Toolkit: Approaches to Private Participation in Water Services

1. Toolkit: Approaches to Private Participation in Water Services Module 1 Considering Private Participation

2. Introduction: Navigating through this E-Learning Module E-learning design: davidstiggers@comcast.net

3. Elements of the Toolkit 1 ConsideringPrivate Participation 2 Planning the Process 9 Selecting an Operator TOOLKIT Appendix A Examples of PP Arrangements 8 Designing Legal Instruments 3 Involving Stakeholders Appendix B Policy Simulation Model 4 Setting Upstream Policy 7 Developing Institutions 5 Standards, Tariffs, Subsidy, Financials 6 Responsibilities & Risks Additional Material CD-ROM

4. Module 1 General Outline of Toolkit Module 1 Considering Private Participation “What can private particpation expect to Achieve?” 1 ConsideringPrivate Participation 2 Planning the Process 9 Selecting an Operator TOOLKIT Appendix A Examples of PP Arrangements 8 Designing Legal Instruments 3 Involving Stakeholders Appendix B Policy Simulation Model 4 Setting Upstream Policy 7 Developing Institutions 5 Setting Service Standards, Tariffs, Subsidies & Financial Arrangements 6 Responsibilities & Risks Additional Material CD-ROM

5. What are the underlying POLICY PROBLEMS for provision of the water services in developing countries? What are the various MODELS OF PRIVATE PARTICIPATION that we can usefully consider? How do they address the problems How can we be sure of GETTING PRIVATIZATION TO WORK? Management Contract for What are the possible EFFECTS OF PRIVATE PARTICIPATION ? Jordan Valley Authority, Irrigation Water Supply, may be the first of its kind. Module 1 - What will we learn?

6. Module 1 - Considering Private Sector Participation • Before introducing Private Participation, Governments need to: • Document particular problems their water utilities face • Diagnose the underlying cases of the problems • Determine whether private participation can address the problems

7. REVIEW: Underlying Policy Problems UNDERSTAND: Effects of Privatization ACHIEVE: Getting PP to work HOW?: Different PP Models Module 1 - Considering Private Participation (PP) “In this Module we will look at four main areas…...”

8. REVIEW: Underlying Policy Problems REVIEW: Underlying Policy Problems UNDERSTAND: Effects of Privatization ACHIEVE: Getting PP to work HOW? Different PP Models Underlying Policy Problems • In this section we REVIEW underlying policy problems related to provision of water services, including • Customer Connections • Supply (flow and quality) • Sanitation service • Money • Assets and Investment • Service providers

9. Underlying Policy Problems “In many countries the provision of water services is unsatisfactory. A number of basic issues influence this……….” Basic issues affecting water services include: • Connection rates– Many households don’t receive water or sanitation services from the utility, although they prepared to pay for service. • Quality of service– Those few connected get water for only a few hours per day, with water not safe to drink, and little sewage treatment. • Lack ofmoney– Solutions would be easier if customers could pay more or governments could raise more tax. • External benefits– Improved water services create benefits for others (e.g. reducing disease), but customers may be unwilling to pay • Assets– With condition of underground assets hard to determine, private providers may be unable to make sensible bids for improvements • Local, provincial and central governmentmay have overlapping responsibilities

10. Underlying Policy 3 Other Factors “………. but three additional factors may create serious obstacles.” • Three other factors may create serious obstacles: • These factors, alone or combined, may create obstacles to plans for water and sanitation service improvement: • Water services are critical to all consumers • Services are often provided under a natural monopoly; supply by one well run firm may be more effective than two or more firms • Required investments are large, and cannot be reversed if returns prove to be less than estimated • The combination of these factors potentially leads to trouble Basic issues affecting water services include: • Connection rates – Many households don’t receive water or sanitation services from the utility, although they prepared to pay for service. • Quality of service – Those few connected get water for only a few hours per day, with water not safe to drink, and little sewage treatment. • Lack of money – Solutions would be easier if customers could pay more or governments could raise more tax. • External benefits – Improved water services create benefits for others (e.g. reducing disease), but customers may be unwilling to pay • Assets – With condition of underground assets hard to determine, private providers may be unable to make sensible bids for improvements • Local, provincial and central government may have overlapping responsibilities • The third factor - investment: • Provided prices are above operating costs, governments can accede to consumer pressure to limit price rises without causing suppliers to cease services. • Unless government makes up any difference between prices and costs, through subsidy, providers will not invest, if prices are too low to cover full costs including investment and repairs to infrastructure • The first two factors: • Customers may doubt that they are getting a good deal, and resist price increases, even if revenue is lower than costs. • As a result, Government faces strong pressure to keep prices below costs, causing problems for improving service.

11. Underlying Policy Problems – The Challenge “Given that the provision of water services is unsatisfactory, and a number of issues influence this…..” • The biggest challenge for governments is to address these issues and thus to encourage investment, in order to: • Improve quality • Lower costs • Extend access to services

12. REVIEW: Underlying Policy Problems UNDERSTAND Effects of Privatization UNDERSTAND:Effects of Privatization ACHIEVE: Getting PP to work HOW? Different PP Models Possible Effects of Private Participation • In this section we show some of the possible effects of Private Participation in water services in developing countries. • We look at three main areas: •  Operation •  Investment •  Policy & enforcement

13. Possible Effects of Private Participation “Private participation changes the water sector, with an operator being independent of government, and with incentive to be profitable. ” Private providers cannot be directed in the same way as a public provider, and the profit incentives can cause it to take actions not in the public interest. However independence and profit can help the government to achieve its objectives. Private participation may have effects in three areas: • The Operating Performance of the utility • The utility’s investment decisions • Policy and its enforcement

14. Possible Effects of PP: Operating Performance Possible Effects of PP: Investment Decisions Possible Effects of PP:: Policy & Enforcement Possible Effects of Private Participation “Private participation changes the water sector, with an operator being independent of government, and with incentive to be profitable. ” Private providers cannot be directed in the same way as a public provider, and the profit incentives can cause it to take actions not in the public interest. However independence and profit can help the government to achieve its objectives. Private participation may have effects in three areas: • The Operating Performance of the utility • The utility’s investment decisions • Policy and its enforcement

15. REVIEW: Underlying Policy Problems UNDERSTAND: Effects of Privatization ACHEIVE Getting PP to work ACHIEVE: Getting PP to work HOW? Different PP Models Getting Private Participation to Work • In this section we show some of the potential issues in getting Private Participation in water services to work. • We look at three main challenges: •  Ability and incentives to invest • Protecting operator from risk of change • Achieving ‘Fairness’ in PP Arrangements

16. Getting Private Participation to Work “The experience of the last decade shows how important it is to get two main issues right – but also how difficult” • Giving ability and incentives: • This means giving the provider enough freedom to make decisions, and so to be expected to take relevant business risks • The provider should be allowed to benefit when it improves business, but should bear any risk it has agreed to bear (and should not be automatically be allowed to renegotiate when things go wrong and if profits decline) • Protecting the Operator from Government changes: • This means protecting the operator from Government changes to the ‘rules of the game’, rather than from bad operating or investment decisions. • This includes protecting the operator from the risk that the government will cut prices after the operator has invested, or other measures that wiill affect the investor’s profitability TWO MAIN ISSUES: • Giving the provider the ability and the incentives to make good operating and investing decisions • Protecting the Operator from risk of losing through Government changing ground rules

17. Getting PP to Work - ‘Fairness’ “In the last decade many PP arrangements have run into trouble or been cancelled. Lessons learnt show that the arrangement must be perceived to be fair and legitimate ” • If the customers or operator feel that the arrangements haven’t been fairly implemented, then they can run into trouble • Examples: Cochabamba and Manila • To work well, the Government must create an arrangement that people perceive as being fair. If not: • Customers & voters may pressure Government to override contractual protections • The Operator may find his property rights or returns are less secure than expected • Private providers may require a higher rate of return if the arrangement is not perceived as being fair

18. Fairness Examples in Toolkit Getting PP to Work - ‘Fairness’ “In the last decade many PP arrangements have run into trouble or been cancelled. Lessons learnt show that the arrangement must be perceived to be fair and legitimate ” • If the customers or operator feel that the arrangements haven’t been fairly implemented, then they can run into trouble • Examples: Cochabamba and Manila • To work well, the Government must create an arrangement that people perceive as being fair. If not: • Customers & voters may pressure Government to override contractual protections • The Operator may find his property rights or returns are less secure than expected • Private providers may require a higher rate of return if the arrangement is not perceived as being fair

19. Rate of Return that must be promised Strength of legal protections Rules perceived as unfair Rules perceived as fair Getting PP to Work: Fairness & Cost “Additionally, perceived fairness allows a lower rate of return to be promised for a given legal protection – and possibly lower potential cost”

20. REVIEW Underlying Policy Problems UNDERSTAND Effects of Privatization ACHEIVE Getting PP to work HOW? Different PP Models HOW? Different PP Models Models of Private Participation • In this section we show the key Private Participation models: •  Management Contracts • Affermage – Lease • Concessions and Divestitures • Joint Ownership

21. Reviewing Module 1Toolkit Approach to PP Models ‘The Toolkit focuses on choices faced when designing PP arrangements rather than describing specific PP models ….’ • The use of ‘standard’ PP models: • However, whilst the Toolkit is structured around these design choices, we do refer to three main types of Private Participation Models, comparing and contrasting the importance of the issues under each model. • The three delegated management models considered throughout the Toolkit are: • Management Contracts • Affermage-Leases • Concessions • The Toolkit does not discuss BOT arrangements, nor arrangements that do not involve private participation. The reasons for this approach include: 1. Many issues arise in more than one PP model. Organizing the Toolkit by issue avoids repetition Example: The question of disputes arises in every model 2. Focusing on matters of substance avoids unproductive discussion of exact meaning of contract types: Example: Focussing on appropriate allocations of risks and responsibilities, and allowing this to determine contract type. 3. Many real world arrangements are in fact hybrids of the ‘standard’ PP models

22. Models of Private Participation “It is useful to understand the nature of some key PP models, and implications for the Challenges of Private Participation.” • Management Contracts • Management Contracts transfer responsibility for managing a utility to an operator – often for 3 to 5 years • Affermage - Leases • In Affermage-Leasesthe operator is responsible for operating and maintaining the business, • but not financing investment - with a term often from 5 to 14 years • Concessions and divestitures • Concessions give the operator responsibility for financing investment, as well as operation and maintenance, with assets returned to government after 25 or 30 years. • Divestiture gives the same responsibilities, but ownership of the assets stays withprivate investor • Joint Ownership • Joint Public / Private Ownership of the Operating Company is a possibility, and offers certain advantages

23. Management Contracts Affermage - Leases Joint Ownership Concessions and Divestitures PP Models Further Details Models of Private Participation “It is useful to understand the nature of some key PP models, and implications for the Challenges of Private Participation.” • Management Contracts • Management Contracts transfer responsibility for managing a utility to an operator – – often for 3 to 5 years • Affermage - Leases • In Affermage-Leasesthe operator is responsible for operating and maintaining the business, • but not financing investment - with a term often from 5 to 14 years • Concessions and Divestitures • Concessions give the operator responsibility for financing investment, as well as operation and maintenance, with assets returned to government after 25 or 30 years. • Divestiture gives the same responsibilities, but ownership of the assets stays withprivate investor • Joint Ownership • Joint Public / Private Ownership of the Operating Company is a possibility, and offers certain advantages

24. REVIEW: Underlying Policy Problems UNDERSTAND: Effects of Privatization ACHIEVE: Getting PP to work HOW?: Different PP models Reviewing Module 1 ‘The Module has looked at a whole range of issues for analysis and allocation of responsibilities & risks in PP design………….

25. Checklist: Module 1 ‘……..and what to do before beginning this process is discussed in this Checklist”

26. Module 1 More information: Other References: Fundamental political-economy problems in the provision of water services and broad strategies for addressing them:Gómez-Ibáňez 2003, Nickson and Franceys 2003, Savedoff and Spiller 1999, and Smith 1997a Recent trends in private participation in water:World Bank 2003 Evidence and arguments about the effects of private participation, including case studies:Abdala 1996, Barlow and Clarke 2002,Bitran and Valenzuela 2003, Brocklehurst and Janssens 2004, Clarke and others 2004, Crampes and Estache 1996, Estache and Rossi 2002, Gray 2001, Harris 2003, Lobina and Hall 2003, Megginson and Netter 2001, Nickson and Vargas 2002, Palaniappan and others 1999, Plummer 2002, Public Citizen 2003, Rivera 1996, Saghir and others 1999, 200, Sirtaine and others 2005, Shirley 2002, Shirley and Walsh 2000, Sirtaine and others 2005 Concessions and management contracts in particular: World Bank 1997b Considering Private Participation:

27. Supporting Material • The Toolkit Financial Model • Toolkit Case Study material • Toolkit Website: http://rru.worldbank.org/Toolkits/WaterSanitation/ • For comments or further details contact Cledan Mandri Perrott at cmandriperrott@worldbank.org

28. Toolkit: Module 1 End of Module

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