REC PEIP

1. REC PEIP National Workshop Albania, 25 September 2008 Reform Strategies to Cope with the Challenges Faced by the Water Industry in Central Europe Andras Kis Corvinus University of Budapest, Hungary

2. Personal Background • Education in economics • Present occupation: Corvinus University of Budapest, Regional Energy Research Centre, Water Economics Unit • Key water utility projects recently: • UNDP GEF Danube Regional Project – working with water utilities and governments • Karlovac, Croatia • Pitesti, Romania • World Bank IBNET Benchmarking Initiative

3. Topics for Today • Key challenges for water utilities in the process of transformation • Strategies for reforming the utilities • Tariff setting policy and related issues Central and Eastern European perspective and examples Discussion after each session

4. Part 1 • Key challenges for water utilities in the process of transformation • Strategies for reforming the utilities • Tariff setting policy and related issues

5. List of Challenges / Changes • Decentralization • Economic transformation • Lower consumption / production • Inefficient operations • Degrading infrastructure • Accession to the EU • Problems with water resources

6. Decentralization of Public Services Local, and not central decisions about most questions of operation More suited to local circumstances Self-financing, no more central government subsidies • but there are some exceptions: e.g. in Hungary disadvantaged areas with high operating costs get subsidies Fragmentation of companies • in Hungary 33 water utilities in 1990, more than 300 today • driven by differences in costs – a mix of new tariffs instead of past uniform tariffs Confronting interests of local governments as owners, regulators, customers, and political actors: • good quality service • low tariffs • dividend • no lay-offs Tariff increases are less likely to happen in election years

7. Economic Transformation in Central and Eastern Europe • High inflation, especially in the 1990s • water and sewage tariffs often lagged behind costs • depreciation of assets does not keep pace with inflation • Poor credit facilities initially • but improved lately • Open economies • world market prices prevail, e.g. recent surge in fuel costs • Unemployed population • lower consumption • unpaid bills • Migration of workers • lower household water consumption • loss of skilled employees

8. Economic Transformation in Central and Eastern Europe • Industrial facilities • shut down or face financial problems - lower demand for water, unpaid bills • experience competitive pressure - water conservation to save costs • introduce new technologies – decreased water use • Example: sugar industry in Hungary - all major factories shut down during the last 15 years • General infrastructural problems may also have an impact on water services

9. Decreasing Production of Drinking Water: The Case of Transdanubian Waterworks, Hungary

10. Consequences of Lower Consumption In most places there is a variable tariff system • less revenue Lower production • somewhat lower operating costs, e.g. less chemical used Existing capacities (water extraction, treatment, pipelines, wastewater treatment) are underutilized • higher unit costs • sometimes redesign needed

11. Low Operating Efficiency of Some Water Utilities • Workforce – low productivity, too many employees, motivational problems • Poor organization of working routine • Old technology – high fuel consumption, loss of water • Poor administration, e.g. database of consumption and payments • e.g. Inkassator in Karlovac • Certain skills are missing: • e.g. modeling capacities, advanced financial planning, sometimes management skills Operating costs are too high - but there is room for more efficient operation, reduction of costs

12. Degrading Infrastructure Due to Poor Finances Focus on emergency repair instead of regular maintenance and replacement • Service may become less reliable • Quality of water may get worse • Network loss may increase • Wastewater backflows • Inefficient wastewater treatment Creates a vicious circle It gets more expensive to provide service e.g. • have to pump more water because of leakage • old machinery consumes more energy Revenues may be lower e.g. • Unreliable water meters

13. Accession to the European Union Regulatory requirements: • Drinking water quality • Wastewater collection • Sewage treatment • Full cost recovery • Integrated planning of river basins (Water Framework Directive) EU regulations also coincide with local interests: • Protection of water resources and nature • Sustainable services • Economic efficiency EU also provides investment grants, but • Grants are not sufficient to satisfy all needs • Operating costs also increase, sometimes substantially

14. Problems with Water Resources Climate change -> more volatile rain pattern, longer arid periods • Climate change forecasts • Example from outside of CEE: recent water shortage in Barcelona Multiple water uses (agriculture, water utilities, industry, transportation, hydro power etc.) • Coordination problems • Decisions are rarely made with economic rationale • Example: water abstraction fee in Hungary Pollution of water bodies • Accidental pollution: cyanide in the Tisza river in 2000 • Sewage discharge: drinking water of Bucharest polluted by Pitesti

15. Part 2 • Key challenges for water utilities in the process of transformation • Strategies for reforming the utilities • Tariff setting policy and related issues

16. Main Groups of Reform Strategies • Metering of Consumption • Invoicing and Collection of Tariffs • Improved Management of the Utility • Cost Saving Investments • Independent Performance Audits • Benchmarking • Private Participation • Reforms at the Regulatory Level

17. Metering Reforms Introduction of water metering and consumption based tariffs • Costs of water meters and their installation • Lower consumption – lower operating costs • More equitable scheme – payment can be linked to consumption • Improved acceptance of future tariff increases Switching to water metering within apartment buildings • The building itself has already been metered • Individual apartments get a direct incentive to mind their consumption • Lower consumption – lower average household bill – lower revenues in the short run • Lower operating costs

18. Metering Reforms Calibration of meters • Regulatory requirement in many countries • Increase trust of consumers • Reduced the gap between metered amounts and actual consumption By-pass meters are planned in apartment buildings in Karlovac, Croatia • Large diameter meters (for big apartment buildings) cannot measure low flows precisely • “By-pass” meter has two meters. For low flows a smaller, more precise meter, for high flows a larger meter.

19. Metering Reforms Other reforms connected to metering • Garden meters to measure consumption of water that will not reach the sewer • Big industrial facilities: water consumption and wastewater discharge as separately metered • Metering of pollution loads at the industrial discharge points into the sewer, usually based on samples – pollution charges can be introduced • Automated meter reading through radio signals – this technology is becoming cheaper and cheaper – quicker and no human error • Less frequent reading of meters

20. Invoicing and Collection of Tariffs Integrated information system of invoices and payments – to know the exact situation Example: after the first careful examination of records in one of our case studies, the water company found out that about 20% their own employees did not properly pay the water bills. Invoicing as internal or outsourced activity • Large utilities in CEE often outsource meter reading and invoicing to specialized companies, selected through competitive bidding

21. Invoicing and Collection of Tariffs Strategies to deal with non-payment and delayed payment: • Issuing a reminder after the payment deadline has passed – requires up-to-date records • Selling the debts to debt collection enterprises • Well publicized legal procedures • Installation of low pressure valves • Cutting off service - depends on the regulations on access to drinking water – public wells in the vicinity • Publication of the names of non-payers • Social tariff schemes • Prepaid water – with automated meter reading this is becoming an option • Discounted debt payment • Community relations – explain the strategy for active collection of bills and the consequences of non-payment

22. Invoicing and Collection of Tariffs Methods of invoice payment • In cash at the consumer – most expensive method, but sometimes the only practical one • In cash at the customer service • Postal cheque • Individual bank transfer • Authorized collection from the bank account Incentives to choose bank transfers. • E.g. discount from the invoice; participation in a lottery

23. Improved Management of the Utility • Incentive based compensation – annual assessment of the performance of employees • Management incentives provided by the owners • Internal performance targets • Example: Nyirsegviz in Hungary has such targets for time need of emergency repairs, and speed of network rehabilitation (meter/day) • Outsourcing of certain activities after competitive bidding • For example meter reading, invoicing, laboratory tasks, vehicle maintenance, information technology • Reduction of redundant workforce • Strategic and annual planning • Introduction of standards (e.g. ISO 9000, 14000 series) • Investigation of illegal connections, water as well as wastewater

24. Cost Saving Investments • Repair of network sections to reduce water loss • Does not always reduces costs. E.g. Karlovac, Croatia water is so cheap that savings in operating costs do not reach the investment costs • Replacement of old technologies with new, fuel efficient ones • E.g. Water pumps, vehicles • New technological procedures • Debreceni Vizmu in Hungary in a research collaboration developed new bacteria and chemicals to be used in wastewater treatment during the summer season. Savings of chemical costs and energy • Process engineering • Example: Nyirsegviz in Hungary • Water and wastewater flows are registered real time, electricity consumption is modeled for the next 15, 30 minutes, 1 hour • Electricity tariffs are based on keeping a predetermined schedule broken down to 15 minute segments • Electricity consumption is influenced through controlling water/wastewater flows

25. Independent Performance Audit • To reveal cost saving and revenue enhancing opportunities • Independent – no interest in keeping existing practices • External expertise and experience

26. Benchmarking • Water utilities compare various aspects of their performance to identify areas for improvement and to share best practices • The process of benchmarking: • Develop the concept of benchmarking (which areas to investigate, what data to collect, determine participants) • Supply data • Evaluate data, make corrections • Compute indicators • Compare indicator values across participants • Learn from best practices

27. Benchmarking Benchmarking Club of the Hungarian Waterworks Association

28. Benchmarking Benchmarking Club of the Hungarian Waterworks Association

29. Benchmarking • World Bank water utility benchmarking exercise – IBNET • www.ib-net.org • 85 countries, more than 2000 utilities • About 70 indicators • In-country and inter-country comparisons • Participating countries from CEE: • Albania, Hungary, Czech Republic, Romania, Croatia, BiH, Moldova • Planned extension: Montenegro, Slovakia, Poland, Bulgaria

30. Private Participation in Water Utilities Advantages: • Municipality or state receives instant revenue instead of future dividends • Additional access to capital for the utility • Sharing of risks between the municipality and the investor • Privatization is often accompanied with specific reforms, e.g. service contract between the utility and the city, tariff schedule • Additional reforms are more likely to happen, e.g. metering, billing, invoicing, cost reductions • New owner may bring useful experience, know-how Disadvantages: • Long term agreements – difficult or costly to break • Financial achievements (e.g. cost saving) to be shared with investors • Questions about the fulfillment of long terms goals, such as protection of water bases, replacement of infrastructure

31. Private Participation in Water Utilities Percentage of privately operated water and wastewater service in the World • The Netherlands 0% • Germany 4% • United States 15% • France 80% • England 100% In CEE some major privately operated utilities: Budapest, Bucharest, Zagreb (wastewater), Sofia, Prague

32. Reforms at the State Level Central tariff administration: • Should be less bureaucratic • Depreciation to be allowed to be fully covered • Novel tariff designs to be accommodated (e.g. fixed tariffs) Taxation • Effluent charges to be linked to pollution – to reward efforts at pollution reduction • Croatia – m3 based effluent charges • Water abstraction fees to be based on resource scarcity, renewability • Hungary – abstraction fee depends on activity too Investment grants are not used efficiently

33. Part 3 • Key challenges for water utilities in the process of transformation • Strategies for reforming the utilities • Tariff setting policy and related issues

34. Sequence of Tariff Reforms Metering of consumption is a prerequisite Identify the purpose of the reform • Cost recovery? • Equity among customers? • Savings for rehabilitation or future expansion? • Social considerations? Select tariff designs • Simple variable tariff • Fixed tariff component • Block tariffs Analysis, modeling of tariff reform Determine tariff levels Public consultation Introduction of new tariffs, with other, supporting reforms

35. Tariff Designs • Simple, variable tariff: EUR/m3– most common in CEE • Fixed and variable tariff: EUR/month + EUR/m3 after consumption. • Variable tariff may not always apply to the first few m3/month • Increasing block tariffs: tariff blocks, the price rises with consumption. Especially at places with capacity problems (water sources or infrastructural bottlenecks) • Decreasing block tariffs: tariff blocks, the price decreases with consumption. To reflect economies of scale. • Pollution charges based on measured or estimated pollution releases. Mostly applies to industrial facilities on the sewer.

36. The Role of Fixed Tariffs: Smoothing Seasonal Pattern of Revenues

37. Distribution Function of the Consumption Transdanubian Waterworks Company, Hungary, 2005 Permanent consumers Seasonal consumers

38. Revenue Stream under Different Tariff Regimes Hypothetical example Permanent and seasonal customers Tariff system A: 1 EUR/m3 Tariff system B: 2 EUR/month + 0.67 EUR/m3 Equal total annual revenues under the two schemes Burden on seasonal customers would increase

39. Cost Recovery • Customers should recover the costs associated with their service – to ensure sustainable services • Economic justification – to avoid overuse • EU requirement (Water Framework Directive) • Cost recovery for major customer groups eliminates cross-financing between • Customer categories: households vs. industry The case of the Karlovac Brewery • Customer categories: permanent vs. seasonal consumers • Services: water vs. wastewater • Geographical locations: e.g. inner city, suburb

40. Levels of Cost Recovery for the Utility as a Whole • Operating costs (e.g. labor, eletricity, chemicals, fuel) • ... + maintenance, replacement of existing infrastructure • ... + upgrade of infrastructure including extension • ... + environmental costs

41. Affordability How will low income households pay their water and wastewater bills? • Increasing block tariff for all customers – first part of consumption is cheaper, then it becomes more expensive. Also helps to conserve water resources • State subsidies to household consumption at locations with high costs (e.g. polluted water resource; small, isolated villages) – Czech Republic, Greece, Hungary, Slovakia • Reduced wastewater charge, or at a flat rate, sometimes linked to property value (Belgium, Japan, Netherlands) • Social water tariffs for selected groups, such as the poor, or large families • General income support – and the family will make the consumption choices

42. Developed under the UNDP/GEF Danube Regional Project • Purpose: Automated calculation of the physical and financial consequences of changes in the operation of W&WW utilities • Tool for structuredanalysis of operational changes, investment projects, and policy reform proposals • Based on the spreadsheets of Excel, Solver, and Visual Basic • “Freeware” (anyone can use it without paying for it), but needs a fair amount of learning before effective use ASTEC Model – Account Simulations for Tariffs and Effluent Charges

43. Data Need for Impact Assessment of Tariff Reforms Book keeping improvements, cost center accounting often needed Knowledge about customer categories e.g. • Number of accounts • Consumption level and pattern • Outstanding revenues Detailed knowledge of present and future costs • By activities (water, wastewater, ...) • By cost types (investment costs, operating costs) • By customer categories Response of customers to changes in tariffs • Elasticity of demand Other considerations • Ability to pay • Regulatory requirements

44. Use of ASTEC in Pitesti, Romania

45. Use of ASTEC in Pitesti, Romania • ... and their impact on • Produced and consumed water quantities • Collected and treated wastewater quantities • Prices • Financial accounts (costs, revenues) • Monthly invoices Changes introduced (examples) • Leakage reducing investments • Network extension • Individual metering of apartments • Separated storm water collection • Effluent surcharge on industrial wastewater • Cost recovery requirement • Outsourcing of repair and maintenance

46. ISPA Project in Pitesti Rehabilitation and upgrade of water treatment, water and wastewater networks and WW treatment ISPA grant and EIB loan Reduced costs (e.g. water network repairs, pumping of water) Increased costs (e.g. advanced treatment of wastewater, EIB loan repayment) Burden as a percent of net income:

47. Use of ASTEC in Karlovac, Croatia

48. Use of ASTEC in Karlovac, Croatia • ... and their impact on • Produced and consumed water quantities • Collected and treated wastewater volumes • Prices • Financial accounts (costs, revenues) • Monthly invoices Changes introduced (examples) • Introduction of a monthly water fee • WWTP investment (primary vs. tertiary) • Reduce the gap between household and commercial tariffs • Exchange rate fluctuations - EBRD loan • Change in government fees paid by ViK Karlovac • Reduced workforce

49. ISPA Project in Karlovac Water network, wastewater network – partial rehabilitation and extension New third stage wastewater treatment plant ISPA grant and EBRD loan • ViK Karlovac agreed to: • reduce the gap between household and industrial tariffs • increase average tariffs • increase bill collection • performance audit and subsequent cost reduction • community relations program to explain the changes

50. ISPA Project in Karlovac – projected change in costs (million HRK/year)