12. Policy Issues
Policy and regulatory frameworks play an important role in shaping and influencing the development and use of infrastructure. This section of the report identifies, at a high level, issues that are relevant to the design and operation of policy frameworks. The objective is not to define what policy should be. Rather, the intention is to draw out key issues, for individual sectors and also issues that span more than one sector. In a departure from previous chapters, a series of generic headings, rather than a sector-by-sector format is used.
Current policy work or regulatory initiatives by sector include:
| Issue | Current Activity |
| Electricity | Reserve Electricity Generation;
Electricity Commission;
National Energy Efficiency Strategy; |
| Telecoms | Commerce Commission initiatives on interconnect, reselling, unbundling local loop;
Project Probe; |
| Roads | Land Transport Strategy;
Regional Land Transport Strategies; |
| Rail | Potential purchase by the Government of the rail network; |
| Emergency planning / catastrophic events risk | Ministry of Civil Defence and Emergency Management |
| Waste water | Ministry of Health's Sanitary Works Subsidy Scheme |
| Water | The Water Programme of Action |
12.1 Introduction
The assets that have been the focus of the infrastructure audit have some particular features that have implications from a policy perspective.
a) Legacy Assets
The infrastructure sectors under consideration comprise a stock of legacy assets, which are a product of past decisions that may or may not be relevant to the present day or the future. The stock of assets is a function of New Zealand's geography, demographics and patterns of development over the last 150 years.
From a policy perspective, the legacy nature of the assets carries a number of implications. There are issues in terms of the value that should be ascribed to assets. Historical or acquisition cost is not necessarily a good measure of underlying value for assets which were acquired many years ago, but still have a useful economic life ahead of them. Depreciated replacement cost is not necessarily a good guide to value either if, in re-designing the system, the asset type, and their configuration would be much different to those in place today.
The appropriate basis for valuing long-life assets70 that are typical of infrastructure sectors has given rise to complex issues in the regulation of the airports and electricity sectors. Issues surrounding value are most acute in the context of economic regulation and the determination of prices that have to be paid for use of the infrastructure assets. Issues in relation to economic regulation are discussed further below.
b) Natural Monopolies
Infrastructure assets usually involve large and lumpy investments that, once made, tend to have relatively low alternative use values. For example, the cost of investing in a road is generally sunk. Once made, the value of the road, apart from the land it sits upon, generally has low, or no, opportunity value.
Large, lumpy and sunk cost investments are generally characteristics of natural monopolies. As the term implies, a natural monopoly asset is one where the barriers to entry are high; often so high that it is not efficient to have competing service providers. In general, road and rail networks and gas and electricity reticulation systems, are examples of sectors with strong natural monopoly characteristics.
Where natural monopolies exist, there can be incentives for service providers to price above, and restrict the quality and quantity of supply of services below, that which would be obtained in a competitive market. In this situation, there can be grounds for considering some form of economic regulation to promote efficient outcomes.
In the context of this review, the issue is whether there is any aspect of the policy framework which has implications for the regulatory environments pertaining to each of the infrastructure sectors and, more generally, any implications for the efficient allocation and use of resources in these sectors. In this regard, a number of issues have been identified which to varying extents span across the various sectors under consideration. In all cases, the issues noted arise, at least in part, because of the asset characteristics described above.
12.2 Potential Impacts of Infrastructure Failure
The first of the issues considered is the extent to which there is a risk of catastrophic failure of any of the infrastructure assets. Given the significant cost to replicate infrastructure assets and their integrated network characteristics, failure of an infrastructure asset could have far reaching economic and social implications.
We understand that Ministry of Civil Defence is undertaking a nation-wide project to assess the risks and consequences of catastrophic infrastructure failures and to develop policies and management practices to mitigate such risks. Key issues for consideration include:
a) Where Would Failure Matter Most?
On a localised level, any infrastructure failure is likely to cause problems within its region. Some infrastructure failures can cause wider consequences for significant parts (or all of) the country. These include:
- Gas and electricity transmission systems and, to a lesser extent, electricity generation capacity;
- Telecoms links, particularly between the North and South Islands, and internationally;
- Water pipelines. Although most systems are local or regional, Auckland relies heavily on the Waikato pipeline.
- Rail infrastructure, although there is potential to divert freight onto roads or shipping.
As a rule, distributed systems utilising localised resources are less likely to create specific points of vulnerability that might affect larger portions of the country. Risk or consequence of failure can also be mitigated by provision of duplicate or back-up infrastructure (increasing the redundancy built into the system). This inevitably carries a (potentially significant) cost.
b) What Is the Role for Policy?
From a policy perspective, the key question would be whether there is reason to believe that a sub-optimal balance of cost, redundancy and risk has been selected and, if so, what is the most appropriate form of intervention to address the issue. From the scan of the nine sectors covered by this review, there are no obvious areas where there is a sub-optimal balance of cost and risk although two points are worth noting. In the electricity sector, there are concerns surrounding the approach to dry year reserve and, in particular, how costs are to be recovered and from whom. Disruption to gas and electricity transmission systems may also disrupt national supplies. Second, in those sectors (e.g. road and water) where the infrastructure is publicly owned and managed, there are issues as to whether alternative procurement models involving the private sector might lead to better cost/risk tradeoffs.
12.3 Policy Issues
12.3.1 Pricing Mechanisms
Prices play a key role in a directing resources to their highest value use. They affect decisions regarding the use of infrastructure assets and decisions about the timing and nature of investment in new and replacement assets.
In most goods and services markets, prices are set by the interaction of willing buyers and sellers. However, this does not apply in the case of a number of the infrastructure sectors.
a) Roads
Roads are paid for via a combination of fuel excise, road user charges (for diesel-powered vehicles), vehicle licensing fees and rates. All of the charges have characteristics which are more akin to taxes than they are prices for most goods and services. This has a number of implications. First, the forms of cost recovery currently used are not a particularly effective tool when it comes to demand management. Auckland roads are congested, but motorists do not receive price signals regarding the costs they impose by entering congested road space. Second, investment decisions cannot be based on pricing information sent by road users. Road users cannot indicate the value they would place on building another road through a pricing mechanism in the same way that they can indicate this through the price they are willing to pay for a house.
The Land Transport Management Act provides some scope for tolling specific situations but does not necessarily allow a more wide-ranging approach to road pricing. Technology developments provide scope for tolling or other forms of road pricing. Policy frameworks need to be developed around alternative ways of paying for roads.
b) Water
In the water sector, there are two particular issues: water abstraction and water supply.
Water Abstraction
Abstraction of water, whether from catchment areas, rivers or ground supplies, is currently not priced. Competing demands for water supplies are managed through the RMA, effectively through rationing processes (the right to extract certain volumes, or volumes up to a given point etc.) Water rights are generally allocated on a first-come, first-served basis. Application of supply to the highest value use is therefore made through judgement rather than market forces. This raises the question as to whether supply is in practice allocated to the highest value use for the nation. This issue is also raised below regarding the purposes of the Resource Management Act.
Potable Water Supply
Very little of New Zealand's potable water supply is charged directly to the end user on the basis of volumes consumed. Most charging mechanisms work through the Territorial Authority's rating systems, with water (and wastewater) charges related to the value of the property rather than actual consumption. As there are only indirect links between volume of consumption and prices (through the extent to which additional investment in greater supply capacity is passed on through charges), there are no monetary incentives on users to minimise utilisation. If water supply is plentiful, and abstraction creates few negative externalities, this is perhaps not a problem. In drought-prone areas, water saving can only be achieved through voluntary or mandatory rationing.
This report does not comment on whether or not water metering should be introduced, but notes that the lack of pricing signals has implications for the economically optimal stock of infrastructure and sustainability issues such as minimisation of impacts on the environment and maximising efficient use of resources. In addition, however, analysis of the benefits and costs of water metering will need to take into account social impacts.
c) Wastewater
A similar situation exists for wastewater, where there are no pricing mechanisms in place, and no direct link between charges to users and the operating and capital costs of the infrastructure.
The absence of clear pricing signals has implications not only for the efficiency of use and minimisation of waste or consumption of a resource, but also for optimising investment decisions. While the introduction of pricing mechanisms might provide a theoretical solution to these matters, in practice the desirability of pricing would need to be considered in the context of implementation costs and ongoing operating costs.
A further issue for the policy framework is the extent to which users should be protected from significant fluctuations in price.
12.3.2 Incorporation of Externalities into Pricing
One of the characteristics of the infrastructure sectors under consideration is the existence of externalities that are currently not priced into services. The RMA process deals to some extent with local externalities, although this is generally through imposing restrictions or requirements on infrastructure investment rather than factoring the costs of externalities into prices.
a) Roads
Vehicle use of the road network gives rise to externalities in a number of respects including:
- Emissions (greenhouse gases, particulates and various localised air quality impacts)
- Noise pollution
- Water pollution (e.g. run-off of oils, tyre residues etc)
- Property damage and personal injury caused by traffic accidents
- Congestion
A major study into surface transport costs (road and rail) has been commissioned by the Ministry of Transport. The results of this work are not public. They are likely, however, to have significant implications particularly in terms of charges for use of the road network. This will have implications for road use as well as the use of other transport modes (rail and coastal shipping/barging)
b) Water and Wastewater
The principal externalities in water and wastewater arise from the impact of the abstraction of water and of the discharge of wastewater of varying treatment levels into the environment. The RMA plays a significant role in determining acceptable levels of externality at the local level, but these are not explicitly priced into service charges.
c) Energy
Pollution externalities are not currently factored into the price of electricity. The proposed carbon taxes are an attempt to do so, although they are also creating considerable uncertainty at present that is affecting the ability of infrastructure operators to invest. This is considered further below.
An issue to consider is whether explicit recognition of externalities (e.g. through the imposition of taxes such as the carbon tax) will have any impact on New Zealand's position vis-à-vis its international competitors and trading partners, when overseas jurisdictions do not factor externalities into the prices of goods and services.
12.3.3 Access Pricing
As noted earlier, the significant economies of scale and scope that is often a characteristic of infrastructure (particularly network assets) mean it is not efficient to have multiple providers of the infrastructure. To minimise the adverse consequences that can be associated with monopoly, policy and regulatory frameworks often separate ownership and operation of the network infrastructure from providers of services who must rely on the network for the delivery of their services. Examples include the separation of electricity energy and lines businesses, interconnection arrangements in the telecommunications sector and access rights arrangements in the rail sector.
The terms and conditions upon which service providers can access monopoly infrastructure is a key factor affecting the degree to which competition can develop in the markets for services to consumers.
Any regulation of access to infrastructure needs to be extremely clear, its purpose and limitations understood by all concerned parties, and certain.
In terms of the sectors reviewed as part of this study, it is clear that access arrangements are a key issue in the telecommunications sector. It will potentially be a growing issue in the rail sector given the imminent acquisition by the Crown of the track and associated infrastructure currently owned by Tranz Rail.
12.3.4 Demand Management
Demand management can be undertaken to a certain extent through pricing structures. Demand management could also be undertaken through rationing (as is the case at the moment for competing demands on water).
Changing technology and user behaviour can also impact on demand. The question for policy is the extent to which other approaches to demand management should extend beyond information provision and education (e.g. as to the cash benefits of using energy more efficiently) to actual regulatory interventions (e.g. requirements for all toilets to be dual-flush; all new refrigerators to meet specific energy efficiency standards etc.).
Areas for consideration for demand-management strategies include:
- Energy (where the National Energy Efficiency Strategy is already considering such measures).
- Water (metering is not commonplace and its introduction would incur significant costs).
- Road transport (the existing structure of road user charges has only limited impact on decisions regarding vehicle use).
12.3.5 Economic Regulation
A number of the issues outlined above concern regulation of specific issues or sectors. Regulatory activity will affect the timing and nature of infrastructure investment and thus the responsiveness of each sector to changing demands.
Key cross-sector regulatory issues identified in this study essentially relate to certainty and clarity over the regulatory regimes. Examples include:
- Energy. There is uncertainty over potential carbon taxes, reserve generation capacity and the role of regulation in the sector generally.
- Telecommunications: Uncertainty over local loop unbundling is likely to have the greatest impact at present, as the extent to which this actually occurs will affect the viability of investment in network infrastructure.
- Airports and ports: the requirement for additional safety and security measures and doubt over who should pay for them, and the potential for price regulation reflecting some element of localised natural monopoly.
12.3.6 Funding
This issue generally affects publicly owned and managed infrastructure, and in particular roads, water and wastewater.
In all three cases, rates is a major source of funding. An issue common to each of these sectors is potential imbalance between demands placed upon the infrastructure assets (and hence costs of ongoing maintenance, rehabilitation and capital works) and the size of the rates base. Examples include rural communities that attract large holiday populations. These communities have to develop water, waste water and road networks to cope with peak demands but generally do no have a large or wealthy permanent rates base.
In the roads sector, a further feature of current funding arrangements is that roads are paid for on a pay-as-you-go basis. This means that current road users must pay for roads that benefit future users (although it can be argued that current road users benefit from investments paid for by past users). It also means that the opportunities to bring forward road projects to optimise their scheduling, and the benefits they confer, are constrained.
The recently enacted Land Transport Management Act potentially creates some opportunity to finance road construction through borrowing from the private sector, but there are a large number of detailed policy issues to work through at the policy framework level and on a case-by-case basis. To attract private sector interest, there will need to be clarity and certainty of policy frameworks.
12.3.7 Resource Management Act ("RMA")
The RMA already articulates many concepts of sustainable development, and requires decision-making to take account of a wide range of issues, beyond the strictly commercial. It is not the purpose of this report to evaluate the RMA. However, the consultation did raise some issues that policy development may need to take into account, as they affect the responsiveness of infrastructure operators to changing demands:
- Inconsistency of Decision Making
A number of infrastructure operators noted that RMA processes produced different decisions across the country, on issues that were extremely similar. This affected the competitiveness of infrastructure providers and their ability to respond to changing demands. - Process and Timing
RMA processes can impose significant time and other costs on infrastructure operators seeking consents to undertake investment. There is also often a high degree of uncertainty over the likely outcomes of a consent process. Infrastructure operators' basic wish has been for high quality and rapid decision making, with a lower burden of time and cost. This comment was also made strongly and repeatedly at the recent GIAB forum. - National Benefit Tests
The RMA generally considers only local or regional impacts. In some cases, this may exclude consideration on the basis of national benefit. This will have implications for optimising the infrastructure stock if consents of infrastructure investment are driven more by local than national considerations: an optimal national stock may not be optimal for each and every region.
12.3.8 Human Capital
There is some concern that the stock of human capital (capability and expertise) is relatively limited and may pose a problem for infrastructure investment or operation. This has arisen in two areas in particular:
a) Road Construction
There is a substantial construction programme underway and ahead for the Auckland and Waikato regions. Some concern has been raised during this study that there may be insufficient labour supply to undertake all of the roading projects within the likely timeframes.
The study concludes that while there are risks in this regard, the issue should not be overstated. Many consultants and contractors in the road industry are internationally based. There is scope to obtain additional human resource from offshore and Australia in particular.
The ability to attract suppliers (both domestic and international) is greater the larger is the size of the project, the longer the stream of projects and the greater the degree of certainty regarding, and commitment to, projects and their timing. In some regions, there are issues concerning the supply of materials (e.g. aggregate) but this is not an issue concerning policy frameworks.
b) Rail
The Government will shortly acquire from Tranz Rail, track and associated infrastructure. Initially, management of the network will remain the responsibility of Tranz Rail (although Tranz Rail will continue is existing practice of contracting the work required to third parties).
The Crown is in the process of establishing a new entity - Track Co - that will have responsibilities for managing the network. Track Co will face a range of issues as it progressively assumes its new responsibilities. Clearly there will, be a degree of dependency on former Tranz Rail employees and contractors during the transition process.
c) Gas Exploration
Some consultees commented that there is limited expertise available for gas exploration activity. Whilst this might be the case, it does not seem to be a serious impediment to exploration activity at present.
12.3.9 Source of Residential Energy
It is generally accepted that use of gas for residential energy (heating, hot water, cooking) is a more efficient use of fuels than via electricity generation. Comment has been passed that there appears to be little investment in gas supplies for residential use. It is not clear to us that this is actually a market failure, but it does have implications for New Zealand's overall energy consumption.
12.3.10 Procurement
The roads, water and wastewater sectors are essentially under public ownership and management. Traditionally, the public sector approach to procurement has involved tendering specific, and generally disconnected, contracts for design, construction and operation. There is international evidence and practice which suggests that whole-of-life approaches to procurement and asset management can deliver significant efficiency gains. For example, those constructing an asset may have stronger incentives to adhere to specifications if they then are responsible for that asset's management.
In the roads sector, alternative procurement models that take a "whole-of-life" approach are being implemented, but their use is not commonplace. The Land Transport Management Act widens the scope for alternative procurement but concerns have been expressed in the sector that the Act is still too restrictive. The implication for policy is a need to ensure there are no unnecessary barriers to alternative procurement models being implemented.
12.3.11 Differences between Government Objectives and Commercial Incentives
There have been instances where public policy objectives for infrastructure and commercial incentives have not been aligned. For example, there are many instances where public policy objectives support the provision of certain levels of infrastructure services (e.g. electricity and telecoms) even though provision of such services may not be commercially viable.
Depending on the nature of the infrastructure and the government's policy objectives, misalignment could imply a case for some form of government intervention. Intervention can be in many forms including provision of subsidies (to users or service providers), direct Government purchase/contracting, various forms of regulation (including, for example, obligations to supply) and direct government provision. The nature of the intervention needs to be fit-for-purpose and address the cause of the misalignment of objectives. Different interventions imply different costs and benefits. These need to be evaluated and trade-offs identified.
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