Melbourne Water Expenditure Review
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+ Melbourne Water Expenditure Review Essential Services Commission FINAL REPORT 25 February 2016 Contents Glossary ..................................................................................................................................... i Executive Summary ................................................................................................................... ii 1 Introduction .................................................................................................................... 1 1.1 Background ....................................................................................................................... 1 1.2 Scope of work ................................................................................................................... 1 1.3 Confidentiality .................................................................................................................. 1 1.4 Structure of report ............................................................................................................ 1 2 Overview of approach ..................................................................................................... 3 2.1 Process for review ............................................................................................................. 3 2.2 Approach for assessing forecasts ....................................................................................... 4 3 Summary of Melbourne Water’s forecasts ...................................................................... 7 3.1 Overview .......................................................................................................................... 7 3.2 Operating expenditure ...................................................................................................... 7 3.3 Capital expenditure ........................................................................................................... 9 3.4 Key drivers and obligations ............................................................................................. 10 3.5 Consultation ................................................................................................................... 11 3.6 Service standards ............................................................................................................ 13 3.7 Demand forecasts ........................................................................................................... 13 4 Assessment of operating expenditure ........................................................................... 15 4.1 Historical and forecast operating expenditure ................................................................. 15 4.2 BAU operating expenditure ............................................................................................. 17 4.3 Assessment by Service .................................................................................................... 27 4.4 Assessment by expenditure type ..................................................................................... 37 4.5 Summary of recommended changes to operating expenditure ........................................ 59 5 Capital expenditure ....................................................................................................... 62 5.1 Historical and forecast capital expenditure ...................................................................... 62 5.2 Generic issues ................................................................................................................. 64 5.3 Major sewer projects ...................................................................................................... 66 5.4 Major water projects ...................................................................................................... 75 5.5 Major waterways and drainage projects .......................................................................... 85 5.6 Major Programs Review .................................................................................................. 93 5.7 Summary of our recommendations ................................................................................. 98 Limitation of our work ............................................................................................................. 104 Liability limited by a scheme approved under Professional Standards Legislation. Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see www.deloitte.com/au/about for a detailed description of the legal structure of Deloitte Touche Tohmatsu Limited and its member firms. © 2016 Deloitte Access Economics Pty Ltd Glossary AER Australian Energy Regulator ASP Activated Sludge Plant BAU Business as usual BNI Business Needs Identifier Business Case CAPEX Capital expenditure DAE Deloitte Access Economics DBTS Digital Business Transformation Strategy EPA Environment Protection Authority Victoria ESC Essential Services Commission ETP Eastern Treatment Plant FIT Feed-in Tariff FWB Fairer Water Bills MCA Multi-criteria analysis MW Melbourne Water NPC Net Present Cost NPV Net Present Value OPEX Operating expenditure PPA Power purchase agreement RANE Risk Adjusted Nominal Estimate REC Renewable Energy Certificate RET Renewable Energy Target TN Total Nitrogen VDP Victorian Desalination Plant WAS Waste Activated Sludge WIRO Water Industry Regulatory Order 2014 WTP Western Treatment Plant Deloitte Access Economics i Executive Summary Background The Essential Services Commission (ESC) is currently conducting a review of Melbourne Water’s proposed services and prices to be charged for the regulatory period 1 July 2016 to 30 June 2021, referred to in this document as the next or fourth regulatory period. Melbourne Water submitted its 2016 Price Submission to the ESC for the fourth regulatory period in October 2015. The price submission includes forecasts of operating expenditure (opex), capital expenditure (capex) and demand, proposed service standards and prices. The ESC will review the price submission and intends to release a draft decision in March 2016, with a final decision in June 2016. Deloitte Access Economics (DAE) and Arup have been engaged by the ESC to review Melbourne Water’s expenditure forecasts. Arup is largely responsible for assessing Melbourne Water’s forecast capex, and DAE is assessing the forecast opex for the period. The ESC has requested that in our review of the capex forecasts we focus on the major projects that comprise a significant proportion of the total capex forecasts and provide advice on whether the expenditure meets certain criteria. For opex, we have been asked to provide advice on whether: Changes in operating costs are consistent with the timing of major capital projects Businesses are fulfilling their obligations and meeting customer service expectations as cost efficiently as possible, and Forecast divergences can be readily explained. The ESC asked that cost allocation, energy, IT and chemical costs be a focus of our review. Process for review We took the following approach to undertaking this review: We reviewed the Price Submission and supporting documentation provided by Melbourne Water to the ESC; We consulted with the metropolitan retailers and Southern Rural Water for their views on Melbourne Water’s Price Submission; We submitted a request for further information and prepared a number of questions for Melbourne Water; We visited Melbourne Water on 26 November 2015 to discuss the Price Submission and our questions; We visited the Western Treatment Plant on Monday 30 November 2015 for a tour of the sites where significant capex is proposed; We prepared a Draft Report which was provided to the ESC and Melbourne Water on 22 December 2015; Deloitte Access Economics ii We held discussions with Melbourne Water regarding the Draft Report and reviewed an initial written response from Melbourne Water to the draft report; and We reviewed responses provided by Melbourne Water following further questions relating to opex and capex. Approach to review In assessing Melbourne Water’s forecast operating and capex for the fourth regulatory period, we have had regard to the requirements of the Water Industry Act (1994) and the Water Industry Regulatory Order (WIRO), as well as the ESC’s Guidance Paper for Melbourne Water’s regulatory review, issued in April 2015. While there are a number of factors listed in the WIRO and Guidance Paper to which we have had regard, our overarching consideration is that the forecasts must be ‘expenditure which would be incurred by a prudent service provider acting efficiently to achieve the lowest cost of delivering on service outcomes over the regulatory period, taking into account a long-term planning horizon.’1 Our review has considered both the need and efficiency of the proposed expenditure. Melbourne Water has made significant cost reductions over the current regulatory period and is to be commended for doing so. Business and procurement processes have been redesigned, staff numbers stabilised (after adjusting for the in-housing of waterways staff) and there has been a clear focus on cost containment. Recommendations - operating expenditure However, through our analysis of Melbourne Water’s proposed opex we have identified the following areas of concerns with the forward forecasts and recommended the following