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Subsidies to the Use of Natural Resources

Environmental Economics Research Paper No.2
This report was prepared by a consultant,
the National Institute of Economic an Industry Research (NIEIR),
for the Department of the Environment, Sport and Territories.
Commonwealth of Australia, 1996
ISBN 0 642 24864 8

3. Water

3.1 Introduction

Water catchment, storage and distribution for household, business and agricultural (mainly irrigation) use is primarily the responsibility of publicly (mainly State) owned enterprises. As Australia is a dry continent with few natural supplies of fresh water in lakes and streams, and a country with a substantial agricultural industry and a significant concentration of population in coastal areas, water resources and water quality issues are of major significance.

A range of pollutants enter water supplies prior to use. The extent of the pollution depends on the water source. Water from controlled, restricted use catchment areas is relatively free of pollutants while supplies from streams, open and relatively unprotected areas may require decontamination before use. During use a range of pollutants are added to water, and water run-off collects pollutants in urban and rural areas. Treatment of these contaminated water flows before their disposal is often inadequate or non-existent.

While most water use is from surface sources(catchments, streams and lakes) ground water is also used. There is a tendency, when surface water becomes unavailable or expensive, for consumers to tap into this “free” resource. Groundwater, like surface water, is one mode of water occurrence in the water cycle. However, because of its large storage volume, its hidden nature, slow movement and slow flushing characteristics, it does require different management consideration. Contamination of ground waters can occur from uncontrolled and difficult to control sources such as seepage from landfill disposal sites, leakage from storage tanks or pipelines, poorly constructed tailings dams, etc. Ground water is usually more at risk from these contamination sources, but as many streams are fed by ground water outflow some degradation of surface water bodies can also occur.

Water resource subsidy issues are closely related to waste water subsidy issues and related to those in several other resource activities. For example forests in catchment areas can significantly enhance water quality (see Forests chapter) and solid waste disposal into land fill may result in leaching of toxics into water supplies. In this report water quality is mainly dealt with in Chapter 5 (waste water treatment and disposal).

The water industry produces some positive externalities or non-market benefits, for example biodiversity preservation and recreational opportunities in catchment areas. These externalities and the costs and benefits of water catchment preservation have not been quantified and are not discussed further.

Reform of the Australian water industry is recognised by Australian governments as being required. Issues such as those raised in the 1992 Industry Commission report on Water Resources and Wastewater Disposal; the Ecologically Sustainable Development process; and environmental problems such as algal blooms led to the creation of the Council of Australian Governments (COAG) Working Group on Water Resource Policy in 1994. This body was established to develop a strategic framework for efficient and sustainable reform of the water industry which will take account of the diversity that exists across the States and Territories.

The COAG Working Group has yet (October1995) to finalise its work, but indications are that there is a high degree of agreement amongst Australian Governments as to what must be done to improve the efficiency of the water industry. In February 1994 the Working Group reported (see Note 1 below) on its work and recommended that Heads of Government, in implementing a strategic frame work for the water industry, have regard to the following principles.

When implemented the strategic framework is expected to improve environmental outcomes and result in a restructuring of water tariffs and reduced or eliminated cross-subsidies for metropolitan and town water services. The report notes that financial assistance for particular consumers may be necessary where cost reductions are not available to offset price increases. In the case of rural water services the framework is intended to generate the financial resources to maintain supply systems should users desire this, allow water to flow to higher value uses subject to certain social, physical and environmental constraints, provide irrigators with a tradable asset (which could also serve as a useful structural adjustment instrument in some cases) and devolve, where appropriate, operational responsibility for irrigation schemes to local areas.

Also noted is that:

“While the need for reform is recognised, the legacy of past investment and poor decisions, particularly in relation to irrigation schemes, means that there are very real constraints on the extent and pace of reform in some areas. Because the changes flowing from the framework are extensive and far reaching in their implications, particularly in rural areas, it is considered that a five to eight year implementation period will be required.” (see Note 2 below)

A second report (see Note 3 below) in February 1995 indicated that in the previous twelve months progress had been made in implementing the strategic framework. The report noted concerns in rural areas about the extent of price increases that might have to occur for rural water services to be financially viable. Also noted, however, was that cost reductions may be achievable in rural water delivery systems, as indicated by efficiency improvements in some areas that will help offset the increase in charges that would otherwise be required to place irrigation schemes on a financially viable basis.

1. Report of the Working Group on Water Resource Policy to the Council of Australian Governments, February, 1994.

2 ibid, p.8.

3 Second Report of the Working Group on Water Resource Policy to COAG, February, 1995.

In the area of asset valuation, which affects rate of return estimates, the COAG Working Group, has agreed on using the Deprival Value methodology for asset valuation. The current situation is variable but most major agencies had been working towards valuing assets on a Replacement Cost basis.

The Deprival Value approach provides a measure of the real economic costs of service provision. The deprival value of an asset is the value to the entity of the future economic benefits that an entity would forego if deprived of the asset. Under this approach to asset valuation, assets are valued at an amount that represents the entire loss, both direct and indirect that may be expected to be incurred if an entity were deprived of the service potential or future economic benefit of the asset at reporting date. (see Note 1 below) Compared to the Replacement Cost method the Deprival Value approach places a lower value on past investments that have proved uneconomic.

 

3.2 Financial subsidies


Water supply (catchment, distribution) has been mainly the monopoly of public enterprises. Responsibility for establishment and management of water catchment areas and distribution facilities has been with these enterprises which are often also responsible for wastewater and sewerage activities. The authorities have not been subject to taxation, and the opportunity cost of catchment land and full capital and recurrent expenditures have seldom been factored into costs of water supplied. Financial subsidies to water supply have been substantial in Australia, particularly in irrigation and non-metropolitan reticulated water systems. In no State is an 8 per cent real rate of return achieved and most (see Table 9) irrigation systems fail to achieve a positive rate of return, that is revenues fail to meet operating costs. Revenue short falls of water authorities mean that governments are called on to make payments to water authorities to cover operating deficits and to make capital works contributions.

Although there is movement towards achieving normal rates of return and full cost accounting and pricing as set out in the COAG water reform agenda, financial subsidies remain, and removal of these subsidies appears to be slow.

More over, current Australian water pricing practices do not provide adequate price signals for the encouragement of efficient water use. The revenue of most authorities comprises a mixture of user charges and hypothecated taxes. On the strict definition of financial subsidy (costs less user charge revenues) they generally receive large subsidies. Efficiency improvements in the activities of water authorities would reduce the price increases required to meet rate of return targets.

Examples of the varying performance and cross-subsidies among metropolitan and rural systems are provided in Table 9, and in the following box which presents data on the various operating elements of the South Australian Department of Engineering and Water Supply. Other examples, for rural water operations, are that in 1990 the Murrumbidgee Irrigation Area (MIA) reported that a 5 per cent real rate of return on assets would require price increases of 250 per cent (see Note 2 below), and in 1992–93 the New

1 See Report of the Expert Group on Asset Valuation Methods and Cost Recovery Definitions for the Australian Water Industry, Working Group on Water Resource Policy, February, 1995.

2 Industry Commission, Water resources and waste water disposal, 1992, p.52.

 

Table 9 Real rates of return for water management in Australia(1990–91) (per cent)


image: table 9

South Wales Department of Water Resources reported that total revenues met only 25 percent of total expenses, and that user charges met only 37 per cent of operating expenses.(see Note 1 below)

As noted above improvements are being made. For example the Rural Water Corporation of Victoria reported a $70 million short fall in revenues to cover operating costs in 1984–85 but by 1993–94 this had been reduced to $13.1 million and the operating deficit is expected to be eliminated in 1994–95. (see Note 2 below)

In assessing the current performance of the water industry, it should be remembered, however, that water supply investments have long useful lives, and most were committed during periods when interest rates were lower than at present, and expected rates of return correspondingly lower. Had they been in the private sector it is likely that, under current high interest rates, some of these assets would have been written down to less than replacement cost. The corollary is that no new headworks investment would be committed until rates of return had risen to current levels.

More recent data than that presented in Table 9 is available for metropolitan areas from the Agriculture and Resource Management Council of Australia and New Zealand (ARMCANZ). This data is presented in Table 10, and shows that in 1993–94 only Melbourne Water had a real rate of return, including hypothecated tax revenue, above 4 per cent. No authority had a real rate of return above 8 per cent.

From departmental, agency and ARMCANZ data it is estimated here that the 1994 financial subsidy associated with below 8 per cent real rates of return to Australian water authorities amounted to about $3.0 billion.(see Note 3 below) That is, water authorities in Australia needed to raise additional revenue and lower costs in the total of about $3.0 billion to earn normal rates of return on assets at replacement cost and obviate the need for contributions to their activities from the consolidated revenue of governments. It should be noted that this estimate has not used the Deprival Value approach to asset valuation discussed in Section 3.1 above.

1 Annual Report, New South Wales Department of Water Resources, 1992–93, p.52.
2 Annual Report, Rural Water Corporation of Victoria, 1993–94, p.4.
3 See notes on Table 11 for basis of estimates.

 

Department of Engineering and Water Supply, South Australia (DEWS-SA)


The department has five major business undertakings related to water supply, sewerage and irrigation and drainage. Operating results for 1991–92 for each business undertaking are as follows, indicating surpluses for metropolitan segments and deficits for country segments, indicating a cross-subsidy from the former to the latter. Such cross-subsidies encourage over use in the cross-subsidised activities.

Overall return on departmental assets is negative with only one segment, metropolitan sewerage, achieving a rate of return above 4 per cent.

image: revenue

Notes:

1 Water and sewerage treatment works, tanks and storage and aboveground mains are valued at current replacement costs; reservoirs, pumping stations, underground mains, service connections, bores and wells, land and buildings, however, are still valued at historical cost and are awaiting a planned revaluation.
2 Segment profit as percentage of asset value; estimated from Annual Report, 1991–92, pp.54–55.
Source:Annual Report, 1991–92 DEWS-SA, pp 54–55.

 

Table 10 ARMCANZ 1993–94 survey: key outcomes for metropolitan water (preliminary)


image: table 10

Recovery of full costs of supply will encourage more efficient use of water to some extent. However, if charges that achieve full cost recovery are based solely on fixed charges rather than on user charges, price incentives will not be provided and use will remain inefficient. Revenues that are raised on the basis of property values and other fixed charges are essentially taxes, not user charges, and give rise to cross-subsidies to higher water users from lower water users.

Water authorities are now moving towards practices that encourage the efficient use of water. In 1993–94, Sydney Water Board increase usage charges as a source of revenue from 21 to 31 per cent.(see Note 1 below) In the same year the Melbourne Water charge was from 23 per cent to 31 per cent and a target of achieving a 50/50 split by 2001 has been set. (see Note 2 below) These pricing changes appear to be impacting on water use. For example, since the Hunter Water Corporation (New South Wales) started to introduce charges based on water use, water consumption per household has declined by almost 25per cent (see Note 3 below).

1 Annual Reports, 1993–94, Sydney Water Board (now Sydney Water Corporation) (p.41), and Melbourne Water (p.7).
2 Annual Reports, 1993–94, Sydney Water Board (now Sydney Water Corporation) (p.41), and Melbourne Water (p.7).
3 James, op.cit., p.17.

The Sydney Water Corporation reported in its (then Sydney Water Board) 1993–94 Annual Report that per capita water consumption fell 7.4 per cent over the 1990–1to 1993–94 period. (see Note 1 below) This reduction cannot be directly attributable to improved financial (pricing, etc.) practices, but it is likely that improved pricing had some impact on water usage and deferral of supply expansion. An example of this likely latter effect is deferral of the Welcome Reef Dam for increased supply to Sydney.

Financial subsidies to water use also include direct subsidies paid to users (such as rebates to pensioners) of water and waste water services; budget papers reveal that these totalled $95.2 million in 1994–95. Removal of these subsidies would raise water prices, particularly in rural areas. Over the longer term, however, subsidy removal would encourage more efficient water supply and use systems and reduce environmental problems associated with water use. Also public agencies, other than water authorities incur costs in the management of water resources. To date these costs have not been recovered from water authorities or water users. In 1993–94 these costs are estimated from budget papers to be about $227 million, some of which could be attributed to public goods aspects of their work.

The above discussion indicates that financial subsidies to water resource activities in Australia are substantial. These subsidies, particularly prevalent in rural areas, probably make a significant contribution to water related environmental problems in Australia. High priority should be given in the COAG reform process to detailed analysis of water provision costs, revenue and prices to determine how these apparent financial subsidies could be removed or modified to achieve more efficient production and use of water, particularly in rural areas. For example, the use of water entitlement transfers could be expanded as restrictions on transfer of entitlements prevent water from moving to users who value it more highly and who probably would use it most efficiently. In 1993–94, the Victorian Rural Water Corporation held a water auction at which one component was sold at a price which reflected the full economic costs of the irrigation water. This development illustrates the potential for future trading in irrigation water and indicates that a range of instruments, not just pricing, can be implemented to improve performance of the Australian water industry. A range of instruments is set out in the COAG agenda for reform (referred to in Section 3.1).

 

3.3 Environmental subsidies


Environmental impacts of water supply mainly falls into the following three groups:

(i) effects on flora and fauna in the catchment areas;

(ii) impacts on conservation and recreation values; and

(iii) impacts on downstream areas such as diverted / reduced flow and cold flow effects.

Impacts may be positive as well as negative. For example, catchment areas can protect flora and fauna as well as contribute to their destruction through dams; many alternative uses of catchment areas could be more environmentally disruptive. Also recreation values can be enhanced as well as destroyed (see Note 2 below) and catchments can mitigate flooding effects on land, people, flora and fauna.

Negative environmental impacts of water supply include the land disturbance effects of dams and distribution network construction, bank degradation from varied flows due to water withdrawals and possible disruption caused by leakage from the network. Reduced water flows resulting from high water usage can harm animal and plant life. In some cases this damage can be reduced by water releases (or environmental flows); this has been done for example in the Murray–Darling system.

1 Sydney Water Board, Annual Report, 1993–94, p.21.
2 For example, to some the recreational values of Lake Pedder, Tasmania, have been enhanced by its flooding for a hydro dam, while for others its values have been destroyed.

Environmental subsidies associated with water use mainly arise from the over-use of water and the absorption of chemicals during water use in the residential, commercial, industrial and agricultural sectors and the subsequent discharge of the contaminated water into streams and oceans. Subsidies are associated with the addition of chemicals and other wastes during the use of water, covered in Chapter 5.

Agriculture accounts for about 70 per cent of Australian water use. Over-use of irrigation, together with land clearing, causes severe salinity and water-logging problems in some areas. This situation seriously threatens agricultural sustainability in these areas.

One major agricultural region for which there is considerable environmental concern is the Murray Darling Basin which includes 75 percent of all irrigated land and produces about one third of total Australian output from rural industries. Widespread land clearing and over-use of water for irrigation have created salinity and water-logging problems in the Basin which are largely irreversible. Production losses have been estimated by the Murray–Darling Ministerial Council to be over $65 million per year. The costs of the current level of salinity on water quality has been estimated to be $37million per year for agricultural and downstream urban and industrial water users. (see Note 1 below) It is not possible, however, to separate out the various agricultural and other land use practices (land clearing, etc.) that have contributed to this cost. Accordingly these externality estimates are not included in this study’s estimates of environmental subsidies.

 

3.4 Summary


The above discussion indicates that financial subsidies to water activities are substantial. Environmental subsidies are difficult to disentangle from other activities and/or adequate data is lacking except where they are related to waste water treatment and disposal (covered in Chapter 4).

A summary of financial and environmental subsidies of the water sector is provided in Table 11.

1 ESD-A, pp.75–78; it should be noted that soil salinity problems are not only associated with irrigation, but are also of significant concern in dryland areas.

 

Table 11: Summary of financial and environmental subsidies, 1994, water sector


image: table 11

Notes

1. The estimates, derived mainly from agency annual reports, include some waste water (sewerage, drainage, etc.) subsidies; these are excluded from the estimates for wastewater in Chapter 4. In general it is not practical to separate government expenditure on water and sewerage services as these services are generally provided by the same authority, or are supervised by the same division in a bureaucracy. In view of the close relationship between expenditure on water and wastewater services, it is not yet possible to provide a satisfactory estimate of financial subsidies to water services separate from liquid waste services.

2. Order of magnitude estimate of revenue increase required to give 8 per cent real rate of return on water and wastewater activities on the basis of data in ARMCANZ and AWRC reports and authority annual reports. This is a particularly difficult exercise because, as indicated in the text, the situation is changing rapidly and much data for 1994–95 is not yet available from agencies. Therefore the estimates presented must be treated cautiously, but indications are from ARMCANZ and authority reports that in 1994–95, rates of return remained well below the 8 per cent real level.

Estimate of subsidies due to water and waste water authorities failing to achieve an 8 per cent real rate of return


South Wales
rural, Department of Water Resources, Annual Report,1992–93
Net operating cost
Non-current assets (written down replacement value)
Net revenues to give 8 per cent real rate of return (10 per cent nominal)
1992–93 shortfall
Estimate of rate of return subsidy in 1994–95

New South Wales, metropolitan, Water Board, Annual Report,1994
Capital assets at written down cost (97 per cent at replacement or market value)
Net revenue to achieve 2.7 per cent real rate of return in 1993–94 (ARMCANZ survey)
To achieve 8 per cent real rate of return would have to increase to
Therefore rate of return shortfall estimated at

Victoria rural, Rural Water Corporation, Annual Report,1993–94
Net cost of service
Non-current assets (written down value at cost no replacement cost estimates available)
Net cost of services projected to be zero in 1994–95
Estimate of rate of return subsidy in 1994–95,
But about double if assets valued at replacement cost

Victoria, metropolitan, Melbourne Water, Annual Report 1993–94
Non-current assets
Net revenue to achieve 5.65 per cent real r ate of return (Annual Report, p.56)
To achieve 8 per cent real rate of return would have to increase to
Therefore rate of return shortfall estimated at

Western Australia, Water Authority of Western Australia (covers metropolitan and rural areas),
Annual Report, 1993
Fixed assets at written down replacement cost
Achieved 1.8 per cent real rate of return in 1992–93
To achieve 8 per cent real rate of return, this would have to increase to
Therefore rate of return shortfall estimated at

Shortfalls estimated
New South Wales rural
Victoria rural
New South Wales — Sydney metropolitan
Victoria — Melbourne metropolitan
Western Australia — rural and metropolitan

Total

$ million

105
2 977
298
403
400


14 417
389
1 153
764


13
469

50
100


10 474
592
838
246



5 721
103
457
354


357
100
764
246
354

$1 818

For all other water (urban, rural) authorities no analysis was conducted .
To summarise, the analysis conducted yielded an estimate of subsidies of just over $1.818 billion. A full analysis would require a major study with resources well beyond those available to this study.
It is believed that these estimates would cover about 60 per cent of the total for Australia, thus giving a total for the whole country of about $3 billion. The basis for this order of magnitude extrapolation is the judged proportion of Australian water services covered by the estimates made and the most recent data available from AWRC and ARMCANZ surveys as presented in Tables 10 and 12.

3. Estimates of public agencycosts not recovered are taken from federal and state budget papers, 1994–95, with no allocation to public goods values.

Estimates of water and waste water public agency costs not recovered.
(Excludes amounts included in rate of return shortfall estimates.)

New South Wales
Budget estimates, 1994–95
Department of Water Resources — administration, services

Victoria
Budget estimates, 1994–95
Net cost of water services, administration

Queensland
Program Statements, 1994–95
Current outlays

Western Australia
Program Statements, 1994–95

South Australia
Estimates of receipts and payments, 1994–95
Underground water exploration, assessment and protection

Tasmania
The Budget, 1994–95
Payments to Rivers and Water Supply Commission

Northern Territory
Not identified

Total

$ million




92.6


 

55.6



70.6




None found




3.1




5.1



$227.0

4. Estimated from federal and state budget papers; capital grants allocated at 10 per cent per year to reflect estimated annual subsidy to users.

Estimates of direct subsidies to water and waste water

New South Wales
Budget Estimates, 1994–95
Water and sewerage rebates for pensioners, etc.
Capital grants (at 10 per cent of amount)

Victoria
Budget Estimates, 1994–95
Capital outlays (at 10 per cent of amount)

Queensland
Program Statements, 1994–95
Capital outlays (at 10 per cent of amount)

Western Australia
Program Statements, 1994–95
Subsidies to low/medium rainfall cropping and g razing

South Australia
Estimates of receipts and payments, 1994–95
Capital payment to Department of Engineering and Water Supply (at 10 per cent of amount)

Tasmania
The Budget, 1994–95

Northern Territory
Not identified

Commonwealth
Budget Statements, 1994–95
Assistance to Western Australia for sewerage infrastructure (10 per cent of amount)

Total

$ million



61.3
1.7



3.5



6.8



20.8




0.5



None found




0.6


$95.2

5. Not estimated due to lack of data.


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