JCYLAB - Final Review Report Issue 2, Rev 1...Review of Operating and Capital Expenditure by Sydney...

Halcrow

Review of Operating and Capital Expenditure by Sydney Desalination Plant Pty Ltd

Review Report

Final

October 2011

Prepared for:

Independent Pricing and Regulatory Tribunal

Halcrow Level 22, 68 Pitt Street, Sydney, NSW 2000 Australia PO Box R1573 Royal Exchange, NSW 1225 Tel +61 2 9250 9900 Fax +61 2 9241 2228 www.halcrow.com/australasia Halcrow has prepared this document in accordance with the instructions of Independent Pricing and Regulatory Tribunal for their sole and specific use. Any other persons who use any information contained herein do so at their own risk. © Halcrow Pacific Pty Ltd, 2011

Review of Operating and Capital Expenditure by Sydney Desalination Plant Pty Ltd

Review Report

Contents Amendment Record This report has been issued and amended as follows:

Issue Rev Description Date Prepared by Checked Approved

1 0 Draft 18 August 2011 CR/MBF/JOS JOS JOS

1 1 Draft – Updated 26 August 2011 CR/MBF/JOS JOS JOS

1 2 Draft – Executive Summary added

26 August 2011 CR/MBF/JOS JOS JOS

2 0 Final 9 September 2011 CR/MBF/JOS JOS JOS

2 1 Final – minor edits 25 October 2011 CR/JOS JOS JOS

Review of Operating and Capital Expenditure by Sydney Desalination Plant Pty Ltd: Review Report JCYLAB - Final Review Report (Issue 2, Rev 1).doc (25/10/2011)

Contents

Executive Summary i

1 Introduction 1 1.1 Overview 1 1.2 Background Information 1 1.3 Previous Determination 2 1.4 Scope of Review 2 1.5 Structure of Report 3 1.6 Limitations 3

2 SDP Submission and Supporting Information 5

3 Review Methodology 6 3.1 Overview 6 3.2 Assessment of Prudence 6 3.3 Assessment of Efficiency 7 3.4 Cost Indexation 8

4 Strategic Management Overview 9 4.1 Overview 9 4.2 Infrastructure Operating Plan 10 4.3 Management of Assets (Asset Management Framework) 11 4.4 Operations and Maintenance Planning 12 4.5 Capital Planning 13 4.6 Summary 14

5 Operating Expenditure 16 5.1 Overview 16 5.2 General Observations 17 5.3 Historical Expenditure 18 5.4 Forecast Expenditure 22 5.5 Assessment of Operating Costs 25 5.6 Energy Costs 33 5.7 Maintenance Costs 52 5.8 Fixed/Variable Cost Split 58 5.9 Findings 62

Contents


6 Capital Expenditure 66 6.1 Overview 66 6.2 Historical Expenditure 68 6.3 Forecast Expenditure 71 6.4 Transfer of Pipeline 75 6.5 Asset Lives 75 6.6 Findings 79

7 Conclusions and Recommendations 82 7.1 Overview 82 7.2 Management Systems and Processes 82 7.3 Operating Expenditure 83 7.4 Capital Expenditure 84

Appendix A Maintenance Schedule

Appendix B Detailed Review of Historical Capital Projects

Review of Operating and Capital Expenditure by Sydney Desalination Plant Pty Ltd: Review Report i JCYLAB - Final Review Report (Issue 2, Rev 1).doc (25/10/2011)

Executive Summary

Introduction Halcrow has been engaged by the Independent Pricing and Regulatory Tribunal (IPART) to undertake an independent review of capital and operating expenditure incurred by the Sydney Desalination Plant Pty Ltd (Sydney Desalination Plant or SDP). This work forms part of the process of reviewing/setting prices for regulated services for the period 1 July 2012 to 30 June 2017.

The Sydney Desalination Plant has been declared a monopoly supplier, pursuant to Section 51 of the Water Industry Competition Act 2006. Accordingly, the Minister for Finance and Services has requested IPART to determine prices for the monopoly services provided by Sydney Desalination Plant.

It is noted that, prior to the Minister’s declaration Sydney Desalination Plant’s costs were included in Sydney Water Corporation’s (Sydney Water’s) cost base and revenue requirements through IPART’s 2008 Determination of Sydney Water’s prices. Accordingly, comparison of actual expenditure with expenditure forecast at the time of the previous determination has been based on that allowed in IPART’s 2008 Determination in respect of Sydney Water.

Scope of Review Halcrow has been engaged to assess the adequacy, appropriateness and efficiency of Sydney Desalination Plant’s past and proposed levels of operating and capital expenditure. The assessment has comprised:

undertaking a strategic management overview of Sydney Desalination Plant’s planning and asset management processes;

examination of the total level of expenditure; and

assessment of expenditure on an individual activity/project basis.

Strategic Management Overview On the basis of Halcrow’s review of the available documentation, which has included the Infrastructure Operating Plan and the Operations and Maintenance Contracts in respect of both the Desalination Plant and the Drinking Water Pumping Station, it appears that Sydney Desalination Plant has appropriate management systems in place at a high level. Whilst reference is made in both the Infrastructure Operating Plan and the Contracts to a number of management plans and protocols, these more detailed documents have not been provided to this review; accordingly, Halcrow has been unable to provide further assessment.

Executive Summary

Review of Operating and Capital Expenditure by Sydney Desalination Plant Pty Ltd: Review Report ii JCYLAB - Final Review Report (Issue 2, Rev 1).doc (25/10/2011)

Notwithstanding, Halcrow understands that protocols for determining the operational (shut down) mode to be adopted when the Desalination Plant is to be shut down are not currently available; given the potential impact of such decisions on the quantum of operating costs, Halcrow considers it essential that such protocols be developed.

Review of Operating Expenditure There is significant variation between actual operating costs and those projected by Sydney Water in its 2007 submission to IPART. The variation is largely driven by much higher electricity charges. Notwithstanding, the expenditure incurred is reflective of SDP’s obligations under its operations and maintenance and energy supply contracts.

SDP has entered into 20 year contracts for electricity and renewable energy supplies. These contracts present significant risks to SDP, locking in fixed prices (which are currently in excess of market prices)

On this basis, Halcrow recommend the disallowance of the full contract prices for energy and RECs, and recommends that only 50 percent of the difference between the contract and market prices be allowed for both energy and REC purchases in the period to 2016/17.

Halcrow also has concerns with the projected increases in prices for chemicals and membranes. While recognising the high historical increase in prices for these items, there is insufficient evidence to support future price increases greater than the movement t in the CPI. Halcrow recommends that the forecast cost of membranes and chemicals be held constant in real terms.

In the absence of information supporting asset maintenance costs other than those incurred in respect of the Operations and Maintenance Contracts, ie. payments to the operations and maintenance contractor, it is recommended that SDP’s forecast asset maintenance costs be adjusted to reflect the contracted amounts.

Review of Capital Expenditure On the basis of the information reviewed, Halcrow concludes that the procurement of both the Desalination Plant and the Water Delivery System, comprising the Drinking Water Pumping Station and the Delivery Pipeline, has been undertaken in a generally prudent and efficient manner.

Executive Summary

Review of Operating and Capital Expenditure by Sydney Desalination Plant Pty Ltd: Review Report iii JCYLAB - Final Review Report (Issue 2, Rev 1).doc (25/10/2011)

The delivery mechanisms adopted in respect of both the Desalination Plant (a design, build operate and maintain (DBOM) contract arrangement) and the Water Delivery System (an Alliance contract arrangement) are consistent with the approach adopted for the delivery of other large scale infrastructure within the Australian water industry. They provide appropriate benefits in each case.

Forecast capital expenditure relates to two (2) principal items; upgrade of the existing Backup Electricity Supply and the capitalisation of Annual Periodic Maintenance.

In respect of the electricity supply upgrade, Halcrow is of the opinion that expenditure on the upgrade is prudent, however, in light of more recent information provided by SDP, a reduction in the forecast cost allowance is proposed.

On the basis of the information presented, Halcrow does not consider that the proposed capitalisation of periodic maintenance expenditure is justified. Disallowance of such capitalisation will require an adjustment to the forecast operating expenditure.

The nominated design lives for both the Desalination Plant and the Water Delivery System are generally in line with Halcrow’s expectations, however, in most cases, the adoption of economic asset lives that are greater than the expected design life is proposed. This will result in comparatively reduced depreciation costs.

Proposed Adjustments to Forecast Expenditure Halcrow’s proposed adjustments to SDP’s forecast expenditure are summarised in Table E.1 and Table E.2, in respect of operating expenditure and capital expenditure respectively.

Executive Summary

Review of Operating and Capital Expenditure by Sydney Desalination Plant Pty Ltd: Review Report iv JCYLAB - Final Review Report (Issue 2, Rev 1).doc (25/10/2011)

Table E.1 SDP’s Efficient Operating Costs at Full Production ($million 2011/12)

2011/12 2012/13 2013/14 2014/15 2015/16 2016/17

Other Costs (Direct payments by SDP)

4.1 4.0 3.5 3.2 3.4 3.5

Adjustment to asset maintenance cost -0.1 -0.4 -0.7 -0.7 -0.1 -0.9

Adjustment for Capitalised Maintenance

1.0 3.4

Revised Other Costs 4.0 3.6 2.8 2.5 4.3 6.0

Total Efficient Costs 69.0 72.5 76.6 79.7 80.6 80.0

Total efficiency adjustment -8.1 -7.8 -9.2 -10.5 -9.9 -9.0

Note: Totals may not add up due to rounding.

Table E.2 Recommended Capital Cost Adjustments ($’000 2011/12)

2012/13 2013/14 2014/15 2015/16 2016/17

SDP Submission 1,147 2,677 0 1,024 3,443

Recommended Adjustments

Upgrade of Backup Electricity Supply -697 -1,627

Capitalised Maintenance -1,024 -3,443

Recommended Capital Expenditure 450 1050 - - -

Review of Operating and Capital Expenditure by Sydney Desalination Plant Pty Ltd: Review Report 1 JCYLAB - Final Review Report (Issue 2, Rev 1).doc (25/10/2011)

1 Introduction

1.1 Overview

Halcrow has been engaged by the Independent Pricing and Regulatory Tribunal (IPART) to undertake an independent review of capital and operating expenditure incurred by the Sydney Desalination Plant Pty Ltd (Sydney Desalination Plant or SDP). This work forms part of the process of reviewing/setting prices for regulated services for the period 1 July 2012 to 30 June 2017.

1.2 Background Information

The Sydney Desalination Plant, which was built by the Blue Water joint venture via a design and construct contract, began supplying water on 28 January 2010. It has a current capacity of 250ML/day, and is able to supply up to 15 percent of Sydney’s current water needs. The plant has been designed so that its capacity can be increased up to 500ML/day. The plant, which is located in Kurnell, is connected to the Sydney Water network at Erskineville by a pipeline that runs under Botany Bay.

The operating rules for the Sydney Desalination Plant are specified in the 2010 Metropolitan Water Plan, which states that, “the plant will operate at full production capacity and supply desalinated water to Sydney Water’s area of operations when the total dam storage level is below 70 percent and will continue to do so until the total dam storage level reaches 80 percent.”1

In May 2011, the Minister for Finance and Services wrote to IPART indicating that he has declared Sydney Desalination Plant a monopoly supplier, pursuant to Section 51 of the Water Industry Competition Act 2006. The Minister has requested IPART to determine prices for the monopoly services provided by Sydney Desalination Plant. Terms of Reference for the review were provided by the Minister, and require IPART to undertake its investigations within a period of six months.

In the context of monopoly businesses, IPART’s role is to protect customers from paying for inefficient or unnecessary expenditure, while ensuring these businesses raise adequate revenue to deliver the required services. To this end, IPART seeks to set prices which do not reward inefficient investment and asset management decisions, or inefficient operations and practices.2

1 NSW Office of Water, 2010 Metropolitan Water Plan, August 2010, p36.

2 IPART, Request for Scope of Work and quote: Review of Operating and Capital Expenditure by Sydney Desalination Plant Pty Ltd, 1 June 2011.

Introduction


The purpose of this review is to inform IPART’s investigations into the prudent and efficient operating and capital expenditure of the monopoly supplier.

1.3 Previous Determination

As noted above, on 6 May 2011, the Minister for Finance and Services declared Sydney Desalination Plant Pty Ltd a monopoly supplier of non-rainfall dependent drinking water. It is noted that, prior to the Minister’s declaration Sydney Desalination Plant Pty Ltd’s costs were included in Sydney Water Corporation’s (Sydney Water’s) cost base and revenue requirements through IPART’s 2008 Determination of Sydney Water’s prices.

Accordingly, comparison of actual expenditure with expenditure forecast at the time of the previous determination will be based on that allowed in IPART’s 2008 Determination in respect of Sydney Water.

1.4 Scope of Review

Halcrow has been engaged to assess the adequacy, appropriateness and efficiency of Sydney Desalination Plant’s past and proposed levels of operating and capital expenditure. The assessment has comprised:

undertaking a strategic management overview of Sydney Desalination Plant’s planning and asset management processes;

examination of the total level of expenditure; and

assessment of expenditure on an individual activity/project basis.

More specifically, Halcrow has assessed:

the efficiency of operating expenditure for the period 1 July 2008 to 30 June 2012, to the extent necessary to assess the efficiency of the proposed operating expenditure;

the efficiency of the proposed operating expenditure for the period from 1 July 2012 to 30 June 2017;

the efficiency and prudence of capital expenditure for the period from 1 July 2007 to 30 June 2012 (although there is no need to review the need to build a 250ML/day plant or a 500ML/day pipeline); and

the efficiency and prudence of proposed capital expenditure for the period from 1 July 2012 to 30 June 2017.3

3 The terms “efficiency” and “prudence”, as they apply for the purposes of this assignment, are explained in the Request for Scope of Work and Quote for the Review of Operating and Capital Expenditure by Sydney Desalination Plant Pty Ltd. They are discussed in more detail in Section 3.

Introduction


In undertaking the review, consideration has to be given to:

Sydney Desalination Plant’s planning and asset management process;

relevant legislation, regulatory requirements and Government policies and initiatives;

current asset condition and renewal requirements;

existing operational requirements;

efficient costs of providing desalinated water services;

current and likely future environmental, health and safety standards.

A vital element of the review will be to provide IPART with sufficient information to gain a detailed understanding of all costs that vary plant output volumes, and the costs that are fixed and do not vary with plant output volumes.

1.5 Structure of Report

This report discusses and presents Halcrow’s key findings and recommendations arising from the review of operating and capital expenditure by Sydney Desalination Plant. Specifically:

Section 1 provides background in respect of Sydney Desalination Plant, IPART and the scope of this review.

Section 2 provides a brief overview of the information provided by Sydney Desalination Plant for the purposes of this review.

Section 3 provides an overview of the approach adopted by Halcrow in reviewing the efficiency of operating expenditure and the prudence and efficiency of capital expenditure.

Section 4 outlines Halcrow’s review of Sydney Desalination Plant’s strategic management process, and more specifically, its approach to planning and asset management processes.

Section 5 outlines Halcrow’s assessment of the operating expenditure incurred/forecast by Sydney Desalination Plant.

Section 6 outlines Halcrow’s assessment of capital expenditure incurred/forecast by Sydney Desalination Plant.

Section 7 summarises the findings of Halcrow’s assessment and presents the conclusions drawn from the review. Recommendations in respect of the prudence and efficiency are also presented

1.6 Limitations

This report has been prepared for IPART by Halcrow for the sole purpose of providing an assessment as to the efficiency of Sydney Desalination Plant’s historical and proposed operating expenditures and the prudence and efficiency of its historical and proposed capital expenditure in the period 2007 to 2017. This report cannot be relied upon by any other party or for any other purpose.

Introduction


Halcrow’s assessment has been undertaken on the basis of information and material provided by Sydney Desalination Plant, from meetings and discussions held with Sydney Desalination Plant/Sydney Water representatives, and on information provided by Sydney Desalination Plant subsequent to those discussions.

Importantly, Halcrow has not undertaken any independent verification of the reliability, accuracy or completeness of the source data and information provided. Therefore, it should not be construed that Halcrow has carried out any form of audit or other verification of the adequacy, completeness, or accuracy of the specific information provided by Sydney Desalination Plant.


2 SDP Submission and Supporting Information

Sydney Desalination Plant’s submission in respect of the review of prices comprises the following documentation:

Sydney Desalination Plant Pty Ltd – Submission to IPART 2012 Pricing Determination (Pricing Submission);4 and

Annual Information Return (AIR).5

Other supporting information that has been provided for the purposes of conducting this review has included:

copies of contract documents related to: o the initial construction and subsequent operation and maintenance of the

Desalination Plant; o the supply of electricity; o the supply of Renewable Energy Certificates; and o the design and construction of the Desalination Delivery System;

various independent review reports;

the Service Level Agreement between Sydney Water and Sydney Desalination Plant Pty Ltd;

more detailed information on costs incurred under different operating modes including when plant is inactive; and

responses to specific questions such as calculation of losses on sale of surplus energy and renewable energy certificates.

4 Sydney Desalination Plant Pty Ltd, Submission to the Independent Pricing and Regulatory Tribunal: Review of Prices for Sydney Desalination Plant Pty Ltd, undated.

5 Sydney Desalination Plant Pty Ltd, SDP Annual Information Return Final 110708.xls.


3 Review Methodology

3.1 Overview

The review of Sydney Desalination Plant’s operating and capital expenditure has comprised a number of elements including:

A desktop review of information provided by Sydney Desalination Plant in its Pricing Submission and AIR.

Preparation of a Request for Information that identified key supporting information required to effectively undertake the review. This was submitted to Sydney Desalination Plant on 15 July 2011.

Meetings with Sydney Desalination Plant representatives in Sydney Water’s Parramatta offices to obtain more detailed information in relation to Sydney Desalination Plant historical and forecast expenditure. Meetings were held on 25 and 26 July 2011.

A desktop review of information provided by Sydney Desalination Plant in support of its Pricing Submission, both during and subsequent to the meetings with its representatives. Additional requests for information were made by Halcrow on the basis of information provided.

The detailed review of key elements of operating expenditure (both historical and forecast) to assess the efficiency of such expenditure.

The detailed review of key elements of capital expenditure (both historical and forecast), including the desalination plant and the desalination delivery system (pipeline) to assess the prudence and efficiency of such expenditure.

Synthesis of data obtained from the above evaluation to draw conclusions in respect of the efficiency and prudence of the expenditure.

Preparation of this report to document the findings of the review.

The following sections outline the basis upon which the prudence and efficiency of expenditure has been assessed.

3.2 Assessment of Prudence

The assessment of whether Sydney Desalination Plant’s capital expenditure is prudent has been split into a number of key tasks.

The first key task has involved the review and assessment of whether Sydney Desalination Plant has in place an effective and robust planning framework. Effective and robust planning frameworks provide the context and strategic direction for capital and operational planning, and enable an organisation to demonstrate that its investment decisions have been prudent and appropriately targeted.

Review Methodology


An effective planning framework typically includes the following key elements:

provides detail on how an organisation aims to achieve its strategic, legislative or regulatory objectives and manage its key risks (ie. transparent and robust principles that ensure alignment between strategic objectives and investment priorities);

identifies drivers for investment, including trigger points;

defines the process, principles and accountabilities for developing the capital and operating plans, and provides transparent and robust principles to ensure alignment between strategic objectives and investment priorities, incorporating customer and stakeholder requirements;

provides a reasoned method of allocating expenditure and prioritising programs/projects, thereby optimising the selection and delivery of the capital and operating expenditure programs;

incorporates approval processes and allows for sufficient monitoring and reporting against budget/implementation plans; and

reflects operating environment and service requirements.

Halcrow’s review of Sydney Desalination Plant’s planning framework has been aimed at assessing whether the above key elements can be identified.

The second key task in the assessment of prudence has involved testing whether Sydney Desalination Plant has been able to demonstrate the rigour with which the framework is applied throughout the organisation. This has involved a more detailed review of actual and proposed capital expenditure, including periodic maintenance projects.

The prudence test has considered the following:

the basis (driver) for the investment;

the outputs (and benefits) associated with each project or expenditure program;

the methods by which projects and initiatives were identified and developed including the application of any risk based processes used to prioritise projects or initiatives; and

the planning and design processes used to develop projects, and evidence of options considered and design development.

3.3 Assessment of Efficiency

In undertaking the review of efficiency, Halcrow has sought to determine whether the costs presented in Sydney Desalination Plant’s Pricing Submission and AIR reflect those that would normally be expected to occur in a competitive environment.

Review Methodology


In undertaking the assessment of efficiency expenditure, Halcrow has sought to determine the following:

the current stage of the design development (as this will provide an indication of the likely accuracy of any cost estimates);

the cost estimation methodology, including the estimating process, key cost components, assumptions and unit rates; and

assumptions surrounding the application of contingencies and escalation factors.

The findings of Halcrow’s review are presented in the following sections of this report.

3.4 Cost Indexation

Throughout this report, all expenditure has been reported in $nominal and $2011/12 real unless otherwise stated. Historical expenditure has been indexed to $2011/11 real using escalation factors provided by IPART. Forecast expenditure has been adjusted to $2011/12 real using Sydney Desalination Plant’s nominated escalation factor, ie. 2.5 percent per annum. An assessment of Sydney Desalination Plant’s escalation factors is outside the scope of this review.

Adopted escalation factors are as shown in Table 3.1.

Table 3.1 Escalation Factors used in this Report

Escalation Factor Escalation from

Nominated by IPART Proposed by SDP

$2005/06 to $2006/07 3.2%

$2006/07 to $2007/08 2.9%

$2007/08 to $2008/09 3.4%

$2008/09 to $2009/10 3.1%

$2009/10 to $2010/11 2.3%

$2010/11 to $2011/12 2.8%

$2011/12 to $2012/13 2.5%

$2012/13 to $2013/14 2.5%

$2013/14 to $2014/15 2.5%

$2014/15 to $2015/16 2.5%

$2015/16 to $2016/17 2.5%


4 Strategic Management Overview

4.1 Overview

Sydney Desalination Plant operates under the provisions of the Water Industry Competition Act 2006 (WICA). It was granted licences as both a Network Operator and a Retail Supplier on 9 August 2010.

Under the provisions of its Network Operator’s Licence,6 SDP is authorised to construct, operate and maintain water industry infrastructure used for the production, treatment, filtration, storage and conveyance or reticulation of drinking water. It is also required to maximise water production when the available storage in Sydney’s water supply reservoirs falls below 70 percent until such time as the available storage rises to 80 percent of capacity.

Under the provisions of its Retail Supplier Licence,7 SDP is authorised to supply drinking water by means of water industry infrastructure used for the production, treatment, filtration, storage, conveyance or reticulation of drinking water under Network Operator Licence No 10_010 and/or the Sydney Water Operating Licence. SDP is authorised to supply water to any person other than a small retail customer within Sydney Water Corporation’s area of operations (as defined in the Sydney Water Operating Licence).

SDP’s licences require that it prepares and operates in accordance with various Plans, including:

in respect of its Network Operator’s Licence: o an Infrastructure Operating Plan; and o a Water Quality Plan; and

in respect of its Retail Supplier Licence, a Retail Supply Management Plan.

6 New South Wales Government, Water Industry Competition Act 2006, Network Operator’s Licence, Sydney Desalination Plant Pty Ltd (ACN 125 935 177), Licence No 10_010, granted 9 August 2010.

7 New South Wales Government, Water Industry Competition Act 2006, Retails Supplier’s Licence, Sydney Desalination Plant Pty Ltd (ACN 125 935 177), Licence No 10_011R, granted 9 August 2010.

Strategic Management Overview


4.2 Infrastructure Operating Plan

4.2.1 General

Sydney Desalination Plant has developed an Infrastructure Operating Plan8 that outlines, at an overview level, the operating regime/environment within which the facility is operated together with SDP’s operational strategies. An appendix to the Plan outlines in detail the strategies adopted to address the various requirements of its WICA licences. It is noted that SDP’s Infrastructure Operating Plan has not yet been subject to audit under the provisions of the WICA, however, Halcrow understands that conduct of an audit is imminent.9

4.2.2 Management systems

As Sydney Desalination Plant is a wholly owned subsidiary of Sydney Water, SDP’s management systems are currently incorporated into Sydney Water’s Water Product Integrated Management System (WPIMS) which is certified to ISO 9001. It is understood that, where Sydney Water procedures differ from SDP procedures (which have not been provided for review by Halcrow), SDP procedures take precedence.

It is also understood that SDP’s Operations and Maintenance Contractor, Veolia Water Australia (refer Section 5.1) has developed management systems in accordance with the requirements of ISO 9001, ISO 14001 and AS/NZ 4801. Although these systems have not yet been audited, they are understood to align with Veolia’s own managements.

Halcrow has not assessed either Sydney Water’s or Veolia’s management systems as part of this review. A review of Sydney Water’s asset management systems and planning processes was, however, undertaken as part of a review of its proposed capital and operating expenditure and asset management plan in conjunction with the 2008 Determination of prices. That review found that, whilst it was continuing to implement an ongoing development/improvement program, Sydney Water had an effective strategic framework for asset management that integrated strategic business planning and tactical service delivery, and which was supported by well documented procedures that enabled transparency and supported consistency.

8 Sydney Desalination Plant Pty Ltd, Infrastructure Operating Plan, Document Number: WTOC0003, Issue: 02, 29th July 2011.

9 Halcrow also notes that SDP’s Infrastructure Operating Plan will have been subject to an initial review by IPART as part of the WICA licensing process.



4.3 Management of Assets (Asset Management Framework)

Under the provisions of the Operations and Maintenance Contracts,10 Veolia is required to operate and maintain both the Desalination Plant and the Drinking Water Pumping Station in accordance with detailed requirements. In particular, it is required to develop and implement a number of management plans including:

Operations Management Plan;

Function Management Plans, including: o Change Management Plan; o Risk Management Plan; o Safety Management Plan; o Project Communications Plan; o Environmental Management System Documentation; o Security Management Plan; o Incident Management Plan; o Asset Management Plan; and o Human Resource Management Plan;

Phase Management Plans, including; o Stakeholder Interface Management Plan; and o O&M Management Plan;

Compliance Management Plan.

In respect of the management of assets, Veolia is also required to:

manage asset renewals, replacements and upgrades and advise SDP of appropriate strategies to achieve this obligation;

assess asset condition and risk of failure;

identify asset criticality on the basis of impact on the operation of the plant; and

develop (and implement) asset management plans in respect of the portfolio of assets.

Whilst it has not been provided for review,11 the Asset Management Plan is expected to outline the basis upon which the portfolio of assets, that together comprise the Desalination Plant and Drinking Water Pumping Station, are managed. The Asset Management Plan will be informed by other management plans, particularly in respect of risk and environmental management.

10 There are two separate operations and maintenance contracts relating to the Desalination Plant and the Drinking Water Pumping Station respectively (refer Section 5.1).

11 SDP contends that the Asset Management Plan is part of the Infrastructure Operating Plan (refer Section 4.2), however, this is a high level document that does not include the detail expected in an asset management plan. The Infrastructure Operating Plan does reference requirements for an asset management plan to be provided under the provisions of the Operations and Maintenance Contract.



Under the provisions of the Operations and Maintenance Contracts,12 the Asset Management Plan(s) is required to describe the functional requirements, processes and activities relating to the management of assets. The Asset Management Plan(s) must meet the requirements of the NSW Government Total Asset Management (TAM) Guidelines. A review of the specific requirements of the Operations and Maintenance Contracts reveals that, provided it is compliant with the specified requirements, the Asset Management Plan(s) will incorporate the key elements expected of such a document and will also comply with key TAM requirements in respect of strategic planning, maintenance planning, capital investment and asset disposal.

4.4 Operations and Maintenance Planning

4.4.1 General

As noted in Section 4.2.2 and outlined in more detail in Section 5.1, Sydney Desalination Plant has contracted out the operation and maintenance of its facilities (both the Desalination Plant and the Drinking Water Pumping Station) to Veolia Water Australia. Performance requirements in respect of operation and maintenance of the facilities are specified in detail in the respective contracts.

On the basis that operation and maintenance is specified on a performance basis, operational and maintenance planning will be undertaken by Veolia. The various management plans identified in the Infrastructure Operating Plan (and listed in Section 4.3) are expected to document Veolia’s procedures for undertaking such planning, however, as these management plans have not been made available to this review, Halcrow is unable to provide further assessment as to their adequacy.

4.4.2 Operation of the facilities

Sydney Desalination Plant’s Infrastructure Operating Plan indicates that a number of operating protocols, which describe the operational interface arrangement and key procedures between the parties, have been developed in conjunction with Sydney Water and Veolia. These protocols address:

the raw water system; storage and distribution;

operation of downstream system;

management of emergency situations;

communication;

planned maintenance/shutdowns; and

operation change request.

12 Sydney Desalination Plant Pty Ltd, Sydney’s Desalination Project, Operate and Maintain Contract, undated, Exhibit C and Sydney Desalination Plant Pty Ltd, Sydney’s Desalination Project, Drinking Water Pumping Station Deed, 18 January 2010, Exhibit C.



These protocols have not been made available for review, however, appear to address appropriate interface issues.

It is not, however, apparent that they include protocols for determining the operational (shut down) mode to be adopted when the Desalination Plant is to be shut down. On the basis of discussions with Sydney Desalination Plant representatives, it is understood that such protocols are not currently available; given the potential impact of such decisions on the quantum of operating costs, Halcrow considers it essential that such protocols be developed.13

4.4.3 Maintenance planning

The Operations and Maintenance Contracts in respect of both the Desalination Plant and the Drinking Water Pumping Station outline specific requirements in respect of maintenance planning. In particular, the Contracts require that the operator (Veolia) must review and update the following on an annual basis (or as other wise directed by SDP):

all plant registers;

maintenance and replacement schedules so that they: o comply with the Operations Management Plan; o incorporate all relevant components and features of any proposed

maintenance and replacement of equipment; o outline the anticipated program of scheduled maintenance for the next

three (3) years; and o indicate what effect (if any) the scheduled maintenance will have on the

facility’s capabilities from time to time; and

the Asset Management Plan.

As previously noted, it is expected that these requirements, which represent appropriate practice, are encapsulated in the various management plans prepared by Veolia.

4.5 Capital Planning

As outlined in Sections 4.2 and 4.3, Sydney Desalination Plant’s capital planning processes are expected to be documented in the Asset Management Plans and, from a broader perspective, in Sydney Water’s WPIMS.

13 Halcrow notes that, under the Operating Rules (as defined in the 2010 Metropolitan Water Plan), the Desalination Plant will be shut down when Sydney’s dam levels rise to 80 percent of full capacity. Furthermore, the plant will continue to operate for the duration of its providing period, which expires in June 2012. Notwithstanding, a number of shut down modes have been identified (refer Section 5.4); protocols for determining the mode to be adopted when the plant is being shut down should be developed.



In practice, the next significant future capital investment is expected to comprise augmentation of the Desalination Plant; the actual timing of a decision to implement this augmentation will be influenced by predicted weather patterns, and seasonal and projected demand levels. 14 It is understood that such a decision will be government led, informed by the overall metropolitan water planning process.

Capital investment proposed during the proposed determination period is driven by external influences and, in the medium term, the need to consider refurbishment and/or renewal of assets. As outlined in more detail in Section 6.3.3, the planning processes adopted in respect of asset refurbishment/renewal are not apparent from the information provided to this review. These processes are implemented by Veolia under the provisions of the Operations and Maintenance Contracts.

4.6 Summary

Sydney Desalination Plant operates under the provisions of the Water Industry Competition Act 2006 (WICA) and holds both Network Operator and Retail Supplier Licences. Under the provisions of its licences, SDP is required to develop and implement various management plans. The Infrastructure Operating Plan, which outlines both the operating regime/environment within which the facility is operated and SDP’s operational strategies, has been provided for review.

On the basis of Halcrow’s review of the available documentation, which has included the Infrastructure Operating Plan and the Operations and Maintenance Contracts in respect of both the Desalination Plant and the Drinking Water Pumping Station, it appears that appropriate management systems are in place at a high level.

Reference is made in both the Infrastructure Operating Plan and the Contracts to a number of management plans and protocols. The descriptive information (title and, where specified, content requirements) provided in these documents indicates that they should outline the detailed processes required in respect of operations and maintenance planning, and to a lesser degree, capital planning. These more detailed documents have not, however, been provided to this review accordingly, Halcrow is unable to provide further assessment. Notwithstanding, Halcrow understands that protocols for determining the operational (shut down) mode to be adopted when the Desalination Plant is to be shut down are not currently available; given the potential impact of such decisions on the quantum of operating costs, Halcrow considers it essential that such protocols be developed.

14 NSW Office of Water, 2010 Metropolitan Water Plan, August 2010, p37.



It is noted that, under the provisions of the WICA, SDP’s Infrastructure Operating Plan and associated management plans are subject to audit. At the time of this review, such audit has not been undertaken, however, Halcrow understands that conduct of an audit is imminent.

It is also noted that the management procedures outlined in this Section relate to the Desalination Plant and Drinking Water Pumping Station. In the event that ownership (together with responsibility for its operation and maintenance) of the Desalination Delivery System (pipeline) is transferred to Sydney Desalination Plant (refer Section 5.1), SDP does not currently have either its own procedures or staff to manage the asset.


5 Operating Expenditure

5.1 Overview

Sydney Desalination Plant has reported actual operating expenditure for the period 2008/09 to 2011/12 amounting to $165.5 million ($2011/12). This is 10.6 percent greater than forecast at the time of the 2008 Sydney Water Price Determination. Forecast operating expenditure for the period 2012/13 to 2016/17 amounts to $435.9 million ($2011/12) on the basis that the desalination plant will be operating at full production, ie. 90 gigalitres per annum, over the full period.

The desalination plant is operated and maintained for Sydney Desalination Plant by Veolia Water Australia Pty Ltd under a contractual arrangement.16 The contract, which has a 20 year operating term, provides that:

Veolia will operate and maintain the plant in accordance with industry best practice and a detailed Operations Management Plan;

the plant will provide drinking water in quantities directed by Sydney Desalination Plant; and

the services performed by Veolia will meet technical requirements specified by Sydney Desalination Plant, including drinking water standards.

Payments under the Operations and Maintenance Contract cover the majority of direct costs incurred in operating the plant, with the exception of energy supply. Sydney Desalination Plant has separate contracts with subsidiary companies of Infigen Energy Limited for the supply of electricity and associated Renewable Energy Certificates (RECs).

The Desalination Delivery System, ie. the pipeline that provides the connection between the desalination plant and the Sydney Water supply network at Erskineville,17 is currently owned, operated and maintained by Sydney Water. Sydney Water intends, however, to transfer ownership of the pipeline, together with responsibility for its operation and maintenance to Sydney Desalination Plant. Accordingly, Sydney Desalination Plant’s forecast operating expenditure includes allowance for the associated costs.

16 Sydney Desalination Plant, Sydney’s Desalination Project; Operate and Maintain Contract between Sydney Desalination Plant and Veolia Water Australia Pty Ltd, undated.

17 The pipeline runs under Botany Bay.

Operating Expenditure


Operation and maintenance of the Drinking Water Pumping Station, which was constructed as part of the Desalination Delivery System, is undertaken by Veolia Water Australia Pty Ltd under a contractual arrangement.18

5.2 General Observations

5.2.1 Quality Assurance

There are discrepancies between SDP’s Pricing Submission and the Annual Information Return (AIR). For example, Table A2.2 in SDP’s Submission shows the water production figure for 2010/11 as 76.7GL while the AIR (Table 1.2) has the figure at 75.451GL.

In addition, there are errors in the descriptions given to items in the original AIR. For example, amounts varying from $7 million to $8 million ($nominal) per year are shown against “Insurance” (Table 5.2); the description of this item was changed by SDP to “Cost (gain) from sale of unused electricity” following a query from Halcrow.

5.2.2 Prudence of Operating Expenditure

The Terms of Reference for this review require Halcrow to apply the efficiency test to operating expenditure and both the prudency and efficiency tests to capital expenditure.19

SDP’s contract prices for both electricity and renewable energy contracts are significantly above current market prices. SDP’s forecasts assume the current difference between contract and market prices will prevail over the term of the proposed price path to 2017.

SDP indicates the prices were competitive at the time they were negotiated and, on the basis of its analysis, NPV positive under most scenarios over the 20 year term of the contracts.22 If accepted, this leaves open the questions of the term of the contracts and the contracted quantities. These matters are discussed in Section 5.6.

18 Operations and Maintenance Contract (Sydney’s Desalination Project; Drinking Water Pumping Station Deed) between Sydney Desalination Plant and Veolia Water Australia Pty Ltd, dated 18 January 2010.

19 IPART, Request for Scope of Work and quote: Review of Operating and Capital Expenditure by Sydney Desalination Plant Pty Ltd, 1 June 2011, Section 3.1.

22 Ibid, p6.



5.3 Historical Expenditure

Sydney Desalination Plant’s expenditure in the period 2009/10 to 2011/12 is significantly different to the projections included in Sydney Water’s submission to the 2008 Price Determination.23 The principal driver for the variation is the much higher electricity expense. There were also delays in the handover of the plant and a cessation of production while AusGrid carried out repairs to the power supply network. The latter two combined to reduce production below forecast.

SDP capitalised expenditure incurred in the period prior to the handover of the plant in accordance with accounting standards. The operating expense figures presented in Table 5.1 include the capitalised expenditure to assist with comparisons.

Table 5.1 compares the operating cost projections included in Sydney Water’s 2007 Submission to the actual costs for 2009/10 and 2010/11 and the budget for 2011/12.24 The figures for 2011/12 are based on the plant operating at full capacity.

23 Sydney Water Corporation, Submission to the Independent Pricing and Regulatory Tribunal for Review of Prices, 14 September 2007, Table 5.3, p48.

24 IPART’s 2008 determination report did not include a breakdown of the costs between electricity and other. The costs (in total) included in Sydney Water’s submission agree in total with the figures adopted by IPART in its determination.



Table 5.1 Cost Comparison: 2007 Submission with Actual ($million 2011/12)

2008/09 2009/10 2010/11 2011/12

SWC 2007 Submission

Payment to plant operator - 13.0 24.9 24.9

Other costs borne directly by SDP - 3.3 6.5 6.5

Electricity - 14.1 28.2 28.2

Total - 30.4 59.6 59.6

SDP 2011 AIR

Payment to plant operator - 6.8 28.2 30.3

Other costs borne directly by SDP - 1.7 3.5 4.1

Electricity -

Total - 20.2 68.2 77.1

Variation

$M - -10.2 8.6 17.5

% - -33.4 14.4 29.3

Note: SDP reports in Table 5.1 of the AIR that it incurred operating expenditure of $20,000 in 2007/08 and $18,000 in 2008/09 ($2011/12) respectively. These amounts are considered immaterial for the purpose of this review.

The higher expenditure over the term of the 2008 Determination is compounded by lower than expected production greatly increasing unit costs. The production figures are shown in Table 5.2.

Table 5.2 SDP Desalinated Water Production 2009/10 to 2011/12 (GL)25

2008/09 2009/10 2010/11 2011/12

2008 IPART Determination - 45.63 91.25 91.25

Actual/forecast - 20.07 76.70 90.00

% variation - -56.0 -15.9 -1.4

The unit cost of desalinated water produced is shown in Table 5.3. This shows that the unit costs (c/kL) for 2011/12, with the desalination plant operating at full capacity, are over 30 percent greater than forecast by Sydney Water in 2007.

25 Sydney Desalination Plant Pty Ltd, Submission to the Independent Pricing and Regulatory Tribunal: Review of Prices for Sydney Desalination Plant Pty Ltd, undated, Table A2.2.



Table 5.3 Operating Unit Cost c/kL ($2011/12)

2008/09 2009/10 2010/11 2011/12

SWC 2007 Submission - 66.5 65.3 65.3

Actual/ budget - 100.6 88.9 85.7

% variation - 51.3 36.1 31.1

The figures in Table 5.2 and Table 5.3 also show the variation in unit costs at different levels of production. Unit costs increase significantly at lower production levels. This reflects the following influences:

some operating costs do not vary with production; and

greater energy efficiency is achieved at higher production levels, ie. electricity usage per kilolitre of desalinated water produced is least at full production.26

The electricity contracts27 were finalised in the period between Sydney Water’s September 2007 Submission and the release of IPART’s 2008 Final Price Determination. Sydney Water committed to bearing the cost of any deviation of the final negotiated prices from their submission for the term of the 2008 Price Determination.28

SDP has also borne the significant increase in electricity network charges over the period. Network charges are a pass through item under the electricity supply agreement.

In its 2007 Submission, Sydney Water stated:29

“The electricity costs in the financial year ended 30 June 2010 include the $4m which is a provisional sum in the D & C contract. The electricity costs are currently based on a price of $76 per MWh (June 2006 dollars) including the green component and transmission charges. Given the current volatility in electricity this price could be substantially higher.”

SDP is committed under the electricity supply and REC contracts to purchase minimum quantities each calendar year. Surplus quantities can be sold in the market. Current market prices are below contract prices implying a loss on any sale.

26 Communication with SDP officers, 25 July 2011.

27 The Electricity Supply Agreement and The Renewable Energy Certificate Supply Agreement.

28 IPART, Final determination and report - Review of prices for Sydney Water Corporation’s water, sewerage and stormwater services, 16 June 2008, p41.

29 Sydney Water Corporation, Submission to the Independent Pricing and Regulatory Tribunal for Review of Prices, 14 September 2007, Table 5.3, p52.



SDP reported ‘devaluation excess RECS’ of $1.4 million in 2009/10 and $1.3 million in 2010/11.30 SDP has advised that these are not realised losses and not part of the building block for pricing purposes.31 In the original design of the renewable energy certificate scheme, surplus RECs could be banked until the end of the scheme.

Contrary to the treatment of the surplus RECs, the energy figures for 2009/10 and 2010/11 include mark to market adjustments.

There are also variations between the 2007 forecasts of payments to the plant operator and actual outlays. These were caused in part by:

shutdown of the plant (to enable AusGrid works) invoked shut down and start up payments to the operator;

the cost of chemicals is passed through by the operator to SDP. Their prices increased significantly above the movement in the consumer price index; and

the operator is entitled to energy efficiency payments when less electricity is used for a given volume of output than prescribed under the contract. These payments amounted to in 2010/11 and are forecast to be

in 2011/12. The energy savings are expected to reduce over time as membranes age. Under full capacity operation, the payments are offset by reductions in electricity costs. The plant operator retains 70 percent of the benefit of any efficiency savings and SDP the remaining 30 percent.

In comparison to the unit operating costs presented in Table 5.3, the Productivity Commission quotes projected operating costs for the Melbourne Desalination Plant of $1.37 per kilolitre and $0.96 per kilolitre for an upgraded Southern Seawater Plant to supply Perth (if operated as a base load supply). Both include the costs of green energy. Operating costs of $0.47 per kilolitre are quoted for the Kwinana desalination plant supplying Perth.33 While the Western Australian Government has paired the Kwinana plant to the wind farm at Emu Downs the

30 SDP Annual Information Return (Table 5.1) and submission to IPART (Appendix 5), July 2011.

31 Email SDP 10 August 2011 states ‘This represents the write down in value of the Greenhouse Trading Certificates when they are marked to market at 30 June 2011. This is purely an accounting entry and the loss on the certificates only materialises once they are sold. As such this is not part of the Opex building block for pricing purposes. The loss if it is ever realised is recovered by the operators through the Renewable Energy Standby Adjustment (see Appendix 3 of submission). This only occurs if the plant is shut down and not producing water.’

32 Email SDP 10 August states ‘No surplus RECs have been sold by SDP in any year.

33 Productivity Commission, Partial Equilibrium models of the urban water sectors in Melbourne and Perth, Australia’s Urban Water Sector, Supplement to the Draft Report, p29.



‘pairing’ has been queried. It is claimed no additional renewable energy facility was constructed to power the plant.34

While the actual operating costs of the Sydney Desalination Plant are much higher than projected in 2007, they remain within the range of other Australian plants, particularly where energy usage is offset by ‘green energy’.

5.4 Forecast Expenditure

SDP initially submitted cost projections for two scenarios in detail and summary figures for an additional five scenarios.35 Halcrow has reviewed the cost figures for the two detailed scenarios.

The scenarios reviewed are:

Operate at capacity for the full determination period; and

Plant does not produce any desalinated water.

Table 5.4 and Table 5.5 show SDP’s projected operating costs for the period 2011/12 to 2016/17 under scenarios of full production and no production respectively.

Table 5.4 SDP’s Forecast Operating Costs at Full Production ($million 2011/12)

2011/12 2012/13 2013/14 2014/15 2015/16 2016/17

Payments to Operator 30.3 31.3 35.0 37.6 37.3 35.6

Other costs borne directly by SDP 4.1 4.0 3.5 3.2 3.4 3.5

Electricity 42.7 45.0 47.3 49.4 49.8 49.9

Total 77.1 80.3 85.8 90.2 90.5 89.0

34 David Knights et al, The sustainability of desalination plants in Australia: is renewable energy the answer?

35 SDP Submission to IPART, July 2011, Table 3.4.



Table 5.5 SDP’s Forecast Operating Costs No Production ($million 2011/12)

2011/12 2012/13 2013/14 2014/15 2015/16 2016/17

Payments to Operator 11.2 11.0 11.6 12.5 12.1 12.4

Other costs borne directly by SDP36 3.2 3.2 3.2 3.2 3.4 3.5

Total 27.9 26.1 26.8 28.1 28.1 28.4

The operations and maintenance contract provides for various shut down modes ranging from very short term to over two years. No costs for shutting down and restarting the plant are included in the tables above. These costs vary between shut down modes.

The four types of shut down modes are:

Short term: 2 to 10 days;

Medium term: 11 to 90 days;

Long term: 91 to days to 2 years; and

Water security mode: 2 to 5 years.

The amounts paid to the operator by SDP associated with each of these modes are shown in Table 5.6.

36 There is no marine monitoring expenditure included under the no production scenario. This amounts to $0.9m in 2011/12, $0.8m in 2012/13 and $0.3m in 2013/14 and is included under other costs borne directly by SDP in the full production scenario.




Additional electricity costs are incurred in conjunction with these activities.

A major driver of costs will be SDP’s ability to match its decision on the shutdown mode with weather conditions as they unfold. While the success of such a choice will only be known in hindsight, SDP was unable to provide details of protocols that would be followed when making such a decision.

There are significant implications flowing from the shut down mode adopted once dam levels are greater than 80 percent. There are varying shut down, start up and stand by costs. Under the water security mode, for example, manning levels at the plant are reduced and new staff will have to be recruited to restart the plant. Various notice periods apply for the different modes.

CIE state “the expected water (production) from desalination (ML/month)” is on average 988.738. This is based on weather conditions over the last 100 years and the adoption of the 70/80 rule.39 This compares with SDP’s projected output of 7500ML a month in 2011/12.40 The expected average monthly output over the longer term adopted by CIE in their evaluation of the 70/80 rule is therefore 13.2 percent of the plant’s capacity.

Sydney Water’s financial consultants (BurnVoir) adopted various operating cycles in the energy and REC tender assessment process. These assisted in quantifying the cost implications of the different tenders under different lengths of operation and shut down/start up frequencies.

Probabilities were assigned to different operating cycles varying from low to high energy usage. The probability weightings adopted were:

Low usage (probability weighting – plant operates 40 percent of the time over the length of the energy contracts;

Medium usage (probability weighting ) – plant operates 55 percent of the time over the length of the energy contracts; and

38 CIE, Review of operating regime for Sydney Water’s Desalination Plant, July 2010, p31, Table 3.2

39 CIE, Review of operating regime for Sydney Water’s Desalination Plant, July 2010, p31, based on water demand in 2014/15.

40 SDP, Annual Information Return, July 2011, Table 1.2 (90,000 ML a year/12= 7500ML a month).

41 Sydney Water, Water Delivery Alliance Issues Paper, p4.



High usage (probability weighting – plant operates 80 percent of the time over the length of the energy contracts.

The need to make decisions as to what shut down mode to adopt is therefore very likely. Such decisions, which will impact actual operating expenditure, should be based on detailed protocols which are not currently available.

In its response to Halcrow’s Draft Review Report, SDP has noted that:42

“… the desalination plant is in a proving period until June 2012 so any decisions on shutting down the plant would not be required until after that time and will depend on the prevailing dam levels.

Halcrow maintains that such protocols are likely to be required to inform operational decision making during the price path to 2017, and the adequacy of the protocols could therefore impact the efficiency of expenditure incurred during that period. The absence of such protocols raises questions as to SDP’s preparedness to assure the efficiency of its costs.

5.5 Assessment of Operating Costs

5.5.1 Overview

As previously noted, SDP’s forecast operating expenditure includes allowance for costs associated with operation and maintenance of both the Desalination Plant and the Desalination Delivery System (pipeline).

There are three major elements of operating costs which are incurred in respect of the Desalination Plant. These are:

Payments to the operator including costs passed through to SDP;

Costs incurred directly by SDP; and

Electricity supply including renewable energy certificates.

An assessment of the various components of SDP’s operating costs is presented in the following sections. Expenditure associated with the supply of electricity is discussed in Section 5.6.

42 SDP, Draft Halcrow Review Report, Review of Operating and Capital Expenditure by Sydney Desalination Plant Pty Ltd (SDP); SDP Comments, 5 September 2011, p8.



5.5.2 Operating costs – Desalination plant

5.5.2.1 Payments to Operator The operating and maintenance contract (as part of the design, build, operate and maintain arrangements) for the desalination plant was let under a competitive tendering process. Bidders were given the opportunity to provide innovative solutions within the ambit of guidance documents. Only proven technology was considered. Halcrow has reviewed the call for tender43 and tender evaluation44 documents and is satisfied that due process was followed. This is supported by the probity advisor’s report.45

Halcrow notes the comments from Degremont in its submission to IPART querying whether the contracted costs represent efficient costs:46

“While Degremont does not dispute that the competitive tendering process for SDP’s Design, Build,

Operate and Maintain overall activities was sound, the operating and maintenance costs have not been

subject to competition in their own right. Degremont believes that there are opportunities to operate the

plant more efficiently and these efficiencies are not reflected in the current contracted amounts. We believe

that the opportunities to operate the SDP more efficiently arise from, for example, more efficient practices

that may reduce energy or chemical use, or extend the life of certain assets.”

Table 5.7 and Table 5.8 show the projected payments to the plant operator for operation at capacity and no production.

43 Sydney Water, Request for Tender; Sydney’s Desalination Project; Design Construct, Operate and Maintain a Desalination Plant, Seawater Intake and Outlet; Volume 1: Tender Requirements, Rev 0, 7 February 2007.

44 Sydney Water, Tender Evaluation Report; Sydney’s Desalination Project; Design Construct, Operate and Maintain a Desalination Plant, Seawater Intake and Outlet; Tender No: 0510022504, June 2007.

45 Deloitte letter, Probity Report – Request for Tender – Design, Construction, Operation and Maintenance of Sydney’s Desalination Plant, dated 19 June 2007 concludes that “… no matter that would lead us to conclude that the process adopted and followed by Sydney Water Corporation in the evaluation of the Request for Tender – Design, Construction, Operation and Maintenance of Sydney’s Desalination Plant has not been conducted in a fair and equitable manner with due regard to probity”.

46 Degremont, Sydney Desalination Plant Pty Ltd Price Determination 2011, 31 August 2011, p3.




The figures shown for capitalised maintenance in 2015/16 and 2016/17 do not represent a reduction in the payment to the operator. They reflect a transfer from SDP’s profit and loss statement to its balance sheet.


‘Fixed costs’ are constant while the plant is operating at capacity or within a particular shut down mode; these costs vary between modes. The lower ‘fixed costs’ under the no production scenario stem from the operator reducing staff numbers, laboratory costs and overheads. In addition, under long term and water security mode shut downs, some membrane replacement and asset maintenance may be avoided. Production staff numbers are reduced under both the long term and water security shut down modes.47

47 SDP submission to IPART, section 3.2.



The components of the fixed cost paid to the operator when the plant is operating at full production and not operating are shown in Table 5.9 and Table 5.10 respectively.48

There is minimal variation in these costs over the proposed term of the price path. They have been determined through a competitive tender process and Halcrow has no information or basis upon which to question their integrity and efficiency, although notes the comments made by Degremont as outlined above.

The cost of membranes and chemicals incurred by the operator are passed through to SDP. Significant increases in prices are included in SDP’s forecasts.49 SDP has assumed that the price of chemicals will increase as follows:

48 Tables 5.9 and 5.10 are derived from a combination of AIR and email sent by SDP on 8 August 2011. While the email shows no additional plant labour cost under the full production mode, this is contrary to advice given by SDP at meetings on 25/26 July 2011. The labour figure in the email has been adjusted for the full production scenario to balance to the total operator fixed cost shown in the AIR.

49 Communication with SDP Officers, 25/26 July 2011.



Fluorsilic acid: CPI + 5 percent a year; and

All other chemicals: CPI + 4 percent a year.

SDP’s forecasts assume a continuation of past trends in chemical costs. The weighted index used in the pass through of chemical costs rose 36 percent (in nominal terms) between July 2007 and November 2010.50 The index fell marginally between November 2010 and June 2011.

SDP’s historical figures include a total nominal increase in membrane prices of 14 percent between 2007 and June 2012.51 The forecast increase is significantly in excess of that which has been incurred to date.

In its response to Halcrow’s Draft Review Report, SDP has noted that:52

“SDP has provided information to Halcrow on past and forecast future increases in a US chemical price index which is used by a major membrane supplier to forecast the price of membranes. This index, combined with the Bloomberg USD/AUD forward curve, forecasts a 6.7 per cent real compound annual growth rate for the period of the new price determination for SDP.

SDP has also provided Halcrow with data on past increases in chemical costs experienced by SDP. Halcrow recognises that chemical prices have increased significantly above the movement in the CPI but does not consider that this trend warrants an assumption that prices will continue to rise above CPI at all. SDP considers that the current trend of increasing chemical prices, combined with the forecast chemical price increases provided (in the context of the discussion about membrane prices53) justify at least some of the proposed increase in chemical prices being passed through. Chemicals are a significant component of SDP’s costs so allowing only CPI increases in this cost component will cause SDP to under-recover its costs.”54

Earlier justification from SDP for future price movements was limited to: “Based on industry advice / US producer price index movements for industrial chemicals”.55

50 Communication with SDP officers, August 2011.

51 Communication with SDP Officers, 25 June 2011.


53 “Most of SDP’s chemicals are bought locally, however the trend in the US chemical price index mirrors SDP’s and Sydney Water’s experience of above CPI increases in chemical costs. As such the forecast presented in this index is considered a reasonable proxy, once adjusted for forecast movements in the Australian dollar, for SDP’s future chemical costs.”


55 SDP, SDP Price Determination; Supplementary Information, document received from SDP, 26 July 2011.



To provide an incentive for improved purchasing practices and more efficient use Halcrow recommends that the forecast cost of membranes and chemicals be held constant in real terms.

5.5.2.2 Costs Direct to SDP Table 5.11 shows the annual forecasts for those costs borne directly by SDP. These are extracted from the AIR and adjusted to $million 2011/12. Some costs (eg. Auditor-General’s fees56) are separately identified in the submission but not in the AIR.

Table 5.11 Costs borne directly by SDP ($million 2011/12)

2011/12 2012/13 2013/14 2014/15 2015/16 2016/17

Marine monitoring program 0.9 0.8 0.3

Acquisitions from SWC (Labour) 2.1 2.1 2.1 2.1 2.3 2.5

Rates and Taxes 1.1 1.1 1.1 1.1 1.1 1.1

Total 4.1 4.0 3.5 3.2 3.4 3.5


Special marine monitoring programs are required by the environmental regulator in the early years of operation of the plant.57 These are not included in the no production scenario.

SDP has no staff. It relies on its parent company (Sydney Water) to provide all management and support services. This arrangement is formalised in a Service Level Agreement. The projected costs are constant in real terms from 2011/12 to 2014/15. The increases in 2015/16 and 2016/17 include estimates of the cost of SDP’s participation in the next IPART price determination ($500,000 across the 2 years).

The initial term of the Service Level Agreement was effective from 1 February 2010 to 30 June 2010, with a mutual option to renew on a rolling six monthly basis.58

The services provided by Sydney Water under the agreement are:59

56 SDP Submission to IPART, July 2011, Appendix 5.

57 Office of Environment and Heritage, Submission to IPART, 25 July 2011, p1.

58 Sydney Water, Service Level Agreement (SLA) for the provision of management and support services by SWC employees acting on behalf of SDP, p4.

59 Sydney Water, Service Level Agreement (SLA) for the provision of management and support services by SWC employees acting on behalf of SDP, p2.



Corporate governance;

Executive management;

Operational management;

Operations contract management;

Electricity and green energy contract management;

Water quality monitoring;

Financial, treasury and accounting services;

Insurance and risk management;

Property management services; and

Environmental, safety and quality audits.

Halcrow sighted a copy of the agreement showing costs of $1.5 million for 2010/11. This is consistent with the figure in the AIR for that year. Under the Agreement, the annual costs were to escalate by CPI. The figure included for 2011/12, and retained for subsequent years, is 40 percent higher. SDP indicated that the additional costs relate to the “inclusion of pipe maintenance performed by SWC and billed to Sydney Desalination Plant” and additional insurance costs incurred by SDP.60 Halcrow has not sighted information in support of these additional costs.

There is no formal job costing system in place and the figures included are based on a broad estimate for each activity. The functions performed by many Sydney Water staff on behalf of SDP are an adjunct to their normal work. On this basis, it is not apparent that effective ring-fencing arrangements are currently in place.

The arrangements should be formalised, activities performed on behalf of SDP and Sydney Water better defined and job costing adopted. This would give greater credibility to the figures.

Halcrow notes SDP’s comment61 that

Halcrow is of the view $2 million per year is a sufficiently

large sum to warrant a formal job costing system.

It is Halcrow’s view that, if SDP was a stand alone entity then the costs of the management and support services currently provided by Sydney Water would at least equal the figures included in the projections, particularly given the complexity of the contracts that SDP administers and the expertise it would need to develop and implement protocols on implementing the appropriate shut down mode.

60 Email from SDP dated 3 August 2011.




The amount included in SDP’s estimate of the payment to Sydney Water in 2011/12 (including Auditor General’s fees, pipeline maintenance and insurance) is about 2.7 percent of total operating cost if the plant operates at capacity. This is considered to be minimal.

5.5.3 Operating costs – Distribution pipeline

Sydney Water intends to transfer ownership of the distribution pipeline to SDP.62 The submission includes annual operating costs for the pipeline of $100,000 ($2010/11).63 SDP has not provided any historical figures or detail of how the forecast is derived. The cost is not separately identified in the AIR, but is included under payments to Sydney Water.

The submission describes the commercial risks associated with the pipeline as:64

“Bulk water pipeline- including risks that the pipeline is damaged (including sections that are under water or underground and therefore unobservable), maintenance takes longer or costs more than anticipated, cathodic protection of the pipeline is not maintained, there is a security breach, poor maintenance leads to water quality problems, or concrete and other materials in contact with groundwater experience accelerated deterioration.”

Further information was requested from SDP on the operating cost projections for the pipeline, however, SDP representatives indicated that there “is no further breakdown”. They did, however, advise that the forecast cost is to cover routine maintenance of the pipeline, including inspections and maintenance of the cathodic protection system,65 and have subsequently advised that “This figure was derived from advice provided from the Alliance that delivered the pipeline.”66

Given that the capital cost of the pipeline is in the order of $650 million (refer Section 6.2.3 for details), the forecast operating costs amount to approximately 0.02 percent of asset value; this is not considered excessive.

Maintenance of the pipeline is currently the responsibility of Sydney Water. In the event that ownership of the pipeline is transferred from Sydney Water, SDP will have to develop its own asset management practices separate from Sydney Water.

62 Transfer of ownership will be subject to the approval of the Boards of both Sydney Water and SDP.

63 SDP Submission to IPART, July 2011, Table 5.1.

64 SDP Submission to IPART, July 2011, Section 4.1.

65 Communication from SDP officers, 25 July 2011.




5.6 Energy Costs

5.6.1 Overview

This section reviews the efficiency of SDP’s electricity use and the reasonableness of its contracted energy supply charges and cost of Renewable Energy Certificates (RECs).

Electricity costs are a major contributor to the cost of operating the desalination plant;67 these costs are borne directly by SDP. At full production they comprise 32.4 percent of the operating costs. The RECs comprise an additional 23.7 percent of operating costs.68

A key consideration is whether the current contracted quantities of electricity and renewable energy certificates match the intended role of the desalination plant over time and who bears the quantity and price risks.

SDP’s contracted energy supply charge and the contracted price of renewable energy certificates are currently in excess of the market price. SDP forecasts that this situation will reverse for the electricity supply charges over the life of the contract,70 but not in the period to 2016/17.

Halcrow notes that, if the electricity and REC contractor was to default and future market prices were to exceed contract prices (as anticipated by SDP), then customers (including SDP) who have paid more than the market price currently would not receive the benefit of future favourable price differentials.

67 When the desalination plant operates at capacity it doubles Sydney Water’s consumption of electricity.

68 SDP Submission to IPART, July 2011, Section 1.7, Profit & Loss Table, pg6, figures for 2016/17.


70 Communication with SDP officers 25 July 2011.



The role of the desalination plant may change over the 20 year life of the energy contracts from providing water security to base load supply. This would, on average, increase electricity usage but remain within the contracted quantities allowed under the electricity supply contract.

The plant is designed to produce water suitable for drinking. The output from the plant is piped into Sydney Water’s drinking water supply network. If there was a developed market and a suitable transport network, then significantly less electricity would be required to produce water of a lower standard.

Government directives to SDP require that 100 percent of energy consumption at the desalination plant is offset from renewable energy sources.73 The output of the purposely built renewable energy wind farm should exceed the needs of the desalination plant under the current operating rules.

In 2010/11 there was disruption to electricity supply while AusGrid repaired the network. The loss of production, the costs of shut down and start up, the costs of surplus energy and potential loss on RECs purchases were all borne by SDP. SDP has made provision in its forward capital estimates for strengthening of the network.

5.6.2 Planning approval

In the September 2006 Environmental Assessment Report, the Director-General of the Department of Planning states:74

“Justification of the proposed desalination plant relies heavily on the proposal being only one of a suite of water supply and management measures outlined in the 2006 Metropolitan Water Plan. The Department considers that the desalination proposal is justified as a contingency measure, in the event of extreme drought conditions.

The desalination proposal put forward by the Proponent is a worst-case option that endeavours to accommodate the most extreme conditions in future. While the Department considers this precautionary approach to be prudent, it is important that a desalination option reflects future requirements and endures only as long as the option proposed by the Proponent remains relevant. In this context, the Department supports the Proponent’s approach of implementing the desalination plant in compartments or stages, and recommends that any capacity in excess of 125 megalitres of desalinated water per day be subject to careful consideration of circumstances at the time of implementation of the proposal.”

73 SDP, Draft Halcrow Review Report, Review of Operating and Capital Expenditure by Sydney Desalination Plant Pty Ltd (SDP); SDP Comments, 5 September 2011, p3; “…the use of renewable energy was a binding legal requirement for the Desalination Project, under both the Project Approval and the SOC Act Directions.”

74 Director-General’s Environmental Assessment Report, September 2006, Executive Summary.



The subsequent decision to build a plant of 250ML per day capacity reflected a favourable plant construction tender for the larger capacity and concerns over the depletion rate of dam water at the time the decision was taken.75 It does have implications for electricity demand (higher demand at a point in time at full production) and the operating rules for the desalination plant (enables the operating rules to be relaxed). 76

The Director-General further states:

“The desalination plant is a highly intensive operation, and as a consequence, will have an indirect significant impact on greenhouse gas impacts. The Proponent and the Government have committed to fully off-setting the greenhouse gas implications of the desalination plant, by effectively powering the plant with renewable energy. The Department considers this commitment to be well beyond what would be reasonable for such a development proposal, and fully supports such a significant off-set commitment.”

Notwithstanding, Halcrow acknowledges that the Planning Approval77 for the desalination plant included a condition that the “desalination plant will be powered by 100% renewable energy, or equivalent”;78 SDP has complied with this requirement.

The analysis below shows the additional cost of purchasing RECs while noting the policy decision (and associated directive) of Government to fully offset the greenhouse gas implications of the desalination plant.

5.6.3 Electricity supply and renewable energy certificate contracts

At current capacity, the desalination plant can meet 15 percent of Sydney’s water needs. It is not proposed to operate the plant at this level of production on a continuous basis; rather, it is intended to operate the plant to provide water security when Sydney’s water storage levels fall below 70 percent of full capacity.


76 SDP has noted (refer SDP, Draft Halcrow Review Report, Review of Operating and Capital Expenditure by Sydney Desalination Plant Pty Ltd (SDP); SDP Comments, 5 September 2011, p2) that the Operating Rules (for the desalination plant) were established subsequent to issue of the Project Approval [in November 2006]; the Operating Rules are specified in the 2010 Metropolitan Water Plan, which was not released until August 2010. Furthermore, it notes that “SDP’s energy contracts were signed on 28 July 2008 and then amended in March 2010. As such, SDP was required to make assumptions about the future operating profile of the plant when the energy contracts were being negotiated.”

77 Planning Approval (under Section 75J of the Environmental Planning and Assessment Act 1979), issued in respect of ““the desalination plant” project” by the Minister for Planning, 16 November 2006.

78 Ibid, p6.



This may change if the operating rules are changed, the population grows and environmental flow levels are reset.

The electricity costs of the desalination plant are borne directly by SDP. For that purpose, SDP has entered into two contracts, each of twenty years duration, with subsidiaries of Infigen Energy.79 One contract is for electricity supply and the other is for the provision of Renewable Energy Certificates (RECs).

The energy supply contract includes:80

a 20 year term;

fixed real prices (

ability to sell load back to the market if electricity demand is lower than forecast; and

pass through to SDP of connection costs, network costs, ancillary service charges and specified charges imposed by NEMMCO.

The REC supply agreement includes:82

a 20 year term;

fixed real prices

SDP is required to place a firm order for RECs 6 months before the start of each calendar year;

a minimum annual number of RECs that SDP must purchase (

ability for SDP to purchase additional RECs if required to offset the plant’s electricity usage;

ability for SDP to sell surplus RECs in the market; and

RECs84 must be sourced from the purpose built wind farm at Bungendore85 (or equivalent).

79 SDP Submission to IPART, July 2011, Section 1.3.

80 Ibid, section 1.3, p x and Electricity Supply Agreement 28 July 2008.

81 Energy Supply Agreement, Schedule 1.

82 Ibid, section 1.3, px and REC Supply Agreement, 28 July 2008.

83 REC Supply Agreement, Schedule 1.

84 Other environmental credits (eg. NGACS) can be substituted for RECs.



5.6.4 Electricity demand and energy consumption

There is not a linear relationship between electricity consumption and water production. The amount of electricity consumed does, however, increase with the quantity of water produced. Electricity consumption per unit of water produced is least at full production.

The desalination plant places an even load on the electricity supply system at full production. The electricity supply system will be underutilised if the plant operates at less than capacity.

The major drivers of electricity consumption of a desalination plant at full production are:

the scale of the plant;

the desalination technology adopted;

the condition of the membranes;

chemical dose;

intake water quality;

intake water temperature; and

output water quality parameters.

Some electricity is consumed when the plant is not producing water. Additional energy is also consumed during shut down and start up modes.

When the desalination plant is operating at full capacity it is expected to use about 360GWh of electricity a year. this corresponds with production of 90GL of desalinated water a year and makes allowance for normal downtime, eg. for maintenance. The wind farm’s expected output is about 450GWh a year.87 The desalination plant will use around 9GWh a year when not producing desalinated water.

REC Supply Agreement, 28 July 2008, p10.

86 Communication with SDP officers, 25/26 July 2011.

87 Sydney Water, An introduction to Renewable energy contracts for Sydney’s desalination plant, including amendments to 31 March 2010, p1.



5.6.5 Incentive mechanisms to reduce electricity costs

The operations and maintenance contract provides an incentive mechanism for the operator to reduce electricity consumption. The operator retains 70 percent of the financial benefit of energy efficiency savings.

The cost savings from reduced electricity consumption must be weighed against additional costs incurred elsewhere (eg. new membranes) and the risks of not meeting licence and contractual commitments (eg. water quality).

The current quality of intake water has enabled Veolia to bypass the second filtration phase for 25 percent of the water processed.88 In addition, starting with all new membranes has reduced electricity consumption below the expected long term average.

SDP’s forward estimates assume reducing energy efficiency in the early years of operation as the membranes age. SDP has forecast energy efficiency savings of 10.43 percent up to the end of 2011/12 dropping to 8 percent in 2012/13, 4 percent in 2013/14 and zero thereafter.

From 2012 some membranes are replaced each year to maintain an average life of membranes in operation at 3.5 years. SDP has calculated that this rate of replacement is optimum given operating requirements and the relative costs of membranes and energy.

The Electricity Supply Contract provides for benefit sharing between Infigen (up to 50 percent) and SDP if interruption rights are negotiated with the supply authority(ies).89

SDP has discussed with Transgrid the sharing of the benefits of deferrals of expenditure on the transmission network arising from reductions in electricity consumption at peak periods. There may be other opportunities for SDP to maximise returns by allowing supply interruptions and/or selling surplus power when the electricity supply system is under stress.

The operation of a desalination plant does not allow the same flexibility to temporarily shut down production as some other industrial processes. Three to four hours notice is generally required and the agreement of the plant operator would be necessary with due regard to contracted production levels and operating conditions. Given current uncertainty, the forward estimates do not include any allowances for these potential benefits.

88 Communication with SDP officers 26 July 2011.

89 Electricity Supply Agreement, 28 July 2008, p26.



Halcrow has not sighted any material in support of the benefit sharing ratios adopted. Whilst SDP has questioned Halcrow’s need for information in respect of this matter given that “The benefit sharing ratios were developed as part of the commercial negotiation of the O&M contract”,90 Halcrow notes that any variation in the benefit sharing ratios, and the extent to which the operator is able to meet the prerequisite performance, will impact on the efficiency of the costs that SDP seeks to recover from its customers.

It is noted the plant operator is penalised if energy consumption is excessive under the terms of the contract.

5.6.6 Comparisons with other plants

The Sydney Desalination Plant will consume about 4kWh/kL at full production based on energy consumption of 360 GWh a year and output of 90GL a year (

. This compares with figures of 4.1kWh/kL quoted for the Perth desalination plants91 and around 5kWh/kL quoted for the Gold Coast plant.92

An Australian survey published in February 200993 indicated that the average energy consumption is 3-3.7kWh/kL for sea water reverse osmosis plants and the CSIRO has stated that current power consumption for seawater desalination is less than 3kWh/kL.94

Siemens, in conjunction with the Singapore Public Utilities Board, has constructed a large pilot plant using new technology that uses about half of the electricity required by a reverse osmosis plant.95 This was done to meet the challenge of the Singapore Government to build a plant that uses a maximum amount of energy of 1.5kWh/kL.

Energy consumption is highly variable between plants and by an individual plant over time based on a number of parameters such as the quality of intake water and membrane age. It is considered that the energy consumption of the Sydney plant is within the range of other Australian plants already built or under construction. New technology is likely to bring major reductions in electricity use in the future.


91 Water Corporation, The Perth Seawater Desalination Plant, September 2006 and Southern Seawater Desalination Plant, February 2008.

92 Queensland Water Commission, updated 6 October 2010.

93 Manh Hoang et al, Desalination in Australia, February 2009, Section 2.2.6.

94 Colin Creighton, Director Water for a Healthy Country, CSIRO, ABC, Ask an expert.

95 Pictures of the future, Spring 2011, p30.



Energy consumption per kL will increase significantly if the plant is not operated at full capacity and is subject to frequent shut downs and start ups.

5.6.7 Energy charges

Unit costs of electricity supply and RECs are fixed in real terms under twenty year contracts. Network costs, determined by the Australian Energy Regulator and ancillary charges are passed through in full to SDP.

SDP is committed to buying a minimum quantity of electricity and a minimum quantity of RECs each year. Any amounts surplus to requirements can be sold into the market. There may be gains or losses on such sales depending on variations between contract prices and market prices.

If the plant does not operate the sale of surplus energy could depress the electricity market price given the large volume of contracted energy.

The average annual prices (per financial year) published for NSW in the national energy market99 are as shown in Table 5.12.

96 Electricity Supply Agreement, Schedule 1.

97 The base charge excludes connection and network charges, metering charges, market charges, change in law and other charges as per agreement.

98 SDP email dated 15 August 2011.

99 AEMO, Website, downloaded 30 July 2011.



Table 5.12 Electricity NEM Data- Average Annual Prices for NSW (nominal)

Year $/MWh

1998/99 33.13

1999/00 28.27

2000/01 37.69

2001/02 34.76

2002/03 32.91

2003/04 32.37

2004/05 39.33

2005/06 37.24

2006/07 58.72

2007/08 41.66

2008/09 38.85

2009/10 44.19

2010/11 36.74

Table 5.12 shows historical electricity prices peaked (by a considerable margin) in 2006/07, which was the year prior to when Sydney Water agreed to enter into the electricity supply agreement for SDP. The higher prices in 2006/07 were largely driven by the prevailing drought conditions and the associated restrictions placed on generators.100

SDP has advised that the spot prices shown in Table 5.12 exclude the following elements, which are included in its contracted electricity prices: 101

Costs for complying with the Small-scale Renewable Energy Scheme and NSW Energy Savings Schemes.

Retailer administration costs.

Load shape premium (reflecting that SDP’s load profile is not flat, and there is a risk that proportionately higher electricity usage will occur in times of high-spot market pricing).

Transmission Losses (SDP’s contract prices are inclusive of the transmission loss factor).

Estimated annual costs for the above elements are shown in Table 5.13.

100 NEMMCO, Potential Drought Impact on Electricity Supplies in the NEM- Final Report, 30 April 2007.




Table 5.13 Cost elements included in SDP Contracted Electricity Prices102

Cost ($/MWh) in each Financial Year

Item

FY13 FY14 FY15 FY16 FY17

Notes:

SRES $/MWh 5.42 2.50 2.50 2.50 2.50 Based on ORER draft purchase percentages for the Small-scale Renewable Energy Scheme, held constant at 6.25% from FY14 onwards at the clearing house rate of $40/STC

ESC $/MWh 1.25 1.63 1.67 1.71 1.76 Based on recent tender pricing on behalf of an Energetics client, with CPI from FY15 onwards

Retailer Margin $/MWh

0.75 0.77 0.79 0.81 0.83 Estimate based on industry information

Load Shape Margin $/MWh

0.75 0.77 0.79 0.81 0.83 Estimate based on industry information

Transmission Losses

0.24 0.27 0.27 0.28 0.29 Based on SFE prices 1 September 2011, with CPI escalation from FY15 onwards, and published Transmission Loss Factor for 2011/12

Total 8.41 5.93 6.02 6.11 6.20

SDP further notes:

“The cost elements in [Table 5.13] offer no benefit if SDP does not consume the contracted minimum consumption and the surplus electricity is sold into the spot market. Accordingly, the sum of the above cost elements needs to be considered when comparing SDP’s electricity contract rates with the wholesale price projections shown in Figures 5.1 and 5.2 of Halcrow’s report.”

On this basis the market price figures should be increased by, for example, $8.41 in 2012/13 to be comparable to SDP’s contracted electricity price.

In a report prepared for the NSW Government, Frontier Economics state that the “current wholesale electricity prices (around $35/MWh) are below LRMC (long run marginal cost) due to excess capacity/soft demand growth”.104 The Commonwealth Treasury states “Wholesale electricity prices are projected to be higher, even without a carbon price. Prices grow relatively strongly to 2030, mainly driven by rising gas prices and higher capital costs for new electricity generation plants that enter the market to meet growing demand”.105

102 Ibid, p5.

104 Frontier Economics, Carbon Price Modelling, A report prepared for the NSW Government, August 2011, p11.

105 Australian Growth, The Treasury, Strong Growth, Low Pollution, Modelling a Carbon Price, Section 4.4.2.



Figure 5.1 contrasts the future movement in wholesale prices previously projected by Commonwealth Treasury with those more recently adopted by its consultants in the absence of a carbon price.106 The difference in the projected prices between the consultants reflects their differing views on the cost of new generation.

Note: Prices in 2010 dollars.

Figure 5.1 Wholesale electricity prices (with no carbon price)

The NSW Government commissioned Frontier Economics to model the impact of the introduction of a carbon price.107 The modelling is based on the Commonwealth Government’s announcement dated 10 July 2011. In Frontier Economics’ modelling, the carbon price “commences at $23/tCO2 nominal in 2012/13 before transitioning to the international price from 2015/16”.108 This sees the price steadily rise to about $53/ tonne by 2031 ($2010).109

The introduction of a carbon price is expected to increase wholesale electricity prices further. The following graph110 compares the predictions of Frontier Economics with those of the Commonwealth Treasury. The difference in prices in 2012 (the proposed date for introducing the carbon price) reflects the

106 Australian Growth, The Treasury, Strong Growth, Low Pollution, Modelling a Carbon Price, Chart 4.16.

107 Frontier Economics, Carbon Price Modelling, A report prepared for the NSW Government, August 2011.

108 Ibid, p9.

109 Ibid, p10, Figure 1: Assumed carbon price.

110 Ibid, p11.



Commonwealth Treasury’s modelling was undertaken on the assumption of a $20/tonne price whereas the announced price was $23/tonne.

Figure 5.2 Average wholesale electricity prices

SDP has advised that:112

“In the week beginning Monday 21 July 2008, when the Renewable Energy Supply Agreement was signed, spot market prices were $52.50/REC. This is above the RSA base price of

. REC market prices are largely driven by changes, or anticipated changes, to legislation impacting on the supply and demand of certificates, which has resulted in significant price volatility. By not fixing a supply price for RECs, a purchaser takes the full risk of the spot market price volatility.”

111 SDP email 15 August 2011.




Changes to the Australian Government’s renewable energy target scheme were announced on 26 February 2010 and came into operation in January 2011. A distinction is now made between small scale technology certificates and large scale generation certificates.113

Figure 5.3 illustrates the variation in REC prices over the last 12 months and supports recent market prices of just under $40 each.114

Figure 5.3 Weekly Spot Price - RECs

In its report to the NSW Government, Frontier Economics also commented on the impact of a carbon price on the price of RECs.116 It stated:

“in the absence of a carbon price, the renewable certificate price (REC) reflects the difference between the wholesale pool price and the marginal cost of new renewables; and

the carbon price raises the wholesale electricity price, which reduces the REC price (the required subsidy to renewables).”


Depending on the absolute level of electricity and REC prices relative to the contract prices, this suggests that the higher wholesale electricity price resulting from the introduction of the carbon price (and

may be offset by a widening of the price differential between the contract and market prices for RECs.

In its modelling SDP has assumed that the current differentials between the contract and market prices will generally prevail for the proposed term of the price path from July 2012.

5.6.8 Historical electricity supply costs

Table 5.14 compares the actual electricity costs117 with those projected by Sydney Water for the desalination plant in its 2007 Submission to IPART.118

Table 5.14 Historical electricity costs ($million 2011/12)

2008/09 2009/10 2010/11 2011/12

SWC 2007 submission 14.1 28.2 28.2

Actual/Budget 11.7 36.5 42.7

Variation

$M -2.4 8.3 14.5

% -17.0 29.5 51.5

The desalination plant was not taken over by SDP until June 2010. Electricity costs incurred from January to June 2010 were capitalised and are to be written off over the life of the plant. To enable actual and projected figures to be compared on the same basis, the above figures include the cost of electricity that was capitalised.

The substantially higher costs in 2010/11 and 2011/12 (current estimate) result from a variation in electricity charges from those projected in 2007. The 2007 estimates already included allowance for a ‘green component’.119

The plant was taken out of service to enable AusGrid to undertake work on the electricity network. While this had the benefits of allowing testing of plant shut down and start up procedures during the testing period, it caused SDP to incur additional costs.

117 SDP AIR, July 2011, Table 5.1.

118 Sydney Water, submission to IPART, September 2007, p51.

119 Ibid, p51.


Review of Operating and Report (Issue 2, Rev 1).doc (25/10/2011)

Halcrow has restricted the analysis of whether the energy costs are efficient to comparing the contracted electricity charges with market prices and the electricity consumed to the drinking water produced.

5.6.9 Forecast electricity supply costs

SDP has forecast the electricity costs shown in Table 5.15 for the period 2011/12 to 2016/17 for full production and Level 3 Shut Down scenarios.120

Table 5.15 Forecast electricity costs ($million 2011/12)

2011/12 2012/13 2013/14 2014/15 2015/16 2016/17

Full production

Electricity 42.7 45.0 47.3 49.4 49.8 49.9

The real increases in full production electricity costs in 2011/12 to 2014/15 reflect SDP’s forecast higher network charges and loss of energy efficiency with the ageing of the membranes.

At zero production, some electricity is required to maintain the plant. In addition, surplus RECs and surplus energy will be available to sell in the market. Any loss or gain on these will depend on the deviation of the market prices from the contract prices.

5.6.10 Quantity and price risks

SDP provided calculations in support of the projected losses on the sale of surplus energy and RECs under the no production scenario.121

The loss on sale of surplus energy, is kept constant in real terms over the period from calendar year 2012 to calendar year 2017. The quantity of surplus energy (MWh) generally trends downward over the period,

120 SDP AIR, July 2011, Tables 5.1 and 5.2.

121 SDP email dated 15 August 2011.



presumably because of loss of energy efficiency. There is an unexplained anomaly in calendar year 2013 where the ‘shortfall volume (MWh)’ is 9 percent less than calendar year 2012 and 6.1 percent less than calendar year 2014.

The assumed market price of RECs does not vary in line with movements in the CPI. This presumably reflects the expected commissioning of new ‘green generation’ plants and the consequent balance between demand and supply.

The quantity of surplus RECs is

generally held constant over the period.

If the plant operates at capacity, the cost of production will be inflated by these same price differences. The cost of RECs will be about double that shown under the no production scenario as the minimum contracted quantity of RECs

SDP has provided the following history of the transfer of the energy supply contract to Infigen Energy and its decision to adopt a position counter to this advice:124

“In Energetics’ report of 7 August 2007 (as referenced in Halcrow’s report), the following recommendation was made on contract duration for the electricity supply agreement:

“By the nature of the anticipated operation, the desalination plant will have a highly predictable usage and load profile over the short term (up to 1 month), however over the medium (1 month to 1 year) and particularly the longer term (greater than 1 year), the unpredictability greatly increases. On this basis a fixed price, fixed term contract of any more than 1 year is unlikely to be the best option for SDP.”

123 Worley Parsons & Energetics Report, 7 August 2007, p23.

124 SDP, Draft Halcrow Review Report, Review of Operating and Capital Expenditure by Sydney Desalination Plant Pty Ltd (SDP); SDP Comments, 5 September 2011, p5&6.



In-line with the advice given, to negate the risk of load variation, SDP’s electricity supply agreement contained minimum usage requirements for the first two years of the contract only. SDP could then nominate the annual contract volume for each subsequent contract year with six months notice.

The amended electricity contract required SDP to bear the financial risk associated with selling surplus energy during a shutdown of the desalination plant. SDP’s analysis found that the increased risk borne by SDP under the proposed amendment was small relative to the value of the 20 year term, fixed real price and no carbon pass-through features of the contract.”

The decision to offset the desalination plant’s electricity usage with renewable energy was met with a long term commitment to a purpose built wind farm. The REC and electricity supply commitments have been bundled by purchasing both from subsidiaries of the one firm.

SDP states that the commitment to the wind farm was driven by the conditions of approval of the desalination plant:125

“Securing a 20-year agreement for the supply of RECs ….. was also necessary for compliance with the Project Approval issued by the Minister for Planning, which included requirements regarding certainty, additionality and availability of renewable energy for the duration of the project. In particular, given that new renewable energy was required by the Project Approval condition on additionality, a 20 year contract with a minimum commitment was essential to give supplier the certainty needed to underpin their offers.”

SDP’s current approach has ‘locked in’ supply and purchase prices and provides security of supply, but in the event of market prices being lower than contracted prices, SDP will incur a loss on any sales in the market. On the basis of the above CIE figures and SDP’s own tender assessment criteria (refer Section 5.4), it is likely to have surplus electricity to sell and will incur substantial additional costs over the price path to 2016/17. The minimum REC purchases equate to about half of the minimum purchases under the electricity supply contract.

Similarly when the plant is producing desalinated water, energy and REC prices will (based on SDP’s own estimates) exceed market prices over the proposed term of the price path commencing 1 July 2012.




SDP has provided its NPV analysis over the life of the electricity supply agreement of the expected benefits (or costs) for various operating cycles of the desalination plant. SDP concludes:126

“This analysis found that SDP is likely to be either indifferent or accrue a net benefit in any scenario that includes a future price of carbon in the market price of power. Without any future carbon price, SDP is likely to be either indifferent or have small net benefit in circumstances where power costs increase in real terms and any shutdown of the desalination plant is of short duration or is deferred for some time after initial commissioning.”

At the Public Hearing on 22 August 2011, Mr Alan Ramsay representing SDP stated:127

“It is a matter of judgement. When the tenders were called and considered, there was a very wide response. There is a trade-off between obtaining a long term contract price in fixed real terms with no carbon pass-through, and the amount of volume that you are prepared to guarantee under the contract. It is a commercial judgement. If you look at the tenders received, the judgement was taken that the optimal mix of price and fixed guarantee was where we set it, in terms of what the market was offering.”

5.6.11 Conclusions

The longer term role of the desalination plant is yet to be determined. The strategy of entering into a 20 year electricity supply agreement with purchases set at the level corresponding to full production provides greater certainty of future supply if the plant becomes a base load supplier or operates at or near full capacity because of drought.

It exposes SDP to financial risk if it has surplus electricity and RECs to sell and/or the market price deviates from the contract price. SDP is fully exposed to movements in network charges. SDP is also exposed to counter party risk if the electricity and REC provider encounters financial difficulty.

There is a large deviation between contract and current market prices. The contract prices for energy are also higher than the National Energy Market (NEM) reported market prices128 at the time Sydney Water entered into the electricity supply contract on behalf of SDP in 2008.129


127 IPART, Investigation into Pricing for SDP, Monday 22 August 2011, Public Hearing Transcript.

128 Spot price plus the additional charges advised by SDP covered by the contract price but excluded from the spot price.

129 AEMO website, downloaded 21 August 2011. The average regional reference price for NSW was $34.57/MWh in March 2008, $33.25/MWh in April 2008, $45.20 in May 2008 and $41.82 in June 2008.



Sydney Water was concerned with the impacts of an emission trading scheme and the possibility of higher electricity charges. Given the length of the contracts, the quantity of contracted electricity, and counter party risk, it is considered, however, that Sydney Water has paid a premium for price certainty, particularly if the plant was to lay idle for any length of time.

At the 2007 Public Hearing to determine Sydney Water’s prices to apply from 1 July 2008, Dr Kerry Schott (Managing Director of Sydney Water) stated:130

“So basically the way the desal plant is likely to operate going forward is it will be running for periods like seven years and then it will be off for a few years, and then it will be on for few years.”

Based on SDP’s current predictions of market prices to 2016/17 (refer to its estimated losses under the no production scenario), customers will pay a substantial premium for the coming price path whether the plant operates or remains idle. Based on estimates of future prices (Frontier and Commonwealth Treasury), this may be reversed in the future.

The fixing of the contracted quantity of electricity at the full production level has amplified these issues.

For the coming price period, Halcrow has adopted SDP’s market price predictions (used in SDP’s calculation of losses on sale of surplus electricity and RECs in the no production scenario) in the calculation of the efficient price. Note that, for electricity, this is above the current spot price and closer to Frontier Econmic’s calculated LRMC.

Given the uncertainty over these prices and the possibility of the introduction of a carbon price, Halcrow has allowed 50 percent of the ‘price premium’ in its calculation of the efficient costs.

There are opportunities not included here for SDP to reduce electricity costs if it is able to profitably enter interruptible load agreements.

130 IPART, Public Hearings into a Review of Sydney Water’s Prices, 7 December 2007.



5.7 Maintenance Costs

5.7.1 Overview

In its Submission, SDP has proposed that all periodic maintenance expenditure incurred from early 2016 is treated as capital expenditure. This is discussed in more detail in Section 6.3.3.

5.7.2 Cost of contracted maintenance

As outlined in Section 5.1, operation and maintenance of both the Desalination Plant and the Drinking Water Pumping Station is undertaken by Veolia under contractual arrangements. In both cases, the respective contracts include an outline of expected maintenance costs, a summation of which is presented in Table 5.17.131 It is understood that the contracted allowances, which include both routine maintenance and periodic maintenance, were provided and agreed as part of the tender process.

Amending Deed 2 of the O&M Contract (Schedule 6)132 defines the two forms of maintenance, as follows:

131 Sydney Desalination Plant, Sydney’s Desalination Project; Operate and Maintain Contract between Sydney Desalination Plant and Veolia Water Australia Pty Ltd, undated, Exhibit D, Schedule 6 and Operations and Maintenance Contract (Sydney’s Desalination Project; Drinking Water Pumping Station Deed) between Sydney Desalination Plant and Veolia Water Australia Pty Ltd, dated 18 January 2010, Exhibit D, Part C.

132 Sydney Desalination Plant, Sydney’s Desalination Project; Operation and Maintenance Contract; Amending Deed No 2 between Sydney Desalination Plant and Veolia Water Australia Pty Ltd, dated 21 April 2010.



“Routine Maintenance means asset maintenance works, other than Periodic Maintenance, and consistent with the indicative budget for these works included in Attachment A to this Schedule.”

“Periodic Maintenance means, for the purposes of determining the Periodic Maintenance cost in paragraph 5 of Part A of this Schedule, works (including marine equipment works) exceeding (Indexed) involving the upgrade, replacement or addition of spare parts or the overhaul or renewal of specific items of plant and equipment and consistent with the indicative budget for these works included in Attachment A to this Schedule.”



Based on the Contracts, it is understood that:

Routine Maintenance is paid for on the basis of the costs determined in the respective Contract; and

Periodic Maintenance payments are paid to the operator on a monthly basis and are calculated by the lesser of:133

o APM(m) The Actual Periodic Maintenance expenditure incurred on an accruals basis (exclusive of GST) in the relevant operating month; and

o TPMi(m) A function of the five-year Total for Periodic Maintenance

Average weekly earnings with the Actual Periodic Maintenance for the month subtracted and the Proceeds of the sale of any equipment added; or

o Zero if Total Periodic Maintenance [TPMi(m)] is less than or equal to zero for the month.

In simple terms, payment for asset maintenance costs are based on contracted allowances, with provision made for adjustments when escalation of labour and ‘other’ fractions vary relative to CPI and when actual periodic maintenance costs exceed a 5 year cap.

It is Halcrow’s view that, in the absence of any other identified related costs, asset maintenance expenditure forecasts should be based on the contracted asset maintenance cost.134 At this stage, it should be assumed that escalation will be equivalent to CPI. Accordingly, an adjustment equal to the variance between SDP’s Submission and the contracted maintenance costs is recommended.

5.7.3 Prudence of maintenance expenditure

Halcrow has reviewed the maintenance cost information included in the Operation and Maintenance Contracts for both the Desalination Plant and the Drinking Water Pumping Station. Both routine maintenance and periodic maintenance are forecast to increase across the 20 year life of the contracts, as shown in Figure 5.4 and Figure 5.5 respectively. Total maintenance expenditure is shown in Figure 5.6.

The annual increase in routine maintenance expenditure over the 20 year life of the contract is in the order of t, whilst the annual increase in periodic

133 Based on paragraph 5 of Schedule 6.

134 SDP has subsequently indicated that reconciliation of asset maintenance costs identified in its 2011 Pricing Submission against contracted asset maintenance costs as undertaken by Halcrow is incorrect due to misalignment of the contract and financial years; the fact that the magnitude and timing of contracted maintenance costs may vary subject to a 5 year cap; and that (under contract) escalation rates will vary from CPI. SDP has not, however, provided details of its derivation of the forecast maintenance costs presented in its Submission.



maintenance is approximately . Whilst the increases over the proposed determination period (ie. up to and including Contract Year 7) is generally as expected, the reasons for the growth, particularly in periodic maintenance, beyond that time is not readily apparent.

It is important to note that maintenance expenditure excludes the cost of membrane replacement, which is separately accounted and has been discussed in



A breakdown of the maintenance cost information presented in the Operations and Maintenance Contracts135 enables a high level assessment of the cost allocation by asset. By reviewing this information, Halcrow has been able to gain an understanding of the nature of key elements of expenditure, and the frequency at which certain maintenance activities are undertaken.

In respect of the desalination plant, separate tables are provided for the ‘Initial Module’ (first 125ML/day) and ‘Second Module’. By way of example, annual periodic maintenance costs for Module 1, which are categorised on the basis of Civil and Building Services, Mechanical, Pipework, Valves and Electrical and Instrumentation are presented in Appendix A.

On the basis of Halcrow’s high level review of this more detailed information, the following observations can be made:

135 Sydney Desalination Plant, Sydney’s Desalination Project; Operate and Maintain Contract between Sydney Desalination Plant and Veolia Water Australia Pty Ltd, undated, Exhibit D, Schedule 6, Attachment A and Operations and Maintenance Contract (Sydney’s Desalination Project; Drinking Water Pumping Station Deed) between Sydney Desalination Plant and Veolia Water Australia Pty Ltd, dated 18 January 2010, Exhibit D, Part C.



The expenditure items listed in the detailed information are considered to be of the nature normally expected in respect of desalination and pumping facilities respectively. Halcrow is of the opinion that forecast expenditure on the listed items is generally prudent, however, in the absence of more detailed maintenance plans, it is difficult to agree that the timing of expenditure where repetition intervals are variable.

Furthermore, without reviewing more detailed maintenance plans, Halcrow is unable to form an informed opinion as to whether the proposed maintenance expenditure is efficient. It is, however, noted that the overall levels of maintenance expenditure were developed within a competitive tender environment; on this basis the proposed expenditure can be deemed, in principle, to be efficient.

Notwithstanding, the concerns in respect of expenditure timing outlined above (which in most cases relate to later in the 20 year contract period), Halcrow is generally satisfied that planned maintenance expenditure within the proposed determination period is generally appropriate and can be deemed prudent and efficient.

5.7.4 Conclusions

In the absence of identified maintenance costs other than those incurred in respect of the Operations and Maintenance Contracts, it is recommended that SDP’s forecast asset maintenance costs be adjusted to reflect the contracted amounts, ie. those amounts payable to the operations and maintenance contractor.

Whilst Halcrow has some concerns related to the frequency (timing) at which some period maintenance expenditure has been forecast, these concerns relate to expenditure to be incurred beyond the proposed determination period. Halcrow is generally satisfied that planned maintenance expenditure with the proposed determination period is generally appropriate and can be deemed prudent and efficient; accordingly, no further adjustments are recommended.

5.8 Fixed/Variable Cost Split

SDP proposes prices that match the variation in its costs at different levels of production.136 A distinction is made between fixed costs (ie. do not vary with the rate of production) and variable costs (ie. do vary with the rate of production).

There is another category of costs (semi-fixed or step fixed costs) that do not have a linear relationship with the production volume but are different when the plant is operating to when it is not. SDP advises that “although these costs can vary in

136 SDP Submission to IPART, July 2011, Chapter 6.



magnitude depending on whether or not the plant is producing water, the actual cost incurred does not vary with the volume of water treated”.137

This category of costs includes the marine monitoring program, laboratory and water testing and a component of the plant operator’s profit and overheads, membrane replacement and periodic maintenance.

In part, SDP proposes that the division of costs between fixed and variable reflects the contractual arrangements with the plant operator. This is identical to IPART’s treatment of the costs for the existing water treatment plants.

In addition, SDP bears some costs directly. These include electricity, marine monitoring, Sydney Water management support and rates and taxes. The electricity costs have a fixed and variable component while the others are categorised as fixed.

A key consideration in the allocation of costs between fixed and variable, is whether cost should be classified as fixed because SDP has entered long term contracts to purchase a minimum quantity at a fixed real price.

The Sydney Catchment Authority (SCA) has questioned this proposition. It proposes that the total costs of the renewable energy certificates be classified as variable costs.138 SDP has classified all of the cost incurred including RECs and loss on sale of surplus RECs (and energy) as fixed under the no production scenario.139 A proportion of the cost of RECs is classified as fixed under the full production scenario.

Table 5.18 recreates SDP’s proposed classification of costs in $2011/12 when the plant is operating at capacity to reconcile to Table 3.2 in SDP’s Submission.

137 Email SDP, dated 8 August 2011.

138 SCA Submission to IPART, 22 July 2011.

139 SDP submission to IPART, July 2011,Table 3.3.



T s

T s


In its email dated 8 August, SDP presents an alternative division of cost between fixed and variable with a much higher proportion of the electricity costs (including RECs) classified as variable costs. It assumes the electricity costs incurred when there is no production (excluding losses on sale of surplus RECs and energy) be classified as fixed costs and all other electricity costs (including RECs) be classified as variable costs.

This is a more reasonable approach and in accord with the normal division of costs between fixed and variable. The split of the remaining costs between fixed and variable, including the recognition of the step fixed costs is considered appropriate.

140 Data presented in this table have been derived by Halcrow; it reconciles to Table 3.2 in SDP’s Submission, but not to information provided in SDP email dated 8 August 2011. Adjustments have been made to the split of energy costs in order to reconcile total fixed and variable costs.



Under this proposal the information presented in Table 5.18 would change to that presented in Table 5.19.

T s

T s


In its response to Halcrow’s Draft Review Report, SDP has commented:142

“Halcrow questions the “the proposed apportionment of costs between fixed and variable”, particularly the split between energy costs. As SDP has previously noted to IPART, it is important to make the distinction between costs and revenues. SDP is aware that some energy costs are fixed and some are variable, however SDP has apportioned fixed and variable costs between proposed variable and availability charges in a way that is intended to ensure that

141 Data presented in this table have been derived by Halcrow; it reconciles to information provided in SDP email dated 8 August 2011, but not to Table 3.2 in SDP’s Submission. Adjustments have been made to the split of energy costs in order to reconcile total fixed and variable costs.

142 SDP comments, Draft Halcrow Report, 5 September 2011,p 4



SDP’s within-year revenues match its costs as much as possible (ie. prior to any adjustment). It is not unprecedented for fixed and variable costs to not be strictly apportioned to fixed and variable charges (eg. refer to Sydney Water’s current prices). It is not clear why this matter is relevant to Halcrow’s review of the efficiency of SDP’s costs.”

Halcrow has undertaken this analysis in accordance with the Terms of Reference143 in order to inform IPART in support of its pricing Determination. Halcrow has not commented on any link between its assessment of the variable/fixed cost split and prices.

5.9 Findings

There is significant variation between actual operating costs and those projected by Sydney Water in its 2007 submission to IPART. The variation is largely driven by much higher electricity charges. Notwithstanding, the expenditure incurred is reflective of SDP’s obligations under its operations and maintenance and energy supply contracts.

SDP is locked in for 20 years to electricity supply and renewable energy agreements. The contract prices under these agreements are currently in excess of current market prices.

SDP has assumed that the current deviation of market prices from contract prices will prevail until at least 2016/17.

Under the agreements SDP must purchase minimum annual quantities. In the event that the SDP does not operate for an extended period it will have surplus energy and RECs to sell in the market.

This matches the

contracted minimum quantity of RECs to be purchased, but is inconsistent with the

The CIE figures suggest an even lower level of operation (refer Section 5.4).

Purchases of Renewable Energy Certificates are budgeted to add 75.6 percent to the cost of electricity and 31 percent to total operating costs at the planned (full) production level in 2011/12. The purchase of RECs is necessary to meet the Government’s approval conditions for the desalination plant.

143 IPART, Request for Scope of Work and quote: Review of Operating and Capital Expenditure by Sydney Desalination Plant Pty Ltd, 1 June 2011, Section 3.1.1.



Sydney Water exposed SDP to significant risk in setting 20 year terms for the energy contracts, locking in fixed prices and high volumes which, in the case of electricity supply, align with full production.

On this basis, Halcrow recommends disallowance of the full contract prices for energy and RECs. Halcrow recommends that only 50 percent of the difference between the contract and market prices be allowed for both energy and REC purchases in the period to 2016/17.

Halcrow also has concerns with the projected increases in prices for chemicals and membranes. While Halcrow recognises the historical and projected increase in prices for these items, in order to provide an incentive for improved purchasing practices and more efficient use, Halcrow recommends that the forecast cost of membranes and chemicals be held constant in real terms.


The absence of detailed protocols to support decisions on shut down modes is a major deficiency. Poor decisions will impact future cost levels. Similarly, the absence of adequate ring fencing between SDP and Sydney Water undermines the accuracy of forecasts of SDP’s management costs.

Table 5.20 shows the recommended efficient cost level for SDP from 2011/12 to 2016/17 in $million 2011/12 after making adjustments to the cost of chemicals, membranes, energy and RECs, and allowances in respect of asset maintenance. The adjustment in respect of capitalised maintenance is discussed in Section 6.3.3.



Table 5.20 SDP’s Efficient Operating Costs at Full Production ($million 2011/12)

2011/12 2012/13 2013/14 2014/15 2015/16 2016/17

SDP Submission 77.1 80.3 85.8 90.2 90.5 89.0

Other Costs (Direct payments by SDP)

4.1 4.0 3.5 3.2 3.4 3.5

Adjustment to asset maintenance cost -0.1 -0.4 -0.7 -0.7 -0.1 -0.9

Adjustment for Capitalised Maintenance

1.0 3.4

Revised Other Costs 4.0 3.6 2.8 2.5 4.3 6.0

Total Efficient Costs 69.0 72.5 76.6 79.7 80.6 80.0

Total efficiency adjustment -8.1 -7.8 -9.2 -10.5 -9.9 -9.0


The proposed apportionment of costs between fixed and variable requires further explanation. The split of energy costs raises particular concern and it is proposed on the basis of information currently available that only those energy costs coinciding with the 9GWh usage at no production (and excluding potential gains or losses on mark to market) be classified as fixed costs.

At the full production level (90GL a year), adopting Halcrow’s recommended efficient cost figures (as presented in Table 5.20) results the unit operating costs presented in Table 5.21.



Table 5.21 Operating Unit Costs per Kilolitre at Full Production ($2011/12)

2012/13 2013/14 2014/15 2015/16 2016/17

Fixed costs ($M) 19.8 23.0 25.7 26.5 26.2

Fixed Cost $/kL 0.22 0.25 0.29 0.30 0.29

Variable costs ($M) 52.7 53.6 54.0 54.1 53.8

Variable costs $/kL 0.59 0.60 0.60 0.60 0.60

Total costs ($m) 72.5 76.6 79.7 80.6 80.0

Total costs $/kL 0.81 0.85 0.89 0.90 0.89

The unit costs shown in Table 5.21 cannot be directly applied to different levels of production because there is not a linear relationship between production levels and electricity costs; the effect of stepped fixed costs for different levels of production; and the costs associated with standby, start up and shut down.


6 Capital Expenditure

6.1 Overview

Sydney Desalination Plant reported actual capital expenditure for the period 2008/09 to 2011/12 amounting to $1,205.3 million ($real 2011/12),144 which is only marginally greater than the $1,202.2 million (in $2011/12 real) included in the 2008 Determination145 of Sydney Water’s prices. Of this amount, $661.8 million relates to design and construction of the Desalination Plant (including the Drinking Water Pumping Station), whilst the remaining $543.5 million relates to the design and construction of the Distribution Pipeline.

Forecast expenditure for the period 2012/13 to 2016/17 amounts to $8.3 million ($real 2011/12). This includes allowances for upgrade of the backup electricity supply to the desalination plant site and capitalisation of periodic maintenance expenditure. As discussed in Section 6.3.2, this forecast may be reduced to approximately $5.9 million following the receipt of additional information provided by SDP.

The Delivery Pipeline is currently owned by Sydney Water. It is proposed to transfer ownership of the pipeline to SDP during 2011/12.

A summary of SDP’s historical capital expenditure and capital expenditure forecast over the proposed determination period, as derived from SDP’s Annual Information Return, is presented in Table 6.1 (in $real 2011/12 terms).

144 Expenditure for 2011/12 is based on budget figures as included in SDP’s Submission.

145 IPART, Final Determination and Report- review of prices for Sydney Water Corporation’s water, sewerage and stormwater services, 16 June 2008, Table 5.6


Table 6.1 Capital expenditure by item ($'000, real 2011/12 excluding non-cash contributed assets)

Water - desalinated 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17

Historical Price Path (2008 Determination)

Forecast Price Path (Proposed Determination)

Pipelines - - - - - - 631,065 - - - - -

Seawater Intake System - - - - - - - - -

Seawater Outlet System - - - - - - - - -

Desalination Plant - - - - - - - -

Pumping Station 342 257 8,858 25,151 9,320 573 352 - - - - -

Other - - - - - - - 1,148 2,677 - 1,024 3,443

Easements - - - - - - - - - - - -

Project Development & Pre-operations payments

36,080 22,839 30,014 19,331 15,034 1,685 549 - - - - -

Land 47,107 6,031 19,589 67 197 12 5 - - - - -

Total 83,529 29,128 556,132 529,955 128,025 2,946 631,970 1,148 2,677 - 1,024 3,443

Note: Table adapted from Table 9.2 of Sydney Desalination Plant’s Annual Information Return


6.2 Historical Expenditure

6.2.1 Overview

As previously noted, reported historical expenditure relates to design and construction of the Desalination Plant and the Desalinated Water Delivery System (comprising the Drinking Water Pumping Station and the Distribution Pipeline).

Table 6.2 provides a comparison between the actual capital expenditure reported by SDP and Sydney Water146 and the amounts included in the 2008 Determination147. There are differences between the figures included by SDP in table A2.4 of their submission with the figures approved by IPART and included in Table 5.6 of the 2008 Determination Report.

Table 6.2 Expenditure Comparison: 2008 Determination with Actual ($million 2011/12)

2007/08 2008/09 2009/10 2010/11 2011/12 Total

2008/09 to

2011/12

2008 Determination Desalination Plant + Distribution Pipeline

760.8 862.0 340.2 1,202.2

Actual

Desalination plant 556.1 530.0 128.0 2.9 0.9 661.8

Pipeline 125.7 370.3 153.9 2.7 16.6 543.5

Total 681.8 900.0 282.0 5.6 17.5 1,205.3

Variation -79.0 38.3 -58.2 5.6 17.5 3.2

As can be seen, there is little difference between the aggregate determined and actual expenditure over the four year term of the 2008 Determination, although the expenditure in individual years show a greater level of variation. There is also a large variation in 2007/08, the last year of the previous determination for which final figures were not available when the 2008 Determination was released.

An assessment of the projects in respect of which the expenditure was incurred is set out in the following sections.

146 SDP submission, Table A2.4.

147 IPART, Final Determination and Report- review of prices for Sydney Water Corporation’s water, sewerage and stormwater services, 16 June 2008, Table 7.6.

Capital Expenditure


6.2.2 Desalination Plant (DBOM Contract)

6.2.2.1 Overview The Desalination Plant was constructed under a design, build, operate and maintain (DBOM) contract. The contracted works comprised design and construction of:

Sea Water Intake Structures;

a Seawater Concentrate Outlet System; and

a Desalination Plant comprising a 250ML/day initial module.

The design of the plant is such that it can be upgraded with a Stage 2 module to an ultimate capacity of 500ML/day.

6.2.2.2 Summary of Findings On the basis of the information reviewed, Halcrow concludes that the procurement of the Desalination Plant has been undertaken in a generally prudent and efficient manner.

A detailed assessment of the Desalination Plant project is presented in Appendix B.

Delivery of the plant under a design, build operate and maintain (DBOM) contract arrangement is consistent with the approach adopted for the delivery of other large scale water treatment plants within the Australian water industry. The design and construct (D&C) approach to the provision of the plant provides an appropriate level of owner control over the design concept, whilst providing opportunity for the delivery of cost efficiencies through a competitive tendering environment.

The process adopted for the selection of the DBOM contractor has been demonstrated to have been robust, a fact that has been endorsed by the independent probity advisor.

Whilst Halcrow has not yet been able to fully reconcile the total actual costs of delivering the plant, the assessment indicates that allowing for approved variations,

Capital Expenditure


6.2.3 Desalinated Water Delivery System

6.2.3.1 Overview The Desalinated Water Delivery System involved design and construction of:

a land pipeline from the desalination plant to Silver Beach in Kurnell;

two parallel pipelines across Botany Bay to Kyeemagh;

a land pipeline from Kyeemagh to the proposed water distribution system connection point, Shaft 11C on the City Tunnel at Bridge Street, Erskineville;148 and

the Drinking Water Pumping Station.

The pipeline was sized to deliver 500ML of water per day, ie. equivalent to the proposed maximum future size of the upgraded desalination facility capacity. It was delivered under an Alliance contract arrangement.

Sydney Water currently owns the entire length of pipeline, however, it is noted that in SDP’s Submission to IPART that “given that the bulk water pipeline is integral to the supply of water from the desalination plant, Sydney Water is considering transferring the pipeline to SDP”. The transfer of this pipeline in 2011/12 has been included as capital expenditure in SDP’s AIR (included with its Submission to IPART) at a cost of $631.1 million ($real 2011/2012) (refer Section 6.4 for further discussion). The Desalinated Water Delivery System has therefore been included in this review by Halcrow.

A detailed assessment of the Water Delivery System project is presented in Appendix B.

6.2.3.2 Summary of Findings On the basis of the information reviewed, Halcrow concludes that the procurement of the Water Delivery System comprising the Drinking Water Pumping Station and the Delivery Pipeline has been undertaken in a generally prudent and efficient manner.

Delivery of the system under an Alliance contract arrangement is consistent with the approach adopted for the delivery of other similar works within the Australian water industry. This approach facilitates an appropriate sharing/allocation of risk, with the use on incentives to drive efficiencies.

The process adopted for the selection of the Alliance partners has been demonstrated to have been robust, a fact that has been endorsed by the independent probity advisor.

148 Sydney Water, Desalinated Water Delivery System, Preferred Project Report, August 2007, p1.1.

Capital Expenditure


Based on review of the independent reviewer’s (HWA’s) documentation, it is evident that there has been robust discussion in respect of the technical solutions developed for the works. Whilst it is apparent that HWA did not agree with some of the design concepts put forward by WDA, there is evidence that WDA investigated improvement opportunities proposed by HWA. Whilst, in Halcrow’s opinion, it appears that HWA did not always take a firm stance on clarifying contentious issues, it is evident that the objectives of the independent reviewer role, ie. to “ … validate, or otherwise, that the solution represents a sound and appropriate technical solution to Sydney Water for the life of the Works” was met.

Efficiency of the developed solution was assured through the combined roles of the independent estimator (cost) and the independent reviewer (technical solution).

6.3 Forecast Expenditure

6.3.1 Overview

In its Submission to IPART (and the accompanying Annual Information Return), SDP has forecast capital expenditure totalling $8.3 million ($real 2011/12) over the proposed determination period from 2012/13 to 2016/17. A breakdown is provided in Table 6.3.

Table 6.3 Future SDP Capital Expenditure ($’000 2011/2012)

2012/13 2013/14 2014/15 2015/16 2016/17

Civil 0 0 0 0 0

Electronic 0 0 0 0 0

Mechanical 0 0 0 1,024 3,443

Electrical 1,147 2,677 0 0 0

Non-depreciating 0 0 0 0 0

Total 1,147 2,677 0 1,024 3,443

Source: based on Table 5.3 presented in SDP Submission to IPART for 2012 pricing determination converted to $2011/2012 using an escalation factor of 2.5%.

The forecast expenditure relates to:

Upgrade of the existing Backup Electricity Supply ($3.8 million in 2012/13 and 2013/14);

Capitalisation of forecast periodic maintenance expenditure ($4.5 million in 2015/16 and 2016/17).

An assessment of the forecast capital expenditure is set out in the following sections.

Capital Expenditure


6.3.2 Upgrade of Existing Backup Electricity Supply

Based on SDP’s submission, the proposed expenditure in 2012/13 and 2013/14 relates to the installation of a backup electricity feeder at a cost of approximately $3,824,000 ($real 2011/12). Based on discussions with SDP, the purpose of the new electrical installation is to provide a backup (second) connection to the 11kV electricity grid to maintain critical plant equipment in the event of the 132kV electricity grid failure. The backup connection does not have the capacity to supply the plant with enough electricity to continue to supply water. In the event of power failure, drinking water would instead be sourced from the Prospect WFP.

Currently the backup electricity line at the plant is connected to the 33kV feeders in the Kurnell area. Ausgrid is, however, planning to decommission the 33kV/11kV network in the near future to remove current restrictions that exist in the area, and to replace this portion of the network with a 132kV/11kV network.

Subsequent to SDP’s submission to IPART, SDP has undertaken an options assessment relating to the backup electricity connection.149 The results of the options assessment will be formally presented to the SDP Board for approval in the near future. Three options have been considered by SDP:

Option 1 – Provide an alternative standby supply at 11kV with the same capacity as the current standby feeders. This option ensures the current plant level of redundancy is maintained. The cost of this option has been estimated by SDP to be $1,500,000.

Option 2 – Duplicate the current 132kV main supply to the Cronulla Zone Substation. This could improve the current plant amenity. Under this option consideration of the placement and connection point within the Zone Substation and cable routing would need to be worked through with Ausgrid. Cronulla Zone Substation is supplied by two independent feeders from Ausgrid’s Sutherland Supply Area. This Area is supplied through Ausgrid’s Sydney South Bulk Supply Point. The cost of this option would be around $17,000,000.

Option 3 – Supply a 132kV supply from an alternate substation to Cronulla. This option would duplicate Ausgrid’s network and the redundancy levels that they currently have in-place. Preliminary cost estimates for this option by SDP are in the order of $120,000,000 to $200,000,000.

149 SDP email 5 August 2011. ‘The cost estimate for the 2nd electricity feeder has been refined since we made SDP's submission to IPART's pricing review. We are now looking at around $1.5 million for the 11kV backup feeder which, as mentioned previously, is required to keep the plant safe in the event of an outage in the 132kV supply and is needed because Ausgrid is decommissioning its 33kV supply (the current backup).

Capital Expenditure


Halcrow investigated whether SDP would have had forewarning of the requirement for a future upgrade at the time the plant was being constructed. Based on Energy Australia’s report150 into the development of the Kurnell 132/11kV zone substation, it was identified that the need for the augmentation would have first been identified after 1 December 2007. On this date, the Minister for Energy issued service standards specified in the “Design, Reliability and Performance Licence Condition for Distribution Network Service Providers”, which Distribution Network Service Providers (DNSPs), such as Energy Australia, are required to follow.

Energy Australia’s report also identifies peak loads exceedences, when they occurred and asset condition issues related to the Kurnell 132/33kV substation. The capacity of the Kurnell substation was exceeded in Summer 2003/2004, Winter 2004, Summer 2004/2005 and Winter 2005 prior to the installation of a third transformer in 2008 at the Kurnell STS. The 33kV assets of the sub-transmission station were found to be affected by Corrosion with the 33kV bulk oil type circuit breakers nearing the end of their useful life in 2014. The need to upgrade the network from Energy Australia’s perspective would be prudent to upgrade the network.

The question arises, given the condition of the network over the 2004-2008 period and the fact that a backup supply would have been investigated during 2007/08, why the possible need of an upgrade in the future wasn’t flagged as a risk to the SDP project. Regardless of this, it is clear that the second (backup) electricity feeder must be upgraded.

Halcrow is therefore of the opinion that expenditure on the upgrade is prudent. On the basis of the information now available, it appears that an estimated cost in the order of $1.5 million represents a more efficient cost than the $3.8 million originally proposed (although it is noted that this amount is still subject to Board approval of the proposed solution). It is noted that the cost estimate includes a contingency allowance of 30 percent which is considered appropriate at the current stage of project development.

150 Energy Australia, Final Report Development of Kurnell 132/11kV Zone Substation, Dual Function Asset, dated December 2010.

Capital Expenditure


6.3.3 Periodic Maintenance

In SDP’s submission to IPART, they have stated that “SDP has assumed that all periodic maintenance incurred from early 2016 can be treated as capital expenditure.” Expenditure on Mechanical Assets of $1,024,000 and $3,433,000 ($real 2011/12) has been identified for 2015/16 and 2016/17 respectively. According to SDP’s submission, this allocation is for periodic maintenance as specified in the Operations and Maintenance Contract.

A review of the maintenance cost information presented in the Operations and Maintenance Contracts151 reveals the following:

Having reviewed the information presented in SDP’s Submission, together with the above assessment of periodic maintenance costs, the basis upon which SDP proposes to capitalise its future periodic maintenance expenditure is not apparent. Whilst it is acknowledged that an element of this expenditure will be associated with asset renewal, and would therefore qualify as capital expenditure, Halcrow does not consider that capitalisation of the entire allocation of periodic maintenance expenditure is justified. Similarly, this assessment would also apply to periodic maintenance of mechanical assets only, which appears to have been proposed in SDP’s Submission.

In the absence of more detailed supporting information, Halcrow does not consider that the proposed capitalisation of periodic maintenance expenditure is justified. Disallowance of such capitalisation will require an adjustment to the forecast operating expenditure, as presented in Section 5.9.

151 Sydney Desalination Plant, Sydney’s Desalination Project; Operate and Maintain Contract between Sydney Desalination Plant and Veolia Water Australia Pty Ltd, undated, Exhibit D, Schedule 6, Attachment A and Operations and Maintenance Contract (Sydney’s Desalination Project; Drinking Water Pumping Station Deed) between Sydney Desalination Plant and Veolia Water Australia Pty Ltd, dated 18 January 2010, Exhibit D, Part C.

152 Allocation to mechanical asset not as clearly apparent for the pumping station.

Capital Expenditure


6.4 Transfer of Pipeline

As previously identified, the Delivery Pipeline is currently owned by Sydney Water. It is, however, proposed to transfer ownership of the pipeline to SDP during 2011/12.153 An allocation of $631.1 million ($real 2011/2012) has been identified in SDP’s AIR for this purpose.

A reconciliation of the costs expected to be incurred by SDP in relation to the transfer of ownership has not been provided to this review; such reconciliation should be provided. On the basis of the figures presented above, however, the forecast expenditure appears reasonable.

6.5 Asset Lives

6.5.1 Desalination Plant

SDP’s submission includes information on proposed economic lives. Design lives have been extracted from the D&C Contract and presented in Table 6.4 for comparison with the SDP Submission.

153 Transfer of ownership will be subject to the approval of the Boards of both Sydney Water and SDP.

154 Expenditure taken from: Sydney Desalination Plant Pty Ltd, Submission to the Independent Pricing and Regulatory Tribunal: Review of Prices for Sydney Desalination Plant Pty Ltd, undated, Table A2.5, and escalated to $real 2011/12.

Capital Expenditure


Table 6.4 Comparison of DBOM contract design life versus proposed economic life in SDP submission.

Asset Minimum Design Life in D&C

Contract*

Proposed Economic Life in SDP Submission

Original SDP Assets

Plant 30

Intake Infrastructure 90

Outlet Infrastructure 100

Sydney Desalination Plant

Civil assets (tunnels, shafts, buried pipelines, concrete structures and substructures, above and below ground storage tanks

100

Ocean intakes and outlets and diffusers 50

Buildings 50

Mechanical assets 25

Electrical assets 25

Instrumentation / control assets 15

SCADA assets 10

Other specialist equipment As specified in the works Warranties

schedule

Note: *Design lives based on design lives presented in Schedule 2 Technical Requirements D &C Contract, Separable Portion 1 and Separable Portion contained in 1A Sydney’s Desalination Project, Design and Construct Contract, Amending Deed No. 3 Sydney Desalination Plant Limited, Sydney Water Corporation, Veolia Water Australia Pty Ltd, John Holland Pty Ltd Amending Deed 3

Design life nominated in the D&C Contract is consistent with that normally expected for civil, marine, buildings, mechanical, electrical, instrumentation and SCADA assets, indicating an efficient approach to asset life planning.

In the SDP’s submission, however, it is stated that economic lives adopted are consistent with those determined by IPART for Sydney Water’s potable water infrastructure. It is also stated that “asset lives were calculated with reference to the engineering life for each asset category”.155 The economic design lives of the intake infrastructure (90 years) and outlet infrastructure (100 years) are significantly greater than the design life of 50 years nominated in the Contract.

155 Asset Lives are described in SDP’s submission titled Sydney Desalination Pty Limited – Submission to IPART 2012 pricing determination.

Capital Expenditure


A design life for the plant (as a whole) is not nominated specifically in the Contract, however, Amending Deed 3 of the Contract states in Schedule 2 - Technical Requirements156 that “the design must be the most cost-effective, based on whole-of-life cost considerations for a 20-year planning period. The contractor must carry out a due whole-of-life cost analysis for the plant”. Halcrow agrees that, from an overall perspective, the selection of a 30 year design life for the plant is reasonable. It may, however, be more appropriate to break the plant down into civil, electrical, mechanical and electronic assets components and assign asset lives on that basis.

Halcrow notes that the Contract includes a forecast of routine and periodic maintenance expenditure which demonstrates that an analysis of asset maintenance requirements, which is fundamental to the realisation of asset life, has been undertaken for a planning period of 20-years. Based on the available information, however, Halcrow is unable to confirm whether costing had been undertaken on the basis of whole-of life asset maintenance.

6.5.2 Desalinated Water Delivery System

SDP’s submission includes information on proposed economic lives. Design lives have been extracted from the WDA report and presented in Table 6.5 for comparison with the SDP Submission.

156 Design lives based on design lives presented on page 11 of 13 Schedule 2 Technical Requirements D &C Contract, Separable Portion 1 and Separable Portion contained in 1A Sydney’s Desalination Project, Design and Construct Contract, Amending Deed No. 3 Sydney Desalination Plant Limited, Sydney Water Corporation, Veolia Water Australia Pty Ltd, John Holland Pty Ltd Amending Deed 3.

Capital Expenditure


Table 6.5 Comparison of WDA Pipeline Design Lives versus Proposed Economic Lives in SDP Submission

Asset Design Life in WDA Basis of Design Report

Proposed Economic Life in

SDP Submission

Original SDP Assets

Pumping Station 25

Distribution Pipeline

Civil 140

Electrical 30

Mechanical 40

Electronic 15

Water Delivery System

Pumping station concrete structures

40 – 60

Pipelines 100

Pumps 20

Valves 30

SCADA 15

In its submission, SDP notes that the proposed economic lives are consistent with those determined by IPART for Sydney Water’s potable water infrastructure. It also notes that “asset lives were calculated with reference to the engineering life for each asset category”.157

It is evident, however, that SDP has adopted longer economic lives than the design lives adopted by the WDA. In particular, economic design life is inconsistent for:

pump station concrete infrastructure design life of 40-60 years versus civil assets economic life of 140 years;

pipelines design life 100 years versus civil assets economic life of 140 years;

pumps design life 20 years versus mechanical assets economic life of 40 years; and

valves design lives of 30 years versus mechanical assets economic life of 40 years.

157 Asset Lives are described in SDP’s submission titled Sydney Desalination Pty Limited – Submission to IPART 2012 pricing determination.

Capital Expenditure


SCADA equipment design life of 15 years matches the design life adopted for electrical equipment.

The nominated design lives are generally in line with Halcrow’s expectations, with the possible exception of that nominated for pumps which could be increased to 25 years. Given the potential for the desalination plant and delivery system to be shutdown for extended periods of time, longer asset lives may actually be achieved.

The adoption of economic asset lives that are greater than the expected design life will result in comparatively reduced depreciation costs.

6.6 Findings

There has been negligible variance between actual capital expenditure and the expenditure approved at the time of the 2008 Determination of Sydney Water’s prices. Historical expenditure relates entirely to design and construction of the Desalination Plant and the Desalinated Water Delivery System (comprising the Drinking Water Pumping Station and the Distribution Pipeline).

Halcrow’s review of the delivery of these projects has led to the conclusion that the procurement of both the Desalination Plant and the Delivery System has been undertaken in a generally prudent and efficient manner.

Delivery of the Desalination Plant under a design, build operate and maintain (DBOM) contract arrangement is also consistent with the approach adopted for the delivery of other large scale water treatment plants within the Australian water industry. The design and construct (D&C) approach to the provision of the plant provides an appropriate level of owner control over the design concept, whilst providing opportunity for the delivery of cost efficiencies through a competitive tendering environment.

Delivery of the Water Delivery System under an Alliance contract arrangement is consistent with the approach adopted for the delivery of other similar works within the Australian water industry. This approach facilitates an appropriate sharing/allocation of risk, with the use on incentives to drive efficiencies.

The process adopted for the selection of both the DBOM contractor and the Delivery System Alliance partners has been demonstrated to have been robust, a fact that has been endorsed by the independent probity advisor.

Whilst Halcrow has not yet been able to fully reconcile the total actual costs of delivering the Desalination Plant, the assessment indicates that allowing for approved variations,

Capital Expenditure


Based on review of the independent reviewer’s (HWA’s) documentation, it is evident that there has been robust discussion in respect of the technical solutions developed for the works, which has ensured that the project objectives have been achieved. Efficiency of the developed solution was assured through the combined roles of the independent estimator (cost) and the independent reviewer (technical solution).

Forecast capital expenditure relates to two items of expenditure; an upgrade of the existing Backup Electricity Supply and the capitalisation of forecast Periodic Maintenance Expenditure.

Upgrade of the Backup Electricity Supply is considered prudent, however, in light of more recent information provided by SDP, a reduction in the forecast cost allowance is proposed. In the absence of detailed program information, a pro-rata adjustment (based on the expenditure timing shown in the AIR) is proposed.


A summary of the proposed expenditure adjustments is presented in Table 6.6.

Table 6.6 Recommended Capital Cost Adjustments ($‘000 2011/12)

2012/13 2013/14 2014/15 2015/16 2016/17

SDP Submission 1,147 2,677 0 1,024 3,443

Recommended Adjustments

Upgrade of Backup Electricity Supply -697 -1,627

Capitalised Maintenance -1,024 -3,443

Recommended Capital Expenditure 450 1050 - - -

It is noted that provision has been made in 2011/12 for expenditure associated with the transfer of ownership of the Distribution Pipeline from Sydney Water to SDP. Whilst the allowance appears to be broadly appropriate, a detailed reconciliation of associated costs is required.

The nominated design lives for both the Desalination Plant and the Water Delivery System are generally in line with Halcrow’s expectations, with the following possible exceptions:

Capital Expenditure


the nominated for pumps in the Drinking Water Pumping Station could be increased to 25 years; and

whilst from an overall perspective, the selection of a 30 year design life for the Desalination Plant is considered reasonable, it may, however, be more appropriate to break the plant down into civil, electrical, mechanical and electronic assets components and assign asset lives on that basis.

In most cases, the adoption of economic asset lives that are greater than the expected design life is proposed. This will result in comparatively reduced depreciation costs.


7 Conclusions and Recommendations

7.1 Overview

Halcrow’s review of Sydney Desalination Plant’s operating and capital expenditure has been principally based on information contained in its Pricing Submission (including Annual Information Return) and information provided by Sydney Desalination Plant in response to formal information requests. Halcrow has also conducted interviews/discussions with Sydney Desalination Plant representatives in order to gain an understanding of its adopted planning processes and the justification for the proposed levels of investment.

From an overall perspective, Sydney Desalination Plant’s historical and forecast expenditure for the period 2012/13 to 2016/17 is deemed prudent and efficient. Halcrow does, however, have concerns regarding Sydney Desalination Plant’s commitments in respect of energy supply and it forecast maintenance expenditure, both Routine Annual Maintenance (operating) and Annual Periodic Maintenance (capital).

7.2 Management Systems and Processes

On the basis of Halcrow’s review of the available documentation, which has included the Infrastructure Operating Plan and the Operations and Maintenance Contracts in respect of both the Desalination Plant and the Drinking Water Pumping Station, it appears that Sydney Desalination Plant has appropriate management systems place at a high level.

Reference is made in both the Infrastructure Operating Plan and the Contracts to a number management plans and protocols. The descriptive information (title and, where specified, content requirements) provided in these documents indicates that they should outline the detailed processes required in respect of operations and maintenance planning, and to a lesser degree, capital planning. These more detailed documents have not, however, been provided to this review; accordingly, Halcrow is unable to provide further assessment. Notwithstanding, Halcrow understands that protocols for determining the operational (shut down) mode to be adopted when the Desalination Plant is to be shut down are not currently available; given the potential impact of such decisions on the quantum of operating costs, Halcrow considers it essential that such protocols be developed.

Conclusions and Recommendations


7.3 Operating Expenditure

There is significant variation between actual operating costs and those projected by Sydney Water in its 2007 submission to IPART. The variation is largely driven by much higher electricity charges. Notwithstanding, the expenditure incurred is reflective of SDP’s obligations under its operations and maintenance and energy supply contracts.

SDP is locked in for 20 years to electricity supply and renewable energy agreements. The contract prices under these agreements are currently in excess of current market prices.

. SDP has assumed that the current deviation of market prices from contract prices will prevail until at least 2016/17.

Under the agreements SDP must purchase minimum annual quantities. In the event that the SDP does not operate for an extended period it will have surplus energy and RECs to sell in the market. This exposes SDP to significant financial risk which SDP estimates

Under the most likely scenario adopted by Sydney Water in the assessment of the energy tenders, . This matches the contracted minimum quantity of RECs to be purchased, but is inconsistent with the contracted minimum energy quantity which aligns with the plant operating 100 percent of the time.

Purchases of Renewable Energy Certificates are budgeted to add 75.6 percent to the cost of electricity and 31 percent to total operating costs at the planned (full) production level in 2011/12. The purchase of RECs is necessary to meet the Government’s approval conditions for the desalination plant.

Sydney Water exposed SDP to significant risk in setting 20 year terms for the energy contracts, locking in fixed prices and high volumes which, in the case of electricity supply, align with full production. Sydney Water’s most likely scenario, as used in its assessment of the energy contracts,

On this basis, Halcrow recommends disallowance of the full contract prices for energy and RECs. Halcrow recommends that only 50 percent of the difference between the contract and market prices be allowed for both energy and REC purchases in the period to 2016/17.

Halcrow also has concerns with the projected increases in prices for chemicals and membranes. While Halcrow recognises the historical and projected increase in prices for these items, in the absence of information to support the projected future price increases, in order to provide incentive for improved purchasing



practices and more efficient use, Halcrow recommends that the forecast cost of membranes and chemicals be held constant in real terms.


7.4 Capital Expenditure

7.4.1 Historical Expenditure

On the basis of the information reviewed, Halcrow concludes that the procurement of both the Desalination Plant and the Water Delivery System, comprising the Drinking Water Pumping Station and the Delivery Pipeline, has been undertaken in a generally prudent and efficient manner.

Delivery of the Desalination Plant under a design, build operate and maintain (DBOM) contract arrangement is also consistent with the approach adopted for the delivery of other large scale water treatment plants within the Australian water industry. The design and construct (D&C) approach to the provision of the plant provides an appropriate level of owner control over the design concept, whilst providing opportunity for the delivery of cost efficiencies through a competitive tendering environment.

Delivery of the Water Delivery System under an Alliance contract arrangement is consistent with the approach adopted for the delivery of other similar works within the Australian water industry. This approach facilitates an appropriate sharing/allocation of risk, with the use on incentives to drive efficiencies.

The process adopted for the selection of both the DBOM contractor and the Delivery System Alliance partners has been demonstrated to have been robust, a fact that has been endorsed by the independent probity advisor.

Whilst Halcrow has not yet been able to fully reconcile the total actual costs of delivering the Desalination Plant, the assessment indicates that allowing for approved variations, the total actual cost exceed the original contract price by 1.23 percent (approximately $12 million). The unaccounted discrepancy may relate to the inclusion of provisional items of work or the payment of incentive bonuses.

Based on review of the independent reviewer’s (HWA’s) documentation, it is evident that there has been robust discussion in respect of the technical solutions developed for the works, which has ensured that the project objectives have been achieved. Efficiency of the developed solution was assured through the combined roles of the independent estimator (cost) and the independent reviewer (technical solution).



7.4.2 Forecast Expenditure

Forecast capital expenditure relates to two (2) principal items:

Upgrade of Existing Backup Electricity Supply; and

Annual Periodic Maintenance.

In respect of the electricity supply upgrade, Halcrow is of the opinion that expenditure on the upgrade is prudent, however, in light of more recent information provided by SDP, a reduction in the forecast cost allowance is proposed.


7.4.3 Asset Lives

The nominated design lives for both the Desalination Plant and the Water Delivery System are generally in line with Halcrow’s expectations, with the following possible exceptions:

the nominated for pumps in the Drinking Water Pumping Station could be increased to 25 years; and

whilst from an overall perspective, the selection of a 30 year design life for the Desalination Plant is considered reasonable, it may, however, be more appropriate to break the plant down into civil, electrical, mechanical and electronic assets components and assign asset lives on that basis.

In most cases, the adoption of economic asset lives that are greater than the expected design life is proposed. This will result in comparatively reduced depreciation costs.


Appendix A Maintenance Schedule

A schedule summarising proposed Routine Annual Maintenance (RAM) and Annual Periodic Maintenance (APM) for the Initial Module of the Desalination Plant, as derived from the Operations and Maintenance Contract, is presented in this Appendix.

Appendix A


$Real 2011/12 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Year 12 Year 13 Year 14 Year 15 Year 16 Year 17 Year 18 Year 19 Year 202010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/8 2018/19 2019/20 2020/21 2021/22 2022/23 2023/24 2024/25 2025/26 2026/27 2027/28 2028/29 2029/30

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 00 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 00 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0

0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 00

APM TOTAL COST -Submerible Mixers 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

$Real 2011/12 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Year 12 Year 13 Year 14 Year 15 Year 16 Year 17 Year 18 Year 19 Year 200 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0

$Real 2011/12 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Year 12 Year 13 Year 14 Year 15 Year 16 Year 17 Year 18 Year 19 Year 20

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0

0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

0

0

$Real 2011/12 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Year 12 Year 13 Year 14 Year 15 Year 16 Year 17 Year 18 Year 19 Year 20

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 00 0 0 0 0 0 0 0 0 0 0 0 0


Appendix B Detailed Review of Historical Capital Projects

A detailed review of the following capital projects is presented in this Appendix:

Desalination Plant (DBOM Contract); and

Desalinated Water Delivery System.

Appendix B


Appendix B


B.1 Overview

As outlined briefly in Section 6.2, historical capital expenditure was incurred in the design and construction of the Desalination Plant and the associated Water Distribution Infrastructure.

The procurement strategy adopted in respect of these works was:

a design, build, operate and maintain (DBOM) contract for the Desalination Plant, including the intake and outlet structures; and

an alliance contract for the water distribution infrastructure (comprising the Delivery Pipeline and the Drinking Water Pumping Station).

According to Sydney Water:158

“A DBOM contract for the desalination plant provides for transfer of process and performance risk and relatively high price certainty. The Risk profile of the desalination plant is relatively low and it involves proven technology on a Greenfield site.

An alliance contract for the water distribution infrastructure allows sharing of the risks involved in designing and constructing a significant pipeline for which a preferred route has not yet received planning approval. Planning approvals are anticipated to be obtained during the procurement process. The alliance contract will provide for sharing of the financial pain, or gain that results from the achievement, or lack thereof, of cost and non-cost objectives”.

In its submission, SDP provided details of expenditure in nominal figures.159 These values have been converted to $real 2011/12 using historical inflation factors provided by IPART. All forecasts are based on a 2.5 percent increase per year.

Table B.7.1 presents a summary of historical capital expenditure from 2005/06 to 2011/12. Table B.7.2 presents tendered/total outturn costs and actual/forecast costs in nominal terms for both the DBOM and Desalinated Water Delivery System contracts.

158 The procurement strategy is described in Sydney Water Internal Memorandum, titled Selection Process Request for Proposal (RFP) for the Water Distribution infrastructure for Sydney’s Desalination Project – Tender 0510022481, dated 1 March 2007.

159 Sydney Desalination Plant Pty Ltd, Submission to the Independent Pricing and Regulatory Tribunal: Review of Prices for Sydney Desalination Plant Pty Ltd, undated, Table A2.4.


Table B.7.1 SDP Capital Expenditure ($’000 real 2011/12)

2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12* Total

Desalination Plant

Plant - - Intake Infrastructure - - Outlet Infrastructure - -

Subtotal - - 497,671 485,406 103,474 676 - 1,087,227 4-year Subtotal - - 589,556

Pre-operations Payment** - - Project Development**** 36,080 22,839 28,634 14,440 11,399 1,685 547 115,625

Non-Dep for SDP 47,107 6,031 19,589 67 197 12 5 73,009 Total - Desalination Plant 83,188 28,871 547,274 504,804 118,705 2,374 552 1,285,767 4-year Total Desalination Plant**** 626,435

Desalinated Water Delivery System Pipeline - - 121,893 362,780 149,786 1,585 5,240 641,283

Pumping Station 342 257 8,858 25,151 9,320 573 351 44,851 Subtotal 342 257 130,750 387,931 159,105 2,158 5,591 686,134 4-year Subtotal - - 554,785

Project Development**** 6,698 5,033 3,838 6,786 4,030 171 26,556 Non-Dep for Pipeline - - - 780 108 897 11,330 13,115

Total - Pipeline 7,040 5,291 134,588 395,497 163,244 3,226 16,921 725,805 4 year Total- Pipeline 578,887 Total 90,227 34,161 681,862 900,301 281,949 5,600 17,473 2,011,572 4 year Total 1,205,322 Forecasts Submitted to IPART for 2008 Price Review

SDP - 115,955 547,876 561,484 158,805 - - 1,384,120 Distribution Pipeline - 20,503 216,898 321,896 188,641 - - 747,938

Total - 136,458 764,774 883,380 347,445 - - 2,132,057

Difference 90,227 (102,297) (82,912) 16,921 (65,496) 5,600 17,473 (120,485)

Notes: Table adapted from page 41 of Sydney Desalination Plant Pty Limited - Submission to IPART 2012 pricing determination *2011-12 values have been estimated with a CPI forecast of 2.8%. **These were included in the DBOM costs. ***The pipeline is currently owned by Sydney Water ****Project Development costs may be incorrect as the line item for Pump Station was moved from the Desalination Plant to the Desalinated Water Delivery System to reflect construction of the Pump Station by the Water Delivery Alliance


Table B.7.2 Project Delivery – Total Capital Costs ($million nominal)

Tendered/Total Outturn Costs

Actual/ForecastCosts

DBOM (plant, intake & outlet infrastructure)

1,006.00 1,000.00

Desalinated Water Delivery System

Land Based Bulk Water Pipeline 352.1 343.6

Botany Bay Bulk Water Pipeline 248.3 248.8

Pumping Station 49.6*** 39.9

Alliance Subtotal 650.0 632.3

Project Development Costs*

DBOM 173.5 131.1

Bulk Water Pipeline** 66.5 36.7

Pumping Station 1.5

Total 1,896.0 1,801.5

Notes: Table adapted from page 41 of Sydney Desalination Plant Pty Limited - Submission to IPART 2012 pricing determination *The project development costs in this table are calculated on a different basis to those in Error! Reference source not found., which contains capital costs calculated for regulated price-setting purposes (ie. accounting adjustments have been removed and the non-depreciating component has been separated out). **The project development costs for total outturn purposes were not disaggregated between the bulk water pipeline ***The Total Outturn cost of the Pump Station shown in the Independent Estimator Report by Currie & Brown is $30,983,000

B.2 Desalination Plant (DBOM Contract)

B.2.1 Overview

As previously noted, the Desalination Plant was constructed under a design, build, operate and maintain (DBOM) contract. The contracted works comprised design and construction of:

Sea Water Intake Structures;

a Seawater Concentrate Outlet System; and

a Desalination Plant comprising a 250ML/day initial module.

The design of the plant is such that it can be upgraded with a Stage 2 module to an ultimate capacity of 500ML/day.

B.2.2 Documentation Reviewed

The following project documentation has been reviewed in relation to this component of the project:

Sydney Water, Request for Tender; Sydney’s Desalination Project; Design Construct, Operate and Maintain a Desalination Plant, Seawater Intake and Outlet; Volume 1: Tender Requirements, Rev 0, 7 February 2007;

Appendix B

Review of Operating and Capital Expenditure by Sydney Desalination Plant Pty Ltd: Review Report JCYLAB - Final Review Report (Issue 2, Rev 1).doc (25/10/2011) 98

Sydney’s Desalination Project, Design and Construct Contract, Sydney Desalination Plant Pty Ltd, Veolia Water Australia Pty Ltd, John Holland Australia Pty Ltd, JZG01\0415936, dated 18 July 2007;

Sydney Water, An overview of Sydney’s desalination plant contracts, including amendments to November 2009, undated; and

Sydney Water, Change Order Register CMF014, undated.

B.2.3 Project Development

The Desalination Plant was granted Concept Approval by the Minister for Planning of NSW in November 2006.

A Design, Build, Operate and Maintain (DBOM) procurement approach, which comprised three stages as follows, was adopted:

Expressions of interest – were submitted by four (4) proponents; these were evaluated against mandatory and desirable criteria;

Request for tender – was issued to two short-listed proponents; these were evaluated against mandatory and desirable criteria; and

Evaluation, finalisation and contract execution – with the preferred proponent.

As previously noted (refer Section 5.5.2.1), Halcrow has reviewed the call for tender160 and tender evaluation161 documents and is satisfied that due process was followed. This is supported by the probity advisor’s report.162

A conventional Design and Construct (D&C) Contract for the plant, between Bluewater (John Holland Pty Limited and Veolia Water Australia Pty Limited) and Sydney Desalination Plant Pty Limited, was signed on 18 July 2007. On the same date, an Operation and Maintenance (O&M) Contract was signed between Veolia Water Australia Pty Limited and Desalination Plant Pty Limited. Several other deeds were also put in place including the Independent Verifier Deed, the DRB agreement, a Subcontractor Deed of Novation, and the Subcontractor Deed of Warranty.

160 Sydney Water, Request for Tender; Sydney’s Desalination Project; Design Construct, Operate and Maintain a Desalination Plant, Seawater Intake and Outlet; Volume 1: Tender Requirements, Rev 0, 7 February 2007.

161 Sydney Water, Tender Evaluation Report; Sydney’s Desalination Project; Design Construct, Operate and Maintain a Desalination Plant, Seawater Intake and Outlet; Tender No: 0510022504, June 2007.

162 Deloitte letter, Probity Report – Request for Tender – Design, Construction, Operation and Maintenance of Sydney’s Desalination Plant, dated 19 June 2007 concludes that “… no matter that would lead us to conclude that the process adopted and followed by Sydney Water Corporation in the evaluation of the Request for Tender – Design, Construction, Operation and Maintenance of Sydney’s Desalination Plant has not been conducted in a fair and equitable manner with due regard to probity”.

Appendix B


The key elements of the D&C Contract were:163

The Contractor is responsible for all aspects of the design, construction, commissioning, validation and completion of the desalination plant and its associated infrastructure, including the seawater intake and outlet structures, connecting pipelines and tunnels, a seawater pumping station and screening facility and drinking water storage tanks.

The Contractor accepted all of the risks associated with these works other than risks expressly accepted by the SDP in the D&C Contract (clause 1.4), including site condition risks (other than geotechnical risks in specified areas east of the desalination plant) and all risks of loss or damage to the works except for damage caused by defined force majure events, the company’s negligence or use or occupation of the works.

Unless granted by extension(s) of time: o the first 44ML/d portion of the works would be delivered by

1 December 2009 with final completion achieved by 19 January 2010 (Separable Portion 1);

o the second portion taking the plant to a capacity of 125ML/day would be delivered by 19 January2010 with final completion achieved by 19 January 2010 (separable portion 1B), and

o A third and final 125 ML/d portion, taking the total capacity to 250 ML/d would be delivered by 19 February 2010 with final completion achieved by 20 April 2010 (separable portion 2).

The contract was performance based and allowed the contractor to be flexible in some regards, but was firm in other regards.

It is noted the original scheduled dates for completion of Separable Portion 1 and Separable Portion 2 were 17 November 2009 and 16 February 2010 respectively. During Halcrow’s meeting with SDP representatives, it was confirmed that final completion of the plant was achieved on 19 January 2010, with the desalination delivery infrastructure (the pipeline) completed one week later.

B.2.4 Contract Price

Sydney Desalination Plant (excluding the pipeline) has reported actual capital expenditure for the period 2007/08 to 2010/11 amounting to $1,087,227 ($real 2011/12). At the time of the 2008 Determination of Sydney Water Corporation’s prices, the forecast capital expenditure over the same period was $1,268 million ($real 2011/12).

163 Extracted from Sydney Water, An overview of Sydney’s desalination plant contracts, including amendments to November 2009, undated.

Appendix B


A comparison between forecast and actual figures across the period is shown in the Table B.7.1. In comparing Historical Capital Expenditure, Halcrow has reconciled information presented in Table B.7.1 and information presented in the Annual Information Return (AIR) for the desalination plant (reproduced in Table 6.1).

A number of variations were approved under the D&C contract. A copy of a change order register, which identifies variations to the agreed project cost, was provided to Halcrow during our meeting with SDP representatives. The agreed variations are shown in Table B.7.3.

5

Halcrow is satisfied that there is an appropriate level of documentation to support these changes. On large expenditure items such as the WDA interface and additional 132 kV feed, Independent Estimators Currie & Brown were employed to provide further guidance on the appropriateness of expenditure. On this basis, Halcrow considers that effective management of contract variations has been implemented.

Appendix B


B.2.5 Detailed Project Review

B.2.5.1 General The Design and Construct (D&C) component of the contract was split into two separable portions, each generally reflecting approximately half of the 250ML/day capacity.

Each major component of the D&C contract is discussed in detail below.

B.2.5.2 Item 1 – Seawater Intake System The majority (57 percent) of expenditure to build the ‘Seawater Intake System’ was expended during the first year of construction, ie. 2007/08, with most of the remaining work completed the following year.

Total expenditure related to the sea water intake structure is ($nominal) which is

Design work, which included investigations, design of land side works, design of the seawater (inlet) delivery conduit, design of the seaside works and design of the intake plant area, was completed as part of Separable Portion 1 and represents

of the Item 1 cost. This is considered reasonable for a complex project of this nature.

‘Preliminaries’, which included Site Establishment, TBM procurement, TBM Ship & Install and Site Disestablishment, represent . The majority of construction expenditure was related to construction of the Sea Shafts, Risers and Intake Heads which represented The remaining construction costs were approximately split across construction of the Intake Conduit and Intake Structure, Screening and Pumps.

It is noted that safety initiatives did not form part of the Item 1 contract amount, however, were applied to the contract as a whole.

B.2.5.3 Item 2 – Seawater Concentrate Outlet System The majority (67 percent) of expenditure to build the ‘Seawater Outlet System’ occurred during the first year of construction, ie. 2007/08, with most of the remaining work completed the following year.

Design work, which included investigations, design of land side works, design of the seawater (outlet) concentrate delivery conduit and design of the seaside works, were completed as part of Separable Portion 1 and represents

. This is again considered reasonable for a complex project of this nature. ‘Preliminaries’ including Site Establishment, TBM procurement and TBM Ship & Install, represent . The cost of Site

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Disestablishment associated with the Seawater Outlet System was included as part of the Item 1 cost.

The majority of construction expenditure was related to construction of the outlet conduit which involved excavation and support, lining, connection to the sea shaft risers; this work represented The remaining construction costs were for construction of the Sea Shaft, Risers and Diffuser Heads, which represented only

B.2.5.4 Item 3 – Desalination Plant Expenditure on the Desalination Plant was marginally higher in 2008/09 ($355,420,000 ($nominal), ie, 48 percent of total) than the previous year ($299,739,000 ($nominal), 40 percent of total), with the remaining expenditure occurring in 2009/10 ($92,368,000 ($nominal), 12 percent) and small amount in 2010/11 ($658,000 ($nominal), less than 1 percent). This correlates approximately with the expected progress of construction. The reduction in expenditure in year 3 of construction aligns with the testing phases of the plant.

Total expenditure related to

Design of the plant itself was split across the two separable portions (each equating to incremental plant capacity of 125ML/day). Overall design costs were

. Given the complex design involving multiple disciplines, design costs as a proportion of construction costs are considered of an appropriate level. It is noted that the largest component of the design cost related to design of the Reverse Osmosis (RO) system,

.

Halcrow would expect that, given the modular nature of the plant, design costs for Separable Portion 2 would be significantly less than for Separable Portion 1, with design work predominantly related to interface works. This is reflected in the total design cost for each separable portion as a proportion of the total cost of the plant (Item 3).

Site Preliminaries represent (Separable Portions 1 and 2) and include costs for Site Establishment,

Project Mobilisation, Preparation of Management Plans, Securities, Insurances, Site Operation and Management and Site Disestablishment. The largest component of Site Preliminaries is for Site Operation and Management, which represent

.

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Construction of the plant included the:

Pre-treatment System;

Reverse Osmosis System;

Potabilsation System;

Drinking Water Storage Tank;

HV Power Reticulation;

LV Power distribution;

I&C, PLC and SCADA equipment;

Miscellaneous (drainage footpaths, buildings etc…);

Testing & commissioning, performance tests and reliability tests;

Second performance and reliability tests after 22 months operating time;

Community;

Communication;

Road Blockers; and

Safety Initiatives.

It is noted that spares for two years of plant operation were included in the capital cost for the desalination plant.

B.2.5.5 Item 4 – Preliminary Activities The contract also included a fourth cost item which was for:

Preliminary Design Activities;

Preliminary Management Plan Activities;

Preliminary Environmental Activities;

Rear access road; and

Safety Initiatives.

No actual expenditure has been attributed to this item in the disaggregation of costs for the Desalination Plant presented in Table B.7.1 and Table 6.1.

B.2.5.6 Cost Summary Table B.7.4 summarises the difference between Total Expenditure recorded in nominal dollars (based on the SDP submission) and Contract Prices related to Items 1, 2 and 3 above. From this table it is evident that the recorded cost difference for some of the Items may be due to ‘Item 4 – Preliminary Activities’ being distributed across Items 1, 2 and 3.

. This difference represents only 1.2 percent of the entire Contract price (excluding provisional items). It is noted that allowances for provisional items and incentives have been removed from this table as they do affect the calculation of the unreconciled difference in Total Expenditure versus Contract Price.

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B.2.6 Overall Comments

On the basis of the information reviewed, Halcrow concludes that the procurement of the Desalination Plant has been undertaken in a generally prudent and efficient manner.

Delivery of the plant under a design, build operate and maintain (DBOM) contract arrangement is consistent with the approach adopted for the delivery of other large scale water treatment plants within the Australian water industry. The design and construct (D&C) approach to the provision of the plant provides an appropriate level of owner control over the design concept, whilst providing opportunity for the delivery of cost efficiencies through a competitive tendering environment.

The process adopted for the selection of the DBOM contractor has been demonstrated to have been robust, a fact that has been endorsed by the independent probity advisor.

Whilst Halcrow has not yet been able to fully reconcile the total actual costs of delivering the plant, the assessment indicates that allowing for approved variations, the total actual cost exceed the original contract price by 1.23 percent (approximately $12 million). The unaccounted discrepancy may relate to the inclusion of provisional items of work or the payment of incentive bonuses.

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B.3 Desalinated Water Delivery System

B.3.1 Background

The Desalinated Water Delivery System involved design and construction of:

a land pipeline from the desalination plant to Silver Beach in Kurnell;

two parallel pipelines across Botany Bay to Kyeemagh;

a land pipeline from Kyeemagh to the proposed water distribution system connection point, Shaft 11C on the City Tunnel at Bridge Street, Erskineville;164 and

the Drinking Water Pumping Station.

The pipeline was sized to deliver 500ML of water per day, ie. equivalent to the proposed maximum future size of the upgraded desalination facility capacity.

Sydney Water currently owns the entire length of pipeline, however, it is noted that in SDP’s Submission to IPART that “given that the bulk water pipeline is integral to the supply of water from the desalination plant, Sydney Water is considering transferring the pipeline to SDP”. The transfer of this pipeline in 2011/12 has been included as capital expenditure in SDP’s AIR (included with its Submission to IPART) at a cost of $631.1 million ($real 2011/2012). The Desalinated Water Delivery System has therefore been included in this review by Halcrow.

The project was constructed by the Water Delivery Alliance (WDA) comprising Sydney Water, Bovis Lend Lease, McConnell Dowell, Kellogg Brown & Root, Worley Parsons and Environmental Resources Management.

B.3.2 Documentation Reviewed

The following project documentation has been reviewed in relation to this component of the project:

Sydney Water (2007), Request for Proposals, Sydney’s Desalination Project, An Alliance For The Design And Construction of the Water Distribution Infrastructure for Sydney’s Desalination Project;

Sydney Water, Desalinated Water Delivery System, Preferred Project Report, August 2007;

Water Delivery Alliance, WP0369 – Stage 1 Option: Install 2 duty Pumps Only (No Standby), dated 12 November 2007;

Letter from Hunter Water Australia to Sydney Water Corporation re Delivery System Desalination Project, dated 6 December 2007;

Hunter Water Australia, Sydney’s Desalination Delivery Infrastructure Independent Review, Final, Revision A, 22 February 2008;

164 Sydney Water, Desalinated Water Delivery System, Preferred Project Report, August 2007, p1.1.

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Currie & Brown, Independent Estimators Report, Revision 3, Final Report on Validation of Desalination Delivery Target Outturn Cost for Sydney Water, dated August 2008;

Water Delivery Alliance, Basis of Design Report, Work as Constructed, WDA-BoD-REP-001, dated 1 December 2009;

Sydney Water, Sydney’s Desalination Project, Water Delivery Alliance, Project Alliance Agreement for Amending Deed No. 1, 116839911, dated 10 March 2008;

Letter from Hunter Water Australia to Water Delivery Alliance re Independent review dated 28 June 2010;

Sydney Water, TOC Variations, undated; and

Sydney Water, An Introduction to the Desalination Pipeline Project Agreement, undated.

B.3.3 Project Development

B.3.3.1 Alliance Arrangement A Request for Proposals (RFP) from proponents wishing to enter into an Alliance contract arrangement with Sydney Water for the planning, design and construction of water distribution infrastructure from the desalination plant to Sydney Water’s existing water distribution system located in Erskineville was issued by Sydney Water on 16 February 2007. The aim of the desalination project stated in the RFP was “to provide Sydney, in the event of an extreme drought, with a sustainable and secure water supply, when combined with the metropolitan water initiatives”. It was indicated that the desalination plant was to have an initial production capacity of 125ML/day, expandable to an ultimate capacity of 500ML/day, with intake/outlet structures and delivery infrastructure sized to 500ML/day.

Seven project objectives in respect of safety, quality, schedule, flexibility, community & stakeholders, environment and cost were identified. The delivery strategy in the RFP outlined six (6) Key Result Areas (KRAs) for gain share on the Alliance project. The driver behind implementing a gain share and pain share arrangement at the time was to encourage game breaking performance which Sydney Water defined as “outcomes beyond the minimum conditions of satisfaction…aspirational outcome beyond that predictable and will require a new way of thinking to achieve. It is not known how it will be achieved at the time of setting the target”. The game breaking performance areas were:

Safety – nil harm.

Functionality – none listed.

Cost – Actual Outturn cost is significantly less than the Target Outturn Cost; Forecast Operating Cost is significantly less than the Target Operating Cost (particularly energy cost).

Schedule – completion four months ahead of Target Ready for Water Date; completion ahead of the Desalination Plant in the event of it being delivered earlier than its contractual program.

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Community & Stakeholder relationships – solution eliminates the need for street level open excavations.

Environmental Impact – solution eliminates the need for underwater trenching in sea grass areas.

Proposals were received from three on the 16 March 2007 closing date.165 According to Sydney Water’s document titled An Introduction to the Desalination Pipeline Project Agreement, Proposals were assessed through a series of interviews, discussions and workshops with the proposed proponents team members against five mandatory criteria and three desirable criteria.166

The ‘mandatory” criteria were:

demonstrated capabilities in project and program management for complex projects, the designing of civil infrastructure such as water pipelines and pumping stations and construction management, including environmental management, health and safety management, community and stakeholder relations, workplace relations and incident management;

having had prime responsibilities, for project and construction, management on project(s) or program(s) of at least $100 million;

specified ISO quality and environmental management system certifications;

specified certifications and satisfactory performances in occupational health and safety management; and

the financial strength and capacities of the proponents’ project manager, construction manager and constructor(s) and their parent companies, and the financial capability of the proponents’ groups as a whole to undertake a project of $500 million or more.

The ‘desirable’ criteria were:

the proponents’ demonstrated capabilities in specified areas to deliver the project’s objectives, with a 40 percent weighting overall;

the appropriateness of the proponents’ proposed approaches to achieving these objectives, with a 30 percent weighting overall; and

the proponents’ and their nominated team members’ personal demonstrated experience in, understanding of and affinity for working in alliances or other collaborative arrangements, with a 30 percent weighting overall.

165 According to Sydney Water proposals were received from: 1. The Connect Alliance (Bovis Lend Lease, McConnell Dowell Constructors, Kellogg Brown & Root, Patterson Britton & Partners and Environmental Resources Management); 2. An A J Lucas consortium(A J Lucas Group, Worley Parsons and Land& Marine Group); and 3. The C2U Alliance (Leighton Contractors, Clough Projects Australia, Maunsell Australia and Sinclair Knight Merz).

166 Sydney Water, An Introduction to the Desalination Pipeline Project Agreement, undated.

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Shortlisted proponents were invited to attend selection workshops at which their performance was also assessed. The initial tender evaluation167 identified two stronger proponents, which were selected to participate in commercial workshops. The financial strength of the three shortlisted tenderers was also assessed by KPMG.

Sensitivity testing of the tender assessment weighting was also undertaken to determine whether significantly different scores would have changed the ranking. According to the Sydney Water tender assessment report, the scoring process provided a high level of assurance that the evaluation process delivered a robust and defendable result.

Following the commercial workshops a preferred tenderer was selected. On 25 May 2007 Sydney Water announced that the Connect Alliance (Bovis Lend Lease, McConnell Dowell Constructors, Kellogg Brown & Root, Patterson Britton & Partners and Environmental Resources Management) had been selected as its preferred partner for the project Water Delivery Alliance team.

Based on the final tender report from Sydney Water, it was clear that the Connect Alliance demonstrated a number of strengths including:

extensive relevant experience;

a sound approach to options development and delivery, especially with regard to managing the projects impact on the community and the environment;

recognition of criticality of the project schedule and to ensure it is achieved;

recognition of the importance of effective integration with Sydney Water and demonstrating collaborative skills;

capability to deliver the current micro tunnel scope and ability to deliver a greater scope if required; and

capability to deliver the pipeline across Botany Bay.

A comment was, however, made that “while not all senior representatives of the members of the consortium have extensive alliance experience, there is a clear willingness to embrace the fundamental commercial aspects of alliance contracting, especially the sharing of project risk”.

167 Water, Evaluation report, Request for Proposals, An Alliance Contract for the Design And Construction of the Water Distribution Infrastructure For Sydney’s Desalination project, RFP 0510022481 file no. 2007/1304, approved 17 April 2007.

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Deloitte were appointed as Probity Auditor for the project; in an interim report168 provided during the tender evaluation process, it Deloitte found that “the request for proposals evaluation and approvals process have been conducted in a fair, equitable and impartial manner, with no party being given any advantage of another or unfairly discriminated against”.

On the basis of a review of the available information, including the probity advisor’s report, Halcrow is satisfied that satisfied that due process was followed in the selection and appointment of the Alliance partner.

B3.3.2 TOC Development Phase Halcrow notes that, in a submission to the Board of Sydney Water on 16 May 2007, budget approval was sought for the TOC development at an expected cost between $10,000,000 and $20,000,000. This included an allowance for Sydney Water personnel committed to the Alliance, but excluded other Sydney Water costs. The budget for the TOC phase was to include:

alliance management, engineering and staff;

establishing a project office, including IT;

geotechnical investigations;

services investigation and pot holing;

surveys;

preliminary design of the pumping station and pipeline;

environmental studies;

community and stakeholder consultation; and

staff recruitment.

Mobilisation costs such as micro tunnelling were excluded from the scope of the TOC. The Board on the same date approved a TOC development budget of $17,700,000. This amount represents approximately 2.7 percent of the final agreed TOC.

The items included in the cost of developing the TOC are what would be expected in a normal alliance arrangement.

The TOC development costs were later revised on 18 July 2007 following “a direction was made under section 20P of the state owned corporation act dated 2 July 2007 requiring the corporation to construct a desalination plant and associated infrastructure for the supply of an annual daily average production of 250 mega-litres per day (the direction)”.169 It is understood, based on the minutes of the 18 July 2007 Board Meeting, that this

168 IAB Services, interim report, Sydney Water Corporation, probity advisor report on – request for proposals for the water distribution infrastructure for Sydney’s desalination project, tender no. 0510022481, dated April 2007.

169 Draft Sydney Water Board Minutes, dated 18 July 2007.

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change resulted in an extension to the Project Development Period, which was set to expire in early October 2007, to mid December 2007, and that Sydney Water was obliged to pay for all direct costs until the TOC was accepted or rejected. A budget increase of $3,600,000 to $21,300,000 for TOC development was required to cover this period.

The minutes also record that a recommendation was also put to the Board to approve a budget of $31,000,000 for long lead-time items, with $500,000 of this related to early works on the pumping station to reduce delay to BlueWater.

Halcrow is of the opinion that, whilst extension to the Project Development Period may have been justified, the Government’s direction to build the plant at a 250ML/day capacity rather that the originally specified 125ML/day capacity should have had little impact on delivery of the Desalinated Water Delivery System which was always to have been sized with a capacity of 500ML/day. The only items that should have been impacted by the Government direction were associated with the pumping station. Noting that the final TOC for the 250ML/day pumping station was in the order of $31 million, an additional allowance of $3.6 million, which represents 11.6 percent of the full capital cost, for TOC development appears excessive.170

B3.3.3 Design Development The Basis of Design Report171 was developed through nine revisions, each capturing the different stages of development of the project. The report outlines the scope of work, functional requirements and technical design criteria which provide the basis upon which the Water Delivery Infrastructure for Sydney’s Desalination project has been constructed.

Under the alliance arrangement, Hunter Water Australia (HWA) was engaged to undertake an independent review of the proposed design concepts. Based on the letter from HWA to Sydney Water dated 6 December 2007, it is understood that an interim progress report submitted to Sydney Water by HWA in October 2007 indicated that the methodology is feasible, the design was conservative and there was significant scope to review some of the proposed pipeline design principals.

170 SDP has subsequently advised that “Although the budget for ‘TOC development’ was $21.3 million, the work undertaken in this phase included quite a lot of early design work, collection of geotechnical data, and preparations for the rapid start of construction. … The geotech data gathered during the period also revealed worse ground conditions than expected, and therefore additional effort (and time) was needed to review and modify designs. As such, there was more work going on in that period than a normal TOC development phase. The additional time in project development allowed for a more realistic final TOC, which was substantially below some of the earlier figures derived by the Alliance partners.”

171 Water Delivery Alliance, Basis of Design Report, Work as Constructed, WDA-BoD-REP-001, dated 1 December 2009.

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At the time when the design was being developed, HWA encouraged Sydney Water to pursue different options to achieve cost reductions, however, acknowledged that alternatives may attract small increases in risk. The key discussion topics between HWA and Sydney Water during the development of the design were:

The potential for reducing the total pipeline length from 17.4 kilometres to 16.7 kilometres through the use of micro tunnelling.

Consideration of the use of rubber ring joints as opposed to welded joints. Based on WDA calculations and advice, the use of welded joints attracted additional costs of approximately 2.5 percent, the use of welding requires less testing than rubber ring joints and the probability of construction defects is significantly greater if rubber ring joints are used.

Consideration of the use 12 metre pipe lengths where possible, thereby reducing the total number of welded joints.

Consideration of a ‘hybrid’ methodology for the Bay Crossing using ‘lay-barge’ and ‘sink and tow’ techniques. HWA noted that the hybrid method was 4 percent more expensive with possibly a higher risk of pipe buckling stresses due to the laying of pipe strings, however, according to HWA there was not a strong case to pursue discussion of this matter further.

Overall, HWA’s interim review generally concluded that the proposed design methodology was consistent with Australian water industry practice, the construction methodology was feasible and there was potential for further optimisation later in the detailed design phase. Overall, HWA gave ‘in-principle’ endorsement to the proposal for water delivery from Kurnell to the discharge location in Erskineville.

Halcrow notes that potential cost implications were not quantified in HWA’s letter; consequently it is not possible to draw conclusions in respect of efficiency on the basis of the information presented. The review undertaken by HWA does, however, lead to the view that the WDA’s engineering methodology and solutions were prudent.

HWA subsequently issued a final report regarding the desalination delivery infrastructure on 22 February 2008. This report further discusses the pipeline route, hydraulics, the pumping station, the land based pipeline, the marine pipeline, the review process and draws a conclusion in respect of the proposed conceptual form of the project. This report clarifies HWA’s role as the independent reviewer, which was split into two phases.

Phase 1 involved work in conjunction with the independent estimator to:

validate the integrity and whole of life implications of the proposed design; and

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validate, or otherwise, that the solution represents a sound and appropriate technical solution to Sydney Water for the life of the works.

Phase 2 involved verification that the works were constructed consistently with design.

In its letter dated 28 June 2010, HWA concludes that “We consider that the delivery system conforms in principle with the requirements of the design objectives … we consider that the as constructed system will meet the overall criteria of flow rates, structural integrity and design life”.

B.3.4 Total Outturn Cost (TOC)

B.3.4.1 Initial TOC Currie and Brown provided independent estimator services to Sydney Water in respect of the Alliance contract. They produced a TOC report with the purpose to “inform SWC the current position with regard to validation of the process and basis of cost used in the TOC, in accordance with the Project Alliance Agreement (PAA) and Currie & Brown’s proposal”172. Currie & Brown documented the:

TOC;

history of the validation process;

four major components of the desalination delivery system (the pump station, micro-tunnelling, trenching and the bay crossing);

program and technical management;

business interruptions;

escalation; and

risks and opportunity.

Currie & Brown’s validation report is based on the TOC value of $668,183,263 as at 6 December 2007. The Alliance Leadership Team (ALT) later revised the TOC to $668,937,269 on 17 December 2007, an increase of $755,006. Sydney Water and WDA eventually agreed on a TOC of $650,000,000 following negotiations in which Currie & Brown were not involved.

Currie & Brown’s report overall highlights that the reported TOC of $668,183,263 is a reasonable interpretation of WDA costs, however, this does not take into consideration the ability to realise opportunities in productivity management and risk calculations. Currie & Brown note, however, that the final agreed TOC of $650,000,000 realises the opportunities presented in their report and represents ‘Value-for-Money’.

172 Specifically clauses 6.4.4, 6.4.5 and 6.4.6 of the PAA.

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Table B.7.5 provides a breakdown of the TOC and identifies where Currie & Brown’s calculations differ. According to Currie & Brown, a quantum difference of $8,000,000 in contingency also exists.

HWA noted that, in arriving at the estimate for the TOC, it was necessary to modify the concept design, which required deletion of a number of features of the design. These deletions included

standby pumps;

internal welds replaced with full external welds in straight pipe lengths; and

mounding of pipe sections in appropriate areas.

HWA states that some of these decisions would not be considered in line with normal design standards. In the event of a power outage or pump failure, the removal of the standby pump is not is not critical as water can be delivered from elsewhere in the supply system. It was HWA and Currie & Brown that suggested the use of single welds. Halcrow notes that surface mounding has been adopted in dedicated ‘pipe tracks’ and similar locations where it does not impose an impediment to land use.

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B.3.4.2 TOC Variations SDP supplied Halcrow with a list of nine variations to the pipeline TOC. These variations are summarised in Table B.7.6.

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B.3.5 Detailed Project Review

B.3.5.1 Pumping Station The Drinking Water Pumping Station, which is located within the desalination plant site, has all critical infrastructure sized to cater for the ultimate Stage 2 capacity of 500ML/day. The building for the pumping station and the pumps themselves, have only been sized to deliver the Stage 1 capacity of 250ML/day (target transfer capacity is 87GL/year), with no redundancy in the pumping capacity. Redundancy has only been provided for surge vessels, ventilation fans and station auxiliary transformers; no other components have no redundancy provision.

The final TOC for the pumping station was $30,983,000. At the time of Currie & Brown’s initial review, the pumping station had a TOC of $26,269,627.

The WDA states that the pump room floor levels are above the 100 year ARI flood level, which conflicts with HWA’s independent report which queried why pumps have been located below design flood levels. At the time of the independent review, the reviewers were advised that a water retaining slab was necessary for this reason. HWA states that it was revealed by the Bluewater consortium (DBOM contractor for the desalination plant) that, in order achieve positive pressures on the inlet side of the pumps, it was necessary to locate pumps below design flood levels; consequently, it was necessary for the building to be water retaining and designed against buoyancy. HWA noted that it did not see any formal documentation relating to amending the design of the clear water tanks (which was part of the DBOM contract), however, they understood that altering the design of the tanks was not a practical alternative.

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The pumping station was originally sized to accommodate two horizontal variable speed pumps. The WDA, however, installed two duty units capable of delivering 275ML/day against a head of approximately 67.2 metres as part of the Stage 1 works. WDA state that, for the Stage 2 upgrade, the two pump units would be replaced with four larger pumps (3 duty and 1 standby) capable of discharging 550ML/day against approximately 120 metres of head. Based on the Currie & Brown report, the reduction in the number of pumps from three to two, lead to a cost saving of $3,730,706; however, additional costs of $305,600 were incurred for additional geotechnical and survey works. The Currie & Brown report does not, however, clarify the costs of the pumps themselves. Although not explicitly stated, it is assumed the pumps formed part of the $12,239,020 hydraulic equipment and piping installation, which was analysed by Currie & Brown on a ‘trade package’ basis rather than an itemised bill of quantities.

The WDA report states that the “pump station valves are sized and arranged to suit the selected pumps and designed flows”. Halcrow was initially concerned by this statement; it appeared that, should the desalination plant be upgraded to its ultimate Stage 2 capacity, then both pumps and the valves would likely become redundant, possibly before the end of their design life. Halcrow consequently sought further clarification from Sydney Water in respect of the decision to build the pumping station with no redundancy.

Sydney Water has advised that the decision to provide no redundancy was made before the TOC was finalised and approved, and that the decision was part of the adjustments made in order to reduce the TOC to the agreed $650,000,000; it was not a decision to provide a saving to the Alliance partners. To support this decision, an issues paper was prepared by the Alliance.173

Sydney Water’s normal practice is to provide N+1 redundancy for pump units, where N is the number of pumps required to meet the specified capacity requirements. Halcrow confirm this approach is typical practice in the water industry. The 2006 Blueprint Design for a plant with a capacity of 125ML/day was for 1 + 1 pumps, to be upgraded to 3 + 1 pumps for the ultimate capacity of 500ML/day. It is understood a previous issues paper174 examined the NPV of installing 2 + 1 ‘small’ pump units for up to 275ML/day, with the pumping station and electrical buildings still sized to house units capable of delivering 550ML/day, which was the basis for the TOC estimate at the time. The issues paper reviewed by Halcrow then examines the implications of installing two pump units with no redundancy; the pumping station and electrical buildings were to be sized for

173 Water Delivery Alliance, WP0369 – Stage 1 Option: Install 2 duty Pumps Only (No Standby), dated 12 November 2007.

174 This was not reviewed by Halcrow but is referred to in Water Delivery Alliance, WP0369 – Stage 1 Option: Install 2 duty Pumps Only (No Standby), dated 12 November 2007.

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275ML/day capacity only, whilst pipework and valves were sized for ultimate duty. Extension to the pumping station and electrical buildings, or alternatively new buildings, would be required to house the additional pump units required to deliver the 550ML/day Stage 2 capacity. Overall cost savings are achieved by use of smaller buildings, one less pump, motor, valve set, VSD, transformer, switchgear set, with an allowance for ‘strategic spares’.

The WDA issues paper outlines benefits related to each of the KRA’s and identifies a total saving of $3,800,000 ($nominal 2007). The probability of both pumps not operating was estimated to be between 0.21% and 0.77% of any calendar year, which equates to a loss of 18-67 hours per year.

The decision to only install only two pumps was endorsed by the ALT on 15 November 2007.

HWA confirmed the pumping station concept was satisfactory and conformed to the project objectives (as amended during the TOC development phase). HWA made comment on the structural design of the pumping station building, noting that it may have been more efficient to raise the clear water tanks rather than having the pumps so close to the water table. The proposed change in levels would, however, have required large areas of rework of already completed design for the plant, which HWA understood was not practical at the time. This added some minor risk due to the potential flooding of the motors.

Halcrow is satisfied that, based on an assessment of risk and in order to reduce costs for delivery of the required 250ML/day capacity alone, the decision to reduce the number of pumps from 2 + 1 standby pump to two pumps only was both prudent and efficient. However, two points of contention remain:

the WDA discussion paper states that valve sets would still be designed for ultimate capacity (ie. 3 + 1 ‘larger’ pumps); this differs slightly from the WDA report which states that valves are designed and arranged to suit the selected pumps and designed flows for the initial capacity (ie. 2 + 0 ‘smaller’ pumps; and

the WDA discussion paper did not discuss the cost implications for the future upgrade of the plant to 500ML/day of reducing the size of the pumping station and electrical buildings.

Halcrow is therefore unable to confirm that costs associated with upgrade to the ultimate capacity would be efficient.

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B.3.5.2 Land Based Pipeline The trunk main (delivery pipeline) is divided into three sections:

Section 1 – Kurnell – Pumping station to Silver Beach;

Section 2 – Botany Bay Crossing; and

Section 3 – Kyeemagh to Erskineville.

Sections 1 and 3 comprise of a DN1800 mild steel land based pipeline, and include connections to the Sydney Water distribution system and allowance for future connections. The primary connection into the system is at Shaft 11C, on the City Tunnel at Erskineville, however, a number of provisions for secondary offtakes to the existing system have been included in the design.

Provision has been made for the following future secondary connections:

DN750 tee connection in the vicinity of Cooks River;

DN750 tee connection for a future purging point at Cooks River;

DN500 tee connection at Canal Road; and

DN900 tee connection at Shaft 11C.

WDA states that “the basis of design is that these cross-connections (should they be utilised in the future will remain closed when pumping is in operation and open when the pumping station is off-line”.175 WDA also states that provision has also been made for a future secondary connection (DN900 at Shaft 11C) to allow the desalination plant to continue operation when the City Tunnel is isolated at Shat 11C; the maximum flow rate through the connection to be 90ML/day. This connection is not currently in service and additional downstream works may be required in the existing system if the secondary connection is brought into service.

The WDA report does not provide details of the reasoning or drivers behind the provision of the future secondary tee connections, however, based on the report it is apparent that the two connections in the vicinity of the Cooks River and the connection at Canal Road, would only ever be used at some time in the future when the plant is not operating. In the absence of detail, Halcrow assumes this provide Sydney Water with greater operational flexibility within its water distribution network.

Halcrow considers the installation of the tee connections to have been prudent and efficient at the time construction, in terms of making provisions for the future as this would have been a relatively low cost during construction. However, given the proposed transfer of the pipeline from Sydney Water to SDP, the installation of the tee connection does not appear to provide any direct benefit to SDP.

175 Water Delivery Alliance, Basis of Design Report, Work as Constructed, WDA-BoD-REP-001, dated 1 December 2009, page 40 of 49.

Appendix B


It could be argued that, given that the connection points are of potential long term benefit to Sydney Water rather than SDP, the cost of their provision should ultimately be borne by Sydney Water; ie. this component of cost should be deducted from the cost of the pipeline when transferred from Sydney Water to SDP. The additional cost associated with installing the tee connections is not apparent from the information provided for this review, however, it is likely to be immaterial in comparison with the total value of the pipeline. Furthermore, Halcrow considers it prudent to include provision for future connection at strategic points of the pipeline, irrespective of ultimate ownership.

Halcrow notes that it was originally intended that cement lined steel pipes would be used for the entire length of the pipeline, however, unlined steel pipes were installed in the tunnel sections. According to HWA, it is unclear how this developed and it was assumed to be due to a communication problem. This was consequently accepted a design/construction reality and according to HWA was satisfactorily managed. No information in respect of the associated cost implications of this change, or an assessment of the impact on pipeline integrity, have been provided to Halcrow for review.

It is noted that, during design development, the proposed steel pipe wall thickness was reduced to 12mm for the land based sections. Whilst no details of the cost implications related to this design change have been provided to Halcrow for review, it is understood that TOC was developed on the basis that 12mm all thickness steel pipes were to be used.

In summary, HWA considered that the delivery system conforms in principle with the requirements of the design objectives. The overall objective was to provide a high degree of confidence that the system will provide a 100 year design life, allowing for a reasonable degree of surveillance and maintenance. HWA noted that, whilst there were significant changes, it considered that the constructed system would meet the overall criteria in respect of flow rates, structural integrity and design life.

It is also noted that during the early development of the design, HWA queried why a better case was not put forth to use welded joints over rubber ring joints, citing that “HWA as ample precedence to demonstrate savings of approximately over 25% in unit rates”. HWA concluded that they “do not completely agree with the WDA rationale we would not reject their conclusion”. No business cases or options analysis quantifying the difference in cost and risk was been provided to Halcrow as part of this review.

B.3.5.3 Marine Pipeline The marine pipeline, ie. the section of pipeline crossing Botany Bay, comprises of twin DN1400 mild steel pipes that have been constructed using an innovative seabed trenching method.

Appendix B


In regard to the pipeline route, HWA noted that they “were advised that a feasibility ‘review’ of alternate pipe laying routes to the west and east of Botany Bay”. HWA did not see any documents relating to the detail decision but note that “by inspection, it is clear that each of these will have similar constraints to the proposed route that would vary in degree”. HWA formally stated they accepted in-principle that no alternative pipeline routes would avoid the identified constraints. HWA did note that savings could be achieved through micro-tunning, improved trenching alignment and dimensions of trenching.

HWA noted that they were not required to review the hydraulics of the pipeline in detail, however, they did noted the thoroughness of the surge analysis, adopted resolution of the surge vessels and pressure relief valves to be reasonable.

B.3.6 Overall Comments

On the basis of the information reviewed, Halcrow concludes that the procurement of the Water Delivery System comprising the Drinking Water Pumping Station and the Delivery Pipeline has been undertaken in a generally prudent and efficient manner.

Delivery of the system under an Alliance contract arrangement is consistent with the approach adopted for the delivery of other similar works within the Australian water industry. This approach facilitates an appropriate sharing/allocation of risk, with the use on incentives to drive efficiencies.

The process adopted for the selection of the Alliance partners has been demonstrated to have been robust, a fact that has been endorsed by the independent probity advisor.

Based on review of the independent reviewer’s (HWA’s) documentation, it is evident that there has been robust discussion in respect of the technical solutions developed for the works. Whilst it is apparent that HWA did not agree with some of the design concepts put forward by WDA, there is evidence that WDA investigated improvement opportunities proposed by HWA. Whilst, in Halcrow’s opinion, it appears that HWA did not always take a firm stance on clarifying contentious issues, it is evident that the objectives of the independent reviewer role, ie. to “ … validate, or otherwise, that the solution represents a sound and appropriate technical solution to Sydney Water for the life of the Works” was met.

Efficiency of the developed solution was assured through the combined roles of the independent estimator (cost) and the independent reviewer (technical solution).

JCYLAB - Final Review Report Issue 2, Rev 1...Review of Operating and Capital Expenditure by Sydney...

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