Part 5: Observations about funding and pricing

Planning to meet the forecast demand for drinking water in Auckland.

Section 57(1) of the Local Government (Auckland Council) Act 2009 sets out Watercare’s obligations to deliver water and wastewater services. One of the Act’s requirements is that Watercare must manage its operations efficiently with a view to keeping the overall costs of water supply and wastewater services to the minimum level needed to effectively maintain the long-term integrity of its assets.

Several important decisions about Watercare’s funding and pricing were made before integration. These were the new water price ($1.30 for each cubic metre of water, including GST, effective from 1 July 2011) for the Auckland metropolitan area and the infrastructure growth charge regime.

Under section 18(f) of the Local Government (Auckland Transitional Provisions) Act 2010, Watercare is required to prepare an indicative funding plan at least four months before the end of the financial year. The Act requires the funding plan to show how Watercare has calculated the proposed prices and charges, a summary of the comparative assessment of different funding options, an appropriate debt to equity ratio, and how any surplus or deficit from the previous year will be applied (for a surplus) or managed (for a deficit).

Watercare prepared its 2011/12 funding plan in February 2011. The funding plan includes funding principles, pricing principles, funding parameters, and funding assumptions. The funding plan was based on the preferred option (named "Scenario 91") that Watercare developed before amalgamation. A briefing workshop to the Watercare Board in February 2011 acknowledged that the funding plan did not present funding options largely because most of the pricing decisions had already been made.

Watercare is currently working on funding and pricing options for the longer term from 1 July 2012. Watercare is using a mixture of in-house resources and an external consultant to consider the pricing for its services and also to examine the balance between variable charging and fixed charging in tariff setting. In 2010, an external consultant also prepared reports on funding and pricing for the Auckland Transitional Authority. Watercare envisages that it will consult with the public on the tariff structure in early 2012.

We consider that Watercare should consider, when developing its longer-term funding and pricing principles:

  1. specifying definitions and terminology;
  2. ensuring that pricing structures are consistent with funding principles – in other words, that funding principles are overarching or pre-eminent and that pricing structures flow from the funding principles;
  3. clearly distinguishing between externally imposed funding constraints, policies, and parameters and those established internally;
  4. indicating what funding tools finance particular aspects of Watercare operations and the approximate extent of the funding;
  5. outlining the extent to which longer-term renewal of infrastructure will be funded in the more immediate future;
  6. providing greater guidance on the consideration and funding scenario outcomes of the intergenerational equity principle; and
  7. providing transparency in the funding of each of the water and wastewater operations.

With point 1, in the papers and reports we saw, there is reference to "no significant accounting loss" and "maintain price increases at a minimum" but no clarity about what this means.

With point 3, an external consultant’s 2010 report to the Auckland Transitional Authority stated that there was a policy that water operations and wastewater operations could not, individually, incur an annual accounting loss of more than $1 million or $2 million collectively. We understand that this was an internal Watercare parameter initially built into the forecasting model to determine pricing options for 2011 and beyond. We are advised that this parameter has subsequently been relaxed.

With point 4, under the Local Government Act 2002, local authorities state in their Revenue and Financing Policies that, for example, operational expenditure is fully met from user charges, asset renewal expenditure is met from a specified combination of user charges and depreciation funds, and new growth capital is met from a specified combination of developer contributions and borrowing. In Watercare’s indicative 2011/12 funding policy, it is difficult to ascertain this degree of detail.

With point 5, other planning reports we reviewed, such as the 2008 Asset Management Plan and the Three waters plan, point to assets reaching three-quarters of their expected life in the next few years. Consequently, the level of renewals is likely to rise, perhaps significantly. Watercare should outline how it will fund an increased renewal profile. The 2011/12 indicative funding plan noted that Watercare will fund 91% of depreciation from revenue. This appeared to be a reduction from the level of depreciation previously funded. However, the plan does not set out the rationale for this percentage or the rationale for depreciation funding over the intermediate and longer term.

With point 6, the indicative funding plan rightly notes (in section 5.3) the issues related to intergenerational equity and the need to seek an appropriate balance between debt and equity funding. However, the section does not provide any definitive answers. Future funding strategies should provide more detail on the issues and funding approaches.

With point 7, a future funding policy should show the degree to which each of the major business segments will be self-funding – that is, whether the operating revenue for water is set to meet operating expenditure for water and whether the operating revenue for wastewater is set to meet the operating expenditure for wastewater. The rationale for any deficit should be explained.

In late 2011, we will review the longer-term pricing and funding options that Watercare is currently creating.

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