WSAA Report: Improving Economic Regulation of Urban Water

• enshrining economic regulators as genuinely independent, with the power to make binding decisions/determinations
• using less prescriptive regulatory approaches
• reducing unnecessary regulatory burden
• providing more incentives for regulated businesses to act appropriately based on their knowledge rather than regulators seeking more and more detailed information
• strengthening accountability – particularly by clarifying regulatory objectives.

These are all sensible actions and worthy of further attention by governments and regulators. However, the recommendations are fairly uncontroversial. Indeed, the need for further reform was identified as far back as the 2004 National Water Initiative, and re-iterated through a number of subsequent reviews by the National Water Commission (NWC) and Productivity Commission (PC). The larger question is “why haven’t they already been implemented?” The likely answer lies in the lack of strong, independent policy champions to advise Government, drive reform and set the scope and bounds for regulation.

We also question whether the identified shortcomings in current regulatory methods are the biggest obstacle facing improved performance in the water sector. A bigger challenge is the lack of clear policy direction on what types and levels of services are socially optimal.

These two issues are briefly examined below.

The need for regulatory policy intermediaries

The WSAA report highlights the merits of separating regulatory policy from practice. Governments periodically commission independent reviews (e.g. the NWC, Productivity Commission and commissions of audit). While often insightful, such reviews are usually opportunistic, and not part of an over-arching regime. Accordingly there do not appear to be any ongoing mechanisms for State governments to review and reform regulatory policy in the urban water sector. Instead, regulators are often asked to advise State governments directly on regulatory policy, including how they should regulate an industry, and the scope and type of regulation they should administer. This creates a conflict of interest for regulators – they have a clear interest to maintain or expand their role. Regulators are also less inclined to be objective and critical of the existing regimes, designed by them.

It would be better to have scheduled, periodic reviews independent of government (but commissioned by government, and operating with its strong support) to:

• advise on progress in implementing reforms previously set by Government;
• objectively review the current regulatory arrangements, assess the costs and benefits and examine innovative or alternative structures;
• provide independent and transparent advice to Government on the scope and conduct of regulation for water businesses; and
• review the performance of regulators in carrying out their functions.

This would not only avoid the problems of self-interest when regulators advise or set policy, it would also give greater impetus for reform and enhance accountability of agencies, to their State Government, to implement the reform agenda.

Clarity of policy direction on types and level of services

Economic regulation does not replace the need for clear policy direction and objectives for water supply.

The WSAA report acknowledges the need for economic regulation to integrate effectively with the broader policy and regulatory framework, thus ensuring all relevant policies and regulations are adequately considered and accounted for when determining revenue requirements and prices. While this is laudable, our concern is that policy intent is not always explicit or articulated in ‘black letter law’. Further, it is often the case that no single agency or authority takes responsibility for setting the policy agenda. In an environment of policy vagary, economic regulation can only do so much to promote efficient outcomes.

The Productivity Commission’s 2011 inquiry into the urban water sector^[1] found there are multiple, often competing, demands on water businesses that are seldom clearly articulated. For example, the concept of ‘water sensitive cities’ requires some water sources to be given priority over others to meet future water supply needs, but the costs and benefits of pursuing this strategy are rarely made transparent. Similarly, the balance between demand management on the one hand and investment in additional supply on the other are matters that require clear government policy, informed by objective assessment of the costs and benefits of different strategies.

The PC reported widespread concern amongst utilities that revisions to regulatory arrangements and service standards (such as wastewater discharge standards) are not made on the basis of rigorous cost–benefit analysis, and in particular, do not consider the cost impacts on water utilities and the communities they serve.

^{[1] Productivity Commission 2011, Australia’s Urban Water Sector, Report No. 55, Final Inquiry Report, Canberra.}

In closing, the desirable features of regulation are not contentious – the issue is one of implementation. In our view, clear guidance to stronger policy institutions and responsive, reform-oriented Governments are key ingredients to achieving change.