By: Dawid Bosman – TCTA senior manager: Advisory Services
What are the demand-side risks of investment in desalination?
There is a saying in Australia: “The easiest way to break a drought is to build a desalination plant…” They should know; they have been there, and have just done that. This article explores how a drought led to a vast investment in desalination capacity in several Australian cities, and what the various responses were in the different regions, when the drought was finally broken. It then reflects on the demand-side risk of the investments, and how different cities responded to it.
The worst drought in Australian history lasted from 1997 to 2009, and left a lasting scar on the national psyche. The densely-populated coastal belt was hit the hardest, and the Murray-Darling basin, sustaining Australia’s primary agricultural zone, was devastated. In response to this crippling drought, Australia built six large desalination plants which, as a cluster, were the most expensive of their kind, to date, anywhere in the world. And then the rains came…
Capital investment in a disruptive environment can be cruel. It is important to know how the drought played out. Australia is not a stranger to droughts; since 1860, when records began, there has been a major drought somewhere on the Australian continent in 82 out of the 150-odd years, and droughts are now regarded as common and often-repeated events of Australian climate.
The Millennium Drought, as the 1997 to 2009 episode is now known, was the most severe of all. Whereas the previous droughts affected only specific regions, this one affected large parts of the continent over several years, including Australia’s five most populous cities, Sydney, Perth, Melbourne, Adelaide and Brisbane, as well as the major food-producing regions in the Murray-Darling basin.
The build programme
It was therefore no surprise that Australia launched a massive build programme of large-scale desalination plants, which yielded six plants in the five most populous cities, coming on-line from 2006 through to 2012. Perth built two plants of 144 and 290M?/d capacity, Adelaide a plant of 300M?/d, Sydney a plant of 250M?/d, and Melbourne a massive plant of 450 Ml/d. The total EPC expenditure amounted to AUD12-billion.
It should be noted that the Australian projects, with the exception of the first Perth plant (Kwinana), set new industry records on a cost-per-design-capacity basis; these costs are certainly not the norm. The high cost was caused by a few contributing factors:
- All the projects except Kwinana required very expensive tunnelling during the construction of the marine works;
- This was Australia’s first foray into the large-scale desalination market; bidders are known to add a risk premium in such circumstances;
- Australia’s high labour cost;
- Very high environmental standards, which required expensive impact mitigation measures; and
- The high cost of borrowing; the projects were financed during the global financial crisis.
This brings us to the demand-side risk of water infrastructure; the risk that the assumed demand projections made during planning may not endure through to the operational phase or, in fact, last for the duration of the facility’s life span. Circumstances may change, which erode the need for a given size of facility. This has significant implications for loan redemption, and for the technology partner who is contracted to run the facility. However the contract may be structured, the risk that an investment may be standing idle, lodges somewhere.
In Sydney, New South Wales, the Kurnell plant operated for a two-year proving period through to December 2012, when it was taken off-line and mothballed. The operating regime was adopted that it will be restarted whenever dams are at 70%, and again be mothballed at 80%. Dam levels are now nearly 100% full, and the prognosis is that a restart within the next two years is unlikely. In the interim, the plant’s contracted operator (Veolia) has taken measures to protect the plant and its equipment during the extended shutdown.
During 2012, the state sold the Kurnell plant to a pension scheme for AUD2,3 billion (approx. R20 billion) under a 50-year leaseback agreement, which released net proceeds of AUD300 million (approx. R2 billion) back to the State for financing other infrastructure.
This allowed the State to disinvest from an asset it no longer viewed as strategic, and so reduce much of the pressure on municipal water rates. It is interesting to note that capital recycling (selling public assets to provide capital for new investment) has now become a regular practice in Australia.
In Melbourne, Victoria, the Wonthaggi plant will remain mothballed for a third year running, and probably remain so for the foreseeable future, since the dams in the region are currently 75% full. The current labour government sees the plant as an important insurance policy – it was, after all, a labour government who committed to the plant back in 2007. But incredibly, the AUD5,7 billion (approx. R53 billion) plant has produced no water since the performance tests and commissioning were completed. Even prior to completion, the project became a significant liability to the Labour government who launched it; a political hot potato, synonymous with waste, mismanagement and spin.
In December 2010 a Liberal-National coalition came to power in Victoria, and early in 2013 the new Water Minister, Peter Walsh announced that it was ‘a personal ambition to never order water from the Wonthaggi Plant’. The desalination plant had become politically ‘toxic’, to the extent that the Sydney Morning Herald speculated that the coalition government “is so determined to use the plant as a political weapon against Labour, it is deliberately planning to keep it mothballed for as long as possible, stressing the idea that the whole thing has been a giant waste of taxpayers’ money”.
Numerous project challenges and setbacks were encountered during construction: Cyclonic weather, labour unrest and low productivity of the workforce caused construction delays of nine months. This resulted in legal claims and counter-claims between AquaSure, the consortium that built, owns and operates the plant, and the State of Victoria, during 2012 and 2013.
By October 2013, claims amounting to AUD1,3-billion, mainly from AquaSure against the State, were finally resolved, which paved the way for AquaSure to refinance AUD3,7-billion of project debt at less than half of its original cost.
“Agreeing to early refinancing now and resolving claims will allow AquaSure to obtain a better risk profile for the desalination plant project, and in turn, this means significantly lower financing charges,” said Walsh at the time. “The amount of savings to be realised by water customers is expected to be significant.”
In December 2014, the Labour Party returned to power in Victoria. The desalination plant is still a sensitive matter, but now less of a political embarrassment.
The events described in this article, the drought, the desalination build programme, and the two wettest years that followed, created a pretext for suggesting how water may be valued in the different parts of Australia. In Western Australia, and to some degree also in South Australia, the value of water security, and its fragility in the light of climate change, seems pervasive and deeply ingrained into the consciousness of nearly all who live there. Of course, the same is true of those who live in other parts of the country, but it seems to a lesser degree, and less pervasive. The relative ease with which the desalinations investments became politicised in Victoria, and the decision in New South Wales to sell the desalination plant, suggest that the price of water may be perceived as more important than climate-independent water security.
Neil Palmer, the chief executive officer (CEO) of the National Centre of Excellence in Desalination Australia (NCEDA), observed that, “Internationally, other countries are looking at Western Australia’s use of desalination as a stand-out example of best practice, and using its plants as environmentally sustainable benchmarks as their energy requirements are offset by purchasing renewable energy. Yet sadly on the east coast the focus around desalination is short term, on current pricing rather than the long-term benefits – avoiding the fact that without desalination, east coast cities will face water deficits in years to come.”
It is clear that an expectation of substantial and sustained demand on a desalination plant will often be unrealistic, unless the region is naturally water scarce, and the yield of the plant is destined purely for base-load supply. In areas where the dam inflows have been slowly decreasing over a number of decades, suggesting a long-term decline in rainfall and increased evaporation, desalination can certainly be a solution, but with the caveat that the demand-side risk be assessed over an extended period.