consumer tariffs in practice - oecdconsumer tariffs in practice ... framing the problem ... retail...

© 2007 IRAR OECD – 14 November – JSP

IRAR

OECD expert meeting on

“sustainable financing for affordable water services: from theory to practice”

Consumer tariffs in practice

- The Portuguese experience -

João Simão Pires

Director, The Institute for the Regulation of Water and Solid Waste

Paris, 14 November 2007

IRAR – Instituto Regulador de Águas e Resíduos

Centro Empresarial Torres de Lisboa, Rua Tomás da Fonseca, Torre G – 8º, 1600-209 Lisboa, Portugal

Tel: +351 210 052 200, Fax: +351 21 371 26 61, [email protected], www.irar.pt

IRAR


IRAR

2

Consumer tariffs in practice: the Portuguese experienceTopics addressed

1 Framing the problem

2 Defining the guiding principles for a solution

3 Outlining, implementing and monitoring the chosen strategy


IRAR

3

Framing the problemThe Portuguese water services sector structure

• Starting point: fragmented industry structure, yet fully integrated local monopolies at the

municipal level.

– Recent (last 15 years) regional aggregation at the wholesale level;

– Introduction and expansion of new management models.

• 23 wholesale water service

providers who serve more than

one municipality

• 275 retail water service

providers, of which:- 245 cases of direct provision by

municipalities

- 15 municipal corporations

- 20 municipal concessions

• a Portuguese household may

have between 1 and 4 distinct

operators involved in the

provision of its water supply and

wastewater services

• 110 municipalities have less

than 10 000 inhabitants

Retail water supply service providers Wholesale water supply service providers


IRAR

4

Framing the problemFinancial sustainability of wholesale operators

• IRAR‟s assessment is that the financial sustainability of wholesale water service operators is

“challenging” in one third of the cases and another third is “unsustainable” unless significant

change is implemented.

Wholesale water supply only Wholesale wastewater

treatment only

Robust/ affluent

Challenging

Unsustainable

Combined wholesale water

services

Note: EPAL excluded from

analysis because it is not a

concession.

In addition to retail water

supply services to Lisbon

city, it is also a wholesale

water supplier to another 20

operators.


IRAR

5

Financial sustainability of wholesale operatorsThe role of structural factors

• Although structural factors such as scale and demographic concentration play a key role, they

do not tell the whole story…

0

100

200

300

400

500

600

700

0 2500 5000 7500 10000 125000 10 20 30 40 50

A. Norte Alentejano

A. Minho e Lima

Simlis

A. Centro Alentejano

A. Centro

A. Santo André

Simarsul

A.T.M. Alto Douro

A. Zêzere e Côa

A. Ave

A. Mondego

A. Cávado

Simria

A. Oeste

Sanest

Simtejo

A. Douro e Paiva

A. Algarve

Wholesale water supply turnover – 2006 (1)

Million euros

Analysis of the impact of contextual factors

Thousands of

households

served (2)

Area covered (Km²)

Simtejo

A. Algarve

A. Douro e Paiva

A.T.M. Alto DouroSanest

A. Ave

A. Oeste

A. Cávado

Simria

(2) Sum of the number of households served by wholesale water supply services with the number of households served

by wholesale wastewater services, when applicable.

A. Centro

A. Norte Alentejano

A. Minho e Lima

A. Mondego

A. Centro Alentejo

Simarsul

A. Zêzere e Côa

A. Santo André

Simlis

(1) EPAL excluded from analysis because it is not a concession. Wholesale water supply activities

cover 5 400 Km², serve 1.2 million households and generate a turnover of 90 million euros.


IRAR

6

Financial sustainability of wholesale operators (ii)Accumulation of customer receivables

• … lack of investment on the retail side means that wholesale operators are not being able to sell

the volumes for which they sized their infra-structure and,

– Not only are they selling less, but their customer receivables are also building up…

181

1.114

528

453

427

271

211

211

195

170

166

143

138

127

103

101

74

61

54

84

0 200 400 600 800 1.000 1.200

SECTOR

Simtejo

AdNA

Simria

AdCávado

AdZC

AdCA

AdTM AD

Simarsul

AdCentro

AdSA

AdAve

AdOeste

AdM L

Simlis

Sanest

AdM ondego

AdAlgarve

EPAL

AdDP

Dias

Days receivables of wholesale water service operators - 2006 Recente evolution of wholesale average days receivables – 2003/06

Days receivables

Retail average (25 to 40 days)


IRAR

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Retail price levelsInsufficient cost recovery

• … and the financial bottleneck lies at the retail (municipal) level:

– End-users not being charged the full service costs;

– Competing demands for municipal budget appropriations.

Média aritmética: € 22/ ano

Média aritmética: € 73/ ano

Sources: APDA – Association of Portuguese Water Distributors, 2004; IRAR analysis.

309 Portuguese municipalities (ranked in descending order)

Arithmetic average for 120 m³

water supply/ year =

€22/ household/ year

Retail wastewater treatment charges for residential customers

Average for municipal

concessions =


Arithmetic average for 120 m³

water supply/ year =


Average for municipal

concessions =


Retail water supply charges for residential customers

Average wholesale

cost recovery levels


IRAR

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48%

40%

6%6%

Retail price levels

“Willingness to pay”

Sources: IRAR “Willingness to Pay Study”, 2007. Results based on national survey comprising 1,010 face-to-face interviews of residential customers.

48%

9%

41%

2%

“How do you rate the

quality of the water

supply services you get?”

“Good”

“Average”

“Bad”

47%

4%

31%

18%

“How do you rate the

quality of the wastewater

services you get?”

“Average”

“Good”

“Bad”

“Compared with the cost

of other utilities my water

bill is…?”

“Cheap”

“Fair”

“Expensive”

“Would you be willing to

pay a little bit more each

month to guarantee a

higher level of quality in

your water services?”…

19%

70%

2%

9%

• One can start by asking end-users if they “are willing to pay a little bit more to guarantee a

higher level of quality” in their water services…

– Which is what we’ve recently done.

“No” “<€2”

“€2 to €5”

“>€5”


IRAR

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Willingness to pay“Why not?”

Sources: IRAR “Willingness to Pay Study”, 2007. Results based on national survey comprising 1,010 face-to-face interviews of residential customers.

• ... Yet, the more interesting issue is understanding why they are not willing to pay more...

15%

5%

16%

44%

19%

“I already pay too much

taxes”

“Its up to the government

to guarantee these

essential services”

“These services are

already too expensive”

“I would pay more and

nothing would change”

“Business”

marketing

challenge

“Government/

Institutional”

marketing

challenge

Reasons advanced by the 70% of residential end-users unwilling

to pay a little bit more to guarantee higher quality of their water

supply and wastewater services


IRAR

10

AffordabilityIdentifying and quantifying the issue

Macro-affordability: “Social issues in the provision and

pricing of water services” – OECD, 2002

0,5%

0,6%

0,7%

0,7%

0,7%

0,9%

0,9%

1,1%

1,2%

1,2%

1,0%

1,4%

1,0%

1,2%

2,1%

2,2%

0,4%

0,8%

1,6%

0% 1% 2% 3% 4%

Portugal (2004) - IRAR

USA (2000)

South Corea (97-98)

Italy (97)

Japan (2000)

Scotland (97-00)

Portugal (2000) - INE

Slovakia (2001)

France (95)

Denmark (98)

England & Wales (97-00)

Germany (2000)

Austria (97)

Netherlands (99)

Luxemburg (97)

Portugal (97) - OECD

Turkey (97)

Hungary (2000)

Poland (99)

Water supply and wastewater charges as % of household disposable income

2,4%

• … If they are not willing to pay for it, can households at least afford it?

– One in ten are likely to be strained, and specific mechanisms have been designed to address their situation.

Sources: IRAR “Affordability Study”, 2007. INE - Portuguese National Statistics Institute, “National Survey of Household Expenditures”, using UNESCO’s COICOP classification, 2000.

1,7%

1,5%

1,3%

Affordability

threshold

Micro-affordability: IRAR “Affordability Study”, 2007

(2004 data)

Methodology

• Household income threshold set at one minimum wage

(€5,125/ year)

• Consumption level of 120 m³/ year

• Affordability threshold set at 3% of household

disposable income (OECD, UK)

Quantification

• 785,000 households below income threshold (19.3% of

total Portuguese households)

• Of these, 426,000 exceed the affordability threshold,

i.e. 54% of low income households

– National maximum of 7.5% likely to impact 6,600

households.

• Conclusion: 10,5% of Portuguese households fail the

chosen affordability criteria.

Location

• In 60 municipalities (out of 309);

• Mostly (47) in the North and Tagus Valley regions;

• In these municipalities, affordability constraints likely to

impact between 15% and 30% of households.


IRAR

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912

804

310

218171

106

Personal

transport

vehicles

Annual household expenditure with different

consumption categories – Portuguese average - 2000

Affordability“Looking at the other 90%”

• … however, for the vast majority of Portuguese households, affordability is, fortunately, not an

issue…

7,33%

Restantes

despesas 92,67%Abastecimento e

saneamento

0,76%

Energia

3,44%

Telefone,

telégrafo e telefax

3,12%

€1013/ year

€106/ year

€475/ year

€432/ year

Other

household

expenditures

92,67%

Water supply and

wastewater

0,76%

Residential

energy (gas &

electricity)

3,44%

Telco

services

3,12%

Household

utilities

7,33%

Residential utility expenditure as % of total

household expenditure – Portuguese average - 2000

Sources: IRAR “Affordability Study”, 2007. INE – The Portuguese National Statistics Institute, “National Survey of Household Expenditures”, using UNESCO’s COICOP classification, 2000.

Clothing &

footwear

Euros/

year

Hygiene &

personal care Tobacco

products

Alcoholic

beverages Water supply

and wastewater

services


IRAR

12

0

50

100

150

200

250

0 15000 30000 45000 60000 75000

Volume supplied to end-users in Lisbon city („000 m3)

(Esc/m3

at constant

2000 prices)

Average price to end-

users

19791979 1979

198619861986

2000

2000

Evolution of average prices per m³ and volumes supplied to end-users in Lisbon (1977/2000)

% vol (80-85) (1)

% preço (80-85)

0 % = - 0.08 = - 0.05- 8 %

+ 100 %

- 5 %

+ 100 %

Residential end-users

Non-residential end-users

End-user total

Source: EPAL analysis; Commission staff working paper “Water Pricing Policies in Theory and Practice”, Jul 2000.

Notes: (1) Estimates of demand-price elasticity in the literature tend to fall in the range of -0.10 to -0.25.

Retail price levels“Ability to pay – a case study”

• … In fact, during the early 1980‟s, over a five-year period, retail water supply prices more than

doubled in real terms in Lisbon city.


IRAR

13

• To address the problem, one needs to understand the system

mechanics governing the interactions among stakeholders and

decision makers that govern decision outcomes around water

service pricing.

Absence of a

consensus around a

common pricing

framework

Opportunistic and

tactical reasoning

behind tariff reviews

Excessive

complexity,

“politics” and

time-waste around

tariff review

processes

Ad-hoc evolution

of tariff structures

Incomprehension

and frustration among

end-users and their

representatives,

amplified by

the media

Very large

heterogeneity of

tariff structures

in the sector

Deficit of

communication and

pro-active end-user

expectation

management

Environmental

Economic

efficiencySocial

Business

Distinct views on

potentially conflicting

goals among

stakeholders and

decision makers

Framing the problem

“Understanding the current deadlock”


IRAR

14






IRAR

15

• Service provision cost efficiency also needs to be improved and that requires the clarification of

the “ground rules” needed to allow capturing potential:

– Economies of scale (increasing the geographical market served)

– Economies of scope (synergies between water supply and wastewater services)

– Process economies (synergies in the vertical integration between wholesale and retail services)

Abastecimento

em alta

Wholesale water supply

Abastecimento

em baixa

Retail water supply

Saneamento

em alta

Wholesale wastewater treatment

Saneamento

em baixa

Retail wastewater collection

Wholesale water services

Retail water services

Water services

End-user tariffs

Transfer prices/ prices charged to retail operators

Allocation criteria for

common costs, income

and capital

Auxiliary non-

core, non

regulated

activities

Guiding principles for a solutionPromoting industry restructuring where it makes sense


IRAR

16

• Key principles of the “Pricing regime governing water and solid waste services provided to

end-users”:

– Full long-term service cost recovery in a continuous improvement scenario

– Promoting the efficient use of water resources and the protection of their quality

– (Urban solid waste: RRRR)

– Defending end-users from monopolistic price-quality value offerings

– Ensuring affordability conditions for those who need them

– Avoiding cross-subsidisation

– Transparency and public disclosure

– Common tariff structure and terminology nationwide

– Equilibrium and common sense

Guiding principles for a solutionNew national legislation


IRAR

17

Custo marginal do serviço para o utilizador

-5 0 5 10 15 20 25 30 35

Nível de consumo por cada intervalo temporal de 30 dias) (m3)

€/ m

3

New national legislationCommon tariff structure: rationale

• The rationale for a common pricing structure needs to be explicitly articulated, openly

discussed, bought into and then, written in stone.

Marginal cost of water supply service to end-users

Water consumption level during each 30 day interval (m³)

€1 household = (1 + VAT rate) = €1.45 business

expenditure (1 – CIT marginal rate) expenditure

Wastewater variable = (Water volume x 0.8) x (water variable component) x relative cost = x% of water variable

component (water volume) coefficient component


IRAR

18






IRAR

19

New national legislationCommon tariff structure: details

• Water supply tariff structure

– Fixed (availability) tariff (€/ 30 days), equal regardless of

meter nominal diameter (up to 25 mm)

– Variable tariff (€/ m³), with 4 increasing blocks

– 0 a 5 m³/ 30 days (25 a 45% of end-users)

– 5 to 15 m³/ 30 days (30 to 60%)

– 15 to 25 m³/ 30 days (10 a 20%)

– Above 25 m³/ 30 days (0 a 10%)

• Wastewater treatment tariff structure

– Fixed (availability) tariff (€/ 30 days)

– Variable tariff (equivalent to a % of the variable water

supply component)

• Possibility of “social” price plan for low income

households (below 2 minimum wages)

Residential end-users Non-residential end-users

• Water supply tariff structure

– Fixed (availability) tariff (€/ 30 days), differentiated

according to meter nominal diameter

– Flat variable tariff (€/ m³), set equal to the 3rd residential

block

• Wastewater treatment tariff structure

– Fixed (availability) tariff (€/ 30 days)

– Variable tariff (equivalent to a % of the variable water

supply component) or flat variable tariff when

measurement is technically and economically justifiable

• All non-residential end-users pay according to a

common price plan

– Government, municipalities, …

– Only possible exception is non-government social

solidarity institutions

Other clarified aspects

• End user and operator rights and duties

• Minimum information requirements and terminology for invoices, meter reading periodicity, invoicing frequency and payment terms

• Possibility of seasonal variable water tariffs (peak-load pricing) in the case of excess demand/ abnormal resource scarcity

• Clarification of activities are already included in the service tariffs and, therefore, cannot be charged separately

• Identification of auxiliary services that can be charged specifically

• Cost items to be included in the determination of service costs

• Rounding procedures


IRAR

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• The strategy reflected in the new legislation seeks to ensure an adequate and politically

balance in terms of decision-right allocation:

– Some key features become a matter of law and are mandatory;

– In addition, the regulator issues non-binding recommendations (coaching role, in addition to controller);

– Significant margin for discretion is still given to local authorities who approve water service tariffs.

“Principles in the new legislation (Tariff Regime)”

+ “Common tariff structure”

+ “Specific local circumstances”

+ (“IRAR recommendation”

x “degree of discretion used by ultimate

decision maker”) =

“Water service tariffs”x

Service utilisation (time and intensity)

=Service costs for each end-user

Outlining the strategyDecision right allocation

Custos mensais do serviço de abastecimento e saneamento

0

20

40

60

80

100

120

140

160

180

200

0 5 10 15 20 25 30

m3 de água consumida/ mês

Eu

ro/ m

ês

Máximo - Não doméstico

Máximo - Doméstico

Mínimo - Doméstico

Mínimo - Não doméstico

IlustrativoMonthly costs of water services to end-users

Illustrative

Monthly water consumption (m³)

Non-residential (maximum)

Residential (maximum)

Residential (minimum)

Non-residential (minimum)

Custos unitários do serviço de abastecimento e saneamento por m3 de água consumida

0

2

4

6

8

10

12

5 10 15 20 25 30 35 40 45 50

m3 de água consumida/ mês

Eu

ro/

m3

Máximo - Não doméstico

Máximo - Doméstico

Mínimo - Doméstico

Mínimo - Não doméstico

Monthly unit costs of water services to end-users per m³ of water consumed

Monthly water consumption (m³)

Non-residential (maximum)

Residential (maximum)

Non-residential (minimum)

Residential (minimum)

Illustrative


IRAR

21

• IRAR‟s role will go beyond the mere enforcement and supervision of the adherence to new legal

requirements

– It will also act as a coach to help the most challenged operators to gradually change.

IRAR

recommendation or

periodic updateUntil June IRAR

On-going activities

• Development of software applications aimed at assisting the operators in implementing the tariff

regime

- Management accounting criteria and tools to determine each service’s P&L

- “On-line Tariff Regime” (simulation of tariff compliance with legislation and IRAR’s

recommendation, revenue simulator and interface for data reporting)

• Training initiatives, ad-hoc financial audits and inspection initiatives to monitor compliance with

new legislation

Analysis of some

tariff proposals

Sept. to December

Reporting to IRAR

(tariffs and operator

financial statements)Feb. to May

Final decision by

local authorities Nov. to January

Regulatory cicleData analysis,

validation, interpretation

and publicationMarch to October

Implementing the strategyThe role of the regulator


IRAR

22

Monitoring the strategy

“The convergence zone”

Convergence

zone simulation

Retail water supply charges for residential customers (120 m³/ year)

Convergence

zone simulation

Retail wastewater treatment charges for residential customers (120 m³/ year)

Sources: APDA – Association of Portuguese Water Distributors, 2004; IRAR analysis.

309 Portuguese municipalities (ranked in descending order)

• IRAR will monitor the pace of conversion towards a full cost recovery zone, which in some

cases will be quite challenging…


IRAR

IRAR – Instituto Regulador de Águas e Resíduos

Centro Empresarial Torres de Lisboa, Rua Tomás da Fonseca, Torre G – 8º, 1600-209 Lisboa, Portugal

Tel: +351 210 052 200, Fax: +351 21 371 26 61, [email protected], www.irar.pt

Thank you!

IRAR

Regulation as an

instrument to improve

the efficiency and the

effectiveness of public

water and waste

services

consumer tariffs in practice - oecdconsumer tariffs in practice ... framing the problem ... retail...

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