Strengthening the South Australia Water Management Plan by
Incenting Access and Investment with
Effective Third Party Regulation
A Plan for South Australia
Water Industry Alliance
September 2010
INTRODUCTION
The water scarcity situation in Australia remains one of the most acute on earth. Massive investment is required in order to achieve and maintain sustainability with respect to water – and that investment must occur rapidly to compensate for changes in weather patterns and water availability that threaten the economic livelihood of the nation.
There is significant opportunity for South Australia to access capital and expertise necessary to ensure water sustainability via third party investment. However, in order to encourage private investment in Australian infrastructure, a clear methodology for the regulation third party access must be developed which addresses the health and environmental compliance requirements and economic regulation.
WHAT IS THIRD PARTY ACCESS?
Third party access can encompass several things. It can mean the separation of production, treatment and distribution systems (wholesale and retail separation); it can mean the use of existing infrastructure as resource supplies for the generation of new supplies/products (e.g. sewer mining); it can mean the outsourcing of operations and maintenance activities; or it can mean private ownership of facilities for the provision of services (public service corporations).
While the Australian community overall envisions that potable water systems remain in public control, there are significant opportunities for private enterprises to provide complementary services. Private party investment in water, wastewater and recycled water infrastructure allows for a broader scope of services, and allows for state and local governments to invest in those core areas (potable water supply). Further, private participation can significantly reduce the risks associated with development and sustainability. Indeed an appropriate mix of public and private investment can provide a the infrastructure fabric necessary to develop new supplies, maximize existing supplies and augment supplies with new uses such as bulk recycled water deliveries and aquifer storage and recovery systems. While this represents a departure from the Australian status quo, economic and resource realities require that these options be considered.
There is an increasing demand for infrastructure, particularly in areas where it may not be economical for state-owned entities to provide service. This can occur as a result of physical costs of infrastructure, the operational and capital inefficiencies of service extension (eg long pipelines), or the potential “speculative” nature of some commercial or residential developments. The risks associated with these activities can be transferred to private companies provided that both the required regulatory oversight to protect consumers (health, safety, environment, costs etc) and the economic regulatory support for investment in infrastructure exists.
As a result, there is prime opportunity for innovation in the water industry: “The water industry in South Australia is changing quite rapidly – so the governance and institutional arrangements supporting the industry also need to change.”[1]
The comprehensive reform established by South Australia’s Water for Good plan supports this diversification of the water industry:
Figure 1 South Australia’s “Water for Good” plan requires fundamental institutional changes in water management.
But in order to be successful, this diversification must be managed and regulated in such a manner that the interests of both the consumer and the public service corporation are considered. Accordingly, a regulatory body, separate from the corporations they regulate, and insulated from political interference must be established, and provided with the charter of oversight.
In South Australia, that role is most efficiently played by the Essential Services Commission of South Australia (ESCOSA). As envisioned in the Water for Good Water Industry Act Discussion Paper (November 2009), ESCOSA will apply their economic regulation of water to South Australia Water (SA Water) with the potential to expand regulatory oversight to other agents and agencies based “on the relative costs of applying independent economic regulation and the likely benefits to customers.”[2] As third-party access to existing infrastructure and the development of independent non-potable water services providers[3] increases, the rationale for ESCOSA to provide oversight also increases.
WHY THIRD PARTY ACCESS?
There are elements of the water scarcity issue that are driving the consideration of third party access and participation in infrastructure. These include:
· The importance of addressing water scarcity;
· The urgency of the problem;
· The massive scale of the solutions required; and
· The significant costs of the distributed solution.
Importance
Australia is one of the most progressive countries in the world when it comes to managing water scarcity, and for good reason: water availability in Australia is colliding with growth pressures. The Australian Davos Connection report “Australia Report 2010 – Risks and Opportunities” states:
Water scarcity emerges as Australia’s biggest challenge. Given that many cities will grow fourfold by 2056 to provide sufficient jobs to meet projected population growth, water scarcity may well pose the single biggest threat to required economic growth and future international competitiveness.[4]
Third party access to support the country’s water resilience goals will significantly increase the availability of resources to deploy infrastructure in this regard, and contribute greatly to the solutions.
Figure 3 Australian Risk Landscape[5]
Urgency
Compounding water scarcity are population growth and shifts in population demographics that Australia is experiencing. A 2010 report suggests that Perth in Western Australia, even under a low growth scenario, will be in water deficit by 2020. Under the high growth and drying climate scenarios, the deficit would be much greater[6]. Indeed in most of Australia’s urban centers, demand will exceed sustainable yield in this century.
Figure 4 Australian urban demand projections[7]
As a result, Australia is facing the certainty of having to invest in large-scale infrastructure projects to meet population demands and water scarcity realities, while at the same time coming to grips with what will be a massive re-investment requirement in existing infrastructure.
Notwithstanding Australia’s public debate on the merits of growth, it is imperative that the water industry prepare for the certainty of growth. Failing to do so will endanger future Australians, limit their opportunities and result in a degradation of their quality of life. Third party access will provide a step increase in the velocity of solutions being developed.
Scale
Today, the scale of the water solutions is such that one entity, one agency, or one government cannot develop and manage the distributed nature of the solutions required. Third party access provides a tertiary source of mindshare to develop and implement sustainable solutions.
The requirements to simultaneously develop new supplies, permanently destroy inefficient demand and maintain operational control of existing infrastructure is a daunting task.
Cost
Adaptability and resilience with respect to water resources infrastructure is imperative if Australia is to meet its growing needs. This adaptability requires substantial additional investment in water supply and wastewater infrastructure to improve efficiencies and meet future needs. Australia’s cities are investing (or planning to invest) $30 billion on water supply infrastructure over the next 10 years. The Commonwealth Government is investing $12.9 billion to address the problems in the Murray-Darling Basin.[8]
This adaptable and resilient water supply will include:
· New supplies (desalination);
· Regionalized water recycling;
· Dual reticulation systems;
· Stormwater capture and storage; and
· Aquifer storage and recovery schemes
Such a plan does not come cheap. The question is: how best to finance these requirements? Third party access can provide access to the necessary capital and technical expertise to meet these needs provided the necessary oversight is built into the program.
CONSIDERATIONS FOR REGULATORY FRAMEWORK
The strawman regulatory framework provided herein highlights areas where regulatory oversight should focus and support third-party investment in infrastructure in South Australia. The key element to regulation in this venue is that it should be enabling and not disabling, and in this way support the Water for Good strategy.
The regulatory environment for third party access must be dynamic yet firmly demand that public health, safety and environmental compliance be paramount considerations. This can be achieved through the adoption of performance-based regulation versus prescriptive regulation. The goals can be furthered by moving from a discrete compliance program to one based on continuous compliance through a combination of financial metrics, condition-based assessments and performance permitting.
Most importantly, regulators must consider the long-term public interest. In some cases this will tend toward traditional regulation. However, in others, new approaches can be more cost effective. For example, some solutions may appear be expensive at the beginning, but can produce significant savings in the long run from reduced maintenance costs.[9] Such options should be encouraged in the regulatory environment.
TENETS OF EFFECTIVE REGULATION
Regulation and regulatory agencies are often seen as impediments to innovation and adaptability. This, however, need not be so. Effective regulation serves to counterbalance the speed and innovation with a set of principles that align the needs of corporations with the goals of society. In this way, effective regulation enables innovation and discourages short-term plans.
Stewart Brand, in the Clock of the Long Now – Time and Responsibility[10], provides several essays on the importance of long term thinking and the value of a considered, balanced approach. These elements have a direct analogy in the regulatory field. It is the job of governance and culture to set the public interest goals, guiding commercial activities, and maintaining the constancy and patience required to see them through[11].
In Brand’s “layers of governance”, each level is allowed to operate at its own pace, safely sustained by the slower levels below and kept invigorated by the livelier levels above. “Every form of civilization is a wise equilibrium between firm substructure and soaring liberty”[12]. With such a perspective, where each layer must respect the different pace of the others, destabilizing positive feedback loops – singularities – can be absorbed and isolated.
Figure 5: Layers of Governance
As with a bicycle wheel, the velocity of each layer increases with increasing radius. But the bicycle wheel remains intact and supports the rider. Carrying the analogy further, if the tire (fashion and commerce) slips on the rim (infrastructure and governance) then the rider supported by the hub (culture and nature) is unlikely to remain upright.
It is with this balance in mind that effective regulation exists. And a culture that embraces the important interrelationships between governance and innovation will succeed. An organizational structure built with due regard to all the layers will be both resilient and successful.
Regulators are often in a position of attempting to “balance the interests of customers and investors”. While tacitly true, this view of regulation has at least five problems, as described by Scott Hempling [13]:
1. Ambiguity. The timescale of the public interest is not defined, and hence is subject to considerable fluctuation and revision. In addition, the customers’ nor the investors’ interests are defined.
2. Nearsightedness. The provision of a regulated service, particularly a utility service, is not a business-customer transaction. It represents the fabric of a society and as such is not a simple transaction. Decisions made by regulators have impacts far beyond the sale of and payment for services.
3. Presumption of conflict. The stated objective of “balance” infers that the public interest of customers and the private interests of investors cannot be aligned. An effective, policy-rich, leadership oriented regulatory environment will drive these elements together to the point where public and private interests are coincident.
4. Passivity. Commissions that lack a clear definition of their goals with respect to the public interests decide issues based on the parties’ positions, not the public interest.
5. Legal looseness. Regulatory proceedings create rights and obligations. Commissions must define the rights and obligations and honour the rights and enforce the obligations.
In order to be effective, the regulatory environment must:
1. Develop a regulatory purpose by:
- Establishing the value judgments necessary for operations – what is the appropriate performance standard? Is environmental sustainability more or less important than economic efficiency?
- Establishing the metrics that demonstrate performance.
- Requiring regulated companies to develop and maintain capital and operational plans that demonstrate the achievement of the public interest goals established by the commission.
2. Identify the regulatory challenges to meet the future public interest.
3. Develop the regulatory infrastructure to meet the need by:
- Providing the commission the authority to act and adapt.
- Demanding the necessary information to ensure the commission has the ability to act.
- Providing the necessary multi-disciplinary, multi-year, strategic thinking capabilities in staff.
- Leading in decision-making and policy development. As noted by Hempling, “reactivity makes regulators captive.”[14]
It is the goal of the regulator to maintain a finger on the pulse of regulated businesses and to provide the structure to ensure that the signs of failure are both noticeable and actionable. A regulator must be able to tell the difference between list and loll[15], to recognize the critical slowing down of systems, and to understand the degradation of stability associated complex systems. In short, the regulator must be capable of determining when a system stands ready to “jump” to a new state of equilibrium.
Figure 6: Characteristic dependence of the equilibrium value N* of the individual number on the relevant parameter B in multiple stable ecosystems. The arrows indicate the direction in which the individual number moves[16].
Figure 7: Method for estimating the proximity to a tipping point. The potential wells represent stable attractors, and the ball, the state of the system. Under gradual forcing (progressing from dark to light blue potential), the right potential well becomes shallower and finally vanishes (threshold), causing the ball to abruptly roll to the left. The curvature of the well is inversely proportional to the system’s response time τ to small perturbations[17].