I thank the Chairman for inviting me to appear before the committee. In my evidence, I want to raise some issues that I consider important in reforming and improving water services in Ireland.
Before deciding on the optimal approach to providing water services in Ireland - drinking water supply and wastewater treatment - it is useful to consider the objectives that should be met. Drinking water should be of the highest quality in order to safeguard public health and also to ensure that key production sectors can operate in Ireland, for example, the food and drinks sector. Related to this is the need to protect the environment and to achieve a high ecological status which supports the tourism sector. Apart from impacting on public health and industry, maintaining high environmental standards, particularly in regard to wastewater treatment, reduces the cost of drinking water treatment.
Water should be produced efficiently; that is, it should be produced at the least cost given the standards that have to be achieved. Likewise, the cost of wastewater treatment should be at the least cost given the standards that need to be achieved. Such production efficiencies benefit both households and businesses through lower charges and, hence, improve competitiveness. Apart from an efficient supply of water services security of supply in the short run and the long run is of significant importance, as interruptions can be costly to business and might deter some businesses from locating in Ireland. Disruptions are also very inconvenient to the general public. Given that drinking water is a scarce resource and one that is provided at significant cost, water should be used efficiently; that is, it should not be wasted. Excessive water demand results in increased infrastructure requirements and, thus, increased costs.
The status quo appears to be at odds with at least some of these objectives. The production of drinking water in Ireland is characterised by a high level of fragmentation. While there are 34 water service authorities, there are over 2,000 separate public and group water scheme supplies. This implies that scale economies and other efficiencies are not captured, resulting in higher costs. A significant portion - over 40% - of treated water is unaccounted for; that is, it is lost through leakage, which implies a higher cost per unit at the tap.
Currently, few consumers face incentives to ensure they use water efficiently, given that almost all households do not pay directly for water, although some members of group water schemes are paying for water and have had meters installed. While businesses face water charges, these do not seem to reflect the cost of production or scarcity. The variation is very large in that the price of water in Wicklow - €3.04 per cu. m. - is more than double that in Kildare - €1.49 per cu. m. - yet both counties receive some of their water from the same source, the Liffey. Dublin city, Fingal and south Dublin, which also receive water from the Liffey, also have very low costs for water.
The price differences across counties indicate that there are significant differences in costs of providing water and, given that the price for water from the same source differs significantly, this indicates there is a degree of cross-subsidisation within local authorities.
Although drinking water in Ireland is generally safe and of high quality, a significant number of exceedances are recorded every year and some of these are highly persistent, threatening public health. The 2007 cryptosporidium outbreak in Galway is an example. In addition, there is a range of concerns about the security of supply in the short and long run. For example, extreme weather events such as the cold winter of 2010-11 have resulted in significant disruption of supplies. Changed weather patterns in response to global warming and changed demand through the pattern of population growth could compromise the ability to meet water demand in the medium to long run.
Given the shortcomings identified above, the commitment by the Government to reform the sector is welcome. The move towards charging households directly for water, which has been resisted for many years, has the potential to result in more efficient use of water and might reduce the volume of waste water that has to be treated. The establishment of Irish Water can yield improvements in the supply of water and waste water treatment services.
Given the range of objectives, the difficult starting position and the complexity involved, the degree to which the services are improved with respect to the objectives I have noted depends on the specific measures taken. Simply aggregating fragmented services into one larger service provider does not necessarily lead to an optimal outcome. The cost of water and waste water services is not trivial, amounting to €1.2 billion in 2010, with operational expenditure, OPEX, accounting for €715 million and capital expenditure, CAPEX, accounting for just over €500 million. Some revenue is raised through direct charges to businesses, which in 2010 amounted to an income of €263 million, that figure coming from the PricewaterhouseCooper report. On the basis of some plausible assumptions the cost per household in 2010 was just over €630. That is not necessarily equivalent to the long-term cost that will have to be charged. These future costs will be influenced by a range of decisions. These include decisions regarding the roll-out of metering, the level of capital investment in pipes and treatment plants, the nature of the financing arrangements, efficiency gains in the supply of water services and reduced demand for water services.
The current reform proposals appear to encompass universal roll-out of water meters. However there are a number of issues regarding the roll-out of meters that can have a substantial impact on the net benefits of the water services reform and these need to be assessed in a thorough cost-benefit analysis. Water abstraction costs differ significantly across the country, an example being the Shannon basin v. the Liffey. Likewise, treatment costs are likely to differ, as are investment needs. Indeed, the potential demand response to metering might enable certain investments to be deferred or even avoided, for example, the Lough Derg-Dublin pipeline. In this context it is likely that the benefits and costs of meters will vary across regions. Therefore the cost benefit analysis of the roll-out of water meters should be done separately for each river basin district as the benefit cost ratios are likely to vary significantly.
The demand response due to charging comprises two elements namely leak reduction and more general demand reduction, which in turn depend on the incentives set through metering and the charging structure. With regard to metering, two aspects are particularly important. First, meters are unlikely to provide the full benefit if they are read infrequently, for example, once a year, as this would give householders insufficient information on their water usage. More frequent meter reading will result in higher costs. However, it is likely that smart energy meters will be rolled out over the next few years. These include a communications module that allows for frequent remote reading of meters. The possibility of linking water meters to the communications module of the smart energy meters should be considered as this has the potential to achieve cost savings by avoiding duplication and reducing meter reading costs. Second, the location of the meter is important. Meters can be located either within a property or at the boundary of the property. The key difference in terms of benefit is that leaks external to a property are not immediately attributable to the householder if the meter is located inside the property. On the other hand, internal meters are more likely to be monitored by householders. Presumably one would notice a leak inside the house. The cost of the two options differs significantly.
A range of figures regarding the cost of rolling out meters have been put forward. In this respect the experience in the UK is of particular interest as different types of options have been implemented there. The Walker review of 2009 considers the cost of alternative meter installations. Internal installation was found to cost between £106 and £385, and external installation in new boxes cost between £293 and £471. Using the highest figure of £471 and the lowest, £106, and assuming that meters are rolled out to 1.48 million households, the total cost in this country would range between less than €200 million and more than €800 million. I have made the conversion to euro. This shows that the type and cost of installation has a very significant impact on the total cost. For this example, the implication of the calculations is that the benefit of external installation would have to be more than €600 million higher than that for an internal installation in order to pass economic criteria. Therefore, a cost benefit analysis should consider the costs and benefits of internal and external installation.
The demand response to water charges depends crucially on the nature of the charging mechanism. The two part structure that has been proposed, where a free allowance is given beyond which a volumetric charge is applied, could result in lower benefits than a purely volumetric system. The reason for this is readily demonstrated. If the free allowance that is given exceeds the total water demanded for a household then the additional or marginal cost of consuming an additional cubic meter of water is zero. One would get all one's water for free. Even if the allowance is set so as to correspond to the average demand across the country then a substantial number of households - those with below average demand - will not face a positive marginal cost. This means they do not face an incentive to conserve water and end up paying nothing. Assuming full cost recovery in the system implies that those who consume above the set volume will subsidise those who consume below that level. To eliminate this the free allowance must be below the minimum demand for water by household. In general, it is difficult to see an advantage in this two part mechanism and ideally charges should be purely volumetric. I would favour a rising tariff.
Household charges are regressive as they do not reflect the ability to pay but are related only to consumption. One obvious solution is not to charge those who might be adversely affected, for example, pensioners or the unemployed. The impact of such concessions is likely to be non-trivial in financial terms. However, while they would help to address the distributional issues such concessions imply that those groups that are exempt from the charges will not be incentivised to reduce their demand for water, which constitutes another cost. A more efficient approach would be to give a cash allowance which would pay for an acceptable level of water and to let individuals decide if they will consume that quantity of water or if they prefer to consume a lower amount of water. This would ensure that they are still incentivised to consume less.
An important reason for amalgamating the water authorities into one company is to generate efficiency savings. These encompass staffing, administration and financing costs. The degree to which such efficiency gains are going to be achieved depends on the approach taken by Irish Water and the regulatory regime. With regard to staffing it would appear likely that Irish Water will in the first instance take over the existing workforce which, given the fragmentation of the service, is likely to be significantly larger than that needed. In reducing staff numbers it will be important to preserve some degree of local knowledge. One model that might be considered is to outsource services but to enable existing staff to tender for the service. Utilising the communications module of the smart energy meters has already been highlighted as a potential source of administration cost savings.
The cost of water and waste water services into the future will depend crucially on the regulatory approach and investment needs. There are alternative models such as price capping or rate of return regulation. Detailed calculations are not possible as key data is not available publicly. However, the difference in terms of price to the household of different scenarios could easily be in the order of 10%. It is, therefore, important to carefully establish the regulatory framework for water services.
The relationship between the economic regulator and the environmental regulator needs to be set out explicitly. It appears the Commission for Energy Regulation, CER, will take on the responsibility of the economic regulation of the proposed Irish Water. The Environmental Protection Agency, EPA, will continue to be the environmental regulator. The relationship between the two, in particular potential conflicts between the two, need to be carefully considered and appropriate measures need to be incorporated in legislation. Conflicts may arise, for example, where environmental regulations imply significant additional investment needs that would increase prices significantly.
In common with other infrastructures and utilities, water services are highly location specific. There is significant spatial variation in costs, capacity and quality. As such, water services have important implications for regional development. For example, the water abundance in the Shannon basin should imply a lower cost of water due to lower abstraction costs holding all else equal. It possesses a natural advantage to attract firms that are water intensive. Charging the same price for water across the country removes this comparative advantage and implies an implicit transfer from water abundant regions to regions where water is scarce. To the extent that a common price implies a distortion of prices, customers in water abundant areas will face a higher price than they should and those in water scarce regions will face prices that are too low. This issue can readily be taken into account by allowing different prices for each river basin district.
This overview of many, but not all, important aspects of water services highlights the decisions regarding the sector's reform have a significant bearing on the cost to customers and, therefore, impact on competitiveness. I hope my briefing has been useful and I am happy to answer questions to the best of my ability to further aid the committee's deliberations. There were quite a number of questions earlier that I would have loved to answer.
