Innovative financing and positioning of the water sector

Transcription

1 Innovative financing and positioning of the water sector A toolbox with practical cases for Aid & Trade and water sector practitioners Client: Netherlands Water Partnership, Netherlands Enterprise Agency Final Report Rotterdam, 10 February 2015

2 Innovative financing and positioning of the water sector A toolbox with practical cases for Aid & Trade and water sector practitioners Client: Netherlands Water Partnership, Netherlands Enterprise Agency (Partners for Water Programme) Gerbrand van Bork Hein Gietema Ilse van de Velde Maaike Zwart Rotterdam, 10 February 2015

3 2 GvB/KK NL

4 Table of contents 1 Executive summary 5 2 Introduction 13 Part I: Finance 4 Water 17 3 Finance 4 Water: the challenges Water supply & sanitation Water safety and water security Conclusions 21 4 Innovative business models Scope extension: internalizing revenue streams from other sectors Drinking water and sanitation Water safety: revenues from land development and recreation Water security: a business model capturing benefits for farmers Improving payment systems Water security: Innovative payment systems Scaling up Water supply and sanitation: umbrella and regional models Water safety & security: scaling up by multi-stakeholder involvement Private sector participation Water supply in rural areas: community enterprise models Water supply and sanitation: Public Private Partnership Water safety: Public Private Partnership practices Conclusions: overall lessons learned 55 5 Innovative financing mechanisms Blending Trust Funds for drinking water and sanitation in small towns Guaranteed loans and microcredit schemes for drinking water & sanitation Microfinance for drinking water and sanitation Crowdfunding platforms Results based financing Revolving funds and pooled finance structures Conclusions: overall lessons learned 71 Part II: Positioning instruments for the water sector 73 6 International practices positioning Local business platforms Capacity building for project development & procurement Local agents and procurement officers Support to project preparation facilities Setting up Development Companies Lessons development banks from other countries 85 3

5 6.7 Summary positioning and conclusions 87 7 Ongoing cases for positioning Intervention options NCICD Jakarta Co-creation in a strategic program lifecycle approach Masterplan Beira 96 8 Synthesis, conclusions and recommendations 99 9 Glossary Literature Interviews held 107 4

6 1 Executive summary Introduction In this report an overview is provided of interesting cases of innovative business models, financing mechanisms and positioning tools deployed in a range of countries in the water sector. We hope this overview serves as a toolbox for Aid & Trade and water sector practitioners. The aim of this report is to create awareness and to share practical knowledge and cases to all relevant practitioners in the water sector involved in international development: government officials working in the area of Aid & Trade and Topsector Water, embassy staff, companies and NGOs. A selection of these tools will also be presented on the TRAIDwheel website; The financing challenges in the water sector There are a number of challenges to finance water projects, especially in developing countries. In short these are: Water supply & sanitation Insufficient cost recovery, cash-flows & returns; Weak governance and financial discipline and performance in water utilities; Limited availability of funds for small scale operators and domestic suppliers; Return-risk perception private sector; The large size and long tenure period of finance needed for funding for the required facilities. Integrated Water resources Management and Delta Insufficient government budgets for the major investments in water management protection; Lack of returns due to difficulties to create private revenue flows; Lack of international experience with PPPs for water safety projects and lack of experience with PPP in many developing countries. Innovations in business models The ways of operating water services is changed by organisational or contracting innovations, extension of scope of services, technical innovations such as IT solutions, etc. Basically the operating concepts change and by these changes additional earnings are realised. The activities as part of these innovations serve to improve the financial feasibility (financial performance, cashflows) and financial sustainability of water related operations. The changes can be characterized by the following elements: Scope extension often in relation to technical innovation: by involving other sectors such as land development and real estate, tourism and recreation, or water to energy innovations in water related projects additional income or new earning models become possible; Technical innovations such as waste water to energy or IT solutions are implemented to create additional services or to improve payment mechanisms for water related services; Private sector participation: private service models, Public Private Partnership (PPP) arrangements, community entrepreneurship models are introduced in areas where traditionally government or NGO provision or traditional procurement modes were dominant. The increasing number of private arrangements for operating concepts in combination with better financial performance enhances possibilities for more private repayable financing schemes; Scaling-up: models where activities are targeted to create larger demand for services and capacity and therefore lower unit costs. This ultimately results in a better financial feasibility and sustainability of the related water or sanitation services. 5

7 For all these elements a number of cases from the international practice have been observed by literature search and interviews and meetings with NGOs, IFIs and donors. An overview of a typology of business models and the identified interesting cases is presented below. Table 1.1 Overview typology of business models Business model Main elements Applicability Case typology Scope extension: revenues from other sectors Waste water to energy Conversion of waste water and fertilizers (re-use) and waste to energy and and health fertilizer Creating additional revenue streams to water Water safety and land Revenues from land or development, recreation recreation development used for water safety Water security: capturing Reaping benefits in benefits in agriculture and agriculture for (partly) microfinance financing water harvesting systems & microfinance to farmers Innovative Payment systems Depending on regulations, feed in tariffs for renewables, market for fertilizer, entrepreneurship Urban areas with demand for land close to coast and proper real estate and land prices Definable direct benefits Interested and committed farmers and microfinance providers Financial INclusion Improves Sanitation and Health programme in India (FINISH) Room for the Rivers in the Netherlands NCICD Flood Protection in Jakarta Water dunen Eko Atlantic Finance for RaiNwater (FERN): Sustainable financing for Sustainable water Improving payment Mobile payment systems, Willingness mobile Mobile payments of systems by ICT more frequent payments providers and utilities to water bills in Kenya, Increasing billing and change systems Tanzania, Uganda and payment rates Zambia Payment for Grants for TA to small scale Existence of regulations Appropriate finance for Environmental services farmers on water intake Sustainable Water Lake Naivasha in Kenya PES payment system for companies Management in the companies Existing value chain Lake Naivasha Basin In kind payments food- agro companies Scaling-up Scaling up to regional Regional water unions authorities (case waste water in Turkey) Multi-stakeholder Involvement of key involvement and cocreation of projects Co-creation of projects or stakeholders in the basin (cases water security in programs Zambia) Private sector participation (including PPP) Institutional setting, willingness local authorities Interests of key stakeholders aligned Strong NGO behind Inter municipal cooperation (waste)water unions WWF Basin-level water stewardship Zambesi Community enterprise Community enterprise Small villages, strong Water for peace: models (rural drinking responsible for water community ownership Community Based 6

8 Business model Main elements Applicability Case typology water) service delivery Approaches in Water Supply Projects for Multi-ethnic Neighbourhoods in Crimea PPP Availability fee based models DBFMO contracts for waste water treatment (NL) or water safety (UK) Lifecycle cost optimizations Availability fee payments based upon KPIs Private financing Developed procurement organisations PPP expertise private sector available PPP availability payments Waste Water Treatment Harnaschpolder Pevensey Bay Flood Defence Broadland Flood Alleviation Scope extension from the water sector to other sectors can reap new revenue streams. Examples are water to energy and flood safety in relation to incomes from land development for urban functions or recreation. The income flows from other sectors can (partially) overcome the often lack of good private revenue potential in water projects. However, to grasp these income streams is not always easy. Stable feed in tariffs for renewable energy and proper connections to the energy grid are important issues for water to energy projects. Reaping the revenue streams from urban development often requires setting up more complex Public-Private Partnership (PPP) structures (such as development companies) in order to bundle the water and urban development functions. These PPP structures are often complex in nature and many governments and private bodies in developing countries or Water OS countries lack experience in PPP contracts. This might limit the potential for application of PPP in these countries or might create high risks. Innovative financing mechanisms Traditionally water supply & sanitation, water safety and security have always been regarded as public goods where the government should play a key role. Therefore, subsidies for capital investments or operations and maintenance or NGO grants have been dominant for water related projects in many countries. An increasing number of Funds and water related projects have been observed where grants are combined with loans (or micro-credits) and equity (so called blending ). Regarding innovations in financing structures the following new types of mechanisms are increasingly observed in the water sector: Blending grants with repayable finance (loans, equity); Micro-credit mechanisms; Guarantees and insurance products; Revolving funds and pooled bond mechanisms (grouped vehicles); Crowdfunding platforms; Output based aid. We have gathered cases of financing mechanisms from the development practice through literature research, meetings with practitioners and IFIs. An overview of the type of instruments and cases is presented below. 7

9 Table 1.2 Overview innovative funding schemes water sector Funding schemes Main elements Applicability Case Innovating financing mechanisms Blending trust funds for drinking water in small Grants and loans for water utilities in small Depending on regulations and Devolution Trust Fund Zambia towns towns institutional setting utilities Blending finance at project level Subsidies can leverage commercial finance Grants necessary for first Willingness commercial banks to enter market Maji Ni Maisha: Innovative Finance for Community Water Schemes in Kenya losses, TA: promotion, upscaling etc. Microfinance for water and sanitation Micro-credit scheme Micro-finance for sanitation in Bolivia, Guatemala, India, Malawi, Peru, Rwanda and Uganda Crowdfunding Funding provided through internet crowdfunding Small easy to communicate projects Crowdfunding: Safe water in Umuonye, Southeast Nigeria platform Grants from public Communicable projects to audience Results Based Financing Grant based upon incentives for delivery Deliverables of projects should be measurable Improving irrigation in the North China plain Output based Aid (Worldbank) Revolving Fund structures and pooled financing vehicles Funding through an SPV Hydrobonds issued Longer term maturity provided Financial sustainable private water companies InnovFin (EIB) US Bond Banks The most important trend here is the increasing use of blending arrangements. Blending of grants, guarantees with loans or micro-credit schemes is both at the project level, but also at fund level are observed. Important lessons relate to optimal risk allocations and the need use also grants to promote and scale up the schemes. Important observation is that Worldbank, EU & EIB Trust Funds and KfW seem to be first movers in this area. Although there are some blending projects undertaken by Netherlands partners (with DGIS funds), overall Netherlands financing instruments are not ideally geared towards blending. Another observation is the upcoming use of revolving fund structures. Revolving funds basically need projects or utilities which are credit worthy and can repay loans or generate dividends on equity. By pooling projects or utilities risks can be spread and transaction costs can be decreased. This is especially important for smaller projects or smaller utilities in the water sector, where transaction costs for banks are high. The applicability of these funds is most of all relevant for projects or utilities which are profitable (can pay interest and can repay loans). This is often more the case in developed countries and in the drinking water and industrial waste water sector. Revolving fund structures are less easily applicable in developing countries or for the other water subsectors. In order to introduce revolving funds in typical water OS or Water Mondiaal countries and WASH sector addition of grants or guarantee funds to these structures will be essential. 8

10 Moreover, in case of pooled funds used to attract capital market resources, an assessment of the maturity of bond and equity markets in developing countries is crucial. Positioning instruments The report presents a range of types of positioning instruments which can be used to promote the Dutch water sector in the target countries. The instruments vary from low risk, low commitment capacity building until sponsorship of full fledged development companies and concessional financing instruments. The aid to trade agenda and policies could make use of this toolbox and identify for which subsectors and countries which instruments are most suitable. Interesting to observe is that the Dutch water sector makes intensive use of low risk, soft positioning instruments such as capacity building and networks or business hubs, but very low use of higher commitment, higher risks instruments such as concessional financing or sponsorship of development companies. Table 1.3 Overview of potential positioning instruments water sector Instrument for Advantages Disadvantages Case positioning Capacity building Building up trusted advisor position; Low commitment of host country Capacity building: Matra South Water Clear presentation institutions for followup Management training. of NL expertise; projects (risk); Low financial risks. Potential conflict in case of support to tenders. Project development facility Direct influence over project development in host country; Potential conflict of interest for companies involved for tenders. Kalangala Infrastructure Services Project, Commitment for Uganda. projects of host country institutions. Appropriate local network structures: Direct involvement of local companies; Low commitment of government Centre of Expertise (CoE) South Africa High level advisory Possibilities for institutions in host (SA). platforms and/or networking and country; Centres of Expertise matchmaking with High running costs; and/or business NL companies; Sustainability risk. support centres. Possibilities for mutual project development and business development. Local agent or representative Knows potential local clients and local sector well; Knowledge and commitment to NL sector? Companies often use local representatives for business Can serve for development market intelligence and sales agent purposes. Local procurement officer Direct influence over procurement process; Risk of conflict of interest. - Possibility for 9

11 Instrument for positioning Local Community Enterprise Development company (special purpose vehicle for urban of infrastructure development) Concessional infrastructure financing instrument (grants & concessional loans to governments, equity) Advantages Disadvantages Case success fee incentives. Placement outside High costs of building Water for peace: government: an institution; Community Based institutional building Government needed: Approaches in Water and bringing in how to ensure the Supply Projects for professional collaboration. Multi-ethnic management for Neighbourhoods in urban development. Crimea. Professional project High transaction costs NCICD Flood development and and costs of Protection in Jakarta. management; sponsoring (equity); Private incentives Higher risks (equity); less delays or In case of PPP joint problems; venture: collaboration Direct influence over issues with procurement and government. when private direct contracting possible; More optimal risk allocations and potential for revenue sharing. Potential to offer a For major projects Korean Development package of large funding Bank. services/products, resources necessary; studies and finance; Risks on government Better competition balance? possible to Chinese and Koreans. Positioning cases of Flood safety Jakarta Indonesia and Beira Mozambique By looking at two ongoing cases: Flood protection in Jakarta and development of Beira Mozambique some issues in the Dutch instruments are highlighted. First of all it is advocated that a more strategic program cycle and value chain approach could be used for positioning, starting at the beginning of such positioning efforts. Program phases from masterplanning, feasibility, design, procurement and implementation and operation should be assessed in connection and interest and strengths of Dutch players could be assessed from the start. Secondly it is shown that current Dutch financing instruments are not well geared towards this types of projects where often equity or loans (or concessional loans to governments) for larger scale infrastructure projects are needed. 10

12 Conclusions In short the analysis and report results in a number of key conclusions: The water sector is evolving towards other sectors. Technological innovation and scope extension foster the development of innovative business models with revenues from these other sectors (energy, urban development, agriculture). The water sector is opening up to more private sector participation and PPPs. Public Private Partnership is on the rise in the water sector. Traditionally PPP has been starting in the drinking water sector (especially in Australia, South Africa etc.). In waste water and (more limited) in flood protection PPPs are more recently introduced. PPP projects are however more complex by nature compared to traditional contracted projects and the applicability of these concepts might differ over the countries and subsectors. Availability payment based PPP schemes might be difficult in many developing and emerging countries because of lack of experience with PPP contracts, absence of multi-annual budgeting in governments and high political risks; Blending of financing instruments is a key trend in international financing of the water sector, both at institutional level and at project level. Current Dutch financing instruments are not yet well geared towards blending with other financial products (equity, loans etc.) or resources (donors, IFIs); The Netherlands water sector currently uses a limited set of different positioning instruments for promotion of the water sector (mainly capacity building and network structures). Other countries such as Korea, Germany etc. use concessional financing instruments for positioning and often blend with grants from development agencies. There is currently in the Netherlands no adequate instrument available for sponsoring large scale infrastructure development companies (equity, loans, grants). Moreover, project preparation facilities are set-up by EU-EIB and others, but are not used by Netherlands agencies such as FMO or RVO. Recommendations: It is advisable to develop a more strategic program cycle/value chain approach for positioning of the Dutch water sector for specific countries, subsectors or projects. Currently, often positioning is assessed per phase of the project cycle. It is recommended to assess the strengths and interest of Dutch parties over the whole project cycle and value chain from the start of processes. Processes for development programs (Masterplans or projects) could start as a cocreation of Dutch public and private sector parties which are relevant for the whole program cycle. Lessons from the ongoing Dutch embassy co-creation pilots ( collective programming ) in Bangladesh and Vietnam could be included in this approach; Systematic assessment of possible positioning instruments for strategic positioning of the Dutch water sector before starting and funding a process. Proper selection of positioning instruments depends on likely effectiveness, strengths, possibilities and risk appetite of the Dutch government and private sector and the match with possibilities in the country context. For example to opt for Dutch government sponsoring of development companies might be too risky given the context for some countries. In specific circumstances positioning instruments can complement each other or some might be more relevant in some phases of the program. Moreover after first using one instrument a switch could be made to higher commitment positioning instruments (such direct concessional support or support to full fledged development companies) in later phases of a project; Combine capacity building &training projects with creation of alumni networks. These contacts in the countries can later play a vital role for business development. Also use can be made out of the local Dutch water companies and NGOs in the countries to create hubs to collaborate regarding business development, partner with Dutch SMEs, develop projects for NL financing instruments etc.; Use or transform NL financing instruments to better position NL private parties. We regard it important to develop DRIVE together with the key sector players for investment projects to be 11

13 suitable for supporting propositions and allow for blending with other instruments and banks, donors agencies/ IFIs. It is advisable to investigate a finance (equity, other) instrument for Development Companies with FMO or others. Moreover, the possibilities to develop a revolving fund for loans for water projects or utilities for developing countries could be assessed where OS grants could be used for TA or guarantees. Finally the possibilities for an NL sovereign (concessional) loan instrument could be investigated; For larger investment projects strategic partnership with countries (water sector players, development banks) that could mobilize complementary contractors or operators and large amounts of (concessional) finance could be considered. It might be considered to team up with for example for NCICD Jakarta project with Indonesian, German or Korean contractors and World Bank, German development bank KfW, ADB or the Koreans where they could cover some large scale expensive construction and financing parts. 12

14 2 Introduction This report has been created in the context of the Water OS and the Partners for Water programmes. Both programmes are executed by the Netherlands Enterprise Agency and the Netherlands Water Partnership on behalf of three Ministries in the Netherlands: Ministry of Foreign Affairs, Ministry of Economic Affairs and the Ministry of Infrastructure and Environment. These collaborating organizations are engaged in a learning process regarding how Aid and Trade can be implemented in practical terms. This report is part of that learning process and provides an overview of interesting cases of innovative business models, financing schemes and positioning tools deployed in a range of countries in the water sector. We hope this overview serves as a toolbox for Aid and Trade and water sector practitioners. A selection of these tools will also be presented on Background There are a number of reasons for providing such an overview or toolbox for practitioners in the sector. Firstly, many water related projects, especially in developing countries, are not profitable and were often financed through grants/subsidies. In areas such as water supply and waste water treatment full cost recovery is still far from reality because of a number of factors, for example low tariffs related to willingness to pay and affordability, political considerations regarding water tariffs, low billing rates etc. Water safety projects such as storm surge barriers are often public goods where it is not easy to introduce specific taxes or value capturing mechanisms to finance these projects. Therefore, many of these projects have been financed by either government budgets (subsidies), donor grants or concessional loans. In the subsector of water security it is often complex to introduce payments schemes. For this reason, traditional subsidies, special taxes or levies were in most situations the normal financing mode. However, in recent years the situation in the water sector is changing. There is a clear trend visible of different financing ways or business models in the sector. Donors are looking more into innovative business models or financing structures 1. There are several factors behind this. First of all, it became more obvious that private sector involvement investments and management - is needed. Public budgets do not suffice for the vast water infrastructure investments needs and with public sector funding often the sustainability of facilities and delivering and charging for services is an issue. Traditional grant finance or NGO support has led to sustainability and efficiency issues. Examples are lack of institutional sustainability (once the NGO leaves the project halts), poor maintenance of structures or equipment, lack of use or lack of revenue streams in the financing structure (and therefore no financial sustainable way of long term operations). Secondly, it became more possible to attract private sector involvement due to innovations in the financial sector. Private service provision of public infrastructure services (Public Private Partnership, PPPs) became ideologically more acceptable. Various schemes were promoted to create leverage by mitigating risks for private sector. By taking out some first downside risks with grants, private finance can step in resulting in a higher level of funding. Also for water microfinance schemes, blending subsidies with other financing products (equity, debt), new vehicles such as impact bonds, dedicated revolving funds and guarantee funds came available. 1 We define a business model as the earning model: how revenue cash-flows are generated of water related activities (operations) in the operating phase of a project. The financing structure we regard as the mixture of different financing instruments (grants, equity, debt) used for (pre) financing the costs of the project or program. 13

15 Finally, it became more necessary to involve private sector; the aid policy of donor countries has shifted in many countries from aid to trade. In order to make this shift possible and stimulate private sector involvement new financing schemes become more necessary. Aim of the toolbox and report The aim of this report/toolbox is to create awareness and to share practical knowledge and cases to all relevant practitioners in the water sector involved in international development: government officials working in the area of Aid & Trade and Topsector Water, embassy staff, companies and NGOs. Ultimately, we hope that this toolbox facilitates and eases the dialogue between the financial sector and the water sector, by explaining theoretical and rather abstract concepts by means of concrete examples and we hope that these innovations will find their way also to new projects, other countries or other sectors whenever useful and applicable. Moreover, we give some recommendations to the Netherlands government regarding development policies and positioning of the Dutch water sector. Scope We concentrate in Section I of this report on innovative business models and financing schemes for water related projects. Innovative should be understood as deviating from the traditional way of financing and / or operating water projects: either from subsidies/grants or by water users paying user charges (tariffs). The innovativeness of the solutions are characterized by several key elements: 1. Innovations in business models The ways of operating water services is changed by organisational or contracting innovations, extension of scope of services, technical innovations such as IT solutions, etc. Basically the operating concepts change and by these changes additional earnings are realised. The activities as part of these innovations serve to improve the financial feasibility (financial performance, cashflows) and financial sustainability of water related operations. The changes can be characterized by the following elements: Scope extension often in relation to technical innovation: by involving other sectors such as land development and real estate, tourism and recreation, or water to energy innovations in water related projects additional income or new earning models become possible; Technical innovations such as waste water to energy or IT solutions are implemented to create additional services or to improve payment mechanisms for water related services; Private sector participation: private service models, Public Private Partnership (PPP) arrangements, community entrepreneurship models, inclusive business models are introduced in areas where traditionally government or NGO provision or traditional procurement modes were dominant. The increasing number of private modalities and operating concepts in combination with better financial performance enhance possibilities for more private repayable financing schemes; Scaling-up: models where activities are targeted to create larger demand for services and capacity and therefore lower unit costs. This ultimately results in a better financial feasibility and sustainability of the related water or sanitation services. 1. Innovations in financing mechanisms Traditionally water supply & sanitation, water safety and security have always been regarded as public goods where the government should play a key role. Therefore, subsidies for capital investments or operations and maintenance or NGO grants have been dominant for water related projects in many countries. More recently, innovations in finance and innovations in business models have stimulated innovative financing mechanisms where traditional subsidy or grant financing is replaced with microfinance or other mechanisms. An increasing number of Funds and 14

16 water related projects have been observed where grants are combined with loans (or micro-credits) and equity (so called blending ). Regarding innovations in financing structures the following new types of mechanisms are increasingly observed in the water sector: Blending grants with repayable finance (loans, equity); Micro-credit mechanisms; Guarantees and insurance products; Revolving funds and pooled bond mechanisms (grouped vehicles); Crowdfunding platforms; Output based aid. We have gathered cases from development practice through literature research, meetings with practitioners and IFIs. The cases can be in different phases of maturity: some cases are still in the development phase, some are in the implementation phase and some have been implemented and clear lessons learned could be identified. In the descriptions we will highlight the maturity of the cases, the concept, the wider applicability and lessons learned. In Section II of this report the focus is on positioning instruments in order to position the Dutch water sector in foreign countries. A number of potential instruments are described which can support business development of NL water players in the targeted countries. For a number of instruments cases studies from practice are presented. These positioning instruments and cases can be useful for further development of a positioning strategy for the NL water sector for any prioritized countries (such as Water OS or Water Mondiaal countries). Readers guide The Section I of this report concentrates on water finance. In chapter 3 - the first chapter of section I - the main challenges in water finance for water supply & sanitation, water safety and water security are addressed. Chapter 4 focuses on innovative business models in the water sector and interesting cases from international developments. In chapter 5 innovative financing mechanisms for water projects with interesting cases from a number of countries will be discussed in more detail. In Section II (Chapter 6) a number of instruments (tools) for positioning of the water sector are described. The section concludes with an overview with pros and cons of these tools. In chapter 7 two ongoing positioning cases are presented and some more strategic positioning options are provided for Flood protection in Jakarta Indonesia and urban development in Beira Mozambique. Chapter 8 integrates all findings in a synthesis of this report and concludes and provides some recommendations. 15

17 Part I: Finance 4 Water 17

18 3 Finance 4 Water: the challenges In this chapter we will address the key challenges in finance for water in three important sectors: water supply & sanitation, water safety and water security. We regard it as important to distinguish between these sectors, because the earning models and financing issues differ quite strongly between these sectors. Water supply and sanitation is defined as provision of drinking water, waste water treatment and small scale sanitation services (WASH). Water safety as part of integrated water resources management is concentrated on providing safety for flooding or other water related disasters. Water security is concerned with securing availability of water for agriculture, food and other purposes, water use efficiency or reducing water pollution. 3.1 Water supply & sanitation In OECD (2010) a number of factors are described which hamper the flow of private finance (or repayable funds) to the water supply and sanitation sector (WSS). These are: Limited cost recovery because of insufficient ability to pay cost recovery tariffs; Affordability constraints of households and or certain groups limit possibilities to arrive at a full cost recovery level of water tariffs especially in developing countries or poor regions. In many countries also low collection rates and leakages affect water revenues in negative manner. Political (un)willingness to raise tariffs can also be an important factor; Weak governance and financial discipline and performance in water utilities; Limited availability of funds for small scale operators and domestic suppliers; Return-risk profile and risk perception of investors of the water sector. There is a perception in the private sector of the water sector as low return-high risk sector, especially for developing countries in relation to low collection rates; Lack of funds at decentralized level; Short tenor of available financing or high market interest rates in relation to time and return profile of projects in many countries; Lack of bankable projects or good bankable project proposals. Solutions for these challenges often aim at more factors at the same time. Moreover, in many developing countries Technical Assistance projects to public water utilities aim to improve governance and financial performance of these utilities. Often IFI s and large donors are involved in these projects. Blending grants with repayable finance basically aims to overcome the funding gap and at the same time bring in private funding into the WSS sector. In the figure below from OECD (2009) this is illustrated. 19

19 3.2 Water safety and water security The key problem in water safety is to organize sufficient government and private funding given the large needs for resources and large size of many water safety projects. Because of climate change a number of areas in the world is becoming more prune to climate vulnerability and floods. Measures to protect these areas such as storm surge barriers, reservoir systems, drainage systems are expensive and the needs are huge. Often the needs and risks are especially relevant for Delta countries such as Bangladesh, Indonesia, Philippines, Mozambique etc. Government funds are limited and the experience with private sector involvement and PPPs in this sector is also still often weak in this type of countries. Moreover, water safety still has the character of a public good and public funding, cost recovery from levies or private funding or insurance is often not easy to organize due to a number of factors such as: Insufficient government budgets in the relevant countries for the major investments in flood protection or drainage systems needed; Difficulties to create private revenue flows for many water safety projects. Even when private revenue flows are created the long term nature of the revenue flows creates a high risk perception for private investors and makes private finance attraction difficult; Affordability issues or political issues regarding setting special taxes or levies to pay for water management/ water safety; Often non existence of a private insurance market for water related risks; Difficulties to organize mechanisms for value capturing of private benefits in case of prevention of damages to real estate assets or other private functions (often because of legal or taxation reasons); The large size and long tenure period of finance needed for funding for the required infrastructure facilities; Lack of international experience with Public Private Partnership (PPP) contracts for water safety projects and lack of experience with PPPs in general in many developing and emerging countries. 20

20 Solutions for these factors often lie in a combination of creating additional private revenue flows by extending the scope of water safety projects to urban land development and tourism and private sector involvement (PPP or development companies). The cases in UK, Indonesia, Mozambique and Lagos all show elements of this approach. 3.3 Conclusions Financial feasibility and bankability of projects is a huge challenge especially in sanitation, water supply in developing countries and water safety and security because of public good nature; There are difficulties to attract private (repayable) finance in water supply and sanitation due to problems in cost recovery, the political influence on water tariffs and related risks and weak governance or performance of many utilities in developing countries; Technical Assistance support aimed at improving the financial performance of water utilities is very important in order to create more financial sustainable projects and utilities and lay the foundations to attract more private finance in the sector. Innovations in the business model and financing mechanisms are needed in order to generate more financial feasible water projects and attract more private finance in order to fund the huge need for water supply, sanitation, water safety and water security projects in many parts of the world. 21

21 4 Innovative business models In this chapter the focus is on innovative business models. We define the business model as the way earnings are generated by either payments of customers for water services or payments for water related services in other sectors. The idea behind most innovations is to create additional revenues (positive cash flows) by either using additional revenue streams by scope extension to other sectors affected, by availability payments from the government, by improving payments systems or by creating stronger financial discipline and efficiency by changing organisation models and private sector involvement. Another important driver relates to scale: by scaling up the activities economies of scale step in and unit costs can decrease. The main drivers of improving the business case of water related projects basically work at the revenue and cost sides of the business models. Important drivers aiming at the revenue side are the following: Scope extension: internalizing revenue streams from sectors affected often induced by technological innovations. Examples are the inclusion of revenue streams from waste water to energy in sanitation or land and urban development related to water safety measures; Improving payment mechanisms: improving water tariff collection rates by introducing more efficient collection systems (for example by using IT technologies) or prevention of illegal water tapping of drinking water; True pricing: the internalization of externalities in water prices or introduction of prices for use of water related resources. Examples are the introduction of payment schemes to farmers or industrial players which extract water from water resources (lakes, rivers etc.); Availability payment schemes: by introducing a regular service fee paid by the government (or any other contracting agent) a payment is generated for private provision of public services. Drivers which address the cost side in business models of water related services are: Scaling-up: scaling up to larger entities *from municipal to region) or scaling-up the demand and supply side. Basically these scaling up activities can bring in efficiency gains or savings in unit costs. Moreover, by scaling up private finance becomes easier to obtain; Specific cost saving measures. Examples are savings in collection costs by IT or mobile applications for water supply or creating water reservoirs for water storage instead of large investments in dykes in water safety. A driver which affects both the revenue side and cost side is private sector participation (including Public Private Partnership models): Private sector participation. Basically, more private sector participation in the water sector can bring in more incentives towards gearing revenues and cost savings and therefore a higher financial discipline. In comparison to traditional grant funding to public utilities or NGOs the financial sustainability of programs can be improved also by the long term ownership created. In the picture below the identified main drivers of improving business models in the water sector are described. In this chapter cases are provided from the international practice which are related to these drivers to improve business models of water operations. In the table below an overview is provided for these cases. 23

22 Table 4.1 Typology of business models Business model Main elements Applicability Case typology Scope extension: revenues from other sectors Waste water to energy Conversion of waste water and fertilizers (re-use) and waste to energy and and health fertilizer Creating additional revenue streams to water Water safety and land Revenues from land or development, recreation recreation development used for water safety Water security: capturing Reaping benefits in benefits in agriculture and agriculture for (partly) microfinance financing water harvesting systems & microfinance to farmers Innovative Payment systems Depending on regulations, feed in tariffs for renewables, market for fertilizer, entrepreneurship Urban areas with demand for land close to coast and proper real estate and land prices Definable direct benefits Interested and committed farmers and microfinance providers Financial INclusion Improves Sanitation and Health programme in India (FINISH) Room for the Rivers in the Netherlands NCICD Flood Protection in Jakarta Water dunen Eko Atlantic Finance for RaiNwater (FERN): Sustainable financing for Sustainable water Improving payment Mobile payment systems, Willingness mobile Mobile payments of systems by ICT more frequent payments providers and utilities to water bills in Kenya, Increasing billing and change systems Tanzania, Uganda and payment rates Zambia Payment for Grants for TA to small scale Existence of regulations Appropriate finance for Environmental services farmers on water intake Sustainable Water Lake Naivasha in Kenya PES payment system for companies Management in the companies Existing value chain Lake Naivasha Basin In kind payments food- agro companies Scaling-up Scaling up to regional Regional water unions authorities (case waste water in Turkey) Multi-stakeholder Involvement of key involvement and cocreation of projects Co-creation of projects or stakeholders in the basin (cases water security in programs Zambia) Private sector participation (including PPP) Institutional setting, willingness local authorities Interests of key stakeholders aligned Strong NGO behind Inter municipal cooperation (waste)water unions WWF Basin-level water stewardship Zambesi Community enterprise Community enterprise Small villages, strong Water for peace: models (rural drinking responsible for water community ownership Community Based water) service delivery Approaches in Water Supply Projects for Multi-ethnic Neighbourhoods in 24

23 Business model typology PPP Availability fee based models DBFMO contracts for waste water treatment (NL) or water safety (UK) Main elements Applicability Case Crimea Lifecycle cost optimizations Developed PPP availability Availability fee payments procurement payments Waste Water based upon KPIs organisations Treatment Private financing PPP expertise private Harnaschpolder sector available Pevensey Bay Flood Defence Broadland Flood Alleviation 4.1 Scope extension: internalizing revenue streams from other sectors The introduction of innovations in waste re-use (waste to energy, waste to health), geodata, IT and mobile applications introduce possibilities for new business models by generating additional income from other sectors. In this paragraph some interesting practical cases are shown where income is generated by integrating other sectors into the water projects Drinking water and sanitation Conversion of sanitation waste to energy and fertilizers Technological innovations can change business models in the water sector. Waste water to energy technologies introduce new earning models as energy (biogas, electricity) can be produced and sold to the market. Also phosphates (fertilizers) can be produced as a product of biological processes re-using waste water or waste. Important considerations for these business models to become feasible are: Availability of local entrepreneurship and affordable microcredits in the country or region; Market upscaling: upscaling of demand side and supply side in order to create scale and lower unit costs; Feed-in tariffs for electricity from renewables in order to create competing prices with traditional electricity production; Connection to the grid or parties with electricity demand; An existing market for fertilizers (in agriculture) with reasonable prices. In order to generate successful business models these aspects have to be assessed relevant for the local market. Below some interesting cases are presented from Kenya, India and Costa Rica. 25

24 Financial INclusion Improves Sanitation and Health programme in India (FINISH) Introduction and objectives Financial INclusion Improves Sanitation and Health programme (FINISH) has the objective of improving health in rural societies not only through creating better sanitation facilities, but also by improved knowledge and raising awareness. This is the concept of "Total Sanitation". The operational goal is to build 500,000 safe sanitation systems in India by the end of Concept The concept is to: Use output based aid (grants) in sanitation to generate an effectuate demand for latrines by awareness and promotion activities and increasing sanitation densities (up to 75%) at 2 euro per latrine; Use of innovative materials: waste wood shipbreaking (Gujarat), bamboo; Supply side pilot of 5,000 units in Rajasthan where 30% reduction in cost of sanitation system construction was achieved by assistance and upscaling the supply side; Develop a sanitation value chain: a pilot to convert 10 tonnes human excreta in marketable compost (fertilizer) and biogas. In Tamilnadu, converting agri waste and human excreta and monetizing biogas (community system), in Gujarat linking toilets to 2,000 new biogas systems. Standardizing biogas approach with SimGas BV. Main sponsor and stakeholders The project is carried out by FINISH SOCIETY for Dutch Ministry of Foreign Affairs (DGIS) since The project is financed with 55 million with the target of 90% commercial/other funding. The NGO WASTE is leading the project together with a range of partners (MFIs, cooperatives, India government). Scale and specifics regarding the business model, financing model The main steps in the approach are: i) Demand generation, ii) demand effectuation, iii) supply side scaling up and quality improvement and decreasing unit costs and prices. The financing model is a combination of DGIS grants, co-finance from cooperatives, microcredits from MFIs and support from the government of India. The idea is that after 2016 the system should be financial sustainable (no DGIS aid necessary). Apart from demand and supply side support the project foresees a health impact study with use of health insurance claim and medical data. 26