29 June 2018

The Hon Judith Collins

Member of Parliament for Papakura
Parliament Buildings
Wellington

Email: Judith.Collins@parliament.govt.nz

Dear Hon Collins

REQUEST FOR INFORMATION UNDER THE LOCAL GOVERNMENT OFFICAL INFORMATION AND MEETINGS
ACT 1987

Thank you for your email dated 21 June 2018 requesting information regarding Watercare’s Central
Interceptor project.

Our Response

Background to the Central Interceptor and Financing

The Central Interceptor (CI) is a wastewater tunnel – 4.5m wide and approximately 13km long including 8
vertical shafts that will run between Western Springs and the Mangere Wastewater Treatment Plant.

The CI Project will deliver the Central Interceptor tunnel and shafts and the following key components:

 2 Link sewers
o Link sewer B – 2.4m wide and 1.1km long
o Link sewer C – 2.1m wide and 3.2km long
o 8 vertical shafts - along the link sewers.
 Numerous connection pipelines, chambers and gates which extend Watercare’s existing networks to
interface with the CI.
 A new Mangere pump station - together with pump station building, mechanical and electrical fit-
out.
 Air treatment facilities to manage odour from the various components of the CI project.
 System wide controls and telemetry integration.

The project has been included in Watercare’s Asset Management Plan (AMP) since at least the 2010
amalgamation of legacy councils in Auckland. The current estimate to complete the project is around $1.1b
with construction planned to commence in 2019 with completion in 2025.
Current Project Status

With consenting and design now complete the project is currently in final procurement phase. Expressions
of Interest for construction have been received and evaluated and a short list of 4 consortia selected to
participate in the RFP process.

The 4 selected consortia are:

 CPB Contractors
 Ghella-Abergeldie Harker Joint Venture
 Pacific Networks, comprising McConnell Dowell, Fletcher Construction and Obayashi
 VINCI Joint Venture, comprising VINCI Construction Grands Projects, HEB Construction and
Solentache Bachy.
Requests for Proposals were issued to the 4 consortia on 10th May 2018 and the parties are now preparing
their proposals which are to be submitted to Watercare mid-September 2018. Watercare expects to select
the preferred tenderer in late 2018 with final contract negotiations being completed first quarter of 2019.
Physical works are expected to start prior to 30 June 2019 and be completed in time for commissioning in
2025.

Watercare’s Funding and Financing of Capital Projects

Watercare funds all of its operating costs and capital projects through water and wastewater service charges,
infrastructure growth charges where there is a growth demand, and borrowings. That means we self-fund
what we deliver and do not receive rates money from Auckland Council or grants from Government. Our
financial position enables us to fulfil the commitment we have made to the Auckland community in our Asset
Management Plan including the delivery of the CI project.

Revenue projections and price paths can’t be directly linked to any single capital project but are set at a level
so that, generally,

 debt incurred by a generation is repaid by that generation and within the life of the assets the debt
finances
 price increases are smoothed over time
 key financial ratios are kept within appropriate limits.
Projected price increases outlined in Auckland Council’s 2018-2028 10-year budget for water and wastewater
charges are: Water by an average 2.5 per cent per annum, Wastewater by an average 3.3 per cent per annum
(note there is a greater capital works programme for wastewater over the next decade).
Watercare’s water and wastewater activities are described separately in the Auckland Council Long Term
Plans. Prospective funding statements for each activity and specific references to the Central Interceptor are
included in each of the 2012-2022 LTP, the 2015-2025 LTP and the recently released 10-year budget for 2018-
2028. Links to those documents on the Council’s website are;

2012-2022 LTP
Long-term Plan 2012-2022 Documents

2015-2025 LTP
The full 2015-2025 budget

2018 -2028 10-year budget

https://www.aucklandcouncil.govt.nz/have-your-say/topics-you-can-have-your-say-on/ak-have-your-
say/docs10yearbudgetsupportinginfo/supporting-information-combined.pdf

The link to Watercare’s most recently published AMP (2016 – 2036) is;
https://www.watercare.co.nz/CMSPages/GetAzureFile.aspx?path=~\watercarepublicweb\media\watercare
-media-library\reports-and-publications\watercare-asset-management-plan-2016-
2036.pdf&hash=c999a1177a85361b806adcf60f74c46bc687f7b4880bc036e62f663d8c7ee825

Alternative Ways to Finance CI

The Mayor’s Letter of Expectation to the Watercare Board in December 2017 requested the Board ensure
that planning and procurement for CI could accommodate the inclusion of CI in a Special Purpose Vehicle
(SPV).

Subsequently in early 2018 a working group was initiated to investigate SPVs as an alternative financing
option which could relieve pressure on the Council Group’s Credit Rating by reducing the debt to revenue
ratio of the Group. Central Interceptor was selected as an example project to allow alternative financing
options to be tested against a real life scenario.

The working group is led by Auckland Council Acting CFO Matthew Walker and includes representatives of:

 Auckland Council
 Watercare
 Council Consultants
o Macquarie
o EY
o Chapman Tripp
 Treasury (as observers).
The working group has focused on creating an SPV structure that could be applied to Council Group projects
to remove debt from the Council Group debt to revenue ratio (“off balance sheet”).
The generic SPV structure as currently developed relies on the following key characteristics:

- A transfer of construction and ownership risk to the SPV and an underwriting of certain risks by the
Crown to enable the SPV to raise finance at acceptable cost.
- Isolation of revenue streams from Watercare and Council to the SPV to allow the SPV to repay finance
and cost of finance.
- Legislative change to allow the SPV to be established and operate
- Auckland Council to collect an annual levy on behalf of the SPV from ratepayers and pay this to the
SPV.

In addition to the above the generic SPV structure applied to Watercare projects such as the CI would require:

- Contractual arrangements between Watercare and the SPV for the purposes of
o Managing the construction of the assets
o Operating and maintaining the SPVs assets post construction
o Managing the interface between Watercare’s assets and the SPVs assets.

Further details of the current proposed SPV structures are available in the presentation given to Auckland
Councillors and Watercare Board members at their 21st June joint workshop (see attachment 3). A recent
issues and action list from the working group is attached as attachment 2.

The Watercare Board remains supportive of the development of an SPV regime to accelerate infrastructure
investment (note there will be no “acceleration” of the CI project which will continue on its present
programme). At its April meeting the Watercare Board discussed the preparation for the CI RFP process and
concluded

 The opportunity to include a novation clause within the construction contract could be taken at or
before the letting of the construction contract.
 Management to continue with the CI programme and issue an RFP to the four consortia in the week
of 7 May 2018. In the interim, no advice will be given to the four consortia regarding a SPV/SIV as
there is far too much uncertainty at this time.
 Management will continue to work as part of the Taskforce on the models and how and when any
such model might be introduced into the CI process without causing delay and/or additional cost to
the project.
 Management to monitor closely the development of and introduction of any legislation which will
enable the creation of a SPV/SIV.
Other Alternatives

Watercare is conscious that whilst it has extremely low balance sheet gearing1 it does exacerbate the Council
group’s debt to revenue ratio. Auckland Council’s target for the ratio is less than 2.65. Watercare’s
standalone debt to revenue ratio as at 30 June 2018 is expected to be 2.69 and is forecast to exceed 4.0
during the mid-2020s when CI is delivered, reflecting not only increased debt attributable to the CI project
but also restraint around increasing revenue with a view to keeping overall costs of services to its customers
at minimum levels2.

Watercare is aware that there is a spectrum of ways to assist the Council Group manage its debt to revenue
constraint, this spectrum can be summarised as follows:

Impact on Group debt to revenue ratio

Negative Beneficial
impact impact

PPP/SPV –
Finance SPV Revise
Issue Watercare Crown HIF
Procurement 3rd party equity spend Raise Equity
standard subordinated model
PPP Not off balance forecasts prices financing
debt debt Off balance
sheet down
sheet

Financing options for major infrastructure / CI include:

 Continue with the existing vanilla debt financing strategy (the ‘status quo’ option, already reflected
in current plans); although this need not necessarily involve borrowing directly from Council.
 Issue subordinated debt which can qualify for partial equity credit3 from S&P; thereby reducing the
extent of the debt impact on the Group’s debt to revenue ratio on consolidation.
 Implement a public-private partnership (PPP) structure to manage procurement and operational
risks. It is unlikely that any PPP structure would achieve off balance sheet financing outcomes to
alleviate impact on the Group’s debt to revenue ratio.
 Implement a Finance SPV structure wholly or partly financed with 3rd party equity. To benefit the
Group’s debt to revenue ratio such a structure would need to be “off balance sheet”.

In addition to financing options there are other actions which would reduce Watercare’s forecast debt to
revenue ratio during the period the Group has limited headroom in its debt to revenue ratio; for example:

 Watercare could reduce the level of new financing required through a reduction in capital
expenditure forecasts over that period.
 Watercare could increase its price path thereby increasing revenue and reducing debt by repaying
debt earlier.
The various options have impacts beyond the Group debt to revenue ratio. A summary of key impacts is
included below, measured relative to the status quo vanilla debt financing option:

1
At 30 June 2017 Watercare’s assets are valued at $9b with a debt level of $1.6b. This gives Watercare a debt to asset ratio of 17%, compared
to Vector 40%. PwC has previously provided benchmark data for international water utilities that indicates an international debt to asset
benchmark range of 40-60%.
2
Consistent with Watercare’s obligations under s57 of the Local Government Auckland Council Act
3
A partial equity credit means that part of the debt is treated as equity for the purposes of calculating the debt to revenue ratio. The effect of this
is a reduction in the debt for the purposes of Credit Rating Agency calculations of debt to revenue and therefore an improvement in the ratio.
 Option Impacts / outcomes compared to current plan
Cost to Watercare Risk transfer Council Group
Customer (construction /
operational) Debt : Revenue Debt servicing4
Current plan – debt
financing as per existing
forecasts
Watercare issues
subordinated debt

PPP – Procure, Finance, Potential to

Operate increase cost

Finance SPV with 3rd Unless off balance

party equity stake sheet

Finance SPV with Crown Dependent on If off balance sheet

HIF Model Crown subsidy

Reduced Watercare Potential

capital spend forecasts
Increased Watercare
price path

Key
status quo as reflected in Watercare’s AMP and Council LTP projections
improvement on status quo
no change to status quo
worse than status quo

Equity Financing

There are various scenarios which result in a reduction in Auckland Council equity stake in Watercare and
therefore the removal of Watercare debt from the Council Group debt to revenue ratio. Generally it is
assumed that if Council holds less than 50% of the equity and the remaining equity holders are Crown related
entities this would be sufficient to remove Watercare from the debt to revenue calculation performed by
Rating Agencies.

A number of scenarios have been discussed with Treasury officials in the past. Below are two indicative
scenarios5. Any other scenario can be modelled in terms of its impact on Watercare’s price path and Auckland
Council’s debt headroom.

4
Debt servicing is defined as the ability for Council Group excl Watercare to service currently unfunded debt through Council revenue, noting
that pursuant to s57 of the LGAC Act Watercare cannot return a surplus from increased prices to Council to assist with broader Group debt
servicing.
5
Under both scenarios below the following has been assumed:
- Sell down occurs at 1 July 2018
- Additional price increase is required to pay ROI to shareholder while keeping the following key ratios in check:
o FFO, not less than 2.5
o Debt to debt + Equity ratio, not more than 45%
o Existing planned price rise is average 3% pa and desired new price rise is less than total 5% pa cumulative.
Scenario 1

Auckland Council sell down of 51% of the shares in Watercare for $4b to a Crown related entity who receive
5% return on that equity. Auckland Council does not receive a dividend on its remaining equity in Watercare.

100% Equity Annual shareholder Additional % price Increase in Auckland

value ($m) return increase per annum (for Council debt headroom on
@ 5% ROI – new 10 years) on water and 1 July 2018 from 51%
shareholders ($m) wastewater tariff equity sale ($m)
over and above status quo
planned increases
$8,000 $200 1.75% $4,149

Scenario 2

Auckland Council sell down of 51% of the shares in Watercare for $2b to a Crown related entity who receive
5% dividend on that equity. Auckland Council also receive a 5% dividend on its remaining equity in
Watercare.

100% Equity Annual shareholder Additional % price Increase in Auckland

value ($m) return increase per annum (for Council debt headroom on
@ 5% ROI - all 10 years) on water and 1 July 2018 from 51%
shareholders ($m) wastewater tariff equity sale ($m)
over and above status quo
planned increases
$4,000 $200 1.75% $2,189

Refer to attachments 4 and 4a for further information in this regard.

Legislation and Economic Regulation

You have requested information on the changes to economic regulations that may be necessary to deliver
the Central Interceptor (CI) project.

There are an extensive number of legislative changes required to facilitate the construction and ownership
of the CI by an SPV/SIV which are specific to Watercare Services Limited and water. These are attached as
attachment 5.

Watercare believes that such extensive changes will take about a year to implement.

It is not yet decided what the charging mechanism will be and once decided, there may need to be further
legislative changes. Watercare utilises a “user pays” charge using a volumetric charge based on a uniform
tariff for domestic customers and a tiered tariff for commercial customers. It is possible the SPV/SIV will
charge a fixed rate per property or a charge based on capital value throughout Auckland, either of which, if
implemented, would remove the nexus between the level of use and charging in relation to CI.
There will be the costs of a new governance structure for the new entity to be recovered. It is not known
what the new entity will be, nor what its borrowing costs will be, nor the rate of return the new entity will
require.

What seems certain is that the new entity would set the charge or levy on customers and receive the
associated cash flow to ensure the arrangement can be implemented without negatively impacting on
Auckland Council’s credit rating. It is possible the cost to customers will be greater than if the CI was
constructed and operated and funded by Watercare in the usual manner that it undertakes other major
projects.

This may require legislative change to specify that s57 of the Local Government (Auckland Council) Act 2009
does not apply to the SPV/SIV structure, or any aspect of the proposed arrangements, in respect of the CI.
s57 is unique to Watercare and the background to the passing of the section is attached as attachment 6.

The work to document the business case and the impact of cost to customers has yet to be completed. Refer
to attachment 7 for further information in regard to charging implications on Watercare customers.

Yours sincerely

David Hawkins
Chief Corporate Affairs Officer