Yanco Creek Full Report

Financing Case Study – Yanco Creek Rehabilitation

Project Public/Private Potential Joint Venture –

Preliminary Evaluation. Copernican Securities.

A study conducted for the Pratt Water Murrumbidgee Valley Water Efficiency Feasibility Project.

Financing.Case.Study.Cover 6/12/04 10:37 AM Page 1

MURRUMBIDGEE VALLEY WATER EFFICIENCY FEASIBILITY

PROJECT

Agreement No: Pratt Water 0013 –NAP

Project Title:

Yanco Creek Rehabilitation Project Public/Private Potential Joint Venture - - Preliminary Evaluation

Author(s): Kerry Adby & Ted Brogan, Copernican Securities

Project Leader: Bill Hurditch

Contact Details:

Copernican Securities Ph: (02) 9251-6016 [email protected]

Project Draft Report Version # Final

Date & Time of Last Revision

14 September 2004

A YANCO CREEK REHABILITATION PROJECT

PUBLIC/PRIVATE POTENTIAL JOINT VENTURE PRELIMINARY EVALUATION

This paper has been prepared for purposes only of furthering discussion and does not constitute a feasibility study nor recommendation for investment. Copyright is retained by Copernican Securities Pty Limited. Reproduction or quotation, in whole or in part, for non-commercial purposes is permitted provided that the source is acknowledged and this caveat on use are included. Copying, duplication or use for commercial purposes without the prior express written permission of Copernican Securities Pty Limited is prohibited,

TABLE OF CONTENTS

EXECUTIVE SUMMARY ..................................................................................................... I

Purpose and Key Findings .................................................................................................... I Yanco Creek System Rehabilitation – The Management Plan Proposal................................. II Approach & Methodology ...................................................................................................III Outcomes of the Analysis ..................................................................................................... V Conclusions .......................................................................................................................VII

1. INTRODUCTION & OBJECTIVE OF THIS PRELIMINARY EVALUATION........1

1.1 Objective & Nexus with the Pratt Water Murrumbidgee Project.................................1 1.2 Background to Consideration of Ability to Finance the Improvements & Possible Financing Methods ...............................................................................................................1 1.3 Objectives of this Preliminary Evaluation ..................................................................3 1.4 Why Consider Yanco Creek System?..........................................................................4 1.5 Overcoming Institutional & Historical Hurdles - Important CAVEAT .......................5

2. INTRODUCTION TO MURRUMBIDGEE REGION, YANCO CREEK SYSTEM & NATURAL RESOURCE MANAGEMENT PLAN...............................................................6

2.1 Murrumbidgee Region ...............................................................................................6 2.2 Summary of Yanco Creek System Natural Resource Management Plan Overview.......8 2.3 Key Water Delivery Issues & Potential for Savings & Increased Water Use Efficiencies .........................................................................................................................10 2.4 Overview of Key Stakeholders and Key Issues..........................................................13 2.5 Some Key Assumptions ............................................................................................15

3. OVERVIEW OF THE YANCO CREEK REHABILITATION PROJECT...............16

3.1 Origin of this Project ...............................................................................................16 3.2 What is the Core Project?........................................................................................16 3.3 What Benefits will Result? .......................................................................................17 3.4 Project Variations to Enhance Viability ...................................................................18

4. BALANCING VARIOUS STAKEHOLDER REQUIREMENTS & INTERESTS & ABSENCE OF A SPONSOR................................................................................................20

4.1 Balancing Stakeholder Requirements & Interests .....................................................20 4.2 The Sponsor.............................................................................................................20

5. FINANCING OF THE PROJECT ...............................................................................22

5.1 Differentiating Economic Benefits & Financial Feasibility.......................................22

B YANCO CREEK REHABILITATION PROJECT



5.2 The Management Plan Approach .............................................................................22 5.3 Sources of Financing ...............................................................................................23 5.4 Establishing Sources of “Income” ...........................................................................23 5.5 Determining the Costs .............................................................................................26 5.6 Regulatory Issues.....................................................................................................26 5.7 Financing of the Project ..........................................................................................26 5.8 Categories of Private Investors & Overview of Requirements...................................28 5.9 Debt & Equity Mix...................................................................................................29 5.10 Key Impediments to Successful Project Delivery & Financing..................................29 5.11 Interface with State Water........................................................................................31

6. POSSIBLE FINANCE & OPERATIONAL ARRANGEMENTS...............................32

6.1 Option 1: Public Funding & Provision ....................................................................32 6.2 Option 2: Irrigator – User Funding &Provision.......................................................32 6.3 Option 3: Public Funding & Private Provision ........................................................33 6.4 Option 4: Public Private Partnerships .....................................................................33 6.5 Option 5: Private Funding & Provision ...................................................................33

7. RISK MATRIX, Risk ALLOCATION & MANAGEMENT.......................................35

7.1 Risk Allocation Principles........................................................................................35 7.2 Risks of Yanco Creek Rehabilitation Project ............................................................35 7.3 Potential Risk Mitigation & Management ................................................................36

8. ANALYSIS OF THE ATTRACTIVENESS OF THE INVESTMENT OPPORTUNITY & CONSTRUCTION OF A INDICATIVE HIGH LEVEL FINANCIAL MODEL.................................................................................................................................38

8.1 The Fundamental Proposition Sought to be Tested by this Report ............................38 8.2 Objectives of Construction of the Model & Limitations of the Model at this Stage of Development .......................................................................................................................38 8.3 Key Model Inputs & Assumptions ............................................................................39 8.4 Water Savings..........................................................................................................41 8.5 Funding Arrangements ............................................................................................41 8.6 Volumes of “Saved” Water ......................................................................................42 8.7 Prices of Monetised “Saved” Water.........................................................................42 8.8 Project Cash Flow & Return Sensitivities ................................................................45 8.9 Capex Overruns assumed for YCS Project ...............................................................45 8.10 Operating Costs & Delivery Charges.......................................................................46 8.11 Income Levels & Equity Participation Assumptions & Sensitivities ..........................47 8.12 Gearing ...................................................................................................................47

C YANCO CREEK REHABILITATION PROJECT



8.13 Model - Financial Outputs.......................................................................................48 8.14 The Value Proposition for Water for Rivers or Other Similar public Interest Investor 51 8.15 What The Non-Market Benefit Contribution Charge Represents...............................53 8.16 Conclusion ..............................................................................................................53

9. PRELIMINARY CONCLUSIONS ON POTENTIAL FINANCIBILITY & RECOMMENDATIONS ......................................................................................................55

9.1 Limits on Investment Appeal ....................................................................................55 9.2 Issues are General and Not Project Specific.............................................................56 9.3 Co-ordination Production of a Full Feasibility Study of Bankable Quality ...............56 9.4 Work to Be Undertaken............................................................................................56 9.5 Indicative Timeframe...............................................................................................57

ANNEXURE “A”..................................................................................................................58

ANNEXURE “B”..................................................................................................................59

ANNEXURE “C”..................................................................................................................60

ANNEXURE “D”..................................................................................................................61

_____________________________________________________________________________

D YANCO CREEK REHABILITATION PROJECT



LIST OF TABLES & EXHIBITS Upside, Base & Downside Cases .....................................................................................IV

Investment Internal Rates of Return - Scenario A Monetise Water Savings & Single Fully Participating Class of Equity.....................................................................................V

Investment Internal Rates of Return - Scenario D1 – Monetise Reduced Level of Water Savings with Non-Participating A Class Equity Plus Non-Market Benefit Contribution Charge Based on Total Allocated System Flow.........................................................V

Sample of Cost & Water Acquisition Opportunities for Water for Rivers from Co-Investment in Yanco Creek Rehabilitation Project....................................................VI

Table 1 – Catchment Profile......................................................................................................6 Table 2 – Catchment Zones .......................................................................................................7 Table 3 – Yanco/Colombo/Billabong Creek System Volumetric Allocation Summary.............12 Exhibit 1 – Yanco Creek Flow Transfer Investigation .............................................................19 Table 4 - Comparative Investor Perspectives ...........................................................................28 Table 5 - Indicative Return Requirements of Various Categories of Investors & Lenders.........29 Table 6 - Simple Sample Risk Allocation Matrix.....................................................................35 Table 7 – Sample Risk Management Mechanisms ...................................................................37 Table 8 – Key Issues & Model Assumptions ...........................................................................39 Table 9 - Price - Volume Assumptions Matrix.........................................................................42 Table 10 - Upside, Base & Downside Cases ............................................................................42 Table 11 - Comparator Pricing Levels YCS Project Assumptions Relative to Value of Water

Traded 2002/2003 ...........................................................................................................44 Table 12 - Reconciliation of Model Costs & Management Plan Estimates ...............................45 Table 13 - Water Delivery Charges Proposed Compared with Other Natural Systems..............46 Table 14 - Income Levels & Investor Return - Summary of Sensitivities & Scenarios..............47 Table 15 - Investment Internal Rates of Return - Scenario A Monetise Water Savings & Single

Fully Participating Class of Equity ..................................................................................48 Table 16 - Investment Internal Rates of Return - Scenario B1 - Monetise Water Savings, One

Class of Fully Participating Equity Plus Non-Market Benefit Contribution Paid on Total Allocated System Flow of 154GL....................................................................................49

Table 17 - Investment Internal Rates of Return - Scenario B2 - Monetise Water Savings, One Class of Fully Participating Equity Plus Non-Market Benefit Contribution Paid Only on Water Savings – Assumed at Base Case of 35GL ............................................................50

Table 18 - Investment Internal Rates of Return - Scenario C – Monetise Reduced Water Savings with Non-Participating Class A Equity ............................................................................50

Table 19 - Investment Internal Rates of Return - Scenario D1 – Monetise Reduced Level of Water Savings with Non-Participating A Class Equity Plus Non-Market Benefit Contribution Charge Based on Total Allocated System Flow ...........................................51

Table 20 - Investment Internal Rates of Return - Scenario D2 - – Monetise Reduced Level of Water Savings with Non-Participating A Class Equity Plus Non-Market Banefit Contribution Charge Based Only on Base Case Water Savings of 35GL ..........................51

Table 21 – Sample of Cost & Water Acquisition Opportunities for Water for Rivers from Co-Investment in Yanco Creek Rehabilitation Project ...........................................................52

____________________________________________________________________________

I YANCO CREEK REHABILITATION PROJECT



EXECUTIVE SUMMARY

Purpose and Key Findings

This report forms part of the research undertaken within the Pratt Water Murrumbidgee Project, which is about private investment options to improve water use and to save otherwise wasted water for productive uses. Part of that project is the examination of specific investment projects that have been considered as having the greatest potential to attract private investment and financing. Such examination also fits with the importance allocated by governments to finding “market based solutions” for water use efficiency, including private participation. Whilst there has been increasing discussion of the need to extend “public private partnerships” to rural water in Australia (and debate as to the desirability of such) most of the discussion has taken place either in a theoretical or broad-brush context. The approach to date has tended to be one of: “Wouldn’t it be nice”, rather than “Is it realistic?” and “What is required to make a project bankable?” The prime objective of this report is to attempt to move out of the theoretical and into the practical by:

Exploring the funding requirements for works in a specific area and for a specific project, viz: -“The Yanco Creek Rehabilitation Project”.

Identifying some of the potentially conflicting objectives and stakeholder requirements by putting the project in its situational context.

Examining the potential existing funding options and requirements of various funding parties.

Testing private sector financiability assumptions. Detailing potential impediments. Presenting for further discussion and development a potential alternative

multilateral funding model. Providing a “Roadmap” to progress further consideration of options.

The specific intention is for the report to further discussion and debate. It is NOT meant to provide a “one size fits all” solution. Equally it does not seek to constitute a feasibility study. Rather, the Yanco Creek System (“YCS”) was selected for detailed analysis because of the amount of work already undertaken and documented in the Management Plan and the perception that the project is attractive due to the relatively low cost of the water savings and the strong likelihood of attracting investment. The report seeks to fill, at a preliminary level only, the gap between an economic benefit study and a financial viability and funding and bankability assessment The key findings of this work, based on the YCS case study, are:

1. Within the perceived risk profile of such projects, a 15 per cent internal rate of return is the minimum requirement to attract private sector investment on a standalone basis.

2. This risk profile assumes a number of key impediments can be overcome. The chief one is the provision of clear title to the saved water for those investing in the project. Others key issues for resolution include:

a. Access to land for works and management b. Clarity on the project’s tax status c. Streamlined coordination of environmental planning approvals

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3. Conventionally, scopes for public water infrastructure projects tend overlook or understate significant cost elements. These include transactional elements such as the costs of monitoring and auditing, and the costs of meeting public accountability under typical public-private structures. In the case of the YCS, an additional estimated cost of $4m was identified.

4. These projects need a clearly-defined sponsor entity to initiate and project manage the undertaking of the work. If this is not a Government entity, an appropriate private party needs to be given the authority to do this, perhaps via an “expression of interest” process.

5. This project, if implemented, would deliver benefits to parties other than the immediate water users. These include environmental and other downstream river health benefits. The capture of the value of those additional benefits could provide an income source to enhance the feasibility of the project.

6. The participation of an equity investor whose return is derived solely from an allocation of water (such as Water for Rivers) would enhance its feasibility prospects.

Whilst the report’s analysis and conclusions relate specifically to Yanco Creek many of the issues identified, impediments and conclusions are generic and have wider application to a range of water saving projects. In addition the methodology developed can be employed as an aid in the proper assessment of other public-private investment opportunities. Yanco Creek System Rehabilitation – The Management Plan Proposal

The Yanco Creek System forms part of the effluent regime of the Murrumbidgee River. Water is diverted into Yanco Creek at the Yanco Off-take Weir west of Narrandera and flows south-west to the Tarabah Weir below the junction of Yanco and Colombo Creeks. Once the water joins the Billabong Creek it is diverted, using the Hartwood Weir, to Forest Creek, the unregulated part of the Yanco Creek System. Map 1 (next page) shows the regional setting and system layout. The Yanco Creek System involves:

Approximately 253 licensed private irrigators the water supply to at least 8 towns and a total allocated flow of 154GL per annum that supports directly the livelihoods of a least 1000 people.

A length of 799kms and a complex water system that is an “absolutely critical water supply system to a vast area of the Riverine Plains of NSW”.

Significant environment and ecological issues. A wide range of stakeholders and valid competing interests that need to be

considered carefully and balanced in any proposal for action. The Yanco Creek Management Plan has been jointly funded by both cash and in-kind contributions from members of the Yanco Creek and Tributaries Advisory Council, State Water and the NSW Department of Infrastructure, Planning and Natural Resources. The Management Plan seeks to address the current loses from the system that are estimate to be up to 50%: - 9% from operational losses and 42% through flood runners, overbanking and losses to ground water. The key findings of the Management Plan have resulted in a quest to mobilise $24.5m to undertake rehabilitation works. A major outcome of the proposed works, which have been identified and costed at a preliminary level in the Management Plan, is the saving of 36GL of general security water.

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The works proposed for the Core Project (the Works) consist of: Site and earth works. Removal or reconstruction of selected weirs. Clearing of Willows and Cumbubgi. Selected engineering works. Introduction of and improvement of metering and monitoring. Environmental, landcare and biodiversity works. Fencing. Indefinite ongoing maintenance works.

The benefits of undertaking the rehabilitation are stated to be:

Economic, including: o Expanding of existing irrigation and encouraging significant additional

investment in on-farm and off-farm projects. o Constructions of new water storage systems to more efficiently manage and

utilise water in peak times. o Attracting new investment in agriculture and other industrial sectors due to

increased water availability and efficiency. Environmental, biodiversity and landcare through retaining the saved water in the

Yanco Creek System and: o Improving surface water quality. o Reducing dryland salinity and water logging. o Minimising irrigation salinity and waterlogging. o Reducing soil erosion and soil acidity. o Reducing stream bank erosion and riparian degradation. o Improving wetland health and arresting native vegetation decline and

reducing weeds, pests and feral animals. Social via:

o Improving the viability of existing landholders and irrigators and creating new opportunities for training and employment.

o Implementing more sustainable agricultural and environmental practices by adopting new technology.

o Contributing to the survival of local and regional communities and retention of education, health, research and financial services through the strengthening of the regional economy.

In the absence of savings current irrigators are facing potential 5% reductions in allocations. Critically if the Management Plan’s assumptions are correct undertaking the Works will result in, in the order of 36GL of, water savings some or all of which can potentially be returned to the river. The Management Plan estimated a cost of $700 for each ML of water saved. At this cost to savings ratio the project was considered to be very attractive. Approach & Methodology

The report outlines the various funding options from public sector to exclusive private sector funding and public private partnerships. The basic assumption is that the project will not be funded exclusively by the public sector and consequently the focus is on the need to attract at least part of the funding from the private sector and for the private sector to carry, in respect of its investment, the majority of project and market risk. The return requirements and acceptable risk profile of different categories of private sector investors are considered and a sample risk allocation matrix is presented. The sample matrix,

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which forms the platform for the finance model and the analysis, allocates construction, market, and operational risk to the private sector but proposes that government retain the regulatory risk. In addition for successful initiation of the project assumption of the currently missing Sponsorship role by government will be necessary. The role of the Sponsor incorporates the funding and development of a full feasibility study, the obtaining of necessary approvals, permits and access rights, the development of a regulatory regime and of a Concession proposal that can be used as the basis for soliciting form the private sector Expressions of Interest or bids in response to a Request for Tenders. Without a Sponsor it is unlikely that many projects will proceed beyond the “discussion” stage to implementation. The considerable funds, resources and goodwill invested in the initial evaluations will be wasted and many opportunities to improve efficiency and achieve savings will falter. In undertaking the analysis we have:

1. Substantially relied on the assumptions, scope of the works, the data, assumptions, conclusions and costings of Capex and Opex contained in the Management Plan.

2. Undertaken NO independent verification of the Management Plan data, costings, assumptions or conclusions.

3. Identified a range of risks and impediments that apply to the project. 4. Assumed that it will be necessary to attract independent 3rd party investors whose

only returns will come from the project, which must be assessed, on a standalone basis. A return hurdle is set at an IRR of 15%.

5. Assumed that water savings can be accessed by investors under a Concession Deed (entered into with the State government) for a term of 15 years and monetised (sold) by way of permanent transfer to produce income as the saving arise. The Concession Deed or other mechanism would also provide access to the land to undertake the initial works and to allow for operation and ongoing maintenance. The Concession Deed would obligate the investor/s to make the investment, carry out the works and operate and maintain the system for the term of the Concession in accordance with the performance criteria detailed in the Concession and suffer substantial financial penalties for non compliance.

6. Developed a Base Case, Upside and Downside Cases for water savings quantities, the prices at which the savings made can be sold and a range of investment structure and income support scenarios. We then ran a series of funding cases and sensitivities through the application of our financial model.

7. Assumed project costs of $29.7m in contrast to the Management Plan’s assumed comparative costs of $25.4m. The additional cost representing additional consultancy scoping costs, a 15% contingency, and additional costs for monitoring, revegetation, fencing and insurance. Operating costs have also been increased to provide for monitoring, management, and undertaking ongoing maintenance works. We have not sought at this stage to optimise the funding structure through gearing, delaying capital injections etc; as the level of accuracy of data does not, at this stage, warrant such attempts at precision.

8. There are three classes of initial investors, each class of which invests $5m (a total of $15m of equity). The investor classes are: Irrigators or other users, independent institutional investor and a public interest investor such as Water for Rivers.

The Base, Upside and Downside cases used to generate the income levels are set out in the Table below.

Upside, Base & Downside Cases SCENARIO DOWNSIDE CASES BASE CASES UPSIDE CASES

A & B 25 GL @ $500 ML 35 GL @ $750 ML 45 GL @ $1000ML C & D 20 GL @ $500 ML 30 GL @ $750 ML 40 GL @ $750 ML

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Internal Rates of Return (IRRs) generated for each of the Base, Upside and Downside Cases under four separate scenarios and structures were calculated to allow an assessment to be made of the potential of the project to attract private sector investors. The scenarios and structures were:-

1. Scenario A – Monetise Water Savings – Single Class of Fully Participating Equity Held by All Investors.

2. Scenario B 1 and Scenario B2 - Monetise Water savings + Single Class of Fully Participating Equity + additional income from Non-Market Benefit Contribution Charge.

3. Scenario C - Monetise Water Savings Plus Introduction of a Class of Non-Participating Equity.

4. Scenario D1 and D2 - Monetise Water savings + Two Classes of Equity (one class Non-Participating) + additional income from Non-Market Benefit Contribution Charge.

Outcomes of the Analysis

It was clear from the IRRs produced by the simplest standalone case, that is from only the sale of water savings, were insufficient to meet the hurdle rate of 15% considered necessary to attract private sector investors. The returns are set out below:-

Investment Internal Rates of Return - Scenario A Monetise Water Savings & Single Fully Participating Class of Equity

VOLUME OF WATER SAVED GL

$500 ML $750ML $1000 ML

25 -11.25% -0.72% 2.21% 35 -1.44% 2.77% 6.66% 45 1.12% 6.07% 12.02%

Of the range of scenarios explored only one met the hurdle requirements, Scenario D1:-

Investment Internal Rates of Return - Scenario D1 – Monetise Reduced Level of Water Savings with Non-Participating A Class Equity Plus Non-Market Benefit Contribution Charge Based on Total Allocated System Flow


$500 ML + NON-MARKET BENEFIT CONTRIBUTION $17.25 ML ON TOTAL ALLOCATED SYSTEM FLOW - 154 GL

$750ML + NON-MARKET BENEFIT CONTRIBUTION $17.25 ML ON TOTAL ALLOCATED SYSTEM FLOW - 154 GL


20 9.24% 11.20% 13.70% 30 11.20% 15.07% 19.57% 40 13.70% 19.57% 26.46%

Scenario D1, by way of comparison with Scenario A detailed above, assumes that not all water savings are monetised. The monetised savings in each of the Downside, Base and Upside Cases are reduced by 5GL. This 5GL is then allocated to Water for Rivers for return to the river. In return for this allocation Water for Rivers is allocated a special, A Class equity entitlement (or shareholding) which does not entitle Water for Rivers to participate in dividends or return of capital distributions, instead it receives its return solely from the “acquisition” of the 5GL for its investment of $5m. Scenario D1 is the same as Scenario C (which did not produce acceptable hurdle rates of return) except that the returns to investors are topped up through the payment of a Non-Market Benefit Contribution, which has been applied to the total allocated system flow of 154GL and set at a level of $17.25Ml per annum. This is the level of income that needs to be added to the other

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project income so as to permit the investor to receive a hurdle rate of IRR of 15% in the mid range cases. The Non-market Contribution Charge allows the capture of the externality benefits that accrue not only to irrigators and to other users but also to the wider community and to the economy at large. The Non-market Benefit Contribution Charge has, for benchmarking and calculation purposes only, been likened to a delivery charge based on either total YCS allocated flows (154GL) or the Base Case level of water savings generated by the YCS project (35GL). It is not intended, however, to suggest that only current users should fund the Contribution Charge, as they are not the sole or even principal beneficiaries of the benefits. The beneficiaries of the YCS Project include: current water users; additional users; landowners; State Water; local governments; State governments; the environment; other water provider companies and their irrigator companies; local communities; the regional economy, etc;.

The Contribution Charge is in essence a “plug”. It represents the additional amount of income that the project needs to earn from some source other than from the sale of the water savings for the project to generate sufficient income in total to meet the targeted IRR considered necessary as a minimum to attract private investment in the YCS Project. The Contribution Charge can be levied on, and shared amongst, a range of beneficiaries and be received in a wide range of forms and combinations, for example from one or more of the following,- grants, low interest loans provided by government to salinity, environmental or biodiversity charges or credit, additional delivery charges, etc. Scenario D1 provides a funding case, which we believe, based on the costings currently available, may be sufficient to attract private sector investment on a stand-alone basis. Scenario D1 is underpinned by two fundamental assumptions, first the ability to raise funds from the capture of the externalities or non-market benefits accruing to other than immediate users and the participation of a public interest investor with an interest in mobilizing investment in and generating water savings for return to the river. The value proposition for an investor such as Water for Rivers is illustrated in Table 21 which s extracted below:

Sample of Cost & Water Acquisition Opportunities for Water for Rivers from Co-Investment in Yanco Creek Rehabilitation Project

WATER ENTITLEMENT UNDER SCENARIO D

PURCHASE @ BASE CASE PRICE OF $750ML

PURCHASE @ MARKET PRICE OF $1000ML

TOTAL WATER FOR RIVERS ACQUISITION OF WATER FOR RETURN TO THE RIVER

Option 1 Investment $5m only

5 GL 5 GL for total cost of $5m

Option 2 In addition to Option 1 - Exercise right to purchase 1/3 of savings as a 1/3 equity holder

5GL 10 GL 15 GL for total cost of $12.5m

Option 3 In addition to Options 1 & 2 purchase additional 1/3 at market price

5GL 10GL 10GL 25 GL for total cost of $22.5m

Option 4 In addition to Options 1 & 2 & 3 purchase additional 1/3 at market price

10GL 35GL for total cost of $32.5m

For the project to be acceptable to investors, however, even if the hurdle rates of return can be met a number of the significant impediments and risks need to be addressed or removed.

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In all cases, however, it is essential that:

1. The bulk of the benefit water savings can be captured by investors to generate project income. It is necessary to clarify that the CAP does not apply to the savings.

2. Water savings from undertaking the project can be sold and that title and the level of security is clear.

3. Regulatory risk to investors and to purchasers (including the level of security applicable) is minimized.

4. The taxation regime for water providers such as the Concessionaire can be clarified and the same taxation treatment available to other water providers and or those undertaking conservation projects is achieved.

5. Access to land to undertake, operate and maintain the project works is available on a secure basis.

6. An efficient mechanism to co-ordinate planning approvals is developed. Whilst there has been considerable work undertaken often on an informal basis, at catchment, stakeholder and regional level to attempt to identify potential savings opportunities one major impediments identified, which applies virtually across the gamut of off-farm water savings projects, and not just in the case of Yanco Creek, is the absence of any process, procedure, protocol or entity charged with the role of acting as a sponsor or project initiator to:

independently assess at a preliminary level the viability of proposals, or take projects forward to full feasibility and implementation

Conclusions

What is clearly illustrated by the application of the finance model to the anticipated cash flows is that in most situations it will not be as easy as was possibly anticipated by the Management Plan to attract external parties as investors unless that party has itself a use for the water and therefore achieves a return on its investment outside of the project cash flows and returns. Independent private sector investment can only be achieved if project earnings from the sale of water can be “topped up”. The form of the topping up can vary and may include a combination of support mechanisms. In addition a range of impediments need to be addressed and rsks clarified or removed. Most of the issues raised and risks identified are not unique to the Yanco Creek project but are common to the asset class as a whole. These issues need to be addressed if independent third party investment is to be attracted into the rural water sector.

Rates of return approaching those required to attract independent third party investors can be achieved if the project has access to the water savings, is able to monetise the savings at between $750 and $1000 per ML and can capture the externality benefit. Whilst the prices required are currently within the range at which water is trading in a number of south eastern Australian Catchments there is an issue as to how sustainable those prices will be in a range of climatic conditions and historic sub economic pricing regimes. A significant apparent deficiency of the Yanco Creek Project (which is the case also for a large number of water savings related projects) is that whilst there is a range of parties with considerable interest in the project and with it being advanced no single party is in control nor has the capacity to make it happen. Progressing this project to the next stage will require the funding and sponsoring of a full feasibility study. Active participation of government as the catalyst for the project and to provide regulatory certainty is essential.

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1. INTRODUCTION & OBJECTIVE OF THIS PRELIMINARY EVALUATION

1.1 Objective & Nexus with the Pratt Water Murrumbidgee Project

The Pratt Water Murrumbidgee Project is about private investment options to improve water use efficiency and to save otherwise wasted water for productive uses. Whilst a significant part of the work to date has concentrated on evaluation of technical aspects of water saving and efficiency, from a business perspective, Pratt Water wishes to examine specific investment projects and opportunities, and establish which ones have the greatest potential to attract private investment or financing. For their part governments have agreed on the importance of finding “market based solutions” for water use efficiency, including private participation. This report forms part of the Pratt Water Murrumbidgee Project. The purpose of this analysis component of the work is to examine a "live" investment project from a business perspective, and to identify possible options by which it can be confidently financed. From this, models and principles can be developed which could be applied more broadly to the water use efficiency task within the Murrumbidgee and beyond. For this purpose, the Yanco Creek System was identified as warranting specific analysis. This analysis includes:

a. Identifying the aims of the various stakeholders in that water supply and use area.

b. Exploring financing issues and impediments (including, market, property/title

and regulatory).

c. Constructing and testing a series of scenarios by which the required water-saving works can be financed by private entities, or a mixture of private and public entities.

d. Recommending changes to current governance, finance, regulation and market

operation to enable this investment, and others like it, to proceed. 1.2 Background to Consideration of Ability to Finance the Improvements & Possible

Financing Methods

Historically rural water supply and carriage have been funded by a combination of public funding, user groups, and private individual financing. The majority of private financing of rural water infrastructure to date has been in relation to on-farm, or on-property, systems, diversions, and storage facilities. Public financing, generally at State or Local Government level, has been in relation to storage, flood control and diversions, the provision of off farm irrigation infrastructure, rural town systems and water treatment. User groups directly, or sometimes via designated Trusts or via levies collected by public authorities, have been concerned with the financing of specific facilities involving the establishment maintenance of storage, diversion and maintenance of waterways and irrigation systems and treatment facilities. The fact that tolls or charges from user groups were included in the financing mix has lead some to assert that these “public” assets were privately financed and in some cases to assert an “entitlement” to or claim over the assets. Payment of a levy, which may include a capital charge and or replacement component, is not however the same as




private funding as it does not carry with it the risks of ownership nor, historically, has the levy or toll included a financing or “cost of capital” charge. Recently in NSW there has been a transfer of public owned (but often partly user funded) irrigation infrastructure assets to private ownership in various forms but generally controlled by user groups). Historically, funding and provision of facilities have often on a piecemeal basis and priorities for the allocation of funds often being difficult to discern. The past two decades have seen increasing moves to greater co-ordination across Catchments and whole systems, as between users, uses, pricing, the control of maintenance and the provision of infrastructure. In part this has been the result of the recognition that action taken in one location can have a significant impact on other parts of the system and the need to rectify prior damage to the environment. Under provisioning for refurbishment of systems and core infrastructure together with significant expansion in usage of irrigation and historic under-pricing of water have also left some difficult legacies. Changes in water pricing policies, salinity issues and requirements for return of water to the environment and biodiversity requirements have placed increased focus not only on the refurbishment of existing asset but on the necessity for leapfrog actions to improve efficiency of water usage, transport and distribution at all levels. Dealing with these problems on a one off basis will not provide the answer. The period has also experienced a significant changes, on a universal basis, in policies and attitudes as the role of government and the provision and pricing of what over the pervious hundred years had increasingly become to be seen as “publicly provided and often publicly subsidised services”. A range of new delivery models have emerged, and in some cases remerged, which combine public and private provision and financing and the purchase and sale of specific deliverables or outputs of benefit either to specific user groups or of public benefit. Meeting the demands for:

greater conveyance, system, and user efficiencies; funding and financing the maintenance and refurbishment of existing systems and

infrastructure;

addressing salinity and environmental issues;

facilitating the move over time to more appropriate water pricing regimes and consequent industry restructuring or crop change;

regional development, and

the concerns of a range of stakeholder groups

in an environment of a changed role of government and increased social responsibility is leading to changes in regulatory regimes that affect water usage and entitlements. Traditional bilateral models of ownership, funding and financing are unlikely to be suitable to meet the requirements of a concept of multilateral “ownership” and responsibility. Nor can it be assumed that public financing of off farm infrastructure will continue to be the norm.




What has become apparent is that facilitation of the introduction of change, meeting of future needs, and the delivery of efficient improvements, refurbishment of existing assets will require the development of new funding, financing and ownership models. Such models will need to recognise and balance the legitimate requirements of all interest groups for certainty and access and simultaneously have the capacity to efficiently mobilise funding from a range of sources to achieve both public and private objectives. Equally apparent is the fact that a single model will not be appropriate to the wide range of different physical, environmental, and economic circumstances. 1.3 Objectives of this Preliminary Evaluation

The concept of private provision, funding and financing of infrastructure has taken over a decade and a half to emerge and become established in Australia as a legitimate and competitive method of “public” infrastructure provision. During the course of the creation of a new model some types of infrastructure have shown themselves to be more suitable and/or publicly acceptable for private provision and funding than others. Not all private or public/private projects have been successful nor has the risk/reward profile in all been suitably, or transparently, allocated. To the contrary they have at times been significantly skewed towards o either the public or private sector participant. Despite problem projects, and the not unexpected difficulties in the establishment of the ground rules of a new model of asset ownership and service delivery, significant benefits have resulted from the opening up of infrastructure and markets to competition, innovation, new technologies and contestability. Significant benefits have resulted from:

The greater level of social benefit and economic and financial analysis associated with infrastructure projects overall and the focus on impediments to co-ordinated approaches and to change.

The increased transparency in total project cost and examination of comparative

delivery options and mechanisms.

The documentation and publication of input and output deliverables and performance indicators.

Increased focus on and greater levels of accountability for ongoing maintenance

and compliance with output and service delivery standards and the application of penalties for non-performance.

Increased innovation in provision and funding and in the introduction of new

technologies, management, and operational models.

Realisation that there is a significant cost to bidding and that to attract ongoing private sector interest in participation government needs to recognise the value of intellectual property and to develop an appropriate process for involvement of the private sector and not raise false expectations or engage in “fishing expeditions”.




The recognition that both the public and private sectors need to balance obligations to shareholders, users, customers and the wider community and to be accountable for their actions. The private sector cannot be expected to finance projects with inadequate returns or where the risks (including those associated with uncertain regulatory environments) relative to returns are not sufficiently attractive. Equally, government cannot be expected to take the risks, including electoral backlash, and the private sector an inappropriate share of the rewards.

Recognition that achievement of “efficiency” may disadvantage particular groups

or policy objectives and that achieving the desired social and economic outcomes may require government to look at new mechanisms to either compensate particular groups or to ensure that wider public benefits are achieved. In achieving a balanced outcome both the public and private sectors have legitimate roles.

Whilst there has been increasing discussion of the need to extend public private partnerships to rural water in Australia (and debate as to the desirability of such) most of the discussion has taken place either in a theoretical or broad-brush context, of: - “Wouldn’t it be nice?” rather than “Is it realistic?” and “What is required to make a project bankable?” The prime objective of this report is to attempt to take that discussion to a new level by:

Exploring the funding requirements for works in a specific area and for a specific project, viz: -“The Yanco Creek Rehabilitation Project”.

Identifying some of the potentially conflicting objectives and stakeholder

requirements by putting the project in its situational context. Examining the potential existing funding options and requirements of various

funding parties.

Testing private sector financiability assumptions.

Detailing potential impediments.

Presenting for further discussion and development a potential alternative multilateral funding model.

Providing a “Roadmap” to progressing further consideration of options.

The specific intention is to Further Discussion & Debate NOT to provide a one size fits all solution. Equally it does not seek to constitute a feasibility study. 1.4 Why Consider Yanco Creek System?

The Yanco Creek System (“YCS”) has been selected for evaluation as a “case study” for several reasons:

1. The recent completion and public availability of the Draft Report –“The Yanco Creek System Natural Resource Management Plan” (the “Management Plan”), Stage 1, Yanco Creek and Tributaries Advisory Council.




2. As a case study it incorporates a wide range of issues of the type that may need to be addressed in other projects.

3. It is perceived by some commentators to be an “easy project” to finance as it is seen

to deliver significant water efficiencies and “savings” for a relatively low level of investment.

The objectives of this report are:

1. First to consider the issues in the context of a private financing environment and to seek to suggest solutions, and

2. Secondly, to test the “ease of financiability” assumption.

1.5 Overcoming Institutional & Historical Hurdles - Important CAVEAT

In undertaking this paper we have relied exclusively on prior studies provided to us together with some interviews and site visits. Those studies include:

The Management Plan1. Sinclair Knight Merz study, “Yanco Creek Flow Transfer Investigation”, 2002 Report to the Murray Darling Basin Commission, “Scope for Water Use Efficiency

Savings as a Source of Water to meet increased Environmental Flows – Independent Review”, March 2003, ACIL Tasman.

We understand that those reports constitute the most comprehensive set of data publicly available and have relied on the data included in those reports. No independent verification of the content of those reports or studies has been undertaken. Many of the studies are preliminary in nature and often were prepared for quite different purposes other than the use to which they are being put for the purposes of this preliminary discussion paper. In using those reports and studies for the purposes of this paper it is clearly recognised that there are considerable shortcomings and a range of assumptions have had to be made. As noted above this report is NOT and does not purport to be in any way a feasibility study or a recommendation on investment. It is preliminary in nature and is intended to provide only an indication of the potential for public/private partnerships in this area, of some of the issues and of the conflicts potentially involved. No independent verification has been made of the capital or operational costs of the Project no of the claimed potential levels of water savings. It is not intended to be conclusive but rather to add to the discussion and to provide a platform and framework for further discussion and work.

These CAVEATS should be clearly understood.

1 Peter Beal, Lee Furness, Jim Parret and Rob Scriven, The Yanco Creek System Natural Resource Management Plan, Stage 1, Draft, 2004.




2. INTRODUCTION TO MURRUMBIDGEE REGION, YANCO

CREEK SYSTEM & NATURAL RESOURCE MANAGEMENT PLAN

2.1 Murrumbidgee Region

a) Overview

The Murrumbidgee Region is in southern New South Wales and represents eight per cent or 84,000 km2 of the Murray Darling Basin.2 From the mountainous and undulating land in the east around Lake Burrinjuck and Lake George, the region, or Catchment, extends to the semi-arid plains around Griffith and Balranald. Rainfall ranges from 320 mm to 990 mm in the west and east respectively with evaporation in the west around 1800 mm each year reducing to 1300 mm in the more mountainous areas.3

b) Catchment Profile Summary

Key characteristics of the Catchment are summarised below:

Table 1 – Catchment Profile4

Major urban centres and towns

Wagga Wagga, Canberra, Queanbeyan, Cooma, Yass, Cootamundra, Tumut, Gundagai, Junee, Henty, Narrandera, Leeton, Griffith, Coleambally, Hay, Balranald

Major tributaries Tumut River, Yass River, Tarcutta Creek, Jugiong Creek, Goodradigbee River and Numeralla River.

Major natural resource issues

Surface water quality, dryland salinity and water logging, irrigation salinity and water logging, soil erosion, soil acidity, streambank erosion, riparian zone degradation, wetland health, native vegetation decline, weeds, pests and feral animals and river regulation.

Water infrastructure 14 dams including, Burrinjuck and Blowering Dams, with capacities of 1.026 million megalitres (ML) and 1.628 million ML respectively. Eight large weirs More than 10,000 kilometers of irrigation channels.

Tenure Nearly 15 per cent of the Catchment is under public and Crown Land management.

c) Catchment Zones

Because of its size and variations, the Murrumbidgee Region is often considered as four distinct zones.5

2 Meredith Hope and Marcus Wright (eds.), Murrumbidgee Catchment Irrigation Profile, Orange, NSW Agriculture, 2003, p.1. 3 Ibid, pp.1-2. 4 Murrumbidgee Catchment Management Board, Murrumbidgee Catchment Blueprint, NSW Department of Land and Water Conservation, 2003, p.15. 5 Hope and Wright, op. cit., p.17.




Table 2 – Catchment Zones

The zones are: The Upper Catchment: Characterised as the region with an elevation greater than 500 meters including the western slopes of the Great Dividing Range and the Snowy Mountains Hydro Electric Scheme. The Mid Catchment: Described as the area east of Burrinjuck Dam to west of Wagga Wagga, the area is predominantly used for industrial and agricultural purposes given its fertile alluvial floodplains and available water supply. The Lower Catchment: Including the Yanco Creek System the lower catchment extends downstream of Wagga Wagga to Balranald. The relatively flat landscape has productive floodplains with significant irrigation operations including Murrumbidgee Irrigation (MI) and the Coleambally Irrigation Cooperative Limited (CICL). The Murray Catchment Management Committee Area: The Murray region includes aspects of the YCS. Yanco Creek is described as an ‘effluent’ of the Murrumbidgee River and eventually joins the Murray River downstream once the water has passed though Billabong Creek and the Edward River. On the riverine plains towards the west of the Catchment, regulation of the river has enabled irrigation and the production of irrigated commodities including rice, cereals, vegetables, citrus, wine grapes and stone fruit.6 Use of irrigation was encouraged by the NSW government (now managed by State Water) to enable farmers to maximize the region’s temperate climate production potential. Approximately 345,000 hectares (ha) are under irrigation in the region and the area accounts for approximately 30 per cent of the total area under irrigation in NSW.7 To enable substantial irrigation, “massive diversion weirs and supply and drainage canals were constructed”.8 Irrigation in the Catchment was legislated for in 1906 and in 1910 the Murrumbidgee Act was passed with the Murrumbidgee Irrigation Area (now Murrumbidgee Irrigation) being established in 1912 with settlers arriving to farm the newly subdivided pastoral properties.9 The region was divided into irrigation areas with the Yanco Irrigation Area defined as 88,760 ha with 1173 farms. Over 70 per cent of landholders are irrigators producing rice, vines, citrus and pastures. Murrumbidgee Irrigation (MI) and Coleambally Irrigation Cooperative Limited (CICL) are the major water users accounting for 71 per cent of the total water used within the Murrumbidgee Valley by 874 licensed users.10

d) Background to the Yanco Creek Management Plan

The YCS is part of the Murrumbidgee Catchment. With 253 private irrigators drawing from the regulated YCS and the unregulated Forest Creek area, maximising the use and value of the water through the system is a priority.

6 Ibid., p.2 7 Ibid. 8 Ibid. 9 Ibid., p.21. 10 Josh Carmody, Baker and McKenzie, pers. comm. 16 June 2004.




From the most recent available figures (1996/97), the total value of agricultural production from irrigation in the area is $476 million using over 2,400,000 ML of water. For the YCS, 1400 ML per day on average flows into the system from the Murrumbidgee River diverted from the main river at the Yanco Creek Off-take Weir. Of that it is believed that in the order of 50 per cent of the water is “lost” within the river system. Whilst this loss both in the YCS and across the Murrumbidgee River Valley is acknowledged, a recent study concluded that the volume of water used “… cannot be accurately determined, as data on the extraction of water from some sources were either scant, or were never collected”.11 With the need for more effective management of water resources for sustainable practice, the Murray Darling Basin Council introduced a limit on water use.12 Known as “The CAP”, the limit is enforced through a range of plans and water sharing agreements with implementation through various agencies and groups including State Water, water service providers and Catchment Management Authorities. 2.2 Summary of Yanco Creek System Natural Resource Management Plan Overview

The YCS, Australia’s longest inland creek system, is a regulated stream of the Murrumbidgee River. Originally an ephemeral stream, the construction of weirs from 1856 now means water flows all year through the 799 km system with 253 licensed water users drawing water from the river system. An average landholdings consists of 180 hectares with an annual water allocation of 972 ML (known as one unit) and multiples of 972, either half or full additional allocations (i.e. 486 or 972 ML per annum respectively).13 The Yanco Creek irrigation area is recognised for growing of winter cereals and summer crops including citrus, stone fruit, wine grapes and rice. The total value of agricultural production is estimated at around $70 - 100 million, which contributes a further $200 - $300 million in benefits to the region.14 The Management Plan was developed through research and a series of consultations and seeks to attract $24.5 million investment in a major infrastructure upgrade to deliver water to the Yanco Creek System (YCS), part of the Murrumbidgee Catchment.15 This investment is expected to result in a potential saving of 36,000 ML of water now currently ‘lost’ in the river system.16

a) Investment Proposal Presented in the Management Plan

The Management Plan suggests a preliminary case for consideration of investment. Prepared using the principles required through various catchment management processes and consistent with the goals of the Murrumbidgee and Murray Catchment Blueprints, the plan “asks for commitment from both individuals and organisations to share responsibility for underpinning the health and productivity of the Yanco Creek System both now and for future generations”.17

11 Hope and Wright, op. cit., p. 3. 12 NSW Irrigators Council, ‘Information’ <http://www.nswirrigators.org.au/pages/irrigation.html 13 MIA and Districts Land and Water Management Plan, p.27. 14 Meredith Hope and Marcus Wright (eds.), Murrumbidgee Catchment Irrigation Profile, Orange, NSW Agriculture, 2003, p.2.; and Beal et al, Ibid., p.22. 15 Peter Beal, Lee Furness, Jim Parret and Rob Scriven, The Yanco Creek System Natural Resource Management Plan, Stage 1, Draft, 2004, pp.57-58. 16 Lee Furness, Murrumbidgee Private Irrigators Inc. pers. comm., June 11 2004. 17 Beal et al, p.i.




The key focus of the Management Plan is to improve, and then maintain, a system of reliable water delivery to achieve water savings by:

Reducing the stream flow impediments; Maintaining the YCS to enhance the riparian and ecological health of the system;

and

Developing community ownership, participation and empowerment for managing the system’s natural resources.

To achieve this, 53 actions have been identified and presented in the report. These provide a basis for further investigation to determine the investment potential of the proposal.18

b) Management Plan’s Case - Investment Required and Expected Benefits –

The key findings of the Management Plan have resulted in a quest to mobilise $24.5 million for the YCS refurbishment. This quest is based on the belief of the authors of the Management Plan that once the works are completed, the investment will result in 36,000 ML of “saved” general security water per annum, including an immediate saving of 11,000 ML at Forest Creek.19 Estimated at a cost of approximately $700 for each ML of water saved, the project is considered to deliver water savings at a very competitive rate. Combined with the potential from using the additional water, it has been argued that the project could deliver a viable investment proposal, once appropriate mechanisms to establish ownership of water rights is clarified. The strong community support and willingness of landholders in the YCS to partner with others in funding the costs of the investment proposal is considered to enhance the opportunity to attract the balance of the funds required.20 Without increased efficiency, the water users of the YCS are expected to lose a further five per cent of total water allocation to achieve greater environmental flows as prescribed through the Water Sharing Plans. Locally, water users would like to retain the saved water losses to expand enterprises, attract new investment, and ensure the viability of communities and the environment for the long-term sustainability of the region. Given the average entitlement per property of 972 ML, with some buying of additional water allocations, the 36,000 ML of saving represents 37 additional allocations, each of 972 ML increasing the potential for expansion, new investment and maximising water flows for environmental purposes. Access to these water savings by irrigators is clearly an important consideration. What is unclear is whether this objective is compatible with either attracting the balance of investment required or the competing demands of other stakeholders, including the environment.

c) Basis for the Management Plan

The Management Plan builds on substantial works already completed in the region. It incorporates proposals from government, irrigators, communities, and other landholders to improve water efficiency and achieve water savings for the benefit of existing and new water users and the broader region.

18 Beal et al, p.iii. 19 Lee Furness, Murrumbidgee Private Irrigators Inc. pers. comm., June 11 2004. 20 Beal et al, p.58.




The study, jointly funded with both cash and in-kind work from members of the Yanco Creek and Tributaries Advisory Council, State Water and the Department of Infrastructure, Planning and Natural Resources, seeks to address the current water losses from the system. Currently over 50 per cent of the water through the YCS is lost, 9 per cent through operational losses and the remaining 43 per cent through flood runners, overbanking and losses to ground water. The Management Plan is a strategic document and from it an operational plan for implementation is being developed.

d) The System

The YCS forms a major part of the effluent regime of the Murrumbidgee River. Water is diverted to the Yanco Creek at the Yanco Off-take Weir, west of Narrandera, and flows south-west to the Tarabah Weir below the junction of the Yanco and Columbo Creeks. Once the water joins with the Billabong Creek, using the Hartwood Weir, it is directed to Forest Creek, the unregulated part of the YCS. Within the 799 km system, additional water flows to supplement peak summer demands can be supplied by the Coleambally Irrigation drainage canal. The YCS is included in both the Murrumbidgee and Murray Catchment Blueprint Plans as the water flows from the Murrumbidgee and drains into the Murray River. 2.3 Key Water Delivery Issues & Potential for Savings & Increased Water Use Efficiencies

a) Impediments causing Water Losses in the Yanco Creek System

The two major supplies of water entering into the YCS are from the Yanco Weir Off-take on the Murrumbidgee River and from the Coleambally Catchment Drains (CCD), DC800. The maximum volume of water directed into the YCS from the Yanco Weir Off-take is 1400 ML per day without major flooding occurring. Supply into the YCS is dependent on a number of factors.21 These include:

The variability of the inflows into the upper reaches of the Blowering and Burrinjuck dams, the two main irrigation storage systems within the Murrumbidgee Valley that deliver water to the YCS.

The capacity of in-stream infrastructure including weirs, channels and physical

impediments of siltation slugs, large woody debris, Cumbungi (weed) and Willows.

Water flowing into runners and now disused streams.

b) Maximising Access to Water Allocations

With summer cropping, introduced in the 1980s, along with existing winter cropping, water demand to respond to seasonal requirements has become an even more critical issue.22 This, combined with the predicted losses of up to 52 per cent together with limited and variable

21 Peter Beal, Lee Furness, Jim Parret and Rob Scriven, The Yanco Creek System Natural Resource Management Plan, Stage 1, Draft, 2004, p.iv. 22 Beal et al., p.27.




measuring (with only 5 measuring points throughout the 799 km system) has highlighted the need to improve the system and supply of water management. Water is allocated into the YCS through a cascading regulatory framework based on the Water Management Act (2000) (amendments are currently being implemented by the State Government) with the total water allocation in the system defined by the Murray Darling Basin Commission. This is known as “the CAP” and limits the total allocation of water available for use throughout the system, including for environmental purposes. The CAP feeds into the management plans of State Water, the key bulk water provider for NSW, and is reflected in regionally based water sharing plans. The water sharing plans form the basis for local implementation plans created by the Catchment Management Authorities. The total water allocations along the Yanco Creek, Colombo Creek, Billabong Creek Forest Creek, Puckawidgee-Moulamein Systems, as detailed in the Table below, are stated to be 154,687ML. Allocations are limited, however, the river regulation volumes are based on previous operational limits. Delivery of regulation amounts to cater for summer cropping is subject to other practical limitations due in many instances to the current state of the system, including:

The inability to predict an increasing demands in various sections due to the long travel time and excessive losses.

Unsatisfactory flow monitoring systems.

Physical constraints and lack of re-regulation capacity in the system due to, for

example, overshot weirs.

Channel capacity restrictions due to infestations of Willows, LWD, and Cumbungi.23

It is these constraints and others that the Management Plan rehabilitation proposals seek to address. The proposals are not without precedent and previous work, limited to de-snagging in 1992, was able to achieve a 15% capacity increase in one section of Colombo Creek.

23 Peter Beal, Lee Furness, Jim Parret and Rob Scriven, The Yanco Creek System Natural Resource Management Plan, Stage 1, Draft, 2004, p.7.




Table 3 – Yanco/Colombo/Billabong Creek System Volumetric Allocation Summary24

No Licences

Total Area (HA)

Irrig (ML)

Town (ML)

Other (ML)

Total (ML)

Pumping Cap (ML/Day)

YANCO CREEK Offtake – Morundah 14 1,871 11,211 241 11,452 274 Morundah – Catch Drain 4 556 2,916 16 2,932 130Catch Drain - Bobaroo 41 5,342 27,052 61 27,113 955Bobaroo – Puckawidgee 15 2,976 12,944 171 13,115 496Subtotal 60 8,874 42,912 0 248 43,160 1,581 COLOMBO CREEK Morundah – Jctn. Billabong 33 2,547 15,292 814 1,019 17,125 458 BILLABONG CREEK Jctn. Colombo – Algudgerie 32 3,402 20,289 605 660 21,554 641Subtotal 65 5,949 35,581 1,419 1,679 38,679 1,099 Algudgerie - Puckawidgee 17 2,589 10,827 197 11,024 480(FORREST CREEK**25) 13 1,441 8,646 379 9,025 234 Puckawidgee - Darlot 36 3,813 23,150 18 2,025 25,193 1,014 Darlot – Moulamein 21 2,110 11,686 1,309 12,995 543 (Outfall Drain/Euroly Creek *26)

23 2,911 493

Waspan Creek 1,833 Cuddell Creek 1,326 TOTAL 249 29,558 144,013 1,437 6,078 154,687 2,718 Flow constraints that inhibit the supply and delivery of water are caused by large woody debris (LWD), the presence of Willows along the banks and a weed, Cumbungi, in the creek and along the banks. Other reasons for failure to deliver water are losses caused in periods of high rainfall because of inadequate weirs and insufficiently high banks to the creek at certain key points. Also water escapes into prior streams and floodrunners. The Management Plan estimates that water losses (from both conveyance and operation) can be as high as 371.70 ML per day in the winter months. Losses in the summer months are significantly less (2 – 3ML/day) but it is estimated that annual losses may be in the order of 37 – 50 GL. State Water has estimated flow losses of up to 49% are occurring within the system (9% operational and 40% transmission). Some significant water savings may be achieved by Willow/Cumbungi removal followed by bank rehabilitation and removal of weirs. However, some continuing losses are probably inevitable due to runoffs into groundwater recharges and escapes into prior streams and

24 Beal et al., p.8 25 Does not include 36.5GL for Forest Creek Unregulated Section as per Murrumbidgee Regulated Water Sharing Plan 26 Not 22C: No allocation assignment.




floodrunners. There is a fine balance between achieving maximum use efficiency and minimising losses and the requirements of other stakeholders and policies. Some of the proposals to change the existing system’s configuration (for example, changes in the Forest Creek off-take regulator) may improve flows and save water but the users may then not have available to them desired natural flows of water. Other improvements (for example, McCrabbs regulator and Wanganella Swamp flow improvements) may be effective from an engineering perspective but may be unacceptable from an environmental viewpoint. 2.4 Overview of Key Stakeholders and Key Issues

a) Key Stakeholders

To encourage debate and participation for the sustainable development of the YCS economically, environmentally, and socially, consultations formed an integral part in the preparation of the Management Plan.27 For close to two years, beginning in July 2002, consultations with various stakeholders provided a comprehensive overview of the key issues and requirements. Key stakeholders for the proposed refurbishment include:

Existing landholders and irrigators Yanco Creek Tributaries and Advisory Committee;

The environment;

Murrumbidgee private irrigators;

NSW Government Department of Infrastructure, Planning and Natural Resources (formerly the Department of Land and Water Conservation);

NSW State Water;

Catchment Management Committees for the Murrumbidgee and Murray Rivers;

Murray Darling Basin Commission;

Murrumbidgee Irrigation;

Coleambally Irrigation Cooperative Limited;

Local Government;

Local indigenous representatives;

Other water users, including The Colombo Creek Ski Club, recreational fishers/river users, communities and individuals using the creek system for recreational purposes.

Industrial users, both up and downstream; and

Communities and towns both up and downstream on the two river systems.

b) Proposals to Support Investment Attraction

The Management Plan presents two major groupings of actions to improve and then maintain the system for reliable water delivery including the removal of flow impediments. In total,





these represent 12 separate activities. Each action has been detailed with costings and responsibilities assigned. These actions, contributing to the pre-feasibility work of the investment proposal, can be summarised as:

Improving measuring and monitoring to address losses.

More effectively manage supply, delivery and seasonal flows.

Improving water management at weirs and creek flows by removing impediments including willows, cumbungi, and refurbishing creek breakouts; and

Instituting alternative supply options including on and off-farm storage, improving the ordering system, management of water and educational information available to users to maximise flows and water efficiency.

It is these actions and the costings, developed in the Management Plan, that form the foundation for the analysis in this report.

c) Key Issues for Success of the Management Plan

Key issues identified through the consultation process are to:

Attract $24.5m in investment to refurbish the YCS.

Deliver 36,000 ML of saved water and retain the saved water28.

Encourage landholders and others to invest in the area to utilise the saved water benefits.

Avoid any reduction in water allocation through penalties, agreed in the water-sharing plan.

Improve and then maintain a system of reliable water delivery by removing the stream flow impediments.

Enhance the riparian environment and the YCS to ensure the ecological health of the creek.

Develop systems and mechanisms for community ownership, participation and empowerment for managing the System’s natural resources.

Ensure the survival of individuals and communities within the region in a sustainable way to deliver social, environmental, biodiversity, land care and economic benefits.

As evidence of local commitment to this project, existing landholders initially indicated a preparedness to contribute up to 50 per cent of the “funds” required via contributions of cash, labour and equipment.29 In subsequent discussions the participation level has been revised down to 40% and may end up at 30%. To address these key issues and move the Project forward, 53 actions were identified that offer a way forward. These include further research to identify the water losses, systems to more effectively measure and monitor river flows including water ordering, methods to determine access and ownership rights to the saved water, establishing approvals processes for the 28 Lee Furness, Murrumbidgee Private Irrigators Inc. pers. comm., June 11 2004. 29 Beal et al., pp.57-58.




refurbishment works and for any further investment and proposals to guarantee supply for improved productivity and economic returns. 2.5 Some Key Assumptions

The most fundamental assumptions in the Management Plan are that :

1. It is possible to attract $24.5m of investment funds, and

2. Water “saved ” can be identified and accessed by investors and not forfeited to the Crown or lost to the environment.

This report seeks to test the first assumption, as adjusted to include additional costs. The second assumption is assumed to be valid for the purposes of this report, although several of the funding scenarios we have developed have assumed or included a mechanism for allocation to the environment.




3. OVERVIEW OF THE YANCO CREEK REHABILITATION PROJECT

3.1 Origin of this Project

This report has its origins in the work undertaken by the Yanco Creek and Tributaries Advisory Council and the Draft Management Plan circulated for comment in 2003. The draft Management Plan is expressed by its authors as being “the first step on a journey towards sustainable natural management of our unique environment”. The draft plan was developed as the outcome of extensive community consultation in 2002 and the recognition that there is a need for a major upgrade of the infrastructure that delivers water to the Yanco Creek communities. The works required in the upgrade are stated to be

“a mixture of physical works, policy development, monitoring and coordination of projects – all which are aimed at ensuring the long-term environmental sustainability of the creek system.”

The philosophy underlying the Management Plan is the assumption of mutual and shared responsibility for underpinning the health and productivity of the Yanco Creek System for both current and future generations. The YCS involves:

Approximately 253 licensed water users. A length of 799kms.

A complex water system that is an “absolutely critical water supply to a vast area of

the Riverine Plains of NSW”.

The water supply of at least 8 towns and the livelihoods of at least 1000 people.

Significant environmental and ecological issues.

Valid competing interests that need to be carefully considered and balanced in any proposal for action.

3.2 What is the Core Project?

The Core Project, discussed in some detail in the Management Plan and subject to preliminary costing, consists of undertaking some of all of the following:

Site and earth works. Removal or reconstruction of weirs. Clearing of Willows and Cumbungi. Removal of snags, LWDs. Selected engineering works.




Introduction and improvement of metering and monitoring. Environmental, landcare and biodiversity works. Fencing. Indefinite ongoing maintenance.

In addition it involves the undertaking of a range of other activities directed at Catchment and broader environmental and water issues. 3.3 What Benefits will Result?

The refurbishment of the YCS as proposed in the Management Plan is the first part of the process to deliver significant economic, social, and environmental benefits to the Yanco Creek area.

a) Economic

It is assumed that a significant proportion of the “saved” water will be retained within the YCS and deliver important economic benefits. This is expected to result in significant further investment for on and off-farm projects including:

Expanding existing operations;

Constructing new systems of water storage to more effectively manage and utilise water in peak times;

Investment in new measurement and monitoring systems; and

Attracting new investment from agricultural or other industrial sectors due to increased water availability.

b) Environmental

By retaining the saved water in the YCS, giving greater water availability, significant environmental benefits are assumed to result, adding to the economic benefits. Examples provided of the principal benefits are:

The removal of water restrictions and blockages caused by willows and cumbungi weed.

Increased efficiencies and information through improved water metering, management and delivery systems.

Monitoring of water quality, flow and ecological issues both within the system and for the riparian environment.

Increased water flows through the system for environmental benefits. In addition to the benefits assumed by the Management Plan in this report we have, in a number of funding scenarios, explored the potential for the return to the environment of between a minimum of 5GL and 35 GL. Actions proposed and costed into the Management Plan to achieve environmental requirements include:

Improving surface water quality; Reducing dryland salinity and water logging; Minimising irrigation salinity and water logging; Reducing soil erosion;




Balancing soil acidity; Reducing streambank erosion and riparian degradation; Improving wetland health; Arresting native vegetation decline in particular areas; and Reducing weeds and pest and feral animals.

Clearly the manner of execution of the Project and the quality of the ongoing maintenance of the YCS will have an important bearing on the extent to which these identified benefits are achieved. Similarly implementation of part only of the Project will result in considerably reduced benefits, if any.

c) Social

From the initial investment, it is expected that significant social benefits will result. These include:

Improving the viability of existing landholders and irrigators. Creating employment and training opportunities for existing and new investments.

Implementing more sustainable agricultural and environmental processes by

adopting new technology to save and manage water more efficiently.

Contributing to the survival of local regional communities by ensuring there is a demand for services (education, research, health, financial, government) and strengthening the regional economy.

Again the timing, completeness, and quality of initial execution and ongoing maintenance will be important. 3.4 Project Variations to Enhance Viability

This report focuses on the “Core Project”, as described, and costed, in the Management Plan. There are, however, alternatives to the method of delivery of savings and other objectives as envisaged by the Management Plan. Those alternatives are not explored in this report, which has limited itself to merely evaluating the financing aspects of the Core Project. Should the Yanco Creek project progress to the next stage then an evaluation of the alternatives should be fully considered. Although a natural watercourse, Yanco Creek is regulated and connected to a variety of other water conveyance systems all of which form part of the broader Murray and Murrumbidgee system. One alternative approach to that is envisaged in the Management Plan and has been at least been partly developed is the Yanco Creek Flow Transfer Evaluation. This is summarised in the Exhibit below. Whilst each of the options considered in the Yanco Creek Flow Transfer alternative may have merit all fall outside the present scope of this report. Nevertheless,

The financial model utilised in this report is capable of subsequent amendment to cater for the capital costs, timings and subsequent operating cost regimes applicable to that solution.

Some work in the nature of creek rehabilitation will remain necessary for Yanco

Creek (particularly in the upstream areas), and




Many of the structural and regulatory issues identified in the report will remain relevant regardless of the engineering/operational solutions being adopted.

Exhibit 1 – Yanco Creek Flow Transfer Investigation

From a wider perspective Yanco Creek may be viewed as a convenient method of by-passing Hay and Balranald and delivering water into the Murray. For users along the Yanco Creek, Colombo Creek, Edward River route this wider perspective is of limited interest but improvements to flows would be welcomed if it ensured more certainty of delivery of water when required and potentially more water available to them generally.

Sinclair Knight Mertz (“SKM”) prepared a Report for Colleambally Irrigation (“CI”) in late 2002 entitled “Yanco Creek Flow Transfer Investigation”. This report describes how CI transfers water from the Murrumbidgee River by diverting it through Colleambally Main Offtake Structure and transferring it downstream to Yanco Creek via the Colleambally Catchment Drain and the Bundure Channel/DC 800 system into Yanco Creek. The routes avoid the constricted zone and area of potential overflows in the early part of Yanco Creek and water can be provided within 2 days of the outfall of DC800 whereas it would take 4 – 5 days to reach that point if transferred via Yanco Creek.

However, the channels were designed primarily to drain excess rainfall from the CI area not for transmission of water to irrigators. There are capacity restrictions along DC 800 which could be alleviated by supply side management (improving capacity in the system) and/or Demand Management (changing the timing of the water requirements) but SKM suggest that ultimately an upgrade of these channels or increased use of pipes and pump stations will provide greater certainty of delivery for users.

Such upgrades include items such as widening the channel bed, clay lining, earthworks, meters, electric pumps and pipelines where necessary. The extent to which upgrades are appropriate and the configuration of channels and pipes that may be used within the CI area to effect water deliveries into Yanco Creek are issues where multiple solutions exist and where the most appropriate mix of engineering solution and route selection would require considerably more research.

Capital costs of the seven options considered by SKM range from $5.2m for a pipeline from the Main Canal outfalling to the Yanco Creek near the existing Colleambally Catchment Drain Outfall (giving an increased capacity of 50 ML/d) to $18.32m for a new channel connecting the Main Channel to DC 800 (giving an increased capacity of 600 ML/d).

Operating costs differ for each of the seven options vary with low maintenance costs for pipelines, high costs for pumping stations and reasonably low maintenance costs for channels. Asset lives also differ widely (pumps – 20 years, new clay-lined channels – 120 years). Present value estimates range from $10.43m to $36.82m at 5% discount rates.




4. BALANCING VARIOUS STAKEHOLDER REQUIREMENTS

& INTERESTS & ABSENCE OF A SPONSOR

4.1 Balancing Stakeholder Requirements & Interests

a) Overview

The Management Plan recommends a series of significant changes to improve the efficiency and flow of the Yanco Creek. The recommendations are expected to deliver benefits both to existing users and particularly for future generations. The importance of the Yanco Creek System to local communities and landholders on the YCS can be illustrated by their description of it as a “prized jewel”.30 With stakeholders representing a range of interests from existing irrigators to recreational users, consultations to progress the proposed refurbishment need to be representative and well coordinated to ensure all interested parties can contribute to and discuss and debate the issues. Building on the significant awareness already raised throughout the two-year development phase of the Management Plan, further consultations to progress the proposed investment to enable the refurbishment of the system are required. The Management Plan acknowledges the need for a coordinated process of consultation involving the wider community to ensure there is strong local support and to attract the investment required. Successful implementation through the attraction of investment funds will only occur if a balance is achieved. Attracting funds will require meeting the objectives of the financier. To date the requirements of financiers or investors have not been discussed or considered. This report seeks to remedy that situation.

b) Clarifying the Issues

While priorities for the YCS have already been identified and embedded in existing Management Plans, a number of matters have been raised that may impact on the proposed investment. These include:

Environmental issues; Access to land; and

Changes that may affect the creek including those raised by the Colombo Creek

Water Ski Club. As a result, further consultations are required to progress the proposed refurbishment and ensure an agreed and consistent way forward. It is expected that these further consultations will involve both key stakeholder and representatives from the wider community. 4.2 The Sponsor

One of the key parties missing from this Project, and likely to be missing from many water savings projects, is a Sponsor. That is, a party with the capacity (both as relates to skills,





authority and financial resources, to initiate the project and coordinate its development through to feasibility stage) and with the incentive to carry the process through to tender, or expression of interest and final implementation. A significant apparent deficiency of the Yanco Creek Project (which is the case also for a large number of water savings related projects) is that whilst there is a range of parties with considerable interest in the project and with it being advanced no single party is in control nor has the capacity to make it happen. A process to allow mobilization and facilitation of bring forward for assessment projects that is responsive to needs, is flexible, yet accountable is required. The alternative is considerable effort expended for little result and potential investors allocating resources to easier and more certain areas




5. FINANCING OF THE PROJECT

5.1 Differentiating Economic Benefits & Financial Feasibility

This report approaches the issue of financing by focusing on:

The ability to fund the Core Project out of the private sector funding sources. Determining what level of support from other sources would be required to make

the Core Project capable of attracting private funding, if the Core Project is not sufficiently attractive to be able to be funded on a purely commercial basis.

In approaching this task and considering the outcomes it is essential to differentiate between financial and economic analysis and sustainability. Financial viability of a project is totally dependent on the income and expenses of the particular project looked at in isolation. The assessment is based on whether or not the Project, from the income of the Project whatever its source, will be sufficient to enable it to meet its outgoings (including financing costs and returns to investors) after factoring in sufficient allowances, or margins, to allow the project to have the capacity to respond to adverse changes in financial conditions or changes in regulations. In contrast, economic sustainability, or viability, extends beyond the project and looks at the increases in total economic output (not simply the income of the project) as a consequence of the project and the ability of the “economy” to recover costs, provide the required rate of return, and sustain production in a range of adverse conditions. The economic assessment includes the benefits that cannot be captured by way of income by the direct investors in, or lenders to, the Project. Justifying additional support for a project may arise out of the pricing in of the wider economic benefits and social, environmental or other policy objectives, which may not be able to be captured in the financial evaluation of the project on a stand-alone basis. We have sought to include these in a number of financing scenarios by the inclusion of a “Non-market Benefit Contribution Charge”. Because of the narrower definition of benefits and returns a project, whilst passing an economic viability test, may not be financially viable. 5.2 The Management Plan Approach

The Management Plan directs most of its attention to the current problems within the YCS. It adopts, as its starting point, capital works programmes and costings generated by local State Water staff. This is a legitimate approach at this initial stage of the project’s development. Whilst the Management Plan recommends further investigation in a variety of areas and makes a number of specific recommendations it does not (and neither does it purport to:

focus on the financing aspects of the Project, seek to identify any classes of investors or lenders who might be attracted to participate

or to identify their requirements or suggest how those might be met. This report seeks to begin that process.




5.3 Sources of Financing

There are basically three sources of financing:

(a) Public Sector; (b) Private Sector, or (c) A combination of both.

Public funding comes in a variety of forms:- from direct investment and public ownership and delivery of facilities to grants, concessional loans and financing facilities which bear a commercial rate of interest. It may be sourced from the Federal Government, its Agencies, State Government or Local Government. Funding in the broader sense may also be made available in the form of reduced payment obligations (e.g. income tax, GST, payroll tax, rates) to support projects, which are seen as meeting policy objectives. Private funding may be made available in the form of debt funds from commercial lenders or equity from a range of parties such as professional investors, superannuation funds or public investors. Usually a project will be funded from a combination of debt and equity sources. It is often possible, particularly in projects, which are seen as having a national significance, or otherwise being worthy of encouragement from a policy perspective, to combine both public and private funding sources. Questions of priority and security are issues that need early resolution, as are the timing of drawdowns and the use to which each tranche of funds is to be put. 5.4 Establishing Sources of “Income”

For a private investor three critical questions are:

1 What are the costs? 2 What is the income?

3 What are the risks?

In relation to Yanco Creek the costs can be estimated via definition of the project and the undertaking of the necessary technical studies. The Management Plan includes estimates and these need to be progressively refined. What is less clear is- “What is the income and where does it come from?” With the YCS Project and many other similar water system related projects there is no clearly defined product or service of the improvement or refurbishment from which income can be earned. Nor is there an obvious buyer as there is a range of public and private benefits. In addition there is no capacity or right of a private sector provider to charge a service or delivery fee the various beneficiaries in the absence of government intervention via the granting of a right or entitlement. The “product” of the YCS Core Project is essentially a service that it is believed will result in a number of benefits or services delivered to a range of parties. These benefits and services include:

Water “savings”(estimated to be in the order of 36GL per annum.




Water delivery efficiencies and improved crop and usage outcomes.

Environmental benefits.

Biodiversity benefits.

Improved land care.

Reduction in flooding.

Potential additional land brought under irrigation (in the order of 3,500 hectares if all savings are allocated to irrigation).

Regional development and social benefits, including ongoing recreational access.

Additional local and regional economic output.

Many of these benefits are externalities and are not benefits, or returns, that can be readily captured by a private financier of the project irrespective of who that party is. Many of the benefits extend to the region at large or are spread even more widely as public benefits. As such it is difficult to capture their value. A strong equity argument can be advanced that the full costs of producing the full package of benefits should be bourne by the public or wider community and not simply by water users (irrigators, stock and domestic and towns). The impact of cost sharing is considered in the financing scenarios discussed in Section 8. For Yanco Creek it will be necessary, if the project is to attract some level of private investment,

first create a reliable income stream that is accessible to the private sector investor, and

secondly, to develop a mechanism to capture that income stream.

An income stream can be created in a number of ways. Some of these are discussed below. One approach could be via the granting of a Concession Deed by the State Government. Under the terms of the Concession Deed entered into with the Government the Concessionaire would agree to:

Demonstrate its ability to raise the necessary funding to undertake the initial works and to operate the Concession in a manner that will meet compliance standards.

Make the investment and undertake the initial project works as specified in

detail the Concession Deed. Undertake ongoing works and maintenance of the system, the Concession.

Operate the Concession for the term of the Concession Deed.

Hand back the Concession at the conclusion of the Concession Period at a

specified standard.

Monitor performance standards.




Be subject to penalties for failure to operate the Concession in strict complanace

with the Concession Deed. In return for funding the cost of the Core Project, estimated by the Management Plan to be in the order of $24.5m, the Concessionaire would be entitled to receive the Concession income. The income could come from a range of sources and might, by way of example, include one or a combination of the following:

1. Entitlement to “own”, and to transfer its interest either temporarily or permanently, some or all of the “saved” water. Thus allowing efficiency benefits to be captured by the investor.

2. Purchase of the “saved” water by friends of the environment 3. A tolling, access or capital charge levied on some or all users of water in Yanco

Creek to recognize the benefit to all users from increased reliability of flow, reduction in over banking, reduction in flooding, removal of Willows, LWD and Cumbungi, etc.

4. A delivery charge from users.

5. A fee that recognies that the Concessionaire is assuming obligations currently

undertaken by others, for example, State Water, landowners and local government.

6. A credit or payment to recompense for the salinity, biodiversity and environmental benefits delivered.

7. Payments or “credits” to allow the capture of the wider social, economic and

development benefits to land owners, local government, and the community at large.

The ability to create an income stream is not the only issue, some other issues, depending on your perspective, are:

From the funder of the project’s perspective:

o “Will the income stream be sufficient relative to the risk of the project and in comparison with other alternative investments, to attract them to the project and what are the risks?”

o What certainty do I have that the income will be paid?

From the perspective of those paying the income stream:

o Is this the most cost effective solution? o What are the benefits? o What amounts will be required to be paid and by whom?

o Is there the capacity on the part of the potential payer to pay now and in the

future?




o What risks are there in terms of future delivery of the service and benefit? The adoption of the Concession Deed approach as outlined above ahs the advantage of also creating a “Sponsor” to advance the project. 5.5 Determining the Costs

The Management Plan contains estimates of costs. A full bankable costing will need to be undertaken which fully scopes the project works and then costs in both initial and ongoing costs and provides an allowance for contingencies. 5.6 Regulatory Issues

Whilst an entitlement system is beginning to emerge regulatory issues are still possibly the major risk area for the YCS Project. These risks relate to uncertainties to entitlements and to transferability, accessing the benefit of, and rights to, savings and the relative entitlements of current license holders in contract to external investors who do not hold a licensee of allocation as well as liability to third parties to whom entitlements are transferred in the event of, for example, reductions in allocation, level of security, change of law or e.g. flood damage. Linked with this is the capacity to take or grant security over allocations, licensees and water business related assets. Regulatory issues are also reflected in pricing certainty. 5.7 Financing of the Project

Subject to the financial project economics being satisfactory in terms of sustainable free cash flow being generated and acceptable security being offered there are a number of potential sources of finance. It will probably be necessary to utilise a “cocktail” of different finance sources and types to most efficiently meet the project’s financing needs. Different types of finance will be required for the project at different phases of its development. Outlined below are some of the different project phases.

a) Development Phase Financing

This phase commences on the making of a decision to further investigate the project and the finding of a Sponsor and extends up to the time when a “go/no go” decision is reached. The development phase work includes the initial engineering studies (to produce both a recommended course of work and an estimate of costs in the range of say +/-25%), a preliminary assessment of operating costs, a review of the regulatory, environmental and planning processes that need to be addressed and some initial validation of water savings and sales prices that may be achieved. This data feeds into a project model, which should allow initial decisions to be made on project optimisation and overall financial viability. Costs of the project during this stage include fees paid to a project director and professional advisers, such as engineers, lawyers, community consultants, and the like. Such costs are unlikely to be less than $500,000 and an amount of this size needs to be provided by a project promoter or Sponsor rather than by a financial institution or other potential investor. To a large extent this is seed capital as there is no certainty of repayment. With this project the uncertainty is increased, as there is limited ability for a single party to crystallise implementation even if it is shown to be financially viable.




As noted earlier for this and many other water asset projects there is no clear sponsor. Possible sources might include private sector parties such as irrigators, local councils, State and Federal Government and private sector entrepreneurs, or industrial companies seeking a role in the construction work on the project or in the ongoing operation. To attract a sponsor there must, however, be some degree of certainty that if the money is expended and the project is assessed as being viable then it will be capable of being implemented. With the YCS and many other similar water projects there can be little certainty due to the absence of a process to bring forward projects, to access to the “water savings” and clearly ascertain the operation of the CAP.

b) Establishment Phase Financing

This stage commences when there is a potentially viable project; a real prospect of a Concession Deed being made available by Government, and clarity as to the regulatory regime. Costs will include those of lawyers (to establish the legislative, tax and regulatory framework that affects the project), consultant engineers (to refine Capex and Opex), public consultation specialist (to work within the local government and local communities to identify initial issues), tax specialists, project managers (to arrange tenders for capital works and on-going operations, sales arrangements for saved water and the sign offs from relevant parties who agree that the project may proceed), financial advisors (to arrange debt and equity) plus a project manager to co-ordinate and drive the process, etc;. Once a “core” of equity investors has been identified and binding commitments to invest made it is necessary to obtain similar commitments from lenders. Debt parties will allow draw-down from their facilities once specified conditions precedent are fulfilled. These include such matters as execution of major project contract documents, effecting necessary insurances, obtaining governmental approvals and tax opinions (or rulings from the ATO), obtaining contracts to perform the remediation works at acceptable prices and reaching agreement for the long term sale of saved water. Some debt facilities may be of short-term duration such as bridging finance to cover initial mobilization or construction, which finance is then taken out by longer-term financiers.

c) Longer Term Financing

The sources of longer-term finance are:

First the contributons made by the equity investors (be they users, professional investors, institutions, water traders, constructors, operators, water supply companies, lenders seeking to enhance their yield or the stockholding public).

Secondly, those institutions that may wish to invest in subordinate debt (sometimes

called mezzanine finance as it lies between traditional debt and equity). Such debt pays a higher coupon (which may be deferred in certain circumstances) but does not enjoy the first ranking security available to traditional debt. Sources include debt lenders who are comfortable with the project economics and its general robustness but wish to enhance their return from participating in the financing, specialised mezzanine investors or others who like the enhanced security position over equity investors.

Thirdly, there are lenders who are willing to take the role of long-term debt

providers. They may be trading banks who offer long term financing with a tailored repayment profile that reflects anticipated project cash flows (for example, principal repayments increasing over time) a zero coupon bond issue (where




interest is paid only on maturity) or a specific bond issue for a fixed (usually long) term. The latter is an unlikely source of funds for this project given its small size and the lack of any credit rating on the bonds (they would probably not reach investment grade, BBB and the issue is too small to bear the costs charged by a rating agency).

d) Public Investment

The public could be invited to subscribe for shares in a vehicle that would own the project. Unless the invitation to subscribe was limited to a small class of sophisticated investors it would, however, require the issue of a product disclosure statement or prospectus, thus requiring a significant standard of care to be adopted in providing information and forecasts, with consequent increases in costs. It would be normal for a retail offering to investors to only be made when the project could demonstrate a successful track record over some years, thus making it difficult for a “start up” project to attract retail funds or to initially list. If, however, a suite of existing projects could be assembled together with some projects in the early stages of development the tapping of the public as equity investors would become more of a possibility. 5.8 Categories of Private Investors & Overview of Requirements

Different categories of investors have not only different risk appetites and return requirements but also differing perspectives. It is important that this is appreciated and that the difference are capitalised on rather than resulting in conflict and irreconcilable differences in combining parties with totally different expectations and requirements.

Table 4 - Comparative Investor Perspectives

TYPE OF INVESTOR INVESTMENT PERSPECTIVE - OBJECTIVES Irrigators – Water Users More water, cost of water, security of access & entitlement, reliability,

delivery times, salinity & other environmental impacts

Water companies Improved customer service, additional revenue & costs, ability to fund, asset maintenance & renewal, system control, ability to deliver, reliability of supply, viability of customers, stranded assets, regulatory regime certainty

Non-industry investors Relative risk v return, steady cash return, some capital gain potential, security/enforceability, known regulatory regime & consistent application, no tax surprises

Government Meet various policy objectives- improve systems & efficiency, risk transfer & sharing, land care, environmental, regional development, economic, agriculture, expanded industry base, exports, competition, tourism, recreation, increase rating base & diversification, accountability, transparency & probity

Other Stakeholders Environmentalists, industry, local communities, local government, special government programmes (e.g. Water for Rivers) recreational users, international treaties, non-irrigator land owners, etc

Different classes of investors have differing return requirements and risk appetite. An indication of the rates of return required by a range of investors is set out in the Table below.




Table 5 - Indicative Return Requirements of Various Categories of Investors & Lenders

5.9 Debt & Equity Mix

The proportions of debt and equity are very much determined by the results of cash flow modelling and market acceptance of the assumption used. Some oil and gas projects in established fields with sponsors of substance (an Oil Major) have been able to attract debt to equity ratios of 90:10 or even total debt finance. This is unusual and more commonly ratios range from 60:40 to 80:20. Most projects have ratios in the range 60:40 to 80:20 meaning that for a project such as Yanco Creek with a total funding requirement of say $30m the equity required would be in the area of $12m to $6m, most probably at the higher end. Both classes of investors have specific requirements (see above) and these include, in the case of equity that a hurdle rate of return is achieved and in the case of debt that various debt service and debt cover ratios are achieved. 5.10 Key Impediments to Successful Project Delivery & Financing

a) General Situation

Yanco Creek cannot be viewed in isolation – it is part of a major rural water delivery system. This increases the number of stakeholders who may be affected by proposed changes and the complexity of any improvements that may be contemplated. Yanco Creek is also a natural watercourse. Effecting improvements to an open channel or a pipe system may not require as many factors to be addressed and the number of approvals would most probably be less. Obtaining access to a large number of properties in public and private ownership along some 799kms of creek front (and the right to undertake the Works both initially and for the life of the Concession) is of itself a significant issue.

31 “Commonwealth Government Securities” or bond rate of return. This rate is perceived to be the “risk free rate” of investment and provides a benchmark against which other investment opportunities can be priced on a basis of relative risk.

BANK LENDERS

CGS31 RISK FREE RATE

ETHICAL INVESTORS

RETAIL INVESTORS

SUPER FUND TYPE INVESTORS

LISTED RETAIL INFRA FUNDS

Cost of funds (current 90 day) 5.4% plus margin of 0.75% to 2.00%

24 June 2004 10 year 5.8% Indexed 10 year bonds 3.2%

15% to 17% for investment of this risk profile

7% to 12% Property Trusts

12% to 20% based on risk profile

4% to 8%




Any improvements to Yanco Creek will also face the issues common to any project, which seeks to deal with water savings. In addition, as noted earlier, there is no clear “product” offering an income source nor a project sponsor to champion the project and fund the development costs.

b) Pre Construction Period

If an investor is to be attracted to invest in excess of $24m then it needs to have a secure source of income. If the income is, as assumed in the Management Plan, to come from access to and potential sale or mortgaging of entitlement to the water savings or some part of the savings then the fundamental issue is establishing a secure and transferable entitlement to “saved water”. Thereafter other issues arise including:

How to measure the volume of saved water?

How to “collect” and access the saved water?

How to apportion saved water and provide a pre-agreed proportion to “the environment” i.e. back into the system.

How to achieve protection against arbitrary regulation which reduces or restricts availability of saved water for use by project participants?

How to reach binding and enforceable agreements with neighbouring water companies (Coleambally Irrigation and Murrumbidgee Irrigation) and government agencies (DIPNR and State Water) in relation to water use and the operation of the system?

How to measure and monitor flows and conduct of the Concession Works?

Obtaining confidence in independent engineering estimates of works needed to increase flows (and contain floods)?

Co-ordination of approval processes and obtaining the necessary authorities to proceed?

c) Construction Period

Obtaining access to all parts of the Creek to perform the work (and subsequently to undertake ongoing maintenance work) will be a major issue to be addressed. This may require legislation to deal with the issue of access and obligations to repair any damage. Making a comparison with rights under a Mining Authority to prospect maybe useful. Alternatively a special Conservation Easement approach might be adopted. A major issue is ensuring adequate observance of all conditions imposed by governmental authorities when granting approvals.

d) Commissioning Period

Commissioning is more difficult to define in this project than in a more conventional infrastructure asset because of the “rolling nature” of the Works that are to be undertaken over a period of some years. Nevertheless, “Commission” is a major milestone and a formula will need to be determined and established to recognise that construction has concluded and operations commenced.




e) Operational Period

This involves ongoing operation and maintenance of the Project and monitoring and reporting on performance against pre-set standards to ensure that obligations due to water users and under the Concession Deed are met and the interests of stakeholders are recognised. 5.11 Interface with State Water.

Depending on the outcome of discussions State Water may wish to continue to have operational control over the YCS. If, however, project participants returns are generated solely by measured quantities of water saved or there are ongoing performance obligations imposed on the party undertaking the Project Works then they would want to have operational control of the system (together with primary responsibilities for monitoring the flow by regular maintenance programmes). Whilst this possible area of conflict can be resolved by the tailoring the deliverables under the Concession Deed and the segregation of obligations and responsibilities there are, however, a number of taxation and other legal liability issues that will need careful consideration.




6. POSSIBLE FINANCE & OPERATIONAL ARRANGEMENTS

6.1 Option 1: Public Funding & Provision

The State continues with its current obligation to remediate Yanco Creek and continues to operate the system and to supply water. This would appear to be the simplest process to implement, as it would not require a structured and detailed approach to private sector sponsors, investors or financiers. Nevertheless it is unrealistic to expect that any commitment of public sector funds and resources would be made available without a significant initial investigation or a concerted lobbying effort by those who might benefit from the project. The project might not be the highest priority for State Water which no doubt has many other competing remediation proposals presented to them. Expenditure would need to be the subject of a budgetary allocation and approval processes. A public benefit study would need to be commissioned and the same environmental, heritage and native title issues would need to be addressed as would be encountered of a purely private sector investment in the project was contemplated. Under this scenario and those discussed later in this report it may be possible to introduce a special interest investor, such as, Water for Rivers, (or other public or “friend of environment” category investor) as a financial participant with the State in a “public” project. They may be prepared to pay for some part of the water saved and / or purchase the water. These funds (whether payable up front or progressively) may be could be used in conjunction with State funds to finance the initial project cost or in funding some part of the project expenses. Public funding of the project retains all the risks of the project within the public sector. 6.2 Option 2: Irrigator – User Funding &Provision

The 253 licensed users along Yanco Creek could, say, form an association (co-operative, trust, company, partnership or joint venture) to perform the necessary remediation of the Creek. Either the association or government would need to play the role of Sponsor and fund the initial development and feasibility costs. That entity or investment vehicle could then assume responsibility for funding and operating the system. The performance obligations could be set out in a Concession Deed with the State Government State Water would need to agree to “step back” from its current obligations to manage that part of the system (whilst retaining their obligation to supply water under the current licenses). Stepping back from the management would not, however, mean that it would not have a role in the determination or monitoring of performance standards. The association of users would need to fund the initial works from either government contributions (care is needed here as “grants” are taxable income and expenses may not be deductible within the same time frame), contributions (levies) from individual users or long-term commercial funding. Commercial lenders to be attracted would need to be assured of the overall project economics and risk profile and that the association would be able to carry out the project works, maintain the system on an ongoing basis in accordance with the budget and the perform the obligations imposed by the Concession Deed, service debt and repay principal. This requires an analysis both of the project and the funding sources available to the association (eg. additional




contributions from association members) and in turn evaluation of the financial condition of those individual members. Lenders would also need to be comfortable with future remediation plans (eg. programmes for Willow and Cumbungi) and their cost estimates, the estimates for and funding of other operational expenses of the system, plus the effectiveness of risk mitigation strategies. 6.3 Option 3: Public Funding & Private Provision

This may be seen as an “outsourcing” by the public sector to a private sector contractor. The contractor would probably work with State Water to design a programme of remediation and then perform it for a price. Thereafter, the contractor would be responsible for the on-going remediation programme plus the operational aspects of Yanco Creek. The structure may encourage the use of a less than optimal remediation programme in an endeavour to contain costs. Unless key performance indicators are well developed and closely monitored the contractor’s performance may not be effective. This option requires 100% public funding but moves some of the risk of construction, commissioning and possibly operation to the private sector contractor for, for example, cost overruns and meeting construction and output standards. 6.4 Option 4: Public Private Partnerships

This project delivery technique involves the government, or its agency, determining the “service need”. Specifications are developed on the basis of “outputs” (e.g. flow rates of “X” ML per annum through Yanco Creek whilst fulfilling water licence obligations). Tenders are called and a Concession awarded to the party who has developed a proposal that delivers those outputs for the least cost and acceptable risk transfer to government over a long concession period. (There would need to be checks to ensure the realism of the proposed design, the solvency and experience of the bidder and that the total price to be paid is less than the price for which government could itself deliver the service). Prior to a tender being called extensive additional feasibility work would need to be developed, funded and performed and data made available to potential bidders in order to solicit competitive bids. For the private party, a public private partnership may offer the prospect of cutting through the usual bureaucratic approval processes as Government may be prepared to facilitate that aspect. On the other hand the obligations assumed by the developer/owner/operator are very detailed and subject to public scrutiny and comment. 6.5 Option 5: Private Funding & Provision

Under this option the private sector party or consortium, in response to a call for expression of interest or formal bids, assumes under the terms of the Concession Deed full operational responsibility for Yanco Creek, the conduct of the Works and the fulfilling of delivery obligations to current water licence holders and acquires the rights to use any saved water. If State Water was agreeable to allow another party to have operational control and management of Yanco Creek and lenders are comfortable with regulatory risk; the quantities of and “title” to water; its future pricing; the cost and efficiency of the remediation proposal, and the ability to measure and monetise the water savings the project is prima facie financable on this basis.




The economics and feasibility of attracting significant private funding and consequently of the potential for private provision of the YCS project are discussed more fully in subsequent sections. Private provision is unlikely to be feasible in the absence of government facilitation via, for example:

Acting as the initial Sponsor to “activate’ the Project through the calling for expressions of interest and at least in part the funding of a full bankable feasibility study and development of Concession terms.

Entering into a Concession Deed for an initial term of 15 years.

Facilitating access to land to allow the Concessionaire to conduct the works and

undertake ongoing monitoring, maintenance, and operation.

Providing regulatory clarity as to the right to deal with the agreed level of “saved” water and security characteristics.

Clarification of taxation treatment in respect of the initial project works and

ongoing maintenance. An additional major factor is the need for recognition of the true cost of provision and delivery of water to users and to the environment and the adoption of a more appropriate pricing structure. These are not issues unique to the YCS Project but are of a generic nature common to many off-farm water saving projects.




7. RISK MATRIX, RISK ALLOCATION & MANAGEMENT

7.1 Risk Allocation Principles

In raising finance for a project such as YCS it would be usual for a risk matrix to be developed which describes all risks to which the project may realistically be subject. The next step is for a judgment to be made (or a negotiation is entered into) to establish which party is best able to assume the risk and what mechanisms should be adopted to minimize the occurrence of that risk. Often, the solution lies in the cover available in the insurance market although sometimes, particularly when premiums are prohibitive or cover unobtainable; an apportionment of risk between the parties is the best solution. There is often a tendency for Government to seek to shift all risk to others. This is not always in the best overall economic interest of the project. There are some risks which Government has traditionally bourne (sometimes unknowingly) and the price the private sector will charge for assuming these risks may well be unrealistically high – to the project’s detriment. The latter position applies particularly in relation to a risk for which there is little or no insurance market. Other risks best allocated to government are essentially regulatory and political risks, that is, the risks that government will change the rules post entering into the Concession Deed. Political and regulatory risks are completely outside the control of the private sector party but are generally within the control of the government. 7.2 Risks of Yanco Creek Rehabilitation Project

The Table below seeks to demonstrate a possible risk allocation. Each project is different and no detailed consideration has been given to the realism, appropriateness, or effect of the allocation in practice for this particular project.

Table 6 - Simple Sample Risk Allocation Matrix

RISKS

SPONSOR

STATE GOVT

BIDDER

WATER FOR RIVERS OR OTHER “PUBLIC” INTEREST INVESTOR

LOCAL GOVT

IRRIGATORS & OTHER USERS

INVESTORS

OTHER

Complexity of Project & Absence of Natural Sponsor

X X X

Financing of Feasibility Study

X X X X

Development of Acceptable Model

X X X

Exposure of Intellectual Property

X X X

Cost of Project Initial

X

Initial Implications of Solution

X X

Approval Risk X X X




RISKS

SPONSOR

STATE GOVT

BIDDER

WATER FOR RIVERS OR OTHER “PUBLIC” INTEREST INVESTOR

LOCAL GOVT

IRRIGATORS & OTHER USERS

INVESTORS

OTHER

Quantifying Potential Water Savings

X

Accessing Water Savings

X X X

Water Price X X X X Cost of Ongoing Operation

X X X

Access Risk X X X Taxation Treatment Risk

X X X

Quantifying Environmental, Salinity & Biodiversity Benefits

X X X

Ability to Monetise Water Savings

X X

Ongoing Operational Risk

X X

Regulatory Risks

X X

Water Volume Risks - Allocation

X X

Environmental & Other Externalities Benefit Credit or Charge

X X X

Interest Rate Risk on Project Debt

X X

Rate of Return on Investment

X X

Recovery of Investment Principal

X

Performance of obligations by Concessionaire

X X

7.3 Potential Risk Mitigation & Management

The Table below introduces some potential risk management mechanisms and solutions. It is not suggested that they are necessarily appropriate for this project, which is still being developed. Rather the intention in setting them out is to show the range of possible alternatives. There are precedents in other areas of Public Private Partnership delivery mechanisms and these may provide answers when issues specific to Yanco Creek are addressed and the YCS project is more fully developed.




Table 7 – Sample Risk Management Mechanisms

RISKS

POSSIBLE RISK MANAGEMENT

MECHANISM

Absence of Sponsor results in inaction. Government assumes role until Award of Tender

Project too Complex to attract Interested Bidders Government develops and offers Concession Deed which cuts across many of the complexities

Feasibility Study undertaken but Project does not proceed

Government may offer to reimburse some costs incurred. As an offset for this funding government may be entitled to the intellectual property developed if, e.g. the project does not proceed within the allotted time after the successful party is awarded the right to negotiate a contract.

Cost of Project - Initial Engineering costs - Sponsor responsibility. Costs because of delays in approvals or concession finalisation - Government responsibility.

Obtaining Approvals Introduce SEPP mechanism.

Level of Water Savings Formula based approach, 5 yearly reviews or based on an assumed level of outputs for a required level of inputs and compliance with performance criteria

Securing Access to Water Savings Concession Deed provides or legislative amendments.

Securing Access to Land to Undertake Works and Ongoing Operation

Power may exist in Water Management Act already. Otherwise, some specific form of easement developed.

Water Price Forward sales to public or private sector parties. Alternatively, floor price or buyer of last resort.

Ongoing Operating Cost Risk Sponsor usually bears this, unless because of a change in State law that applies specifically to the project.

Risks to Third Party Insurability Statute.

Regulatory Risk Normally accepted by Sponsors but this is unfamiliar territory for Sponsors and some binding assurance may be required.

Performance by Concessionaire KPIs introduced but with relief events (e.g. force majeure).




8. ANALYSIS OF THE ATTRACTIVENESS OF THE

INVESTMENT OPPORTUNITY & CONSTRUCTION OF A INDICATIVE HIGH LEVEL FINANCIAL MODEL

8.1 The Fundamental Proposition Sought to be Tested by this Report

The YCS Management Plan suggests that the Yanco Creek Rehabilitation Project is an attractive investment proposition because it delivers competitive water savings at an estimated cost in the order of $700 per ML. It is this proposition that this report seeks to test. The second objective is to consider what would be the likely requirements of the independent private sector investors for the project to be sufficiently attractive for them to invest, to ascertain the impediments, and consider how these impediments can be removed or addressed. In focusing on independent private sector investors it is recognised that a public sector investor would have different criteria as the public sector’s motivation is not simply the relative financial risk / reward comparison of investment in a single stand-alone project. Public sector investment is driven of consideration of broader policy, economic and social considerations in addition to he economics of the specific project. However, the same detailed analysis and assessment of the project, of risks, costs and benefits still needs to be undertaken with exactly the same rigour. Similarly private sector investors who are also irrigators or have other linkages with the water industry or the region may use different assessment criteria, as they are able to achieve “returns” other than merely from the standalone income of the project. These returns could, for example, include access to additional water for use in their agricultural or other businesses; increased reliability of access of supply or of timing of delivery; ability to expand activities or to change crops or increased value of their existing property. 8.2 Objectives of Construction of the Model & Limitations of the Model at this Stage of

Development

A basic financial model has been utilized to indicate the likely performance of the project against a number of “Base Case” assumptions, that is of a business case that is seen as being reasonably likely to be achieved. Higher (“Upside”) and lower (“Downside”) cases have also been considered. This is intended to be only a preliminary model to be used to determine basic relationships and whether on a “first cut” the project can be structured to provide a suitable and justifiable investment on either:

a stand-alone basis, or with other support mechanisms.

Given the quality of assumptions used and the low order of accuracy inherent in the data at this early stage we have not sought to optimise the cash flows by introducing such refinements as the timing of contributions, taxation benefits, gearing through the use of lower cost debt facilities from banks, trading of some or all of the water savings on a temporary basis to possibly capture the higher price premium (currently in excess of 35%) relative to the price of a permanent transfer or other financing techniques (such as securitisation or leasing) nor have ongoing costs or revenues been adjusted to reflect the impact of inflation.




8.3 Key Model Inputs & Assumptions

The key assumptions are set out in the Table below and further explained in the subsequent text.

Table 8 – Key Issues & Model Assumptions

ISSUE ASSUMPTION IN MODEL

Capital Structure

It is assumed that $15m is raised from investors to provide the equity for the project. Equity is raised: $5m from, for example, Water for Rivers or other similar

environmental, biodiversity or public interest fund. $5m from Irrigators and or other YCS water users. $5m from independent third party sophisticated investors

such as infrastructure companies, superannuation funds etc.

Shareholder Rights

Several Options or Scenarios were explored as to the payment of dividends and the return of capital on expiry of the Concession Term.

Capital Costs

An cost of $29.7m was assumed for modeling purposes. This contrasts with a cost of $25.4m in the Management Plan. The additional amount being an allowance for contingency and to address ongoing costs not fully addressed in the Management Plan’s costings.

Length of the Concession

The Concession period is assumed to be a total of 15 years including a construction period of 1.5 years.

Obligations Under the Concession Deed

Under the Concession Deed the Concessionaire is obligated to Carry out the Project Works as detailed in the Concession. Undertake ongoing maintenance works for the Concession

period. Meet specified key performance criteria, or incur penalties. Hand back the Concession at an agreed standard at the end

of the Concession period. To adhere to a range of environmental and planning

conditions.

Income under the Concession

It is assumed that the Concessionaire will be entitled to an agreed quantity of water saved. It will have an entitlement to on-sell the water. Under some scenarios it will also be entitled to receive a Non-Market Benefit Contribution credits, charge or levy to allow it to capture some part of the wider economic benefits or externalities resulting from undertaking the Works and the ongoing benefits delivered over the 15 year Concession Period




ISSUE ASSUMPTION IN MODEL

Volumes of Water Available

Several different volume and pricing scenarios were run. These reflect the views expressed in the Management Plan as to the likely levels of savings. To allow the implications of different levels of savings on the project’s financing capacity Base Case, Upside and Downside Case scenarios are considered. It is assumed that savings are made on a staged basis and that the Concessionaire can gain access to the savings over the same period as the works are undertaken.

Monetisation of the Water Savings

It is assumed that the water savings can and are monetised, that is they are sold by way of permanent sales on the same profile as the funds are expended in undertaking the Project. The sale of water forms part of the capital raising and funding required to complete and to maintain the project for 15 years

Water Pricing

Three scenarios are included. It is assumed that water will be sold on a permanent transfer basis progressively as it is earned for either:- $500ML- Downside Case $750ML – Base Case $1000ML – Upside Case

Taxation Treatment

It is assumed that the Concessionaire will under one of the existing provisions achieve a situation whereby all Project costs and expenses are deducted against income as expenses are incurred.

Access to the Land

It is assumed that access to the land to undertake works and maintain the YCS will be granted via, for example, the provisions of the Water Management Act 2000, as amended, for no fee.

Capital Costs

Increased allowances, as detailed in Table 12, were made.

Drawdown of the Investment Funds – Construction Time

An 18-month drawdown and construction period is assumed.

Operating Costs

Higher Operating Costs than those assumed in the Business Plan have been assumed for a number of items and additional management structural costs for a private entity with external investors have been built into costs.




8.4 Water Savings

The principal objective of Project in addition to the environmental and social benefits resulting is to improve efficiency gains and to “create” water savings. It has been assumed, as did he Management Plan, that water savings can be captured by the Project (on the basis that without the investment they would not have arisen) and can then be used for a number of purposes, including:

Allocation in whole or in part to the environment by way of sale or donation from a public interest investor.

Allocation to investors for their own use.

Allocation to investors for sale to external parties.

Unless some or part of the water savings can be “sold” then there will be no income to the Project and private funding will not be possible. The capture assumption is therefore fundamental to the potential to fund the project out of the private sector. It is assumed that water savings are sold by way of a permanent trade at market value. Sales are entered into on an arms length basis at the time that savings are deemed to arise. Savings are deemed to arise based on the required works having been undertaken as per the schedule of Works in the Concession Deed. It is also assumed that Shareholders wishing to so would have first option to purchase at market price the water saved. This will allow them to “retain” their “entitlements to saved water”. This could be particularly attractive for Water for Rivers who may wish to give any water it acquires “back to the River”. In addition under two of the scenarios considered Water for Rivers, or similar type of investor, would also receive a right to 5GL of saved water as a consequence of its investment of $5m.. The entitlement is the result of altering the structure so that it will be allocated Non-participating shares. Instead of receiving dividends from the operations of the Project it will receive 5 GL of saved water at no additional cost. This 5 GL allocation would be in addition to any water purchased at market prices. Under two of the scenarios proposed Water for Rivers, or other similar type of investor, could achieve access to a minimum of 15 GL in perpetuity for a maximum cost of $12.5m (assuming a water price of $750ML). Water for Rivers through participating as an investor can, in addition to being a co-sponsor to kick start the project, achieves a return of water to the environment and as an ongoing shareholder is able to ensure that the Concession terms are adhered to for the life of the Concession. 8.5 Funding Arrangements

The share capital, (equity) is contributed in one amount up front. We have assumed for evaluation purposes that no borrowings are utilised by the project (although of course individual shareholders could borrow to fund their participation). Some water is assumed to be saved in year 2 and this increases progressively until the end of year 6. In some scenarios revenue is also earned from an externality or non-market benefit contribution credit or charge payable from year 2 to the end of the concession period (this Contribution is discussed more fully below). Revenue also comes from interest earned on unspent capital.




8.6 Volumes of “Saved” Water

We have assumed that the project sponsors will be able to negotiate a formula in their Concession Deed which specifies the volume of water that will be deemed to be saved in the event certain expenditures are committed, remediation works completed and the YCS is maintained in accordance with the performance criteria in the Concession Deed. The following volumes and price mixes are assumed in the different scenarios.

Table 9 - Price - Volume Assumptions Matrix

SCENARIO WATER VOLUME GL

$/ML WATER PRICE CASE 1

$/ML WATER PRICE BASE CASE

$/ML WATER PRICE CASE 3

Cases A & B 25 500 750 1000 35 500 750 1000 45 500 750 1000 Cases C & D 20 500 750 1000 30 500 750 1000 40 500 750 1000Management Plan Assumption of Water Savings

36

8.7 Prices of Monetised “Saved” Water

This is an area where it is difficult to achieve consensus, particularly in respect of the future prices that may be achieved for annual trades of water. Whilst in practice the shareholders may wish to reserve some of the saved water for trading purposes so as to allow them to capture the value of any increases in water price over the term of the Concession (and any premium between the value of temporary trades and permanent trades which are currently in excess of 35%) we have adopted the conservative approach and assumed in the model that all saved water is sold as permanent water as it is earned and that an upper price of price of $1,000,000 per GL, (or $1000 per ML) is achievable. The price assumptions used in the various scenarios are set out in the Table above. The Base Case, Upside and Downside Cases are illustrated in the Table 10 below.

Table 10 - Upside, Base & Downside Cases

SCENARIO DOWNSIDE CASES BASE CASES UPSIDE CASES A & B 25 GL @ $500 ML 35 GL @ $750 ML 45 GL @ $1000ML C & D 20 GL @ $500 ML 30 GL @ $750 ML 40 GL @ $750 ML It is assumed that options to purchase some or all of the water savings at an agreed market related price might be provided to one or more classes of Investors. Through this mechanism it is possible to meet the objectives of returning some water to the environment and to also allow some access by existing licence holders. The Management Plan assumed that all savings of water can be retained and their value captured in one-way or another. We have made the same assumption as regards the ability to capture the value of water savings. However, we have not assumed (as did the Management Plan) that all savings would be utilised to provide additional irrigation allocations.




Clearly the ability to capture all of the water savings and to then achieve value for them for the YCS Project is a major assumption that needs to be tested, as it is by no means clear that the water “saved” does not automatically revert to the State. The treatment of these savings under the CAP is critical. As parties other than existing licence holder currently have no access to water allocations or entitlements it is not clear how the right to the water is obtained and sold except for water “acquired” by the Water for Rivers type investor. In the latter case it is assumed that the value can be captured within the constraints of the CAP as that portion of water would be returned to the environment. A threshold issue that needs to be established is the ability to capture the value of water savings for the project investors. Unless this issue can be positively resolved the ability to privately finance a significant portion of the YCS Project is unlikely. By way a reality check on prices the recently released, May 2004, Australian Irrigation Water Provider Benchmark Data Report for 2002/200332 records the prices for water traded on both a permanent and temporary basis in a number of systems were considered. The sustainability of achieving on an ongoing basis the prices recorded needs to be considered in light of both:

current climatic conditions and the pressure for prices to more fully reflect full costs, and

economic value rather than historic pricing levels.

In the Table 11, below, we have compared the prices used in this YCS Study Assumptions with the actual prices recorded for both Permanent and Temporary water trades in 2000/2003 season. As illustrated in the Table the Base Case YCS price assumption of $750ML compares favourably with the average price for a Permanent Trade of $957ML and $1129ML for the highest Permanent Trade of the 2002/2003 season.

32 Published by ANCID and funded by ANCID, ANCID Members and the Australian Government Department of Agriculture, Fisheries and Forestry (ANCID Report).




Table 11 - Comparator Pricing Levels YCS Project Assumptions Relative to Value of Water Traded 2002/200333

YCS STUDY

ASSUMPTIONS ONLY ($ML)

PERMANENT

WATER TRADE

AVERAGE

FOR SEASON ($ML)

PERMANENT

WATER TRADE

PEAK PRICE FOR SEASON

($ML)

TEMPORARY

WATER TRADE

AVERAGE

FOR SEASON ($ML)

TEMPORARY

WATER TRADE

AVERAGE

FOR SEASON ($ML)

YCS Downside Case

500

YCS Base Case

750

YCS Upside Case

1000

Murray Irrigation

372 450 288 350

Murrumbidgee 758 1000 ND NDCentral Irrigation

1300 1400 70 80

G-MW Murray Valley

835 900 195 310

G-MW Sherpparton

1130 1350 341 500

G-MW Central Goulburn

1130 1350 280 500

G-MW Rochester

1130 1350 364 500

G-MW Pyramid-Boort

1130 1350 364 500

G-MW Torrumbarry

830 850 242 306

G-MW Swan Hill Pumped

1130 ND ND ND

Sunraysia - 1150 1300 255 310Harvey 50 450 15 35Average of Trades

957 1129 282 398

Another key issue that requires closer examination is the ability of the market to absorb a permanent transfer of up to 30GL without price levels being eroded below those assumed for financial modelling purposes. This risk has been addressed in part in the preliminary finance model by assuming that the sales are staggered over a periods of 5 years. The detailed feasibility study would need to examine the market demand and ways of hedging this risk. The level of security to be accorded to the water savings will play an important part in determining the price.

33Id. Pg. 64




8.8 Project Cash Flow & Return Sensitivities

A limited range of sensitivities has been performed. These are further discussed below. 8.9 Capex Overruns assumed for YCS Project

No investigations have been made to independently verify the cost estimates in the Management Plan. Overruns of capital expenditure have been dealt with by including an additional contingency figure in the assumptions. Clearly, performing true sensitivity testing will need to occur but it is felt that insufficient confidence is held in the current assumptions for such sensitivities to provide any meaningful results. We have essentially adopted the capital expenditure figures developed for the Yanco Creek and Tributaries Advisory Council but have:

Included a period during which approvals would be obtained. Extended the time during which Willow and Cumbungi removal occurs up to the

end of the assumed 15-year concession period.

Included scoping consultancy costs and incidental costs such as insurance, revegetation, fencing (at 50% of previous expenditure) and monitoring for the duration of the concession period.

Provided a contingency of 15% for the first six years during the eradication and

ongoing capital works thereafter have not been inflated. A comparison of the Model and Management Plan estimates for Capex and Operating costs is detailed in the reconciliation in the Table 12. The same Capex numbers were used for all scenarios and for each of the Base, Upside and Downside Cases. No cost has been assumed for the payment of compensation, if any, to landowners for the access rights or the conservation corridor.

Table 12 - Reconciliation of Model Costs & Management Plan Estimates

ITEM MODEL MANAGEMENT PLAN Initial & Ongoing Works Before Contingency

25,632,740 22,133,810

Initial Works Contingency

3,286,997 0

Ongoing Works Contingency

557,915 0

Total Costs (Including Contingency)

29,777,651 25,429,070

Total Cost Difference

+4,348,581




8.10 Operating Costs & Delivery Charges

No sensitivities have been performed on operating costs and this should await a more precise estimate nor have they been adjusted for inflation. However, the operating costs assumed in the Management Plan were supplemented by the addition of costs, which we believed needed to be provided for outside the construction period and where we considered the allowances were too little. We have adopted the costings already developed but believe that there will be both a practical and a commercial requirement for the Concessionaire to continue with the regeneration programme for the full duration of the Concession, although at a reduced rate of expenditure. In the main the difference in operating costs can be considered as a variation in basic approach as a consequence of the involvement of a independent professional investor; to include the level of accountability required for a public-private partnership project and to ensure that the performance criteria in the Concession Deed are met. The Management Plan refers to irrigators contributing their investment share in cash or in kind, including through the provision of labour. Given the need to adhere to specific performance standards as to the timing of work and the quality of the performance, both initially and on an ongoing basis, we have included additional recurring costs. The same operating cost numbers were used for all scenarios. Again by way of attempting to provide a rough reality check by benchmarking these costs against the experience of other water providers the May 2004, Australian Irrigation Water Provider Benchmark Data Report for 2002/2003 (ANCID Report), was considered. As YCS is a “natural” water system direct comparison is difficult as the operating costs of comparable natural systems are not disclosed in the 2002/2003 ANCID report. However, comparison of delivery charges levied on irrigators for supply from a range of other natural systems relative to the operating cost assumptions for YCS and the Non-Market Contribution Charge for YCS proposed under 2 of scenarios (discussed subsequently) appear to suggest that the YCS “delivery cost” outcomes are of the right order of magnitude and that the Non-Market Contribution Charge (of $17.25ML per annum charged on a base equal to the total allocated YCS flow of 154GL) is not unreasonable.

Table 13 - Water Delivery Charges Proposed Compared with Other Natural Systems34

SCHEME WATER DELIVERY CHARGE

$ML

ENVIRONMENTAL CHARGE $ML

TOTAL WATER DELIVERY CHARGE +

ENVIRONMENTAL CHARGE $ML

NON-MARKET CONTRIBUTION

CHARGE ($ML)

YCS – Ongoing Operating Costs

**2.31 **Already included in the Non-Market Contribution Charge

YCS -

17.25

SW Dawson Valley

19.34 ND 19.34

SW Mary River

22.10 ND 22.10

SW Nogoa Mackenzie

9.83 ND 9.83

Sunraysia – Diverters

0 0 0

34 ANCID Pg. 54




8.11 Income Levels & Equity Participation Assumptions & Sensitivities

This is an area where sensitivities have been performed. The elements driving income levels and participation in dividends and investor returns were varied as follows:

Table 14 - Income Levels & Investor Return - Summary of Sensitivities & Scenarios

VARIABLE DOWNSIDE CASE

BASE CASE

UPSIDE CASE

APPLIED TO EACH CASE FOR SELECTED SCENARIOS

Water Savings

25GL Scenarios A & B

20GL Scenarios C & D


30 GL Scenarios C & D


40GL Scenarios C & D

Sale Price

$500 ML $750 ML $1000 ML

Equity Structure

Single Class of Fully Participating Equity, or

Special Non-

Participatory A Class Equity allotted to Water for Rivers or similar public interest special category investor

Eternality – Non-Market Benefit Contribution

Included or Not Included Applied to either 154 GL

Scenarios C1 & D1, or

35GL Scenarios C2 and D2

The various outputs of the model are discussed below. 8.12 Gearing

No sensitivities have been performed at this stage as we have some reservations concerning the amount of debt the project could support and whether conventional commercial lenders would be prepared to commit funds to the project as currently scoped. Clearly, introducing borrowings in some of the more robust cases would allow for a reduced need for equity contributions and, we would expect, enhance the return on the reduced equity.




8.13 Model - Financial Outputs

Four separate scenarios and structures were tested.

5. Scenario A – Monetise Water Savings – Single Class of Fully Participating Equity Held by All Investors.

6. Scenario B 1 and Scenario B2 - Monetise Water savings + Single Class of Fully

Participating Equity + Non-Market Benefit Contribution Charge. 7. Scenario C - Monetise Water Savings Plus Introduction of a Class of Non-Participating

Equity.

8. Scenario D1 and D2 - Monetise Water savings + Two Classes of Equity (one class Non-Participating) + Non-Market Benefit Contribution Charge.

a) Scenario A – Monetise Water Savings – Single Class of Fully Participating Equity Held by All Investors

The starting point – Scenario A was to look at the Internal Rates of Return (IRR) outcomes generated by the project income and expenditure where:

all 3 classes of investor (irrigators, independent investors and special category investors, such as Water for Rivers) invested their monies on day one,

all investors received the same rate of dividend, and

all investors received their capital back in a lump sum in 15 years time on the

expiry of the Concession. .The Base Case was set at Savings of 35GL, against (a Management Plan savings estimate of 36GL) and a Water Price of $750/GL. In addition Upside and Downside Case were run. Clearly the IRRs produced under Scenario A (other than in the 45GL @ $1000 per ML Upside Case) are inadequate from the perspective of an external independent investor assessing the project on a stand-alone basis. In addition, in other than possibly the case of the 45GL/$1000 per ML case, it would be impossible to obtain bank financing for investment in the project. However, the 45GL case assumes that an additional 9GL of savings over the 36GL that the Management Plan assumed could be generated. It is therefore appear to be outside the parameters of a realistic project based on the Management Plan data. The IRRs generated in Scenario A under the various cases are set out in the Table 15, below.

Table 15 - Investment Internal Rates of Return - Scenario A Monetise Water Savings & Single Fully Participating Class of Equity


$500 ML $750ML $1000 ML

25 -11.25% -0.72% 2.21%35 -1.44% 2.77% 6.66%45 1.12% 6.07% 12.02%




b) Scenario B 1 and Scenario B2 - Monetise Water savings + Single Class of Fully Participating Equity + Non-Market Benefit Contribution Charge

Scenario B is the same case as Scenario A except that the returns are topped up through an Non-market Benefit Contribution Charge designed to capture the benefits flowing to all water users and to other external parties from the investment. The Non-market Benefit Contribution Charge value is set in the model in Scenario D1 to achieve an IRR of in the order of 15% pa, as this is the level thought necessary to attract independent third party investors. Using this methodology a Non-market Benefit Contribution Charge of $17.25 per ML per annum is necessary to provide the required rate of return. The same charge of $17.25ML (calculated in Scenario D) is then applied to the total system allocated flow of 154GL for the purposes of running Scenarios B1 and B2. The outcomes for Scenarios B1 and B2 are summarised in the Table 16 and Table 17. Scenario B2 is the same as Scenario B1 except that instead of applying the Non-Market Benefit Contribution Charge to the total allocated system flow of 154 GL the same rate of $17.25 per ML per annum is charged but only on the Base Case water saving at the assumed level of 35GL.

Table 16 - Investment Internal Rates of Return - Scenario B1 - Monetise Water Savings, One Class of Fully Participating Equity Plus Non-Market Benefit Contribution Paid on

Total Allocated System Flow of 154GL





25 6.40% 8.59% 11.04%35 8.13% 11.55% 15.36%45 10.04% 14.79% 20.26%

The outcomes for Scenario B2 are illustrated in Table 17 and demonstrate the sensitivity the IRRs to the income of the Project. Clearly at this level the Project could not be financed through raising funds from the private sector alone. To achieve the target 15% IRR, considered necessary to attract independent private sector investment, would require a Contribution Charge of in the order of $75 per ML per annum if the charge is based on the 35GL saved as a consequence of carrying out the Works and not on the full currently allocated YCS flows of 154GL




Table 17 - Investment Internal Rates of Return - Scenario B2 - Monetise Water Savings, One Class of Fully Participating Equity Plus Non-Market Benefit Contribution Paid Only

on Water Savings – Assumed at Base Case of 35GL


$500 ML + NON-MARKET BENEFIT CONTRIBUTION $17.25 ML ON BASE CASE SAVINGS OF 35GL

$750ML + NON-MARKET BENEFIT CONTRIBUTION $17.25 ML ON BASE CASE SAVINGS OF 35GL


25 -1.69% 2.04% 4.57%35 1.50% 5.10% 8.94%45 3.54% 8.35% 14.17%

c) Scenario C - Monetise Water Savings Plus Introduction of a Class of Non-Participating Equity

Scenario C assumes that not all the water savings are monetised. The monetised savings in each of the Downside, Base, and Upside Cases are reduced by 5GL. It is assumed that this 5 GL will be allocated to Water for Rivers. Water for Rivers although a 1/3 equity holder will hold special, A Class equity entitlement, that will not entitle Water for Rivers to participate in dividends or other distributions. Instead it will receive its return for its investment of $5m from the “acquisition” of the 5GL. In addition it would be entitled to purchase other savings at agreed prices. The volumes of water to be monetised are reduced by 5 GL to reflect the lower amount available for that purpose. The IRRs available under Scenario C 30GL @ $1000 per ML case, as illustrated in the Table below, are approaching the levels at which it may be possible to attract some categories of investors (after optimising the structure and timing of the cash flows). To do so however will require the removal of a substantial portion of other risks so as to attract retail investors and will result in additional capital raising costs for a Prospectus and ongoing compliance and reporting costs. The IRRs attainable under the Scenario C Base Case demonstrate that something more is required to meet the assumed private investor 15 % hurdle rate Under the Base and most of the Upside scenarios. One possible example of this “something more” is illustrated in Scenarios D1 and D2.

Table 18 - Investment Internal Rates of Return - Scenario C – Monetise Reduced Water Savings with Non-Participating Class A Equity


$500 ML $750ML $1000 ML

20 Result Not meaningful due to negative equity

position at end of Year 15 – capital cannot be

repaid

-1.89% 3.04%

30 -1.89% 4.46% 9.03%40 3.04% 9.03% 16.55%




d) Scenario D1 and Scenario D2 - Monetise Water savings + Two Classes of Equity + Non-Market Benefit Contribution Charge

Scenario D1 is the same as Scenario C except that the returns to investors are topped up through the payment of a Non-Market Benefit Contribution which has been applied to the total allocated system flow of 154GL and set at a level of $17.25Ml per annum. This is the level of income that needs to be added to the other project income so as to permit the investor to receive a hurdle rate of IRR of 15% in the mid range cases. The levels of IRR achieved in some of the higher cases are ones that may attract investors.

Table 19 - Investment Internal Rates of Return - Scenario D1 – Monetise Reduced Level of Water Savings with Non-Participating A Class Equity Plus Non-Market Benefit Contribution Charge Based on Total Allocated System Flow





20 9.24% 11.20% 13.70%30 11.20% 15.07% 19.57%40 13.70% 19.57% 26.46%

Scenario D2 is the same case as Scenario D1 except that the Contribution Charge has been applied to only the 35GL of water savings rather than to the full 154GL of total allocated system flow.

Table 20 - Investment Internal Rates of Return - Scenario D2 - – Monetise Reduced Level of Water Savings with Non-Participating A Class Equity Plus Non-Market Banefit Contribution Charge Based Only on Base Case Water Savings of 35GL



$750ML + NON-MARKET BENEFIT CONTRIBUTION $17.25 ML ON BASE CASE SAVINGS OF 35GL


20 -2.31% 3.23% 5.91%30 3.23% 7.25% 11.77%40 5.91% 11.77% 19.14%

Again the 30 GL @ $1000 per ML is approaching a level of return where with gearing, optimising and presales it may be possible subject to the removal of other risks to attract some categories of private sector investors. 8.14 The Value Proposition for Water for Rivers or Other Similar public Interest Investor

The role suggested for Water for Rivers or other like-minded investor is essentially to act first as a catalyst in the generating of water savings, and then to act as a co-investor. The potential to achieve water savings and efficiencies, to deliver environmental benefits and to achieve social, regional development and economic outcomes requires an initial investment of




in the order of$24m to $29m and an ongoing investment of in the order of $0.5m per annum. In the absence of at least some level of private investment it is assumed that Yanco Creek rehabilitation will not occur in the medium to long term. Water for Rivers objective is to generate water savings and to achieve a return of water to the river and to the environment. Co- investment will allow YCS:

to proceed, and to generate savings.

In addition it will allow water for Rivers to leverage its investment and share the risk with others. Investment as a co-investor with others in the rehabilitation of Yanco Creek would allow the generation of savings initially and, importantly would provide a vehicle or mechanism to both initially deliver the project and to ensure the operation maintenance of the Yanco Creek System in perpetuity to deliver savings on an ongoing basis. Co-investment also reduces both the project and moral hazard risks to Water for Rivers. The initial investment cost to Water for Rivers is only its 1/3 equity contribution of $5m. The additional payments for purchases are only made as the project stages are completed and savings are delivered. In addition it reduces its ongoing risk. The mechanism proposed would also meet accountability and transparency standards at a level appropriate for projects involving the expenditure of public funds. Co-investment and the holding of an equity interest in the project enables Water for Rivers to monitor compliance and exert influence on the selection of, for example, the Operator, and levels of performance. A sample of the potential for Water for Rivers to acquire water savings for return to the river and the cost of a range of acquisition options are illustrated in the Table 21below.

Table 21 – Sample of Cost & Water Acquisition Opportunities for Water for Rivers from Co-Investment in Yanco Creek Rehabilitation Project

WATER ENTITLEMENT UNDER SCENARIO D

PURCHASE @ BASE CASE PRICE OF $750ML

PURCHASE @ MARKET PRICE OF $1000ML

TOTAL WATER FOR RIVERS ACQUISITION OF WATER FOR RETURN TO THE RIVER

Option 1 Investment $5m only

5 GL 5 GL for total cost of $5m

Option 2 In addition to Option 1 - Exercise right to purchase 1/3 of savings as a 1/3 equity holder

5GL 10 GL 15 GL for total cost of $12.5m




Option 3 In addition to Options 1 & 2 purchase additional 1/3 at market price

5GL 10GL 10GL 25 GL for total cost of $22.5m

Option 4 In addition to Options 1 & 2 & 3 purchase additional 1/3 at market price

10GL 35GL for total cost of $32.5m

8.15 What The Non-Market Benefit Contribution Charge Represents

The Non-market Benefit Contribution Charge has, for benchmarking and calculation purposes only, been likened to a delivery charge based on either total YCS allocated flows (154GL) or the Base Case level of water savings generated by the YCS project (35GL). It is not intended, however, to suggest that only current users should fund the Contribution Charge as they are not the sole or even principal beneficiaries of the benefits. The beneficiaries of the YCS Project include:

Current water users. Additional users. Landowners. State Water. Local governments. State governments. The environment. Other water provider companies. Local communities. The region.

The Contribution Charge is in essence a “plug”. It represents the additional amount of income that the project needs to earn from some source other than from the sale of the water savings for the project to generate sufficient income in total to meet the targeted IRR considered necessary as a minimum to attract private investment in the YCS Project. The Contribution Charge can be levied on, and shared amongst, a range of beneficiaries. 8.16 Conclusion

What is clearly illustrated by the application of the finance model to the anticipated cash flows is that in most situations it will not be as easy as was possibly anticipated by the Management Plan to attract external parties as investors unless that party has itself a use for the water and therefore achieves a return on its investment outside of the project cash flows and returns. Independent private sector investment can only be achieved if project earnings from the sale of water can be “topped up”. The form of the topping up can vary and may include a combination of support mechanisms. Support mechanisms could include, for example,:




grants,

longer-term and subsidised interest rate loans,

delivery charges to users,

an environmental, salinity or biodiversity levy or credit to recognise the

environmental and other benefits delivered from the project,

or other forms of Non-market Benefit Contribution credit, charge, levy or toll to allow the capture of the externality benefits originating from the from the Works.

Whilst we have essentially adopted the capital expenditure programme in the Management Plan, we believe that it will be necessary to continue an active ongoing programme of remediation to ensure the continued availability of water savings. These costs, which continue for the duration of the concession, significantly impact on economic returns. If the project can either achieve higher prices for water than the $750 ML, assumed in the Base Case, or can be structured with an appropriate tolling arrangement that allows the capture of externalities via the Non-Market Benefit Contribution, then an IRR sufficient to attract independent commercial investors can be achieved. In all cases, however, it is essential that:

7. The bulk of the benefit water savings can be captured by investors to generate project income. It is necessary to clarify that the CAP does not apply to the savings.

8. Water savings from undertaking the project can be sold and that title and the level

of security is clear.

9. Regulatory risk to investors and to purchasers (including the level of security applicable) is minimized.

10. The taxation regime for water providers such as the Concessionaire can be clarified

and the same taxation treatment available to other water providers and or those undertaking conservation projects is achieved.

11. Access to land to undertake, operate and maintain the project works is available on

a secure basis.

12. An efficient mechanism to co-ordinate planning approvals is developed. Whilst there has been considerable work undertaken often on an informal basis at catchment, stakeholder and regional level to attempt to identify potential savings opportunities one major impediments identified, which applies virtually across the gambit of off-farm water savings projects and not just in the case of YCS is the absence of any process, procedure, protocol or entity charged with the roll of acting as a sponsor or project initiator to:

independently assess at a preliminary level the viability of proposals, or take projects forward to full feasibility and implementation.




9. PRELIMINARY CONCLUSIONS ON POTENTIAL

FINANCIBILITY & RECOMMENDATIONS

9.1 Limits on Investment Appeal

The project as currently scoped requires considerable structuring to deliver certainty of cash flow. In some circumstances it could represent a potential investment proposition. Some of the issues, which limit the project’s appeal, are:

1. The absence of a clear Sponsor for the Project, leading to a lack of responsibility for funding a full Feasibility Study, the potential vagaries as to commitment to proceed and the implementation of a solution.

2. The ethereal nature of the Project and the absence of clear project assets that can be offered to investors and or as security to debt financiers.

3. Regulatory uncertainty as to rights to effect the rehabilitation, deal with saved water, level of security, operate the system and deal with adjoining water companies.

4. The absence of a mechanism and clear regulatory regime to allow investors to:

a. Capture water savings.

b. Obtain a secure title or property right to the savings.

c. Transfer, on either a permanent of temporary basis, the water savings.

5. Perceived timing problems with obtaining and coordinating all necessary approvals. 6. The current sub-economic pricing regime for water which neither reflects the

economic value of water not the true cost of storage, transmission and delivery to end users.

7. Concern over future pricing regimes and potential regulation of prices.

8. The political acceptability of introducing a Non-Market Contribution “levy” or charge to supplement cash flows.

9. Lack of clarity on the questions of the “correct” engineering/hydrological solution and its cost.

10. The need to develop a “deemed” water saving concept rather than than an relying on actual measurement regime (this may also be a benefit).

11. Potential practical difficulties with obtaining physical access to the creek through adjoining properties.

12. A general lack of understanding amongst potential investors of the dynamics of the rural water industry.

13. Lack of clarity as to third party liability and insurability of risks.




14. A taxation regime that does not reflect the changing water industry ownership

dynamics. 9.2 Issues are General and Not Project Specific

Most of the issues raised and risks identified are not unique to the Yanco Creek project but are common to the asset class as a whole. These issues need to be addressed if independent third party investment is to be attracted into the rural water sector.

Rates of return approaching those required to attract independent third party investors can be achieved if the project has access to the water savings, is able to monetise the savings at between $750 and $1000 per ML and can capture the externality benefit. Whilst the prices required are currently within the range at which water is trading in a range of south eastern Australian Catchments there is an issue as to how sustainable those prices will be in a range of climatic conditions and historic sub economic pricing regimes. 9.3 Co-ordination Production of a Full Feasibility Study of Bankable Quality

To advance the Project further requires a full feasibility study. To do so requires finding a Sponsor to:

1. Promote the project. 2. Assist in coordination of efforts. 3. Fund the cost of the full feasibility study, and

4. Provide a process to work through the plethora of planning and regulatory

approvals as well as dealing with stakeholder and wider community concerns. It is important that the feasibility study prepared be of bankable quality and addresses all the risk issues. It is unlikely that a Sponsor outside the public sector will be able to be attracted, as it is not in practical terms within the capacity of the private sector to initiate the project and capture the benefits within a reasonable risk profile. 9.4 Work to Be Undertaken

A wide range of work needs to be undertaken. This would include:

Ongoing Community Consultations.

Engineering Scope, Design & Costing.

Hydrological Study.

Quantifying the water savings.

Detailed environmental, biodiversity, land care and salinity studies. Some issues to be considered are included in further detail in Annexure “A“




Resolution of issues on access to the Water Savings, entitlements, transfer rights

and the interaction with the CAP.

A full EIS and EPBC investigation.

Surveying of the route of the YCS and assembly of a titles register.

Development of a process for planning approvals.

Development of a practical solution to the access to land question either via the Land Management Act or through, for example, a Conservation Easement approach.

Resolution of any compensation issues.

Development of a suitable Concession Deed and performance criteria.

Obtaining a tax ruling on the treatment of expenditure.

Undertaking a detailed Native Title and Historic Sites audit. Aspects of this

requirement are further discussed in Annexure “D”.

Development of Detailed Financial Study & Model.

Establishing Regulatory Regime & In Principle Approvals from Governments.

Development of a Funding Strategy & Structure.

Initial Financial Market Testing of Structure & Funding Proposal.

Identifying an Operator.

Establishing an appropriate monitoring regime for compliance with performance criteria and a suitable penalty regime for non-compliance.

Identifying suitable Investors.

Preparation of an Offering Memorandum and full suite of project documentation.

Marketing the investment proposal to investors and securing investment.

9.5 Indicative Timeframe

Indicatively a period of 18 months should be allowed for a full bankable feasibility study to be undertaken. It is important that the work be undertaken on a consultative basis with potential investors so that their requirements can be anticipated. Assuming that the outcome from the feasibility study is positive then an additional 6 to 9 months to put the project out to Tender or Expression of Interest and document the project with the preferred bidder will be necessary.




ANNEXURE “A”

Environmental Issues International, National and Regional Significance In the Murrumbidgee Catchment, there are a number of listed sites of ecological significance. These include sites under the Japan-Australia Migratory Birds Agreement and the China –Australia Migratory Birds Agreement, nationally important wetlands and endangered ecological communities. As well, migratory shorebirds and a range of threatened species exist in the Catchment, which would automatically require assessment under the Australian Government Environmental Protection Biodiversity Conservation Act (EPBC). With state and national environmental issues, it may be possible to establish a bilateral agreement on the environmental processes to be undertaken by an investor. The Australian government and the NSW government have signed a draft bilateral agreement to streamline the approvals process but clarification and specific agreements from both state and national representatives would be needed before the commencement of any works if the process was to gain accreditation by both governments. Further details on the environmental significance of the area are available from the Murrumbidgee Catchment Blueprint February 2003 and on-line from Environment Australia, www.deh.gov.au. Local summaries can be accessed from the site. Details for the Leeton area are:

http://www.deh.gov.au/cgi-bin/erin/ert/epbc/epbc_report.pl?loc_lga=Leeton%20%28A%29;output=html;search=Report;search=Search;loc_type=lga;report=epbc;proc=process;loc_state=NSW#summary

The EPBC Act has established processes and timelines for each of the three stages. Once a project is referred under the Act and coordinated with other approvals, processes required for an investor can be completed within a relatively short time frame in the investment process. Further details can be found at http://www.deh.gov.au/epbc/.




ANNEXURE “B”

Considerations for Community Consultations The community around the YCS is familiar with consultations and the timelines required, in part because of the natural resource management protocols and processes in developing and implementing plans and because of their involvement and participation in the Management Plan. Options for further consultations may include:

Awareness raising Fact sheets, media releases, mailouts, newspaper advertisements/editorials, radio interviews, public presentations and background notes to schools giving reasonable lead times for meetings and details for further information.

Consultations

Meetings at various times of the day and offering child care facilities to enable attendance by farming families/partnerships: o Telephone surveys; o Providing the opportunity for one-on-one meetings between the investor

and stakeholder or community representative; o Calling for submissions and accepting written, oral and visual

presentations; o Championing local groups to canvas ideas and present summaries of the

issues; and o Site visits.

All details and findings should be recorded and accessible to the community as reference documents, to increase awareness and provide a historical record of the events and processes undertaken. These findings may be of interest to and provide support for other communities seeking to attract investment to improve the management of water in their area or Catchment. Because of the importance of the Yanco Creek to all members of the community, consultations may include representatives from:

Business and business organisations (other than those listed as key stakeholders); Cultural organisations; Charitable groups and causes; Educational institutions; Emergency services; Financial services (existing local institutions); Community health services; Libraries (including for knowledge of historical information); Local community action groups (including all various environmental groups); Men’s/women’s groups; Political/lobby organisations; Research organisations; Rural businesses and associations (other than those listed as key stakeholders); Rural counsellors; Sporting associations, clubs and groups; Tourism associations; Youth groups and networks.




ANNEXURE “C”

Some Additional Funding Options for Assistance Public sources of financial and other assistance may be available from a range of local, State and Commonwealth sources. While unable to raise the total funds required, some programs may provide leveraging assistance to assist in attracting the investment required. Listed is an example of some options, a comprehensive assessment of all relevant grants and services would yield more programs for consideration.

Local government support including planning and development approvals assistance.

NSW Government including the Department of State and Regional Development and the Department of Infrastructure, Planning and Natural Resources: o ‘Developing Regional Resources Program’ which provides funding for local or

regional organisations investigating economic opportunities and innovative approaches to development; and

o ‘Regional Business Development Scheme’ to assist firms relocating to regional areas of existing operations expanding in a rural area.

o http://www.business.nsw.gov.au/help.asp?cid=175&subCid=193 o ‘Area Assistance Scheme’ providing grants to local organisations to improve

community well being and how communities function. o http://www.planning.nsw.gov.au/programservices/improvement.html

Australian Government including: o ‘Agriculture Advancing Australia: Farm Innovation Program’; o ‘Agriculture Development Projects’; o ‘FarmBis Australia’; and o ‘Fisheries Action Program’ www.affa.gov.au/content/ o Foundation for Rural and Regional Renewal www.frrr.org.au o ‘Venture Capital Limited Partnerships Program’; o ‘Innovation Access Program’; and o ‘Innovation Investment Fund’ www.ausindustry.gov.au o Area Consultative Committee services and programs

http://www.acc.gov.au/index.aspx o Regional Partnership Program www.regionalpartnerships.gov.au o ‘Investment and Trade in Regional Australia Package’ to attract investment into

regional areas. www.dotars.gov.au/regional/factsheets/regional_australia_package.aspx

o Initiatives from the Council of Australian Governments (COAG) for leveraging assistance.




ANNEXURE “D”

Aboriginal & Historic Sites Any proposed developments, including the YCS refurbishment, need to be consistent with Australian law and protocols for the protection of both Indigenous and European history and culture. Within the YCS, initial assessments have been carried out while preparing the Management Plan, providing a basis for further work. Indigenous History and Culture The area around the YCS is home to the Wiradjuri nation, the largest Aboriginal language group in New South Wales.35 Wiradjuri means ‘people of the three rivers’, the Macquarie, Lachlan and Murrumbidgee Rivers which provided both livelihood and food to the Wiradjuri people.36 Historical evidence of the Wiradjuri people around the Murrumbidgee River and Yanco Creek is evident by artifacts and sites of significance in the area. While less evidence remains than from the rivers to the north, this is in part because of the ephemeral nature of the Yanco Creek prior to irrigation. Native Title Australian law, through the Native Title Act 1993, recognises the rights and interests of Aboriginal and Torres Strait Islander people in land and waters according to their traditional laws and customs and that Indigenous Australians may continue to hold native title. Non-Indigenous investors or land users seeking access to a particular area can lodge a non-claimant application to find out the native title status of the area and then, depending on the outcome, proceed through established systems to seek access to the area. Further details are available at:

http://www.nntt.gov.au/applications/apps_landing.html Cultural Registers To protect cultural heritage and enable access and potentially development, the National Parks and Wildlife Services (NPWS) maintains the Aboriginal Heritage Information Management System. As a part of the NSW National Parks and Wildlife Act 1974, the database records all Aboriginal objects, Aboriginal places and other Aboriginal heritage values in NSW that have been reported to the NPWS. This list is not conclusive as some objects and significant sites may not have yet been found. For investors or land users seeking access to an area, particularly if it covers a large area such as a river catchment or contains data of a sensitive nature (for example, information on burials), a Data Licence Agreement may be required. This is an agreement between the National Parks and Wildlife Service and proponent detailing the access to and use of the information. Further details are available at:

http://www.nationalparks.nsw.gov.au/npws.nsf/Content/Protecting+Aboriginal+heritage

35 Peter Beal, Lee Furness, Jim Parret and Rob Scriven, The Yanco Creek System Natural Resource Management Plan, Stage 1, Draft, 2004, p.25 36 National Parks and Wildlife Service, South-western slopes Regional History, February 4, 2004, <http://www.nationalparks.nsw.gov.au/npws.nsf/Content/South+Western+Slopes+-+regional+history>.




http://www.atns.net.au/biogs/A000811b.htm

Non-Indigenous History and Culture With European settlement around the YCS dating back to 1856, plans for the Yanco Creek refurbishment would need to consider heritage sites or items of state significance.37 Cultural Register Details are held on The Register of the National Estate managed by the Australian Heritage Council under the Australian Heritage Council Act 2003.38 Further details may also be available from local government. Further information:

The Register of the National Estate http://www.ahc.gov.au/register/index.html and ://www.heritage.nsw.gov.au/><http

37 Beal et al, op. cit., p.25. 38 Australian Heritage Council, Welcome, <http://www.ahc.gov.au/>

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