Legislative Council Wednesday 22 November
Ms FORREST (Murchison ) - Mr President, I say from the outset I can see both sides of this debate. When the proposed takeover was first mooted by the Treasurer with a view to making TasWater mark 2 a GBE, I publicly stated I had some sympathy for the suggestion.
In my view a state-owned business providing water and sewerage services to Tasmania is not without its merit. When we cast our minds back, this was the original intent of the former Labor government. For a range of reasons this was not to be. One of them was because this House would not accept the proposal at that time. I still believe this is likely to be the best model for such crucial infrastructure. The question now is whether this is the right model.
I believe too much of the focus on this proposed reform has centred around the ownership rather than the model. Should we not focus on the best way to run water and sewerage services, on setting prices with or without government intervention, whether to give greater emphasis to running a sustainable operation rather than pursuing a commercial rate of return, how to fund it and determining appropriate distributions to owners? These are the important matters and, I would contend, of greater importance than focusing so much time and energy on ownership per se.
I also appreciate and acknowledge the Government's efforts to keep water and sewerage prices at an affordable level. There are many residential and business customers who are finding these costs difficult to pay. I know people of Tasmania want safe and clean drinking water and compliant sewerage systems at a price they can afford, and I fully support this.
I do not believe a business providing essential services such as these should be making a profit above what is needed to renew, upgrade, maintain and expand water and sewerage services where needed in Tasmania.
I have expressed concern a number of times on ministerial interference in pricing when operating in a regulated environment. I am always concerned this risks making pricing of essential services a political football, subject to the whims and vagaries of a four-year election cycle, an election commitment that risks seeing a race to the bottom to win votes by offering the lowest price when compared to their political opponents and then worrying about how the gap will be funded after the election.
A capital-intensive business whose value depends on asset renewal and maintenance needs to ensure it raises enough revenue to achieve this. If additional funding by way of government grants or concessions is required to achieve this, other areas of government service delivery and activity will no doubt suffer.
Back to the questions: Do we have the right model here? Will it achieve what the Government is telling us? Does the Government have all the details and the plans needed to achieve this admirable plan and desired outcome?
There has been much commentary around this hostile takeover bid. Yes, I agree, this whole process could have been handled a lot better. I am not sure who the architect of the approach taken was, but I suggest this aspect of it is why we are here today; it has been a dismal failure.
However, my job is to review the legislation before us rather than be distracted by the completely destructive manner in which this proposal has made its way to us here to make a determination. The key questions include: Has the Government made a case for this change? Will the proposed bespoke GBE deliver what the Government suggests? Does the Government fully understand what it is taking on? Has it done thorough due diligence? Are things going as badly as the Treasurer suggests? Has TasWater failed to deliver what was expected? Are changes needed with the current legislation if this bill is not supported, to ensure TasWater mark 1 delivers more needed compliant infrastructure in a timely manner? Is TasWater in its current form capable of delivering on all expectations of Tasmanians, its owners and 29 councils and the Government? I will address these in my following comments.
Every two years at GBE hearings we get to have a closer look at TasWater's financials and spend an hour or two trying to understand this business. There were always a couple of things that stood out for me with regard to TasWater. The first thing to hit me about the financials was the simple fact that TasWater has effectively been borrowing to pay dividends to its owners since its inception, though this has improved in recent times, particularly with the reduction in dividend payments to owners more recently. Needless to say, businesses usually pay dividends from profits, so borrowing to do so sets off alarm bells.
Of course, TasWater never quite saw it like that. To TasWater, it was paying out profits to owners and borrowing to fund capital works. You can look at it that way if you like. The reality is that there were years when all the profits were paid out. It was reckless to have such a high level of payments to owners when so much capital was needed in the business, which then had to be borrowed. The simple fact was that the net effect of these competing demands meant borrowings were higher because of the payments to owners.
The Treasurer's submission to the committee put the same argument and he said -
TasWater's dividend policy is neither good for commercial practice, nor does it make adequate provision for expected future capital requirements. No commercial enterprise would pay dividends of such a significant level, when the assets it relies on to deliver its services are deteriorating faster than they can be replaced.
The second thing that used to hit me was whenever TasWater received operating funds from the Government, it went straight to the bottom line. That means profits were greater, hence the income tax equivalents to owner councils were greater. When TasWater was paying out most of its after-tax profits as dividends to owners, the consequent dividend payments to owners were greater. That is crazy. Governments were paying amounts to TasWater whether it was via a grant or via the pensioner discount amounts, but the increased profits flowed out to the owners, maybe with a lag of a year or so. The payments meant to prop up TasWater were instead flowing out to councils. As I said it was crazy. The more the Government paid in assistance to help TasWater operate, the more the owners took out in tax payments and dividends. It seems like a pretty dumb model.
Hence when the Government announced its plan to take over TasWater, I thought it could be a good move. I do not have the background in local government most of the other members of this House have, so I have never understood the logic behind the way both the councils and the wholly owned subsidiary, TasWater, were structured, whether they just grew like Topsy, which I suspect, or whether it was part of a grand design.
It is important to reflect on this point and explore it more fully because it needs to be considered as part of the bigger picture. Councils have a combined debt of $82 million, yet they have cash reserves of $380 million and more net assets than the state itself. I repeat: the councils have more net assets than the state itself. These figures are from the Auditor-General's annual report each year. The figures I have mentioned are from the 2016 figures because the 2017 figures are not out yet. They will be out later this month.
Councils with low debt and high cash reserves were requiring their subsidiary, TasWater, with virtually no cash and debt - which is now at $475 million - to keep borrowing so the councils could remain virtually debt-free. Yet, both the councils and TasWater have relatively stable revenue streams. They are different operations to be sure, but not that different, yet they are run completely differently.
The only explanation that makes any sense is not only was there underinvestment in water and sewerage assets, as finding (1) of the committee's report suggests, it is probably far worse - it was chronic underinvestment. We have so much catching up to do. How else do you account for how two reasonably similar businesses, councils and TasWater, both with reasonably stable revenue sources, both requiring a lot of capital spending each year, have such radically different borrowing needs and different financial goals? Why is that? Why do they have different financial goals?
TasWater was supposed to run like a business and to make a profit, to make a return on assets and to pay returns to owners. Councils are considered to be doing well if they do not borrow. They break square each year and deliver services to the public. When did these twins take such different paths in life and why? As I mentioned earlier, I am not sure the public wants TasWater to be run profitably. They want services at the best possible price, which nevertheless allows TasWater to run sustainably. Do they want TasWater to be able to cross-subsidise other council activities? I would like to see the evidence if that is actually the case, because I do not believe it is.
That is why I agree with the Government's move with this takeover of legislation to remove the need for the entity to make a commercial rate of return. It is to ensure a sustainable, efficient and effective investment in water and sewerage assets. While I agree with the change of emphasis by abolishing the need for a commercial rate of return, I want to fully understand it. Therefore I ask: can the Leader explain how the National Competition Rules affect or otherwise impact on government businesses not required to make a commercial rate of return? What would happen in the future, say, if the business found itself competing in the marketplace with a private provider? The business is nonetheless required to make income tax equivalent payments and pay loan guarantee fees, is it not?
While the Leader is at it, can she kindly explain why a GBE was the chosen model rather than a state-owned company?
Forestry Tasmania, now Sustainable Timber Tasmania, is a GBE. I am not sure what advantage that has given the company.
Explaining the difference between a GBE and a state-owned company in this specific instance will perhaps enable us to try and understand what the Government is up to.
I note the requirements of the Tasmanian Government Businesses Governance Framework Guide which is available on the Treasury website. I will quote from that because it is a basis for the questions I have put to the Leader.
They are talking about the key differences - there is a table on page 6 of the document between the government business framework versus the private sector framework and why government businesses have to do certain things. I note two of the dot points. The first dot point says -
Government businesses are subject to the National Tax Equivalent Regime, which essentially mirrors the Commonwealth's Income Tax Assessment Act 1936, Income Tax Assessment Act 1997, and the Taxation Administration Act 1953 (as amended);
The next dot -
to neutralise the potential advantage of Government businesses being able to borrow at a more favourable rate than in the private sector, the businesses have limited access to Government guarantees and pay guarantee fees where an implicit or explicit guarantee is provided;
That gives the basis for why they are required to pay income tax equivalent from guarantee fees. I am not sure how this actually fits.
The Treasurer also, in his submission to the committee, made some points on this. He said -
For these reasons, under the Government's plan, the Treasurer will be responsible for pricing in Tasmania's water and sewerage industry under amended pricing principles that do not refer to a commercial rate of return on assets.
This does not imply the new government business established by the Water and Sewerage Tasmania Bill 2017 will operate unsustainably by not earning a commercial rate of return on its assets. The Bill sets out as an objective of the new business, to ensure 'sustainable, efficient and effective investment'. In addition, the business 10 year infrastructure plan is required to achieve the lowest sustainable cost of providing water and sewerage services. Furthermore, the pricing principles which will apply to the new business require prices to cover all costs. The requirement to operate on a sustainable basis will also be included in the Ministerial Charter for the new government business.
Pricing asset values and a rate of return on assets is inexplicably linked and are at the very heart of this discussion. One cannot have an all-encompassing discussion without first understanding all of these concepts.
This is one area I thought the committee might have explored a little further. I do not intend to be critical of the committee here because I know how hard committee work can be, especially given the time constraints in this instance and the extraordinarily heavy committee workload of many members.
Pricing, asset values and rates of return are critical, both to the current TasWater and the alternative suggested by the Government.
How various parameters affect asset values are set out on page 67 of TasWater's 2017 annual report. It says 'asset values affect the prices that can be charged'(tbc). I am pretty sure that is the case for the water and sewerage assets. It certainly is the case with our electricity assets.
Asset values determine the amount of depreciation and hence profits. The estimated lives of assets affect the amount of depreciation and profits. Prices affect asset values, further operating expenses also affect asset values and, importantly, how much capital renewal is needed in the future will also affect asset values.
An asset might be making x-dollars each year, but if it has to be replaced or relocated, it is not worth much. It really is a complex web of interrelationships.
Councils place great store on the assertion they hand over assets worth such and such and they deserve a return on those assets each year. I am not sure I completely agree with that assertion.
I regard a council as being the custodian of those assets, and now TasWater is the custodian. The councils have a right, or indeed an obligation, to see those assets are looked after. I am not sure the rights and obligations extend to them extracting returns from TasWater to cross-subsidise their other activities.
I venture to say, and I am sticking my neck out because others will probably not agree, that the assets were overvalued when councils transferred them to the original entities. The councils claim to deserve a return each year is a little over-hyped. They are given the amount needed to be spent - in other words, taking into account the capital renewal factor, the assets were probably overvalued. That is an observation with hindsight.
Mr Valentine - The value of the assets was at a certain level and then it was revalued and valued down. You may have been right in the first instance but they have been revalued.
Ms FORREST - You can prosecute your case. I will keep going with mine. Water and sewerage assets have no intrinsic value. The original costs of these assets is irrelevant. The replacement value is irrelevant. It is a matter of how much they will earn, taking into account future operating expenses and future capital expenditure needed to keep the assets operating.
It is my belief that councils, in extracting the level of returns they have over the last few years, have not acted in the best interests of TasWater. That is not to say they were not acting in the best interests of councils, though. That is the crux of the problem.
The question is whether the Government offers a credible solution. I want to emphasise the word 'credible'. I do not know we can solve the problems. The question is whether the Government is offering a credible solution.
I must add that the current Chair of TasWater, Miles Hampton, has not been blind to the problems created by councils drawing out too much. The committee's report on page 55 quotes evidence by Mr Hampton outlining his success, despite resistance from owners, to inflict a little more pain on councils by restricting distributions.
It must be noted that TasWater has made some changes. I went looking for more detail in the committee's report and how the Government's proposal was going to work. Yet finding 17 said -
There is insufficient information to clearly demonstrate the veracity of the Government's financial modelling with respect to long-term funding of Tasmania's water and sewerage infrastructure needs.
Was there insufficient information or did the committee not have enough time? What was the problem? Did the Government provide all the modelling it has done? Further on finding 28 said -
Treasury has prepared a business case for the new entity and the Government believes it is financially sustainable.
The member for McIntyre in her contribution talked about high-level modelling. Are we being asked to decide this all-important question based on a report of belief? We need a little more than that. The Government has always been quick to describe TasWater as having a lazy balance sheet - I am getting a little tired of the term - but that is a lazy statement unless it is adequately explained.
In my view, what the Government means is that TasWater should borrow more. TasWater retorts that it is not a question of how much one can borrow; it is more a question of the level of borrowings that can be serviced, which the Government should know about. It could borrow more but it does not because it could not service the extra debt. Pure and simple. If prices are to rise less rapidly, revenue will grow more slowly and the amount of debt that can be serviced will be lower. It is all determined by the interest cover - the measure the Auditor General has used every year in his reports - and that is the amount of operating cash available to pay interest. TasWater's minimum interest cover is two times. The committee's report had an extensive quote from Mr Hampton on page 36 that explains TasWater's position, which I agree with, that there should be interest cover at least two times.
Ms Rattray - You liked my question?
Ms FORREST - I was interested in the response. If one is to be a prudent manager, that is the hallmark. Compared to most other businesses, it is still low. TasWater's income streams are fairly stable so low coverage is still okay. Some other businesses would need a higher interest cover, but - and this is a big but - according to Mr Hampton, the Government's model has interest cover way below two times. The Government's submission mentions interest cover falling to 1.6 before increasing to 1.7 two years later in 2025-26.
TasWater's current interest cover is three times and the Government plans to run it down by borrowing more, down to 1.6 times. The Government then tried to reassure the committee by submitting, importantly, that the projections reveal upward-trend interest coverage in the latter years, which suggests that in the longer term it will return to the 2.0 target.
The Government is saying it will borrow more and run with an interest cover as low as 1.6 times. Let us not forget at this point that in order to do this it has to change a section in the current act that requires TasWater to make a current commercial rate of return. The Government has been critical of TasWater for running a lazy balance sheet and then tacitly admits TasWater may have been constrained by the act it had to operate under. That tacit admission comes in the form of a change to the act to allow for a sustainable operation rather than one having to make a commercial rate of return.
What are the specific assumptions used to derive the Government's interest cover of 1.6 times? There are two possible prices that can be used. The Government has proposed a maximum-minimum price increase. The maximum price increase is 3.5 per cent and the minimum price increase is 2.75 per cent. Which one is used in the Government's case presented in the scant two-page summary in its submission? Do we know? Does the committee know which one was used?
The Government model includes the accelerated spending but does it include the Macquarie Point relocation and the solving of the problems of the Launceston combined system, for instance? That is part of the rationale for the Government taking it over. What assumptions were used to derive the results contained in the Government submission? Which assumptions has the Government used to present its case? Why has the Government not given more detail? Why have we not been presented with different scenarios?
I asked TasWater if it could tell me about the Government's modelling. After all, that was the starting point for everyone, TasWater's 10-year plan. I have been curious to see the Government's detailed modelling ever since it told TasWater to step aside - 'We will show you how to run a business', they said. What I was given by TasWater was a model with four scenarios, with two different rates of price increases - the 2.75 per cent and the 3.5 per cent increases in each year. With each price increase scenario it was modelled with and without the additional expenditure on the major projects, so that gave four scenarios in total. The Government worst-case amount of interest cover out of the four scenarios is less than one - 0.8, to be precise. The best scenario is only 1.2 times.
I believe it is a very important matter and I am not sure that it is one that is well understood by those promoting the takeover. The Government's worst-case amount of interest cover out of the four scenarios is less than one. Is the associated risk of such a low interest cover fully understood and appreciated? Why is the amount of interest cover important?
If it is less than one, that means there is insufficient cash being generated from operations to even pay the interest. In other words, borrowings would be needed to pay interest and then extra borrowings would be required to fund all the new capital works. It is not a good position to be in. Having interest cover of two times means there is a fairly reasonable expectation TasWater would be able to pay interest and have money left over for some of the capital upgrades, plus a little bit of a buffer needed by every business in case of unexpected outcomes. We know that can happen with storms and flood damage, as we have seen in recent times.
Who do we believe regarding this vital consideration? I do not know if the committee dug deeper but I could not find anything in the report into this critical area. Why did the Government not voluntarily give more information about the modelling? I suspect the Government has provided the best-case scenario results not the worst ones, as you would expect would be the case. We have nothing else to suggest otherwise.
The whole matter depends on who you believe. Has the Treasurer given us his model with a pollyanna gloss? Another glaring omission from the modelling, which the Government claims supports the case, is: what are the effects on the Government's budgets? Some of the payments to councils are to come from consolidated revenue. Councils may not be concerned where this money comes from, but I am.
In this aspect I do not fully understand the Government's case. A leap of faith is required at this stage to bridge the gap between proposal and understanding the proposal sufficiently to enable an informed decision to be made. I suspect the Government has not done the due diligence required. Due diligence is always difficult when it is in the case of a hostile takeover.
I note the Government is incorporating a specific clause in the bill for the new company, clause 22. That clause is there to help it conduct the due diligence after the takeover. What is the point? It is a bit late then.
My take from all this is that TasWater has been prudent. The Government, on the other hand, has done a bit too much chest-beating. Some of the claims are assertions rather than evidence backed by conclusions, or at least we have not seen the evidence to suggest otherwise.
A little bit tongue-in-cheek, I could ask whether the Government, by chance, has been outsourcing and selling its TasWater message to Mr McQuestin's office. Running second seems to be his speciality at the moment. However, maybe not.
Ms Rattray - What does that have to do with the bill?
Ms FORREST - I am wondering where they have outsourced it. One matter that remains unresolved is what an appropriate return to councils really is. Whether under existing arrangements or whether pursuant to the Government's proposal, what will see the councils getting 50 per cent of profits after 2025?
My view is both are wrong. The current model and the proposed model are wrong and not in TasWater's best interests. Yet, because the councils depend on distribution from TasWater, which the Government recognised with its counteroffer, distributions or payments to councils, as they are called in the bill, if deemed necessary for the longer term should be set and indexed over time. That is if they are to be supported. Whether it ends up as an income tax equivalent or a loan guarantee fee topped up by a dividend, does not matter. Councils are naturally concerned about the Government's offer to pay a dividend based on profits. Profits can be easily fudged, to put it crudely. Profits, prices and asset values are interrelated. The Government will be paying the piper and the cynic in me suggests it will get the tune it wants.
My other reservation about a government takeover of TasWater is governments do not have a great record in running its businesses and the Treasurer will argue with that. I had a discussion with the Treasurer today and he will argue this point. I have not had a chance to read the Treasurer's annual financial report yet; I will do that once we get through all this. I am talking historically here. Both Hydro Tasmania and TasNetworks are fully loaded up with debt and have been for some time. Governments can always justify this by pointing out others run their businesses in a similar manner and it is a self-fulfilling argument for members of the herd with a shared mentality.
Simply, excessive debt makes adapting to future challenges more difficult and none of us knows what the future holds. The TasWater takeover bill contains provisions requiring the new corporation to formulate a 10-year infrastructure plan to be agreed with the Government which then must be reflected in the corporate plan and budgets which set out what the business does from year to year. It sounds like a good idea, but is it credible, given the way the Government has run its own affairs?
I find it somewhat disingenuous of the Government to criticise TasWater for underspending and delays in infrastructure spending. They really should look in their own backyard.
When it comes to sticking to infrastructure plans, this Government has been woeful. The previous government was just as bad. In its first year, 2014-15, the current government underspending on infrastructure compared to what was budgeted was $123 million less. The next year the figure was $58 million. In the most recently completed year, 2016-17, the amount was $105 million. A total of $286 million in three years was supposed to be spent and was not spent on infrastructure.
The past year has seen the Government berating TasWater for not spending enough. Yet its own record on infrastructure spending is awful. This is not a matter of this being the fault of a previous government. You cannot blame this one on the previous government. This Government has spent $286 million less than it promised to do. This is not a promise made before taking office, when it did not have a chance to do a full due diligence, but a promise made after due consideration of all budgetary challenges facing this state.
This makes me a little wary of anything the Government may say about future infrastructure spending and being critical. In view of these criticisms, I thought I should have a look and run a check on TasWater's figures to see if they were as bad, and try to ascertain who was being more credible in this area, if any were. I had a quick look at TasWater's latest financials for 2016, which were only provided a few days ago. I was particularly interested to see how the actuals compared to what was budgeted back in June 2016, and it was also published on the TasWater website. The overall cash position was exactly as budgeted. Their operating cash was $8 million less, payment to councils were as budgeted, the capital spending was only $2 million less and $5 million more was borrowed. Overall cash changes were as budgeted. Essentially in 2016-17 TasWater came in on budget. One needs to give them credit for that, surely.
The Government has recently published comments on the Productivity Commission's draft report on horizontal fiscal equalisation, the so-called GST review, in which it was quite critical - and rightly so - of the commissioner's response. The commissioner's report noted its conclusions on these issues are predicated on assertions, not evidence, and, if anything, its conclusions point to minimal impact.
I cannot escape feeling the same about the Government's TasWater takeover proposals. That is where I stand at this time. My mind remains open to hearing other comments from other members, particularly those who had the benefit of having so much more evidence during the committee process. I look forward to hearing those members' contributions and also the Leader's reply. She may be able to shed more light rather than the political stuff in the last little effort. I thought we had already had the second reading speech; anyway that is what we get.
At this stage, as noted in the committee report, I am not sure the Government has fully made its case. We can and will solve TasWater's problems, and I agree there are problems and I have alluded to some throughout my contribution. I am not sure whether this will be started today or at a later time under a more collaborative approach. It has been, nonetheless, a useful public discussion. Some of the issues requiring solutions have been aired. There are some challenging issues requiring further consideration.
Discussion has become too fixated on who owns TasWater. That should be a secondary matter. There have been a number of representations from people, some saying support, some saying oppose, and when I have engaged with a lot of these people, the issues they raise are issues that will remain if we do not fix the overall structure. Even if we remain with the current structure, we need to make changes. If we change it, I am not sure this is the right model. We will see where we go with all of this.
Most of the issues requiring solutions have been aired. There are areas we should be focusing on, not only to understand the issues, but also to determine the most appropriate, effective and efficient model that could or should be implemented; that is the key.
To go back to those key areas we really need to understand better - the setting of prices, with or without Government intervention; whether to give greater emphasis to running a sustainable operation rather than pursuing a commercial rate of return; how it will be funded; and determining the appropriate distributions to owners. These are the important matters. Who owns them will then be an easy matter. At this stage I will await the other member's contributions and I will determine my final decision on this following the Leader's reply.