1

Water and Wastewater Utilities

The World Bank’s Objective of Sustainability

The Financial Perspective

Paul KrissChina Water and Urban Sector Coordinator

The World Bank

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Discussion Points!

Current companies are treated like service providers

Financial Sustainability - Closing the Revenue Gap!

Use of Subsidies – Ok But With Caveats

The Importance of Long Term Financing to WSS

Managing Financial and Governance Risks – A Framework For Allocating Risks, Public or Private

The Role of Utility Managers in Explaining the Situation

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Getting the Private Sector Involved“Expectations Must Be Realistic”

0

20

40

60

80

100

120

140

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Year

US

$ b

illio

ns

Energy Telecom Transport Water & Sewage

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The MDGs – A Startling Reminder of the Financing Challenge Ahead!

Halve by 2015 the proportion of people without sustainable access to safe drinking water

Halve by 2015 the proportion of people without access to basic sanitation

Translates into a doubling of investment needs from $15 billion to $30 billion for water supply & sanitation alone (as part of 180B for all water)

Investment needs per

annum (B USD)

0

25

50

present MDG needs

wastewater treatment

sanitation

water supply

?

?

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Levels of Financial Sustainability

Marginally Creditworthy

Sustainable Cost Recovery

Cost Recovery

Pay-As-You-Go

Recovery of Cash Outlays

Unviable Loss Making

Utilities

Creditworthy in Tested

Country Conditions

Capital & Operational

Subidies

Capital

Subsidies

Profitable in Any Given Year

But Not Sustainable in Long Term

Anticipates Long Term Cost

Impacts (I.e. FX, asset revaluation)

Reliable Refinancing Sources &

Security for Loans

Country Conditions and

Developed Financial Markets

Public

Private

Guarantees

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The Finance Challenge - An Uphill Battle for Developing World and

Infant Sectors

35%

50%

75%

100%

CurrentCoverage

Years to Full Coverage at Annual Growth Rates

5% 10% 15%

30 years

20 years

8 years 4 years 2 years

6 years9 years

13 years 8 years

Less Than One Year

Assumes 1.3 population growth rate.

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Tariffs Not Recovering Costs

Low Service Coverage In the Backdrop of Increasing Demand!

Poor Operating Performance – High Losses

Low Capacity to Service Existing Debts

Inherently Inefficient Systems

Traditional Financing Constraints – Scarce Resources with Lingering Subsidy Mentality

Non-Existent or Ineffective Regulatory Framework

Governance Issues – Non-Transparent Transactions

Investments Can Only Expand with

Improved Sector Performance!

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Going Forward!Long-Term Sustainable Strategy

Improve Sector Performance – Closing the Revenue Gap is Key!

With Decentralization, There is a Need to Bring in Provincial and Local Governments as Key Stakeholders in the Financing of Water Investments – (ie. contributors of equity, guarantors, or direct borrowers).

Over-Reliance on Subsidies Will Only Delay Progress. The Use of Subsidies Should be Transitional and Primarily Aimed at Serving Poor Communities.

Performance indicators are normally required in WB projects to measure performance such as debt ratio, cost recovery ratio, revenue per connection, technical losses, etc.

Make Use of All Sources of Financing – Public or Private and Create Framework Where Risks Are Properly Allocated and Bound By Enforceable Contracts.

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Foundation for a Sustainable Tariff Policy

Cost Recovery

Improved Management Break ThroughFinancing Limits

Financial ViabilityExpand Coverage/Service Poor Communities

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Some Fundamental Premises!

While Water is a Basic Human Need, There is a Definite Cost Incurred in Delivering it to Communities.

In Most Cases, Users Are Not Paying For the Cost of Water, But For the Service of Delivering It!

So, one Either Provides a Service or Not!

The Options on Who Pays for that Service are Limited! Nevertheless need to be openly discussed.

The More the Willingness of Users to Pay, the More Financing Options that Exist.

With Greater Financing Options, More Service Can Be Expanded to Needy Communities!

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There is No Magic Solution -Someone Has to Pay!

Consumers

Taxpayers

Who Pays How Financed

User Tariffs

Earnings

Borrowings

Government Subsidies

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Cost Recovery Means Different Things to Different People!

What it Is Not – Recovering Just Some Explicit Costs, But Not Others (Subsidized Pricing)

What it Can Be in Certain Circumstances –Recovering All Explicit Cash Commitments (Internal Cash Flow Pricing)

What it Should Be – Recovering Both Explicit and Implicit Costs Plus Earn A Fair Return on Invested Capital (Full Cost Recovery Pricing)

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At the Root of the Misunderstanding!Explicit Versus Implicit Charges

Implicit Charges

Recovery of Investment Costs

Currency Risk

Water Resources

Delayed O&M

Bad Debts

Environmental

Profits

Explicit Charges

O&M

Principal &Interest Payments

On Debt

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Experience Has Shown that Financial Trouble is Guaranteed if Water Utilities Base their Tariffs Only On Explicit Charges.

Because Implicit or (Hidden) Charges Often Have a Way of Becoming Explicit, like:

Real FX Losses With Currency Devaluations.

Delayed O&M Turns Into Major Investment Requirements or a Loss of Performance.

Bad Debts Ultimately Have to Be Written Off With a Corresponding Loss of Revenue.

Improper Revaluation of Assets or Depreciation Rules Shortchanges the Replacement of Capital.

And, Water Tariffs Are Politically Charged and Cannot Be Adjusted Easily.

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Some Additional Observations!

The Debate is Not Between Public Versus Private, But About Financial Sustainability.

Private Operators Have Been Criticized for Many Things, But at Least They Have Embraced the Concept of Full Cost Recovery.

Instead, Public Sector Has Traditionally Disregarded Implicit Costs and Even Shielded Utilities From Explicit Ones Through Subsidy Arrangements.

But Again, Someone Has to Pay! The User or The Taxpayer. Society Pays When No or Poor Service is Offered.

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Some Allowance for Subsidies Can Be Made for Transition Periods!

Subsidies Can Be Utilized in the Short-Term to Bridge a Finance Gap - But Primarily, In Cases Where Affordability

is at Issue and For Poor Communities

Capital Subsidy

Reduces the need

for borrowing and

the explicit debt

servicing

commitments

Allows one class of

consumer to

subsidize the cost of

another

Cross Subsidies Operational Subsidy

Reduces O&M and

other costs of doing

business

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The Problem of Subsidies

APPROPRIATE COSTS LEVEL

CO

STS

TA

RIFFS

TIME

Realized loss if subsidies cannot be sustained

User Need to Pay

Taxpayer have to pay

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The Importance of Long-Term Finance to Water Infrastructure

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Long-Term Financing Has A Significant Effect on Tariff Levels

Effect of Loan Maturities on Tariffs

0

10

20

30

40

50

60

70

80

90

0 5 10 15 20 25

Maturity in Years

Tarif

f

Sugbon

Bohol

Malabuyoc

OBA Cambodia

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Moreover…

Public Sources of Debt Finance Are Limited – We Must Look to Private Sources of Finance.

Subsidies Are Also Limited and Cannot Be Relied on to Establish and Maintain Creditworthiness, thus Constraining Commercial Lending.

Used Prudently Debt Can Allow For a Substantial Leveraging in Order to Expand Coverage.

However, To Make Use of Favorable Financing Leverage, Returns Must Exceed the Cost of Financing.

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Managing Financial Risks

Towards a Sustainable Fund Channeling and Governance Framework

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Risks Related to Implementation and Financing of Water and Wastewater

Supply Projects

System Design & Planning - Developing Appropriate Investment Program

Construction Risk - Timely Completion of Constructing According to Design Standards

Operation & Commercial Risks - Efficient operation and Management of Water Utility Business

Regulatory Risks - Ensuring efficient tariff levels and quality standards

Financing - Securing Required Equity and Investment Financing to Achieve Investment Goal

Credit Risks – Ensuring timely debt servicing of loans

Devaluation/Currency Risks – Guarding against catastrophic Impacts due to major devaluations and macro instability

Other Risks, such as Political, Terrorism, Force Majure

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Attributes of a Sustainable Framework -Public or Private

Roles Must Be Clearly Defined and Incentives Must Be Internally Consistent – When in Conflict, the Financial Trade-Offs Must be Explicit.

Risks Should Be Allocated to the Party That is Most Capable of Managing Such Risks.

Third-Party Agreements Should be Utilized to Hold Responsible Parties Accountable and to Convert Implicit Charges to Explicit Ones.

Agreements Should be Enforceable.

There Must be an Appropriate Balance of Power. Authority.

If Utilities Treated as Service Providers – Managers should Explicitly State Risks.

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Effect of Allocating Risks

Local Govts.

Private Sector

Banks

NationalGovt.

Utilities

LocalGovts.

PrivateSector

In Many CasesToday!

Where to Go!

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Towards a Sustainable Fund Channeling and Governance Framework

Banks

UtilitiesLGU

MOF - FX Risks Banks - Intermediaries Utilites - Borrower

MOF

LGU-Guarantor Private Firms Regulator

Regulator

Private Firms

Bound by Enforceable Legal Agreements With Recourse for Non-Performance

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ManagementPublic Private

Unbundling Finance And Management!Looking at Sustainable Hybrid Solutions

Leases/Affermage

Concessions

Divestitures

BOTs

Municipal

DepartmentMgnt. Contracts

Corporatized

Muni. Service

Mixed Company

Operating

Company plc

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Some Examples of Hybrid Approaches

Design Build Lease (DBL)

Banks

LGU

IFIs

Private

1. Public long-term debt channeled through banks2. MOF takes up FX Risks for a premium3. Bank On-lend to local governments4. LGUs lease out construction and O&M to private sector5. Private sponsor contribute equity portion 6. Lease fee to LGU covers debt service7. Loan to LGU is secured by fiscal allocation8. Bid on Lowest average tariff or highest equity contribution

MOF

Most Applicable

Characteristics

1. For Greenfield investments 2. Resistance on existing water utility 3. Decentralized local governments with capacity to borrow4. Smaller towns which do not attract private project finance 5. Private sponsor wiling to contribute equity6. Cost recovery tariffs

premium for FXrisk

lease

loans

sub-loans

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Some Examples of Hybrid Approaches

Output Based Aid to Extend Coverage

IFIs

Concession

1. IFIs/Donors lend or grant funds to central government2. Central government utilized funds to subsidize investment

Cost for extending coverage to poor communities3. Central government enters into agreement with

private operator to reimburse cost based on connectionsmade.

4. Private operator finances other investment andoperating costs on its own on cost recovery basis

5. Tariffs set to recover all costs except subsidy portion

Govt

Most Applicable

Characteristics

1. High connection cost to reach outlying areas2. Poor communities unable to pay for connection 3. Cost recovery tariffs can sustain O&M and returns

investment from private operators

BanksSponsors

OBA grants

loansequity

loans

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Some Examples of Hybrid Approaches

Bulk Water BOT with Amalgamation

Private BulkBOT

1. IFIs/Donors lend to public utilities for rehabilitation andextension

2. Private financed BOT with private operator withback-to-back agreements from utilities

3. Possible also private concessions to manage utilities, but as separate autonomous entities

3. Each utility would have separate tariffs based on own cost structure

4. Bid however done for all activities under a cluster approach5. Private equity and either public or private debt depending on

availability

Utility

Most Applicable

Characteristics

1. Regional water source needed 2. Economies gained by clustering smaller less attractive

utilities3. Private long term debt unavailable4. Amalgamation provides sufficient market to

attract equity interest5. No threat to autonomy of local govt.

Utility

Utility Utility

IFIs

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Some Examples of Hybrid Approaches

Affermage with Public Debt Finance

1. IFIs/Donors lend to public utilities for rehabilitation andextension

2. Private bid to rehabilitate network and operate it3. Revenue sharing agreement between Utility and operator4. Bid on revenue sharing

Most Applicable

Characteristics

1. High cost recovery risk for private operatorbut great need to improve performance

2. No private debt markets

IFIs

Public Utility

Private Operation

Revenue sharing &rehabilitation program

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Some Examples of Hybrid Approaches

Workout and Rehabilitation of Failing Utility

LGU Utility

1. Tri-Partite Agreement Between MOF, Local Government and Utility on Financial Recovery Program

2. MOF Reschedules Debt, LGU assumes Financial Commitmentsfor Equity and Tariff Increases

3. Utility Adheres to Performance Improvement Program WithQuarterly Monitoring

4. Lending Resumes Upon Fulfillment of Agreed Actionswith Local Government Guaranteeing Repayment By UtilityWith Fiscal Transfer as Security

5. Can be Turned Over to Private Operator as in Affermage

MOF

Most Applicable

Characteristics

1. Failing Utility of Sector with Significant losses2. No record of Creditworthiness 3. New Responsibilities for Local Governments

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Recapping….

The Water and Wastewater Sector is Facing an Uphill Battle to Expand Coverage.

The Debate is Not Between Public or Private, But Improving Sector Performance.

There is No Magic Solution! Cost Recovery Should Be the Foundation to A Sustainable Tariff Policy.

Subsidies Are Problematic in the Long Term if Public Transfers Can not be Sustained.

If Utilized Prudently, Long-Term Financing Can Contribute Significantly Towards Expanding Investments.

A Fund Channeling and Governance Framework Based on the Appropriate Allocation of Risks and Third Party Agreements is the Mechanism Needed to Align Incentives and Improve Governance.

Hybrid Models Mixing Public - Private Finance and Management Options Offers a Pragmatic Approach in the An Environment of Increased Perceived Risks.

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Thank You!