Source document: https://docs-lawep.s3.us-east-2.amazonaws.com/1697804721386.pdf (Ireland)
Statement on Funding of water services Thank you, Chair, I appreciate the opportunity to make a presentation from the Department’s perspective on aspects of the funding of water services in Ireland.

I am accompanied today by Mr Colm Lavery, Principal Officer and Mr Patrick O’Sullivan, Principal Officer from the Water Division of the Department.
My understanding is that the Committee had specific questions regarding the overall funding position prior to the establishment of Irish Water at your last meeting, which I will seek to address, as well as providing some perspectives on the overall funding of the sector to assist the Committee’s consideration of the Expert Commission’s report.
As we have provided a detailed note with historical information on capital and operational costs as well as forecasts to 2021, I will focus on some of the key trends and relevant issues in this presentation.

Expenditure on water services and funding arrangements prior to 2014 Prior to 2014, the Department managed two capital investment programmes – the multi-annual Water Services Investment Programme (WSIP) and the Rural Water Programme (RWP).
Over the eight year period 2006-2013 just under €3.5 billion in Exchequer resources was invested on water services under these programmes.

The WSIP was focused on public water services capital projects valued over €1m, while the RWP covered investment in small public water and sewerage schemes (projects valued at under €1m) as well as the recoupment to local authorities of grants paid to the non-public water sector, mainly group water schemes.
The Exchequer grants for public water services projects generally covered about 75% of the overall costs.

The balance was funded by local authorities from revenue from commercial water charges, capital contributions from major users, the water component of development levies and borrowings.

Under these arrangements, the overall strategic direction of the WSIP and the projects outlined therein were selected by the Department, following prioritisation by local authorities.
The advancement of projects through key stages required Departmental approval and grant approval was provided on a project by project basis, with approvals setting the split between the Exchequer and local authority funding.

The capital expenditure on public water services in 2013, including the estimated local authority contribution, was some €319m.

At the end of 2013, local authorities had an outstanding debt in relation to borrowing for water and waste water projects of some €600m.
1 Prior to 2014, local authorities were wholly responsible for operational expenditure decisions.

Operational costs were met from non-domestic charges and local authority own-resources.

The most important of these own resources was the general purpose grant provided from the Local Government Fund (LGF).
While the general purpose grant had reflected the commitment by the State to provide funding to local authorities in respect of domestic water services following the abolition of water charges in 1997, local authorities had discretion as to how they applied the general purpose grant across expenditure lines.
Based on local authorities annual financial statements, and adjusting for services not transferred to Irish Water, the expenditure by local authorities on operation of public water and waste water services was about €720m in 2013, and would have risen to €732m in 2014 allowing for network growth and adjusting for increases in commercial rates charges.
Funding arrangements for public water services in 2014 The capital funding for Irish Water in 2014, provided as a capital contribution from the Minister for Finance, was set at €239m, which would have been the same as under the previous Exchequer funding arrangements of the WSIP and RWP had they remained in place.

Irish Water utilised this funding and borrowings to finance a capital programme of €740m, including metering and establishment costs in 2014.
Overall Irish Water operational costs including financing costs in 2014 were €778m.

This covered functions transferred from local authorities as well as new Irish Water activities.

This expenditure was financed from non-domestic revenue, borrowings and operational subvention.

Funding from the LGF to Irish Water was based on an estimate of the net funding which would have been provided to local authorities towards water services from general purpose grants, if the function had remained with them, i.e.
operational costs less revenue from domestic charges, with some adjustment for expected operational savings and the cost of financing the local authority outstanding water debt which did not transfer to Irish Water.

On this basis, the subvention to Irish Water in 2014 was €439m; €47m was recouped to local authorities for their water financing costs; and the general purpose grant to local authorities was reduced accordingly.
2 Funding arrangements in 2015 onwards Funding arrangements from 2015 have reflected the commencement of economic regulation and domestic water charges.

Capital funding is provided by a capital contribution from the Minister for Finance, with the balance of capital expenditure facilitated through borrowing and customer revenue.

A total of €406m in capital funding was provided in 2015 and 2016.
An amount of €270m is scheduled for 2017 and similar amounts would be expected each year to 2020 under the Irish Water business plan.

The business plan did not envisage the requirement for a contribution in 2021, on the basis that capital expenditure in that year would be met wholly by borrowing and customer revenue.
Turning to the operational side, operational subvention to Irish Water is designed to cover the costs of  providing the free allowance for children;  capping water charges at €160/€260 per annum depending on household size; and  capping the unit charge at €3.70 for each 1,000 litres of water supplied and waste water removed.

Funding is also provided for working capital, which reflects the time lag between charging and receipt of revenue.
The Irish Water business plan generally reflects an average annual subvention of €467m and average working capital of €32m between 2017 and 2021.

In 2017, €475m is to be provided in line with the business plan, and this is being increased by €125m to cover the suspension of water charges provided for in the Water Services (Amendment) Act 2016.
If water charging were to remain suspended in 2017, a further €114m would be required, bringing the total additional funding requirement in 2017 above the business plan projection to €239m.

Comparison between Operational Expenditure The Irish Water Business Plan forecasts efficiencies in operational expenditure of €1.1 billion over the period to 2021.

These will be subject to scrutiny and challenge by the CER.
As a consequence, the operational costs excluding financing costs will reduce from €769m in 2014 to €614m in 2021 at 2015 prices.

By comparison, if the functions had been retained by local authorities and allowing for the upward pressure in costs from new facilities and similarly 3 excluding financing and commercial rates costs, it is estimated that the equivalent local authority figure in 2021 would have been of the order of €695m.
However, a couple of points need to be borne in mind in comparing operational costs under both models.

Firstly, the PWC Independent Assessment in 2011, based on engagement with local authorities, recognised that operational expenditure by local authorities was artificially constrained for budgetary reasons.
This is supported by EPA analysis that while 34% of incidents associated with licensed waste water discharges in 2012 were for capacity issues, including need for infrastructural improvements, 38% of incidents were due to operation and maintenance issues.

PWC estimated that some €60m was required to address this “opex backlog”.

Secondly, there are costs reflected in the Irish Water model which would not have arisen for local authorities.
These include some costs related to the set-up – developing new systems etc, which are treated as operational expenditure under accounting rules, but are treated as capital expenditure by the CER.

It also includes a range of activities relating to new functions, e.g.

customer billing, and running new asset management systems, as well as new programmes, e.g.

the first fix programme.

Many of these costs would be characterised as “spend to save” programmes, i.e.
expenditure now to deliver future efficiencies.

Thirdly, a much higher level of performance is expected from Irish Water operations, across a range of metrics including leakage, customer service, environmental compliance, reduction in boil water notices etc, as Irish Water avails of economies of scale and deploys new asset management systems and standard operational approaches.

A performance assessment framework is being put in place by the CER in this regard.
Considerable capital investment was made by local authorities over the period 2000 to 2013, particularly to build new waste water treatment capacity.

Exchequer capital spending on public water services peaked at €432m in 2009, but declined to €319m by 2013.

By comparison, the average core capital spending under the Irish Water business plan is €590m.
However, it is not only a question of the amount of funding required, it is also a question of ensuring that the funding model supports the most efficient delivery of services, the right investment decisions and the appropriate balance between capital investment and on-going maintenance.
Aside from the limitations on strategic planning and economies of scale 4 presented by a dispersed model based on 34 authorities rather than a single regulated utility, the previous funding model faced particular challenges from  The absence of a national asset management system to inform prioritisation of capital maintenance and investment;  Funding lines which tended to incentivise capital investment over capital maintenance;  Lack of certainty on overall Exchequer funding at a programme and project level over an extended time period given the annual Exchequer budgetary process; and  Delays in project implementation due to misalignment in the availability of funding from the two main funding sources – Exchequer and local authorities.
Key requirements of a funding model From this past experience, some conclusions can be drawn on the key features of an efficient funding model for the future, if such a model is to support the correct investment decisions and the most efficient operations of water services.
These would include that:-  The model should ideally provide a level of certainty of funding over a multi-annual period to ensure appropriate strategic planning and timely delivery;  Decisions on operations and capital investment should be integrated and made by a single authority, and the sources of funding available should not skew this decision making process;  Costs and outputs should be benchmarked against best practice internationally; and  The funding model is likely to require an element of cost recovery and promotion of conservation to ensure compliance with the Water Framework Directive.
On the latter point, the Minister has recently received further correspondence from the European Commission which, inter alia, points to the need for the recovery of costs to ensure that the serious needs of the public water and waste water system in terms of both maintenance and investment can be met.

I am aware that the question of compliance with the Water Framework Directive will be dealt with at a future meeting of this committee, so I will focus on the other features of the funding model today.
5 From an organisational perspective, the single public water utility, with the new asset management approaches developed by Irish Water, can address the key issues around appropriate project selection, achieving economies of scale and securing greater efficiency in operations.
As described by the CER and Irish Water, the regulated approach ensures that the appropriate funding requirement over a reasonable time cycle is determined in an open and transparent manner, delivering efficiencies alongside service improvements.

Generally for a regulated water utility, when the funding requirement is settled, the revenue can be raised through charges and borrowing, with some State support.
This gives the utility the greater certainty regarding its investment plans and operational decisions.

If, however, the model is reliantly mainly on State support to cover this revenue requirement rather than charges, other options need to be examined to provide a level of assurance that the business plan of Irish Water can, following regulatory review, be delivered.
It has to be acknowledged that funding what the Expert Commission termed the “regulatory settlement” through general taxation, inevitably introduces risks of funding shortfalls, or funding uncertainty as water services funding would have to be considered as part of the normal budgetary process.

Ring-fenced funding would provide greater certainty and underpin delivery of the business plan but does present challenges in relation to the normal management of the public finances.
There are examples such as the local property tax or plastic bag levy, for example, where revenues raised are directed to particular areas.

It is fair to say that the greater the link between the revenue stream and its purpose, the more certainty can be provided on the funding environment for the utility, and the greater the support for long-term planning, generation of efficiencies and service improvements.
There are also international examples of regulated utilities where the Government provides some guidance to the utility and the regulator as to the likely funding parameters over a multi- annual process.

The recent decision on the 2017-2018 Revenue Control period by the CER had some component of this approach.

The business plan for Irish Water to 2021, considered by Government set out a perspective on the likely subvention and capital requirements over the period.
As such, the Department in its engagement with Irish Water and the CER on the 2017- 2018 Revenue Control, indicated that the Business Plan projections represented the outer limits of State support.

In the first Revenue Control Period, a Ministerial Policy Direction was issued under Section 42 of the Water Services (No.2) Act, 2013 which set some conditionality around State funding.

6 The overall funding model also needs to support policy to address deficiencies in the non-public water sector.
In particular, significant capital funding is currently provided by the Department to the Group Water Sector under the Rural Water Multi-Annual Programme.

To ensure parity of treatment between the public water system and the group water sector, a system of operational subsidies was introduced for the group water sector from 1997.

These subsidies are paid to the schemes by local authorities, who are recouped in full for this expenditure from the Local Government Fund.
The subsidies have been adjusted, following consultation with the National Federation of Group Water Schemes, in light of the suspension of domestic water charges.

In total about €50m is required on an annual basis to fund the non-public water services.

Conclusion In summary, a stable multi-annual funding approach would underpin improvements in service and compliance by Irish Water.
In line with the Irish Water business plan which is prepared on the basis of achieving such outcomes, by 2021, an annual amount of approx.

€1.4 billion will be required to fund the capex and opex cost of water and waste water services not met by the non- domestic sector.

Ideally, the manner in which this is funded needs to ensure that best value for money is achieved from the existing asset base and the right operational and investment decisions are made to deliver the best outcomes for customers.
More detailed financial information is set out in the note we have provided the Committee and I am, of course, happy to answer any questions.

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