Seqwater expenditure review PRUDENCY AND EFFICIENCY ASSESSMENT Updated Report for the Queensland Competition Authority March 2018 Important Notice If you are a party other than the Queensland Competition Authority, KPMG: • owes you no duty (whether in contract or in tort or under statute or otherwise) with respect to or in connection with the attached report or any part thereof; and • will have no liability to you for any loss or damage suffered or costs incurred by you or any other person arising out of or in connection with the provision to you of the attached report or any part thereof, however the loss or damage is caused, including, but not limited to, as a result of negligence. If you are a party other than the Queensland Competition Authority and you choose to rely upon the attached report or any part thereof, you do so entirely at your own risk. Limitations The responsibility for determining the adequacy or otherwise of our terms of reference is that of the Queensland Competition Authority. The services provided under our engagement (‘Services’) have not been undertaken in accordance with any auditing, review or assurance standards. Any reference to ‘audit’ and ‘review’, throughout this report, is not intended to convey that the Services have been conducted in accordance with any auditing, review or assurance standards. Further, as our scope of work does not constitute an audit or review in accordance with any auditing, review or assurance standards, our work will not necessarily disclose all matters that may be of interest to the Queensland Competition Authority or reveal errors and irregularities, if any, in the underlying information. In preparing this report, we have had access to information provided by Seqwater, as well as publicly available information. We have relied upon the truth, accuracy and completeness of any information provided or made available to us in connection with the Services without independently verifying it. The publicly available information used in this report is current as of March 2018. We do not take any responsibility for updating this information if it becomes out of date. This report provides a summary of KPMG’s findings during the course of the work undertaken for the Queensland Competition Authority under the terms of the engagement contract. The findings in this report are subject to change as our analysis progresses during the course of this engagement Any findings or recommendations contained within this report are based upon our assessment and our reasonable professional judgement based on the information that is available from the sources indicated. Should the project elements, external factors and assumptions change then the findings and recommendations contained in this report may no longer be appropriate. Accordingly, we do not confirm, underwrite or guarantee that the outcomes referred to in this report will be achieved. We do not make any statement as to whether any forecasts or projections will be achieved, or whether the assumptions and data underlying any such prospective financial information are accurate, complete or reasonable. We will not warrant or guarantee the achievement of any such forecasts or projections. There will usually be differences between forecast or projected and actual results, because events and circumstances frequently do not occur as expected or predicted, and those differences may be material. KPMG | i © 2018 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name and logo are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. Executive summary Seqwater as it is known today was officially formed on 1 January 2013, in accordance with the South East Queensland Water (Restructuring) Act 2007 as amended by the South East Queensland Water (Restructuring) and Other Legislation Amendment Regulation (No.1) 2012. This resulted in the merger of Seqwater and Linkwater, as well as transfer of responsibility for certain functions of the then Water Grid Manager to Seqwater. This followed the earlier merger of Seqwater and Watersecure in July 2011. As a result, Seqwater now owns and operates 26 dams, 37 water treatment plants (WTPs), 51 weirs and two bores and aquifers that supply up to 90 per cent of Southeast Queensland’s (SEQ) drinking water. It also owns and operates a 600‐kilometre network of pipelines, as well as the Western Corridor Recycled Water Scheme (WCRWS) and Gold Coast Desalination Plant (GCDP). Seqwater’s bulk water prices are set by the Queensland Government and subject to review by the Queensland Competition Authority (QCA or Authority) at the government’s request. In May 2017, the Authority was tasked with conducting an investigation into Seqwater’s proposed bulk water prices for the period 1 July 2018 to 30 June 2021.1 This represents the second investigation by the Authority following the establishment of Seqwater on 1 January 2013.2 To support its investigation, the Authority has engaged KPMG to independently assess the prudency and efficiency of Seqwater's forecast operating and capital expenditure (opex and capex respectively) associated with its bulk water supply activities. Specifically, in accordance with our terms of reference and at the request of the Authority, KPMG evaluated: • Seqwater's forecast opex and capex over the period 1 July 2018 to 30 June 2028 (consistent with the current 10-year price path); • Seqwater's actual capex (to the extent available) over the period 1 July 2014 to 30 June 2018, where this exceeds capex recommended by the QCA in the previous price investigation;3 and • Costs arising from any review events over the period 1 July 2015 to 30 June 2018. An assessment of the historical and forecast opex and capex represents a critical component in any investigation of (regulated) bulk water prices. To do this, and consistent with the Authority’s Terms of Reference, we have assessed the prudency and efficiency of Seqwater’s expenditure forecasts. To do this, we have adopted the following definitions: • Prudent, if it can be justified by reference to an identified need or cost driver; and • Efficient, if it is the least cost to deliver on an appropriately defined scope and standard of works and minimises Seqwater's long‐run costs of providing bulk water supply services. Where KPMG has assessed expenditure as not prudent or inefficient, we have either identified appropriate adjustments to the proposed expenditure profile provided by Seqwater to better align with 1 Queensland Government. Treasurer and Minister for Trade and Investment. Referral Notice for the Review of South East Queensland Bulk Water Prices. 25 May 2017. 2 The first pricing investigation was completed for the period 1 January 2015 to 30 June 2018. 3 KPMG note actual capex over this period was less than that allowed by the QCA and therefore this second evaluation was not required. KPMG | i © 2018 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name and logo are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. that of a prudent or efficient service provider, or we have excluded the expenditure from the forecast altogether. A detailed review of Seqwater’s demand forecast was considered out of scope for the purposes of KPMG’s assessment provided the forecasts within the regulatory submission are within the range published by Seqwater as part of its Water Security Program (WSP). As part of this review, KPMG has confirmed that the demand forecasts included in the regulatory submission are consistent with those presented under the WSP. Specifically, Seqwater has provided for a hybrid demand scenario encompassing a combined low and medium growth scenario in its submission to the Authority. KPMG provided its initial assessment to the QCA on 14 November 2017. This assessment was based on information provided by Seqwater over the period 11 August 2017 to 22 September 2017, as well as meetings held with Seqwater staff during 21, 22 and 24 August 2017.4 On 31 January 2017, Seqwater submitted its response to the QCA’s Draft Report. QCA sought for KPMG to reconsider its findings in lieu of this submission, and further information, provided by Seqwater to the date 26 February 2018. This report has been updated to now include KPMG revised recommendations arising from the evaluation of Seqwater’s response. KPMG has not sought to update all areas of its report and instead focused solely on those key areas where Seqwater has provided sufficiently robust information warranting further consideration. These key areas include: • Sampled capex projects (see Sections 7.8, 7.13, and 7.15); • Assessment of systematic issues (see Section 7.21); • Opex step changes (see Section 8.10); • Productivity targets (see Section 8.11); and • Review events (see Section 9). Further, to maintain the integrity of our original findings, we have not sought to adjust the language in the original assessment sections. Finally, KPMG has also assessed additional allowances sought by Seqwater (see Section 10), specifically: • More flexible arrangements in relation to large projects providing for the capitalisation of opex; and • Additional expenditure (capex and opex) associated with remobilisation of one train at the Luggage Point Advanced Water Treatment Plant (AWTP) as part of the Western Corridor Recycled Water Scheme (WCRWS). Our approach To support the Authority with its investigation, KPMG has approached this task by focusing on three separate, though interrelated, steps as shown in Figure 1. KPMG assessment approach, below. As Step 1, KPMG reviewed Seqwater’s governance arrangements and planning frameworks for consistency with good industry practices, providing for appropriate controls (e.g.