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The first separate water bills have arrived, and attention is shifting from how the new water services organisations are structured to what they’re charging. Mike Chatterley looks at three pricing questions that will shape the success (or otherwise) of the reforms.
The reaction to the first water bills from new water organisations was predictable. A cost that used to hide in a rates bill has turned up on its own piece of paper, and the size of that bill has surprised some and prompted questions about why it is what it is.
Much of that reaction may be directed at the visible change rather than its underlying cause. The new water organisations have largely inherited the charging approaches used by predecessor councils, including rates based on capital value. What has changed is that those charges are now more transparent and separate from the broader rates notice.
Costs are now more visible to those paying the bills
Water services (and their supporting network infrastructure) are expensive to operate, costs are rising, and – with the exception of Watercare – the way services are charged for was never designed to reflect what they cost. All of that is now becoming visible to the people paying the bills.
Water organisations need more revenue than their shareholding councils were collecting. Networks are ageing, regulatory standards are tightening, past under-investment has to be caught up, and operating and capital costs are increasing.
In many cases, there’s a substantial gap between the revenue councils were previously raising and what water companies need to be financially sustainable, and that gap needs to be closed. This includes ensuring that revenues support borrowing at levels that lenders, particularly the New Zealand Local Government Funding Agency, are comfortable with.
At the same time the basis of charging needs to change. A key change is the requirement to progressively shift from rating mechanisms based on property values towards utility-style water charges, a shift that will create new winners and losers. The combination of revenue increases and the redesign of charging approaches makes for an extremely challenging pricing transition, one that’s difficult to explain to a public that’s only now learning the true cost of their water services.
The Commerce Commission adds a further perspective. Councils and water organisations must disclose what revenue they collect, what they spend, and how they intend to look after their assets. The Commission has the power to impose price-quality regulation if necessary.
So the new water bills have three audiences – the customer, the regulator, and the lender. Satisfying these audiences comes down to three questions: How much revenue is actually needed? Who should pay? And is this enough to meet lending requirements and provide comfort to the water organisation’s board that it can meet its obligations?
How much revenue is needed?
The pricing question that gets the least public airtime is whether the revenue requirement is the right number.
This number is not fixed. It’s a function of operating costs, planned investment, and the ability to borrow. It will go up or down depending on what investment gets prioritised, how well renewals are planned against the actual condition of assets, how efficiently work is done, and the costs of operating the networks. Every dollar that’s not needed as a result of better investment planning and better asset management means a dollar less to recover from customers.
A water organisation that asks for a large increase without first showing it has stress-tested its operating budgets and capital programme will find the increase hard to defend. This is especially important because capital expenditure projections are significantly higher than what councils have historically delivered, and this begs questions about delivery readiness and supply chain capacity.
Water companies that increase revenues quickly to fund ambitious capital programmes may find themselves sitting on unplanned cash surpluses, or worse, sacrificing value-for-money in an effort to push money out the door.
Who pays: harmonise or cost-to-serve?
For a multi-council water organisation, a key choice is between everyone in the region paying the same charge for the same service, or each community or group of customers paying what its own network costs to operate.
Harmonisation of charges is favoured by some – same service, same charge. However, it also means some households pay more so that others can pay less. This often results in a transfer from communities with newer or cheaper networks to those with older or more expensive ones, or from urban areas to sparsely populated ones.
Cost-to-serve is the safer political bet, and for this reason it has been hard-wired into the foundation documents for some new water companies. But it leaves small communities with the challenge of how to afford expensive upgrades to infrastructure.
In its assessment of several water services delivery plans, DIA flagged projected revenue increases that could not be reconciled with reasonable benchmarks for affordability. In these cases, applying cost-to-serve principles locks in the affordability challenges the reforms were intended to help resolve.
Neither approach is wrong. Both involve difficult trade-offs, and higher revenue requirements make transitioning from one approach to another harder still.
Complicating this is the sheer number of tariff structures, rating differentials, and property-value based charging regimes that the new organisations’ boards are inheriting from each district.
Can we fund it? Lending requirements matter more than rating opinions
Pricing transitions involve walking a fine line between sufficient revenue and financial sustainability. Ultimately, to access the borrowing needed to finance capital investment, a water services organisation needs to generate enough cash to meet strict lending covenants.
Recent commentary from S&P shows that rating agencies and the sector's main lender are looking at different things.
S&P recently warned that amalgamations of councils could undo the balance-sheet separation the reform was meant to deliver. A water organisation owned by one council looks, in the group accounts, much like Watercare did inside Auckland Council before 1 July 2025. That’s correct from an accounting perspective, and a credit rating is a useful opinion that councils that are borrowing in their own name watch for good reason.
However, a credit rating is not what water organisations borrow against. When lending to a water company, LGFA takes security over the water charges, and determines the level of borrowing it’s prepared to provide with reference to the company’s funds from operations. Importantly, LGFA has said that whether rating agencies consolidate a water organisation’s borrowing when assessing a council’s rating makes no difference to how those covenants are calculated.
That covenant is a cash-flow test. Take the revenues, strip out operating costs and interest, and what’s left over needs to be sufficient to service the debt. Where the debt sits in a council's group accounts does not change this equation.
In my view, the accounting treatment is secondary. Lenders to local government are lending to LGFA, whose standing rests on the sector's collective capacity to strike rates and charges, backed by a liquidity facility from the Crown.
Pricing is now a critical governance question
The reform years were spent asking whether the debt could be shifted off the books. Now the focus has shifted to whether enough revenue can be recovered to fund the investments needed, while satisfying lending covenants and keeping bills affordable.
Boards must grapple with this question at the same time as transitioning charges away from rates based on property value towards more conventional water charges.
Answering this question requires that financial strategies and pricing principles are decided before the tariff structure is built. How the revenue requirement is stress-tested, whether the organisation harmonises or charges according to cost, and how to manage redistributional impacts through the price transition, are all questions boards should be asking.
Boards that tackle these questions early give themselves the best opportunity to deal with these challenges, and to avoid causing the sort of backlash that has plagued water reforms the world over.
