Encouraging Private Sector Investment In Sustainable Water Resource Management

Article by Alan Rosengarten and Jo Draper

Australia has experienced some of its driest weather conditions for more than 100 years. As water storage levels continue to fall, public and government attention has started to focus on how best to manage our growing demand for water and the deteriorating quality of our rivers and ground water. Increasingly, Australian governments are recognising the harmful environmental effects of some of our past water and agricultural policies and are seeking to adopt strategies that will promote the efficient and ecologically sustainable management of Australia's water resources.

A report published in 2000—Repairing the country: A national scenario for strategic investment—estimated that the cost of rectifying the damage caused by our management of Australia's natural resources will be around $65 billion over the next 10 years (including around $28 billion of private sector investment). This level of investment is well beyond that currently allocated by both the public and private sectors. Given the tight budgetary constraints that the Federal and State Governments have imposed on themselves, this level of investment simply cannot be met without a significant contribution from the private sector. However, current political and economic frameworks do not encourage private sector participation in ecologically sustainable projects. In relation to projects that would assist in rectifying some of the damage to our waterways, some of the main problems are:

• A lack of properly defined and consistent water rights – at the moment, there is substantial inconsistency in the nature of water rights across Australia. This is particularly significant when some of the regions with the most desperate need for investment involve multiple jurisdictions. This inconsistency also contributes to (but is not the only cause of) uncertainty about the nature of the rights flowing to the holder of a water right. The challenge facing Australia is to adopt a co-ordinated approach for dealing with these issues.
• Inadequate methods of valuing water and the absence of a sophisticated water trading market – the introduction of market forces would assist in ensuring that our limited water resources are allocated to their most efficient use. Two of the factors restricting the development of a national water market are: the inability to separate the right to use water from the ownership of land (although this will change in New South Wales from mid 2003 when the access licence regime under the Water Management Act 2000 comes into force, and in Western Australia, changes to the rights in the Water & Irrigation Act in 2001 mean that a licence can be granted to a person who has physical and legal access to the land, notwithstanding that they are not the owner or occupier) and restrictions on inter-State transfers of water rights (although pursuant to the Council of Australian Governments (COAG) Water Reform Framework, each State and Territory has committed to the principle of cross-border sales of water entitlements).
• A failure to value all of the costs and benefits (including externalities) associated with water management measures. For example, although Australian governments are increasingly recognising the impact of their investment decisions on salinity levels and are developing strategies for addressing this issue (for example, the Murray-Darling Salinity and Drainage Strategy and the Basin Salinity Management Strategy), these strategies do not encourage environmental accountability on the part of the private sector. One option for addressing this issue is to introduce a national salinity trading scheme (along the lines of the renewable energy certificates introduced to encourage green energy) under which landholders seeking to manage their land in a way that increases salinity would be required to buy salinity credits from people who have gained credits by taking action to reduce salinity levels (for example, through undertaking revegetation or investing in new infrastructure). Although a number of salinity trading schemes already exist (for example, the Hunter River Salinity Trading Scheme), these schemes are of a targeted nature and do not address the broader objective of managing salinity at a national level.

Addressing these issues is fundamental to Australia's long-term ability to rectify the damage caused by past resource management practices and requires a co-ordinated approach by governments. This is particularly so given that many of the most affected areas (for example, the Murray-Darling Basin) cross State borders and therefore directly impact on a number of governments.

Australia's federal structure means that any solution to these problems will require significant State involvement, possibly through the forum of COAG, which has been working on many of these issues over a number of years.

The recent agreement between the Federal, New South Wales and Victorian Governments to establish and fund a joint government enterprise to achieve water savings through water infrastructure and efficiency improvements to enable increased environmental flows to the Snowy River, demonstrates the ability of Australian governments to work together to deal with the economic, environmental, policy and social issues that will be an inevitable result of any long-term solution to these problems.

While the longer term solutions will take time, there are opportunities for private sector investment in the short term, which should not be overlooked. A starting point for governments is to identify projects that are likely to be attractive to the private sector and in which the private sector can provide a 'value for money' solution, particularly through the use of innovation and the assumption of risk. Private sector participation in such projects could be sought through the public private partnership (PPP) models that each State government has established. One potential area where a PPP model may be workable is in the replacement of Australia's open irrigation channels with pipelines.

A recent study carried out in Victoria found that the replacement of open irrigation channels with pipelines has the potential to generate real and sustainable water savings by reducing the amount of water lost through seepage, evaporation and leakage. The study also found that pipelining projects will generally result in positive environmental outcomes while improving customer service levels and the security of supply to water users.

This is a key area for water reform, as producers of irrigated agricultural products are the main users of Australia's consumptive water supply. In Victoria alone, more than 70 per cent of harvested water is used for agricultural and irrigation activities. Of this, approximately 980,000 megalitres of water or 29 per cent of the water allocated for consumptive use is lost each year, which is greater than Victoria's annual urban and industrial water consumption combined.

State and Federal governments have begun to respond to the findings of this study. In February this year, the New South Wales Government joined with the Federal Government in committing a total of $5.3 million towards a feasibility study into water efficiency in the Murrumbidgee Valley. A key component of this study, which is expected to take 12 to 18 months, is to investigate the upgrade of water infrastructure such as irrigation channels.

In Victoria, the Victorian and Federal Governments recently funded a feasibility study into the $300 million Wimmera Mallee Pipeline Project. This Project, which has been described as one of the most significant water infrastructure projects ever to be undertaken in Victoria, involves the replacement of 17,500 kilometres of open channels with pipeline, throughout an area of more than 2.3 million hectares. The feasibility study for the Project, which was completed in October 2001, estimated that as much as 93,000 megalitres of water would be saved each year if the Project was implemented. The Victorian Government has since engaged a consultant to design the pipeline system and develop a business case for the project.

This Project serves as one example of the type of project that may be suitable for delivery using a PPP. Two of the key challenges to the use of the PPP model for the delivery of these types of projects are:

• achieving an optimal allocation of risks between the parties
• developing a payment structure that incentivises the private sector to invest in the projects, while at the same time ensuring that the government's objectives are achieved.

While the aim of the PPP model is to shift key risks to the private sector, an optimal risk allocation between the parties will be guided by the principle that the party that is best able to manage a risk should bear that risk.

In a project like the Wimmera Mallee Pipeline Project, it would be usual to expect that the developer would assume the design, construction, operation and maintenance risks of the project. However, the developer may expect the government to share some of these risks, including interruptions to the delivery of water during the construction period, interface issues between upstream dams and the pipelines, up-stream contamination or pollution, and uninsurable force majeure events.

The payment structure for a project is, of course, closely linked with the risk allocation model adopted for the project. In the case of a pipelining project, the payments to the developer may include components dependant on the availability of the pipeline, its performance against agreed performance levels and the benefits delivered to the environment. Also, if the factors that inhibit private sector investment (some of which are identified above) are addressed, the payment structure could include the developer receiving water rights in respect of the savings created by the project. These water rights could then be traded to a government authority (eg an environmental trust) to increase environmental flows to distressed rivers. Similarly, the developer could also receive salinity credits, which could be traded to create another source of revenue for the project.

The government funds to support such projects, as well as fully publicly funded projects, could be raised by a number of sources. Some possible sources of funds that have been discussed include the proceeds from the sale of Telstra, an environmental levy (similar to the Medicare levy) or the issue of government bonds. The government could also consider introducing tax concessions. For example a report by the Allen Consulting Group recommended the use of 'Green Bonds' for approved investments. These 'Green Bonds' would be based on the Infrastructure Borrowing Tax Offsets Scheme and would be designed to overcome the long-term nature of the investment required by enabling financiers to offer lower cost financing. Each of these options is worthy of more consideration.

In conclusion, there is little doubt as to the magnitude of the challenge facing Australian governments. However, there is also little doubt that the Australian community is committed to solving our water management crisis.

We suggest that one of the keys to solving this crisis is to encourage private sector investment in water management measures. By helping to relieve the funding burden of governments, the private sector can go a long way towards ensuring that vital water savings are captured at a time when they are most needed.