Water prices are regulated by governments as in almost all cases water is a monopoly business. This is not a bar to private investment in the water sector; gas and electricity prices are also regulated. But if the regulated price is set at a level that does not allow a commercial return on the capital deployed, it will preclude private sector involvement.
The policies of all Australian governments are to stop subsidising water; hence the commitment in the National Water Initiative (NWI) to bring rural and urban water to the lower and upper-bound pricing respectively.
Reforms introduced by COAG, have included: the adoption of the principles of consumption based pricing; the introduction of two-part tariffs; and the removal of most cross-subsidies for urban water users. The NWI builds on these initial pricing reforms to implement the principles of user pays and full cost recovery for best practice water pricing. Under the NWI jurisdictions have also committed to develop pricing policies for (metropolitan) recycled water and stormwater that are congruent with pricing for potable water and stimulate efficient water use no matter what water source. The objective is to ensure that the pricing arrangements facilitate adoption of the least-cost options to balance supply and demand in the long term.
The NWI also aims to achieve consistency in water charging across jurisdictions for water storage and delivery and for attributing costs of water planning and management. This is important for encouraging private sector involvement in urban and rural sectors because investors will be able to make clearer comparisons of costs and economic returns across different water investment options.
At present, the total cost of supplying water in both urban and rural areas in Australia is dominated by the cost of transmission not the water itself. This is of particular relevance in rural areas where users are generally charged only for channel usage and diversion costs - factors such as scarcity of water and storage costs are rarely included. At present, in most cases, rural water pricing will barely cover the operational expenses of the supplier and funding for new or upgraded infrastructure is often sought from other sources. This is a significant issue in rural and regional Australia because if pricing for water remains low the cost of maintaining or upgrading infrastructure for new investors will probably outweigh the potential return they can make on an investment.
In most urban areas large water utilities price water in the upper-bound and this provides the cashflow to enable significant capital expenditure. It has been observed, however, that dividend and other returns to government owners of these utilities are often high and at the expense of investment in infrastructure. Historically, water was not priced in cities based on volume; water "rates" were paid based on the unimproved capital value of the land to which the water was supplied. Since then charges are, in almost all centres are based on two-part tariffs with a volumetric element. The most recent trend has been to introduce block pricing so that the price per KL increases with the volume of water consumed.
A cost-reflective price for water is an important factor for new entrants who wish to compete for customers on price with existing suppliers. They can do this offering a new source of water, such as recycled water, the marginal cost of which is likely to be higher than that from existing surface water resources. Suppliers can, however, also compete on other attributes other than price, such as the ability to use recycled water during periods where first use water is restricted or where there is a desire by governments or the community to minimise disposal of effluent to sensitive environments.
The economics of recycled water requires careful consideration. How much of the cost of transforming wastewater into usable fresh water should be borne by:
(a) the polluter who has produced the wastewater,
(b) the end user of the recycled water, or
(c) the community which benefits because less wastewater is released to the environment.
If one took the view, for example, that the polluter should only pay to treat wastewater to the primary stage6, then the financial cost allocated to the end user of the water is much higher than if, as many would argue, the polluter should bear the cost of treating wastewater to at least the tertiary7 stage of treatment.
With greater private sector involvement in the water sector it is important to have incentives in place to encourage behaviour in the market that leads to beneficial community and environmental outcomes. The provision of water, especially from surface water resources and reservoirs, is a high fixed cost business and the marginal cost of supplying an additional GL of water is very low. As a consequence there is a natural incentive for water companies to sell more water, because the marginal profit of each additional GL is very high indeed.
At the same time, when supplies are constrained by drought, the cost of providing additional water can have a very high marginal cost, especially if it comes from recycling or desalination. Governments who wish to preserve the cashflows of their own water companies and thereby continue to extract high dividends, have a clear economic incentive to impose water restrictions and otherwise constrain demand so that investment in new infrastructure may be postponed and the low marginal cost of water provision maintained.
It can be argued that the best way to balance these competing interests is for water companies to be able to charge an economic price for water so that there is a financial incentive to invest in new water infrastructure and that consumers recognise that inefficient or profligate use of water (like any other essential commodity) comes at a significant price.
Q11: | How significant are pricing barriers to private sector involvement in water and wastewater services? Can anything more be done to reduce them? |
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6 At the primary treatment stage, solid particles are removed from the sewage.
7 At this advanced level of treatment, solid particles have already been removed (primary treatment) along with dissolved solids (secondary treatment). Treatment at the tertiary level removes harmful compounds from the water and water are also disinfected to remove bacteria, viruses and parasites.