A Discussion of Regulatory Issues in the Water and Sanitation Sector

Katharina Gassner, PhDWorld Bank Group

IWA Bucharest, June 17, 2014

Outline

Regulation in the International Context

Country Specific Options for Establishing a Regulatory Framework

The Role of the Private Sector

Regulating State-Owned Enterprises

Benchmarking

3

Economic Regulation in InfrastructureWhy is it Needed?

Infrastructure markets are imperfect and long term contracts are incomplete.

Regulation is different from Policies. It is a technical function that helps balance the interests of users and of operators. It is meant to issue/enforce decisions/recommendations using technical tools

and consistent with boundaries set by pre-existing policies/laws/contracts. Regulation does not replace policies.

Regulation provides a level playing field to all stakeholders in the sector. autonomous third partyequal treatment of all operators, private and public effective regulation provides a transparent, predictable operating environment

(important for investment!)

Economic Regulation focus on Ex-ante Interventions, not on Ex-Post actions. This is the difference with Competition Laws.

The Rise of Regulatory Agencies outside the OECD (by sector)

19821991

19941997

20002003

20062009

20120

50

100

150

200

250

ICT Electricity WSS

# o

f n

ati

on

al re

gu

lato

rs

Sources: ITU (ICT); authors’ database (electricity and WSS)Note: WSS is incomplete.

Regulation as ONE of the tools for Government

Establishing a Regulatory Framework:No One-size-fits-all

Regulatory Functions Need to be Matched to Sector Objectives

Problem Possible regulatory core functions

The utility is efficient, but average tariffs are above cost

Limit tariffs to no more than costs

The utility is efficient, but average tariffs are below cost

Provide a neutral and authoritative view on reasonable cost recovery tariffs, providing legitimacy for tariff increases

The utility is inefficient. Average tariffs are below actual costs, but above efficient costs

Support effective governance and incentive structures to provide pressures for efficiency

Allow tariffs to rise to cover actual costs (in short term these costs may be above efficient levels, but in longer term these costs should decrease to efficient levels)

The utility is inefficient. Average tariffs are below efficient cost

Support effective governance and incentive structures to provide pressures for efficiency

Allow tariffs to rise to cover actual costs

Tariffs are at cost, but some customers cannot afford service

Allow cross-subsidies between consumer categories

Option 1: Standard Independent Regulatory Model

Option 2: Regulating Private Providers by Contract

Example: Bucharest Water and Wastewater Concession

1990 1995 2000

Liberal-democratic Government elected

The Example of the Bucharest Water Concession

Associate EU membership

End of Communist dictatorship

1996 2007

Full EU membership

RGABICAB Apa Nova

November: Veolia takes over

19981997

March: Concess-ion signed

2001

May 2001 and Oct. 2002:Staff strikes

2002 2006

Apa Nova sells 10% of shares to employees

2008

Comprehensive agreement and contract amendment

2003

-

20

40

60

80

100

120

140

160

180

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Water quality

Customer satisfaction

Staff per 1,000 connections

Non-revenue water (l/km/d)

Typical Household Bill (real)

The Results of the Apa Nova Water Concession

♦ Was the Bucharest water and wastewater concession a success, as measured by:– Access? Increased from 90 to 92 percent and expanding in the unmapped areas– Quality of service? Improved and approaching Western European standard– Tariff? Remained below average and far below Western European level– Operating efficiency? Increased thanks to higher labor productivity and energy efficiency– Fiscal impact?Saved US$349 million– Private investment mobilized?EUR200 million (US$250) since the start of the concession

♦ What are the lessons for future water PPPs?– A committed public authority– A committed and expert advisory team– A well-prepared, high quality, and transparent transaction process– An unusually thoughtful and innovative contract design– A well-negotiated plan for the staffing reduction– Well-designed and implemented contract monitoring and dispute resolution arrangements.

The Connection Between Utility Performance and Private Sector Participation

Global evidence on a sample of suggests private sector participation has a strong positive effect on performance:

• number of residential water connections up by 12 %• electricity sold per worker up by 32%• residential coverage in sanitation services up by 19%• bill-collection rate in the electricity sector up by 45%• distribution losses in electricity down by 11%• hours of daily water service up by 41%

These effects—differences in averages between the pre-PSP and the post-PSP period—occur over five years or more and are over and above the change for similar SOEs.

Source: Does Private Sector Participation Improve Performance in Electricity and Water Distribution? Katharina Gassner. Alexander Popov. Nataliya Pushak. PPIAF 2009

An Important Role for Private Investment Flows –but they are vulnerable to crises….

Private investment commitments to PPP projects in developing countries, by sector, 1990–2009

0

20

40

60

80

100

120

140

160

180

1990 1995 2000 2005 2009

2009 US$ billions* Number of projects

13

Source: World Bank and PPIAF, PPI Project Database *Adjusted by the US Consumer Price Index

Mexico and Argentina

Expansion

TequilaCrisis

Asian Crisis

Brazil Crisis Market

Liquidity Global Crisis

?

… and difficult in WSS

Telecom Electricity Transport Water and sewerage

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

Latin America & Caribbean Europe & Central AsiaSub-Saharan Africa East Asia & PacificSouth Asia Middle East & North Africa

Source: PPIAF PPI database

The Role of Regulation in the Case of State Owned Enterprises

Objective: improve the accountability for water and sanitation sector performance

The institutional framework needs to:

♦ take into account conflicts between roles (ownership vs rule making)

♦ impose on service operators a set of rules and contractual relationships that:– establishes accountability through absolute clarity of roles and

objectives;– specifies rights and obligations consistent with those roles– provides necessary incentives and sanctions to encourage efficiency

(hard budget constraint);– ensures that incentives are aligned with wider social interests;– sets out clear principles and processes to be applied when

circumstances change or disputes arise.

Benefits of benchmarking in regulation

Strong incentives are provided to operators to be efficient and innovative, mitigating the costs of operation and the capital expenses;

An on-going pressure is put on the water utilities to improve the quality of service;Main advantages of benchmarking

use A fairer recovery of costs and of the capital investments is assured;

An increase of transparency and sharing of information, minimising its asymmetry between different stakeholders (specially between regulator and operators).

Compulsory or voluntary

Economic and/or quality of service aims

Publicised or just for operators

Benchmarking

8th September 2008

WSS regulation in England and Wales (E&W) is pointed out, in the literature, as one of the successful examples of YC application

Determination of the Overall Performance Assessment, measured through a compilation of several performance indicators

Quality of service

YC (Sunshine regulation)

Office of Water Services (OFWAT)

Regression DEA

Determine the efficient costs that are the basis for the X factors calculation (in the price cap formula)

Case studies – Benchmarking to set prices (1/2)

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Chile

WWS regulation in Chile (SISS)

Based on benchmarking in which a (efficient) model company is set for each operator;

There is no comparison with real operators but with a hypothetical operator;

… efficient operator is imposed to enable the regulator to

determine the base costs for the setting of tariffs and it can further include the expected

productivity earnings (X factor) in the price cap formula

Colombia

La Comisión de Regulación de Água Potable y Saneamiento Basico (CRA)

Economic regulation of the water sector

Definition of methods and tariff formulas

It uses benchmarking (DEA technique) to compute the efficient administrative costs and the efficient OPEX;

Based on a system of price cap defined for a period of five years which also includes a prices floor (minimum limit of 50 %).

Regulatory Process

Case studies – Benchmarking to set prices (2/2)

Case studies – Benchmarking to improve quality (1/2)

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The regulator (now Essential Services

Commission – ESC) applies sunshine

regulation here since 1994.

• the quality of service supervision

… increases the transparency and accountability of the WWS.

Victoria, AustraliaResponsible for…

the quality of the supplying (e.g. water quality and compliance with the norms);the service reliability (e.g. interruptions, non-revenue water and blockages);the services availability (e.g. prices, special customers and lack of payment);the customer service (e.g. call centres, claims and customers’ satisfaction).

• the economic regulation

The WSS performance improvement can be seen, i.e., in the evolution of

the indicator water interruptions

Case studies Benchmarking to improve quality (2/2)

20

ERSAR - Sunshine regulation model

16 PIs computed and published annually;

Reference values for each PI;

Explanatory factors (for each PI);

Operators are categorized with three balls (green, yellow and red).

Portugal

Set of PIs Number

Protection of user interests 5

Operator sustainability 7

Environmental sustainability 4

Conclusion (1/2)

Working towards more effective economic regulation in infrastructure

is key, because regulation influences the performance of the sector, in

the short (productive efficiency) and long term (investment and

expansion of services).

Not everything is regulation: sector policy matters, and weaknesses there (in rules and institutions) have a major impact on results on the ground.

Improving internal governance is an equally important pillar of reform, i.e.: for PPPs: Contracts design for SOEs: internal systems of incentives and governance which

affect their own drivers of performance and sensitivity to economic regulation.

Conclusion (2/2)

The benefits of using yardstick competition are well visible in the cases

analyzed, including in the case of sunshine regulation (takes longer, but often

best option).

Ultimately, what matters for successful regulation is

technical soundness of decisions, coupled with common sense that

recognizes the political/social dimension of these services;

legitimacy, autonomy & accountability of the regulatory institutions;

transparency, predictability & credibility of the rules & processes in place.

A last word: good communication can strengthen a regulator, increase its

effectiveness and improve its autonomy.

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THANK YOU

Dr. Katharina Gassner

kgassner@worldbank.org