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Channel Deepening Supplementary Environmental Effects Statement Expert Witness Presentation. 17 July, 2007. Planning Panels Victoria Department of Sustainability and Environment. The Rules of the Game.

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## Channel Deepening Supplementary Environmental Effects Statement Expert Witness Presentation

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**Channel Deepening Supplementary Environmental Effects**StatementExpert Witness Presentation 17 July, 2007 Planning Panels VictoriaDepartment of Sustainability and Environment**The Rules of the Game**Neo-classical economics is the standard theoretical framework for assessing the net worth of projects • Economic analysis is conducted according to an established body of theory and practice • This standard is exemplified by the Economic Analysis of Investment Operations, World Bank (WB, 2001) and the Handbook of Cost-Benefit Analysis from the Commonwealth Department of Finance (DOF, 2006)**Rules of the Game - Methodology**Meyrick has used cost-benefit analysis (CBA) - we agree that this is the appropriate framework. • Meyrick cites DOF, 2006 as their guide - we agree - and also include WB, 2001 guidelines as a even more relevant guide • SEES section 5.3 refers to a PWC/COPS economic model - it is based on data from the Meyrick CBA - inbound data determines the outbound results • Economic impact analysis is not relevant here - CBA data has provided the input that drives the economic model - same result could have been achieved with a export based toy factory!**Rules of the Game - Methodology continued**DOF handbook agrees with our conclusion - no evidence presented to privilege CDP over other transport infrastructure investments at the macro-economic level. “Employment multipliersseldom measure actual benefits or opportunity costs and should generally not be included in cost-benefit analyses. Likewise, ‘secondary benefits’are often another way of presenting primary benefits that have already been included in the analysis or that represent transfers. While secondary effects of a project may be important for distributional analysis or for planning purposes, their inclusion in a cost- benefit analysis involves inappropriate double counting.” DOF, 2006, pg 47 • If the CBA is negative the economic impact is negative & vice versa - the focus should be on the CBA analysis**Cost Benefit Analysis Rules! Ok**Meyrick agrees’ “the project would only proceed if benefits exceed costs” SEES, Technical Appendix 4, Section 2.1. • What is the objective of the project? To create value in the Victorian/Australian economy, and hence to improve the welfare of Victorians & Australians. • Meyrick CBA says benefits>costs - the World Bank says: “Good economic analysis should leave no doubts about the project’s contribution to the country’s welfare”. WB, 2001, pg 3. WB, 2001, pg 3**Setting the goal posts**There must be a high probability that the CDP will deliver net benefits, relative to doing nothing & net benefits equivalent to any project of comparable commercial risk • Paid for by taxpayers, without repayment, it serves a commercial enterprise. It is the marine equivalent of extending the Sydney airport runaway - but without the landing charges • Direct financial beneficiaries are commercial operators who will save money (much of it overseas), have a history of cartel behaviour & are subject to strong economic cycles**Is this a high probability outcome?**Can the CDP confidently deliver: a efficient shipping market AND sufficient cost savings per TEU, in the period 2008 to 2035 to repay a commercial return on the estimated $500 to $1000m capital investment compared with any other project(s) that could have been made and/or business as usual? Meyrick seeks to demonstrate that the net benefits are positive (that is they have positive NPV) that is at least equal to what else could have been earned in another, equivalent investment.**Appropriate assumptions results in the CDP having a negative**NPV, a clear sign not to implement the project Economists@Large have used the same economic model with more conservative assumptions and industry standard methods of calculation resulting in an NPV of -$0.54bn • The SEES’ cost-benefit analysis forecasts net project benefits or net present value (NPV) of $1.35bn • SEES financial calculations, modelling assumptions and cost omissions have caused the Channel Deepening Project’s (CDP) NPV to be overstated**Appropriate assumptions results in the CDP having a negative**NPV, a clear sign not to implement the project Economists@Large have used the same economic model with more conservative assumptions and industry standard methods of calculation resulting in an NPV of -$0.54bn • The SEES’ cost-benefit analysis forecasts net project benefits or net present value (NPV) of $1.35bn • SEES financial calculations, modelling assumptions and cost omissions have caused the Channel Deepening Project’s (CDP) NPV to be overstated**The SEES’ cost-benefit analysis forecasts net project**benefits or NPV of $1.35bn Channel Deepening Project Benefits & Costs (SEES) NPV ($m) Project Benefits Project Costs Net Project Benefits 2,000 1,500 1,000 500 0 Dry Bulk Vessels Liquid Bulk Vessels Container Vessels SourceExtrapolated from data from SEES**Appropriate assumptions results in the CDP having a negative**NPV, a clear sign not to implement the project Economists@Large have used the same economic model with more conservative assumptions and industry standard methods of calculation resulting in an NPV of -$0.54bn • The SEES’ cost-benefit analysis forecasts net project benefits or net present value (NPV) of $1.35bn • SEES financial calculations, modelling assumptions and cost omissions have caused the Channel Deepening Project’s (CDP) NPV to be overstated**Economists@Large have reworked the economic model with more**appropriate assumptions resulting in an NPV of -$0.54bn Channel Deepening Project Benefits & Costs (EcoLarge) NPV ($m) Project Benefits Project Costs Net Project Benefits 2,000 1,500 1,000 500 0 -500 Dry Bulk Vessels Liquid Bulk Vessels Container Vessels SourceExtrapolated from data from SEES and analysis by EcoLarge**Appropriate assumptions results in the CDP having a negative**NPV, a clear sign not to implement the project Economists@Large have used the same economic model with more conservative assumptions and industry standard methods of calculation resulting in an NPV of -$0.54bn • The SEES’ cost-benefit analysis forecasts net project benefits or net present value (NPV) of $1.35bn • SEES financial calculations, modelling assumptions and cost omissions have caused the Channel Deepening Project’s (CDP) NPV to be overstated**SEES financial calculations, modelling assumptions and cost**omissions have caused the CDP’s NPV to be overstated The method of calculating of Net Present Value (NPV) is not to accepted industry standards • Assumptions within the economic model are non-conservative • Significant costs that should be in the economic model have been omitted or under-estimated**SEES financial calculations, modelling assumptions and cost**omissions have caused the CDP’s NPV to be overstated The method of calculating of Net Present Value (NPV) is not to accepted industry standards • Assumptions within the economic model are non-conservative • Significant costs that should be in the economic model have been omitted or under-estimated**The method of calculating of NPV is not to accepted industry**standards Use of an inappropriately low discount rate, 6%, overstates the net present value (NPV) of the project • In the valuation of any project, the WACC is the appropriate discount rate to use, which is approximately 12% for PoM’s case • If we use a 12% discount rate, NPV reduces to $0.25bn • Forecasting the benefits of the CDP over 25 years is against the industry standard of 10 years plus a terminal value • If benefits are forecast for 10 years and a terminal value is used, the NPV reduces from $1.35bn to $1.02bn • Using both a 12% discount rate and a 10 year forecast period leads to the NPV reducing to $0.07bn**The method of calculating of NPV is not to accepted industry**standards Use of an inappropriately low discount rate, 6%, overstates the net present value (NPV) of the project • In the valuation of any project, the WACC is the appropriate discount rate to use, which is approximately 12% for PoM’s case • If we use a 12% discount rate, NPV reduces to $0.25bn • Forecasting the benefits of the CDP over 25 years is against the industry standard of 10 years plus a terminal value • If benefits are forecast for 10 years and a terminal value is used, the NPV reduces from $1.35bn to $1.02bn • Using both a 12% discount rate and a 10 year forecast period leads to the NPV reducing to $0.07bn**World Bank uses discount rate of 10-12%.2**Use of an inappropriately low discount rate, 6%, overstates the net present value of the project. NPV ($m) NPV decreases as Discount Rate increases 1 Discount Rate Notes1. Source: Extrapolated from data from SEES2. Source: Beli, et al, 1997. Handbook on economic analysis of investment operations, World Bank**World Bank uses discount rate of 10-12%.2**Meyrick & Associates Use of an inappropriately low discount rate, 6%, overstates the net present value of the project. NPV ($m) NPV decreases as Discount Rate increases 1 Discount Rate Notes1. Source: Extrapolated from data from SEES2. Source: Beli, et al, 1997. Handbook on economic analysis of investment operations, World Bank**World Bank uses discount rate of 10-12%.2**Meyrick & Associates Use of an inappropriately low discount rate, 6%, overstates the net present value of the project. NPV ($m) NPV decreases as Discount Rate increases 1 Economists@Large Discount Rate Notes1. Source: Extrapolated from data from SEES2. Source: Beli, et al, 1997. Handbook on economic analysis of investment operations, World Bank**The method of calculating of NPV is not to accepted industry**standards Use of an inappropriately low discount rate, 6%, overstates the net present value (NPV) of the project • In the valuation of any project, the WACC is the appropriate discount rate to use, which is approximately 12% for PoM’s case • If we use a 12% discount rate, NPV reduces to $0.25bn • Forecasting the benefits of the CDP over 25 years is against the industry standard of 10 years plus a terminal value • If benefits are forecast for 10 years and a terminal value is used, the NPV reduces from $1.35bn to $1.02bn • Using both a 12% discount rate and a 10 year forecast period leads to the NPV reducing to $0.07bn**The method of calculating of NPV is not to accepted industry**standards Use of an inappropriately low discount rate, 6%, overstates the net present value (NPV) of the project • In the valuation of any project, the WACC is the appropriate discount rate to use, which is approximately 12% for PoM’s case • If we use a 12% discount rate, NPV reduces to $0.25bn • Forecasting the benefits of the CDP over 25 years is against the industry standard of 10 years plus a terminal value • If benefits are forecast for 10 years and a terminal value is used, the NPV reduces from $1.35bn to $1.02bn • Using both a 12% discount rate and a 10 year forecast period leads to the NPV reducing to $0.07bn**In the valuation of any project, the WACC is the appropriate**discount rate to use1, which is approximately 12% for PoM’s case WACC = Weighted Average Cost of Capital = discount rate [ ] [ ] Equity (E) E WACC = X + X Cost of Equity Cost of D X (1 - tax rate) D + E Debt (D) + E Cost of Equity = Risk-free rate of return + Systematic Risk of PoM X Equity Risk Premium Cost of Equity = 6.25% + 1.23 X 6%4 = 13.5% [ [ ] ] $758m 2 $78m 2 WACC = X + X 13.5% 6.34%2 X (1 – 30%) $837m 2 $837m 2 = 12.6% => discount rate ~12% Notes1. FINSIA, Financial Analysis and Valuation Handbook 20072. Port of Melbourne Annual Report 2007 3. Systematic Risk of PoM / Beta value may be higher than 1.2 4. Industry standard for Equity Risk Premium rate is 6%. E.g. Grant Samual, Qantas Target’s Statement (p6) p153**The method of calculating of NPV is not to accepted industry**standards Use of an inappropriately low discount rate, 6%, overstates the net present value (NPV) of the project • In the valuation of any project, the WACC is the appropriate discount rate to use, which is approximately 12% for PoM’s case • If we use a 12% discount rate, NPV reduces to $0.25bn • Forecasting the benefits of the CDP over 25 years is against the industry standard of 10 years plus a terminal value • If benefits are forecast for 10 years and a terminal value is used, the NPV reduces from $1.35bn to $1.02bn • Using both a 12% discount rate and a 10 year forecast period leads to the NPV reducing to $0.07bn**The method of calculating of NPV is not to accepted industry**standards Use of an inappropriately low discount rate, 6%, overstates the net present value (NPV) of the project • In the valuation of any project, the WACC is the appropriate discount rate to use, which is approximately 12% for PoM’s case • If we use a 12% discount rate, NPV reduces to $0.25bn • Forecasting the benefits of the CDP over 25 years is against the industry standard of 10 years plus a terminal value • If benefits are forecast for 10 years and a terminal value is used, the NPV reduces from $1.35bn to $1.02bn • Using both a 12% discount rate and a 10 year forecast period leads to the NPV reducing to $0.07bn**If we use a 12% discount rate, NPV reduces to $0.25bn**Channel Deepening Project Benefits & Costs (6% discount rate) NPV ($m) Project Benefits Project Costs Net Project Benefits 2,000 1,500 1,000 500 Dry Bulk Vessels Liquid Bulk Vessels Container Vessels SourceExtrapolated from data from SEES**If we use a 12% discount rate, NPV reduces to $0.25bn**Channel Deepening Project Benefits & Costs (12% discount rate) NPV ($m) Project Benefits Project Costs Net Project Benefits 2,000 1,500 1,000 500 Dry Bulk Vessels Liquid Bulk Vessels Container Vessels SourceExtrapolated from data from SEES**The method of calculating of NPV is not to accepted industry**standards Use of an inappropriately low discount rate, 6%, overstates the net present value (NPV) of the project • In the valuation of any project, the WACC is the appropriate discount rate to use, which is approximately 12% for PoM’s case • If we use a 12% discount rate, NPV reduces to $0.25bn • Forecasting the benefits of the CDP over 25 years is against the industry standard of 10 years plus a terminal value • If benefits are forecast for 10 years and a terminal value is used, the NPV reduces from $1.35bn to $1.02bn • Using both a 12% discount rate and a 10 year forecast period leads to the NPV reducing to $0.07bn**The method of calculating of NPV is not to accepted industry**standards Use of an inappropriately low discount rate, 6%, overstates the net present value (NPV) of the project • In the valuation of any project, the WACC is the appropriate discount rate to use, which is approximately 12% for PoM’s case • If we use a 12% discount rate, NPV reduces to $0.25bn • Forecasting the benefits of the CDP over 25 years is against the industry standard of 10 years plus a terminal value • If benefits are forecast for 10 years and a terminal value is used, the NPV reduces from $1.35bn to $1.02bn • Using both a 12% discount rate and a 10 year forecast period leads to the NPV reducing to $0.07bn**Calculating the value of the CDP over 25 years is against**the industry standard of 10 years plus a terminal value • Forecasting is inherently difficult. It is difficult to forecast 5 years into the future, let alone 25 years. • Projects benefits are usually forecast 5-10 years into the future and then a terminal value for ongoing benefits is included. • “Discounted Cash Flow analysis requires forecasting a company’s free cash flow over a determined period,often 10 years”1 • “Grant Samuel has prepared a high level discounted cash flow analysis of Qantas based on a 10 year forecast model”2 Notes1. FINSIA, Financial Analysis and Valuation Handbook 2007 2. Grant Samuel, Qantas Target’s Statement**The method of calculating of NPV is not to accepted industry**standards Use of an inappropriately low discount rate, 6%, overstates the net present value (NPV) of the project • In the valuation of any project, the WACC is the appropriate discount rate to use, which is approximately 12% for PoM’s case • If we use a 12% discount rate, NPV reduces to $0.25bn • Forecasting the benefits of the CDP over 25 years is against the industry standard of 10 years plus a terminal value • If benefits are forecast for 10 years and a terminal value is used, the NPV reduces from $1.35bn to $1.02bn • Using both a 12% discount rate and a 10 year forecast period leads to the NPV reducing to $0.07bn**The method of calculating of NPV is not to accepted industry**standards Use of an inappropriately low discount rate, 6%, overstates the net present value (NPV) of the project • In the valuation of any project, the WACC is the appropriate discount rate to use, which is approximately 12% for PoM’s case • If we use a 12% discount rate, NPV reduces to $0.25bn • Forecasting the benefits of the CDP over 25 years is against the industry standard of 10 years plus a terminal value • If benefits are forecast for 10 years and a terminal value is used, the NPV reduces from $1.35bn to $1.02bn • Using both a 12% discount rate and a 10 year forecast period leads to the NPV reducing to $0.07bn**If benefits are forecast for 10 years and a terminal value**is used, the NPV reduces to $1.02bn Channel Deepening Project Benefits & Costs (25 yr benefits, 6% discount rate) NPV ($m) Project Benefits Project Costs Net Project Benefits 2,000 1,500 1,000 500 Dry Bulk Vessels Liquid Bulk Vessels Container Vessels Notes1. Source: Extrapolated from data from SEES2. SourceExtrapolated from data from SEES**If benefits are forecast for 10 years and a terminal value**is used, the NPV reduces to $1.02bn Channel Deepening Project Benefits & Costs (10 yr benefits + TV, 6% discount rate) NPV ($m) Project Benefits Project Costs Net Project Benefits 2,000 1,500 1,000 500 Dry Bulk Vessels Liquid Bulk Vessels Container Vessels Notes1. Source: Extrapolated from data from SEES2. SourceExtrapolated from data from SEES**The method of calculating of NPV is not to accepted industry**standards Use of an inappropriately low discount rate, 6%, overstates the net present value (NPV) of the project • In the valuation of any project, the WACC is the appropriate discount rate to use, which is approximately 12% for PoM’s case • If we use a 12% discount rate, NPV reduces to $0.25bn • Forecasting the benefits of the CDP over 25 years is against the industry standard of 10 years plus a terminal value • If benefits are forecast for 10 years and a terminal value is used, the NPV reduces from $1.35bn to $1.02bn • Using both a 12% discount rate and a 10 year forecast period leads to the NPV reducing to $0.07bn**The method of calculating of NPV is not to accepted industry**standards Use of an inappropriately low discount rate, 6%, overstates the net present value (NPV) of the project • In the valuation of any project, the WACC is the appropriate discount rate to use, which is approximately 12% for PoM’s case • If we use a 12% discount rate, NPV reduces to $0.25bn • Forecasting the benefits of the CDP over 25 years is against the industry standard of 10 years plus a terminal value • If benefits are forecast for 10 years and a terminal value is used, the NPV reduces from $1.35bn to $1.02bn • Using both a 12% discount rate and a 10 year forecast period leads to the NPV reducing to $0.07bn**Applying a 12% discount rate to a 10 year forecast with a**terminal value, the NPV reduces to $0.07bn Channel Deepening Project Benefits & Costs (25 yr benefits, 6% discount rate) NPV ($m) Project Benefits Project Costs Net Project Benefits 2,000 1,500 1,000 500 Dry Bulk Vessels Liquid Bulk Vessels Container Vessels SourceExtrapolated from data from SEES**Applying a 12% discount rate to a 10 year forecast with a**terminal value, the NPV reduces to $0.07bn Channel Deepening Project Benefits & Costs (10 yr benefits + TV, 12% discount rate) NPV ($m) Project Benefits Project Costs Net Project Benefits 2,000 1,500 1,000 500 Dry Bulk Vessels Liquid Bulk Vessels Container Vessels SourceExtrapolated from data from SEES and EcoLarge analysis**Non-conservative assumptions and omissions have led to**overstating the economic case for the CDP The method of calculating of Net Present Value (NPV) is not to accepted industry standards • Assumptions within the economic model are non-conservative • Significant costs that should be in the economic model have been omitted or under-estimated**Non-conservative assumptions and omissions have led to**overstating the economic case for the CDP The method of calculating of Net Present Value (NPV) is not to accepted industry standards • Assumptions within the economic model are non-conservative • Significant costs that should be in the economic model have been omitted or under-estimated**Assumptions within the economic model are non-conservative**• Shipping industry forecasts based on world economic growth over 30 years must be conservative • Assumptions in forecasts of fleet composition have not been conservative • Economists@Large have forecast a more conservative estimate of fleet composition • Applying this conservative forecast to just container vessel operating costs causes a reduction of NPV from $1.35bn to $0.71bn • Using this estimate of fleet composition as well as a 12% discount rate and a 10 year forecast period plus terminal value, results in an NPV of -$0.09bn**Assumptions within the economic model are non-conservative**• Shipping industry forecasts based on world economic growth over 30 years must be conservative • Assumptions in forecasts of fleet composition have not been conservative • Economists@Large have forecast a more conservative estimate of fleet composition • Applying this conservative forecast to just container vessel operating costs causes a reduction of NPV from $1.35bn to $0.71bn • Using this estimate of fleet composition as well as a 12% discount rate and a 10 year forecast period plus terminal value, results in an NPV of -$0.09bn**Shipping industry forecasts based on world economic growth**over 30 years must be conservative • All forecasts are based on world economic growth, trade growth and container growth for 30 years • A conservative rate of world growth has been used. General trend – increase in shipping and an increase in ship sizes globally • Detailed predictions are difficult • Container shipping industry is only 40 years old, a 30 year forecast seems inappropriate • The nature of the shipping industry**Shipping industry forecasts based on world economic growth**over 30 years must be conservative “Shipping is cyclical and to a certain extent depends on trade cycles. Currently seen is a worldwide boom …This (boom) has prompted warnings from shipbrokers that the charter market could collapse” (Deloittes Touche Tohmatsu, Key Issues in Global Shipping, Nov 2005) "The market is hugely vulnerable to a downturn in demand. A renewed surge of ordering activity in the opening months of the year appears to have exposed the containership industry to the threat of collapse. It may be possible to get through the next three years undamaged, but there are huge risks.” (Howe Robinson, Quaterly Analysis, as reported in Lloyds List 25/4/2005) “After four years of buoyant shipping markets, giving statistics never seen before, there are a number of disquieting voices being heard predicting a severe correction of the markets or even a new crisis recalling the sad days of the 80s” (Barry Rogliano Salles (BRS) Shipping and Shipbuilding Markets in 2006, 2007)**TEU**2005 2010 2015 2020 2025 2030 2035 Shipping industry forecasts based on world economic growth over 30 years must be conservative Increase in average container vessel size over time1 Source: 1. Meyricks & Associates, Channel deepening: Benefit-Cost analysis, 2007, p7**$350m**$300m $250m $200m $150m $100m $50m 2010 2015 2020 2025 2030 2035 Shipping industry forecasts based on world economic growth over 30 years must be conservative Container Vessel Operating Cost Savings Due to Channel Deepening1 “(Vessel size) can be speculatively evaluated by reference to the past relationship between trade volumes and ship size – though this does require some fairly imaginative analysis.”2 Source: 1. Meyricks & Associates, Channel deepening: Benefit-Cost analysis, 2007, p49 2. Drewry Shipping consultants, Port of Melbourne Channel Deepening Study, 2001, p69**Assumptions within the economic model are non-conservative**• Shipping industry forecasts based on world economic growth over 30 years must be conservative • Assumptions in forecasts of fleet composition have not been conservative • Economists@Large have forecast a more conservative estimate of fleet composition • Applying this conservative forecast to just container vessel operating costs causes a reduction of NPV from $1.35bn to $0.71bn • Using this estimate of fleet composition as well as a 12% discount rate and a 10 year forecast period plus terminal value, results in an NPV of -$0.09bn**Assumptions within the economic model are non-conservative**• Shipping industry forecasts based on world economic growth over 30 years must be conservative • Assumptions in forecasts of fleet composition have not been conservative • Economists@Large have forecast a more conservative estimate of fleet composition • Applying this conservative forecast to just container vessel operating costs causes a reduction of NPV from $1.35bn to $0.71bn • Using this estimate of fleet composition as well as a 12% discount rate and a 10 year forecast period plus terminal value, results in an NPV of -$0.09bn**Assumptions in forecasts of fleet composition have not been**conservative Source: 1. Meyricks & Associates, Channel deepening: Benefit-Cost analysis, 2007, p10**Assumptions in forecasts of fleet composition have not been**conservative Source: 1. Meyricks & Associates, Channel deepening: Benefit-Cost analysis, 2007, p10

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