PPPs in Infrastructure Day 2 Session 6.1 Service Standards, Tariffs and Subsidies Sabino Escobedo, TAG Financial Advisors 1
Day 2 Risks & Responsibilities Session 10 Session 6 Session 6.1 Service Standards, Tariffs & Subsidy Service Standards, Tariffs & Alternative Subsidy Output Based Aid Financing Sources: Project Finance Carbon Finance Mobilizing Capital Markets Output Based Aid Day 2 Session 9 Combining PPPs With EU Grants Session 7 Responsibilities & Risks Session 8 Contingent Liability Management Subnational Projects 2
Session 6.1 - What will we cover? How are Levels of Services, Cost, Tariffs and Subsidies interlinked? Can we define realistic, affordable targets for Coverage and Quality of Service? Management Contract for Jordan Valley Authority, What are the key issues in establishing a mix of Tariff and Subsidy? Irrigation Water Supply, may be the first of its kind. What is the importance of Cost Recovery? What are the issues to get effective private and public financing for Private Participation? 3
Balancing Service Standards, Tariffs & Subsidies In this Session we describe an iterative process, to answer the question How can we afford better services under a new Arrangement? START Specify Services IMPLEMENT Design Finance NO Estimate Cost YES Does it work? Set Tariffs & Subsidies 4
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. START Specify Services First we IMPLEMENT look at how service NO goals are set for Design the Utility under the proposed Finance Private Participation Arrangement Estimate Cost Two main issues YESto be defined: Does it work? Coverage of service Quality of service Set Tariffs & Subsidies 5
Service: Coverage targets There are three main ways of defining Utility service coverage targets New Connections or %age of households connected Geographic area to be served Served by direct service connections, kiosks, standpipes etc, and public latrines or other improved services (for sanitation) % age of roads with service (e.g. main sewers) 6
Service: Quality Targets It is usual to have more than one type of quality target that can be set for the Utility Example: What voltage norms are acceptable? At what pressure should water be available? Example: Should power be available 24 hours a day seven days a week, or only at certain times? Availability of Service Example: Should the water be treated to strict guidelines ( e.g. WHO or EU) or is flexibility allowed for some non-critical parameters? Technical standards Example: What percentage of wastewater should be treated, and to what standard? Example: What payment methods? How are complaints handled? Water Quality Effluent Treatment Customer Service 7
Buenos Aires: Service Levels Service Levels Tariff Subsidy Finance Scope Model 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. Targeting 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) Water 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. Concession 8
Estimating Cost of Services Once initial objectives have been set, Government should estimate the cost of providing the service. START Specify Services IMPLEMENT Design Finance NO Estimate Cost YES Does it work? Set Tariffs & Subsidies 9
Cost of Service The Cost of Service has three elements Operating & Maintenance Expenses Day to day expenses involved in providing services and keeping the system functioning, including labor, fuel,electricity, chemicals, maintenance etc.. 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 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 Depreciation Return on Capital 10
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 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 the 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 11 cover all of those costs, or whether tax payers should subsidize the service.
Cost recovery and tariff implications Can we afford to pay for better services? START Specify Services IMPLEMENT Design Finance NO Estimate Cost YES Does it work? Set Tariffs & Subsidies 12
Cost Recovery and Tariff To be viable: Tariffs + Subsidies = Total Cost of Service SUBSIDY Service Coverage Service Quality TARIFF INCOME INCENTIVES COST OF SERVICE 13
Cost Recovery and Tariff To be viable: Tariffs + Subsidies = Total Cost of Service SUBSIDY Service Coverage Service Quality TARIFF INCOME INCENTIVES COST OF SERVICE Willingness to Pay Social Acceptability External Benefits 14
Use of Subsidies If Cost of Service exceeds Tariff income, then a Subsidy will be needed START Specify Services IMPLEMENT Design Finance NO Estimate Cost YES Does it work? Set Tariffs & Subsidies 15
Types of subsidy Private Participation can involve suitable subsidy arrangements Money from Paid to Customer to help pay the bill OUTPUT BASED Utility/Operator for outputs Utility/Operator for inputs INPUT -BASED Utility or Operator as implicit or ad hoc support Customer Revenue Government Revenue Development Agency grant or loan with concessional element Where Subsidy comes From Who Subsidy paid To 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) 16 Where subsidies are paid to and for what?
Types of subsidy We will look at some specific Input and Output Subsidy forms. Money from Paid to Customer to help pay the bill OUTPUT BASED Utility/Operator for outputs Utility/Operator for inputs INPUT -BASED Utility or Operator as implicit or ad hoc support Customer Revenue Cross-subsidy Customer bail-out Government Revenue Social security provisions Implicit subsidy or bail-out Development Agency grant or loan with concessional element Donor Financed Output based Aid Input subsidy 17
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.. 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 18
Output Based Aid OBA Box 5.3 Output Based Aid Output -based aid refers to the approach in which the government contracts to a third party the delivery of a service to consumers for which public funds, complemented in some cases by user fees, are paid contingent on the actual delivery of these services as determined in performance - based contracts with public or private providers. It aims to encourage providers to deliver the services the government wants by tying some or all of the payments to the delivery of specified outputs or outcomes. It also seeks to enhance accountability for the use of public funds by focusing on measurabl e outputs or results. Output -based aid has been used in many sectors. In water, o utput -based aid can be used to: Expand access to services by linking the payment of a subsidy to access or new connections Cushion the move to cost recovering tariffs paying s ubsidies for a transition period Help disadvantaged groups by providing an ongoing payment to an operator of the difference between the desired tariff (paid by the household) and full cost Achieve positive externalities by, for example, subsidizing the ach ievement of environmental targets. Output -based aid s potential advantages include: Better targeting of government and donor funding Greater accountability of the service provider Reduced costs, as providers can decide how to produce contracted outputs. The extent to which the potential benefits are realized depends on the design of individual schemes. Questions that need to be answered include: What is the rationale for public funding? How might budgetary constraints and sustainability issues influence des ign? Who are the intended recipients? How will they be targeted? What criteria should govern eligibility? Will services be provided in a competitive or monopolistic market? What should the service package include? How should key performance standards be de fined? What should be the form and size of payment? How will payments be structured? What should be the form and duration of the contract? How will issues of contract adaptation and dispute settlement be addressed? What should be the scope of the scheme? W ho should be responsible for administering the scheme? 19
Balancing Service Standards, Tariffs & Subsidies This is an iterative process. Can we afford better services? START Specify Services IMPLEMENT Design Finance NO Estimate Cost YES Does it work? Set Tariffs & Subsidies 20
Finalizing Tariff, Subsidy and Service Level Finally we have: 3. Evaluated any necessary subsidies Develop options, looking for an acceptable trade-off between tariffs, services and subsidies SUBSIDY Balancing the cost & tariff issues Following our Process, we have: 1. Arrived at Cost of Service TARIFF INCOME COST OF SERVICE Following our Process, we have: 2. Looked at acceptable Tariff scales INCENTIVES 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 Once we are happy with the balance between Cost, Tariff and subsidy we can proceed 21 to incorporate them into the design of the Private Participation Arrangement.
Design & Implement: Design Issues What key issues should we include in the Private Participation Arrangement design? START Specify Services IMPLEMENT Design Finance NO Estimate Cost YES Does it work? Set Tariffs & Subsidies 22
Design Issues PP is possible even if Tariffs don t cover costs The Arrangement has to cover various issues: Example: Amman Management Contract Cost Recovery for O&M Cost of Service = Management Costs + Operations + Capital Investment Operator s 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 23
Design & Implement: Financing Implications How to involve private and public finance? START Specify Services IMPLEMENT Design Finance NO Estimate Cost YES Does it work? Set Tariffs & Subsidies 24
Private Finance What might be the potential sources of funding for a prvately financed project? First we should be aware of some of the potential SOURCES OF FINANCE : o Equity from a project promoter o Equity from other investors o Loans local or foreign banks o Bonds o Export Credit Guarantees Finance o Loans from development agencies o Grants from development agencies 25
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 Day 2 Session 7 ] - 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 26
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: 27
A Development Agency Finance Arrangement One possible Example: model for securing effective disbursement 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. 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: Example: The operator makes new connections as part of his contract. For those in low income areas he receives a specific fee say, for example, $150 per connection 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: 28
Reviewing Session 6.1 In this Session we have considered the elements and process of establishing affordable Levels of Service, and some of the design and financing implications. START Specify Services IMPLEMENT Design Finance NO Estimate Cost YES Does it work? Set Tariffs & Subsidies 29
PPPs in Infrastructure THANK YOU! Sabino Escobedo, TAG Financial Advisors 30
Checklist: Session 6.1..and the process is detailed in this Checklist 31
More Information: Session 6.1 32
Contacts For comments or further details contact: Penny Williams Cledan Mandri-Perrott Sabino Escobedo David Stiggers pwilliams4@worldbank.org cmandriperrott@worldbank.org sescobedo@tagfinancialadvisors.com davidstiggers@comcast.net 33
PPPs in Infrastructure THANK YOU! Sabino Escobedo, TAG Financial Advisors 34