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

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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 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 4 5 Setting Service Standards, Tariffs, Subsidies & Financial Arrangements Module 4 Setting Upstream Policy

5 Module 4 - What will we learn? 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? What are the Responsibilities of other levels of Government? How do we IDENTIFY the level of Government to be responsible for water services? COMPETITION – how can we establish it?

6 Module 4 Setting Upstream Policy Identify the Reform Leader (Module 2 ) 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 Introduce Private Participation ALLOCATE Responsibilities to different levels of Government DETERMINE Market Structure ESTABLISH Competition Rules

7 Allocate Responsibilities Step 1 – Examining existing 3 Steps - ALLOCATE Responsibilities to different levels of Government Step 3 DECIDE Which levels of Government responsible for tariff setting, environmental issues etc. Step 2. DECIDE Which level of Government should be responsible for water service provision 3 Steps - ALLOCATE Responsibilities to different levels of Government Step 1. EXAMINE Responsibilities under current law & institutional arrangements 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. 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

8 Allocate Responsibilities at different Government Levels 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 Step 3 DECIDE Which levels of Government responsible for tariff setting, environmental issues etc. 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 Dividing up the responsibilities for water services is a three step process, ………,……… then we need to set up the legal & institutional framework 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

9 Allocate Responsibilities Step 1 – Examining existing 3 Steps - ALLOCATE Responsibilities to different levels of Government Step 3 DECIDE Which levels of Government responsible for tariff setting, environmental issues etc. Step 2. DECIDE Which level of Government should be responsible for water service provision ALLOCATE (In 3 Steps) Responsibilities to different levels of Government Step 1. EXAMINE Responsibilities under current law & institutional arrangements 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 Example: Question of Responsibility in Brazil

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 3 Steps - ALLOCATE Responsibilities to different levels of Government Step 2. DECIDE Which level of Government should be responsible for water service provision Step 1. EXAMINE Responsibilities under current law & institutional arrangements Step 3 DECIDE Which levels of Government responsible for tariff setting, environmental issues etc. 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.

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 2. DECIDE Which level of Government should be responsible for water service provision Step 1. EXAMINE Responsibilities under current law & institutional arrangements Step 3 DECIDE Which levels of Government responsible for tariff setting, environmental issues etc. Example: Economy of Scale - Small towns in France

12 Step 3 DECIDE Which levels of Government responsible for tariff setting, environmental issues etc. 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 3a DECIDE Which levels of Government responsible for tariff setting, environmental issues etc. Step 1. EXAMINE Responsibilities under current law & institutional arrangements Step 2. DECIDE Which level of Government should be responsible for water service provision Step 3b ESTABLISH Regulatory regimes and institutions

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 3 Steps - ALLOCATE Responsibilities to different levels of Government Step 2. DECIDE Which level of Government should be responsible for water service provision Step 1. EXAMINE Responsibilities under current law & institutional arrangements Step 3 DECIDE Which levels of Government responsible for tariff setting, environmental issues etc. 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.

14 Step 3 DECIDE Which levels of Government responsible for tariff setting, environmental issues etc. 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 1. EXAMINE Responsibilities under current law & institutional arrangements Step 2. DECIDE Which level of Government should be responsible for water service provision Step 3b ESTABLISH Regulatory regimes and institutions

15 Allocate Responsibilities Step 3b – Regulators A Regulatory institution or arrangement needs to be set up to monitor contract performance and set the tariffs. 3 Steps - ALLOCATE Responsibilities to different levels of Government Step 2. DECIDE Which level of Government should be responsible for water service provision Step 1. EXAMINE Responsibilities under current law & institutional arrangements Step 3 DECIDE Which levels of Government responsible for tariff setting, environmental issues etc. 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? 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.

16 Allocate Responsibilities Step 3b – Regulators A Regulatory institution or arrangement needs to be set up to monitor contract performance and set the tariffs. 3 Steps - ALLOCATE Responsibilities to different levels of Government Step 2. DECIDE Which level of Government should be responsible for water service provision Step 1. EXAMINE Responsibilities under current law & institutional arrangements Step 3 DECIDE Which levels of Government responsible for tariff setting, environmental issues etc. 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? National or Local Regulation: A compromise?

17 Allocate Responsibilities Step 3b – Regulators A Regulatory institution or arrangement needs to be set up to monitor contract performance and set the tariffs. 3 Steps - ALLOCATE Responsibilities to different levels of Government Step 2. DECIDE Which level of Government should be responsible for water service provision Step 1. EXAMINE Responsibilities under current law & institutional arrangements Step 3 DECIDE Which levels of Government responsible for tariff setting, environmental issues etc. 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.

18 Allocate Responsibilities Step 3b – Regulators A Regulatory institution or arrangement needs to be set up to monitor contract performance and set the tariffs. 3 Steps - ALLOCATE Responsibilities to different levels of Government Step 2. DECIDE Which level of Government should be responsible for water service provision Step 1. EXAMINE Responsibilities under current law & institutional arrangements Step 3 DECIDE Which levels of Government responsible for tariff setting, environmental issues etc. 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. 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.

19 Determine Market Structure 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 Cross Sector Structure Limits on ownership or other affiliations between water utilities and companies in other sectors 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

20 Market Structure: Horizontal DETERMINE Market Structure Horizontal structures relate to service areas – and this section looks at decisions on selecting service areas 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 Cross Sector Structure Limits on ownership or other affiliations between water utilities and companies in other sectors Horizontal Structure Interaction between providers at the same level on the value chain 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

21 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 Horizontal Structure: Environmental & Technical ENVIRONMENTAL & TECHNICAL FACTORS: Configuration of Existing Networks Least Cost technical solutions to improve supply 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 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 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

22 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 Horizontal Structure: Environmental & Technical ENVIRONMENTAL & TECHNICAL FACTORS: Configuration of Existing Networks Least Cost technical solutions to improve supply

23 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 Horizontal Structure: Environmental & Technical ENVIRONMENTAL & TECHNICAL FACTORS: Configuration of Existing Networks Least Cost technical solutions to improve supply Water Resources issue 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 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

24 Empirical research shows economies of scale in water services 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 Horizontal Structure: Service Efficiency 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 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

25 Aspects of water services provided by a network are the same for most customers 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 Horizontal Structure: Administrative boundaries 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 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

26 Grouping areas together may increase the financial attractiveness 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 Horizontal Structure: Financial Attractiveness & Capacity 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. 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.

27 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 Horizontal Structure: Transaction Costs 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 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

28 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 Horizontal Structure: Transaction Costs Benefits & Costs Increasing Size & Scope

29 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 DETERMINE Market Structure 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 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 Vertical Structure Interaction between providers at different levels on the value chain

31 Vertical Market Structure: The Value Chain The various Water Services components can be shown as items on a Value Chain Water Abstraction Sludge Treated Water Treatment Customers Treatment Disposal Transport Distribution Collection Discharge 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 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

32 Unbundling, or vertical separation, has to be done with care related to the horizontal structure issues as well as the value chain 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 Vertical Structure: Unbundling 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. 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 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

33 When deciding whether to vertically separate services, consider several issues: Vertical Structure: Unbundling 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 When deciding whether to vertically separate services, consider several issues: Vertical Structure: Unbundling 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 More Detailed Analysis of Unbundling Issues Example: Senegal Sewage & Water Unbundling

35 Market Structure: Cross Sector DETERMINE Market Structure 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 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

37 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 More Detailed Analysis of Cross Sector Benefits Example: Gabon & Morocco

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 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

41 Competition: For the Market ESTABLISH Competition Rules Competition for the Market consists of re-bidding private sector contracts at regular intervals Competition via Capital Markets Competition in the Market 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. This was the case in France where consolidation has happened over several years, reducing competition

42 Competition: via Capital Markets ESTABLISH Competition Rules Competition via Capital Markets occurs when Operators can purchase their competitors through buying shares on the Financial Markets, or through mergers Competition for the Market Competition via Capital Markets Competition in the Market Competition via Capital Markets Issues: Threat of Purchase: maintains competitive pressure on Operators, and an incentive to maintain the companys financial health When does this occur?: when companys 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]

43 Competition: via Capital Markets ESTABLISH Competition Rules Competition via Capital Markets occurs when Operators can purchase their competitors through buying shares on the Financial Markets, or through mergers Competition for the Market Competition via Capital Markets Competition in the Market Competition via Capital Markets Issues: Threat of Purchase: maintains competitive pressure on Operators, and an incentive to maintain the companys financial health When does this occur?: when companys 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] Example: UK Capital Market

44 Competition: In the Market ESTABLISH Competition Rules 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 Competition for the Market Competition via Capital Markets Competition in the 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 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. 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.

45 Competition: In the Market ESTABLISH Competition Rules 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 Competition for the Market Competition via Capital Markets Competition in the 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 Alternative Small Scale Providers

46 Reviewing Module 4 The Module has looked the main areas of upstream Policy that should be established before developing PP design………… Identify the Reform Leader (Module 2 ) Introduce Private Participation ALLOCATE Responsibilities to different levels of Government DETERMINE Market Structure ESTABLISH Competition Rules

47 Module 4 More Information ……..and further background information is available

48 Supporting Material The Toolkit Financial Model Toolkit Case Study material Toolkit Website: For comments or further details contact Cledan Mandri Perrott at

49 Toolkit: Module 4 End of Module

50 Toolkit: Module 4 Return to Start

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

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

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

55 Allocate Responsibilities Step 3b – Regulators 3 Steps - ALLOCATE Responsibilities to different levels of Government Step 2. DECIDE Which level of Government should be responsible for water service provision Step 1. EXAMINE Responsibilities under current law & institutional arrangements Step 3 DECIDE Which levels of Government responsible for tariff setting, environmental issues etc. 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

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

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58 Horizontal Structures: 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. National Utilities – Metropolitan Utilities – Rural Areas National Utilities Back to Module

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

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61 Horizontal Structure: 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 National Utilities – Metropolitan Utilities – Rural Areas Metropolitan Utilities Back to Module

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

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

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65 Horizontal Structure: Rural & Small Towns 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 DIvoire (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 National Utilities – Metropolitan Utilities – 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 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. Back to Module

66 Horizontal Structures: Small Towns - Franchising Back to Module

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68 When deciding whether to vertically separate services, consider several issues: Vertical Structure: Unbundling 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 companys operations. It is important to have clear contract conditions for transfer of water, or services between different providers to ensure accountability for service quality. 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 companys 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. 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. 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 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

69 Back to Module 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 There may be economies of scale and scope in vertical aggregation, affecting: Management overheads Maintenance Equipment Billing and Collection There may be economies of scale and scope in vertical aggregation, affecting: Management overheads Maintenance Equipment Billing and Collection 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] 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] 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 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 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

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

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72 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 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 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 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. 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. 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 Governments decisions. 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 Governments decisions. Back to Module

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

74 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 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. 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. 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 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 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 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 Back to Module

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

77 Competition: Alternative Providers Back to Module

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


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