of these will be incorporated in the 2012-13 GSCs; and
(c) capital and operating expenditure that is not considered to be prudent and efficient. This is a risk that should not be compensated for.
In addition, given the annual review of GSCs, which are to be finalised by end July 2011 and then approved by the Price Regulator, it is likely that any mid-year review of GSCs following a material review event (however defined) would be unlikely to be finalised much before the determination of GSCs for 2012-13. In this regard, the Authority noted that the QWC’s review mechanisms were not triggered in 2010-11 despite flood impacts that still remain to be fully evaluated.
Therefore, given the limited magnitude of the risks assumed by the GSCs, and having regard for the requirement to minimise the cost of regulation, it is considered that, unless a review event materially impacts a GSCs within-year free cash flows, 2011-12 GSCs should be reviewed at the same time as 2012-13 GSCs are determined.
In this regard, the Authority is aware that the GSPs are quite constrained in terms of their free cash flows as:
(a) the return on drought assets is limited to the actual cost of debt;
(b) the GSPs carry a high level of debt as determined by Government (about 90%); and
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(c) drought assets, for which the return on assets is limited to cost of debt only, account for 67% of the RAB across the Grid. For the GSPs, the proportion of drought assets is 25% for Seqwater, 72% for LinkWater and 100% for WaterSecure.
Free cash flows were estimated to be of the order of 7% of the total GSC for Seqwater, 6% for LinkWater and 14% for WaterSecure. The higher ratio for WaterSecure reflected a higher depreciation allowance due to its shorter life assets. The Authority took these issues into account in developing a framework for adjusting GSCs.
The Authority identified a range of incidents or changes (Events) for which changes to capital, fixed operating and variable charges are to be allowed, upon application by the GSPs. These Events were formally specified in the previous version of the Market Rules, and as such were identified in the Authority’s Draft Report. The Events and the charge to which they are relevant are identified in Table 7.1 below.
Table 7.1: Prescribed Events relevant to Changes in GSCs
Event Capital Charge Fixed Operating Variable Operating Charges Charges
Change in Law or Change in x x Government Policy
Emergency Event x
Change in Demand or Supply x Source
RAB Adjustment x
Actual Cost of Debt x
In its Draft Procedures, the QWC adopted an approach based on an analysis of each charge. In doing so, the QWC noted that its approach was intended to recognise the emerging regulatory capabilities and organisational capacities of the entities by putting in place very intensive regulatory oversight with low thresholds and frequent reviews of progress.
Based on the detailed submissions received to date, the Authority considered in the Draft Report that the capabilities of the entities are progressively being developed, and therefore sought to establish processes and thresholds more consistent with those required in mature regulatory jurisdictions.
The Authority also proposed that the process for varying the Review Thresholds also provide for the ongoing development of information requirements relevant to any submissions for changes to GSCs.
Stakeholder Submissions on the Draft Report
Seqwater submitted that the Review Thresholds proposed in the Draft Report are complicated by the interrelationship between the Authority’s proposed approach and the Market Rules.
The WGM submitted that practical examples should be included to demonstrate how the recommended adjustment process would work.
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Authority’s Final Decision
The Authority notes that the Market Rules have been amended since the Draft Report and Seqwater’s submission.
The revised Market Rules remove the requirement for the Authority to separately recommend GSCs for WaterSecure. Nonetheless, to retain consistency with the approach adopted to the draft GSCs, the Authority recommends that the application of Review Thresholds be applied separately to WaterSecure and Seqwater.
Although the detailed specification of the Events that trigger a Review are no longer specified in the amended Market Rules, the Authority proposes to retain them as they are considered relevant for this purpose. The Events are discussed in more detail below. During the 2011-12 year, the Authority will also separately consider any WaterSecure and Seqwater applications for a review of GSCs.
The Authority accepts the WGM’s submission that practical examples would assist the comprehension of the Review Thresholds. Hypothetical examples of the review process have interspersed throughout the chapter in boxed sections.
7.3 Cost Impacts of Changes in Law, Government Policy and Emergency Events
Draft Report
For the 2010-11 year, the QWC applied a quarterly $100,000 Review Threshold for Regulatory Pass-through Events, namely:
(a) changes in capital charges (return on capital and return of capital) resulting from unanticipated capital expenditure in response to changes in law or government policy; and
(b) changes in fixed operating charges resulting from changes in law or government policy or a category 4 or 511 emergency event as defined in the South East Queensland (SEQ) Water Grid Emergency Response Plan.
The QWC did not apply a specific threshold for changes in other Allowable Costs in response to regulatory cost pass-through events. These were to be considered on a case-by-case basis on application from the GSP.
The QWC set a review threshold of 0.25% of maximum allowable revenue determined by the Minister in the 2010-11 regulatory period wherever costs relevant to Capital Charges, or Fixed Operating Charges vary for reasons other than a regulatory cost pass-through event (events other than those noted in (a) and (b) above.)
LinkWater submitted that review thresholds as proposed by the QWC for 2010-11 should be applied by the Authority for 2011-12.
Seqwater considered that the materiality thresholds and other review procedures administered by the QWC could, with some modification, be adopted by the Authority. Seqwater suggested
11 Level 4 events are major events affecting single or multiple regions, involving a major impact for a small population or a moderate impact for a large population. Level 5 events are catastrophic events with a large scale impact across SEQ with other utilities affected. Examples of Level 4 include cryptosporidium outbreaks, failure of a water treatment plant, drought declarations, fire or pandemic alert. Level 5 events include dam wall breach, extreme emergency supply restrictions, and flood, fire and cyclone impacts on multiple assets.
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that cost pass-through arrangements should be extended to apply to variable cost changes, where volumetric cost increases occur in consequence of a level 4 or 5 emergency event.
Seqwater also identified budgeting risk in estimating operating costs that may differ due to external factors, such as the quality of source raw water (for example, due to flood). Seqwater included a buffer in its water treatment cost forecasts of $1.143 million in 2011-12 to provide a contingency for unforeseen episodes of poor raw water quality. Seqwater’s consultant PwC recommended that cost pass-through arrangements should also incorporate eligibility for operating cost ‘budgeting risk’ at least for a transitional period.
Seqwater supported current QWC thresholds for reviews for reasons other than regulatory cost pass through.
Seqwater also advised that, at the time of its submission to the Authority, the impacts of the 2011 flood emergency event were not known with certainty. In separate consultation, Seqwater noted that treatment costs per ML may vary substantially due to water quality impacts of flood events that are categorised as being below Level 4 under the SEQ Water Grid Emergency Response Plan. Seqwater suggested that the threshold should be low for such changes.
In the Draft Report, the Authority stated that it was clear from the limited risks that the GSPs face and the annual review of GSCs, the Government has effectively adopted a regulatory approach much closer to a ‘cost of service’ model than the ‘incentive regulation’ model in place with most other regulated entities in Australia. Broadly speaking, under a cost of service approach, costs are passed through on an ‘as incurred’ basis, while under an incentive regulation approach regulated entities have an incentive to manage their costs by retaining any variations from estimated efficient costs for a period of time.
At the same time, the Government has not adopted a complete ‘cost of service’ approach as the Direction Notice requires the Authority to provide incentives for the entities to invest, innovate and pursue efficiency improvements consistent with their roles and responsibilities.
Changes in law, Government policy and emergency events are beyond the control of the GSPs. However, GSCs are able to ensure that their response is prudent and efficient.
The Authority therefore proposed that the prudent and efficient costs of a GSP’s response to changes in law, Government policy and emergency events should be passed through to GSPs as from the date the additional costs are incurred. Amongst other things, this recognised that, in a competitive market, unforeseen cost imposts arising from such events would apply to all service providers and would be passed through to customers.
At the same time, in order to minimise the administrative cost of regulation, it is proposed that, unless a review event materially impacts a GSC’s within-year free cash flows, the impact of such events on 2011-12 GSCs should be determined at the same time as 2012-13 GSCs are determined.
In the Draft Report, the Authority also considered that the materiality threshold that should be adopted for a ‘within year’ review of the cost impact of such events should have regard for the impact on a GSC’s free cash flow.
In this regard, as indicated earlier, free cash flows were estimated to be of the order of 7% of the total GSC for Seqwater, 6% for LinkWater and 14% for WaterSecure. The Authority therefore considered that a ‘within year’ review should only be undertaken if the events, in combination with any other review events (discussed later), are likely to account for 5% of a GSPs GSCs.
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Different review thresholds could be adopted for the different entities and, if this approach were to be adopted, the Authority would propose thresholds of 3.5%, 3% and 7% of GSCs for Seqwater, Linkwater and WaterSecure respectively, being 50% of estimated free cash flows for each.
With respect to the issues raised by Seqwater in regard to the impact of an emergency event on raw water quality, it is proposed that additional prudent and efficient costs in respect of raw water quality should be subject to the approach outlined above.
Stakeholder Submissions on the Draft Report
Seqwater supported the Authority’s recommended approach to adjusting GSCs in response to a change in law or government policy.
Seqwater submitted that the Authority should address the changes to the Market Rules in its Final Report, specifically relating to the Review Thresholds. Seqwater asked the Authority to model a hypothetical adverse cost event to test whether this would jeopardise the business’ capacity to meet its debt servicing obligations. Seqwater suggested that this analysis may show that a lower review threshold is warranted, perhaps being the differentiated threshold discussed above (3.5% for Seqwater).
Seqwater also raised concerns about the threshold of level 4 or 5 for emergency events noted in the Authority’s Draft Report. Seqwater submitted that the level of the emergency event does not [necessarily] relate to the cost impact on Seqwater’s operations but that other environmental (raw water quality) and related risks associated with even lower level events could raise costs substantially. Seqwater requested that the Authority give further consideration to a revised and lower trigger mechanism (in addition to the existing emergency event triggers) which would capture such environmental and other costs.
Authority’s Final Decision
The Authority’s revised free cash flow modelling has estimated Seqwater’s free cash flows remains at 7% of total GSCs. WaterSecure free cash flows are estimated at 13%, while LinkWater remain consistent with the Draft Report at 6%. As a result, the Authority considers that a 5% review threshold remains appropriate, as there are no amendments to the Market Rules which would warrant a change. The Authority will continue to treat Seqwater and WaterSecure separately for the purposes of free cash flow modelling that information the review threshold level.
The Authority’s Draft Report noted that in regard to the impact of an emergency event on raw water quality, it is proposed that additional prudent and efficient costs in respect of raw water quality should be subject to the same approach as for emergency events. For the purpose of clarity, the Authority recommends that the additional costs of a raw water quality event, no matter the level of any related emergency event, would be subject to full cost pass-through at the end of the period, with a review threshold of 5% of Seqwater’s total GSC for any inter- period review.
7.4 Changes in Forecast Demand or Water Sources
Draft Report
All charges are currently set on the basis of forecast volumes, costs and sources of water by the WGM. The Direction Notice requires that the GSPs are required not to bear volume or source risk, either in total or across production or dispatch points, over the regulatory period.
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The variable operating cost allowance for 2010-11 was set based on the annualised average $/ML cost for energy costs, chemical/treatment costs and other variable operating costs where relevant, multiplied by the forecast production volumes. The QWC provided for quarterly adjustments to variable operating charges to take account of changes in volumes.
The QWC’s variable operating cost allowance would be adjusted quarterly taking account of the difference between actual and forecast volumes, using a standard $/ML cost for each major asset compared to the assumed volume and mix. The $/ML standard cost would not be subject to review and the GSPs remain subject to the risk of such changes.
The QWC set the variable operating cost Review Threshold at $50,000 per quarter for 2010-11. Variations can be accumulated to the next quarter.
Seqwater and its consultant PwC noted that the current QWC review process of quarterly adjustments accounts for differences in volumes using a standard unit cost ($/ML) for each major asset, that is, a linear relationship between volume and unit costs. However, this approach does not recognise that some variable costs are semi-fixed or non-linear in nature.
In the Draft Report, the Authority noted that demand forecasting and decisions regarding sources of supply are not under the control of the GSPs but are determined by the WGM. Furthermore, the Manual requires that the GSPs are not to be subject to volume or source risk whether in total or across production or dispatch points over the regulatory period.
The Authority therefore considered that the cost implications of changes in water volumes/source should be treated in the same manner as changes in law, Government policy and emergency events.
In other words, the prudent and efficient costs resulting from changes in forecast demand or water sources should be passed through to GSPs as from the date the additional costs are incurred. At the same time, in order to minimise the administrative cost of regulation, unless there is a material impact on a GSP’s within-year free cash flows, the impact of such events on 2011-12 GSCs should be determined at the same time as 2012-13 GSCs are determined.
Furthermore, as outlined earlier, the Authority considered that a ‘within year’ review should only be undertaken if the events, in combination with any other review events (discussed later), are likely to account for 5% of a GSP’s GSCs.
The costs likely to be impacted are the variable operating costs that are usually determined on the basis of annualised $/ML for energy costs, chemical/treatment costs and other variable operating costs multiplied by annual forecast volumes, if demand varies from forecast. They would also be impacted by any change in unit costs.
In this regard, however, the Authority’s preferred approach of publishing the Variable Operating Charges on a $/ML basis for the listed facilities in each GSP (e.g. WTPs, pipelines, etc) should reduce the need for an unders and overs adjustment for differences between forecast and actual volumes (and when reset should also take into account changes in the source of water).
At the same time, as noted by Seqwater, usage/dosage rates and average unit costs for inputs may also be affected by changes in demand or supply sources. In other words, the link between demand and variable costs may not be linear and $/ML costs may change. This issue would be addressed when reviewing the cost impacts as outlined above.
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Box 7.1 – Hypothetical example of recommended Review Thresholds
Example 1 – Change in variable cost unit rates
In January 2012, the WGM alters the operating mode of the Grid, requiring LinkWater to double the volumes transported in the NPI.
The increase in volumes is reflected in LinkWater’s bills to the WGM, which are based on actual volumes. However, the increased volume requires LinkWater to make greater use of pumping, relative to gravity feed, to meet the required volumes. This increases LinkWater’s energy costs per ML transported by 10%.
LinkWater estimates that the total cost impact of the change in operating mode is less than 5% of its 2011-12 GSCs. As a result, LinkWater funds the additional costs for the remainder of the 2011-12 year without any immediate increase in GSCs. At the setting of the 2012-13 GSCs, LinkWater submits that the changed operating mode of the Grid in 2011-12 increased its variable cost unit rates, and that this was due to a change in demand volumes.
The Authority reviews the increased 2011-12 unit rates and finds them to be efficient. The Authority retrospectively increases the recommended 2011-12 variable operating charge and recommends to the Price Regulator that LinkWater receives an under-recovery payment to compensate it for the additional costs incurred during 2011-12.
Stakeholder Submissions on the Draft Report
Seqwater supported the Authority’s recommended approach to adjusting GSCs in response to a change in demand or water source and allowing volumetric charges to be billed on actual volumes.
Authority’s Final Decision
The Authority proposes no change from the Draft Report recommendations.
7.5 Adjustments for RAB and Cost of Debt
Draft Report
The Authority is required under the Direction Notice to adjust the GSCs to ensure that asset returns equal the actual cost of debt at the end of the regulatory period in order for the GSPs to be immunised from interest rate exposure.
Under the Direction Notice, the Authority is to accept the RAB for each GSP at 1 July 2011 provided by the QWC, and any subsequent adjustments made to the RAB by the QWC for 2010-11.
For the 2010-11 GSCs, the QWC made an end-of-period adjustment to reflect differences in capital expenditure (non-drought and drought) and the actual cost of debt incurred during 2009- 10 from forecasts for that year. Any changes to the cost of debt for non-drought assets were also to be adjusted in GSCs throughout the year.
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Seqwater submitted that the approach proposed by the QWC for adjustments to the actual cost of debt should be adopted.
LinkWater submitted that it was unclear whether immunisation refers to the movement in the actual debt rates or to the absolute value of the interest liability incurred. LinkWater sought clarity as to the Authority’s interpretation.
In the Draft Report, the Authority stated it understood that ‘immunisation against interest rate exposures’ is intended to require that the actual cost of debt be applied on an ex post basis for each asset/debt tranche and compared to the total provision as forecast for the GSCs, with adjustments made to account for any differences. The Authority noted that such adjustments do not occur with any frequency due to the nature of QTC’s funding arrangements.
The Authority proposed to make adjustments to 2011-12 GSCs to account for changes in actual costs of debt and the revised RAB as required under the Direction Notice. This included the impact on the WACC applied to non-drought assets.
However, unless there is a material impact on a GSC’s within-year free cash flows, the impact on 2011-12 GSCs should be determined at the same time as 2012-13 GSCs are determined.
Furthermore, as outlined earlier, the Authority considered that a ‘within year’ review should only be undertaken if the events (in combination with any other review events (discussed later)) are likely to account for 5% of a GSPs GSCs.
Box 7.2 – Hypothetical examples of recommended Review Thresholds
Example 2 – Change in cost of debt
In response to an unforeseen financial crisis, QTC increases Seqwater’s cost of debt by 0.75% on 30 September 2011.
Seqwater estimates that the increase in cost of debt, if applied to Seqwater’s capital charge, would increase its expected 2011-12 GSCs by more than 5%. Seqwater applies to the Authority to review its GSCs in October 2011. The Authority confirms the interest rate increase, and the ensuing impact on Seqwater’s capital charge. In November 2011, the Authority recommends to the Price Regulator an increase in Seqwater’s 2011-12 GSCs, effective immediately.
Stakeholder Submissions on the Draft Report
No comments were received from stakeholders regarding the Authority’s approach to adjusting GSCs for changes in RAB and cost of debt.
Authority’s Final Decision
The Authority proposes no change to the Draft Report recommendation.
7.6 Adjustments for Under- or Over-Spend of Capital and Operating Costs
Draft Report
The GSCs for 2011-12 are based on forecasts for capital and operating costs that are likely to vary from actual costs incurred throughout the year. The Direction Notice and Manual require
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the Authority to consider a process for adjusting GSCs for under or over-spend of capital and operating costs.
Drought related capex is to be accepted as prudent and efficient and capex continuing from a previous regulatory period is to be accepted as prudent.
In setting the 2010-11 GSCs, the QWC noted differences between ongoing forecast and actual capex from 2009-10, and incorporated adjustments for the differences.
Under the QWC’s approach, where capex has commenced in a previous regulatory period, the Price Regulator will accept that the capital expenditure was prudent, but will expect justification by the GSP of the reasonableness of the total project costs being rolled into the RAB.
Capital expenditure related to renewals and maintenance is rolled into the RAB effective January each regulatory period. Where renewals expenditure in 2010-11 is lower than forecast, GSPs can retain cost savings of up to 10% of the forecast cost. For example, if capex is 90% or more of budgeted capex, GSPs will be able to retain the saving in 2010-11 GSCs. If capex is less than 90% of the budgeted amount, GSPs can retain up to a maximum of 10% of the budgeted cost.
The QWC also applied the 10% tolerance band to fixed operating costs – they would only be adjusted if they fell by more than 10% from expected levels.
Seqwater submitted that the approach adopted by the QWC should be continued. Seqwater also advised that at the time of its submission to the Authority, the impacts of the 2011 flood emergency event were not known with certainty, and adjustments in Allowable Costs arising from the Seqwater/WaterSecure merger may not be finalised in time for the GSCs.
GSPs did not comment on the scope for efficiency incentives. LinkWater identified potential efficiency savings in labour costs associated with project management of 0.4% in 2011-12 rising to 1.2% from 2012-13 onwards.
In the Draft Report, the Authority noted that the Direction Notice requires the Authority to develop a process for adjusting the GSCs for under or overspend of capital and operating costs.
Under the Market Rules and Direction Notice, drought capex continuing from a previous period is to be included into the RAB at the project cost
It is standard regulatory practice to incorporate prudent and efficient capex in the RAB when determining the (forward looking) allowable revenue for a regulated entity at the commencement of a regulatory period. Similarly, the latest estimate of efficient operating costs is incorporated. The Authority proposed to follow this standard practice when calculating GSCs. The main difference with the GSPs is that the regulatory period is only one year.
While a number of the GSPs’ risks have been addressed earlier, GSPs will remain exposed to:
(a) any under- or over-expenditure of operating costs in 2011-12 that is not addressed in the calculation of 2012-13 GSCs;
(b) the costs in 2011-12 of any variations from the estimate of capital expenditure and operating costs incorporated in 2011-12 GSCs; and
(c) capital and operating expenditure that is not considered to be prudent and efficient.
So far as capital expenditure variations are concerned, the Authority proposed that 2011-12 GSCs should be adjusted to account for the impact on Capital Charges (return on and of capital)
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of any variation between actual prudent and efficient capital expenditure and the estimate of capital expenditure incorporated at the time the GSCs were initially calculated. In other words, GSPs should receive Capital Charges in respect of all prudent capital expenditure from the date on which it is included in the RAB. Capital expenditure is however considered to not be appropriate for any incentive arrangements. The approach proposed for GSCs is consistent with that applied by the Authority in other regulated industries.
Consistent with the approach proposed for other review events, it is proposed that this be done at the same time as 2012-13 GSCs are being calculated unless the impact on Capital Charges in 2011-12 is, together with the impact in 2011-12 of any other review events, is greater than 5% of a GSP’s GSC.
It is noted that, under the Manual, capital costs are only entered into the asset base at commissioning and the Authority accepted that this is a reasonable approach.
In response to Seqwater’s comments, adjustments to reflect updated cost estimates for the effects of the 2011 floods and merger allowable costs can be accommodated within the proposed arrangements.
Box 7.3 – Hypothetical example of recommended Review Thresholds
Example 3 - Capital expenditure cost increase
Capital expenditure on LinkWater’s SCADA consolidation project completed in December 2011 suffers a significant cost increase from the approved amount of $3.2m to an actual cost of $8.4m.
LinkWater estimates that the increase in capital costs in not sufficient to increase its expected GSCs by more than 5%. LinkWater funds the additional capital cost during the 2011-12 year without any immediate increase in GSCs. During the investigation of the 2012-13 GSCs, LinkWater submits that it incurred higher than expected capital expenditure.
The Authority reviews the increased 2011-12 capex and finds it to be efficient despite the increase in cost. The Authority retrospectively increases the recommended 2011- 12 capital expenditure and recommends to the Price Regulator that LinkWater receives an under-recovery payment to compensate it for the additional costs incurred during 2011-12.
With respect to operating costs, this is an area where regulators have typically applied incentive mechanisms to encourage efficiency improvements. Such mechanisms often take the form of a sharing arrangement for cost savings between the service provider and its customers.
Consistent with the requirements of the Direction Notice for the Authority to provide incentives for the entities to invest, innovate and pursue efficiency improvements, the Authority recommended that an incentive structure be implemented to encourage GSPs to achieve efficiency gains. Under such an arrangement, GSPs will be permitted to retain 50% of any efficiency gains achieved in 2011-12 in 2012-13 GSCs. However, the efficiency gains must be the result of specific initiatives put in place by the GSPs, and should be submitted for consideration as part of the 2012-13 review.
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Box 7.4 – Hypothetical examples of recommended Review Thresholds
Example 4 – GSP efficiency gain
LinkWater instigates a restructure of its SCADA operator scheduling system to reduce reliance on worker overtime. As a result of the changes, LinkWater is able to save $500,000 in wage costs during the 2011-12 year.
During the investigation of the 2012-13 GSCs, LinkWater submits that it achieved efficiency gains of $500,000 during the 2011-12 year. The Authority investigates the efficiency gains, and recommends:
(a) No reduction to the approved 2011-12 GSCs (i.e. LinkWater retains the $500,000 cost saving); and
(b) A payment to LinkWater during the 2012-13 year, in addition to the normal 2012- 13 GSCs, of $250,000 (a 50% efficiency incentive).
Example 5 – Grid efficiency gain
In response to Grid efficiency investigations, the WGM alters the operating mode of the Grid in August 2011, which results in Seqwater decommissioning one of its WTPs.
Apart from the direct reduction in variable operating costs, which are accounted for in Seqwater’s invoices of actual volumes, decommissioning the plant allows the cancellation of renewals capital expenditure of $3 million and reallocation of WTP operators, reducing wage costs related to overtime by $400,000.
In the investigation of 2012-13 GSCs the WGM submits that efficiency gains were achieved as a result of the change in operating mode. The Authority investigates the WGM’s submission, in conjunction with Seqwater, and concludes that the WGM’s submission is justified. The Authority then retrospectively reduces Seqwater’s recommended 2011-12 GSCs, and reduces 2012-13 GSCs.
Any other variations in operating costs in 2011-12 will be borne by, or to the benefit of, the relevant GSP. Nevertheless, the Authority noted the limited time available for this initial review has not enabled a detailed review of fixed operating costs. Therefore, should a subsequent review indicate greater efficiencies to be possible, these would be excluded from future charges. This is particularly relevant in the absence of detailed analysis of the merger of WaterSecure and Seqwater.
Similarly, any capital or operating expenditure that is found not to be prudent and efficient will be borne by the relevant GSP and not incorporated in GSCs.
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Box 7.5 – Hypothetical examples of recommended Review Thresholds
Example 6 – Fixed operating cost increase
As a result of enterprise bargaining agreements, Seqwater spends 3% more than it budgeted on fixed employee costs in 2011-12.
Seqwater is not entitled to recover the overspend of fixed employee costs in 2011-12, and no adjustments are made to the 2011-12 GSCs.
Stakeholder Submissions on the Draft Report
Seqwater submitted that it is carrying significant cost risk relating directly to information deficiencies due to being a newly formed and amalgamated business. Seqwater considered that these risks are little different to other unforeseeable and external risks which are addressed by the review trigger mechanisms.
The WGM endorsed the need for an incentive structure to encourage GSPs to achieve efficiency gains. However, the WGM submitted that the report should clarify that these efficiency gains exclude gains achieved through Grid operation and planning.
The WGM requested clarity regarding under-expenditure not related to efficiency gains, and noted that there is no trigger for the WGM to request a review, other than change in demand or supply source.
Authority’s Final Decision
The Authority does not consider that cost risk or budget risk is an unusual or unforeseen risk. While these risks may be enhanced by the recent formation and merger of the entities, the Authority considers that Seqwater is still best placed to manage these risks and it is appropriate that Seqwater bears them. The Authority notes that the review triggers, cost pass-through measures and allowable cost categories recommended in its Draft Report already remove or reduce many of Seqwater’s operational and financial risks. As a consequence, the Authority does not recommend Seqwater’s suggestion for an additional adjustment mechanism.
The Authority accepts the WGM’s comments regarding efficiency gains. The Authority recommends that cost savings achieved as a result of WGM decisions regarding Grid operation and planning should not be retained by the GSPs. To address this matter, the Authority recommends that the WGM is also allowed to recover efficiency gains, in addition to the GSPs by a reduction in future payments to the GSP. That is, specific initiatives or Grid operating decisions made by the WGM in 2011-12 should be submitted for review at the time of the 2012- 13 review.
The Authority notes the WGM’s submission that there is no trigger for the WGM to request a review of GSCs other than for change in demand or supply source. The Authority considers that the primary purpose of the Review Thresholds is to allow an update to the GSCs should the financial circumstances of the GSPs deteriorate significantly. As a consequence, the Authority does not recommend an additional trigger to allow the WGM to initiate review of the GSCs for the purpose of a reduction in GSCs.
157 Queensland Competition Authority Chapter 7: Review Thresholds
7.7 Procedures for Reviewing GSCs and Review Thresholds
Draft Report
The general procedural steps for reviewing GSCs consistent with the amended Market Rules are identified in 7.1 above.
Further, the Authority noted in its Draft report that the QWC’s Procedures included a range of detailed requirements for GSCs to comply with in submitting proposals for reviews. Similar to the QWC proposals, the Authority recommended that GSPs provide a notice in writing to the Price Regulator, as required under the Market Rules, with details including:
(a) demonstration of the business case for expenditure, including justification of the expenditure in terms of the GSP’s approved strategic and operational plans;
(b) demonstration that the expenditure is the most effective means of achieving the required outcome;
(c) demonstration of compliance with internal governance (including board approvals), business case approvals, procurement, and project management processes and audit;
(d) where a significant emergency event has occurred, demonstration of how the additional costs are required to meet the requirements of the SEQ Water Grid Emergency Response Plan; and
(e) detailed supporting documentation enabling independent engineering review or other assessment of the reasonableness of capex or opex (with relevant details as indicated in earlier chapters).
Submissions should be certified by the Board of Directors as is any submission relating to the setting of GSCs. The Price Regulator may require additional information on a case by case basis in order to properly assess GSPs’ claims.
Stakeholder Submissions on the Draft Report
No comments were received from stakeholders regarding the procedures for reviewing GSCs and Review Thresholds.
Authority’s Final Decision
The Authority proposes no change to the Draft Report recommendation.
7.8 Summary of Review Thresholds
Table 7.2 below summarises the review thresholds proposed by the Authority.
158 Queensland Competition Authority Chapter 7: Review Thresholds
Table 7.2: Summary of Proposed Review Thresholds
Trigger/Event Eligible Cost category Review Threshold
Change in law or policy, or All Zero, with assessment to be undertaken at end Government specified emergency of regulatory period unless cost impact (in event combination with impact of other Events) is 5% of GSC in which case assessment will commence on the date of the GSC’s request.
Change in Demand or Supply Variable Operating Charge As above Source (applications by GSPs).
Change in Demand or Supply Variable Operating Charge As above Source (applications by WGM)
Change in Cost of Debt Capital Charge As above
Change in RAB Capital Charge As above
Change in actual capex from that Capital Charge As above initially estimated
159 Queensland Competition Authority References
REFERENCES
Department of Environment and Resource Management (DERM). 2010. Regional Water Security Program. Revision 1. March.
Queensland Competition Authority (QCA). 2000. Statement of Regulatory Pricing Principles for the Water Sector. Final Report. December.
QCA. 2010. Gladstone Area Water Board: Investigation of Pricing Practices. Final Report. June.
QCA. 2010. SEQ Bulk Water Grid Service Charges for 2011-12: Investigation Plan. Final. October.
QCA. 2011. SEQ Interim Price Monitoring for 2010-11: Part B – Detailed Assessment. Final Report. March.
Queensland Water Commission (QWC). 2010. Methodology and Approach in Determining Grid Service Charges for 2009-10: Queensland Bulk Water Transport Authority (LinkWater). Final Report. February.
QWC. 2010. Methodology and Approach in Determining Grid Service Charges for 2009-10: Queensland Bulk Water Supply Authority (Seqwater). Final Report. February.
QWC. 2010. Methodology and Approach for Determining Grid Service Charges for 2010- 11: Queensland Bulk Water Supply Authority (Seqwater). Final Report. August.
QWC. 2010. Methodology and Approach for Determining Grid Service Charges and Level of Grid Service Charges for 2010-11: Queensland Manufactured Water Supply Authority (WaterSecure). Final Report. December.
Queensland Government. 2010. SEQ Water Market Rules. July.
QWC. 2010. South East Queensland Water Strategy. Final Report.
QWC. 2011. Methodology and Approach in Determining Grid Service Charges and Level of Grid Service Charges for 2010-11: Queensland Bulk Water Transport Authority (LinkWater). Final Report. February.
Seqwater. 2011. Seqwater 2011-12 Grid Service Charges: Submission to the Queensland Competition Authority – Business and Regulatory Issues. Submission. March.
Sinclair Knight Merz (SKM). 2011. Grid Service Charges 2011-12: Assessment of Capital and Operating Expenditure – Grid Service Provider: LinkWater. Final Report. May.
SKM. 2011. Grid Service Charges 2011-12: Assessment of Capital and Operating Expenditure – Grid Service Provider: Seqwater. Final Report. July.
SKM. 2011. Grid Service Charges 2011-12: Assessment of Capital and Operating Expenditure – Grid Service Provider: WaterSecure. Final Report. July.
South East Queensland Water Grid Manager (WGM). 2011. SEQ Water Grid Operating Strategy. Version 3. March.
WaterSecure. 2011. Water Grid Service Charges for 2011-12: Submission to the Queensland Competition Authority. Submission. March.
160 Queensland Competition Authority Definitions
DEFINITIONS
Declared Water Services is defined by the Market Rules as: water services declared by the Minister under Chapter 2A, Part 5A, Division 2 of the Water Act 2000.
Infrastructure, where capitalised, is defined by the Market Rules as: Water Supply Works and any other water storage, treatment, transportation and reticulation infrastructure owned or controlled by a Grid Participant, including dams, reservoirs, weirs, pipelines, water treatment plants, desalination plants, advanced water treatment plants, pump-stations, other ancillary infrastructure and works and all other such infrastructure under development or developed at any time in the future to supplement, enhance, augment, or replace such infrastructure.
Initial Regulated Asset Base is defined by the Market Rules as: the Regulated Asset Base as at 1 July 2008
Relevant Assets is defined by the Market Rules as: assets required to provide Declared Water Services
Regulated Asset Base is defined by the Market Rules as:
(a) for the year commencing on 1 July 2008 the Infrastructure determined and notified by the State; and
(b) thereafter the Infrastructure notified under paragraph (a) as adjusted pursuant to section 8.11, including without limitation any additional infrastructure approved by the State of Queensland in accordance with the South East Queensland Water Strategy and the Regional Water Security Program.
Price Regulator means the Minister for Energy and Water Utilities.
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