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Toolkit: Approaches to Private Participation in Water Services Module 5 Setting Service Standards, Tariffs, Subsidies & Financial Arrangements.

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Presentation on theme: "Toolkit: Approaches to Private Participation in Water Services Module 5 Setting Service Standards, Tariffs, Subsidies & Financial Arrangements."— Presentation transcript:

1 Toolkit: Approaches to Private Participation in Water Services Module 5 Setting Service Standards, Tariffs, Subsidies & Financial Arrangements

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 5 5 Setting Service Standards, Tariffs, Subsidies & Financial Arrangements Module 5 Setting Service Standards, Tariffs, Subsidies & Financial Arrangements

5 Module 5 - What will we learn? What are the issues to get effective private and public financing for Private Participation? Can we define realistic, affordable targets for Coverage and Quality of Service? Management Contract for Jordan Valley Authority, Irrigation Water Supply, may be the first of its kind. What are the key issues in establishing a mix of Tariff and Subsidy? What is the importance of Cost Recovery? How are Levels of Services, Cost, Tariffs and Subsidies interlinked?

6 Balancing Service Standards, Tariffs & Subsidies In this Module we describe an iterative process, to answer the question How can we afford better services under a new Arrangement? Set Tariffs & Subsidies Estimate Cost Specify Services YES Does it work? NO IMPLEMENT Design Finance START There is a need to balance Level of service with Level of Tariffs. Better service costs more. Governments have the task to decide what is affordable. The diagram illustrates the elements and the process followed in this Module There is a need to balance Level of service with Level of Tariffs. Better service costs more. Governments have the task to decide what is affordable. The diagram illustrates the elements and the process followed in this Module

7 Balancing Service Standards, Tariffs & Subsidies IMPLEMENT Set Tariffs & Subsidies Estimate Cost Specify Services YES Does it work? NO Design Finance START Setting Level of Service is an iterative process. First, having chosen a proposed Level of Service, then there is a need to Specify the Services technically. Setting Level of Service is an iterative process. First, having chosen a proposed Level of Service, then there is a need to Specify the Services technically. Then it is necessary to Estimate the Cost of the level of service and of any related investment. In this Module we describe an iterative process, to answer the question How can we afford better services under a new Arrangement?

8 Balancing Service Standards, Tariffs & Subsidies IMPLEMENT Set Tariffs & Subsidies Estimate Cost Specify Services YES Does it work? NO Design Finance START The Government then has decide: whether the Cost of this level of service can be supported, and what Tariff Levels need to be set for effective cost recovery. if any Subsidy has to be used to make an affordable service to the customer including Type of Subsidy). The Government then has decide: whether the Cost of this level of service can be supported, and what Tariff Levels need to be set for effective cost recovery. if any Subsidy has to be used to make an affordable service to the customer including Type of Subsidy).

9 In this Module we describe an iterative process, to answer the question How can we afford better services under a new Arrangement? Balancing Service Standards, Tariffs & Subsidies IMPLEMENT Set Tariffs & Subsidies Estimate Cost Specify Services YES Does it work? NO Design Finance START 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. 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 of the Module we discuss: Implications for Design of PP Arrangements Guidance on Structuring Finance for the Arrangement. In the final sections of the Module we discuss: Implications for Design of PP Arrangements Guidance on Structuring Finance for the Arrangement.

10 Specifying Service Levels To start the process we need to choose preferred Levels of Service and define the technical and operational basis needed to reach these service levels. IMPLEMENT Set Tariffs & Subsidies Estimate Cost Specify Services YES Does it work? NO Design Finance START First we look at how service goals are set for the Utility under the proposed Private Participation Arrangement Two main issues to be defined: Coverage of service Quality of service

11 Specifying Service Levels To start the process we need to choose preferred Levels of Service and define the technical and operational basis needed to reach these service levels. IMPLEMENT Set Tariffs & Subsidies Estimate Cost Specify Services YES Does it work? NO Design Finance START First we look at how service goals are set for the Utility under the proposed Private Participation Arrangement Two main issues to be defined: Coverage of service Quality of service Service Coverage TargetsService Quality Targets

12 Estimating Cost of Services IMPLEMENT Set Tariffs & Subsidies Estimate Cost Specify Services YES Does it work? NO Design Finance START Once initial objectives have been set, Government should estimate the cost of providing the service.

13 Cost of Service When a Utility cannot cover its cost, service will suffer Estimating Cost of Service: Once initial objectives have been set, Government should estimate the cost of providing the service. Average costs are used as an effective basis. This is an important step, since it will be important to determine to what extent Cost Recovery can be achieved by the chosen Tariff level. The reasoning behind this assessment of the level of Cost Recovery is that : "When a Utility cannot cover its cost, service will suffer If you cut back on essential expenditure (Examples: Chemicals, Pump replacement or expansion of the network) the services suffer. Similarly reduction in maintenance, renewal or expansion of the system may also increase the costs of operation in the medium term Cost estimating is difficult and technical, but need to look at three main elements: Operating & Maintenance Expenses Depreciation Return on Capital Essential to first have a clear idea of total costs, then you can separately decide whether the tariff should cover all of those costs, or whether tax payers should subsidize the service.

14 Estimating Cost of Service: Once initial objectives have been set, Government should estimate the cost of providing the service. Average costs are used as an effective basis. This is an important step, since it will be important to determine to what extent Cost Recovery can be achieved by the chosen Tariff level. The reasoning behind this assessment of the level of Cost Recovery is that : "When a Utility cannot cover its cost, service will suffer If you cut back on essential expenditure [Examples: Chemicals, Pump replacement or expansion of the network] the services suffer. Similarly reduction in maintenance, renewal or expansion of the system may also increase the costs of operation in the medium term Cost estimating is difficult and technical, but need to look at three main elements: Operating & Maintenance Expenses Depreciation Return on Capital Cost of Service When a Utility cannot cover its cost, service will suffer Essential to first have a clear idea of total costs, then you can separately decide whether the tariff should cover all of those costs, or whether tax payers should subsidize the service. Operating & Maintenance; Depreciation; Return on Capital Depreciation: Capital Maintenance

15 Cost recovery and tariff implications Can we afford to pay for better services? IMPLEMENT Set Tariffs & Subsidies Estimate Cost Specify Services YES Does it work? NO Design Finance START

16 To be viable: Tariffs + Subsidies = Total Cost of Service Service Quality Service Coverage COST OF SERVICE TARIFF INCOME Cost Recovery and Tariff INCENTIVES SUBSIDY Cost of Service tells Government how much it will cost to provide the service. In addition to Service Coverage and Quality costs, Governments need to consider: Annual cash needs of the utility and financial ratios required by lenders (e.g. debt repayment rates) Environmental or social costs that the government decides should be borne by the Utility Cost of Service tells Government how much it will cost to provide the service. In addition to Service Coverage and Quality costs, Governments need to consider: Annual cash needs of the utility and financial ratios required by lenders (e.g. debt repayment rates) Environmental or social costs that the government decides should be borne by the Utility Next step is to determine how much should be recovered through Tariffs. If not full cost recovery from the Tariff (if Cost of Service exceeds Tariff income) : either Subsidies will be needed, or Services need to be lowered. If not full cost recovery from the Tariff (if Cost of Service exceeds Tariff income) : either Subsidies will be needed, or Services need to be lowered.

17 To be viable: Tariffs + Subsidies = Total Cost of Service Service Quality Service Coverage COST OF SERVICE TARIFF INCOME Cost Recovery and Tariff INCENTIVES SUBSIDY Willingness to Pay Social Acceptability External Benefits Tariff Setting: Three reasons why a tariff for full cost recovery may be considered too high: Willingness to Pay: The extent to which people are unwilling to pay the full cost of service Social Acceptability: People are willing to pay but it is considered socially unacceptable to pay what the service costs require External Benefits: Environmental or Public Health issues make it beneficial to charge less Tariff Setting: Three reasons why a tariff for full cost recovery may be considered too high: Willingness to Pay: The extent to which people are unwilling to pay the full cost of service Social Acceptability: People are willing to pay but it is considered socially unacceptable to pay what the service costs require External Benefits: Environmental or Public Health issues make it beneficial to charge less

18 Use of Subsidies If Cost of Service exceeds Tariff income, then a Subsidy will be needed IMPLEMENT Set Tariffs & Subsidies Estimate Cost Specify Services YES Does it work? NO Design Finance START

19 Types of subsidy Private Participation can involve suitable subsidy arrangements Who Subsidy paid To Where Subsidy comes From This Table illustrates some of the main categories of Subsidies. Subsidies can be categorized: Where the money comes from?: Customer Revenue Government Revenue Development Agency Grant or Loan with concessional element. (These are generally used to make structuring a subsidy fund easier, or for easing in a new tariff structure in the short term) Where subsidies are paid to and for what? This Table illustrates some of the main categories of Subsidies. Subsidies can be categorized: Where the money comes from?: Customer Revenue Government Revenue Development Agency Grant or Loan with concessional element. (These are generally used to make structuring a subsidy fund easier, or for easing in a new tariff structure in the short term) Where subsidies are paid to and for what?

20 Types of subsidy We will look at some specific Input and Output Subsidy forms…. Input Based Subsidy Traditionally subsidies were paid to help utilities recover their costs (Input Based Subsidy). However, this supports the costs, not the results. Input Based Subsidy Traditionally subsidies were paid to help utilities recover their costs (Input Based Subsidy). However, this supports the costs, not the results. Output Based Subsidy A better approach (and especially where a Private Operator isinvolved) is to make payment contingent on specific outputs, or Output Based Subsidy. Output Based Subsidy A better approach (and especially where a Private Operator isinvolved) is to make payment contingent on specific outputs, or Output Based Subsidy. Now we will look at the various forms of Input and Output based subsidy in more detail

21 Types of subsidy Private Participation can involve suitable subsidy arrangements Output Based SubsidyInput Based Subsidy Output Based Aid: Expert Insight Subsidy: Targeting the Poor

22 Balancing Service Standards, Tariffs & Subsidies This is an iterative process. Can we afford better services? IMPLEMENT Set Tariffs & Subsidies Estimate Cost Specify Services YES Does it work? NO Design Finance START

23 Develop options, looking for an acceptable trade-off between tariffs, services and subsidies Finalizing Tariff, Subsidy and Service Level INCENTIVES COST OF SERVICE TARIFF INCOME SUBSIDY 4. Now we have reached the point where we have to consider if we have reached a Balance between Costs and Tariffs. If the tariff/subsidy revenues are not sufficient then we can look at various alternative ways of adjusting our tariff/cost of service arrangements, for example: Adopt cost recovery tariffs for all customers Set Tariffs below cost for some customers and apply a subsidy Reduce costs (and thus necessary tariff levels) by reducing coverage and service levels Balancing the cost & tariff issues Once we are happy with the balance between Cost, Tariff and subsidy we can proceed to incorporate them into the design of the Private Participation Arrangement. Following our Process, we have: 1. Arrived at Cost of Service Following our Process, we have: 2. Looked at acceptable Tariff scales Finally we have: 3. Evaluated any necessary subsidies

24 What key issues should we include in the Private Participation Arrangement design? IMPLEMENT Set Tariffs & Subsidies Estimate Cost Specify Services YES Does it work? NO Design Finance START Design & Implement: Design Issues

25 Design Issues The Arrangement has to cover various issues: –Cost of Service = Management Costs + Operations + Capital Investment –Operators fee in a Management Contract may be financed by others, and payment linked to outputs. –Investment elements in lease and management contracts can be partially financed by governments, investors and operators –Concession models have been developed that can include subsidy, such as using Output Based Aid, retaining Government control of how the subsidy is used PP is possible even if Tariffs dont cover costs The Private Participation Arrangement has to be clearly defined to show where the funds to cover all costs of service will come from. These costs include the cost of Management and all necessary Capital Investment as well as the Operational Costs needed to provide the Service. Examples: Guyana Management Contract: Donors finance the Operators Management Fee Operator not affected by financial health of utility Amman, Jordan : Performance-based Management contract Operators performance links to a profit sharing incentive

26 Design Issues The Arrangement has to cover various issues: –Cost of Service = Management Costs + Operations + Capital Investment –Operators fee in a Management Contract may be financed by others, and payment linked to outputs. –Investment elements in lease and management contracts can be partially financed by governments, investors and operators –Concession models have been developed that can include subsidy, such as using Output Based Aid, retaining Government control of how the subsidy is used PP is possible even if Tariffs dont cover costs Comment: Use of Aid in Concession models For Concessions it was sometimes though that either the tariff had to have full cost recovery or the government was committed to increase tariffs accordingly. This is because in a concession the operator has to cover all costs, including investment, from revenues. However, subsidies can be combined with concessions, and Output based Aid can help to recover costs as well as improve services Example: Partial Investment by Operator: Senegal, ONES : Affermage- lease contract with Operator used to transfer substantial responsibilities to the Operator but with only a limited investment Total investment too large to be financed by the private operator, covered by Government. The Government asset holding company took remaining major investments in bulk water transport and distribution

27 Design Issues The Arrangement has to cover various issues: –Cost of Service = Management Costs + Operations + Capital Investment –Operators fee in a Management Contract may be financed by others, and payment linked to outputs. –Investment elements in lease and management contracts can be partially financed by governments, investors and operators –Concession models have been developed that can include subsidy, such as using Output Based Aid, retaining Government control of how the subsidy is used PP is possible even if Tariffs dont cover costs Example: Amman Management Contract Cost Recovery for O&M

28 Design & Implement: Financing Implications How to involve private and public finance? IMPLEMENT Set Tariffs & Subsidies Estimate Cost Specify Services YES Does it work? NO Design Finance START

29 Private Finance What might be the potential sources of funding for a prvately financed project? The actual project funding could be a mix of various finance sources. For example: The operator could put up 30% of the investment required, with the remainder from banks or other financial institutions. The actual project funding could be a mix of various finance sources. For example: The operator could put up 30% of the investment required, with the remainder from banks or other financial institutions.

30 Private Finance What issues to consider when involving Private Finance? The way that the arrangement is designed, and the security offered against risks will affect the perception of operators, investors and lenders about the level of risks involved and ultimately the viability and cost of the project. This in turn will affect the level of investment cost, and in this in turn affects the cost of provision of service under the Private Participation arrangement [Risk allocation is an important subject dealt with in Module 6 ] - The cost recovery potential and tariff stability are issues that will have a direct bearing on this. Need to consider the views of potential lenders at the arrangement design and bid stages to ensure that a viable project can be put out to bid, and that investors will be interested to be involved The amount of investment required needs to be considered, to ensure that debt levels and risk are viable. The phasing and type of investment can be considered in order to rapidly increase cash flow, allow the operator to reduce costs and free up cash later for more investment.

31 Arrangement TypePrivate Operator Public Finance Management Contract o Operator brings efficiencies o Operating cost income needed o Capital investment needed o Operating costs by government o Investment needed to support effective operational improvement o Capital investment needs are defined by government Affermage Lease o Operator brings efficiencies o Revenues cover operational cost o Insufficient cash flow to cover investment o Operator can prepare investment program for needed improvements o Investment for identified capital works o Need to use operators insights in required investment o Need to control size and use of investment Concession o Revenues cover operational and investment costs o Can mobilize substantial amounts of private capital o Government finance can subsidize to meet water sector goals. o Involving development agencies may lower costs through cheaper finance Involving Public Financing There is still a place for Public Financing. The needs differ for each PP Arrangement type These three types of arrangement have an increasing involvement from private sector finance, with a potential role for public sector finance in all three types: Management Contracts bring focused management skills and efficiency to a utility. Where the utility is in financial difficulty, then public finance will be needed for operational and capital investment costs. Public or development agency finance will be needed to support the reforms being implemented by the operator, for example replacing pumps, emergency works, training, as the major improvements will not be attained with management effort alone. Management Contracts bring focused management skills and efficiency to a utility. Where the utility is in financial difficulty, then public finance will be needed for operational and capital investment costs. Public or development agency finance will be needed to support the reforms being implemented by the operator, for example replacing pumps, emergency works, training, as the major improvements will not be attained with management effort alone. Affermage- lease contracts: Although the utility may be generating sufficient cash flow to cover operating costs, it may not be enough to service borrowings. The operator can propose a capital works investment program that will achieve the operational and financial improvement targets to be funded by the public sector. To be successful there is a need to ensure that there is adequate capital in the utility, but to ensure that there is not excessive borrowing or investment Affermage- lease contracts: Although the utility may be generating sufficient cash flow to cover operating costs, it may not be enough to service borrowings. The operator can propose a capital works investment program that will achieve the operational and financial improvement targets to be funded by the public sector. To be successful there is a need to ensure that there is adequate capital in the utility, but to ensure that there is not excessive borrowing or investment

32 Arrangement TypePrivate Operator Public Finance Management Contract o Operator brings efficiencies o Operating cost income needed o Capital investment needed o Operating costs by government o Investment needed to support effective operational improvement o Capital investment needs are defined by government Affermage Lease o Operator brings efficiencies o Revenues cover operational cost o Insufficient cash flow to cover investment o Operator can prepare investment program for needed improvements o Investment for identified capital works o Need to use operators insights in required investment o Need to control size and use of investment Concession o Revenues cover operational and investment costs o Can mobilize substantial amounts of private capital o Government finance can subsidize to meet water sector goals. o Involving development agencies may lower costs through cheaper finance Involving Public Financing There is still a place for Public Financing. The needs differ for each PP Arrangement type Concessions: The fact that governments can mobilize substantial amounts of finance through private funds does not mean that it should rely entirely on private finance. Public or development agency finance can: Concessions: The fact that governments can mobilize substantial amounts of finance through private funds does not mean that it should rely entirely on private finance. Public or development agency finance can: Be focused to subsidize water infrastructure to achieve specific social or development goals Make use of development agency rather than private funds, this may reduce total cost of funds Options to use public funds in concessions include: Government lending to the concession company or equity investment (joint ownership) Direct financing of some infrastructure (so no return for the Concessionaire) Government OBA fund to extend service to new areas

33 Arrangement TypePrivate Operator Public Finance Management Contract o Operator brings efficiencies o Operating cost income needed o Capital investment needed o Operating costs by government o Investment needed to support effective operational improvement o Capital investment needs are defined by government Affermage Lease o Operator brings efficiencies o Revenues cover operational cost o Insufficient cash flow to cover investment o Operator can prepare investment program for needed improvements o Investment for identified capital works o Need to use operators insights in required investment o Need to control size and use of investment Concession o Revenues cover operational and investment costs o Can mobilize substantial amounts of private capital o Government finance can subsidize to meet water sector goals. o Involving development agencies may lower costs through cheaper finance Involving Public Financing In practice it is possible to adapt the main contract models, to form Hybrid Arrangements to suit the specific PP needs Hybrid Arrangements: These main contract models can be adapted or tailored to suit actual project conditions. As an example: Limited investment by the Operator in a Management Contract or Affermage can sometimes be obtained, often with additional guarantees provided for the Operator, in order to support key investments necessary to ensure operational improvement (e.g. network meters, spare parts). Hybrid Arrangements: These main contract models can be adapted or tailored to suit actual project conditions. As an example: Limited investment by the Operator in a Management Contract or Affermage can sometimes be obtained, often with additional guarantees provided for the Operator, in order to support key investments necessary to ensure operational improvement (e.g. network meters, spare parts).

34 A Development Agency Finance Arrangement One possible model for securing effective disbursement This figure illustrates one possible structure for incorporating government and development-agency financing in an arrangement, showing a public investment or subsidy fund established by Government and a development agency. It is not the only model, but gives some ideas of one approach. This incorporates two options: Investment lending : Finance from the public fund as a loan to the operator – to invest in infrastructure Payment per output: The subsidy fund would make payment when the operator provides specified services: Example: Major investments needed to replace decaying pipe networks could be an unacceptable risk for the private operator if he had to provide the necessary investment himself. Example: Major investments needed to replace decaying pipe networks could be an unacceptable risk for the private operator if he had to provide the necessary investment himself. Example: The operat or makes new connec tions as part of his contrac t. For those in low income areas he receive s a specifi c fee – say, for exampl e, $150 per connec tion Example: The operat or makes new connec tions as part of his contrac t. For those in low income areas he receive s a specifi c fee – say, for exampl e, $150 per connec tion

35 In this Module we have considered the elements and process of establishing affordable Levels of Service, and some of the design and financing implications…. Set Tariffs & Subsidies Estimate Cost Specify Services YES Does it work? NO IMPLEMENT Design Finance START Reviewing Module 5

36 Checklist: Module 5 ……..and the process is detailed in this Checklist

37 More Information: Module 7

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

39 Toolkit: Module 7 End of Module

40 Toolkit: Module 7 Return to Start

41 Toolkit: Module 7 DO NOT MOVE or ERASE THE FOLLOWING SLIDES

42 Service: Coverage targets There are three main ways of defining service coverage targets % age of roads with tertiary pipe New Connections or %age of households connected Geographic area to be served Definition: Coverage is a measure of the number of people who receive the Service Served by direct connections, kiosks, standpipes etc, and public latrines or other improved services (for sanitation) Back to Module

43 Service: Coverage targets There are three main ways of defining service coverage targets % age of roads with tertiary pipe New Connections or %age of households connected Geographic area to be served DESIGN ISSUES TO CONSIDER: TYPICAL PROBLEM: Defining coverage only in terms of piped connections by the Operator to dwellings may increase costs. Customers may prefer other options that may be available to them at a lower cost. [La Paz Alto – Bolivia] POSSIBLE SOLUTIONS: Flexible definitions of coverage may allow the operator to provide several types of service, offer more choice to customers and reduce cost e.g.: Bulk supply arrangements with other providers – offering cheaper and rapid service to poor areas The definition of connected can be extended to allow standpipe provision for a number of houses, rather than a single in-house connection [Manila concession] People can be considered connected regardless of who provides the connection [Manila concession– private local networks, bulk water supplied by the Operator] DESIGN ISSUES TO CONSIDER: TYPICAL PROBLEM: Defining coverage only in terms of piped connections by the Operator to dwellings may increase costs. Customers may prefer other options that may be available to them at a lower cost. [La Paz Alto – Bolivia] POSSIBLE SOLUTIONS: Flexible definitions of coverage may allow the operator to provide several types of service, offer more choice to customers and reduce cost e.g.: Bulk supply arrangements with other providers – offering cheaper and rapid service to poor areas The definition of connected can be extended to allow standpipe provision for a number of houses, rather than a single in-house connection [Manila concession] People can be considered connected regardless of who provides the connection [Manila concession– private local networks, bulk water supplied by the Operator] Each solution for Defining Coverage has a particular relevance to specific problems, but each measure has to be used in a way that relates to the actual conditions. For example: Number of new connections is relatively straight forward to implement and monitor – however Operators may select to only connect cheap construction or lucrative paying accounts, unless specific targets for the poor are set. [As Buenos Aires Concession] Each solution for Defining Coverage has a particular relevance to specific problems, but each measure has to be used in a way that relates to the actual conditions. For example: Number of new connections is relatively straight forward to implement and monitor – however Operators may select to only connect cheap construction or lucrative paying accounts, unless specific targets for the poor are set. [As Buenos Aires Concession] Back to Module

44 Service: Coverage targets There are three main ways of defining service coverage targets % age of roads with tertiary pipe New Connections or %age of households connected Geographic area to be served DESIGN ISSUES TO CONSIDER: TYPICAL PROBLEM: Defining coverage only in terms of piped connections by the Operator to dwellings may increase costs. Customers may prefer other options that may be available to them at a lower cost. [La Paz Alto – Bolivia] POSSIBLE SOLUTIONS: Flexible definitions of coverage may allow the operator to provide several types of service, offer more choice to customers and reduce cost e.g.: Bulk supply arrangements with other providers – offering cheaper and rapid service to poor areas The definition of connected can be extended to allow standpipe provision for a number of houses, rather than a single in-house connection [Manila concession] People can be considered connected regardless of who provides the connection [Manila concession– private local networks, bulk water supplied by the Operator] DESIGN ISSUES TO CONSIDER: TYPICAL PROBLEM: Defining coverage only in terms of piped connections by the Operator to dwellings may increase costs. Customers may prefer other options that may be available to them at a lower cost. [La Paz Alto – Bolivia] POSSIBLE SOLUTIONS: Flexible definitions of coverage may allow the operator to provide several types of service, offer more choice to customers and reduce cost e.g.: Bulk supply arrangements with other providers – offering cheaper and rapid service to poor areas The definition of connected can be extended to allow standpipe provision for a number of houses, rather than a single in-house connection [Manila concession] People can be considered connected regardless of who provides the connection [Manila concession– private local networks, bulk water supplied by the Operator] Each solution for Defining Coverage has a particular relevance to specific problems, but each measure has to be used in a way that relates to the actual conditions. For example: Number of new connections is relatively straight forward to implement and monitor – however Operators may select to only connect cheap construction or lucrative paying accounts, unless specific targets for the poor are set. [As Buenos Aires Concession] Each solution for Defining Coverage has a particular relevance to specific problems, but each measure has to be used in a way that relates to the actual conditions. For example: Number of new connections is relatively straight forward to implement and monitor – however Operators may select to only connect cheap construction or lucrative paying accounts, unless specific targets for the poor are set. [As Buenos Aires Concession] Example: Buenos Aires Concession Service Levels Back to Module

45 Service: Quality Targets Customer Service Water Quality Pressure Availability of Service Effluent Treatment It is usual to have more than one type of quality target that can be set for the Utility Example: Should water be available 24 hours a day seven days a week, or only at certain times? Example: Should water be available 24 hours a day seven days a week, or only at certain times? Example: Should the water be treated to strict guidelines ( e.g. WHO or EU) or is flexibility allowed for some none-critical parameters? Example: Should the water be treated to strict guidelines ( e.g. WHO or EU) or is flexibility allowed for some none-critical parameters? Example: At what pressure should water be available? Example: At what pressure should water be available? Example: What percentage of wastewater should be treated, and to what standard? Example: What percentage of wastewater should be treated, and to what standard? Example: What payment methods? How are complaints handled? Example: What payment methods? How are complaints handled? Back to Module

46 Service: Quality Targets Customer Service Water Quality Pressure Availability of Service Effluent Treatment It is usual to have more than one type of quality target that can be set for the Utility Targets for Input Based Technical Standards: 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). Input standards might be important where Operator investment is not crucial (as for short duration contract). However, input standards do not provide incentives for the Operator to provide the most cost effective way to provide service to customers Back to Module

47 Buenos Aires: Service Levels Service Levels Precise geographic areas specified for expansion. Targeting poor areas. Five year expansion program. Objective to increase connected households from 49% to 79 % for water and from 21% to 40 % for sewerage. Tariff Subsidy FinanceTargeting poor required 15 percent of investment but only brought 1 percent more revenue. Structured to bring a lot of private finance near the start of the contract to bring early major new infrastructure (over $1.6 billion) ScopeWater and sewerage utility serving major conurbation, with plan for improving existing infrastructure and expansion of served connections. 1.6 million connections in first 8 years, half of those connected live under poverty line. ModelConcession Back to Module

48 Cost of Service The Cost of Service has three elements Operating & Maintenance Expenses Depreciation Return on Capital Day to day expenses involved in providing services and keeping the system functioning, including labor, electricity, chemicals, maintenance etc.. The interest on debt and the return on equity. The weighted average cost (of debt and equity) is an appropriate measure of return on capital Reduction in value of the assets over time or the amount of money needed to be set aside to replace assets as they wear out Back to Module

49 Depreciation: Capital Maintenance Approach Back to Module

50

51 Output subsidy Output based subsidy supports delivery using explicit & performance based targets OUTPUT BASED INPUT-BASED Paid to Money from Customer to help pay the bill Utility/Operator foroutputs Utility/Operator forinputs Utility or Operatoras implicit or ad hoc support Customer Revenue Government Revenue Development Agency grant or loanwith concessional element Donor Financed Output–based Aid Customer bail-out Implicit subsidy or bail-out Cross-subsidy Social security provisions Input subsidy Social security provision linked specifically to water services. For example subsidies can be targeted to help to low income families to pay their Water bills. In the Chile case study the municipalities pay the water operator to do this. The municipalities assess which households should benefit, central government provides the subsidy and the operator administers it. Donor financed output base aid to Utilities. New structures have been developed which allow development agencies to support utilities directly through subsidy linked to a government controlled subsidy fund, that in turn pays a subsidy fund that can pay the Operator when particular outputs are produced, e.g.: Link payment to new connections Cushion the move to cost recovery tariff, by paying subsidy for a transition period Subsidize disadvantaged groups Subsidize achievement of externalities, such as environmental targets Back to Module

52 Output subsidy Output based subsidy supports delivery using explicit & performance based targets OUTPUT BASED INPUT-BASED Paid to Money from Customer to help pay the bill Utility/Operator foroutputs Utility/Operator forinputs Utility or Operatoras implicit or ad hoc support Customer Revenue Government Revenue Development Agency grant or loanwith concessional element Donor Financed Output–based Aid Customer bail-out Implicit subsidy or bail-out Cross-subsidy Social security provisions Input subsidy Example: Social Subsidy Santiago Chile Example: OBA Subsidy Morocco Towns Back to Module

53 Input subsidy Care must be taken with input subsidy as it supports cost regardless of output Customer bail-out Implicit or Ad-hoc subsidy Cross- subsidy Social security provisions Input subsidy Implicit & Ad- Hoc subsidies Governments sometimes provide subsidies in ways that are not immediately obvious, and there is a need to consider how to avoid unintended subsidies. Examples: Subsidies for cost of debt: lending money at concessional rates or debt write-off. Bearing of business risk by government: Government guarantees for the operator. May be necessary for the arrangement to proceed at all. Customer bailouts: operator risks are covered by unplanned tariff increase e.g. Manila tariffs increased above planned level because of unexpected exchange rate depreciation. In-kind grants and tax exemptions: Land and water rights grants, tax exemptions etc. given to public authorities may be extended to the private operator Direct Cash Input subsidy to the utility: Financing support: There is a general issue of the financing of new infrastructure, or renewal and expansion of existing works. When not covered by the tariff, the financing of this is often carried by the Government, and amounts to an input subsidy Cash subsidy to reduce tariff: The operator can be paid to keep tariffs below the economic level, for social reasons. This can be phased out over a planned period, with the operator expected to reduce his costs through increased efficiency. Example the Guinea 1990 lease contract subsidized operator costs linked specifically to (a) foreign currency costs and (b) debt servicing costs, and tapered out after 6 years. Cross subsidies: One customer pays more for the service so that other customers can pay less. Can help support social goals whilst overall the utility is self financing. Techniques used include: increasing block tariffs where basic water needs (a block) are provided to all at low price, with volumes in excess of that sold at a higher price. Industrial customers charged at a higher rate than residential customers Cross subsidies are common, but care has to be taken to resolve potential disadvantages Back to Module

54 Ensure that subsidies and the tariff level give the operator sufficient resources and a financial incentive to connect and serve poor households When many poor households are unconnected, prefer access or connection subsidy to consumption subsidies Ensure subsidies are targeted, transparent, and triggered by household demand Get enough information to tell whether a proposed tariff or subsidy will hurt or help poor households Because tariffs and subsidies have to be adjusted over time, work out how to incorporate concerns about the poor in decisions to adjust tariffs Targeting the poor The objective of targeting benefits to the poor needs careful design and implementation to be effective, and the following issues should be considered….. Back to Module

55 Output Based Aid OBA Back to Module

56 Santiago (Chile): Social Subsidy Service Levels Coverage: incorporated in 5 year investment plans with interim targets. Services to nearly 100% of population in service area Quality: As national regulations and 5 yr investment plans with interim targets TariffCost recovery: All cost recovered through tariff. Both fixed charge and variable charge. Separate volumetric charge for wastewater. SubsidyDirect subsidy to those identified as poor, identified from social registers. Funded by central government, operator gives as discount to customers and is reimbursed by municipality. Subsidy covers a maximum of 100% of the first 20 cubic meters of monthly consumption to low income families, and can amount between 25% & 85% of total water and sewerage bill FinanceDonor financing not provided, but previous World Bank and other donor loans provide prior to privatization ScopeWater and sewerage utilities serving 18 communities with approximately 1.3 million connections ModelDivestiture. Aguas Andinas 50% owned by a consortium SUEZ and Agbar, the remainder by government agency, pension funds and other shareholders Back to Module

57 Morocco Towns: OBA subsidy (review) Service Levels Objective: to expand access to water and sanitation to the poor living in recently legalized informal settlements in urban and peri-urban areas. Studies required to verify connection costs, given that the incumbent is a private sector operator. Tariff SubsidyOBA subsidy proposed. Some care to be given to ensure that the proposed OBA structure adequately covers transfer of performance risk to the service provider. [Subject of review by GPOBA 2005] FinanceTargeting poor required 15 percent of investment but only brought 1 percent more revenue. Structured to bring a lot of private finance near the start of the contract to bring early major new infrastructure ScopeWater and sewerage utilities serving major conurbations, X million population with plan for improving existing infrastrucure and expansion of served connections Model Concessions (Amendis in Tangiers and Lyonnaise des Eaux de Casablanca, in Casablanca) plus public sector incumbent in Meknes region. Back to Module

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59 Amman (Jordan): Management Contract – Cost Recovery Service Levels Coverage: disconnect some existing storm water connections Quality: A number of quality targets including water and effluent quality, reduction in losses, improvement of constancy of supply, various technical system improvements and improved customer bill collection. TariffCost recovery for operation and maintenance costs. Does not cover investment costs or depreciation. Residential tariffs based on a rising block structure with first 20 cubic meters at a flat rate. Commercial and industrial based on a higher fixed rate. Wastewater similar to water, but at lower rates SubsidyNone FinanceNo operator finance. Donor financing for studies ( GTZ), an Operating Investment Fund ( World Bank) for rehab and renewal. Several other donors financing substantial capital investment, TA and the Project Management Unit (EU funds) ScopeWater and sewerage utilities serving Amman and several municipalities (300,000 water connections ModelPerformance based Management Contract. Operator, LEMA, was a joint venture between SUEZ (75%) and Montgomery Watson and Arabtech Jardenah ( 25%) Back to Module

60 Toolkit: Module 7 DO NOT MOVE or ERASE THE PREVIOUS SLIDES AFTER END OF MODULE


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