Driving sustainable water management through pricing and governance

Most Australians are familiar with the Bunnings Warehouse jingle – "lowest prices are just the beginning" – unfortunately, it’s not as simple for water utilities which must do much more to provide not only value for money but also ensure long-term sustainability.

While freshwater falls from the sky, there is a myriad of processes involved in making sure the water delivered to homes is safe to drink directly from the tap and that wastewater is disposed of in a safe and environmentally responsible manner.

Water is an essential resource and vital to human life. As such, water is costed to be relatively cheap (and Australians are lucky to have safe, clean drinking water in the majority of cases). However, there are many things to consider when pricing water. While water may fall from the sky, there are also sky-high capital expenditure costs to setup the reservoirs, pipes and treatments facilities.

In Australia, we have come a long way within the water sector. In my hometown of Melbourne, we have gone from beer being the safer option to rehydrate compared to then industry-contaminated water from the Yarra River, to having world-class catchment management, including restricted access to pristine sources resulting in minimum treatment required.

Securing safe water supplies was achieved initially through an ambitious government in the late 1800s which kickstarted water infrastructure through government debt and recovery from rates imposed for water supply and sewerage on properties. These rates for water and sewerage then became the basis of our water bills today.

Borrowing on from the Ozwater’25 theme of 'looking back, moving forward', there are also upcoming challenges with climate change and increasing volatility of extreme weather events.

We will have to not only deal with the increasing extremes of wet/dry periods and increased average temperatures but consider how to adequately price this into economic regulatory framework.

We can no longer rely on water falling from the sky but will have to rely more extensively on manufactured water, whether it be from desalination, recycled water or some alternative form – and with it, increased expenses to treat such water.

From the sustainability and equity point of view, we will also have to price water to be fair and reasonable but also ensure there is sufficient investment to allow for asset renewal and overcome challenges.

This includes water utilities needing to decide on whether to invest with a “just-in-time” mindset or perhaps smooth out cost recovery by beginning the process early to ensure intergenerational equity for current and future customers.

Water utilities also need to respond to customer expectations that water and sewerage “just works” every time we turn on a tap or flush the toilets – but how much redundancy do you build in before it is classified as gold plating?

Similarly for ageing assets, apart from deciding on when and how to recover costs from customers for asset renewals, there is also the question of the timing of renewals considering the high capital expenditure required.

How the pricing system works

Before considering pricing principles, governance structures for water utilities need to be addressed, as this influences the methodology for how customers are charged.

Around the world, there are many ways for water utilities to be financially structured, including being privately owned, franchised but publicly owned, or government owned but not necessarily operated.

In Australia, the majority of water utilities are government-owned and usually as a state-owned corporation or operated by local councils. While state-owned corporations can issue separate water bills solely focused on water and sewerage services, local councils may choose to incorporate their services into property rates instead.

For Victoria, all the water utilities are state-owned corporations with the current pricing framework evolving from being rates based on property value to being reflective of the actual cost of delivery of water and sewerage services.

To ensure value for Victorians, the maximum price allowed to be charged by the water corporations are determined by the Essential Services Commission (ESC) which is the independent economic regulator.

All Victorian water corporations must undergo a vigorous price submission process with the ESC where the main determining factor is not only the cheapest price possible but that customers get the maximum value possible for their bills.

The ESC reviews whether the proposed expenditure by the water corporation is prudent and efficient and applies what is known as the building block model.

The building block model is a common form of economic regulation in Australia and, as the name implies, it determines the maximum revenue (or revenue requirement) a utility can earn through building blocks, which takes into consideration:

• Return on capital
• Regulatory depreciation
• Operating expenditure
• Tax equivalent
• Any incentive mechanisms set by the regulator

The ESC also utilises a concurrent unique framework called PREMO (Performance, Risk, Engagement, Management and Outcomes) for assessing the price submissions from the water sector.

Water corporations are encouraged and assessed by the ESC on their engagement with customers (including testing willingness-to-pay initiatives) and their track record for delivery of past commitments, among other considerations.

What is actually in a water bill

Looking into the nitty gritty of a Victorian water bill, this is usually split between a fixed charge and a variable usage charge.

If you look closer, you may notice that the fixed charge is actually a significant portion of the bill compared to the usage charge – this is because the water isn’t the expensive component, it’s the infrastructure that processes and transports the water to the property. This includes dams, treatment plants and pipes, along with investment in health and environmental standards.

However, when designing a tariff, it is not as simple as identifying the revenue required and retrofitting a tariff in. There are additional elements to consider, including the appropriate ratio between fixed versus usage charge.

In Victoria, the usage charge is utilised (and sometimes split into tiers) rather than one simple fixed charge to ensure the value of water is captured and to promote water efficiency.

However, it is also balanced with the fixed charge to recognise that a large portion of the cost is from treatment and delivery of the water, as well as to ensure water corporations have a steady stream of revenue rather than relying solely on usage charges, which can fluctuate with the seasons and climate.

Future focus

While water corporations need to have a fine balancing act for fixed and usage charges now, water corporations will also need to think ahead to the future. For Melbourne, this means a deep think on where our future water supply will come from.

As highlighted in the Victorian Central and Gippsland Region Sustainable Water Strategy 2022, Melbourne may need to rely on manufactured water for up to 65% of its water needs by 2050 (compared to 35% in 2020) – and as we all know, manufactured water such as desalination is not cheap.

We may also need to consider whether the current approach to water pricing is the best way - bringing in lessons from the energy sector, we may be able to adopt novel approaches for water pricing such as consideration of time-of-use tariffs combined with digital meters to smooth demand for non-essential water use or potentially various optional tariffs such as a “green” tariff to contribute tangible environmental outcomes.

In summary, unfortunately pricing for water isn’t as simple as “lowest prices are just the beginning” but requires a lot of fine-tuning and in-depth thinking from our water utilities and regulators.