Opinion: Leaky analysis – Three waters reform

Opinion by Wayne Maxwell, Kāpiti Coast District Council

Decisions about how our district’s three waters services – water supply, wastewater, and stormwater – are managed and delivered in the future are a big deal. We agree that the Government’s Three Waters Reform programme presents a once-in-a-generation opportunity to rethink how New Zealand Inc. delivers safe and reliable water services at less cost for all. However, there are questions over the modelling that has been used to inform the proposal.

The “at less cost” promise

From the outset, funding and affordability was acknowledged as the main issue that the country faced. The Government is not proposing any new funding tools to solve this issue. Instead, the Government’s Three Waters Reform proposal is based on the premise that larger water service entities (WSEs) will be able to deliver water services at significantly lower costs than your local council, due to ‘economies of scale’ and their ability to borrow more. This is how they intend to keep costs as affordable as possible.

Currently, everyone pays for their water services through rates. These are a mix of volumetric (water meters, pay for what you use) and fixed charges (everyone pays a standard amount). There’s more behind it, but the key point is you currently pay for your three waters through your rates, and this would not change under the proposed new model. The difference will be that the WSEs will be charging you these rates, not your local council.

The model

The Government has taken advice from the Scottish regulator, the Water Industry Commission for Scotland (WICS), including the development of a model that estimates costs for each council over the next 30 years. It is based on a set of standard assumptions, which shows the estimated cost per connection if councils go it alone, versus the estimated costs under the four WSE proposal.

For Kāpiti, the WICS cost per connection in 2051, before adjusting for inflation, is estimated to be $2,627 if we go it alone, and $1,255 if we are part of Entity C. Our Long-term Plan forecasts our cost per connection in 2051 to be $884 before adjusting for inflation. Accepting some variation is likely, this says our costs would have to be 300 percent higher than we have in our Long-term Plan. How does WICS reach such a different number?

As part of our own due diligence, we engaged international consultants, Castalia, to help us analyse WICS’ model. Castalia’s analysis, along with our own interrogation of the model, has demonstrated that the model does not accurately represent the Kāpiti Coast situation.

Asset values

In our view WICS’ starting position for Kāpiti is overstated. WICS has used national averages to estimate the value of Kāpiti’s water assets at $940 million, but the actual replacement value of our assets is $548 million – only 58 percent of the WICS number. WICS estimates the useful life of our water assets to be around 80 years, when in reality, our water assets have an average life of 68 years. Our assets are revalued by external experts every 2–3 years, so we’re confident the asset values and useful lives are accurate and current. This is important when it comes to depreciating our assets (what we should spend on replacing worn out pipe and plant items), as reducing the useful life increases our depreciation expense. For example, if we were to use WICS modelling as a yardstick, depreciation on our water assets would be $12 million per annum but should increase to $16 million. Our actual depreciation is $8 million per year.

Capital expenditure

WICS has assumed Kāpiti will have capital expenditure (capex) spending of $12 million per year on asset renewals, plus $17 million per year on growth and improving the level of service. After adjusting for the consumers’ price index (CPI), that adds up to $1.5 billion over 20 years. Our Long-term Plan (LTP) includes $1.1 billion for the same period – about $400 million less. The renewal expenditure would be funded by depreciation, in effect; but the balance is assumed to be fully funded by debt. It appears WICS has not accounted for development and financial contributions, which councils use to fund growth capex. Using the conservative growth assumption of 0.8 percent per annum in the model, this potentially overstates required debt by a further $125 million over the 30-year period.

Debt

The biggest influence on water bills is the assumed borrowing capacity. In the WICS model Kāpiti, like all councils, is assumed to have a maximum debt capacity of 250 percent debt to revenue (in fact our Long-term Plan forecasts our debt to be well under 200 percent of revenue). However, the WSEs essentially have unlimited borrowing capacity due to the government underwriting their debt. As modelled, WSE C is expected to get up to 645 percent debt to revenue.

If the council reaches its borrowing limit, the assumption is that further capex will have to be paid for out of rates, rather than borrowing. This is the main driver of increased revenue according to the model.

Operating expenditure

The WICS model forecasts just over 60 percent gains in operating expenditure (opex) efficiency. This equates to 2 percent per annum, every year. For Kāpiti, this is considered unlikely, because our operating costs are already very low.

WICS has highlighted Watercare as an efficient operating model, with the scale equivalent to that suggested in the four WSE proposal. However, Castalia states that our costs are lower than those achieved by Watercare in Auckland. They calculate our combined opex costs for water and wastewater are $489 per connected property per year, while for Watercare customers the costs are $534.

That said, we all expect that there should be gains from a larger entity. The Government is using the reported savings achieved in Scotland between 2002 and 2020 as real-world evidence. The problem is we’re not comparing apples with apples, as our population is spread over a much wider area, largely concentrated in urban areas. To put this in context, Entity C will cover almost 500 kilometres, from Gisborne to Nelson, whereas 80 percent of the Scottish population lives within 70 kilometres, between Edinburgh and Glasgow. What this means is that there won’t be significant joining up of our water infrastructure and the benefits this would bring.

The WICS modelling also assumes individual councils won’t generate any efficiency improvements. This seems improbable; the sector should expect to share benefits as they’re identified, including through the expertise provided from the two regulators. There should be some, albeit smaller, efficiency gains even for smaller organisations.

Assumptions vs the Kāpiti reality

The main argument behind the case for change is that the proposal will be cheaper for everyone. The WICS model provides the main support for this “less cost for all” argument. Castalia’s analysis casts doubt over the validity of the findings, and by virtue of the standardised assumptions may also translate to inaccuracies for other councils.

From a Kāpiti perspective, we acknowledge that this is just a model. Rather than having a debate about this model, we would prefer to see effort put into developing a better model, drawing on the rich data that was provided by councils early this year. The Three Waters Reform proposal is a big deal – it’s an estimated $54 billion worth of assets that we’re talking about, across the country, and everyone wants to see the best outcome achieved. Therefore, it deserves the time and effort to get the details represented as accurately as possible.

Where to from here

So where to from here? Councillors will meet again in the coming weeks to explore other aspects of the proposal such as how we retain a local voice and the potential for privatisation under the WSE model before formalising their feedback to the Government by 30 September. No decisions to opt in or out are being made at this stage.