Risks and opportunities from amalgamation in our water sector

Andreas Heuser, director, Castalia and president Law and Economics Association of New Zealand.

The Government is proposing to reform local authorities’ three waters services into a small number of regional public water corporations (RWCs).

These proposals are ambitious and come with risks and opportunities for local authorities. Robust early thinking about balance sheet and revenue/expenditure implications, as well as community interests, can help local authorities optimise outcomes for their local residents.

Impact on individual authorities will be vastly different

The latest Cabinet papers propose creating three to five RWCs, offering some grant funding for participation. Local authorities, under current proposals, may opt-out.

The Department of Internal Affairs is currently informing local authorities, Maori representational interest and other stakeholders about the proposed reforms via roadshows.

Clearly, there are serious, persistent problems with some of the country’s drinking and wastewater services. The news headlines highlight historical underinvestment in some areas, management oversight failures, and an absence of regulatory enforcement.

The Government’s plans are ambitious. The thinking is that larger RWCs can generate scale economies and improve management sophistication. While that rationale for change is questionable, the need for investment in some localities is clear.

There are significant differences in investment levels and performance across the country. Some local authorities have made appropriate investments and kept up maintenance over the years. Others have not.

The very reason for the reforms (differences in investment and management) is also the reason that the reforms will be very challenging for local authorities. For those authorities considering joining the amalgamation, the major challenge will be to determine where in the regional grouping that investment is needed, and who is going to pay for it.

Community (including iwi/hapu) interests are diverse, and local government is closer to these communities than central government

Community representation

Local authorities have a lot of important issues to think through on behalf of their residents and ratepayers.

There are three key topics that local authorities need to work through as the amalgamation proposals are discussed and negotiated between regional neighbours and central government.

1. Drivers of individual local authorities’ equity shares in the RWCs – asset values, debt levels and investment. 2. Sources of cross-subsidies – changes to water rates and tariffs. 3. Community representation – balancing regional boundaries with local community interests.

Assuming amalgamations are pursued, the best outcome is that local authorities and central government negotiate a “deal” to join RWCs (or go it alone) which is fair and in the best interests of water consumers in the long-term. Water services impact on well-being, and reforms deserve serious consideration by local authorities on their residents’ behalf.

Local authority RWC shareholding

Individual local authorities’ equity shares in the RWCs will be driven by how assets, investment levels, and debt are treated for valuation purposes.

Asset values and the corresponding water-related debt will determine the value of local authorities’ shareholding in the new RWCs.

This will be a key point of negotiation and a key determinant of whether, and on what terms, a local authority should join the RWC.

The government has already reached its view on the appropriate number of RWCs, and the investment needed in assets by different local authorities, relying on a modelling exercise by the Scottish water regulator (Water Industry Commission for Scotland or WICS).

That modelling is based on very limited input information and questionable assumptions.

It produces implausible results on investment needs and cost savings. Unfortunately, the results could not be properly tested prior to cabinet decisions because WICS refused to share the model.

Local authorities will therefore need to ensure their asset values, and investment plans are appropriately understood and incorporated into any RWC valuation. Getting clarity at local authority level, and at the regional grouping level will be critical.

Debt levels will be a major point of discussion. The government has not yet considered the different levels of debt held by each local authority, nor the different approaches to financing water infrastructure.

Some local authorities use long-dated general-purpose borrowing, others use current income to fund investment. Determining the levels of debt that transfer to the new RWCs will be highly complex, and also subject to debate.

Water rates and tariffs

Moving to regional water rates and tariffs will create winners and losers.

A core focus of the government’s RWC proposals, and underlying WICS modelling, is identifying how to equalise the differences in costs and service levels between geographic areas.

In practice, this could mean cross-subsidies from low-cost of service areas to high-cost of service areas. It will also mean that areas with appropriate investment levels and asset condition may support other areas with lesser investment levels.

There will be winners and losers between areas. The government has indicated that grant funding will likely be available to smooth out some of the differences. This may make up for the cross-subsidy effect.

However, the funding levels and allocation regime have not been disclosed. How will the government decide which areas require more, or less, grant funding support?

Regional boundaries

Setting regional boundaries will make it harder to balance different community interests.

Central government prefers the three to five RWC model. While this clarity of objective is welcome, a strict limit may end up overlooking local water services nuances that are well known to local government.

Community (including iwi/hapu) interests are diverse, and local government is closer to these communities than central government.

There are differences in desired service levels and differences in ability to pay. For example, many Christchurch residents oppose chlorination, and many Motueka residents are happy without reticulated drinking water. Maori with mana whenua interests have often negotiated specific arrangements. Local authorities will need to ensure the RWC proposal will adequately reflect local needs.

Some local authorities may therefore wish to take the initiative together with their neighbours. There are opportunities to use the detailed knowledge developed during this reform process to co-design a regional water delivery model that is fit for local purposes, while also satisfying need to improve investment levels and management.

As late as 2019, the Government had committed funding for local authorities that wished to initiate joint regional model discussions themselves.

Constructive engagement will achieve best outcome

There are risks and opportunities for the local government sector in the reform process. Local authorities can forearm themselves by understanding the balance sheet, income, expenditure and community interest ramifications of amalgamation in their area at a detailed level.

They should also understand the position of other local authorities joining the grouping. Only then can local authorities develop a mutually beneficial strategy for the negotiation and decision-making process for joining, or opting out.