114427 submission from_nekon_pty_ltd_re_pricing_investigation_principles_and_approach_111012

Price & Service Plan 2012 – 2015
Southern Water
Response from Nekon Pty Ltd
ensuring sustainable, responsible and affordable water delivery for Tasmanians
Prepared 30 September 2011

Price & Service Plan 2012 – 2015, Southern Water Response from Nekon Pty Ltd
ensuring sustainable, responsible and affordable water delivery for Tasmanians
Table of Contents
Executive Summary............................................................................................................. 1
Background ........................................................................................................................ 2
The Situation ................................................................................................................... 2
The Reforms .................................................................................................................... 3
Southern Water................................................................................................................ 5
The Pricing Issue ................................................................................................................. 6
Background...................................................................................................................... 6
Economic Considerations ................................................................................................... 6
A Proposed Solution............................................................................................................. 8
The Theoretical Model ....................................................................................................... 8
Alternative Solutions ......................................................................................................... 9
The Practical Solution...................................................................................................... 10
Tariff Implications........................................................................................................... 11
Bibliography & References .................................................................................................. 15

ensuring sustainable, responsible and affordable water delivery for Tasmanians Page 1
Executive Summary
In formulating this response to the proposed water pricing changes to be implemented
within the areas serviced by Southern Water, a number of issues were considered. An
examination of both the global and national water situation provided the context for a
heightened need to efficiently price water. Effective pricing signals facilitate better water
consumption (demand) and operating (supply) decisions.
The first best economic model of pure marginal cost pricing was also considered. Whilst
impractical to implement within the context of the current Australian and Tasmanian urban
water industry structure, it does provide directional focus. Second best alternatives were
examined with our preference being a move towards taking a long run marginal cost
approach.
Choosing the most appropriate pricing model is complex for a number of reasons including
economic, commercial, social and political issues and priorities, which must be considered at
both regional and national levels. For the immediate future, this submission supports the
move to a two-part pricing mechanism where economic efficiency is maintained through an
emphasis on the variable component, and a minimal fixed charge component. Economic
efficiency is maintained in principle and a nationally aligned pricing system is introduced.
In this light, this submission proposes that the fixed, network access charge be minimised
to:
 Support the allocative efficiency benefits gained through marginal cost pricing (the
variable usage charge),
 Set reasonably tight operational efficiency targets,
 Ensure competitively geared cost management processes are established and
maintained, and
 Achieve pricing alignment at a national level.
The resulting comparatively higher volumetric charge would have a number of positive
effects including the:
 Signalling of the long run consequences of consumer consumption decisions in terms
of infrastructure needs. A higher volumetric charge would provide a greater incentive
to alter water consumption patterns, possibly reducing the need for capacity
expansion.
 Provision of some of the necessary financing for capital expenditure and distribution
of the related costs of this according to consumption.
It is understood that full cost transparency is yet to be achieved, and is a fundamental
requirement for an effective marginal cost pricing model. Similarly, a more informed
response to the Draft Price and Service Plan requires the availability of more data and
access to Southern Water’s operating costs, consumption patterns and other related
information. This submission has raised at least two pricing model alternatives, and
requests Southern Water and the Office of the Tasmanian Economic Regulator to seek
further responses on the proposed pricing model whilst making the following information,
and any other information necessary to make an informed decision, available for the
deliberations:
 More detailed explanation of the numbers driving Southern Water’s Draft Price and
Service Plan
 The provision of serious alternatives from which to select
 Wherever possible, access to the supporting data, calculations and assumptions
 Provision of data and assumptions set upon which to test and propose viable
alternatives.
In the absence of more detailed consumer profile data and a more in-depth understanding
of the scale of consumers requiring transitional tariff arrangements, a commercially viable
alternative is difficult to propose.

By 2050 water forecasters are expecting global water shortages or a
‘gap’ between the supply and demand for water, driven, in a macro
sense, by the increase in population.
Science Alert, Global Water Availability to 2050,
Future Directions International, Thursday 20 January 2011
Background
The Situation
Ultimately, the global water ‘gap’ will be driven by our increased demand for food, including
milk, meat and other high water-usage agricultural products. Within 40 years, the ‘gap’ is
expected to be about 3,000 cubic kilometres of water per annum; equivalent to the annual
flow of three Nile Rivers. Others predict the gap to be around 6,000 cubic kilometres. Whilst
this global water gap will vary regionally, Australia has been identified as having a high
water-stress level.1
While two thirds (2/3) of people on Earth use less than 60 litres of water a day, during
2008/09 Australian household water consumption per capita was 81 KL or 222 litres per
day.2
The graph below shows water consumption per capita for each of the Australian
States/Territories. In 2008-09 Tasmanian householders consumed just under 140 KL per
capita per annum – assuming 2.7 persons per household3
, this equates to 378 KL per
household. The Office of the Tasmanian Economic Regulator recently reported (September
2011) in its Water and Sewerage State of the Industry Report 2009-10 that the average
consumption per connection within Southern Water’s region was 458 KL. However, a lack of
metering in Tasmania’s southern region prevents accurate measurement of consumption in
the area.
Graph 1: Australian Household Water Consumption by State, 2008-09
Source: ABS, 4610.0 - Water Account, Australia, 2008-09
1
Maplecroft, global assessment, November 2010, as reported in Science Alert, Global Water
Availability to 2050, Thursday 20 January 2011
2
ABS, 4610.0 - Water Account, Australia, 2008-09,
http://www.abs.gov.au/AUSSTATS/abs@.nsf/DetailsPage/4610.02008-09?OpenDocument
3
Australian Bureau of Statistics, Census 2006, average household size for Tasmania’s
southern region statistical division 610 & Greater Hobart 605, 2011

Tasmanian householders are the third highest water consumers in Australia. It is also
interesting to note that lower household consumption is evident within the States currently
operating under a two-part pricing scheme, where the variable component is designed to
send the most efficient pricing signals to both suppliers and consumers.
The rising cost of water in Australia is significant. From a national perspective, the ABS
reported a near doubling of the average price of water in 2008-09 with the average price
paid by households being $1.93/kL4. Water increases for 2011-12 are also evident with the
South Australian government approving a 26.3% average increase for consumers of
drinking water5, and similar increases have been announced for Barwon Water (Vic),
Sydney Water, (NSW), Brisbane Water (Qld), Hunter Water (NSW), and South East Water
(Vic).
Regulatory bodies, utilities, irrigators and consumers alike are pushing for reform to
moderate these price increases. Development of a coherent set of national objectives is
critical for Australia's water sector - from the National Water Initiative and beyond. A push
for competitive pricing and pricing regimes that are competitive at a national level are
warranted for a number of reasons including, but not limited to:
 Many businesses and householders span multiple states and territories in their
investments and operations (including property investments, holidays and travel,
living parts of the year in different states due to weather and family considerations,
and the increasing number of grey nomads traversing the nation)
 Water data is becoming more available for the average person
 Competitive pricing at national levels will help ensure monopolistic profit taking and
inefficient cost management practices at an individual utility level are self-regulated
and minimised.
Australia, and specifically Tasmania, is often cited by global water authorities as a leader in
innovation6
, and is the focus of many international studies. However, this recognition is due
to the introduction of a competitive pricing model in the agricultural sector via the water
trading system. On the urban water supply and delivery side, Tasmania is struggling to
meet quality standards, and the pricing system is inherently inefficient. Whilst some regions
within Southern Water’s service area have introduced usage charges, others have not; with
the Hobart metropolitan area currently basing its water charges on property values. The
Tasmanian Water and Sewerage Industry’s 2011-12 Price Determination Investigation and
its Draft Price and Service Plan Guideline, are set to potentially improve the pricing regime
through standardisation, more economically efficient pricing, transparency and fairness.
The Reforms
Reforms are in place to move to a more economically effective, consistent and equitable
pricing model. Guidelines have been provided by Tasmania’s Water and Sewerage Industry
Act 2008, Interim Price Order. Section 68 of the Industry Act includes the following pricing
principles for regulated water and sewerage services:
“…the price is to provide for efficient pricing through a two-part pricing for water
services based on the recovery of fixed costs and variable costs…”,
“…the price is to provide effective incentives to promote economic efficiency,
reduce costs or otherwise improve productivity with respect to a regulated
service…”, and
4
Australia Bureau of Statistics, Water consumption down, water prices up, 4610.0 - Water
Account Australia, 2008-09 Media Release, 2010
5
South Australian Government Regulatory Statement - 2011-12 Drinking Water and
Sewerage Prices, 2011
6
London Economics, Economic Brief: Reform in the Australian urban water sector; the
Productivity Commission Inquiry, April 2011

“…the price charged to a particular customer or class of customers is to reflect
the costs that are directly attributable to the provision of the regulated service to
that customer or class of customers.”.
For Tasmania, urban water reform was the outcome of a review of the challenges facing the
industry; namely, concerns over service levels and asset management coinciding with a
need for major capital investment and predicted price increases. An innovative model was
developed: consolidating 32 local government businesses into three independent water
corporations considered to have sufficient scale to advance performance (shown in Figure 2
below).
Figure 1: Tasmanian water industry
Source: Comparison of Victorian and Tasmanian Urban Water Reform Institutional
Models - Northern Tasmanian Water and Sewerage Reform Program
The upside to reform is significant – it provides a wealth of benefits, stemming from the
consolidation of smaller entities. Duplicated overheads across businesses are eliminated
while the new, large water businesses achieve both economies of scale and attract industry-
leading delivery partners.
The new models rationalise and align tariffs, bringing greater equity to consumers, as well
as central responsibility for price planning for the future. Tariff regulation will help ensure
prices are linked to justifiable costs and are supported by the principle of “user pays”.
Additional benefits to the consumer will include a higher, more transparent level of service –
driven by regulatory frameworks which promote investment into justifiable service
outcomes and reduce the long-term risk of price shock and service interruption.
For any major, wide-ranging reform process there is a trade-off between detailed planning
and execution to ensure an effective change, and achieving this change within a reasonable
cost and timescale.
Hindering the success of the change program in Tasmania has been the management of the
cost impact of reform on consumers and the reluctant relinquishing of individual Council
powers with respective to water and sewerage. The process of asset valuation and transfer
has also exposed a legacy of underinvestment and inadequate system design by some local
governments in their infrastructure, with corresponding upgrade programs needed to bring
the asset base to a sustainable standard.

The clear benefits of industry reform are underpinned by transparency, business
consolidation and tariff rationalisation. Timely and effective planning is crucial to avoid
‘crisis response’ situations – and attempts to unpick a partially completed reform could
prove to be very costly in the long term.
Southern Water
Southern Water was established on 1 July 2009 to deliver water and
wastewater services to the 200,000 residents and businesses of
southern Tasmania. It operates throughout 12 council areas,
including Hobart, Clarence and Glenorchy, Brighton, Central
Highlands, Glamorgan-Spring Bay, Huon Valley, Kingborough,
Derwent Valley, Sorell, Southern Midlands and Tasman. Southern
Water’s vision is to create lasting value for our communities by
providing sustainable water and wastewater solutions. This is being
achieved by improving the economic, environmental and public health
outcomes for all of Southern Water’s customers.

Getting the price for water “right” is increasingly seen as an
important tool for overcoming these problems, and for channelling
the management of this key natural resource in a more sustainable
direction.
The OECD Environment Program 1999-2000
The Price of Water: Trends in OECD Countries
The Pricing Issue
Background
There is widespread international concern that poor water management will be one of the
major limiting factors on sustainability in the new millennium. Water shortages, degrading
water quality and the lack of competitiveness of water-intensive economic production are all
pushing water management issues higher on the international agenda.
Natural monopolies arise in industries such as water supply because the relatively high
capital investment required creates natural barriers to entry. Further, the entrenched owner
is able to capitalise on economies of scale and scope, producing at a lower cost than
potential new entrants. Thus larger, single operators are theoretically more profitable and
efficient than multiple smaller operators.
Originally, utilities, such as water, were privately operated. Concerns arose when it was
deemed that monopolistic profit taking by the private sector undermined our constitutional
right to water. Section 100 of the Australian Constitution guarantees the right to water by
all Australians, where the Commonwealth shall not give preference,
“…nor abridge right to use water
The Commonwealth shall not, by any law or regulation of trade or commerce,
abridge the right of a State or of the residents therein to the reasonable use
of the waters of rivers for conservation or irrigation.”
Nationalisation of key industry assets, such as electricity, gas, and airlines began after
World War Two. However, this was short lived, as concerns quickly arose around public
ownership inefficiencies resulting in price distortions and deteriorating assets. Private
industry was, and is currently considered, ultimately better positioned to deliver cost
efficiencies, service improvements and investment.
Economic Considerations
In a democratic and market economy such as Australia’s, the creation of a fair and equitable
pricing regime, is best achieved through the application of economic principles and
competitive markets. It is important to note that economic efficiency does not just extend
to the costs of delivering water services, but is inherently dependent upon the correct
signals being given to consumers through efficient pricing mechanisms. Prices signal the
cost of providing the services, and allow consumers to evaluate consumption decisions.
Where prices do not reflect the true cost of water services, decisions regarding consumption
are distorted and resources will more than likely be inefficiently allocated – creating a
similar situation to that which Tasmania is currently experiencing.
Choosing the most appropriate pricing model is complex for a number of reasons:
 A theoretically perfect pricing model is inherently doomed due to the current, and
forecast worsening of, the water ‘gap’ – where Demand exceeds Supply at a global
level.
 The economic basis of water pricing is that the supplier must be able to recover all of
its costs including operations, maintenance, investment, opportunity costs such as

greenhouse gas emissions and water scarcity, and benefits such as improved health
and standards of living due to higher quality potable water.
 Economic efficiency demands that prices are set at marginal cost. Under marginal
cost pricing, price is set to recover the cost of supplying an extra unit of water for a
given level of infrastructure. In capital intensive industries such as water storage and
supply, the utility will not generate sufficient revenue to cover costs.
 True costs of supply and delivery are not known, or not transparently communicated.
Nor are they effectively separated throughout the industry’s vertically integrated
supply chain.
 The Tasmanian water industry is suffering from historical under-investment which
requires capital intensive works programs to bring the assets up to Australian
standards.
 In Australia, urban water pricing considerations also include sewerage and drainage
costs (horizontal integration).
 Water storage and supply has limited capacity with very lumpy capacity expansion
patterns.
 The regulator must ensure the presence of pricing equity; balancing the needs of low
income groups against those of the financial sustainability of the supplier.
 Marginal costs are typically not stable in the short run, experiencing significant
fluctuations in price depending upon available capacity and supply. A sawtooth, or
factory roof pattern is often used to describe this characteristic. Short run marginal
costs fall to zero following each extension of capacity and then rise to full cost as
capacity becomes exhausted, new investment is installed and short run marginal
costs fall to zero fall to zero once again. Alternatively, prices are pushed upwards
when supply is cut short such as during a drought, and may fall to zero during floods
(assuming capacity is not exhausted).
 Any change initiative requires significant effort to gain support amongst the
community. There will be winners and losers in any scenario, and these people also
significantly impact our political environment, and thus the industry regulators.
How then, is an appropriate pricing model for a water business selected? Criteria designed
to assist in the evaluation of an appropriate pricing model are:
 Allocative efficiency – society gets the greatest return form its scarce resources by
putting those resources to their most productive use in the economy. This is
achieved when consumption and production decisions are based on prices that reflect
the opportunity cost of the available resources, and consists of both Demand and
Supply efficiencies.
o Demand efficiency when users are charged no more or no less than it costs to
produce the unit of service to them
o Supply efficiency (revenue adequacy)when producers are able to recover
sufficient cost to sustain the provision of the services required
 Productive or technical efficiency – where goods and services are produced at
minimum cost given the available technology.
 Dynamic efficiency – optimising the allocation of resources over time, including
generating additional resources, to maximise overall benefits to society. An example
is finding better ways to produce or deliver goods and services.
 Based on a solid theoretical foundation.
 Fair and objective.
 Price stability should be supported.
 Transparent and reliable.
 Practical and understandable.
 Flexible – can be applied to different circumstances and yield different outcomes for
different groups.

A Proposed Solution
The Theoretical Model
According to standard economic theory, prices should be set at marginal cost (MC) since, in
the absence of externalities, this maximises economic welfare. This is because such prices
reflect the costs involved in providing an additional amount of output. Where the user
values an extra unit more than it would cost to produce it, it is economically efficient to
produce that unit, and vice versa. Setting prices equal to marginal cost means that users
will continue purchasing extra units until it is no longer economically efficient to produce
them at that price. Marginal cost based pricing therefore send signals to consumers and
producers encouraging them to balance the benefits obtained by consuming a good or
service with the costs of providing it.
Under a strict Marginal Cost pricing model, the price of water is its short-run marginal
operating cost. This assumes that capacity (supply, storage or water availability) is in
excess of demand and that distribution (supply delivery) is available, as and when
demanded. Price may equal zero when the existing supply ‘safely’ exceeds demand. Price
will rise as supply is reduced to meet a rising level of demand. The applicable marginal costs
consist of those additional costs incurred in operating and distributing the amount of water
demanded. Once demand increases to the point of capacity, price will increase vertically
until demand is reduced, or consumers are willing to pay for the additional investment
required to increase capacity. This situation is shown in Graph 3 (as adapted from Efficient
Urban Water Pricing, by Professor Hugh Sibly, School of Economics and Finance, University
of Tasmania, The Australian Economic Review, vol 39, no 2, pp227-237).
Graph 2: Adding Extra Capacity, Marginal Cost Pricing Model
S1 = current supply as
constrained by capacity.
Where Supply (S1) exceeds
Demand (D1), the efficient
market price is pe.
Price pc is the price where
capacity is reached. At
capacity, any increases in
demand will significantly
increase price.
Once capacity is added (refer
green S2 line), an efficient
market is again restored with
supply exceeding demand
(D2), and price retreating
back to p3.
Several issues arise when applying this perfect theoretical model to practical urban utilities,
including:
 The fact that on a global basis demand exceeds supply and Australia is considered to
have a relatively high water stress level (primarily due to the fact that we produce
93% of our own food, export food to other countries, population growth, continued
urbanisation, and lack of effective water consumption education and pricing signals).
 The true cost of utility operations and delivery is unknown or not publicly available.
 In Tasmania, urban water pricing includes sewerage, with drainage remaining with
the Councils.
 Equity and fairness must be maintained for social and political purposes.
S1 S2
D1
pe

 Equity and fairness should be considered at a national level, thereby promoting
competition at a national level amongst the regional utilities.
 Monopolistic pricing must not be seen to be exerted.
 Tasmania’s current water industry has been under capitalised.
 Tasmania has a ready supply of fresh water, relinquishing the high cost need for
desalination, yet still requiring suitable harvesting and reticulation systems.
Whilst the ‘first best’ solution is to set price equal to marginal cost to achieve allocative
efficiency, when dealing with a natural monopoly or networked/reticulated business such as
water, the utility will not make sufficient revenue to recover its fixed costs (because average
cost is below marginal cost). Ultimately, efficient pricing signals are not being provided to
consumers and utilities may not be sustainably compensated for operating and delivery
costs; issues achieving both allocative efficiency and revenue adequacy arise.
Alternative Solutions
Adaptions made to the theoretical model have been proposed to overcome the above
mentioned shortcomings. It is worth noting, that there is no ideal, and the best move at this
point in time is to take some action towards implementing an efficient market model and
adjusting it as required.
In situations where Marginal Cost is less than Average Cost and the utility needs to recoup
its operating costs via a sustainable pricing mechanism, Sibly (2006) advocates the use of a
fixed charge related to property values (as a proxy for the consumer’s ability to pay).
However, this is not to say that water charges should reflect property values in their
entirety; rather it is a suggested second best solution to recovering operating costs via a
fixed charge when the ideally efficient Marginal Cost priced variable charge will not.
The introduction of a fixed or lump sum charge has been suggested to compensate the
water utilities for the difference between their Average Cost and Marginal Cost, thereby
ensuring they are financially sustainable. Rather than subsidies and taxation, which Coase
(1946 as quoted by Altmann, 2007, p9) considers distortionary, a fixed charge covering the
cost of the network connection is recommended. A volumetric charge set at marginal cost
maintains economic efficiency with the fixed charge filling the shortfall.
Australia’s economic regulators tend to support Coase’s two part pricing proposition. Moving
forward, the Tasmanian legislation stipulates a, “…two-part pricing for water services based
on the recovery of fixed costs and variable costs…”7
.
It has been further suggested that both volume consumed and distribution were variable
costs: volume according to usage, and distribution by network distance.8
Another alternative is to use Long Run Marginal Cost, which effectively brings forward
investment (capital works programs) by ‘budgeting’ for it now. Long run marginal cost
pricing includes costs related to scarcity, negative and positive externalities, and planned
supply investment requirements. Turvey (quoted in Altmann, 2007) defines long run
marginal cost of water supply as the sum of marginal capacity costs, marginal operating
costs, marginal distribution costs and per connection overhead costs. Whilst including
marginal capacity costs differs from conventional economic theory, it was argued that
commitments to expand capacity are made years in advance to their implementation. Hence
the variable is not the incremental expenditure, but rather the timing. It was shown that a
one year change in commissioning new capacity can have a significant marginal cost
impact. The UK Office of Water and the Essential Services Commission in Victoria have both
employed this concept of marginal cost pricing in their business models.
7
Section 68: Pricing principles, Water and Sewerage Industry Act 2008,Tasmania, 2011
8
Vickrey, W.S. Some implications of marginal cost pricing for public utilities. American
Economic Review, 45(5): 605-620, 1955.

A mix of both Long Run (LRMC) and Short Run Marginal Cost (SRMC) pricing has also been
suggested where price is set at the higher of either the LRMC or SRMC. Effectively, when
supply exceeds demand and capacity is at safe limits, SRMC is used; in times of drought or
when capacity limits are reached, LRMC is applied. Whilst such a proposition supports
revenue adequacy, it requires a relatively high degree of administrative flexibility and
community communication. Given the current economic climate, price increases and price
stability are sensitive issues for water users.
North American water suppliers use the Average Incremental Cost approach in price setting.
This is the additional cost per unit of additional consumption when both additional annual
costs and consumption are expressed as the present value of their flows. The benefit of
averaging costs is the achievement of price stability. Again, this is a volumetric pricing
model, but less attractive in allocative terms than marginal cost approaches and is highly
dependent on the underlying discount rates applied.
The Practical Solution
Selecting an appropriate pricing mechanism for water utilities is complex and requires the
quantification and balancing of many variables including tariff price, fixed and variable
costs, network and infrastructure costs, supply and demand constraints, political agendas,
social goals, community expectations, regulatory frameworks, and asset quality. For
Southern Water, this is further complicated by the need to achieve operating efficiencies,
equitable pricing and improved transparency from the recent merging of the water
operations of 11 different Council areas. All this, in the absence of a competitive water
market, could result in a game of blind’s man bluff.
From a purest perspective, economic efficiency within the water industry is unattainable in
the current environment. We need to work with a ‘first best’ or ‘second best’ solution.
The ‘first best’ model is one based on marginal cost pricing, as it is this that best achieves
allocative efficiency and supports movement towards productive and dynamic efficiency
gains. It is also based in sound economic theory, provides the basis for transparent and fair
pricing, and facilitates price flexibility. The difficulties arise in price stability and
understanding the true costs that need to be included. Another key difficulty is ensuring
allocative efficiency within a monopolistic networked environment that is highly regulated
and vertically and horizontally integrated.
Given the current state of the State’s water assets and relatively significant quality issues,
there is an immediate need to invest in capacity building and examine ways to better
improve our dynamic and productive efficiency levels. By raising the marginal cost to
include long run variables, capacity building is expedited whilst maintaining economic
efficiency. Recognising the potential shortfall in recouping operating costs, it is
acknowledged that a fixed charge – or network access charge – may be required. This
submission proposes that this fixed, network access charge be minimised to:
 Support the allocative efficiency benefits gained through marginal cost pricing (the
variable usage charge),
 Set reasonably tight operational efficiency targets,
 Ensure competitively geared cost management processes are established and
maintained, and
 Achieve pricing alignment at a national level.
The resulting comparatively higher volumetric charge would have a number of positive
effects including the:
 Signalling of the long run consequences of consumer consumption decisions in terms
of infrastructure needs. A higher volumetric charge would provide a greater incentive
to alter water consumption patterns, possibly reducing the need for capacity
expansion.
 Provision of some of the necessary financing for capital expenditure and distribution
of the related costs of this according to consumption.

Ultimately, higher volumetric charges (with lower fixed charges) allow households and other
consumers to better manage their water bills through conscious decisions regarding the
volume of water consumed. A single or two person household – such as a retiree – who
might typically only consume approximately 60 to 100 KL water per annum, will no longer
be charged the same as a 4 to 5 person household which may consume at least twice as
much water as the retiree. Similarly, water conscious family households have a greater
ability to reduce their water bills through changing consumption habits.
In the medium term, continued research and development into water industry technologies,
and supply and delivery alternatives is strongly supported. Longer term, an unbundling of
price signals for new water sources from the cost of delivery, and retailing, infrastructure is
also supported.
For the immediate future, this submission supports the move to a two-part pricing
mechanism where economic efficiency is maintained through an emphasis on the variable
component, and a minimal fixed charge component. Economic efficiency is maintained in
principle and a nationally aligned pricing system is introduced.
Tariff Implications
It is understood that full cost transparency is yet to be achieved, and is a fundamental
requirement for an effective marginal cost pricing model. Similarly, a more informed
response to the Draft Price and Service Plan requires the availability of more data and
access to Southern Water’s operating costs, consumption patterns and other related
information. An alternative to consider is based on average estimation with guidelines and
data sourced from:
 Tasmanian Water and Sewerage Industry, Pricing Principles
 Tasmanian Water and Sewerage Industry, 2011-12 Price Determination
Investigation, Draft Price and Service Plan Guideline
 Tasmanian Water & Sewerage State of the Industry Report 2009-10
 Southern Water’s Price and Service Plan Summary 2012-2015
 Southern Water’s Annual Report 2009-2010
 National Water Commission’s Review of Pricing Reform in the Australian Water
Sector 2011
 Australian Bureau of Statistics’ Census data and Water Accounts
 Pricing strategies of selected Australian water industry participants:
o Hunter Water, New South Wales,
o Sydney Water, New South Wales,
o South East Water, Victoria,
o Barwon Water Victoria,
o SA Water, South Australia, and
o Brisbane Water, Queensland.
Table 1 shows a comparison of pricing strategies across the selected water utilities for
standard users.
Table 1: Water Utility Pricing Comparison
Source: various utility pricing fact sheets 2010-2011
Urban Water Pricing Comparisons
Residential Non-Resi Resi 1
Business Resi Non-Resi Resi 2
Non-Resi2
Resi
Non-
Resi
Resi 3
Non-Resi3
Resi Non-Resi
Fixed Service Charge, $
Fixed Water per 20mm 272.32 272.32 18.84 18.84 144.82 144.82 82.44 82.44 150.63 150.63 234.60 273.00 167.16 167.16
Fixed Water 100mm 6,808.00 6,808.00 471.12 3,619.82 3,619.82
Fixed Sewerage diameter 20 mm (or 1 tenement) 488.71 488.71 521.25 1,042.50 539.54 539.54 335.68 398.64 499.59 302.64 325.00 325.00 475.92 475.92
Fixed Sewerage diameter 100mm (or 5 tenements) 2,443.55 2,443.55 26,062.50 13,488.50 13,488.50
Volumetric
Variable Sewerage per KL 0.65 1.71 1.71 1.53 1.69
$ / KL 0.90 0.90 1.90 1.90 2.10 2.10 1.75 2.13 1.98 1.98 1.93 2.13 0.67 0.79
Plan FY13 Water Charges, 2010-2011
SA Water (SA)
Brisbane Water
(QLD)
Hunter Water
(NSW)
Sydney Water (NSW)
South East Water
(Vic)
Barwon Water
(Vic)
Sthn Water

Table 1 shows that Southern Water’s pricing plan, as compared to other industry
participants, is relatively highly geared towards maximising the Fixed Costs with a minimal
Variable Usage charge. National alignment and a higher variable component to that
proposed by Southern Water is achieved through the application of an average approach to
the pricing structure.
Table 2 offers an alternative consideration where the variable water usage rate is increased
from $0.90KL to $1.72 or $1.84KL and the fixed water charge if reduced (for a 20mm
connection) from $272.32 to $133.08. In the absence of key underlying data from Southern
Water, both economic theory and the pricing strategies of other Australian water utilities
suggest more efficient pricing signals will be given to both consumers and the utility (under
this alternative pricing model).
Table 2: Alternative Pricing Model for Consideration - Average Tariffs
Source: Southern Water’s Draft Price and Service Plan 2012-2015 Summary,
averages derived from pricing information sheets published by the selected
utilities
Applying these figures to Southern Water reveals that revenue requirements are also
maintained.
Table 3: Revenue Requirements, Southern Water
Source: base data from Southern Water Annual Report 2009-2010
Based on Southern Water’s 2009-10 total revenue of $101,879,000 a forecast required
revenue for 2012-13 assuming 3% annual growth over the 3 years to 2012-13 yields a
required revenue of approximately $111,326,000. Separating this into Water and Sewerage
Urban Water Pricing Comparisons
Residential Non-Resi Residential Non-Resi
Fixed Service Charge, $
Fixed Water per 20mm 272.32 272.32 133.08 139.48
Fixed Water 100mm 6,808.00 6,808.00
Fixed Sewerage diameter 20 mm (or 1 tenement) 488.71 488.71 449.50 514.04
Fixed Sewerage diameter 100mm (or 5 tenements) 2,443.55 2,443.55
Volumetric
Variable Sewerage per KL 1.35
$ / KL 0.90 0.90 1.72 1.84
Plan FY13
AVERAGESthn Water
Southern Water's Requirements
Connections
Number
(2009-10)
Revenue
(2009-10)
avge rev per
connex
(2009-10)
Revenue
Required
(2009-10) % Revenue
Sales
Revenue
forecast
20012-13
(3% growth
pa)
Connections
Number
(2012-13)
avge rev /
connex
(2012-13)
TOTAL 101,879,000 111,325,934
Water 98,385 51,933,000 527.85 51,933,000 51% 56,748,591 98,385 576.80
Sewerage 90,241 44,974,000 498.38 44,974,000 44% 49,144,304 90,241 544.59
Other (Irrigation, Regates, Fees) 4,972,000 5%
expected water supplied, ML 43,600
Water Revenue, Residential 75% based on revenue breakbrown for Hunter Water 42,561,443 89,597 475.03
Water Revenue, Non residential 25% NB: Frontier economics Resi=60 to 70%, Industrial = 10%, 14,187,148 8,788 1,614.38
Number of households (ABS data 2006) commercial = 20 to 30% 89,597

revenues and dividing by the number of connections gives an average revenue per water
connection of $576.80 and $544.59 for sewerage for 2012-13.
Applying a 75% split for Residential and 25% for Non-residential water consumption, results
in an average revenue per connection of $475.03 for residential and $1,614.38 for non-
residential.
Applying the ratio of 60% fixed and 40% variable as detailed in Southern Water’s Annual
Report 2009-2010 to the proposed ‘average’ tariff structure of Fixed Water Charge = $135
and Variable Charge = $1.84 KL, shows that Southern Water’s revenue requirement is
exceeded (Table 4). So as not to unduly exceed revenue requirements, the fixed charge
could be reduced even more. At the very least, further investigation and modelling are
required to identify a more “ideal” pricing scheme or selection of pricing alternatives.
Table 4: Proposed Pricing Impact, per Residential & Non-Residential User
Residential Non-Residential
Required Proposed Avge Required Proposed Avge
Water only TOTAL $475.03 $546.18 $1,614.38 $2,505.89
$KL $1.84 $1.84
Fixed, $ $135 $540
A figure of 60% Fixed and 40% Variable has been communicated as an estimation of the
split within Southern Water’s pricing model. However, another view of the available data
suggests this may be more along the lines of 47% Fixed and 53% Variable; again it is
recognised that figures are derived from averages and slightly misaligned time periods. This
was derived by taking the average revenue per water connection for 2012-13 of $576.80
less $272.32 (47%) for a standard fixed charge, yielding $304.48 (53%) for variable
charges.
Further dividing the variable component of $304.48 by the $0.90 charge per KL suggests an
average consumption rate of 338 KL per annum. This average differs from that proposed in
Southern Water’s Draft Price and Service Plan 2012-2015 Summary, Example 1 of 200 KL
per annum for standard residential customers and, Example 4 suggests a medium sized
non-residential customer consumes 800KL per annum. The recently released State of the
Industry report suggests another average consumption figure of “…458 KL for the southern
region”9
. Again, averages could be taken and further assumptions made.
A meaningful response to the proposed pricing strategy demands more than these relatively
high level assumptions and averages.
It is acknowledged that residential water consumption prices will increase. However, by
giving greater emphasis to the volumetric charge than currently allowed, consumers – most
particularly, householders – are given some degree of control over the extent to which they
will be affected since they can alter their water consumption patterns. Tables 5a-b show
that an alternative pricing scheme with a lower fixed charge and higher volumetric charge
will deliver Southern Water’s revenue requirement of $613 per household (based on an
average household consumption of 378 KL per annum10
).
9
The Office of the Tasmanian Economic Regulator, Tasmanian Water and Sewerage State of
the Industry Report 2009-10, p 39, 2011
10
ABS, 4610.0 Water Account, Australia, 2008-09 & Census Data (2006) profiles for
Statistical Divisions 605 & 610, 2011

Table 5a: Constant Revenue to Southern Water (water only)
Table 5b: Pricing Assumptions (water only)
Table 5b shows the Fixed Charge as being reverse engineered down from $272.32 to $84
(similar to that charged by South East Water, Victoria) and the variable charge increased
from $0.90 to $1.40 per KL. Southern Water’s revenue of $613 is maintained. This
alternative model, better supports economic efficiency and consumers’ freedom in deciding
the quantity of water they consume.
It is recognised that Table 5b provides yet another alternative to the “average” model
presented earlier in Tables 2 and 4. In the absence of more detailed consumer profile data
and a more in-depth understanding of the scale of consumers requiring transitional tariff
arrangements, a commercially viable alternative is difficult to propose. In formulating a
sensible response, Southern Water and the Office of the Tasmanian Economic Regulator is
requested to seek further responses on the proposed pricing model whilst making the
following information, and any other information necessary to make an informed decision,
available for the deliberations:
 More detailed explanation of the numbers driving Southern Water’s Draft Price and
Service Plan
 The provision of serious alternatives from which to select
 Wherever possible, access to the supporting data, calculations and assumptions
 Provision of data and assumptions set upon which to test and propose viable
alternatives.
SW's Draft
Pricing Plan
Proposed
Alternative
Type of Household average average
Household consumption, KL 378 378
Variable Charge 340$ 529$
Fixed Charge 272$ 84$
TOTAL WATER (ex sewerage) 613$ 613$
SW Draft
Pricing Plan
2012/13
Proposed
Alternative
Fixed Water, 20 mm connection ($) 272.32 84.00
Volumetric Charge, Water ($KL) 0.90 1.40
Fixed Sewerage, per 1 ET($) 488.71 481.77

Bibliography & References
Annual Reports for Sydney Water, Hunter Water, Barwon Water, South East Water, SA
Water and Brisbane Water
Australian Bureau of Statistics, various National Regional Profiles (1379.0.55.001), 2011
Australian Bureau of Statistics, Water consumption down, water prices up, 4610.0 - Water
Account Australia, 2008-09 Media Release, 2010
Australian Bureau of Statistics, Water Account (4610.0), 2011
Australian Government, Urban water in Australia: Future directions, National Water
Commission, 2011
Allen’s Arthur Robinson, Summary of Productivity Commission reports on Australia’s urban
water sector, url:www.aar.com.au/pubs/water/fowmay11.thm, 2011
Altmann, D. Marinal cost water pricing: Welfare effects and policy implications using
minimum cost and benchmarking models with case studies from Australia and Asia, Doctor
of Philosophy Thesis submission, University of Adelaide, School of Economics, 2007.
Coase, R. The marginal cost controversy, Economica, 13(8): 169-189, 1946.
Deloitte/AWA, State of the water sector 2010-15: Preliminary report, 2010
Economic regulation of the South Australian Water Industry, Statement of Issues, The
Essential Services Commission of South Australia, 2010.
Ernst & Young, Spotlight on water,
Frontier Economics, Approaches to urban water pricing, Waterlines Occasional Paper, no.7,
2008
Hughes, N., Hafi, A., Goesch, T., Brownlowe, N. Urban water management: Optimal price
and investment policy under uncertainty, Australian Bureau of Agricultural and Resource
Economics Canberra Conference, 2008
London Economics, Economic Brief: Reform in the Australian urban water sector; the
Productivity Commission Inquiry, April 2011
OECD, The price of water: Trends in OECD countries, The OECD Environment Program
1999-2000,
PriceWaterhouseCoopers, Infrastructure Australia: Review of urban water security
strategies, 2010
Pricing fact sheets and publications for Sydney Water, Hunter Water, Barwon Water, South
East Water, SA Water and Brisbane Water
Roberts, R., Mitchell, N., Douglas, J. Water and Australia’s economic growth,
Sibly, H. Efficient urban water pricing, The Australian Economic Review, 39(2):227-237,
2006
Sibly, H. Urban water pricing, Agenda, 13(1):17-30, 2006.
South Australian Government Regulatory Statement - 2011-12 Drinking Water and
Sewerage Prices, 2011

Office of the Tasmanian Economic Regulator, Water and Sewerage State of the Industry
Report 2009-10, 2011
Office of the Tasmania Economic Regulator, Tasmanian Water and Sewerage Industry 2011-
12 Price Determination Investigation Draft Price and Service Plan Guideline, 2011
Southern Water, Draft Price and Service Plan 2012-15 Summary, 2011
The Allen Consulting Group, Urban water: A vision and roadmap for national progress, Gap
Forum on Urban Water, 2009
Turvey, R. Analysing the marginal cost of water supply, Land Economics,158-168, 1976
52(2):
Vickrey, W.S. Some implications of marginal cost pricing for public utilities. American
Economic Review, 45(5): 605-620, 1955.
Water and Sewerage Industry Act, Section 68: Pricing principles, 2008. url:
http://www.thelaw.tas.gov.au/tocview/index.w3p;cond=;doc_id=13%2B%2B2008%2BAT%
40EN%2B20090623150000;histon=;prompt=;rec=;term=

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