Ms Maria Graham:

Thank you, Chairman. I appreciate the opportunity to make a presentation from the Department's perspective on aspects of the funding of water services. I am accompanied by Mr. Colm Lavery and Mr. Patrick O'Sullivan, principal officers in the water division of the Department.

My understanding is that at the last meeting the committee had specific questions about the overall funding position prior to the establishment of Irish Water. I will seek to address them, as well as providing some perspectives on the overall funding of the sector to assist the committee in its consideration of the expert commission's report. As we have provided a detailed note with historical information on capital and operational costs, as well as forecasts to 2021, which I think all members of the committee have received, I will focus in this presentation on some of the key trends and relevant issues.

Prior to 2014, the Department managed two capital investment programmes - the multi-annual water services investment programme, WSIP, and the rural water programme, RWP.

Over the eight-year period 2006-13, just under €3.5 billion in Exchequer resources was invested in water under these programmes. The WSIP was focused on public water services capital projects valued over €1 million, while the RWP covered investment in small public water and sewerage schemes valued at under €1 million, as well as the recoupment to local authorities of grants paid to the non-public water sector, mainly the group water schemes. The Exchequer grants for public water services projects generally covered about 75% of the overall costs. The balance was funded by local authorities from revenue from commercial water charges, capital contributions from major users, the water component of development levies and borrowings.

Under these arrangements, the overall strategic direction of the WSIP and the projects outlined therein were selected by the Department following prioritisation by local authorities. The advancement of projects through key stages required departmental approval and grant approval was provided on a project-by-project basis, with approvals setting the split between the Exchequer and local authority funding. The capital expenditure on public water services in 2013, including the estimated local authority contribution, was approximately €319 million. At the end of 2013 local authorities had an outstanding debt in regard to borrowing for water and wastewater projects of approximately €600 million.

Prior to 2014 local authorities were wholly responsible for operational expenditure decisions and operational costs were met from non-domestic charges and local authority own resources. The most important of these own resources was the general purpose grant provided from the local government fund, LGF. While the general purpose grant had reflected the commitment by the State to provide funding to local authorities in respect of domestic water services following the abolition of water charges in 1997, local authorities had discretion as to how they applied the general purpose grant across expenditure lines. Based on local authorities' annual financial statements, and adjusting for services not transferred to Irish Water, the expenditure by local authorities on the operation of public water and wastewater services was about €720 million in 2013 and would have risen to €732 million in 2014, allowing for network growth and adjusting for the increases in commercial rates charges, which happened in 2014.

The capital funding for Irish Water in 2014, which was provided as a capital contribution from the Minister for Finance, was set at €239 million, which would have been the same as under the previous Exchequer funding arrangements of the WSIP and RWP had they remained in place. Irish Water utilised this funding and borrowings to finance a capital programme of €740 million, including metering and establishment costs in 2014. Overall, Irish Water operational costs in 2014, including financing costs, were €778 million. This covered functions transferred from local authorities, as well as new Irish Water activities. This expenditure was financed from non-domestic revenue, borrowings and operational subvention. The funding from the local government fund to Irish Water was based on an estimate of the net funding which would have been provided to local authorities towards water services from general purpose grants had the function remained with them, that is, operational costs less revenue from non-domestic charges with some adjustment for expected operational savings and the cost of financing the local authority outstanding debt as this did not transfer to Irish Water. On this basis, the subvention to Irish Water in 2014 was €439 million, approximately €47 million was recouped to local authorities for their water financing costs and the general purpose grant to local authorities was reduced accordingly.

Funding arrangements from 2015 onwards have reflected the commencement of economic regulation and domestic water charges. Capital funding is provided by a capital contribution from the Minister for Finance with the balance of capital expenditure facilitated through borrowing and customer revenue. A total of €406 million in capital funding was provided in 2015 and 2016. An amount of €270 million is scheduled for 2017 and similar amounts would be expected each year to 2020 under the Irish Water business plan. The business plan did not envisage the requirement for a contribution in 2021 on the basis that capital expenditure in that year would be met wholly by borrowing and customer revenue.

Turning to the operational side, operational subvention to Irish Water is designed to cover the costs of providing the free allowance for children, capping water charges at €160 or €260 per annum depending on household size and capping the unit charge at €3.70 for each 1,000 litres of water supplied and wastewater removed. Funding is also provided for working capital, which reflects the time lag between charging and receipt of revenue. On this basis, the Irish Water business plan generally reflects an average annual subvention of €467 million and average working capital of €32 million between 2017 and 2021. In 2017, €475 million is to be provided in line with the business plan and this is being increased by €125 million to cover the suspension of water charges provided for in the Water Services (Amendment) Act 2016. If water charging were to remain suspended in 2017 for domestic users, a further €114 million would be required, bringing the total additional funding requirement in 2017 above the business plan projection to €239 million.

I want to turn to comparisons between the operational expenditure under both models. The Irish Water business plan forecasts efficiencies in operational expenditure of €1.1 billion over the period to 2021, and these will be subject to scrutiny and challenge by the CER. As a consequence, the operational costs, excluding financing costs, will reduce from €769 million in 2014 to €614 million in 2021 at 2015 prices. By comparison, if the functions had been retained by local authorities, and allowing for the upward pressure in costs from new facilities and similarly excluding financing and commercial rates costs, it is estimated that the equivalent local authority figure in 2021 would have been of the order of €695 million.

A couple of points need to be borne in mind when comparing operational costs under both models. First, the PwC independent assessment in 2011, based on engagement with local authorities, recognised that operational expenditure by local authorities was artificially constrained for budgetary reasons. This is supported by EPA analysis which indicates that while 34% of incidents associated with licensed wastewater discharges in 2012 were for capacity issues, including the need for infrastructural improvements, 38% of incidents were due to operation and maintenance issues. PwC estimated that approximately €60 million was required to address this operational expenditure, OPEX, backlog. Second, there are costs reflected in the Irish Water model which would not have arisen for local authorities. These include some costs related to the set-up, such as developing new systems and so on, which are treated as operational expenditure under accounting rules but are treated as capital expenditure by the CER. It also includes a range of activities relating to new functions, for example, customer billing and running new asset management systems, as well as new programmes such as the first-fix programme. Many of these costs would be characterised as “spend to save” programmes, that is, expenditure now to deliver future efficiencies. Third, a much higher level of performance is expected from Irish Water operations across a range of metrics, including leakage, customer service, environmental compliance and reduction in boil water notices, as Irish Water avails of economies of scale and deploys new asset management systems and standard operational approaches. A performance assessment framework is being put in place by the CER in this regard.

Considerable capital investment was made by local authorities over the period from 2000 to 2013, particularly to build new wastewater treatment capacity. Exchequer capital spending on public water services peaked at €432 million in 2009 but declined to €319 million by 2013. By comparison, the average core capital spending under the Irish Water business plan is €590 million.

However, it is not only a question of the amount of funding required, it is also a matter of ensuring that the funding model supports the most efficient delivery of services, the right investment decisions and the appropriate balance between capital investment and ongoing maintenance. Aside from the limitations on strategic planning and economies of scale presented by a dispersed model based on 34 authorities rather than a single regulated utility, the previous funding model faced particular challenges from: the absence of a national asset management system to inform prioritisation of capital maintenance and investment; funding lines which tended to incentivise capital investment over capital maintenance; a lack of certainty on overall Exchequer funding at a programme and project level over an extended period in light of the annual Exchequer budgetary process; and delays in project implementation due to misalignment in the availability of funding from the two main sources, namely, the Exchequer and local authorities.

From this experience, conclusions can be drawn on the key features of an efficient funding model for the future, particularly if such a model is to support the correct investment decisions and the most efficient operations in respect of water services. These would include: that the model should ideally provide a level of certainty of funding over a multi-annual period to ensure appropriate strategic planning and timely delivery; decisions on operations and capital investment should be integrated and made by a single authority, and the sources of funding available should not skew this decision-making process; costs and outputs should be benchmarked against best practice internationally; and the funding model is likely to require an element of cost recovery and promotion of conservation to ensure compliance with the water framework directive. On the latter point, the Minister has recently received further correspondence from the European Commission which, inter alia, points to the need for the recovery of costs to ensure that the serious maintenance and investment needs of the public water and wastewater system can be met. I am aware that the question of compliance with the water framework directive will be dealt with at a future meeting of this committee, so I will focus on the other features of the funding model today.

From an organisational perspective, the single public water utility, with the new asset management approaches developed by Irish Water, can address the key issues relating to appropriate project selection, achieving economies of scale and securing greater efficiency in operations. As described by the Commission for Energy Regulation, CER, and Irish Water, the regulated approach ensures that the appropriate funding requirement over a reasonable time cycle is determined in an open and transparent manner, delivering efficiencies alongside service improvements. Generally, for a regulated water utility, when the funding requirement is settled, the revenue can be raised through charges and borrowing, with some State support. This gives the utility the greater certainty regarding its investment plans and operational decisions. If, however, the model is reliant mainly on State support to cover this revenue requirement rather than charges, other options need to be examined to provide a level of assurance that the business plan of Irish Water can, following regulatory review, be delivered.

It has to be acknowledged that funding what the expert commission termed the "regulatory settlement" through general taxation inevitably introduces risks of funding shortfalls or funding uncertainty because water services funding would have to be considered as part of the normal budgetary process. Ring-fenced funding would provide greater certainty and underpin delivery of the business plan but does present challenges for the normal management of the public finances. There are examples, such as the local property tax or the plastic bag levy, where revenues raised are directed to particular areas. It is fair to say that the greater the link between the revenue stream and its purpose, the more certainty can be provided on the funding environment for the utility and the greater the support for long-term planning, generation of efficiencies and service improvements.

There are also international examples of regulated utilities where the Government provides some guidance to the utility and the regulator as to the likely funding parameters over a multi-annual process. The recent decision on the 2017-2018 revenue control period by the CER had some component of this approach. The business plan for Irish Water to 2021, considered by Government, set out a perspective on the likely subvention and capital requirements over the period. As such, the Department, in its engagement with Irish Water and the CER on the 2017-18 revenue control, indicated that the business plan projections represented the outer limits of State support. In the first revenue control period, a ministerial policy direction was issued under section 42 of the Water Services (No. 2) Act 2013 and this set some conditions for State funding.

The overall funding model also needs to support policy to address deficiencies in the non-public water sector. In particular, significant capital funding is provided by the Department to the group water sector under the rural water multi-annual programme. To ensure parity of treatment between the public water system and the group water sector, a system of operational subsidies was introduced for the group water sector from 1997. These subsidies are paid to the schemes by local authorities, which are reimbursed in full for this expenditure from the local government fund. The subsidies have been adjusted, following consultation with the National Federation of Group Water Schemes, in light of the suspension of domestic water charges. Approximately €50 million is required on an annual basis to fund the non-public water services.

In summary, a stable multi-annual funding approach would underpin improvements in service and compliance by Irish Water. In line with the Irish Water business plan, which is prepared on the basis of achieving such outcomes, an annual amount of approximately €1.4 billion would be required by 2021 in order to fund the capital expenditure and operational expenditure cost of water and wastewater services not met by the non-domestic sector. Ideally, the manner in which this is funded needs to ensure that best value for money is achieved from the existing asset base and that the correct operational and investment decisions are made to deliver the best outcomes for customers. More detailed financial information is set out in the note we have provided for the committee and I am, of course, happy to answer any questions members may wish to pose.