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19/04/2016 Reform of Municipal Services in Eastern Ukraine
Deutsche Gesellschaft für Internationale
Zusammenarbeit (GIZ) GmbH
Reform of Municipal Services in Eastern Ukraine
Regulatory Policies and Tariff Determination in the Water supply and
Sewage Sector
Kiev, 20.04.2016
Sector development - Policy objectives driven
Reform of Municipal Services in Eastern Ukraine
19/04/2016
Government sets
policy objectives
and strategy
Business plan
designed to meet
objectives
Tariffs set to
finance business
plan activities
Government policies – what are they?
19/04/2016
• Sector Economic policies, e.g.
• Economic development (priorities)
• Government deficit and debt reduction
• Social policies, e.g.
• Protection of poor and vulnerable
• Health policies
• Environmental policies, e.g.
• Protection of natural resources
• Clean energy
• Compliance with international obligations / conventions
Reform of Municipal Services in Eastern Ukraine
Government policies – what are they?
19/04/2016
• Sector specific, e.g.
• Sector structure: privatisation, commercialisation etc.?
• Role of local government?
• Cost recovery: definition, how, by when?
• Development priorities: sector, geographic, consumer type?
• State funding for investment?
• Regulation: powers, pricing expectations.
• Levels of service: water quality, pressure etc.
• Many more . . . . .
Reform of Municipal Services in Eastern Ukraine
Government policies – important characteristics for
regulation
19/04/2016
• Realistic (not a wish list)
• Objectives driven
• Objectives measurable, e.g. water quality to a
defined standard
• Time bound, e.g. to meet the objectives by a set date
Reform of Municipal Services in Eastern Ukraine
Functions of utility
• Water supply on demand, at the prescribed quality
and pressure.
• Wastewater collected treated and disposed of in
accordance with environmental regulations.
• Utilities need the money to enable them to do this
Reform of Municipal Services in Eastern Ukraine
Business plan principles
• What do we need to do?
• How are we going to do it?
• What will it cost?
• Where will the money come from?
Reform of Municipal Services in Eastern Ukraine
Inter-relationships
Government
Policy
e.g. service standards,
timetable etc. Regulation
Tariffs set to finance
agreed business plans
Service
delivery
Business plans to meet
policy objectives
Customers
Improved services
and their payment.
Reform of Municipal Services in Eastern Ukraine
Required revenue
• Revenue required to be able to carry out functions of
water supply and wastewater services?
• Revenue to cover costs
• Operational costs
• Capital maintenance
• Cost of finance
• Other?
Reform of Municipal Services in Eastern Ukraine
Tariff policy principles
19/04/2016
• Limited by legal obligations
• Interpretation of Government policy
• Delivers policy objectives
• Regulatory consistency
• Transparency and accountability
• Balanced between needs of stakeholders
(consumers, investors, service providers)
• Conforming with good regulatory practice
• Foundation of tariff setting methods and models
Reform of Municipal Services in Eastern Ukraine
Business plan cost projections
19/04/2016
• Operational cost projections to include for realistic
expectations of improved efficiency
• Capital maintenance (depreciation and infrastructure
renewals) determined using current cost accounting
principles
• Return on capital:
• Rate to reflect risk class of business
• Capital value to reflect actual investment by
business (not grants)
Reform of Municipal Services in Eastern Ukraine
Operational costs analysis (Kosovo example)
PR
PZ
PE
MIT
GJA
FE
GJI
y = -3E-07x + 33.467R² = 0.4288
-5
10 15 20 25 30 35 40 45
- 20,000,000 40,000,000 60,000,000
Co
st p
er
10
00
m3
Water production m3 / year
Water resources & treatment per m3 production (excluding energy)
RWC submitted
WWRO determined
Linear (RWC submitted exc. Peja and Gjakova)Linear (Best performing exc Peja and Gjakova)
Reform of Municipal Services in Eastern Ukraine
Capital maintenance
• Conventional accounting
• Asset replacement financed by depreciation
BUT
In water supply and wastewater:
• Long life assets, and not equal to accounting lives (often remaining
life indeterminate)
• Many assets fully depreciated
• Depreciation needs to account for Inflation
• Financing (grants, loans, equity investment)
Reform of Municipal Services in Eastern Ukraine
Ofwat solutions (used in Kosvo and elsewhere)
Underground assets (infrastructure)
• Infrastructure renewals accounting
• Network is a single asset, asset life infinite, therefore no
depreciation
• Investment in renewals / replacement operational expenditure
• Expansion of the network added to Regulatory Asset Base (RAB)
Above ground assets (non-infrastructure)
• Current cost depreciation
Grants and capital contributions
• Activities financed by grants not included in revenue requirement
Reform of Municipal Services in Eastern Ukraine
How to measure network renewals investment
Reform of Municipal Services in Eastern Ukraine
Opening Regulatory Asset Base (RAB)
Asset values
• Historic or current cost?
• Assets fully depreciated but still in use?
• Inherited assets - how much gifted and how much equity?
Market capitalisation + debt
• Requires privatisation
Business purchase price
• Concessions
Arbitrary value
• Kosovo (water EUR 200 per connection, wastewater EUR 100 per
connection)
• Northern Ireland (£1 billion) Reform of Municipal Services in Eastern Ukraine
RAB movements
Principle
• Opening value determined at start of year 1
• Increases with investment
• Decreases with depreciation (above ground only)
• Decreases with disposals
• Adjusted for inflation
Reform of Municipal Services in Eastern Ukraine
Determination of return
Capital asset pricing model (CAPM)
• Risk free rate + risk premium
• Utilities should be low risk
• Typical returns: 5 – 6 % (real)
• Weighted average cost of capital (WACC)
• State-owned – does CAPM apply?
Reform of Municipal Services in Eastern Ukraine
19
Price cap incentive regulation - illustration
Time (yrs)
£
Tariff review 1 Tariff review 2
Regulator’s
projection of costs
Actual costs
Regulator’s
projection of
income Actual income
Reform of Municipal Services in Eastern Ukraine
Business plan framework (Kosovo example)
Regulatory
accounts
Asset
management
Operational
Commercial
Financing
Performance,
e.g. NRW and
operational
cost
projections
Performance,
e.g. collection
efficiency,
cost
projections, e.g.
connection fees
Investments,
capital
maintenance
and
enhancement
Sources of
finance,
grants etc.
Regulatory
asset base,
c.c.
depreciation
Regulator
inputs
Return on
capital,
boundary
conditions,
inflation..
Business plan primary inputs Business plan supplementary inputs
BUSINESS
PLAN
Tariff model
sub-routine
Cost and performance
projections
Tariffs
Tariff application
Agreed performance
targets / commitments
Projected financial
statements
Reform of Municipal Services in Eastern Ukraine
Tariff = Required revenue / sales
Tariff = [Operational costs + Capital maintenance + Cost of finance]
Sales
• Tariffs (base year price levels)
• Financial projections
• Income statements
• Balance sheets
• Cash flow
• Obligations
Outputs
Reform of Municipal Services in Eastern Ukraine
Tariffs and obligations
• Tariffs set to meet business plan obligations including:
• Efficiency expectations
• Investments
• Performance expectations
• In theory: if utility does not deliver customers should expect
their money back
• In practice: not easy to enforce (unless privatised)
Reform of Municipal Services in Eastern Ukraine
RWC Obligation
Operating cost efficiency
Water supply services Reduce annual operating costs from the submitted level of EUR 6.562,000 to EUR 5.373,000, a reduction of EUR 1.190,000 (at 2011 price levels). The bulk of the reduction in operating costs (EUR 992,000) is expected to be derived from improved efficiency in water supply business activities with the remaining reductions expected from efficiency gains in water resources/treatment and distribution activities.
Wastewater services Reduce annual operating costs from the submitted level of EUR 216,000 thousand to EUR 201,000, a reduction of EUR15,000 (at 2011 price levels), largely through efficiency improvements in wastewater collection activities.
Commercial (revenue collection) efficiency
Households Commercial Institutional
2011 (current) 58% 90% 98%
2014 (minimum) 67% 96% 100%
Capital investment
2012 – 2014
(EUR x 1000 at 2011 price levels)
RWC resources
Grants Total
Water supply Infrastructure renewals 9,436 9,011 18,447
Infrastructure enhancement 1,110 200 1,310
Non-infrastructure capital maintenance 1,965 360 2,325
Non-infrastructure enhancement 4,032 4,327 8,358
Total 16,543 13,897 30,440
Wastewater services Infrastructure renewals 1,401 1,870 3,271
Infrastructure enhancement 100 450 550
Non-infrastructure capital maintenance - - -
Non-infrastructure enhancement 59 - 59
Total 1,560 2,320 3,880
Customers & sales
Water supply Household connections to increase from 89,000 in 2011 to 102,500 by end 2014
Wastewater Household connections to increase from 68,900 in 2011 to 82,400 by end 2014
Water sales To increase from 22.4 million m3 per year in 2011 to 25.8 million m
3 per year by 2014
Water and wastewater sales turnover (exc. connection fees and other income)
To increase from EUR 12.2 million in 2011 to EUR 15.8 million by 2014 (at 2011 price levels)
Reform of Municipal Services in Eastern Ukraine
Performance
What to monitor?
• Outputs (not inputs)
• Water quality, pressure, reliability, efficiency
• Wastewater collection, discharge quality, efficiency
• Performance relative to plan
• Comparative performance
Performance measurement – outputs driven
(Kosovo example)
Group Performance measure Sub-group
weighting
Group weighting
Water
Drinking water quality 30%
100% 45%
100%
Pressure 5%
Availability 35%
Service coverage 20%
Cost efficiency 10%
Wastewater
Discharge quality 20%
100% 35% Reliability 20%
Service coverage 50%
Cost efficiency 10%
Financial / commercial Profitability 10%
20% Commercial efficiency 10%
Reform of Municipal Services in Eastern Ukraine
Performance monitioring relative to planned
(Kosovo example)
0% 20% 40% 60% 80% 100%
PZ
MIT
GJI
FE
PR
PE
GJA
Ideal
EUR (2010)
RWC overall performance
09 Water supply 09 Wastewater 09 Profitability 09 Commercial efficiency
10 Water supply 10 Wastewater 10 Profitability 10 Commercial efficiency
Reform of Municipal Services in Eastern Ukraine
Tools
Regulatory accounts
• Linked to model
• RAB and return on capital
Performance returns
• Also linked to model
• Measure against business plans
Reform of Municipal Services in Eastern Ukraine
Regulatory enforcement
Performance reporting
• Awards
• Name and shame
Fines
• Does not work for state-owned businesses
Financial rewards
• Bonuses dependent upon performance
• Requires strong audit mechanisms
Other powers?
Reform of Municipal Services in Eastern Ukraine
Hypothetical exercise
• Dnipropetrovsk and Novomoskosvk
• 3 year tariff model
• Operational costs based upon current level of performance
• Investments from asset management plans:
• Capital maintenance (infrastructure renewals and
depreciation)
• Capital enhancement (increases RAB)
• Opening RAB based upon UAH per connection (6000 for
Dnipropetrovsk and 4500 for Novomoskosvk)
• Return on RAB, 5%
Reform of Municipal Services in Eastern Ukraine
Outputs
Reform of Municipal Services in Eastern Ukraine
19/04/2016
-
2.00
4.00
6.00
8.00
10.00
12.00
14.00
16.00
2016 2107 2018 2016 2107 2018
Tari
ff (
UA
H/m
3)
Dnipropetrovsk Novomoskosvsk
Return on capital
Current cost depreciation
Infrastructure renewals
Operating costs (including net bulk water purchases and sales)
Sensitivity analysis - Dnipropetrovsk
Reform of Municipal Services in Eastern Ukraine
Sensitivity analysis - Novomoskosvk
Reform of Municipal Services in Eastern Ukraine
Example – outputs
Principal tariff drivers
• Opening RAB
• Rate of return on RAB
• Capital costs
Secondary drivers
• Depreciation rate
• Opening split of assets between above and under
ground
Reform of Municipal Services in Eastern Ukraine
Future tariff reviews
19/04/2016 Reform of Municipal Services in Eastern Ukraine
• Takes significant preparation
• Estimate earliest review for tariffs 2019 - 2021
• Operational costs based upon current level of performance
• Investments from asset management plans:
• Capital maintenance (infrastructure renewals and depreciation)
• Capital enhancement (increases RAB)
• Opening RAB based upon UAH per connection (6000 for
Dnipropetrovsk and 4500 for Novomoskosvk)
• Return on RAB, 5%
19/04/2016
Switch to tariff cycle slide
Reform of Municipal Services in Eastern Ukraine
Regulatory calendar – estimated (fast-track)
19/04/2016 Reform of Municipal Services in Eastern Ukraine
Deadline Activity Responsibility Voda-kanls
Comm Gov
31 Oct 2016 Draft government policy and objectives 30 Nov 2016 Consultation 31 Jan 2017 Final policy and objectives 30 Apr 2017 Legal instruments (legislation, licences etc.) 31 May 2017 Development of draft tariff policy 30 Jun 2017 Consultation 31 Jul 2017 Finalisation of tariff policy 31 Oct 2017 Development and issue of draft models, guidelines etc. 30 Nov 2017 Consultation on draft tariff determination principles, model, regulatory
accounting guidelines and other regulatory instruments
31 Dec 2017 Finalisation and issue of final tariff determination principles, model, regulatory accounting guidelines and other regulatory instruments
31 Jan 2018 Training of vodakanals in use of regulatory tools 30 Apr 2018 Submission of business plans, tariff proposals, and supporting information.
31 Jul 2018 Publication of draft tariff determinations 31 Aug 2018 Representations from vodakanals on draft tariff determination 30 Sep 2018 Final tariff determinations for 2019 to 2021 31 Oct 2018 Deadline for appeals against tariff orders 1 Jan 2019 Adoption of 2019 tariffs, adjusted in accordance with inflation criteria
(assuming no appeals)
Summary
19/04/2016
• Policy objectives - realistic, time-bound, measurable.
• Policy implemented through business plans
• Tariff revenue sufficient to meet objectives
• Regulatory models using RAB, infrastructure renewals and current cost
depreciation
• Tariffs contingent upon performance (effectively an implied contract)
• Performance monitoring against business plan expectations
• Future tariff reviews will take time to set up (2019 earliest)
Reform of Municipal Services in Eastern Ukraine
Reform of Municipal Services in Eastern Ukraine
19/04/2016
As a federal enterprise, GIZ supports the German Government in achieving its objectives in the field of international cooperation for sustainable development.
Published by Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ) GmbH
Registered offices, Bonn and Eschborn, Germany
Reform of Municipal Services in Eastern Ukraine 15/75 Khreshchatyk Street, 01001 Kyiv, Ukraine T/F +38 044 495 50 07
E [email protected] I www.ims-ukraine.org I www.giz.de/ukraine I www.gfa-group.de
Responsible
Wolfgang Hützen
Authors
Keith Burwell
In cooperation with
Implemented by