Presentation to the Portfolio Committee: Water & Environment

1. Presentation to the Portfolio Committee: Water & Environment Pricing strategy and funding model Presentation byMr Onesmus AyayaChief Financial Officer13 April 2010 1

2. Contents • Journey to success • Background • Status Quo • DWA Trading Entity Context • Budgeting for cost recovery • Review of pricing strategy • Financial management Improvement • Revenue Management • Financial Accounting • Asset Management • Supply Chain Management • Resource Implications • Recommendations 2

3. Opening remarks • What happens when one looks at large undertakings from a process perspective? • The question seems impractical given large undertakings are executed through both traditional bureaucracies and increasingly complicated networks of public, private, and non-profit providers. • In giving highlights of pricing/funding model review , we may take cognisance of other major undertaking by government- both great successes and monumental failures- process issue comes to the fore. • Nearly all major undertakings by government seem to follow a predictable path, a series of steps that I am inclined to call, somewhat optimistically, the journey success in project design and execution. 3

4. JOURNEY TO SUCCESS MAP DEMOCRATIC COMMITMENT IDEA DESIGN IMPLEMENTATION DESIRED RESULTS Re-evaluation 4

5. Journey to success The journey to success in the case of the project initiatives in South Africa do occur according to the following map: The projects must be based on a good idea: raise funds for water security The idea must be given specifics that become an implementable The project design must win the approval of legislators/Minister -signaling a moment of democratic commitment. There must be competent implementation mainly by the bureaucrats The project initiative embarked on must generate desired results: Water to Gauteng. Overtime, both what is being done to implement the project and how it is being done should be subjected to re-evaluation 5

6. Mandate of DWA and WTE • DWA has three main types of responsibilities. • Custodian of water resources - responsible for the allocation and health of the nation's water resources; • Trusteeship role - owns and cares for water resource infrastructure; and • Regulatory and oversight role - responsible for the performance of the public entities and municipalities in the water sector. 6

7. Context On WTE • The Water Trading Entity (WTE) was established in compliance with the Public Finance Management Act (PFMA) and is structured into two functional components: water resource management (residing with the CMAs) and infrastructure management [residing with the National Water Resource Infrastructure (NWRI) Branch] and operational clusters. • The regulatory role on water resource management and planning is centralised at head office-main account, with the clusters and regions involved in the daily oversight of the schemes through the CMAs and the proto-CMAs. • The CMAs represent a decentralised structure, as a requirement of the National Water Act, also responsible for enhancing access, flow and quality of water. 7

8. Context On WTE…cont • This necessitates for the CMAs to interact with the various sectors i.e. Agriculture etc. It further renders them as capable to confirm the registered volumes of consumption by water users on WARMS, the information of which is critical for the WTE to bill accurately to its customers. • Infrastructure management constitutes of construction (i.e development of new infrastructure) and operations and maintenance. 8

9. Context On WTE…cont • WARMS is the water user register constituting a database on the state of water in the country, in terms of quality and quantity, as entrenched in the National Water Act. • Expectation for the WTE to service the TCTA debt and yet the former is not consulted during the planning as well as expenditure thereof. • There is an urgency to revisit the TCTA payment of R300m monthly with or without collection. 9

10. BACKGROUND AND PURPOSE OF THE WATER TRADING ENTITY…Cont Massive scale (custodian of infrastructure with a replacement value of some R123 billion, and construction unit implementing projects to the tune of some R2 billion per year) 10

11. National Water Act, Water Services Act, PFMA, Other Legislation and Policies Head Office DWA Current Role DWA Future Role Regional Offices Operator Sector Leader Policy Maker Developer NWRIA Regulator and Monitor Regulator CMA WRC Water Institutions WUA WSA WSP Mandate Synopsis 11

12. Mandate Synopsis Institutions Mandate Policy Development Head Office Regulation Regulatory Mandate and Role DWAF Sector Leadership Regional Offices Oversight and Monitoring Water Infrastructure Development and Management TCTA and NWRIB Water Resource Management CMA Research WRC Implementation Mandate and Role Association of Water Users- Local Level WUA WATER INSTITUTIONS Ensures Delivery of Water Services WSA Provision of Water Services WSP Entity under a Municipality Municipal Entity 12

13. DWA’s Trading Accounts DWA TRADING ENTITY Trading Account 2 and 3 Trading Account 4 Trading Account 1 Integrated Water Resource Management Integrated Systems, Bulk Water Supply, Equipment Trading Account Water Services Scheme To be Migrated to CMAs ? To be Migrated to SANWRIA? Transferred to municipalities? 13

14. DWA’s Mission: Ensuring that water services are provided to all South Africans in an efficient, cost effective and sustainable way Trading Entity s brief: To ensure that the water supply is conducted in an efficient, cost effective and sustainable way that ensures proper accounting and reporting Financial Management: Trading Entity’s brief: To manage, account and report on revenue generated from water users Funding Model and Pricing: Alignment with Strategy 14

15. DWA’s Trading Entity: Strategy and NWRI Structure DDG: NWRI CD: Construction CD: Operations CD: Engineering Services CD: Business Management Construction Central Central Operations Construction South Southern Operations Centralised Functions Construction North Northern Operations Construction Equipment Eastern Operations Decentralised Functions 15

16. WTE SPECIFIC CHALLENGESEXTENT OF INFRASTRUCTURE • 240 schemes • 334 dams (34 billion cum storage) • 6929 km canals • 171 km tunnels • 990 km pipelines • 56 pump stations – 211 MW • Other infrastructure • 28 wastewater treatment works • 34 water treatment works • 2581 buildings • 3006 measuring facilities (1070 hydro, 1724 geohydro,212 meteorological stations) • Land – 795,563 Ha plus 137,264 Ha servitudes 16

17. Budgeting for cost recovery • Pricing based on cost recovery requires sound budgeting practices • Budgets required at the Scheme level as users are registered at the scheme level • Challenges • The regional structures are not aligned to the strategic objectives of DWA. • No clear segregation of functions at regions i.e overlap between WTE and main account functions. • Understatement of expenditure within the regions. 17

18. Budgeting: O&M • Challenges • The pricing strategy is based on the cost within the respective schemes whilst overheads within head office are currently not catered for. • The current budgeting framework does not reflect the need to expend on O&M in terms of a coherent life-cycle strategy for the infrastructure, not simply recover actual costs. • The current budgeting framework is therefore not aligned with international practices within infrastructure operations. 18

19. Budgeting ...cont • Solutions • Establishment of structures where services are shared such as corporate services should be apportioned between main and WTE and other structures should be funded under main account. • Revision of pricing strategy and the funding model will assist WTE in operations and maintenance of infrastructure assets. 19

20. Budgeting: O&M...cont • Solutions • There must be a provision from the fiscus to cater for support functions until such a time that the pricing structure is revised accordingly. • Budgets need to align with the asset management plans (prepared ito GIAMA), that have a minimum planning horizon of 10 years as informed by demand assessment, risk and service performance needs. • The pricing strategy needs to differentiate between the various sectors and socio-economic imperatives. • A prioritisation model is being established as a guide to decision making on budget allocations, to be aligned with the Departmental strategic objectives. 20

21. Water Trading Entity 21

22. Raw Water Pricing Strategy Review 22

23. Brief Background The National Water Act (NWA), 1998 defines the mandate of the DWA as responsible for: Effective, Sustainable and Equitable management of water resources in the country. Furthermore, the NWA grants the Minister of Water Affairs the regulatory authority over water services institutions. 23

24. Brief Background…cont The pricing strategy was seen as a process that evolves over time and aimed at achieving, in a coherent manner the: Efficient and cost effective allocation of water, Equity, Fairness in the allocation mechanism, and Long term sustainability of the natural environment. 24

25. Brief Background…cont • The NWA allows for full cost recovery from registered users. • The Public Finance Management Act (PFMA), 1999 provides for the development of mechanisms to conduct operations: • Effectively • Efficiently and • To make economic use of resources. • The department has embarked on a number of interlinking projects geared at enhancing its ability to achieve these goals. 25

26. Brief Background…cont • The Department conducted a project (“Sakhile”) in 2008 to: • verify and • value its infrastructure in terms of prevailing accounting standards and prepare asset management plans in terms GIAMA • The objective of these plans is to formally document and communicate to stakeholders the strategy and plan for the life-cycle management of the infrastructure in order to meet performance and service delivery objectives. 26

27. Brief Background…cont • Amongst other things, the exercise highlighted the following: • A substantial portion of the infrastructure is in poor or very poor condition ( replacement value estimated to be some R10bn); • Current levels of funding are not nearly sufficient to enable adequate maintenance, renewal and upgrading; and • This scenario of exposure to risk of infrastructure failure will continue to escalate. 27

28. Drivers • WTE conducted a project (“Sakhile”) in 2008 to verify and value its infrastructure assets. • A substantial portion of the infrastructure is in poor or very poor condition (R10 billion backlog). • Current levels of funding are not nearly sufficient to enable adequate maintenance, renewal and upgrading of infrastructure. • Exposure to the risk of infrastructure failure will continue to escalate. • The current pricing strategy gazetted in Government Gazette No. 29696 on 16 march 2007 in terms of s 56(1) of National Water Act, 1998. • Recovery of operations and maintenance costs • A return on assets to provide for future betterments; and • A depreciation charge to provide for ongoing capital refurbishment and rehabilitation costs. • Exemption of ROA ( example. irrigators) • Various stakeholders have from time to time also challenged the relationship between components of the pricing strategy and departmental expenditure. 28

29. Drivers…cont • The R2.6 billion shortfall is as a result of capping (10% plus PPI) 29

30. Problem Statement Water pricing for socio-economic growth Vehicle to subsidise in a more coordinated manner Effective management of the extreme sensitivity of some customers to price adjustments Disparities in tariffs due to an unstructured infrastructure funding model The need to review the pricing strategy in a stakeholder-driven process, understood and supported by the key water use sectors and stakeholders Address resource pollution remains a problem Support the development of clean energy Inequitable and unsustainable difference in the financial burden state/private funded infrastructure 30

31. Problem Statement • Various challenges which impact on the achievement of the abovementioned objectives and the Department’s ability to function optimally have been encountered since the introduction of the new pricing strategy. 31

32. Problem Statement…cont • These include: • A need to compare the current pricing strategy with National government mandate and strategies (i.e. the charges in tariff to be linked inflation target and CPIX etc) • The challenges that exist on the current pricing strategy and the implication thereof on the Full economic cost recovery, Price increasing capping and Tariff exemptions. • The current pricing strategy not doing what it supposes to do with regard to the raising of adequate funding and Influencing water use behaviours in a manner that supports water conservation and demand management. 32

33. Problem Statement…cont • Alignment of legislation to value chain arrangements • NWA/WSA/MFMA. • Water sector pricing not yet fully supporting the development of clean energy • Effective management of the extreme sensitivity of some customers to price adjustments • The need to review the pricing strategy in a stakeholder-driven process with the objective to satisfying the life-cycle funding requirements of the national water resources infrastructure in a way that is understood and supported by the key water use sectors and stakeholders 33

34. Problem Statement…cont • Disparities in tariffs that are due to an unstructured infrastructure funding model, • The infrastructure funding model being a sub-set of the pricing strategy as oppose to the pricing strategy being the sub-set of the infrastructure funding model. • The current pricing strategy only being applicable to the raw water and not for the entire value chain of the water sector on an integrated basis • The current public finance principles utilised 34

35. Problem Statement…cont • The current structure, mechanism and process used to fund the infrastructure • Cross subsidies • Pricing strategy need to align its with the current institutional realignment and other projects (i.e Sakhile for Infrastructure asset data). • A need for a training strategy analysis and development, both short and long term to cover those currently working on the project and those involved in the entre value chain and the funding model to allow for a cost for training fund to be created to assure a project sustainability • The Gaps and inconsistency that exist in the value chain concerning the application of regulation, guiding principles, business plans, agreements and DWA not imposing a tariff methodology on (loose arrangements) water boards 35

36. Problem Statement…cont • Lack of customer analysis (i.e customer grouping and customer tariff analysis) to determine associated charges • Need for a domestic & Industry tariff vs. Irrigation tariff analysis and comparison • Lack of rigorous monitoring and reporting of illegal and unregistered water users and over utilization of water by farmers,due to Independent water regulator non-existence • Existence of different data sources, with a need for verification and validation • A need for an analytical, structured and methodological process to be put in place when it comes to commissioning and decommissioning decisions. • Need for NWRI and WRM review • Need for an in depended regulator 36

37. Problem Statement…cont • Lack of municipal oversight and partnership COGTA (DPLG) with respect to water services. • Water pricing for socio-economic growth - the need for the pricing strategy to also be used as a vehicle to subsidise in a more coordinated manner, certain sectors i.e. currently no coordination between the Departments of Agriculture and Water Affairs. • Water resource pollution remains a problem due to the lack of implementation of Waste Discharge Charge System • The need to make full use of provisions in Section 56 of the NWA – i.e. differentiate between municipalities. 37

38. Problem Statement…cont • An inequitable and unsustainable difference in the financial burden carried by those who are supplied out of state funded infrastructure as opposed to those who are supplied out of privately funded infrastructure (off budget schemes). • Charges need to reflect the relative socio economic value of water. • The need to reflect the intergenerational share of debt (cost) burden. Look at ownership along the value chain where for example different institutions are getting direction from various legislation, resulting in reporting silos. 38

39. Project Goals and Objectives • The water sector infrastructure funding model and pricing strategy review project is to be designed to meet the challenges presented by the current and growing imbalances which exist between the supply of and demand for water in South Africa. • To this end, a project is under design to review the infrastructure funding model and pricing strategy for the entire water sector value chain, and • In executing this revision, we are guided amongst other by the achievement of Social equity; Ecological sustainability; Financial sustainability; and Economic efficiency principles. 39

40. Project Goals and Objectives…cont • The goal of this project is therefore, to assist the department in achieving the above-mentioned objectives through efficient application of a pricing strategy, that is anchored on a funding model benchmarked against best practice. • At an operational level, the project will thus facilitate achievement of the following objectives: • Efficient revenue management; • Key customer focus; • Effective infrastructure lifecycle management; • Improved accountability; • More effective use of available sector funding; 40

41. Project Goals and Objectives…cont • Improved environmental management measures; • Better manage the supply and demand of water; • Better coordination with other government departments; • Better coordination with the private sector; • Provide for the ability to meet growth in demand; • Stakeholder cooperation; and • Ring fencing of water business to address related challenges. 41

42. Underlying Principles • The project will be a people-led process managed according to the following underlying principles: • Sectoral and affected stakeholders fully included in deciding on appropriate solutions to the pricing of raw water in the country; • Fair and equitable treatment of all sectoral interests; • Alignment with the Water Sector Institutional Realignment Project; • Alignment and linkages with departmental initiatives, and avoid “reinventing the wheel”; • Best practices driven; • Transparency • Solutions will be based on the achievement of government and department’s objectives; • Strict adherence to legal norms; and • Evidence based solutions through rational quantification. 42

43. Project Scope • Project Includes : • The Review of the entire water sector as-is situation including (refer to project plan implementation plan for details) : • Catchment management; • Funding Model; • Institutional Realignment; • Technical; • Regulatory, Legal and Governance; and • Stakeholders Communication and consulting 43

44. Project Scope…cont • Key attributes of the current raw water Pricing Strategy such as: • Legal efficacy; • Financial viability; • Constitutional mandate of the department; • Affordability and socio-economic sustainability; • Water quality improvement; • Private sector debt funding; • Other issues, i.e. clean energy promotion, etc; • Ecological sustainability; and • Fiscal analysis. 44

45. Project Scope…Cont • Assessment of options and the development of a position paper Through: • Considering the As-Is recommendations; • Funding position paper; • Water sector value chain pricing position paper; • international project funding arrangements; • Fiscal impact analysis; and • Costs benefit analysis of proposed solutions. 45

46. Project Scope…Cont • Evaluate effectiveness of block tariff system and multi year systems; • Assess economic value of water; • Development of a coherent water infrastructure funding model; • Gazetted and reviewed National Water Pricing Strategy; and • Tariff calculation principles, methodologies and guidelines. 46

47. Project Deliverables • The main deliverables are: • The Project Charter; • Project Plan; • An as-is report (situational assessment); • Assessment of options and the development of a position paper; • Development of a coherent water resources infrastructure funding model; • Gazetted and reviewed National Raw Water Use Pricing Strategy; and • Tariff calculation methodologies and guidelines. 47

48. Critical Success Factors • Participation, consultation of all relevant stakeholders; • Support by DWA senior management; • Adequate / appropriate resourcing of the project; • Designation of the project as a priority in the current financial year; • Integration with other relevant departmental initiatives; • Communication and change management; • Transparency within the sector; and • Alignment with the IR project. 48

49. Assumptions • There will be no need to invest in or change existing technological infrastructure • There are resources (human and financial) committed into the project • The project has support at the right levels of management • The project is necessary and a priority to be undertaken this financial year • Solutions will be based on benchmarked best practice • Information on asset values, operations costs and economic life is available • Sector stakeholders will commit the necessary resources to the project 49

50. Areas of Dependencies • While broad institutional arrangements have been agreed, institutional realignment has not been completed, whereas the funding model and pricing strategy depend on the water sector institutional framework. 50