Methodology for CBA preparationSOP Environment

Programming Meeting for water and wastewater projects in the period 2008-2009

Mamaia, 10-13th July 2008

Massimo Marra

JASPERS Regional Office for Romania and Bulgaria

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JASPERS activities

� ‘Joint Assistance to Support Projects in European Regions’� Advisory services to MAs and Final Beneficiaries – EC/EIB/EBRD

√ Objectives: increase the capacity of beneficiary countries, support them to make best use of EU funding, improve/speed up fund absorption

� JASPERS concentrates on Major Projects :

- Transport and other sectors €50 M > capital cost- Environment €25 M > capital cost

� JASPERS priorities are :- large projects supported by Cohesion Fund and ERDF- other Cohesion Fund projects- other ERDF projects

� Horizontal Issues covering more than one country/sector (as CBA)

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What does JASPERS offer?

� Assistance from early stages of project through to the

decision to grant assistance

� Preparatory work required to deliver a mature project e.g.� Advice on conceptual development and project structuring

� Advice on project preparation e.g. cost-benefit analysis, financial

analysis, environmental issues, procurement

planning.

� Review of documentation: feasibility studies, technical

design, tender documents.

� Advice on compliance with EU law (environmental,

competition and others) and conformity with EU policies

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� Article 40 Council Regulation 1083/2006 –

- Major Projects: MS to provide the Commission with (…)

a cost-benefit analysis, including a risk assessment and the foreseeableimpact on the sector concerned and on the socio-economic situation ofthe MS

� EC Guidance

- WD 4: clarifications for period 2007-2013

- WD 4: MS encouraged to develop own CBA framework

- EC CBA GUIDE– revised version published in June 2008

� ULTIMATE GOALS

� Ensure soundness and consistency across project proposals

� Facilitate and speed up approval process (both RO and EC)

Rationale for JASPERS support on CBA

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National CBA Guidelines

� Being developed jointly by Romanian Authorities (MESD – MEF) and JASPERS

� National CBA Guidelines to be consistent with EC and Romanian requirements (HG 28/2008)

� Valid for ALL projects co-financed by Structural Funds

� General CBA Guidance document� Rationale and objectives

� What is a CBA and why/when perform it (small projects)

� General methodological Approach (discount rates, reference period, etc.)

� Macroeconomic assumptions and data to be used

� Valid for all sectors

� To be formally embedded in national approval process

� Sectoral CBA Guidelines for Water, Transport, SW and Energy� Strategic approach and definition of objectives

� Project identification and demand assessment

� Feasibility and Option Analysis

� Financial Projections

� Economic Analysis

� Risk and Sensitivity analysis

� Conclusions and presentation of results

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STRUCTURE OF CBASTRUCTURE OF CBASTRUCTURE OF CBASTRUCTURE OF CBA1. Option and Feasibility Analysis1. Option and Feasibility Analysis1. Option and Feasibility Analysis1. Option and Feasibility AnalysisHow can an objective be achieved? Are the selected options feasible?

2. Financial Analysis2. Financial Analysis2. Financial Analysis2. Financial AnalysisDoes the project need cofinancing? Does the project need cofinancing? Does the project need cofinancing? Does the project need cofinancing? How much money is necessary to implement the option selected?

3. Economic Analysis3. Economic Analysis3. Economic Analysis3. Economic AnalysisIs the project worth cofinancing?Is the project worth cofinancing?Is the project worth cofinancing?Is the project worth cofinancing? What is the impact on the area where the project is going to be implemented?

4. Risk Analysis4. Risk Analysis4. Risk Analysis4. Risk AnalysisWhich are the most likely financial and economic results?

CBA main

elements

CBA main

elements

General CBA Structure

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Sequence of CBA – Water/WW projects

� Strategic approach and definition of objectives

� Project identification and Option Analysis

� Financial Projections

� Economic Analysis

� Risk and Sensitivity analysis

� Conclusions and presentation of results

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Strategic approach

� Main strategic drivers

� Compliance with EC Directives

� Improvement of water resource management (Regionalisation)

� Expected impact on regional development

� Project must be consistent with National policy,

NSRF and SOP priority areas

� Project to support the achievement of SOP

objectives

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Definition of Project Objectives

Objective 1 Provide adequate water and sewerage services, at accessible tariffs

Objective 2 Provide adequate drinking water quality in all urban agglomerations

Objective 3 Improve the purity of watercourses

Objective 4 Improve of the level of WWTP sludge management

Objective 5 Create innovative and efficient water management structures

SOP Objectives – Priority Axis 1

Example Project Objectives

Specific Objective Values without project Expected value after

completion

1. Increase in coverage of water

and sewerage services

% of population connected to

water supply and sewerage

systems

% of population connected to

water supply and sewerage

systems

2. Improvement of quality of

drinking water to meet EU

standards (98/83/EC)

% of population with drinking

water meeting EU standards

% of population with drinking

water meeting EU standards

3. Increase of coverage of

wastewater treatment to meet

Urban WWT Directive

Number of agglomerations with

adequate wastewater treatment

Number of agglomerations with

adequate wastewater treatment

4. Establish efficient operators

and associated structures

(ROCs, IDAs)

Number of ROC/IDA with

adequate set up and capacity to

manage water/ww systems

Number of ROC/IDA with

adequate set up and capacity to

manage water/ww systems

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Option Analysis and Selection

Assessment of existing infrastructures

Identification of problems(How/Why objectives are not met)

Identification of options(What can we do to meet

objectives)

First screening and shortlistMulticriteria analysis

Comparison of retained options(technical and economic)

Selection of preferred option

Project Objectives

National policy and

SOP Objectives

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Financial Analysis

� To establish the level of financial self-sufficiency, financial performance and sustainability of the project

� Projections of financial flows of the project for without(baseline) and with project scenarios:

� Total planned investment (including residual value)

� Revenues (demand evolution and tariff increases)

� Operating and maintenance costs (also estimate cost savings)

� In local currency and then translation into euros

� Reference period typically 30 years

� Financial discount rate set at 5%

� Project impact = Difference between with and without scenario

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Establishing scenarios

With Project Without project

Macroeconomic data Shall be valid for all projects (NSRF)

Population dynamics Same in both scenarios

Service levels

Connections and metering rate

Water consumption (domestic&not)

Physical losses & infiltration

O&M costs

Financial performance

EBITDA & EBIT

Cash flows and reserves

Debt service coverage (DSCR)

Tariff development and Affordability

Tariff increase steps Polluter pays Principle!!

Affordability constraints Equity considerations!!

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Project profitability indicators

� Incremental cash flows used to determine financial performance indicators before and after EU grant� “before” FNPV/C needs to be <0 (or FRR/C< 5%)

� If revenue generating: Funding Gap calculation

� Project assessment with requested EU grant: � financial package completed with cofinancing &

loans

� ensure FRR/K (return on “national” capital) not excessive

� Financial sustainability� requires cumulative cash flow positive for all years

� ideally at project level, surely needed at operator level

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� Only for revenue generating projects (as per Art. 55 of Regulation 1083/2006

� If project revenues do not cover O&M costs, then the project is not revenue-generating

� Calculation based on incremental revenues and costs, and normally using constant euros

� Depreciation and contingencies not to be included

� See details in Working Document 4: Guidance on the

Methodology for Carrying Out Cost-Benefit Analysis, prepared by the Commission in August 2006

Funding Gap (1)

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Funding gap rate:DIC

DNRDICR

−

=

Funding gap

The “funding gap” is the part of the investment cost which is not going to be paid back by the project net revenue. The funding-gap rate is the complementary to 100% of the gross self-financing margin.

* Discounted net revenue = + discounted revenue – discounted operating costs + discounted residual value

DIC: Discounted Investment cost

DNR: Discounted Net Revenue*

Funding gap

R%

Gross self-financing margin

(100-R)%

Funding Gap (2)

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Factors to consider in establishing FG

Article 55(2): “Eligible expenditure on revenue-generating projects shall not exceed the

current value of the investment cost less the current value of the net revenue from the

investment over a specific reference period (…)

In the calculation, the managing authority shall take account of the reference period

appropriate to the category of investment concerned, the category of project, the

profitability normally expected of the category of investment concerned, the application

of the polluter-pays principle, and, if appropriate, considerations of equity linked to

the relative prosperity of the Member State concerned.”

� Polluter pays principle: Scenario for tariffs should reflect the correct application ofthe Polluter Pays Principle. For Water: WFD 2000/60/EC - Article 9. – “MemberStates shall take account of the principle of recovery of the costs of water services,including environmental and resource costs, (…) in accordance in particular with thepolluter pays principle.”

� Affordability (equity): WFD 2000/60/EC - Article 9. – “Member States may in sodoing have regard to the social, environmental and economic effects of the recovery[…]". Practically, total charges paid by the users for water and wastewater servicesshould not exceed certain commonly accepted thresholds.

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Tariff setting and Affordability

MESD policy on Affordability: 4% of income for the poorest 10% ofhouseholds @ per capita 75 litres/day.

Higher tariffs may be required if financial sustainability of ROC isendangered. In these cases, special measures to reduce the financialburden on the poorest households

Total cost to be covered by tariffs (PolluterPays)

Rationale for

Funding Gap

Affordability Limit

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Economic Analysis

� To establish if the project has a positive net contribution to society (ENPV>0, ERR> social discount, B/C ratio positive)

� Similarly to financial analysis comparisons between benefits and costs, but:

� Costs measured in term of “opportunity” foregone

� Benefits reflects both saving in costs and external benefits not valued by financial prices

� Social discount rate set at 5,5%

� Incremental impact on society = Difference between with and without ‘economic’ scenario

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Economic Analysis

� Identifying benefits

� Benefits from improved access to drinking water

� Benefits from improved quality of bathing and surface waters

(use and non use values)

� Resource costs savings

� Other benefits difficult to monetise

� Adjusting costs

� Fiscal corrections

� Converting financial prices into economic prices

� Add negative externalities

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Project benefits and Negative Externalities

Project Benefits

Type Base for calculation Monetary value Comments

Access to drinking water Nr. Of households in project service area

148 Euro/household/year (2008 value)

Values for following years ofprojection to be increased byreal GDP growth

Improvement of water bodies(use value)

Nr. Of people living in theproject service area

20.4 Euro/person/year(2008 value)

Values for following years ofprojection to be increased byreal GDP growth

Improvement of water bodies(non use value)

Nr. Of households inproject service area

0.004 – 0.011

Euro/household/year/KM river

See Annex

Cost savings to customers –

private wellNr. Of households newly

connected315 Euro/household/year

Cost savings to customers –

sewage disposalNr. Of households newly

connected348 Euro/household/year

Cost savings to operator – waterabstraction

Incremental watersavings (in m3)

Water abstraction fee (Apele Romane)

To be detailed in technical FS

Cost savings to operator – energyconsumption

CO2 emission savings (intonnes)

From 25 Euro/tonne in 2010 to 45 Euro/tonne in 2030

To be detailed in technical FS.

Negative Externalities

Type Base for calculation Monetary value Comments

Increase in CO2 emission –

sludge digestionCO2 emission (in tonnes) From 25 Euro/tonne in 2010 to

45 Euro/tonne in 2030 To be detailed in technical FS.

Increase in CO2 emission –

sludge transportationCO2 emission (in tonnes) From 25 Euro/tonne in 2010 to

45 Euro/tonne in 2030 To be detailed in technical FS.

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Adjusting Costs

� Economic costs (conversion factors):

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Sensitivity and Risk Analysis (1)

� Purpose is to assess the robustness of the project financial and economic profitability indicators (FRR/C, FNPV/C, ERR, ENPV)

� First, identification of key variables and their impact in terms of changes in the profitability indicators

� Second, calculate “switching values” for those variables for which a variation of 1% results in a variation of more than 5% in the profitability indicators

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Sensitivity and Risk Analysis (2)

� Finally, estimate probability distributions for the profitability indicators based on the probability distribution of all the key variables (Monte Carlo)

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CBA Conclusions

� Standard format for presenting CBA results

(Application Form info requirements)

� Does the project needs co-financing??

� Financial analysis FNPV/C <0;

� Revenue Generating Funding Gap

� Financial sustainability ensured

� Is the project worth co-financing??

� Economic analysis results

� ENPV, ERR and B/C ratio

� Other benefits/costs not monetised needs to be listed

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THANK YOU!

marra@eib.org