National Water Act, 1998 (Act No. 36 of 1998) A Pricing Strategy For Raw Water Use Charges 5. Implementation of the New Pricing Strategy 5.3 Pricing Strategy for Water Use

 

 

In terms of the Act, the Minister may, with the concurrence of the Minister of Finance, from time to time by notice in the Gazette, establish a pricing strategy for charges for any water use (S 56(1)). This pricing strategy may contain a strategy for setting water use charges-

 

Each of these are discussed in more detail below. The pricing strategy can only be applied to water management areas or schemes where annual water use has been registered or licensed. In the process of registration an assessment will be made of the average annual volumetric use of all water users. The database of registered or licensed annual volumetric use, as well as the estimated annual growth in demand of authorised water users supplied from Government waterworks, will form the basis on which unit sectoral charges will be calculated for each water management area, scheme or system. The end user sectors for which unit sectoral charges for 1st tier water will be calculated and announced annually on a water management area basis are the following:

 

The charge for storage dams from which no abstraction takes place (excluding dams storing waste water), as defined under 5.2, will be dealt with under the industrial / mining / energy sector. The determination of annual estimated water use by means of the registration process for the irrigation and stream flow reduction sectors is set out in Part 7 of this document.

 

5.3.1 Funding water resource management

Resource management expenditure relates to those activities that are required to regulate, manage and maintain the water resource or catchment. These costs differ from overheads in that they are not related to water sold from individual schemes but are rather the costs related to the management of all water within a water management area as defined in terms of the national water resource strategy (Chapter 2, Part 1 of the Act). These can include the costs of the following functions to be performed by the Department and/or water management institutions exercising delegated or assigned powers under the National Water Act:

 

 

Initially, water resource management will continue to be the task of the Department of Water Affairs and Forestry. However, the National Water Act clearly states that the intention is to create Catchment Management Agencies (CMAs) in a staged and progressive manner and to delegate or assign significant water resource management functions to these bodies. Where CMAs do not exist, the DWAF will function as the CMA. The activities of the CMAs will be funded from the water resource management charges, which may be made by and are payable to the relevant CMA.2 In water management areas where not all catchment management functions have been delegated to CMAs, the relevant CMA will collect charges, and funds due to the DWAF will be passed on to the Department. If the CMA exists, but lacks capacity, this can be done by the DWAF and the relevant portion passed on to the CMA.

 

To deal with the determination of charges for water resource management, the DWAF’s budget has been restructured to contain an Integrated Catchment Management Trading Account providing for the allocation of departmental costs and collection of revenue with regard to the following main activities, under which headings the functions mentioned above can be grouped:

 

 

The annual budgets for the listed activities can include the costs of the DWAF regional and / or CMA operational personnel and administrative expenditure, consulting services and work performed by contractors.

 

2 CMAs may also receive funding from funds appropriated by Parliament, and from other sources.

 

Implementing a charge to fund water resource management

 

The determination of water resource management charges by initially DWAF and later CMAs, will proceed in the following manner:

 

 

 

 

 

 

 

 

 

 

 

 

 

5.3.2 Funding water resource development and use of waterworks

Water resource development and use of waterworks relate to those activities required to fund the planning, design, development, operation, maintenance and betterment (improvement) of Government water schemes and schemes to be funded by water management institutions.

 

5.3.2.1Government water schemes

 

Water resource development costs (i.e. capital costs)

 

In terms of section 56(2)(b) of the National Water Act, 1998, water resource development costs can include the related costs of investigation, planning, design and construction of water schemes, which constitute the capital cost of projects. The most significant departure from the financing methods used by the DWAF in the past can be found in the treatment of capital costs, which are different from all other costs. This is because long term capital investments, such as water schemes, often have a life which extends beyond a financial year. Three common financial approaches can be used for determining the capital portion of the unit cost of water; they are the "funding" approach, the "depreciation" approach and the "rate of return" approach.

 

 

 

 

In assessing these three approaches, it is important to note that the current DWAF accounting policy is in line with the "funding" approach, namely on a cash basis with strict cost controls against budget. Fund accounting is not consistent with Generally Accepted Accounting Practice (GAAP), and is not favoured by organisations dependent on external investors and lenders. The Public Finance Management Act, 1999 requires State financing to adapt to GAAP. Moreover, the funding approach is problematic in water-scarce countries in that unit costs will decrease when loans have been repaid.

 

The first tier pricing strategy for Government water schemes set out in this document is based on the "rate of return" approach, which is applied together with depreciation. The reasons for this are as follows:

 

 

 

Thus, in order to recover water resource development costs, the capital component of the unit cost of water supplied from Government water works will be determined by a depreciation charge and a return on assets charge.

 

Depreciation

 

Depreciation is defined as the systematic allocation of the depreciable amount of an asset over its useful life and will be applied as follows:

 

 

 

 

 

The depreciable portion and useful lives listed in the table relate to new water resource asset components and could change with each re-estimate. The annual depreciation cost of existing assets could therefore also adjust with each re-estimate and will be based on the re-estimated remaining useful life.

 

 

Return on Assets

 

This component of the charge will be determined by applying an average percentage to the current depreciated replacement value of water infrastructure assets. This will be done with a view to generate capital to fund the annual cost of planning, design and construction of new and augmentation schemes or demand management measures. The percentage return will be determined in consultation with the Department of Finance on the real long term cost of capital to Government. A figure of 4% has been suggested as being an appropriate rate to meet the projected long term growth in demand for raw water supplied from Government water schemes. This approach assumes that the marginal unit cost of new schemes will equal the average unit cost of existing assets, revalued at current price levels. Although it can be argued that the cost of new schemes would be higher than the replacement cost of existing schemes due to the fact that the cheaper dam sites have been exhausted, it is also true that demand management can reduce demands and thus the annual capital cost requirements. These two opposing influences are assumed to balance out.

 

This component of the charge will be set on a scheme-related basis, but will be applied only to those sectors with increasing demands. These sectors have been identified as the local government, industrial, mining and energy sectors. Investigations into the historic growth in demand of these sectors have confirmed that application of an average annual rate of four percent to the depreciated replacement cost of the relevant State water infrastructure assets would achieve a breakeven return.

 

Setting of water resource development charge

 

The new approach to determine the capital cost component of water supplied from Government water schemes, consists of two components, i.e. the depreciation and return on assets charges, which will be determined by dividing allocated annual costs by the expected water sales.

 

Depreciation of assets on a straight line basis will result in constant real term annual costs between intervals of revaluation of assets, to which the PPI can be applied as inflator. The depreciation charge will thus not be subject to sudden variations and will give rise to smooth sectoral charges.

 

As far as the return on assets component of the charge is concerned, it is important to note that the strict application of a constant rate to the depreciated replacement value of water infrastructure would give rise to declining financial returns over time in real terms (i.e. the depreciated replacement value of an asset is lower in year 2 than year 1). The resulting annual return on assets charges determined in this way would also lead to significant hikes in tariffs when asset components of a scheme reached the end of their useful lives and had to be replaced, thus restoring the asset value and increasing the return on assets above that of the previous year.

 

In order to avoid spiked tariffs, it will be necessary on a scheme-by-scheme basis to establish equalised return on assets values which are constant in real terms. Such an "average" return will be calculated over a 45 year period for all asset components making up the scheme or system. Between the periodic revaluation of scheme assets, the equalised annual return on assets value, plus the annual depreciation cost, will be inflated by the PPI for purposes of setting smooth water resource development charges.

 

Pre-financing (Section 56(2)(b)(iii) of the Act)

 

The return on assets charge caters for financing the development cost of new schemes and could thus be used to finance the cost of development of augmentation schemes prior to the delivery of water. The return on assets charge will thus be utilised to finance the annual costs of planning feasibility studies for committed augmentation schemes.

 

A unique developmental situation may occur where a large augmentation scheme is planned and executed, but for certain reasons the infrastructure did not become State property and the construction expenditure has to be financed by the established water utility from payments from water users from the existing Government water scheme before water is delivered into the system by the augmentation scheme. This is the situation in the case of the Lesotho Highlands Water Project Phase 1A, which was built to augment the Vaal River System and where expenditure required to service the loans obtained by the TCTA to build the scheme was and continues to be recovered from the Vaal River System water users. This was done to ensure a smooth price setting process in the long term and the avoidance of sudden and significant hikes in water prices.

 

In future the return on assets revenue obtained from current Government water schemes must only be used to fund state-owned augmentation schemes, but payment for the expenditure incurred for schemes owned by other institutions, such as the LHWP Phase 1, will have to continue to be recovered by additional charges to water users in the relevant system.

 

Assurance of Supply (Section 56(4)(b)(iii) of the Act)

 

In determining tariffs of multi-purpose waterworks, it will be necessary to consider the level of assurance at which water is supplied to the various users in order to allocate capital costs between different users. Users that require a higher assurance of supply, for example, would have to pay a premium for their water allocation relative to those users who require a lower assurance of supply. This will be effected in the following way:

 

 

 

Treatment of Reserves

 

When the new pricing structure has been phased in, the depreciation and return on assets charges will result in reserve funds theoretically being built up over time. However, as long as Government water schemes are owned by the State, these reserve funds will revert to the Treasury, either indirectly by reducing the annual augmentation of the Departmental Trading Account from Treasury funds, or directly as a result of annual surpluses on the Trading Account flowing to the Treasury. Thus, the DWAF will be in a position to finance capital cost requirements for depreciation on specific schemes from its general revenue base on the Trading Account and to finance the development of augmentation schemes from Exchequer budget allocations. DWAF will establish an accounting system to record the extent and use of these funds.

 

Use of waterworks costs

 

These are the costs, both direct and indirect, that are incurred in the operating and maintenance of Government water schemes. These are broken down between direct and indirect scheme costs.

 

 

 

Implementing a charge to fund water resource development and use of waterworks on Government water schemes

 

The DWAF has created three separate trading accounts for:

 

 

Water resource development and use of waterworks charges will be implemented as follows:

 

 

 

 

 

 

 

 

 

 

5.3.2.2Schemes funded by water management institutions

 

 

 

 

5.3.3 Achieving the equitable and efficient allocation of water

It is important to note that the proposals regarding the funding of water resource management and water resource development and use of waterworks that have been described above will make a significant contribution towards achieving the equitable and efficient allocation of water.

 

However, in the context of increasing water resources scarcity, it may be necessary to introduce additional economic incentives in order to optimise the allocation of scarce water resources between competing uses. Such economic incentives could be introduced in water-stressed areas; the objective being to shift water use from low to high values.

 

This charge may only be introduced by DWAF on a regional or national basis and the revenue will accrue to the Treasury. If it were deemed necessary to introduce economic incentives in water-stressed areas, this could be achieved administratively via an explicit charge or via market-orientated mechanisms.