Strategic Management Overview and Review of Operating and … · 2014-07-17 · sewerage business to recover an amount of revenue that is equal to the full efficient costs of providing

Strategic Management Overview and Review of Operating and Capital Expenditure for Essential Energy’s water and sewerage business in Broken Hill

REVIEW REPORT

FINAL REPORT

26 January 2014

The SKM logo trade mark is a registered trade mark of Sinclair Knight Merz Pty Ltd.

Strategic Management Overview and Review of Operating and Capital Expenditure for Essential Energy’s water and sewerage business in Broken Hill

REVIEW REPORT

FINAL REPORT

26 January 2014

Sinclair Knight Merz Floor 11, 452 Flinders Street Melbourne VIC 3000 PO Box 312, Flinders Lane Melbourne VIC 8009 Australia

T +61 3 8668 3000 F +61 3 8668 3001 www.globalskm.com

COPYRIGHT: The concepts and information contained in this document are the property of Sinclair Knight Merz Pty Ltd (SKM). Use or copying of this document in whole or in part without the written permission of SKM constitutes an infringement of copyright.

LIMITATION: This report has been prepared on behalf of and for the exclusive use of SKM’s client, and is subject to and issued in connection with the provisions of the agreement between SKM and its client. SKM accepts no liability or responsibility whatsoever for or in respect of any use of or reliance upon this report by any third party.

Essential Energy (Water) Expenditure Review – FINAL REPORT January 2014

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Executive Summary Overview

The Independent Pricing and Regulatory Tribunal (IPART) is conducting a review of maximum prices for Essential Energy’s water and sewerage monopoly services from 1 July 2014. As part of the price review process, IPART aims to set prices that will allow Essential Energy’s water and sewerage business to recover an amount of revenue that is equal to the full efficient costs of providing its regulated water and associated services.

To inform this price determination, IPART has engaged SKM to undertake a review of Essential Energy’s proposed expenditure. The review includes:

A review of Essential Energy’s proposed capital expenditure from 1 July 2013 to 30 June 2019;

A review of Essential Energy’s proposed operating expenditure from 1 July 2013 to 30 June 2019;

A strategic review of Essential Energy’s asset management systems and practices and long term investment plans; and

A review of Essential Energy’s proposed methodology for allocating costs to the mines for the purposes of setting prices

The approach to the review of these different aspects is indicated in the relevant sections (and in Appendix D for capital expenditure).

Capital Expenditure Review

The prudent and efficient capital expenditure for the whole of Essential Water’s capital program from 2013/14 to 2018/19 was assessed. A detailed assessment was undertaken of 10 selected projects (refer Section 3.2) and a general assessment of Essential Water’s overall capital program (refer in Section 3.3).

The outcomes of the detailed assessment of the ten (10) selected projects has resulted in the forecasted spend over the four year regulatory period from 2014/15 to 2017/18 being recommended to be reduced by a total of $7,837,000 ($2014 including corporate overheads) to $28,250,000 ($2014) from the original budget of $36,087,000 ($2014) which represents an reduction of 21.7% for the 10 projects.

The outcomes of the general assessment of the remaining eleven (11) projects in the capital program has resulted in the forecasted spend over the four year regulatory period from 2014/15 to 2017/18 being recommended to be reduced by a total of $1,562,000 ($2014 including corporate overheads) to $14,548,000 ($2014) from the original budget of $16,110,000 ($2014) which represents an reduction of 9.7% for the 11 projects.

The assessment of the capital program has resulted in the recommended forecast spend over the four year regulatory period from 2014/15 to 2017/18 being reduced by a total of $9,399,000 ($2014 including corporate overheads) to $42,798,000 ($2014) from the proposed budget of $52,197,000 ($2014). This represents an overall reduction of 18%.

Essential Energy

Expenditure Review - FINAL REPORT

... CLlll Ul<KT MlRI January 2014

_SKM

Table E 1 provides a summary of the recommended adjustments to Essential Water's capital program for the period 2013/14 (FY2014) to 2018/19 (FY2019) including the four regulatory period (FY2015 to FY2018). This is also shown graphically in Figure E 2.

• Table E 1 Summary of recommended adjustments to EE's capital program· all projects

Re :iulatorv Period FY15-FY18\

2013/14 2014/15 2015/16 2016/17 2017/18 2018/19 Total

FY15-FY18

Overhead 20% 19.50% 19% 18.50% 18% 17.50% -amount

Essential Energy's proposal $000's ($2014) Water $3,922 $10,017 $11,447 $6,249 $8,348 $9, 145 $36, 061 Wastewater $543 $1,789 $1,530 $1,598 $2,521 $2,418 $7,437 Corporate $893 $2,361 $2,595 $1,569 $2,174 $2,312 $8,699 Total $5,357 S14,166 $15,572 S9,415 ,$13,043 S13,875 $52,197 Change to Essential Energy's proposal $000's ($2014) Water -$1,525 -$4,823 ~$6,731 $2,772 $3,255 $235 -$5,526 Wastewater $0 -$583 -$372 -$422 -$498 -$152 -$1,876 Corporate -$305 -$1,113 -$1,479 $317 $279 -$275 -$1,997 Total -$1,830 .,$6,519 ~.583 $2,668 $3,036 -$192 ..$9,399 Recommended prudent and efficient capital expenditure SOOO's ($2014) Water $2,397 $5,194 $4,716 $9,021 $11,604 $9,379 $30,534 Wastewater $543 $1,205 $1, 157 $1, 176 $2,022 $2,266 $5,561 Corporate $588 $1,248 $1,116 $1,886 $2,453 $2,038 $6,703 Total $3,528 $7,647 $6,989 $12.083 $16,079 $13683 $42.798

These adjustments have resulted in a significant reduction in capital spend in the first two years of the regulatory period but an increased spend in the third and final (fourth) years of the regulatory period. In the two years either side of the regulatory period there is a reduction in the 2013/14 year and approximately the same spend proposed in the 2018/19 year.

• Figure E 2 Summary of recommended adjustments to EE's capital program - all projects

Overall Capital Program 20,000

0 0 o. 15,000 ~ o::t P4 10,000 0 N '\/).

x Cll 5,000 Q. a

2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19

Financial Year

• Historical and proposed capital program • Recommended adjustment to capital program

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Essential Energy Expenditure Review – FINAL REPORT January 2014

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A detailed breakdown of the recommended adjustments for each project in the capital program for each year of the regulatory period is shown in Table 13. In summary, all projects have been kept in the capital program, but with material adjustments to timing and cost.

Other supporting tables are provided in Section 3.2, Section 3.3 and Section 3.4 that summarise the different components of the adjustments to capital expenditure. Independent of the detailed analysis a broad ranking of EW’s proposed capital projects has been provided in Table 14 for general guidance.

Some recommendations for enhancements to Essential Energy’s Capital planning processes for assuring robust justification for prudency ad efficiency are provided in Section 3.5.

Operating Expenditure Review

The review of the proposed operating expenditure for prudency and efficiency was informed by an assessment of:

The variations in real $2014 compared with the base year (FY2013) for each of water direct cost, sewerage direct cost and corporate cost

The allocation and quantum of corporate costs from Essential Energy to Essential Water; with The outcomes of the opex assessment summarised in Table E 3.

Table E 3 Proposed opex adjustments and prudent and efficient operating expenditure - FY2014 to FY2019

Total Regulatory

Opex FY2015-FY2018

2013/2014 2014/2015 2015/2016 2016/2017 2018/2018 2018/2019

10,212 9,188 9,128 9,322 9,121 9,082 36,759

2,292 2,494 2,478 2,564 2,510 2,498 10,046

2,501 2,382 2,373 2,436 2,387 2,384 9,578

15,005 14,064 13,979 14,322 14,018 13,964 56,383

102 288 391 688 900 911 2267

23 89 144 184 232 291 648

0 58 116 178 233 290 585

125 435 651 1050 1365 1492 3501

10,110 8,900 8,737 8,634 8,221 8,171 34,492

2,269 2,405 2,334 2,380 2,278 2,207 9,398

2,501 2,324 2,257 2,258 2,154 2,095 8,993

14,880 13,629 13,328 13,272 12,653 12,472 52,882

Opex Item

Regulatory Period All in $2014 real -$'000k

SKM's recommended efficient operating expenditure

Water

Sewerage

Corporate

Total

Essential Energy's Proposal

Water

Sewerage

Corporate

Total

SKM's Proposed Adjustments

Water

Sewerage

Corporate

Total


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As described in Section 4.3, Section 4.4 and Section 4.5 This is underpinned by

Adoption of a general productivity target of 1%p.a. for direct opex (both water and sewerage);

An increased allowance for personnel transferring from opex to capex projects;

Opex savings from capex projects captured

Targeted reduction in corporate overhead allocation progressively over the regulatory period.

Mines Costs allocation review

A structured approach to effectively understand the balance and use of assets for supplying water as between urban customers and mines customers, to assess Essential energy’s options for cost allocation and to make an informed recommendation on potential alternative approaches is outlined in Section 5. This approach involves considering:

Background information (Section 5.2) including o Water supply to mines (Section 5.2.1), Water usage by mines and urban customers – both

untreated / unfiltered and treated filtered (Section 5.2.2), Previous mines agreement (Section 5.2.3) and Essential’s Energy’s mines costs allocation proposal (Section 5.2.4)

Identification and assessment of the building blocks for pricing (Section 5.3), including

o Cost allocation options considered by Essential Energy, EE assessment of these limited options and its preferred approach and EE’s view on appropriate returns

Assessment of the review by NSW Public Works Department of EE’s proposal and consideration of its recommendations (Section 5.4).

As flagged in Section 5.1, it is evident that the five (5) key influencers of building a robust cost allocation and pricing model and key aspects to assess and form a view on are (1) Respective consumption of asset capacity and therefore the capital value of assets – and how assets are split for valuation for capital recovery and replacement cost of water assets (2) Basis of asset valuation – DORC versus RAB (3) Updating of asset values to contemporary values (4) incorporation of future capex; and (5) most importantly the basis of allocating cost associated with provision of the water supply services (opex).

Having considered these key aspects SKM considers that the most appropriate mines cost allocation model should be as follows (which would enhance the model proposed by Essential Energy):

1. Allocation of asset capacity Consumption - Replacement cost for water assets

The allocation of the replacement costs of water supply assets to mine and urban customers on actual usage would be more soundly based if undertaken on the basis of Scenario B as described in Section 5.5.1 and shown in Figure E 4 below. Another feasible Scenario (Scenario A) is also defined in Section 5.5.1.

Both Scenarios have strong validity, but of the two, SKM considers that Scenario B is the most appropriate, particularly given the history of the Menindee pipeline. SKM does not have all the necessary asset value data to undertake the calculations to enable more detailed quantitative


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assessment of these Scenarios but recommends that Essential Energy does assess both in detail. Both are recommended for assessment because Scenario A, when coupled with decisions on the other key factors in the allocation of costs, may have some advantages in achieving a better balance of costs between urban and mines customers from a broader perspective.

2. Future capex in the next regulatory period has not been included in the replacement asset cost allocations and should be.

3. Basis of asset valuation.

A consistent basis should be used to calculate Essential Water’s aggregate notional revenue requirement for its business and also for determining the mines revenue requirements (at present they are different, the former being calculated on RAB and the latter on ODRC). IPART’s prescribed RAB would seem the most appropriate basis for these.

In any event the replacement asset values should be updated to reflect current day values and be enhanced by basing on a better estimate of residual asset life (including actual condition) rather than just “elapsed age”.

4. Operating expenditure allocations

Operating expenditure should be assigned on the basis of actual volumes of water supplied to each of the mines and urban customers respectively, as outlined in Section 5.5.4.

These enhancements would provide a more defensible position to the allocation of costs to mines and urban customers. It is acknowledged that significant potential business and other implications may exist if these recommendations are adopted and other factors will need to be considered before implementation.

Figure E 4 Scenario B - Proposed asset allocations if treated as fully integrated water supply system – excluding Menindee Pipeline

An assessment of Essential Energy’s approach to sewerage pricing for mines has been assessed and is considered reasonable at this stage.


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Strategic asset management

Essential Water’s asset management practices and procedures were assessed based on its WAMP (Water Asset Management Plan) submitted to IPART, the supporting information provided for business cases, documentation provided in response to RFIs and discussions with essential Water/Energy personnel.

Detailed outcomes of the review Strategic Asset Management review are provided in Section 6.An overview of the findings is:

Long Term Capital Investment Strategy – significant opportunities to develop robust long term capital investment strategies founded more clearly on defined and documented holistic and integrated service delivery strategies, stronger linkages with risk based asset management drivers and clearer definition of mandatory and discretionary expenditure (with the latter driven by a risk based approach). A general commentary is provided at Section 3.7.

Asset Management Framework - Essential Energy demonstrates a sound understanding of asset management principles, including contemporary service/objective driven asset management. However, the application of these asset management principles does not appear to have been translated into a structured asset management framework that clearly:

o defines and connects Essential Energy’s asset management practices across strategic, tactical and operational levels over the asset life-cycle;

o defines roles and responsibilities; or o links Essential Energy’s asset management systems to broader corporate systems and

plans.

Asset Management Practices – It is evident that Essential Energy personnel have a strong understanding of their assets. Review of investment cases and technical documentation for sampled individual capital projects also demonstrate that asset risk and life-cycle considerations have been taken into account.

However, in the absence of a structured asset management system the consistent application of risk management and investment decision making across Essential Energy’s asset base cannot be adequately demonstrated to support expenditure and prioritisation proposals. Mandatory and discretionary expenditure is not immediately identifiable and risk-cost trade-offs that support capital investment and operating expenditure are unable to be justified clearly and robustly.

Risk Management – Essential Energy regularly employs risk management in the management of its assets - notably in the management of risks associated with drinking water quality and project delivery. Essential Energy’s practices are aligned with AS/NZS ISO 31000:2009 Risk Management - however risk assessments do not consistently employ Essential Energy’s Corporate Risk Management Procedure (terminology, ratings and consequence categories).

Asset risks are, at present, unable to be well-articulated with a clear link to all Essential Energy service and performance objectives (including customer service and environmental outcomes), in particular for Essential Energy’s sewerage network.


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An understanding of these risks is essential to provide confidence that there will be ‘no surprises’ in long term investment planning. Improvement opportunities also exist in Essential Energy’s risk-based capital investment prioritisation process – establishing risk-appetites that define mandatory and discretionary expenditure, and prioritising risks across different drivers.

Information Management - Essential Energy do link maintenance activities and asset failures to individual assets through their CMMS (Mainpac), permitting economic analysis to be performed as part of a renewal decision making process. However, other important asset management information (in particular risk data) is stored in stand-alone documents and spreadsheets rather than in a corporate database - limiting the resilience and efficient retrieval, interrogation and reporting of key data.

Continuous Improvement – Essential Energy recognises the need for an ‘asset management improvement journey’ and has identified this as a key strategic objective in its Water Asset Management Plan (WAMP). The development and implementation of an improvement plan is endorsed by SKM.

An equivalent Sewer Asset Management Plan is not yet prepared and its development similar to the WAMP is encouraged. Essential Energy intends to include such a plan in its 'Water Asset Management Plan' (i.e. WAMP - Water Division is not going develop two separate documents).

SKM considers that it would be preferable (and prudent asset management practice) to keep these as discrete documents (or failing that as discrete sections of a comprehensive over-arching asset management plan) as the decision rules and decision frameworks will be different for the water and sewerage assets.

Industry Benchmarking

The National Water commission and IPART have undertaken some limited benchmarking on high level operational parameters in 2010/2011. It was evident then that Essential Water had scope for efficiency improvement.

It is evident now that if Essential Water continues to focus on its cost efficiency initiatives and progresses some of the recommendations from this review it will be on a strong cost efficiency improvement journey where it will be able to demonstrate significant improvement compared with its past performance and compare far more favourably with its group of comparators water utilities. Strong management of and reduction in corporate overheads will be a key part of this improvement journey.

This is discussed in Section 7.


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Contents1. Background 1

1.1. The 2014 Price Review 11.2. Key Features of Essential Energy’s Water Operations 11.2.1. Overall 11.2.2. Water Supply System 11.2.3. Sewerage System 3

2. Overview of Pricing Methodology 73. Capital Expenditure Review 9

3.1. Overview of Forecast Capital Expenditure 93.2. Review of selected projects/ programs 123.2.1. Overview 123.2.2. Detailed assessment of individual Capital Projects 133.2.3. Outcomes of detailed review of selected projects – prudent and efficient Capex 553.3. General Capital Program Review 583.3.1. General review of key remaining capital projects 583.3.2. General business decision-making 633.3.3. Essential Water – historical capex performance (current regulatory period) 683.3.4. Outcomes of the general assessment of capital program 703.4. Overall recommended adjustment to capital program 723.5. Improvements to Capital program planning process 733.6. Broad Ranking of EW’s Proposed Capital Projects 763.7. Long Term Capex Investment Strategy 78

4. Operating Expenditure Review 834.1. Context 834.2. Overview of Historical and proposed opex for 2014/15 to 2017/18 844.3. Assessment of Direct Opex 884.3.1. Comparison of Opex variances (year on year) 884.3.2. Overall recommendations re adjustments to direct Opex 934.4. Assessment of Corporate Overheads 994.4.1. Process of Cost Allocation – CAM Cost Allocation Methodology 994.4.2. Capex – Opex split of corporate costs 1014.4.3. Initiatives to reduce overhead costs 1024.4.4. Outcomes of Corporate Overhead cost assessment 1044.5. Opex savings from capex 1064.6. Key Recommendations 1084.7. Reference Information 108


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5. Mines Costs Allocation Review 1095.1. Overview of Approach 1095.2. Background 1105.2.1. Water Supply to mines 1105.2.2. Water Usage by Mines 1105.2.3. Previous Mines Pricing Agreement 1135.2.4. Essential Energy’s proposal 1135.3. Proposed pricing methodology / Building Block Approach 1145.3.1. Overview 1145.3.2. Cost allocation options considered by EE 1155.3.3. EE’s conclusions on proposed prices 1165.3.4. Allocation of Costs for Capital Returns 1175.4. Public Works Department (PWD) review of EE proposals 1175.5. SKM’s assessment of mines issues 1185.5.1. Consumption of capital value of assets - Replacement cost for water assets 1185.5.2. Basis of asset valuation 1215.5.3. Incorporation of future capex 1225.5.4. Allocation of Opex 1225.6. Mines Sewerage pricing 1235.7. Key Recommendations 1235.8. Reference Information 124

6. Review of Asset Management Systems and Practices 1256.1. Background 1256.2. Key Findings 1256.3. Further Discussions and Recommendations 1266.3.1. Asset Management Framework and Systems 1266.3.2. Essential Energy’s Asset Risk Management Practices 129

7. Industry Performance 1327.1. Overview 1327.2. Efficiency Initiatives 1347.2.1. SKM’s assessment 135

Appendix A – Essential Energy Schematics 136Appendix B – Essential Energy Business Structure 141

EE Organisational Arrangements 141

Appendix C - General Approach to Capex Assessment 142Appendix D – Corporate Cost Allocation Methodology – Further detail 143

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Essential Energy


January 2014

Document history and status

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A 23110/2013

B 31 October 2013

c 2 December 2013

D 17 December 2013

E 27 January 2014

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SKM_FINAL REPORT_26 Jan 2014_Rev D_FINAL

David Lynch, Nicholas Rhoden, Michael Bendeli

Michael Bendeli

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Name of project: Strategic Management Overview and Review of Operating and Capital Expenditure for Essential Energy's water and sewerage business in Broken Hill

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1. Background 1.1. The 2014 Price Review The Independent Pricing and Regulatory Tribunal (IPART) is conducting a review of maximum prices for Essential Energy’s water and sewerage monopoly services from 1 July 2014. As part of the price review process, IPART aims to set prices that will allow Essential Energy’s water and sewerage business to recover an amount of revenue that is equal to the full efficient costs of providing its regulated water and associated services.

To inform this price determination, IPART has engaged SKM to undertake a review of Essential Energy’s proposed expenditure. The review includes:

A review of Essential Energy’s proposed capital expenditure from 1 July 2013 to 30 June 2019;

A review of Essential Energy’s proposed operating expenditure from 1 July 2013 to 30 June 2019;

A strategic review of Essential Energy’s asset management systems and practices and long term investment plans; and

A review of essential Energy’s proposed methodology for allocating costs to the mines for the purposes of setting prices

1.2. Key Features of Essential Energy’s Water Operations

1.2.1. Overall Essential Water is effectively an operating division of the overall Essential Energy networks corporation. It is a “stand-alone” business in terms of its operations but shares corporate services functions with the broader Essential Energy business. These corporate services include IT, human resources, regulatory and executive management.

Essential Water functions include providing:

water supply services to urban customers in the Broken Hill and Menindee townships and the villages of Sunset Strip and Silverton township, and to various mines (CBH, Perilya North, Perilya South and Potosi) proximate to the Broken Hill township;

sewerage services predominantly to urban customers in the Broken Hill township and in a more limited manner to the mines; and

some limited trade waste services.

1.2.2. Water Supply System Figure A- 1 (Appendix A) shows the key features of Essential Water’s overall water supply system. The key water assets comprise:

Large Water Storages o Umberumberka dam o Stephens Creek reservoir o Imperial Lake reservoir



Bulk supply pipelines o Menindee o Umberumberka o Stephens Creek o Imperial Lake

Balance Tanks

Water Treatment Plants (3 No.)

Disinfection facilities (chlorinator[s])

Service Storage reservoirs (12 No.)

Booster and Pressure pump stations

220 km water reticulation mains

Customer water meters

Figure A- 2 and Figure A- 3 (Appendix A) show the key features and more detail of the water supply system within the Broken Hill township and that to the mines, which are proximate to the township. It is evident that the majority of the water supply assets are integral to supplying water to both the Broken Hill urban customers and the mines. That is there are few assets that could be identified as servicing the urban customers only or the mines only.

Raw water (un-chlorinated and untreated raw water) comes direct from the catchment system - either from the Umberumberka reservoir, Imperial Lake or the Stephens Creek reservoir. Stephens Creek reservoir not only receives water from its own catchment but from the Darling River via the Menindee pump station and pipeline.

The raw water that supplies the mine is fed from 2 No. raw water tanks on the Block 10 Hill. These tanks are concrete in construction; one with a capacity of 2.27 ML and the other 4.50ML. Water is pumped directly to these tanks from the pumping stations at Stephens Creek reservoir, Imperial Lake and Umberumberka reservoir. When the local reservoirs are empty the water is pumped from the Darling River at Menindee into the Balance Tank at Kinalung, from where it is pumped into the Stephens Creek Reservoir.

Water sourced from the Darling River at Menindee reaches Broken Hill by three pumped lifts of approximately 90m static head each (90m Menindee to Kinalung, 90m Kinalung to Stephens Creek and 90m Stephens Creek to Broken Hill). The pumped distance is approximately 116 km from Menindee to Stephens Creek reservoir and 20km from Stephens Creek reservoir to Broken Hill.

The pipeline from Menindee – Kinalung – Stephens Creek reservoir is a 600NB above ground steel pipe. The pipeline from Stephens Creek reservoir to Broken Hill is made up of 600NB above ground steel pipe, 600NB sintakoted steel pipe buried and 600NB buried Rocla pipe. The pipeline from Umberumberka reservoir is a combination of 450NB above ground cast iron pressure/rising main to Blue Anchor Tank then a combination of 450NB above and below ground steel, ductile iron and Rocla pipe to Broken Hill.



The Imperial Lake Main is mostly 450NB buried Ductile Iron with some 500NB Ductile Iron and 450NB above ground steel pipe.

The treated water supply to the township and the mines comes from the Mica Street Water Treatment Plant (MSWTP) in Broken Hill. The MSWTP is supplied raw water via the system as previously described. From Mica Street the treated water is stored in the 2 service reservoirs/storage tanks at Mica Street. One tank is a 9ML steel tank and the other a 4.5ML mass concrete tank with reduced capacity of 2.5ML due to structural issues.

Treated water is subsequently pumped to the 2 service reservoirs on the Block 10 Hill; one being a 9ML steel tank and the other a 4.6ML concrete tank. These tanks provide water to the reticulation system that feed the mines as well as Broken Hill township. The Block 10 tanks also feed the Hebbard Street tank, a 9ML steel tank that feeds the mines from the southern side of town as well as the town reticulation system.

1.2.3. Sewerage System Figure A- 4 (Appendix A) shows the key features of Broken Hill’s sewerage system. The key sewerage assets comprise:

228 km sewer reticulation mains (including 3,400 maintenance holes, 152 sewer vent stacks)

20 km pressure (“rising”) mains

Sewer pump stations (11 No.)

WWTPs/Wastewater treatment plants (Wills St. WWTP; South Broken Hill WWTP)

11 km treated effluent disposal mains.

All sewage receives primary and secondary treatment and UV disinfection. In particular:

There is no bypassing of any of the sewage treatment facilities; and

No treated sewage is used for potable water supply.

Note: Essential Water refers to sewage being treated to a “tertiary standard”. SKM’s understanding is that Essential Water’s sewage treatment involves only trickling filtration followed by maturation ponds and UV disinfection. There are no specific nutrient removal processes (i.e. for targeting nitrogen and phosphorus removal to meet EPA licence requirements). On this basis treated effluent from Essential Water’s wastewater treatment plants will be referred to as “secondary treated effluent” – and not “tertiary treated effluent.

Essential Water’s WWTP EPA licences for discharge to the environment do have a requirement for enhanced disinfection (UV disinfection as well as chlorination) to meet stringent microbiological standards. However it is unclear whether this was driven by the need to facilitate water recycling /re-use or for normal discharge to the environment.

The volumes of sewage treated and the volumes of secondary treated effluent not re-used and thus disposed of to the environment from each of Broken Hill’s two sewage treatment plants are indicated in Table 1. These are based on reported figures for the 2011/12 EPA licence period(1 October 2011- 30 September 2012). [NB: It is assumed that these would be little different for the 2012 – 2013 year.]

Essential Energy


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• Table 1: Sewage Volumes treated & secondary effluent disposed of to the environment

Influent Sewage Volumes Secondary Effluent Volumes to WWTP Treated Environment

kl p.a. kl p.a.

Wills StWWTP 1,283,534 840,555

South Broken Hill WWTP 316,520 305,258

Total 1,600,054 1,145,813

The volumes of secondary treated effluent used for beneficial purposes by both the mines andl other users are indicated in Table 2. These are based on reported figures for the 2011/12 EPA licence period (1 Oct 2011- 30 Sept 2012). It is noted that there is approximately a 3% discrepancy between the aggregate influent sewage volumes (column 1, Table 1) and the sum of the volumes of secondary treated effluent disposed of to the environment (column 2, Table 1) and volumes of secondary effluent beneficially re-used (Table 2). This is reasonable as it is within the bounds of expected meter accuracy.

• Table 2 Volumes of Secondary effluent beneficially re-used

Recycled Water User Volume

kl p.a.

Private User 1,791

Silverlea 4,687

Perilya 140,305

Cristal Mining 10,859

Broken Hill Golf Course 249,378

Broken Hill Racecourse 5,450

Council waste depot 3,897

Total 416,367

Secondary treated effluent disposed of to the environment (an ephemeral creek) has its own dedicated pipeline. All re-used secondary effluent is drawn from the Wills St WWTP at the "site boundary". There are at least three (3 No.) dedicated separate pipelines (with their off-takes at the WWTP) transferring secondary treated effluent to the respective re-users properties.

Provision of the infrastructure to transfer treated effluent to the re-users properties has been funded by the respective re-users with no contribution from Essential Water. Two of the major pipelines are owned by the major re-users, namely Broken Hill Golf Course and the Perilya mine (with some of the smaller re-users having off-takes from one of the major re-user's pipeline).

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Essential Energy


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_llM

Each of the owners of the reuse pipelines has an agreement with Essential Water for the supply of secondary treated effluent. The re-users are only charged a nominal amount (currently approximately 16.5 cents/kl) for the secondary treated effluent. Essential Water does not seek to recover the costs of treatment and this nominal charge does not reflect any material contribution to

the costs of producing the secondary treated effluent.

This is considered justified because:

• All the wastewater/sewage inflows need to be treated to the "secondary treated standard" (including enhanced disinfection using UV) in any event and the secondary treated effluent would otherwise have been discharged of to the environment; and

• There is an advantage to Essential Water in terms of load based fees (for discharges to the environment) with approximately 25% lower volumes and loads discharged than would

otherwise occur.

• Figure 1: Sewage treatment

Treatment of treated effluent costs - costs

should be ~!located to · sewerage given that it is

effluent that would

have otherwise ~een discharged in!o the

0!'JViron ment.

The other issue to consider is whether the use of this secondary treated effluent (sold at a nominal charge) is used as a substitute for water which would be sourced from the main water supply

system, thereby assigning an advantage to the re-users and in particular Perilya mine that the urban customers do not have and leaving urban customers to fund a greater proportion of water

supply assets.

Essential Water considers that this secondary treated effluent is effectively - for these re-users - a "new water" supply. If this secondary treated effluent was not available for re-use then these re

users would not source water from the potable water supply system.

SKM_FINAL REPORT _26 Jan 2014_Rev E_Fu1al_Redae!ed docx PAGE5



In particular (and notwithstanding the arid environment):

Broken Hill Golf Course – would almost certainly be returned to a dirt golf course (as water from the potable supply system would be uneconomic);

Perilya – use the water for grounds irrigation, including maintaining large ovals for the community. It is considered likely that if it had to pay more for the secondary treated effluent or substitute this irrigation water with water at the higher price from the potable water supply system that it would dramatically reduce its water usage for these “discretionary” purposes; and

Silverlea and the Private User are opportunistic users (the former providing a community service).

Conclusion In summary and on balance SKM considers:

this assessment to be realistic, namely that the re-use of secondary treated effluent is largely opportunistic use of a “new” water source and does not result in a material substitution of water from the potable water supply system;

as all sewage is treated to the same standard and the standard of effluent disposed of to the environment is the same as that of that re-used, all the costs of treating sewage should be treated as sewerage costs (and included in sewerage pricing). No cost should be re-allocated to the water business or included in the water prices; and

Essential Energy incurs no additional costs in distributing secondary treated effluent beyond those incurred in generating the secondary treated effluent and for its normal disposal.



2. Overview of Pricing Methodology Essential Energy’s submission is based on IPART’s “building block” methodology to determine its notional revenue requirement for each year, 2014/15 to 2017/18. EE’s notional revenue requirement each year is the sum of operating costs, return on capital (RAB x WACC), depreciation, return on working capital and tax allowance. This is calculated for each year of the proposed determination period. This is summarised as a simple schematic in Figure 2.

EE uses IPART's regulated asset base to determine its capital returns.

Figure 2: Overview schematic of revenue build-up methodology

Essential Energy has two mine customers (Perilya is the larger; and CBH) as well as residential and other non-residential customers. The total revenue requirement from its residential and other non-residential customers is obtained by establishing its total revenue requirement overall and then deducting

revenue from the mines each year;

revenue from trade waste and miscellaneous services (but this is a small component); and

any government grants and subsidies.

This is repeated for each year of the regulatory period. The mines revenue requirement is calculated as indicated in Section 5. Figure 3 shows an indicative example of the methodology for a total notional revenue requirement for 2014/15 of $22.3m, with $5.0m from mines.

Figure 3: Example of methodology for 2014/2015



Escalation rates

Essential Water capex and opex forecasts are provided in Real (2014) dollars. It has assumed that

all costs1 (including materials, salaries and wages) underpinning both the capex and opex forecasts will remain constant, in real terms, throughout the proposed regulatory period. If any cost areas do increase by more than CPI, these increases will be offset by productivity improvements. Example, if salaries and wages increase by 2.7% pa (in nominal terms), and CPI is 2.5%, Essential Energy would absorb the difference as a productivity improvement of 0.2% pa to offset the real increase.

Note 1: An increase in electricity costs has been forecast, but this is due to volume increase, not real price increases.

Essential Energy


SPICLllHNl<KfM[RI January 2014

_5.IM

3. Capital Expenditure Review 3.1. Overview of Forecast Capital Expenditure

Essential Energy has proposed a total capital expenditure of $52.197 million ($2014) for the four year regulatory period 2014/15 (FY15) to 2017/18 (FY18). This capital expenditure comprises expenditure of $43.273 million ($2014) for water services and $8.924 million ($2014) for sewerage services. All costs include the 20% corporate overhead. These projects and costs are listed in Table 3.

Table 4 and Figure 4 provide Essential Water's proposed/forecast capital expenditure over the six years from 2013/14 to 2018/19 split up between the water and sewerage services/assets.

Table 5 shows a breakdown of expenditure to date and proposed forecast costs for each project.

• Table 3: Capital expenditure forecast for regulatory period 2014115 to 2017/18 only (20% corporate costs included)

EW Project Capex $2014

Project FY15-FY18 ID ($Millions)

Water Services

WP1 Stephens Creek Emergency Pump Station .. WP2 Stephens Creek Reservoir Dam Wall rehabil itation .. WP3 Imperial Lake Reservoir Dam Wall rehabilitation .. WP4 Mica St Service Reservoir No 1 Replacement .. WPS Rocky Hill Service R.eservoir No. 2 Replacement .. WP6 Service Reservoirs - Refurbishment .. WP? Menindee WTP Major Works .. WPS Broken Hill water reticulation replacement .. WP9 Reservoir General Works .. WP10 Menindee & Umberumberka Pipeline Repairs .. WP11 Water Pumping Station Refurbishment I Overhauls .. WP12 Mica St WTP Capital Works Program .. WP17 Stephens Creek to Mica St Rocla Pipeline Replacement .. WP18 Sunset Strip WTP - Potable Water Upgrade .. WP19 SCAD A and Telemetry Upgrades .. WP20 Other Works ..

Subtotal 43.273

SKM_FINAL REPORT_26 Jan 2014_Rev E_F1nal_Redac:!ed docx PAGE9

Essential Energy


SPICLlllUl<KTMlRI January 2014

_5.IM

EW Project Capex $2014

Project FY15-FY18 ID ($ Millions)

Sewerage Services

SP13 Replacement of Wills St Waste Water Treatment Plant .. SP15 Sewer Reticulation Repair .. SP16 Sewer Pump Station Refurbishment /Overhauls .. SP21 South Waste Water Treatment Plant - Refurbishment .. SP22 Other Works ..

Subtotal 8.924

Total 52.197

• Table 4 Essential Water's proposed/forecast capital expenditure budget (FY14 to FY19)

ReaulatorvPeriod FY15-FY18)

2013/14 2014/15 2015/16 2016/17 2017/18 2018/19 Total

FY15-FY18 Essential Energy's proposal $000's ($2014) Water $3,922 $10,017 $11,447 $6,249 $8,348 $9,145 $36,061 Wastewater $543 $1,789 $1,530 $1 ,598 $2,521 $2,418 $7,437 Corporate $893 $2,361 $2,595 $1 ,.569 $2,174 $2,312 $8,699 Total $5,357 $14,166 ~15,572 $9,415 $13,043 $13,875 $52,197

• Figure 4 Essential Water's proposed/forecast capital expenditure budget (FY14 to FY19)

Forecast capital expenditure 16,000

14,000

8 12,000 0

~ 10,000 c:t ... 8,000 0 N v. 6,000 x QI

4,000 a. "' u 2,000

2013-14 2014-15 2015-16 2016-17 2017-18 2018-19

Financial Year

• Water Services • Sewerage Services

SKM_FlNAL REPORT_26 Jan 2014_Rev E_F1nal_Redacred docx PAGE 10

Essential Energy (Water)


January 2014

• Table 5: Historical costs (expenditure to date) and proposed capital program

Actual and forecast costs (latter in Real $2014)

$'000 - Including OVertieads

WATER

. c 1: S E ncy Pu ·ng o. Ml

R ·r m au R ar Project 3: mperial Lalle Reser.oir Dam Wall RehabilitatiOn

Projects 4: Mica St Senice Reserwoir Replacement

Projects 5: Rocky Hill Ser.ice ReseMir Replacement

Project 6: Ser.ice Reser.oirs - RelJrtJishment

Project 7: Menindee WTP MajOl WDl1<s

p

p

Project 11: Wal.er Pumping Station RefurbishmenUO..elflauls

Project 12: Mica SI WTP Gapital Works Programme

Project 19: SCADA & Telemetty Upgrade$

Project 18: Sunset Strip WTP - Potable Water Upgrade

Project 17: Stephens Cl< to Mica st Recla Pipe~ne Replacement

· c 13: I e ent of · 1s St asle at Ti tm t P

Project 15: Sewer Reticulation Repair

Project 16: Sewer Pump Statton RelJrbishmenUOlerhaolS

Project 2t : South Waste Water Treatment Plant - Refurbishment

Project 22: other Works

Sewer Total

Nominal Nominal Nominal 2014$ 2014 $ 2014 $ 2014$ 2014 s 2014$

Actual Actual Actual Forecast Forecast Forecast Forecast Forecast Forecast TOTALS

._o_TAL __ CAP1T ____ AL __ w_OAkS ____ P_ER __ REGULA _____ J_ORY ___ sUBllllS5 _____ '°" ________ ..... ___ ,_.654 ______ ~_49!1 _______ ~_529 _______ 5.3S7 __ .._ __ '~--' .. _____ ,_~_572 ______ ~_4_,_s ____ ,_J_,MJ__..._ __ '3.t7--..... __ '1_~_,_l ,~l __ 23. __ • .... :.lll 52,19111 -.o12f

SKM_FINAL REPORT _£ti Jan 2014_Re~ E_Final_Redacted docx PAGE 11

Essl'ntial Energy (Water)


''"'"'" .. ""'M'"' January 2014

_JKM

3.2. Review of selected projects/ programs

3.2.1. Overview

Within the capital program, ten (10) projects have been selected for detailed assessment of the forecasted capital expenditure and program. These projects represent a total of $36,087,000 ($2014) or 69% of the capital program. The ten projects selected are listed in Table 6.

SKM has undertaken a review of 10 capital projects (or programs of works) to assess the prudency and efficiency of the associated capital expenditure.

The projects listed in Tab le 6 were selected to test this based on a range of criteria including significance of capital spend, strength of the various drivers (mandatory and discretionary), robustness of decision making processes (e.g. risk based asset management), programs of works and potential for adjusting timing.

For each project an overview of the project is provided which includes evidence to support the decision making, followed by an assessment of the prudency and efficiency of each project and recommendations for adjustment to capital expenditure and program.

The outcomes of the detailed assessments of the individual projects/programs of works (as nominated in Table 6) are provided in Section 3.2.2. Note: All costs in this section include the 20% corporate overhead costs nominated by Essential Energy.

• Table 6 Capital projects assessed in detail (includes 20% corporate costs)

EW Project Capex

ID Project FY15-FY18

($Millions)

WP1 Stephens Creek Emergency Pump Station .. WP2 Stephens Creek Reservoir Dam Wall rehabil itation .. WP4 Mica St Service Reservoir No 1 Replacement .. WPS Broken Hill water reticulation replacement .. WP9 Reservoir General Works .. WP10 Menindee & Umberumberka Pipeline Repairs .. WP11 Water Pumping Station Refurbishment I Overhauls .. SP13 Replacement of Wills St Waste Water Treatment Plant .. SP15 Sewer reticulation repairs .. SP16 Sewer Pump Station Refurbishment /overhauls ..

Total 38.087

SKM_RNAL REPORT_26 Jan 2014_Rev E_Final_Redac!ed docx PAGE 12

Essential Energy


... cu .. ..... ,N... January 2014

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3.2.2. Detailed assessment of individual Capital Projects

WP1 Stephens Creek Pump Station No. 4 Planned Capex [FY15-FY18]

~Million

Project overview

The Stephens Creek Pump Station transfers water from Stephens Creek Reservoir and Menindee Lakes to the Mica St Water Treatment Plant. The proposed Stephens Creek Pump Station is intended to operate in the event that the Stephens Creek existing pumping station is out of service due to a major failure. The new pump station at Stephens Creek is to provide the ability to supplement the existing pump station to supply peak Broken Hill Water demands and to have provision for additional pumps to be added in the future to enable decommissioning of the existing pump station.

The project has been initiated to manage the risk that is posed to the security of the Broken Hill water supply of not having an alternate pumping option at the Stephens Creek Reservoir in the event of a failure at the Stephens Creek pump station.

The pump station has been proposed to be constructed between 2013/14 and 2015/16. The total cost has been estimated at~ of which - (including 20% corporate overheads) is to be spent in the current regulatory period (in 2013/14).

Evidence to support project

The Stephens Creek No. 4 Pump Station Investment Case (Essential Water, 2013) states that the goal of this project is to construct an alternative pumping option at Stephens Creek Reservoir that is available to be used in as part of the current pumping regime or as a standalone unit that can independently meet the average raw water supply needs of Broken Hill. The primary drivers for the project as follows:

Minimise the risk to Broken Hill's water supply if the existing Stephens Creek pump station becomes inoperable.

Securing Broken Hill's water supply by introducing pumping redundancy at Stephens Creek Reservoir (n-1 ).

o Umberumberka can only supply 10 MUd due to pumping capacity constraints. Broken Hill's water demand is approximately 12 MUd in winter and 24 MUd in summer. Umberumberka Reservoir often reaches zero capacity and it cannot be topped up from an alternate resource.

o Imperial Lake dam usually only holds 5 days supply unless it has been topped up by a rare rain event.

Provide the means to pump directly from the Darling River into Broken Hill in the event Stephens Creek Reservoir is unable to be drawn from. Reductions in the cost of water supply through the introduction of newer technologies and a more efficient design would be offset by increased power and maintenance costs at the new pump station, so there is no assumed change in Opex.

Essential Water has described the existing Stephens Creek Pump Station as a critical asset in

SKM_FINAL REPORT_26 Jan 2014_Rev E_F1nal_Redac!ed docx PAGE13

Essential Energy


... , .......... ,M... January 2014

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WP1 Stephens Creek Pump Station No. 4 Planned Capex [FY15-FY18)

smMillion

Broken Hill's water supply system and an extended outage of this pump station would result in the inability to meet the customer service requirements for water supply.

A risk assessment conducted by Essential Water has identified the risks of a failure at the existing pump station. A combination of structural issues, flood and fire risk means could potentially lead to three months of unreliable water supply to Broken Hill which is considered an unacceptable level of risk.

The Investment Case (Essential Water, 2013) states that the consequence of not completing this project could be "catastrophic", if the existing pump station were to fail in a time of drought. This would be the case if the failure occurred at a time when Broken Hill is completely reliant on water supplied from the Darling River and the Imperial Lake emergency supply was exhausted during the failure. Essential Water would be unable to supply a safe water supply to Broken Hill until the problem was rectified (3 months).

Failure to supply Broken Hill with a secure water supply would result in irreparable damage to Essential Water's brand and corporate reputation. The only option would be for Essential Water to transport water from Stephens Creek to Broken Hill, the cost of which could be greater than $40,000,000.

Essential Water has identified that a new pump station at Stephens Creek will provide a backup to the existing pump station in the event of fa ilure. There is limited evidence of alternative solutions being considered that would reduce the water supply security risk.

EW has acknowledged that no formal option study was undertaken to develop alternative solutions. However, EW has advised that it made an internal management decision to incorporate n-1 redundancy at Stephens Creek Pump Station to secure the critical link from the Darling River. As Stephens Creek pumping station is the major link in the chain to supply raw water from Broken Hill from both the major local reservoir and the permanent supply from the Darling River at Menindee any consideration to an alternate permanent raw water source and its delivery to Broken Hill would require a major change in the bulk water strategy for Broken Hill.

By comparison, an options assessment has been conducted for an emergency pump station which provides a power supply alternative for the proposed plant (Aurecon in 2011 ). Following this concept and detailed designs (Aurecon, 2012) have been undertaken for the emergency pump station.

Although it is intended for emergency use, the design has considered the option of operating this pump in parallel with the Stephens Creek main pumping station in order for Stephens Creek to be able to supply Broken Hill's peak demand. It is suggested the design of the emergency pumping station should be considered as an alternative pumping station that could supplement the existing pumping station for an immediate need and could be expanded in the future with installation of additional pumps to eventually replace the existing pumping station for the delivery of raw water to meet the peak demand of the Mica Street WTP.

Being completely independent from the existing pump station structure and with a separate power

SKM_FINAL REPORT_26 Jan 2014_Rev E_F1nal_Redacl.ed docx PAGE 14

Essential Energy


.. m ......... ,M... January 2014

__DM

WP1 Step.hens Creek Pump Station No. 4 Planned Capex [FY15-FY18]

smMillion

supply, this project would provide security of raw water supply to Broken Hill in the event of total failure of the existing pumping station.

In the Review of Capex Costs & the Capital Investment Plan for Essential Water's IPART submission (Public Works Department, Sep 2013), it is stated that, if re-use of existing pumping equipment is pursued and the location of the Stephens Creek Emergency Pumping Station site is reconsidered (to achieve significant savings related to constructing the access road), cost savings in the order of $1 M to $2M could be achieved.

Au re con provided a cost estimate of~ (or ~m including 20% corporate overheads) for the pump station. NSW Public Works Department adjusted this to ~m (or ~m including corporate overheads) due to invalid quotes used in the estimate. The NSW Public Works Department estimated cost of the pump station is~ (or :mm including corporate overheads).

The PWD has suggested that alternative options should be explored as these may provide greater benefits or reduced costs to the project.

It is noted that WP11 provides a ballpark figure of ~ to upgrade the existing Stephens Creek pump station structure.

Is the project prudent? I The risk assessment conducted by Essential Water confirms that an extended outage at the existing Stephens Creek Pump Station poses a significant and unacceptable risk to water supply to Broken Hill. Based on this assessment it is clear that action is needed to reduce the risk of not being able to supply water to Broken Hill due to a failure at Stephens Creek Pump Station.

The initial project driver was that the pump station be available in an emergency situation. However, EW did not wish to build a station that could not be integrated into the existing pumping regime as this was not considered a prudent spend. That is the station would continue to have to be maintained with associated OPEX costs and not be available to assist in the supply of water to Broken Hill.

Notwithstanding this it is unclear overall that the project drivers and functionality for the solution are well established and due to this uncertainty there is potential that the solution being proposed not optimal. The pump station will act as an emergency pump station however there have been additional "benefits" identified later in the design process which have been used to justify the project in the Investment case. The pump station will also be used to supplement the existing pump station and in the future take over from the existing pump station.

Overall, the project is prudent but needs to be modified (or better justified) in clarity of objectives, scope and timing. SKM acknowledges that it is prudent to secure the "spine" of the water supply system (including Stephens Creek Reservoir and Pump Station) although this does not appear to be consolidated into a comprehensive integrated water supply strategy {and which is well documented).

SKM_FINAL REPORT_26 Jan 2014_Rev E_F1nal_Redac!ed docx PAGE 15

Essential Energy


SRCUll U ll MTNm January 2014

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WP1 Stephens Creek Pump Station No. 4

Is the project efficient?

Planned Capex [FY15-FY18)

smMillion

I o The options assessment focused on power supply alternatives for what is fundamentally an emergency pump station. There is limited evidence of a broader options assessment for solutions to meet the identified project need(s} such as building a new pump station to replace the existing pump station. Concept design and detailed design has been conducted for an emergency pump station where the additional benefits of being able to supplement the existing pump station and in the future take over from the existing pump station have been identified.

There is uncertainty that the proposed solution is most efficient. The cost estimate for the pump station appears to be reasonable for the proposed solution. However there may be opportunitiies to reduce the cost or provide improved outcomes for the proposed solution by confirming the project need and objectives and revisiting the design.

The solution proposes installing a switchboard in the existing building with the risk that it may become inoperable in the event the existing pump station fails. However EW's detailed design, which includes a standby Genset, will attempt to mitigate this risk and allow the pump station to run continuously in a major power or structure failure event at the existing Pump Station.

EW has advised in response to SKM's suggestions that it acknowledges that there are cheaper options for the proposed pump station, such as diesel pumps or alternative location, all of these have been assessed internally as not being the optimal solutions (although the supporting evidence has not been sighted by SKM}. For example, EW considers that diesel pumps have higher maintenance costs, are more inefficient to run and have greater environmental impacts (such as fuel storage requirements). EW chose the location of the pump station based on the requirement not to have a low lift pump, and its proximity to the incoming Menindee pipeline.

The switchboard in the existing building was not considered a significant risk as the new pump station was to have a standby generator available in the event of a power or other failure at the existing pump station.

Overall, SKM has concluded on balance that the proposed funding and/or timing is not efficient as there is likely to be a more efficient overall response than that proposed by EW.

Additional supporting information which would help to better justify the works proposed.

An options assessment with a clear definition of the problem and objectives is not available for this project. A broad options assessment has not been undertaken or considered fully. Full replacement of the existing pump station and decommissioning of the existing pump station may be a lower cost alternative considering that - is being proposed to be spent on upgrading the existing Stephens Creek pump station structure.

It is noted that ~m (includes corporate costs) is shown in the current regulatory period (FY14) for this project. It has been assumed that tendering and construction for project works has not yet commenced. If this assessment is adopted Essential Water, it seems unlikely that EW will spend anything in 2013/14 and would likely delay any spending of the ~m until late in FY15 - FY1 8.


Essential Energy


SRCU ll U ll MTNm January 2014

_DM

WP1 Stephens Creek Pump Station No. 4

Recommendations

Planned Capex [FY15-FY18)

-Million

EW plans to undertake works at the existing SCPS as described in WP1 1 and additionally build the SCPS No. 4. In WP1. [NB: This is variously described as an emergency pump station and also as a replacement pump station]. Once the existing pump station is upgraded, there is limited evidence to show that the residual risk to supply security is high enough to warrant building an emergency pump station as well . Completing both the upgrade of the existing SCPS and building the new SCPS No. 4 is clearly not a prudent or efficient approach.

The evidence presented identifies opportunities for optimisation of the solution. Unless there is evidence provided to proceed with construction of the project as planned, the project should be delayed to enable all the options to be explored and conduct further concept and detailed design to identify opportunities for optimisation of the solution. Essential Water should conduct the associated design and undertake this work as planned.

It is proposed the project be delayed to allow "re-scoping" work to be completed including problem

definition, design objectives, options assessment, benefit/cost analysis and re-design in the 2014/15 year and deferral of other works until later in this regulatory period and/or the next regulatory period with construction of essential works commencing in 2016/17.

It is noted that ~m (including 20% corporate costs) was to be spent in the current regulatory period (2013/14 ). It has been assumed that the tendering and construction phase for the project has not commenced at this stage. It seems unlikely that EW will spend anything in 2013/14 and would likely delay any spending of the ~m (i.e. !!llllm + 20% corporate costs) until 2016/17 (see below).

A preferred strategy would be to spend minimum funds on the existing pump station only to make it safe and pool the savings to replace the existing pump station in full in a new facility at a later date, potentially into the next regulatory period unless a stronger case is made than at present.

Overall:

• the project is prudent (because at least some level of improvement in redundancy is required). The current level of supply security and redundancy provided by the existing pump station in its current condition is inadequate; but

• the proposed expenditure is inefficient because the timing of the works, the extent of the works is unclear without a proper risk assessment and options analysis (although EE has

undertaken a form of risk assessment). Further there are a number of linked projects including works contemplated by WP11 which have not yet been rationalised or optimised.

• SKM has assumed that no work will be undertaken in 2013/2014 (and the funds indicted by EE for FY14 have been removed), .m has been allowed for the design and options assessment work in 2014/2015 and the project deferred until the last half of the regulatory

period with !!llllm in FY17 and ~min FY18.

SKM_FINAL REPORT_26 Jan 2014_Rev E_Final_Redacl.ed doc:x PAGE 17

Essential Energy


.. m ......... ,N... January 2014

_DM

WP1 Stephens Creek Pump Station No. 4 Planned Capex [FY15-FY18)

- Million -------!

WP1 is linked with some works contemplated in WP1 1 where approximately m is provided for related works of building structural fixes and valves and motors overhauls at the Stephens Creek pump station. SKM believes that it is inefficient to provide for the full cost of a new emergency pump station (which will later be converted to the primary pump facility replacing the existing pump station) and also allow the full cost (of . m) for these refurbishment works as indicated in WP11.

Further EE could have (but it appears that it has not) assessed the option of providing a completely new pump station faci lity in the short term as a total solution to all these issues. It is unclear (without doing the work) whether this would result in a lower overall cost to address the stated risks and asset shortcomings compared with the aggregate amounts proposed by EE. It is also unclear whether the risks associated with the existing building could be deferred for a few years for this to occur.

Consequently SKM has made a judgement in terms of providing reasonable efficient funds overall to undertake works (of whatever form ultimately is decided by EE) to address the stated drivers:

• allow the full cost for the WP1 (of ... m) with an adjusted timing but with an adjusted distribution of funds as follows- nil in FY14, .min FY15, nil in FY1 6, ... in FY17 and Sllllm in FY18. NB: No funds have been provided in FY16 for practical timing reasons (EE needs to confirm an efficient response and its track record in delivery of notionally committed projects).

• reduce the funds in WP11 by . m (still leaving . m for remedial works at Stephens Creek Pump Station).

So in aggregate ... m (direct costs) has been provided for works at Stephens Creek Pump Station.

SKM_FINAL REPORT _26 Jan 2014_Rev E_F1nal_Redacl.ed docx PAGE 18

Essential Energy


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WP2 Stephens Creek Reservoir Dam Wall Rehabilitation

Project overview

Planned Capex [FY15-FY18] -M (or -M incl'g FY19)

Stephens Creek Reservoir was constructed in 1892 and comprises a 15.2 metre high by 140 metre wide zoned earth-fill embankment with dual concrete spillways on either side. The dam is located on Stephen's Creek, approximately 15 kilometres north east of Broken Hill. The dam contributes approximately 75% of the city's annual water consumption and is also integral to accessing water from the Darling river as water is pumped into the Stephens Creek holding pond and then transferred into Broken Hill via the Stephens Creek pumping station. It is a key asset in the main spine of Broken Hill's water supply system.

This project is proposed to upgrade the dam to meet the safety requirements necessary to comply with NSW Dams Safety Committee requirements. The reservoir has deficiencies to withstand flood and earthquake at the modern day design standards.


Stephens Creek Reservoir is a prescribed dam under the Dam Safety Act. Essential Water is obligated to meet the requirements of the Dam Safety Act and meet the requirements the regulator of the Dam Safety Act (NSW Dam Safety Committee).

Essential Water recently conducted two studies to assess the capacity of the Stephens Creek Reservoir - a Hydrological and Dam Break Study (GHD, 201 0) and a Flood Capability Compliance Assessment (Aurecon, Oct. 2012) was undertaken to review its outcomes. The assessments establish the dam consequence category based on a probable loss of life approach.

The Flood Capability Compliance Assessment was provided to the NSW Dam Safety Committee who has written to Essential Water (Letter of 13 Dec. 2012) endorsing the consequence category and recommendations in the report and acknowledges that the dam currently has a capacity to withstand a 1 :900 year flood event and needs to be upgraded 1: 10,000 year flood event. The NSW Dams Safety Committee has additionally stated that the dam needs to be upgraded to withstand a 1 :5000 year earthquake.

The NSW Dams Safety Committee instructed Essential Water (Letter 13 Dec. 2012) to submit an upgrading program and options study to address the flood and earthquake deficiencies by September 2013.

To address the deficiencies of the existing Dam, feasibility stage options were identified in the Flood Capability Compliance Assessment (Aurecon, Oct. 2012). The preferred option (Option 7) requires levelling the dam crest, installing a 1.2 metre high cantilever wall, raising the spillway walls and providing erosion protection to the embankment and silt buttressing at an estimated capital cost of~ Million (direct costs) or ... Million (including 20% corporate overheads) over a six year period (FY14 to FY19). It is noted that EE has added other "direct costs" of some tlllMillion (refer investment case) which totals ~Min direct costs. However, EE is overall only proposing a total of . Million (including 20% corporate overheads) for this project for the years FY15 to FY19 with Million of this in the regulatory period FY15 to FY18.


Essential Energy


SRCUll U llMTNm January 2014

_DM



Review of Capex Costs & the Capital Investment Plan for Essential Water's IPART submission (Public Works Department, Sep 2013) identified a risk that there has not been enough investigation undertaken to date regarding the dam wall deficiencies to adequately determine the scope of works required and cost of the project. The PWD report indicates that:

• No details are available at this stage on the extent of work involved in the required safety upgrade of the dam earth-fill embankment, concrete training walls or the concrete spillway structures which also present a major deficiency in the dam; and

• The works for a spillway capacity upgrade and to improve the structural adequacy of the dam are interdependent and confirmation of the suitability of the preferred option to be pursued to construction will require further significant investigation and design to be undertaken.

The options developed for EW have not been adequately scoped or quantified and are considered to be at the initial feasibility stage. These options are focused on the spillway upgrade and do not address the overall dam major deficiencies and as such it remains unclear as to whether the preferred option is feasible.

The basis or method for determining the option cost estimates has not been documented or substantiated and insufficient information is available for the purposes of this review.

Recent survey work has revised key design levels and these will need to be taken account of in further investigation and design activities.

Considering the age of the dam and design basis used it is expected that the dam will now not comply with modern design standards. Any raising of the dam wall will likely require considerable stabilising works.

The Consequence Category for the dam has been determined by others in accordance with current guidelines. The currently preferred upgrade option (Option 7) is limited to increasing spillway capacity and does not address issues with the structural integrity of the dam. Studies to date do not provide sufficient detail to enable confirmation of the most suitable upgrade option to satisfy the requirements of the NSW Dams Safety Committee or the adequacy of current budget provisions.

GBG Australia has completed non-destructive testing of the existing spillway (April 2012) to assess its current condition but no assessment of the structural integrity of the dam has been completed. Further options and cost investigation, following the dam's structural assessment in 2014/15, will be required to determine the full extent of work involved, firm up the costs and select the most appropriate and feasible option.

Essential Water has stated that structural assessment of the dam wall is expected to take place in 2014/15 when the dam is less than 10% full and also acknowledge that a full understanding of the scope and costs involved in upgrading the dam wall will not be realised until the structural assessment has been conducted.

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WP2 Step,hens Creek Reservoir Dam Wall Rehabilitation

Planned Capex [FY15-FY18]

- M (or - M incl'g FY19)

Essential Water has proposed an indicative program comprising the commencement of detailed design works in 2014/15 subject to favourably dry climatic conditions with construction over the

period 2015/16 to 2018/19.

Essential Water has also noted that delaying the structural assessment (due to high water levels

in the dam) could lead to formal regulatory action by NSW Dam Safety Committee to address deficiencies of the spillway.

Is the project prudent? I Stephens Creek Dam Wall Rehabilitation Project has a mandated requirement to comply with the NSW Dams Safety Committee requirements. However there appears to be no documented obligation provided by the NSW DSC to Essential Water on the timing for these works.

Essential Water has completed sufficient investigations to show that the dam is deficient and requires upgrade to address flood capacity. The deficiencies have been clearly identified by the NSWDSC.

The Dam is also required to be upgrade to meet earthquake requirements. Although confirmed by Essential Water verbally that earthquake capacity has been accounted for, there is limited evidence provided to show that work has been completed to assess this requirement.

Is the project efficient? I There has been preliminary investigation and feasibi lity option assessment completed for the

safety upgrade of the reservoir. The options are primarily focused on spillway capacity upgrade. Further work is required including structural assessments of the dam wall in order to develop and select a preferred option.

Essential Water and the Public Works Department have recognised the need for further investigation to define the cost and scope and stage construction. This means that the timing of these works is uncertain.

The evidence provided for this project indicates that there is a strong possibility that the scope and cost of the upgrade could vary significantly (and most likely increase) once the structural assessment of the dam wall has been completed.

This project has a number of practical implementation issues as it is reliant on a series of favourable conditions to enable the project to be undertaken on time and cost including dry conditions in the catchment and the dam wall having a structural condition which does not cause substantial additional work to be required and the program of works able to be completed during the dry period.

At this stage the NSW Dams Safety Committee has only asked for a program and options assessment, there has been no mandated timeframe requirement to upgrade the dam.

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Additional supporting information which would help to better justify the works proposed

There is no evidence of NSW Dams Committee instructing Essential Water to complete upgrade works in a specified timeframe.

EW acknowledges that there is no specified timeframe to upgrade the Stephens Creek Dam Wall, but is relying on the general strength of the documentation from the DSC - and in particular the DSC's letter dated 17/12/ 12 - that EW is expected to address the issues with the dam wall sooner rather than later. EW considers that funds should be made available, so that if the right conditions exist, it can proceed with the necessary works.

SKM has sighted extensive relevant documentation between the NSW DSC and EW (on both Stephens Creek Reservoir and Imperial Lake dam) and it is clear that there is no unambiguous guidance or direction on timing of any specific works or remedial actions more generally. It would be helpful for the NSW DSC to provide guidance or direction to Essential Water and remove the uncertainty on timing and the nature of the "mandatory" obligation.

An f-N Curve for the dam will have a limit of tolerability and provide an informed view that the works can be delayed or needs to be conducted urgently. This information may be contained within a Portfolio Risk Assessment (PRA) report or a separate risk assessment report for Stephens Creek Dam.

There is no evidence provided of a contingency (backup) plan if the works are not able to go ahead. It is unclear how Essential Water would manage its risks if the works are unable to occur.

There is also no evidence or indication of an upper bound cost in the event that the dam wall needs significant upgrade beyond the identified costs.

There is limited evidence to show that the 1 :5000 earthquake requirements will be addressed in the preferred option. EW acknowledges this but has indicated that it intends to complete a structural assessment of the Dam Wall in 2013/14 that will address this requirement and which would inform future construction works.

Recommendations

It is recommended that Essential Water delay the dam upgrade for the following reasons:

• At this stage the NSW Dams Safety Committee has only asked for a program and options assessment, there has been no mandated timeframe requirement to upgrade the dam.

• There is a high degree of uncertainty of the program and costs of the project, in particular:

o Investigations and design for upgrading the spillway, dam wall and embankments are incomplete; and

o Completion of the works and investigations are reliant on favourable catchment conditions.

Investigations and design for upgrading the dam to meet the dam safety requirements specified should continue in the FY1 5-FY18 period. The investigations and design should be completed as planned and recommended by NSW Public Works Department to enable a full understanding of

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WP2 Step,hens Creek Reservoir Dam Wall Rehabilitation

Planned Capex [FY15-FY18]

-M (or -M incl'g FY19)

the scope of works and cost of completing the project prior to any works to upgrade the dam are implemented.

Tendering and construction of the dam safety works should be delayed until the final year of the regulatory period (2017/18) once investigations and design are completed.

Consideration should be given to more efficient staging, prioritisation and packaging of works that would reduce the high level risks linked with the stated deficiencies and are able to occur in the climatic conditions presented. Lower priority and lower risk works can be packaged separately.

Overall SKM considers that in the absence of any clear NSW DSC direction that:

• it is prudent to commence the initial preparatory works in this regulatory period following the investigations and detailed design phase. Delaying the upgrade would not be acceptable 1if a suitable construction window occurred. Thus funds should be available later to commence the works if conditions allow and after all investigations and design have been conducted; and

• given the significant uncertainties around the project, the balance of the major works for this project should be deferred to commence in the last year of the regulatory period with the

balance of the works to be undertaken in the next regulatory period. This means that the project funds have been allowed as follows (all in direct costs) to achieve the outcomes reasonably achievable in the FY15 to FY18 regulatory period:

o over 2014/15 and 2015/16 with~ to be spent in 2016/17. This (direct costs) should be provided to complete investigations, assessments.

design and tendering in 2014/15- 2016/1 7 years with construction to commence in 2017/18. [NB: This~ is not to add to the overall project budget); and

o ~Kin FY18 to commence the substantive works with the balance in the next regulatory period including ~Kin FY19.

• Any other expenditure once scope, timing and budgets are more confidently determined is to be deferred to the next regulatory period.

These recommendations are dependent on written approval of the NSW Dams Safety Committee of its specific requirements and timing of obligations.

There are significant trade-offs between any urgency (if not clearly stated), the timing of obtaining sufficient and adequate information to properly scope and cost the works (including resolving the interdependencies and integration with other projects (which could provide some mitigation), the practicalities of undertaking the works and the balance between the risks of not taking these works versus reducing expenditure available for other basic works which could reduce the risk to basic water supply reliability.

The NSW DSC should also provide guidance/direction on the relative importance of rehabilitation works for the Stephens Creek reservoir versus Imperial Lake especially given the former is more important overall to water supply to the Broken Hill township.

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WP4 Mica Street Service Reservoir No. 1 Replacement

Project overview

Planned Capex [FY15-FY18) .M No. 1 Service Reservoir at Mica St Water Treatment Plant is a rectangular mass concrete tank which was constructed in 1892 and has a capacity of 6MUday at full supply level. The service reservoir (tank) acts as a balancing and reserve storage.

The existing service reservoir is in poor condition Essential Water has proposed to replace this service reservoir with a new reservoir at a site adjacent to the existing reservoir at an estimated cost of~ (direct cost).

The No. 1 Service Reservoir at Mica St Water Treatment Plant was allocated for replacement current regulatory period at a cost of~ (direct cost). However this work has not been undertaken and has now been proposed to be completed in the FY15-FY18 regulatory period.


Essential Water has determined that the existing tank is in poor condition and should be replaced. The following evidence is provided to show that the existing tank is at the end of its useful life:

• A 2007 GHD Structural Condition Assessment report states that the Mica Street No. 1 Reservoir, Broken Hill has leaked for many years as a result of extensive cracking in the mass concrete walls. Temporary repairs have been applied on a number of occasions previously. These repairs have all failed after a period of time.

• Relining options studies and structural assessments (GHD 2006, 2007) have concluded that there was extensive cracking and due to safety factors the water storage would be limited to half capacity removing 3ML of treated water storage from the system.

The GHD May 2007 report identifies the risk that if the water level increases above 3.5m the structural wall may collapse. Mica St WTP Service Reservoir No 1 is located on an elevated site within a residential area and any collapse could have serious impacts, including extensive flooding of properties.

The existing service reservoir has a limited functional storage at half capacity, due to its elevation and reduced storage level, the pumps at the treatment plant have difficulty delivering water to the storage. Currently the service reservoir (tank) acts as a balancing and reserve storage to support the main reservoir Mica St Service Reservoir No. 2.

The Investment Case for the Mica St Service Reservoir No. 1 Replacement Project (EW, 2013) and the Broken Hill Potable Water Network Tank and System Review (GHD, 2011) provide the reasons for dual storages (Service Reservoir No.2 and No. 1) to be maintained at Mica St.

These are primarily to allow Mica St Service Reservoir No. 2 to be taken off line for relining while maintaining water supply to Broken Hill and to

• act as a balancing storage to maintain sufficient storage to meet summer peak demand; and

• Maximise treated water production during low energy tariff periods and provide security of supply as a buffer to meet water network failures.


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Planned Capex [FY15-FY18] .M The Potable Water Network Tank and System Review (GHD, 2011 ) report states that the existing tanks within the network have 24 hours peak day demand in reserve storage. Mica St Service Reservoir No. 2 provides an additional 8 hours of peak daily demand supply.

The Potable Water Network Tank and System Review (GHD, 2011) states that the Mica St Service Reservoir No. 1 is not required under normal operations, but if the service reservoir is removed it w ill result in the tank not being available for alternative system operation while the existing Mica St Service Reservoir No. 2 is refurbished. Tanks are generally refurbished every 15-25 years and this usually takes 2-4 months to complete. Essential Water has advised that Mica St Service Reservoir No. 2 is due for relining in the next three years.

Essential Water considers this project prudent as reflected in its Investment Case (Essential Water, 2013) that due to the structural deficiency of the existing tank an unacceptable risk to water supply is evident.

Essential Water has completed a risk assessment to determine the number of storage hours it deems necessary to deal with a range of system failures. This indicates that:

1. If Mica St No. 1 is decommissioned, it is unrealistic to supply significant areas of Broken Hill directly from the Plant whilst Mica St No 2 is being refurbished; and

2. The option to decommission Mica Street No1 completely and have no Mica St Service Reservoir when Mica St No 2 is removed from service would result in attempting to flow pace upstream pumping station/s through the WTP using 0.2ML buffer of WTP filtered water tank will result in high risk of damage to filtered water pumps or boosters and flooding to the reservoir area and possibly to Railway Town area during failure modes and at higher flows.

3ML, 6ML and 9ML sizes for a new Mica St Service Reservoir No. 1 have been considered in the risk assessment which will provide 2.5hrs, Shrs and 8hrs peak daily demand respectively.

With a 3ML reservoir, the occurrence of another significant operational disruption and/or the combined risk of failure of WTP and the upstream pumps or pipeline/s while No 2 Tank is offline and being refurbished is considered as representing too high a risk (with only 2.5hrs of storage time available). The risk assessment concludes that replacement with a 6ML service reservoir is considered the least risk and most economical option.

Essential Water's Investment Case states that replacement with a 6ML service reservoir is estimated to cost - (direct costs), this has been used in the proposed Capex program

The estimate provided by Essential Water in the NSW Public Works Department review estimates the cost to be - revised up from the high level estimate provided by Essential Water of - (including planning and design).

Is the project prudent? I Based on the structural condition assessment indicating the poor condition of the existing service reservoir, the existing reservoir is unsuitable for refurbishment or repair and is at the end of its


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Planned Capex [FY15-FY18) .M useful life. It is recommended that the tank is decommissioned to prevent failure and the potential damage it may cause to surroundings.

EE has indicated that Mica St Service Reservoir No. 1 is not required for normal operation as there is adequate storage in the network. Peak demand can be met by the water treatment plant and 24 hours storage is provided in the system. The project drivers relating to requirements to provide balancing storage at peak demand and provide benefits of pumping during off-peak power

periods are possible however the benefits have not been quantified and are insufficient justification for the tank to be replaced . Mica Service Reservoir No. 2 to be offline for servicing is the fundamental reason for Mica St Service Reservoir No. 1 being replaced and reliable availability of this tank.

The risk assessment provides a convincing case that with the configuration of the network and not

having Mica St Service Reservoir No. 1 while Mica St Service Reservoir No. 2 is offiine for relining the water treatment plant would need to be operated in a way that may cause damage to the water treatment plant pumps.

It is prudent to undertake refurbishment works for the Mica St Service Reservoir No. tank. However this view is qualified to the extent that adoption of a replacement tank as the only option to allow Mica St Service Reservoir No. 2 to be refurbished has not been sufficiently demonstrated.

Is the project efficient? I Prima facie there appears to be no need to increase the storage capacity in the Broken Hill System as there is 24 hours peak daily demand in storage without Mica St No. 1 and No. 2

service reservoirs. However Essential Water considers that practically it is unable to access all of the water stored in town and so a 24 hour reserve target is not fully met. Trying to use all the storage will mean areas of Broken Hill running out of water or significant loss of water pressure.

Nonetheless the key issue relating to storage requirements at Mica St No. 1 is to provide optimum pumping conditions for the Mica St Water Treatment Plant while Mica St No. 2 is being refurbished for 2-4 months once every 15-20 years. EW does acknowledge that Mica St No 1 & 2 do provide extra redundancy to the reticulation network. .

There is insufficient evidence provided to show that sizing of the reservoir is optimum. No evidence of benchmark or historical costs being used to determine the cost of replacement of the service reservoir. The cost of replacement allocated, ~ is considered to be high for a storage reservoir of this size.

There is also insufficient evidence provided to show that alternative options which would allow Mica St Service Reservoir No. 2 (main reservoir) to be refurbished have not been identified and considered which may provide a lower cost alternative. For example the pumps at the water treatment plant could be upgraded to allow flow pacing or temporary storage provided downstream of the water treatment plant to allow suitable operation of the pumps.


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Planned Capex [FY15-FY18] .M In summary, alternative options may be available to allow refurbishment of the Mica St Service Reservoir at a lower cost.


There is no identification in the asset management strategy of a need for back up storage to enable the main Mica Street reservoir to be replaced.

There is limited evidence demonstrating that there are no other more efficient alternatives which would allow the Mica St Service Reservoir No. 2 to be refurbished without the construction of a 6ML Service Reservoir No. 1 tank.

EE acknowledges the point put forward by SKM in relation to optimal sizing of the replacement reservoir. EW is confident that when the reviews indicated by SKM are carried out the optimal capacity for Mica Street No1 would be confirmed as 6ML (though that is not evi.dent yet}.

EW has provided additional relevant commentary on other matters raised by SKM as follows:

• EW considers that to have the water treatment plant flow paced to supply the reticulation system directly is not practical for a number of reasons, including

o The water from Mica Street does not go by dedicated mains to the other service

reservoirs around town. As the mains going to the other service reservoirs are part of the reticulation system, failure of the water treatment plant during this critical period would immediately affect the supply to the reticulation.

o The failure of the water treatment plant can occur from process and physical failure of the plant plus the failure of the delivery of raw water to the water treatment plant.

• EW also notes that the disinfection process used is chlorination and for effective disinfection a 30 minute retention time is needed. Disinfection occurs at the last stage of the water treatment plant so if water was going straight from the water treatment plant into the reticulation system to be consumed effective disinfection would not occur.

Recommendations

It is recommended that a full options assessment and hydraulic study be undertaken to identify and clarify the project drivers and identify the best option to address these. This would identify other options which could be undertaken at a significantly lower cost than replacing the No. 1 reservoir (e.g. providing flow pacing pumps at the WTP say or another alternative, or undertaking the refurbishment of the No 2 reservoir during a low water demand period (winter)).

There is limited evidence of a need for the No 1 reservoir to provide additional system storage. Consideration of temporary solutions to allow Mica St reservoir No. 2 refurbishment should be explored.

It is recognised that Capital works will be required resolve this issue (either a new tank or network modifications} to enable refurbishment and maintenance of Mica St reservoir No. 2. However


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Planned Capex [FY15-FY18] .M replacement of Mica St reservoir No. 1 is not necessarily the best option to achieve this and if a new servicing reservoir is considered the best option to address the drivers then a review to optimise the size of the service reservoir should be completed also.

SKM considers that the cost of the reservoir being considered to be high with further optimisation also possible.

Consequently SKM recommends that the overall project construction cost for the project should be reduced by ~(direct costs only) - or~ including overheads - and funds in the proposed budget should be used to fund an options assessment and optimisation study with timing of the works postponed to allow the options study and optimisation to be completed.

Overall SKM recommends that, unless building the No. 1 reservoir is demonstrated to be the lowest cost option (in which case the tank replacement should proceed):

• the project should be delayed to allow options investigation and concept design to occur in 2014/15, with detailed design and tendering in 2015/16 and construction in 2016/17; and

• direct costs of ~ be provided for the options assessment and concept design, ~ for detailed design and tendering and ~ for construction of the new tank and decommissioning of the existing tank deferred to later years in the regulatory period.

The overall rationale is to enable EE to adopt a solution to refurbish the No. 2 reservoir once alternative solutions for its refurbishment have been more fully explored.

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WPS Broken Hill water reticulation replacement Planned Capex [FY15-FY18) -M

Project overview

Broken Hill's water reticulation system comprises approximately 220 kilometres of mains. A small amount of reticulation was constructed in the 1890's, with the majority of the reticulation being constructed from 1930 to late 1960s when rapid development occurred.

Essential Water has had a program of mains replacement in the current regulation period and has proposed to continue the program in the FY15-FY18 period. The proposed project is a continuation of this program for the next 1 O years.


The Broken Hill Water Mains Replacement Project Investment Case (Essential Water, Sep, 2013} proposes to replace 2.1 km of pipeline per year at a cost of~/ km from 2014/15. The Investment Plan provides the following reasons for the project to proceed.

Essential Water maintains a high service standard in ensuring customers have a reliable and safe water supply. To maintain this standard, aged and failing water mains need to be replaced when they become increasingly unreliable (Investment Case, Essential Water, Sep 2013).

The planned replacement is part of Essential Water's strategy to maintain a main renewals program to ensure a reliable supply of water to its customers.

To balance this service standard EW also needs to ensure prudent expenditure on its assets and not replace mains prematurely. This balance is achieved by replacing mains that have a history of failing through bursts and age analysis. These are tracked using the Mainpac system which then identifies pipelines for replacement based on their age and recent pipe burst history. EW then adopts a relatively flat expenditure, around .k per year plus other direct costs, to put a financial limitation on the main renewal program. This expenditure is reviewed on a year basis to ensure service standards are being met and there is not a significant increase in asset deterioration (Investment Case, Essential Water, September 2013).

Reticulation replacement at a rate of 820m per year is the service level target listed in the Strategic Plan (Essential Water, September 2013) in order to maintain pipe burst levels and customer service to an acceptable level. This appears to be an error in this plan and should be 1.5 to 2.1 km p.a. (as advised by EE). However while the 2.1 km and . Im are cited in EE's Investment Case the actual direct cost estimates appear to be based on something like 1.7km at . Im. Additionally the asset strategy is to maximise life and replace on the basis of age and/ or condition as per the Asset Renewal Plan (JWP, Dec 2007) or number of bursts per 12 months.

The JWP report outlines a 30 year renewal plan from 2006-2036. The plan indicates the replacement rate for reticulation is based largely on pipeline age, there is limited information on actual condition of the assets (or of the consequence costs of asset failure}. The renewals plan for water supply proposes~ ($2006) be spent on reticulation mains replacement over the 30 year period. The proposed spend for the regulatory period (FY15-FY18) according to the Asset Renewal Plan allocates only ($2006) of pipeline replacements and


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WPS Broken Hill water reticulation replacement Planned Capex [FY15-FY18] -M

($2006) for meter replacements.

The Investment Case proposes a budget of - (direct costs) on mains replacement over the next 10 years and - on other direct costs including meter replacement.

The Investment Case proposal is based on replacing approximately 2.1km of pipeline per year -up from the current program based on 1.5km per year. The activities planned over the next regulatory period 2014/15 to 2018/19 are:

Broken Hill

a) Reticulation mains replacement - - per year b) Valve/hydrant replacement -~ every three years

c) Meter replacement -~ per year

Menindee

a) Reticulation mains replacement -~in 2016/17

b) Valve/hydrant replacement-~ in 2016/17

c) Meter replacement-~ in 2014/15

Sunset Strip reticulation general -~ in 2016/17

The Investment Case states that capital costs are based on an allowance of - per km for 2013/1 4 and - per km for 2014/15 onwards. The step change reduction in cost is due to Essential Water proposing to move from open trenching for which Essential Water's historical costs are - per km, to trench less technology which it has been suggested will lower the

cost of replacement to - per km.

However notwithstanding the above, SKM notes that while the 2.1km and . Im are cited in EE's Investment Case the actual direct cost estimates appear to be based on something like 1.7km at . Im from 2014/15 onwards.

Is the project prudent? I Replacement of reticulation mains which have reached the end of their useful life and are in line with Essential Water's asset strategy.

Essential Water's asset strategy provides sufficient evidence to support a program of ongoing mains renewal at a level which maintains an acceptable level of service to customers. There appears to be limited information regarding condition of water reticulation.

The JWP Asset Renewal Plan indicates that replacement of water reticulation pipelines is based mostly on asset age. The condition of pipelines should be the primary driver for the asset renewal program. which does not seem to be the case.

The asset strategy needs to be consistent the mains renewal program and investment case wlhich does not seem to be the case.


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Is the project efficient? I The level of replacement proposed in this project is not well linked to the asset strategy. There are discrepancies between the proposed replacement rate in the Investment Case and the asset strategy (this is acknowledged by EW as an error and the Strategic Plan needs to be corrected). The level of replacement proposed does not appear to be linked to the Asset Management Strategy or the Asset Renewal Plan directly.

Mains replacement is identified as part of Essential Water's Strategy Plan and part of the Asset Renewal Plan however there are large discrepancies between the proposed level of replacement identified in these reports, the current replacement rate and the level of replacement proposed in the investment case and subsequently this program.

The Strategic Plan submitted to IPART identifies a replacement rate of 820m/ year. This appears to be an error and as now advised by Essential Water should be 1.5km to 2.1 km per year. The current replacement rate is approximately 1.5kml year.

The Asset Renewal Plan allocates only ~ ($2006) of pipeline replacements and ~ ($2006) for meter replacements and for the 30 years, - ($2006).

The Investment Case proposes a level of replacement of 2 .1 km per year of pipeline.

Essential Water has stated that the current level of replacement is maintaining manageable levels of pipe bursts and adequate level of customer service. There is limited supporting evidence to justify the level of replacement proposed in this project and this is considered to be too high.

The level of replacement appears to be based on maintaining the same level of spend as previous years but by using trenchless technology being able to replace more pipelines. This is not considered to be suitable justification for a higher replacement rate.

There is a discrepancy in the Investment Case proposed cost of pipeline replacement. It is proposed to replace 2100m of pipeline per year at a cost of . Im which equates to~The investment case has only allocated ~ per year for pipeline replacements.

There has been no specific evidence provided by Essential Water to justify the replacement costs. In particular there is no risk based justification of the replacement rate or the associated expenditure in terms of risk managed or benefits delivered.

It is difficult to judge the replacement rate as being efficient as the average pipeline diameter has not been provided and the ground conditions are unknown. The nominal pipeline diameter varries between 75mm and 375mm, it has been assumed that the average diameter is 150mm for this assessment. The forecast cost of mains renewal using trenchless construction of . Im is considered to be an efficient cost for replacement of the reticulation pipelines. ~is a high cost for renewal with open trenching in soil, other than if rock is being encountered during excavation this rate is suitable. The replacement rates should be maintained.


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SKM proposes that an efficient replacement rate, in the absence of risk based supporting information, would be 1.Skm p.a. in line with the replacement rate in the current regulatory period.

There is no evidence (technical reports) provided to show that it is achievable or that that all pipelines can be replaced with trenchless technology.


There is limited justification to support the proposed pipeline replacement rate (noted that the Strategic Plan submitted to IPART needs to corrected to reflect EW's proposed replacement rate of 1.Skm to 2.1km p.a. not 0.82km p.a. ). However while the 2.1km and $250/m are cited in EE's Investment Case the actual direct cost estimates appear to be based on something like 1.7km at . Im from FY15 onwards.

Essential Water needs to provide quantitative justification for the level of replacement which is linked to asset condition and level of service.

The step change reduction in replacement cost from ~/km to ~/km is assumed to be due to an anticipated adoption of a trenchless construction method. This is not explicitly documented.

The length of pipeline to be replaced in the 2014/15 to 2017/18 years has not been calculated from the JWP report.

Recommendations

SKM recommends that:

• funding be reduced to a level that supports a proposed reticulation mains replacement level of 1.Skm per year, as a replacement level of 2.1 (or the imputed 1.7) km per year is considered to be inadequately justified: and

• the budget should allow for an annual mains replacement of 1.4km with trenchless technology at a cost of . Im and of 0.1km with open trenching at a cost of . Im. The meter replacement program proposed should remain as is and is not adjusted.

There is no evidence to show that it is achievable or that all pipelines can be replaced with trench less technology and as such an allowance has been made for 1 OOm of pipeline to be replaced each year using open trenching.

It is further recommended that Essential Water:

• conduct a feasibility study/ technical assessment to confirm that trenchless technology is achievable for Broken Hill reticulation replacement program.

• complete a water mains renewal strategy for the renewal program which includes enhanced:

o Identification and prioritisation of water reticulation, meters and valves for replacement.

o Assessment of the key indicators to determine the effectiveness of the renewal program and whether the program on a sound risk based approach needs to continue at the same

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WPS Broken Hill water reticulation replacement Planned Capex [FY15-FY18) -M

rate or can be scaled back or needs to be increased (based on achieving an acceptable level of service to customers).

The total investment in the regulatory period (FY15-18) for the mains renewal program is recommended to be reduced to~ (direct costs) with a total length of pipeline replacement of 6.0km over the 4 year period. The ~ (direct cost) indicated for completion of a feasibility study and renewal strategy in 2014/15 is to be absorbed into the overall aggregate provision SKM has proposed.

WP9 Reservoir General Works Planned Capex expenditure

Project overview

Essential Water proposes to undertake works at the Stephens Creek reservoir including:

• Reinstatement of the terminal levee bank and main levee bank at Stephens Creek Reservoir

which have been damaged due to significant inflows in recent years.

• Desilting Stephens Creek terminal pool.

• Installing a pipeline in the terminal pool levee to transfer water from the main pool to the terminal pool.

Jn the Review of Capex Costs & the Capital Investment Plan for Essential Water's IPART submission (Public Works Department. Sep 2013) there is reference to a different program of works for Stephens Creek, Imperial Lake and Umberumberka Reservoirs which is not included in the Investment Case. The Investment Case is limited to Stephens Creek Reservoir internal levees remediation/restoration works and associated desilting, and additional works for an associated internal transfer pipeline.


Essential Water has prepared an Investment Case (July, 2013) for the works at Stephens Creek to repair the terminal levee and the main levee and desilt the terminal pool area.

The Stephens Creek Reservoir is the main reservoir for supplying bulk raw water to Broken Hill. The reservoir is shallow with a large surface area resulting in big losses due to evaporation. Levees have been constructed on the reservoir floor and water is moved to or held in areas of greater depth thereby creating less surface area to reduce the effects of evaporation.

Two levees have been built on the reservoir floor. The first levee is close to the dam wall and holds water that is pumped to Stephens Creek Reservoir from the Darling River at Menindee. This supply is critical to secure water supply to Broken Hill in dry periods. The second levee cuts the reservoir in half running in a north westerly direction, and is primarily used to transfer water


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from the outer floodplain into the inner-reservoir area.

In February 2010 the Stephens Creek Reservoir filled very quickly from a large rainfall event and both the internal levee and the smaller terminal pool storage levee suffered extensive damage.

There is no spillway on the terminal pool storage levee and it would have suffered major damage during this flood event. Currently this section of the reservoir is still underwater making it impossible to determine the total extent of the damage to this levee.

Prior to the damage of the pool levee, it became evident that the pool was only capable of storing up to 2 day's supply for Broken Hill. When the terminal pool storage levee is to be repaired there needs to be some desilting of the immediate pool area and the walls will need to have the integrity to hold water within the pool and not allow this water to seep back into the reservoir. This desilting w ill restore the pool capacity for the aimed 5-7 day supply requirement.

Another part of this project is the need to transfer water from the western side of the main internal levee to the inside of the reservoir pool in order to further reduce evaporation and maximise yield. It has been proposed for pipes to be installed from the 2 valves located on the main levee to the outlet tower so that water can be pumped directly from the reservoir floodplain.

The Investment Case (July, 2013) for the works at Stephens Creek provides the basis for the works to proceed summarised as follows.

The fundamental need for the levees is to increase the efficiency of the Stephens Creek reservoir in relation to its ability to store bulk water that has either been harvested from its catchment or transferred to Stephens Creek Reservoir from the Darling River at Menindee. It is better to increase the efficiency of the reservoir than to spend the money on the electricity and ongoing operational, maintenance and capital costs of the pipeline and associated pumping stations.

The timing is reliant on the amount of water held in the reservoir. The work cannot be done when there is water in the reservoir. The work is reliant on the ground drying to a condition where heavy earth moving equipment can access the site. At present the reservoir could possibly be approaching this condition by mid-2014 but if there are substantial rains within the Stephens Creek catchment area, resulting in intakes into the reservoir, this will put back the timing of the proposed work.

As mentioned above there is the possibility that conditions may not be suitable to carry out this work within the determination period but the work needs to be highlighted and budgeted for. The local drought/rain cycle is usually follows a pattern of two years of wet followed by 8 years of dry weather. Rains in recent years have filled the storages, but these are now starting to deplete and is probable that the levees will be dry enough for the proposed works to take place sometime in the next few years. Due to the size of the proposed project, expenditure has been extended over a five year period, so large costs are not incurred in any one period.

It is also critical the reservoir works are completed while there is storage in Imperial Lake and Umberumberka as there will be minimal or very high turbidity storage in the terminal storage.

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The Investment Case states that to carry out the work Essential Water will need to be in a drought situation for at least 6 to 12 months, so the floor to the reservoir can be exposed and allowed to firm enough to enable earth moving plant to access the site. There is however a possibility that a large rain event would cause the reservoir to fill again. In this case it would take 2 years to be at a stage where this work can be carried out.

The Review of Capex Costs & the Capital Investment Plan for Essential Water's IPART submission (Public Works Department, Sep 2013), states that:

The upgrade options for the Stephens Creek Levee Works are a reasonable approach for remediation and restoration of the works. However, additional activities and works are recommended to reduce the likelihood of damage reoccurring and to more comprehensively address the major deficiencies.

Assessments and investigations of the levees will enable a design of required works to be undertaken aimed at improving structural integrity and minimising maintenance and operation risks.

Prior to undertaking the works at the terminal levee Essential Water needs to consider the identified alternative options to achieve the functionality of the terminal pool and costings.

Essential Water has completed an NPV assessment to demonstrate that savings made through reduction in evaporation in the reservoir justify the main levee construction.

According to the Investment Case the total investment (in direct costs) to repair the levees and install the pipe is~ over the 5 year period 2014/15 to 2018/19 with a proposed spend of ~in the regulatory period FY1 5-FY18.

The estimated total costs (in direct cost terms) are:

• main levee repair: ~

• terminal levee repair and desilting work: ~

• the pipe from the internal levee to the terminal levee: ~

Is the project prudent? I The project has been assessed as prudent only on the basis that some form of works are considered to be required and there appears to be some economic merit to undertaking the works. The NPV assessment for the main levee within the Stephens Creek Reservoir provides some indication of the benefits of this levee.

However there has been no condition assessment or design provided for the works required to repair the main levee and the works to repair the terminal levee are unknown due to the levee currently being submerged.

Nor is there sufficient evidence provided to justify benefits of the terminal pool levee and associated works.


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Is the project efficient? I There has been no basis provided for the scope and cost to repair the main levee. There has been no allowance provided to ensure that the damage is prevented in the future.

There has been no basis provided for the scope and cost to repair the terminal levee and desilt the terminal pool. There is no way to estimate the damage to the terminal levee at Stephens Creek. There has been no allowance provided to ensure that the damage is prevented in the future, although it is acknowledged that this is not the primary purpose of the project.

The project is reliant on favourable conditions to enable the construction of the levees to occur on time and cost including dry conditions in the catchment and the terminal levee not requiring substantial additional works due to an exceptionally poor condition.

The ability to meet the program and costs are highly uncertain.


In the Review of Capex Costs & the Capital Investment Plan for Essential Water's IPART submission (Public Works Department. Sep 2013} there is reference to a different program of works for Stephens Creek, Imperial Lake and Umberumberka Reservoirs which is not included in the Investment Case. The Investment Case is limited to Stephens Creek Reservoir internal levees remediation/restoration works and associated desilting, and additional works for an associated internal transfer pipeline.

Recommendations

Due to the uncertainty of the scope, costs and reliance on site conditions to complete the works the project construction works should be delayed to allow Essential Water to conduct further investigations, options assessments and design to quantify the scope and costs of completing the levee works.

The repair of the main levee appears to be suitable, provided that an allowance is provided to ensure that the damage is prevented in the future, the works shall be delayed until 2016/17.

For the terminal levee Essential Water should conduct further investigations and options assessments to consider the merits of an alternative deep storage option to achieve the functionality of the terminal pool storage. Construction of a storage to achieve the objectives of the terminal pool should be delayed until 2016/17.

Desilting of the terminal pool should be delayed until after the outcomes of the terminal storage are finalised (2016/17).

Overall, SKM recommends that:

• A provision of~ {direct costs) in both years 2014/15 and 2015/16 has been allowed for investigations, options assessments and design to be completed to ensure optimal


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solutions are investigated. These are part of the capital expenditure proposed and do not increase the overall capital budget. Effectively the works have been deferred for two years to allow this upfront work to be completed to better define the scope of works.

• The substantive works be deferred for commencement until FY17 with completion in the next regulatory period; and

• A provision of Siii Million (direct costs) has been made in the last two years of the regulatory period for essential works with the balance of the funds moved to the next regulatory period (if required) for some further works when their full extent is known and has been better justified.

WP10 Menindee & Umberumberka Pipeline Repairs Planned Capex expenditure

Project overview

The Umberumberka Pipeline was first constructed in 1913 partly as a cast iron rising main pipeline and partly as a wooden stave gravity pipeline. Subsequently the wooden pipeline has been replaced with mostly salvaged DICL pipe in the 1960's, and approximately one third of the Umberumberka gravitational section of the pipeline was replaced in the 1990's with new pipe.

In the mid 2000's, approximately 300m of main was replaced from Karl's Creek towards Umberumberka. The balance of the 2 mile (3,219m) pressure/rising main is in poor condition w ith many bands fitted, lead joints cut out and many pipe joints leaking while under pumping pressure.

Essential Water has stated that the Umberumberka pipeline will require substantial replacements over the next 20 years and the suction pipe at Umberumberka can fail at any time discharging water from the dam and needs to be replaced ASAP.

The Menindee pipeline was installed the 1950's and consists of 600mm nominal bore mild steel cement lined pipe. The original steel was 5mm thick. The pipeline is approximately 36 miles (57.9km) from Menindee to Kinalung pumping stations. Isolation valves are located every 2 mile (3,219m) and due to minimal maintenance are extremely difficult to operate and pose a high risk to manual handling.

A major failure occurred on the Menindee pipeline in 2002 due to loss of cement lining and corrosion of the steel plate.

The scope of work identified by Essential Water for this project is to undertake preventative maintenance along the Menindee and Umberumberka pipelines by replacing a combined total of 350m of pipeline per year which has been identified by Essential Water as being at risk of failure together with scour, air and isolation valves which. In addition there is an allowance for replacing

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sections of the pipeline during 2017 /18 in excess of the 350m pipeline replacement allowance.

It is noted that~ (direct costs) was allocated in the current regulatory period (FY11-FY14) to replace sections of the Menindee pipeline and this work was not completed.


The Investment Case (Essential Water, July 2013) states that for the Menindee pipeline:

• Subsequent to its recent failure, a survey of pipe thickness over 15 of the 23 sections of pipelines, found less than 1 % of the pipe were less than 3mm thick at the top of the pipe. A recent survey of pipe thickness over four sections of pipe to date, shows approximately 14% of the pipes are now less than 3mm thick at the top of the pipe. In 2012 due to the number of patches on pipes, a number of isolated pipes were completely replaced. There are in excess of 100 pipe defects requiring welding repairs each year during winter maintenance.

• The isolation valves are critical for maintenance. These valves enable 3.2 km sections of the pipeline to be quickly isolated for emergency repairs or planned repair I maintenance and then returned to service again. Several of the valves that have been removed have bent spindles or do not seal, which means more sections of pipeline than is actually necessary are required to be taken offline and drained to effect repairs. This increases the down time of the main, placing greater risk to the water supply and increases the cost of repairs. Failures are expected to increase on the Menindee pipeline.

The 350 metres of pipe was chosen based on the number of bursts recorded on the maintenance management system and identified old sections of pipe from the JWP report. Essential Water has selected 350 metres as an achievable annual replacement program, both financially and taking into account current asset condition. The expectation is that replacing 350m annually will significantly extend the life of the asset, and slightly decrease ongoing maintenance costs. This 350m total is made up of a single 250m length of the Umberumberka main and a total of approximately 1 OOm of the Menindee to Stephens Creek Rising Main made up of multiple short lengths of pipe replaced due to failure that cannot be repaired with localised patching.

Essential Water is conducting Phased Array Ultrasonic Non Destructive Testing (PAUNDT) to assess the remaining operational life in the pipeline and to target those sections that are under distress due to corrosion and reduced pipe wall thickness.

It has been identified through numerous studies such as the GHD Options Report (Apr 2006), Alf Griggs condition evaluation (Aug 2009) and Essential Water's ongoing Phased Array Ultrasonic Non Destructive Testing (PAUNDT) that there has been significant deterioration in the structural condition of the Menindee Pipeline. The recent history of pipe bursts and increasing expenditures due to pipeline patch repairs is indicative of a pipeline that is under stress.

Essential Water has assessed the following options to address the deteriorating condition of the Menindee and Umberumberka pipelines:

• Adopt the current practice of pipeline patch repairs during winter maintenance (not


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replacement of the major isolation valves); or

• Undertake 350m pipeline and valve replacement program

From these options Essential Water has adopted the 350m pipeline replacement and valve program as its preferred option. It was cited in the Essential Water Menindee and Umberumberka Pipeline Investment Case {Jul 2013) that by selecting this option there would be a reduced risk of:

• Major damage to the pipeline from valve failure

• Losing a significant water supply source for Broken Hill

• Emergency repairs that are costly

• WHS issues associated with operating badly worn valves

Essential Water has indicated that replacement of sections of the Menindee and Umberumberka pipeline in this project will not renew the lifespan of these pipelines in full. Essential Water is currently undertaking investigations to establish the condition of the Menindee pipeline and is trialling innovative ways to renew the life of these pipelines without incurring the full cost of replacement (estimated at $100M) which would have an unacceptable impact on customer bills.

The Asset Renewal Plan (JWP, Dec 2007) outlines a 30 year renewal plan from 2006-2036. The report indicates that for the Umberumberka pipeline, a regular replacement rate of~ ($2006) per year shall be started from 2006 and continue for 30 years to replace this pipeline. The Report indicates that the - of repairs should be completed between 2006 and 2011 and Menindee pipeline replacement should be started from year 2016/17 at a rate of -per year and continue until the entire pipeline is replaced.

A summary of Essential Water's estimate of the preferred Menindee and Umberumberka Pipeline works is provided from the Review of Capex Costs & the Capital Investment Plan for Essential Water's IPART submission (Public Works Department, Sep 2013). The total cost of this work tor the four year period is estimated by PWD at - · In particular, PWD has proposed that

• an annual allowance of~ (direct costs) be provided for Menindee Pipeline works, except for FY18, as below:

0

0

0

0

for pipeline replacement in multiple small sections for replacing 2 isolation valves (in FY15 only) and for replacing 20 air valves for cathodic protection on the Menindee Pipeline in (16/17)

• an annual expenditure for Umberumberka pipeline replacement works varies from ~ to~ (direct costs for a single 250m pipe section) each year plus~ for replacing 10 air valves on the Umberumberka pipeline each year from 2014/15 to 2017/18.

The proposed work and cost in the Public Works Department Review is not reflected in the Investment Case which has only provided - (direct costs) in the Capex plan for the four years of regulatory period. The cost of completing this work has been stated as being lower than the amount outlined in the Public Works Department review.


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Is the project prudent? I There is sufficient and compelling evidence from investigations to date that suggests sections of the Menindee pipeline are in poor condition. The maintenance costs are high and it is prudent for valves to be replaced to enable shutdown of sensibly short sections of the main.

The asset strategy for the Menindee and Umberumberka pipeline is to provide preventative maintenance of the pipeline until a long term renewal plan is established.

There is limited evidence on the condition of the Umberumberka pipeline. There is insufficient quantitative evidence to justify the replacement rate which is being proposed for the Umberumberka pipeline. This replacement rate is more reflective of a renewal strategy which is not planned to be started until 2016/17 according to the JWP Asset Renewal Plan.

Due to the importance of these pipelines for the water supply security to Broken Hill it is recommended that a program of replacement in some capacity be adopted with only the extent to be resolved.

Is the project efficient? I The replacement rate in this project for the Menindee pipeline as proposed (small sections, less than 1 OOm) is part of the preventative maintenance strategy to reduce maintenance levels on the pipeline. Renewal of the life of the entire pipeline is anticipated to involve more substantial work in the future, the planning for which is yet to be finalised.

The replacement rate for the Umberumberka pipeline is a significant portion (250m per year) of the pipeline and is considered too high to be part of a preventative maintenance strategy. It effectively is progressive replacement of the whole pipeline. The replacement rate is more likely to be part of a renewal program to replace the entire pipeline. As specified above there is limited evidence of the condition to justify the replacement rate proposed.

No details of a cost estimate or of the current condition of pipe sections proposed for replacement, or of a concept design for the replacement have been provided. The unit replacement cost rate of ~Im proposed by PWD for a DN600 pipeline appears high.

SKM considers that, notwithstanding a clear overall strategy between an optimised expenditure for and between reactive maintenance, proactive maintenance and proactive renewal for managing the risk to water supply from failure of the major water supply pipelines:

• an efficient unit replacement cost rate would be approximately ~Im for a DN600 pipe;

• 350m p.a. in aggregate for replacement of sections of the Menindee and Umberumberka mains is reasonable and efficient;

• The aggregate direct cost amount of~m for the FY15 to FY18 period (and ~m for FY15 to FY19) is reasonable and efficient (as the above yields annual provisions which are close to or slightly above the amounts proposed by EW for FY15 to FY18); but

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• There should be a better distribution of funds between the Menindee and Umberumberka mains. Prima facie the Menindee main is of greater importance than the Umberumberka main and should potentially receive a greater share of these funds (currently only 29% for the former), particularly as no or limited condition information was sighted to support a greater focus on the Umberumberka main.

Consideration should be given to prioritising the replacement of isolation valves as this will reduce the shutdown time of the pipeline.


There is limited evidence to justify the replacement rate for the Umberumberka pipeline.

EW acknowledges that the total replacement length of the Umberumberka main can be reduced to 400m over the regulatory period but suggests that this should be carried out as one single package of works during the regulatory period to take advantage of economy of scale and reduce the need from four project establishment costs to one.

On this basis, the funds for this project could be reduced or maintained at the same level and redirected to the high priority Menindee pipeline.

Recommendations

SKM recommends that Essential Water:

• as a matter of urgency prepare a priority replacement plan for these pipelines based on a risk assessment analysis using structural condition data, asset age, historical failure data, operating pressures, repair cost, loss of supply etc.

• continue with a preventative maintenance strategy until the bulk water supply strategy, full condition assessment and the options assessments have been undertaken and a robust rehabilitation plan established.

• continue with minor replacements of the pipeline until this assessment work is complete.

• reduce the level of replacement specified for the Umberumberka pipeline to 100m per year focussing on replacing pipeline in the poorest condition as part of the preventative maintenance strategy.

Essential Water should prioritise the installation of at least two isolation valves on the Menindee main to reduce shutdown time, installation of the valves recommended for completion in 2014/15.

SKM recommends the following other works/activities and funding for the FY15-FY18 period:

• Complete the condition assessment of the Menindee pipeline and undertake condition assessment of the Umberumberka pipeline.

• Prepare an options assessment and pipeline rehabilitation plan for the Umberumberka and Menindee pipelines to outline the replacement plan, identify the full extent of the works and prepare a priority replacement program for both the Menindee and Umberumberka pipelines

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. M

based on a risk assessment analysis using structural condition data, asset age, historical failure data, operating pressures, repair cost, loss of supply etc.

• The funds and timing of works proposed by EW are reasonable and efficient (direct cost

amount of ... m for the FY15 to FY18 period) but should be better distributed between the two mains with the majority used to address the Menindee pipeline risks. The costs of the condition and options assessments indicated above are to be absorbed within the proposed expenditure.

Water Pumping Station Refurbishment I Overhauls

Planned Capex expenditure WP11

Project overview

This project is on-going work, driven by scheduled maintenance tasks. Essential Water has six pump stations and two booster pumping stations along the Menindee and Kinalung pipelines plus a pumping Station at Umberumberka and Imperial Lake.

Essential Water proposes to undertake scheduled overhauls and replacements of pumps, motors, associated pipework, valving, switch gear, power supplies and controls at each of the major water pumping stations. The total proposed capital cost is plus other direct costs ~ over a five year period from 2014/15 to 2018/19 of which of work should be completed in 2018/19. The component works proposed are outlined below:

• At the Menindee Pump Station: Replacement of the four high lift pump isolation and nonreturn valves, replace the high lift pumps section manifold, pump house road repairs and notional works - at a direct cost over 5 years of ~ + other direct costs;

• At Kinalung Pump Station: Replacement of the electrical starter panels and works of a

general nature - at a direct cost over 5 years of~ + other direct costs;

• At the Interconnecting Channel Pump Station: Remediation of the site due to erosion from large rain events- although there are no direct costs in FY15 to FY18 with only . K (direct costs) to be spent in 2013/14.

• At Stephens Creek Pump Station: Works include refurbishment of major pump station isolation and non-return valves, overhauls of the three high lift pump motors, an upgrade of the pump station pump well plus other minor notional works - at a direct cost over 5 years of

~ + other direct costs;

• At Umberumberka Pump Station: Replacement of the suction manifold from the reservoir wall to the pumps station, replacement of the third diesel pump unit w ith a remote controlled diesel unit, overhaul of one of the existing diesel units and other minor notional works - at a direct

cost over 5 years of ~ + other direct costs; and

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WP11 Water Pumping Station Refurbishment I Overhauls

Planned Capex expenditure

• At Imperial Lake Pump Station the electrical switchgear requires upgrading plus other minor works. (5 years of work~ + other direct costs)


The fundamental need for the project is outlined in the Investment Case for the project (Essent ial Water, Sep 2013). The works enable Essential Water to produce a reliable water supply through on-going maintenance and replacement programs to ensure its civil, mechanical and electrical assets as required are kept up to date. This is managed with information from Essential Water's internal Maintenance Management System (MAINPAC). The maintenance schedules in the MAINPAC system are based on historical asset data as well as specified criteria to ensure an optimal balance between the costs of maintenance versus the risk of breakdown.

The MAINPAC package software is used to identify works required to be undertaken in this regulatory period. Essential Water's Investment Case states that the forecast works have been identified by MAIN PAC as requiring attention during the upcoming determination period. As well as MAIN PAC, assessment of the assets has shown deterioration to the stage replacement or repair is required e.g. the access road.

The costs are based on historical costs from carrying out similar work, as well standard rates to undertake major overhauls from approved suppliers.

A major component of work in this project is to upgrade the Stephens Creek Pump Station building. The Investment Case (Essential Water, Sep 2013) states that, studies have been carried out and structural deficiencies have been identified in the existing pump well. This work will bring the existing building and pump well up to current building and structural standards. Although this work has yet to be formally quantified ,~ has been allocated for it. This work was included in the program due to the risk of building fai lure, causing potential loss of life significant damage to corporate reputation.

Preventative maintenance is identified in the strategic plan for water pump stations. The works are carried out in line with Essential Water's 30 year asset management plan.

Is the project prudent? I Preventative maintenance for water pump stations is part of Essential Water's strategic plan. SKM considers that completion of ongoing replacement of components of water pumping stations to be prudent.

The majority of the works identified in this project are refurbishments, replacements and overhauls. Essential Water records the condition of such asset components in its MAIN PAC system and this is used to identify prioritise the works to be completed. Nevertheless there appears limited evidence to adequately justify each component of works in the Strategic Plan as being essential works that need to be undertaken as part of a preventative maintenance strategy.

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These project works are considered prudent overall (across the various pump stations). However with respect to the structural upgrade of Stephens Creek Pump Station, there is an apparent overlap with project WP1 which is providing a new pump station (Stephens Creek PS No. 4) for emergency pumping now and ultimately to replace the existing Stephens Creek pump station. It is not considered prudent to spend >. Million on upgrading the existing Stephens Creek pump station and build a new pump station. There is a lack of direction for the Stephens Creek Pump Station project which needs to be consolidated into an overall optimised solution and plan.

Is the project efficient?

There is limited evidence to show that the works need to be completed within the FY15 to FY18 regulatory period. There is no options assessment or concept design to outline the works required and there is limited evidence or basis of cost estimation for the works. Essential Water has stated that the costs are based on historical costs from carrying out similar work, as well standard rates to undertake major overhauls from approved suppliers. There is no evidence of examples of similar work being used to estimate costs, which would show more transparency in the process.

There is insufficient information provided to justify the cost of components, no quantities have been provided. The following observations have been made regarding the cost estimates and scope of works provided:

• The ~ has been included in the Investment Case for a starter panel at the Menindee Pump Station but is not provided for in the detailed scope of works. There is either an error or this amount should be removed from the funds proposed. EW has not indicated that these works are required or this amount is needed, and so it has been removed from the proposed amounts sought.

• A further ~ has been removed from the funds sought because of the reasons outlined in the recommendations for WP1 and also because

o Of a particular concern that there is no evidence of any options assessment, concept design or cost estimate being completed for the work to be conducted at Stephens Creek Pump Station which represents >~ of the project and there is no evidence 0€ consideration of the works being undertaken in WP1 .

o There appears to be no robust basis for the estimated cost associated with the structural works to be undertaken at the Stephens Creek Pump Station.

o Replacement of valves at Stephens Creek Pump Station~ appears to be high.

o There is of unallocated notional works listed for the pump stations. A direct cost of is provided for the Stephens Creek and ~ is provided for the Umberumberka Pump Stations. This is a large amount allocated to unspecified works.

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There is limited evidence to of any options, concept design and cost estimates provided for the works in particular the Stephens Creek Pump Station.

There is no link or strategy outlined for the Stephens Creek Pump Station replacement.

EW acknowledges SKM's views on the remedial work requested at the Stephens Creek Pump Station. EW has advised that it is planning an extra pumping station with one pumping unit and the capacity for a second unit if needed in the future to be constructed at Stephens Creek that can be used to augment the existing pumping options and have the ability to operate completely independent in the case of structural failure or fire at the existing Stephens Creek Pump Station or electricity network failure.

EW has emphasised that the fact that the existing pump station was built in the 1890's to the then building standards which are materially different to, and does not meet, contemporary building standards. The building and the associated well that the pumps and motors are located in is now 120 years old and in an isolated location and is the main pumping station at Stephens Creek. EW considers that this needs to be addressed.

SKM acknowledges these needs but has formed its views primarily from a broader strategic and efficiency viewpoint.

Recommendations

SKM recommends that, for the reasons indicated above, the amount proposed by EW for FY15 to FY 18 be reduced by ~ (direct costs) for this project, with this reduction to be spread evenly over the four years.

Essential Water should complete a holistic strategy integrating the Stephens Creek Pump Station replacement with the works outlined in WP1 . It appears non-optimal to both build a new emergency pump station with the capacity to be further upgraded to replace the existing pump station and concurrently refurbish the existing pump station.

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SP13 Replacement of Wills St Waste Water Treatment Plant


Project overview

The Wills Street Waste Water Treatment Plant {WWTP} was constructed in 1938, and has an operational capacity of 3MU day incorporating a system of primary sedimentation, sludge digesters, separating filters and UV treatment. The plant has been upgraded a number of times over the preceding 70 plus years, but the plant and associated infrastructure is now in need of a major upgrade.

Essential Water's preferred option is to replace the plant at an estimated cost of ~M plus other direct costs ~M. Design should be completed in 2017/18, followed by construction in the next regulatory period.

It is noted that funds were allocated in the current regulatory period (FY11-FY14) to refurbish the existing wastewater treatment plant and of this~ was spent between 2011 and 2013.


In 2009 GHD consultants conducted a condition assessment of the existing plant and found that it was in poor condition and required extensive rehabilitation. Additionally the OH&S of the plant has been assessed by GHD and found to be deficient and in need of major improvements to meet the current OH&S standards.

The Investment Case (Essential Water, Sep 2013) justifies proceeding with the project as follows:

• Replacing the plant will provide a reliable treatment system and alleviate on-going treatment performance and OH&S issues.

• The existing plant is leaking and contaminating groundwater. Essential Water is not meetiing the conditions of its Environmental Protection Licence {EPL). Essential Water has been directed to provide the EPA with a detailed update on whether the WWTP is to be refurbished or replaced by 30 June 2014.

• Essential Water is required to supply a safe place of work under the Safe Work Act.

The Investment Case (Sep 2013} states that despite requiring more capital, it has been decided to replace the plant at an estimated cost of ~M plus other direct costs ~M. This recommendation has the support of the NSW Department of Public Works, which was engaged in July 2013 to assess Essential Water's operations and capital program. The new plant would have a 60 year asset life.

Refurbishment of the existing plant had been considered which would cost tM and extend the asset life by 20 years, following this the plant would need to be replaced. Essential Water was considering replacement of the plant as the most suitable option, but has determined that replacement would better mitigate the risks that exist with the existing plant such as the cost of escalation of the refurbishment works and also the potential for a revision in the licence discharge limits prior to the previously scheduled STP replacement in 2031132 which would bring the need for replacement forward and likely increase costs.


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SKM considers this a real risk as the current WWTP plant only employs rudimentary treatment processes inconsistent with the achievement of contemporary environmental obligations.

A Risk Based Asset Renewal Strategy {GHO, 2009) indicated that work to refurbish or replace the existing plant was necessary.

A Broken Hill Wastewater Treatment Strategy Options Assessment (GHO, 2011) considered options to reliably achieve the proposed effluent quality. The primary advantage of refurbishing the Wills St and South WWTPs in the short term is that it defers the capital cost of constructing a new WWTP. Although this option is of a lower cost a multi-criteria analysis determined that decommissioning the South WWTP and Wills St WWTP and constructing a new WWTP would provide the best overall outcome for Essential Water and the Broken hill community {from an overall social, environmental and economic viewpoint).

A single new WTTP is the preferred option for the following reasons:

• A newly constructed WWTP would have improved service reliability levels over the existing WWTP infrastructure, even with refurbishment;

• The existing WWTPs do not meet modern OH&S standards; and

• The new Wills St WWTP has the greatest flexibility for future upgrade (e.g. to meet more stringent effluent treatment requirements such as nutrient removal) although this is considered to be a minor benefit given that the treated effluent is to be reused.

SKM notes that the above assessment is highly sensitive to the assigned criteria weightings as the difference between the MCA results for each of the three options is minimal.

The new plant will be designed to meet the current population base in Broken Hill including any flows from South Broken Hill. The plant will have an expected useful life of 60 years, and will enable Essential Water to meet current requirements of environmental licences and relevant OH&S regulations. The higher operating capacity of the new plant will accommodate the sewage flows currently processed by the South WWTP as it will in turn be converted to a pump station to reduce the on-going operating costs associated with running two WWTPs.

Essential Water is looking at undertaking this project over five years commencing 2017 /18 to ensure adequate operation of the plant for at least 60 years. Design would be completed by a consultant in 2017/18 with the tendering and construction phase proposed to be completed in the next regulatory period. The delay has been proposed due to financial constraints and limitations on borrowings.

Cost estimates have been prepared by a Consultant for both replacement and refurbishment of the plant. The NSW Department of Public Works have verified that cost estimates are suitable. Financial modelling has been undertaken which indicates that the cost passed onto customers due to replacement will be similar to refurbishment and would still be less than the NSW state average cost for sewer network charges.

SKM_FINAL REPORT_26 Jan 2014_Rev E_F1nal_Redacl.ed docx PAGE~?

Essential Energy


... ,u .... ,.., M'"' January 2014

__DM


Is the project prudent?


I For Essential Water to meet EPA and OHS obligations it is considered a prudent investment for the Wills St WWTP to be replaced to address its stated deficiencies.

There is sufficient supportive evidence including risk assessments and condition assessments of the existing plant to show that options have been considered and that replacing or refurbishing the Wills St WWTP is necessary.

Is the project efficient? I For the purposes of this regulatory period (as distinct from the project overall), the proposed expenditure (which represents only approximately 3% of the total estimated project expenditure) is considered efficient. The efficiency of the overall project cost proposed can be re-assessed in the next regulatory period.

Options assessment has been completed to show that replacement of the Wills St WWTP is preferred. The replacement of the plant has a significantly higher NPV than refurbishment of the WWTP and the WWTP is justified on the basis of a multi-criteria assessment.

There is some doubt that replacing the existing treatment plant is the most efficient option from an economic perspective. Significant cost savings can be made by refurbishing the existing plant if this was able to be achieved.

A cost of ~M seems to be reasonable for replacement of the WWTP as does . M for refurbishment. Essential Water has delayed construction into the next regulatory period due to financial constraints on borrowing.


It has been assumed that no interim works are required to be completed in this regulatory period to address EPA and OHS concerns.

Recommendations

SKM recommends that further design and economic assessment, including benefit/ costs ratio, be undertaken to justify quantitatively the preferred option as between refurbishment and replacement. This assessment can be provided to EPA in June 2014 for endorsement which has been determined as the date for which Essential Water needs to have determined which option will proceed. This work would need to be completed prior to the FY15-FY18 regulatory period; as such no provision has been included for this work.

No changes have been made to the project program and costs proposed in the regulatory period FY15-FY18.

SKM_RNAL REPORT_26 Jan 2014_Rev E_F1nal_Redac!ed docx PAGE48

Essential Energy


... cu .. ..... ,M... January 2014

_DM

SP15 Sewer reticulation repairs Planned Capex expenditure

Project overview

The sewer reticulation in Broken Hill has a total length of 228km, an average age of 51 years and is mostly earthenware pipe. To date Essential Water has undertaken reactive maintenance of its sewers

Essential Water is proposing a programmed system of reticulation repair and replacement. This project plans to re-line a maximum of 25% of the sewer mains located in Broken Hill over a nine year period, starting with the most problematic mains as identified through MAINPAC data.

Essential Water is proposing to replace or reline approximately 55 km of sewer mains and 68 access chambers (man holes) in Broken Hill and surrounds over the next nine years.

Essential Water is proposing to reline sewers at a cost of - (direct costs) over the four year period 2014/15 to 2017/18. In this time it is anticipated that 20,500m of sewer will be replaced.


The investment case (Essential Water, Sep, 2013) for the project outlines the following reasons for the project to proceed:

• The majority of the sewer mains are constructed from earthenware clay and are progressively cracking or being displaced. There is also anecdotal evidence that the frequent firings (blasting) from the local mines have contributed to the sewer mains cracking or displacement.

• The mains cracks and displacements have given rise to the sewer reticulation system experiencing a rise in inflow and infiltration following storm events. Generally the normal flow through Wills WWTP is 3 ML per day, however, in a storm event it increases to 12 ML per day. This increase has caused pumping issues at Essential Water's sewer pump stations and has the potential to cause surcharges or release or sewer from its system into the environment. Increased energy charges would be increased also.

• Without intervention, maintenance costs are expected to continue rising with the steady increase in the frequency and cost of EW's reactive sewer maintenance program over the last 5 years.

Essential Water outlines the proposed solution in the Investment Case. Essential Water proposes moving to a programmed system of reticulation repair and replacement. This project plans to reline a maximum of 25% (55km) of the sewer mains located in Broken Hill over a ten year period, starting with the most problematic mains as identified through MAINPAC data.

MAIN PAC records all instances of surcharges, blockages and past repairs to identify areas and lines most in need of relining or replacement. Most works will entail relining with a sleeve (PVC or PE) with the remainder being replaced where relining cannot be undertaken. This target is dependent on the condition of individual mains and the state of associated sewer access chambers.


Essential Energy


... cu .. ..... ,M... January 2014

__DM


However, by starting with the most problematic mains, the proposed project is expected to result in a significant reduction in the sewer maintenance program over the same period.

A replacement rate of 6km p.a. would keep pace with replacement based on the remaining asset life of sewer assets. Overall this would involve over the nine years (all in real $2014):

• 55km of existing pipeline being relined with PVC piping at a cost of - per km;

• 1 km of pipeline being entirely replaced at a cost of - per km; and

• 2% of the total approximately 3400 manholes being repaired (68 in total) at ~ each.

In the Investment Case, Essential Water proposes to reline 1000m of sewer at a cost of -in 2014/15, followed by relining 6500m of sewer at a cost of - from 2015/16 to 2017/18. The 2014/15 Capex program is not consistent with the Investment Case and the latter appears to be an error, as confirmed by Essential Water.

In 2011 /2012 Essential Water engaged a contractor to reline 900 metres of problematic mains in Broken Hill for a cost of - - These mains were primarily selected due to access issues and were required to be cleaned periodically.

Is the project prudent? I These works are considered prudent based on the evidence of the rising cost of sewer maintenance and large amount of infiltration during a wet weather event it is prudent to move to a renewal program to replace the sewers which have reached the end of their useful life.

ts the project efficient? I There is limited evidence provided and a lack of a robust basis to conclude that 25% (55km} of the sewer reticulation should be replaced. The replacement rate is only or largely determined by asset age which does not necessarily equate to remaining useful life and should only be used as a starting point. There is no supporting evidence for a deterioration rate or to show that 25% of sewers have a poor condition and need to be replaced. The basis for 55km replacement would be better justified by a condition assessment of the sewer system via CCTV inspection or analysis and documented data to show percentages of pipe lengths experiencing blockages.

The cost of relining has been estimated at - per km based on a test project conducted in Broken Hill in 2011. On this basis relining is significantly cheaper than full replacement of sewers (estimated at - per km).

However there is limited evidence of an options assessment or technical assessment to justify that relining is the most suitable option for renewal of the pipelines in Broken Hill. There has been no evidence provided of an assessment of the feasibility and suitability of a system wide relining program for Broken Hill.

The method of identification of sewers for relining seems to be reasonable (based on the use of MAINPAC and prioritising sewers with high blockages, surcharges and past repairs), although


Essential Energy


SRCUll U llMTMm January 2014

__DM


there is no evidence of a strategy to prioritise sewers in the event that a sewer needs to be replaced and cannot be relined. For example, it would be inappropriate to reline 400m of pipe which has not collapsed and has a better condition compared with foregoing relining of say 100m of pipe which needs full replacement due to collapse and is in worse condition.

The 2014/15 Capex program is inconsistent with the Investment Case and appears to be in error. In the Investment Case, Essential Water proposes to reline 1 OOOm of sewer at a cost of~ (direct costs) in 2014/15 whereas the Capex program has allocated~ (direct costs) plus other direct costs to be spent in 2014/15. EW has confirmed that the ~and 1 OOOm of sewer main replacement should have been for 2013/14 and only the .K is for 2014/15. The quality of such supporting information and avoidance of these inconsistencies represents a significant business improvement opportunity.

Overall SKM considers that the expenditure is inefficient and needs to be reduced and restructured because:

• This represents a significant change in strategic direction for addressing the concerns identified and is a substantial ramp up in works that have not been undertaken other than at a pilot level previously and especially when it is unclear what an efficient relining/replacement program is;

• The level of the program has not been well justified with a target replacement program based on consumption of a notional asset life rather than a condition or risk based driven approach;

• Rather than starting with this program it would be more appropriate to establish the effectiveness and cost efficiency of the proposed relining works and gradually ramp up over a period of time through and beyond the regulatory period at an justified and appropriate level (as required); and

• No indication has been provided of the preparedness and/or capability of Essential Water to implement and deliver such works.

The aim should be to use this regulatory period to establish the benefits of the relining program and to ensure that it is being efficiently delivered.

Supporting information which would help to justify the works proposed

Evidence of an options assessment or technical assessment for comparison between replacement and relining of sewers to show that relining is suitable for a Broken Hill sewer replacement program would better demonstrate project efficiency.

The 55km proposed for replacement (or other length) would be better justified by a condition assessment of the sewer system via CCTV inspection or report to show percentages of pipe lengths experiencing blockages.

There seems a lack of evidence to support the optimality of replacing 1 km p.a. of sewer pipes.


Essential Energy


""'-'" .. ""'M'"' January 2014

_DM


Recommendations

It is recommended that Essential Water delay the sewer renewal program for 6 months to allow a feasibility study and options assessment (relining vs. replacement) to be completed and to complete a sewer renewal strategy for the renewal program which includes:

• Annual program of identification and assessment of the suitability for renewal or replacement.

• Prioritisation of sewers for renewal (including CCTV inspection)

o SKM recommends CCTV camera inspection of sewers be undertaken of sewers identified for replacement (or sewers classified as of greatest risk) using the MAINPAC system to confirm the need for replacement. CCTV camera inspections could be conducted at the start of each year to identify sewers to be relined and replaced in the following year(s).

SKM recommends that the program be scaled back for the FY15 to FY18 regulatory period with a proposed expenditure (as direct costs) adjusted as follows compared with EW's proposed amount:

• In FY15: Provide for .K -a reduction of .K (or 50% compared with that proposed);

• In FY16: Provide for ·K- a reduction of .K (or 25% compared with that proposed);

• In FY17: Provide for .K - a reduction of .K (or 25% compared with that proposed);

• In FY18: Provide for ·K-a reduction of .K (or 25% compared with that proposed).

Overall SKM recommends that an efficient amount for the regulatory period is ~m compared with that proposed by Essential Water of ~m.

SKM further recommends that at the conclusion of the 4 years of sewer relining Essential Water should undertake an assessment of the key indicators for sewer condition, including length of rodded sewers, blockages, maintenance costs and inflows to the WWTP during wet weather events. This would assist in determining the effectiveness of the renewal program and whether the program needs to continue at the same rate or could be scaled up or down based on a determination of what represents efficient expenditure levels. At this stage there is no evidence that 55km of sewer replacement over 9 years is justified.

To the extent necessary and justified Essential Water could seek further funds in the next regulatory period.

SKM_FINAL REPORT _26 Jan 2014_Rev E_Final_Redacl.ed docx PAGE 52

Essential Energy


... CUllUll KTM<U January 2014

__DM

SP16 Sewer Pump Station (SPS) Refurbishment /overhauls


Project overview

Essential Water has 11 sewerage pumping stations (SPSs) with associated pumps, motors, buildings, electrical supplies and civil works. These need to be regularly maintained or refurbished to ensure they operate effectively. Sewerage pumping stations are essential in transferring large quantities of sewage to the Wastewater Treatment Plants (WWTPs) and reliable operation is important in maintaining service levels to Broken Hill customers.

The proposed investment involves the refurbishment or replacement of pump wells, pumps, motors, pipework and control systems at a proposed cost of~ (direct $2014) plus ~other direct costs over the four year period from 2014/15 to 2017/18.


The investment case (Essential Water, Sep, 2013} for the project outlines the following reasons for the project to proceed:

• Essential Water has developed a 10 year program of works based on assets identified at risk through its asset inspection and condition assessment (using the 2010-11 Asset Management Plan).

• To ensure SPSs are operating effectively and meeting EPA requirements sewer pump stations need to be regularly maintained. Failure of sewers will result in Environmental and customer impacts. Replacement/ refurbishment of components are based on the MAINPAC asset management package.

Essential Water is proposing to undertake the following activities in relation to the SPS refurbishment/overhauls:

1. Capital expenditure 2014/15 (~)

o SPS civil - Warren Street storage .. k. King St fencing ,k, Rakow Street .. k. Wentworth Road fencing tlk, Kanandah Street fencing k

o SPS Mechanical (pumps) Kanandah Street submersible package unit . k. Rakow St valves . k


o SPS civil - King Street relining .. k. Wentworth Road relining .. k

o SPS Mechanical (pumps) - Warren Street pump overhaul .. k. Racecourse Trust valves t k. South Road valves ,k,


o SPS civil - Racecourse Trust relining .. k. Racecourse Road relining .. k


o SPS civil - Slag Street relining and pipework . k. Rakow Street paint building . k


Essential Energy

EKpenditure Review - FINAL REPORT

SR CUllUll • TM<U January 2014

__DM

SP16 Sewer Pump Station (SPS) Refurbishment /overhauls


Is the project prudent? I Preventative maintenance for sewer pump stations is part of Essential Water's strategic plan. It is considered prudent to complete ongoing replacement of components within the sewer pump stations. There is sufficient evidence to suggest that some expenditure is well justified and prudent.

According to Essential Water the condition of components is recorded in the MAINPAC system and this is used to identify prioritise the works to be completed.

The majority of the works identified in this project are refurbishments, replacements and overhauls for which it is justified that works need to be undertaken as part of a preventative maintenance strategy.

In saying this there is limited evidence provided to justify each component of works in the project.

Is the project efficient? I Components for replacement are specifically identified and there are no unallocated funds, notwithstanding that there is limited evidence to show that the works proposed are optimal.

There is no options assessment or concept design to outline the works required and there is limited evidence of cost estimation for the works. Essential Water has stated that the costs are based on historical costs from carrying out similar work, as well standard rates to undertake major overhauls from approved suppliers. There is no evidence of examples of similar work being used to estimate costs, which would show more transparency in the process.

All costs appear to be reasonable for the works proposed. Overall SKM's balanced judgement is that the proposed expenditure would be efficient if the more substantive evidence was obtained.

Outstanding gaps

Evidence of the cost estimation basis for each component, that the works have been identifiedl to be completed in the regulatory period (with robust planning supporting this timing) and that the project is strongly linked to and driven by the asset management approach and needs would strengthen demonstration of project efficiency.

Recommendations

According to the program outlined in the Investment case there is ~ which has been allocated to be spent in 2017/18 which should have been allocated to 2014/15.

No net change is proposed to the project cost and program. A minor adjustment has been made in FY15 and FY18.


Essential Energy


""'-'" '.""' .... January 2014

__DM 3.2.3. Outcomes of detailed review of selected projects - prudent and efficient Capex

The assessment of the 10 projects outlined in Section 3.2 has provided the basis for the recommendations and adjustment to project programme and costs. This is subject to further discussion with Essential Water in terms of the matters raised in the review assessment.

For the seven (7) water services projects assessed, SKM recommends that the forecast spend over the four year regulatory period from 2014/15 to 2017/18 be reduced by a total of $6,413,000 ($2014 including corporate overheads). This represents a 21.4% total reduction for these projects.

For the three (3) sewer services projects assessed, SKM recommends that the forecast spend over the four year regulatory period from 2014/15 to 2017/18 be reduced by a total of $1,423,000 ($2014 including corporate overheads) which represents an 23.1% total reduction for these projects.

Overall, for the ten (10) project assessed, the forecasted spend over the four year regulatory period from 2014/15 to 2017/18 has been recommended to be reduced by a total of $7,837,000 ($2014 including corporate overheads) which represents an overall reduction of 21.7%.

Figure 5 provides a comparison between Essential Water's proposed program and forecast costs and the adjusted programme and forecast costs based on recommendations in this report for the four year regulatory period 2014/15 to 2017/18.

The recommended adjusted program for the 10 projects is shown in Table 7 and Table 8. Adjustments to timing and cost have been highlighted in mustard colour.

• Figure 5 EE's Proposed and SKM recommended adjusted capital program -for the selected water and sewerage projects

Overall Capital Program 18,000 16,000

§ 14,000

e 12,000 <:r 10,000 .-I 0 8,000 N ~

>C Cll

6,000 c. 4,000 a

2,000

2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19

Financial Year

• Historical and proposed capital program • Recommended adjustment to capital program

SKM_RNAL REPORT _26 Jan 2014_Rev E_F1nal_Redac!ed docx PAGE 55



January 2014

• Table 7 Adjustment of selected water projects in capital program - costs and timing

Selected Projects (all Forecast Costs are in $2014)

WATER

Project 1 Stephens Creek Emergency Pumping Station (No.4 Unit) Qnd udes20%corporate cOSISj

Direct costs (exclooes 20% corporate costs)

Recommended ~tment (total direct costs only)

Project 2 Stephens Creek Reservoir Dam Wall Rehabilitation Qncludes 20%corporate cosls)

Direct costs (exclu<les 20% corpora1e costs)

Recommen<le<I aqustment (total direct costs only)

Projects 4 Mica St Service ReselVl'.>ir Replacement (includes 20v, corporate costs/

Direct cosls (exclooes 20% corporate costs)

Recommen<led adjustment (total <lirect costs only)

Projects Broken fill Reticulation Replacement QnclU<les20%corporate coslsj

Direct costs (exclu<les 20% corporate costs)

Recommended adjustment (total direct costs only)

Project 9 Reservoir General Works Qnd u<les20% corporate co51S1

Direct costs (excludes 20% corporate costs)

Recommen<led adjustment (total diect costs only)

Project 10 Menin<lee & Umberumberka Pipeline Repairs Qnd udes 20%corporate cosls)


Recommended adjustment (lolal direct costs only)

Project 11 Water Pumping Station RefilrbiShmen t/Overhauls Qnclu<les 20%COfpOrate costsl

Direct costs (excludes 20'!!. corporate costs)


Nominal Nominal 2014 $

Actual llctual Foreca•

2014 s 2014 s

Foreca!I Foreca!I Forecast

Note: Addition of corporate overheads is in line with the targeted op ex reductions over FY15 to FY18 - namely 19. 5% in FY15, 19% in FY16, 18.5% in FY17and18% in FY18.

SKM_FINN.. REPORT _26 Jan 2014_Re¥ E_F111al_Redscted docl PAGE S6

----1

Essenlial Energy


_ siil"'fY20l4 • Table 8 Adjustment of selected sewerage projects in capital program - costs & timing

Regulatory Period FY15-FY18)

Selected Projects (all Forecast Costs are in $2014) Nominal Nominal Nominal 2014$ 2014 s 2014$ 2014 s 2014$ 2014$

Actual Actual Actual Foreca!ll ForecaSI ForecaSI Foreca!I ForecaSI Forecast

SEWERAGE

Proj ect 13 Replacement of Wills St Waste Water Treatment Plant (includes 20% corporate cost.sl



Project 15 Sewer Reticulation Repair indudes (includes 20% corporate costs}

Direcl costs (excludes 20% corporate costs)

Recommended a<fJUStment (taal direct costs only)

Proj ect 16 Sewer Pump Station RefurbiShment/Ovemauts (includes 20% corporate costs)

Direct costs (excludes 20% coqiorate costs)


Note: Addition of corporate overheads is in line with the targeted reductions over the 4 year regulatory period - namely 19.5% in FY15, 19% in FY16, 18.5% in FY17 and 18% in FY18.

SKM_FINN.. REPORT _2ti Jan 2014_Re~ E_F1nal_Redacted docl PAGE 'JI

Total

Essential Energy {Water)


'"""" .. ""™'"' January 2014

_DM

3.3. General Capital Program Review

3.3.1. General review of key remaining capital projects

Essential Water has responded to a series of RFls, particularly focussing on the decision maki'ng processes used and/or being implemented by Essential Water. These responses have informed SKM's views regarding the robustness of the remaining projects that were not assessed in detail and the overall capital program proposed by Essential Water.

The remaining 11 projects represent $16, 110,000 of the forecasted budget for the 2013/14 to 2017/18 period. The recommended adjustment to these projects is detailed in Table 11. Details and outcomes of the high level assessment of these remaining 11 projects are provided in the following.

A. WP12 - Mica St WTP Capital Works program ( Proposed budget ~) o Further information sought from EE on the breakdown of the capital project components

contributing to the Capex cost/proposed budget of the following water projects and in particular more specific detailed information on whether this is supported by a sound and

efficient asset management program.

Upgrade of the booster pumps is supported from maintenance management system (MMS) job

history and original job cards that predate the 20 year old MMS system.

The proposed project consists of works to be conducted between 2013/14 to 2017/18 involving the following activities:

• Engage consultant to select suitable duty booster pumps.

• Tender for booster pumps.

• Apply for Essential Water approval to proceed.

• Purchase and install booster pumps.

• Design suitable alum system.

• Tender for alum plant quotations.

• Apply to Essential Water for approval to proceed.

• Purchase and install alum system.

• Identify worn assets and remaining asset life.

• Obtain quotations and Essential Water approval to purchase.

• Purchase and install in low demand period.

Overall Assessment The Mica St Water treatment plant was upgraded in 2010. It is understood that these works were not completed at that time due to funding constraints.

SKM understands that the works also involve upgrading the sludge lagoons which accounts for a significant amount of the upgrade, these works have not been outlined above.

Basis for replacement needs to be supported by condition assessment and ability to meet service level and reliability targets.

The timing and costs for this project are supported.

SKM_RNAL REPORT _26 Jan 2014_Rev E_Final_Redac!ed docx PAGE 58

Essential Energy


... ,u ....... ,N... January 2014

_DM

B. WP17 - Stephens Creek to Mica St Roe/a Pipeline Replacement (Proposed budget $0)

a Further information sought, in particular on the timing of this project at the end of the regulatory period and the potential for deferral.

There is potential to defer this project (or parts of it) depending on the deterioration of this section

of the main over the next 4 years and the assessed risk at the time. This pipeline is the main

pipeline into Broken Hill from Stephens Creek and Essential Water has had one burst on this section in the last 6 weeks. Essential Water will monitor the bursts and assess over the next 4

years. This is a Rocla pipe so Essential Water cannot monitor thickness of the pipe plus all the

"failures" and issues faced by Essential Water are associated with the rubber rings failing in the

socket connections.

o Information on the extent to which this project is driven by condition assessment?

Essential Water intends that this project will be driven exclusively by condition assessment and risk. The condition assessment will be by monitoring the number and frequency of bursts.

Essential Water has provided the following approach which is the same as the approach used for the Menindee and Umberumberka pipeline (Project WP10).

The proposed WP17 project consists of: (extracted from Menindee & Umberumberka Project WP10 investment case, 23 July 13) -for the period 2014/15 to 2017/18:

• Continue with pipe thickness monitoring. (Not relevant to Recla pipe)

• Identify individual pipes or short sections requiring priority replacement.

• Review estimates, define project governance structure and project management plan.

• Apply to Board to proceed.

• Develop specifications and tender for suitable pipes and valves.

• Plan pipeline outages.

• Undertake pipe and valve replacements during w inter maintenance or low demand periods.

• Project completion.

• Project review - lessons learned.

Assessment

This project is being deferred to 2018/19. No funding is allocated in this regulatory period.

As an additional step in the process, Essential Water needs to demonstrate quantitatively that replacement is a more prudent and efficient response option than continuing with a preventative maintenance strategy.

C. WP19 - SCADA and telemetry upgrades a Further explanation of the driver for this project (especially the ranking of high for security

of supply and public safety).

Essential Water's SCADA system has been in operation since 1995. This allowed the Menindee, Kinalung, Stephens Creek and Umberumberka pumping stations to become unmanned.

SKM_RNAL REPORT _26 Jan 2014_Rev E_F1nal_Redac!ed docx PAGE 59

Essential Energy


""'-'" .. ""'M'"' January 2014

_DM

SCADA is also used to monitor and control the Menindee town supply as well as the Sunset S1rip town supply. The system has become unreliable in recent years with multiple fai lures. When the system fails and pumping is critical from that station, operations personnel must go to site to manually operate those pumps while SCADA technicians urgently respond to the system failure.

Since the SCADA automation of the major pumping stations, those water pumping PS operational positions have been made redundant. Clearly a system failure causes major disruption to the planned works of the relatively small remaining workforce. These staff must operate the pumping stations during such situations which cannot be sustained for extended periods (e.g. many days).

Sustained system failure or short term failure of critical sites can result in the inability to provide supply to Broken Hill. Storages in Broken Hill provide approximately 24 hours supply during high demand. A sustained system failure will result in minimal water in Broken Hill, severe restrictions and subsequently a high risk to the security of supply and public safety.

o An estimate of the costs that SCADA and telemetry upgrades might offset.

Essential Water has indicated that an estimated cost saving of $30,000 per critical SCADA loss

event lasting 1 week could be achieved.

Assessment

• This project is being justified due to the risk of disruption to security of supply and public safety. The security of supply risk has been explained. The public safety risk is unclear for this project.

• The definition and qualitative nature of the prioritisation criteria (security of supply, public safety etc.) are not well defined. The use of quantitative criteria would make the assessment clearer.

• An NPV assessment would assist in the justification of this project.

• The projects which are proposed to transition from preventative maintenance to renewal can be justifiable from an economic or level of service perspective.

• Essential Water would benefit from establishing threshold criteria to assess the need for replacement of assets. Once the cost of maintenance reaches a certain level, or the service level targets are not being met the asset can be replaced.

• Overall: Project should be completed as planned.

D. WP18 - Sunset Strip WTP - Potable water upgrade ( Proposed budget ~)

No supporting information sought or sighted by SKM on this project. This was not one of the agreed 1 O projects reviewed in detail.

Assessment

No changes are proposed. These works are prima facie prudent and the expenditure is not material. It is unlikely that this is essential to undertake in FY15 or early in the regulatory period (as there are other higher projects. However, in practical terms it would be better to undertake this earlier in FY15 to FY18 to assist usmoothing" of the capital program.

SKM_RNAL REPORT_26 Jan 2014_Re~ E_Final_Redacl.ed docx PAGE BO

Essential Energy


... ,u .. '"""'Mm January 2014

_BM

E. WP20 - Other Works (Proposed budget~ million)

o A more detailed breakdown of the components contributing to this category of works.

Essential Water has indicated that specific examples of these works include:

• Replacing service reservoir chlorine boosters at Hebbard St Tank and Wyman St Tanks.

• Replacing chlorinators on the Menindee pipeline at Menindee, and for Silverton;

• Installation of a chlorinator on the Umberumberka pipeline - estimated cost of .k.

• Meter replacements - estimated cost of .k per year.

• $20k per year on unforeseen reticulation works; and

• Dedicated main from Mica St (Williams St) crossing to Rocky Hill - estimated cost of .k.

Of these the dedicated main to Rocky Hill has scope to be deferred and/or a reduction in the

quantum of this "budget" amount given it is rated low under all category headings.

Assessment

• The Mica St crossing to Rocky Hill has scope for deferral, with the works and the estimated budget of~ deferred to the next regulatory period.

• The works listed under this project do not provide adequate justification for the $2.6 million allocated in the budget. There is insufficient information provided to assess the basis of al I the costs.

• SKM notes that the average expenditure in this category of "Other Works" for water projects was $522K p.a. over the last 4 years from FY11 to FY14. EW now proposes to increase expenditure of this nature to an average of $651K p.a. for the FY15 to FY18 regulatory period (an increase of approximately 25%).

• SKM recommends that the proposed funds for annual expenditure on such unallocated works should be reduced to no more than the average of the last 4 years. This is based on the significant amount of unallocated costs (in this broad bucket), the substantial increase proposed, the lack of adequate justification of them and their relatively lower priority within the overall water capital budget. If there are material projects or amounts these should be separately identified and justified. Specifically SKM recommends that project budget for these uother Works" be reduced by 20 per cent in the absence of more substantive project definition or justification based on specific key drivers (e.g. asset management).

• SKM notes that with respect to Rocky Hill, SKM considers that this is of low priority and could be deferred, but has elected to apply a broad reduction as above which would comprehend or include any deferral of this project.

SKM_RNAL REPORT_26 Jan 2014_Rev E_Final_Redacl.ed doc:x PAGE 61

Essential Energy


... , ....... ,."™'"' January 2014

__DM

F. SP22- Other Works (Proposed budget~ million)

o Provision of a more detailed breakdown of the components comprising this category of

works.

Essential Water has indicated that specific examples of these works include:

• Notional works at Wills St WWTP - estimated cost of . k per year

• Road plus fence replacement Wills St WWTP - estimated cost of . k

• Wills St WWTP Grit Collector overhaul - estimated cost of . k

• Desludging second half of Wills St WWTP 'Tertiary" pond - estimated cost of . k

• Replacing major valves and magnetic flow meters Wills St WWTP - . k

• Electrical general work - estimated cost of . k

• Replacing tubes and cards on Wills St WWTP UV - estimated cost o4 k every 3 years

• Chemical systems (lime) works - estimated cost of t k

• Kanandah Road SPS convert from mono pumps to submersible and/or upgrade - estimated

costof . k

• Rising main to Wills St WWTP.

In general, there appears scope for deferral andfor reduction in the quantum of this "budgee

amount given it is rated low under all category headings (four "traffic light" system).

In particular, there appears scope for deferral of:

• road and fence replacement at Wills St WWTP (of . k) depending on condition of internal roads and the extent of safety and all weather access issues and condition of security fencing.

Asset condition and risk assessment needed at the time.

• possible reduction on desludging of tertiary pond at Wills St. This is dependent on whether

Essential Water continues to have on-going issues with blue green algae in the ponds. This

has been an issue for at least 10 years now. Typically and based on SKM's experience the timing of desludging works can be varied within a broad "window". The specific timing needs to

be better demonstrated.

Assessment

• There is a significant amount of budget allocated to works at the Wills St wastewater treatment plant which is planned to be replaced starting in 2018/19. There is no link to the replacement of the Wills St WWTP provided.

• It is unclear as to why works at Kanandah Road SPS are included in "other works" rather than the Project 16 - Sewer Pump Station overhauls.

• The works listed under this project do not provide sufficient justification for the whole of the $2.68 million allocated in the budget. There is insufficient information provided to assess the basis of all the costs and the timing of works.

SKM_RNAL REPORT_26 Jan 2014_Rev E_F1nal_Redac!ed docx PAGE 62

Essential Energy


'"'u" .. ""'M'"' January 2014

_DM

• SKM notes that the average annual expenditure in this category of "Other Works" for sewerage projects was $227K p.a. over the last 4 years from FY11 to FY14 (or $287K p.a. over the last three years). EW now proposes to increase annual expenditure of this nature to an average of $669K p.a. for the FY15 to FY18 regulatory period (an increase of over 120% annually and in aggregate).

• SKM recommends that the proposed funds for annual expenditure on such unallocated sewerage works should be reduced substantially to no more than the average of the last 4 years.

This is based on the significant amount of unallocated costs (in this broad bucket), the substantial increase proposed, the lack of adequate justification of the works and their relatively lower priority within the overall water capital budget. If there are material projects or amounts these should be separately identified and justified.

• Specifically SKM recommends that project budget for these "Other Works" for sewerage be reduced by 50 per cent in FY15 and by 25% in each of the last three years of the regulatory period in the absence of more substantive project definition or justification based on specific key drivers (e.g. asset management). This still leaves a substantially increased quantum of $1.793m (direct costs) for such works.

3.3.2. General business decision-making

Essential Water has provided further information on its formalised decision processes in relation to prioritising capital works and a range of specific related topics in terms of capex decision-making.

The Capex Prioritisation table (and associated criteria), as per Essential Water's inception meeting presentation to IPART, was created as an internal prioritisation exercise to ascertain whether any proposed projects could be deferred or reduced based on four specific identified risk factors. Broadly the categories could be defined as:

• Public Safety - defined as potential for loss of life, injury, illness from asset failure.

• Security of Supply - defined as compliance with AWQC, maintaining a safe and secure water supply to EW customers.

• Regulatory Compliance - potential for regulatory action through failure to maintain or renew assets.

• Prudent Commercial Investment - business savings in asset renewal, reduction in maintenance costs etc.

These categories and the associated criteria appear to be both qualitative and quite subjective and as such are simply qualitative assessments of projects. This prioritisation table was presented to the Network NSW Board to allow the board to assess the relative importance of the individual projects contained in the proposed CAPEX program. While helpful at one level and in providing a quick snapshot, it is not useful in providing supporting justification for individual projects or their expenditure in any rigorous manner.

SKM_RNAL REPORT_26 Jan 2014_Rev E_Final_Redac!ed doc:x PAGE.63

Essential Energy


... ,u .. ..... ,N... January 2014

_DM

Essential Water has cited Project 17: Stephens Creek Rocla Replacement as an example of how this is used- namely, deferral of a project (originally scheduled for replacement to start in 2016/17 [based on 30 year plan dated 7-May-13] and has been moved to start in 2018/1 9).

Overall corporate governance: Essential Water has provided the following explanations. [NB: Based on Essential Water's Water Asset Management Plan (AMP), Chapter 4 - with references below to sections in the AMP.]

• Capital Governance (AMP, Section 4.3.2)

The provision of water and sewerage services is capital intensive requiring the application of rigorous and efficient capital budgeting and approval processes. Essential Water has a capital governance framework and processes in place to control capital (and operational) planning and expenditure, and to ensure that the intended program of capital works is delivered in a prudent manner.

The governance of capital projects within Essential Water is based upon three key elements:

o Annual capital budgeting process;

o Approval of capital expenditure in accordance with Essential Water procedural guidelines; and

o Capital governance structures and processes within the respective business units to monitor capital expenditure.

• Business Case Approval (AMP, Section 4..4 .10)

"All network investment related business cases are subject to approval by the Group Manager Water, Regional Manager Far West, Executive General Managers, Chief Operating Officer or Board depending on the level of expenditure being committed."

All projects with a total spend of greater than $100k require a business case to be submitted for approval by Senior Management before the project commences. Water projects with an expected cost >$500k require a full CID to be developed and reviewed and approved by the Corporate Finance team prior to business approval and project commencement. Business approval is carried out in line with the corporate delegation levels in the associated policy CEOP8076 Treasury: Recurring delegations.

In addition, Water projects are now also subject to the non-system (being non-electricity related) capital governance processes within EE.

These processes seem reasonable.

Assessment

The approach followed by Essential Water to conduct a risk based assessment and a business case for each project and presenting this information to the board is a suitable model for good decision making within the business.

The robustness of the decision making process can be improved by moving towards a more quantitative process rather than a qualitative process:

• The driver for a project needs to be robust and linked directly to meeting strategic service level

SKM_FINAL REPORT _26 Jan 2014_Rev E_Final_Redac!ed docx PAGE~

Essential Energy


SRCUllUllMTM<U January 2014

_DM

targets and reliability. [NB: These targets should all be documented and board level approved within Essential Water's strategic plan.].

• The service level and reliability targets need to be quantitative and explicitly adopted -with the distinction between mandatory and "discretionary'' targets made clear ..

• Risk assessment needs to be measured against these quantitative targets.

• Options assessments within the business case needs to be to be measured against these quantitative targets and also be based on an NPV assessment and supported by a triple bottom line assessment.

Overall water supply and security strategy and critical water assets - Information was sought from Essential Water on this strategy and how Essential Water's decision-making takes account of

o The fundamental nature of the water supply system (with one major supply source and reservoir - with dependent assets - and two lesser sources of water, and one major water treatment plant);

a Risk (to supply etc.)

o How this is efficiently managed through asset replacement, asset refurbishment and other management options (e.g. contingency plans).

Essential Water has prioritised water supply assets criticality by identifying the critical assets in the water supply system from source to consumer. Essential Water's has noted that its arid climate and reliance on key assets means the water supply and security cannot be compromised.

Essential Water has a critical assets register for water supply which identifies the risk for each asset the consequences and likelihood of the risk at a semi-quantitative level. There is a control allocated to each asset depending of the criticality of the asset which provides a management or maintenance strategy for each asset. As indicated in Section 6 the definition and structure of critical assets, the asset categorisation, their formal adoption and use to robustly define drivers for a project(s) is a work in progress.

Assessment

The critical assets register (from source to consumer) to assess the criticality of each component within the water supply system and allocation of a management method seems suitable for asset management but is an early stage of development. Essential Water intends to build on this and make it more robust during the next regulatory period.

Such a formally defined critical assets register does not currently exist for sewerage system assets but Essential Water intends to develop one. This would improve sewerage system asset management.

Project prioritisation process: Information was sought on how project prioritisation processes and decision-making operate within Essential Water in a capital rationed environment {using as an example the group of projects put forward as part this regulatory Water Plan). Essential Water has indicated that:

• The project weightings determine the priority order (qualitative level);

SKM_RNAL REPORT_26 Jan 2014_Rev E_F1nal_Redacl.ed doc:x PAGE 65

Essential Energy


""'-'" .. ""'M'"' January 2014

_DM

• The water business does not prepare a formal asset risk register, nor an annual "State of the Assets" report from which asset performance gaps would be evident or could be derived. The water business is a small operation and does not have the resources to pull together a formal report of this nature. However, a general report on the state of the major pipelines is prepared each year.

• The water business instead identifies other new projects through the status reports from the MAINPAC system and from site inspections. Projects are then prioritised using weightings against relevant criteria (aligned to Corporate Strategy) to ensure an appropriate corporate fit. This is discussed in more detail in Section 7.1 of Essential Water's !PART submission.

Assessment

The robustness of the decision making process can be improved by moving towards weightings that are quantitative rather than qualitative.

Other potential drivers of capex: Essential Water has confirmed that none of the capital projects proposed for the period are driven by a need:

• to increase asset capacity (e.g. pipes, plants); or

• upgrade the quality of water supplied to customers; or

• upgrade treated wastewater effluent quality discharged.

Assessment

The assessment of individual projects appears consistent with the advice that none of the projects identified are based on increasing capacity or improving quality (potable water, treated effluent).

The projects assessed in the capital works program are either driven by compliance or replacements/ refurbishments to reduce maintenance costs or replacement of assets that are damaged or at their end of useful life.

Capex /Opex trade-offs: Information and some general commentary on Capex /Opex trade-offs (including over time) in support of efficient business decisions and impacts on service provision was sought from Essential Water.

Essential Water has advised that most of its proposed projects (other than those indicated in Section 3.6) will not necessarily result in an obvious Capex/Opex trade-off over the next regulatory period. This is because of the age of the Broken Hill assets. If Essential Water was able to upgrade and/or replace all of its aged assets, then there would be a trade-off as modern machinery tends to be more efficient and reliable, spare parts are readi ly available and many tasks are automated. In the absence of this option, there continues to be a significant amount of operating expenditure required to maintain the aged assets.

Having said this, Essential Water has built significant cost savings into its forecasts for the next regulatory period, including a reduction of six FTEs. Over time as more of Essential Water's assets are replaced it is expected that some more trade-offs could be made especially as opportunities arise to reduce FTE's if with greater automation.

SKM_RNAL REPORT_26 Jan 2014.Rev E_F1nal_Redac!ed docx PAGE 66

Essential Energy


Sl"1.All U ll MT M'"1 January 2014

_DM

Assessment

SKM considers that there are opportunities to drive some lower opex with some of the future capex initiatives but that these will be limited as the greatest single driver of works and expenditure is asset condition.

Replacement of reticulation pipelines (sewer and water}, pipeline repairs and replacements such as Umberumberka and Menindee pipelines, the SCADA system upgrade have all been justified on the basis of reducing Opex and these need to be captured within Opex savings (Section 3.6).

Maintenance costs needs to be monitored closely over the next regulatory period to determine whether the level of capital spending on assets such as the reticulation pipelines can be reduced, maintained or needs to be increased.

"Core" underlying Capex: The underlying core Capex mainly relates to mains replacements. Other major works are generally contracted out.

Assessment

Essential Water is starting a program of mains replacement for sewer and water reticulation and several of the larger transfer mains are aging and are nominated to be replaced over the next 23 years under the remaining part of the 30 year asset management plan.

Sewer and water pump station works have been part of the funds spent in the current regulatory period and are part of the proposed regulatory period.

Essential Water has also proposed Dams works and an assessment of the regulatory requirements is to be undertaken annually from the proposed regulatory period onwards.

In the previous period there were funds allocated to miscellaneous works. The majority of these allocated funds were not spent according to the breakdown of costs for the previous regulatory period. The reasons for this are unclear.

In this next regulatory period Essential Water has included these miscellaneous works under Project 20 and 22. As these funds were not spent in the previous regulatory period it is not considered "coren Capex. SKM considers that it is reasonable to anticipate some level of unexpected emergency replacements, but this should be based on historical performance, experience with other similar asset and an efficiency driver as move towards more proactive asset management driving costs down overall.

SKM_RNAL REPORT _26 Jan 2014_Rev E_F1nal_Redacl.ed docx PAGE 67

Essential Energy


SRCU ll U ll MT M<U January 2014

_DM 3.3.3. Essential Water - historical capex performance (current regulatory period)

The capital program during the period 2010/11 to 2012/13 has been analysed to assist in providing recommendations for the 2014/15 to 2017/18 regulatory period. The actual historical capital expenditure over the three years from 2010/11 to 2012/13 (budget and actual) is shown is Table 9 and Figure 6.

• Table 9 Historical capital expenditure - Essential Water actual performance

Historical costs $2014 ($,000)

Service 2010-11 2011-12 2012-13 2010-11 2011-12 2012-13

Budget Budget Budget Actual Actual Actual

Water 3,170 5,215 5,237 5,665 3,137 3,516

Sewerage 696 2,859 2,807 1,990 1,362 2,005

Total 3,866 8,074 8,044 7,654 4,498 5,520

• Figure 6 Historical capital expenditure - Essential Water actual performance

5,000

~ 4,000

~ 3,000 x cu Q,

~ 2,000

1,000

0

Historical costs $2014

2010-11 2011-12

Financial Year

2012-13

• Wate r - budgeted

Water - Actual

• Sewerage - Budgeted

• Sewerage - Actual

The actual average annual spend for water services was $4.106 m p.a. compared with a budget of $4.541 m p.a.; for sewerage services the actual average annual spend was $1. 785 m p.a. compared with a budget of $2.121 m per year. Overall the actual average spend was $5.891 m p.a. compared with a budget of $6.661 mp.a.

Essential Water's actual capital expenditure for the three year period 2010/11to2012/13 was $17,673,000 ($2014) compared with the budgeted amount $19,984,000 ($2014).

The actual average annual spend over the three year period 2010/11 to 201 2/13 is $770,000 ($2014) per year lower than the budgeted average annual spend over the same period. The proposed budgeted average annual spend over the 6 year period 2013/14 to 2018/19 is $6,014,000 ($2014) p.a. higher than the actual average annual spend over the three year period 2010/11to2012/1 3.

SKM_RNAL REPORT_26 Jan 2014_Rev E_F1nal_Redacl.ed docx PAGE 68

Essential Energy


. .. cu .... ,.., Mm January 2014

_DM

The following observations have been made using information provided at Table 9, Figure 6 and Table 10 and also in the Review of Country Energy's Water Business (Broken Hill) Advice on Capital Expenditure (Halcrow, 2009). For the 3 year comparison between budgeted amount vs. actual spend, it is evident that:

• Overall Essential Water has spent less than the budgeted amount for the current regulatory period, although reprioritisation of works has occurred during the course of the current regulatory period. This has resulted in several projects which were part of the capital program not being completed and other projects not identified in the plan being completed.

• There have been several projects which were included in the capital program which have not been completed in the regulatory period.

o Mica St WTP No. 1 tank replacement - No spend FY11-13.

o Menindee to Stephens Creek pipeline replacement- No spend FY11-13.

o Wills St Wastewater treatment plant refurbishment - $2.SM spend FY11-13.

• There have been projects which were not included in the capital program however have been completed in the regulatory period with significant expenditure including:

o Water reticulation and mains- $4.6M spend FY11-13.

o Sewer reticulation and mains - $640k spend FY11-13

o Sewer pump stations -$1.35M spend FY11-13

Essential Water has advised that the variance between planned expenditure and actual expenditure in the current regulatory period (FY11-FY14) was related to:

• Its Capex program for this regulatory period being based on a strategy that involved mainly replacing major assets.

• IPART's determination proposing moving to a refurbishment strategy for some major projects.

• This prompted a review and further analysis of these projects. This combined with unplanned emerging issues requiring immediate attention from Dam Safety Committee meant that Capex was relatively low and not necessarily spent as implied in the determination. Essential Water is now in a position to deliver the program based on these further studies and options work.

Assessment

The Wills Street Wastewater Treatment Plant refurbishment was not completed as planned as Essential Water determined that replacing the existing plant was not the most suitable option.

There has been a reprioritisation of projects since the pricing determination for the current regulatory period. Partly this is based on emerging issues however the change in decision to replace the Wills St WWTP rather than refurbish cannot be attributed to this. The conclusion from these observations is that there were business decisions in the previous planning period that were not prudent (at the time) or then efficient.

Observations from the planning undertaken for the proposed capital program signals that the approach outlined in the asset management plan is not being fully implemented and decision making is based heavily on qualitative criteria.

SKM_RNAL REPORT_26 Jan 2014_Rev E_Final_Redacl.ed docx PAGE 69

Sfl!llCUll llllNT MUU

_BM

Essential Energy


January 2014

Ensuring the asset management plan is followed for each project and moving towards a quantitative approach is likely to lead to less changes resulting from emerging "surprises" follow ing the capital program approval. However SKM considers that there is still some "rubberiness" in the overall capex numbers.

• Table 10 Capital Expenditure from FY11-FY14 regulatory period (Appendix C - Essential Water submission to IPART)

Fln:incllll year onds I

SOOD Nominal

Warw

R05ervo1rs:tank11 Mica StrHt wlll•r lnlatmenl p111111 No 1 t1tnll replllce~m Other Tolal nu;e~nks

Ma1n1

Retll:IJllLion

Pipelines

4'ot11t>dael0 S#eph{/ns C.'HA pipellf)(J l'fl~/flfl(l(

Umbllrun1b4Jrlc11 pipeline rep/'11cemtH11

OlhtH

Pump WlllOO:I

water ueaunem pi.ants

~~ ==:::=;;:

TolalwMel'

~

Pl.Imp SlatlOn&

Rettculabon

se-rage lnlatmefll plants

Wlll!I Strllel .StWf',. i'9elm!tnl plalll replacefllelll

Otllet

Total 4ewef1191! lrea!m*"ll plants

MiscetlallllOOfa

TollllMWer9fe

Toltil

2D1t

!PART Actval

0 0 Ui96 8 2656 0

nla 624 n/9 274 nla 274

f\/a 624 2,596 281 2 ,656 274

n/8 i.070 n/11 929 f\/e 3 rV8 69l n/e 322 f\/a 1,562

I 1.221 0 1.263 0 1283 0

239 75 248 5.% 252 270

nla 671 n/a 21 nla 6

1.'60 646 1,15!0 606 1,534 217

"'" 959 n/a 583 fl/a ).058

r\/a 1.264 nla 285 nla 239

1.481 , 906 9 90" 8

2,M1 5.25& 5,013 3,015 5,0M 3,420

n/11 0 f\/a 169 n/a 0

n/a 532 f\/e 150 rVll 665

r\/11 3 lll'B 246 n/a 222

205 , 713 7.543 6117 2 603 910

nla 20 Ml II" I tW g(J

205 1 293 2,543 730 2603 1,009

441 t7 205 14 129 55

141 1,146 2,741 1.309 2,731 1.HO

7, 102 7,761 4.324 - - - - -

3.3.4. Outcomes of the general assessment of capital program

$,252

nl•

5.252

0

rn

!,717

.,,, nl•

4,505

nla

nl•

3.291

13,NI

nl•

nt•

nl•

IU5f

0

5,351

ns G,121

• f ,f72

1,179

2.002 2,517

0

.,, 5tl

1.m 2,IOO

1.711

11

11,812

119

1.347

471

Z..8'0

102

3,032 .. 5,1CM

•l·Bll

The outcomes of the general assessment of the capital program (based on all the information in Sections 3.3.1 to Section 3.3.3) are summarised in Table 11.

SKM_RNAL REPORT _26 Jan 2014_Re~ E_Final_Redac!ed docx PAGE70

Esse

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Proj

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3.4. Overall recommended adjustment to capital program This section provides an overall summary and recommendation on the prudent and efficient capital expenditure for the whole of Essential Water’s capital program from 2014/15 to 2017/18. This is based on the detailed assessment of selected projects from Section 3.2 and the general assessment of Essential Water’s capital program in Section 3.3.

The outcomes of the detailed assessment of the ten (10) selected projects has resulted in the forecasted spend over the four year regulatory period from 2014/15 to 2017/18 being recommended to be reduced by a total of $7,837,000 ($2014 including corporate overheads) to $28,250,000 ($2014) from the original budget of $36,087,000 ($2014) which represents an reduction of 21.7% for the 10 projects.

The outcomes of the general assessment of the remaining eleven (11) projects in the capital program has resulted in the recommended forecast spend over the four year regulatory period from 2014/15 to 2017/18 being reduced by a total of $1,562,000 ($2014 including corporate overheads) to $14,548,000 ($2014) from the original budget of $16,110,000 ($2014) which represents an reduction of 9.7% for the 11 projects.

The assessment of the capital program has resulted in the recommended forecast spend over the four year regulatory period from 2014/15 to 2017/18 being reduced by a total of $9,399,000 ($2014 including corporate overheads) to $42,798,000 ($2014) from the proposed budget of $52,197,000 ($2014). This represents an overall reduction of 18%.

Table 12 provides a summary of the recommended adjustments to Essential Water’s capital program for the period 2013/14 (FY2014) to 2018/19 (FY2019) including the four regulatory period (FY2015 to FY2018).

Table 12 Summary of recommended adjustment to capital program

2013/14 2014/15 2015/16 2016/17 2017/18 2018/19Total

FY15-FY18Overhead amount 20% 19.50% 19% 18.50% 18% 17.50% -

Essential Energy's proposal $000's ($2014)Water $3,922 $10,017 $11,447 $6,249 $8,348 $9,145 $36,061Wastewater $543 $1,789 $1,530 $1,598 $2,521 $2,418 $7,437Corporate $893 $2,361 $2,595 $1,569 $2,174 $2,312 $8,699Total $5,357 $14,166 $15,572 $9,415 $13,043 $13,875 $52,197Change to Essential Energy's proposal $000's ($2014)Water -$1,525 -$4,823 -$6,731 $2,772 $3,255 $235 -$5,526Wastewater $0 -$583 -$372 -$422 -$498 -$152 -$1,876Corporate -$305 -$1,113 -$1,479 $317 $279 -$275 -$1,997Total -$1,830 -$6,519 -$8,583 $2,668 $3,036 -$192 -$9,399Recommended prudent and efficient capital expenditure $000's ($2014)Water $2,397 $5,194 $4,716 $9,021 $11,604 $9,379 $30,534Wastewater $543 $1,205 $1,157 $1,176 $2,022 $2,266 $5,561Corporate $588 $1,248 $1,116 $1,886 $2,453 $2,038 $6,703Total $3,528 $7,647 $6,989 $12,083 $16,079 $13,683 $42,798

Regulatory Period FY15-FY18)

Essential Energy


''"' .. " •• ,..,Mm January 2014

__DM This is also shown graphically in Figure 7. The capital program adjustment has resulted in a significant reduction in capital spend in the first two years of the regulatory period and an increased spend in the third and fourth (final} years of the regulatory period. In the two years either side of the regulatory period there is a reduction in the 2013/14 year and approximately the same spend proposed in the 2018/19 year.

• Figure 7 Summary of overall recommended adjustment to EE's capital program (all projects)

Overall Capital Program 20,000

8 0 15,000 ~

o:I" Pol 10,000 0 N 11\-)( GI a. 5,000 ra u

2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19

Financial Year

• Historical and proposed capital progra m • Recommended adjustme nt t o capital program

A detailed breakdown of the recommended adjustments for each project in the capital program for each year of the regulatory period is shown in Table 13. In summary all projects have been kept in the capital program, but with adjustment to timing and cost as highlighted in mustard/orange colour.

3.5. Improvements to Capital program planning process

Essential Water's planning process for the capital program could be improved to strengthen the robustness of their decision-making processes to support demonstration of the prudency and efficiency of its capital expenditure.

Based on the information provided by Essential Water for assessment of the capital program, the following observations have been made regarding the proposed capital program (FY15-FY18):

• The detailed assessments highlight that the approach for planning of the capital program outlined in Essential Water's Water Asset Management Plan is not being fully implemented for all projects.

• In some cases a risk based approach towards identifying the need for a project is not implemented. When a risk assessment is conducted, target objectives are generally qualitative rather than quantitative. In the strategy plan, generally there are only qualitative targets for service level and the reliability level of water and sewer assets which needs to be addressed.

SKM_RNAL REPORT _26 Jan 2014_Rev E_F1nal_Redact.ed docx PAGE73



In some cases options selection is not sufficiently comprehensive to identify (or document) all the broad reasonable and feasible potential options which may be able to meet the project need/driver and objectives.

In some cases concept designs have not yet been undertaken. Where there has been limited/no concept design completed, there is little opportunity to test the solutions ability to meet the objectives and functional requirements and gain confidence that the solution is achievable.

In some cases evidence of a basis for cost estimates are not provided. Best practice project cost estimation to ensure robustness would draw on various sources of information including engineering risk based cost estimates (e.g. RANE analysis, Monte Carlo analysis) conducted and examples of historical costs or benchmark costs to supplement and support engineering estimates. In particular one might expect P50 and P90 cost estimates to be included in investment cases.

There is limited evidence of an implementation plan including contingency plan and sensitivity analysis of project timing to address project risks and key dependencies. There is also limited evidence provided to show that a program of works is achievable.

The process of project prioritisation is qualitative and open to subjective interpretation which may mean that projects in the capital program are not prioritised appropriately and may lead to changing of priorities as has occurred in the current regulatory period.

In undertaking the above and the whole assessment in Section 3, it is acknowledged that Essential Water is a reasonably small water authority with limited funds and resources available. Given this and the observations from the current regulatory period and planning undertaken for this regulatory period, the approach outlined by Essential Water in the Water Asset Management Plan may need to be adjusted so that the approach is achievable.

The robustness of the decision making process can be improved by implementing a quantitative process rather than a qualitative process. A quantitative approach provides greater transparency and less subjectivity in the decision making.

Projects needs to be aligned with Essential Water’s strategic plan and use the approach outlined in the asset management plan.

The drivers/ objectives for a project need to be linked to meeting strategic service level and reliability targets. (These targets shall be documented and board level approved within Essential Water’s strategic plan).

The service level and reliability targets need to be specifically defined and measurable (quantitative).

Risk assessment needs to be measured against these quantitative targets and risk level consequence and likelihood given a measurable definition.

Options assessments within the business case needs to be to be measured against these quantitative targets and also be based on an NPV assessment.

Essential Water should complete for each project an implementation and contingency plan that outlines an achievable program and considers the constraints and risks.



January 2014

• Table 13 Recommended adjustment to capital program (all projects)

Actuals in Nominal and forecasts in Real 52014 Nominal Nominal Nominal 2014S

$'000 - Including Overheads Actual Actual Actual Forecast

WATER

Prcject 1: Stephoos Creek ElllefljellCy Pumping StatiOn (N0.41..M)

. St c all h 1·

Project 3: mperial Lake Reser.cir Dam Wall Retiabilitation

Projecis 4: Mica St Sen.ice Resenoir Replacement

Projects 5: Rocky Hill Sen.ice Res r

Project 6: Senice Reser.oirs - Ret.11t>ishment

Project 7: Menindee WlP Major Woos

Projeci a: Broken Hill RebculaliOO Replacement

Prcject 9: Reseooir General Woos

Project 10: Meniooee & Umberumberka Pipeline Repairs

Project 11: Water Pimping Station Rellrbtshment/Olerhauls

2: ia t s m

Project 19: SCADA & Telemetry UP!lrades

Project 18: Sunset Strip WTP - Potable Water Upgrade

t R I

Prcjecl 20: Other W Ollts

aWTOlml

SEWER

Project 13: Replacement or Wms St Waste Water Treatment Plant

Prcject 15: S~ Reticulation Repair

Project 16: Sewer Punp Station Rel.llt>ishmertlO..ertlauls

Project 21: South Waste Water Treatment Plant - Rellrbishment

Project 22: Other Works

OTM. C\PITAI.. WOlmS POl REGULATORY l&HllSllOll 1.&M 4,499 5,520

SKM_FINAL REPORT _2ti Jan 2014_Rev E_Final_Redacled doc.x

2014$ 2014 $ 2010 2010 2014$

Forecast Forecast Forecast Forecast Forecast TOTALS

1,6'1 &.• 12,Ul3 2t,at111 G.3 ~

PAGE 75

Essl'ntial Energy {Water)


""'-'" .. ""'M'"' January 2014

_BM

3.6. Broad Ranking of EW's Proposed Capital Projects

In broad terms all EW's capital projects are prudent, particularly given the state of EW's assets and the obligations being imposed on it.

However many (or most) projects are not efficient either because of one or more of the following -insufficient justification of timing of works as appropriate, insufficient justification of the specific works proposed in terms of drivers, options analysis lacks sufficient breadth and depth or works are proposed in the absence of an overall strategy without any integration or cohesive plan linking them (on a risk basis) to the risk management and customer service obligations.

SKM has prepared a table (refer Table 14) that presents a snapshot summary and broad overview and prioritisation of the projects proposed by Essential Water for the FY 15 - FY 18 regulatory period. This is based on a more general assessment against various criteria including of risk (e.g. safety, customer service water supply obligations), preparedness and ability to respond, value and efficiency and timing.

A broad prioritisation ranking of VH (Very High), H (High}, M (Medium) and Low (L) has been adopted.

SKM notes that the assessments of all projects (whether of the detailed nature or this high level overview) are on a sight unseen basis. The costs in Table 14 are DIRECT COSTS ONLY.

SKM's proposed revised timing of these is as reflected in Table 13 of this report. Generally it appears Essential Water's capital projects are not receiving the benefit in terms an efficient application of corporate costs for a large business such as Essential Energy.

• Table 14 Broad High Level Overview of Capital Project Prioritisation

Efficient Project

Project Brief Title Rank Amount Comments No.

$m real

WATER FY15/FY18

Only

WP1 Stephens Creek PS No 4

• Essential design, scoping and refurbishment works

VH • • Other works (redundancy) HIM -WP2 Stephens Ck Reservoir Dam - Unless mandated by NSW DSC defer rehabilitation works to next regulatory period. If mandated

• Essential design and scoping VH - would be "VH". Stephens Ck PS No 4

works and rehab works will have the ability to bypass the • Other works M - reservoir and pump directly to BH with

capacity to supply

WP3 Imperial Lake dam rehab works H/M - If clearer direction from NSW DSC this would be VH/H. Stephens Creek Reservoir should have a higher ranking

WP4 Mica St Res'voir No1 replac'ment

• Essential scoping/design wks VH • Other Works M


H IC:LAllUltMT!lllW

__DM

Essential Energy


January 2014

Project Project Brief Title

No.

WP5 Rocky Hill Service Reservoir Replacement

WP6 Service Reservoirs -Refurbishment

WP7 Menindee WTP Major Works

WPB Broken Hill water reticulation replacement works

WP9 Reservoir General Works

WP10 Major supply pipeline works

• Menindee main

• 'Umberumberka main

WP11 Water pump station refurbishment works

• Stephens Creek

• Other Pump stations

WP12 Mica St WTP Capital Works program

WP17 Stephens Creek to Mica St Rocla Pipeline Replacement

WP18 Sunset Strip WTP - Potable water upgrade

WP19 SCADA and telemetry upgrades

WP20 Other Works

SEWERAGE

SP13 Wills St. WWTP Replacement

SP15 Sewer reticulation repairs

SP16 Sewer Pump Station Refurbishment /overhauls

SP21 South WWTP refurbishment

SP22 Other Works

Rank

M

MIL

M

M

HIM

VH

HIM

HIM

M/L

M

L

L

M

M/L

HIM

M

HIM

L

M/L

SKM_FINAL REPORT _26 Jan 20H_Rev E_Final_Redactell docx

Efficient Amount Comments

$m real ---- It is easier and quicker to address local reticulation pipe failures and these are less critical to overall water supply reliability than a major pipeline failure. - Some rationalisation required. Some H (e.g. internal levees and pipes), some M. - Menindee: Most critical part of the water supply spine. Pipes & valves -safety issues, failure history, poor condition. Valves could be prioritised.

Umberumberka: Less critical than Menindee. Failure history, poor condition but less evidence. - Rationalisation with WP1 and WP9 also.

-• Being deferred. Problem understood to be joints, not pipe per se. ---- Has a clear licence obligation. but is only required later in FY15-FY18 -•

• -PAGEn



3.7. Long Term Capex Investment Strategy The following is a general statement and commentary on Essential Water’s capital investment strategy and linked strategic asset management approach.

Essential Water’s assets are generally characterised as being old and in poor condition (although this has not been robustly determined). All the projects are of importance but their timing could not confidently be said to be optimal. Some aspects of the projects proposed could be deferred at least (and/or perhaps avoided) if sound long term strategies (for all service objectives) were in place, an integrated risk based approach is pursued and prioritisation processes are in place.

The following general comments can be made on Essential Water’s capital investment strategy, acknowledging that Essential Water is a relatively small water utility and appears to have limited resources to deal with significant issues:

The capital investment strategy is very fluid and there does not appear to be a well-founded optimised long term investment plan in place. The long term strategies do not appear to be clear or well documented.

There is clearly unresolved “tension” between short term “must do” projects and formulating a solid longer term asset investment plan (of optimised projects). The focus is on the former and there seems little time for the latter to be robustly developed while attending to the former and in establishing how the former fits into the latter.

Essential Water’s risk assessment of its asset base and service delivery does not currently adequately or sufficiently inform its Long Term Planning. It has plenty of scope for improvement. For example, with respect to the Menindee and Umberumberka pipeline: o SKM understands that a presentation to IPART and Treasury in September 2012 proposed

replacement of the whole of the Menindee pipeline in 2029/2030 to 2033/2034 and the Umberumberka pipeline in 2037/20389 to 2039/2040.

o On the basis of the current regulatory submission, it appears that Essential Water’s strategy is to progressively replace significant “long” sections of the Menindee and Umberumberka pipelines concurrently such that over time the same outcome is achieved (i.e. effectively a whole new pipeline with an acceptable asset life restored).

o There seems limited documented information available and analysis to (a) support this as the optimal strategy (although prima facie it may well be), (b) to establish that it is optimal to progressively replace both pipelines concurrently (rather for example focussing preferentially on the Menindee pipeline over the Umberumberka pipeline), and (c) to establish what the optimal progressive rate of replacement and overall time frame for complete replacement should be informed by a risk based approach (especially to ensure an adequate and reliable water supply service to customers).

o In summary, there appears to have been (on the face of it) a change in tack but without sufficient supporting analysis (based on a quantitative risk based approach) where the optimum approach has been determined and justified linked to current rate of deterioration, current condition and consequences of “failure” (including impacts of varying extended periods of interruption to supply).



Another example appears to be that there is no cohesive overall optimised plan to address the various particular and related deficiencies of the Stephens Creek pump stations (as reflected in projects WP1, WP11 and WP12).

Similarly Essential Water does not have a satisfactorily clear framework supported by adequate documentation to distinguish between mandatory and discretionary expenditure. For example: o A sound framework does not appear to be in place to effectively and efficiently distinguish

and prioritise within and between projects which have a safety component (e.g. the Stephens Creek Reservoir and Imperial Lake rehabilitation projects) on the one hand and asset risks which could have a material impact on customer service obligations (e.g. continued safe and reliable operation of the Menindee pipeline in supplying water to the Stephens Creek Reservoir and Broken Hill customers). It is clear in both cases that there are deficiencies that need to be remedied.

o The relative consequences of “failure” have not been robustly assessed, tested and/or documented to establish the respective merits of projects competing for capital. This includes better identification of the consequences of a failure event and the consequential likelihood of the impact of failure impacting others (e.g. cars on highways) – i.e. not only the likelihood of the failure event itself – and hence the overall risk (the product of the two).

Better identification of the consequences of a failure event would include developing, testing and costing of alternatives to reduce the consequences of failure and to mitigate the overall risk (on which the respective projects are founded). This would include more clearly identifying the consequences of failure and hence overall risk (in the case of say Imperial Lake dam failure whether to the highway or households subject to inundation) and the options to eliminate/reduce/mitigate the consequences of failure and hence overall risk (e.g. by purchasing properties and hence risk to life, managing the highway through warning systems, through increased asset inspection frequencies and more robust contingency plans).

o The obligations imposed on Essential Water by the NSW Dams Safety Committee (DSC) for the Stephens Creek Reservoir and Imperial Lake rehabilitation projects are imprecise. There is sufficient documentation that makes clear what the various aspects of safety to be addressed are and the broad remedial works required for both the Stephens Creek Reservoir and the Imperial Lake dam. However there is no clear indication of the timing for these works nor an explicit direction from the NSW DSC (and therefore to that extent there is some flexibility in meeting these obligations and/or at least imprecision as to what extent these are “mandatory” obligations).

Only one document sighted (a letter from the NSW DSC to Essential Water dated 9 August 2010) comes close to providing Essential Water with a clear direction on timing (in which Essential Water is advised that if it does respond satisfactorily to identifying remedial actions it would be issued with a Section 18 notice to make the dam safe by 30 September 2011). Since then there has been much correspondence between Essential Water and the NSW DSC and initiatives undertaken by Essential Water to respond to the NSW DSC’s demands but no further clarity on timing of remedial works in the case of either reservoir/dam.

o Further the NSW DSC appears to have focussed more on Imperial Lake (from a safety viewpoint) whereas from a customer service viewpoint the Menindee pipeline and the



Stephens Creek Reservoir would appear to be more important overall to Broken Hill from a broader water supply viewpoint. That is a process does not appear to be in place for resolving these competing objectives.

o Overall, it would seem to be helpful to Essential Water and prudent for the NSW DSC (without any diminution of Essential Water’s accountability) to provide guidance and desirably direction to Essential Water on these matters. This would assist Essential Water’s decision-making and prioritisation processes and in making judgements on how it best meets the broad sweep of all its obligations. This could include a more comprehensive risk assessment by both Essential Water and the NSW DSC taking into account the timing of the works, risk mitigation expectations and the impacts if actions on remedial works are delayed and what shorter term risk mitigation measures might need to be in place.

In summary: o There is a real risk that the lowest NPC of Essential Water meeting its service obligations

is not met and/or that the risks to its service delivery and other obligations may also not be met.

o There is an impression that because EW is always dealing with short term matters or discrete issues that there is not an opportunity to get ahead of the game with some robust long term planning in place.

o It is recommended that Essential Water and the NSW DSC use the above dam remedial works project examples as a “test case” to establish how the general processes around specifying the utility (water) obligations and their prioritisation might be improved and in particular in Essential Water’s case to urgently clarify what aspects of Essential Water’s obligations for remedial works are mandatory and what aspects might be “discretionary”.

There are also a range of other matters and examples that support the above. These include:

There are a number of projects (e.g. WP2, WP3 and WP11) which are all dependent on favourable weather conditions for the works to proceed and for the expenditure to occur. If these conditions do not materialise then expenditure could be low and substantial shortfalls compared with the budgets sought would occur.

It would seem prudent in such circumstances for Essential Water to take an objective view of the program as a whole (as distinct from an assessment of individual projects) and also justify the reasonableness of the funds for the whole regulatory period on a probabilistic view. This could be achieved by using a Monte Carlo technique, risk adjusted process (e.g. RANE) or similar for the program as a whole and for individual projects in particular. There does not appear to be evidence of Essential Water undertaking either of these.

Inter-temporal aspects (putting aside the technical aspects): Essential Water appears to have shifted to better considering and achieving this but there is little by way of supporting information or justification. The current projects are generally consistent with a long term plan but the timing does not appear optimised and the efficiency of delivery of projects over time is not well demonstrated.



An increased capital program is proposed for this regulatory period but there seems to be an opportunity for “smoothing” the program, after adjustments proposed by SKM for the capital program while still addressing the high short term risks.

With improvements to current asset management practices and decision-making processes (including prioritisation processes both within aspects of individual projects but particularly between projects) a sounder longer term plan could be developed and greater confidence derived that the projects being proposed are optimal over time. Some of the future projects (e.g. Menindee pipeline) may be more important than some current projects or aspects of them (e.g. reticulation works or even the Stephens Creek dam rehabilitation).

In summary from a strategic review of EW’s long term investment plans SKM broadly considers that:

An overall strategic approach is missing. For example, why would the spine of the system (Menindee pipeline, intermediate booster pump stations, the Stephens Creek reservoir and possibly the Wills St water treatment plant) not be targeted as a priority for restoration to “good condition” and as the primary focus for ensuring water supply reliability in the long term as compared with a range of “ad-hoc” and “small” projects? At the moment everything seems to be “important”. A robust long term strategy, effective prioritisation processes and a transition strategy (from the current approach to a more robust longer term approach) seems to be missing and is desperately needed.

Similarly there could be more effective prioritisation between the Menindee and Umberumberka pipelines risks (and the associated enhancements/replacement works) and between the Stephens Creek Reservoir and Imperial Lake dam risks (and the associated rehabilitation works).

The projects proposed by EW for the next four years broadly have a short to medium term focus although they are broadly consistent with a longer term plan (when this is documented). Projects proposed are broadly consistent with the long term business need to manage risks (safety, customer service etc.) though it seems clear that an optimised Long Term Capital Investment Strategy is not yet in place

o the long term program (to the extent that it exists) is more qualitative and subjective at present;

o the current decision-making is reasonably sound but will be significantly enhanced when the asset management systems (and improvements to them) that EW has commenced to (or will in future) implement. In future it is expected that decision-making will be more explicitly, quantitatively and objectively based on asset condition, consequences and risk, than at present (although is undertaken to a limited extent now).

o Regardless, EE does not appear to have explicitly or robustly

a. prioritised its projects using effective and objective qualitative or quantitative processes (the “traffic light” presented is inadequate for this purpose);

b. considered the trade-offs between customer service obligations against other obligations



c. considered the inter-temporal implications of current asset management systems and practices based on asset condition, consequences of failure and risk to produce a sound long term plan of proactive asset management with a mix of operational maintenance and capital improvement initiatives.

SKM strongly recommends that there be more rigorous risk based justification of all projects linked with clearer risk based decision-making and prioritisation processes. There needs to be stronger clarity, definition and linkages in the “end-to-end” justification of the merits of projects and the associated expenditure (from drivers and objectives identification, assessment of current performance, identification of shortcomings, risk based decision-making and prioritisation processes, assessment of a wider suite of solution options, identification of most efficient option and associated expenditure, timing and deliverability assessment).

It is important that EW continues to address its risks progressively and address the highest risks in the short term, and that these be adequately funded, even though that might not be the most efficient means to do so. However the expectation would be that Essential Water would by the next regulatory period have an optimised Long Term Capital Investment Strategy in place which is driven by a robust and rigorous risk based approach.

Mandatory and Discretionary Expenditure

EE identifies drivers for individual projects but the objectives and precision on the benefits are less clearly defined. There is significant scope to place these in a better framework for decision making where objectives that flow from these drivers are clearly defined and an assessment of whether these are Mandatory (safety, service obligations, environmental/operating licence obligations, statutory obligations) or Discretionary (based on a sound risk based decision processes, economic benefits).

There appears to be limited consideration and/or documentation of mandatory versus discretionary drivers and little quantitative assessment of the impacts on objectives and expenditure in deferring works or meeting a regulators objective at a lower cost (e.g. mitigating the consequences of a dam failure by buying out properties in the floodplain).

EW is on an improvement journey with significant scope for improvement.



4. Operating Expenditure Review 4.1. Context

The population trend indicates that the resident numbers in Broken Hill are decreasing, as shown in Figure 8 (and Figure 3.1 of EE’s submission) while household numbers appear to be increasing (fewer persons per household). Essential Water has forecast that overall volumes of water supplied and sewage treated will change little overall. While this assumption seems reasonable, with the most likely future impact being climate change placing pressure on per household usage, experience in the last 4 years has shown a different picture.

Actual treated water sales have been lower than the expected volumes for the previous period. The IPART determined sales and actual results are summarised in Table 4-3 of EE’s submission, with lower sales particularly evident for residential customers. However it is also evident that both residential and water sales have increased overall and from year to year during the current regulatory period.

This lower than anticipated residential water consumption over the previous regulatory period compared to the regulatory allowance is directly attributable to:

Substantially higher rainfall over the summer months for the three years of the previous regulatory period than for the preceding nine years (as shown in Figure 4-1 of EE’s submission); and

The continuing decline in population which is lowering average household consumption level.

Figure 8: Historical population trend in Broken Hill

Estimated water volumes and billable sewage volumes have been provided in EE’s submission (at Table 11-1) and in its AIR Information return to IPART. In summary, these broadly indicate that EE has assumed that water volumes will decrease slightly over FY15-FY18 and sewage volumes will remain static.



Overall, SKM considers that the assumption of:

somewhat constant or slightly declining water volumes supplied seems reasonable (with greater variability likely dependent on climatic conditions); but

constant sewage volumes is not reasonable. Experience suggests that sewage volumes are more likely to be linked with population numbers than household numbers. Consequently, as population numbers have been declining at approximately 1% p.a. over the last 5 years (and are predicted to continue to decline), the sewage volumes on which costs are based should also reflect a decline of approximately 1% p.a.

4.2. Overview of Historical and proposed opex for 2014/15 to 2017/18

EE’s historical actual opex (FY2011 to FY2013), current budgeted opex (FY2014) and proposed future opex for the next regulatory period (FY2015 to FY2018) – all in real $ - as per EE’s regulatory submission (at Figure 6.1) is shown in Figure 9.

Figure 9: EE historical, current year and future years opex profile

Some observations are that Essential Water’s:

Regulatory opex approved by IPART for the current regulatory period has been exceeded in each year, largely due to the “over-expenditure” / “over-allocation” of corporate overheads.

Proposed regulatory opex for the next regulatory period is proposed to be effectively constant in real terms, approximately the same as approved for the FY2013 year.

Fixed allocation of corporate overhead cost of 20%, means that the aggregate direct opex (water plus sewerage) is also proposed to be effectively constant in real terms.

A base year is selected as a starting point upon which to base future opex forecasts. In choosing a base year, the year needs to reflect a relevant and justifiable starting point. Normally this would be the most recent year for which financially audited accounts are available.



Essential Water has selected FY2013 Actuals as the base year from which to base projections of future opex because it considers that:

FY2013 is the most recent full year of actual values.

SKM notes that EE has advised it that the FY2013 Actuals (as presented in EE’s submission) have been approved by its Board (in September 2013) and now represent the most recent financial year’s audited account numbers. This being the case SKM is satisfied that this is an appropriate base subject to some review of the significant movements (especially increases) in opex line items during FY2013 from FY2012 numbers.

It reflects savings initiated by the formation of Networks New South Wales (NNSW) and is a relatively efficient base to start from.

EE considers that the FY2013 base year already includes a large number of savings initiatives and cost reduction measures arising through the formation of Networks New South Wales and the resulting restructure within Essential Energy. These savings have led to reduced overhead rates (refer Section 4.3 ) and, when combined with an increased level of capital expenditure, mean that operating costs are forecast to remain fairly flat in real terms over the next five years. Refer Table 16 (and also Figure 6-1 in EE’s submission).

SKM has commented on the capex-opex interaction in later sections and the impact of corporate overheads allocated from EE to the EW business.

Opex is trending down from prior years indicating an appropriate starting point.

SKM notes that this trend does continue during this regulatory period but “stabilises” or there is no additional real productivity savings generated after FY2013 and there is no significant new facilities being installed or to be managed.

The level of FTEs remains relatively consistent from FY13 to FY14 (less than 1 FTE difference). Previous years have higher levels of FTE.

Essential Water has advised that following assumptions and step changes from the FY13 base year into the FY2015 to FY2018 regulatory period:

All costs are uplifted by CPI in nominal $ (2.5% p.a.) but are constant in FY2014 dollars.

The overarching assumption is to keep Opex flat in real terms for the next regulatory period because:

o Standard year on year real wages increases have not been factored into the forecast. Any real wage increases will be offset by productivity and efficiency gains driven by NNSW savings initiatives and repairs and maintenance savings as a result of replacement Capex programs. This implies that productivity and efficiency targets of approximately three per cent year on year are factored into the forecast.

SKM notes that this does not really reflect bona-fide productivity savings that benefit customers unless it can be concurrently demonstrated that there is an enhanced service (or equivalent) associated with this. Absorption of wage or salary increases above CPI is not per se a productivity improvement.



o Other Opex cost components are relatively fixed in nature and required to operate the business and maintain current levels of service. These costs have been held flat in real terms in the forecast. Although these costs are held flat for forecasting; in order to offset the standard wage increases, it will be this area that the productivity and efficiency gains are to be actually realised.

There is a step change from the base year in relation to FTEs. FTE numbers are decreasing due to natural attrition and not being replaced in positions where efficiencies have been identified. The savings from the reduction of 6 FTEs are factored into the forecast.

A further step change is included in the opex forecast for increased electricity costs due to increased volumes of water being pumped along the 116 kilometre Menindee pipeline. In eight out of every ten years, water has to be pumped from Menindee lakes. Despite the rains of recent years, the storages closer to town are depleting and a typical dry period is expected for the next regulatory period. The increase is a step change from the base year of $165k to align the forecast with a typical year of pumping water from Menindee. The forecast is kept at this level for all years in the next regulatory period.

A summary of EW’s proposed Opex for the regulatory period (and one year either side of it) is provided in Table 15. This provides context for the following more detailed tables that provide a breakdown of the opex by function and by line item – as shown in Table 16 (also refer Table 6.1 in EE’s submission) and Table 17 respectively.

SKM notes that for all the Opex tables throughout Section 4 of this report, the opex costs for “effluent” have been included in the Sewerage Opex – not in water Opex – for the reasons indicated in Section 1.2.3, namely that these costs are primarily incurred for sewage treatment rather than for production of alternative water (for re-use). This is more appropriate and to this extent differs from EW’s AIR return which still has effluent production costs in Water Opex.

Table 15 Summary of Essential Water’s Opex: Water/sewerage/corporate for FY14-FY19

Total Regulatory

Opex FY2015-FY2018

2013/2014 2014/2015 2015/2016 2016/2017 2018/2018 2018/2019

10,212 9,188 9,128 9,322 9,121 9,082 36,759

2,292 2,494 2,478 2,564 2,510 2,498 10,046

2,501 2,382 2,373 2,436 2,387 2,384 9,578

15,005 14,064 13,979 14,322 14,018 13,964 56,383

Opex Item



Water

Sewerage

Corporate

Total



Table 16: Essential Water’s operating expenditure breakdown by ‘Function’

Note: opex costs for “effluent” have been included in the Sewerage Opex – not in water Opex.

Financial year ending 30 June 2013 2014 2015 2016 2017 2018 2019Unit Actual

Water - treated, chlorinated, untreated, treated effluent

Installation Inspection $000 - - - - - - - Quality of Supply Invest Stds $000 - - - - - - - Reservoirs $000 325 341 307 305 311 304 303 Water Pipelines $000 305 319 287 285 292 285 284 Water Pumping Stations $000 2,681 2,810 2,528 2,512 2,565 2,510 2,499 Water Reticulation $000 2,436 2,553 2,297 2,282 2,330 2,280 2,270 Water Treatment Plant $000 3,998 4,190 3,769 3,745 3,824 3,742 3,726

-allocated proportion of Corporate $000 2,170 2,042 1,868 1,860 1,903 1,865 1,861

Total water operating expenditure $000 11,916 12,255 11,056 10,989 11,225 10,986 10,943 Sewerage

Sewerage/Effluent Mains $000 147 150 163 162 167 164 163 Sewer Pumping Stations $000 295 301 327 325 336 329 328 Sewer Reticulation $000 772 786 855 849 879 860 857 Sewer Treatment Plants $000 1,038 1,056 1,149 1,141 1,181 1,156 1,151

- sewerage reuse $000 - - - - - - - -allocated proportion of Corporate $000 503 458 515 514 533 523 523

Total sewerage operating expenditure $000 2,755 2,750 3,009 2,991 3,097 3,032 3,021

T otal water and sewerage business $000 14,671 15,005 14,065 13,980 14,323 14,019 13,964

Allocation of Water and Sewerage Business Costs by Function:Operating expenditureW ater % 81% 82% 79% 79% 78% 78% 78%Sewerage % 19% 18% 21% 21% 22% 22% 22%

Operating Expenditure of Water and Sewerage Business

Activities by Function (Actuals expressed in nominal $'000; projections in 2013/14 $'000)

FY YEAR

$Real FY2014

P ro jections



Table 17: Essential Water’s total operating expenditure breakdown by ‘Line Item’

Note: opex costs for “effluent” have been included in the Sewerage Opex – not in water Opex.

4.3. Assessment of Direct Opex

4.3.1. Comparison of Opex variances (year on year) It is more instructive to establish and assess the year on year variances (in real $2014) at both a “functional” level (refer Table 18) and at a “Line Item” level (Table 19) and ascertain the extent of the focus on productivity improvements. All differential opex is measured relative to the base year of FY2013 initially and then year on year (in $2014 real). Some observations include:

For direct water opex (excluding corporate overheads): o There is a substantial net reduction in FY2015 of $1,025k relative to FY2014. This is

largely due to a planned reduction in FTEs in FY2015 (72%) and to a lesser extent reduced materials (12%) and fleet costs (11%).

Financial year ending 30 June 2013 2014 2015 2016 2017 2018 2019Unit Actual

CorporateT otal C orporate O pex $000 2,673 2,501 2,383 2,374 2,436 2,389 2,384

Water - treated, chlorinated, untreated, treated effluentLabour (excl employee provisions) $000 5,914 6,197 5,460 5,425 5,538 5,419 5,396 Payments to associated unregulated (ie $000External consultants $000Hire & contract services $000 379 397 350 347 355 347 346 Bulk water purchases $000Materials $000 960 1,006 886 881 899 880 876 Energy $000 1,548 1,622 1,619 1,608 1,645 1,609 1,602 Licence fees $000Fleet $000 945 990 873 867 885 866 862 Allocated proportion of Corporate opex $000 2,170 2,042 1,868 1,860 1,903 1,865 1,861

Total Water Opex (incl'g corporate)$000 11,916 12,255 11,056 10,989 11,225 10,986 10,943

Sewerage Labour (excl employee provisions) $000 1,631 1,660 1,806 1,795 1,857 1,817 1,810 Payments to associated unregulated (ie non $000External consultants $000Hire & contract services $000 88 89 97 96 100 98 97 Materials $000 109 111 121 120 124 122 121 Energy $000 148 150 163 162 168 164 164 Licence fees $000Fleet $000 277 281 306 304 315 308 307 Allocated proportion of Corporate opex $000 503 458 515 514 533 523 523

Total Sewerage Opex (inl'g corp)$000 2,755 2,750 3,009 2,991 3,097 3,032 3,021

Net Essential Water O pex$000 15,005 14,065 13,980 14,323 14,019 13,964

P ro jections


Activities by Item (actual in nominal $'000; projections in

2013/14 $'000)

FY YEAR

$Real FY2014



o FY2014 has effectively the same real opex as FY2013 and thus is still an inflated base with which to compare, as no material productivity improvements occur until FY2015. Arguably the productivity improvements could have occurred earlier.

o Over the whole 4 year regulatory period there is a reduction in the opex base of approximately $1092k (or 10.7% real reduction). But most of this comes in the first year (FY2015) due to the labour savings. For FY2016 to FY2018, there is only a net further reduction in real costs of $67k in the base opex over the three years, i.e. there is little further net productivity improvement. There are various net increases in FY2017 in a small number of functional areas and line items (e.g. labour increase) which immediately decrease in the following FY2018 effectively for the same functional areas and line items.

For sewerage opex (excluding corporate overheads):

o There is an increase of approximately $217K p.a. in the opex base over the four year regulatory period representing an increase of approximately 9.5% or a real increase of approximately 2.5% p.a. Most of this increase ($202K p.a.) occurs in the first year of the four regulatory period (i.e. FY2015) and is driven by additional labour costs.

o In the period FY2016 to FY2018 there is effectively no productivity improvement.

Table 18 Essential Water’s differential operating expenditure breakdown by ‘Function’

Financial year ending 30 June 2014 2015 2016 2017 2018 2019

Water - treated, chlorinated, untreated, treated effluent

Installation Inspection $000Quality of Supply Invest Stds $000Reservoirs $000 7 -34 -2 6 -7 -1Water Pipelines $000 7 -32 -2 7 -7 -1Water Pumping Stations $000 61 -282 -16 53 -55 -11Water Reticulation $000 56 -256 -15 48 -50 -10Water Treatment Plant $000 92 -421 -24 79 -82 -16

-allocated proportion of Corporate $000 -182 -174 -8 43 -38 -4

Total water operating expenditure $000 42 -1,199 -67 236 -239 -43Sewerage

Sewerage/Effluent Mains $000 -1 13 -1 6 -4 -1Sewer Pumping Stations $000 -2 27 -2 11 -7 -1Sewer Reticulation $000 -6 69 -6 30 -19 -4Sewer Treatment Plants $000 -8 93 -7 40 -25 -5

- sewerage reuse $000 0 0 0 0 0 0-allocated proportion of Corporate $000 -57 57 -1 20 -10 0

Total sewerage operating expenditure $000

-74 259 -17 106 -65 -11

T otal water and sewerage business $000 -32 -940 -84 342 -304 -54


Activities by Function (Actuals expressed in nominal $'000; projections in 2013/14 $'000)

DIFFERENT IA L OPEXC omparison Real Year X vs Year (X -1)

Base Year - FY 2013 (latest A udited y ear)A ll $ in real FY2014



Table 19 Essential Water’s total differential operating expenditure breakdown by ‘Line Item’

General

o Energy prices are considered to increase at CPI (2.5%) or be flat in real terms over the regulatory period. Assuming a flat real increase in energy prices is a reasonable and conservative assumption.

o A small increase in electricity costs has been forecast, but this is due to a small increase in demand, not real price increases. Energy for water increases by approximately 1% p.a. real (although most of this occurs from FY13 to FY14), and for sewerage increase by approximately 1% p.a. real (with most of this occurring between FY15 and FY 2014).

Financial year ending 30 June 2014 2015 2016 2017 2018 2019Unit

CorporateT otal C orporate O pex $000 -239 -118 -9 63 -48 -5

Water - treated, chlorinated, untreated, treated effluentLabour (excl employee provisions) $000 136 -737 -35 113 -119 -23Payments to associated unregulated (ie $000 0 0 0 0 0External consultants $000 0 0 0 0 0Hire & contract services $000 9 -47 -2 7 -8 -1Bulk water purchases $000 0 0 0 0 0Materials $000 22 -120 -6 18 -19 -4Energy $000 35 -3 -11 36 -35 -7Licence fees $000 0 0 0 0 0Fleet $000 22 -118 -6 18 -19 -4Allocated proportion of Corporate opex $000 -182 -174 -8 43 -38 -4

Total Water Opex (incl'g corporate)$000

42 -1,199 -67 236 -239 -43

Sewerage 0 0 0 0 0 0Labour (excl employee provisions) $000 -12 146 -12 63 -40 -8Payments to associated unregulated (ie non $000 0 0 0 0 0 0External consultants $000 0 0 0 0 0 0Hire & contract services $000 -1 8 -1 3 -2 0Materials $000 -1 10 -1 4 -3 -1Energy $000 -1 13 -1 6 -4 -1Licence fees $000 0 0 0 0 0 0Fleet $000 -2 25 -2 11 -7 -1Allocated proportion of Corporate opex $000 -57 57 -1 20 -10 0

Total Sewerage Opex (inl'g corp)$000

-74 259 -17 106 -65 -11

Net Essential Water O pex$000

-32 -940 -84 342 -304 -54


Activities by Item (actual in nominal $'000; projections in

2013/14 $'000)

DIFFERENT IA L OPEXC omparison Real Year X vs Year (X -1)

Base Year - FY 2013 (latest A udited y ear)

Projections



o However there is no obvious reason for these increases in demand other than some small increase associated with the proposed Mica St WTP and Menindee WTP capex works. It is arguable that there should not be any increase at all or any real increases of this magnitude (as water demands are constant or in SKM’s view likely to decrease). This is also related to the likely decrease in in-house use and the fall in demand for sewage (where SKM considers that sewage volumes should decrease).

For corporate overheads: o There is a decrease in allocated corporate costs base in FY2014 and FY2015 mainly due

to the change to the new methodology but in the last three years of the regulatory period there is effectively no change in the allocated corporate costs base.

Other specific relevant information provided by Essential Water re opex trends includes:

The overarching assumption is to keep operating expenditure flat in real terms for the next regulatory period. The reasoning for this assumption are as follows:

o Essential Water has assumed that all costs (including materials, salaries and wages) underpinning both the capex and opex forecasts will remain constant, in real terms, throughout the proposed regulatory period. If any cost areas do increase by more than CPI, these increases will be offset by productivity improvements.

Standard year on year real wages increases have not been factored into the forecast. Wage increases will be offset by productivity and efficiency gains driven by NNSW (Network NSW) savings initiatives and repairs and maintenance savings as a result of replacement capital expenditure programs. This implies that productivity and efficiency targets of approximately three per cent year on year are factored into the forecast. Example, if salaries and wages increase by 2.7% pa (in nominal terms), and CPI is 2.5%, we are assuming productivity improvements of 0.2% pa to offset the real increase. Hence we have not factored any escalation rates into our forecasts.

Note: SKM considers that this is not a bona-fide productivity saving as nothing is captured to reduce operating expenditure as a result in real terms. Where such opportunities for productivity savings exist they should be captured regardless of real wages changes. Further in this particular case it is not evident what those specific savings are or in whatareas those productivity and efficiency gains are to be actually realised.

o Other operating cost components are relatively fixed in nature and required to operate the business and maintain current levels of service. These costs have been held flat in real terms in the forecast.

Note: SKM considers that there are specific opportunities for productivity improvement as discussed later.

There is a step change from the base year in relation to FTEs. FTE numbers are decreasing due to natural attrition and not being replaced in positions where efficiencies have been identified. The savings from the reduction of 6 FTEs are factored into the forecast.

Note: SKM notes that this is a once-off effect as noted above. Thereafter there is little change.



A further step change is included in the opex forecast for increased electricity costs due to increased volumes of water being pumped along the 116 kilometre Menindee pipeline. In eight out of every ten years, water has to be pumped from Menindee lakes. Despite the rains of recent years, the storages closer to town are depleting and a typical dry period is expected for the next regulatory period. The increase is a step change from the base year of $165k to align the forecast with a typical year of pumping water from Menindee. The forecast is kept at this level for all years in the next regulatory period.

Note: SKM notes that this is reasonable and that its effect has been absorbed to some extent (refer Table 19). Increased pumping costs are also reflected in the below, but have not been specifically attributed to water pumping stations, due to the pro-rata method used. Furthermore they are either wholly or partly offset by the reduction in FTEs

Increased costs associated with water quality issues (step change FY2012 -2013).

o A step change in Water Treatment plant costs between FY2012 and FY2013 is due to increased costs required to address water quality issues related to high organics in the water. The FY2013 level is representative of on-going quality issues as water storage levels reduce due to drier conditions combined with increased water treatment plant costs to address earlier failure issues.

Note: SKM notes that this is reasonable although there would be an opportunity to reduce costs with a return to normal rainfall years. In the longer term this should not be built into the opex base unless more rigorously demonstrated.

Redirecting FTEs between Opex and Capex project has reduced opex over a number of years.

o In years with relatively low Capex, project and general management functions spend more time on operational activities and hence opex is relatively higher in these years (years 2013, 2014, 2017). This explains the year on year variations in opex even though the basis of the underlying costs has been kept constant in real terms.

Note: SKM notes that while some allowance has been made, the full extent and supporting rationale for this is not clear. SKM considers that there should be a greater opportunity for cost saving with the shift in personnel from opex (in the recent periods of low capex) to capex with the increased capital programs over the regulatory period. These savings in opex should be both be greater than appears apparent in Essential Water’s forecasts and should also result in a permanent reduction in the opex cost base. Once the capex projects are finished these costs should not just automatically return to opex.

It is normal prudent business practice to have a base/minimum core of “operational” staff with the numbers of personnel associated with capex projects (e.g. as project managers) “floating” up and down geared around capex project delivery needs (although there might a small core capital “governance” team). It does not seem prudent or efficient to maintain the same personnel numbers as “permanent employees” geared around a peak or even “average” capex program. This would be an unnecessary and inefficient cost to opex. Outsourcing is typically



more efficient when there is widely varying capex program needs (numbers of projects, expenditure, complexity etc.).

The cost of EE employees on capex projects is built into the capex project costs assessed. Capex numbers do not need adjustment as the capex numbers (budgets) already include the costs of these personnel (as embedded project management costs on the project cost estimates – which is normal management practice). In particular, it is relevant to note that EE builds in an approximately 15% add-on (although this varies up/down slightly) as a direct cost for project management activities on top of the base direct cost for the works (and before EE adds its corporate overheads cost component).

External Consultants and Contractors services are engaged when Essential Water does not have either the expertise or the capacity to conduct a particular piece of work, or if an independent view is required on a particular matter. Contractors are normally engaged to conduct a specific piece of work or to provide an assessment and recommendations on a particular asset type or project. Examples include the engagement of Aqualift contractors to clean the interiors of filtered water tanks and of Adept Contractors to conduct pressure vessel testing. Sometimes consultants are engaged to make an assessment of assets and/or project works. Examples include the JWP Report “Asset Renewal Plan for Water Supply and Sewerage Services in Broken Hill Region (2007)” and the GHD report, “Optimised Depreciation Replacement Cost Valuation of System Assets of Country Energy’s Water Business (2009)”.

Projections of Hire and Contract Services are based on the 2012-13 financial year.

o Total opex in future years has been split into the different spend categories according to the split in the base year. The Hire and Contract Services line has relatively small year on year movements, in real terms, compared with changes in total opex over the years.

Overall, the variations in total opex are largely due to the declining total headcount costs offset by rising electricity costs and shifts in the amount of resource between opex and capex due to fluctuations in capital project resource needs.

4.3.2. Overall recommendations re adjustments to direct Opex SKM considers that there seems little point in making specific adjustments / reductions in a range of line items or functional areas items given that overall opex is relatively flat in real terms and without a detailed activity study being undertaken or in the absence of such work being undertaken by Essential Water. However it also seems clear that on the basis of the overall review work and our broad water utility experience that there is scope for efficiency or productivity improvements, in addition to that for indicated by Essential Water for its water and sewerage activities.

SKM therefore proposes that the following three types of adjustments to Essential Water’s opex, (which are discussed in more detail following), namely a:

General productivity target of 1%p.a. real be adopted for both water and sewerage direct opex;

Specific allowance for personnel transferring from opex to capex: and

Capture of Opex savings from capex.



General Productivity Savings Target: 1%p.a. real for both water and sewerage direct opex.

Essential Water has noted a 1% p.a. cost reduction seems high for sewerage on the basis that the average imputed annual productivity savings ($85k p.a. for sewerage - and an aggregate of approximately $327k over the regulatory period) per loss of population per year (EE assumed 166 people loss per year) yields a high $/per person lost/year (of approximately $500). SKM considers that this approach is inappropriate (and materially overstates the impact of the productivity saving on EW). SKM considers the approach indicated as follows is more appropriate.

SKM proposes that the basic concept should be to at least maintain the unit opex cost per customer in real terms over the next regulatory period at approximately the same level as at FY14 or better at FY13 (noting that as part of a continuous improvement program lower targets would normally be set) unless a material new driver of sewerage opex is evident (e.g. new environmental obligations or sewage treatment facilities) that impose new real increases in costs. These do not appear to be evident.

The other key assumption relates to population numbers. The numbers used by SKM have been obtained by extrapolating from the information shown in Figure 8. SKM has assumed a current population of approximately 18,500 and an annual population reduction of 200 persons over the regulatory period. [NB: EE assumed a reduction of 166 persons per year based on a population decline of approximately 2000 persons over the last 12 years. However, it is evident that the population decline is steeper at approximately 220 persons per year over the last 5 years. Thus SKM has assumed a decline of 200 persons per year.]

SKM considers that a reasonable sewerage opex target for the FY15 to FY19 period should be $135 opex per person per year. SKM notes that there has been a significant unit opex increase from FY14 to FY15 underpinning this already.

If the unit sewerage opex cost is maintained at $135 per person per year unit, this would yield the productivity savings indicated in Table 20 (last row) of $326k in aggregate for the regulatory period. This is equivalent to a broad productivity improvement of approximately 1% overall, refer Table 23.

Table 20 Productivity estimate – Sewerage (based on maintaining current $/head/year) Total Regulatory

Opex (total or prod'y

saving)FY2015-FY2018

2013/2014 2014/2015 2015/2016 2016/2017 2018/2018 2018/2019

2,292 2,494 2,478 2,564 2,510 2,498 10,046

18,500 18,300 18,100 17,900 17,700 17,500

123.9 136.3 136.9 143.2 141.8 142.7

0 23.5 34.5 147.5 120.5 135.5 326.0

Sewerage Productivity Assessment

Opex Item

Regulatory Period All in $2014 real - $'000k

Sewerage (as proposed by EW)

Population (assumed 200 reduction p.a.)

Productivity saving(if opex maintained opex at $135 /per head/year)

Opex: Annual $Cost per headbased on EE's Proposed opex



Similarly for water, if the assumed unit water opex cost target is approximately $495/per person per year the savings generated would be as indicated in Table 21. The aggregate savings over the four year regulatory period is $1,119K and equates to a 0.85% p.a. productivity improvement. SKM has rounded this off to 1% p.a. (which equates to an aggregate productivity saving of $1,308K for the regulatory period) as shown in Table 23. A target water unit opex cost target of approximately $490/per person per year would generate the 1% p.a. water opex productivity savings.

The reasonableness of the unit water opex cost target was assessed over a longer period (than for sewerage) given its apparent greater variability (due to pumping costs variability). This involved a 2 year backward look at unit water opex costs in $/person/year (FY11 = $418; FY12 = $445), most recent year (FY13 = $521) and 2 year forward look (FY15 =$552; FY16 = $502). Depending on how these years are analysed the reasonable range seems to be $488 to $506/per person per year. On this basis, SKM adopted $495/per person per year for the purposes of Table 21. If the two extremes are removed (FY11 and FY14), the appropriate unit cost is $491/per person per year.

Overall SKM considers that a 1% p.a. productivity target is appropriate and reasonable, particularly as there are more opportunities in reducing asset management costs.

Table 21 Productivity estimate – Water (based on maintaining current $/head/year)

To support the above, areas where SKM considers that there would be specific opportunities for savings include:

Sewage volumes should decrease with the decreasing population. These volumes should be little dependent on households. Therefore energy, chemicals and maintenance costs would decrease. Similarly for water although to a lesser extent as per capita household water consumption may increase to partially offset the decreasing population effects.

For example, if sewage energy costs alone were to be maintained flat or decrease (consistent with SKM’s view that sewage volumes should decrease), then this would contribute up to approximately 50% of the 1% p.a. from sewage costs alone.

Sewerage: Opportunities exist on a unit cost comparator basis. SKM considers that the sewerage comparators indicate reasonable scope for improvement and lowering the cost base,

Total Regulatory Opex

(total or prod'y saving)

FY2015-FY2018

2013/2014 2014/2015 2015/2016 2016/2017 2018/2018 2018/2019

10,212 9,188 9,128 9,322 9,121 9,082 36,759

18,500 18,300 18,100 17,900 17,700 17,500

552.0 502.1 504.3 520.8 515.3 519 0

N/A 129.5 168.5 461.5 359.5 419 5 1,119.0

Water Productivity Assessment

Opex Item

Regulatory Period All in $2014 real - $'000k

Water (as proposed by EW)

Population (assumed 200 reduction p.a.)

Opex: Annual $Cost per headbased on EE's Proposed opexProductivity saving(if opex maintained opex at $495 /per head/year)



notwithstanding the commentary in Section 7, and the view that EW appears to be close to the “average” of its peers. For sewerage at least, EW does not suffer from geographic disadvantage (in fact arguably the reverse as its network is reasonably compact and its treated effluent disposal costs should be relatively low) and its treatment facilities are rudimentary and should be low cost facilities.

Proactive maintenance with enhanced asset management systems (as Essential Water intends to pursue) would deliver lower reactive maintenance costs for both its water and sewerage systems than has currently been allowed in EW’s proposed opex budgets for FY15 to FY18 (while at least maintaining the current level of service). This includes with enhanced asset management systems and tools enabling better focussing of resources (as well proposed actual asset upgrade works themselves).

NB: EE has indicated that it considers a 1% reduction to water Opex to be high and does not seem reasonable. In particular it considers that proactive maintenance will only reduce unplanned overtime (but the FTE will still be a cost to the business) with reduction in materials etc. expected to be minimal. EW has indicated that most of the overtime is associated with shift work at the water treatment plant.

SKM’s experience is that there are significant savings to be achieved with implementation of a risk based asset management system (which comprehends asset maintenance). With a well-designed asset management system there will be a better balance between (and a more economically efficient response overall) as between proactive maintenance, reactive maintenance and capital initiatives. Savings will not only occur as a result of reduced overtime, rather the overall cost base of maintenance (whether in normal hours or outside of normal hours; and the proactive/reactive maintenance balance) should be reduced.

It has been readily demonstrated that there is a usually a significant cost benefit in both reduced capex and opex or that an enhanced the level of service can be achieved with the same/current expenditure levels. One or the other must be achievable given where EW is on its asset management improvement journey. This represents a key challenge for EW in the next regulatory period, namely to demonstrate an efficient opex and capex mix for its business (water and sewerage assets).

For Water: In general it is evident from Section 7 that the opportunities for improvement in unit opex costs are greater (given that EW has higher unit water costs than most of its peers).

[These endeavours (for water and sewerage) are appropriate and would facilitate the necessary improvement in its cost base and asset management performance to lower the unit cost of the comparator performance indicators and bring Essential Water more into line with other comparable water entities (see Section 7)].

SKM notes EW’s general comment that there has been no “contingency” opex incorporated into the opex forecasts in its IPART submission; and its view that increases in prices (e.g. for fuel/diesel/energy) and commodities are likely to be greater than its CPI assumption and that unforeseen contingent expenditure is also likely. EW considers that maintaining opex costs real over a 4 year period is considered a stretch target. However SKM notes that there is no broad analysis to support EW’s view or of the reasonableness of the base opex for water and sewerage.



Personnel Transferred from opex to capex: A specific allowance for personnel transferring from opex to capex with increased capex programs (more than has been assumed or implied by Essential Water). The amount currently allowed for by Essential water is not transparent but would seem low. SKM understands that EE has put forward the proposition that while the capital program is low that the base opex carries opex for personnel that would otherwise be allocated to capital and that the total opex attracts a greater proportion and amount of corporate overheads. When capital programs rise then these opex costs should be lower as the costs get transferred into and incorporated into the capex programs. [NB: This is separate from the allowance for a reduction in 6 FTEs indicated to occur between FY14 to FY15 (although no specific information has been provided on the quantification, description or breakdown of these). These appear to be associated with reduction in water treatment plant and water network operations and maintenance personnel due to natural attrition without replacement. The personnel referred to above are related to capital activities presumably either with EW directly or through support from EE.] SKM notes that EE adds a 15% amount to its base direct capex costs for project management and related activities. Normally, internal and other project management costs might comprise at least 3-4% of the direct capex cost. Consequently, if more EW personnel are involved in capex projects as they ramp up in the next regulatory period a greater transfer of costs out of opex (to capex). Alternatively the capex costs should be reduced unless new personnel or outsourcing support is provided. An estimate of additional costs that should be transferred from (as they already embedded in the capex forecasts) is provided in Table 22.

Table 22 Estimate of Opex Costs Transfer to Capex

Item FY15 FY16 FY17 FY18

Rec'd Capex - SKM Adjusted: $MWater and Sewerage (includes Corporate costs)

7.65 6.99 12.08 16.08

Average Capex last 4 years -$M(incl'dg corporate costs) 5.75 5.75 5.75 5.75

Difference compared with last 4 years$M 1.9 1.24 6.33 10.33

Direct Cost difference in Capex - $M 1.59 1.04 5.34 8.75

Total Transfer based on 3.5% direct cost difference ($'000s) 55.6 36.5 187.0 306.4

Proportion to Water 0.81 0.8 0.88 0.85

Water - Total Transfer based on 3.5% direct cost difference ($'000s)share of capex for that year

45.1 29.2 164.5 260.4

Proportion to Sewerage 0.19 0.2 0.12 0.15

Sewerage - Total Transfer based on 3.5% direct cost difference ($'000s)share of capex for that year

10.6 7.3 22.4 46.0



This is based on the adjusted SKM capex program (Table 12) and assumes that 3.5% of the total annual increased capex spend differential (direct costs) between the proposed program spend in each year of the next regulatory period and the average for the last four years. The latter is an average of approximately $4.8M p.a. excluding corporate overheads). These amounts are apportioned in each year based on the relative water and sewerage capital spends in that year. The outcomes are included in Table 23.

SKM notes that EE does not consider this a reasonable assumption. However in the absence of more detailed information on how such costs are managed as between opex and capex and as between EW and EE support for various aspects of capex related activities and is related to its commentary on where how opex costs shift as the extent of capital programs move up/down, SKM considers the above assessment to be reasonable. SKM acknowledges that the capex forecasts include costs for project management and related activities.

Opex savings from capex These cost savings are summarised in Section 4.5.SKM has seen no evidence that these costs have been included as savings in the opex forecasts. In any event these are considered to be greater than estimated in the business investment cases cited. In particular for example the estimates of the benefits of new capex initiatives related to asset management (e.g. of pipelines) would be expected to be greater than indicated. A small notional amount has been added to those savings explicitly indicated in Table 25 (which are based only on those EE Investment Cases sighted).

Essential Water has commented that:

Opex savings from Capex are rough estimates and in reality are difficult to quantify, measure and understand the actual timing of realising these savings; and

Keeping opex real for the 4 year period without any contingent increases or wage increases has assumed a level of Opex savings through Capex albeit not explicitly.

SKM considers that if savings are included in EE Investment Cases then it is contingent on EE to capture those savings. If they too difficult to quantify, measure and capture then it does not seem prudent to base Investment Cases on them.

Overall Proposed Opex Adjustments

The overall outcomes and SKM’s proposed adjustments in direct opex costs (without corporate costs) for the regulatory period are shown at Table 23.

EE has generally commented that overall further downward pressure appears unreasonable over the next 4 years. .



Table 23 Proposed adjustments to direct opex (water and sewerage)

4.4. Assessment of Corporate Overheads

4.4.1. Process of Cost Allocation – CAM Cost Allocation Methodology Essential Energy is one of a group of three network businesses (Essential Energy, Endeavour and Ausgrid) within Networks NSW. An overview of the business and organisational arrangements is shown in Appendix B.

Corporate costs are allocated from Essential Energy to Essential Water but not any corporate costs from outside Essential Energy (e.g. from the Networks NSW business as a whole).

Corporate costs are the shared costs as defined in Section 4.5 of EE’s Cost Allocation Methodology (CAM) document. They comprise the costs that support the operational functions of Essential Energy e.g. IT, Payroll and Finance. The complete list is shown in Table 5 (Shared costs – Cost allocation policies and framework), Section 4.5 of the CAM. [NB: The nature of costs that are shared with the water business can be seen in the column titled “Categories of distribution services” – with “Water” designation.]

Simplified schematics of the how the CAM methodology operates applies to corporate costs are provided at Figure 10 and Figure 11.

2013/2014 2014/2015 2015/2016 2016/2017 2018/2018 2018/2019

1 102 193 282 373 460 546 1,308

2 23 48 72 97 121 145 337

3 0 45 29 165 260 165 499

4 0 11 7 22 46 71 86

5 0 50 80 150 180 200 460

6 0 30 65 65 65 75 225

125 377 535 872 1132 1202 2916

13,688 13,444 13,449 12,886 53,467

Labour shifts from opex to capex - water

Labour shifts from opex to capex -sewerage

Opex savings from capex investment - water

Opex savings from capex investment -sewerage

Total adjustments

Proposed Adjusted TOTAL REGULATORY OPEX

General Productivity - Water (1% p.a )General Productivity - Sewerage (1% p a.)

SKM Proposed adjustments to Direct Opex

Total Regulatory

Opex FY2015-FY2018

Regulatory Period FY15 to FY18All in $2014 real -$'000k

$ Amounts are Cumulative



Figure 10 Corporate Cost Allocation

Figure 11 Corporate overhead allocation rate calculation

This calculation is undertaken at the start of each year based on forecast aggregate corporate budget. It results in significantly varying allocation rates each year depending on the level of project spend. Allocation rates have typically been much higher than the “industry accepted” target of 20%, as proposed by Essential Energy (and based on the outcomes of the previous regulatory review, Halcrow (2010)).

For 2013/2014 onwards a new regulatory Allocation Method is to be used. The allocation of corporate overheads will be kept at a flat capped rate of 20% of the actual direct cost of every activity (opex and capex). This intended to:

Alleviate historical variations in annual allocation rates

Ensure that overhead rates are consistently maintained in line with acceptable industry rates.

The key allocators are:

Departmental spend FTE $ spent (or Numbers of personnel) on projects Direct labour



FTEs Numbers Fleet usage (fleet) Customer complaints (customer operations) Managerial estimates on FTE involvement (corporate affairs)

Clause 3.2(a)(5) of the AER’s (Australian Energy Regulator) Cost Allocation Guidelines require that the CAM include a description of the categories of distribution services that Essential Energy provides to which costs are attributed, and the types of persons to which these services are provided. Under clause 6.2 of the NER, distribution services are classified as:

Direct control services, which are further categorised into: o Standard control services o Alternative control services

Negotiated distribution services (of which EE has none).

Table 2 of the CAM provides a detailed list of Essential Energy’s services that constitutes Standard Control Services and Alternative Control Services under the NER.

Directly attributable costs - are those which are identified as fully dedicated to a particular business segment based on their nature. Table 3 in the CAM sets out what are directly attributable costs at the function level for 2014-19. The only one clearly related to water are the network operations costs. The shared costs allocation methodologies applied are shown at Table 4 (CAM).

How these are attributed to the different types of corporate costs can be seen in the Table 5 of the same CAM section (the detailed allocators – as against the key parameters indicated above). An appropriate allocation method is chosen for each department based on a relevant causal driver so that the costs are fairly distributed between the businesses. For example, payroll costs are influenced by the number of staff, so the appropriate allocation method is the number of FTEs.

Overhead Rates and Method of Allocation

Corporate overheads are allocated to Essential Water by Essential Energy and relate to centralised functions within Essential Energy that Essential Water receives a share of. These costs are determined by Essential Energy and hence Essential Water has limited control over these costs. In the previous regulatory period Essential Water adopted an approach of restricting the overheads to capital spend to approximately 20 per cent of direct capital spend in order to not over inflate the RAB. Therefore any excess corporate overhead remains as operating costs. The forecast corporate overhead rate for both direct operating and capital spend have been capped at 20 per cent for the next regulatory period.

More detail is provided in Appendix D and in Essential Energy’s CAM (Cost Allocation Methodology) document which is currently in draft form.

4.4.2. Capex – Opex split of corporate costs Essential Water allocates the corporate overhead between opex and capex activities based simply on their dollar spend (refer Section 12.5, IPART submission). This ensures that every project dollar spent in any year receives its share of the associated overheads. This was deemed the most suitable method for allocation for the business as it is simple to perform and easy to understand.



As from FY2013/14 onwards, the corporate allocation rate will always be 20% of the direct project spend, the amount of corporate overhead will fluctuate with the spend amount of projects undertaken in any year. In years of low expenditure, the amount of overheads will be low, in years of higher expenditure, the amount will be higher.

[NB: Recent advice from EE suggests that at least at present this is not happening internally as it appears the actual allocations to date in FY14 are 22.83% for October capex projects and an average of 22.95% for July to September period.

Operationally, Essential Water is unable to spend exactly the same amount on projects every year. This is especially the case with capital expenditure as water projects can take many years to finalise from the beginning of the concept phase. Capping the rate will allow the corporate overheads to be “evened out”.

As a rule, allocations are not applied to general project contingencies - of which there are none in the forecast numbers. However, where consultants have provided indicative costs that included acceptable industry contingencies, these have been included in calculating the overhead rate and are receiving a share of allocations.

4.4.3. Initiatives to reduce overhead costs Since the formation of Networks New South Wales (NNSW) in mid-2012, Essential Energy has had a particular focus on reducing corporate overhead costs based on two key programs:

1. NNSW led initiatives program – This is seeking to reduce total corporate costs through the alignment and roll out of best practice policies between the 3 NNSW distributors, Ausgrid, Endeavour Energy and Essential Energy. Areas being addressed here are fleet, procurement and organisation structure (operating models).

2. Essential Energy led initiatives – In mid-2012, Essential Energy developed and rolled out a number of cost saving initiatives. These addressed areas such as overtime, travel, agency staff expense, salaries and wages, legal, mobile phones and aircards, marketing and various corporate programs. Significant savings were achieved in FY2012/13 financial year, compared to the previous year, and the program has been continued and expanded in 2013/14.

The combined impact of these cost saving programmes was a significant reduction in corporate overheads in 2012/13, which is anticipated to continue in 2013/14 and beyond. Since corporate costs are split between Essential Energy’s electricity and water businesses, the water business is now being allocated a reduced amount of corporate overhead costs compared with previously. This is in line with the previous IPART regulatory review of Country Energy which advocated moving to a 20% corporate cost allocation.

For the proposed regulatory period 2015-19, Essential Energy is proposing to cap the corporate overhead costs allocated to the water business at 20 per cent of direct costs, for both capital expenditure and operating expenditure.

Previous years corporate overheads have been much higher than the 20 per cent range. In FY13 a sharp reduction was seen with a heavy focus on savings initiatives. These initiatives are expected to be held at these levels, and where possible, reduced into the future. Table 24 shows that in a comparable direct spend year, such as FY2014, that these costs are being held relatively



flat in real terms. In reality however, labour is the most costly corporate overhead component will increase in real terms. The corporate overhead for Essential Water has been held at 20 per cent regardless of these real impacts implying productivity/efficiency savings. With the increased Capex program, there is a greater level of overhead required to manage and administer these projects (Project management, corporate governance, procurement etc.) and, therefore the quantum of overhead at 20 per cent is varied to accommodate this.

Table 24 Total actual and forecast overhead (Real $2014)

Table 24 also shows that the rate of overheads as a proportion of direct project spend has declined since 2012 and is forecast to be constant at 20 per cent over the next five years. This decline is the result of efficiency measures that have started to take place and are forecast to continue into the next regulatory period. Some of the efficiency initiatives that have led to a reduction in overhead costs are a reduction in staff numbers through a hiring freeze and natural attrition, and reductions in overtime, agency staff, fleet, marketing and travel costs. It is noted that while the calculated overhead rate in the last regulatory period varied from 20 to 61 per cent, the amount actually applied to capital projects was closer to the 20 per cent recommended by IPART and Halcrow (2010 review).

The high level of overheads to operating spend in 2012 is due to higher than normal overheads being allocated to Essential Water by Essential Energy in that year, compounded by lower than budgeted capital spend. This resulted in a large amount of under-recovered overhead operating costs.

Essential Energy believes that due to its size Essential Water, the Water business arm, derives value through economies of scale. Essential Water has cited as an example that, based on 80 FTEs, the HR function costs less than $300 per annum per employee and Health Safety around



$2500 per annum per employee. The benefits of the purported economy of scale to Essential Water do not appear immediately evident or flow through to corporate costs.

4.4.4. Outcomes of Corporate Overhead cost assessment The following general conclusions are made in relation to corporate cost allocation:

1. The corporate cost allocation methodology in broad terms appears sound, particularly given that administrative simplicity is a key objective.

However some specific worked numerical examples showing where all of Essential’s Energy’s total corporate costs land after distribution (in quantitative $ terms) would better demonstrate fairness, equity, nexus (to some actual direct benefits) and whether there is truly economies of scale benefits flowing to Essential Water.

2. Prima facie the total corporate overhead dollars allocated to the Essential Water business seem high both in relative terms and absolute terms.

To establish whether the absolute $ numbers in the Essential Energy corporate overhead distribution pool (pre distribution) are fair and reasonable would require a separate exercise. This would be necessary to assure the robustness of the $number allocation to Essential Water.

3. Notwithstanding the reasonableness of the methodology, it is of concern that there is no separate underlying justification of either the quantum of costs, the basis of the allocation or the percentage of corporate costs to direct opex (either by comparison with other water organisations or by some broader “benchmarking”).

4. The corporate cost allocation of 20% seems high.

o There are comparable stand-alone water businesses to Essential Water (e.g. rural irrigation, geographically dispersed, similar level of Opex. who themselves are on an improvement path) where corporate costs as a percentage of direct opex vary from 17% to 25%.

o However there are a number of larger water authorities – but smaller than Essential Energy as a whole – where the corporate costs as a percentage of direct opex are in the range 9% to 13% (for example some of the South East Queensland water businesses). Prima facie there seems a case for further reducing corporate overheads generally and therefore the allocation to Essential Water. Essential Energy as a whole should be closer to these benchmarks and Essential Water should receive a benefit from it.

The Essential Water business should receive a benefit from the economies of scale associated with Essential Energy. It is not apparent how this occurs when compared with water businesses of the scale of Essential Energy.

Further work should be undertaken before the next regulatory review to better justify corporate costs as a stand-alone item.

o In capital intensive businesses (like energy and water) the corporate cost as a proportion of direct opex would generally be expected to be less than 20%.



5. The justification for treating a $opex and a $capex the same in terms of attracting the same overall corporate cost loading seems simplistic. Further assessment should be undertaken of this for the next regulatory period.

Overall SKM has taken the view that the detailed line by line “bottom up approach” for the allocation of corporate costs (using the CAM), while prima facie a reasonable approach, is better tested against a “top down approach” and a range of broad comparator basis as indicated above. Based on the latter SKM considers that there is further scope for reduction in corporate costs.

In summary, SKM recommends based on the above that further reduction of the corporate overhead costs and allocation be adopted to deliver 18% by the end of this regulatory period (in equal increments). A more comprehensive and detailed analysis of reasonable costs should be undertaken before the next regulatory review, to establish a sounder basis for justifying the appropriate level of corporate costs and what further potential for their reduction might be, both from a “bottom up” and a “top down approach”.

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4.5. Opex savings from capex

The opex savings claimed as benefits in the capex investment I businesses cases relevant to the next regulatory period is provided at Table 25.

• Table 25: Opex savings generated from capex projects (EE view)

Project Name Impact on Operating

Rationale Expenditure

Stephens Creek #4 Nil Reductions in the cost of water supply through the Emergency introduction of newer technologies and a more efficient Pumping Station design at the new pump station. would be offset by

increased po.....-er and maintenance costs at the new pump station, so there is no assumed change in operating expenditure.

Stephens Creek Increase of $80k pa, There is no impact on operating expenditure in the Dam Wall once works are regulatory period 2015-19, but once the capital works are Rehabilitation completed. No impact completed in 2018-19, there is an estimated increase in

in 2015-19. operating costs of $80k pa to allow for increased dam wall inspection costs.

Imperial Lake Increase of $9k pa, Once the capital works are completed in 2016-17. there is Reservoir Dam Wall once works are an estimated increase in operating costs of $9k pa to allow Rehabilitation completed. for increased dam wall inspection costs.

Mica St Reservoir Nil No change in operating expenditure resulting from this Replacement project as this is just a replacement of the existing

reservoir

Rocky Hill $8k pa increase in Increased maintenance costs slightly reduced by Reservoir operating expenditure allowing Essential Water to run the treated water Replacement as this is an additional process more economically by running the water

tank. treatment plant and filling up the reserves during low

electricity tariff times.

Service Reservoir Nil No impact on operating costs as Essential Water has Refurbishment always run a preventative maintenance program.

Menindee WTP Nil No impact on operating costs as Essential Water has Major Works always run a preventative maintenance program.

Water Reticulation $20k pa saving Operating reduction of approx. $20k per annum once Works trenchless technology can be utilised.

Reservoir General $115k saving pa, once Once construction is completed, maintenance costs will Works construction completed . reduce by $115k per annum

Menindee & $30k pa saving from Reduced R&M costs as a result of a more proactive Umberumberka January 2015 onwards. maintenance programme. Pipeline Repairs

Water Pump Nil No impact on operating costs as Essential Water has Stations R&M always run a preventative maintenance program.

Mica St WTP Capital Nil No impact on operating costs as Essential Water has Works always run a preventative maintenance program.


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Project Name Impact on Operating

Rationale Expenditure

SCADA & Telemetry Minimal change in A better SCADA system will lead to improved monitoring of upgrades operating expenditure pumps, pipelines and other infrastructure, and will improve

the reliability of the water supply, and reduce overtime costs, but not significantly.

Sunset Strip WTP Not yet determined but Additional chemicals, electricity, maintenance, sampl~ng upgrade to potable - estimated to be an costs. water extra >$100k p.a.

Replacement of Nil impact in 2015-19 Project not completed in 2015-19 Regulatory period, but Wills St WWTP Regulatory period once it is completed we expect to reduce operational and

maintenance costs, though this will be offset by increase in electricity use - it will not require continued on-going maintenance of two WWTPs.

Sewer Reticulation $27k pa saving Operating cost reduction of $27k per annum - based on 5 Repair per cent annual reduction of the existing $550k per year.

Sewer Pump $50k pa saving Pro-active maintenance of sewer pump stations will lead to Station overhauls reduction in overtime and other reactive maintenance /Refurbishment costs.

With respect to the savings in the above table:

• It is unclear whether these savings have been explicitly captured in the opex forecasts for the next regulatory period;

• At face value, there are net savings indicatively - of $145k p.a. ($242k less $97k p.a.) which excludes Sunset Strip WTP, or say $45k p.a. including it (depends on timing which is uncertain at present).

• The savings estimates may be low

o Essential Water is working positively to a more proactive maintenance program to reduce maintenance costs. Greater benefits would normally be expected from such programs than indicated here. A higher target should be set;

o With sewer repairs there would be less sewer inflows to the WWTP with some potential cost saving;

o As rehabilitation works are completed, there should be less inspections (of sewers or

pipelines) with some cost savings;

o While Rocky Hill may result in a modest increase - with an efficient proactive program for

tanks (especially new tanks) this would be expected to be negligible .

• Overall and Future

o .Noted that beyond the 2015-2019 regulatory period, it is anticipated that there would be further net savings especially associated with replacement of the Wills St WVl/TP.

SKM_RNAL REPORT _26 Jan 2014_Rev E_F1nal_Redacl.ed docx PAGE 107



4.6. Key Recommendations Based on the information in Sections 4.2 to Section 4.5, SKM recommends that Essential Energy’s proposed regulatory operating expenditure for FY2015 to FY2018 be adjusted as indicated in Table 26.

The adjustments to water and sewerage opex are as carried forward from Table 23 and the adjustments to corporate cost allocations are based on the proposals in Section 4.4.4.

Table 26 Overall recommended Opex

Note: SKM has relied on EE’s latest version of its AIR submitted to IPART (October 2013). FY$2014 real is referred to in EE’s submission but labelled as FY2013 real in the AIR.

4.7. Reference Information Responses to SKM’s RFIs (RFI 1 to 5)

Documentation accompanying RFI responses

Essential Energy’s IPART submission documentation o AIR Excel spreadsheet o Cost allocation methodology (CAM).

Total Regulatory

Opex FY2015-FY2018

2013/2014 2014/2015 2015/2016 2016/2017 2018/2018 2018/2019

10,212 9,188 9,128 9,322 9,121 9,082 36,759

2,292 2,494 2,478 2,564 2,510 2,498 10,046

2,501 2,382 2,373 2,436 2,387 2,384 9,578

15,005 14,064 13,979 14,322 14,018 13,964 56,383

102 288 391 688 900 911 2267

23 89 144 184 232 291 648

0 58 116 178 233 290 585

125 435 651 1050 1365 1492 3501

10,110 8,900 8,737 8,634 8,221 8,171 34,492

2,269 2,405 2,334 2,380 2,278 2,207 9,398

2,501 2,324 2,257 2,258 2,154 2,095 8,993

14,880 13,629 13,328 13,272 12,653 12,472 52,882

Opex Item


SKM's recommended efficient operating expenditure

Water

Sewerage

Corporate

Total


Water

Sewerage

Corporate

Total

SKM's Proposed Adjustments

Water

Sewerage

Corporate

Total



5. Mines Costs Allocation Review 5.1. Overview of Approach This section represents a structured approach to effectively understand the balance and use of assets for supplying water as between urban customers and mines customers, to assess Essential energy’s options for cost allocation and to make an informed recommendation on potential alternative approaches. Each of the elements of this approach need to be well considered:

Background information (Section 5.2) including o Water supply to mines (Section 5.2.1)o Water usage by mines and urban customers – both untreated / unfiltered and treated

filtered (Section 5.2.2)o Previous mines agreement (Section 5.2.3)o Essential’s Energy’s proposal (Section 5.2.4)

Identification of the building blocks for pricing (Section 5.3)

o Cost allocation options considered by Essential Energy o EE assessment of these limited options and its preferred approach o EE’s view on appropriate returns

Review by NSW Public Works Department of EE’s proposal and consideration of its recommendations (Section 5.4)

SKM assessment of most appropriate cost allocation model for mines pricing (Section 5.5):

Most importantly it is evident from a consideration of all the information indicated above that to make a robust decision about fair, equitable, reasonable allocation of costs (that have a strong nexus to the relevant driver of expenditure - whether asset capacity consumption for “capital” recovery costs or operating use of an asset say for operating expenditure recovery) there are five (5) key aspects are key to consider. These interact with one another and are: o Method of valuing replacement value of assets – this involves an understanding of the

respective usage or consumption of water assets by the mines and urban customers so that their value can be allocated as part of the cost build-up for the respective beneficiaries.

o Basis of asset valuation – DORC versus RAB o Updating of asset valuations o Incorporation of future capex; and most importantly

o The basis of allocating cost associated with provision of the water supply services (operating expenditure).

Recommendations

Mines sewerage pricing is also briefly considered.



5.2. Background

5.2.1. Water Supply to mines The location of the mines and the assets used to supply water to the mines (and to Broken Hill’s urban customers) are shown in Appendix A at Figure A- 1 (overall system schematic) and Figure A- 2 and Figure A- 3 (for the specific local infrastructure supplying water to the mines).

Key relevant points to note are that:

The mines are immediately adjacent to, and so close to, the Broken Hill township that they are effectively can be considered as a single unit; and

The proximity of the mines to the Broken Hill township means that, as a first approximation most of the same assets are used and integral to supplying water to both the mines and to urban customers.

Furthermore the water supply system is so integrated that all the major water supply assets used to supply water to each of the mines - including the various sources of water (dams, major storage reservoirs), water treatment plants, bulk supply pipelines, balance tanks, service reservoirs and pump stations – are the same as for the urban customers and such assets should be considered as part of a common pool of assets whose costs are to be allocated on an appropriate basis.

There are differences at the margin notably

o A greater proportion of the water reticulation mains are required to service urban customers than the mines; and

o The majority of water supplied to urban customers is treated (on average >90% of the total water supplied to urban customers is typically filtered). A lower percentage of the total water supplied to mines is also filtered (historically some 83% on average, although significantly lower in FY2013 at 70%). Overall some 70% of all filtered water is supplied to urban customers. This means that some adjustment of the water treatment plant depreciation may be required.

5.2.2. Water Usage by Mines A summary of water used by the mines is provided as follows:

Water usage volumes for mines and Broken Hill overall (mines plus urban customers) – refer Table 27 and Figure 12 where it is evident that mines water usage has increased significantly in the last two years compared with previous years; and

Proportion of filtered and unfiltered water for mines water usage – refer Table 28.

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• Table 27: Water Usage Volumes - Mines and Broken Hill Urban customers

Volumes of water usage - by mines and Broken urban users

ML p.a. Customer 1-------r------r-------r--------.,.-----.-------

FY 2008 FY 2009 FY 2010 FY 2011 FY 2012 FY 2013

Filt'd Unfilt'd Filt'd nfilt'd Filt'd Unfilt'd Filfd nfilt'd Filt'd nfilt'd Filt'd Unfilfd

Mines Only

Perilya

CBH

•••••••••••••• Broken Hill Urban+ Mines

Total 348.0 406.2 3193.2 389.9 171.8 496.9 610.7 278.5 3943.5 546.3 630.7 986.8

Total Mine

sage 30.7% 78.7% 28.2% 35.9% 23.2% 23.3% 29.6% 26.9% 29.8% 50.0% 30.1% 60.2%

%age total

• Figure 12: Water Usage • Mines and Broken Hill Urban Customers

Annual Water Consumption 4000 ~~~~~~~~~~~~~

3,500 --- ---

E 3,000

~ 2,500 I:

~ 2,000 ~

a. 1,500 • Mines

:E 1.000 • Broken H1I Other

500

0


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• Table 28: ProporUons of Filtered and Unfiltered Water used by Mines

o/oage of total BH filtered and BH unfiltered water

Averaging Period respectively used by mines

Filtered Unfiltered

Average FY2008 to FY2013

[6 years} 28.1 % 47.7%

Average FY2012 & FY2013

[last 2 years] 30.0% 56.6%

The average overall proportion of filtered and unfiltered volume of water usage for the whole Broken Hill system (all customers) is 88% and 12% respectively (over the last 6 years but excluding the first quarter of FY2008 where the AIR shows that total BH unfiltered water usage is shown as being less than the mines only unfiltered water usage). The variation in overall filtered water proportion of total water usage for Broken Hill is relatively narrow - 88.5% (2008), 89.1 % (2009), 89.36% (2010), 92.8% (2011 ), 87.8% (2012) and 82.4% (2013).

The proportions of overall or total water usage (filtered and unfiltered) and filtered water (only) usage for the mines and Broken Hill urban customers respectively for the last two years (FY2012 and FY2013) are indicated in Table 29.

• Table 29: Proportion of water supplied to mines and urban customers

Average for FY 2012 & 2013 Proportion used of water supplied

[last 2 years] Filtered Water Only Total water supplied [Filtered + Unfiltered]

Mines 30.0% 34.0%

Broken Hill urban customers 70.0% 66.0%

Mines usage only:

• percentage of filtered water of total mines water usage = 7 4.8%

• percentage of unfiltered water of total mines water usage = 25.2%

Some key features of mines water usage are:

• Perilya {North & South)

o is the dominant mines user of water from the water supply system

o uses predominantly filtered water supply

o uses significant quantities of secondary treated effluent (refer Table 2) in addition to water

supplied from the water supply system (Table 27)

• CBH

o uses very little water overall and is a very small water user by comparison with Perilya

o what little water it does use is predominantly unfiltered.




5.2.3. Previous Mines Pricing Agreement Until the previous IPART review of Essential Energy’s prices (2009), the mining operations in Broken Hill were paying charges in accordance with the Mines Charges Agreement entered into in 2002. This agreement set water charges for mining operations in Broken Hill until June 2012, when mining operations were expected to cease. The mines agreement expired in 2012, with charges to continue at 2012 levels until new arrangements are in place.

The basis of setting the prices in the recently expired agreement does not appear to be well known.

As the mining operations continued past 2012, a Mines Price Review Working Group (an inter-government department working group comprising NSW departmental representatives – from Office of Water, Treasury, Division of Resources and Energy, Treasury, Office of Finance and the Department of Premier and Cabinet - and Essential Energy) was formed in April 2013 to address the future of the Mines Charges Agreement. This Working Group recommended that:

The mines agreement not be renewed;

Mines fall under the jurisdiction of IPART for making a determination for Broken Hill mines pricing, along with general water and sewer pricing for the Broken Hill area of Essential Water;

Cost reflective prices for mines water pricing need to be developed based on cost reflective pricing principles, similar to those applied to large electricity users.

Other relevant facts:

The Working Group noted that:

o a cost reflective price would likely be predominantly fixed due to the fixed cost nature of the water business; and

o Perilya considers that, though the mines agreement, it is currently paying a roughly equivalent level for water services to the amount derived from cost reflective prices;

Perilya clearly stated its intention to be placed on a commercial tariff (as per Essential Water’s tariff schedule) because a higher proportion of variable charges provides Perilya with incentives to invest in other water sources (approx. $4-5M capital spend);

Essential Energy (EE) plans to adopt a separate pricing regime for mining operations.

Consultation has occurred (in September 2013) between Perilya and Essential Energy regarding appropriate pricing principles and outcomes (as outlined below).

Based on these discussions (and history) Essential Energy proposes to introduce a separate pricing regime for mining operations. For this purpose, EE has calculated the total revenue requirements adopting IPART’s ‘building block’ methodology to calculate EE’s revenue requirement over the determination period.

5.2.4. Essential Energy’s proposal Essential Energy is proposing that a mines pricing regime be applied to the mines operating in Broken Hill for the next regulatory period (as indicated in the following sections).



For the 2012/13 year (an interim year), Perilya and Broken Hill Operations (BHO) were charged $ for their water usage.

5.3. Proposed pricing methodology / Building Block Approach

5.3.1. Overview Essential Energy (EW) has calculated its total revenue requirement by adopting IPART’s ‘building block’ methodology to calculate the revenue requirement over the determination period.

The ‘building block’ costs of service provision (as designated in IPART’s Issue Paper – Water, June 2013 for Broken Hill) include:

Operating costs – these are the on-going expenses to run and maintain the water utility, including maintenance and administration costs;

Return of capital (depreciation) – this is calculated with reference to the Regulatory Asset Base (RAB) that includes all prudent and efficient capital expenditure; and

Return on capital – this is calculated with reference to the RAB.

A tax allowance.

The sum of the above costs would then represent the total revenue requirement that service prices will be set to recover.

The process proposed for setting site specific prices for Broken Hill mining companies is:

Use the current replacement value of assets (as calculated by GHD) that are used to supply water to the Mines;

Historical records indicate that the Mines paid for 78 per cent of the Menindee Pipeline through the Broken Hill Water Board (BHWB), so this portion of Menindee Pipeline assets is excluded;

Apportion the return on and of these assets (WACC and depreciation);

Include a maintenance charge based on annual maintenance for a year over total the asset value multiplied by the asset replacement value relating to the Mines; and

Costs have been apportioned on Water usage (average over past two years).

Essential Energy has proposed the above approach to derive a price for the Mines because it considers that:

this is in line with commonly accepted regulatory practices with which it has experience and is also similar to the method for calculating specific pricing for large customers for electricity (e.g. for approximately 25 customers in Essential Energy’s distribution area); and

other methods, including using RAB and apportioning maintenance changes based on water usage, were modelled but resulted in more expense for the Mines and on that basis were discounted as viable options.



5.3.2. Cost allocation options considered by EE

Operating costs for water assets

For EE overall, operating costs are allocated directly to project level, with materials, labour etc. being booked to various OPEX projects. For example, Wills St WWTP has a distinctive project number which records costs associated with this site. Costs directly allocated to a project may be further split (within a project) between various activity identifiers to indicate whether the activity is planned or an emergency.

For the purposes of allocating operating costs (including operations and maintenance costs) EE proposes and has essentially only considered allocating opex on the basis of replacement cost values of assets (as these are defined in the following sections).

EE does not propose to allocate operating expenditure (or any proportion of it) based pro-rata on water usage as between the mines and urban customers. Rather it has allocated operating expenditure as between the mines users and Broken Hill urban users (residential and non-residential) on the basis of the proportional allocation of asset values. However, when it comes to allocating costs between the mines themselves (i.e. between Perilya and BH Operations/CBH: The fixed charges are split on the basis of proportion of total water usage (filtered + unfiltered)and the filtered and unfiltered variable charges are split based pro-rata on actual filtered and unfiltered water usages between the respective mines.

Replacement cost for water assets

In selecting the proposed allocation to mines of the replacement cost for water assets, Essential Energy considered the following options:

1. Option 1: Mines contribute to the cost of the entire asset base as a proportion of their water usage across all customers.

2. Option 2: Mines contribute 100 per cent to the asset costs associated with the Menindee pipeline and a further contribution of all other assets based on their proportion of water usage.

3. Option 3: Mines contribute 100 per cent to the unfunded portion of asset costs associated with the Menindee pipeline. It is recognised that the mines originally contributed 78 per cent of capital costs to the original construction of the Menindee pipeline meaning that the mines would only be required to pay for the return on and of the remaining 22 per cent of those assets, as well as a contribution to all other assets based on their proportion of water usage.

Essential Energy considers that:

Option 1 is not appropriate as it does not accurately align the underlying Water assets primarily consumed by the mines or recognise that the Menindee Pipeline was originally built in order to provide water for the Mines.

Option 2 is not appropriate as this option does not recognise that the mines originally funded 78 per cent of all Menindee pipeline construction costs nor include other assets actually consumed by the mines.

Essential Energy


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• Option 3 best recognises the past capital contribution to the Menindee pipeline and hence is

considered the most equitable option, noting that Options 1 and 2 would result in significant

increases in costs to the mines.

The outcomes of the options proposed above are indicated in Table 30.

Essential Energy proposes that Option 3 be adopted because it considers that this is the most cost reflective of the options considered in respect of the mines. Thus, consistent with Option 3, Essential Energy proposes that the prices for the mines be set to recover annual revenue of $4,882,080, as indicated in Table 30.

• Table 30: Example Mines charges for the 2013/14 Year based on Replacement Cost

No. Option Fixed Variable charge Variable charge

Total Charge charge filtered unfiltered

1 Percentage of all assets - - - -based on usage

2 100% Menindee Pipeline - - - -plus percentage

3 Assuming mines paid the - - - -78% of Menindee

5.3.3. EE's conclusions on proposed prices

Based on revenue implicit in Option 3, as set out in Section 5.3.2, Essential Energy proposes that the total annual revenue sought from mines (of - ) be converted into a fixed and variable price as follows:

A. Annual Fixed charge: -

• to be recovered via a monthly or daily charge, to reflect the largely fixed costs of supplying

water to the Mines (does not vary significantly if consumption changes); and

B. Variable charge (both filtered and unfiltered water):

• to be recovered through a per kl volumetric usage charge. Variable charges for filtered and untreated water will be set based on the total 2012/13 mines actual water usage.

Essential Energy believes it is appropriate to apportion the total fixed charges to each mine that consumes water in Broken Hill on the basis of water usage. For example if a mine consumes 75 per cent of total mines water usage, 75 per cent of the fixed charge would be attributable to that mine. EE's proposed mines charges are indicated in Table 31.

• Table 31 : EE proposed mines tariffs (real for next regulatory period)

Variable charge Variable charge Description Dally Fixed charge treated/filtered unfiltered

[centslkLJ [centslkLJ

EE proposed Mines tariffs - - -Note: The fixed charge component above is to be apportioned between mines based on water usage.


Essential Energy


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5.3.4. Allocation of Costs for Capital Returns

Essential Energy has calculated the 'building block' cost components for mines by apportioning the asset values and operating costs pro-rata based on water usage by mines. Two different values for the 'Return of Capital' and 'Return on capital' components have been calculated by using the:

• Current replacement cost (CRC - DORC) of existing assets as of June 2012

o This uses the DORC (Depreciated optimised replacement costs) as per GHD's 2009 report which provides residual asset lives based on consumption of notional asset life (i.e.

nominal asset life less years from date of installation). This report has not been updated

and residual lives do not reflect actual asset condition; and

• RAB as of June 2012.

A summary of these approaches {based on Option 3 as per Section 5.3.2) as provided by EE is shown in Table 32.

• Table 32: Outcomes of using DORC vs RAB for capital return determinations

Return of/on Capital Option Fixed Variable charge Variable charge

Total Charge charge filtered unfiltered

Proposed charges $ $ $

$

Based on DORC - - - -replacement cost

Based on RAB values - - - -Actual charges [2012/2013) - - - -Note: As between the mines (i. e. between Peri/ya and BH Operations/CBH: The fixed charges are split on the basis of proportion of total water usage (filtered + unfiltered)and the fiftered and unfiltered variable charges are split based on actual filtered and unfiltered water usages between the respective mines.

5.4. Public Works Department (PWD) review of EE proposals

Essential Energy also engaged the NSW Department of Public Works to review the proposed methodology and supporting calculations specifically for mines customers. SKM understands that the NSW PWD acknowledges Essential Energy's proposed methodology but has suggested some enhancements. In particular, the PWD has provided comments and/or recommendations after its review of EE's proposed calculations of total revenue requirements for the mines as follows:

A. The CRC (current replacement cost) of assets has been obtained by extrapolation by indexing

the 2008-09 values by CPI. PWD recommended that the latest MEERA (Modern Engineering Equivalent Replacement Asset) values as of June 2012, and if available June 2013, be used (rather than extrapolation by indexing).

B. The basis for RAB values used in the calculations should be verified and, if necessary,

modified to reflect the latest (June 2012) information.

C. Standard asset life of 98 years has been used for calculating depreciation. Use of average

asset life of 70 years is recommended.

SKM_RNAL REPORT_26 Jan 2014_Rev E_Final_Redacl.ed docx PAGE 117



D. The Return on Capital component has been incorrectly calculated using the WDCC (written-down current cost) of assets. The IPART methodology for calculating the Weighted Average Capital Cost (WACC) should be used to calculate this component of cost.

E. Apportioning of filtered and unfiltered water usage by mines for calculating the Return of Capital component (capital depreciation) needs to be reviewed. Capital investments on dams, transfer mains and pumping stations should be apportioned to both filtered and unfiltered water usage by mines. Whereas, investment on water treatment plants and chlorinators are to be apportioned for the filtered water usage by mines.

F. As EE is planning to adopt uniform pricing for all mining operations (including Perilya), the water usage by all the mines should be considered to arrive at proportionate cost components. Currently, only Perilya mine water usage has been considered in the calculations.

G. It has been observed that the total unfiltered water used by the mines for years 2011/12 and 2012/13 is higher than the total Broken Hill unfiltered water usage. The unfiltered water usage figures need to be checked and modified.

H. Operating cost of approx. $12.7 Million (in 2011/12) has been incorrectly apportioned. If apportioned based on % water usage by mines, this component in both the options would be about 50% of the total operating costs.

It is unclear as to the extent that Essential Energy has adopted these PWD recommendations and no advice has been provided or documentation sighted to make an properly informed view. However it appears that some recommendations have not yet been adopted (e.g. Items E, G and H above). SKM would have a somewhat different view on other PWD recommendations (e.g. Item B where a more sophisticated estimate of asset lives based on asset condition should be adopted.)

5.5. SKM’s assessment of mines issues As flagged in Section 5.1, and as is evident from the preceding sections, the five (5) key influencers of building a robust cost allocation and pricing model are (1) Consumption of capital value of assets – valuation method for capital recovery and replacement cost for water assets (2) Basis of asset valuation – DORC versus RAB (3) Updating of asset values to contemporary values (4) incorporation of future capex; and (5) most importantly the basis of allocating cost associated with provision of the water supply services (opex).

5.5.1. Consumption of capital value of assets - Replacement cost for water assets SKM considers that consumption of asset capacity is the key driver for the allocation of the replacement costs/value of water assets as between the two primary user groups (mines customers and Broken Hill urban customers). It would also be an enhancement if assets were disaggregated to a greater extent (at least at this first stage) to be better linked with the asset capacity consumption driver (and respective consumption of each asset by the two key user groups. This would enable these “capital recovery” cost to be better targeted (including for the calculation of returns on capital) to the appropriate beneficiary

Essential Energy has identified its options as described in Section 5.3.2. The following represents a variation of each of the Options outlined there and enhances them.



SKM proposes two potential improvement scenarios for better targeting for allocation of replacement costs for water assets (however determined) based on better allocation of assets and asset capacity consumption. These are identified as Scenario A and Scenario B.

A. If the whole of the water supply system is considered as a fully integrated system, assets would be better allocated as shown in Figure 13.

B. If the whole of the water supply system is considered as a fully integrated system except that the Menindee pipeline is excluded given its history, assets would be better allocated as shown in Figure 14. This is closest to how the Menindee pipeline is currently proposed to be treated by EE. This only differs from Scenario A in the way in which the Menindee pipeline is treated.

Figure 13: Scenario A - Proposed asset allocations if treated as fully integrated water supply system

Figure 14: Scenario B - Proposed asset allocations if treated as fully integrated water supply system – excluding Menindee Pipeline



Both Scenarios have strong validity, but of the two, SKM considers that Scenario B is the most appropriate, particularly given the history of the Menindee pipeline. SKM does not have all the necessary asset value data to undertake the calculations to enable more detailed quantitative assessment of these Scenarios but recommends that Essential Energy does assess both in detail. Both are recommended for assessment because Scenario A, when coupled with the other key factors in the allocation of costs, may have some advantages in achieving a better balance of costs between urban and mines customers from a broader perspective.

The rationale for the assets split indicated in Scenario A and Scenario B is as follows:

Urban water reticulation assets

o These assets are assumed to have (based the system layouts sighted) to have negligible service provision for the mines and therefore should be wholly allocated to urban customers.

Water Treatment Plant(s)

o The value of this asset should be split on the basis of capacity of the asset consumed. Normally this would involve proportioning on the basis of either the respective peak usage of treated water plant capacity or a combination of the peak and average usage of treated water plant capacity. At present, for simplicity the best surrogate is actual average volumetric filtered water usage. So the asset should be split on average filtered water usage for the mines and urban customers – the average of which for the last two years is 30% and 70% respectively. This could be reviewed in the next regulatory period.

Remainder of all commonly shared assets (i.e. all assets but excluding the urban water reticulation assets, water treatment plant(s) and the Menindee pipeline

o The value of these assets should be split on the basis of capacity of the assets consumed. Normally this would involve proportioning on the basis of either the respective peak usage of treated water plant capacity or a combination of the peak and average usage of treated water plant capacity. At present, for simplicity the best surrogate is actual average totalwater usage. So the asset should be split on average total water usage for the mines and urban customers – the average of which for the last two years is 34% and 66% respectively. This could be reviewed in the next regulatory period.

Menindee Pipeline. This could be treated in two ways

o Scenario A: Some proportion of the 78% of the pipeline originally funded by the mines should be allocated to urban customers on the basis that they derive a material benefit from this pipeline – if treated as part of a fully integrated water supply system. This 78% would be allocated on the same basis as above for “commonly shared assets”, namely 66% (of the 78%) would be allocated to urban customers. The balance of the 78% would be unallocated (as the mines have previously paid for this).

The remaining 22% would be allocated as per “commonly shared assets”. o Scenario B: The whole of the 78% (previously funded by the mines) would be unallocated.

The remaining 22% would be allocated as per “commonly shared assets”.



The above allocation of asset should be easy to determine and simple to administer.

A more onerous variation of this would be to allocate every single asset based on respective use to service the mines and urban customers respectively.

5.5.2. Basis of asset valuation Having decided the proportion of assets (based on consumption of capacity) to be allocated to Mines and urban water customers respectively the next key issue is how the assets are valued. There are two primary possibilities DORC (Depreciated Optimised Replacement Cost) or RAB basis.

Regardless of whether DORC or RAB is used the following improvements should be made to the values attributed to Essential Energy’s water assets. Asset values should be updated to reflect:

A better estimate of actual residual asset life

o Currently this is based on a nominated or notional design life for a particular asset less the elapsed time since its installation/construction (“elapsed age”).

o Over time and as information is progressively accumulated (as part of Essential Water’s enhanced asset inspections regime and asset improvement initiatives), this should be based on an estimate of the asset’s actual residual life which would in turn be based on the actual condition of an asset

o In the near term, a desktop review could and should be undertaken to ensure a more realistic value is placed on each asset. This would in part be based on work that Essential Water has already commenced.

o Note: The actual residual life should be looked at from a structural and a service perspective.

Updated current estimate of asset values.

RAB vs DORC

It is noted that Essential Energy has chosen to adopt DORC rather than the RAB values as the basis of its regulatory submission for determining mines pricing charges. Given that Essential Energy’s total revenue requirement (“notional revenue requirement”) for each year (from 2014/15 to 2017/18) from all sources is calculated using IPART's regulated asset base (RAB), it seems inconsistent and incongruous that the mines pricing is calculated on a different basis.

The mines revenue requirement should be determined on the same valuation basis – whether RAB or DORC. RAB is preferred as being consistent with IPART’s methodology, as long as Essential Water has the necessary revenue to fund its future capital commitments to meet service needs.

The implications of this would be that a greater proportion of the total revenue requirement would be recovered from mines via variable charges and less from fixed charges. If implemented the implications for potentially “stranding” of assets would need to be more fully considered.

Many of the NSW PWD comments / recommendations in relation to asset valuation are broadly consistent with SKM’s recommendations, noting in particular those in relation to:



The basis for RAB values used in the calculations should be verified and, if necessary, modified to reflect the latest (June 2012) information

Asset values should not be based on age (whether 98 or 70) but rather on a view of actual estimate of residual life (this could be desktop and/or condition assessment) but over time move to an actual condition based assessment of residual asset life.

5.5.3. Incorporation of future capex On the basis of the material sighted, and Essential Energy has confirmed, no future capex proposed in the next regulatory period has been included in the replacement cost asset base (or from the current regulatory period?).

The replacement cost asset base (whether DORC or RAB is used) should be increased to reflect the additional capex planned for the 2014/15 to 2017/18 regulatory period.

5.5.4. Allocation of Opex It is noted that Essential Water allocates its total annual operating expenditure to mines and urban customers on the basis of the same pro-rata apportionment of asset values excluding Menindee pipeline (as is allocated to mines).

SKM considers that operating expenditure should be assigned on the basis of actual volumes of water supplied to each of the mines and urban customers respectively. As a first approximation this would be on total water usage (given that filtered water represents 88.4% of all total water usage). This could and should be refined further although this may not provide significantly greater precision.

The reasons for this are that:

some expenditure is directly related to volumes of water supplied - e.g. energy, chemicals, chlorination/UV disinfection, maintenance and materials (normal wear and tear); and

some expenditure is clearly not related to asset values per se but rather to overall service provided, and water supplied is a better way to allocate these costs – e.g. corporate costs (representing approximately 20% of all opex), inspections, labour, contractors, consultants and fleet costs.

It is arguable that some expenditure may be related to or be driving maintenance costs based on “age”/”asset value”. This is estimated to be only approximately 10% of total annual opex.

The impacts of this are that the mines would pay a greater proportion of the operating expenditure than is currently proposed by Essential Energy. Based on using 2013/2014 from the mines cost allocation sheet of $13.258m as an example (although it is noted that this number appears to be different in this spread-sheet compared with that in the AIR for this year, even allowing for de-escalation), the potential implications are indicatively that:

If DORC is used – the mines variable charge would increase by approximately $ k ($ k less $ k); or



If RAB is used - the mines variable charge would increase by approximately $ k ($ k less $ k)

Some other adjustments between the fixed and variable charges may need to occur and a full reconciliation would need to be undertaken. Nevertheless if the opex cost allocation proposed by Essential Energy is adopted that a significant cross-subsidy to the mines from urban customers would occur (and is potentially occurring now).

It is acknowledged that there are significant potential and business implications based on the above analysis and recommendations which will need to be further considered before finalisation of this draft report and/or if implemented.

5.6. Mines Sewerage pricing Essential Energy has not attempted to provide specific pricing of sewer for the Mines but proposes to continue charging them at standard rates (as for other commercial customers).

The basis for this is that the revenue from such charges is small and little different if charged on a more complicated cost allocation basis. The total cost is approximately $ K p.a. which is only approximately 3% of the expected mines water revenue.

Furthermore the sewage volumes generated by the mines for treatment are only approximately 2% of all sewage volumes treated. For example, Perilya has an installed outflow meter which recorded sewage volumes of 34,475 kL in 2012 (with a usual range of 28,000 to 35,000 kL per year. Perilya is charged at normal commercial rates. BH Operations do not have any industrial sewerage or trade waste discharges. Only are charged on normal commercial rates for the administration building.

As noted earlier, mines own the infrastructure and pumps that supply the treated effluent. These are located on the boundary of Wills St WWTP.

SKM considers EE’s approach for sewerage pricing to be reasonable.

5.7. Key Recommendations SKM recommends that the following enhancements to mines pricing be considered: Table 1

1. Replacement cost for water assets

The allocation of the replacement costs of water supply assets to mine and urban customers on actual usage would be more soundly based if undertaken on the basis of the method indicated in Figure 14 – if the water supply system is considered a fully integrated system after exclusion of the Menindee pipeline - or Figure 13, if the water supply system is considered fully integrated including the Menindee pipeline. Essential Energy should remodel the cost allocations on this basis.

Once the key issues have been resolved (including the broad philosophical questions outlined in preceding sections), the following enhancements to the allocation of costs could be made (as indicated in Items 2, 3 and 4 below).



2. Future capex in the next regulatory period has not been included in the replacement asset cost allocations and should be.

3. Basis of asset valuation.

A consistent basis should be used to calculate Essential Water’s aggregate notional revenue requirement for its business and also for determining the mines revenue requirements (at present they are different, the former being calculated on RAB and the latter on ODRC). IPART’s prescribed RAB would seem the most appropriate basis for these.

In any event the replacement asset values should be updated to reflect current day values and be enhanced by basing on a better estimate of residual asset life (including actual condition) rather than just “elapsed age”.

4. Operating expenditure allocations

Operating expenditure should be assigned on the basis of actual volumes of water supplied to each of the mines and urban customers respectively, as outlined in Section 5.5.4.

On the face of it there currently appears to be a significant cross-subsidy to the mines from urban customers. These enhancements would establish whether this is so and provide a more defensible position to the allocation of costs. It is acknowledged that significant potential business and other implications may exist if these recommendations are adopted and other factors will need to be considered before implementation.

Essential Energy’s approach to sewerage pricing for mines is considered reasonable at this stage.

5.8. Reference Information The following sources of information related to mines costing were considered:

EE Regulatory submission to IPART

Response to SKM’s RFI No 3, 16 October 2013

Excel spreadsheet entitled “EE 2014 water price review_Attachment 7_EE (Water) 2013 AIR”

EE_2014 price review_Attachment 5_Cost Allocation Methodology_CAM

Attachment 8_ Mines Specific Pricingv2 with RAB

Essential Energy 2014 - submission Attachment 8_Cost reflective mines pricing_v1

Mines Pricing Methodology Review_Services NSW



6. Review of Asset Management Systems and Practices

6.1. Background A strategic review was performed on Essential Energy’s asset management systems and practices - with a focus on the rigour of Essential Energy’s approach to managing the whole life of its assets. This strategic review included consideration of:

The robustness of Essential Energy’s systems for linking asset management decisions with current and future levels of service and performance requirements, including customer service and environmental outcomes.

The way in which Essential Energy manages the risks associated with asset failure or under performance, including any issues relating to the process for determining and prioritising future infrastructure expenditures.

An evidence based strategic review was employed – considering the existence of a structured corporate asset management framework (and its alignment with contemporary risk-based, service-driven asset management practices), along with evidence of the application of the framework in the development of Essential Energy’s capital investment and operating expenditure programs.

This findings and recommendations of this strategic review take into account Essential Energy’s organisational context – its size, history, network characteristics and current asset management ‘maturity’ – recognising that all infrastructure organisations are on an asset management ‘journey’.

Operational level documentation (condition assessment guidelines, asset creation procedures, etc.) were not included in this review.

6.2. Key Findings Asset Management Framework - Essential Energy demonstrates a sound understanding of asset management principles, including contemporary service/objective driven asset management. However, the application of these asset management principles does not appear to have been translated into a structured asset management framework that clearly defines and connects Essential Energy’s asset management practices across strategic, tactical and operational levels over the asset life-cycle; and links Essential Energy’s asset management systems to broader corporate systems and plans.

Asset Management Practices – It is evident that Essential Energy personnel have a strong understanding of their assets. Review of investment cases and technical documentation for sampled individual capital projects also demonstrate that asset risk and life-cycle considerations have been taken into account. However, in the absence of a structured asset management system the consistent application of risk management and investment decision making across Essential Energy’s asset base cannot be adequately demonstrated to support expenditure and prioritisation proposals. Mandatory and discretionary activities are not classified through the expenditure program development process (until a project investment case is developed) and risk-cost trade-offs that support capital operating expenditure are unable to be justified clearly and robustly.



Risk Management – Essential Energy regularly employs risk management in the management of its assets - notably in the management of risks associated with drinking water quality and project delivery. Essential Energy’s practices are generally aligned with AS/NZS ISO 31000:2009 Risk Management - however risk assessments do not consistently employ Essential Energy’s Corporate Risk Management Procedure (terminology, ratings and consequence categories). Asset risks are, at present, unable to be well-articulated with a clear link to all Essential Energy service and performance objectives (including customer service and environmental outcomes), in particular for Essential Energy’s sewerage network. An understanding of these risks is essential to provide confidence that there will be ‘no surprises’ in long term investment planning. Improvement opportunities also exist in Essential Energy’s risk-based capital investment prioritisation process – establishing risk-appetites that define mandatory and discretionary expenditure, and prioritising risks across different drivers.

Information Management - Essential Energy do link maintenance activities and asset failures to individual assets through their CMMS (Mainpac), permitting economic analysis to be performed as part of a renewal decision making process. However, other important asset management information (in particular risk data) is stored in stand-alone documents and spreadsheets rather than in a corporate database - limiting the resilience and efficient retrieval, interrogation and reporting of key data.

Continuous Improvement – Essential Energy recognises the need for an ‘asset management improvement journey’ and has identified this as a key strategic objective in its Water Asset Management Plan (WAMP). The development and implementation of an improvement plan is endorsed by SKM.

6.3. Further Discussions and Recommendations

6.3.1. Asset Management Framework and Systems

Industry Asset Management Frameworks

Several industry-developed Asset Management frameworks currently exist and have been adopted by various infrastructure organisations. Those commonly adopted by urban water utilities include:

British Standards Institution Publicly Available Specification PAS 55 : 2008 Asset Management

Water Service Association of Australia (WSAA)’s Aquamark benchmarking framework

The Institute of Public Works Engineering Australasia (IPWEA)’s International Infrastructure Management Manual (2011 Ed.)

A suite of International Standards for Asset Management (ISO 55000) has also been in development since 2010 and is expected to be published in late 2013. Essential Energy also aims to conform with the New South Wales (NSW) Government’s Total Asset Management framework, which forms part of the NSW Government's capital expenditure submission framework.

Essential components of a robust Asset Management framework

It is appreciated that Essential Energy is a small organisation (network size/complexity and customer base) in the context of urban water utilities reviewed by IPART. At the same time,

SlllC:Ull Ull MT MUil

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Essential Energy


January 2014

Essential Energy faces challenging operational circumstances through highly variable rainfall in its local catchment - where drought conditions can cause salinity and other water quality problems and result in a dependence on inter-catchment water transfers from the Darling River on average eight out of every ten years. Managing the material risks that these challenges present - while operating in a resource constrained environment - underlines the need for robust asset management practices to ensure capital and operating expenditure is targeted and efficient.

All of the above-mentioned frameworks, while exhibiting slightly different structures and terminology, recognise the following essential components of an asset management framework:

• the need for asset management systems and practices to be driven by service/performance obligations and broader organisational objectives and planning - where performance of all assets (individual assets and/or asset classes) against the stated objectives is understood and managed using a risk-based approach (aligned with International Standard AS/NZS /SO 31000:2009 Risk Management);

• the different levels of an asset management system (policy, strategy, tactical and operational) and the application of each level over the asset life-cycle (create/acquire, operate/utilise. maintain, dispose/renew);

• the important role of information management in facilitating asset management decision making and reporting; and

• the need for a performance monitoring and continuous improvement mindset.

The high-level schematic in Figure 15 summarises these key elements of contemporary risk-based asset management thinking, on which this strategic review has been performed.

Organtsattonal Context Corporate Plan Corporate Poficies The Mlss1011 and Vision • enduring .and oot t>me dependent

Roles and Responsibilities Resources and C3pab1llty Plan Change management I business review

lnfonnation Systems and Knowtodg• A..et Register

• Asset cond1bon assessment data Malnlenance manageme<ll system - linked to assets Operabonal datall<nowledge Fallure data Finaooaf sys.rem

AaHt Life.Cyckt CreatelAcqUH'e Opera1eNhhse Ma1ntafn Dispose/Renew

Asset Management Slrat.egy - formalising how the ~ Mission and Vision will be delivered including a bmeframe for delivery Goals to reach sometime 1n itie future System and asset portfolio focus

Programs of actions arid coordinating actiV.ties to achieve the Strategy. Includes Asset Management Plans, business cases, investment decision making frameworks monttoring & review processes

lmplementabon of the Asset Management Plans. incl. maintenance request procedures, 'hands on' delivery of works •nfonmation oollect1an, etc.

• Figure 15 Overall Asset Management Conceptual Framework

SKM_FINAL REPORT _26 Jan 2.014_Rev E_F1nal_R>:!d3c!ed docx PAGE 127



The need for an over-arching corporate asset management framework

Essential Energy demonstrates a sound understanding of asset management principles, including contemporary service/objective driven asset management. This is particularly demonstrated within its Water Asset Management Plan (WAMP) and was evidenced in discussions with Essential Energy personnel. However, the application of these asset management principles is not adequately translated into a structured asset management framework that clearly achieves the ‘essential components’ described above.

Key information demonstrating Essential Energy’s approach to asset management can be found across a number of documents, notably:

Water Asset Management Plan (WAMP) 2013/14 to 2022/23

JWP Asset Management Plan 2007 (also titled the Country Water Asset Renewal Plan for Water Supply and Sewerage Services in the Broken Hill Region)

Essential Water Strategic Plan FY13 - FY18

Essential Energy Submission to IPART’s Review of Prices for Water and Sewerage Services to Broken Hill and Surrounds (September 2013)

Essential Water Drinking Water Quality - Management Framework Gap Analysis (Nov 2012)

Some individual documents demonstrate clear links between specific levels of service and performance requirements and proposed risk management activities (namely the Drinking Water Quality - Management Framework Gap Analysis and the JWP Asset Management Plan), but the relationship of these documents with each other is not adequately defined. For example, the relative function of the WAMP and the Essential Water Strategic Plan has not been documented; nor the links between these documents and overall Essential Energy corporate planning documents and procedures (such as the Corporate Risk Management procedure CEOP2111 and Capital Governance Framework – Capital Portfolio and Investment Approvals procedure CEOP2191). This has been observed to be the case more broadly with all asset management documentation reviewed across strategic, tactical and operational levels. Similarly, the use of Essential Energy’s information management systems in asset management decision making and performance monitoring/reporting is not adequately documented.

It should be noted that the above comments do not imply that Essential Energy does not have a strong understanding of its assets, or that the proposed capital and operating expenditure is not appropriate. The lack of evidence of a structured asset management framework suggests that investment decisions may be strongly reliant on individual staff knowledge.

Having a structured corporate asset management framework in place improves organisational resilience (through codification of practices); supports broader ownership of asset management activities; and increases transparency and objectivity in decision making – helping provide confidence to senior management, the Board and economic regulator (IPART) that asset related expenditure decisions are based on a clear, documented and Board-approved systems.

Recommendation: Essential Energy should establish an over-arching asset management framework. This can initially be a schematic or similar document outlining the relationship between the various key corporate documents and the asset management practices at strategic, tactical and operational levels over the asset life-cycle.



This should evolve over time into a more robust, Board-approved framework aligned with an industry-developed standard (such as the impending ISO 55000 standard), containing as a minimum the essential components discussed above.

Improvement Opportunity: A well-developed, robust contemporary risk based asset management framework should contain an Asset Risk Assessment Decision Making corporate procedure and an Investment (Risk Treatment) Decision Making corporate procedure – existing separate to tactical asset management plans. At present, what could be understood to be Essential Energy’s asset risk assessment decision making procedures are contained within the JWP Asset Management Plan and Drinking Water Quality - Management Framework Gap Analysis. There is no investment decision making procedure currently identified (this being distinct from the corporate Capital Governance Framework). The Asset Risk Assessment Decision Making procedure should take into account Essential Energy’s levels of service and performance requirements (Sections 7 and 8 of the Essential Water Strategic Plan FY13 – FY18) and the ‘function’ of each asset in the achievement of these requirements (as defined in Reliability Centred Maintenance theory).

Asset Management Plans:

An equivalent Sewer Asset Management Plan is not yet prepared and its development similar to the WAMP is encouraged. Essential Energy intends to include such a plan in its 'Water Asset Management Plan' (i.e. WAMP - Water Division is not going to be two separate documents).

Recommendation & Improvement opportunity: SKM considers that it would be preferable (and prudent asset management practice) to keep these as discrete documents (or failing that as discrete sections of a comprehensive over-arching asset management plan) as the decision rules and decision frameworks will be different for the water and sewerage assets.

6.3.2. Essential Energy’s Asset Risk Management Practices

Need for systematic asset risk assessment - linking risk assessments to service and performance requirements

It is understood that Essential Energy’s water business identifies new projects through status reports from its Mainpac (maintenance management) system and from site inspections. Discussions also indicate that Essential Energy adopts its drinking water quality risk assessment register (File: Assessment of Broken Hill's drinking water supply system) as the parent risk register for the water supply network. This risk register demonstrates an appropriate level of detail for Essential Energy in assessing asset failure risks for one of its service requirements (continuity of water supply). A similar register does not exist for the sewerage network or other service requirements of the water supply network (e.g. environmental).

Reviewed documentation indicates that Essential Energy does manage identified risks associated with asset failure or under performance. However, with the exception of water quality, there does not appear to be a systematic application of risk management across all assets, taking into account their risk of failure across all of Essential Energy’s service and performance requirements.

Acknowledging the value of identifying potential projects through site inspections and maintenance/ failure history (from Mainpac), a systematic approach to asset risk management is essential to provide confidence that there will be ‘no surprises’ in short and long term investment planning.



For example, it is understood that the Stephens Creek Pump Station No.4 Project, which is currently identified as the highest priority project for the 2014-2019 regulatory period, was not ‘flagged’ for inclusion in Essential Energy’s capital investment program until the drinking water quality risk assessment was performed. The old age of the pumping station building was known, but the immediate and unacceptable level of risk that it presented to the water supply of Broken Hill (and relative importance compared to other projects already on the capital investment program) was presumably not recognised until this systematic risk assessment was performed on all assets within Essential Energy’s water supply network.

It is understood that Essential Energy does not have in place the following items that are considered good industry practice when systematically applying service/performance driven risk management to an asset base:

Defining ‘asset functions’ (for each asset class) and ‘risk/failure events’ with regards to Essential Energy’s levels of service and performance requirements (consistent with Reliability Centred Maintenance theory – recognising a function-driven asset hierarchy);

Assessment of likelihood of failure and consequence of failure with regards to these asset functions and risk events – resulting in a corporate asset risk register (and associated risk matrix) containing the likelihood and consequence assessment of individual assets against the performance and service requirements in Sections 7 and 8 of the Essential Water Strategic Plan FY13 – FY18

Evaluation of Essential Energy’s organisational risk appetite with regards to Essential Energy’s levels of service and performance requirements – defining critical and non-critical assets through the risk assessment stage of the risk management process (as defined in AS/NZS ISO 31000:2009 Risk Management) and recognising mandatory and discretionary activities through the risk evaluation stage of the risk management process.

Performing risk treatment investment decision with systematic consideration of operating, capital and non-asset-specific activities.

Recommendation: Subsequent to the development of Asset Risk Assessment Decision Making procedure, Essential Energy should continue its systematic asset risk assessment (building on the drinking water quality risk assessment) of all water and sewerage network assets. Risk assessment results should be stored within a corporate risk register, ideally within a corporate database / enterprise asset management system.

Improvement Opportunity: Improvement opportunities also exist in Essential Energy’s risk-based capital investment prioritisation process – establishing risk-appetites that define mandatory and discretionary expenditure, and prioritising risks across different drivers.

It is noted that Essential Energy’s Corporate Risk Management Procedure (CEOP2111) does identify management approval levels for risk management decision making, with the Essential Energy Board is ultimately responsible for risk management across Essential Energy. As such, the Board determines Essential Energy’s appetite for risk. Essential Energy’s asset management framework should support the Board in their risk appetite decision making, particularly through clear demonstration of risk-cost trade-offs for discretionary expenditure projects and programs.



Identifying Mandatory and Discretionary Expenditure

The CAPEX Prioritisation Table employs a ‘traffic light’ system to reflect the relative importance of each capital investment project proposed for the next regulatory period against the four following drivers (Public Safety, Security of Supply, Regulatory Compliance, and Prudent Commercial Investment). ‘Regulatory compliance’ reflects mandatory expenditure (projects driven by regulatory obligations). It is noted that mandatory expenditure needs are not discussed in other reviewed documentation – including risk assessment procedures and risk registers. The identification of mandatory and discretionary expenditure appears to serve as a mechanism to assist in the prioritisation of projects in the capital investment program.

Consistency of Risk Management practices

Essential Energy has a Corporate Risk Management Procedure (CEOP2111 – which is aligned with AS/NZS ISO 31000:2009 Risk Management) and employs risk management in a number of places throughout its asset management practices. Some examples include:

The management of risks associated with drinking water quality (a risk assessment performed on all assets within Essential Energy’s water network)

Water supply network renewals planning (within the JWP Asset Management Plan) Management of project delivery risks (within project Investment Cases) Establishing a three-tiered criticality rating system to set maintenance classes for mechanical

and electrical equipment (within table Critical Plant_Pumps-19-September-2013 09-16-571)

It is assumed that these applications of risk management are ‘divisional’ risk management activities (as defined in the Corporate Risk Management Procedure, although the divisional risk management procedures that drive these risk management activities have not been evidenced (with the exception of the risk assessment decision making procedure within the JWP Asset Management Plan). Reviews of various risk management activities show that they do not consistently employ Essential Energy’s Corporate Risk Management Procedure. For example:

The corporate consequence/risk categories (Health & Safety, Financial, Reputational, Business Interruption; Environmental) are not used in many of the divisional risk assessments. This includes the CAPEX Prioritisation Table that was presented to the Network NSW Board to allow the board to assess the relative importance of the individual projects contained in the proposed CAPEX program (this table included categories: Public Safety, Security of Supply, Regulatory Compliance, and Prudent Commercial Investment).

‘Risk ratings’ and ‘consequence ratings’ are sometimes used interchangeably in different risk assessments – for example at. page 50 of the Essential Water Strategic Plan and the 2011 Mica St Tank project delivery risk assessment.

Likelihood and consequence ratings result in a different risk rating being assigned than would be suggested by the Corporate Risk Management Procedure. For example, the drinking water quality risk assessment register assessment of the ‘Menindee pipeline chlorinator - suction manifold for high lift pumps’ is assigned a ‘Very High’ risk (for its likelihood-consequence rating of D4), where the Corporate Risk Management Procedure would assign this a ‘Moderate’ risk.

Improvement Opportunity: Ensure consistent application of Essential Energy’s Corporate Risk Management Procedure.



7. Industry Performance 7.1. Overview Based on 2011/12 data, Essential Energy (Water)/Country Energy ranked above average for key water unit opex expenditure KPIs (varying from 20% to 50%above) and are close to and effectively at the industry average for key sewer unit opex expenditure KPIs.

Essential Energy (Water) considers that its water opex KPIs are generally in line with Essential Energy selected peers, particularly those with high industrial usage.

As previously reported in IPART’s benchmarking for Country Energy (2010) and NWC’s National Performance Report (2011-2012), Essential Water’s operating cost per property for comparable regional urban water businesses, as reflected in Figure 16, Figure 17, Figure 18 and Figure 19:

For water (excluding pumping): is materially higher than most of its peers on a per ML supplied basis and a per length of mains basis; and

For sewerage (excluding pumping): is in the middle of the pack on both a per property and per length of mains/pipes/channels basis. This is somewhat biased to the low side as EW’s sewage treatment facilities are rudimentary. .

Notwithstanding Essential Water’s views (as indicated below), the general conclusion is that there is significant scope for performance improvement for both water and sewerage services.

Essential Water believes (as per Section 6.4 of its submission) that it does not have a true peer water network business against which it can be reasonably be compared. It believes it has unique influences that militate against economic efficiency and need to be considered in “benchmarking” its performance including that there is no other water business of a similar size that operates:

In a remote location In an arid region Is dependent (most years) on pumping water significant distances Has 50% of its water demand from one industry

Adjusting for the pumping costs alone does not take all the other costs associated with operating and maintaining the bulk supply line into account, e.g. all Essential Water materials must travel a considerable distance, staff have to travel significant distances to maintain the infrastructure and a “premium” is paid to attract suitably qualified staff and contractors to work in the area.

It is also worth noting the unusual operating expenditure results for FY2011/12 which are due to the influence of the disproportionately higher allocation of corporate costs to EW’s opex budget compared with its capex budget in that year. This stems from EE’s historical approach in seeking to recover a fixed amount of corporate costs from EW as a whole spread recovered through its capex and opex budgets; and where capex is relatively lower, a greater proportion and quantum of the corporate costs are borne by opex. For FY2011/12, the capital expenditure was so low that an excessive amount of corporate overheads were allocated to opex activities – more than double compared with other years, and which ultimately was one of the catalysts to change the method of allocation of EE corporate costs for the Water business. The impact of this is shown in the most

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_DM recent National Performance Report (of which some have been shown in Section 6.4 of EW's submission to IPART).

EE has added another "data point" to these graphs to indicate forecast improvement (implicitly assuming all other water businesses remain static in their performance improvement). This is shown as the "Essential Energy 2015F" bar second form the left in the figures following.

Note in the following figures the colour coding is as follows:

• EE actual performance

• EE 11l1i:tecl PMf'S

• IPART selected EE peers (2009)

• Figure 16 Water operating costs (excluding pumping costs) per ML of water supplied

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SKM_RNAL REPORT _26 Jan 2014_Rev E_F1nal_Redact.ed docx PAGE 133



NB. Essential Water mains length includes the transfer main from Menindee to Broken Hill. Data source: National Water Commission, National Performance Report 2011-12 Urban water utilities

Figure 18 Sewer operating costs per property 2011-12 Average

Data source: National Water Commission, National Performance Report 2011-12 Urban water utilities

Figure 19 Sewer operating costs per kilometre of sewer mains & channels 2011-12 Average

Data source: National Water Commission, National Performance Report 2011-12 Urban water utilities

7.2. Efficiency Initiatives Since the formation of Networks NSW, there has been a strong focus on improving the efficiency of Essential Energy, including the operations of the water business. This is evidenced through the monthly management of financial reports and the focus on cost reduction to improve economic efficiency throughout the whole business.



All of the measures shown in the benchmarking graphs are considered to not reasonably reflect Essential Water’s improved performance in FY2013 and its on-going performance improvement journey. Figure 16, Figure 17, Figure 18 and Figure 19 have been amended to include a data point showing Essential Water’s notional performance in FY2015 based on its submission numbers. These graphs include the forecast Essential Energy position for 2015 (converted back to 2011/12 dollars) for the same measurement criteria. The average bars have been recalculated to use the 2015 forecast Essential Energy data (as per its AIR /SIR).

This shows a marked improvement in relative performance against other water utility comparators.

Essential Water has undertaken specific improvement initiatives (as per Section 6 of its submission) based on an overarching push to reduce costs within the whole of Essential Energy. These include the following significant initiatives:

o A reduction of 6 FTEs over the period. The breakdown by department is available in the Water Strategic Plan.

o All wage increases are to be absorbed through efficiency gains. o Capping corporate overheads applied to projects at 20%

7.2.1. SKM’s assessment The improvements in corporate cost allocations and other adjustments in expenditure proposed should continue Essential Water on a satisfactory improvement path to bettering or matching comparable water utilities (as per the NWC “benchmarking”).



Appendix A – Essential Energy Schematics Figure A- 1: Overall Water Supply Schematic



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Figure A- 4: Broken Hill Sewerage System



Appendix B – Essential Energy Business Structure EE Organisational Arrangements



Appendix C - General Approach to Capex Assessment

In assessing the prudency and efficiency of capital expenditure is assessed by seeking evidence on specific projects to support robust responses to the following questions.

Prudency – Is it prudent for Essential Water to complete the project? 1. Specification of the project/program drivers and “Problem Definition” / “Business Need”

o How well defined are these (and the differentiation between mandatory vs discretionary drivers);

2. An indication of how the proposed project / program fits within EE Water’s broader asset management framework and other business strategies (including “SCI” if relevant, corporate strategies, specific business strategies);

3. What supporting information and data is available/used to robustly underpin the above and decision-making in general (quantitative preferably or qualitative)

4. In each case what “Options Analysis” is undertaken (including Capex /Opex /policy balance);

5. What Options ranking process(es) are used;

Efficiency - Is the project planned to be conducted efficiently?

6. What work is undertaken to ensure adoption of the optimum and efficient o Sizing of facilities; and

o Timing and staging of works

7. What processes are used to develop rigorous risk based cost estimates for projects and programs of works for inclusion in the regulatory Capex including o Use of historical expenditure and benchmarked costs? and

o Adoption of an efficient risk based cost (risk cost – P50 /P90, which is adopted?)

8. Examples of business cases to support the projects/programs 9. Implementation and delivery

o What delivery methods are used and how are they assessed as efficient?

o How robust is timetable for project delivery (noting typical delays associated with planning and other approvals)?

o What is EE Water’s historical capital delivery performance (against planned timetables and budgets) and how is this reflected in moderation of the proposed “budget” numbers?

10. Overall, what is the nature and specifics of the business decision and prioritisation processes EE Water has in place to support all of the above (including Board involvement).



Appendix D – Corporate Cost Allocation Methodology – Further detail

Non-Causal allocators

In accordance with clause 2.2.4(c).3 of the AER’s Cost Allocation Guidelines, this section presents the supporting information for the non-causal cost allocators used by Essential Energy. The Guidelines state that if a shared cost is immaterial, or if a causal relationship cannot be established without undue cost and effort, then Essential Energy may allocate the costs using a non-causal allocator, with the AER’s approval. Essential Energy has adopted the following two types of non-causal allocators, the justification and methodology of which are discussed in details below:

Weighted average of all other causal allocators; Departmental total direct spend.

Where no causal allocator is feasible (true overheads), Essential Energy applies a weighted average of all other causal allocators to attribute some overheads to business segments (refer CAM, Section 4.1).

Causal Allocators

The feasibility of establishing a causal relationship for these costs is affected by the need to apply resources to monitor, record and analyse data on activities undertaken by staff, which would be significant. Weighted average allocators are used to allocate costs that are typically used in providing services across all business segments where the effort and cost of recording time spent on different business segment activities would not be commensurate with the benefits gained by the improved accuracy in cost allocation. Essential Energy has noted that this approach is similar to that used by other electricity distribution businesses (e.g. Aurora and ETSA Utilities).

Essential Energy considers this weighted average approach to be the most appropriate allocator for fixed overhead costs, in particular corporate costs, because it leverages the direct cost allocations as well as all other causal allocators used in the business by averaging the allocations according to their relative weightings of salary (Direct Labour), FTEs and Fleet usage (the three weighted average allocation methodologies).

The weighted average approach for Direct Labour is carried out by first identifying total salaries by department, then sorting these salaries according to their allocation methodologies. Where a causal (data based) or managerial estimate allocation methodology has been applied, total departmental salaries are split between business segments according to that methodology. To obtain the allocations for Direct Labour, a weighted average of the salaries for all causal and managerial estimate allocation methods is applied.

A similar approach is taken to allocate FTEs and fleet usage by department.

Worked examples of the weighted average approach for the Direct labour (salaries) and Fleet usage methodologies are provided in Figure 4 of the CAM.



Total Departmental Direct Spend

In accordance with the AER’s decision on the classification of Essential Energy’s Regulated Services as Standard Control Services and Alternative Control Services, in this CAM any costs allocated to the Regulated Network are further allocated into Standard Control and Alternative Control Services, where the costs relate to the provision of both service categories.

Field labour time is recorded against job identifiers which enable a direct allocation between Standard Control and Alternative Control Services tasks. However, for the majority of the corporate overheads attributable to Regulated Services, there is no ideal causal allocator to identify the proportion of costs spent on Standard Control and Alternative Control Services, as activities and cost drivers often vary depending on the nature of cost items.

Essential Energy considers that to establish a causal relationship between costs and Standard Control and Alternative Control services would require the completion of detailed timesheets which will add to the administrative burden of Essential Energy without necessarily guaranteeing an optimal allocative outcome. Where much of the overarching business management functions indirectly affect both Standard Control and Alternative Control Services, there is no meaningful direct way to allocate time between these services when work (decisions or actions) affect the overarching operation of Essential Energy’s business. Therefore, an indirect allocation methodology is needed to apply this allocation.

Essential Energy considers that “departmental total direct spend” is the most appropriate allocator for these costs allocated on a non-causal basis. Departmental total direct spend includes labour costs, purchases, contractor costs and plant expenses.

The “Departmental spend” approach is undertaken by first identifying total direct spend for each department for the Regulated Network, then calculating the proportional spend on Standard Control Services and Alternative Control Services (the percentages should add up to 100%) of costs directly allocated to the Regulated Network). The percentage allocation of Regulated Network among all service categories (being Regulated Network, Unregulated Services and Negotiated Services) are then applied to the Standard Control and Alternative Control Services percentages respectively to arrive at a total percentage.

For example, if $12 of IT costs is allocated to Department A which had $50 direct spend on Standard Control Services and $25 on Alternative Control Services, $8 of these IT costs will be allocated to Standard Control Services and $4 to Alternate Control Services.

Figure 5 in the CAM demonstrates how the department spend allocator is applied in allocating to standard control services and alternative control services.

Documents

Strategic Management Overview and Review of Operating and … · 2014-07-17 · sewerage business to recover an amount of revenue that is equal to the full efficient costs of providing