Article by Brian M. Lucey Mar 02, 2016
Brian M. Lucey is Professor of Finance at the School of Business, Trinity College Dublin. He can be contacted by email on blucey@tcd.ie or on +353 1 8961552. He also write a fortnightly column on matters economic and financial in the Irish Examiner
Closing Irish water wont cost €7b, nor anything like it. Today we read, based on internal (and therefore of course unbiased …) documents from Irish Water that to close it would cost “up to €7b).
No, it wont
We are told the four cost headings are
cash costs, sunk costs, benefits forgone and the lost possibility of getting its debts off the exchequer’s books.
Of these cash costs are €100m. The sunk costs are about €500m for the meters (which of course Siemens would have installed for free…) and an eye-watering €170m for IT and other systems to administer. The other costs are given as €1.6b in foregone charges to 2021 and a vague and unspecified €1.6b in “savings” which Irish water would make. I cant see €7b there but just over €4b- the remaining €3b must be from savings that would be made on state debt service if and when IW was “off books”, which it is not of course.
Closing IW is an investment decision. Lets look at this.
First, any investment decision must discount. No discounting seems evident here. If we are to get €1.6b in charges over the next 5 years, or €320m per annum, these must be discounted. The today, or present, value of a 5y annuity of €320m depends on the interest or discount rate. Right now the interest rate on the national debt is about 4%. That gives a present value of €1.4b. But in IW land what is €200m between friends. Actually, its €400m if we treat the other €1.6b in the same way. So its not €7b but €6.6b to close. Lets move on
Second, in investment decision making, for the investment, only incremental costs are relevant. These are costs that will change depending on the go/no go decision. Thus sunk costs are, to the decision to close IW or not, irrelevant. To be sure, they must be paid for, but they are sunk, and irretrievable regardless of IW continued existence or otherwise. So we have to take off the cost of closure at least another €670m reducing the cost to €6b.
Third, the cash costs, these are real.
Fourth, the €3b in missing costs, attributable it seems to savings on the national debt. Two issues arise here. IW is NOT and will not for some considerable time be off the books. So any costs from it not existing in the future and the costs of water being on the state are, at best, probabilistic. They should be discounted by some % to reflect the likelihood. Second, the savings would appear to be a lump sum value of some savings per annum. Some discounting on that would be needed. So we perhaps might reduce this cost from €3b to , lets do a Drummer, €1b. Total cost now €4b.
But wait…if we don't have IW we wont need the “water conservation grant”. That costs just a tad under €100m per annum. If we assume that it will last forever then its present value, at 4% is €2.5b. If we use the 5y horizon IW seem to use its €445m. Total cost of closing IW now is €1.5-3.5b.
All of this assumes of course that the charges wont in some way be recouped in tax, that the meters wont be ever used etc. But even if we assume that, there is no way, from the figures presented, that closing IW would cost €7b, but rather a small % of same. Once again IW seems to have its numbers cockeyed.