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Toolkit: Approaches to Private Participation in Water Services Module 6 Allocating Responsibilities and Risks.

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Presentation on theme: "Toolkit: Approaches to Private Participation in Water Services Module 6 Allocating Responsibilities and Risks."— Presentation transcript:

1 Toolkit: Approaches to Private Participation in Water Services Module 6 Allocating Responsibilities and Risks

2 Introduction: Navigating through this E-Learning Module E-learning design: davidstiggers@comcast.net

3 Elements of the Toolkit TOOLKIT 1 Considering Private Participation 2 Planning the Process 5 Standards, Tariffs, Subsidy, Financials 4 Setting Upstream Policy 3 Involving Stakeholders 6 Responsibilities & Risks 7 Developing Institutions 8 Designing Legal Instruments 9 Selecting an Operator Additional Material CD-ROM Appendix B Policy Simulation Model Appendix A Examples of PP Arrangements

4 General Outline of Toolkit TOOLKIT 1 Considering Private Participation 2 Planning the Process 4 Setting Upstream Policy 3 Involving Stakeholders 6 Responsibilities & Risks 7 Developing Institutions 8 Designing Legal Instruments 9 Selecting an Operator Additional Material CD-ROM Appendix B Policy Simulation Model Appendix A Examples of PP Arrangements Module 6 5 Setting Service Standards, Tariffs, Subsidies & Financial Arrangements Module 6 Allocating Responsibilities and Risks

5 Module 6 - What will we learn? What are the key areas of RESPONSIBILITY for provision of the water services, and how can they be defined? Is it possible to use a standard model of private participation for a specific case, or is some tailored or hybrid model required? What are the key areas of RISK associated with the responsibilities, and how can they be defined? Management Contract for Jordan Valley Authority, Irrigation Water Supply, may be the first of its kind. What rules or mechanisms can be established to ensure that the allocation of risk is maintained in a clear and effective manner for the private participation arrangement? Who is best able to manage these risks and responsibilities, and how best to allocate these? Plus! Additional Material: Tariff Reset

6 ANALYZING Responsibilities & Risks ALLOCATING Responsibilities & Risks DESIGNING Risk Allocation Rules EXAMPLES Allocation - Different PP Models ANALYZING Responsibilities & Risks Module 6 Allocating Responsibilities and Risks A big part of designing the PP Arrangement is defining and allocating the business responsibilities between the various parties. Risk associated with these responsibilities has also to be allocated between the parties, and this is also a key part of designing the Arrangement. A big part of designing the PP Arrangement is defining and allocating the business responsibilities between the various parties. Risk associated with these responsibilities has also to be allocated between the parties, and this is also a key part of designing the Arrangement. The basic process for allocating Responsibilities and Risks is: Identify the main areas of Responsibility involved in delivering the services and the Risks associated with each Responsibility Allocate each area of Responsibility and Risk to the party best able to manage it Design the Arrangement to achieve the best allocation of risks and responsibilities The basic process for allocating Responsibilities and Risks is: Identify the main areas of Responsibility involved in delivering the services and the Risks associated with each Responsibility Allocate each area of Responsibility and Risk to the party best able to manage it Design the Arrangement to achieve the best allocation of risks and responsibilities

7 Module 6 Allocating Responsibilities and Risks ANALYZING Responsibilities & Risks ALLOCATING Responsibilities & Risks DESIGNING Risk Allocation Rules EXAMPLES Allocation - Different PP Models ANALYZING Responsibilities & Risks ALLOCATING Responsibilities & Risks DESIGNING Risk Allocation Rules EXAMPLES Allocation - Different PP Models ANALYZING Responsibilities & Risks Analyzing Responsibilities & Risks In this section we ANALYZE key issues related to provision of water services, looking at two main areas: Key areas of RESPONSIBILITY. How can they be defined? Key RISKS related to these Responsibilities. How can they be defined? In this section we ANALYZE key issues related to provision of water services, looking at two main areas: Key areas of RESPONSIBILITY. How can they be defined? Key RISKS related to these Responsibilities. How can they be defined?

8 Module 6 Allocating Responsibilities and Risks ANALYZING Responsibilities & Risks ALLOCATING Responsibilities & Risks DESIGNING Risk Allocation Rules EXAMPLES Allocation - Different PP Models ANALYZING Responsibilities & Risks ALLOCATING Responsibilities & Risks DESIGNING Risk Allocation Rules EXAMPLES Allocation - Different PP Models ANALYZING Responsibilities & Risks Analyzing Responsibilities & Risks Analyzing RisksAnalyzing Responsibilities

9 Module 6 ANALYZING Responsibilities & Risks ALLOCATING Responsibilities & Risks DESIGNING Risk Allocation Rules EXAMPLES Allocation - Different PP Models ALLOCATING Responsibilities & Risks Allocating Responsibilities & Risks A key aim of private participation is to allocate risks between the Operator and the Contracting Authority.

10 Module 6Allocating Responsibilities & Risks How can we best allocate Risks and Responsibilities between the Contracting Authority and the Operator? Some Guidelines: Each Responsibility is allocated to the party best able to undertake it Each Risk is born by the party best able to manage it, taking account of the parties ability to: Predict changes in the relevant factors Influence or control the risk factor Control the impact of the risk on the value of the water and sanitation business Diversify or absorb the Risk NOTE: COST OF RISK Bearing Risk has a cost. If Risk is allocated to the Operator, he will generally expect to be able to recover the cost. Allocating Risk to the party best able to manage it helps to reduce costs to the contracting authority and customers. Example: One party may be better able to predict nonpayment Example: one party may be better able to reduce nonpayment through customer management Example: one party may be better able to reduce nonpayment through ability to offer credit terms Example: One party may be able to diversify risk across a portfolio of projects

11 Allocating Risks Example (1): Demand Risk Example: Demand Risk affects many elements of water and sanitation companies, it can have a significant impact on the business value, and fluctuations in demand can drastically affect investment needs. The extent to which Demand Risk is shared between the Contracting Authority and the Operator depends on the particular circumstances of the project including: Availability of good information on Demand Economic Stability The Operators willingness to accept Risk In practice the Operator will be reluctant to accept full Demand Risk, and will seek to pass it onto customers through: Tariffs or ……. Reduced Service Levels

12 Allocating Risks Example (2): Currency Risk Example: Currency Risk is made up of Exchange Rate and Convertibility Risks. Exchange rate risks comes from unpredictable variation in Exchange Rate. Convertibility Risk comes from uncertainty as to whether the Government will restrict conversion of the local currency into foreign currency Currency Risk affects the business value through several mechanisms: Operational Costs e. g. Affects costs of imported inputs, such as energy costs Maintenance and construction Costs e.g. Affects price of imported parts used in new construction Finance Costs e.g If Loans in foreign currency but revenues from local currency, then exchange rate fluctuations will affect business profitability.

13 ..or, for this we example, can show graphically how Currency and Convertibility Risks affect the value of the business through several mechanisms…….. Cash Flow Operating & Maintenance Currency Convertibility Risk Total Costs New Investment Input Prices Financing Risk Exchange Rate Risk Allocating Risks Example (2): Currency Risk

14 Module 6 ANALYZING Responsibilities & Risks ALLOCATING Responsibilities & Risks DESIGNING Risk Allocation Rules EXAMPLES Allocation - Different PP Models Plus! Additional Material: Tariff Reset DESIGNING Risk Allocation Rules Designing Allocation of Responsibilities & Risks The next step is to design the Rules that will allocate the risks and responsibilities Rules for adjusting Tariffs are an important mechanism for allocating Risk between the parties, including: Cost Pass Through Indexation Tariff Resets Other risk-allocating rules are also reviewed (e.g. Bonuses and compensation on termination) Rules for adjusting Tariffs are an important mechanism for allocating Risk between the parties, including: Cost Pass Through Indexation Tariff Resets Other risk-allocating rules are also reviewed (e.g. Bonuses and compensation on termination)

15 Module 6 Designing Allocation of Responsibilities & Risks We will consider two main subjects related to Risk Allocation TARIFF ADJUSTMENT MECHANISMS ALLOCATION OF OTHER RISKS

16 Module 6 Designing Allocation of Responsibilities & Risks Rules for adjusting tariffs are the key mechanism for allocating risk among Customers, the Operator and the Contracting Authority…… TARIFF ADJUSTMENT MECHANISMS ALLOCATION OF OTHER RISKS Cost pass-through Tariff Indexation Formulas Tariff Resets

17 Module 6 Designing Allocation of Responsibilities & Risks Rules for adjusting tariffs are the key mechanism for allocating risk among Customers, the Operator and the Contracting Authority…… TARIFF ADJUSTMENT MECHANISMS ALLOCATION OF OTHER RISKS Cost pass-through Tariff Indexation Formulas Tariff Resets Tariff IndexationCost Pass Through

18 Module 6 Designing Allocation of Responsibilities & Risks Rules for adjusting tariffs are the key mechanism for allocating risk among Customers, the Operator and the Contracting Authority…… TARIFF ADJUSTMENT MECHANISMS ALLOCATION OF OTHER RISKS Cost pass-through Tariff Indexation Formulas Tariff Resets Tariff IndexationCost Pass Through Tariff Resets Example: Why the need for Tariff Resets?

19 Module 6 Designing Allocation of Responsibilities & Risks In addition to Tariffs…………………………. important mechanisms covering other risks must also be must be designed TARIFF ADJUSTMENT MECHANISMS ALLOCATION OF OTHER RISKS Cost pass-through Tariff Indexation Formulas Tariff Resets Bonuses & penalties Government Guarantees Termination Triggers & payments Transition periods at commencement Contract Duration

20 Module 6 Other Mechanisms for Allocating Risk Some other key risk allocation mechanisms include: Bonuses and penalties Government guarantees Termination triggers and payments Transition periods at commencement Contract Duration ALLOCATION OF OTHER RISKS Although Tariff adjustment rules are the main ways of allocating risks, other risks are allocated between Operator and the Contracting Authority by contract

21 Module 6 Other Mechanisms for Allocating Risk Some other key risk allocation mechanisms include: Bonuses and penalties Government guarantees Termination triggers and payments Transition periods at commencement Contract Duration Bonuses & Penalties Performance payments such as penalties and bonuses encourage efficiency gains by sharing some element of risk with the Private Operator The Contract may lay out a list of penalties if the Operator does not perform. The Contract may also include bonuses if the Operator exceeds certain targets Bonuses are the main mechanisms for transferring risk in a Management Contract. A management Contract without performance bonuses only gives an Operator weak incentive to improve performance Guarantees The Contracting Authority or a Government entity may provide guarantees to the Operator against certain risks, such as: Operating debt Exchange rate guarantees related to foreign debt This guarantees downside risk, making it more attractive to the Operator. Care must be taken not to included risks that the Operator might be able to cover by himself more effectively Termination triggers and payments An arrangement will usually set out a list of triggers that entitles parties to terminate early, for example: Requisition, expropriation or seizure of water systems by Government The occasion of force majeure that makes the contract unworkable If penalties exceed a certain threshold the Contracting Authority may have the right to terminate. Termination payments compensate the Operator for costs that would otherwise be lost under early termination (e.g. sunk investment costs by the Operator). The way that these payments are calculated and applied helps to determine the allocation of risk Transition periods Where information problems increase the risk a transition period can be built in at the commencement of the arrangement. This allows an initial grace period when the Operator to collect information needed to run the business on a commercial basis, without accountability for performance improvements. Terms can be adjusted to reflect any major differences from the initial assumptions The longer the Contract Duration the more difficult it is to predict the effect of various parameters for the life of the contract. This may make the risks and the costs become unacceptably high to the various parties. Reset mechanisms can help reduce risks to manageable levels for long duration contracts, particularly where private investment is involved

22 Module 6 ANALYZING Responsibilities & Risks ALLOCATING Responsibilities & Risks DESIGNING Risk Allocation Rules EXAMPLES Allocation - Different PP Models EXAMPLES Allocation - Different PP Models Different PP Models Allocating Responsibilities & Risks In this section we look at the way that three standard PPP models deal with Risk and Responsibilities: Management Contract Affermage/Lease Concession Each of these models is defined by the particular allocation of Risks and Responsibilities. These models can be tailored to meet specific situations, or hybrid versions of these models used. In this section we look at the way that three standard PPP models deal with Risk and Responsibilities: Management Contract Affermage/Lease Concession Each of these models is defined by the particular allocation of Risks and Responsibilities. These models can be tailored to meet specific situations, or hybrid versions of these models used.

23 Module 6 Different PP Models Allocating Responsibilities & Risks Operator Risks: Contract Form: OperationalTechnical Management Contract Affermage - Lease Concession Service Contract (by comparison) RegulationFinancial Commercial Forex Each of the three standard models of private participation is defined by the allocation of responsibilities and risks Risk Level: These are an indication of the level of Risk taken by the Operator for specific issues under the various PP models. Risk Level: These are an indication of the level of Risk taken by the Operator for specific issues under the various PP models.

24 Module 6 Different PP Models Allocating Responsibilities & Risks Operator Risks: Contract Form: OperationalTechnical Management Contract Affermage - Lease Concession Service Contract (by comparison) RegulationFinancial Commercial Forex Each of the three standard models of private participation is defined by the allocation of responsibilities and risks Concession: The Operator assumes full responsibility for service delivery, including: Management Operation Maintenance of existing assets New Investment Concession: The Operator assumes full responsibility for service delivery, including: Management Operation Maintenance of existing assets New Investment Affermage – Lease Responsibility for operating and maintaining assets plus commercial and management responsibilities, passes to the Operator The publicly owned company continues to be accountable for new investments) Affermage – Lease Responsibility for operating and maintaining assets plus commercial and management responsibilities, passes to the Operator The publicly owned company continues to be accountable for new investments) Management Contract: The Operator fills the Key management positions in the water company. The publicly owned company continues to be accountable for other responsibilities (e.g. operating and maintaining assets, new investments). Management Contract: The Operator fills the Key management positions in the water company. The publicly owned company continues to be accountable for other responsibilities (e.g. operating and maintaining assets, new investments).

25 …each model has a particular application to the balance between Costs and Revenues as well as Political and Regulatory Risks Module 6 Different PP Models Allocating Responsibilities & Risks Political and Regulatory Risk Costs/Revenues LOWHIGH Operator willing to sink capital Operator willing to take operating and commercial risk only Operator will only take limited risk Tariffs dont cover O&M costs Tariffs cover O&M costs only Tariffs cover total costs Concession Lease/Affermage Management Contract Management Contract Looking at the balance between Costs and Revenues and Political and Regulatory Risks for each model …………. Management Contract The risk transferred to the Operator depends on a performance bonus. The formula for the bonus sets how much risk is taken by the Operator. In general, the least amount of risk is transferred to the Operator under a Management Contract. Management Contract The risk transferred to the Operator depends on a performance bonus. The formula for the bonus sets how much risk is taken by the Operator. In general, the least amount of risk is transferred to the Operator under a Management Contract. Affermage – Lease The risk transferred to the Operator is significant, but depends on the contract details and the way that the operators remuneration is determined. Affermage: the tariff adjustment rules relating to the Operators tariff (or affermage fee) are the most important Lease: the Operator gets the customer tariff minus the lease payment. Tariff adjustment related to customer tariff are the most important. Affermage – Lease The risk transferred to the Operator is significant, but depends on the contract details and the way that the operators remuneration is determined. Affermage: the tariff adjustment rules relating to the Operators tariff (or affermage fee) are the most important Lease: the Operator gets the customer tariff minus the lease payment. Tariff adjustment related to customer tariff are the most important. Concession: The Operator takes the greatest overall risks or responsibilities of the three models Concession: The Operator takes the greatest overall risks or responsibilities of the three models

26 Module 6 Different PP Models Allocating Responsibilities & Risks Political and Regulatory Risk Costs/Revenues LOWHIGH Operator willing to sink capital Operator willing to take operating risk only Operator wont take any risk Tariffs dont cover O&M costs Tariffs cover O&M costs only Tariffs cover total costs Concession Lease/Affermage Management Contract Management Contract HYBRID MODELS In addition to the three basic PP Models, it is possible to design and implement hybrid structures that combine effective elements of different structures, balance risk, mobilize capital but protect the poor HYBRID MODELS In addition to the three basic PP Models, it is possible to design and implement hybrid structures that combine effective elements of different structures, balance risk, mobilize capital but protect the poor ….but it may be necessary to adapt the standard models to meet particular needs

27 Module 6 Different PP Models Allocating Responsibilities & Risks Political and Regulatory Risk Costs/Revenues LOWHIGH Operator willing to sink capital Operator willing to take operating risk only Operator wont take any risk Tariffs dont cover O&M costs Tariffs cover O&M costs only Tariffs cover total costs Concession Lease/Affermage Management Contract Management Contract HYBRID MODELS In addition to the three basic PP Models, it is possible to design and implement hybrid structures that combine effective elements of different structures, balance risk, mobilize capital but protect the poor HYBRID MODELS In addition to the three basic PP Models, it is possible to design and implement hybrid structures that combine effective elements of different structures, balance risk, mobilize capital but protect the poor Examples; Risk in Hybrids - Amman (MC) - Cartagena Affermage/Lease ….but it may be necessary to adapt the standard models to meet particular needs

28 Reviewing Module 6 The Module has looked at a whole range of issues for analysis and allocation of responsibilities & risks in PP design…………. Including Tariff Reset ANALYZING Responsibilities & Risks ALLOCATING Responsibilities & Risks DESIGNING Risk Allocation Rules EXAMPLES Allocation – Different PP Models ANALYZING Responsibilities & Risks

29 Checklist: Module 6 ……..and the allocation process is detailed in this Checklist

30 More Information: Module 6

31 Supporting Material The Toolkit Financial Model Toolkit Case Study material Toolkit Website: http://rru.worldbank.org/Toolkits/WaterSanitation/ For comments or further details contact Cledan Mandri Perrott at cmandriperrott@worldbank.org cmandriperrott@worldbank.org

32 Toolkit: Module 6 End of Module

33 Toolkit: Module 6 Return to Start

34 Toolkit: Module 6 DO NOT MOVE or ERASE THE FOLLOWING SLIDES

35 Key Areas of Responsibility MANAGEMENT OPERATIONS & MAINTENANCE INVESTMENT & FINANCE Direct staff Set human resource Policy Establish or improve business processes Manage inventory Maintain assets Commercial responsibilities (e.g. billing & collection Issue demand and capacity forecasts Arrange finance Prepare technical designs Construct assets There are three key areas of responsibility in utility management There are three key areas of responsibility in utility management. We show here examples of tasks for each area………….. Back to Module

36 Responsibilities in the main PPP models Concession & Divestiture Affermage & Lease Management Contract MANAGEMENT OPERATIONS & MAINTENANCE INVESTMENT & FINANCE Direct staff Set human resource Policy Establish or improve business processes Manage inventory Maintain assets Commercial responsibilities (e.g. billing & collection) Issue demand and capacity forecasts Arrange finance Prepare technical designs Construct assets ……and here we can see which Responsibilities are dealt with under each of the three main PPP models Back to Module

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38 Module 6 Tariff Adjustment Rules: Cost Pass-Throughs Cost pass-throughs should be considered for important costs over which the operator has no control Rules for adjusting Tariffs often allow changes in the cost of certain inputs, that are then passed through immediately to the Customers. This effectively allocates the Risk to the Customers. Items that can be treated as pass-throughs include: Bulk Water price increases Costs of changes in sales or value added taxes Costs of changes created by regulations governing the quality of water or waste water Example: Tangiers Concession – Bulk Water Cost Bulk water is supplied to the Concessionaire, by a Government owned body. The bulk water prices are not in the control of the Concessionaire. If the price of bulk water goes up, then the Tariffs are increased by the same amount, and the Operator neither loses or gains from the change. Customers therefore bear the risk of bulk water costs. Back to Module

39 Module 6 Tariff Adjustment Rules: Tariff Indexation Formulas Index formulas serve to adjust tariffs to reflect a change in an index of prices, rather than the Operators actual costs Tariffs are adjusted at regular intervals (example: every 6 months) rather than response to specific events. Indexation attempts to anticipate changes in certain determinants of the cost of service, and Tariffs are automatically adjusted according to certain rules. Tariff indexation formulas provide different adjustment methods, including: Change in average level of prices (e.g. by the consumer price index) Customized price index related to changes in utilitys likely costs (e.g. a basket of prices, such as exchange rates and prices of specified utility inputs) No indexation ( as often happens in USA) but with a nominal rate set for the tariff, and all changes made during Tariff Reset ( as discussed in the next section ) Back to Module

40 Module 6 Tariff Adjustment Rules: Tariff Indexation Formulas Index formulas serve to adjust tariffs to reflect a change in an index of prices, rather than the Operators actual costs Tariffs are adjusted at regular intervals (example: every 6 months) rather than response to specific events. Indexation attempts to anticipate changes in certain determinants of the cost of service, and Tariffs are automatically adjusted according to certain rules. Tariff indexation formulas provide different adjustment methods, including: Change in average level of prices (e.g. by the consumer price index) Customized price index related to changes in utilitys likely costs (e.g. a basket of prices, such as exchange rates and prices of specified utility inputs) No indexation ( as often happens in USA) but with a nominal rate set for the tariff, and all changes made during Tariff Reset ( as discussed in the next section ) Indexation: Changes in average prices Custom Price Index - Gabon Concession Back to Module

41 Tariff T in period n is equal to the tariff in the previous period multiplied by the proportional increase in the consumer price index (CPI So, if the consumer price index increases from 100 to 105by 5 percent, that isand X is 1 percent, the tariff increases by 4 percent. CPI X indexation is also known as RPI X indexation, where RPI stands for the retail price index. Tariff Indexation: Price Indices Index formulas automatically adjust tariffs according to certain rules. Two examples are given here using known price levels … Other tariff indexation formulas adjust prices according to a custom price index that more nearly reflects changes in the utilitys likely costs (as Gabon example), although this can be more complex Average Price index: Tariff Indexation adjusting the tariff according to the change in the average level of prices measured by, say, the consumer price index: CPI X indexation: Includes a tariff indexation formula that is based on changes in the consumer-price index minus some proportion X: This kind of tariff indexation formula protects the utility from general inflation, but exposes it to risks of changes in prices of particular inputs. If the price of electricity and chemicals increase by more than the average rate of inflation, the utility will lose. Conversely, if the price of those inputs rises by less than the average rate of inflation, the utility will gain. Back to Module

42 Where the custom price index i is determined by a formula such as: is the weight accorded to the price of the first input Where: is the price of the first input in period n, and so on. Custom Index: Gabon Some tariff indexation formulas adjust prices according to a custom price index that more nearly reflects changes in the utilitys likely costs The Gabon concession included a formula for quarterly tariff adjustments to account for changes in the exchange rate and the prices of inputs such as fuel, personnel, imported goods, inflation, and import taxes. This was expressed as: This kind of indexation is more complicated but it also exposes the utility to less risk Back to Module

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44 Module 6 Tariff Adjustment Rules: Tariff Resets It is not possible to identify in advance all the factors that may affect an Operators profits. Indexation cannot cover all cases, and Tariff Resets allow Tariffs to be adjusted in a predictable fashion Tariff Resets are used in long duration contracts (e.g. affermage–lease, concession or divestiture). Tariffs are Reset against a set of rules that allow tariffs to be adjusted in a predictable fashion. The rules are agreed before the arrangement. We should note that the Operator has to bear more risk: The longer the gap between resets The less that resets pass on tariff changes to customers Depending on the chosen Objectives that will govern the Tariff Reset Back to Module

45 In this Section we look at some considerations when designing Tariff Reset Rules Tariff Resets: Design Issues What are the Objectives of a Tariff Reset? There are a number of issues that we can look at with regard to Tariff Resets: If review shows new Tariff needed, what is the method for setting the new Tariff? What triggers the Tariff review and any Tariff Reset? Back to Module

46 We will look at Tariff Reset issues in the context of this diagram… Tariff Resets: Objectives and Scope Allow Operator to earn set Rate of Return (efficient or not) Allow Operator to earn set Rate of Return (efficient or not) Allow efficient Operator to earn set Rate of Return Return Operator to position it would be without change OBJECTIVE TRIGGER SCOPE Partial Review Full Review Event BasedPeriodic On Request

47 Back to Module The Objectives chosen affect the choice of Tariff Review Type Tariff Resets: Objectives and Scope Allow Operator to earn set Rate of Return (efficient or not) Allow Operator to earn set Rate of Return (efficient or not) Allow efficient Operator to earn set Rate of Return Return Operator to position it would be without change OBJECTIVE SCOPE Partial Review Full Review With the Objective of allowing a reasonable return on capital, a Full Tariff Review based on the Operators actual financial Position is appropriate With the Objective of allowing an efficient Operator to have a reasonable return on capital, a Full Tariff Review with adjustments for potential efficiency improvements is sought. The Operators financial position, costs and revenues are assessed and then optimized to bring them in line with a theoretical efficient Operator With the Objective of allowing an efficient Operator to have a reasonable return on capital, a Full Tariff Review with adjustments for potential efficiency improvements is sought. The Operators financial position, costs and revenues are assessed and then optimized to bring them in line with a theoretical efficient Operator Efficient Cost Estimates Options for estimating efficient costs include: Benchmarking Operator against similar companies Use of independent expert to evaluate performance Market testing (e.g. ask for other bids for services) Efficient Cost Estimates Options for estimating efficient costs include: Benchmarking Operator against similar companies Use of independent expert to evaluate performance Market testing (e.g. ask for other bids for services)

48 Back to Module The Objectives chosen affect the choice of Tariff Review Type Tariff Resets: Objectives and Scope Allow Operator to earn set Rate of Return (efficient or not) Allow Operator to earn set Rate of Return (efficient or not) Allow efficient Operator to earn set Rate of Return Return Operator to position it would be without change OBJECTIVE SCOPE Partial Review Full Review With the Objective of allowing an efficient Operator to have a reasonable return on capital, a Full Tariff Review with adjustments for potential efficiency improvements is sought. The Operators financial position, costs and revenues are assessed and then optimized to bring them in line with a theoretical efficient Operator With the Objective of allowing an efficient Operator to have a reasonable return on capital, a Full Tariff Review with adjustments for potential efficiency improvements is sought. The Operators financial position, costs and revenues are assessed and then optimized to bring them in line with a theoretical efficient Operator Efficient Cost Estimates Options for estimating efficient costs include: Benchmarking Operator against similar companies Use of independent expert to evaluate performance Market testing (e.g. ask for other bids for services) Efficient Cost Estimates Options for estimating efficient costs include: Benchmarking Operator against similar companies Use of independent expert to evaluate performance Market testing (e.g. ask for other bids for services) What are Reasonable Costs? Market Testing

49 The Objectives chosen affect the choice of Tariff Review Type Tariff Resets: Objectives and Scope Allow Operator to earn set Rate of Return (efficient or not) Allow Operator to earn set Rate of Return (efficient or not) Allow efficient Operator to earn set Rate of Return Return Operator to position it would be without change OBJECTIVE SCOPE Partial Review Full Review The Objective of returning the Operator to the financial position it would have been in if not for some unexpected changes in particular variables. A Partial Tariff Review looks solely at the variables in question. The Objective of returning the Operator to the financial position it would have been in if not for some unexpected changes in particular variables. A Partial Tariff Review looks solely at the variables in question. Examples of variables for Partial Review: What additional costs have been incurred as a result of currency devaluation? How has a slow down in demand growth affected change in Operators net revenue? Examples of variables for Partial Review: What additional costs have been incurred as a result of currency devaluation? How has a slow down in demand growth affected change in Operators net revenue? Back to Module

50 …..other questions may arise. Tariff Resets: Objectives and Scope Allow Operator to earn set Rate of Return (efficient or not) Allow Operator to earn set Rate of Return (efficient or not) Allow efficient Operator to earn set Rate of Return Return Operator to position it would be without change OBJECTIVE SCOPE Partial Review Full Review Objectives: Other possible Questions Other questions may need to be answered: How should the reasonable rate of return be determined? How should the value of assets on which a return is allowed be set? Should a return on operations, or a management fee, be allowed in addition to return on capital A decision will have to be made for the basis of calculations of Tariff. Examples: Use a historic test year Be forward looking, based on cost and revenue projections. If so, what time period to use? o Immediate future (say next 5 years)? o Full Term of the arrangement? It is a good idea for the Contract to spell out as clearly as possible the procedures, principles and objectives that will apply at Tariff Reset Objectives: Other possible Questions Other questions may need to be answered: How should the reasonable rate of return be determined? How should the value of assets on which a return is allowed be set? Should a return on operations, or a management fee, be allowed in addition to return on capital A decision will have to be made for the basis of calculations of Tariff. Examples: Use a historic test year Be forward looking, based on cost and revenue projections. If so, what time period to use? o Immediate future (say next 5 years)? o Full Term of the arrangement? It is a good idea for the Contract to spell out as clearly as possible the procedures, principles and objectives that will apply at Tariff Reset Back to Module

51 …..other questions may arise. Tariff Resets: Objectives and Scope Allow Operator to earn set Rate of Return (efficient or not) Allow Operator to earn set Rate of Return (efficient or not) Allow efficient Operator to earn set Rate of Return Return Operator to position it would be without change OBJECTIVE SCOPE Partial Review Full Review Objectives: Other possible Questions Other questions may need to be answered: How should the reasonable rate of return be determined? How should the value of assets on which a return is allowed be set? Should a return on operations, or a management fee, be allowed in addition to return on capital A decision will have to be made for the basis of calculations of Tariff. Examples: Use a historic test year Be forward looking, based on cost and revenue projections. If so, what time period to use? o Immediate future (say next 5 years)? o Full Term of the arrangement? It is a good idea for the Contract to spell out as clearly as possible the procedures, principles and objectives that will apply at Tariff Reset Objectives: Other possible Questions Other questions may need to be answered: How should the reasonable rate of return be determined? How should the value of assets on which a return is allowed be set? Should a return on operations, or a management fee, be allowed in addition to return on capital A decision will have to be made for the basis of calculations of Tariff. Examples: Use a historic test year Be forward looking, based on cost and revenue projections. If so, what time period to use? o Immediate future (say next 5 years)? o Full Term of the arrangement? It is a good idea for the Contract to spell out as clearly as possible the procedures, principles and objectives that will apply at Tariff Reset TABLE: More detailed issues on Tariff Reset Objectives & Risk Allocation Back to Module

52 …..and each Objective will have specific financial implications. Tariff Resets: Objectives and Scope Allow Operator to earn set Rate of Return (efficient or not) Allow Operator to earn set Rate of Return (efficient or not) Allow efficient Operator to earn set Rate of Return Return Operator to position it would be without change OBJECTIVE SCOPE Partial Review Full Review Case Study: Financial Implications of Objectives Back to Module

53 There are three main Triggers for Tariff Resets……. Tariff Resets: Timing of Tariff Resets Allow Operator to earn set Rate of Return (efficient or not) Allow Operator to earn set Rate of Return (efficient or not) Allow efficient Operator to earn set Rate of Return Return Operator to position it would be without change OBJECTIVE TRIGGER SCOPE Partial Review Full Review Event Based Periodic On Request Periodic Review: Permitted Tariffs are reviewed and reset on a regular basis (e.g. every 5 years) In principle, the Operator retains profits and losses earned between reviews Example: Used in United Kingdom Periodic Review: Permitted Tariffs are reviewed and reset on a regular basis (e.g. every 5 years) In principle, the Operator retains profits and losses earned between reviews Example: Used in United Kingdom On Request: Timing of Tariff reviews not set in advance. Resets triggered at request of an interested party (e.g. Operator or a customer). Trigger can be if Operators profitability diverges too far from a reasonable rate of return. This allows Operator to pass changes in Costs or Revenues to customers. Example: traditional approach in United States On Request: Timing of Tariff reviews not set in advance. Resets triggered at request of an interested party (e.g. Operator or a customer). Trigger can be if Operators profitability diverges too far from a reasonable rate of return. This allows Operator to pass changes in Costs or Revenues to customers. Example: traditional approach in United States Event Based Review: Used to adjust just for specific Variables Specific events will trigger Tariff review Example: Tariff review held if (a) demand varies by more than 10% or (b) local currency depreciates by more than a set amount or (c) changes in legislation or standards (Partial Review) Event Based Review: Used to adjust just for specific Variables Specific events will trigger Tariff review Example: Tariff review held if (a) demand varies by more than 10% or (b) local currency depreciates by more than a set amount or (c) changes in legislation or standards (Partial Review) Back to Module

54 There are three main Triggers for Tariff Resets……. Tariff Resets: Timing of Tariff Resets Allow Operator to earn set Rate of Return (efficient or not) Allow Operator to earn set Rate of Return (efficient or not) Allow efficient Operator to earn set Rate of Return Return Operator to position it would be without change OBJECTIVE TRIGGER SCOPE Partial Review Full Review Event Based Periodic On Request Event Based Review: Used to adjust just for specific Variables Specific events will trigger Tariff review Example: Tariff review held if (a) demand varies by more than 10% or (b) local currency depreciates by more than a set amount or (c) changes in legislation or standards (Partial Review) Event Based Review: Used to adjust just for specific Variables Specific events will trigger Tariff review Example: Tariff review held if (a) demand varies by more than 10% or (b) local currency depreciates by more than a set amount or (c) changes in legislation or standards (Partial Review) Event Based Reviews - The Gambia Lease - Gabon Concession Back to Module

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56 …. as shown in this Table with the Utilitys 10 year predicted and actual financials Here we look at an example where actual returns are less than predicted, Example; Need for Reset Present Value of actual Revenue over the 10 year period is 5% lower than expected. Total Costs only drop by 1% because of the high proportion of fixed costs Present Value of actual Revenue over the 10 year period is 5% lower than expected. Total Costs only drop by 1% because of the high proportion of fixed costs What if, in the first year of the arrangement, the water consumption drops by 3 percent rather than increasing as projected? Back to Module

57 …. as shown in this Table with the Utilitys 10 year predicted and actual financials Example: Need for Reset What if, in the first year of the arrangement, the water consumption drops by 3 percent rather than increasing as projected? Conclusion: Given the potential impact on the value of the business from demand fluctuations, the operator may be unwilling to enter into the contract without being confident that it will be permitted to adjust tariffs to account for unpredictable shocks of this nature. The same will apply for other significant sources of risk. Conclusion: Given the potential impact on the value of the business from demand fluctuations, the operator may be unwilling to enter into the contract without being confident that it will be permitted to adjust tariffs to account for unpredictable shocks of this nature. The same will apply for other significant sources of risk. Instead of earning a modest profit over the first 10 years, the operator will make a loss in present value terms Back to Module

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59 Call for a Tariff Reset?: The Operator operates and maintains the business, and makes some investment. These factors have affected performance over 5 years: Local currency devalued, increasing some costs The Operator has not been able to reduce non revenue water as much as expected – this has increased operational costs Electricity prices are higher than forecast Call for a Tariff Reset?: The Operator operates and maintains the business, and makes some investment. These factors have affected performance over 5 years: Local currency devalued, increasing some costs The Operator has not been able to reduce non revenue water as much as expected – this has increased operational costs Electricity prices are higher than forecast Case Study: Financial Implications of Objectives First, we look at an example of the Financial Position of a Hypothetical Operator. In this example, what might trigger the need for a Tariff Reset? Why the need for a Reset? Initial Tariff set at 1.19 $/m 3, with expected Return on Capital for the first 5 years of 10%. Why the need for a Reset? Initial Tariff set at 1.19 $/m 3, with expected Return on Capital for the first 5 years of 10%. Why the need for a Reset? Initial Tariff set at 1.19 $/m 3, with expected Return on Capital for the first 5 years of 10%. Unexpected variation in Exchange Rate increases Fixed Costs from 40 to $48 million Why the need for a Reset? Initial Tariff set at 1.19 $/m 3, with expected Return on Capital for the first 5 years of 10%. Unexpected variation in Exchange Rate increases Fixed Costs from 40 to $48 million Why the need for a Reset? Initial Tariff set at 1.19 $/m 3, with expected Return on Capital for the first 5 years of 10%. Unexpected variation in Exchange Rate increases Fixed Costs from 40 to $48 million Variable Costs have increased by 50% from $0.25 /m 3 to $0.375 /m 3 because of (a) increase electricity costs and (b) higher than expected non- revenue water Why the need for a Reset? Initial Tariff set at 1.19 $/m 3, with expected Return on Capital for the first 5 years of 10%. Unexpected variation in Exchange Rate increases Fixed Costs from 40 to $48 million Variable Costs have increased by 50% from $0.25 /m 3 to $0.375 /m 3 because of (a) increase electricity costs and (b) higher than expected non- revenue water Back to Module

60 First, we look at an example of the Financial Position of a Hypothetical Operator. In this example, what might trigger the need for a Tariff Reset? Call for a Tariff Reset?: The Operator operates and maintains the business, and makes some investment. These factors have affected performance over 5 years: Local currency devalued, increasing some costs The Operator has not been able to reduce non revenue water as much as expected – this has increased operational costs Electricity prices are higher than forecast Call for a Tariff Reset?: The Operator operates and maintains the business, and makes some investment. These factors have affected performance over 5 years: Local currency devalued, increasing some costs The Operator has not been able to reduce non revenue water as much as expected – this has increased operational costs Electricity prices are higher than forecast Case Study: Financial Implications of Objectives Posting a Loss This all Resulted in an Operators Loss $2.1million in year 5 ******The Operator requests a Tariff Reset.**** Posting a Loss This all Resulted in an Operators Loss $2.1million in year 5 ******The Operator requests a Tariff Reset.**** Why the need for a Reset? Initial Tariff set at 1.19 $/m 3, with expected Return on Capital for the first 5 years of 10%. Unexpected variation in Exchange Rate increases Fixed Costs from 40 to $48 million Variable Costs have increased by 50% from $0.25 /m 3 to $0.375 /m 3 nbecause of (a) increase electricity costs and (b) higher than expected non- revenue water Why the need for a Reset? Initial Tariff set at 1.19 $/m 3, with expected Return on Capital for the first 5 years of 10%. Unexpected variation in Exchange Rate increases Fixed Costs from 40 to $48 million Variable Costs have increased by 50% from $0.25 /m 3 to $0.375 /m 3 nbecause of (a) increase electricity costs and (b) higher than expected non- revenue water Back to Module

61 Case Study: Financial Implications of Objectives Next, using this Example we can review the financial impact of each Objective option. Allow Operator to earn A reasonable Rate of Return on Capital (efficient or not) Allow Operator to earn A reasonable Rate of Return on Capital (efficient or not) Allow only an efficient Operator to earn a reasonable Rate of Return on Capital Return Operator to position it would be if not for unexpected changes (e.g. Currency Devaluation) OBJECTIVES Back to Module

62 Case Study: Financial Implications of Objectives Next, using this Example we can review the financial impact of each Objective option. Allow Operator to earn A reasonable Rate of Return on Capital (efficient or not) Allow Operator to earn A reasonable Rate of Return on Capital (efficient or not) Allow only an efficient Operator to earn a reasonable Rate of Return on Capital Return Operator to position it would be if not for unexpected changes (e.g. Currency Devaluation) Return on Capital Efficient Operator: Return on Capital Compensate for unexpected change: e.g. Currency Devaluation OBJECTIVES Back to Module

63 Case Study: Objective Return on Capital Objective: Allow Operator to earn a reasonable Rate of Return on Capital (efficient or not) Objective: Allow Operator to earn a reasonable Rate of Return on Capital (efficient or not) FINANCIAL IMPACT OF RESET OBJECTIVES Full Review: New tariff = (A*r + FC 6 + VC 6 ) / D 6 Target return on assets (r) is 10 percent. Projected Demand in Year 6 (D 6 ) is 58.0 million m 3 (based on 3 percent a year demand growth). FC 6 and VC 6 are the projected fixed and variable costs in Year 6, assumed unchanged. A= Capital Employed; D= Projected Average Demand; E= Value associated with efficient Operator; FC= Fixed Costs; VC= Variable Costs; r = Return on Capital Full Review: New tariff = (A*r + FC 6 + VC 6 ) / D 6 Target return on assets (r) is 10 percent. Projected Demand in Year 6 (D 6 ) is 58.0 million m 3 (based on 3 percent a year demand growth). FC 6 and VC 6 are the projected fixed and variable costs in Year 6, assumed unchanged. A= Capital Employed; D= Projected Average Demand; E= Value associated with efficient Operator; FC= Fixed Costs; VC= Variable Costs; r = Return on Capital Projected Demand, Year 6 $1.38 New Tariff for Year 6 ($/m 3 ) 10.0% Operators Rate of Return on Capital (Year 6) Back to Module

64 Case Study: Objective Efficient/Reasonable Rate FINANCIAL IMPACT OF RESET OBJECTIVES Full Review: New tariff = (A*r + EFC 6 + EVC 6 ) / D 6 Target return on assets, for notional efficient operator, (r) is 10 percent. Projected Demand in Year 6 (D 6 ) is 58.0 million m 3 (based on 3 percent a year demand growth). Assume the fixed costs of an efficient operator (EFC 6 ) are $48 million (as an efficient firm could have done no more to mitigate the impact of currency devaluation). Assume the variable costs of an efficient Operator (EVC 6 ) $0.30 per m 3 (assuming an efficient operator would have achieved non-revenue water targets, but could not have avoided increased electricity prices). A= Capital Employed; D= Projected Average Demand; E= Value associated with efficient Operator; FC= Fixed Costs; VC= Variable Costs; r = Return on Capital Full Review: New tariff = (A*r + EFC 6 + EVC 6 ) / D 6 Target return on assets, for notional efficient operator, (r) is 10 percent. Projected Demand in Year 6 (D 6 ) is 58.0 million m 3 (based on 3 percent a year demand growth). Assume the fixed costs of an efficient operator (EFC 6 ) are $48 million (as an efficient firm could have done no more to mitigate the impact of currency devaluation). Assume the variable costs of an efficient Operator (EVC 6 ) $0.30 per m 3 (assuming an efficient operator would have achieved non-revenue water targets, but could not have avoided increased electricity prices). A= Capital Employed; D= Projected Average Demand; E= Value associated with efficient Operator; FC= Fixed Costs; VC= Variable Costs; r = Return on Capital Objective: Allow only an efficient Operator to earn a reasonable Rate of Return on Capital Objective: Allow only an efficient Operator to earn a reasonable Rate of Return on Capital Projected Demand, Year 6 $1.30 New Tariff for Year 6 ($/m 3 ) 5.7% Operators Rate of Return on Capital (Year 6) Back to Module

65 Case Study: Objective - Return to expected position FINANCIAL IMPACT OF RESET OBJECTIVES Partial Review: New tariff = Existing tariff + ( SFC - SVC)/D 6 Projected Demand in Year 6 (D 6 ) is 58.0 million m 3 (based on 3 percent a year demand growth). SFC and SVC are the changes in fixed and variable costs attributable to the specified variables. In this example the specified variable considered is the exchange rate which has caused the increase of $8 million in fixed costs, but not a related increase in variable costs A= Capital Employed; D= Projected Average Demand; E= Value associated with efficient Operator; FC= Fixed Costs; VC= Variable Costs; r = Return on Capital Partial Review: New tariff = Existing tariff + ( SFC - SVC)/D 6 Projected Demand in Year 6 (D 6 ) is 58.0 million m 3 (based on 3 percent a year demand growth). SFC and SVC are the changes in fixed and variable costs attributable to the specified variables. In this example the specified variable considered is the exchange rate which has caused the increase of $8 million in fixed costs, but not a related increase in variable costs A= Capital Employed; D= Projected Average Demand; E= Value associated with efficient Operator; FC= Fixed Costs; VC= Variable Costs; r = Return on Capital Objective: Return Operator to position it would be in if not for Currency Devaluation Projected Demand, Year 6 $1.33 New Tariff for Year 6 ($/m 3 ) 7.2% Operators Rate of Return on Capital (Year 6) Back to Module

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67 Tariff Reset Objectives & Resulting Risk Allocation Resulting Risk Allocation: The chosen Objective will have implications on the resulting Risk Allocation Resulting Risk Allocation: The chosen Objective will have implications on the resulting Risk Allocation Example: Some examples of issues that will arise from each particular Objective are shown. Example: Some examples of issues that will arise from each particular Objective are shown. Objective: These are some of the alternatives that might be considered as the Objective when designing Tariff Resets. Objective: These are some of the alternatives that might be considered as the Objective when designing Tariff Resets. Back to Module

68 Tariff Reset Objectives & Resulting Risk Allocation Back to Module

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70 To market test the costs that the operator says it must incur to perform a particular activity, the contracting authority calls for bids from other firms to perform the activity: If the other firms bids differ little from the cost submitted by the operator, the operators costs are assumed reasonable. If bids are much lower than the operators submitted cost, the contracting authority reduces the tariff accordingly and contractsor requires the operator to contractthe function out to the preferred bidder. This approach can give the operator strong incentives to ensure its submitted costs are as low as possible. But it is only effective for activities that can be effectively separated from the rest of the business (for example, meter reading). It also increases the complexity of the tariff reset. Market Testing is a way to determine whether the Operators Costs are reasonable. The transaction costs of calling for bids and possibly contracting with a new firm need to be weighed against the potential benefits. Back to Module Market Testing: What are Reasonable Costs?

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73 Event Based Reviews: Gambia & Gabon Back to Module

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75 Risk Share – Hybrids: Amman & Cartagena Back to Module

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77 How are these Risks likely to vary? Analyzing Risks Risk is an unavoidable factor in provision of water and sanitation services How can we Forecast the effects of possible Risks on major Project Variables? What are the likely scenarios that will help us assess the extent of the Risks? What Risks are related to the Responsibilities we take? Given the complexity of PP projects, how are the various Risks interlinked? There are a number of questions that we need to answer when analyzing Risks: Back to Module

78 Risks: Responsibilities carry Risks Remember, each area of responsibility for delivering water service carries risks Examples: ASSET CONDITION oTender documents provide information on assets. oThe Operator uses this information to make his bid. oThe actual state and value of the assets is different from the assumptions, with a direct effect on operation and maintenance costs. COLLECTIONS oSome customers will not pay. oThe Operator makes assumptions on levels of bad debts, varying with time. oEconomic conditions will vary, and so does the ability of customers to pay. CONSTRUCTION oConstruction of new plant involves a series of risks. Labor costs, timing of equipment delivery and cost and need of permits can all affect project costs and construction times (positively or negatively) Back to Module

79 Risks: Forecasts and Variance How are Project Variables affected under various Risk Scenarios ? Important major project variables typically include: Demand Interest rates Foreign Exchange Rates However, while we know past and present values, we cannot predict future values with certainty. What we can do is to model various scenarios for each of the key project variables, and analyze the effects on the project outcomes for each of the scenarios. Demand depends on various parameters including : Growth in per Capita income Population Change in weather Preferences Technology …………….and none of these can be forecast with certainty!!!!! Demand depends on various parameters including : Growth in per Capita income Population Change in weather Preferences Technology …………….and none of these can be forecast with certainty!!!!! EXAMPLE: Forecasting issues – Demand Analysis Back to Module

80 We can use modeling techniques to help assess Risk and aid in its management In the Toolkit we give a policy simulation model that treats Demand (and two other variables – Interest and Foreign Exchange Rates) as being subject to Risk. The use of such modeling techniques shows that: Risk is measurable (at least approximately!) Measuring Risk is a useful step to Managing Risk Risks: Forecasts and Variance Back to Module

81 High demand Low demand Example: Assessing Demand Risk Household demand (million m³) Year 250 200 150 100 50 0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Good Forecast Modeling lets us look at the likely effect of variation in key project parameters Given the uncertainty in key elements affecting Demand, it is only possible to give a good forecast that will give the average or expected outcome: In addition to this good forecast, there are a range of different scenarios that will give higher or lower forecast levels of demand over time. There is a need to evaluate the potential effect of these on the project, for example: Are existing investment plans viable under all cases? What will happen to the Operators profits? Back to Module

82 Assessing Risk under different Scenarios Net Present Value (NPV) of cash flows to operator (million pesos) 1,000 900 800 700 600 500 400 300 200 100 0 Frequency out of 10,000 - 200 - 160- 120- 80 - 40 0 40 80 120160200240280320360 400 BEST FORECAST OF NPV OF CASH FLOWS TO OPERATOR UPSIDE RISKDOWNSIDE RISK There is a need to assess project Risks under different scenarios. This example shows the varying Net Present Value of potential cash flow values of an Operators business, under different scenarios of Water Demand. The Y axis illustrates the chance (or Risk) of achieving each level of NPV. EXAMPLE: This shows about a 9.5 % chance (950 out of 10,000) that the Operators NPV will be between 0 and 20 million pesos (i.e. for the tallest blue bar here) EXAMPLE: This shows about a 9.5 % chance (950 out of 10,000) that the Operators NPV will be between 0 and 20 million pesos (i.e. for the tallest blue bar here) EXAMPLE This shows about a 0.2% chance (20 out of 10,000) that NPV will be as low as -200 million pesos EXAMPLE This shows about a 0.2% chance (20 out of 10,000) that NPV will be as low as -200 million pesos Back to Module

83 Many risks affect the water sector One risk is often a bundle of other more specific risks Risks are interrelated Risks: Links between Risks Currency Risk Renewals Exchange Rates Interest Rates Permitting & Consents Cash Collected RegulationTariffs RevenueDemand EconomyNon Payment Labor Relations Existing Assets Environment Site Conditions Currency Convertibility Labor Costs Labor Force Wages Input Prices Operating Costs Maintenance Cash Spent Cashflow New Investment Financing costs Political Environment Risk can be divided into two categories; Operation related Risks Set of risks associated with Operation & Maintenance Investment related Risks Set of investment related risks, including new and renovated infrastructure as well as any other investment needs. Back to Module

84 Many risks affect the water sector One risk is often a bundle of other more specific risks Risks are interrelated Risks: Links between Risks Currency Risk Renewals Exchange Rates Interest Rates Permitting & Consents Cash Collected RegulationTariffs RevenueDemand EconomyNon Payment Labor Relations Existing Assets Environment Site Conditions Currency Convertibility Labor Costs Labor Force Wages Input Prices Operating Costs Maintenance Cash Spent Cashflow New Investment Financing costs Political Environment Example: This diagram shows the complex and interlinked risks that may have to be considered when establishing a PP Arrangement Example: This diagram shows the complex and interlinked risks that may have to be considered when establishing a PP Arrangement

85 Example: Demand Risk & Cashflows Currency Risk Renewals Exchange Rates Interest Rates Permitting & Consents Cash Collected RegulationTariffs RevenueDemand EconomyNon Payment Labor Relations Existing Assets Environment Site Conditions Currency Convertibility Labor Costs Labor Force Wages Input Prices Operating Costs Maintenance Cash Spent Cashflow New Investment Financing costs Political Environment Continuing with this example: A variation in any one parameter will flow through to a total increase or decrease in the value of the business. The blue shaded boxes show, for example, how variations in Demand have an impact on other areas of risk, and ultimately on the cashflow of the business Back to Module

86 Toolkit: Module 6

87 DO NOT MOVE or ERASE THE PREVIOUS SLIDES AFTER END OF MODULE


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