PUBLIC SUBMISSION

TO

CHARGE RULES ISSUES PAPER FOR INFRASTRUCTURE OPERATORS

BY

MACQUARIE RIVER FOOD & FIBRE

ON

15 July 2008

Macquarie River Food & Fibre Submission on ACCC’s Water Charge Rules Issues Paper 15th July 2008

Executive Summary

Macquarie River Food & Fibre (MRFF) repeats concerns raised in our May submission to ACCC on Water Market Rules, that more than pursuing free market objectives, ACCC’s Issues Papers demonstrate the underlying political imperative of the Federal Government at present, to force unbundling of water rights with the primary purpose of more water becoming available for the Federal Government to purchase. This concern is based on the lack of attention ACCC is focusing on protecting the ongoing viability of Infrastructure Operators and demonstrating how issues such as stranded assets will be avoided, by embedding these issues as ‘tests’ of whether water charge and market rules are meeting objectives.

The key points in the following submission are similar to those in our May submission and are summarized in the dot points below:

  • A termination fee template, that allows for a fee based on 15 times the annual access charge to cover the three components of Operations & Maintenance, Capital Expenditure and conveyance losses is essential to the security of Infrastructure Operators’ businesses;
  • Water access and delivery entitlements must not be forced to be unbundled in Infrastructure Operator schemes due to the security risks this creates for the Infrastructure Operator. A termination fee is a one-off opportunity to cover future costs associated with an exiting member’s licence. There will be substantial risks (including inflation, interest rates and other variables) that will be borne by the Operator and remaining members, by enabling members to exit a scheme after paying a one-off fee. However one risk that must not be passed onto the Operator is the risk of having unsecured liabilities with exiting members who want to transform their WAL but not cease their delivery entitlement. This places Operators in an untenable position, as has been experienced by southern NSW valleys, which have not been able to recoup the ongoing delivery entitlement related expenses from the member. Therefore when a member wishes to exit and pays a termination fee, this process must terminate his access and delivery entitlements on the scheme.
  • Macquarie Infrastructure Operators need more guidance, interaction and support from ACCC in order to establish water charge rules, particularly termination fee templates as soon as possible, so as not to delay trade opportunities for those members wishing to exit.
  • Distinctions between classes of Operators with a view to creating less onerous and more flexible timeframes and rules for smaller Operators is supported by MRFF;
  • Independent Reviews in order to inform pricing decisions and improve efficiency are not appropriate and demonstrate an over-regulatory, one-size fits all approach to dealing with Operators, whether they are massive State-owned corporations or small, private Operators. ACCC needs to look at more cost-effective and voluntary mechanisms, using the market mechanisms that drive efficiency already in existence for Macquarie Infrastructure Operators. For instance national benchmarking studies and a focus on assisting / facilitating the sharing of information regarding new technology would be a much better approach than interfering via independent reviews and creating higher costs for those members that are supposedly meant to be the beneficiaries of such reviews.
  • The ACCC’s role must be limited to setting water charge rules, not setting the internal prices of operators or scrutinizing asset management plans etc.
  • ACCC must ensure that Infrastructure Operators’ viability is not eroded as a key test of the appropriateness of new water charge rules, their standards, transitional arrangements and implementation.
  • ACCC must recognize and compliment rather than duplicate or seek to replace the existing governance arrangements and obligations of the directors of limited liability companies.

Introduction

MRFF is an organization representing the interests of 600 irrigators in the Macquarie Valley, including the interests of riparian irrigators and the individual members of the valley’s 7 irrigation schemes. MRFF promotes triple bottom line sustainability in water use and water policy and advocates a free and open water trading market, apart from where physical or environmental constraints exist or where there is an externality or third party impact.

MRFF brings to ACCC’s attention that the major focus of our submission on water market rules was termination fees and therefore MRFF requests that ACCC reconsiders our 9th May submission, in combination with this submission in considering our comments on water charge rules (MRFF has included its 9th May submission as an appendix to this submission to ensure that ACCC is able to consider both submissions in response to its Water Charge Rules Issues Paper).

Responses to ACCC Questions:

MRFF has provided responses to questions raised in ACCC’s Issues Paper below. It has omitted addressing some questions, based on a lack of ability to foresee some of the issues ACCC raises in order to make comment due to the extremely preliminary status of Macquarie Infrastructure Operators’ progress towards implementing the concepts of new water market, trading and charge rules.

4.1 Methodological Issues

Question 1:

Are there any matters not mentioned above that are relevant in establishing a methodology for determining prices consistent with the objectives and principles of the Act?

MRFF supports the principles and application of consistency and transparency in pricing for access or termination of access, as per ACCC’s statement (Issues Paper, p18) “the key point to note is that the water charge rules may require the same approach to be followed when determining:

  • fees or charges related to access to an operator’s network’ or
  • fees or charges relating to the termination of access to an operator’s network”.

However in reviewing the dot points listed on ACCC Issues Paper, p17 regarding a typical methodological framework:

  • ‘undertaking a review of the efficiency of the proposed expenditure program and substantiating the link to expected service levels and other deliverables’

MRFF makes the comment that ACCC needs to look at a much more flexible approach than it has potentially indicated, in terms of independent reviews that provide information regarding efficiency and then impact on the price setting process.

4.2 Service Standards & Obligations

Question 2:

Are there any issues the ACCC should be aware of in relation to service standards?

Re d) the extent to which service standards are, or should be reported publicly:

It is hard to see the relevance of this additional cost-incurring activity on Macquarie Infrastructure Operators. The Macquarie schemes are privately owned, not-for-profit, customer-member based bodies, so it is the customers and the regulators who have an interest in service standards, not the general public. Market drivers and the structure of Macquarie Infrastructure Operators has delivered continual improvements in efficiency, which pass on to members and this practice occurs without regulation or formalization of the many different aspects of water charge rules that ACCC is considering.

MRFF supports the requirement for Infrastructure Operators to communicate with and involve customers in establishing service standards and understands that Macquarie Infrastructure Operators already define services to be provided to customers in the licence agreements / contracts.

Another comment with respect to service standards is the caution ACCC needs to take in defining generic service standards to be delivered by all Infrastructure Operators. Obviously the scale of the business has implications for the economies or otherwise associated with delivering specific services. Services that are administratively labour intensive or associated with specific technology may not be efficient investments for smaller Infrastructure Operators such as those in the Macquarie.

The basic services and associated standards that Macquarie Infrastructure Operators currently offer and could continue to offer include:

  • Service re delivery of water – and associated losses, timeliness
  • Information services
  • Internal temporary and permanent trading facility

Question 3:

Are there any issues the ACCC should be aware of in relation to legislative and regulatory obligations

MRFF refers ACCC to State Water Corporation’s (SWC) approach to service standards; there is no contract as such committing State Water to service standards; however there is a Customer service charter specified as a requirement of the Operating Licence. SWC is required to negotiate the Charter with customers. MRFF sees the State Water process as the formalization of the methodology that has been in practice over time with Infrastructure Operators.

Given the scale of SWC’s business, ACCC needs to consider issues of scale, cost /benefit analysis to customers and whether the market forces that already exist are able to deliver the desired outcome to customers in terms of service standards for much smaller Infrastructure Operators such as those in the Macquarie.

MRFF notes the lack of flexibility in the current IPART process regarding the provision for Operators or valleys to charge for other valley-specific services – for instance specific environmental levies or monitoring and research programs that have been supported by Macquarie irrigators in the past have been removed from water charges by IPART. It is the opportunity for valley-based flexibility in pricing that allows customers’ collective priorities and preferences to be addressed much more specifically than the current water pricing system allows.

Another comment with respect to legislation is the IPART legislation and Water Management Act legislation and IPART’s consequent interpretation of cost sharing obligations of individual irrigators. Natural resource water management charges are one area of existing water charges that MRFF has argued should be largely classified as community service obligations, and not the responsibility of irrigators or operators. This is based on MRFF’s premise that the community now requires a level of monitoring and management from Government departments that is not related to the existence of irrigation, but is based on the intrinsic value the community places in knowing that water resources are being managed by the Government. However other stakeholders have been successful today in having natural resource management costs classified as externalities, which are therefore the responsibility of irrigators to fund. There is extremely limited or virtually no transparency, accountability or contestability at present with resource management charges, which makes it very difficult for irrigators to make a case against the charges.

This lack of transparency with natural resource management charges raises an issue of contradiction in ACCC’s approach to water charge rules, where small, private Infrastructure Operators are going to be required to deliver a higher level of efficiency, transparency and accountability that is not required of or enforced on the Government departments that charge irrigators for so-called services at present.

4.3 Expenditure Profile

Question 4) In transitioning towards upper bound pricing:

a) What factors may influence the path or pace of transition? How might these factors be addressed?

b) Are there circumstances in which upper bound pricing cannot or should not be achieved?

MRFF supports the NSWIC position that NSW irrigators do not support upper bound pricing. MRFF believes upper bound pricing is contradictory to the principles of promoting a free water market and acts as an interference to create distortions in the market. MRFF’s experience of the application of upper bound pricing in the most recent IPART pricing round, demonstrated less rigor, accountability and transparency on the part of service providers.

However in determining the methodology for setting termination fees, MRFF makes the point that unlike other aspects of water pricing, where there is an opportunity to review and increase prices if necessary over time, the issue with termination fees is that they are a one-off. The risk and implications of underestimating the termination fee all lie with the remaining customers of the Infrastructure Operator, so ensuring an adequate multiplier (15) and the requirement of upfront payment rather than tagging or annual payment of the termination fee is critical in terms of the Infrastructure Operator’s risk management.

MRFF makes an additional point in consideration of upper-bound pricing which is linked to comments above regarding cost sharing principles and externalities. At present, there is little conclusive published work in Australia on accurately defining and measuring externalities. Sunwater’s most recently commissioned study on the subject concluded that externalities are very difficult to quantify. At present MRFF believes there have been incorrect assumptions made and misuse of theory regarding externality principles to apportion large shares of costs of so-called negative externalities onto irrigators. MRFF cautions that with any application of upper bound pricing for water charges, cost shares need to be re-examined and corrected. A most obvious example of the current error in application of cost sharing principles to externalities is the case of flood mitigation in the Macquarie. There is a large flood mitigation expense component in the water charges in the Macquarie due to Burrendong dam and despite the obvious major beneficiaries being towns and the broader community, downstream irrigators currently fund a large proportion of the associated costs.

A second reference that ACCC should consider in relation to upper bound pricing and externalities is the recent report by ABARE for QLD Department of Natural Resources, Mines & Energy, titled “Addressing Externalities through Water Charges”.

This report has found (p1) that ‘avoiding the generation of externalities through the establishment of well defined property rights in the first instance is more effective than trying to deal with them through regulation or market intervention’. The report also found that (p2) ‘even when there is a rationale for government intervention the net benefits of the intervention must be greater than the costs of the intervention, so that the action leads to a net benefit to society as a whole. For example, if the costs of monitoring and enforcing a site specific charging regime exceed any potential benefits, the optimal solution may be to use a second best instrument, or to do nothing.’ MRFF is certain that this kind of cost/benefit analysis has not been applied in the setting of NSW water charges to date.

Question 5:

To what extent are the two approaches applied consistent with the conditions listed above? Are there any issues that the ACCC should be aware of when considering the two approaches?

MRFF makes the comment that with respect to termination fees, provided there is consistency between the two approaches (renewals annuity approach and regulatory asset base approach), as per the conditions listed on p 22 of ACCC’s Issues Paper, the ACCC should not be prescriptive in selecting one method over the other as the method Infrastructure Operators must use. The choice of method should have zero impact on the quantum of the termination fee, as it is a one-off, upfront payment. Hence the issue of smoothing the annuity into an equal amount or more accurately mapping expenditure and hence the charge over a longer time period becomes irrelevant.

However with respect to general water charges MRFF notes that the Regulatory Asset Base approach has been selected by SWC and has been supported by irrigators as fairer method of calculation that limits the amount of capital held in reserve until such time as it is needed. It would no doubt make economic sense for Operators to use the same method for calculation of annual charges as for the termination fee.

4.3.2 Asset Valuation

Macquarie Infrastructure Operators currently work under a less formal, though completely transparent and member-scrutinized system of making provision of capital expenditure. Operators accumulate reserves in good years for the purpose of capital upgrades and works. Then capital expenditure is funded out of accumulated reserves or the Operator may need to make a capital call on members. Members see it as the Operator’s management issue to ensure reserves are adequate for necessary works.

4.3.3 Expenditure Efficiency

Macquarie Operators undertake rigorous budgeting for annual O&M and in addition to this, consideration is given to funding the next planned capital expenditure. An important characteristic of the current system is the flexibility of the capital program, based on what type of season it is. For instance a dry year is a good opportunity for channel sealing and this is an opportunity that can be determined during the season, provided there are financial reserves in place for the work.

MRFF is concerned that ACCC may have had a limited experience regarding the efficiency drivers within Infrastructure Operator businesses. Farmers and Infrastructure Operators in the Macquarie (due to their structure and business drivers) have had decreasing terms of trade over a long period. This has driven increases in efficiency, with activities undertaken for members’ benefit and for the ongoing sustainability of each scheme.