Securing Australia's Urban Water Supplies

Securing Australia’s Urban Water Supplies: Opportunities and Impediments

November 2006 Marsden Jacob Associates Financial & Economic Consultants

ABN 66 663 324 657 ACN 072 233 204

Internet: http://www.marsdenjacob.com.au E-mail: [email protected]

Postal address: Level 3, 683 Burke Road, Camberwell Victoria 3124 AUSTRALIA

Telephone: (03) 9882 1600 International: +61 3 9882 1600 Facsimile: (03) 9882 1300 International: +61 3 9882 1300

Author(s): Dr John Marsden and Phil Pickering

This report has been prepared in accordance with the scope of services described in the contract or agreement between Marsden Jacob Associates Pty Ltd ACN 072 233 204 (MJA) and the Client. Any findings, conclusions or recommendations only apply to the aforementioned circumstances and no greater reliance should be assumed or drawn by the Client. Furthermore, the report has been prepared solely for use by the Client and Marsden Jacob Associates accepts no responsibility for its use by other parties.

Photos on cover: Garden sprinkler – Marsden Jacob Associates Hinze Dam, 3 December 2002 - Courtesy of Gold Coast Water Maree area in outback South Australia – Image courtesy of Emergency Management Australia

TABLE OF CONTENTS Page

EXECUTIVE SUMMARY...... I

1. INTRODUCTION ...... 1

2. WATER CONSUMPTION AND DEMAND...... 5

3. WATER RESOURCES AND CLIMATE ...... 9

4. WATER SUPPLY PLANNING AND INFRASTRUCTURE...... 14 Water supply planning under climate uncertainty ...... 15 Implications for capital investment...... 17 Water-supply planning objectives...... 20

5. WATER SUPPLY AND DEMAND OPTIONS...... 22 Integrated Water Cycle Management...... 23 Unit Costs of Supply Options ...... 24 Purchase of water for cities...... 27 Water recycling ...... 29 Summary Perspective on Water Supply Options...... 36

6. FINANCIAL CAPACITY...... 37

7. PRICING AND COST RECOVERY...... 44 Costs of water supply...... 44 Cost recovery ...... 45 Tariff structures ...... 47

8. MARKET AND INSTITUTIONAL ARRANGEMENTS...... 52

BIBLIOGRAPHY...... 56

List of Figures

Figure 1: Direct Costs of Water Supply/Demand Options– Sydney, Adelaide, Perth, Newcastle...... iv Figure 2: Findings on Impediments and Opportunities for Securing Australia’s Urban Water Supplies...... xi Figure 4 : Water Usage Per Capita by Sector, selected countries...... 5 Figure 5: Consumption per capita (2004/05) ...... 6 Figure 6: Trend in rainfall, 1950 – 2005 ...... 9 Figure 7: Annual Inflows for South-West Dams (south-west WA)...... 11 Figure 8 : Annual Inflows for Lal Lal Reservoir (Ballarat /Geelong) ...... 11 Figure 9: Annual Inflows for Warragamba and Three Nepean dams (Sydney Region) ...... 12 Figure 10: Annual Inflows for Wivenhoe Dam (south-east Queensland) ...... 12 Figure 11: Total Storage Capacity and Annual Usage – Mainland State Capitals ...... 14 Figure 12: Capital Cities – Water Capital Expenditure Per Capita Over 5 Years (2001-2005) ...... 18 Figure 13: Direct Costs of Water Supply/Demand Options– Sydney, Adelaide, Perth, Newcastle ...... 24 Figure 14: Levelised Cost of Water Supply and Demand Options – 3 Cities...... 26 Figure 15: Comparative risk levels of reclaimed water and other events − (number of people likely to experience various events over a year from each ten million Australians...... 32 Figure 16: Cash Outflows and Inflows of Major Water Utilities (annual average 2001-2005)...... 39 Figure 17: Major Water Utilities – Payments To and From State Government 2004/05...... 40

List of Tables

Table 1: Indicative Full Cost Degree of Cost Recovery, Australian Capital Cities, 2005...... vii Table 2: Goals for per capita consumption ...... 7 Table 3 : Impact of Climate Scenarios on Estimated Yields and Required Timing of Next Source ...... 20 Table 4: Recycled water use as a proportion of treated water...... 30 Table 5: Cost of Recycled Water by Scheme...... 31 Table 6: Water and Wastewater Capital Expenditure Per Capita 2001-2005 ...... 38 Table 7 : Payments to Governments from Capital City Water Utilities (2004/05)...... 41 Table 8 : Comparative Net Debt and Capital Expenditure (2004/05) – State and Water Businesses ...... 41 Table 9 : Estimated Full Cost of Water Supply to Major Australian Cities ...... 45 Table 10: Indicative Full Cost Degree of Cost Recovery, Australian Capital Cities, 2005 ...... 47 Table 11: Major Water Utilities – Long Run Marginal Cost and Price...... 49

GLOSSARY AND ABBREVIATIONS

ACCC Australian Competition and Consumer Commission ATSE Australian Academy of Technological Sciences and Engineering AWA Australian Water Association CoAG Council of Australian Governments CRSWS Central Region Sustainable Water Strategy (Victoria) CSO Community Service Obligation DSE Department of Sustainability and Environment, Victoria ERA Economic Regulation Authority (Western Australia) FAO Food and Agriculture Organization of the United Nations IPART Independent Pricing and Review Tribunal, NSW IPR indirect potable reuse – purified recycled water discharged into a water body before being used in the potable water system ISF Institute for Sustainable Futures IWCM integrated water cycle management LRMC long run marginal cost – the long term incremental cost associated with the demand (say from a new entrant), often a period of 20 years or more in utility industries. MJA Marsden Jacob Associates NCC National Competition Council NWC National Water Commission NWI National Water Initiative PAWC Power and Water Corporation, NT PPP public private partnerships ROMAR reverse osmosis managed aquifer recharge SEQ South-east Queensland TWFAP Toowoomba Water Futures Advisory Panel Wentworth Wentworth Group of Concerned Scientists Group WHO World Health Organization WSAA Water Services Association of Australia

Basic measures kL kilolitre = 1,000 litres or 1 m3 (cubic metre) and weighs 1 tonne ML megalitre = 1,000 kL (or 1,000 m3) GL gigalitre = 1,000 ML TL teralitre = 1,000 GL or 1 km3 (cubic kilometre)

[page intentionally left blank] Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

EXECUTIVE SUMMARY

1. Historically, Australia’s major cities have been almost totally reliant on traditional surface water supplies and are therefore susceptible to the impacts of drought and climate change. While judgements may differ, the current drought now appears to be, at least, equivalent to the Federation drought of 1895 to 1902.

2. The current drought raises strong concerns. First, it is extreme in terms of the historical record. Second, it is a portent of a future under climate change. Third, it is a reminder (for south-eastern Australia at least) that climate and rainfall patterns can change abruptly as they have already done in the south-west of Australia.

3. Current water supply capacity across Australia has been typically planned to require restrictions on demand as frequently as 1 in 25 years based on the long-term historical record. Unfortunately, in many cases the long-term historical record no longer provides a reliable or confident indicator of current or future rainfall and streamflows. As a result, for many cities current supply capacity is now grossly inadequate and restrictions have become more frequent and more severe.

4. All capital cities with the exception of Darwin and Hobart now have inadequate water supplies and most are relying on increasingly severe restrictions to balance demand and available supply. Some regional cities are facing sharply diminished supply and extreme restrictions. Significant investment in water conservation and new water supplies is required.

5. The severity of the current drought has caught much of Australia off-guard, requiring hastily implemented actions to restore a balance between demand and supply of water as quickly as possible. As the Prime Minister recently noted: The simple fact is that there is little or no reason why our large cities should be gripped permanently by water crises… Having a city on permanent water restrictions makes about as much sense as having a city on permanent power restrictions. The Hon. John Howard, 17 July 2006

6. The availability of potable water, without lengthy or severe restrictions, is a fundamental indicator of urban water supply performance.

7. The purpose of this review is to provide a high-level perspective on water supply and demand for Australia’s large cities and to identify impediments to, and opportunities for, securing future urban water supply by restoring and maintaining the demand supply balance. 1

Water Supply Planning Under Uncertainty and Differences in Investment Levels

8. Across the States, there appear to be major differences in the way water supply planning and decision making for their capital cities has dealt with climate risk and uncertainty. The drought raises questions about how water supply planning should

1 This review is supported by research notes for each State and Territory, which are available at ES.i www.marsdenjacob.com.au.

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deal with the uncertainties of climate variability and the extent past rainfall and streamflow (the ‘100-year’ record) remains valid or useful as the basis for projecting future rainfall and streamflows.

9. These differences in the way climate uncertainty and risk have been treated correlate with recent levels of expenditure on water supply infrastructure. Over the past five years per capita expenditure in Perth, which has incorporated a ‘step-down’ climate scenario into planning for many years, has been twice or more the level of water supply investment in Sydney, Melbourne, Brisbane and Adelaide, which have not adopted scenario planning approaches or not done so until very recently.

10. Looking forward, there are also differences in announced water supply strategies and levels of future capital expenditure. While Perth will continue to spend heavily in comparison with other capital cities, substantial infrastructure investment expenditures will also be made in south-east Queensland. Many of the regional centres hit hardest by the drought, including Toowoomba, Goulburn and Ballarat, have urgently moved to develop emergency water sources.

11. To date, publicly foreshadowed expenditure on water supply for the other major cities is comparatively low, although explicit contingency strategies and options have been publicly indicated for Sydney and recently for Melbourne. With finalisation of the Central Region Sustainable Water Strategy, a robust planning framework for Melbourne and surrounding regions has now been adopted. But there are few firm commitments. The published planning documents for most other cities, including Adelaide, Hobart and Darwin, do not appear to countenance a downward ‘step-change’ in rainfall and therefore have not publicly identified the contingency measures that would be required.

Water Supply and Demand Options

12. Water planners have two fundamental options available to ease water restrictions – to encourage water conservation or to increase water supply. Voluntary water conservation is often the most affordable, environmentally sensitive option available to urban water users.

13. Most major Australian urban centres are currently subject to policies and strategies to reduce per capita water usage by 20 per cent or more over time. Water conservation alone is generally insufficient to meet the needs of an expanding population, particularly in fast growing regions such as Western Australia and south-east Queensland.

14. In terms of the elements of the respective strategies, the Sydney and Melbourne strategies place very heavy reliance on demand management and set more ambitious targets for reductions in per capita use than do other capital cities.

15. For Australia’s coastal cities, an extensive array of additional water supply and demand management options are available which potentially allows diversification of supply against climate variability and climate change. Supply options which are not rainfall dependent obviously include seawater desalination which, with the notable exception of Brisbane, can potentially offer large scale supply immediately ES.ii

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

and for coming decades. Greenhouse emissions from desalination are high and can be offset directly or via trade of greenhouse credits as envisaged by the Kyoto Protocol. In addition, careful attention is required to minimise impacts on the marine environment. There are generally technical solutions available to minimise these impacts and these then become a question of cost.

16. For Australia’s major inland cities and towns, some of which are facing the most severe drought in the country, recycled water and purchase of irrigation entitlements may be among the few alternative water supplies available.

17. Opportunities for substitution of non-potable water for potable water will arise in power station cooling and in mining operations. Although much of the ‘low hanging fruit’, i.e. inexpensive, socially acceptable recycling opportunities, has already been harvested, additional opportunistic, small-scale initiatives are being developed daily.

18. Indirect potable reuse (IPR) – where purified recycled water is discharged into a water body before being used in the potable water system – has successfully been implemented in Europe, Singapore and the United States. In addition, returns to rivers are currently observable in Australia on the Murrumbidgee, Kingaroy and other inland towns located on river systems. The key issue is not whether the science or the engineering are feasible, but the extent to which IPR will be accepted by the public. Major new water recycling initiatives are frequently comparable with, or more expensive than, the cost of desalination due to long transportation distances and/or the need for third pipe systems.

19. There is also important potential for cities to purchase water entitlements from irrigators. Significant trades have already occurred in Adelaide and Perth, but have, to date, been excluded as a matter of policy for other capital cities.

20. As emphasised by the National Water Commission in its June 2006 report to CoAG, all feasible water supply options should be on the table for consideration. The Wentworth Group of Concerned Scientists endorse a similar view, stating that there is now a need to “accept that desalination, potable reuse, and recycling and urban- rural trade are all legitimate options for our coastal cities and often better options than building new dams and damaging more coastal rivers.”

Variation in Supply Costs

21. Marsden Jacob’s analysis of the costs of the major supply and demand options available to Australian cities (Figure 1) emphasises: the very low cost of most options in favourable locations and situations; the very high cost (>$3.00/kl) of many options in unfavourable locations and situations; the corresponding lack of any simple universal cost ranking which can be simply applied to each and every situation; the dominating influence of the cost of pipelines and pumping where water needs to be transported over distance; ES.iii

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

that the relative cost of water management options can be counter-intuitive. For example, the cost of rainwater tanks and recycling schemes in some areas can be considerably higher than the cost of conventional water. Rainwater tanks deliver the highest benefit compared with cost in areas that receive consistent rainfall during the year. In areas that receive little rainfall during summer months, such as Perth, rainwater tanks supply relatively little water and at high unit cost with the result that other water sources are typically required to make up the shortfall during the heaviest periods of water use; the need to examine water supply and demand management options on a situation-by-situation basis; and there is some undesirable variation in the costing methodologies applied by the different States and a lack of disclosure for others.

22. This variation in costs from location to location impedes simple understandings of comparative costs. This means that solutions appropriate to one area can be inappropriate to another and that options favoured by popular opinion may not always be cost effective. This issue appears particularly relevant to popular supply options such as recycling or rainwater tanks.

Figure 1: Direct Costs of Water Supply/Demand Options– Sydney, Adelaide, Perth, Newcastle

$10.00 $9.30 $9.00

$8.00

$7.00 $6.00 $6.00 $5.60 $5.00 $5.00 $/kL $4.00 $4.00 $3.00 $3.00 $3.00 $2.61 $3.00

$2.00 $1.50 $1.58 $1.30 $1.45 $1.68 $1.00 $1.15 $1.30 $0.25 $0.30 $0.63 $0.00 $0.10 $0.20 $0.15 $0.06 $0.08 $0.00 $0.22 r t e r e s e s s X on ng e ing u te u SI i n cti anks men wa u t e r re d lination water BA thin e n e ed t t u r pipelin table re e wa o c men Gro oss ater recycl h t p surfac L w an d Rainwater t tc ec Storm r an Ca hase irrigationmand wat manag c De Indi Seawater desa otable p Long dis Pur Dams Non

Source: Marsden Jacob Analysis based on water supply plans for Sydney, Adelaide, Perth, Newcastle. Lower bound of indirect potable reuse estimate based on Toowoomba. Note: Comparable costings for Melbourne are not available and no costings are available for Queensland.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

23. Choice of additional water supplies and demand management measures involves more than comparison of unit costs. In times of uncertainty and increased risk, ‘security through diversity’ and rainfall independent sources are potentially powerful criteria supplementing a triple bottom line assessment.

Public Perceptions and Leadership

24. Community perceptions and acceptance are also critical, particularly for water recycling, desalination and the possibility of purchasing water from rural users.

25. There is some tendency for potentially controversial options to be censored out of consideration before the portfolio of choices is presented to the public. Subsequent resistance on the part of the public also has the potential to remove some water supply options from consideration. Strong and timely leadership is required to determine the options to be pursued and how and when the community should be engaged, especially because the risks of inaction are high.

26. Survey research confirms the importance of public trust in the responsible water authority or local council in promoting or undermining public acceptance of non- familiar supply options, particularly water recycling. There is a clear need and role for authoritative, factual information from government.

27. Public trust is bolstered by having clear, widely adopted standards and guidelines. For unfamiliar options such as indirect potable reuse, state or national guidelines should be developed as a matter of priority.

Financial Capacity

28. On a standalone basis, virtually all water businesses supplying the capital cities have significant financial capacity to fund both increased levels of capital expenditure and the dividends to the State Governments. Most of the businesses have paid dividends but have not increased capital expenditure significantly and certainly not increased it to the levels required to have avoided the current shortfall in supply.

29. Dividend payments from the major water businesses typically range from 50 per cent to 90 per cent of after-tax profit. This compares with an average dividend payout rate of 60 per cent to 70 per cent for Australian private sector businesses. The level of dividends would only constrain investment if the water businesses were not able to access sufficient financing for capital projects. However, the strong balance sheets and ability to raise additional revenue demonstrate that none of the major water businesses is under any immediate cash constraint.

30. By contrast, many of the smaller regional and council-owned water businesses operate under far tighter cash constraints. These organisations would have to increase prices significantly to pay for major new water supply investments. This raises serious questions about affordability, particularly in those areas where the economy has already been affected by drought and in regional towns with a relatively high proportion of low or fixed income residents. ES.v

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

31. A more immediate concern is that most water businesses are effectively subsidiaries of State Governments, with the result that increased expenditure, and consequent borrowings, translate into the State budget and may impact the State’s financial ratios and thus the State’s credit ratings.

32. There appears to be some conflict between the assumptions of economic regulators that a ‘BBB’ credit rating is adequate and the realities of the impacts of water business debt levels on the aspirations of most States to achieve or maintain ‘AAA’ or ‘AA’ credit ratings. The effect of these aspirations is potentially to reduce the appetite of the State governments for additional debt and infrastructure expenditure. The evidence suggests that the State Treasuries have, in the past, acted to constrain investment in water infrastructure, but that these constraints have been lifted once water supply investment has become a clear priority. This empirical question may warrant further attention.

Ability to Increase Levels of Cost Recovery

33. Major water supply augmentations to cater for drought or climate change are likely to require an increase in water utility borrowing and an ongoing increase in the price of water. Economic regulators can approve increased revenue levels to cover increased levels of capital expenditure where these are efficient and are required to address the risk of inadequate supply. Furthermore, there is scope to increase revenue levels even for existing levels of service if governments were to require higher dividends or if stronger cashflows were required in the future to allow for greater debt funding.

34. Regulated water prices and revenues are not set in the same way as other utilities such as electricity or telecommunications. The regulatory asset value for water businesses is often well below the efficient replacement cost of the infrastructure. This is not generally the case in the other utility sectors. As a result, if water prices were set in the same manner as other utility industries, the level of water prices/revenue would increase sharply. Marsden Jacob estimates indicate that there could potentially be scope to increase revenue levels across Australian capital cities on average by as much as 33 per cent (Table 1) and still remain within the upper bound of efficient pricing levels. That is, if the same approach as applied to electricity, gas and telecommunications, were to be applied for water, then annual revenue levels for the water businesses of Australia’s eight capital cities could, in aggregate, be up to $600 million per year higher.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Table 1: Indicative Full Cost Degree of Cost Recovery, Australian Capital Cities, 2005

City : Indicative Current total Current Revenue ‘Extra’ full cost 1 water degree of full increase for revenue ($m) revenue cost recovery 100% ($m) ($m) recovery Sydney 775 587 76% 32% 188 Melbourne 633 431 68% 48% 202 Brisbane 219 184 84% 19% 35 Adelaide 255 209 82% 22% 46 Perth 360 266 74% 34% 94 Hobart 26 23 89% 13% 3 Darwin 37 30 80% 25% 7 Canberra 82 66 80% 25% 16 Total 2,387 1,796 75% 33% 591

Source : Marsden Jacob analysis based on WSAAfacts 2005 Note Marsden Jacob understand that underlying asset values may not be reliable in all cases. Costs and revenue levels should be considered a preliminary indication only.

35. In sum, the water businesses serving the capital cities appear to have the capacity to finance substantially higher infrastructure expenditures through higher levels of debt and revenue. However, this capacity is likely to be constrained in smaller inland cities and towns due to the lower ability to pay of many regional customers.

36. Importantly, the fact that water authorities could raise additional revenue does not mean that the usage charge must be increased. Other charges, including the fixed administration charge and developer charges could alternatively be increased.

Price Signals and Efficient Tariff Structures

37. There is a popular concern that water is priced too cheaply and in particular that the volumetric usage charge is too low. In addition, there are many consumers of water that do not receive a price signal – water users do not know the true cost of the water consumed: around 30 per cent of Australians rent their accommodation and do not receive water bills which are sent instead to their landlords. This practice and legislative requirement means that renters do not know their water bill; and all Australian States offer some form of discount to concession cardholders on water and energy bills. As an example, in Victoria, around 30 per cent of all water accounts can receive a discount of up to $154 on total water and sewerage charges with a uniform discount applying to each element of the water bill (excluding the parks and drainage levy). That is, in at least the case of Victoria, the discount applies to both the fixed administrative charge and importantly the volumetric charge.

Is this the most efficient way of providing assistance to persons holding concession cards? Alternatively, a greater discount could be provided on the ES.vii

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

fixed administration charge and all subsidies on the volumetric charge could be removed; and in some cases, such as Adelaide, Perth and Canberra, water users pay a significantly lower price for low volumes of water use. Pricing signals could be strengthened if all water use was charged at the true cost and the fixed charge was reduced accordingly to compensate.

38. Moreover, governments at all levels, intervene heavily to reduce the cost of water to final consumers. For instance: the Queensland Government makes a 40 per cent contribution to the capital costs of the infrastructure of council water businesses; the Victorian Government makes periodic contributions to major water projects benefiting water users in both Melbourne and non-metropolitan centres. For instance, the State Government has recently announced a $30 million2 subsidy payment for the pipeline from the Goulburn Valley to Bendigo; and the Australian Government has earmarked $1.6 billion over the five years to 2010 for funding of water projects under the Water Smart Australia programme. Administered by the National Water Commission (NWC), the fund targets “big ticket” projects to provide quantum changes in water management and “aims to accelerate the development and uptake of smart technologies and practices in water use across Australia”.

Is the current approach of subsidising investments in water infrastructure benign, or is it distorted by sending inefficient price signals to the water businesses and water users. The answer is an empirical matter depending on whether or not the subsidies affect incremental charges, i.e. the usage/volumetric charge and the developer charges.

39. The primary purpose of the usage charge should be to send a signal regarding the cost of increasing water usage. This can be achieved by setting the usage charge such that it recovers the incremental cost of new water sources, including recognition of environmental externalities.

40. In general, economic regulators across Australia have begun to shift the level of the usage charge toward the incremental financial cost of new water sources. However: it appears that only Sydney, Melbourne and Perth have well developed, publicly available estimates of the incremental cost of supply. Both NSW and Victorian regulators have indicated that the estimates need further refinement; no systematic review of the environmental costs has been made as part of any price inquiry in Australia. Without such a review, any price increase to accommodate environmental costs will be arbitrary at best. A relevant question is the extent to which a separate environmental levy is justified if adequate water has been allocated for environmental purposes (in accordance with the National Water Initiative); and

ES.viii 2 Department of Primary Industries 2006, p. 3.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

efficient water pricing requires efficient tariff structures, especially an appropriate volumetric charge. The desire to strengthen the price signal in order to promote water conservation by pricing above incremental cost may distort the pricing signals for investment and potentially competition, including through third party access. The logic and impacts of existing multiple part tariffs needs to be fundamentally considered.

41. These several pricing and tariff questions should be reviewed as a matter of priority.

Institutional Arrangements

42. Institutional arrangements for water supply planning and delivery vary substantially across Australia. The single unifying feature is that these functions remain under government control. All States employ a lead agency model for water supply planning, but there are numerous variations. Queensland has moved from the previously fractured and uncoordinated approach associated with multiple infrastructure owners to rely initially on the Department for Natural Resources and Water and now on the newly established Queensland Water Commission. The Queensland case had illustrated that drought/climate change are not the only reason for inadequate supply capacity.

43. Overall, there is a need to take a big picture view that incorporates the needs of all water users and the environment and then allow the implementation to occur locally. However, there remain several unanswered questions regarding how best to deal with water supply planning amongst small council-owned businesses and how private sector involvement might be integrated.

Summary and Directions

44. This review identifies major impediments to securing water supplies for Australia’s major cities and corresponding opportunities to rectify and improve the situation comprehensively. These are summarised in the checklist shown in Figure 2.

45. To improve effectiveness, e.g., planning and management of urban water supplies, there is a need to: i) understand the strengths and weaknesses of the several different approaches to dealing with climate uncertainty and risk in water supply planning. ii) benchmark and understand the similarities and differences in the pricing methodologies – as applied – used to set regulated prices/revenue levels for water and other utility services. Should the definition of full costs applied to water continue to differ from the definition applied to other utility sectors? Desirably, a national regulator such as the Australian Competition and Consumer Commission (ACCC) or National Competition Council (NCC) should be asked to examine and improve the consistency of regulatory price setting for water; iii) agree common methodologies for the costing and comparison of supply and demand management options; ES.ix

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

iv) develop a clear picture of the costs and drivers of major water supply and demand management options to clarify strategic thinking, allow comparisons, speed strategic evaluations and ensure appropriate usage charges; v) consider more fundamentally the meaning of efficient water pricing. To what extent do State, Commonwealth and National Water Initiative grants affect the efficiency of the pricing structures and customer awareness of the true costs of water? What is the appropriate logic and level of multiple part tariffs? vi) understand the levels and drivers of public trust in the major water authorities across Australia in terms of the potential acceptance or rejection of non- traditional supply options.

46. Other questions, less immediate but potentially important in terms of improving the efficiency of water planning and management, include: vii) given the fundamental importance of water supply planning in the face of climate uncertainty, which market-based approaches to water supply and delivery offer net advantages? viii) water entitlements, water allocations and water trading are focussed on bulk water systems and entitlements held by irrigators and other major users. To what extent could this approach be more fully applied to major urban centres? What lessons are available from the success, or otherwise, of retail contestability in electricity?

— || —

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Figure 2: Findings on Impediments and Opportunities for Securing Australia’s Urban Water Supplies

Planning approach

Often slow and partial recognition of climate uncertainty and risk

Scope to improve planning approaches under uncertainty and risk

Range of Options Considered

No universally superior water supply options in all locations

Misperceptions and pre-censoring of key non-traditional options (especially desalination, recycling and purchase of water from irrigators)

Triumph of perceptions over science, particularly via rushed decision processes

Scope for measured consultation, consideration and education campaigns

Pricing and tariff structures

Additional revenue potential

Various subsidies may risk distorting price signals if volumetric charges are effectively subsidised

Financial

Sufficient financial capacity in major water businesses to fund new investment, regional businesses face tighter constraints

Centralised control of debt and capital programs can constrain investment

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

1. INTRODUCTION

1. Since 2002, virtually all of the eastern mainland States and an enlarged area of the south-west of Australia have moved into drought (Figure 3). The widened coverage of the drought across Australia means that, with the exception of Darwin, all mainland capital cities and most other urban centres now have insufficient supplies of water to meet unrestricted levels of demand and are reliant on restrictions to close the gap between available supply and demand. Drought has come to town! It is no longer limited to ‘the bush’.

2. Reduced urban water availability contrasts with the sharp increases in urban populations. Since the mid-1970s, Perth’s population has more than doubled, yet streamflows into dams have fallen to a third. More recently, drought conditions have been experienced much more widely and have intensified. In south-east Queensland, the major dams are forecast to be completely dry early in 2008 if current inflows continue and no drought contingency measures are developed. Two-thirds of all major urban centres in Australia are currently facing some form of water restriction.3 The drought is now comparable with, or worse than, the Federation drought of 1895-1902.

3. The current drought raises strong concerns. First, it is extreme in terms of the historical record. Second, it is a portent of a future under climate change. Third, it is a reminder (for south-eastern Australia at least) that climate and rainfall patterns can change abruptly as they have already done in the south-west of Australia.

4. Current water supply capacity across Australia has been typically planned to require restrictions on demand as frequently as 1 in 25 years based on the long-term historical record. Unfortunately, in many cases the long-term historical record no longer provides a reliable or confident indicator of current or future rainfall and streamflows. As a result for many cities, current supply capacity is now grossly inadequate and restrictions have become more frequent and more severe.

5. The drought and associated shortfalls in supplies focuses attention on the need for rigorous long-term water resource management, water conservation and infrastructure planning and on the ability to implement them.4 The management of water has become a key policy and political issue Australia-wide. In recognition of the water situation, several State Premiers have, at times, assumed direct responsibility for the management of water supply options for the State. Many of

3 Sixteen of the 24 Australian cities with a population greater than 50,000 are facing some form of water restriction due to drought. 4 For more than a decade, Australia’s urban water sector has experienced extensive economic reform under the 1994 Council of Australian Governments (CoAG) Water Reform Agenda and more recently through the 2004 National Water Initiative. One of CoAG’s major achievements was to commit governments to separating the responsibility for water resource management policy, standard setting, regulatory enforcement and service provision from the agencies which actually delivered and sold water to customers. Despite these major reforms and their benefits, many urban centres are facing adverse climatic changes to their ability to maintain the balance between consumptive demand and reliable supply. To some extent, these adverse changes have been offset by beneficial potential technological changes.

FINAL REPORT, 21 November 2006

Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

the regional centres hit hardest by the drought, including Toowoomba, Goulburn and Ballarat, have urgently moved to develop emergency water sources.

6. The severity of the current drought has caught much of Australia off-guard, requiring hastily implemented actions to restore a balance between demand and supply of water as quickly as possible. As the Prime Minister recently noted:

The simple fact is that there is little or no reason why our large cities should be gripped permanently by water crises… Having a city on permanent water restrictions makes about as much sense as having a city on permanent power restrictions. The Hon. John Howard, 17 July 2006

7. The Department of the Prime Minister and Cabinet commissioned Marsden Jacob Associates (MJA) to provide a high-level review and discussion paper on water supply and demand in Australia’s major urban centres. The purpose of the review is to provide an overview of the situation and identify impediments to, and opportunities for, securing future urban water supply in Australia, in each of the eight capital cities, and in selected regional centres.

8. In examining opportunities for, and impediments to, more effective and efficient provision of water supply and associated demand management, the review seeks to focus particularly on the basic requirements for effective and efficient water supply − requirements and issues which are common and fundamental regardless of how the water industry is organised in terms of market and institutional arrangements.5

9. The common and fundamental requirements include:

i) minimum supply for essential use;

ii) institutions and institutional and market arrangements which command high absolute levels of confidence in their ability to deliver water with fit-for- purpose quality;

iii) an effective framework for water supply planning in the presence of climate risk and uncertainty;

10. To ensure that these fundamental requirements are met efficiently requires:

iv) a robust process and framework for water supply planning which considers all options and does not pre-censor non-traditional options such as desalination, purchasing water from irrigators or potable re-injection of reclaimed water, or pre-endorse others such as rainwater tanks;

v) systematic evaluation of options against economic, social, environmental and risk criteria including the ability to diversify sources away from rainfall dependent sources;

5 For a discussion of issues relating to third party access and other options for private involvement in the water sector, see MJA (2005).

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

vi) efficient price signals to customers so that they are aware of the true cost of their additional demand and of savings from reduced demand. This principle also requires that customers bear or enjoy the cost impacts of any supply choices they may make;

The objective of broader efficiency in terms of natural resource management and investment as recognised by the National Water Initiative require:

vii) an effective system of property rights to water for all users above a suitable threshold (with the threshold level dependent upon transaction costs);

viii) statutory water resource management plans which define the water sources that may be used/developed for water supply, the entitlements to use the consumptive pool(s) and the choices made on the tradeoffs between environmental needs and the size and availability of the consumptive pool(s).

Mechanisms and incentives for better performance and efficiency are also required. Increased private sector involvement is one such mechanism.

FINAL REPORT, 21 November 2006

Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Australia’s Water SupplyStatus and Seasonal Outlook,October 2006 : National Water Commission, Source Figure 3: Australian Rainfall and Dam Storage Levels Rainfall and Dam Storage Levels 3: Australian Figure

FINAL REPORT, 21 November 2006

Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

2. WATER CONSUMPTION AND DEMAND

11. As a nation, Australia’s urban centres consumed 2,600 gigalitres in 2005.6 By 2025, Australia’s population is projected to have increased from 20.3 million in 2005 to 24.7 million in 2025. Other things equal, increased demand for water will contribute to the current shortfall of supply.

Per Capita Use

12. Compared with countries examined by the Food and Agriculture Organization of the United Nations (FAO), the distinguishing feature of Australia’s water consumption is not the high level of use for urban or residential purposes, but rather, the high level of use in agriculture, mostly for irrigated crops (Figure 4).

13. Per capita use for domestic/residential purposes in Australia is higher than European countries, but less than in the USA, Canada or New Zealand.

Figure 4 : Water Usage Per Capita by Sector, selected countries

1,800 Domestic Agriculture Industrial 1,600

1,400

1,200

1,000

800 kL/person/year 600

400

200

l a a n n zi i on a ca ica a i r r ands and Indi st er Af B China l erati al Japa exico m ingdom e M Canada K h her ed Z Paki Australia Indones Germany mic Rep of f A et a o Sout N ew ian F N es United at uss St R Iran, Isl ed nit U

Source: FAO AQUASTAT database (accessed August 2005)

14. Across the Australian capital cities, total consumption per capita for urban water use varies from a low of around 120 kilolitres per annum for Melbourne to a substantial

6 WSAAfacts 2005, figures for reporting water authorities for major urban centres.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

350 kilolitres per annum for Darwin (Figure 5). Per capita water use for residential purposes is more uniform.7

Figure 5: Consumption per capita (2004/05)

400

350

300

250

200 kL/person pa 150

100

0 Sydney Melbourne Brisbane Adelaide Perth Hobart Darwin Canberra

Residential Non-residential Source: WSAAfacts 2005

Note: Hobart’s residential volume represents its bulk water supplies to its eight Councils. For six of the Councils there is little metering of residential use. The estimate may therefore overstate the level of residential use per capita.

Current Restrictions

15. The nature of restrictions on water use varies across Australia. Currently, 16 of the 24 major cities in Australia are facing some form of water restriction. These range from relatively benign two-day per week outdoor watering restrictions to total outdoor water use bans. Comparisons of restrictions across States are made difficult by lack of consistency in terminology and content. For example, in November 2006, Level 4 restrictions were imposed in SEQ, which included bucket only outdoor watering on alternate days.8 In Ballarat, Stage 4 restrictions have been imposed that ban outdoor watering of any form.

7 These comparisons are based on the use of scheme water from the supply authority and do not reflect the use of garden bores which are particularly important for Perth. When adjusted for garden bore use, Perth’s per capita consumption for residential purposes is at least 20 per cent higher than indicated by the consumption volumes reported for the Integrated Water Supply Scheme for Perth. See Marsden Jacob Associates (2006). 8 Queensland Water Commission (2006) “Level 4 restrictions start 1 November”, 31 October

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Targeting Levels of Per Capita Use

16. Most major urban centres are subject to policies and strategies to reduce per capita consumption. In several cases, the policy is to reduce unrestricted per capita consumption to the levels currently or recently achieved by restrictions (Table 2). Typically, the reductions sought are around 20 per cent over time, with larger reductions assumed in the Sydney and Melbourne water plans.

Table 2: Goals for per capita consumption

Actual consumption Target per capita annual consumption (kL/person pa)1 (kL/person pa) City 2001 2005 Total Change from 2001 TOTAL CONSUMPTION Sydney 154 124 120 by 2011 (licence2) -22%

107 by 2020 (water plan3) -31%

100 by 2030 (water plan3) -35%

Melbourne 148 120 116 by 20154 -22% 108 by 20204 -27%

Brisbane 183 181 1465 -20%

Adelaide 185 151

Perth 190 152 155 by 20127 -20%

Canberra 165 134 153.5 by 20138 -7% 130.8 by 20238 -21%

RESIDENTIAL CONSUMPTION Brisbane 107 104 99 by 2010 -7% residential 91 by 2015 -15% -21% 84 by 20205 Adelaide 114 99 -22% by 20256 household

Notes: 1 Based on WSAAfacts 2005 unless otherwise stated. 2 Licence condition. 3 As shown in ISF, et al (2006) Review of the Metropolitan Water Plan: Final Report. 4 Department of Sustainability and Environment (2006) Sustainable Water Strategy – Central Region: Action to 2055, Our Water Our Future initiative, October, p. 39. 5 Considered achievable by South East Queensland Water and Wastewater Management and Infrastructure Study. In 2004, Brisbane City set a target of 18 per cent reduction within six years (by 2010). SEQ Regional Plan, p 101. 6 Water Proofing Adelaide 2005 2025. Target relates to household use of 280 kL rather than per capita use. Household use shown in WSAAfacts was 271 kL in 2001. 7 State Water Strategy (2003), p. 15. 8 Thinkwater, actwater Volume 1: Strategy for sustainable water resource management in the ACT (2004), April, p. 3. Note this includes bulk water sales which are not included in the earlier figure.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

17. Targets for reductions in per capita use vary across Australia. The capital cities with the highest per capita consumption – Darwin and Hobart – have not proposed any water use reduction targets. Brisbane, Perth, Adelaide and Canberra have all proposed reductions of around 20 per cent from pre-restriction levels. The two capital cities with the lowest per capita use – Sydney and Melbourne – have proposed the boldest water conservation targets (27 per cent and 35 per cent reductions from 2001 levels respectively). Sydney’s water plan in particular relies heavily on these targets to avoid the construction of major new water sources, however explicit contingency options (desalination, groundwater and deep storages) have been identified in case supply/demand targets are not met.

18. Water conservation targets of 20 per cent or more are equivalent to the water that could be made available from a major new water source such as a desalination plant, recycling or a dam augmentation. Water conservation measures are typically environmentally and socially superior to conventional water source options. Water conservation is therefore a key strategy to address the water supply demand balance in Australia.

19. Large-scale water conservation measures, such as retrofitting of water saving appliances, does come at a cost. This cost must be weighed against the benefits of the measure. For example, the review of Sydney Metropolitan Water Plan suggests some water conservation measures, such as appliance standards and labelling, may cost very little, while other measures, such as the installation of rainwater tanks may cost as much as $3 per kilolitre – well above the cost of other measures such as recycling.9

20. Prudent planning suggests that all Australian cities – even those not currently experiencing drought – should rigorously examine the costs and benefits of water conservation options. Water conservation has the potential to delay or avoid the need for water restrictions or major water source augmentations. Where aggressive water conservation targets have been adopted, water supply plans should explicitly examine the course of action that will be taken if these targets are not met.

9 Institute for Sustainable Futures et. al. (2006).

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

3. WATER RESOURCES AND CLIMATE

21. With the exception of Perth, Australia’s major urban centres are overwhelmingly supplied from surface water sources. Even in Perth, the bulk of groundwater is taken from aquifers, which respond to changes in rainfall over time.

22. Historically, water planning in Australia has focussed on easy-to-access and cheap- to-use surface water sources rather than alternative sources, such as recycled and reclaimed water and other manufactured water such as desalinated seawater. These non-traditional sources tend to be restricted by their economic cost and by community perceptions of the quality of this water.

23. The Australian continent as a whole has shown a consistent drying trend over the past 50 years (Figure 6). While rainfall in the tropical north-west has actually increased, in the more populated areas of Australia there has been a decline. Similar trends are also evident for extreme daily rainfall, with increases in north-western and central Australia and decreases in southern and eastern Australia from 1950 to 2005 (Gallant et al. 2006). Droughts have also become hotter and more intense in these regions (Nicholls 2004). The fall in rainfall and its effects on streamflows in the south-west is significant and often highlighted, however, significant downtrends in rainfall are also evident along the entire Australian east coast.

Figure 6: Trend in rainfall, 1950 – 2005

24. Some of the observed changes to rainfall over this period have been abrupt or stepped rather than gradual. For example, a sharp downstep in rainfall and streamflows has occurred in the south-west since the mid 1970s (Figure 7). This downstep is due to the southward contraction of pressure belts and storm tracks which are increasingly located in more southern latitudes, i.e., the ‘roaring forties’ have shifted to become the ‘furious fifties’. This phenomenon is not limited to the

FINAL REPORT, 21 November 2006

Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

south-west of WA. Indeed, similar downsteps in rainfall and streamflow patterns are evident in places such as Ballarat (Figure 8) and detectable in the Murrumbidgee10 but remain ambiguous in other systems (Figure 9). Major investigations into climate, rainfall and streamflow projections are now underway for the catchments supplying major capital cities.11

25. The drying over the past 50 years in southern and eastern Australia is broadly consistent with the rainfall and streamflow projections by CSIRO. Simulations of climate variability and change (BRANZ, 2006) have shown a drying of the southern portion of the continent and a possible moistening over some parts of the tropical north. The CSIRO models show a wide spread in rainfall projections, consistent with the large uncertainties on regional rainfall projections. For 2030, the southern part of the continent shows potential changes ranging from a slight increase to a 20 per cent decrease (for any given location). For 2070, the projections for reduced rainfall are even more significant and about double the predicted rainfall reductions in the year 2030.12 Background on Australian rainfall and climate is provided in Box 1.

26. Shifts in rainfall in the south-west of WA are readily observable in the raw data, in part because rainfall variability is low in the south-west and does not disguise them. In contrast, in the eastern States, the El Niño – La Niña pattern has a strong influence with the result that rainfall variability is high and the seasons swing from flood to drought. Where rainfall and streamflow variability is high, it serves to mask any shifts in average levels of rainfall that may occur.

27. In summary, evidence from local and international research points to the possibility of a down-step in inflow into many of Australia’s major dams. The south-west of Western Australia has experienced this down-step for more than nine years. The key insight for water supply planners is that historic models of inflow should not be relied on as indicative of the future.

10 See CSIRO investigations on climate and rainfall in the Murrumbidgee, such as, Charles, S., Bates, B., and Viney, N. (2003). See also ACTEW water planning: Bates, B., Charles, S., Kirby, M., Suppiah, R., Viney, N. and Whetton, P., 2003,. 11 For instance, current investigations described in the recent audit of Sydney’s Metropolitan Water Plan 2006 by ISF, ACIL Tasman and SMEC (2006), pp. 16 and 67. 12 All projections are expected to be updated following the release of the fourth IPTC assessment of climate change.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Figure 7: Annual Inflows for South-West Dams (south-west WA)

1,000,000

900,000

800,000 Average 1911 - 1974 338,000ML

700,000

Average 1997 - 2005 600,000 114,000ML

500,000 Average 1975 - 1996 400,000 177,000ML

300,000

200,000

100,000

0 1911 1915 1919 1923 1927 1931 1935 1939 1943 1947 1951 1955 1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003

Source: http://www.watercorporation.com.au accessed 18/10/06. Data for 2006/07 for year to 27/09/06.

Figure 8 : Annual Inflows for Lal Lal Reservoir (Ballarat /Geelong)

60,000 Average 1930 – 1997 Average 1997 – 2005 Average27,000 MLpre 1997 Average post 1997 27,400 ML 12,000 ML 50,000 11,600 ML

40,000

30,000

20,000

10,000

0 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Source: Department of Sustainability and Environment

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Figure 9: Annual Inflows for Warragamba and Three Nepean dams (Sydney Region)

8,000,000

7,000,000 Average 1949-1990 6,000,000 2,011,000 ML Average 1909-1948 937,000 ML 5,000,000 Average 1991-2005

4,000,000 572,000 ML

3,000,000 Long-term average = 1,334,000 ML 2,000,000

1,000,000

0 1909 1913 1917 1921 1925 1929 1933 1937 1941 1945 1949 1953 1957 1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 Inflow for 2006 is for first six months of year

Source: Sydney Catchment Authority

Figure 10: Annual Inflows for Wivenhoe Dam (south-east Queensland)

4,500,000

4,000,000 Average 1949-1991 1,066,000 ML 3,500,000

3,000,000 Average 1992-2005 Long-term average 426,000 ML 863,000 ML 2,500,000 Average 1909-1948 608,000 ML 2,000,000

1,500,000

1,000,000

500,000

0 1909 1913 1917 1921 1925 1929 1933 1937 1941 1945 1949 1953 1957 1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005

Source: Department of Natural Resources and Water

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Box 1: Background on Australian Rainfall and Climate

Australia is the driest inhabited continent on the planet with population centres clustered on the wet coastal fringes around the south and east. Australia also has the most variable rainfall and runoff. The continent spans a tropical (monsoonal) climate regime in the north through an arid interior and a southern coast on the fringe of the southern ocean mid latitude storm tracks. This produces the characteristic rainfall distribution shown below. Australian annual rainfall and rainfall regimes

There is significant rainfall along the eastern coastal fringe associated with storm systems and their interaction with the Great Dividing Range. The major cities are located inside the coastal fringes where rainfall occurs. The interior of the continent receives very little rainfall because it sits beneath the descending branch of the subtropical ridge, as is characteristic of the planet's desert regions. El Niño events have a significant effect on Australian weather patterns and involve extensive warming of the central and eastern Pacific Ocean, leading to an increased probability of dry conditions, particularly in the eastern part of Australia. La Niña describes the reverse of the El Niño effect and is related to changes in atmospheric conditions and ocean circulation, associated with an increased probability of wetter conditions. The features of rainfall in Australia make it particularly sensitive to greenhouse driven climate changes. Though rainfall is hard to project in models, one of the consistent results that emerge is that the dry regions tend to get dryer and wet regions wetter under greenhouse scenarios (Houghton, 1996; Houghton et al., 2001). An additional concern is that the southern coast and cities (Perth, Adelaide, Melbourne and Hobart) are dependent on the passage of frontal systems to provide much of their rainfall. If these frontal systems were to contract to the south, there is potential for major rainfall reductions in these regions. This is a particular concern in light of studies that indicate a contraction of the southern ocean storm track in recent decades (Thompson and Soloman, 2002, Karoly 2001, Hartman et al 2003) and the role of both greenhouse and ozone forcings in this contraction (Arblaster and Meehl, 2006). Temperature trends in Australia over the past century are consistent with global trends in showing a more or less steady warming and a corresponding increase in evaporation rates across Australia. This warming further reduces water availability, particularly in areas that have experienced reductions in rainfall. Note : This background material reflects analysis undertaken by Dr James Risbey and Marsden Jacob in the development of the Department of Environment & Heritage (2006), Climate Change Impacts & Risk Management – A guide for Business and Government, prepared by MJA and Broadleaf Capital.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

4. WATER SUPPLY PLANNING AND INFRASTRUCTURE

28. The majority of urban water in Australia is currently sourced from large dams and piped to city centres. Since streamflows in Australia are highly variable, Australian dams are around three times larger relative to consumption than in Europe or America.13 (Australia has over 500 major dams and stores more water than any other country, up to three Olympic size swimming pools for each person.)

29. Perth and Adelaide are exceptions to this rule: Perth draws around 60 per cent of water supply from groundwater sources, which have a significantly lower variability between years; and Adelaide has substantial drought security through its ability to draw on the River Murray. During ‘normal’ streamflow years, SA Water draws only approximately 37 per cent of Adelaide’s water from the River Murray, but in times of drought relies heavily on the Murray for its annual water supply.

30. South-east Queensland (SEQ) has by far the largest ratio of storage to annual usage, reflecting the extreme variability in annual rainfall (Figure 11). Sydney and Melbourne face less climate variability. However, like SEQ, most cities rely heavily on dams and therefore require a large storage buffer against low rainfall years.

Figure 11: Total Storage Capacity and Annual Usage – Mainland State Capitals

3,000

2,500

2,000

1,500

1,000

0.9x Total Capacity / Usage (GL) 6x usage 3x usage 500 4x usage usage

0 2x usage Sydney Melbourne SE Qld Perth Adelaide Total Storage Capacity Annual Water Usage

Source: Marsden Jacob analysis

13 See Bates, B. and Thomas, J., 2003.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

31. Risk of streamflow variability and change is mitigated where a city has diversified sources. Brisbane and Sydney operate essentially one dam systems, relying primarily on Wivenhoe and Warragamba dams, respectively. Although the Thomson Dam accounts for around 50 per cent of Melbourne’s supply capacity, the remaining dams are spatially separated and therefore supply is somewhat more diversified.

Water supply planning under climate uncertainty14

32. A fundamental indicator of the performance of water supply systems is resilience in times of drought and stress. For urban water supply, this indicator translates to the availability of potable water without lengthy or severe restrictions.

33. Inappropriate restrictions can be defined as those levels of duration and frequency of restrictions where the costs to the community could have been avoided at a lower cost15 through some combination of water conservation or investment in new water sources, including recycling, purchase of water and interlinking pipelines.

34. The difficulty with this definition is that inappropriate restrictions are rarely intended. In general, inappropriate restrictions will arise only where they are unanticipated − and this highlights the difficulties of assessing water supply reliability in a period where it is uncertain whether the drought is merely an example of climate variability, or whether, via increased severity or frequency, it is an example of climate change.16 These are questions of how risk and uncertainty are addressed and managed.

14 Water planning across Australia is typically conducted through two mechanisms – statutory water plans (specified in Schedule E of the NWI) and water supply plans: the statutory water plans relate to specific water sources and specify the environmental and other public benefit outcomes for the relevant water system, the overall objectives of water allocation policies, pathways to correct overallocation or overuse, the reliability of the consumptive pool and a range of other matters; water supply plans set out the strategy for ensuring demand and supply balance is achieved and maintained into the future. They set out the intended order and sequence by which supply sources will be accessed, infrastructure required and demand reduction strategies to be implemented. The statutory water plans define the consumptive pools and entitlements to them; the water supply plans describe the intended timing and extent of access to these pools. Statutory plans are typically drawn up by the relevant government department with input from water businesses and natural resource management bodies. 15 Cost includes financial, social and environmental costs. 16 A major contentious issue in assessing future water supplies is whether there has been a shift in the climate or whether current conditions are consistent with the historical record (climate change versus climate variability). For the purposes of immediate water supply planning, it is not relevant whether the current drought represents a substantive change in the climate or that the climate is the same, just more variable than previously modelled. For longer term planning the difference is not moot.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

35. Precisely how climate-related uncertainties in water supply and demand are being treated by the governments and authorities for water supply planning and operations varies widely across Australia. Distinguishing characteristics include: the varying recognition of past changes in streamflow and the reliance or rejection of long-term streamflows as the best indicator of future streamflow levels and variability;17 the extent of, and manner in which, climate change projections from CSIRO are incorporated into the projections regarding future streamflows; and the level of service requirements adopted, i.e., what probabilities/frequencies, severity and duration of water restrictions are appropriate and acceptable.

36. Other pertinent differences include: the willingness to consider alternative options for city supply such as purchase of water from irrigators or the direct injection of reclaimed water; the degree of reliance on reductions in per capita levels of water consumption through behavioural change or changes in urban design; and the extent to which explicit and specific options or strategies have been identified as contingencies to be triggered in the event of extreme and/or continued drought conditions.

37. Perth, which has had the longest experience of the capital cities in dealing with rainfall and streamflow reductions has progressively moved to the more conservative position to meet future water requirements. Water Corporation’s planning and strategy is based on: (i) future streamflows which are centred on either the average experience since 1997, i.e., the ‘nine-year scenario’. In contrast, water planning in virtually all other capital cities has, until recently, been based on historical records of up to 100 years,18 in some cases the longest available historical series. The nine-year scenario implies much lower rainfall predictions than the 100-year historical record. Scenarios based on the even lower average streamflows of the past five years are also explicitly examined; (ii) a reduction in the acceptable frequency of total sprinkler bans from 1-in-33 years to 1-in-200 years. This reduction reflects the view that the Perth customer base has tired of water restrictions and that the economic cost of restrictions is high. Across Australia, the economic impact of sustained restrictions is given different levels of recognition and attention and water supply planning in jurisdictions other than Perth is commonly based on a 1-in-25 year frequency for total sprinkler bans;

17 For an early example of recognition of the potential for climate change in the context of Canberra’s water supply, see CSIRO (2004) and Marsden Jacob Associates (2003a, b, c) The approach was recently published in Risbey, Hamza and Marsden (2006). 18 The water planning time frame is distinct from the drought contingency planning timeframe. The water planning timeframe is used to determine the timing and scale of water source augmentations. By contrast, drought contingency planning is typically dominated by the water restriction policy and emergency water supply solutions. Typically water restrictions and emergency supplies are triggered on the basis that recent inflow levels will continue for at least another year.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

(iii) equal consideration of scenarios both with and without demand management initiatives to reduce per capita consumption. Water supply planning in most other cities – in presentation at least – assumes significant reductions in per capita consumption and down-plays the possibility of failing to meet these targets; and (iv) specific contingency options which are well identified, specified and publicly canvassed. For example, in one single document, specific options identified for Perth include accessing water from the South West Yarragadee aquifer, purchasing additional water from the piping of the delivery systems of Harvey Water (the irrigation cooperative) and additional desalination plants.19 In contrast, prior to October 2006, Melbourne had no publicly announced contingency options.

38. The scenario-based approach to water supply planning adopted for Perth is now beginning to be applied across other capital cities as the possibility of step changes in rainfall and streamflows is acknowledged.20 For example, the Victorian thinking for Melbourne and the wider central region has shifted sharply: the final version of the Central Region Sustainable Water Strategy (CRSWS) adopts a robust scenario approach to deal with the uncertainties of climate change and variability. The CRSWS examines comprehensively the different implications of assuming that streamflows in the future are centred on either a) the long-term historical record, or b) a continuation of streamflow levels recorded over the past years.

39. Nonetheless, important differences in approach remain between the cities in terms of how climate uncertainty is being addressed. These differences in approach might reflect the different situation of the respective capital cities, but unavoidably raise the question of how the uncertainties and risks related to climate and streamflow change are best handled in water supply planning.

Implications for capital investment

40. One of the issues raised by the observed differences is the matter of regulatory consistency. For the economic regulators, approval of the capital expenditure programs of water businesses requires consideration of whether the expenditure is necessary and efficient. The regulators need to make informed judgements on whether the projected expenditures represent prudence or gold-plating.21

19 Water Corporation, 2005. 20 Reliance on the long-term ‘100-year’ historical record is a feature of both traditional water supply planning and operational rules. In particular, the operational rules applied by several governments in determining seasonal allocations for irrigators depend on minimum flow levels recorded historically. These rules are inadequate when, as in the current season, minimum flows are below previous minimums. 21 If the economic regulators in each State have approved the future capital expenditure program for their respective water supply business(es), then – given the observed difference in the ways risk and uncertainty are handled in the water supply planning processes – a relevant question is whether in concept the different regulators would be able to approve the programs of water businesses in other States.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

41. Particularly in a highly capital-intensive industry such as water, vigilance against unnecessary capital expenditure is essential. Equally, however, we need to ensure that we do spend when it is necessary to do so and that we have appropriate means/mechanisms to be able to make those decisions.

42. As noted by one stakeholder, “Understanding risk and developing a process for determining when you proceed with new infrastructure is important. If you get [decisions on supply capacity] wrong, either way, no one will forgive you as the commentators will be equally harsh on ‘white elephants’ as they would be on cities not having enough water.”

43. An immediate and material implication of the different planning approaches used in each city is the relative capacity of water supply infrastructure and the levels of capital expenditure. Over the past five years, in per capita terms, twice as much has been spent on water infrastructure in Perth than in Sydney, Melbourne, Brisbane or Adelaide (Figure 12). High levels of per capita expenditure were also observed in Darwin and Canberra, reflecting for the former, large one-off developmental expenditures, and in the latter, emergency expenditures following the fires.22

Figure 12: Capital Cities – Water Capital Expenditure Per Capita Over 5 Years (2001-2005)

600

501 500

421

400

312 300 $ per person per $

213 200 172 146

115

100

0 Sydney Melbourne Brisbane Adelaide Perth Darwin Canberra

Source: WSAAfacts 2005

22 In Darwin, capital expenditure on water supply infrastructure included a major water pipeline to the Wickham Point LNG plant. Other large expenditure items included the development of the Howard East Borefield and increasing the capacity of the Darwin River Spillway. In Canberra, ACTEW recently completed the augmentation of two major treatment plants – the Mt Stromlo and Googong Water Treatment Plants. The new Mt Stromlo facilities were required to cater for the poor water quality after the bushfires of 2003.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

44. The differences in planning approaches have also been reflected in the levels of announced future expenditure on water infrastructure. Despite the broad geographic extent and the lengthening period of recurrent drought, surprisingly few cities have publicly announced firm plans for major augmentations of water supplies in the next ten years.

45. The exceptions are Brisbane and Perth: the Queensland Government has committed to the construction of two new dams at Traveston Crossing and at Wyaralong. It has also adopted a drought response strategy that includes the Western Corridor Recycling Scheme, Tugun desalination plant and bore water schemes. Expenditure on water infrastructure in the next five years will exceed $2 billion. The government’s planning framework places heavy emphasis on planning options for possibility that recent low streamflows conditions will continue; and in Perth the Kwinana desalination plant is about to be commissioned and there are plans in the future to build a second desalination plant, trade water from the south-west irrigators and access groundwater from the South West Yarragadee aquifer. The Water Corporation plans to spend an average of $600 million per year over the next ten years – more than the recent combined expenditure of all four Melbourne water businesses.

46. Sydney’s Metropolitan Water Plan relies predominantly on accessing water from the Shoalhaven River, demand management measures and water recycling to achieve a balance of supply and demand. With these initiatives, the plan aims to avoid the need for major new water sources within the next ten years. If streamflows do not improve from current levels, or if demand management targets are not met, the contingency strategy involves construction of a desalination plant and groundwater access. The setting aside of recommended environmental flow levels could also contribute to the achievement of demand-supply balance, at least for consumptive purposes, if required.

47. The situation, approach to water planning and the resulting strategies are evolving rapidly under the pressure of the drought and the realisation that the drought may foreshadow the future impacts of climate change. Recent water supply planning exercises undertaken in many jurisdictions, including Melbourne, Adelaide, Darwin and Hobart, had suggested that water demand would not exceed long-term supply for at least ten years. The final version of the Victorian Central Regional Sustainable Water Strategy now implies quite a different conclusion, and Adelaide and other SA towns on the Murray face an emergency situation, particularly for the 2007-08 season.

48. The very direct link between how climate uncertainty and risk is incorporated into the water supply planning process and the suite of resulting outcomes cannot be over-emphasised (Table 3). The choice of climate scenario dictates the estimate of the system yield, which in turn dictates the required additions to supply and therefore levels of forward capital and operating expenditures and ultimately the level of the volumetric charge of the tariff. These links emphasise the need for a

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

robust approach for treating climate uncertainty in water supply planning and ensuring that water supply planning is effective and efficient.

Table 3 : Impact of Climate Scenarios on Estimated Yields and Required Timing of Next Source Year when Climate Estimated Yield of Integrated Water Supply next new Scenario Scheme (90% reliability) source needed 64 year 512 GL/year 2052/53 (1911-1974) 31 year 437 GL/year 2034/35 (1975-2005) 9 year 363 GL/year 2018/19 (1997-2005) 5 year 312 GL/year 2004/05 (2001-2005)

Source: Water Corporation Note: Based on April 2005 Source Development Plan and 155 kilolitres per capita demand scenario.

Water-supply planning objectives

49. The challenge of water supply planning is to ensure that demand and supply are kept in balance and that future shortfalls in water supply (whether due to climate variability, climate change or other factors) are to occur no more frequently than indicated by the pre-agreed objectives relating to the frequency, severity and duration of restrictions. The second part of this challenge is to achieve this balance at minimum expected total cost.

50. To cater for drought years, water service providers must construct more capacity in their system than they would typically need in a non-drought year. Regulators and other decision makers must therefore weigh up the trade-off between the likelihood of drought occurring and the cost of maintaining additional capacity into perpetuity (see Box 2).

51. To minimise future costs requires not simply that the costs of planned infrastructure are both necessary and efficient: all costs must be considered. This includes recognition of the costs to the environment, the cost of contingency options, the costs of restrictions and the costs of all other measures, such as water saving measures, that are likely to be included in a drought strategy.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Box 2: Supply Buffer and Probability of Total Sprinkler Ban

The Economic Regulation Authority (ERA) in WA has explicitly considered the cost versus restriction trade-off in its recent price inquiry and reported the required supply buffer compared with the probability of a total sprinkler ban.

Supply Buffer and Probability of Total Sprinkler Ban

The figure demonstrates that Perth requires water sources that can supply 9% more than the current annual demand in order to reduce the probability of total sprinkler bans to 0.5% (i.e. only required once every 200 years). Based on the ERA’s projections of cost, the total cost to provide 1-in-200 year drought security would be as little as $18 to $27 per year for a residential customer using 250 kilolitres per year.23

23 Long run marginal cost of water $0.82 to $1.20/kL, as reported in ERA, 2005, p. 97

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

5. WATER SUPPLY AND DEMAND OPTIONS

52. Water planners have two fundamental options available to ease water restrictions – to encourage water conservation or to increase water supply. Options available to restore and maintain the balance between water demand and supply include: demand management through the introduction of water saving appliances and behaviour modification; new dams and groundwater access; desalination of seawater; better interlinking of water sources (existing and future) through pipelines and grids; recycling of water for agricultural, industrial and potable uses; greater use of stormwater, especially in greenfield locations; and the purchase of water from other sectors and/or other suppliers.

53. Voluntary water conservation is often the most affordable, environmentally sensitive option available to urban water users. Low-level restrictions may be seen as simply customer obligations to use water responsibly. However, higher level restrictions impose substantial costs on the community with heavier impacts on the 70 per cent of the population that identify having a healthy, green garden as important.24, 25 Based on ‘willingness to pay’ estimates, the annual cost of extreme restrictions is the same magnitude as the capital cost of a desalination plant.26

54. Structural alternatives to potable water supplies, including stormwater recycling and water sensitive urban design, are typically only cost effective in greenfield situations, where new developments can be designed with water conservation in mind. While greenfield sites represent only a small proportion of the city in any particular year, the growing population will mean that structural changes introduced on a small scale now will dominate the cityscape of the future.

55. Historically, dams have been the major water sources for Australian cities. Several factors combine to make major new dams unlikely in the future, except in SEQ: for most major cities the best sites for dams have already been taken. Moreover, in most cases the next ‘best’ location cannot be used as environmental objectives and the desire to preserve or restore river health have become increasingly important with some sites declared as heritage rivers; the environmental damage and costs of dams is increasingly recognised and there is a desire to preserve the remaining natural rivers. As a result the planning and approval processes are slow, perhaps up to 10 years;

24 Roseth, N., 2006, p. 5 25 Marsden Jacob Associates, 2006a. 26 Marsden Jacob Associates, 2006a.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

the net cost of water from dams is rising with climate change resulting in reduced rainfall and streamflows, leading to the need for larger dams to assure historical reliability. In addition, (actual and expected) increases in rainfall intensity requires substantially larger spillways, also increasing the costs of dams (existing and potential); and dams are not very useful in extended drought regimes: since potential new sites are generally less favoured due to the effect of rain shadow, their yields may be particularly unreliable due to drought. Moreover, another dam whose potential yield may be strongly correlated with existing dams may not be the best or even an effective option for increasing system reliability against drought sequences. Best practice now emphasises a diversity of water sources in a portfolio selected not simply on least cost and timing, but also on the reduction in the covariance between sources.

56. Governments and water utilities are increasingly turning to alternative sources of water supply including demand management, water sensitive urban design, desalination, water recycling and the purchase of water entitlements from irrigators. The consideration and evaluation of alternative sources is leading to an increasingly integrated approach − albeit with some gaps and omissions.

Integrated Water Cycle Management

57. One of the most significant developments in water management in recent years has been the increasing focus on integrated water supply planning, including water recycling and demand management. This allows different sources of water to be compared side-by-side with traditional infrastructure solutions. Recognition of the full water cycle means that often-overlooked options, such as stormwater, are given equal opportunity to be assessed on their merits. This advance blurs the traditional boundaries between the supply of water, wastewater and stormwater services to provide what is termed ‘integrated water cycle management’ (IWCM).

58. IWCM requires the cost of all potential water sources to be well defined and understood. The approach moves beyond the traditional focus on water agency costs alone and examines the full range of costs and benefits across the community - including infrastructure providers, government agencies, businesses and residents.

59. IWCM is gradually being adopted across Australia and is reflected in the wide range of water sources examined in recent metropolitan water plans. Each city has a unique combination of issues and available resources, however, general trends in cost and resource availability can be seen to emerge. For example, some of the highest volume options available, including desalination and large recycling schemes range from moderate cost to expensive, depending primarily upon the distance that the water needs to be transported. By comparison, smaller opportunistic recycling schemes located on, or close to sites of use can be very inexpensive. A number of options have a broad range of costs depending on the precise options employed, including demand management, the reduction of network losses, stormwater reuse and the purchase of water from irrigators (which may, or may not, require extensive piping networks).

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Unit Costs of Supply Options

60. An indication of the reported unit costs associated with each of the main options available to secure urban water supplies and to balance demand and supply is shown in Figure 13. The span of each bar reflects the range of unit costs derived from the published water plans for Sydney, Adelaide, Perth and Newcastle.27 In some cases, such as demand management, the range of costs reflects the potential for both very low cost options (such as water efficient showerheads) and very high cost options (including some options promoted through the Building Sustainability Index or BASIX in NSW).

Figure 13: Direct Costs of Water Supply/Demand Options– Sydney, Adelaide, Perth, Newcastle

$10.00 $9.30 $9.00

$8.00

$7.00 $6.00 $6.00 $5.60 $5.00 $5.00 $/kL $4.00 $4.00 $3.00 $3.00 $3.00 $2.61 $3.00

61. Marsden Jacob’s analysis of the costs of the major supply and demand options available to Australian cities emphasises: the very low cost of most options in favourable locations and situations; the very high cost (>$3.00/kl) of many options in unfavourable locations and situations; the corresponding lack of any simple universal cost ranking which can be simply applied to each and every situation;

27 Melbourne is excluded from this analysis because cost data is not provided in the final CRSWS and the costing shown in the draft strategy are understated due to the methodology employed.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

the dominating influence of the cost of pipelines and pumping where water needs to be transported over distance; and the relative cost of water management options can be counter-intuitive. For example, the cost of rainwater tanks28 and recycling schemes can be considerably higher than the cost of conventional water sources in some areas; and the need to examine water supply and demand management options on a situation-by-situation basis. Figure 14 shows the cost schedules facing Sydney, Adelaide and Perth against consumption in 2001 – the last common year without restrictions. In some cases, the figure shows the range of cost estimates for an option.

62. Factors affecting the cost of supplying water29 include: distance and lift required from the source of water to point of consumption. Water supply distances vary – from the relatively close 65 kilometres between Sydney and Warragamba Dam, to around 600 kilometres between Mundaring Weir and Kalgoorlie; type of water source – e.g., dam, groundwater, recycling, desalination. Dams and groundwater sources have conventionally been a source of inexpensive water. Recent trends toward water recycling and desalination will see the cost of water sources increase substantially; level of treatment – treatment levels vary according to local requirements, the approach to drinking water quality and safety standards30 adopted in each State and the quality of the source water. Some cities, such as Melbourne, Perth and Darwin, have strict catchment management policies and therefore require relatively little treatment processes for water from surface water source; and density – the density of development determines the cost of distributing the water across the city with dense development usually reducing the average costs due to economies of large scale.31

63. Failure to examine and appreciate relative costs in the local situation can lead to an inefficient choice of options and unnecessary antagonism. Further, with the mounting political pressure to implement alternative water supply solutions, it is imperative that water supply planners and government agencies explicitly clarify the environmental and social benefits of each solution to determine when high cost, alternative solutions are justified.

28 Rainwater tanks deliver the highest benefit compared with cost in areas that receive consistent rainfall during the year. In areas that receive relatively little rainfall during summer months, such as Perth, rainwater tanks supply relatively little water and at high unit cost with the result that other water sources are typically required to make up the shortfall during the heaviest periods of water use. 29 Refer Werner, L. and Pickering, P. 2002. 30 Most States are moving toward the multiple barrier approach prescribed in the National Health and Medical Research Council’s 1996 Australian Drinking Water Guidelines. 31 Conversely, density also increases the cost of retrofitting in built-up areas.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Figure 14: Levelised Cost of Water Supply and Demand Options – 3 Cities

$7.00 Appliance standards Sydney Western Sydney Recycled and labelling Water Initiative $6.00 Residential outdoor BASIX Grey areas represent range of $5.00 highest and lowest cost Leakage estimates for option Rainwater reduction tanks $4.00 Non- Committed residential recycling $/kL $3.00 Residential indoor

$2.00

Indirect Potable Recycling $1.00 Desalination

$0.00 0 100 200 300 400 500 600 Water supplied in 2001 = 625 GL

$7.00 Irrigation Adelaide Water recycling Piping - - grey water Bradfield Qld Loss Rainwater tanks reduction $6.00 Stormwater Loss reduction (floating cover) Dams $5.00 - Fi i Loss reduction (aquaducts)

$4.00

Large scale Piping water re-use Piping water from Ord

$/kL - $3.00 Water Great recycling - Artes- localised ian Bore $2.00

Desalin- Desalinationation $1.00 Piping from Clarence (NSW) $0.00 0 100 200 300 400 500 600 Water supplied in 2001 = 195GL

$7.00 GW - Gnangara Perth Catchment thinning $6.00 Catchment thinning - Wungong GW - Desalination - Wellington Gingin $5.00 Irrigation efficiency #2 GW Collie $4.00 - Yanchep - Eginton Piping from Ord

$/kL Irrigation $3.00 efficiency - Waroona

GW - SW Dams $2.00 Yarragadee - Wellington - Brunswick

$1.00 Desalinat- ion

$0.00 0 100 200 300 400 500 Water supplied in 2001 = 263 GL

Sources: 1) Sydney – Sydney Water, Indirect potable recycling and desalination - a cost comparison and Institute for Sustainable Futures, ACILTasman and SMEC (April 2006), Review of the Metropolitan Water Plan: Final Report; 2) Adelaide - Water Proofing Adelaide – Options Assessed; 3) Perth - Water Corporation, Integrated Water Supply Scheme Source Development Plan 2005

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Purchase of water for cities

64. The purchase of water entitlements from irrigators is potentially an attractive option – and in some cases one of the few viable options for cities and towns. In rural Australia, water entitlements are bought and sold at prices ranging from $600 to $1,500/ML. This is equivalent to 60 cents to $1.50/kL.

65. Historically there has been some opposition to the transfer of water between irrigation and metropolitan urban water uses. Echoes of Sir Henry Bolte’s 1967 statement that “not a drop of water will cross the divide to meet the needs of Melbourne'' remain.

66. In the 2005 survey by Marsden Jacob of water service provider stakeholders, both the opportunities for trade and a political reticence to take advantage of this source were identified.

67. Stakeholders surveyed by Marsden Jacob noted:32 To deal with the concerns over the adequacy and reliability of supply, many urban authorities would like to purchase water rights from irrigators. Canberra, Sydney and Melbourne are all close to the supply grid provided by the Murray-Darling-Snowy systems which opens major opportunities for trade. Political government often finds this fact uncomfortable. and Thinking and policy on water resource management is compartmentalised. Compared with the low cost water available in the irrigation areas, the alternatives for the metropolitan area are prohibitive. The opportunity to bring low cost water into the city is not being taken. [City] uses around 9% of the State’s water but the people think that [City] uses 90% and the country only 10%.

68. However, major opportunities are available to trade in water to redress the significant demand management issues arising from the take up of existing supply sources facing Australia’s metropolitan centres. Despite the availability of low-cost water in the major irrigation centres, water trading has not occurred with urban areas in most cases.

69. Nevertheless, SA Water has purchased around 19 GL of water from irrigators in the Lower Murray Swamps and the Western Australian Water Corporation is completing contracts with Harvey Water to pay for the piping of the part of the South West system. In both of these instances, the water provided by irrigation is already within the system that supplies the metropolitan centres.

70. The increasing physical integration of water systems (Box 3) will increase opportunities for trade to improve the security of water supply.

32 MJA, 2005.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

71. Opportunities in Sydney may be more limited as The Sydney basin agricultural sector uses up to 12 billion litres of water per year from the drinking water system, and draws a further 110 billion litres per year directly from rivers and farm dams. The total water use by farmers of around 122 billion litres per year is much less water than the combined household use in Sydney of around 375 billion litres per year.

There is little doubt, however, that this volume of water does represent a significant potential supplement.

72. In Victoria, historically legislation limited the ability of entities outside of irrigation areas from owning entitlements. Essentially, this barrier to urban areas accessing irrigation water has been removed. The new Water (Resources Management) Act 2005 has, for the first time, allowed non-landholders to hold up to 10 per cent of entitlements in each system (non-water use). The Central Region Sustainable Water Strategy has proposed an important first example of trade in water from irrigators to cities (Box 3). The fact that Bendigo and Ballarat are rural centres not metropolitan Melbourne has eased political concerns. Nonetheless, there is currently little or no trading market for water in Australia’s urban areas.

Box 3 : Increasing Physical Integration of Water Supply and Markets

Current and future examples of such physical integration include : through the River Murray, Adelaide enjoys immediate connection with the irrigation systems of the southern Murray-Darling Basin. SA Water has already purchased around 19 GL of water from dairy irrigators in the Lower Murray swamps. the extension of Perth’s integrated water supply scheme to include the south-west dams, and thus to link water resources originally developed for irrigation with water resources intended for the metropolitan region. Efficiency savings gained by piping the south-west irrigation system are being traded by Harvey Water to provide major supplements to the Perth system. Since Perth’s Integrated Water Supply Scheme also supplies the Goldfields and Agricultural Water Supply scheme water from the south-west could ultimately supply mines in the Kalgoorlie-Boulder area; the interlinking of water supplies in Central Queensland already allows Gladstone to purchase water from the Fitzroy and for water to be traded across the Fitzroy-Burdekin watershed; with the potential to link water in Snow Hydro’s Tantangara storage to ACT storages and supply, ACTEW Corporation has the potential to purchase water from Murrumbidgee and/or Murray irrigators and secure Canberra’s future water supply. Such a trade would also entail the purchase of release rights from Snowy Hydro; the increasing physical integration of the Melbourne system with the regions. Melbourne’s water supply is already linked with irrigation via the Thompson Dam and Melbourne’s supply augments supplies to regional water authorities such as Western Water. The Central Region Sustainable Water Strategy proposes to supply water from purchased from Goulburn Valley irrigators to Bendigo and Ballarat via extensive pipelines. Ballarat’s supplies are already linked to Geelong’s since both cities share water from Lal Lal Reservoir. Potentially a pipeline linking Melbourne to Geelong would allow, through substitution, water to be traded from Macallister irrigators to Ballarat and other areas served by Central Highlands Water. There is also potential to link the 32 km gap between the Goulburn Valley storages and Melbourne supply which would allow water to be traded between Macallister, Ballarat, Melbourne, Goulburn Valley and ultimately the remainder of the southern Murray-Darling Basin. These examples illustrate the progressive interlinking of catchments and water supply systems and the increased potential for trade, particularly large trades from irrigators to cities.

Source: updated from MJA (2005)

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Water recycling

73. On average, Australian cities recycled around eight per cent of wastewater in 2004/05.33 The proportion of reuse is higher in many regional urban centres, where alternative methods of wastewater disposal are often costly and where water can be more economically transported for municipal or irrigation use. Thus, the much higher level of recycling in regional cities is in large part explained by the smaller volume of recycled water available, relative to the demand for recycled water from horticulture and other irrigation in the local area.

74. In contrast, the major cities have the potential to produce very large volumes of recycled water but have relatively little irrigation activity within proximity of the treatment plant. The high cost of pipelines to take recycled water to where it can be used means that the economics of large-scale recycling are frequently adverse compared with other sources of water. In addition, supplementing drinking water supplies with recycled water requires the recycled water to spend time in an environmental buffer such as a reservoir or river or aquifer. This is the reason recycling is often an expensive option given the coastal location of our sources of wastewater. Nonetheless, when compared with Europe, Australia has the third highest volume of water recycled and, on a per capita basis, Australia is second behind only Spain.34

75. Several governments (Victoria, Western Australia, South Australia and the ACT) have set recycling targets for their water organisations (Table 4).

76. Note however that some State targets are best described as ‘aspirational’ rather than firm as the economic feasibility of achieving these targets has not be evaluated.35 Therefore, relying on these targets as a proxy for the demand for recycled water may overstate future levels of demand for recycled water.

77. Nonetheless, several major proposed water recycling plants will increase the level of water recycling in the capital cities significantly, including: the Western Corridor Recycled Water Scheme in South East Queensland has the potential to free up to 40 GL per annum of fresh water from the region’s dams; the Western Sydney Water Recycling Initiative will recycle 27 GL per year; and the Eastern Corridor Water Recycling Plant in Victoria could recycle up to 139 GL per year.

33 Weighted average of cities reported in WSAAfacts 2005. 34 WSAAfacts 2005, Durham, B. and Angelakis, A (2006) 35 It should be noted that targets can lead to inappropriate investment and undermine rational pricing of recycled water.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Table 4: Recycled water use as a proportion of treated water

Proportion recycled (%) 1996–97 2001–02 2004-05 Targets State/Territory NSW 7.3 8.9 Victoria 4.6 6.7 20 (2012)a Queensland 11.6 11.2 b South Australia 9.9 15.1 30 (2025)c Western Australia 6.1 10.0 20 (2012)d Tasmania 2.3 9.5 e ACT 0.8 5.6 20 (2013)f Northern 4.8 5.2 - Territory Australia 7.3 9.1 Capital cities Sydney 2.2 2.8 12 (2011)g Melbourne 5.7 11.6 Brisbane 4.0 5.0 Adelaide 15.1 20.7 Perth 3.8 3.6 Hobart Source: ATSE (2004) Water Recycling in Australia, p. 7, WSAAfacts 2005 Notes: a. DSE, Victoria. b. The Queensland Government is currently preparing the SEQ Water Recycling Action Plan, which will nominate targets and strategies for water recycling. c. SA has also set a 24 per cent country target for 2005 (both targets are unlikely to be met) (Government of SA 2004, p.17). d. Regional WA already achieves 40 per cent reuse (Government of WA 2003, pp. 31–34). e. Tasmania has transferred the onus for these targets to local government (DPI 2000, p12). f. ACT Government 2004, p.4. g. NSW is seeking to recycle 70 GL in Sydney by 2011. This would be equivalent to 12 per cent of Sydney’s drinking water supply (Government of NSW 2005).

78. Water recycling may take a number of forms, each with substantially different costs, quantities and value to the end user. The various forms include: municipal parks, gardens and golf courses: for many regional communities, municipal water recycling schemes represent the lowest cost method of disposal. Municipal water recycling opportunities are proportionately less in large cities, where substantial volumes of wastewater must be disposed of; industrial reuse: commercial users may apply water in cooling, wash-down or other industrial processes. In some cases, recycled water is treated through reverse osmosis or similar processes to obtain a high quality water product. The quantity that can be recycled is constrained by the number of industries within a close proximity of a wastewater treatment plant that can make use of recycled water in their processes; agricultural reuse: substantial volumes of recycled water could be made available for agricultural use. In many cases, the vast distances between the wastewater treatment plant and the customer make the cost prohibitive;

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

third pipe residential: treated wastewater can potentially be used for non- drinking purposes such as garden watering and toilet flushing. Many third pipe schemes are currently under way across Australia. The benefit of third pipe schemes often hinges on the ability to reduce costs in other parts of the water supply or wastewater system; indirect potable reuse: water can be treated to an extremely high quality and then returned into a river, surface- or ground-water supply for eventual re- extraction and use in the potable water supply system.

79. The following table lists the known costs of recycling schemes around Australia:

Table 5: Cost of Recycled Water by Scheme

Location Use of recycled water Cost estimate ($/kL) Western Sydney Recycled Water Environmental flow replacement, $5.80 Initiative1 residential and agriculture Rouse Hill, NSW (existing)2 Residential $3.00-$4.00 Melbourne Eastern STP3 >$3.00 Sydney Water Indirect Potable Reuse4 Indirect Potable $2.23-2.61 Olympic Park, NSW (existing)2 Residential $1.60+ (operating costs only) Redcliffe City opportunities, QLD5 Irrigation and Residential $2.50 Springfield, QLD (existing)2 Residential $1.45 SA opportunities6 Industrial and municipal $1.40 High quality industrial water7 Industrial $0.85 - $1.40 Redcliffe City opportunities, QLD5 Irrigation $0.80 Logan City opportunities, QLD5 Parks and gardens $0.80 Toowoomba opportunities, QLD5 Agriculture $0.45 Some rural and regional towns 7 Golf Courses and Parks Least cost disposal method (i.e., <0)

Sources: 1. Institute for Sustainable Futures, ACILTasman and SMEC (2006). MJA understands that the component of the initiative aimed at replacing environmental flows would cost significantly less as a standalone project. 2. Parliamentary Library (2005) “Issues encountered in advancing Australia’s water recycling schemes” 3. AWCRRP Seminar Presentation (2004) ‘The Big Picture’ 4. Sydney Water, Indirect potable recycling and desalination - a cost comparison. Asset lives not provided in fact sheet – range represents 25-100 year life, discounted at 6 per cent real pre-tax. 5. IPWEAQ Conference Paper (2003) “Integrated Urban Water Management and Water Recycling in SE Queensland – Recent Developments” 6. SA Government “Waterproofing Adelaide Information Sheet: Large Scale Wastewater Reuse” (unit cost derived based on 6% return and 50 year average asset life for treatment and pipes). 7. MJA Analysis

80. In addition to cost, increasing the uptake of recycled water faces a number of barriers: The main barriers to re-use of water in Australia are issues of public confidence, health, the environment, reliable treatment, storage, economics,

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

the lack of relevant regulations, poor integration in water resource management, and the lack of awareness.36.

81. The Australian Academy of Technological Sciences and Engineering (ATSE) found: The bottom line is that the Australian community is far more sensitive to very small health risks that might flow from any hazards implicit in using recycled water than they are to other, much higher probability risks over which they perceive they have more personal control. [p. 140]

82. This is highlighted by the negligible risk (10-6 to 10-7) of contracting viral disease from eating vegetables irrigated with reclaimed water meeting WHO standards (Shuval et al 1997, pp. 15-20)37 (Figure 15).

Figure 15: Comparative risk levels of reclaimed water and other events − (number of people likely to experience various events over a year from each ten million Australians.

Having asthma 1,111,111

Being unemployed 769,231

Having diabetes 226,684

Premises burgled 169,492

Having your car stolen 68,493

Having a stroke 60,947

Contracting Hepatitis 15,299

Being robbed 11,889

Contracting Ross River Virus 1,628

Killed in a car accident 926

Dying of skin cancer 671

Accidently drowning 200

Being murdered 180

Killed in a plane accident 25.6

Struck by lightning 7.1

Contracting leprosy 1.6

Winning division 1 of X-Lotto 1.2

Virus from reclaimed water produce 1

0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 Increasing Risk

Source: ATSE 2004 p. 141

36 Dillon, P., 2002. 37 “A risk assessment approach was developed to arrive at a comparative risk analysis of the various recommended wastewater irrigation microbial health guidelines for unrestricted irrigation of vegetables normally eaten uncooked. The guidelines compared are those of the WHO and the USEPA/USAID. The laboratory phase of the study determined the degree of contamination of vegetables irrigated by wastewater. Based on these estimates of the risk of ingesting pathogens, it is possible to estimate the risk of infection/disease based on the risk of infection and disease model developed for drinking water by Haas et al. (1993). For example, the annual risk of infectious hepatitis from regularly eating vegetables irrigated with raw wastewater is shown to be as high as 10-3. The study indicates that the annual risk of succumbing to a virus disease from regularly eating vegetables irrigated with effluent meeting WHO guidelines (1,000 FC/100mL) is negligible and of the order of 10-6 to 10-7.” [emphasis added]

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

83. Assurance to the public of the quality of the reclaimed water is, therefore, essential if reclaimed water is to be widely used. MacDonald and Dyack (2004, p. 11) noted that: Overall acceptance of reuse has been shaped by: trust in authorities and scientific information; positive attitudes towards the environment and environmental stewardship; and seeing that the decision making process is fair.

84. Resistance on the part of the public has the potential to remove some water supply options from consideration. Moreover, anticipation of public concerns sometimes leads to likely controversial options being culled before options are put to the public. This is particularly the case with recycling and potable re-injection. Strong and timely leadership is required to determine which options should be pursued, and how and when the community should be engaged, especially if the risks of inaction are potentially catastrophic.

85. Public trust is bolstered by having clear, widely adopted standards and guidelines. A number of guidelines have been developed for non-potable recycling, however no standards or guidelines have yet been established for indirect potable reuse. Particularly for unconventional options such as indirect potable reuse, state or national guidelines should be developed as a matter of priority.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Box 4: Indirect Potable Reuse Indirect Potable Reuse (IPR) refers to the addition of purified recycled water to a waterway or aquifer that feeds into a potable water supply. IPR is common for British and European cities located on major rivers, with water on the Thames reported to be used eight times. Australian examples include the discharge of around 30 gigalitres/year of high quality discharge from Canberra which subsequently flows through the Murrumbidgee to the water supplies of Leeton and Griffith and the Queensland town of Kingaroy where, in European style, the offtake for the town’s water supply is located downstream of the town’s wastewater treatment plant. Most of these examples are not high profile or highly publicised. Highly publicised IPR has been successfully implemented in Singapore and the United States. IPR has been proposed for Toowoomba, Western Australia, Goulburn and South East Queensland. Toowoomba The inland town of Toowoomba has been suffering serious water supply issues in recent years. As at November 2006, Toowoomba dam storages were at 19.2 per cent and residents were at level 5 water restrictions. 1 In June 2005, Toowoomba City Council submitted the ‘Water Futures Toowoomba’ funding proposal to the National Water Commission. The initiative proposed Reverse Osmosis treatment of 6.5 gigalitres per year of recycled water from the Wetalla Water Reclamation Plant, injecting the majority of the recycled water into Cooby Dam for indirect potable reuse. The proposal also envisaged long-term community consultation over several years, and the Toowoomba Water Futures Advisory Panel (TWFAP) was established for this end, involving key stakeholders, experts and community leaders. Some vocal community objection grew, and in August 2005 a public meeting was arranged to oppose the project. Following questioning of the proposal by the local Federal Member, the Parliamentary Secretary for Water , announced in March 2006 that federal funding for the project was conditional to the holding of a referendum within six months.2 An independent technical assessment of water supply options was required. In April 2006, the referendum date and question was decided by Council, and the decision made to disband the TWFAP given the timeframe for referendum. The independent technical assessment was undertaken by Parsons Brinckerhoff, and returned in July 2006. It also explored other options including importing groundwater (in exchange for Class A recycled water for irrigation) and collecting and treating by-product water from coal gas seam production. At an estimated cost of supply of $1.68 per kilolitre, IPR was found to be preferred on cost and reliability.3 The referendum was put to residents on July 29th with the question ‘Do you support the addition purified recycled water into Toowoomba's water supply via Cooby Dam as proposed in Water Futures – Toowoomba?’. The referendum was rejected (61 per cent opposed the initiative). 4 Some proponents of IPR have criticised the nature and haste of a referendum, suggesting that successful implementation of IPR will require government agencies and water providers to build trust and confidence over time. This suggests that assessment of community acceptance should come at the end of a long consultation process. Many residents perceived that they were being used as the ‘guinea pigs’ of the nation and that they were not engaged on the full range of available options. Resentment could also have stemmed from public funding of the ‘yes’ case only. Following the referendum, a plan for future water supply has not yet been finalised, however supply from Brisbane’s Wivenhoe dam may be an option (at a high cost), as well as likely permanent water restrictions. South East Queensland The Queensland Government, while supporting the Water Futures Toowoomba project subject to a positive referendum decision, does not currently have a policy to use recycle water for indirect potable use. Premier Beattie has stated “We would never use indirect recycled water unless the people voted for it in a referendum in March 2008, and even then, even then we would only use it if there was an Armageddon situation, that is, we had no other alternatives.”5 The Western Corridor Recycled Water Project, the largest recycled water project in the southern hemisphere, notes this approach while designing the project with the capacity and infrastructure to allow all options for the use of recycled water to be considered.6

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Western Australia The Water Corporation also has a recycled water strategy which incorporates the option of indirect potable consumption among a number of different alternatives. In 2003 the Water Corporation commissioned independent and ongoing research into community acceptance of wastewater reuse by CSIRO7. They have developed an eight-year forward plan, based on a model produced by the Water Reuse Association around the experience of Orange County in the United States.8 The WA approach involves a longer timeframe than Toowoomba, with 2015 as the estimated starting point of possible indirect potable consumption. The strategy also involves detailed and early community engagement on a suite of water source options (e.g. water trading, desalination, recycling) and recycled water as a drinking water source via reverse osmosis managed aquifer recharge (ROMAR). The Water Corporation will conduct a trial of ROMAR starting in 2008. The ROMAR trial involves treatment at the Beenyup Wastewater Treatment Plant and injection of 5 ML/day into the Leederville aquifer. The broader plan for indirect potable reuse involves treatment of 150 ML/day (injection of 30-40 GL/year) from 2015. If the project proves successful, there is potential to deliver more than 70 GL/year of drinking water by recycling via ROMAR, using the whole of Perth current wastewater discharge The program has a focus on community acceptance and involvement at the front end of the process. The Water Corporation has paid particular attention to keeping key stakeholders and regulators briefed on developments in an effort to keep the community informed and engaged. Goulburn Goulburn is an inland town of 22,500 residents which, like Toowoomba, has been suffering serious water supply shortages in recent years. Storages as at October 2006 were at 26 per cent9, and for the first time on record (147 years) the town received no rainfall for the month of October 2006.10 The town has been on Level 5 water restrictions since October 2004, with all outdoor town water use banned. Goulburn Mulwaree Council is considering the option of indirect potable water recycling amongst a number of options, and has received Federal Government funding for a consultation process involving community and business surveys, stakeholder analysis and reference groups. Consultation is expected to be completed by the end of December 2006, taking a period of several months.11 If health and regulatory requirements can be met, and the NSW Government provides one-third of the project costs, the National Water Commission will consider a funding recommendation for the remainder of the proposal.12 The indirect potable component involves treatment of wastewater then natural filtration through wetlands upstream of the main water supply dam. The water would be blended with water in the dam and treated again before being added to drinking water. Notes 1 http://www.toowoombawater.com.au/water-supply.html accessed 10/11/2006. 2 http://www.malcolmturnbull.com.au/news/article.aspx?ID=405 accessed 10/11/06 3 Parsons Brinckerhoff, 2006. Future Water Supply Options for Toowoomba City and Customer Shires Pre-feasibility Study. Accessed 3/11/06. From: http://www.nrw.qld.gov.au/water/pdf/toowoomba/water_supply_options.pdf. 4 http://www.abc.net.au/news/newsitems/200607/s1700516.htm , accessed 8 November 2008. 5 http://www.abc.net.au/am/content/2006/s1701422.htm , accessed 10/11/2006 6 SEQWater, June 2006, Western Corridor Recycled Water Project update. 7 Po, M., Nancarrow, B.E., Leviston, Z., Porter, N.B., Syme, G.J. and Kaercher, J.D. (2005). Predicting Community Behaviour in Relation to Wastewater Reuse : What drives decisions to accept or reject ? CSIRO Land and Water : Perth. 8 All statements not otherwise referenced in this section, pers comm. Water Corporation 2006. 9 http://goulburn.local-e.nsw.gov.au/files/4509/File/StoragetableOct06.pdf accessed 09/11/2006 10 http://www.goulburn.nsw.gov.au/news/pages/4547.html accessed 09/11/2006 11 Goulburn Mulwaree Water Management Strategy, Goulburn Mulwaree Council 12 http://www.malcolmturnbull.com.au/news/article.aspx?ID=444 accessed 10/11/2006

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Summary Perspective on Water Supply Options

86. For Australia’s coastal cities, an extensive array of additional water supply and demand management options are available which potentially allows diversification of supply against climate variability and climate change. Supply options which are not rainfall dependent obviously include seawater desalination, which with the notable exception of Brisbane38, can potentially offer large scale supply immediately and for coming decades. Greenhouse emissions from desalination are high and can be offset directly or via trade of greenhouse credits as envisaged by the Kyoto Protocol. In addition, careful attention is required to minimise impacts on the marine environment. There are generally technical solutions and this is largely a question of cost.

87. For Australia’s major inland cities and towns, some of which are facing the most severe drought in the country, recycled water and purchase of irrigation entitlements may be among the few alternative water supplies available.

88. Opportunities for substitution of non-potable water for potable water will arise in power station cooling and in mining operations, although much of the ‘low hanging fruit’, i.e. inexpensive, socially acceptable recycling opportunities, has already been harvested, additional opportunistic, small-scale initiatives are being developed daily.

89. Indirect potable reuse (IPR) – where purified recycled water is discharged into a water body before being used in the potable water system – has successfully been implemented in Europe, Singapore and the United States. In addition, returns to rivers are currently observable in Australia on the Murrumbidgee, Kingaroy and other inland towns located on river systems. The key issue is not whether the science or the engineering are feasible, but the extent to which IPR will be accepted by the public. Major new water recycling initiatives, due to long transportation distances and/or the need for third pipe systems, are frequently comparable to, or more expensive than, the cost of desalination.

90. As emphasised by the National Water Commission in its July 2006 report to CoAG, and recently reiterated by the Wentworth Group of Concerned Scientists, there is now a need to “accept that desalination, potable reuse, and recycling and urban- rural trade are all legitimate options for our coastal cities and often better options than building new dams and damaging more coastal rivers.” 39

38 There are very few sites in the region suitable in terms of the access to power and water reticulation network. Moreton Bay is a major constraint to the siting of desalination plants. Minimising environmental impact requires siting them to the north or south of the Bay, further reducing the number of suitable sites. 39 Wentworth Group of Concerned Scientists, 2006.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

6. FINANCIAL CAPACITY

91. A key question is whether or not the water industry has the financial capacity to undertake investment programs necessary to ensure demand supply balance without reliance on inappropriate restrictions. Potential financial constraints to investment in the water industry include the: water utility’s ability to recover costs; utility’s financial capacity; and financial position of the respective State or Territory Government.

92. Water utilities may withhold and/or delay investment if there is no mechanism to recover costs from customers or if government funding is not available. New South Wales and Victoria have economic regulators with the power to determine prices. Other States have some form of economic regulation or oversight that can provide advice to government on the appropriate level of prices. As noted earlier, while the revenue generated to cover the cost of existing assets is typically well below commercial levels, economic regulators recommend that revenue should be sufficient to recover the efficient cost of all new investments, in full.40

93. Water utilities can be constrained by a lack of available cash flow to support their capital or operating programs. In particular, investment in water infrastructure can be constrained when water utilities have competing demands for a fixed capital budget. Table 6 illustrates the relative size of the water and wastewater programs (in per capita terms41) over the past five years. The table highlights the: comparatively large per capita expenditure on wastewater in Sydney, Brisbane and Perth; comparatively large per capita expenditure on water in Perth, Darwin and Canberra; and low overall per capita expenditure in Melbourne, Adelaide and Canberra.

40 In States other than New South Wales and Victoria, economic regulators provide advice but do not determine prices. The State or local government sets water prices and therefore the total level of cost recovery will depend on how closely the government accepts the regulator’s advice. 41 Expenditure from 2001-2005 divided by total population receiving water services in 2005.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Table 6: Water and Wastewater Capital Expenditure Per Capita 2001-2005

1,000

900

800

700

600

500 $ per person per $ 400

300

200

100

0 Sydney Melbourne Brisbane Adelaide Perth Darwin Canberra Wastewater Water Source: WSAAfacts 2005

94. Other cash flow demands, including dividend, tax and interest payments, also have the potential to constrain the cash flow available for investment in water infrastructure. Figure 16 illustrates the average cash inflows and outflows of Australia’s major water utilities over the past five years. The figure demonstrates that the majority of expenditure has been directed at operations and capital expenditure42, with significant interest costs for the Sydney and Melbourne businesses. Dividend payments to the State Government represent a substantial proportion of expenditure for the Melbourne water businesses and the Water Corporation. Importantly, the Water Corporation in particular also receives a large, almost offsetting payment from the State Government for providing Community Service Obligations (CSOs).

42 Strictly speaking, the cash flows identified in the chart are expenditure on “Property, Plant and Equipment” – in most cases, the result provides an approximate indication of the level of capital expenditure, particularly when considered over a number of years.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Figure 16: Cash Outflows and Inflows of Major Water Utilities (annual average 2001-2005)

2,000 Dividends Tax CSOs 1,800 Other Customer Revenue Interest CSOs Dividends Tax 1,600 Other Interest costs 1,400 Capital Expenditure Operations

1,200 Capex 1,000 $ million p.a. $ million 800 Revenue

600

400 Operations

200

0 Outflow Inflow Outflow Inflow Outflow Inflow Outflow Inflow Outflow Inflow Outflow Inflow

Sydney Melbourne SA Water Water ACTEW Power and Consolidated Consolidated Corporation Water Source: Annual Reports and Marsden Jacob analysis. Separate cash flow statements were not available for Brisbane Water.

95. The diagram above illustrates that dividend payments have, in some circumstances, caused cash outflows to exceed cash inflows. However, it is not uncommon for cash outflows to exceed cash inflows in businesses with extensive capital investment and a growing customer base. Cash shortfalls are financed by increasing the business’s net borrowing position. An appropriate indicator of investment constraint is therefore the financial strength and borrowing ability of the business. When debt levels are high compared with industry standards, the business may be required to moderate or reduce borrowings and therefore choose between competing cash flow options.

96. The case studies presented throughout this paper demonstrate the strong financial capacity of most major water businesses to finance major new capital expenditure. (This strong, positive conclusion needs to be tested for council-owned water businesses in Queensland and NSW.)

97. Where water pries are subject to economic regulation, prices determined by the regulator will aim to provide sufficient cashflow in the business to maintain financial viability over time – typically defined as being consistent with maintaining a BBB credit rating or better. All of the major water businesses currently have low levels of debt and significant room to increase borrowings if required. Cashflow is therefore not currently a major hindrance to water businesses, however many water businesses with currently very low levels of debt are being required to debt fund increased levels of expenditure in order to place their balance sheets on a more commercial basis. As debt levels grow into the next decade and beyond, the ability of water businesses to increase borrowings will diminish and, unless prices are increased, cashflow may become a more critical constraint. On the other hand, the ability to

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

increase levels of cost recovery, by possibly an average 33 per cent, would increase borrowing capacity commensurably.

98. The financial position of the water utility can affect the aggregate revenue and debt levels of a State and thus, the State’s credit rating. Because of this, governments may potentially request a change in dividend payments or constrain capital or operating budgets to ensure that State financial targets are met. Figure 17 illustrates the payments made from water utilities to the state (via dividends and tax payments) and the payments that were returned to the water utilities as Community Service Obligation payments. Water utilities receive CSO payments in recognition of services that are undertaken at less than a commercial rate of return, such as pensioner concessions. The Western Australian Water Corporation and SA Water are also paid substantial CSOs to supply water and wastewater services below cost to non-metropolitan areas.

99. Dividend payments from the major water businesses typically range from 50 per cent to 90 per cent of after-tax profit. This compares with an average dividend payout rate of 60 per cent to 70 per cent for Australian private sector businesses.

Figure 17: Major Water Utilities – Payments To and From State Government 2004/05

800 Net Payment to State Govt 2004/05:

+102 +115 +145 +176 -5 +86 600

400

200 $ million

-200

-400 Sydney Melbourne SA Water Water Corporation Power and Water ACTEW Consolidated Consoliodated (WA) Corporation (NT) CSOs Dividends Tax

100. In most cases, State Governments receive a net surplus from state-owned water utilities. However, as demonstrated in Table 7, net returns to government from water utilities are a relatively minor component of general government revenue. The major exception is Brisbane Water, (not shown) which is wholly owned by Brisbane City Council rather than the State Government. Brisbane Water does not record water dividends as separately identifiable revenue in annual financial statements. Brisbane Water’s revenue represents some 32 per cent of total council revenues.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Table 7 : Payments to Governments from Capital City Water Utilities (2004/05)

Returns to government ($m) (cash) General Return to 2 Dividends Tax less Total Government Govt as a % CSOs1 (GG) Revenue of GG Water utility ($m) Revenue Sydney 133 48 -79 +102 41,364 0.2% Consolidated Melbourne 162 67 -50 +178 29,826 0.6% Consolidated SA Water 165 83 -105 +143 10,592 1.3% Water 307 157 -288 +176 14,224 1.2% Corporation Power and - 5 -52 -47 2,713 -1.7% Water Corp ACTEW 32 14 0 +46 2,391 1.9%

Notes: 1. Community Service Obligation payments from government represent payments to water utilities for services that earn less than a commercial rate of return (e.g., pensioner concessions and some country services). 2. General government refers to the revenues received by the State or Territory Government. It does not include the revenues for commercialised public business enterprises owned by the government – only their payments to “Treasury”.

101. In contrast to dividend revenue, the net debt of water utilities often represents a large share of total State or Territory net debt (Table 8) and therefore can have a significant impact on government financial ratios, targets and therefore credit ratings. For instance the net debt of Sydney Water and Sydney Catchment Authority was $2.9 billion in 2004/05 – approximately 25 per cent of the net debt recorded for the entire NSW public sector. As Brisbane Water is wholly owned by Brisbane City Council, the net debt for Brisbane Water is even more significant, comprising around 50 per cent of Brisbane City Council’s net debt.

Table 8 : Comparative Net Debt and Capital Expenditure (2004/05) – State and Water Businesses

Net debt2 Capital expenditure

Water and Total Public Water utilities Total Public Sector Water Business Wastewater Sector Proportion supplying: ($ billion) ($ billion) Expenditure ($ million) ($ million) Sydney 11.7 2.9 6,598 510 8% Melbourne -11.7 2.4 3,087 395 13% Adelaide -0.6 1.3 839 57 7% Perth 4.0 1.1 2,414 228 9% Darwin 1.2 0.1 326 15 5% Canberra -1.6 0.2 277 57 21%

Notes: 1. Brisbane City Council net debt implied from annual report 2004/05. 2. Positive net debt represents an overall deficit position while negative net debt represents a surplus position. Sources: WSAAfacts and ABS (2006) Government Financial Statistics 2004-05, Australia, (ABS Cat. No. 5512.0)

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

102. During the 1990s, State credit ratings were elevated to the status of a critical performance indicator of financial probity and management. Today, all States and Territories now seek to achieve and maintain a credit rating of at least ‘AA’ if not ‘AAA’.

103. The effect of this target is to constrain the willingness of governments and their treasury departments to allow substantial borrowings by government itself or its major enterprises, including its water businesses.

104. While the respective economic regulators typically suggest that a “BBB” status may be appropriate for major water businesses and that a debt to regulated asset value ratio of 60 per cent may be appropriate, these businesses are not, in fact, standalone. Rather they are subsidiaries of government. As a result, regulator-preferred ratios and ratings for a major enterprise may conflict with the higher objective of a ‘AA’ or ‘AAA’ rating for the State or Territory as a whole.

105. This tension is illustrated by the following extract of comments by Standard and Poor’s − in this particular case on New South Wales: Some of the state’s efforts to reduce net financial liabilities over the past five years are likely to be eroded due to weaker general government finances and record spending by the state’s trading enterprises to fund infrastructure.… Net financial liabilities is Standard & Poor’s preferred measure of the state’s future financial obligations…43

106. As a result, the apparent scope to increase borrowings may only be available if the State were to reject the sanctity of ‘AAA’ status. This empirical question may warrant further attention.

107. Financial drivers are only one component of the government’s decision to endorse capital expenditure for a water utility. In recent years, the political spotlight has focused firmly on water issues and decisions regarding major water supply options such as desalination and large-scale water recycling have typically been deferred to the State Government.

108. A preliminary review of the evidence suggests that the State Treasuries have, in the past, acted to constrain investment in water infrastructure, but that these constraints have been lifted once water supply investment has become a clear priority.

109. In summary, on a standalone basis, virtually all water businesses supplying the capital cities have significant financial capacity to fund both increased levels of capital expenditure and the dividends to the State Governments. Most of the businesses have paid dividends but have not increased capital expenditure significantly and certainly not increased it to the levels required to have avoided the current shortfall in supply. The strong balance sheets and ability to raise additional revenue demonstrate that none of the major water businesses is under any immediate cash constraint.

43 New South Wales Treasury Corporation, TCorp – Financial Markets – Ratings, Extract from Standard & Poor's Service review of New South Wales, September 2005, www.tcorp.nsw.gov.au/html/fm_r.cfm

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

110. By contrast, many of the smaller regional and council-owned water businesses operate under far tighter cash constraints. The funding capacity of small water authorities and local governments is dependent upon the ability to increase prices. These organisations would have to increase prices significantly to pay for major new water supply investments. This raises serious questions about affordability, particularly in those areas already affected by the drought and in regional towns a high proportion of pensioners and other concessions cardholders.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

7. PRICING AND COST RECOVERY

111. There is a widespread concern that water is inappropriately priced leading to excess consumption and unwarranted adverse externalities, particularly affecting the environment. Examination of this concern in an urban context requires first a consideration of the cost of supplying water to urban centres and levels of cost recovery and second the structure of the tariff (i.e., the apportionment of revenue between fixed administrative charges and volumetric charges and the impact and interaction of the multiple subsidy, grant and concession arrangements).

Costs of water supply

112. There are a number of different concepts of cost. The choice of costs to include in any cost calculation differs according to the purpose of the question asked. For the purposes of evaluating supply-demand options, the most important question relates to the costs of supply looking forward. For established urban centres, a very large part of the cost of dams, treatment plants and other infrastructure involved in water supply, such as pipes, is a sunk cost. Two relevant questions (and cost measures) are therefore: ignoring sunk costs, what are forward cash costs of incremental additions to water supplies in each city? This is the concept of Long Run Marginal Cost (LRMC); and what should be the full or total cost of water supply in each city if we had to replace or replicate the entire system, for instance in the hypothetical situation where a new entrant sought to challenge the existing incumbent. This is the concept of efficient cost, sometimes called the by-pass price.

Both measures are now widely applied by economic regulators.

113. The efficient cost is the aggregate of the return on, and return of, the (efficient) capital base plus operating expenses. This cost definition is applied to set regulated maximum prices for monopoly services in other utility services such as telecommunications. In terms of the CoAG Water Pricing Principles this is the concept of upper bound pricing (see Principle 4 in NCC 1998, p.112-113).

114. Marsden Jacob has applied the concept of efficient replacement cost (or by-pass price) consistently to each of the eight capital cities. The resulting estimates (shown in Table 3) are based on a uniform six per cent rate of return.44

44 Several recent determinations by economic regulators indicate the appropriate real pre-tax rate of return for regulated water industry businesses: the ERA (WA) has recommended 5.6 per cent; IPART (NSW) has recommended 5.7 per cent – 7.1 per cent; the ESC (Victoria) has recommended elements that total to 5.8 per cent real pre-tax; and, for the Gladstone Area Water Board, the Queensland Competition Authority has recommended elements that total to 6.2 per cent real pre tax. For this exercise, we have applied a standard 6 per cent rate of return.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

115. To facilitate the comparison of cost levels these costs estimates can be expressed on a per property or per kilolitre basis (Table 9).

Table 9 : Estimated Full Cost of Water Supply to Major Australian Cities

City Full annualised cost Cost per property per Levelised Cost (cost per ($ million) annum ($) kilolitre - $/kL)

Sydney 775 460 1.47

Melbourne 633 413 1.47

Brisbane(a) 219 522 0.86

Adelaide 255 517 1.54

Perth 360 554 1.59

Hobart(b) 26 312 0.63

Darwin 37 863 1.06

Canberra 82 601 1.56

Notes:(a) Includes bulk water purchases from SEQWater (b) Costs for Hobart exclude the retail costs associated with the councils that Hobart Water supplies.

Sources: WSAAfacts 2005 and Marsden Jacob analysis

116. The table demonstrates that: a city with high water usage, such as Darwin, may appear expensive on a per property basis, but is among the lowest cost service providers on a volumetric (per kilolitre) basis. However, Hobart is the lowest cost supply regardless of how measured; in terms of costs per kilolitre, five of the eight cities lie in the tight range of $1.47 to $1.59/kL; and for these five cities the levels of average costs for water are broadly similar to the estimates of LRMC shown in Table 11 below.

Cost recovery

117. The cost of supplying water is distinct from the price at which the water utility sells water to the customer. Currently, all of Australia’s major urban water businesses are charging enough to cover their minimum cashflow requirements (including debt and interest repayments), however none of the businesses are charging sufficiently high prices to earn a commercial return on existing (sunk) assets.

118. The fact that prices do not provide a commercial return on assets may appear contrary to the aim of encouraging investment in the water industry. However, Australian economic regulators argue that prices need only be sufficient to recover future expenditure to encourage investment in the industry. Water utilities, which have historically received very low returns on investment, need not be compensated

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

for past investments to the same extent that they are compensated for new investments. To avoid sharp rises in water prices when pricing reforms were introduced, regulators have drawn a “line in the sand” and required past investments to be written down substantially for regulatory purposes. 45

119. While Australian water regulators adopt similar terminology as they do for electricity, gas and telecommunications, the differences in approach are substantial. The regulatory asset value of water businesses is typically well below the efficient replacement cost of infrastructure. In contrast, the regulatory asset value for setting regulated prices for other utility sectors is set precisely at the level of efficient replacement cost. An example is the case of, say, gas pipelines, monopoly telecommunications services or airports.46

120. As a result, the level of water prices/revenue approved by economic regulators is below the maximum level consistent with a competitive market. It follows that the level of water prices is below the counterpart level that would be determined using the replacement cost approach applying to telecommunication services such as access to the “last half mile of the copper system” or to electricity and gas transmission pipelines.47, 48

121. Table 10 compares the estimate of the full cost of supplying water services to each capital city with the current (regulated) level of revenue. The difference between the full cost of water supply and current revenue levels is shown in the final column. This indicates that perhaps as much as $600 million a year in additional revenue could be generated if water prices were increased to cover full cost if full cost were defined in the same manner as occurs in other utility sectors.49 This estimate of almost $600 million per annum is a maximum, and the actual level may be lower since the publicly available information does not indicate the extent to which the infrastructure costs have been optimised.

45 For discussion see, MJA, 2003. 46 See for example, the ACCC’s approach to Sydney Airports Corporation Limited’s proposal to increase its regulated prices. The approach (in this case focussing on land values) is discussed in ACCC, 2001. 47 See ACCC (2003), particularly Chapter 5 and ACCC (1997). 48 See ACCC (2004). These principles for electricity revenues are applied where appropriate in the gas transmission sector. 49 Relevant assumptions here include a 6 per cent return on the depreciated replacement value of assets. This is assuming that there would have been no demand-side reductions in consumption due to price increases in response to full cost pricing.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Table 10: Indicative Full Cost Degree of Cost Recovery, Australian Capital Cities, 2005

City : Indicative Current total Current Price ‘Extra’ full cost water degree of full increase for revenue ($m) revenue cost recovery 100% ($m) ($m) recovery Sydney 775 587 76% 32% 188 Melbourne 633 431 68% 48% 202 Brisbane 219 184 84% 19% 35 Adelaide 255 209 82% 22% 46 Perth 360 266 74% 34% 94 Hobart 26 23 89% 13% 3 Darwin 37 30 80% 25% 7 Canberra 82 66 80% 25% 16 Total 2,387 1,796 75% 33% 591

Source : MJA analysis based on WSAAfacts 2005

122. Comparison of current revenue levels with the indicative full cost estimates suggests that if full cost were to be defined in the same manner as in other utility sectors, then the level of cost recovery is only 75 per cent. Across the capital cities, the level of cost recovery is estimated to range from a low of 68 per cent for Melbourne, to a high of almost 89 per cent for Hobart.

123. Should the definition of full costs applied to water continue to differ from the definition applied to other utility sectors?

124. The indicative analysis also estimates the additional revenue that would be generated if prices were increased to recover the full cost of supply. As already noted, the reason that the estimated full cost revenue exceeds the actual or current (regulated) level is that the regulatory asset values have, in the past, been uniformly set at a discount to the efficient replacement cost in order to keep water prices low or at least to prevent sharp rises.

125. While the indicated magnitudes for additional revenue from this preliminary analysis cannot be regarded as precise, they appear to be material. These are regulatory issues which need to be examined systematically by a national regulator, i.e., the NCC or the ACCC.

Tariff structures

126. There is a popular concern that water is priced too cheaply and in particular that the volumetric usage charge is too low. A separate issue is that there are too many consumers of water that do not receive a strong price signal:

127. Economic efficiency is served when the marginal cost of supply is equal to the price. Volumetric charges should therefore reflect what is termed the Long Run Marginal Cost (LRMC) of providing new water sources. LRMC represents the actual cost of augmenting the water supply system to cater for growing demand, but excludes the 47

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

sunk cost of existing assets. In order to send a signal about the cost of new water supplies, the water industry in Australia and elsewhere in the world have adopted two-part tariffs, in which the volumetric charges reflect the long-run marginal cost of supply and the separate service charge (usually fixed) recovers all remaining administrative and sunk asset costs.

128. In accordance with the 1994 CoAG Agreement on Water Reform, recent regulatory decisions regarding the volumetric charge indicate that most major water businesses either have, or are moving toward, a volumetric charge in line with the long-run marginal cost of supply. However: most regulators and water businesses have not defined the incremental cost of supply adequately. It appears that only Sydney, Melbourne and Perth have well developed, publicly available estimates of the incremental cost of supply. Both NSW and Victorian regulators have indicated that the estimates need further refinement; no systematic review of the environmental costs has been made as part of any price inquiry in Australia. Without such a review, any price increase to accommodate environmental costs will be arbitrary at best. If choices on the tradeoff between the environment and consumptive use are − consistent with the NWI − already made and recorded in the statutory water plan, then should there be a separate environmental levy? and efficient water pricing requires efficient tariff structures. The desire to strengthen the price signal in order to promote water conservation by pricing above incremental cost conflicts with the need for pricing to ensure that innovation, investment and potentially competition are efficiently promoted. The logic and impacts of existing multiple part tariffs need to be fundamentally considered.

129. In addition, many regulators have promoted the use of tiered tariffs (i.e., a unit charge that increases with water use) to further encourage water conservation. Although popular, the logic and rationale for a second step that is higher than the LRMC is not well developed. Typically, the second step represents an arbitrary multiple of the first step. One exception is the Western Australian Economic Regulatory Authority, which has recommended setting a first price step at a conservative estimate of the LRMC and that the second step is set at the higher level given by a more aggressive climate change scenario (the ERA has recommended transition to this arrangement over a number of years).50

130. For several capital cities, the marginal price paid for additional volumes of water consumed appears to be substantially above the calculated or likely LRMC (Table 11). These anomalies suggest that it is timely to re-evaluate the practical meaning and implications of “efficient water pricing”.

50 This approach can continue with government-owned monopolies running water but with third party access, it is likely to create a raft of difficulties. A higher volumetric charge than LRMC could also lead to under-consumption of water compared with potential investment options.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Table 11: Major Water Utilities – Long Run Marginal Cost and Price

City Estimated LRMC Water Usage 2006/07 ($/kL) Volumetric Price ($/kL)1

Sydney 1.20-1.50 2 <1.096 kL/day 1.264 >1.096 kL/day 1.634

Perth 0.82-1.20 3 0-150 kL 0.493 151-350 kL 0.732 351-550 kL 0.950

551-950 kL 1.268

>950 kL 1.588

Adelaide Approx <125 kL 0.470 4 1.09 >125 kL 1.090 5 Melbourne – 0.50-0.54 0-440 l/day 0.8184 Yarra Valley 440-880 l/day 0.9601 >880 l/day 1.4185 6 Melbourne – 0.74 0-440 l/day 0.8205 City West 440-880 l/day 0.9628 >880 l/day 1.4223

Notes: 1. Applies to full fee paying customers only. Discounts of around 30% are available to Concession Card holders. 2. IPART (2005) Sydney Water Corporation, Hunter Water Corporation, Sydney Catchment Authority - Prices of Water Supply, Wastewater and Stormwater Services 3. Economic Regulation Authority (2005), Final Report on the Inquiry on Urban Water and Wastewater Pricing 4. “[The] second tier water price reflects current estimates of LRMC”: ESCoSA, Transparency Statement Water and Wastewater Prices In Metropolitan And Regional South Australia 2006-07, p.32 5. Yarra Valley Water, Water Plan $0.02 transport opex, $0.33 LRMC, plus Melbourne Water LRMC for supplying Yarra Valley $0.15-$0.19 6. City West Water Plan 2005-06 to 2007-08. It is unknown if this estimate incorporates Melbourne Water’s estimate of LRMC. 131. Assuming that volumetric charges are already set at the level of the estimated LRMC, the under-recovery of total costs (estimated above at up to $600 million per annum) therefore in principle affects the level of the separate service charge only.51 At the level of principle, it does not require that the volumetric usage charge is increased.

51 It is typically claimed that the fixed element of the water bill has little impact on economic efficiency. The volumetric charge influences the level of consumption from year to year, but the annual fixed charge has relatively little influence on any consumer behaviour. In theory, the fixed water charge may influence decisions regarding the construction of new homes, however in practice the water charge represents a relatively small cost compared with the other costs of construction and ownership.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

132. In addition, many water users are not charged the full volumetric charge: around 30 per cent of Australians in some states rent their accommodation and do not receive water bills which are sent instead to their landlords. This practice appears widespread and is a legislative requirement in Victoria and WA. It means that renters do not know their water bill. There is a view that reform of residential tenancy acts is required; and all Australian states offer some form of discount to concession cardholders on water and energy bills. As an example, in Victoria, around 30 per cent of all water accounts can receive a discount of up to $154 on total water and sewerage charges with a uniform discount applying to each element of the water bill (excluding the parks and drainage levy). That is, in at least the case of Victoria, the discount applies to both the fixed administrative charge and importantly the volumetric charge.

Is this the most efficient way of providing assistance to persons holding concession cards? Alternatively, a greater discount could be provided on the fixed administration charge and all subsidies on the volumetric charge could be removed; and in some cases, such as Adelaide, Perth and Canberra, water users pay a significantly lower price for low volumes of water use. Pricing signals could be strengthened if all water use was charged at the true cost and the fixed charge was reduced accordingly to compensate.

133. At the same time, governments at all levels, intervene heavily to reduce the cost of water to final consumers. For instance: the Queensland Government makes a 40 per cent contribution to the capital costs of the infrastructure of council water businesses; the Victorian Government makes periodic contributions to major water projects benefiting Melbourne’s water users. For water users in non-metropolitan urban centres such as, say, Bendigo, the State Government has recently announced a $30 million52 subsidy payment; and the Australian Government has earmarked $1.6 billion over the five years to 2010 for funding of water projects under the Water Smart Australia programme. Administered by the National Water Commission, the fund targets “big ticket” projects to provide quantum changes in water management and “aims to accelerate the development and uptake of smart technologies and practices in water use across Australia”.

134. A first question is: what are the levels and distribution of subsidies and grants from the State and Commonwealth budgets to the water businesses and their customers? A second question is: is the current approach of subsidising investments in water infrastructure benign, or is it distorted by sending inefficient price signals to the water businesses and water users? The answer is an empirical matter depending on

52 Department of Primary Industries, 2006, p. 3.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

whether or not the subsidies affect incremental charges, i.e. the usage/volumetric charge and the developer charges.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

8. MARKET AND INSTITUTIONAL ARRANGEMENTS

135. A major thrust of the National Water Initiative (NWI) is to establish firm entitlements to water backed by statutory water management plans and robust registers to facilitate trade in entitlements and allocations. This direction is firmly focussed on the bulk water systems and entitlements held by irrigators and other major users. However, this direction is not generally not applied to date in the major urban centres. Should it be? Are there net advantages in residential customers being assigned water entitlements? In a different direction, what lessons are available from the success or otherwise of retail contestability in electricity?53

136. Victoria will assign bulk entitlements to the three Melbourne retailers and the larger water users. South-east Queensland is moving to pool its water sources. Both these initiatives raise the question of how the interlinking and pooling of water sources should be managed. Does this pooling require the introduction of market mechanisms to determine the ‘call order’ of supplies and pool prices (as in electricity markets), or can this best be handled via the administrative decisions of a system operator?

137. Given the fundamental importance of water supply planning in the face of climate uncertainty, do market-based approaches offer any net advantages at all?

138. In addition to water supply considerations, the industry is subject to growing economic challenges in the face of price regulation and the gradual opening of the market to competition for customers. Recent applications by Services Sydney in New South Wales and United Utilities in Western Australia demonstrate private sector interest in large-scale water supply management and direct competition for customers. Such interest needs to be able to be incorporated within the planning process for a region’s water supplies. A key conclusion from a recent paper prepared by Marsden Jacob on third party access stated: Perhaps the most important question however relates to how to reconcile third party access with water resource planning and the demands of Australian communities for governments to be accountable for ensuring that water is not only safe for public health, but also reliable and secure. Consistent with the IPART recommendations, the planning process should be made to be transparent. In particular, the schedule of intended source developments for major authorities should be posted to establish the benchmarks in terms of costs and timing that would need to be bettered by any private entrant.54

139. Private entry should not occur unless the prospective entrants can better the cost and reliability benchmarks of the public sector incumbent. Prospective entrants need to know the benchmarks they need to beat. If large-scale competition for customers is

53 A key point is that transaction costs are likely to be too high to give al households an entitlement. However, the proposal may be worthwhile for some large urban users. 54 Marsden Jacob Associates (2005), p. 92 52

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

to proceed then an independent and robust framework and process for water supply planning is required to set the benchmarks that would need to be bettered by potential private entrants.55 In this direction, Queensland has formally separated the planning function from the incumbent suppliers and from the policy department. In the counter direction, Victoria emphasises the strong synergies from having water supply planning being undertaken by the department and the incumbent supplier.

140. The economic reforms of the 1990s saw many water businesses corporatised or commercialised and, to level the competitive playing field, saw the introduction of tax equivalent regimes and dividend payments. To ensure that the water utilities with their strengthened commercial focus recognise environmental, health and other public policy objectives, they are subject to licensing and other forms of regulation. In addition, every State or Territory has an economic regulator that provides advice, arbitration or direction on water pricing and other financial issues.

141. Major urban water businesses are typically state-owned or government-owned corporations operating under corporate law. As at October 2006, the supply and delivery of water to Australia’s major urban centres remains, for the most part, wholly owned by the State or Territory government. The exceptions are Queensland, Tasmania and some regional centres in NSW, where the water businesses are owned by local government. Currently, there is little or no competition for customers in the water sector.

142. In the case of water businesses owned by local governments and government-owned businesses in regional urban centres in Victoria, the legal form is typically a commercialised division or arm of a government department or the council. Similarly, there is generally little or no competition for the right to supply a particular market, although innovative proposals such as AGL’s proposal to distribute recycled water in Sydney via a refitted network of gas pipes may provide some exception.56

143. The main avenue for private involvement and competition in the urban water sector is in competition for supplies, i.e., in competitive procurement and contracting out of key functions and activities. See Box 5.

55 See Marsden Jacob Associates (2005). 56 ‘Cheaper water - the simple solution at hand’, Sydney Morning Herald, 20 January 2006. Available at http://www.smh.com.au 53

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Box 5 : Private Involvement in Urban Water Sector

Sydney Water has the Prospect Water Treatment Plant and two similar plants under public-private partnership (PPP) arrangements. Moreover, prior to 23 November 2005, the NSW Government had indicated that the foreshadowed desalination plant would also be a PPP arrangement. Melbourne retailers similarly retain the management function and ownership of assets, but contract out most other functions. South East Water, for example, contracts out operating and maintenance; civil, mechanical and electrical engineering; some design and project management; and meter reading. Customer service functions, including billing, have been retained internally, however bill production is outsourced. Water Corporation (WA) has retained operations and maintenance functions in the country, but in Perth has contracted these via alliances with the private sector. Design and construction of the capital program is largely outsourced as is the contract for meter reading. Planning, project management and the customer service functions have generally been retained in- house. SA Water and ACTEW Corporation (ACT) have both entered into comprehensive long-term contracts with the private sector for the management, operations and capital programs of their respective cities. Power & Water Corporation (PAWC) in the Northern Territory reports that 100 per cent of the design, project management and construction activity in their capital expenditure program is undertaken by the private sector. Around 80 per cent of PAWC’s maintenance and repairs are similarly undertaken by the private sector. A stakeholder stated: In Power and Water Corporation, around 75% of utility costs are private sector driven. Capital projects are designed, project managed and constructed by the private sector, in addition to around 80% of maintenance and repair work. Operations, front line emergency response and billing have been retained in-house. Functions undertaken by PAWC itself internally include governance and oversight, planning and strategy, frontline emergency, retail interface and billing. Outside the metropolitan areas, the smaller municipality owned water businesses in NSW and Queensland to date appear to have made less use of contracting out than their generally larger Victorian counterparts. Nonetheless, there are important Design Build Operate arrangements either in place or in train for Wagga Wagga and Bega and at least seven similar arrangements in Queensland regional centres. Source: MJA 2005

144. The location and responsibility for urban water supply planning varies across Australia. For example: for SEQ, prior to 2006 each of the 18 or so local government owned water businesses was responsible for ensuring its own water supplies. SEQWater had been formed by Brisbane City Council, a number of smaller councils and the Queensland Government to manage some of the major sources. Nonetheless, at the beginning of 2006 the 19 major water sources were shared among 12 different owners. There was no adequate mechanism for integrated planning of water supplies and little capacity for water supply planning within many of the council-owned businesses. Progressively during 2005 the Department of Natural Resources and Water assumed an increasing role and in mid-2006 the Queensland Government established the Queensland Water Commission with the explicit responsibility for water supply planning and the development of common policies, including on restrictions;

for Sydney, the location and responsibility for water supply planning has shifted from Sydney Water at the time of the first Metropolitan Water Plan to the departments. Currently, water supply planning for Sydney is coordinated by the 54

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

Metropolitan Water Directorate located within the Department of Premier and Cabinet;

for Melbourne and other parts of the central region, water supply planning has been led by the Minister and the Department, with close collaboration and support from the regional urban water authorities. A team of six to eight professionals within the Department spearheaded this planning initiative, but there is a strong emphasis on ensuring that involvement, collaboration and skill capacity is maintained within the regional urban water authorities; and

for Perth, the responsibility for water supply planning has to date been centred in the Water Corporation, although the Department of Premier and Cabinet during 2004-06 played a major role in developing high level state water strategies and policies.

The recently released draft State Water ‘Plan’ provides the policy and planning framework for Western Australia − it is not a Water Supply Plan, nor a statutory water management plan as envisaged by the NWI.

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

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Department of the Prime Minister and Cabinet Securing Australia’s Urban Water Supplies: Opportunities and Impediments

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