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Toolkit: Approaches to Private Participation in Water Services

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1 Toolkit: Approaches to Private Participation in Water Services
Module 4 Setting Upstream Policy

2 Introduction: Navigating through this E-Learning Module
E-learning design:

3 Elements of the Toolkit
1 ConsideringPrivate Participation 9 Selecting an Operator 2 Planning the Process TOOLKIT Appendix A Examples of PP Arrangements 8 Designing Legal Instruments 3 Involving Stakeholders Appendix B Policy Simulation Model Elements of the Toolkit: Toolkit is developed in ten main sections, two Appendices and Supplementary Material: Overview: Provides an overview of the approach taken in developing the Toolkit, discusses the key issues of providing water and sanitation services, the definition of basic principles and provides tools and options for planning and design of reforms to resolve the situation 1 Considering private participation: A review of the key issues that governments can resolve in order to introduce private participation, including resolution of policy problems, effects of privatization, making privatization work, the various private participation models, and how the Toolkit approach works. 2 Planning the process of introducing private participation: A four step process for developing policy, designing details of the arrangement, selecting the operator and managing the arrangements are reviewed. Key elements of the overall design such as stakeholder consultation, government institutions to manage the arrangement and key analytic and advisory work to support the arrangement are discussed. 3 Involving Stakeholders in the design of the arrangement: Discussion on ways of identifying and involving stakeholders in the design of the arrangements and of distributing the benefits and costs of private participation so as to increase support and long term sustainability. 4 Setting upstream policy: This considers some of the key reform choices for the water sector upstream of the design of the private participation arrangement, such as the allocation of responsibilities among different tiers of government, definition of the market structure for the water sector (including appropriate scale and scope for the water utilities) and establishing policies and rules governing competition. 5 Setting service standards, tariffs, subsidies, and financial arrangements: A section reviewing the key issues related to setting targets relating to coverage and quality; the implications of those targets for the cost of service; options for supplementing tariff revenue with subsidies; and some implications for design of the arrangement and its financing. 6 Allocating responsibilities and risks: Provides advice on the identification, assessment and allocation of risks and responsibilities among customers, the operator, and the government and how to design tariff-adjustment and other rules to achieve the desired allocation. 7 Developing institutions to manage the relationship: The choice and design of institutions—including courts, arbitration panels, independent experts, and regulatory agencies—that will interpret and apply the rules over the life of the arrangements. 8 Designing legal instruments for the arrangement: This section considers how the chosen arrangement can be embodied in legally effective documents (such as laws, contracts and licenses). It also describes how the government can retain legal power to implement the arrangement, how to check on potential constraints, and how to design legal mechanisms to enforce obligations and ensure successful provision of service. 9 Selecting the Operator: A review of the key issues to be addressed and steps involved in selecting an operator governments can use to select the operator. This includes detailed discussion on selection methods, selection criteria, managing the bidding process and some key bidding issues. Additional Toolkit material The Toolkit includes other supplementary material: Appendix A Examples of Private Participation Arrangements The Toolkit includes sixteen examples of arrangement designs in developed and developing countries. These highlight the specific design aspects following the sections in the Toolkit. Appendix B The Policy simulation model This is an Excel based policy simulation model. It illustrates issues discussed, suggests outputs that government’s modelers might produce and illustrates possible modeling approaches. It shows how the three key issues can be integrated: Stakeholder costs and benefits (Chapter 3) Setting tariffs, subsidies and coverage (Chapter 5) Allocating risk (Chapter 6) 7 Developing Institutions 4 Setting Upstream Policy 6 Responsibilities & Risks 5 Standards, Tariffs, Subsidy, Financials Additional Material CD-ROM

4 General Outline of Toolkit
Module 4 1 ConsideringPrivate Participation 9 Selecting an Operator 2 Planning the Process TOOLKIT Appendix A Examples of PP Arrangements 8 Designing Legal Instruments 3 Involving Stakeholders Appendix B Policy Simulation Model Module 4 Setting Upstream Policy This presentation reviews Module 4 of the Toolkit ‘Approaches to Water Privatization’. Module 6, one of 10 related sections of the Toolkit, covers issues of Setting Upstream Policy in a Private Participation Arrangement Elements of the Toolkit: Toolkit is developed in ten main sections, two Appendices and Supplementary Material: Overview: Provides an overview of the approach taken in developing the Toolkit, discusses the key issues of providing water and sanitation services, the definition of basic principles and provides tools and options for planning and design of reforms to resolve the situation 1 Considering private participation: A review of the key issues that governments can resolve in order to introduce private participation, including resolution of policy problems, effects of privatization, making privatization work, the various private participation models, and how the Toolkit approach works. 2 Planning the process of introducing private participation: A four step process for developing policy, designing details of the arrangement, selecting the operator and managing the arrangements are reviewed. Key elements of the overall design such as stakeholder consultation, government institutions to manage the arrangement and key analytic and advisory work to support the arrangement are discussed. 3 Involving Stakeholders in the design of the arrangement: Discussion on ways of identifying and involving stakeholders in the design of the arrangements and of distributing the benefits and costs of private participation so as to increase support and long term sustainability. 4 Setting upstream policy: This considers some of the key reform choices for the water sector upstream of the design of the private participation arrangement, such as the allocation of responsibilities among different tiers of government, definition of the market structure for the water sector (including appropriate scale and scope for the water utilities) and establishing policies and rules governing competition. 5 Setting service standards, tariffs, subsidies, and financial arrangements: A section reviewing the key issues related to setting targets relating to coverage and quality; the implications of those targets for the cost of service; options for supplementing tariff revenue with subsidies; and some implications for design of the arrangement and its financing. 6 Allocating responsibilities and risks: Provides advice on the identification, assessment and allocation of risks and responsibilities among customers, the operator, and the government and how to design tariff-adjustment and other rules to achieve the desired allocation. 7 Developing institutions to manage the relationship: The choice and design of institutions—including courts, arbitration panels, independent experts, and regulatory agencies—that will interpret and apply the rules over the life of the arrangements. 8 Designing legal instruments for the arrangement: This section considers how the chosen arrangement can be embodied in legally effective documents (such as laws, contracts and licenses). It also describes how the government can retain legal power to implement the arrangement, how to check on potential constraints, and how to design legal mechanisms to enforce obligations and ensure successful provision of service. 9 Selecting the Operator: A review of the key issues to be addressed and steps involved in selecting an operator governments can use to select the operator. This includes detailed discussion on selection methods, selection criteria, managing the bidding process and some key bidding issues. Additional Toolkit material The Toolkit includes other supplementary material: Appendix A Examples of Private Participation Arrangements The Toolkit includes sixteen examples of arrangement designs in developed and developing countries. These highlight the specific design aspects following the sections in the Toolkit. Appendix B The Policy simulation model This is an Excel based policy simulation model. It illustrates issues discussed, suggests outputs that government’s modelers might produce and illustrates possible modeling approaches. It shows how the three key issues can be integrated: Stakeholder costs and benefits (Chapter 3) Setting tariffs, subsidies and coverage (Chapter 5) Allocating risk (Chapter 6) 7 Developing Institutions 4 Setting Upstream Policy 6 Responsibilities & Risks 5 Setting Service Standards, Tariffs, Subsidies & Financial Arrangements Additional Material CD-ROM

5 Module 4 - What will we learn?
What are the Responsibilities of other levels of Government? How do we IDENTIFY the level of Government to be responsible for water services? Management Contract for Jordan Valley Authority, Irrigation Water Supply, may be the first of its kind. How do we DEFINE an appropriate Market structure for the Water Sector? Four clicks COMPETITION – how can we establish it?

6 Module 4 Setting Upstream Policy
In this Module we look at the issues that Governments need to address to set Policy upstream from the design of the Private Participation Arrangement This involves three broad topics These steps do not need to be considered in sequence, as the results are often examined simultaneously as the reform strategy develops ALLOCATE Responsibilities to different levels of Government Identify the Reform Leader (Module 2) DETERMINE Market Structure Introduce Private Participation 3 clicks reveal ESTABLISH Competition Rules

7 Allocate Responsibilities Step 1 – Examining existing
“The first step is to identify current responsibilities of each level of Government, the legal and constitutional basis for these, and to identify any unclear areas” In many countries, responsibilities for water services are spread between two or three levels of government. For Example Federal states, like India, the constitution may assign roles to regional or state government, with some responsibility with central government Local governments may be involved in reform at national level Even in non-federal states the division of responsibility may not be clear Example: Jamaica – service provision is at national level, with small systems and standpipe payments at local level. However, legal and financial relationships between utility and local government is not clearly defined. [See also Brazil case study] “Systems can work well with distributed responsibilities, but introduction of private participation has to be done with care so as the change in roles does not cause conflict.” 3 Steps - ALLOCATE Responsibilities to different levels of Government 3 Steps - ALLOCATE Responsibilities to different levels of Government Step 1. EXAMINE Responsibilities under current law & institutional arrangements Step 2. DECIDE Which level of Government should be responsible for water service provision Step 3 DECIDE Which levels of Government responsible for tariff setting , environmental issues etc.

8 Allocate Responsibilities at different Government Levels
“Dividing up the responsibilities for water services is a three step process, ………” “,……… then we need to set up the legal & institutional framework” ALLOCATE (In 3 Steps) Responsibilities to different levels of Government In this section we look at a three step ALLOCATION process: Current legal responsibilities and institutions Decide which level of Government to be responsible for water services Decide level of Government responsible for issues such as tariff setting, quality and managing water resources. Create legal instruments that allow this to happen, and adequate power to each level of Government CREATE LEGAL INSTRUMENTS These have to : Be clear Allocate appropriate responsibilities Allocate adequate powers to each level of Government Note: This subject is covered in Module 8 Step 1. EXAMINE Responsibilities under current law & institutional arrangements Step 2. DECIDE Which level of Government should be responsible for water service provision Step 3 DECIDE Which levels of Government responsible for tariff setting , environmental issues etc.

9 Allocate Responsibilities Step 1 – Examining existing
“The first step is to identify current responsibilities of each level of Government, the legal and constitutional basis for these, and to identify any unclear areas” ALLOCATE (In 3 Steps) Responsibilities to different levels of Government 3 Steps - ALLOCATE Responsibilities to different levels of Government Step 1. EXAMINE Responsibilities under current law & institutional arrangements Example: Question of Responsibility in Brazil Step 2. DECIDE Which level of Government should be responsible for water service provision Step 3 DECIDE Which levels of Government responsible for tariff setting , environmental issues etc.

10 Allocate Responsibilities Step 2 – Choose Level
“ Generally the tier of Government ( local, provincial or federal) responsible for water delivery should also be the Contracting Authority with the Private Operator” Although the tier of government responsible for water services should generally be the Contracting Authority, many factors influence the choice of tier: Need for collective choice mechanism: in order to set an equitable service level and tariff, best if control is at a local level, representing the area of service. Different capacities at different levels of government: Provision of water services needs specialized technical and commercial skills that may be in short supply, and perhaps only available at national level. Economies of scale: It may be more efficient to have a single service provider serving several towns and villages rather than a number of smaller providers. Dilemma of regional water storage and transmission networks: These may cut across several local areas. It may be possible to separate regional transmission systems from local distribution systems. 3 Steps - ALLOCATE Responsibilities to different levels of Government Step 1. EXAMINE Responsibilities under current law & institutional arrangements Step 2. DECIDE Which level of Government should be responsible for water service provision Step 3 DECIDE Which levels of Government responsible for tariff setting , environmental issues etc.

11 Allocate Responsibilities Step 2 – Choose Level
“ Generally the tier of Government ( local, provincial or federal) responsible for water delivery should also be the Contracting Authority with the Private Operator” ALLOCATE (In 3 Steps) Responsibilities to different levels of Government Step 1. EXAMINE Responsibilities under current law & institutional arrangements Step 2. DECIDE Which level of Government should be responsible for water service provision Example: Economy of Scale - Small towns in France Step 3 DECIDE Which levels of Government responsible for tariff setting , environmental issues etc.

12 Allocate Responsibilities Step 3 – ‘External’ issues
“ Institutions and rules need to be set up to monitor performance, regulate contract obligations, set tariffs and regulation and compliance with relevant laws and codes (e.g. environmental , water resources etc.)” ALLOCATE (In 3 Steps) Responsibilities to different levels of Government Step 3b ESTABLISH Regulatory regimes and institutions Step 1. EXAMINE Responsibilities under current law & institutional arrangements Step 2. DECIDE Which level of Government should be responsible for water service provision Step 3a DECIDE Which levels of Government responsible for tariff setting , environmental issues etc. Step 3 DECIDE Which levels of Government responsible for tariff setting , environmental issues etc.

13 Allocate Responsibilities Step 3a – Monitoring/Tariffs
“ Central Government can monitor contract performance and set tariffs. Difficulties may arise when Municipalities or states take on this responsibility” In the case of municipalities or states there are three options for allocating responsibility for monitoring operator performance and adjusting tariff and quality controls: Assign functions to the level of Government where services are provided: Example: municipal contract supervision units for municipal contracts Establish a National Regulator: Even if services are provided at municipal level, with responsibility for monitoring performance and adjusting tariff and quality controls. Spread functions among various levels of Government: The level to depend on who is best to perform particular functions. 3 Steps - ALLOCATE Responsibilities to different levels of Government Step 1. EXAMINE Responsibilities under current law & institutional arrangements Step 2. DECIDE Which level of Government should be responsible for water service provision Step 3 DECIDE Which levels of Government responsible for tariff setting , environmental issues etc.

14 Allocate Responsibilities Step 3 – ‘External’ issues
“ Institutions and rules need to be set up to monitor performance, regulate contract obligations, set tariffs and regulation and compliance with relevant laws and codes (e.g. environmental , water resources etc.)” ALLOCATE (In 3 Steps) Responsibilities to different levels of Government Step 3b ESTABLISH Regulatory regimes and institutions Step 1. EXAMINE Responsibilities under current law & institutional arrangements Step 2. DECIDE Which level of Government should be responsible for water service provision Step 3 DECIDE Which levels of Government responsible for tariff setting , environmental issues etc.

15 Allocate Responsibilities Step 3b – Regulators
“ A Regulatory institution or arrangement needs to be set up to monitor contract performance and set the tariffs. There is a need to decide what are the best Regulatory arrangements, and at what level of Government it should be established. Should it be at national, state or local level? 3 Steps - ALLOCATE Responsibilities to different levels of Government LOCAL or NATIONAL REGULATION? THE ISSUES: Local Governments:  Close to customer. If acts as both contracting authority and regulator avoids coordination problems.  Local decision makers may have less capacity and knowledge of comparative data National Regulators:  Has capacity and experience to act for all service providers in the country. Example: OFWAT in England & Wales  There may be coordination problems. Local government may feel national regulators infringe on their power. Some countries had problems where powers duplicated at national and local level. Step 1. EXAMINE Responsibilities under current law & institutional arrangements Step 2. DECIDE Which level of Government should be responsible for water service provision Step 3 DECIDE Which levels of Government responsible for tariff setting , environmental issues etc.

16 Allocate Responsibilities Step 3b – Regulators
“ A Regulatory institution or arrangement needs to be set up to monitor contract performance and set the tariffs. There is a need to decide what are the best Regulatory arrangements, and at what level of Government it should be established. Should it be at national, state or local level? 3 Steps - ALLOCATE Responsibilities to different levels of Government National or Local Regulation: A compromise? Step 1. EXAMINE Responsibilities under current law & institutional arrangements Step 2. DECIDE Which level of Government should be responsible for water service provision Step 3 DECIDE Which levels of Government responsible for tariff setting , environmental issues etc.

17 Allocate Responsibilities Step 3b – Regulators
“ A Regulatory institution or arrangement needs to be set up to monitor contract performance and set the tariffs. There is a need to decide what are the best Regulatory arrangements, and at what level of Government it should be established. Should it be at national, state or local level? Different mechanisms and Regulators for different tasks. Some of the key tasks include: Contract monitoring & tariff setting Example: municipal contract supervision units for municipal contracts Environmental protection: It is possible for services to be provided at municipal level, with responsibility for monitoring performance and adjusting tariff and quality controls. 3 Steps - ALLOCATE Responsibilities to different levels of Government Step 1. EXAMINE Responsibilities under current law & institutional arrangements Step 2. DECIDE Which level of Government should be responsible for water service provision Step 3 DECIDE Which levels of Government responsible for tariff setting , environmental issues etc.

18 Allocate Responsibilities Step 3b – Regulators
LOCAL or NATIONAL REGULATION?: ENVIRONMENT PROTECTION & WATER RESOURCE MANAGEMENT Rules on Environmental Protection and Water Resource Management are particularly important to a private operator, since governments tend to be stricter with private operators than with Government utilities on compliance with environmental standards. Poor overall water resource management may bring additional costs Example: Illegal groundwater abstractions may deplete resources so much that the Operator has to develop new sources to meet obligations Example: Upstream discharges may pollute and increase treatment costs, when increased discharge rules would be more effective New regulatory arrangements need to be in place before Private participation. A dedicated Water Resource institution is best the arbitrate between competing water users. The Model of River Basin Agencies, originated in France, is finding increasing favor throughout the world, where typically they represent the interests of all water users, and are financed through charges on abstraction and discharge. Allocate Responsibilities Step 3b – Regulators “ A Regulatory institution or arrangement needs to be set up to monitor contract performance and set the tariffs. There is a need to decide what are the best Regulatory arrangements, and at what level of Government it should be established. Should it be at national, state or local level? Different mechanisms and Regulators for different tasks. Some of the key tasks include: Contract monitoring & tariff setting Example: municipal contract supervision units for municipal contracts Environmental protection: It is possible for services to be provided at municipal level, with responsibility for monitoring performance and adjusting tariff and quality controls. Water resource management: The level to depend on who is best to perform particular functions. 3 Steps - ALLOCATE Responsibilities to different levels of Government Step 1. EXAMINE Responsibilities under current law & institutional arrangements Step 2. DECIDE Which level of Government should be responsible for water service provision Step 3 DECIDE Which levels of Government responsible for tariff setting , environmental issues etc.

19 Determine Market Structure
Once Market Structure has been chosen, Government will have to decide what areas of privatization will be sought, and in what sequence: Example: If an existing utility is divided into a bulk supply company and a distribution company, should private participation be invited in both parts? Existing Market Structure is maintained in many cases, in order to minimize disruption and transition costs. However it may be better to consider a range of market options (as described in this section) It is better to make any changes before introduction of Private Participation Determine Market Structure “ Market Structure refers to the number of service providers and their responsibilities. There are three main market structure models Horizontal Structure Interaction between providers at the same level on the value chain Vertical Structure Interaction between providers at different levels on the value chain DETERMINE Market Structure Cross Sector Structure Limits on ownership or other affiliations between water utilities and companies in other sectors

20 Market Structure: Horizontal
“ Horizontal structures relate to service areas – and this section looks at decisions on selecting service areas” HORIZONTAL STRUCTURE Deciding on Service Areas The options range from having a single provider responsible for the whole country, to allowing every town and village to have its own provider, and, in between, various groupings of rural and city areas. Various issues are considered: Environmental and Technical factors Impact on Service Efficiency Administrative boundaries & collective choice Financial attractiveness and capacity Transaction Costs Horizontal Structure Interaction between providers at the same level on the value chain Horizontal Structure Interaction between providers at the same level on the value chain DETERMINE Market Structure Vertical Structure Interaction between providers at different levels on the value chain Cross Sector Structure Limits on ownership or other affiliations between water utilities and companies in other sectors

21 Horizontal Structure: Environmental & Technical
ENVIRONMENTAL & TECHNICAL FACTORS: Configuration of Existing Networks Least Cost technical solutions to improve supply Horizontal Structure: Environmental & Technical ‘Technical & Environmental coordination can either be by awarding all responsibility to a single entity, or by ensuring adequate contracts or rules related to coordination’ Single Utility? When areas are served by a single network (like Capital City and Villages C & D in the example) there may be an argument for a single utility covering this area Least - Cost Technical Options? If the best technical and financial scheme involves a scheme serving several areas, there may be an argument for a single provider serving the whole area Capital City Secondary Town Provincial Center Town Village A Village B Village C Village D Village E Village F BOUNDARY BOUNDARY RIVER Bulk Supply Treatment Plant Transmission Pipe Reservoir Transmission Quality Standards It is normal to have more than one type of quality target for a utility, covering various service parameters. Typical examples are: Availability of Service Should water be available 24 hours a day seven days a week, or only at certain times? Pressure At what pressure should water be available? Water Quality Should the water be treated to strict guidelines ( e.g. WHO or EU) or is flexibility allowed for some none critical parameters Effluent Treatment What percentage of wastewater should be treated, and to what standard? Customer Service Targets What payment methods? How are complaints handled? In addition to these output based Quality Standards, target levels for input based technical standards will often be specified for the Operator to follow (such as minimum depth and diameter of pipes).

22 Horizontal Structure: Environmental & Technical
ENVIRONMENTAL & TECHNICAL FACTORS: Configuration of Existing Networks Least Cost technical solutions to improve supply Horizontal Structure: Environmental & Technical ‘Technical & Environmental coordination can either be by awarding all responsibility to a single entity, or by ensuring adequate contracts or rules related to coordination’ Capital City Secondary Town Provincial Center Town Village A Village B Village C Village D Village E Village F BOUNDARY BOUNDARY RIVER Bulk Supply Treatment Plant Transmission Pipe Reservoir Transmission Quality Standards It is normal to have more than one type of quality target for a utility, covering various service parameters. Typical examples are: Availability of Service Should water be available 24 hours a day seven days a week, or only at certain times? Pressure At what pressure should water be available? Water Quality Should the water be treated to strict guidelines ( e.g. WHO or EU) or is flexibility allowed for some none critical parameters Effluent Treatment What percentage of wastewater should be treated, and to what standard? Customer Service Targets What payment methods? How are complaints handled? In addition to these output based Quality Standards, target levels for input based technical standards will often be specified for the Operator to follow (such as minimum depth and diameter of pipes).

23 Horizontal Structure: Environmental & Technical
ENVIRONMENTAL & TECHNICAL FACTORS: Configuration of Existing Networks Least Cost technical solutions to improve supply Water Resources issue Horizontal Structure: Environmental & Technical Common resource? If areas compete for the same resource (for example abstracting from the same reservoir as Capital City and Provincial Center) it may make sense to have a single provider to resolve conflict ‘Technical & Environmental coordination can either be by awarding all responsibility to a single entity, or by ensuring adequate contracts or rules related to coordination’ Capital City Secondary Town Provincial Center Town Village A Village B Village C Village D Village E Village F BOUNDARY BOUNDARY RIVER Bulk Supply Treatment Plant Transmission Pipe Reservoir Transmission Quality Standards It is normal to have more than one type of quality target for a utility, covering various service parameters. Typical examples are: Availability of Service Should water be available 24 hours a day seven days a week, or only at certain times? Pressure At what pressure should water be available? Water Quality Should the water be treated to strict guidelines ( e.g. WHO or EU) or is flexibility allowed for some none critical parameters Effluent Treatment What percentage of wastewater should be treated, and to what standard? Customer Service Targets What payment methods? How are complaints handled? In addition to these output based Quality Standards, target levels for input based technical standards will often be specified for the Operator to follow (such as minimum depth and diameter of pipes).

24 “Empirical research shows economies of scale in water services”
Horizontal Structure: Service Efficiency “Empirical research shows economies of scale in water services” Economies of Scale? As more customers are added to the service, generally the unit cost drops. This can be important in small towns and villages that lack the scale to employ specialist managers and staff There are limits to this. Utilities that are too large become difficult to manage Capital City Secondary Town Provincial Center Town Village A Village B Village C Village D Village E Village F BOUNDARY BOUNDARY RIVER Bulk Supply Treatment Plant Transmission Pipe Reservoir Transmission

25 Horizontal Structure: Administrative boundaries
“Aspects of water services provided by a network are the same for most customers ” Collective Choice? Customers need a collective way to decide on key service issues. Using local government boundaries can give a democratic voice in this matter However, technical considerations may dictate a larger service area, and then some way of coordinating responses between administrative areas is a good idea Capital City Secondary Town Provincial Center Town Village A Village B Village C Village D Village E Village F BOUNDARY BOUNDARY RIVER Bulk Supply Treatment Plant Transmission Pipe Reservoir Transmission

26 “Grouping areas together may increase the financial attractiveness”
Horizontal Structure: Financial Attractiveness & Capacity “Grouping areas together may increase the financial attractiveness” Financially Attractive? Operators, particularly the large international companies, may have large fixed marketing costs. This gives a preference for the larger projects where these costs can be absorbed. However once established in a large urban center, there may be scope for further expansion to surrounding towns, peri–urban, and rural areas, to benefit from efficiency of private participation. Grouping poor areas, or less developed areas, with wealthy ones is a way to attract private operators to serve poorer areas, allowing cross subsidization, and meeting social goals. Care must be taken to ensure that the overall project is still attractive to the Operators. Capital City Secondary Town Provincial Center Town Village A Village B Village C Village D Village E Village F BOUNDARY BOUNDARY RIVER Bulk Supply Treatment Plant Transmission Pipe Reservoir Transmission

27 “The costs of changing market structure can be substantial”
Horizontal Structure: Transaction Costs “The costs of changing market structure can be substantial” Transaction costs need to be included in any Trade-off analysis between alternative options. Aggregation or disaggregation may require transfer of assets, liabilities and staff. To carry out these transfers an inventory of assets is needed, and technical issues need to be addressed Example: It may be technically difficult (and costly) to completely separate two systems previously joined, and physical transfers (each with a transaction cost) will still have to be carried out for each area Capital City Secondary Town Provincial Center Town Village A Village B Village C Village D Village E Village F BOUNDARY BOUNDARY RIVER Bulk Supply Treatment Plant Transmission Pipe Reservoir Transmission

28 “The costs of changing market structure can be substantial”
Horizontal Structure: Transaction Costs “The costs of changing market structure can be substantial” Capital City Secondary Town Provincial Center Town Village A Village B Village C Village D Village E Village F BOUNDARY BOUNDARY RIVER Bulk Supply Treatment Plant Transmission Pipe Reservoir Transmission Benefits & Costs Increasing Size & Scope

29 “National Utilities – Metropolitan Utilities – Rural Areas”
Horizontal Structure: Common Issues “National Utilities – Metropolitan Utilities – Rural Areas” This section gives access to additional information on common issues: Pros & cons of a National Utility Considerations in the case of a Metropolitan or Municipal Utility Ensuring service provisions in rural service areas & small towns National Utility: Ghana Metropolitan Utility: Manila Metropolitan Utility Buenos Aires Small towns: Franchising Examples

30 Market Structure: Vertical
“ Vertical structure relates to the provision of water services from Source to Tap and beyond. There is the possibility of unbundling these water service components” Horizontal Structure Interaction between providers at the same level on the value chain DETERMINE Market Structure Vertical Structure Interaction between providers at different levels on the value chain Vertical Structure Interaction between providers at different levels on the value chain Cross Sector Structure Limits on ownership or other affiliations between water utilities and companies in other sectors

31 Vertical Market Structure: The Value Chain
“The various Water Services components can be shown as items on a Value Chain” ‘Unbundling’ ‘Unbundling’ is the where items on the value chain are given to separate service providers. More typical in the electricity sector, but still feasible in the water sector Water Abstraction Sludge Treated Water Treatment Customers Disposal Transport Distribution Collection Discharge

32 VERTICAL SEPARATION IN THE WATER SECTOR
Unbundling – An Example: If responsibility for serving Capital City is separated from responsibility for supplying Villages C & D, issues of vertical separation follow. One option would be to separate reservoir and pipelines from distribution services, resulting in 4 separate providers: 1 Bulk Supply Business: Reservoir and pipelines 3 Distribution businesses: Capital City, Villages C& D Of course, this is only one option. Vertical Structure: Unbundling “Unbundling , or vertical separation, has to be done with care related to the horizontal structure issues as well as the value chain ” VERTICAL SEPARATION IN THE WATER SECTOR Here are four typical examples of ‘unbundling’ used in the water sector: Wastewater separated from Water Supply. Bulk Water Production & Treatment separated from Water Distribution. Wastewater Treatment & Discharge separated from Collection Water Transmission separated from Distribution Capital City Secondary Town Provincial Center Town Village A Village B Village C Village D Village E Village F BOUNDARY BOUNDARY RIVER Bulk Supply Treatment Plant Transmission Pipe Reservoir Transmission

33 “The issues and solutions will be specific to the particular case ”
Vertical Structure: Unbundling Issues “When deciding whether to vertically separate services, consider several issues: ” The current structure of the sector How to ensure quality of service Planning investment Where new investment or management is needed Taking advantage of scale and scope Managing payment risk Managing scarce water resources Promoting decentralized decision making “The issues and solutions will be specific to the particular case ”

34 “The issues and solutions will be specific to the particular case ”
Vertical Structure: Unbundling Issues Example: Senegal Sewage & Water Unbundling “When deciding whether to vertically separate services, consider several issues: ” The current structure of the sector How to ensure quality of service Planning investment Where new investment or management is needed Taking advantage of scale and scope Managing payment risk Managing scarce water resources Promoting decentralized decision making More Detailed Analysis of Unbundling Issues “The issues and solutions will be specific to the particular case ”

35 Market Structure: Cross Sector
“ It is possible for water services to be provided jointly with other utility services (for example power or gas). The issue is whether they should be separated or combined” Horizontal Structure Interaction between providers at the same level on the value chain DETERMINE Market Structure Vertical Structure Interaction between providers at different levels on the value chain Cross Sector Structure Limits on ownership or other affiliations between water utilities and companies in other sectors Cross Sector Structure Limits on ownership or other affiliations between water utilities and companies in other sectors

36 Market Structure: Cross Sector - benefits
“ Grouping services can offer benefits…….” Possible benefits of grouping services together include: Economies of scope Reducing payment risk Financial sustainability and cross subsidy The Module starts with a section ANALYZING key issues related to provision of water services: Key areas of RESPONSIBILITY and how can they be defined? Key RISKS related to these Responsibilities, and how can they be defined? We look at ways of determining the best ALLOCATION of Responsibilities and Risks between the operator and the contracting authority. Next we look at how DESIGNING rules and mechanisms can ensure that the allocations of Responsibility and Risk are carried out effectively. Finally we consider EXAMPLES of how we can Allocate Risks and Responsibilities under different models of PP arrangements.

37 Market Structure: Cross Sector - Benefits
“ Grouping services can offer benefits…….” Example: Gabon & Morocco Possible benefits of grouping services together include: Economies of scope Reducing payment risk Financial sustainability and cross subsidy More Detailed Analysis of Cross Sector Benefits The Module starts with a section ANALYZING key issues related to provision of water services: Key areas of RESPONSIBILITY and how can they be defined? Key RISKS related to these Responsibilities, and how can they be defined? We look at ways of determining the best ALLOCATION of Responsibilities and Risks between the operator and the contracting authority. Next we look at how DESIGNING rules and mechanisms can ensure that the allocations of Responsibility and Risk are carried out effectively. Finally we consider EXAMPLES of how we can Allocate Risks and Responsibilities under different models of PP arrangements.

38 Market Structure: Cross Sector - Disadvantages
“ ……Grouping services can also pose disadvantages” Possible disadvantages of grouping services together include: Problems in cost allocation and tariff setting Competitive distortions Loss of management focus

39 Market Structure: Cross Sector - Disadvantages
“ ……Grouping services can also pose disadvantages” Possible disadvantages of grouping services together include: Problems in cost allocation and tariff setting Competitive distortions Loss of management focus More Detailed Analysis of Cross Sector Disadvantages

40 Establish Competition Rules
“ Market structure is likely to evolve based on the rules established for competition as defined at the time of the Transaction” Competition for the Market Competition via Capital Markets Competition in the Market ESTABLISH Competition Rules

41 Competition: For the Market
Issues: Rebidding is an efficient way of maintaining competitive pressure to provide high quality service at reasonable price: because the contractor risks losing the contract at the next bid stage Typically long term contracts (up to 50 years): necessary for the contract to mimic competition – such as price controls, based on competitive comparisons Should firms be encouraged to bid for several projects?  Firms can bid for several contracts; increase demand, spread overhead cost and benefit from economies of scale  If firms are allowed to expand without limits, it may develop into a monopoly, making difficult for new entrants at re-bid stage. The issue of maintaining competition may limit the number of contracts an operator may be allowed to win, to prevent a monopoly. Example: Metro Manila – operators were not allowed to win both of the two Concessions for this major urban area In most developing countries, however, it may be necessary to allow operator to develop their demand base to gain economies of scale. “ Competition for the Market consists of re-bidding private sector contracts at regular intervals” This was the case in France where consolidation has happened over several years, reducing competition Competition for the Market Competition for the Market Competition via Capital Markets ESTABLISH Competition Rules Competition in the Market

42 Competition: via Capital Markets
“ Competition via Capital Markets occurs when Operators can purchase their competitors through buying shares on the Financial Markets, or through mergers” Issues: Threat of Purchase: maintains competitive pressure on Operators, and an incentive to maintain the company’s financial health When does this occur?: when company’s shares can be bought and sold ( often for service providers, more restricted for asset owning companies Mergers & Acquisitions: Governments may want to restrict mergers and acquisition, as this would have similar issues to allowing a company to win multiple contracts, including difficulties of establishing competitive service benchmarks Example: Mergers have been prevented in the UK water Services market to ensure sufficient Operators remain for comparative competition [See Box 4.9] Competition for the Market Competition via Capital Markets Competition via Capital Markets ESTABLISH Competition Rules Competition in the Market

43 Competition: via Capital Markets
“ Competition via Capital Markets occurs when Operators can purchase their competitors through buying shares on the Financial Markets, or through mergers” Issues: Threat of Purchase: maintains competitive pressure on Operators, and an incentive to maintain the company’s financial health When does this occur?: when company’s shares can be bought and sold ( often for service providers, more restricted for asset owning companies Mergers & Acquisitions: Governments may want to restrict mergers and acquisition, as this would have similar issues to allowing a company to win multiple contracts, including difficulties of establishing competitive service benchmarks Example: Mergers have been prevented in the UK water Services market to ensure sufficient Operators remain for comparative competition [See Box 4.9] Competition for the Market Competition via Capital Markets Competition via Capital Markets ESTABLISH Competition Rules Competition in the Market Example: UK Capital Market

44 Competition: In the Market
“ Competition in the Market is when Operators are free to enter and offer services in a Market. More usual in consumer goods market, more difficult to organize in Water Services market” ALTERNATIVE PROVIDERS Exclusivity may prevent small-scale alternative providers from offering services in areas unlikely to be connected. Small scale Alternative Providers may be able to expand service coverage, with provision of bulk supply arrangements by the Operator. Exclusivity Issues: Often Exclusivity given to Operators, it limits competition, but may be needed to make the contract economic.  Liked by Operators - Protects Operator from competition and some uncertainty of future demand. Prevents inefficient duplication of pipe networks. Helps preserve cross subsidies (since high paying customers cannot change providers)  Customers may benefit from more liberal entry policies. May prevent small scale Alternative Providers from offering services Competition for the Market Competition via Capital Markets Competition in the Market ESTABLISH Competition Rules Competition in the Market

45 Competition: In the Market
“ Competition in the Market is when Operators are free to enter and offer services in a Market. More usual in consumer goods market, more difficult to organize in Water Services market” Exclusivity Issues: Often Exclusivity given to Operators, it limits competition, but may be needed to make the contract economic.  Liked by Operators - Protects Operator from competition and some uncertainty of future demand. Prevents inefficient duplication of pipe networks. Helps preserve cross subsidies (since high paying customers cannot change providers)  Customers may benefit from more liberal entry policies. May prevent small scale Alternative Providers from offering services Competition for the Market Competition via Capital Markets Competition in the Market ESTABLISH Competition Rules Competition in the Market Alternative Small Scale Providers

46 Responsibilities to different levels of Government
Reviewing Module 4 “The Module has looked the main areas of upstream Policy that should be established before developing PP design…………” ALLOCATE Responsibilities to different levels of Government Identify the Reform Leader (Module 2) DETERMINE Market Structure Introduce Private Participation ESTABLISH Competition Rules REPRISE OF IINITIAL SLIDE: Setting Level of Service is an iterative process First this involves technical analysis and costing of the level of service and any related investment. The Government then has decide whether the cost of this level of service can be supported, what Tariff Levels need to be set for effective cost recovery and if any Subsidy has to be used to make an affordable service to the customer. We look at these elements, including types and use of subsidy Estimating the Trade off between Level of Service and Tariff/Subsidy is best done with a financial model such as the one provided with the Toolkit: If the cost of services proves too high then the process is iterated, amending the elements until a satisfactory balance between Level of Service and Tariff is found. When the balance between Cost of Service and Tariff is satisfactory, then we can proceed with the design and Implementation of the chosen arrangement. In the final sections we discussed Implication for design of PP Arrangements and looked at some guidance on Structuring Finance for the arrangement.

47 Module 4 More Information
“……..and further background information is available” Finally, this Checklist gives a useful reminder of the detailed issues to be considered in this process, towards arriving at Upstream .

48 Supporting Material The Toolkit Financial Model
Toolkit Case Study material Toolkit Website: For comments or further details contact Cledan Mandri Perrott at There are some supplementary materials that will help you understand this further. The toolkit includes a spreadsheet based financial Policy Simulation model that will assist in balancing tariffs, subsidies and coverage targets as covered by Module 5 [ as well as integrating with some of the other key financial issues covered in other Modules] There are 16 case studies, and some of these have been referred to in this module. The full toolkit can be read or downloaded from the website, and questions or comments made to the task manager.

49 Toolkit: Module 4 End of Module END OF PRESENTATION

50 Toolkit: Module 4 Return to Start END OF PRESENTATION

51 Toolkit: Module 4 DO NOT MOVE or ERASE THE FOLLOWING SLIDES
END OF PRESENTATION

52 Examining Responsibilities: Conflict
Back to Module “Brazil - unclear institutional structure led to legal questions on responsibility”

53

54 Economies of Scale Back to Module “France – example of municipalities combining service areas for improved efficiency”

55 Allocate Responsibilities Step 3b – Regulators
LOCAL or NATIONAL REGULATION: WHAT ABOUT A COMPROMISE? A compromise assigns different functions to different levels of Government Local contract monitoring units may be best for monitoring service levels and quality targets National bodies may be limited to: Defining common methods for price setting Acting as clearing house to share & compare information about various providers The arrangements need to assign functions clearly at national and local levels The complexity makes these arrangements more difficult to put in place, and they are prone to conflict if responsibilities are not clearly defined 3 Steps - ALLOCATE Responsibilities to different levels of Government Step 1. EXAMINE Responsibilities under current law & institutional arrangements Step 2. DECIDE Which level of Government should be responsible for water service provision Step 3 DECIDE Which levels of Government responsible for tariff setting , environmental issues etc.

56 “The costs of changing market structure can be substantial”
Benefits & Costs: Increasing Scale & Scope Back to Module “The costs of changing market structure can be substantial”

57

58 “National Utilities – Metropolitan Utilities – Rural Areas”
Horizontal Structures: National Utilities Back to Module “National Utilities – Metropolitan Utilities – Rural Areas” National Utilities A National Utility is a single entity providing services to all urban centers, and maybe some rural areas. Policymakers have two options with existing National Utilities before Private Participation: Leave the Utility for Private Participation Examples: Senegal, Gabon and Ghana Divide the Utility into several units. These units may be regions or by separating large cities from the rest of the utility Examples Honduras & Nepal Some countries may decide to create a national utility before private participation to gain a stronger more effective organization, offering economies of scale. This was the case in Guyana, where the service for the capital city was merged with the regional utility serving rural and regional areas.

59 Horizontal Structures: Ghana - National
Back to Module “Ghana - a proposal to split into two utilities created resistance”

60

61 “National Utilities – Metropolitan Utilities – Rural Areas”
Horizontal Structure: Metropolitan Utilities Back to Module “National Utilities – Metropolitan Utilities – Rural Areas” Metropolitan Utilities A Metropolitan Utility serves a major city and some surrounding areas. The Government will want to consider: Retaining a large metropolitan utility as a single entity? [Bucharest, Sofia] Minimizes disruption and transaction costs. Benchmarking can be done with operators in other cities and countries Dividing the metropolitan utility into several parts? [ Manila – Box 4.4] Facilitates comparative competition, can provide a backup operator for another utility Amalgamating several existing providers into a single entity? How to deal if a metropolitan utility services several local government areas? Need to consider how local governments can be involved in decision making. The Buenos Aires experience [Box 4.5] shows how difficulties can arise if they are not involved

62 Horizontal Structures: Manila – Metropolitan
Back to Module “Manila - Bulk water transfers needed to make it work”

63 Horizontal Structures: Buenos Aires - Metropolitan
Back to Module “Buenos Aires - A single Metropolitan service provider proved practical”

64

65 “National Utilities – Metropolitan Utilities – Rural Areas”
Horizontal Structure: Rural & Small Towns Back to Module “National Utilities – Metropolitan Utilities – Rural Areas” Rural Areas Rural Areas Local Community issues: The views of the local community are a key influence on Market Structure design, as they are interested and ultimately responsible for efficient service delivery. Example: Senegal. Local communities in Senegal prefer to organize their own local private or community based water services. They prefer to offset the lower costs and higher service levels offered by the national utility against the ability to retain control over their own local services. Rural areas are often considered commercially unattractive (consumption is low, and costs are higher because of the low population density). Several options can be considered to attract private participation for small towns and rural areas: As single, national, utility may be created, with special targets for rural areas However, it may prove not to be feasible for the operator to manage remote areas, or the extensive cross subsidy that may be needed [Cote D’Ivoire (SODECI)] Several Operators may be created regionally, or for towns with associated rural areas. These may operate alone or with support from larger operators ( say, through a franchise) A combination of both options, with smaller operators allowed to compete for local services

66 Horizontal Structures: Small Towns - Franchising
Back to Module

67

68 Vertical Structure: Unbundling Issues
Government may decide that improvement or Private Participation is only needed in one link of the Value Chain. Example: Privatizing water or sewage treatment – with distribution remaining public Additionally, Governments may choose to carry out improvements in phases. It is possible to have different Private Participation models for different parts of the Value Chain, taking those most commercially viable, retaining those needing more public investment [Box 4.7 Senegal]: Example: Brno, Czech Republic – BOT for wastewater treatment; affermage-lease for water supply and waste water collection Back to Module “When deciding whether to vertically separate services, consider several issues: ” The current structure of the sector How to ensure quality of service Planning investment Where new investment or management is needed Taking advantage of scale and scope Managing payment risk Managing scarce water resources Promoting decentralized decision making Making changes is costly – need clear reasons to reorganize When only one company is responsible for provision of service from source to tap it may be possible to be more efficient. Note that involvement of several companies may introduce complications. Example: The distribution company may argue that quality problems at the tap are the fault of poor raw water quality from the bulk suppliers, who may blame the distribution company’s operations. It is important to have clear contract conditions for transfer of water, or services between different providers to ensure accountability for service quality. There are trade-offs between investments in different levels in the value chain Example: Either new production or reduced leakage will increase water into supply. Making a single company responsible for the value chain makes these trade-offs easier. Investments need to be co-ordinated across the value chain to be fully effective.

69 “The issues and solutions will be specific to the particular case ”
When there is a single company providing all services, then there is a single payment risk related to billing & collections to customers. Introduction of other operators may mean that they do not have a direct relationship with customers, and the payment will have to be made by the distribution utility. Example: The bulk water supplier may wonder if he will be paid by the distribution utility. Waste Water systems find it difficult to enforce payments as they cannot effectively cut off service to customers. Alternative payment methods can be found, for example: Financed through local property taxes Water distribution utility to collect on behalf of wastewater utility [Example: Chaumont, France] Vertical Structure: Unbundling Issues Back to Module “When deciding whether to vertically separate services, consider several issues: ” There may be economies of scale and scope in vertical aggregation, affecting: Management overheads Maintenance Equipment Billing and Collection The current structure of the sector How to ensure quality of service Planning investment Where new investment or management is needed Taking advantage of scale and scope Managing payment risk Managing scarce water resources Promoting decentralized decision making Some large countries with scarce water resources have built regional or national water storage and management systems Examples: Umgeni Water & Rand Water in South Africa National Office of Drinking Water in Morocco Frequently water distribution and wastewater services are left to local providers When Governments want to promote local control, they may decide to separate municipal distribution facilities from bulk supplies and regional transmission schemes. Example: Ostrava, Czech Republic: Private Participation introduced to municipal distribution, after separation from the regional bulk supply company “The issues and solutions will be specific to the particular case ”

70 Vertical Structures: Senegal – Water & Sanitation
Back to Module “Senegal - Water & Sanitation separated to get improvements”

71

72 Market Structure: Cross Sector - Benefits
Back to Module It may be difficult socially or politically to cut off water services on default. It is possible to link defaults on water payments to cutting off other services (such as telephone or electricity), leaving the water still connected. “ Grouping services can offer benefits…….” Other utilities may be more robust than Water, allowing for some cross subsidies [Box 4.8 – Gabon & Morocco]. Whilst cross-subsidies have disadvantages, they are a part of the Government’s decisions. Possible benefits of grouping services together include: Economies of scope Reducing payment risk Financial sustainability and cross subsidy When Governments want to promote local control, they may decide to separate municipal distribution facilities from bulk supplies and regional transmission schemes. Example: Ostrava, Czech Republic: Private Participation introduced to municipal distribution, after separation from the regional bulk supply company

73 Cross Sector: Gabon & Morocco
Back to Module “ These examples show how cross sector integrated schemes can work, for water and electricity, and also sanitation ”

74 Market Structure: Cross Sector - disadvantages
An Operator may be affected competitively because it operates in more than one market. Example: A company providing both Water and Cable TV might use its water profits to expand the more profitable TV service, instead of investing more in water Back to Module “ ……Grouping services can also pose disadvantages” There are limits to the number of things a Management team can do well. Whether a Management Team loses focus depends on the size and complexity involved. However, the larger companies can attract higher quality managers Possible disadvantages of grouping services together include: Problems in cost allocation and tariff setting Competitive distortions Loss of management focus It may be difficult to allocate costs if different services are under the same company. This may make tariff setting complicated. Accounting rules can address the problem, but do not fully solve it.

75

76 Competition: Capital Markets - UK
Back to Module “England & Wales - Number of Competitors seen to influence effective competition”

77 Competition: Alternative Providers
Back to Module

78

79 Toolkit: Module 4 DO NOT MOVE or ERASE THE PREVIOUS SLIDES AFTER “END” OF MODULE END OF PRESENTATION


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