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Billions down the drain in Kafkaesque desal nightmare

Published: The Age - 28-Mar-2011
Author: Kenneth Davidson

AquaSure's contract can be broken, and it would be far cheaper if we did.

THERE is no commercial contract that can't be broken, including the desalination contract with AquaSure. The issue is what is fair compensation. The courts would determine this on the present-day value of the contract, based on an independently determined discount rate applied to future streams of payments if the contract was fulfilled.

The desal plant is not needed. Melbourne's catchment area gets more than sufficient rainfall to meet the city's existing and future needs.
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If the contract is fulfilled, in the first year the government will have to pay AquaSure $763 million, rising by 7.3 per cent a year over the 28-year life of the contract. This means that half way through the contract, in 2026, AquaSure will be paid $2 billion, rising to $5.1 billion in the final year.

Dam water costs about 55¢ a kilolitre, which is marked up to $1.80 for sale to households. The 150 gigalitres supplied by AquaSure - which must be paid for irrespective of whether it is used - will cost Melbourne Water $5.09 a a kilolitre in 2012. In 14 years' time, the desal water will cost $13.33 a kilolitre and in 28 years it will be $34 a kilolitre. In contrast, the dams and pipes with a life of more than 100 years would be paid off in 28 years' time, when the cost of water in real terms would be less than 55¢ a kilolitre.

But it gets worse. The payment to AquaSure is the manufactured price. The water has to be marked up to cover the cost of wholesale and retail distribution. The mark-up on dam water is more than 300 per cent, which provides a dividend to the government of about $300 million a year and helps pay the salaries of teachers, nurses and police.

Based on average household consumption of 400 kilolitres, households pay about $1400 a year now for water, including parks and sewerage. In 2012, when households will have to take 40 per cent of their water from the desal plant, they will have to pay about $3000 for their water - providing the wholesale and retail mark-up is reduced to just over 200 per cent. The impact is three-fold: retailers will have to cut back on staff and maintenance, will not pay dividends, and will have to seek a government subsidy in order to make water affordable for two-thirds of the population.

Households will not be able to avoid the pain by putting in rainwater tanks or abandoning their gardens and limiting their consumption because AquaSure has a take-or-pay contract.

Unless the contract is cancelled, the government will be forced to pay larger subsidies each year - until AquaSure offers to put the government out of its misery by offering to take over metropolitan water assets in exchange for a renegotiation of water prices.

But, as late as last year, the then water minister, Labor's Tim Holding, said the cost of desal water would be $1.37 a kilolitre. He forgot to include the capital cost. Even worse, Kim Wells, now Treasurer, believed him.

The Kafka-esque dimension to this self-induced fiscal and environmental nightmare is in Melbourne Water's balance sheet for 2010. It doubled the value of its net assets to $4 billion by the simple expedient of revaluing the assets based on higher future cash flows, which will be caused by the increase in the price of water set in train by AquaSure. There is no point to this exercise unless the previous government was attempting to fatten up Melbourne Water and the retailers for privatisation, so that the assets would be about equal to the debt owed to AquaSure.

The Auditor-General describes the desal plant and its capitalised financial costs as a ''leased asset and a liability of the state'' rather than a public-private partnership. He calculates the net present value of the 28-year financial commitment by the government to be $6.4 billion. This means he believes a fair, upfront payment to cancel the leasing deal is $6.4 billion.

The cost of borrowing that amount at the semi-government rate of 5.5 per cent and repayable over 10 years is $628 million a year - $135 million less than the cost of the leasing agreement in the first year - and $6.3 billion in total to repay the debt. By comparison, if the contract is maintained, Victoria will have paid $10.7 billion - $4.4 billion more - and still have another $12.9 billion to pay off on the debt over a further 18 years.

Senior columnist Kenneth Davidson writes a monthly column for The Age.


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