Turnbull turns up the water pressure

By Dan Howard and Thomas Klempfner.

Key Points:
The Federal Government's Discussion Paper sets out the case for - and obstacles to - deeper engagement by the private sector in water.

Since his appointment as Parliamentary Secretary to the Prime Minister with responsibility for water policy in January 2006, Malcolm Turnbull MP has turned his energies to the promotion and implementation of the National Water Initiative ("NWI"). The NWI, agreed to by the States and the Commonwealth in June 2004, aims to increase the efficiency of water use and to ensure the health of river and groundwater systems. Key objectives of the NWI include:

• the return of over-allocated river systems to sustainable levels to meet environmental outcomes
• the conversion of old water rights to water access entitlements providing perpetual access to a share of the water resource
• the removal of institutional barriers to trade in water
• more efficient management of water in urban environments through measures such as recycling; and
• implementation of full-cost recovery pricing for water in both urban and rural sectors.

The NWI says very little about private investment in the water sector.

In August this year, Mr Turnbull moved to expand the policy debate by releasing "A Discussion Paper on the Role of the Private Sector in the Supply of Water and Wastewater Services."

Mr Turnbull identifies a range of potential benefits of private sector involvement in the water sector. These include:

• providing funds for the maintenance, renewal and replacement of water and wastewater assets
• improving efficiencies in water delivery through new technologies and innovative management; and
• creating competition in the water and wastewater services market.

The Discussion Paper acknowledges the important role the private sector already plays through contracts with urban water utilities. Some of the services contracted out to private firms include the design and construction of capital works, maintenance of water supply and sewerage systems, laboratory services, information technology and hydraulic modelling. Mr Turnbull argues corporate involvement in the water sector should go beyond contracting out to deeper engagement through public private partnerships (PPPs) and third party access to water and wastewater infrastructure. According to Mr Turnbull various obstacles preclude this deeper level of engagement by private firms.

Barriers to private sector investment in water

The Discussion Paper identifies three key obstacles to private investment in water infrastructure.

Water prices

Water prices are regulated by governments as in almost all cases water is a monopoly business. If the regulated price is set at a level that does not allow a commercial return on the capital deployed, it will preclude private sector involvement.

In urban areas recent reforms have seen the introduction of full cost recovery through two part pricing. In rural areas, however, prices barely cover operational costs, with factors such as storage costs and water scarcity rarely included. The Discussion paper identifies this as a significant issue: if water pricing remains low the cost of maintaining or upgrading infrastructure for new investors may outweigh their potential return.

Monopoly infrastructure

The high cost of establishing water and waste water transmission infrastructure means that there is often only one supply network in any location, which can be an impediment to the establishment of competitive markets. New entrants can also face problems obtaining accurate information about the value and condition of water supply and sewerage assets.

Risk management

Private investment in water infrastructure necessarily involves contractual arrangements between the public water authority and the investor. Contracts should identify key risks arising out of the project and the party responsible for each risk category. The appropriate allocation of risk between the parties is crucial in determining the success or failure of the venture.

Public private partnerships give rise to several categories of risk that need to be shared efficiently and equitably. These include financing, operational, regulatory, demand, maintenance, environmental and climate change risks, to name a few.

Facilitating private sector investment in water

Mr Turnbull believes these obstacles need to be minimised in order to encourage greater private sector involvement in the provision of water and wastewater services. He floats two specific proposals: a national code for third party access and national guidelines for contracting with the private sector.

National code for third party access

Mr Turnbull notes that third party access to water infrastructure services is already potentially available under the terms of Part IIIA of the Trade Practices Act (Cth). Access-seekers to a monopoly infrastructure service may seek declaration of the service by applying to the National Competition Council ("NCC"). The NCC then makes a recommendation to the relevant minister. The minister's decision is then open to review by the Australian Competition Tribunal. Once the service is declared, the access-seeker has the right to enter into negotiations with the service provider on the terms and conditions of access. In case of disagreement, either party can refer the matter to the ACCC for a determination.

The Discussion Paper states that the processes under Part IIIA of the Trade Practices Act can be prolonged and costly and notes that the NSW Government is in the process of developing a state-based access regime. Mr Turnbull suggests that the development of an industry-specific national code may facilitate third party access to water infrastructure services. The code would offer guidance on access protocols, pricing, risk sharing, arbitration, compliance and other key issues. Mr Turnbull suggests that the existence of an access code would provide all parties with greater certainty and minimise the potential for drawn-out negotiations and legal manoeuvres.

National guidelines for contracting with private sector

In Australia, private sector involvement is relatively new and there is likely to be a general lack of experience and knowledge in the development of contracts to manage third party access or other forms of private sector involvement in the water industry, particularly amongst some of the smaller operators in regional and isolated areas. The Discussion Paper canvasses the option of developing national guidelines for contracts in the water sector to manage private sector involvement. Infrastructure financing, construction and management involves a multiplicity of risks arising from high sunk costs, long life cycles, unpredictable asset maintenance and expansion requirements and changes in regulations. In the water industry additional sector specific risks may apply such as climate change, health risks and environmental risks that could be covered by such guidelines.

The future of water infrastructure

Australia's ongoing water crisis necessitates a multi-pronged policy response, including investment in infrastructure. The State Governments have embarked on major infrastructure developments such as the Eastern Water Recycling proposal in Melbourne, the Western Sydney Recycled Water Initiative in Sydney and Queensland's SE water grid. In NSW alone, expenditure on water infrastructure in 2006-07 is estimated at $990 million or 10 percent of the State's infrastructure budget[1]. Continuing reforms by the States and under the National Water Initiative, potential actions arising from the Discussion paper and growing budget expenditures by the States and the Commonwealth should help underwrite a prolonged water infrastructure investment cycle. The opportunities for private sector involvement in the financing, delivery and management of water services have never been greater.

[1]   NSW Treasury, State Infrastructure Strategy 2006-07 to 2015-16.

For further information, please contact Dan Howard.