Water Journal : Water Journal December 2013
WATER DECEMBER 2013 38 Feature Article WHY COST-REFLECTIVE PRICING IS IMPORTANT At its core, the proposition is that the community must know what is the true cost of the service with which they are being provided. This is not to say that they must pay the full cost, just that these costs should be transparent. There are compelling public policy reasons that may support a price lower than the true cost being paid; however, these reasons should be explicit and their value capable of justi cation. It is a fallacy to believe that increased costs around service provision can be prevented by constraining water prices. This practise merely conceals the issue and inhibits ef cient decision- making by obfuscating the facts upon which decisions are made. Hiding the cost does not make it go away! If prices are less than the cost of the provision of the service then inevitably this 'structural de cit' will result in either the unsustainability of the service provider or, as is normally the case, the provision of external nancial support. As was clearly recognised by COAG, such external nancial support had commonly been provided by way of: • Equity investments by government and local government owners -- as these investments are made to cover operating losses they generally do not meet the characteristics that most people would use to de ne an investment, as they are not likely to generate a return. • Cross-subsidisation -- this is where the costs are smeared over a broader base, with users paying an averaged price -- some paying more than the actual cost of the service provision, while others pay less. There are competing equity arguments around the ef cacy of such practices that are beyond the scope of this paper. The point is that such practises should be justi ed, with their existence being known and their rationale transparent. Cost-re ective pricing is important for the best allocation of resources across the community. A lack of clarity around the cost of the provision of a service will inevitably distort future investment decisions, with the cost of the attendant errors requiring payment -- ultimately by the customer (normally the community). Take, for example, a decision to augment a water supply when prices have been suppressed beneath the point of long-run cost recovery -- the true demand for that service is unknown. It is possible that if it was priced in alignment with its true cost the forecast future demand, upon which investment decisions to augment supply were based, would not require augmentation. The work that was initiated some 20 years ago that was encapsulated into the NWI was predicated upon sound business principles. It is inevitable in an environment of increasing prices that pressure is brought to bear to keep prices as low as possible; however, this should not be misunderstood as some form of justi cation for the introduction of poor business practises. The true cost of the provision of water services can be minimised by robust planning, ef cient operation and also through the utilisation of improved nancing models. Concealing the cost will only result in the cost being transferred elsewhere -- not in any savings. Should subsidies be warranted, their existence and value should be explicit. The provision of such subsidies (such as Community Service Obligations) is not inconsistent with the principle of full cost recovery; indeed, it is just an example of the sensible and balanced implementation of such policies. IMPLEMENTATION OF THE REFORM AGENDA There has been limited response from governments to the urban water reform recommendations made by the Productivity Commission, the National Water Commission and Infrastructure Australia in their respective reviews over two years ago. At present the NWC has commenced its engagement with NWI parties, Australian Government agencies, industry stakeholders (including AWA) and the public to gather information and evidence to inform the 2014 NWI Triennial Assessment. CONCLUSION AWA has previously submitted that full cost-re ective pricing is critical if economically ef cient allocation of water resources and investment in them is to be made. It has acknowledged that this principle is not inconsistent with the delivery of stated social objectives that may be delivered through subsidisation of water prices, but where this occurs all subsidies should be transparent and bounded. The merits of cost-re ective pricing in the urban water industry are as compelling today as they were in the 1990s, as has been af rmed by the conclusions of the successive investigations completed in recent years by the Productivity Commission, the National Water Commission and Infrastructure Australia. The 2014 Triennial Assessment process of the NWI can serve as an opportunity to recommit to the attainment of this policy imperative. This opportunity should be seized to ensure the momentum of the change agenda that has been (only) partially implemented is not lost. Charles Darwin observed that it is not the strongest of the species that survives, nor the most intelligent -- it is the one that is the most adaptable to change. We submit that change unguided by objective is inef cient. The sustained implementation of change over the long term guided by strong policy objectives represents the preferred pathway for the optimal evolution of the urban water industry. In seeking to guide micro economic reform, the NWI correctly identi ed cost-re ective pricing as a necessary platform upon which urban water industry could realise ef ciencies. It is hoped that the current review can leverage on the strengths of earlier work, to recalibrate the vision to accommodate contemporary drivers, but then to re-energise momentum within the industry to the attainment of this objective for the delivery of long-term ef ciency gains. WJ THE AUTHORS Jim Grayson (email: email@example.com) is CEO at Gladstone Area Water Board, Director at WSAA, and Chair of the AWA Water Management Law and Policy (WMLP) Specialist Network Committee. Erin Cini (email: firstname.lastname@example.org) is Director at Element Solutions and a member of the AWA WMLP Committee. REFERENCES AECOM (2010): Review of Regional Water Quality & Security. Infrastructure Australia. Council of Australian Governments (1994): The Council of Australian Governments' Water Reform Framework. Environment Australia, Canberra. Council of Australian Governments (2004): Intergovernmental Agreement on a National Water Initiative. COAG. Council of Australian Governments (2008): COAG Work Program on Water -- November 2008 -- Agreed Actions. COAG. Council of Australian Governments (2010): NWI Pricing Principles. COAG. National Water Commission (2011a): Review of Pricing Reform in the Australian Water Sector. April 2011. National Water Commission. Canberra. National Water Commission (2011b): Urban Water in Australia: Future Directions. April 2011. National Water Commission, Canberra. Productivity Commission (2011): Australia's Urban Water Sector. Productivity Commission, Canberra.
Water Journal November 2013
Water Journal February 2014