Local Water Infrastructure Bill
What is the Local Water Infrastructure Bill project?
The New Zealand Taxpayers’ Union has commissioned a Bill to repeal and replace the Government’s Three Waters scheme. Law firm Franks Ogilvie has been working on the Bill for several months, with an experienced parliamentary drafter and a Technical Advisory Group.
The Local Water Infrastructure Bill builds on the model proposed to Parliament by Communities 4 Local Democracy. That model was supported by a large number of asset-owning councils across New Zealand and is similarly supported by the Taxpayers' Union.
The project expects to result in a Bill ready to be completely fleshed out soon after the election. Some of the technical details will be best done by drafters and officials with access to all the information held within the Government, and the PCO will need to review the work to ensure consistency with their current drafting style. Some important provisions of the Bill will be fully drafted and available to all parties to allow for a swift repeal and replacement of Three Waters should a Parliamentary majority exist to do so after the election.
How do the local water reforms differ from the Three Waters scheme?
The Three Waters scheme is an asset grab by central government from local communities. Assets managed and paid for locally are to be transferred to ‘entities’ outside the reach of democratic dismissal and replacement. The ‘entities’ can supposedly manage them better.
The Local Water Infrastructure Bill will instead restore the local authority ownership of water service infrastructure. But it does not leave the status quo. Costs and responsibility are to be clarified by transferring water service assets and operations into Council Controlled Organisations (CCOs) with their own boards of directors and separate accounting.
CCOs are a tried and true mechanism. The council owned water utilities will draw on the familiar board procedures and directors duties of the Companies Act to insulate management from ordinary political pressure, and to oblige them to focus on efficient management of their water service businesses. Councils will retain the power to sack and replace boards over the long term, but with certain protections against routine interference in the water businesses.
Local authorities will continue to have oversight of water asset management, but their water utilities will keep water operations at arms-length from other council activities, making it easier to see whether money is being spent effectively and making infrastructure investment decision-making easier to regulate for reliability and long term adequacy.
What is included in the reforms?
The Bill largely excludes stormwater – the third water. It therefore deals only with the ‘two waters’ – drinking water and wastewater. These water services, and assets relating to them, will be required to be transferred to the water utilities by a date specified in the Bill.
Stormwater is not included in the mandatory reforms, because it is not necessary, and because stormwater assets are often multi-use (for example, road land often also drains stormwater, public parks store and channel stormwater). However, a Council may decide to transfer stormwater infrastructure and processes especially any that are practically inextricable from drinking water and wastewater services.
A key aspect of the Bill is respecting local autonomy in decision-making. So councils may transfer stormwater assets and managements to the water utilities if they choose.
Why will water utilities do a better job than councils have?
The government dropped the ball on water service quality regulation and enforcement. In over 60 years of having jurisdiction, the Ministry of Health managed one prosecution of a council delivering water services. That council was Hastings. The comprehensive new regime of drinking water regulation by Taumata Arowai under the Water Services Act 2021 changes everything. It makes it legally dangerous for people in charge of water supplies to ignore the new safety standards.
The separation and specific responsibilities of the water utilities will also ensure more direct accountability for the service delivery standards (cost, reliability and quality aspects other than safety). That responsibility will no longer be diffused in large council bureaucracies. Instead it will be focused on the boards of the water utilities.
The existing pollution and wastewater regulation will continue to apply, including under the Resource Management Act 1991. Reform of that Act is a separate project.
How will water utilities be incentivised to invest in infrastructure?
Water utilities will be subject to two new forms of regulation, intended to incentivise them to effectively balance the interests of current and future water users by investing appropriately in water infrastructure while charging current users a fair price. This is likely to be a specialised unit within the Commerce Commission which already carries out a similar role for other network industries.
Their capital expenditure planning will get enhanced oversight by the Office of the Auditor-General. Under the status quo, the Auditor-General is required to report on local authorities and CCOs to (among other things) assess their compliance with targets including those relating to asset management. The Bill makes those reports a trigger mechanism for independent regulatory intervention.
If a report from the Auditor-General indicates a lack of confidence in the adequacy of a water utility’s planning, or that it is unreliable at reporting its own performance, a regulator will have powers to intervene.
The Bill proposes that the primary economic and service performance regulator be the Commerce Commission. That does not affect Taumata Arowai’s role as the regulator for water safety. The economic regulator will have the power to require compliance with mandatory performance standards.
In extreme cases, intervention may take the form of putting a water utility under the control and management of a neighbouring water utility that is considered competent. That transfer of management (with a management fee liability) may be for a set period, or until further order of the Regulator.
Such intervention is expected to be rare. Information disclosure regulation by the Commerce Commission has been seen to influence the behaviour of other reticulation utilities (such as electricity lines companies) without much need for direct intervention. When companies and communities can see from benchmarking that their local operation is wasteful, inefficient, just too expensive or unreliable the independent measurement and comparison gives their boards strong incentives to shape up.
The regulations will specify methods of accounting and reporting to the Commerce Commission. There will be particular focus on service reliability measures and pricing and asset management practices. This ‘light-touch’ regulation is backed by the threat of more substantial price-quality regulation for outliers.
What about the Government’s water safety reforms? Are these being reversed?
The Bill relies on the enforcement role of Taumata Arowai under the Water Services Act 2021, putting water safety standards first. Other aspects come after safety. For example, any duty on drinking water suppliers to maintain aesthetic quality will be expressly weighed against what people would choose in cost terms. The duties to guarantee supply even in droughts will be assessed against a similar measure
What about wastewater and stormwater regulation?
The current wastewater and stormwater regulation regime is obscure. The government seems not to have thought it through in practice. Under the current law, Taumata Arowai is charged with regulating wastewater and stormwater in a statutory purpose section, but how it fits with the responsibilities of regional authorities under the RMA is unclear. Regarding wastewater, TA is currently empowered to set standards that must be applied by the consent authority when considering resource consents, but there does not appear to be direct enforcement power in the Act. There are no clear regulatory functions for stormwater.
We propose that stormwater be excluded from the regulatory framework unless there is a necessary functional link between the stormwater asset and the drinking water network. We have not proposed anything new for regulation of wastewater.
Will there be co-governance under the reforms?
Co-governance is undemocratic and undermines the rule of law. All New Zealanders have similar expectations for clean, safe, reliable and inexpensive water services. Meaningful consultation with mana whenua and other Māori representatives is expected in a manner consistent with the local government sector’s usual practice. It is commonplace for councils to have locally appropriate consultation arrangements with iwi and hapū for other local government and local service functions, and many councils now have a specially designated Māori elected member.
The ambiguous provisions of the Three Waters legislation offend against the certainty standards of the rule of law, as well as negating equality before the law. The Bill avoids provisions that may be open to abuse e.g. to demand ‘capacity building’ payments and other costs and delays unrelated to any objective or scientific measures of water quality and service delivery. Councils will have normal governance of the water utilities subject to protection of the utilities’ independence in achieving statutory compliance. The utilities may of course listen to cultural claims but just as with any other citizens’ preferences, the utilities will not be obliged to give preference to such claims where they will add materially to cost.
In accordance with the localism principle that local communities know what’s best for them, councils will be able to influence the desired levels of community engagement with provisions in the CCO’s governance and oversight structures, if they believe that is in the interests of local water users.
Taumata Arowai the regulator has its purposes simplified, to focus exclusively on water quality and related tangible benefits. There is still provision for a Māori Advisory Committee but it advises the body, not exclusively its board. A water utility can of course have regard to any spiritual and cultural claims, but not to the extent that it conflicts with the objective of high standards of drinking water quality without waste and unnecessary cost.
Can water utilities join together?
The Bill enables (but does not require) water utilities to merge. It is for local communities to decide whether bigger is better, not central government ministries. However, it is expected that many local water services will find it more economical to combine with neighbouring services, to attain the required new standards and to access scale efficiencies.
The Bill provides a default scheme whereby shareholding councils can negotiate and seek community input on any decision to merge water utilities. No one-size-fits-all approach is mandated.
To overcome ‘patch protection’ and other loyalty impediments to sensible rationalisation, particularly within single watersheds or catchment areas, the Bill establishes an arbitration scheme to give binding rulings on the complex asset valuation issues that can arise when merging large entities. The arbitrators will be experts in engineering, water infrastructure and asset management who will be able to provide quick and authoritative rulings.
If they do join, will more efficient councils end up picking up the tab for less efficient ones?
Within council districts there are already probably unavoidable cross subsidies, from some users or ratepayers, to others. Some level of cross-subsidy is inevitable when water utilities join together, and the Bill specifically allows for this. However, unlike the Three Waters reforms where councils had no say in having water users in their district forced to source water on uniform terms from a cross-regional statutory monopoly, the shareholding councils can take into account the possibility or likelihood of cross-subsidies when services are merged. They can be taken into account in valuations.
What about communities that simply cannot afford to pay for the minimum standard services? Who will look after them?
The Bill recognises that central government may be drawn into providing financial support for upgrades and services where there are genuine affordability concerns due to low ratepayer base relative to assets. But it reserves to the government power to make sure that does not become an attractive default option for financially irresponsible communities.
How will the water utilities pay for what they have to do?
They can do what Councils do at the moment – that is charge connection fees or put water service costs into rates, or charge for usage where there is metering. The difference will be that:
a) Water charges will be separate, and only for water services, so councils will not be able to fudge the water costs and use water charges as a disguised rate increase;
b) Water utilities will not be able to charge more than is needed to provide good water services, including the cost of their capital;
c) Water utilities will be able to pass through the costs of water services as and when needed, without councillors being able to force them to postpone necessary spending or to incur debt for operational expenses;
d) Water utilities must charge enough to make water services self-sustaining.
Can water utilities charge enough to afford to do what is needed to bring services up to scratch?
Cost for water utilities and for communities depends on how much investment is needed and how much has been delayed. That differs from council to council.
But the government has promoted unrealistic estimates of costs and promoted the idea that somehow essential upgrades and replacements can only be afforded if everything is centralised and overseas savers’ funds can be accessed to pay for our water services. Castalia says that the investment plans for water infrastructure of most of the sample of councils they have audited appear prudent and readily fundable. They found that the consultants engaged by DIA wildly overstated investment needs.
As Castalia explains it “the government has assumed that one factor, scale, will deliver fantastical cost savings. This is plain wrong and the international evidence confirms this. Because the government's consultants could claim such big cost savings from scale, they were able to include enormous estimates of needed capital expenditure”.
Under the Bill reforms, water utilities will carry on with stricter requirements for forward planning. They will be audited or vetted by the Commerce Commission and the Auditor General.
Will water service CCO charges be much more than what people pay now for water services, either directly in water charges or indirectly through rates?
There are no free lunches. In areas where there is a backlog of necessary investment, water service charges will rise. In some areas it will be substantial. But the water utilities will be required to borrow and otherwise match the cost of new and replacement assets and operations to services provided, so that future users will be expected to meet the costs, including interest, of long-lasting assets.
Will they be as much as the government has been saying they will increase by without Three Waters?
How do we know it will not be as much?
Because the government has used cost estimates in their "no Three Waters scenario" that are massively overstated. They compare their Three Waters reform costs to a scenario where there is no regulation (even though Taumata Arowai is well established), no changes to council borrowing or any other improvement.
Castalia’s analysis shows that the government has been making wild assumptions, apparently designed to make it look as if their scheme was essential, and that it would somehow make the inflated spending cost less than if the same spending was incurred under current arrangements. It is conceivable that centralisation could cut interest rates on borrowing, but the government claims do not recognise how much extra cost communities incur when they must pay for work controlled from distant head offices.
So are you saying that the government has been lying?
Yes – repeatedly. We can provide chapter and verse if the government deny it.
If their council owners can’t tell water utilities what to charge, what will stop them over-charging?
They will be under the eye of a special section of the Commerce Commission. The utilities will have to comply with a disclosure regime so that their costs and charges and services can be measured against national standards, ensuring that the Commission and water users will know the true costs, and be able to compare them with other water utilities. A utility that is persistently charging more than enough to meet their costs (including the cost of debt capital and the funding from the Council) will go under Commission price control. That will mean their maximum revenues or prices will be set by the Commission.
What if water utilities ‘gold plate’ their networks?
Effective regulation must discourage gold-plating. The Bill provides for two separate regulatory options that could address it:
a. First, one of the matters the Auditor-General is required to report on is the extent to which the utility has performed in accordance with its asset management plan and other planning documents. If substantial underperformance indicating mismanagement or reckless spending is identified, the matter can be referred to the Commerce Commission for intervention (see How will water utilities be incentivised to invest in infrastructure? above).
b. Secondly, under the information disclosure regime overseen by the Commission, water utility capital expenditure plans and forecasts will be published and updated. The Commission will have power to intervene and stop silly projects, just as it will have power to intervene and make water utilities get going on investment that will be needed to maintain service quality standards.
Must water utilities provide pipes where needed to serve new housing and other development? What if they do not, or they try to charge too much for it?
A water utility must provide water and sewerage service to developers and users who ask them to, at not more than a reasonable cost of providing the connections and service, even if the water utility would prefer not to extend their network. There can be genuine dispute about what is reasonable cost. When someone who needs a connection first in an area needs service – how much should they pay towards pipes many times bigger than their needs, so that the pipes are there to serve future increased demand? The law will contain provision for compulsory arbitration on the costs and charges that can be recovered. Developers will be free to install what is needed (with quality independently supervised) if they think the water utility’s charge is too high.
But there will be requests for services that are economically irrational. A water utility will not be bound to create capacity to serve demand where it is too uncertain that the infrastructure return will cover its costs within a reasonable time.
Will the water utilities be able to borrow what they need?
The law will allow them to borrow as their council owners can. Their independence from council owners in capital budgeting and recovering costs, including amounts needed to meet the cost of capital (debt and equity) is designed to make them desirable borrowers, perhaps more desirable than their parent councils. That could mean their interest burdens are lower than if the same borrowing was by a council, which borrowers might fear would divert spending into vanity projects and political pork-barrelling instead of building the economic capacity of their regions.
It is expected that many of them will borrow through the specialist Local Government Funding Agency that allows councils to collaborate in accessing debt finance markets. They benefit from interest rates that are already at or close to the same interest rate the Crown borrows at. Creditors have unique rights if local government debt is defaulted on, including raising a special rate and selling properties if the rate is not paid.
Owner Councils will not be able to stop water utilities from raising the funds they need, even if it means that those councils find it makes it harder for them to borrow as well. In other words, water utilities will be permitted to borrow as their Boards decide, irrespective of the effect on the perception of the creditworthiness of their parent councils.
How do we know they will borrow enough – don’t they have to have “balance sheet separation” for that?
It is unlikely that in the longer run lenders will allow there to be much difference in overall cost, if a region gears itself highly with debt of both the water utility and a council, all to be serviced from charges and rates on the same pool of ratepayers and residents and businesses. If the water utility is seen as less likely to default, its interest rates might be lower than those paid by its parent, and there could be a corresponding increase in the rate paid by the council, unless it curtails its own borrowing to ensure the total for the region remains prudent.
We believe that the focus on balance sheet separation might have been a political strategy, to be an excuse for depriving councils and communities of ownership and control of their own water service assets. It seems clear that the low interest held out as the justification was based on expectation by rating agencies that central government would put its credit behind the new centralised water entities, so that lenders would not have to rely on enforcement if they became insolvent or ran into political storms and user strikes. The “low interest” justification was offered even though it is likely not to be materially lower than the interest rates on which local government can borrow currently.
Why does your scheme not make it easier by having a Water Service Funding Agency like Labour has in its bill, so the government can support Water CCI borrowing and get lower interest rates?
The Bill does not exclude options to address financing challenges for specific councils. For example, Auckland’s growth rate gives it requirements not faced by other cities. Several targeted options could deal with that challenge better than the one-size-fits-all government three waters mega bureaucracy. Targeted options include revenue bonds (backed by the revenue from specific network expansions) and implicit Crown fiscal support (which Three Waters includes). The appropriateness would depend on the specific local challenge.
Is there anything to stop privatisation by a council selling off its water utility?
Water utilities are owned by their local councils, or a combination of councils. The Bill maintains the provisions from the Local Government Act 2002 that prevent divestment of water service assets. The ability of communities or groups which wish to take over their own supply is an exception to that.
Will a water service CCO be able to issue shares to anyone other than its Council?
They can issue shares to neighbouring councils, because part of the intention is that councils cooperate and put their water services together for greater scale and efficiency. The new law will contain provisions to facilitate that for regions that want it.
It is unlikely that private investors would want to put up equity capital, even if they need it and the law allowed it because:
a. Council control is necessary for so long as they have the benefit of Council type powers to collect water charges the way rates can be enforced.
b. The water utility cannot pay to the shareholder more than the cost of capital, as set by the Commerce Commission, so there is no room for speculative gain.
c. Payment of dividends is subject to community consultation and (if required thresholds are met) binding referenda.
Can water utilities make a profit?
The Commerce Commission regulation is designed to ensure they can’t use their monopoly power to charge more than is enough to meet the fair cost of the capital needed to deliver the required standards of service. If they can achieve efficiencies so that there is a surplus within that restriction, they may accumulate it to increase their capital and reduce the need for borrowing.
Will a Council get a dividend from its water utility? If so, why?
They may pay the council an amount that is deemed by the Commerce Commission to be the cost of equity capital to the water utility. That should be enough to allow the council to service debt it may have incurred to acquire and build the assets the water utility will get from the Council when it is formed. If a water utility was not permitted to pay the cost of capital, it would be necessary to transfer a lot of Council debt to the water utility, which raises many questions about how much, the terms (given that the lenders may not want to change) and other complicated matters. There are many examples of CCOs that pay a dividend to their council owner.
Will a Council be able to lend to its water utility, or guarantee its debts, to get lower interest rates for the water utility?
A council could choose to lend or guarantee, if it felt that was in the best interests of its region and residents, but it is not very likely. Some may be bound by terms of their own borrowing to avoid such support.
Can a council force the water utility to lend to the Council?