Bigger councils are building 'gold-plated' plants because their ratepayers won't have to pick up the tab; smaller councils are nervous about being amalgamated and shut down, reports Jonathan Milne
According to Palmerston North City Council, its new $500 million wastewater treatment plant will be the best in the country. According to the Office of the Auditor-General, there is no credible plan to fund it.
A damning new report from the international rating agency S&P Global says it's an example of councils accelerating or "gold plating" Three Waters projects in the hope their ratepayers will never have to pick up the tab.
The final bills to implement the Government's Three Waters reforms are before Parliament, yet S&P says uncertainty around the transition is muddying the waters and essentially encouraging some councils to game the system.
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S&P has been the Government's go-to at every iteration of the development of its Three Waters reforms – which makes its reports this week to big institutional investors and other clients all the more extraordinary.
Under the headline "pipedream or panacea", the ratings agency first establishes a baseline of the value of Three Waters assets and debt held by the country's councils and the cost of the work needed to bring it up to scratch.
And then, in five succinct pages, it warns of a coming storm that may spell the end of some of the country's 67 councils.
"We believe there has been too little scrutiny of the affordability of the perceived NZ$120 billion to $180 billion investment in the Three Waters reforms," the reports conclude.
"There is no free lunch, and New Zealanders face much higher costs to fund this investment no matter who delivers it." – S&P Global report
"No matter who delivers the required infrastructure, the cost of such investment is astronomical. If councils fund the investment, general property and targeted rates will likely soar to record levels. If water services entities fund the investment, water charges will likely soar instead."
The Government argues that its four big new water services corporations will bring efficiencies of scale and will better prioritise the required investment than councillors with short-term horizons governed by elections; opponents led by National leader Christopher Luxon argue those benefits are overstated and could be achieved through smaller regional council-controlled organisations instead.
"In either scenario," the reports say, "there is no free lunch, and New Zealanders face much higher costs to fund this investment no matter who delivers it."
Winners and losers
As well as the lucrative job of sense-checking the Government's Three Waters reform models, S&P is contracted to provide credit ratings for 25 of the country's councils, accounting for 83 percent of the loan book of the Local Government Funding Agency, and 78 percent of the country's water-related debt. If it downgrades a council's credit rating, that has a massive impact on that community's debt repayments.
It predicts about 15 of its council credit ratings could be upgraded between now and 2027, regardless of the Three Waters reforms. In addition, Palmerston North and one other could be upgraded in response to the reforms. And one council – believed to be Whangārei – faces a rating downgrade because of the reforms.
Whangārei has read the writing on the wall; its council leadership has been among the most vocal critics of the reforms, and challenged the programme in the High Court. Just last week, High Court Justice Jillian Mallon acknowledged the transfer of councils' water assets to the four big new corporations constituted an uncompensated "expropriation", but said the court had no power to over-ride Parliament's decision.
Many councils will see Balance After-Capital Account deficits improve
The reason why some councils are winners and some are losers, in simple terms, is that some like Whangārei have healthy revenues drawn from water infrastructure that carries little or no debt. This may have seemed a smart idea to successive generations of Whangārei councillors, but what it means is that the ratepayers of one generation have paid upfront for infrastructure for future generations, rather than spreading the load.
Now they face losing control of those water assets, with just a one-off $90m sugar hit from Govt to cover their sunk costs.
By contrast, other councils have followed the more orthodox path of paying for their capital infrastructure through borrowing – and in Palmerston North's case, increasing and accelerating that borrowing as it became clear that a new regional corporation would take over responsibility for managing the city's water infrastructure and repaying its debt.
"The biggest winner would be Palmerston North City Council," S&P says. "This is because it is likely to shift its yet-to-be-built wastewater treatment plant – Nature Calls, which could cost several hundred million dollars – to one of the water services entities."
Councils knew the reforms would relieve them of all water-related debt. The ratings agency says: "We believe there are instances where this has incentivised councils to accelerate water projects or 'gold plate' some projects."
Palmerston North Mayor Grant Smith was upbeat when he addressed the local Rotary Club last week. Unlike some other centres, he said, the city’s Three Waters reticulation infrastructure was among the best in the country.
The council was pushing ahead with environmental consents and the construction of its $500m Nature Calls wastewater plant. “This is our city’s ongoing responsibility until it isn’t,” he told them.
That's a somewhat blithe assessment of a more vexing problem.
If the Three Waters reforms don't proceed, Palmerston North and its ratepayers could be in real trouble. S&P lead analyst Anthony Walker, the lead author of this week's reports, tells Newsroom the cost of the new wastewater plant would breach the city's debt cap (200 percent on revenue) and it would likely have to cancel the project.
With the new plant, generations of ratepayers would be in hock to servicing unprecedented debts at high interest rates; without it, the city would be stuck with tired, outdated and over-capacity sewage treatment infrastructure. Either way, the people of Palmerston North would be in the poo.
That has underlined Government concerns about councils' planning and decision-making on Three Waters infrastructure that needs to be sustainable over several generations, not just over three year election cycles. Indeed, S&P's reports say councils' longterm infrastructure planning is almost entirely unreliable, all over the country – its analysts say they simply don't believe councillors' promises to rein in debt.
And the Palmerston North wastewater plant plans have prompted the Auditor-General to issue a rare adverse opinion, criticising the city council's failure to consult on alternative funding backstops if the Three Waters reforms don't proceed. "Palmerston North City Council did not have a credible plan for funding its activities and planned projects," the auditor said. "In our view, the Council needed to consider other options, such as reducing levels of service, removing or deferring planned projects, and increasing rates further to keep debt amounts within its own parameters."
Right now, the Nature Calls wastewater plant is awaiting regional council consents to dispose of some UV-treated waste in the Manawatū River, and disperse more of it on land. But meanwhile, concern is growing in the city. Newly elected councillor William Wood is calling for a proper council debate on alternative financing options. "The Palmerston North City Council will require additional funding and support to be able to fund the upgrades that we are required to make to get consent from the regional council to continue to operate," he tells Newsroom.
He echoes the uncertainty expressed by S&P. "Under both the Government and the Opposition’s plan there are changes to the status quo in terms of funding and investment and I am sure these will be realised after the next election – no matter who wins."
Three Waters reforms: Most councils better off from a debt perspective
Similarly, Anthony Walker says Horowhenua, Wellington and Hutt City have all put the foot to the floor to break ground on Three Waters infrastructure projects they fear might not otherwise be signed off by the big new regional water corporations that the law says will take over running their drinking water, wastewater and stormwater networks in July 2024.
"Our view is that a lot of them have done it because if they start the process, they are determining their own future," he says. "And the water entity wouldn't be able to change it, once the process is commenced or the infrastructure is built.
"Whereas if you're going to start something in 2025, you're relying on a third party water infrastructure provider to do what you want – and that's going to be much harder."
Pressure for amalgamations
Much of the debate about Three Waters has been driven by Auckland (population 1.67 million) and Christchurch (pop 405,000). These cities – and Wellington, Hutt and Palmerston North – have sufficient scale to exercise some control over their own destiny.
That's not the case for small councils. Kaikōura has just 4300 residents at last count; Mackenzie District has about 5000. Chatham Islands has only 800 residents. And for some councils, water capital expenditure makes up most of their spending. S&P reports that water infrastructure is 61 percent of Porirua City Council's capital spending, and 56 percent of South Taranaki District's. It also makes up half the spending for Tasman, Marlborough, Hutt City and New Plymouth.
Councils in New Zealand already have far fewer responsibilities than in countries with which we compare ourselves, such as the UK and Australia. When our councils lose responsibility for water infrastructure, do they have much left beyond scheduling the buses, choosing the books for the library and, perhaps, mowing some berms?
That's a key question underpinning the Review into the Future for Local Government, commissioned by the Government in the realisation that the Three Waters reforms would enfeeble many. Submissions to the review closed this week, with Local Government NZ president Stuart Crosby expressing frustration at the lack of concrete proposals, thus far.
The review team's draft report notes capability, capacity, and funding constraints, particularly for smaller councils. It argues there are areas for potential collaboration that can harness local agility and scale efficiencies, says S&P. "If the Crown adopts this, it could make smaller councils nervous, especially once key water responsibilities shift to water services entities."
Investment in transport and water assets are the largest items in a territorial authority's capital expenditure programme. "Water assets alone represent about 40 percent of the average council's planned capex between 2025 and 2029. For some councils this is more than 50 percent. Therefore, councils are likely to become smaller once the reforms commence.
"Councils that are already small face the risk of further contraction or indeed questions over their long-term viability.
"Other delivery areas, particularly regulatory functions, are resource-intensive with little obvious need for variation across neighbouring councils. If the local government sector is to leverage scale efficiency, it could cast doubt on the need for 78 local councils, especially at the smaller end."
The reports say some councils, especially smaller ones, will forgo their responsibilities, leading to new amalgamation discussions.
Unsurprisingly, that S&P assessment hasn't been welcomed by those in local government. They want Three Waters and the Future for Local Government Review concluded, before any decisions are made on winding up and amalgamating councils.
"This would then determine the services that local government will provide to communities," says Local Government Funding Agency chief executive Mark Butcher.
"We would note that in most other countries, the size of the average council is much smaller than in New Zealand. On this basis it does not necessarily follow that amalgamation will occur. While it would be up to the Government, it is possible that any future government would leave it up to individual communities to decide whether amalgamation was the best option for them.
In recent years, Hawke's Bay and Wairarapa communities have voted no to amalgamation – the last amalgamation was the establishment of Auckland Council, and before that, Banks Peninsula.
But if small councils are to continue to struggle along, quite literally in isolation, then they will be faced with increased infrastructure spending – and increased borrowing. That is likely to drive down their credit ratings.
What would downgrades mean?
Credit rating downgrades wouldn't just hurt ratepayers in those councils, and threaten the viability of smaller councils. They would also affect the creditworthiness of the Local Government Funding Agency, the body that conducts the borrowing on behalf of the country's city, district and regional councils.
S&P says that's what is really crucial to the sector and its financial security.
Responding to questions from Newsroom, Mark Butcher plays down the risk of ratings downgrades for councils and the agency. The agency has improved its own financial profile by increasing its equity base over the past 10 years, he says. It's grown its initial equity base from $25m to $104m through retained earnings, and has borrower notes that can be converted into equity of $331m. Its debts are jointly guaranteed by 71 territorial and regional councils.
He defends Palmerston North's wastewater plant investing, and says "gold plating" is a subjective assessment. He gives the example of Christchurch City Council's new proposed multi-use arena. "While some people may argue that an arena with a roof is gold plating, the community was strongly supportive of the council proceeding. This was after consideration of the cost to ratepayers."
Of course, the Auditor-General found that in Palmerston North's case, there was not the same consultation on financing models.
"Our understanding is that Palmerston North considered various options for its proposed wastewater treatment plant," Butcher says. "This was done using technical advisors and working closely with mana whenua, iwi and the community.
"Choosing a land-based discharge system will have a higher cost than one that discharges into the Manawatū River. While any community will have differing opinions, the preferred option was selected after taking into account all of these views, including a consideration of the cost."
