July 2008

1. The Australian Water Industry July 2008 Brett Mathieson Manager Regulation & Planning Yarra Valley Water, Melbourne, Australia

2. NT - PAWA Power/Water Western Australia Water Corporation - State Owned Company Covers whole State South Australia SA Water - State Owned Company Covers Whole State Canberra ACTEW Power/Water Australian Urban Water Industry A Diverse Range of Utility Structures Queensland Wholesalers State Owned Brisbane Water is fully Owned Business Unit of Brisbane City Council Rest: Local Government New South Wales State Owned Sydney Catchment Authority (wholesale) Sydney Water & Hunter Water - Rest: Local Government • Victoria • State Owned Retail Companies: • Yarra Valley Water • South East Water • City West Water • State Owned Authorities: • Melbourne Water (wholesale) • Rest: 15 Utilities Yarra Valley Water Ltd 2

3. Common Structural & Institutional Themes • Separation of Service Delivery, Regulation, Policy setting (and usually ownership) • Amalgamation of small rural and regional water authorities (not universal) • Progressive establishment of independent regulatory framework • Corporatisation of water utilities • Retention in public ownership • Pricing Reforms –cost reflective/consumption based • Strong role for private sector in the market • National 3rd Party Access regime for essential infrastructure

4. Planning for Long Drys Total River Murray System Inflows (including Darling River) WET DRY

5. Industry responses • Prolonged and severe restrictions • Water conservation • Integrated planning • Major augmentations – desalination • Recycling • Water sensitive urban design • Interconnected water systems and multiple sources of supply

6. Victorian Water Grid

7. State Water Grid - Benefits • Will accelerate state wide urban-urban water trading • Accelerate the introduction of third party access • Lower the cost of Wholesale water • Expand the scope of rural to rural trading • Will beak down city-country barriers • Will lead to uniform standards of water security and drought management across the state • Ensure water restrictions are spread more evenly across the State • Need a State based Water Grid Manager to exploit the potential of the Grid

8. Yarra Valley Water’s Smart Account Need to make water bills more informative & effective……

9. Conclusions • Demand/Supply balance has driven institutional reforms • Integrated networks being established with multiple sources of supply and customers • Water grid manager has critical role to optimise the supply demand balance • How far a full market-oriented approach could be pursued requires more analysis: • A competitive urban water market does not exist anywhere • No ‘off the shelf’ solutions. How is water special? • Monopoly, variable supply, competing environmental uses • Safe drinking water & ‘essential for life’

10. Make Up of the ESC Building Block • Revenue Requirement for any year is the sum of:- • Operating Expenditure • Controllable • Bulk Charges • Return on Assets (RAV times WACC) • Existing Assets (constructed prior to start of regulatory period) • New Assets (constructed during regulatory period) • Return on Assets (Asset value times depreciation rate) • Existing Assets (constructed prior to start of regulatory period) • New Assets (constructed during regulatory period) • Benchmark Tax Liability • Adjustments from previous regulatory period

11. Calculating Price Increase • Quantities for products are forecast for the regulatory period • Prices for year 1 are input (or previous years prices increased by X factor if tariffs not changed) • Prices for following years are the previous year increased by X factor • Forecast revenue for each year is the sum of the product of quantities and prices • The X factor is set so that the NPV of the forecast revenue = NPV of the revenue requirement

12. Breakdown of Costs Regulatory vs Accounting Views

13. Building Block -> Pricing

14. Additionally (or consequently) we observe • Increased public awareness and scrutiny • Many new private sector participants including strong international interest (construction of pipelines & plants esp. desalination, interest in new instruments e.g. water trading) • Political interest (be seen to be responding) • Desire for ongoing efficiency and service improvements • Pressure to innovate • Structural reform

15. New South Wales • Sydney Water vigorously defended a third party access claim by Services Sydney Pty Ltd • Led to the 1995 IPART review into the Industry structure for Water and Wastewater services in the Greater Sydney Metropolitan area • Private sector involvement in water recycling and new developments • Water Industry Competition Act passed in 2006 with draft Regulations to support legislation released in 2008

16. Western Australia • In July 2007 the Western Australia Treasurer announced an inquiry into competition in the water and wastewater sector focusing on: • Greater efficiency in developing and delivering new water sources and other services requiring significant capital investment • Opportunities for enhanced competition including the introduction of third party access to existing water and wastewater related infrastructure • Other reforms to the water and wastewater market which may enhance competition • The Economic Regulation Authority (ERA) was commissioned to undertake the inquiry • A Further consultation report on the establishment of an independent procurement entity was released in April 2008 which examines procurement models. • Noted introduction of competition via bulk supply water market would provide benefits but problematic to introduce in the short term • ERA’s final report is due by Government 31 July 2008

17. Proposed Structure - South East Queensland

18. Benefits of Vertical Separation • Increasing geographic diversity through inter-regional transfers • Reduced system losses • Increasing water efficiency and demand management • Planning reforms based on total water cycle • Improved accountability • Improved Regulatory effectiveness through transparency of costs & internal cross-subsidies • Scope for ‘grid bypass’ below materiality threshold will facilitate small-scale competitive wholesale sourcing • Potential for wholesale trading

19. Structure has potential for competition • Difficult to make competition ‘in the market’ work in a VI model • Ring-fencing and TPA regimes unlikely to be enough to support new entry • Incumbent has strong incentives to frustrate access • Platform for further competition where feasible • Competition provides improved scope for product innovation, retailer efficiency, promoting localised solutions • Provision for development of market rules, licensing regime and customer protection framework • New entrants require certainty of explicit policy / regulation • Separate network providers motivated to provide services to all customers • New entrants known to be interested in SEQ water sector • Wholesale Opportunities in localised sourcing, grid bypass mechanism • Retail opportunities in service bundling and differentiation • But competition has to pay its way • Challenges in pricing, minimising transaction costs

20. Water Grid Manager • Assess scope for external trading (e.g. Urban/Rural trading) • Statement of opportunities (Electricity and Gas Model) • Technology and Interconnection require changes to cost transparency • Financial performance and operational efficiency will require more activity than “set and forget” • Must be able to explicitly price the trade offs in system cost/security