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Water network access undertaking

Supporting submissionssion

January 2012

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Sydney Water – Water network access undertaking: Supporting submission Page | iii

Executive Summary

The Water Industry Competition Act 2006 (WIC Act) was introduced to promote competition in water services, and to create a licensing regime that protects public health, consumers and the environment.

To support the emergence of competitive bulk water and retail markets, Sydney Water has prepared a water network access undertaking in accordance with section 38 of the WIC Act. This voluntary undertaking is the first to be proposed by a publicly owned water utility in Australia.

Competition in bulk water and retail markets is still emerging in Sydney. This initial undertaking reflects this, by adopting an ‘incremental’ approach to the level of detail in the terms proposed. Sydney Water has developed detailed terms and conditions for the provision and pricing of its existing water network infrastructure, termed the ‘water transport service’. This service will facilitate competition between existing bulk suppliers and new entrants into water retail markets.

The undertaking also establishes a framework for third parties to negotiate the terms and conditions, including rights of arbitration, for new interconnection and off-take points. Detailed terms and conditions for those services can be negotiated once a firm proposal is received by Sydney Water.

Sydney’s bulk water and retail markets do not currently have the same codified rules as other network industries, such as gas and electricity. The undertaking has, therefore, been drafted to reflect the current policy environment, with sufficient flexibility to adapt to changing circumstances. Should many of the issues covered in the undertaking be further formalised through the development of a ‘water code’, then this would provide greater certainty to market participants and simplify the terms and conditions of the undertaking.

For the undertaking to be binding, it must be approved by the Independent Pricing and Regulatory Tribunal (IPART), which will invite public submissions as part of the approval process.

Non price terms and conditions

The access undertaking establishes the right for applicants to obtain access to Sydney Water’s water network infrastructure. It clearly defines the negotiation and dispute resolution processes, and confidentiality provisions that will apply to third party access. The core principles are that Sydney Water will provide non-discriminatory access and will negotiate in good faith.

The ‘standard access agreement’ provides the detailed terms and conditions for the water transport service. Under the agreement, and in accordance with its Operating Licence, Sydney Water will transport drinking water1 from existing interconnection points to customers (households, businesses etc). Sydney Water’s Operating Licence prescribes terms and conditions for water quality and system performance relating to pressure, continuity and response times to water main breaks.

Sydney Water considers that the standard access agreement will facilitate effective competition in bulk water and retail markets by:

• providing certainty in relation to the provision of the water transport service

• facilitating an applicant’s ability to connect new infrastructure to Sydney Water’s water networks

• allowing for individual negotiations relating to issues specific to each applicant (for example, coordination protocols)

• enabling applicants’ customers to retain the benefits of community service obligation (CSO) funding from the NSW Government, and

1 Drinking water is also referred to as ‘potable’ or ‘treated’ water.

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• including a detailed framework for negotiation of terms and dispute resolution mechanisms in the event that agreement cannot be reached.

Charging method for the water transport service

Sydney Water has developed a charging method for the water transport service which is designed to encourage effective competition in bulk water and retail markets.

The principles underlying the charging method are that:

• all customers, regardless of their choice of retailer, contribute to water security projects (some recycling and water efficiency programs) currently funded through postage stamp water prices, and

• customers in low cost areas continue to contribute to the provision of services to customers in high cost areas.

In applying these principles, access arrangements to the nine water filtration plants (WFPs) needs

to be considered. Four of the WFPs are privately owned, which allows new entrants to negotiate

directly with the private operators.

The charging method involves:

1. establishing the efficient level of costs to be recouped through access charges, assuming Sydney Water ceased providing any bulk water or retail services to all customers

2. a structure of charges consistent with the structure of water prices set by IPART, and

3. accounting for the different ways in which an applicant might obtain access to water treatment services from the privately owned WFPs.

The charging method is broadly referred to as ‘building blocks plus’, and is summarised in figure 1.

Figure 1 Illustration of proposed water transport service charging method

The primary benefit of the ‘building blocks plus’ approach to charging is that it transparently identifies the individual costs included in the access charge. Such transparency should facilitate efficient negotiations between Sydney Water and applicants in applying the charging method.

To align with final prices, the undertaking provides for a single set of charges across Sydney

Water’s network. The structure of charges is a combination of fixed and volumetric, consistent with

current water prices.

Transport network

+ Water security

projects

Bulk supply +

Retail

Contestable revenue

Price of

water

Access charge

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Sydney Water proposes to maintain its current allocation of risk in relation to water sales when applying the charging method. To do this, the total charges paid by retailers each year will need to be subject to an annual volume adjustment. The volume adjustment will balance any ‘windfall’ losses or gains associated with water sales being greater or less than the forecasts used to set access charges.

To accommodate the different ownership arrangements of the WFPs, Sydney Water has proposed three purchasing options for applicants, being:

Option A: The applicant purchases both water transport services and water treatment services from Sydney Water.

Option B: The applicant purchases water transport services from Sydney Water and intends to negotiate directly with the privately owned WFP operator(s) for the provision of water treatment services.

Option C: The applicant purchases water transport services from Sydney Water and does not require water treatment services for any of its bulk supply.

The charging method is applied to each option so that the outcome is consistent with the charging principles outlined in section 41 of the WIC Act. The detailed terms and conditions included in the undertaking are suitable for Option A. It will be necessary to negotiate individual terms and conditions for Options B and C based on the access seeker’s proposal.

The charging method also requires sufficient flexibility to adapt to changing circumstances. Changes to industry structure, the level and structure of water prices, or to commitments under the Metropolitan Water Plan, may require changes to the components of the access charge.

As part of the access undertaking, Sydney Water is proposing a charging method for endorsement by IPART, as opposed to precise charges that could occur in all circumstances. The application of the charging method can then be negotiated on an individual case by case basis. Should the parties not be able to agree on the charges to apply, either party could refer the matter to IPART for arbitration. However, by endorsing a charging method, the scope for dispute between the parties is effectively narrowed.

Fostering the emergence of competition

This voluntary undertaking demonstrates Sydney Water’s ongoing commitment to fostering competition in Sydney’s water industry, and constitutes a further step towards creating a competitive market. It builds on the agreements developed by Sydney Water in 2008, which included stakeholder engagement and input. Sydney Water looks forward to reviewing submissions by stakeholders on its proposed undertaking.

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1 Introduction

1.1 Background

In 2006, the NSW Government introduced a range of reforms to encourage private sector participation in the supply of water and wastewater services in NSW. The WIC Act is designed to promote competition, investment and innovation in water industry infrastructure, while safeguarding public health, the environment and consumers. The Water Industry Competition Amendment Bill 2011 was subsequently passed on 22 November 2011.

The WIC Act (as amended) establishes:

• an access regime to permit private sector access to certain water and wastewater infrastructure services

• a licensing scheme to regulate the involvement of the private sector in the supply of these services

• a dispute resolution process, and

• an ability for the Minister to include conditions in retail licences that allow for the sharing of costs to secure Sydney’s water supply across retailers.

The access regime covers water and wastewater infrastructure situated in, on or over land referred to in schedule 1 of the WIC Act (scheduled areas). At the moment, the scheduled areas are Sydney Water’s and Hunter Water’s areas of operations.

For a service within a scheduled area to be covered by the regime, it must be the subject of either:

•••• a coverage declaration, or

•••• an access undertaking.

Infrastructure that is the subject of a binding non-coverage declaration is exempt from the regime.

Key points

•••• Sydney Water has prepared a voluntary water access undertaking for approval by IPART.

•••• The undertaking establishes negotiation and arbitration arrangements for the provision and pricing of water transport, interconnection and off-take services.

•••• The undertaking contains detailed terms and conditions, including a proposed charging method, for the water transport service.

•••• New interconnection and off-take services are not anticipated to be required in the short term and, as a result, detailed terms and conditions for these services have not been included in the proposed undertaking. These can, however, be negotiated if and when a firm proposal is received.

•••• Sydney Water proposes to provide the water transport service consistently with its current Operating Licence obligations. The Operating Licence sets standards for water quality, pressure, continuity and response times to water main breaks.

•••• Sydney Water’s proposed charging method is based on a careful assessment of all the services covered by water prices, including the contribution some customers make to cover the cost of serving other customers. Sydney Water also proposes to continue to bear its current level of volume risk.


Overview of Sydney Water

Sydney Water is a State-owned corporation that provides water, wastewater, recycled water and stormwater services to about 5 million people in Sydney, the Illawarra and the Blue Mountains.

In 2010-11, about 1.8 million individual properties were connected to Sydney Water’s drinking water system, and 1.7 million to the wastewater system. Around 500,000 properties were provided with stormwater services. Sydney Water also produces about 50 GL of recycled water. Recycled water is for non-drinking residential purposes (eg outdoor watering), for irrigation and industry, and to provide environmental flows to the Hawkesbury-Nepean River.

Water and wastewater services are capital-intensive. For Sydney Water, bulk water supply and treatment makes up less than a third of total costs. Wastewater costs represent almost half the total costs, with wastewater treatment being the largest single component. Figure 1.1 below shows an indicative breakdown of costs for a typical household across the supply chain.

Figure 1.1 Indicative structure of Sydney Water’s costs(a)

Notes (a) These are indicative cost proportions only. The precise allocation of costs for the charging method will be undertaken in accordance with IPART’s Draft Cost Allocation Guidelines.

Early stages of competition

Competition in the urban water industry is relatively new in Australia. The WIC Act is Australia’s first third-party access regime and licensing system for the urban water industry.

There are currently two bulk water suppliers in Sydney: the Sydney Catchment Authority (SCA)2 and Sydney Desalination Plant Pty Limited (SDP). SDP has both a Network Operator and Retail

2 The SCA provides raw water from its dams, which is then treated through a water filtration plant. A small

amount of raw water is provided directly for industrial use.


Supplier licence for drinking water under the WIC Act. SDP has the ability to sell water to customers that use over 15 ML a year through its Retail Supplier licence.

A number of other private sector providers have Network Operator and Retail Supplier licences for non-drinking water supply and wastewater services. Currently, Sydney Water is the sole provider of retail services for drinking water across its area of operations.

The WIC Act allows for greater participation by the private sector in Sydney’s water industry. However, the extent of competition, and when this competition may emerge, is still unclear. State-owned monopolies have traditionally provided water and wastewater services in Sydney. Sydney Water has not yet received any proposals seeking access to its water network infrastructure.

It is also worth defining some of the relevant bounds of competition in Sydney’s water industry. Drinking water can be considered a generic product when provided through Sydney Water’s water network infrastructure. Sydney Water’s Operating Licence 2010 to 2015 requires it to manage drinking water quality to the satisfaction of NSW Health in accordance with the Australian Drinking Water Guidelines (unless NSW Health specifies otherwise).

This means that competition using Sydney Water’s water transport network does not extend to new retailers offering differing levels of water quality to customers. Instead, the quality of water provided by retailers to customers is determined by water quality standards covering all customers. Should retailers seek to offer different water quality standards, then this would occur through separate transport networks (eg recycled water transport networks).

Equally, water network system standards are already set in Sydney Water’s Operating Licence. Sydney Water does not intend to offer different water network system standards to individual retailers.

1.2 Sydney Water’s water access undertaking

Sydney Water has prepared a voluntary water access undertaking for approval by IPART under section 38 of the WIC Act. The undertaking covers the provision and pricing of services provided by the water transport network, and is the first voluntary undertaking prepared by a government-owned water utility in Australia.

The undertaking has three main elements, namely:

1. provisions covering the negotiation process, dispute resolution and confidentiality arrangements for all services covered by the undertaking

2. standard terms and conditions for the water transport service, and

3. the charging method for the water transport service.

For reference, a diagram of the structure of the undertaking is provided in Attachment A.


Services provided

The undertaking covers the provision of water transport, interconnection and off-take services. These services are described in Box 1.1 below.

Box 1.1 Water transport, interconnection and off-take services

Water transport service: the transport of treated water from existing interconnection points on the water supply transport network and the water filtration plants to customers.

Interconnection service: the right to:

(a) connect the applicant’s interconnection infrastructure to the water supply transport network at the

interconnection point located downstream of a water filtration plant, and

(b) use the interconnection point to inject treated water into the water supply transport network.

Off-take service: the right to connect the applicant’s off-take infrastructure to a point on the water supply

transport network to extract a volume of treated water.

The undertaking provides for negotiation and arbitration by IPART (if necessary), for all three services. It also contains a charging method and detailed terms and conditions terms for the water transport service (schedules 2 and 3 of the undertaking, respectively).

Sydney Water does not consider it practical to include detailed terms and conditions and charging methods for the provision of interconnection and off-take services in this initial undertaking. This is because Sydney Water cannot reasonably anticipate the location or capacity of new interconnection or off-take points. In these circumstances, Sydney Water’s proposed undertaking provides for good faith negotiations and dispute resolution mechanisms for interconnection and/or off-take services. If a firm proposal is submitted to Sydney Water for a new interconnection and/or off-take point, Sydney Water would at that stage be in a position to negotiate suitable terms and conditions.

Term of the undertaking

The proposed term of the undertaking is from the date of IPART approval until 30 June 2016, when the next price determination is anticipated to expire. The expiry date can be confirmed once IPART releases its 2012 price determination.

Sydney Water does not consider it practical to extend the term of the undertaking beyond June 2016. This is the first undertaking lodged by a water utility in Australia, and it is likely that the undertaking could be reviewed and updated in light of experience gained during the initial term. Moreover, there are strong links between the charging method for the water transport service and the water prices determined by IPART in its price determination. Changes to the form of price regulation (which may result from greater competition), the structure of water prices, and the pricing structures of bulk suppliers, could have significant implications for the charging method.

Water transport services

The water transport service is the core or standard service provided by Sydney Water, and involves the ‘end-to-end’ delivery of treated water from interconnection points to customers.3 The main infrastructure assets used to provide the service are water mains, reservoirs and pumping stations.

3 Sydney Water does not currently transport treated water to an off-take point, where another provider would

transport the water to customers.


Sydney Water’s Operating Licence specifies the performance standards for its water networks.4 The performance standards cover water pressure, water continuity, and response times to water main breaks. Sydney Water does not consider it necessary to identify service standards beyond those in its Operating Licence in this undertaking. If an applicant requires different service standards for its customers, then these can be negotiated on a case by case basis. However, given the realities of operating and maintaining a water supply network, Sydney Water is unlikely to be able to offer tailored service standards to individual applicants.

Sydney Water already has agreements in place with the SCA, SDP and the operators of the privately owned water filtration plants (WFPs) covering the injection of treated water into the networks. Therefore, it is not necessary for the undertaking to include terms and conditions on the operation of these interconnection points. Should an applicant seek to establish new interconnection or off-take points, Sydney Water would negotiate terms and conditions based on a firm proposal.

Transporting treated water from interconnection points to customers involves a variety of activities in addition to its movement and maintenance of the network, including:

• informing customers of planned or unplanned service disruptions, including a 24 hour leaks and faults telephone service

• replacement of customer water meters

• backflow prevention, and

• investigating water theft.

For this initial undertaking, Sydney Water proposes to undertake these activities in accordance with its existing Customer Contract, unless specifically requested not to by an applicant. Should an applicant seek to establish such services directly with its customers (for example, in the case of large water users), then suitable arrangements can be negotiated on a case by case basis.

Charging method for the water transport service

Sydney Water has developed a charging method for the water transport service consistent with the charging principles contained in section 41 of the WIC Act. There are a number of factors that need to be recognised and incorporated into the charging method, which include:

1. current water prices include an allowance to fund (or partly fund) the provision of various ‘water security projects’, including some recycling projects and Sydney Water’s water efficiency program

2. under postage stamp water prices, customers served in low cost areas contribute to serving customers in high cost areas, and

3. Sydney Water bears virtually all volume risk on water sales. In particular, Sydney Water makes large fixed payments to the SCA, SDP and the privately owned WFP operators.

To encourage effective competition in bulk water and retail markets, the charging method:

1. includes the IPART-approved costs of water security projects

2. has a fixed and variable component, consistent with the structure of postage stamp water prices, and

3. includes an annual ‘volume adjustment’, based on the difference between forecast and actual water use.

4 Sydney Water’s Operating Licence 2010-2015 also contains asset management obligations. For example,

Sydney Water is required to demonstrate that it has robust, transparent and consistent processes, practices

and programs to ensure sustainable delivery of service levels and regulatory requirements, based on sound

risk management.


In applying these principles, a further issue to be addressed is access to services provided by the nine WFPs. Four of the WFPs are privately owned, which allows new entrants to negotiate directly with the private operators.

The privately owned Prospect WFP treats about 80% of the SCA’s raw water. Given its economies of scale, the cost per kL of treating water through Prospect WFP is less than the other eight WFPs. Under postage stamp pricing, Sydney Water obtains additional revenues from customers served by Prospect WFP to partly cover the cost of the other eight WFPs. This situation allows for the possibility of ‘cherry picking’, where an applicant seeks to exploit the difference between Prospect WFP’s specific costs and postage stamp water prices; effectively by negotiating directly with the Prospect WFP operator for the provision of treated water.

In order to maintain postage stamp pricing, Sydney Water has identified three options by which an applicant can seek to compete in bulk water and retail markets. In each case the charging method is applied to promote ‘competition on its merits’. The three options are:

Option A: The applicant purchases both water transport services and water treatment services from Sydney Water. The provision of water treatment services would be subject to a separate agreement to be negotiated with Sydney Water. By selling water treatment services directly to the applicant, Sydney Water can set the charges for the service consistent with the current postage stamp prices.

Option B: The applicant purchases water transport services from Sydney Water and intends to negotiate directly with the privately owned WFP operator(s) for water treatment services. In this case, Sydney Water proposes that the charging method includes any ‘unavoidable’ costs (including revenues recovered to partly fund high cost WFPs) that Sydney Water would still incur if it ceased purchasing treated water from the privately owned WFP operator(s).

Option C: The applicant purchases water transport services from Sydney Water and does not require water treatment services for any of its bulk supply (for example, desalinated water supply). In this case, Sydney Water does not propose that any of the charges payable by the applicant will include consideration of water treatment services.

Sydney Water considers that this initial undertaking need not precisely define the charges that would occur under all circumstances. Instead, Sydney Water proposes that IPART endorse the charging method. The application of the charging method can then be negotiated with applicants on a case by case basis. Should the parties not be able to agree on the charges to apply, either party could refer the matter to IPART for arbitration. However, by endorsing a charging method, the scope for dispute between the parties should be narrowed.

1.3 Structure of the following chapters

The structure of the following chapters of this supporting submission is as follows:

Chapter 2 describes the undertaking and the non-price terms of the standard access agreement for the water transport service.

Chapter 3 describes and explains the charging method for the water transport service.


2 Access undertaking and agreement

This chapter describes and explains the terms of the undertaking and standard access agreement. Section 2.1 describes the undertaking and Section 2.2 the standard access agreement.

2.1 Access undertaking

The access undertaking establishes the right for applicants to negotiate and obtain access to Sydney Water’s water transport network on fair and equitable terms and conditions. The terms of the undertaking establish the basis on which Sydney Water will negotiate in good faith.

Clause 1 – Background

This section provides the context for negotiations between Sydney Water and applicants. It notes Sydney Water’s status as a State-owned corporation, and the services it delivers, namely water, wastewater and some stormwater services.

This section also sets out the objectives of the undertaking, including the provision of a framework for access to water network transport services consistent with the WIC Act. The undertaking seeks to balance:

• the legitimate interests of Sydney Water to recover all efficient costs associated with providing access, including a reasonable return on the assets employed commensurate with its commercial risk

• the public benefits arising or likely to arise from competition, and

• the interests of applicants seeking access to the water supply network.

This section also explains the objective of providing an efficient, effective and binding dispute resolution process.

Key points

•••• The access undertaking establishes the right for applicants to obtain access to certain services provided by Sydney Water’s water network infrastructure. It clearly defines the negotiation and dispute resolution processes, and confidentiality provisions.

•••• The core principles underlying the undertaking are that Sydney Water will provide non-discriminatory access and will negotiate with applicants in good faith.

•••• The undertaking covers transport, interconnection and off-take services, with detailed terms and conditions and a charging method for transport services, contained in separate schedules.

•••• Should an applicant seek access to interconnection or off-take services during the term of the undertaking, a separate agreement for the provision of these services would be negotiated with Sydney Water.

•••• The undertaking does not cover water treatment services as this is specifically excluded by the provisions of Part 3 of the WIC Act.

•••• The proposed standard access agreement is attached as a schedule to the undertaking.

•••• The standard access agreement includes provisions specific to the transport service in addition to normal commercial and legal requirements.


Clause 2 – Term and variation

Sydney Water is proposing that the term of the access undertaking be from the date of IPART approval until 30 June 2016 (see Chapter 1).

Given that competition in bulk water and retail markets is relatively new, Sydney Water has yet to receive any proposals from applicants to access the water transport network. As such, Sydney Water seeks the ability to vary the undertaking, with IPART approval, should circumstances change to the extent that the undertaking is no longer commercially viable. This clause therefore strikes an appropriate balance given the uncertainties over the extent and timing of competition.

Clause 3 – Scope

The undertaking applies to the negotiation of transport, interconnection, and off-take services. The undertaking will not apply to water treatment services or to the supply of bulk water.

Sydney Water understands that IPART has no jurisdiction to approve an undertaking that seeks to regulate the provision of water treatment services under Part 3 of the WIC Act. In particular, Part 3 specifically excludes infrastructure services for the filtering, treating or processing of water. Therefore, IPART has no jurisdiction under Part 3 to approve an undertaking which seeks to include and regulate treatment services, or to arbitrate disputes in relation to such services.

However, access to water treatment services is likely to be a critical component of any applicant’s ability to enter and compete in bulk water and retail markets. This issue is discussed further in Chapter 3, which covers the proposed charging method.

Clause 4 – Price and non-price terms

Given the early stages of competition in the water industry, it is important that the undertaking defines the most likely scenarios in the emerging market for the term of the undertaking. In particular, it is assumed that an applicant will:

• obtain sufficient quantities of water otherwise than from a public water utility

• supply customers who are or will be connected to Sydney Water’s network, and

• acquire water treatment services from Sydney Water (if required).

These assumptions define the detail contained in the undertaking. In particular, detailed terms and conditions for new interconnection and off-take points have not been included as they are unlikely to be required over the next four years, being the duration of the proposed undertaking. That said, the undertaking does provide applicants with the right to negotiate access to these services, including the right to arbitration.

There are also strong links between the proposed charging method and access to water treatment services, even though these services are excluded from the undertaking. As such, the detailed terms and conditions apply to circumstances where the applicant also purchases water treatment services from Sydney Water. If the applicant chooses to negotiate directly with one of the privately owned WFP operators, then it will be necessary to negotiate terms and conditions on a case by case basis at that point.

This section of the undertaking also includes clauses which ensure that access will be provided on a non-discriminatory basis and that Sydney Water will not hinder or prevent access in any respect.

Finally, the section outlines ring-fencing arrangements for information provided during the negotiation and term of an access agreement.

Clause 5 – Negotiating for access

This section of the undertaking establishes a framework for applicants to seek to negotiate access with Sydney Water.

Sydney Water must negotiate in good faith in accordance with the framework set out in the undertaking.


The framework proposed outlines how Sydney Water will:

• deal with preliminary inquiries

• assess access applications

• negotiate an access agreement, and

• execute the standard access agreement.

Clause 6 – Dispute resolution (including arbitration)

This clause sets out the dispute resolution procedures to be followed should a dispute arise in relation to:

• the negotiation of an access agreement

• the negotiation of services additional to an agreement, or

• any decision by Sydney Water to unilaterally vary the prices at which services are provided.

Under the framework, either party may give a written ‘dispute notice’ specifying the dispute to be dealt with in a manner set out in Clause 6 of the undertaking.

The framework also allows for negotiation by senior representatives of each party and mediation, in addition to a detailed arbitration process. IPART is able to choose whether to conduct the arbitration, or not. If IPART is the arbitrator, the arbitration will be conducted in accordance with the procedures, and IPART will have the powers, set out in Division 7 of Part 4A of the Independent Pricing and Regulatory Tribunal Act 1992. If IPART does not wish to arbitrate the dispute, the parties can either agree the appointment of a private arbitrator or request the President of the NSW Chapter of the Institute of Arbitrators and Mediators Australia to appoint an arbitrator.

Clauses 7 to 9 – Confidentiality, contact details and definitions

These clauses contain the standard commercial requirements relating to maintaining the confidentiality of information, providing contact details for service and defining key terms in the undertaking.

Schedules to the undertaking

The undertaking includes five schedules containing administrative information, the standard access agreement and detailed charging method (see Box 2.1). The standard access agreement is described in section 2.2 below and the charging method is explained in Chapter 3.

Box 2.1 Schedules to the access undertaking

Schedule 1 – Water network services

This schedule defines the services to be provided (transport, off-take, interconnection). As the terms and

conditions for access to off-take and interconnection services have not been developed, schedule 1 also

includes preliminary negotiation requirements for access to those services.

Schedule 2 – Charging method

This schedule outlines the access charging principles in terms of which Sydney Water will calculate access charges. The principles include:

a) generating expected revenue for the service that is at least sufficient to meet the efficient costs of providing access to the service, and including a return on investment commensurate with the regulatory and commercial risks involved

b) allowing multi-part pricing and price discrimination when it aids efficiency

c) not allowing a vertically integrated service provider to set terms and conditions that discriminate in favour of its downstream operations, except to the extent to which the cost of providing access to other operators is higher, and

d) providing incentives to reduce costs or otherwise improve productivity.

The schedule also establishes three options by which the access applicant may seek to purchase water


treatment services and sets out the charging method for each option.

Schedule 3 – Standard access agreement

This schedule contains the standard access agreement to be negotiated between the parties, setting out the

terms and conditions for access to Sydney Water’s infrastructure and water network transport services.

Schedule 4 – Proforma statement in relation to the negotiating process

This schedule contains a proforma statement to be signed by Sydney Water and the access applicant. The proposed statement affirms that all negotiations for access to the water network services will be conducted in accordance with the negotiation procedure outlined in Section 6 of the undertaking and which will evidence to IPART that the negotiations were undertaken in good faith.

Schedule 5 – Access application information

This schedule sets out the information the access applicant should provide to Sydney Water when applying for access, including applicant details, access request details, prudential requirements and any ring-fenced information relevant to the services being sought.

Schedule 6 – Systems Operations and Planning Information

This schedule sets out the systems operation and planning information that Sydney Water must provide as part of a Preliminary Assessment of the access application.

2.2 The standard access agreement

The standard access agreement contains the detailed terms and conditions for the most likely applicants, i.e applicants requiring the water transport service. It is intended that, following negotiation, this document will become a legally binding agreement between Sydney Water and an applicant in relation to the provision of water transport services.

Clause 1 – Definitions

This section defines all the key terms of the agreement, and requires each party to perform its obligations under the agreement at its own cost, unless expressly provided otherwise.

Clause 2 – Commencement and term

In line with the term of the undertaking, it is proposed that the agreement will expire on 30 June 2016.

To provide greater certainty to applicants over the long-term provision of the water transport service, if a new agreement is not reached before the expiry date, Sydney Water agrees to continue to provide the service under the existing terms and conditions (with CPI indexation of access charges) until a new agreement reached.

Clause 3 – Conditions precedent

An access seeker must satisfy a number of pre-conditions before Sydney Water can enter into a legally binding agreement for the supply of the water transport service. The proposed pre-conditions are that the applicant has obtained:

• all identified approvals (for example, a retail supplier’s licence), and

• relevant management plans and insurances.

The conditions precedent are reasonable, as they require the approvals, plans and insurances that any prudent provider of water services would have in place. The applicant is also required to pay Sydney Water all reasonable costs5 in giving approvals, consents, or permissions required to satisfy a condition precedent.

5 Reasonable costs are defined as incremental or additional costs incurred, or to be incurred, by Sydney Water,

acting reasonably that are attributable to the access holder, including any directly attributable capital and

operating costs.


Sydney Water undertakes not to unreasonably withhold or delay the fulfilment of conditions precedent. If the access seeker also requires water treatment services, Sydney Water will not commence provision of services under the agreement until the access seeker enters into a separate agreement for the provision of water treatment services.

This section of the agreement also includes the terms on which the agreement can be terminated in the event that the conditions precedents are not met.

Clause 4 – Forecasts

It is important that Sydney Water receives reasonable forecasts of the anticipated water use of an access holder’s customers on a quarterly basis. These forecasts are necessary for financial and operational planning. They will also assist for audit purposes. Sydney Water may also require specific performance data (eg water use over the course of a day) from large water users so that it can operate the network in a safe and efficient manner.

This section addresses the provision of such forecasts to Sydney Water by the access holder, including forecasts of the number of customers and the volume of treated water. It also outlines broad timing requirements for the provision of forecasts and describes the purposes for which the forecasts are required. It further requires the parties to comply with any additional forecasting (and auditing) requirements outlined in the Coordination Protocol at Schedule 3 of the agreement.

In Sydney Water’s view the provision of the forecasts is not an onerous requirement as access holders should already be preparing these sorts of forecasts for their internal financial and business planning purposes.

Clause 5 – Water network services

As referred to earlier in this submission, the detailed terms and conditions of access in the agreement are limited to the provision of the water transport service. The agreement does not propose to cover access to other services within the scope of the access undertaking, for example, off-take services or interconnection services (for reasons explained in Chapter 1).

Clause 6 – Water transport service

In line with Section 5 above, this clause incorporates the provisions upon which Sydney Water will provide the water transport service. These include provisions to allow Sydney Water to provide routine treatment (for example, chlorination and fluoridation) of all water within the network so that it meets the specified water quality standards.

This clause also stipulates that it is the responsibility of the access holder to read its customers’ water meters, including the meter reading number. In addition, clause 6 provides Sydney Water with meter reading and audit rights in relation to access holder customers, and requires the parties to comply with metering requirements set out in the Coordination Protocol.

Clause 7 – Customer transfers

Section 7 requires the access holder to provide water supply and billing services to its customers, from the date of transfer.

For services currently provided by Sydney Water (other than water transport services) that will not be transferred to a new access holder (eg wastewater services), this section provides that the Sydney Water Customer Contract still applies.

Clause 8 – Water treatment service

As detailed in Chapter 3, a key element of promoting competition in bulk water and retail markets is access to water treatment services. This clause acknowledges that the access holder will have in place a separate agreement for the provision of water treatment services. Executing a separate agreement is a condition precedent to Sydney Water’s provision of the water transport service to the Access Holder under the standard access agreement. An access seeker may negotiate other arrangements with Sydney Water if it has obtained treated water from other sources.


Clauses 9 & 10 – Charges, billing and payment

These clauses contain standard commercial requirements in charging (including GST), billing and payment. The clauses also provide billing dispute procedures.

Clause 11 – Community service obligations

Notwithstanding a customer’s choice of retailer, the access agreement provides that community service obligations (CSOs) must continue to be available to all customers, when applicable. Clause 11 stipulates that any CSO funding that Sydney Water receives in relation to an access holder’s customers must be passed through to the access holder to be passed on, in turn, to its customers.

This section also allows Sydney Water to deliver the benefits of CSOs to access holder customers and allows Sydney Water to continue to provide broader social programs and demand management initiatives.

Clause 12 – General obligations

Clause 12 provides that Sydney Water:

• must continue to comply with its obligations under the Sydney Water Act 1994 and the Sydney Water Operating Licence, and

• must comply with any obligations imposed under Section 55 of the WIC Act, if Sydney Water is declared to be a ‘retailer of last resort’.

It is also stipulated that the access holder must comply with all laws and approvals with respect to the provision of water supply services to its customers and must comply with all reasonable directions from Sydney Water in relation to the access holder’s actions which may impact on Sydney Water’s network, or on the management of incidents and emergency events.

Clause 13 – Maintenance, emergency events and incidents

Clause 13 ensures Sydney Water retains the right to maintain the integrity of the broader water supply system, while ensuring it keeps all parties informed through the Coordination Protocol.

These rights include the maintenance and operational requirements of the parties, including planned and unplanned maintenance, handling of incidents and emergency events, notification requirements and rectification costs.

Under the terms of the proposed access agreement, Sydney Water will continue to be responsible for managing the water transport network, and will continue to provide ‘network services’ to all customers in its area of operations, regardless of retail supplier arrangements. This is because Sydney Water is the operator of the network and continues to be the distributor, meaning that it is well placed to coordinate and manage responses to emergencies and incidents. The demarcation between the role of the distributor and retailer will be set out in the Coordination Protocol.

Clauses 14 to 17 – Confidentiality, acknowledgements indemnity, liability & insurance

These clauses cover Sydney Water’s proposed confidentiality, indemnity and liability and insurance arrangements and includes standard authorisations and warranties to be provided by the access holder.

It should be noted that the access holder would be required to have appropriate insurances in place under WIC Act licencing arrangements. In the event that Sydney Water requires different or additional insurance to be provided, this would be due to specific circumstances not contemplated under the licence requirements.


Clause 18 – Security

The development of competition in retail markets could result in a substantial change in Sydney Water’s credit risk. Sydney Water’s revenue could change from a large number of small payments from customers to large payments from a small number of access holders. In these circumstances, Sydney Water’s revenue risk increases due to the reduction in the number and diversity of entities from which it receives income.

To offset this increase in risk, Sydney Water proposes that access holders maintain an unconditional bank guarantee, or letter of credit. The amount of the bank guarantee or letter of credit would be set equal to the average of expected charges for a period to be negotiated with the access holder and will be held by Sydney Water for the duration of the agreement. The amount of the security will be reviewed by Sydney Water every 12 months.

Clause 19 – Suspension, disconnection and termination

Sydney Water retains the right to suspend all or part of the agreement in circumstances of default and both parties retain the right to terminate all or part of the agreement under various circumstances. Section 19 outlines the requirements on the parties in relation to suspension, disconnection and termination.

Clause 20 – Change of control / assignment

Clause 20 incorporates the conditions that will apply in circumstances where there is a change of ownership or control of the access holder.

It should be noted that in the event of significant changes of ownership and control of the access holder, the Minister and IPART have vested authority to amend or revoke WIC Act licences.

Clauses 21 & 22 – Material change and force majeure

These clauses provide standard commercial terms regarding material changes in circumstances and force majeure events occurring during the term of the undertaking.

Clause 23 – Dispute resolution

This section provides generic terms regarding dispute resolution. The framework for dispute resolution under the agreement includes an option for mediation, alternatively the parties may approach the court for relief.

Clause 24 – General

These clauses cover standard commercial arrangements including communication of notices, governing law and jurisdiction, amendments, waivers, further acts and documents, consents, counterparts, no representation or reliance, expenses, stamp duties, and general terms regarding the status of the agreement and the relationship of the parties.

Schedules to the standard access agreement

The standard access agreement also includes four schedules covering the agreement details, the access holder total share methodology, the Coordination Protocol, and charges for the service (see Box 2.2 below).


Box 2.2 Schedules to the standard access agreement

Schedule 1 Agreement details

Standard agreement details to be completed at the time of an agreement being negotiated between the

parties.

Schedule 2 Access holder total share methodology

This schedule contains the method for determining the access holder’s total share of the water market.

Schedule 3 Coordination Protocol

This schedule will incorporate a Coordination Protocol to be developed between the parties at the time of

negotiating an access agreement. The Protocol may include, but will not be limited to, arrangements and

procedures which codify information provision, communications, planned and unplanned maintenance,

emergency event management, customer inquiry management and payment of monies owing between the

parties.

Schedule 4 Charges

This schedule will contain the access charges payable each year.


3 Charging method

Sydney Water has developed a charging method6 for the water transport service consistent with the charging principles contained in section 41 of the WIC Act.

Sydney’s bulk water and retail markets do not have the same codified rules which apply to other network industries, such as gas and electricity. The charging method reflects the current policy environment and key considerations include:

• a number of ‘water security projects’, including recycling projects and water efficiency programs which are currently funded through existing water prices

6 For clarity, ‘charges’ refers to the charges levied for the provision of the water transport service, while ‘prices’

refer to the prices set by IPART which are paid by households and businesses for water services. The WIC Act

refers to ‘pricing principles’, which are referred to as ‘charging principles’ in this submission.

Key points

•••• Sydney Water has developed a charging method for the water transport service designed to encourage effective competition in bulk water and retail markets, while protecting Sydney Water’s legitimate business interests.

•••• Sydney Water is seeking IPART’s endorsement of the charging method, leaving scope for individual negotiations.

•••• The core principles of the charging method include:

o all customers, regardless of their choice of retailer, contributing to water security projects currently funded through postage stamp water prices, and

o customers in low cost areas continuing to contribute to the provision of services to customers in high cost areas.

•••• In applying these principles, a further important consideration is the provision of water treatment services by the nine WFPs. Four of the WFPs are privately owned, which allows new entrants to negotiate directly with the private operators for the provision of these services.

•••• By negotiating with the private operators, new entrants could engage in ‘cherry picking’, paying (lower) location specific charges while obtaining postage stamp water price revenues.

•••• To address the different ownership arrangements, three options are identified that allow the applicant to acquire:

o both water transport services and water treatment services from Sydney Water

o water transport services only but intends to negotiate directly with the privately owned WFP operator(s) for treatment services, and

o water transport services only, without needing water treatment services.

•••• Sydney Water also proposes to continue to bear the current volume risk over water sales through an annual adjustment mechanism.

•••• The charging method requires sufficient flexibility to adapt to changing circumstances. Changes to industry structure, the level and structure of water prices, or commitments under the Metropolitan Water Plan, may require changes to the charging method.


• assumed purchases of water or availability payments by all retailers to SDP, as allowed for under the WIC Act

• postage stamp pricing, whereby customers served in low cost areas contribute to customers served in high cost areas

• the majority of volume risk on water sales is currently borne by Sydney Water

• differing ownership arrangements of the WFPs, where five are owned by Sydney Water and four are privately owned, and

• the charging arrangements between Sydney Water and the SCA. Sydney Water currently makes all fixed payments to the SCA.

To promote competition on its merits, the charging method needs to transparently address each of the matters identified above.

The remainder of this chapter is structured as follows:

• Section 3.1 contains the proposed scope of the undertaking for charging purposes

• Section 3.2 sets out the charging principles contained in section 41 of the WIC Act which IPART must consider when approving the charging method

• Section 3.3 outlines the current industry arrangements, including the full suite of services funded through postage stamp water prices

• Based on an understanding of current industry arrangements, Section 3.4 describes and justifies the charging method, including indicative worked examples, and

• Finally, section 3.5 assesses the charging method against the charging principles contained in the WIC Act.

3.1 Scope of the undertaking for charging purposes

Sydney Water considers that IPART should endorse a charging method for this initial undertaking, which can be applied in negotiation with applicants on a case by case basis. Should the parties not agree on the charges to apply, either party could refer the matter to IPART for arbitration.

Sydney Water considers that this approach has the benefit of defining the issues and costs to be included in the charging method, while still leaving scope for negotiation depending on the applicant’s particular circumstances, the prevailing industry arrangements and IPART’s price determination.

3.2 Charging principles

Section 41 of the WIC Act specifies the charging principles that IPART must consider when deciding whether or not to approve an access undertaking. These are that the charges should:

(a) generate expected revenue for the service that is at least sufficient to meet the efficient costs of providing access to the service, and include a return on investment commensurate with the regulatory and commercial risks involved

(b) allow multi-part pricing and price discrimination when it aids efficiency

(c) not allow a vertically integrated service provider to set terms and conditions that discriminate in favour of its downstream operations, except to the extent to which the cost of providing access to other operators is higher, and

(d) provide incentives to reduce costs or otherwise improve productivity.

In applying these principles, section 41(3) provides that: ‘These principles must be implemented in a manner that is consistent with any relevant pricing determinations for the supply of water, including (where applicable) the maintenance of “postage stamp pricing” (that is, a system of pricing in which the same kinds of customers within the same area of operations are charged the same price for the same service).’


The charging principles at (a) to (d) above are the same as those contained in Part IIIA of the Competition and Consumer Act 2010 (Cwth) (CCA). The Australian Competition and Consumer Commission (ACCC) must apply these charging principles when undertaking any arbitration under Part IIIA.

Sydney Water was a party to the first arbitration resulting from a declaration under Part IIIA. The declaration applied to Sydney Water’s Bondi, Malabar and North Head wastewater networks. Sydney Water’s proposed charging method for its wastewater networks was endorsed by the ACCC (see section 3.5).

3.3 Current industry arrangements

Sydney Water has developed its charging method so as to align closely with the prevailing industry arrangements, including the current IPART price determination. This section first describes the current industry arrangements, including the 2010 Metropolitan Water Plan, which provides the overarching framework for the supply and demand for water in Sydney.

The section then outlines the range of services funded through water prices, explains the current postage stamp water pricing, details how Sydney Water purchases raw water and water treatment services from the SCA and the privately owned WFPs, respectively.

The Metropolitan Water Plan

Sydney Water’s provision of some products and services, especially in relation to balancing the supply and demand for water, is determined by the NSW Government’s Metropolitan Water Plan. The majority of Sydney Water’s costs from commitments under the plan are recovered through the water prices set by IPART.

The 2010 Metropolitan Water Plan adopts a portfolio approach to balancing water supply and demand, using a number of diverse elements. These include augmentation of the Warragamba and Nepean dam storages, desalination, increased recycling and water efficiency programs.

Sydney Water is one of several organisations working together to implement the plan. Projects to balance water supply and demand have represented a large proportion of Sydney Water’s capital expenditure program, particularly investments in desalination, recycling and water efficiency.

Services funded from current water prices

Water prices currently fund the traditional elements of the water supply chain, plus other projects and programs, which Sydney Water provides to help maintain the water supply/demand balance (as determined by the Metropolitan Water Plan). The traditional water supply chain is illustrated in Figure 3.1and described briefly below. The additional projects and programs funded through water prices are also described.


WATER TRANSPORT

DAM WATER

20% DESALINATION

16%

Figure 3.1 Illustration of the water supply chain (a) (b)

Notes: (a) These are indicative cost proportions only. (b) The retail proportion of costs includes various

ancillary and miscellaneous costs outside contestable retail services.

Bulk water, including the water filtration plants

The water supply chain starts at the bulk water level. The current suppliers of bulk water are the SCA (rainfall supplied dams) and SDP (desalinated water).

There are seven major dams that store Sydney's water. From the dams, the water passes to one of nine WFPs around the Sydney Water network. 7 The WFPs filter and treat the water by removing identified contaminants, which are set out in each plant's performance targets.

Five of the nine WFPs are owned and operated by Sydney Water, with the remaining four WFPs being privately owned. The privately owned WFPs are situated on the Prospect, Illawarra, Macarthur and Woronora water delivery systems, and Sydney Water has long-term contracts in place with each private operator. Approximately 80% of the SCA’s raw water is treated through the Prospect WFP.

7 A limited amount of raw (untreated) water is supplied directly for industrial use.

WATER TREATMENT

A typical annual water bill

comprises:

12% 4%

48%

RETAIL


The desalination plant uses reverse osmosis technology to extract fresh water from seawater. After screening and pre-treatment to remove any solids and sediment, the water is then pushed through membranes under high pressure. Fresh water passes through the membranes and the remaining seawater concentrate is returned to the ocean. The water is then treated to meet Australian Drinking Water Guidelines before being transferred to a storage tank ready for supply to customers.

Based on current industry costs, bulk supply (including treatment) accounts for almost half of the total water supply costs (see section 3.4).

Water transport network

Sydney Water transports drinking water to customers through a network comprising 265 service reservoirs, 171 pumping stations and nearly 21,000 kilometres of water mains. The performance requirements of the water transport network are set out in Sydney Water’s Operating Licence 2010-2015. Licence conditions cover water quality, water pressure, continuity and response times to water main breaks.

Transporting drinking water from interconnection points to customers involves a variety of ancillary activities in addition to the movement of the water and the maintenance of the network. These activities include:

• informing customers of planned or unplanned service disruptions, including a 24 hour leaks and faults telephone service

• replacement of customer water meters

• backflow prevention, and

• investigating water theft.

The cost of the water transport network, as well as maintaining the network, also accounts for almost half of the total water supply costs.

Retail

Retail services include responding to customer billing inquiries, reading water meters and generating bills.

The current estimated cost of providing retail services is approximately 4% of total water supply costs. However, this proportion of costs includes various ancillary and miscellaneous costs (eg provision of water supply system or service location diagrams), outside contestable retail services. As such, the contestable component of costs is less than 4%.

Water security projects

In addition to the traditional elements of water supply, a number of projects support the supply/demand balance of water and are, therefore, funded through water prices. These include some recycling projects, proposed recycled water ‘avoided costs’ and water efficiency programs.

Recycled water schemes

Two major recycling schemes funded through water prices are the St Marys and Rosehill recycled water schemes. The St Marys scheme involves highly treated recycled water for environmental flows into the Hawkesbury-Nepean River.

The Rosehill recycled water scheme provides recycled water for irrigation, fire fighting, cooling towers, boilers and some manufacturing processes.

Sydney Water was directed by the NSW Government under section 20P of the State Owned Corporations Act 1989 to deliver these two recycling projects. In addition, both schemes were subject to a Ministerial direction to IPART under Section 16A of the Independent Pricing and


Regulatory Tribunal Act 1992. This requires IPART to include Sydney Water’s efficient costs of complying with the government directions when setting prices.

Sydney Water has sought funding through water prices of about $8 million ($2011-12) a year for each of the two schemes.

Recycled water avoided costs at Rouse Hill

IPART's recycled water framework makes provision for the ‘avoided’ costs of recycled water schemes to be offset against recycled water developer charges and recovered through water and wastewater prices. 8

In August 2011, Sydney Water implemented a revised development servicing plan (DSP) and developer charge for the Rouse Hill recycled water system. In calculating the developer charge, Sydney Water deducted the present value of drinking water avoided costs of $1.9 million ($2010-11). Should IPART accept that these are avoided costs, they will be recovered through postage stamp water prices in the 2012 price determination.

Water efficiency programs

Sydney Water is required under its Operating Licence to undertake and promote water efficiency programs. Sydney Water’s water efficiency initiatives cover residential, business and school programs.

The costs of Sydney Water’s water efficiency programs are also funded through water prices. Sydney Water has sought funding of approximately $5 million a year over the four years ending 30 June 2016 to provide its water efficiency programs.

Postage stamp water prices

IPART currently sets annual water prices on a uniform or postage stamp basis. This means properties are charged the same water prices regardless of their location.

The two main postage stamp water prices are the service (fixed) price and the usage price. The service price is based on the number of ‘equivalent’ meters connected to a property. An equivalent meter expresses the size and number of water meters connected to a property relative to the standard 20mm water meter connected to most residential houses and businesses.9 Service revenues currently account for approximately 20% of Sydney Water’s total water revenues.

Usage prices are currently set as one price per kL of water consumed (Tier 1 only). For Sydney Water, IPART sets the water usage price by reference to the long-run marginal cost (LRMC) of water. Based on the information currently available, Sydney Water considers that $2.35 per kL (in $2011-12) represents the most reasonable estimate of the LRMC of water in Sydney. Revenue from the usage price generates some 80% of Sydney Water’s total water revenues.

Postage stamp pricing has implications for the charging method. In particular, customers in low cost areas contribute to the provision of services to customers in high cost areas.

Postage stamp pricing can lead to ‘cherry picking’, where a new entrant seeks to pay location-specific access charges and then targets those customers where revenue exceeds location specific costs. To address this issue, the structure of access charges needs to be consistent with the structure of water prices.

8 See IPART's Guidelines for the Calculation and Treatment of Avoided Costs and Deferred Costs of Recycled

Water.

9 Based on IPART’s formula, a 40mm connected water meter is equal to 4 equivalent (20mm) meters. Therefore,

a property connected by a 40mm water meter will pay four times the service charges paid by a house

connected by a standard 20mm water meter. The formula for converting a meter size to equivalent meters is:

meter size (mm)2/400. See IPART (2008) Review of prices for Sydney Water Corporation’s water, sewerage,

stormwater and other services.


Water filtration plants

As described earlier, dam water is treated through one of nine WFPs. Of these plants, Prospect WFP currently treats approximately 80% of all the water supplied by the SCA. Due to economies of scale, the cost per kL of treating water through the Prospect WFP is far lower than the other eight WFPs.

Through postage stamp pricing, customers served by Prospect WFP make a contribution to the cost of serving customers whose water is treated through the other eight WFPs. That is, Sydney Water obtains a contribution from customers served by Prospect WFP to partly cover the cost of treating water at the eight other plants.

To prevent cherry picking, the charging method must include the contribution made by households and businesses served by Prospect WFP to the costs of the smaller plants.

Sydney Water also has long-term contracts in place with each privately owned WFP operator and makes ‘availability’ payments in addition to volume-based payments to these operators. Should any of the privately owned WFPs provide services directly to other retailers, Sydney Water could be placed at a significant competitive disadvantage because Sydney Water would still be required to make all the availability payments under the current contracts.

Payments to the Sydney Catchment Authority

IPART sets the prices charged by the SCA. Currently, the SCA recovers all of its fixed charges from Sydney Water. Specifically, the SCA’s determination requires the SCA to obtain a monthly fixed payment from Sydney Water (currently approximately $7.2 million a month). Volume-based prices are also determined for Sydney Water and three councils.

In the future, the SCA may sell a proportion of its raw water to retailers other than Sydney Water. Should this occur, it would no longer be appropriate for Sydney Water to make all fixed payments to the SCA. Instead, effective competition will require all retailers purchasing water from the SCA to contribute to its fixed costs. The most practical means of sharing these fixed payments would be in proportion to the volume of water supplied to each water retailer.

Sydney Water has requested IPART to amend the SCA’s next price determination to require the SCA to recoup its fixed payments across all retailers in proportion to the volume of water sold to each retailer across Sydney Water’s area of operations. This change would facilitate more effective competition in bulk water markets. Sydney Water does not propose that IPART set fixed fees for the three councils.

Sydney Water’s charging method assumes IPART will adopt Sydney Water’s recommended change to the SCA’s price determination. In doing so, it will avoid the need for the charging method to address the issue of the SCA’s fixed payments. However, should IPART require Sydney Water to continue to make all fixed payments to the SCA, the charging method would need to include a proportion of the fixed costs across retailers that purchase raw water from the SCA.

Water retailer licence conditions – payments by retailers to SDP

The desalination plant is a key element in Sydney’s water security plan, and the plant is required to maximise water production when dam storage levels are below a prescribed threshold.

If Sydney Water was required to purchase all of SDP’s water (or make all availability payments), it would be placed at a significant competitive disadvantage in the same manner as described above in relation to the SCA availability payments.

Sydney Water’s charging method assumes that each retailer will be required to contribute to SDP’s costs as part of their respective retail licence conditions, as allowed for under the WIC Act. Sydney


Water notes that IPART has included a methodology for adjusting the prices charged by SDP to share costs if it acquires customers in addition to Sydney Water.10

3.4 Charging method

Sydney Water’s charging method is based on the principle that Sydney Water should recover those costs it would still incur if it ceased providing bulk supply and retail services to all customers. The structure of charges to recover these costs is then set in a manner consistent with postage stamp water prices. Finally, the charging method needs to take into account the ability of new entrants to negotiate directly with the privately owned WFP operators.

Sydney Water already has experience in setting fair and reasonable charges for access to its infrastructure networks. In particular, Sydney Water has an ACCC-endorsed charging method for access to its wastewater networks. There are many parallels between charging for the provision of services provided by water and wastewater networks.

Sydney Water’s charging method for wastewater networks is briefly described below, followed by a detailed description of the charging method for the water transport service and an indicative application of the charging method.

Wastewater networks charging method

Sydney Water’s Malabar, North Head and Bondi wastewater networks were previously declared under Part IIIA of the then Trade Practices Act 1974 (now the CCA). Under Part IIIA of the CCA, the ACCC has the power to arbitrate third-party access disputes. As noted earlier, the access charging principles contained in Part IIIA of the CCA mirror those contained in the WIC Act.

In November 2006, Services Sydney sought access to Sydney Water’s wastewater networks and sought ACCC arbitration in respect of the method for setting charges for access to the declared networks.11

Sydney Water proposed a ‘retail-minus’ approach to access charging. Under the retail-minus approach, Sydney Water subtracts the ‘avoidable’ cost of providing contestable services (wastewater treatment, disposal and retail services) from the final price paid by customers. The access charge therefore represents the ‘residual’ amount remaining once the costs of contestable services are subtracted from the revenue obtained from wastewater prices.

An illustration of the approach is provided in Figure 3.2 on the following page.

The approach promotes effective competition in contestable services by ensuring the margin between wastewater prices and the access charge is equal to the ‘fully distributed’ cost incurred by Sydney Water in providing contestable services.

In endorsing Sydney Water’s proposed approach, the ACCC stated that:

“The Commission considered that the only practical way to ensure that the difference between retail prices and access prices is equivalent to the avoidable costs of treatment, disposal and retailing is to estimate such avoidable costs and to subtract them from retail prices.”

12

10 See IPART (2011) Review of water prices for Sydney Desalination Plant Pty Limited, Final Report.

11 See ACCC (2007) access dispute between Services Sydney Pty Ltd and Sydney Water Corporation, Arbitration

report.

12 ACCC (2007), p. 34.


Figure 3.2 Illustrative approach of the ‘retail minus’ charging method

An important consideration in adopting the retail-minus approach was Sydney Water’s vertically integrated structure. Another important factor was that Sydney Water had not previously identified and individually costed all the elements of wastewater services (including subsidies across high and low cost wastewater networks).

The water transport service: Sydney Water’s proposed charging method

Sydney Water’s proposed charging method for the water transport service involves:

1. establishing the overall level of costs to be recouped through charges, assuming Sydney Water ceased providing any bulk water or retail services to customers

2. designing a structure of charges consistent with the structure of water prices, and

3. accounting for the different ways in which an applicant might obtain access to water treatment services from the privately owned WFPs.

This approach to access charging is broadly referred to as the ‘building blocks plus’ approach.13 An illustration of the approach is provided in Figure 3.3 on the following page.

13 See for example, ACCC (2002) Local Carriage Service, for pricing principles and indicative prices for a general

discussion of the different approaches to calculating access charges for local carriage services.

Monopoly services ‘Residual’ access

charge

Contestable services

Calculate avoidable costs

Final price


Figure 3.3 Illustrative example, proposed water supply network access charging method

For the water transport service, the building blocks plus approach is preferred to the retail-minus approach, even though both approaches will generate the same charges. The main benefit of the building blocks plus approach is that it transparently identifies the individual costs included in charges. Such transparency should facilitate efficient negotiations between Sydney Water and applicants when applying the charging method.

Total costs to be recovered

The total costs to be recovered include the estimated cost of the water transport network, plus water security projects. In addition, the charging method may have to incorporate additional costs depending on whether the applicant purchases water treatment services directly from a privately owned WFP operator (see section 3.3 above).

Structure of charges to recover total costs

The structure of charges is as follows:

1 a proportion of the water service price paid by each customer is calculated with reference to the cost of providing water security projects and retail services, and

2 the balance of revenues necessary to recover total costs is recovered through a volume-based charge calculated on injected volumes. Injected volumes are set equal to the billed metered consumption of customers multiplied by a ‘gross-up factor’ to account for non-revenue water.

The fixed charges are calculated as follows:

Water network charge = (Fixed component)

(Service Price less Water Security Charge) * Access Holder’s Equivalent meters less Average Water Retail costs per property * Access Holder’s properties.

Water Security Projects charge = (Fixed)

Water Security Projects Charge * Access Holder’s Equivalent meters

Monopoly services Calculate incurred

costs

Contestable services

Check for consistency

Final price


The volumetric charge then captures the balance of the revenues given the revenue obtained from the fixed charges. This charge is based on the injected volumes of water, and is expressed as:

Water network charge = (Volumetric component)

Water network usage charge * Access Holder’s water use * Gross Up Factor

Purchasing water treatment services - options available to applicants

To accommodate the different ownership arrangements of the WFPs, Sydney Water has identified three purchasing options available to applicants, being:

Option A: The applicant purchases both water transport services and water treatment services from Sydney Water.

Option B: The applicant purchases water transport services only and intends to negotiate directly with the privately owned WFP operator(s) for the provision of water treatment services.

Option C: The applicant purchases water transport services only and does not require water treatment services for any of its bulk supply.

The charging method is applied to each option so that the outcome is consistent with the charging principles contain in section 41 of the WIC Act.

Under Option A, the charging method would be applied as described earlier. The applicant would also negotiate and enter into a separate agreement with Sydney Water for the provision of water treatment services.

Under Option B, the charging method includes the cost of:

•••• the water transport network, plus

•••• water security projects, plus

•••• ‘unavoidable’ costs based on Sydney Water ceasing to purchase any treated water from the privately owned WFP.

The applicant may have an agreement with Sydney Water for the provision of water treatment services through a Sydney Water-owned WFP. The applicant will also negotiate a separate agreement with a privately owned WFP.

At this stage, it is not possible for Sydney Water to quantify ‘unavoidable’ costs associated with the water treatment services provided by the privately owned WFPs. In particular, Sydney Water may seek to renegotiate the terms of its long-term contracts with the WFP(s) to better allocate costs appropriately among retailers. In addition, given the low cost of treating water through Prospect WFP, unavoidable costs would include any revenues obtained to partly cover the cost of treating water through the other eight WFPs.

Under Option C, the charging method would also be applied as described earlier. The applicant would have no separate agreement with Sydney Water or a privately owned WFP for the provision of water treatment services. The applicant would not require these services because:

•••• its source of bulk supply does not require treatment (eg desalinated water), and/or

•••• treatment services are provided by a facility other than the nine WFPs.

Injected volumes

It is important to note that the volume of water that is injected into the water supply network is greater than the actual volumes of billed consumption. This is due to loss factors including network


leakage, water meter under-reads and unfettered water use (eg fire fighting), termed non-revenue water. The volumes injected (purchased) by each retailer will need to be increased by a factor that includes each retailers’ contribution to non-revenue water.

The forecast gross-up factor is calculated as bulk supply divided by (bulk supply less non-revenue water).

Annual volume adjustment

Sydney Water proposes to maintain its current allocation of risk over water sales in applying the charging method. As described in section 3.3 above, retail services represent a small component of overall industry costs. This means that retailers could make large ‘windfall’ gains or suffer large windfall losses if retailers were required to accept the risk of forecasting errors on water sales.

To maintain the existing allocation of risk, the total charges paid by retailers each year will need to be subject to an annual volume adjustment. The volume adjustment will balance any losses or gains associated with water sales being greater or less than forecast.

It is important to note that differences between forecast and actual water sales can change both the revenue and costs of each retailer. This is because under the assumed retail licence conditions, each retailer will purchase water, or make availability payments, to SDP in proportion to its market share. This means any unexpected increase (or decrease) in total water sales will decrease (or increase) the retailer’s payments to SDP even, if the water used by the retailer’s customers remains unchanged.

The volume adjustment is as follows:

The value of the total annual volume adjustment is set equal to:

the change in billed consumption * Water Usage Price, less

the change in the volumes purchased from the SCA * SCA’s volumetric charge, less

the change in treated water volumes * average variable cost of treating water, less

the change in the water network charges (volumetric component)

where all changes are expressed as the difference between forecast and actual outcomes.

Each retailer would be required to pay (or receive from) Sydney Water an amount equal to the total volume adjustment multiplied by their share of total metered consumption.

Indicative application

To illustrate the application of the charging method, Sydney Water has applied the method based around the proposed costs and water prices for the 2012-13 financial year. It should be stressed that these are indicative costs only, to provide an illustrative example of the charging method.

Once IPART has released its 2012 price determination, Sydney Water will need to allocate total allowable costs across the water supply chain.

The example provided below excludes the situation where the access holder negotiates directly with one of the privately owned WFPs. That is, it excludes any unavoidable costs incurred by Sydney Water should it cease purchasing water treatment services from the privately owned WFPs. The example is applied to a retailer that serves a typical residential customer and three non-residential businesses.

Key information

Tables 3.1 and 3.2 below show the example water costs and prices. Table 3.3 shows some additional key statistics needed to apply the charging method. Table 3.4 shows the equivalent meters and water use of the example residential customer and three non-residential businesses.


Table 3.1 Example costs for water services, thousands(a)

2012-13 % of total

Bulk supply

SCA 210,000 17%

SDP 279,000 22%

Water treatment 148,000 12%

Water supply network 580,000 46%

Water security projects 23,000 2%

Retail 20,000 2%

Total 1,260,000 100%

Notes (a): Percentage total may not add due to rounding

Table 3.2 Example water prices and revenues

Price Unit Quantity Revenue ('000)

Service $166.70 Equivalent meters 1,666,897 277,872

Usage $2.26 Kilolitres 434,570,000 982,128

Total 1,260,000

Table 3.3 Key additional statistics (example only)

Unit Value

Number of properties Number 1,822,390

Total bulk water inputted Kilolitres 487,141,221

SDP Volumes produced Kilolitres 92,000,000

SCA volumes Kilolitres 395,141,221

Non-revenue Water Kilolitres 52,571,221

Table 3.4 Equivalent meters and water use of the example properties

Equivalent meters Water use (kL)

Residential house 1 200

Shopping mall 6 26,000

Large hotel 25 95,000

Soft drink producer 225 450,000

Calculated charges based on forecast outcomes

The total costs included in the charging method are equal to the cost of the water transport network plus water security projects, which totals $603 million ($580m plus $23m).


The water security projects charge is equal to the cost of providing water security projects divided by the total number of equivalent meters. It therefore equals $13.80 per equivalent meter ($23m divided by 1,666,897).

The average cost of providing retail services by Sydney Water per property is set equal to the total cost of providing retail services divided by the total number of properties. It therefore equals $10.97 per property ($20m divided by 1,822,390).

Based on the total costs to be recovered as revenues from fixed charges, the volumetric charge is calculated at $0.708 per inputted kL. The gross-up factor is calculated at 1.121.

Based on these calculations, the access charge payable by the retailer for the residential house is:

Water network charge = (Fixed component)

($166.70-$13.80)*1 – ($10.97)*1 = $141.93

Water Security Projects charge = $13.80 *1 = $13.80 (Fixed)

Water network charge = (Volumetric component)

$0.708*200*1.121 = $158.84

The annual access charge for the residential property is $314.56. The calculated outcomes for all four examples are shown in table 3.5.

Table 3.5 Access charges for the four example properties

Network Network Water security Total charge

(fixed) (Variable) (Fixed)

Residential house $142 $159 $14 $315

Shopping mall $906 $20,649 $83 $21,638

Soft drink producer $3,812 $75,447 $345 $79,604

Large hotel $34,392 $357,382 $3,105 $394,879

Annual volume adjustment – total adjustment to be shared between retailers

As described earlier, the annual volume adjustment maintains the current allocation of risk over water sales. As an example, the volume adjustment is calculated assuming total billed consumption is 2% greater than forecast.

The total annual volume adjustment equals:

the change in revenue water * the water usage price

= (+8,691,40014 kL * $2.26 = $19,642,564)

less the change in the volumes purchased from the SCA * the SCA’s volumetric charge

= (+8,872,78215 kL * $0.1088 = $965,553)

14 This volume is based on forecast billed consumption multiplied by 2%

15 This volume is based on the increase in total (bulk) water use.


less the change in treated water volumes * average variable cost of treating water

= (+8,872,782 * $0.13 = $1,195,548)

less the change in the water network charge (volumetric component)

= (+9,742,82416 * $0.708 = $6,902,564)

The total annual volume adjustment is therefore $10,578,899. Each retailer would be required to pay Sydney Water an amount equal to the total volume adjustment multiplied by their share of revenue water.

3.5 Assessment against the access charging principles

Sydney Water’s proposed charging method is consistent with the charging principles contained in the WIC Act. A brief assessment of the method against each principle is provided below.

S41(a) generate expected revenue for the service that is at least sufficient to meet the efficient costs of providing access to the service, and include a return on investment commensurate with the regulatory and commercial risks involved

The charging method is set to recover the costs that Sydney Water would continue to incur if it ceased providing bulk water and retail services to customers. It includes both the cost of providing and maintaining the water transport network and the cost of water security projects. Including the cost of water security projects is necessary for effective competition under the charging principles. It is also permissible, as the charging principles specify, that the revenues generated must be at least sufficient to meet the efficient costs of providing access to the service.

S41(b) allow multi-part pricing and price discrimination when it aids efficiency

The structure of access charges is based on a combination of fixed and volumetric components. This structure aids economic efficiency as it produces the correct margin between access charges and water prices. This in turn encourages effective competition in the provision of contestable services, which is consistent with promoting economic efficiency.

S41(c) not allow a vertically integrated service provider to set terms and conditions that discriminate in favour of its downstream operations, except to the extent to which the cost of providing access to other operators is higher

Sydney Water’s proposed charging method does not favour any of its contestable services at the expense of competitors. This is demonstrated by the fact that it transparently identifies the cost of both the monopoly and contestable elements.

S41(d) provide incentives to reduce costs or otherwise improve productivity.

The incentives for Sydney Water to improve productivity are primarily derived from its governance arrangements as a State-owned corporation, and the manner in which IPART sets water prices. Sydney Water has an incentive to keep its costs at, or below, that approved by IPART. In the long term, these productivity improvements will translate into lower access charges.

S41(3) implemented in a manner that is consistent with any relevant pricing determinations for the supply of water and the provision of sewerage services

The proposed charging method is closely aligned with current industry arrangements, including the prevailing IPART price determination. This is reflected in the method ensuring consistency between access charges and water prices.

16 This volume is equal to the increase in revenue water multiplied by the forecast gross-up factor.

Sydney Water – Water network access undertaking: Supporting submission – Page | 30

Abbreviations

The table below lists the abbreviations used in Sydney Water’s submission.

Abbreviation

ACCC Australian Competition and Consumer Commission

BOO Build Own Operate

CPI Consumer Price Index

CSO Community Service Obligation

DSP Development Servicing Plan

FDC Fully Distributed Cost

GL Gigalitre

IPART Independent Pricing and Regulatory Tribunal of NSW

kL Kilolitre

LRMC Long Run Marginal Cost

ML Megalitre

NSW New South Wales

SCA Sydney Catchment Authority

SDP Sydney Desalination Plant Pty Limited

SOC State Owned Corporation

WFP Water Filtration Plant

WIC Act Water Industry Competition Act 2006

Sydney Water – Water network access undertaking: Supporting submission – Page | 31

Glossary

This table defines technical or unfamiliar terms used in Sydney Water’s submission.

Term Definition

BOO Build Own Operate. Sydney Water has entered into BOO contractual arrangements with external organisations to operate the majority of Sydney Water’s water filtration plants.

CSO Community Service Obligation. Sydney Water is required to provide certain community service obligations. Sydney Water’s CSOs result in some customer groups not being required to pay the full value of their bills. The unpaid component of the bills is funded by NSW Treasury.

Corporate costs Corporate costs are costs that cannot be directly attributed to a product, or costs that are shared among more than one product. They are separately traced in the regulatory cost model. These shared or common costs are primarily planning, administration, financial management, IT, human resources and property costs. Divisions contributing to these are: Finance & Regulatory, Corporate Services, Human Resources, Sustainability, Office of the Managing Director and Property (discrete part of Asset Management).

Exempt property The Sydney Water Act 1994 specifies that certain types of properties are exempt from paying service charges. Exemptions are granted following a formal application and on-site inspection. Land owned and used by organisations that provide not-for-profit community services is generally exempt.

Postage stamp pricing Where all customers within each property type pay the same charge for a particular service, regardless of their location, size or other particulars of the property.

Property For Sydney Water’s purposes, a property is a billable entity, ie, the legal entity that will attract a bill for the services provided.

Raw water Untreated water as supplied by the Sydney Catchment Authority.

Recycled water Wastewater or stormwater treated to a high standard as appropriate for particular uses in homes, agriculture or industry.

Reticulation pipes Smaller pipes that connect individual properties to larger trunk pipe networks and major infrastructure.

Unfiltered water Unfiltered water, subject only to limited chemical treatment (typically chlorination)

SDP

Provided in accordance with

Standard Access Agreement

Water Supply Transport Network

Transport Service

Customers are those

connected to the Water

Supply Transport Network or

who are part of SWC’s

planned roll-out to

additional customers

Injection

Points

SYDNEYWATER

ACCESS HOLDER

SERVICES

SWC

Treatment Plants

A

B

C

Water Treatment

Serviceprovided

under

separate

agreement

Access

Holder

customers

CHARGES• Transport • Water Treatment

• Other

*Additional services to be provided by SWC on terms negotiated and agreed between the parties

SERVICES*Attachment A

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