114427 submission from_nekon_pty_ltd_re_pricing_investigation_principles_and_approach_111012

Price & Service Plan 2012 – 2015 Southern Water

Response from Nekon Pty Ltd ensuring sustainable, responsible and affordable water delivery for Tasmanians

Prepared 30 September 2011

Price & Service Plan 2012 – 2015, Southern Water Response from Nekon Pty Ltd

ensuring sustainable, responsible and affordable water delivery for Tasmanians

Table of Contents

Executive Summary ............................................................................................................. 1

Background ........................................................................................................................ 2

The Situation ................................................................................................................... 2

The Reforms .................................................................................................................... 3

Southern Water ................................................................................................................ 5

The Pricing Issue ................................................................................................................. 6

Background...................................................................................................................... 6

Economic Considerations ................................................................................................... 6

A Proposed Solution ............................................................................................................. 8

The Theoretical Model ....................................................................................................... 8

Alternative Solutions ......................................................................................................... 9

The Practical Solution ...................................................................................................... 10

Tariff Implications ........................................................................................................... 11

Bibliography & References .................................................................................................. 15


ensuring sustainable, responsible and affordable water delivery for Tasmanians Page 1

Executive Summary

In formulating this response to the proposed water pricing changes to be implemented

within the areas serviced by Southern Water, a number of issues were considered. An

examination of both the global and national water situation provided the context for a

heightened need to efficiently price water. Effective pricing signals facilitate better water

consumption (demand) and operating (supply) decisions.

The first best economic model of pure marginal cost pricing was also considered. Whilst

impractical to implement within the context of the current Australian and Tasmanian urban

water industry structure, it does provide directional focus. Second best alternatives were

examined with our preference being a move towards taking a long run marginal cost

approach.

Choosing the most appropriate pricing model is complex for a number of reasons including

economic, commercial, social and political issues and priorities, which must be considered at

both regional and national levels. For the immediate future, this submission supports the

move to a two-part pricing mechanism where economic efficiency is maintained through an

emphasis on the variable component, and a minimal fixed charge component. Economic

efficiency is maintained in principle and a nationally aligned pricing system is introduced.

In this light, this submission proposes that the fixed, network access charge be minimised

to:

Support the allocative efficiency benefits gained through marginal cost pricing (the

variable usage charge),

Set reasonably tight operational efficiency targets,

Ensure competitively geared cost management processes are established and

maintained, and

Achieve pricing alignment at a national level.

The resulting comparatively higher volumetric charge would have a number of positive

effects including the:

Signalling of the long run consequences of consumer consumption decisions in terms

of infrastructure needs. A higher volumetric charge would provide a greater incentive

to alter water consumption patterns, possibly reducing the need for capacity

expansion.

Provision of some of the necessary financing for capital expenditure and distribution

of the related costs of this according to consumption.

It is understood that full cost transparency is yet to be achieved, and is a fundamental

requirement for an effective marginal cost pricing model. Similarly, a more informed

response to the Draft Price and Service Plan requires the availability of more data and

access to Southern Water’s operating costs, consumption patterns and other related

information. This submission has raised at least two pricing model alternatives, and

requests Southern Water and the Office of the Tasmanian Economic Regulator to seek

further responses on the proposed pricing model whilst making the following information,

and any other information necessary to make an informed decision, available for the

deliberations:

More detailed explanation of the numbers driving Southern Water’s Draft Price and

Service Plan

The provision of serious alternatives from which to select

Wherever possible, access to the supporting data, calculations and assumptions

Provision of data and assumptions set upon which to test and propose viable

alternatives.

In the absence of more detailed consumer profile data and a more in-depth understanding

of the scale of consumers requiring transitional tariff arrangements, a commercially viable

alternative is difficult to propose.



By 2050 water forecasters are expecting global water shortages or a

‘gap’ between the supply and demand for water, driven, in a macro

sense, by the increase in population. Science Alert, Global Water Availability to 2050,

Future Directions International, Thursday 20 January 2011

Background

The Situation

Ultimately, the global water ‘gap’ will be driven by our increased demand for food, including

milk, meat and other high water-usage agricultural products. Within 40 years, the ‘gap’ is

expected to be about 3,000 cubic kilometres of water per annum; equivalent to the annual

flow of three Nile Rivers. Others predict the gap to be around 6,000 cubic kilometres. Whilst

this global water gap will vary regionally, Australia has been identified as having a high

water-stress level.1

While two thirds (2/3) of people on Earth use less than 60 litres of water a day, during

2008/09 Australian household water consumption per capita was 81 KL or 222 litres per

day.2 The graph below shows water consumption per capita for each of the Australian

States/Territories. In 2008-09 Tasmanian householders consumed just under 140 KL per

capita per annum – assuming 2.7 persons per household3, this equates to 378 KL per

household. The Office of the Tasmanian Economic Regulator recently reported (September

2011) in its Water and Sewerage State of the Industry Report 2009-10 that the average

consumption per connection within Southern Water’s region was 458 KL. However, a lack of

metering in Tasmania’s southern region prevents accurate measurement of consumption in

the area.

Graph 1: Australian Household Water Consumption by State, 2008-09

Source: ABS, 4610.0 - Water Account, Australia, 2008-09

1 Maplecroft, global assessment, November 2010, as reported in Science Alert, Global Water

Availability to 2050, Thursday 20 January 2011 2 ABS, 4610.0 - Water Account, Australia, 2008-09,

http://www.abs.gov.au/AUSSTATS/[email protected]/DetailsPage/4610.02008-09?OpenDocument 3 Australian Bureau of Statistics, Census 2006, average household size for Tasmania’s

southern region statistical division 610 & Greater Hobart 605, 2011

http://www.abs.gov.au/AUSSTATS/[email protected]/DetailsPage/4610.02008-09?OpenDocument



Tasmanian householders are the third highest water consumers in Australia. It is also

interesting to note that lower household consumption is evident within the States currently

operating under a two-part pricing scheme, where the variable component is designed to

send the most efficient pricing signals to both suppliers and consumers.

The rising cost of water in Australia is significant. From a national perspective, the ABS

reported a near doubling of the average price of water in 2008-09 with the average price

paid by households being $1.93/kL4. Water increases for 2011-12 are also evident with the

South Australian government approving a 26.3% average increase for consumers of

drinking water5, and similar increases have been announced for Barwon Water (Vic),

Sydney Water, (NSW), Brisbane Water (Qld), Hunter Water (NSW), and South East Water

(Vic).

Regulatory bodies, utilities, irrigators and consumers alike are pushing for reform to

moderate these price increases. Development of a coherent set of national objectives is

critical for Australia's water sector - from the National Water Initiative and beyond. A push

for competitive pricing and pricing regimes that are competitive at a national level are

warranted for a number of reasons including, but not limited to:

Many businesses and householders span multiple states and territories in their

investments and operations (including property investments, holidays and travel,

living parts of the year in different states due to weather and family considerations,

and the increasing number of grey nomads traversing the nation)

Water data is becoming more available for the average person

Competitive pricing at national levels will help ensure monopolistic profit taking and

inefficient cost management practices at an individual utility level are self-regulated

and minimised.

Australia, and specifically Tasmania, is often cited by global water authorities as a leader in

innovation6, and is the focus of many international studies. However, this recognition is due

to the introduction of a competitive pricing model in the agricultural sector via the water

trading system. On the urban water supply and delivery side, Tasmania is struggling to

meet quality standards, and the pricing system is inherently inefficient. Whilst some regions

within Southern Water’s service area have introduced usage charges, others have not; with

the Hobart metropolitan area currently basing its water charges on property values. The

Tasmanian Water and Sewerage Industry’s 2011-12 Price Determination Investigation and

its Draft Price and Service Plan Guideline, are set to potentially improve the pricing regime

through standardisation, more economically efficient pricing, transparency and fairness.

The Reforms

Reforms are in place to move to a more economically effective, consistent and equitable

pricing model. Guidelines have been provided by Tasmania’s Water and Sewerage Industry

Act 2008, Interim Price Order. Section 68 of the Industry Act includes the following pricing

principles for regulated water and sewerage services:

“…the price is to provide for efficient pricing through a two-part pricing for water

services based on the recovery of fixed costs and variable costs…”,

“…the price is to provide effective incentives to promote economic efficiency,

reduce costs or otherwise improve productivity with respect to a regulated

service…”, and

4 Australia Bureau of Statistics, Water consumption down, water prices up, 4610.0 - Water

Account Australia, 2008-09 Media Release, 2010 5 South Australian Government Regulatory Statement - 2011-12 Drinking Water and

Sewerage Prices, 2011 6 London Economics, Economic Brief: Reform in the Australian urban water sector; the

Productivity Commission Inquiry, April 2011



“…the price charged to a particular customer or class of customers is to reflect

the costs that are directly attributable to the provision of the regulated service to

that customer or class of customers.”.

For Tasmania, urban water reform was the outcome of a review of the challenges facing the

industry; namely, concerns over service levels and asset management coinciding with a

need for major capital investment and predicted price increases. An innovative model was

developed: consolidating 32 local government businesses into three independent water

corporations considered to have sufficient scale to advance performance (shown in Figure 2

below).

Figure 1: Tasmanian water industry

Source: Comparison of Victorian and Tasmanian Urban Water Reform Institutional

Models - Northern Tasmanian Water and Sewerage Reform Program

The upside to reform is significant – it provides a wealth of benefits, stemming from the

consolidation of smaller entities. Duplicated overheads across businesses are eliminated

while the new, large water businesses achieve both economies of scale and attract industry-

leading delivery partners.

The new models rationalise and align tariffs, bringing greater equity to consumers, as well

as central responsibility for price planning for the future. Tariff regulation will help ensure

prices are linked to justifiable costs and are supported by the principle of “user pays”.

Additional benefits to the consumer will include a higher, more transparent level of service –

driven by regulatory frameworks which promote investment into justifiable service

outcomes and reduce the long-term risk of price shock and service interruption.

For any major, wide-ranging reform process there is a trade-off between detailed planning

and execution to ensure an effective change, and achieving this change within a reasonable

cost and timescale.

Hindering the success of the change program in Tasmania has been the management of the

cost impact of reform on consumers and the reluctant relinquishing of individual Council

powers with respective to water and sewerage. The process of asset valuation and transfer

has also exposed a legacy of underinvestment and inadequate system design by some local

governments in their infrastructure, with corresponding upgrade programs needed to bring

the asset base to a sustainable standard.



The clear benefits of industry reform are underpinned by transparency, business

consolidation and tariff rationalisation. Timely and effective planning is crucial to avoid

‘crisis response’ situations – and attempts to unpick a partially completed reform could

prove to be very costly in the long term.

Southern Water

Southern Water was established on 1 July 2009 to deliver water and

wastewater services to the 200,000 residents and businesses of

southern Tasmania. It operates throughout 12 council areas,

including Hobart, Clarence and Glenorchy, Brighton, Central

Highlands, Glamorgan-Spring Bay, Huon Valley, Kingborough,

Derwent Valley, Sorell, Southern Midlands and Tasman. Southern

Water’s vision is to create lasting value for our communities by

providing sustainable water and wastewater solutions. This is being

achieved by improving the economic, environmental and public health

outcomes for all of Southern Water’s customers.



Getting the price for water “right” is increasingly seen as an

important tool for overcoming these problems, and for channelling

the management of this key natural resource in a more sustainable

direction. The OECD Environment Program 1999-2000

The Price of Water: Trends in OECD Countries

The Pricing Issue

Background

There is widespread international concern that poor water management will be one of the

major limiting factors on sustainability in the new millennium. Water shortages, degrading

water quality and the lack of competitiveness of water-intensive economic production are all

pushing water management issues higher on the international agenda.

Natural monopolies arise in industries such as water supply because the relatively high

capital investment required creates natural barriers to entry. Further, the entrenched owner

is able to capitalise on economies of scale and scope, producing at a lower cost than

potential new entrants. Thus larger, single operators are theoretically more profitable and

efficient than multiple smaller operators.

Originally, utilities, such as water, were privately operated. Concerns arose when it was

deemed that monopolistic profit taking by the private sector undermined our constitutional

right to water. Section 100 of the Australian Constitution guarantees the right to water by

all Australians, where the Commonwealth shall not give preference,

“…nor abridge right to use water

The Commonwealth shall not, by any law or regulation of trade or commerce,

abridge the right of a State or of the residents therein to the reasonable use

of the waters of rivers for conservation or irrigation.”

Nationalisation of key industry assets, such as electricity, gas, and airlines began after

World War Two. However, this was short lived, as concerns quickly arose around public

ownership inefficiencies resulting in price distortions and deteriorating assets. Private

industry was, and is currently considered, ultimately better positioned to deliver cost

efficiencies, service improvements and investment.

Economic Considerations

In a democratic and market economy such as Australia’s, the creation of a fair and equitable

pricing regime, is best achieved through the application of economic principles and

competitive markets. It is important to note that economic efficiency does not just extend

to the costs of delivering water services, but is inherently dependent upon the correct

signals being given to consumers through efficient pricing mechanisms. Prices signal the

cost of providing the services, and allow consumers to evaluate consumption decisions.

Where prices do not reflect the true cost of water services, decisions regarding consumption

are distorted and resources will more than likely be inefficiently allocated – creating a

similar situation to that which Tasmania is currently experiencing.

Choosing the most appropriate pricing model is complex for a number of reasons:

A theoretically perfect pricing model is inherently doomed due to the current, and

forecast worsening of, the water ‘gap’ – where Demand exceeds Supply at a global

level.

The economic basis of water pricing is that the supplier must be able to recover all of

its costs including operations, maintenance, investment, opportunity costs such as



greenhouse gas emissions and water scarcity, and benefits such as improved health

and standards of living due to higher quality potable water.

Economic efficiency demands that prices are set at marginal cost. Under marginal

cost pricing, price is set to recover the cost of supplying an extra unit of water for a

given level of infrastructure. In capital intensive industries such as water storage and

supply, the utility will not generate sufficient revenue to cover costs.

True costs of supply and delivery are not known, or not transparently communicated.

Nor are they effectively separated throughout the industry’s vertically integrated

supply chain.

The Tasmanian water industry is suffering from historical under-investment which

requires capital intensive works programs to bring the assets up to Australian

standards.

In Australia, urban water pricing considerations also include sewerage and drainage

costs (horizontal integration).

Water storage and supply has limited capacity with very lumpy capacity expansion

patterns.

The regulator must ensure the presence of pricing equity; balancing the needs of low

income groups against those of the financial sustainability of the supplier.

Marginal costs are typically not stable in the short run, experiencing significant

fluctuations in price depending upon available capacity and supply. A sawtooth, or

factory roof pattern is often used to describe this characteristic. Short run marginal

costs fall to zero following each extension of capacity and then rise to full cost as

capacity becomes exhausted, new investment is installed and short run marginal

costs fall to zero fall to zero once again. Alternatively, prices are pushed upwards

when supply is cut short such as during a drought, and may fall to zero during floods

(assuming capacity is not exhausted).

Any change initiative requires significant effort to gain support amongst the

community. There will be winners and losers in any scenario, and these people also

significantly impact our political environment, and thus the industry regulators.

How then, is an appropriate pricing model for a water business selected? Criteria designed

to assist in the evaluation of an appropriate pricing model are:

Allocative efficiency – society gets the greatest return form its scarce resources by

putting those resources to their most productive use in the economy. This is

achieved when consumption and production decisions are based on prices that reflect

the opportunity cost of the available resources, and consists of both Demand and

Supply efficiencies.

o Demand efficiency when users are charged no more or no less than it costs to

produce the unit of service to them

o Supply efficiency (revenue adequacy)when producers are able to recover

sufficient cost to sustain the provision of the services required

Productive or technical efficiency – where goods and services are produced at

minimum cost given the available technology.

Dynamic efficiency – optimising the allocation of resources over time, including

generating additional resources, to maximise overall benefits to society. An example

is finding better ways to produce or deliver goods and services.

Based on a solid theoretical foundation.

Fair and objective.

Price stability should be supported.

Transparent and reliable.

Practical and understandable.

Flexible – can be applied to different circumstances and yield different outcomes for

different groups.



A Proposed Solution

The Theoretical Model

According to standard economic theory, prices should be set at marginal cost (MC) since, in

the absence of externalities, this maximises economic welfare. This is because such prices

reflect the costs involved in providing an additional amount of output. Where the user

values an extra unit more than it would cost to produce it, it is economically efficient to

produce that unit, and vice versa. Setting prices equal to marginal cost means that users

will continue purchasing extra units until it is no longer economically efficient to produce

them at that price. Marginal cost based pricing therefore send signals to consumers and

producers encouraging them to balance the benefits obtained by consuming a good or

service with the costs of providing it.

Under a strict Marginal Cost pricing model, the price of water is its short-run marginal

operating cost. This assumes that capacity (supply, storage or water availability) is in

excess of demand and that distribution (supply delivery) is available, as and when

demanded. Price may equal zero when the existing supply ‘safely’ exceeds demand. Price

will rise as supply is reduced to meet a rising level of demand. The applicable marginal costs

consist of those additional costs incurred in operating and distributing the amount of water

demanded. Once demand increases to the point of capacity, price will increase vertically

until demand is reduced, or consumers are willing to pay for the additional investment

required to increase capacity. This situation is shown in Graph 3 (as adapted from Efficient

Urban Water Pricing, by Professor Hugh Sibly, School of Economics and Finance, University

of Tasmania, The Australian Economic Review, vol 39, no 2, pp227-237).

Graph 2: Adding Extra Capacity, Marginal Cost Pricing Model

S1 = current supply as constrained by capacity. Where Supply (S1) exceeds

Demand (D1), the efficient market price is pe. Price pc is the price where capacity is reached. At capacity, any increases in demand will significantly

increase price. Once capacity is added (refer green S2 line), an efficient market is again restored with

supply exceeding demand

(D2), and price retreating back to p3.

Several issues arise when applying this perfect theoretical model to practical urban utilities,

including:

The fact that on a global basis demand exceeds supply and Australia is considered to

have a relatively high water stress level (primarily due to the fact that we produce

93% of our own food, export food to other countries, population growth, continued

urbanisation, and lack of effective water consumption education and pricing signals).

The true cost of utility operations and delivery is unknown or not publicly available.

In Tasmania, urban water pricing includes sewerage, with drainage remaining with

the Councils.

Equity and fairness must be maintained for social and political purposes.

S1 S2

D1

pe



Equity and fairness should be considered at a national level, thereby promoting

competition at a national level amongst the regional utilities.

Monopolistic pricing must not be seen to be exerted.

Tasmania’s current water industry has been under capitalised.

Tasmania has a ready supply of fresh water, relinquishing the high cost need for

desalination, yet still requiring suitable harvesting and reticulation systems.

Whilst the ‘first best’ solution is to set price equal to marginal cost to achieve allocative

efficiency, when dealing with a natural monopoly or networked/reticulated business such as

water, the utility will not make sufficient revenue to recover its fixed costs (because average

cost is below marginal cost). Ultimately, efficient pricing signals are not being provided to

consumers and utilities may not be sustainably compensated for operating and delivery

costs; issues achieving both allocative efficiency and revenue adequacy arise.

Alternative Solutions

Adaptions made to the theoretical model have been proposed to overcome the above

mentioned shortcomings. It is worth noting, that there is no ideal, and the best move at this

point in time is to take some action towards implementing an efficient market model and

adjusting it as required.

In situations where Marginal Cost is less than Average Cost and the utility needs to recoup

its operating costs via a sustainable pricing mechanism, Sibly (2006) advocates the use of a

fixed charge related to property values (as a proxy for the consumer’s ability to pay).

However, this is not to say that water charges should reflect property values in their

entirety; rather it is a suggested second best solution to recovering operating costs via a

fixed charge when the ideally efficient Marginal Cost priced variable charge will not.

The introduction of a fixed or lump sum charge has been suggested to compensate the

water utilities for the difference between their Average Cost and Marginal Cost, thereby

ensuring they are financially sustainable. Rather than subsidies and taxation, which Coase

(1946 as quoted by Altmann, 2007, p9) considers distortionary, a fixed charge covering the

cost of the network connection is recommended. A volumetric charge set at marginal cost

maintains economic efficiency with the fixed charge filling the shortfall.

Australia’s economic regulators tend to support Coase’s two part pricing proposition. Moving

forward, the Tasmanian legislation stipulates a, “…two-part pricing for water services based

on the recovery of fixed costs and variable costs…”7.

It has been further suggested that both volume consumed and distribution were variable

costs: volume according to usage, and distribution by network distance.8

Another alternative is to use Long Run Marginal Cost, which effectively brings forward

investment (capital works programs) by ‘budgeting’ for it now. Long run marginal cost

pricing includes costs related to scarcity, negative and positive externalities, and planned

supply investment requirements. Turvey (quoted in Altmann, 2007) defines long run

marginal cost of water supply as the sum of marginal capacity costs, marginal operating

costs, marginal distribution costs and per connection overhead costs. Whilst including

marginal capacity costs differs from conventional economic theory, it was argued that

commitments to expand capacity are made years in advance to their implementation. Hence

the variable is not the incremental expenditure, but rather the timing. It was shown that a

one year change in commissioning new capacity can have a significant marginal cost

impact. The UK Office of Water and the Essential Services Commission in Victoria have both

employed this concept of marginal cost pricing in their business models.

7 Section 68: Pricing principles, Water and Sewerage Industry Act 2008,Tasmania, 2011 8 Vickrey, W.S. Some implications of marginal cost pricing for public utilities. American

Economic Review, 45(5): 605-620, 1955.



A mix of both Long Run (LRMC) and Short Run Marginal Cost (SRMC) pricing has also been

suggested where price is set at the higher of either the LRMC or SRMC. Effectively, when

supply exceeds demand and capacity is at safe limits, SRMC is used; in times of drought or

when capacity limits are reached, LRMC is applied. Whilst such a proposition supports

revenue adequacy, it requires a relatively high degree of administrative flexibility and

community communication. Given the current economic climate, price increases and price

stability are sensitive issues for water users.

North American water suppliers use the Average Incremental Cost approach in price setting.

This is the additional cost per unit of additional consumption when both additional annual

costs and consumption are expressed as the present value of their flows. The benefit of

averaging costs is the achievement of price stability. Again, this is a volumetric pricing

model, but less attractive in allocative terms than marginal cost approaches and is highly

dependent on the underlying discount rates applied.

The Practical Solution

Selecting an appropriate pricing mechanism for water utilities is complex and requires the

quantification and balancing of many variables including tariff price, fixed and variable

costs, network and infrastructure costs, supply and demand constraints, political agendas,

social goals, community expectations, regulatory frameworks, and asset quality. For

Southern Water, this is further complicated by the need to achieve operating efficiencies,

equitable pricing and improved transparency from the recent merging of the water

operations of 11 different Council areas. All this, in the absence of a competitive water

market, could result in a game of blind’s man bluff.

From a purest perspective, economic efficiency within the water industry is unattainable in

the current environment. We need to work with a ‘first best’ or ‘second best’ solution.

The ‘first best’ model is one based on marginal cost pricing, as it is this that best achieves

allocative efficiency and supports movement towards productive and dynamic efficiency

gains. It is also based in sound economic theory, provides the basis for transparent and fair

pricing, and facilitates price flexibility. The difficulties arise in price stability and

understanding the true costs that need to be included. Another key difficulty is ensuring

allocative efficiency within a monopolistic networked environment that is highly regulated

and vertically and horizontally integrated.

Given the current state of the State’s water assets and relatively significant quality issues,

there is an immediate need to invest in capacity building and examine ways to better

improve our dynamic and productive efficiency levels. By raising the marginal cost to

include long run variables, capacity building is expedited whilst maintaining economic

efficiency. Recognising the potential shortfall in recouping operating costs, it is

acknowledged that a fixed charge – or network access charge – may be required. This

submission proposes that this fixed, network access charge be minimised to:

Support the allocative efficiency benefits gained through marginal cost pricing (the

variable usage charge),

Set reasonably tight operational efficiency targets,

Ensure competitively geared cost management processes are established and

maintained, and

Achieve pricing alignment at a national level.

The resulting comparatively higher volumetric charge would have a number of positive

effects including the:

Signalling of the long run consequences of consumer consumption decisions in terms

of infrastructure needs. A higher volumetric charge would provide a greater incentive

to alter water consumption patterns, possibly reducing the need for capacity

expansion.

Provision of some of the necessary financing for capital expenditure and distribution

of the related costs of this according to consumption.



Ultimately, higher volumetric charges (with lower fixed charges) allow households and other

consumers to better manage their water bills through conscious decisions regarding the

volume of water consumed. A single or two person household – such as a retiree – who

might typically only consume approximately 60 to 100 KL water per annum, will no longer

be charged the same as a 4 to 5 person household which may consume at least twice as

much water as the retiree. Similarly, water conscious family households have a greater

ability to reduce their water bills through changing consumption habits.

In the medium term, continued research and development into water industry technologies,

and supply and delivery alternatives is strongly supported. Longer term, an unbundling of

price signals for new water sources from the cost of delivery, and retailing, infrastructure is

also supported.

For the immediate future, this submission supports the move to a two-part pricing

mechanism where economic efficiency is maintained through an emphasis on the variable

component, and a minimal fixed charge component. Economic efficiency is maintained in

principle and a nationally aligned pricing system is introduced.

Tariff Implications

It is understood that full cost transparency is yet to be achieved, and is a fundamental

requirement for an effective marginal cost pricing model. Similarly, a more informed

response to the Draft Price and Service Plan requires the availability of more data and

access to Southern Water’s operating costs, consumption patterns and other related

information. An alternative to consider is based on average estimation with guidelines and

data sourced from:

Tasmanian Water and Sewerage Industry, Pricing Principles

Tasmanian Water and Sewerage Industry, 2011-12 Price Determination

Investigation, Draft Price and Service Plan Guideline

Tasmanian Water & Sewerage State of the Industry Report 2009-10

Southern Water’s Price and Service Plan Summary 2012-2015

Southern Water’s Annual Report 2009-2010

National Water Commission’s Review of Pricing Reform in the Australian Water

Sector 2011

Australian Bureau of Statistics’ Census data and Water Accounts

Pricing strategies of selected Australian water industry participants:

o Hunter Water, New South Wales,

o Sydney Water, New South Wales,

o South East Water, Victoria,

o Barwon Water Victoria,

o SA Water, South Australia, and

o Brisbane Water, Queensland.

Table 1 shows a comparison of pricing strategies across the selected water utilities for

standard users.

Table 1: Water Utility Pricing Comparison

Source: various utility pricing fact sheets 2010-2011

Urban Water Pricing Comparisons

Residential Non-Resi Resi 1 Business Resi Non-Resi Resi 2 Non-Resi2 Resi Non-

ResiResi 3 Non-Resi3 Resi Non-Resi

Fixed Service Charge, $

Fixed Water per 20mm 272.32 272.32 18.84 18.84 144.82 144.82 82.44 82.44 150.63 150.63 234.60 273.00 167.16 167.16

Fixed Water 100mm 6,808.00 6,808.00 471.12 3,619.82 3,619.82

Fixed Sewerage diameter 20 mm (or 1 tenement) 488.71 488.71 521.25 1,042.50 539.54 539.54 335.68 398.64 499.59 302.64 325.00 325.00 475.92 475.92

Fixed Sewerage diameter 100mm (or 5 tenements) 2,443.55 2,443.55 26,062.50 13,488.50 13,488.50

Volumetric

Variable Sewerage per KL 0.65 1.71 1.71 1.53 1.69

$ / KL 0.90 0.90 1.90 1.90 2.10 2.10 1.75 2.13 1.98 1.98 1.93 2.13 0.67 0.79

Plan FY13 Water Charges, 2010-2011

SA Water (SA)Brisbane Water

(QLD)

Hunter Water

(NSW)Sydney Water (NSW)

South East Water

(Vic)

Barwon Water

(Vic) Sthn Water



Table 1 shows that Southern Water’s pricing plan, as compared to other industry

participants, is relatively highly geared towards maximising the Fixed Costs with a minimal

Variable Usage charge. National alignment and a higher variable component to that

proposed by Southern Water is achieved through the application of an average approach to

the pricing structure.

Table 2 offers an alternative consideration where the variable water usage rate is increased

from $0.90KL to $1.72 or $1.84KL and the fixed water charge if reduced (for a 20mm

connection) from $272.32 to $133.08. In the absence of key underlying data from Southern

Water, both economic theory and the pricing strategies of other Australian water utilities

suggest more efficient pricing signals will be given to both consumers and the utility (under

this alternative pricing model).

Table 2: Alternative Pricing Model for Consideration - Average Tariffs

Source: Southern Water’s Draft Price and Service Plan 2012-2015 Summary, averages derived from pricing information sheets published by the selected utilities

Applying these figures to Southern Water reveals that revenue requirements are also

maintained.

Table 3: Revenue Requirements, Southern Water

Source: base data from Southern Water Annual Report 2009-2010

Based on Southern Water’s 2009-10 total revenue of $101,879,000 a forecast required

revenue for 2012-13 assuming 3% annual growth over the 3 years to 2012-13 yields a

required revenue of approximately $111,326,000. Separating this into Water and Sewerage

Urban Water Pricing Comparisons

Residential Non-Resi Residential Non-Resi

Fixed Service Charge, $

Fixed Water per 20mm 272.32 272.32 133.08 139.48

Fixed Water 100mm 6,808.00 6,808.00

Fixed Sewerage diameter 20 mm (or 1 tenement) 488.71 488.71 449.50 514.04

Fixed Sewerage diameter 100mm (or 5 tenements) 2,443.55 2,443.55

Volumetric

Variable Sewerage per KL 1.35

$ / KL 0.90 0.90 1.72 1.84

Plan FY13

AVERAGESthn Water

Southern Water's RequirementsConnections

Number

(2009-10)

Revenue

(2009-10)

avge rev per

connex

(2009-10)

Revenue

Required

(2009-10) % Revenue

Sales

Revenue

forecast

20012-13

(3% growth

pa)

Connections

Number

(2012-13)

avge rev /

connex

(2012-13)

TOTAL 101,879,000 111,325,934

Water 98,385 51,933,000 527.85 51,933,000 51% 56,748,591 98,385 576.80

Sewerage 90,241 44,974,000 498.38 44,974,000 44% 49,144,304 90,241 544.59

Other (Irrigation, Regates, Fees) 4,972,000 5%

expected water supplied, ML 43,600

Water Revenue, Residential 75% based on revenue breakbrown for Hunter Water 42,561,443 89,597 475.03

Water Revenue, Non residential 25% NB: Frontier economics Resi=60 to 70%, Industrial = 10%, 14,187,148 8,788 1,614.38

Number of households (ABS data 2006) commercial = 20 to 30% 89,597



revenues and dividing by the number of connections gives an average revenue per water

connection of $576.80 and $544.59 for sewerage for 2012-13.

Applying a 75% split for Residential and 25% for Non-residential water consumption, results

in an average revenue per connection of $475.03 for residential and $1,614.38 for non-

residential.

Applying the ratio of 60% fixed and 40% variable as detailed in Southern Water’s Annual

Report 2009-2010 to the proposed ‘average’ tariff structure of Fixed Water Charge = $135

and Variable Charge = $1.84 KL, shows that Southern Water’s revenue requirement is

exceeded (Table 4). So as not to unduly exceed revenue requirements, the fixed charge

could be reduced even more. At the very least, further investigation and modelling are

required to identify a more “ideal” pricing scheme or selection of pricing alternatives.

Table 4: Proposed Pricing Impact, per Residential & Non-Residential User

Residential Non-Residential

Required Proposed Avge Required Proposed Avge

Water only TOTAL $475.03 $546.18 $1,614.38 $2,505.89

$KL $1.84 $1.84

Fixed, $ $135 $540

A figure of 60% Fixed and 40% Variable has been communicated as an estimation of the

split within Southern Water’s pricing model. However, another view of the available data

suggests this may be more along the lines of 47% Fixed and 53% Variable; again it is

recognised that figures are derived from averages and slightly misaligned time periods. This

was derived by taking the average revenue per water connection for 2012-13 of $576.80

less $272.32 (47%) for a standard fixed charge, yielding $304.48 (53%) for variable

charges.

Further dividing the variable component of $304.48 by the $0.90 charge per KL suggests an

average consumption rate of 338 KL per annum. This average differs from that proposed in

Southern Water’s Draft Price and Service Plan 2012-2015 Summary, Example 1 of 200 KL

per annum for standard residential customers and, Example 4 suggests a medium sized

non-residential customer consumes 800KL per annum. The recently released State of the

Industry report suggests another average consumption figure of “…458 KL for the southern

region”9. Again, averages could be taken and further assumptions made.

A meaningful response to the proposed pricing strategy demands more than these relatively

high level assumptions and averages.

It is acknowledged that residential water consumption prices will increase. However, by

giving greater emphasis to the volumetric charge than currently allowed, consumers – most

particularly, householders – are given some degree of control over the extent to which they

will be affected since they can alter their water consumption patterns. Tables 5a-b show

that an alternative pricing scheme with a lower fixed charge and higher volumetric charge

will deliver Southern Water’s revenue requirement of $613 per household (based on an

average household consumption of 378 KL per annum10).

9 The Office of the Tasmanian Economic Regulator, Tasmanian Water and Sewerage State of

the Industry Report 2009-10, p 39, 2011 10 ABS, 4610.0 Water Account, Australia, 2008-09 & Census Data (2006) profiles for

Statistical Divisions 605 & 610, 2011



Table 5a: Constant Revenue to Southern Water (water only)

Table 5b: Pricing Assumptions (water only)

Table 5b shows the Fixed Charge as being reverse engineered down from $272.32 to $84

(similar to that charged by South East Water, Victoria) and the variable charge increased

from $0.90 to $1.40 per KL. Southern Water’s revenue of $613 is maintained. This

alternative model, better supports economic efficiency and consumers’ freedom in deciding

the quantity of water they consume.

It is recognised that Table 5b provides yet another alternative to the “average” model

presented earlier in Tables 2 and 4. In the absence of more detailed consumer profile data

and a more in-depth understanding of the scale of consumers requiring transitional tariff

arrangements, a commercially viable alternative is difficult to propose. In formulating a

sensible response, Southern Water and the Office of the Tasmanian Economic Regulator is

requested to seek further responses on the proposed pricing model whilst making the

following information, and any other information necessary to make an informed decision,

available for the deliberations:

More detailed explanation of the numbers driving Southern Water’s Draft Price and

Service Plan

The provision of serious alternatives from which to select

Wherever possible, access to the supporting data, calculations and assumptions

Provision of data and assumptions set upon which to test and propose viable

alternatives.

SW's Draft

Pricing Plan

Proposed

Alternative

Type of Household average average

Household consumption, KL 378 378

Variable Charge 340$ 529$

Fixed Charge 272$ 84$

TOTAL WATER (ex sewerage) 613$ 613$

SW Draft

Pricing Plan

2012/13

Proposed

Alternative

Fixed Water, 20 mm connection ($) 272.32 84.00

Volumetric Charge, Water ($KL) 0.90 1.40

Fixed Sewerage, per 1 ET($) 488.71 481.77



Bibliography & References

Annual Reports for Sydney Water, Hunter Water, Barwon Water, South East Water, SA

Water and Brisbane Water

Australian Bureau of Statistics, various National Regional Profiles (1379.0.55.001), 2011

Australian Bureau of Statistics, Water consumption down, water prices up, 4610.0 - Water

Account Australia, 2008-09 Media Release, 2010

Australian Bureau of Statistics, Water Account (4610.0), 2011

Australian Government, Urban water in Australia: Future directions, National Water

Commission, 2011

Allen’s Arthur Robinson, Summary of Productivity Commission reports on Australia’s urban

water sector, url:www.aar.com.au/pubs/water/fowmay11.thm, 2011

Altmann, D. Marinal cost water pricing: Welfare effects and policy implications using

minimum cost and benchmarking models with case studies from Australia and Asia, Doctor

of Philosophy Thesis submission, University of Adelaide, School of Economics, 2007.

Coase, R. The marginal cost controversy, Economica, 13(8): 169-189, 1946.

Deloitte/AWA, State of the water sector 2010-15: Preliminary report, 2010

Economic regulation of the South Australian Water Industry, Statement of Issues, The

Essential Services Commission of South Australia, 2010.

Ernst & Young, Spotlight on water,

Frontier Economics, Approaches to urban water pricing, Waterlines Occasional Paper, no.7,

2008

Hughes, N., Hafi, A., Goesch, T., Brownlowe, N. Urban water management: Optimal price

and investment policy under uncertainty, Australian Bureau of Agricultural and Resource

Economics Canberra Conference, 2008

London Economics, Economic Brief: Reform in the Australian urban water sector; the

Productivity Commission Inquiry, April 2011

OECD, The price of water: Trends in OECD countries, The OECD Environment Program

1999-2000,

PriceWaterhouseCoopers, Infrastructure Australia: Review of urban water security

strategies, 2010

Pricing fact sheets and publications for Sydney Water, Hunter Water, Barwon Water, South

East Water, SA Water and Brisbane Water

Roberts, R., Mitchell, N., Douglas, J. Water and Australia’s economic growth,

Sibly, H. Efficient urban water pricing, The Australian Economic Review, 39(2):227-237,

2006

Sibly, H. Urban water pricing, Agenda, 13(1):17-30, 2006.

South Australian Government Regulatory Statement - 2011-12 Drinking Water and

Sewerage Prices, 2011



Office of the Tasmanian Economic Regulator, Water and Sewerage State of the Industry

Report 2009-10, 2011

Office of the Tasmania Economic Regulator, Tasmanian Water and Sewerage Industry 2011-

12 Price Determination Investigation Draft Price and Service Plan Guideline, 2011

Southern Water, Draft Price and Service Plan 2012-15 Summary, 2011

The Allen Consulting Group, Urban water: A vision and roadmap for national progress, Gap

Forum on Urban Water, 2009

Turvey, R. Analysing the marginal cost of water supply, Land Economics,158-168, 1976

52(2):

Vickrey, W.S. Some implications of marginal cost pricing for public utilities. American

Economic Review, 45(5): 605-620, 1955.

Water and Sewerage Industry Act, Section 68: Pricing principles, 2008. url:

http://www.thelaw.tas.gov.au/tocview/index.w3p;cond=;doc_id=13%2B%2B2008%2BAT%

40EN%2B20090623150000;histon=;prompt=;rec=;term=

http://www.thelaw.tas.gov.au/tocview/index.w3p;cond=;doc_id=13%2B%2B2008%2BAT%40EN%2B20090623150000;histon=;prompt=;rec=;term

http://www.thelaw.tas.gov.au/tocview/index.w3p;cond=;doc_id=13%2B%2B2008%2BAT%40EN%2B20090623150000;histon=;prompt=;rec=;term

114427 submission from_nekon_pty_ltd_re_pricing_investigation_principles_and_approach_111012

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