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Whilst road pricing has been a hot topic in recent months in various states across Australia, the evolution of charging commuters for roads across Australia’s has been a long series of developments. With many challenges to defining how to charge commuters – including competing priorities and governance, and new technology such as EV’s, we unpack this topic below.

The challenges to tackling road pricing

Road pricing has made its way into the news recently for a number of different reasons.

Firstly, in 2021 the Victorian government introduced the Zero and Low Emission Vehicle (ZLEV) charge which levied electrical vehicle owners 2.8c for each kilometre they travelled. The intent was to charge EV users for the costs they impose on Victoria’s road network.

However, in October the High Court of Australia ruled the charge invalid, as it amounted to an excise duty, which under the Constitution, can only be levied by the Commonwealth.

Secondly, in the last year the NSW Government also announced the Independent Toll Review. This has come about because of emerging public concerns about the affordability of current tolls on Sydney motorways, particularly given the rising cost of living. Concerns have been accentuated by the inequities in tolling, whereby some motorists on their daily commute face quite significant charges, while other motorists in Sydney, pay very little.

The Independent Review has released a discussion paper which considers the efficiency and fairness of existing tolling arrangements that are set out in PPP contracts with road concessionaires.

The challenges posed by toll roads are merely a subset of the broader issues in road user charging. Whilst governments think that users should pay more directly for roads, developing a comprehensive set of road prices that applies across Australia’s road network is challenging.

Frontier Economics’ has been providing economic consulting advice in the transport sector – and on the development of road user charges – for many years. Here, we unpack the challenges of road pricing and discuss a possible path forward.

Why is pricing road use challenging?

Our Local, State and Federal governments are entering into a challenging space when it comes to the pricing roads. There are multiple reasons why pricing road use is challenging:

Firstly, there are multiple objectives to consider when pricing roads which are sometimes conflicting. Road charges can:

  1. Fund the development or expansion of a new motorway – as is the case with tolls.
  2. Be used to recover the ongoing costs of maintaining or operating the road network more generally – by accounting for the wear and tear vehicles impose on the road pavement, or
  3. Help manage congestion and reduce emissions – by encouraging better decision making when it comes to reducing vehicle use; to limit these third-party costs.

The second reason is that we have Local, State and Federal Government roads. This creates challenges because you immediately have multiple governments involved, and we have motorists travelling, potentially in one trip, on multiple roads that are owned by different governments. The charging arrangements for that entire network therefore becomes far more complicated.

The final layer to this is that is that different governments have different powers in respect to vehicles, vehicle use and charging. The Federal Government has responsibility for the importation and design of new vehicles, and the power to levy the fuel excise, which is often argued to be the main mechanism for implicitly funding the road networks. The State Governments are far more confined in their ability to levy state-based road charges, however, they are in charge of things like registration. So, this limits the ability for any one government to create a comprehensive charging structure on its own.

Electric Vehicles (EV) and road charges

It’s necessary for all governments to consider a reformed approach to road pricing now, because of the emergence of Electric Vehicles (EVs) – who don’t pay the fuel excise. And currently the main mechanism used to implicitly fund road development is this fuel excise. This funding is expected reduce over time, as more motorists take up EVs. Essentially, motorists will be using less fuel, and as we use less fuel, this funding source will disappear.

The time to deal with this is now. Solving this problem means moving away from current arrangements which is challenging. States, such as Victoria, have tried to go it alone by implementing road use charges for EV. But this approach has been struck down in the High Court Challenge. So, you can see states acting on their own isn’t really a great option.

What can be done to create fairer and more efficient road pricing

The first step is to acknowledge that road pricing is an issue across governments and one that might benefit from intergovernmental co-operation. An intergovernmental agreement could be developed, that sets out:

Some pricing improvements for heavy vehicles have already been achieved. It’s been a slow process with incremental improvements but there is no reason why that process, which we have been heavily involved for the last 15 years with can’t be expanded.

Given the outcomes of the High Court Case, governments need to work together on this emerging issue, and a better, intergovernmental, solution is required if we are to create road charges that are more efficient and fair for all motorists across Australia.

Frontier Economics' Tim McNamara, Mike Woolston and Dinesh Kumareswaran were commissioned by the Water Services Association of Australia (WSAA) to produce the report Understanding Efficiency to explain in "plain English" the concepts of economic efficiency and how they apply to the water sector. The report also illustrates what efficiency looks like under different scenarios using examples from the water sector and detailed case studies. Below is the Executive Summary of the report.

About this report

The aim of this report is to explain in ‘plain English’ the concepts of efficiency and how these are utilised within businesses, by economic regulators and others to assess service and expenditure proposals in pricing submissions and business cases.

Efficiency in the urban water sector

It is important for businesses to be able to understand and demonstrate efficiency, not just to get approval of pricing submissions from regulators – but also to demonstrate they are providing value for money to customers, owners, and other stakeholders.

Common or dictionary definitions of ‘efficiency’ tend to focus on the relationship between inputs and outputs of producing a good or service, but this narrow interpretation may lead to misconceptions. Minimising costs may not necessarily be consistent with providing customers’ desired service levels, maintenance and investment in asset capability and supply resilience, or delivering broader outcomes which are desired by customers or society.

Rather, economic efficiency can be seen as synonymous with value for money - providing the services customers want at the lowest long-term cost. The regulatory frameworks applied by most economic regulators do provide for broader ’value for money’ outcomes in assessing efficiency.

Some common misconceptions about efficiency

There are a number of common misconceptions about demonstrating efficiency in the urban water sector. These related misconceptions include:

  1. Efficiency means prices need to be flat or declining
  2. Efficiency is about cutting costs to the minimum
  3. Efficiency is incurring lowest possible costs over the upcoming determination period
  4. Efficiency means providing services at the lowest possible standards consistent with regulatory and other obligations
  5. Efficiency is about deferring new investment as long as possible and running assets to fail
  6. Efficiency means minimising costs even if this leads to higher risks
  7. Efficiency means neutralising the impact of other drivers of expenditure (e.g. growth) so prices remain constant overall without having to disaggregate the drivers
  8. Efficiency means demonstrating on a once-off basis that a business is efficient relative to the industry standard.

A common thread underlying these misconceptions is that ‘efficiency’ is synonymous with cost minimisation. Not only is cost minimisation in itself not an appropriate objective - but it is not an appropriate interpretation of what it means to be ‘efficient’.

Minimising costs may not necessarily be consistent with:

How is efficiency measured and demonstrated?

While how best to demonstrate efficiency may depend on the audience, fundamentally it is about demonstrating that a proposal is in the long-term interests of customers.

The overarching approach of economic regulators in determining efficient levels of expenditure for regulated urban water businesses, which they then allow to be recovered in regulated prices, typically involves:

Typically regulators adopt a ‘prudency and efficiency test’ to provide assurance that the businesses are (1) doing the right things; and (2) doing those things as efficiently as possible.

Regulators typically assess the prudency and efficiency of operating and capital expenditure individually, as well as the trade-off between these two types of expenditures:

What lessons does recent regulatory experience provide?

We examined a number of recent regulatory reviews and decisions by state economic regulators. This provided a number of key insights and lessons that can be drawn upon for future periods.

Guidance for demonstrating efficiency 

We have identified some overarching guiding principles that should be adopted to demonstrate the efficiency of expenditure proposals regardless of the context in which efficiency is being measured or demonstrated: 

However, there is no single methodology or technique that is appropriate to use in all circumstances to measure and demonstrate efficiency. The appropriate approach may vary depending on factors such as the nature of the: 

Table 1. Approach to demonstrating efficiency - a guide

Step  Type of expenditure  Evidence/ 

data required  

Techniques  Example 
Outline why the spending is in the long-term interest of customers  All  Link spending to specific outcomes for customers in terms of services and prices over the long term 

Clear ‘golden thread’ narrative 

Investment Logic Mapping  See section 4.2 and 5.5 
Prudency: Link spending to non-discretionary obligation  Non-discretionary 

opex & capex 

Identify key drivers including relevant legislative or regulatory obligations  Understanding of non-discretionary service (and related) outcomes, including their timing   Central Coast Council (section 3.3.3) 
Prudency: Demonstrate that customers want the proposed service/level or outcome  Discretionary opex & capex  Customer feedback  Surveys, customer forums  Case study 2 
Prudency: Demonstrate that customers are willing to pay for this service  Discretionary opex & capex  WTP studies  Choice modelling  Case study 2 
Analyse a range of options to produce the desired outcome  All  List of alternative options including capital vs recurrent solutions – ideally in business case  Cost-benefit analysis  Case study 3 
Identify a preferred option  All  Business case or similar  Cost-benefit analysis (benefit -cost ratio, NPV etc)  Case study 3 
Undertake sensitivity analysis to demonstrate the preferred option is robust  Capex/major opex step change  Business case or similar (preferred option is superior under a range of assumptions/scenarios)  Sensitivity analysis 

Real options analysis 

Scenario analysis 

Case study 3, Sydney Water resilience expenditure (section 3.6.3) 
Ensure/demonstrate the preferred option/proposed services will be delivered at the lowest cost  Opex   Historical expenditure  

Productivity growth (continuing efficiency) forecasts 

Market-tested estimates  

Base-step-trend 

Benchmarking  

 

Case study 1 
Ensure/demonstrate the preferred option/proposed services will be delivered at the lowest cost  Capex 

Step jump in opex 

Robust procurement process (e.g. market-testing or similar) 

Detailed approach to managing delivery of project and associated risks 

Proposed expenditure is within long-term context & strategy 

Consideration of scope for application of continuing efficiency factor  

Business case methodology  Powercor ICT investment (section 3.4.3) 
Benefits realisation (ex pt)  All  Ex post assessment of benefits and costs  Post project review  See section 2.2 

 

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Frontier Economics' recently advised a number of clients in relation to the Queensland Competition Authority's review of its approach to climate change related expenditure. Below are some highlights and commentary on our advice included in the final position paper.

The Queensland Competition Authority (QCA) has released its final position paper for the Climate Change Expenditure Review 2023, referencing our independent advice to Dalrymple Bay Infrastructure (DBI) and Aurizon Network.

The QCA initiated this review to:  

Economic regulators need to perform a difficult balancing act when assessing expenditure proposals related to managing climate change risks. The impact of climate change on regulated infrastructure (and, therefore, on users of that infrastructure) is fraught with uncertainty.  

Uncertainty over whether regulators will approve climate change related expenditure—or over whether recovery of such expenditure would be disallowed once it has been incurred—may deter regulated businesses from making prudent and efficient investments to improve the resilience of their networks.  

Clear guidance about how proposals for climate change related expenditure will be assessed by regulators can help reduce this uncertainty and encourage prudent and efficient investments that may otherwise be foregone. 

For this reason, other economic regulators, should conduct their own reviews and publish formal guidelines on how they intend to assess regulatory proposals for climate change related expenditure. The QCA’s guidelines are not specific to any particular industry or jurisdiction, so would be a relevant starting point for other regulators and regulated businesses beyond Queensland. 

Managing climate uncertainty to invest prudently and efficiently in resilience

Of the many issues covered by the QCA’s review, our advice focussed on the development of a framework to assess the prudency and efficiency of climate change adaptation expenditure.  

Below are some highlights: 

We advised Aurizon Network that:  

“In assessing prudent and efficient ex ante resilience expenditure the QCA should encourage regulated entities to pragmatically incorporate the uncertainty inherent in climate change related risks into their proposals for adaptation expenditure.” 

 In our report to DBI, we added:  

“Climate-resilience should be a necessary condition to project prudency and efficiency. Investing in infrastructure that is vulnerable, by design, to an accepted range of climate-related risks is likely to be lower cost in the short term but higher cost in total over the life of the asset.” 

We discussed the development of an upfront expenditure framework that could facilitate investment under uncertainty, providing advantages to both regulated infrastructure providers and their customers. That is, a framework which: 

We considered that these elements together would promote regulatory certainty and facilitate investment in prudent and efficient levels of infrastructure resilience.  

The Coal Effect – funding and financing approaches to address residual stranding risk

Fossil fuel exposed firms are exposed to transition risk, or risks arising from the process of adjusting towards a lower-carbon economy. This can impact forecasted demand, the value of assets and liabilities, and thereby the risk profile and viability of the regulated business. 

A key driver of transition risk for coal exposed companies is policy change. Net zero targets, can reduce domestic demand for coal. However, targets vary in status, development and expected achievement date. This uncertainty, in combination with uncertainty around technological development and carbon abatement costs, makes future demand for coal similarly unclear. 

We identified a scenario where Aurizon Network may support more adaptation expenditure to increase the resilience of the network (with the expenditure to go into the regulatory asset base). However, future customers may be unwilling or unable to continue to pay for past adaptation expenditure. These factors create asset stranding risk, which may disincentivise a regulated business from investing in network resilience today, even if the investments are supported by current customers. 

We then considered options the QCA might adopt to address asset stranding risk. We discussed the merits of addressing an increased stranding risk associated with climate change via an uplift to the allowed rate of return (i.e., the ‘fair bet’ approach) that would be just sufficient to compensate investors for the increase in stranding risk.  

Also considered was the use of accelerated depreciation, which has been used by regulators in Western Australia (ERAWA) and New Zealand (the Commerce Commission) to address the stranding risks faced by gas pipelines following the adoption of emissions targets that have shortened the expected economic life of those regulated assets. 

In our advice, we recommended that the QCA should confirm clearly that:  

Overall, we identified the benefits in the QCA providing clear upfront guidance on the types of information and evidence it would require from regulated businesses, to demonstrate asset stranding risks and management responses.  

This could include the QCA needing to take into consideration a larger range of plausible future scenarios, rather than focusing on just the expected future profile of demand at a given point in time, reflecting the long-term uncertainty faced by the coal industry. 

Frontier Economics Pty Ltd is a member of the Frontier Economics network, and is headquartered in Australia with a subsidiary company, Frontier Economics Pte Ltd in Singapore. Our fellow network member, Frontier Economics Ltd, is headquartered in the United Kingdom. The companies are independently owned, and legal commitments entered into by any one company do not impose any obligations on other companies in the network. All views expressed in this document are the views of Frontier Economics Pty Ltd.

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This bulletin explains why it is essential for regulators in Australia to adopt financeability tests as standard practice whenever they make a regulatory determination, and to take the results of those tests seriously.Financeability tests are used by regulators in the UK to assess whether the revenues they allow a business to earn over a price control period will be sufficient to finance the business’s operations efficiently. These tests act as an early warning against a regulated business becoming financially constrained or insolvent—an outcome that  ultimately harms consumers, or taxpayers, who may be called on to rescue a regulated business providing essential public services from collapse.

By contrast, in Australia, regulators have either refused to employ financeability tests or run them but only pay lip service to the results.

A Case Study: The Thames Water ‘financeability’ problem

Thames Water is Britain’s largest water company, providing water and wastewater services to 15 million customers in London and the Thames Valley.

In late June 2023, alarming reports began to circulate that Thames Water was struggling to meet its debt obligations and may be on the brink of collapse. The crisis deepened as the CEO stepped down suddenly following criticisms about the company’s poor environmental performance and record leakage rates, and a new Chair was appointed hastily to regain control of the situation.

The UK Government and the water sector regulator, Ofwat, began drawing up rescue plans for Thames Water amidst fears that the company might become insolvent. The crisis ended when shareholders agreed to inject £750 million of equity capital into the business, to reduce its debt burden.

The media was quick to blame the financing decisions of the company’s private owners for its woes. Previous owners of Thames Water, including Australian bank Macquarie (dubbed the ‘vampire kangaroo’ by some in the British press), were accused of loading the business with excessive debt, while extracting huge dividends, leaving it unable to meet its financial obligations.

The Thames Water debt crisis

Thames Water is one of the most indebted water companies in Britain. At the time of the crisis, it had £16 billion of debt and a gearing ratio (the proportion of its assets that are financed with debt rather than equity) of around 80%. Ofwat noted that Thames Water (and some other companies) had “borrowed too much.”[1] This meant that the company faced large debt repayments.

The situation was worsened by the fact that nearly 60% of Thames Water’s debt was inflation-linked. That is, a significant portion of the interest Thames Water needed to pay was linked to the retail price index (RPI) measure of inflation. The RPI is similar to the consumer price index (CPI). However, it also includes mortgage interest payments, which makes it more sensitive to changes in interest rates. Hence, Thames Water’s interest bill grew significantly as inflation rose sharply over 2022 and 2023.

But the size of Thames Water’s debt obligations is only one part of the equation.

Inflation and the regulator’s revenue limits

As a natural monopoly, the amount of revenue that Thames Water is allowed to earn is capped through periodic price controls by Ofwat.

A part of that revenue allowance is an amount to cover real interest payments. However, to the extent that a company holds inflation-linked debt, its actual interest bill in each year will be the sum of a base (real) rate plus outturn inflation that year.

Ofwat allows the regulatory asset base (RAB) of the businesses to grow each year in line with actual inflation. Recovery of this inflation-indexed RAB, over 50 years or more, provides the business with compensation for the inflation component of  its interest costs.

Herein lies a problem: the business is contractually obliged to pay the entire interest bill every year. But, it will take decades to recover through regulated prices the inflation component of that bill. When inflation starts rising, the mismatch between the business’s regulated cash flows in each price control period and its interest obligations widens.

In short, Thames Water faced a perfect storm: a large pile of debt, rapidly rising interest repayments linked to inflation, and regulated revenues that were insufficient to cover these increasing costs. All of this added up to material risk of default on its debt obligations.

UK regulatory financeability tests: an early warning system

Ofwat has a statutory duty to:

“secure that companies...are able (in particular, by securing reasonable returns on their capital) to finance the proper carrying out of their functions.”[2]

If the annual revenue allowance set by Ofwat is insufficient to pay the business’s interest bill or to attract equity finance, the business will be unable to finance its activities properly or invest in assets. In these circumstances, the business would be unable to deliver services of proper quality to consumers.

Moreover, the financial collapse of essential service providers such as water companies, energy networks or communications firms can cause catastrophic disruptions and economic costs to consumers.

Recognising this, Ofwat and other UK regulators with similar financing duties have developed ‘financeability tests.’ These act as an early warning to detect whether the revenue allowances set by the regulator would be insufficient for an efficient business to remain financeable. If the tests show a likely deterioration in financeability, the regulator can adjust revenue allowances to avert the problem.

Ofwat sets revenue allowances based on a ‘benchmark’ business that uses debt to finance 60% of its assets and maintains a BBB+ credit rating.[3]

The purpose of Ofwat’s financeability test is to assess whether the revenue allowances set in this way are in fact sufficient to support that BBB+ rating at the benchmark 60% gearing. It is effectively a test of the internal consistency of the regulatory decision.

Ofwat and Thames Water

Ofwat decided in its 2019 revenue determination for Thames Water that it needed to accelerate the recovery of costs by £125 million in order for a benchmark business in Thames Water’s circumstances to maintain a BBB+ rating at 60% gearing.

Thames Water argued that, even after bringing forward these allowed revenues, a benchmark business with 60% debt finance would be unable to finance the delivery of its statutory obligations or attract the required amount of equity finance. Ofwat did not accept Thames Water’s representations.

Ofwat also performed a separate test of ‘financial resilience’ based on Thames Water’s actual gearing (at the time) of 80%. Ofwat expressed concerns that Thames Water was very highly geared and noted the company should take steps to improve its financial resilience.

Under this two-pronged test:

Australian regulators seem to prefer a late warning system

Whereas Ofwat and Thames Water differed in their views about whether the regulatory allowance was sufficient to support financeability, there was strong agreement that consideration of financeability is a vital component of regulatory best practice.

By contrast, Australian regulators have been slow to embrace financeability tests. Regulators in Australia fall into three groups:

The Thames Water case provides a timely reminder that even the largest and most well-resourced regulated businesses can face serious risk of insolvency, which can be disastrous for consumers. Properly implemented financeability tests can avoid such outcomes. Therefore, it is important to consider:

Features of a good regulatory financeability test

Financeability tests are an essential element of best practice regulation

It is in the long term interests of customers that an efficient provider of essential services is financeable, so that it can provide services desired by customers. This requires that regulated revenues are sufficient for an efficient business to meet its financial obligations as they fall due and to invest what is needed to deliver regulated services.

If regulated businesses cannot provide their services because they are financially constrained or insolvent, then customers or taxpayers will bear the cost. If the regulated business is financially constrained, it may be unable to make the investments needed to provide the level of service today or into the future that customers want. If a regulated business becomes insolvent, then it will likely be taxpayers that step in to ensure the essential services continue to be provided.

This is why financeability tests are a key part of best practice regulation. The purpose of a financeability test is to ensure that the revenue allowance is sufficient for an efficient business to meet its financial obligations over the forthcoming regulatory period.

The test should also allow the regulator to diagnose the source of the problem, so that appropriate corrective action can be taken.

A two-pronged test is needed to determine appropriate action

Financeability problems can arise because:

The first is a case of internal inconsistency in the regulator’s process and is for the regulator to resolve. The second is a case of risky financing practices and is for the firm and its owners to resolve.

Regulated businesses should be free to depart from the regulatory benchmark if they choose. The business then keeps any benefits, and bears any costs, of such a departure. Neither the regulator nor consumers should be called on to immunise regulated businesses against bad outcomes arising from such decisions.

The Ofwat approach described above involves a two-part test:

A similar two-pronged test is applied by the NSW Independent Pricing and Regulatory Tribunal (IPART).

The source of any financeability concern can be identified more easily by using two separate tests:

Recent financeability test practices in Australia

There are almost no examples of Australian regulators taking action to address financeability concerns arising from their decisions to set inadequately low revenue allowances. Some regulators perform no test at all, so have no way to detect the existence of a problem. But, many that do perform financeability tests have chosen to take no action, even when the test has clearly identified a financeability problem.

‘Narrating away’ the outcomes of a financeability test

It is important that regulators acknowledge the outcomes of their financeability tests, respond consistently and do not try to apply a narrative that seeks to ‘explain away’ a potential problem.

IPART

The most important financeability metric considered currently by rating agencies for Australian regulated energy and water businesses is the funds from operations to net debt (FFO/Net Debt) ratio

In IPART’s 2020 determination for Sydney Water, the FFO/Net Debt ratio fell below of the minimum 7.0% threshold specified in IPART’s benchmark test in every year of the regulatory period. This suggested strongly a failure of the benchmark test. IPART should have adjusted Sydney Water’s revenue to ensure an efficient, benchmark business could remain financeable.

However, IPART concluded that the failure of the test on the FFO/Net debt ratio did not indicate a problem. This is because, amongst other reasons, that ratio was expected to improve over the regulatory period towards the target ratio (from 6.6% in 2020-21 to 6.8% in 2023-24). However, it would remain below the required threshold in every year.[4]

According to IPART, there was no problem to fix because the failure of the test was forecast to become less severe over time.

Australian Energy Regulator (AER)

In 2022, the AER undertook a major review of its methodology for setting the allowed rate of return for electricity and gas networks. As part of that review, the AER presented a simplified financeability test to assess the impact of its proposed methodology.

The AER’s test used the FFO/Net debt ratio as the sole metric and set a threshold of ≥7.0% for a ‘pass’.

The AER found that the FFO/Net debt ratio for 25% of the businesses fell below the threshold for a pass.

The AER concluded that there was no evidence of a financeability concern (at the industry level) under its proposed rate of return methodology because 75% of the firms appeared to pass the test.

Of course, this ignored the fact that a quarter of the industry had failed the regulator’s own test.[5]

Not adjusting regulatory decisions in response to a failure of the benchmark financeability test and instead narrating away the outcome is as good as having no test at all.

Applying the wrong solution to the problem

The regulatory response to a financeability problem should properly address the underlying cause of the problem. Without addressing the cause, remedial actions may be misdirected, leading to inefficient outcomes.

If the financeability problem was caused by the business taking imprudent or risky financing decisions (e.g., by gearing up more than the benchmark level), it should not fall to consumers to ‘bail out’ the business for those poor decisions. That would impose unnecessary costs on consumers and create poor incentives for the business to avoid bad financing decisions in future.

However, if the financeability problem was caused by the regulatory allowance being set too low for a efficient business to remain financeable, then the regulator, not shareholders, should fix the problem.

IPART has made this distinction clear:

“If the source of the concern is that prices are too low even for a benchmark efficient business, we think the appropriate remedy is to review our pricing decision. In essence, this step would involve correcting a regulatory error. The financeability test could help identify any such error by applying additional information that may not have been available in the building block model used to set prices.

If the source of the concern is that prices are adequate for a benchmark efficient business but too low for the actual business because its owners have been imprudent or inefficient, there are appropriate remedies. The owners could reduce the business’s level of debt by injecting more equity, accept a lower than market rate of return on their equity, or both. It is an important principle that an inefficient business should not be rewarded for its imprudent decisions at the expense of customers.”[6]

The best way to diagnose the source of a financeability problem is to apply a two-pronged test of the sort used by IPART and Ofwat. Because the benchmark test assumes that the regulated business always finances itself efficiently and prudently, the only explanation for a failure of that test would be a regulatory error that requires correction.

Calibrating the financeability tests incorrectly

Even when a test is structured correctly, it will only be useful if it accurately reflects the financial flows of an efficient benchmark business. If the thresholds for passing the test are set unrealistically low, then genuine financeability tests will go undiagnosed and uncorrected.

For example, when running its benchmark test, IPART assumes that businesses faces real, rather than nominal, debt obligations. But, in reality, companies in Australia issue nominal debt and therefore must pay nominal interest expenses.

Assuming that an efficient regulated business faces lower (i.e., real) interest expenses than it in fact does makes IPART’s benchmark test too easy to pass. Hence, the test is prone to ‘false negatives’—i.e., conclusions that there is no financeability problem, when there is one.

Recommendations for improvements to regulatory financeability tests

These examples show that regulators in Australia either do not apply financeability tests at all, or if they do, typically find reasons not to fix a problem identified by their own financeability tests.

The Thames Water example is a reminder that regulated businesses can face serious financeability problems.

Ofwat concluded at the last price control that Thames Water needed an uplift in allowed revenues of £125 million to support an efficient credit rating, at an efficient level of gearing. The crisis that Thames Water faced would probably have been worse than it was, had Ofwat adopted the approach that Australian regulators follow and ignored the results of its own financeability analysis.

Because regulated businesses deliver essential services, it is consumers that suffer if these businesses become insolvent or financially constrained. In the case of insolvency, taxpayers may also be called upon to rescue the business from collapse.

Therefore, regulators in Australia should view financeability tests as an essential part of best practice and incorporate them as a standard feature into their revenue setting processes.

A good framework for regulatory financeability tests should:

If the cause is imprudent or risky financing decisions by the business, it should be left to investors to deal with. However, a failure of a benchmark test indicates that the problem is a regulatory one. In these situations, the regulator should take action to fix the problem, rather than explain it away or shift the onus on shareholders.

A two-pronged test allows regulators to pinpoint the cause of the problem and ensure that tailored action is taken.

Regulators should take the outcomes of these tests seriously and not dismiss a clear failure of the test by simply assuming that their regulatory decision is adequate.

To find out more about how we advise on regulatory issues and financeability, pricing reviews, and more, please reach out to our team.

[1] Ofwat, Thames, debt and water sector finance, 24 July 2023. [2] UK Legistation, Water Industry Act 1991, section 2(2A)(c). [3] Ofwat, PR19 determinations: Thames Water final determination, December 2019. [4] IPART, Review of prices for Sydney Water from 1 July 2020, Final Report, June 2020, p 178. [5] AER, Draft rate of return instrument, Explanatory statement, June 2022, p. 24. [6] IPART, Review of our financeability test, Issues paper, May 2018, p. 32

Frontier Economics Pty Ltd is a member of the Frontier Economics network, and is headquartered in Australia with a subsidiary company, Frontier Economics Pte Ltd in Singapore. Our fellow network member, Frontier Economics Ltd, is headquartered in the United Kingdom. The companies are independently owned, and legal commitments entered into by any one company do not impose any obligations on other companies in the network. All views expressed in this document are the views of Frontier Economics Pty Ltd.

The case for developer charges: fair water infrastructure contributions promote better development outcomes and reduce infrastructure costs to the community

Developer groups have opposed Sydney Water and Hunter Water’s planned reintroduction of infrastructure contributions (or ‘developer charges’). These charges to developers help recover the area-specific, development-contingent costs of providing or upgrading the water, wastewater and stormwater drainage networks to serve new development.

However, such contributions have never been more important to the community. These charges signal to developers the costs of providing infrastructure in different areas, and thus promote socially optimal development decisions – i.e., development in locations where the benefits to the community exceed the costs. They also minimise price increases to customers’ water bills (helping to reduce cost of living pressures), and they allow some of the land value uplift generated by rezoning to fund much needed infrastructure.

Cost-reflective infrastructure contributions can also be an efficient and fair funding source for infrastructure provided by local councils to serve new developments, including much needed public open space, transport (eg, local roads) and local stormwater infrastructure.

The reintroduction of water and wastewater developer charges

The term ‘rent-seeking’ was first used to describe the wasting of resources by entrepreneurs to fight for artificially created wealth transfers. This is an apt description for the time spent in recent years by developers seeking to convince the NSW Government to resist the reintroduction of cost-reflective water, wastewater and stormwater infrastructure contributions (or ‘developer charges’) in Sydney and the Hunter.

Following a review by the NSW Productivity Commission in 2020, the NSW Government committed to reform the infrastructure contributions system, with a key element being the phased reintroduction of developer charges for Sydney Water and Hunter Water’s water, wastewater and stormwater services. This follows over a decade of these charges being set to zero (set by Ministerial direction in 2008). The consequence has been that Sydney Water and Hunter Water’s additional costs to provide water infrastructure to service new developments has not been recovered from developers, but from all water, wastewater and stormwater customers via their quarterly bills.

Under the methodology set by the NSW Independent Pricing and Regulatory Tribunal (IPART), these infrastructure contributions would recover Sydney Water and Hunter Water’s costs of providing water, wastewater and stormwater services to new development areas that are above and beyond the retail price revenue the water utilities will receive from servicing customers in the new development areas over time.[1]

Developers have long opposed paying these infrastructure contributions, arguing these costs should be borne by the wider community. They have suggested a broader revenue base (i.e., anyone but them) for infrastructure funding is needed, and that there is limited public benefit to infrastructure contributions.

Given concerns about housing affordability, the community is naturally interested in the key supply-side and demand-side drivers of house prices. Seeing an opportunity, developer groups have sought to re-prosecute their case opposing the developer charges as they claim they increase development costs and house prices.[2]

However, given the incentives at play, this requires closer scrutiny. Do these charges really increase development costs and house prices? What are the implications to the broader community and water customers if these infrastructure contributions are not reintroduced?

A cost to whom?

Infrastructure contributions may be a new cost to developers, but not to society. That is, infrastructure contributions do not create costs, they just represent a way of recovering them.

Since 2008, the costs of providing development-contingent water infrastructure have been paid by all water, wastewater and stormwater customers across Sydney Water and Hunter Water’s areas of operation through their regulated prices. IPART, with responsibility for setting maximum charges levied by Sydney Water and Hunter Water, explicitly accounts for these when setting the charges that are levied on customers via their quarterly bills. This decade old subsidy from water customers (including households) to developers has added billions of dollars to water bills of households and businesses, directly impacting the affordability of these essential services.

In 2019, IPART estimated that by 2029, Sydney Water’s average customer would be paying an additional $140 per year for their water, wastewater and stormwater services if infrastructure contributions were to continue to be set to zero.[3]

Despite the overwhelming current media focus on the cost of living, this impact on the affordability of water is one of the few areas that has escaped public scrutiny.

Re-introducing cost-reflective infrastructure contributions would simply reallocate these costs back to developers, who are creating the need to incur them and benefitting from them. This is in line with the “impactor pays” principle, enshrined in the Council of Australian Government’s National Water Initiative Pricing Principles, which were designed to increase the efficiency of Australia's water resources and infrastructure assets. This principle also underpins funding for a range of other critical services.

The reintroduction of infrastructure contributions would provide bill relief to all water customers, which will be increasingly important as major metropolitan centres in Greater Sydney and the Hunter continue to grow, and households face cost of living pressures.

Supporting planning objectives and efficient development

Cost-reflective infrastructure contributions also support planning objectives, by signalling to developers the costs of providing water infrastructure to different areas in Sydney and the Hunter – with some areas being higher cost and others lower cost to service, and these variations being ideally reflected in infrastructure contributions.

This price signal would encourage efficient development decisions. Currently, without such cost-reflective infrastructure contributions, developers do not need to consider the different cost of providing water infrastructure to different areas in Sydney. This means there is a risk they develop in areas where the costs to the community of providing such infrastructure exceeds the benefits of the development.

Smearing development-contingent costs across all water customers risks diluting one of the key signals related to the cost of development between locations, which in turn can contribute to inefficient investment in relatively high-cost areas.

As the NSW Premier and Productivity Commission have recently said, we need to improve how we plan and develop Sydney to minimise stretching of infrastructure services, including building more housing in infrastructure corridors to enhance amenity, lower infrastructure costs and improve housing affordability.[4]

Water infrastructure contributions and house prices

Provided developers have sufficient line of sight of infrastructure contributions (i.e., they are aware of these contributions before they purchase developable land), the economics of housing supply tells us that these costs are not necessarily passed through to homeowners through higher house prices.

As observed through numerous studies across multiple jurisdictions and the NSW Productivity Commission (see Box 1 in PDF Bulletin), they are likely to be factored into the prices developers pay for developable land – resulting in a lower than otherwise price to the landowner, who may still receive significant windfall gains by virtue of their land being rezoned or deemed developable.

That is, infrastructure contributions can allow some of the land value uplift generated by rezoning to fund much needed infrastructure.

If there are occasions where this means the landowner is not willing to sell to the developer, this would indicate that the benefits of the potential development in that location (as measured by what the developer is willing to pay for the land) does not exceed its costs to the community. However, this is unlikely to be common, as in an environment of increasing population, the value of developable land in and surrounding cities often exceeds its opportunity cost in alternative uses (e.g., for industrial use or agricultural production).

This key conclusion – that housing affordability is not exacerbated by infrastructure contributions, provided developers are aware of these contributions before they purchase developable land – is also backed up by empirical literature. Abelson (1999)[5], Ruming, Gurran and Randolph (2011)[6], Davidoff and Leigh (2013)[7] and Murray (2018)[8] all found that the incidence of development contributions likely falls on developers or landowners rather than home buyers.

The most reliable Australian evidence is consistent with this view; with little credible evidence to the contrary.[9]

The NSW Productivity Commission has observed that, as a policy to increase housing supply, setting Sydney Water and Hunter Water’s infrastructure contributions to zero has been ineffective and costly, predominantly resulting in a transfer of wealth from water customers to owners of developable land, “including those that would have developed land regardless”.[10]

Where to from here?

Cost-reflective infrastructure contributions can help to fund infrastructure more fairly, reduce pressure on water bills to residential and non-residential customers, and support better planning and development outcomes.

The focus should not be on whether these contributions should be reintroduced, but rather how to:

Resources spent on doing these well, rather than “rent-seeking”, will deliver value to the whole community, including developers.

Importantly, for the same reasons as outlined above, cost reflective infrastructure contributions can be an efficient and equitable funding source for infrastructure provided by local councils to serve new development – including public open space, transport (such as local roads) and stormwater infrastructure.

[1]  Retail prices to customers reflect network-wide average costs (i.e., all customers face the same prices, regardless of their location within the utility’s network). Infrastructure contributions therefore recover the difference between the costs of servicing a specific development area and network-wide average costs.

[2] Daily Telegraph, Water torture for new housing, May 12, 2023.

[3] IPART, Prices for Sydney Water from 1 July 2020, Issues Paper, September 2019, p 29.

[4] NSW Premier Chris Minns puts Sydney NIMBYs on notice, 15 May 2023; Sydney Morning Herald, Sydney’s richest suburbs need to be higher, denser to solve housing crisis, 31 May 2023.

[5] Abelson, P, 1999, ‘The real incidence of imposts on residential land development and building’, Economic Papers, vol. 8, no. 3.

[6] Ruming, K, Gurran, N, & Randolph, B, 2011, ‘Housing Affordability and Development Contributions: New Perspectives from Industry and Local Government in New South Wales, Victoria and Queensland’, Urban Policy and Research, vol. 29, no. 3, pp. 257–274.

[7] Davidoff, I & Leigh, A, 2013, ‘How do Stamp Duties Affect the Housing Market’, Economic Record, vol. 89, no.286.

[8] Murray, CK, 2018, ‘Developers pay developer charges’, Cities, vol. 74, pp. 1–6.

[9] Bryant (2017) finds a substantial impact on house prices however there are a number of concerns with the empirical approach taken. UQ Economist Cameron Murray’s paper, in response to the work of Bryant, is more convincing, having applied a clear empirical strategy exploiting unanticipated changes to the developer charge regime to identify the impact of these developer charges, finding no impact on house prices and therefore house buyers. Even more illustrative is the replication of the results of Bryant (2017) when ignoring the mechanical relationship between house characteristics and developer charges.

[10] NSW Productivity Commission, Review of Infrastructure Contributions in New South Wales, Final Report, November 2020, p 101.DOWNLOAD FULL PUBLICATION

The economics of water security in Australia’s hydrogen transition

Hydrogen gas has been hailed as the next big clean energy source, and Australia, with its abundance of renewable energy potential, is seen as well positioned to lead the charge to net zero. Governments and utilities are increasingly turning their focus to how the potentially large but uncertain water requirements to support Australia’s hydrogen transition can be met.

The quantity and variability of Australia’s water resources compared with other continents is well known, as are the expected reductions in average groundwater and surface water supplies available for consumption. The challenge for Governments and utilities is how to plan for and deliver water services to meet growth in underlying demand as well as potentially large but uncertain growth in industrial water demand –  including to support Australia’s hydrogen transition.

In this context, it is critical that a sound economic framework is utilised to evaluate supply and demand side measures to meet potential growth in water demand, and provide efficient price signals to water users relating to the economic, social and environmental cost of water supply. This bulletin explores how integrating the economics of water security early in the hydrogen planning process can support informed decisions about how this transition occurs, including the location of hydrogen assets and their water sources, and ensure investment in water supply occurs when and where it maximises value to the community.

Australia’s hydrogen transition could have significant water requirements

Demand for ‘clean’ or ‘green’ hydrogen is expected to dramatically increase over the next decade as it replaces other hydrocarbon-based energy sources, such as liquid fuels for vehicles and natural gas for electricity generation and heating. Australia appears well placed to take advantage of increasing global momentum for clean hydrogen with big ambitions to grow our domestic hydrogen sector, with the “aim to position our industry as a major global player by 2030.”[1] Significant resourcing including state and private funding is being committed to support this ambition.

Year-round access to a secure source of water is critical for the delivery of Australia’s hydrogen transition. The National Hydrogen Strategy notes that water required for a large-scale hydrogen production industry will be significant. Given uncertainty around the future growth of Australia’s hydrogen sector, estimates of future water demand vary, ranging from just under the current annual supply for the whole of Southeast Queensland,[2] to around one-third of the water currently used by the Australian mining industry.[3] While the water demand is uncertain, in either scenario, it is potentially significant.

The National Hydrogen Strategy acknowledges that “Australians will want the new jobs and growth of clean hydrogen to be achieved without compromising safety, cost of living, water availability, access to land or environmental sustainability”.[4]

It notes that Australia will therefore need to consider how to balance hydrogen’s demands with other water priorities.[5] Some of which “may have higher economic, social or cultural value.” [6]

Delivering cost-effective hydrogen is likely to be a complex optimisation problem

The National Hydrogen Strategy states that “the most ideal sites for production facilities will have access to renewable electricity and water supplies”. [7]

Implicit within this is that there is a complex optimisation across numerous input and output/product markets – whether to transport energy, water and/or hydrogen.

For example, the Hunter Valley Hydrogen Hub on Koorangang Island was chosen as the location for a hydrogen hub based on its “proximity to high energy users, existing skilled workforce, existing energy infrastructure and land available for complementary businesses.”[8]

The Water Services Association of Australia states that: “For hydrogen production, 11% of Australia is suitable when considering energy needs only. This is reduced to only 3% when factoring water and transport infrastructure”.[9]

A key element when considering the cost of water in this optimisation is:

 

diagram titles "Cost effective hydrogen supply involved optimsing across three key areas" which are water supply, hydrogen demand and energy supply.

 

The costs of water supply are variable but in many places are already increasing

The challenges in providing water security in Australia are well known.

Australia has a highly variable climate and set of rainfall patterns. Changes to rainfall patterns, declining groundwater availability and changes to water allocation (in part related to increasing environmental considerations)—all increasingly exacerbated by climate change— are reducing the capacity of existing and primarily climate dependent systems to supply water to the community.

Alongside this, water demand particularly in many urban areas is expected to grow as result of population growth, increasing temperatures and evaporation rates and community expectations for irrigated ‘cool green’ communities.

For this reason, in many urban supply areas, water security is increasingly being met by climate independent sources of supply (such as desalination and recycling facilities) combined with water conservation and demand management. While often cost effective relative to investment in more traditional climate dependent sources (such as new dams), these measures are increasing water supply costs over time, reflected in higher water usage prices.[10] The era of low-cost water is over.

The National Hydrogen Strategy notes that other uses for water may have higher economic, social or cultural value.

However, the impact on availability of water and/or other users, will vary depending on site specific characteristics, such as the size of the hydrogen scheme, the supply and demand balance in the area and the other competing water uses.

In some cases, investment in a hydrogen scheme that displaces other water demand can deliver a net benefit to the community (i.e. where hydrogen displaces low-value demand).

Identifying and enabling investment in these value enhancing opportunities for hydrogen production requires identifying the range of economic, social and environmental costs and benefits of water supply.

In broad terms, in rural areas the cost will largely by the social and environmental costs of displacing current users. In metropolitan areas it could be the cost of measures to increase supply or where this is not possible, to manage demand.

Rural areas

Non-metropolitan areas are likely to be closer to the source of renewable energy and water supply, but further away from hydrogen demand (for example, export infrastructure).

In addition, while water licences can appear to be a relatively cheap source of water, without access to a high security access licence, water may not be available when it is needed.

In many rural regions, additional water supply options can be limited, which means that the cost of meeting the additional demand associated with the hydrogen scheme can be significant. Inland desalination can be prohibitively expensive, and many communities rely almost 100% on rainfall dependent water sources, which are becoming a less and less secure source of water.

In the instance where proponents can access a secure licence at a reasonable price, as most rural water systems are fully allocated, providing water to the hydrogen scheme is likely to displace current users, such as farmers and households.

This displacement of demand can generate a range of economic, social and environmental impacts and can present equity and socio-economic concerns, especially when the water is used to provide hydrogen for export to other countries.

Even in the instance where there are allocations available (the hydrogen scheme does not displace demand), at a minimum, the high reliability requirements of the hydrogen scheme would increase the risks and variability to other users.

This highlights the need for an economic model to help understand the socio-economic impacts of allocating water to a hydrogen scheme. This is similar to analysis that we undertook to help understand the impact of Basin Plan water recovery, that has significantly reduced water available to irrigators, industry and other water users, to improve environmental outcomes.[11]

Diagram showing the spectrum of water supply costs

Metropolitan areas

Alternatively, the hydrogen scheme could be located close to metropolitan areas, such as near Newcastle or Perth. This is likely to be located near the source of hydrogen demand (both domestic demand and export infrastructure for international demand) but can require transportation of the energy. It also presents unique water security challenges.

While connecting a hydrogen scheme to the existing water supply may seem like a simple solution (i.e. use what we already have), doing so will subject the plant to broader, complex water security rules, regulations and planning impacts, as a large customer in a bigger water supply system, which could have implications for secure hydrogen production (for example, hydrogen production may need to be subject to water restrictions).

As shown in the graphic below, connecting the hydrogen scheme to the existing water supply, is likely to bring forward investment by a number of years, and/or trigger additional investment, in water supply or demand measures. These additional measures often represent more costly water supply options, as the lower cost options, such as surface and groundwater, have been fully utilised. This means that even in the presence of cost reflective prices, water prices are likely to increase in future.

While wastewater recycling or stormwater harvesting are also possible options, recycling is not a costless source of water because there are competing uses for it. For example, any recycling supplied to a hydrogen plant, is recycling that cannot be used to meet other non-potable, and increasingly, potable, needs.[12] In other words, using recycling to meet demand is not necessarily a low economic cost option.

An alternative option that is regularly raised is the construction of a desalination or wastewater recycling scheme to directly supply a new hydrogen scheme. However, like other major industrial customers, it may be the case that these hydrogen schemes remain connected to the water supply grid (to allow potable ‘top-up’).

Even if the hydrogen plant itself is not subject to water restrictions, restricting other users water supply while maintaining supply to the hydrogen plant can, as above, present equity and socio-economic concerns. For example, should a desalination plant built to service a hydrogen plant be required to service the broader community during periods of extreme drought?

In every case mentioned above, water security planning must be undertaken in a way to appropriately manage the, albeit uncertain, hydrogen demand.

Regardless of the water supply option adopted, supplying water for hydrogen schemes is likely to add the cost of building more water supply infrastructure on top of several other investments in water security, wastewater and stormwater management that are already planned over the next thirty years.

This highlights the need to holistically plan across the water cycle and across various (competing) water demands, to identify and enable investment where and when hydrogen delivers a net benefit to the community.

diagram for meeting water demand

A sound economic framework is critical to supporting Australia’s hydrogen transition

However, in many planning processes to date, there has been limited consideration of:

This may be because:

However, without proactive planning and engagement – supported by a sound economic framework– there is a risk that:

These examples highlight that while the cost of water may appear to be a small proportion of the cost of a hydrogen scheme, there is a need to consider the site-specific value of hydrogen schemes, including any implications across the water cycle early in the planning process. This requires planning and collaboration across the hydrogen, energy and water sectors underpinned by:

An economic framework for understanding the broader economic, social and environmental costs and benefits of meeting the broad range of water demands, including the opportunity cost of water supply options. While groundwater or wastewater resources may seem a low-cost solution to providing water for hydrogen in some areas, consideration should be given to the impact on competing users and the opportunity cost of alternatives uses of these resources.

If the water or wastewater resource could be used by other users, meeting the demand of hydrogen schemes will bring forward investment in the broader water supply system, imposing costs on the community.

While these steps are not always easy and require collaboration across sectors and disciplines across the public and private sector (including engineers, planners, scientists and economists), they provide a robust framework to better identify, quantify, value and incorporate these costs and benefits into decisions.

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Frontier Economics and Tim Cummins & Associates have analysed the social and economic issues associated with water recovery for the environment in Victoria under the Murray Darling Basin Plan. The report can be found here.

This 2022 report updates previous analysis undertaken in 2017, both commissioned by the Victorian Government to help inform Victoria’s policies on water recovery and Basin Plan implementation.

Under the Basin Plan, the relevant Governments agreed that 2,750 GL of water would be recovered for the environment by 30 June 2024 — the ‘Bridging the Gap’ water recovery requirement. This water was to be recovered mostly from buying water entitlements from farmers, by enabling water efficiency projects, or by investing in projects that deliver the same environmental outcomes using less water. Beyond the ‘Bridging the Gap’ water recovery, the Basin Plan allows for enhanced environmental outcomes from the recovery of an additional 450 GL per year of environmental water through efficiency measures.

There is unambiguous evidence that environmental watering is restoring the environmental values of the Basin. However, we found that Basin Plan water recovery has had significant socio-economic impacts on irrigators and communities in northern Victoria, and that further water recovery from the consumptive pool will add to the impacts already being experienced. The socio-economic impacts of the Basin Plan in Victoria are particularly apparent in the Goulburn Murray Irrigation District (GMID) — without the Basin Plan, water use in the GMID could be expected to have been about 50% higher in recent years (2018-19 to 2021-22) and GMID milk production could also have been expected to be about 50% higher than was observed. In a repeat of the Millennium Drought, the socio-economic impacts of the Basin Plan will also affect the horticultural industries of the Victorian Mallee and surrounding areas — requiring an extra 25,000 hectares of high value horticulture to be dried off due to the reduced consumptive pool.

The report considers the range of mechanisms that have been used to recover water for the environment and enhance environmental outcomes — including water entitlement buyback, on-farm investments, off-farm investments, and Sustainable Diversion Limit Adjustment Mechanism (SDLAM) projects. As a result of the way in which water was recovered, there is now more volatility in the total volume of allocations available for irrigation from one year to the next.

There are reasons to be optimistic about meeting most of the ‘Bridging the Gap’ requirements of the Basin Plan by 30 June 2024. On current estimates, up to 94% of the 2,750 GL requirement could be achieved (leaving a shortfall of 160.3GL). However, if various identified risks cannot be managed, the shortfall in the 2,750 GL requirement at 30 June 2024 may be significantly larger —up to 372.3GL. ‘Constraints projects’ constitute most of the projects at risk.

After considering four scenarios of future implementation of the Basin Plan and the current state of play, we consider a sensible and plausible scenario is for Basin Plan implementation to focus on current or alternative SDLAM projects to offset the full 605GL in a timely manner (rather than by the current 30 June 2024 deadline). Buying back an additional 372.3 GL of water entitlements, instead of extending the deadline, would involve significant socio-economic impacts.

Information about the broader set of reports and a fact sheet are also available here.

The property sector has been exploring the ways that climate change could affect business, and until now, this has mostly been focused on the physical effects. However, it is important that businesses don't overlook transition risks as they start to deal with the move to a low carbon economy. There is growing industry level discussion about the potential material financial impacts of this transition for the property sector. We see three key issues as important for those businesses navigating their way through this challenge.

These are:

Frontier Economics and Edge Environment have partnered to provide comprehensive sustainability and economic advice to guide businesses through climate change risk and reporting. A new article, co-authored by Ben Mason from Frontier Economics, along with Mark Siebentritt, Miranda Siu and Jackie McKeon from Edge Environment, discusses the challenges that the property sector face navigating this complex area.

To read the full article, click below:

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Infrastructure Australia today released the 2021 Australian Infrastructure Plan, which provides Australia’s green, grey and blue infrastructure sector with a 15 year roadmap to drive economic growth, maintain and enhance our standard of living and improve the resilience and sustainability of Australia’s essential infrastructure.

The 2021 Plan provides Infrastructure Australia’s reform pathway to respond to the 180 infrastructure challenges and opportunities identified in the 2019 Australian Infrastructure Audit. There are a number of key themes in the plan. We highlight and discuss several of these below.

The inclusion of waste and social infrastructure (such as green and blue infrastructure) for the first time, alongside energy, transport, telecommunications and water.

The need for place-based decision-making, including the need to holistically plan blue, green and grey infrastructure.

Recognition of the need for a consistent approach to valuing the economic, social and environmental benefits of blue, green and grey infrastructure (which has also been recognised by NSW’s Department of Planning Industry and Environment). Frontier Economics has discussed this in two recent bulletins: Greening our cities: from vision to value and Greening our cities: from vision to reality.

The need to embed sustainability and resilience into infrastructure decision-making, including the importance of a consistent all-hazards, systems approach to resilience planning and quantification of the costs, impacts and benefits of resilience investment.

Recognition of the need for clear management and governance of the water cycle, including stormwater and waterways.

The need to remove targets, mandates and subsidies for certain types of water, including recycled water. (For a look at how to encourage uptake of recycled water initiatives, and barriers, Frontier Economics undertook a review for Infrastructure NSW.)

It is a comprehensive plan addressing all aspects of infrastructure. It puts forth a compelling vision of Australia in 2036, that includes liveable, attractive and resilient communities with social infrastructure supporting a strong, healthy and prosperous nation.

The urban economics team at Frontier Economics advises across these areas. For more information or to discuss a project, please contact us.

Once thought of as purely an environmental issue, climate change is now recognised as a major threat to economies and financial markets around the world. As a result, public and private sector organisations are being asked to provide public disclosures of how current and future climate risks will impact their operations.

Recognising the increased need for climate change impact reporting with a greater focus on financial analysis, Frontier Economics and sustainability services consultancy Edge Environment are very excited to be partnering with each other to offer clients advice that combines in-depth environmental expertise underpinned by solid economic analysis and modelling.

“The requirements for climate disclosure reporting have been increasing around the world in recent years. We have seen climate change shift from being primary an environmental or “green” issue to one with legal, governance and financial implications” said Dr Mark Siebentritt, Edge’s Commercial Director and one of its climate risk analysis experts.

“We are seeing many of our clients step up their analysis of climate risk. This is in response to commentary by financial regulators in Australia about the need for companies to address what is now regarded as a foreseeable and material risk. Change is also coming through international markets with some countries like England and New Zealand headed toward mandatory climate risk disclosure reporting.”

One of the key challenges of climate risk disclosure reporting aligned to frameworks like the Taskforce on Climate Related Financial Disclosures (TCFD), is the need to better understand the financial implications of climate change.

“The impacts of climate change on the financial statements of an organisation is complex.  Companies can find it challenging to do this as there are many drivers that need consideration. For example, take the impact of extreme heat on a property portfolio. You first need to understand the risk of such extreme weather in different climate change scenarios. Then you need to understand the physical impacts of extreme heat, this may include increased energy costs, damage to the property and even consideration of whether the property is unhospitable in extreme heat. Finally, you need to place a financial value on these physical impacts. Climate risk specialists and financial experts working together can give companies these insights” said Ben Mason, economist at Frontier Economics.

“A key risk companies are often interested in is around energy supply transitioning to renewables and the impacts on energy prices. We have energy network models and have provided shadow carbon price advice to various clients.”

Building on our expertise in TCFD reporting, Frontier Economics is expanding into ESG related advice more broadly. Ensuring decisions are based on sound and rigorous economics is critical for companies navigating this complex area.

Background

Edge Environment and Frontier Economics have worked across a broad range of climate risk projects, including within the property, infrastructure and government sectors. Together, this partnership provides a unique opportunity to better understand both financial risks and opportunities for Australian and New Zealand businesses.

About Edge Environment

Edge is a specialist sustainability advisory company focused on Asia-Pacific and the Americas. Its teams are based in Australia, New Zealand, the United States and Chile. Edge exists to help its clients create value from tackling one of world’s most fundamental challenges: creating truly sustainable economies and societies. Edge does this by combining science, strategy and storytelling in a way that gives our clients the confidence to take ambitious action, and do well by doing good.

About Frontier Economics

For more than twenty years, Frontier Economics has contributed sound economics to many important debates and decisions in Australia, New Zealand and the Asia-Pacific. Governments, regulators and businesses use our economic advice to inform policy development, market design, regulation and investment. Frontier Economics prides itself on delivering quality, independent economic input that can lead to better decisions and better outcomes for our clients.

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