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Do desalination plants make economic sense?

Desalination is a form of insurance and previous investments are currently paying off in many cities around Australia. But insurance comes at a cost, so how much of it is worth buying?

Dry conditions are raising questions across the nation about urban water security and supply augmentations.

With governments, water utilities and customers still dealing with the political and economic fallout of the price impacts of major augmentation decisions made a decade ago during the Millennium drought, the importance of getting long lived investment decisions right cannot be overstated.

Fortunately, since the Millennium drought the water industry has learnt a lot about the economics of investments in desalination and other manufactured sources.

The following four considerations are central to decision making around desalination.

1. Portfolio effects – understanding the sum of the parts

The cost of desalination is often compared to the cost of new dams. While understanding the cost per unit of water produced has some value, it does not tell the full story.

It is important to account for portfolio effects which consider how any new source works together with existing sources to meet the desired objective.

For example, investing in a new dam might be the cheapest option on an average dollar per kilolitre basis, but if the dam is located in a catchment where rainfall is highly correlated with rainfall to existing dams, it might contribute little towards meeting the appropriate level of water supply security.

Desalination might be more expensive on a dollar per kilolitre basis, but it can supply water when it is most needed.

These portfolio effects can be readily assessed to determine whether desalination fits the optimal mix for any city or town.

2. Customer preferences – how much does the community value water security?

The appropriate level of water supply security depends on the costs and benefits of increasing (or decreasing) water supply security.

Understanding the costs of increasing water supply security is mostly a technical engineering problem. However, understanding the benefits is an economic problem requiring an understanding of customer preferences.

This has been an area of extensive research with many studies having been undertaken on the costs of water restrictions in Australian cities.

This matters for desalination because the higher the appropriate level of water supply security, the greater the benefits from desalination will tend to be.

3. Climate resilience – is the investment robust over different climate sequences?

The benefits of desalination also depend on future rainfall and temperature. If the construction of a desalination plant is followed by a sequence of relatively wet years, the benefits are likely to be far lower than under a sequence of extremely dry years.

Most modelling of supply augmentations draws on historical data of system inflows. In many Australian cities, there is more than 100 years of data to draw upon. However, the Millennium drought highlighted the risk of expecting inflows to storages to revert to historical norms.

Rainfall and inflow records across many parts of Australia are highlighting potentially significant impacts of climate change and other factors on inflows.

In some ways, arguing about how much of this change can be attributed to climate change misses the point. What is required is the adoption of more robust ways of testing the resilience of different water supply augmentation and demand side responses to a much broader range of possible inflow sequences that could be plausible in the future.

4. Construction and operation – optimising desalination

Because we simply do not know exactly when it will rain and when desalination plants will be required, there is a risk of getting investment decisions wrong with the benefit of hindsight. Indeed, many decision makers have been harshly criticised for just that.

While judgement should be based on the quality of the risk-based decisions made at a point in time, not with the benefit of hindsight, there are embedded options that need to be considered based on their ability to reduce the cost of uncertainty.

These include readiness options (i.e. splitting the build decision into component parts and completing various stages that reduce the lead time for implementation such as environmental and planning approvals) and staging (i.e. the idea of building with the option for modular additional components of supply to come online flexibly over time).

In terms of operation, desalination plants are expensive to run, including as a result of significant energy costs. However, their effectiveness is limited if storages are left to decline too far before being turned on.

To maximise the benefits from desalination, it is important to consider the full range of options for constructing and operating desalination plants.

Desalination and other climate independent sources will have an increasingly important role to play in securing water supplies to our cities and towns. Demand management will only achieve so much, and many of the easy wins on the demand side have already been made. But supply augmentations are long lived decisions with the potential to attract significant attention across the community and they have a cost that lingers in bills for decades.

Proper economic appraisal can be used as an effective engagement tool. It will help to build ownership and understanding of decisions and ensure that the best augmentation solutions are implemented at the right time, in the right way, and that solutions are operated to get the balance right between cost to customers and the benefits we all receive from secure water supplies.

About the authors

Chris Olszak | Chris Olszak is a founding director of Aither and an expert on water policy, markets and infrastructure across Australia. He plays an active role leading many of Aither’s high profile and complex engagements working across governments, utilities, investors, regulators and agricultural enterprises.

Simon Hone | Simon Hone is a leading Australian economist with extensive experience in undertaking innovative applied research into infrastructure, environmental, resource, and agricultural issues. He leads Aither’s quantitative economics practice developing sophisticated models to aid decision making under uncertainty.

Aither is a national team of advisors that specialise in water markets, policy, infrastructure and natural hazards. Its service offerings cover economics, public policy, strategy and performance. Aither is a purpose-driven company that aims to inspire and enable positive change in the management of water and natural resources.