Guidelines for User Fees - African Development Bank · Please refer to the long version of this publication, “Guidelines for User Fees and Cost Recovery for Urban, Networked Water

Guidelines for User Fees

and Cost Recovery

For Urban

Water and

Sanitation

Guidelines for User Fees

and Cost Recovery

For Urban

Water and

Sanitation

This document was prepared by the Water Partnership Program (WPP) of the AfricanDevelopment Bank under the supervision of the Bank’s Operations Policy and Compliance

Department with inputs from an international consultative stakeholder workshop for Bank staffand external stakeholders.

While every effort has been made to present reliable information, the African Development Bankaccepts no responsibility whatsoever for any consequences arising out of its use nor is anyopinion expressed in this publication necessarily the opinion of the Bank. The material in thispublication is copyrighted. Copying and/or transmitting portions or all of this work withoutpermission of the African Development Bank may be a violation of the applicable law.

AcknowledgementsThanks to consultants from IRC, The Netherlands, and Cranfield University, UK, CatarinaFonseca, Richard Franceys and Chris Perry.

The African Development Bank Group undertook the study with the financial support of its WaterPartnership Program donors i.e. the Government of Denmark, the Netherlands and Canada(CIDA)

Publication dateOctober 2010

LogoAfrican Development Bank, External Relations and Communication Unit, Yattien-Amiguet L.

Graphical ConceptualizationAfrican Development Bank, External Relations and Communication Unit in cooperation withFinzi Usines graphiques; Justin Kabasele T. and Mouna Lazzem

PhotoAfrican Development Bank

PrintingFinzi Usines Graphiques

CoordinationConsultant Sören Bauer

Additional explanation and information Please refer to the long version of this publication, “Guidelines for User Fees and Cost Recoveryfor Urban, Networked Water and Sanitation Delivery”, on the AfDB website www.afdb.org

Table of contents

iii

Table of contentsExecutive Summary

Introduction

1 Step one1.1 Determining the Economic, Policy and Institutional Environment

2 Step two2.1 Setting Cost Recovery and Service Objectives

3 Step three3.1 Determining Revenue Requirements3.2 Calculating Average User Fees3.3 Future Costs for Sustainability3.4 Support to Revenue through Societal Contributions (Subsidies)

4 Step four4.1 The Basis for Charging User Fees

5 Step five5.1 Implementation of User Fees and Cost Recovery System

Conclusion

Table and Annexes

Table 1: Summary of the Five Steps Comprising Guidelines for User Fees & Cost Recovery for Urban Water & Sanitation Services

Scenario A: Government subsidy for Capital Maintenance and Cost of Capital ,typically poor Non Revenue Water and limited Bill Collection Efficiency

Scenario B: Government subsidy only for Return on Equity Capital - full Debt Servicing, reasonable Non Revenue Water and Bill Collection Efficiency

Scenario C: No subsidy for private equity return, full Debt Servicing, good

Non Revenue Water and Bill Collection Efficiency

vi

1

33

33

6691112

1212

1515

16

17

17

19

21

23

iv

ADF

AFDB

CGP

CPIA

GDI

GDP

IWRM

LRMC

MDGs

O&M

PPP

RMC

WACC

WPP

WTP

List of abbreviationsAfrican Development Fund

Africa Development Bank

Country Governance Profile

Country Policy and Institutional Assessment

Gross Domestic Income

Gross Domestic Product

Integrated Water Resources Management

Long Run Marginal Cost

Millennium Development Goals

Operation & Maintenance

Polluter Pays Principle

Regional Member Country

Weighted Average Cost of Capital

Water Partnership Program

Willingness To Pay

v

willingness to pay can be accommodatedthrough technology choice and customizingservice levels to reach an affordable tariff. Suchan approach, it is hoped, can achieve both socialand financial goals.

The Guidelines were developed through thesupport of the Water Partnership Program andwere extensively reviewed by the Bank.

This publication will provide important and usefulguidance for task managers within the BankGroup as well as among stakeholders workingwith the critical issue of financial sustainabilityfor urban water sector investments.

Ali Kies, Director OWAS / AWF

Foreword

The Guidelines presented here touch upon a verycritical issue for all urban water sector invest-ments: how to ensure that urban water andsanitation services are financially viable, in additionto being environmentally and socially sustainable?

Urban water and sanitation utilities fulfil a uniquerole in an urban setting. Often seen bygovernments as instruments for achieving socialand economic policy, utilities are unsustainableunless they are operated on commercialprinciples.

The authors of these Guidelines suggest that thevarying capacity of customers’ ability and

vi

wastewater disposal to preserve thenatural environment by signalling toconsumers the cost to the economy ofthe resources used by the services.

iii The Bank Group’s Integrated WaterResources Management (IWRM) Policyconsiders water as an economic, socialand environmental good. In a context ofgrowing water scarcity exacerbated byrapid population growth and urbanization,climate change and environmentaldegradation, mismanagement of waterresources, and misallocation of budgetaryresources, the Bank Group and its RegionalMember Countries (RMCs) have to adopta new approach to water resourcesmanagement anchored on sustainability inall its dimensions.

iv The recovery of financial costs (operatingand maintenance expenditure, investmentcapital including interest on debt finance,indirect sector support costs includingenvironmental and economic regulationand resource opportunity costs) isnecessary in the context of integratedwater resources management (IWRM). Inparticular, economic and financial pricingof water serves to guide consumerscollectively towards an allocation patternof water resources among the various

Executive summary

i The Africa Water Vision and the MillenniumDeveloent Goals (MDGs) relating to waterand sanitation services are to halve by2015, the proportion of people who do nothave access to safe drinking water andbasic sanitation. Sector experience stronglysuggests that sustainability is critical to theachievement of MDGs for water, sanitationand irrigation projects. There are three keydimensions to sustainability: environ-mental, social and financial. This set ofguidelines focuses on the financialdimension, while taking into account thesocial and environmental dimensions. Arobust cost recovery system is necessaryto achieve financial sustainability of watersector projects and programmes.

ii Cost recovery through the levying andcollection of user fees serves two principalfunctions:

• Strengthening internal generation ofsufficient revenue to support continuingdelivery of services to users over thelong-term, including extension ofservice coverage, particularly to low-income households, and improvedservice quality;

• Promoting better use of scarce waterresources and management of

vii

competing uses that maximizes publicwelfare. Sustainability also requiresadequate wastewater management andimplementation of the Polluter PaysPrinciple (PPP).

v However, the point of departure varies bycountry, sector, and sub-sector: in somecases, cost recovery is extensive, wellestablished and effectively implemented.In other cases, it is minimal – either throughlack of policy commitment to the objectiveor poor implementation of policy. Similarly,willingness and/or capacity to pay bycustomers (and willingness to charge byservice providers and regulators) varies bycountry and within countries (for example,between urban and rural) and bytechnology (networked or non-networkedwater and sanitation services).

vi In sum, these factors create a continuumof contexts and opportunities for costrecovery interventions, which in turninfluences what is feasible, desirable andthe timescale that may be required to meetspecified policy objectives. TheseGuidelines, through a logical step-by-stepapproach, are intended to facilitate thatprogress. The key point is that failure toattain financial sustainability of water andsanitation projects is highly likely to hinderscaling-up and therefore delayachievement of the MDGs for the watersector.

vii These Guidelines, one of three coveringthe water sector (urban, rural and irrigation),focus on urban water supply andsanitation. The guidelines apply to urbanareas (including cities and towns) withpiped water and sewerage networks. Inthe common situation where urban wateris networked but for the majority of urbaninhabitants sanitation is non-networked, itis necessary to refer also to the Guidelinesfor Rural Water and Sanitation, for guidanceon on-site sanitation issues.

viii Five (5) key steps are proposed to befollowed in developing, setting andimplementing user fees and costrecovery systems for urban and othernetworked water supply and sanitationprojects:

• Step One: Determine the economic,policy, and institutional context in thecountry, with respect to water andsanitation services. An understandingof the country’s economic conditions,including the institutional and socialenvironment is necessary to facilitatethe promotion of effective cost recoverythrough user fees.

• Step Two: Set cost recovery andservice objectives. A systematicapproach should be followed toreconcile financial and policyobjectives. Setting user fees is an

viii

iterative process of considering serviceobjectives, calculating cost reflectivetariffs then, having taken into accountpotential efficiency savings, judgingthe proposed tariffs againstaffordability and willingness to pay.Cost recovery and service objectivesare best negotiated with stakeholders.

• Step Three: Undertake investmentplanning, costing and appraisal of theservices (selected in Step Two), todetermine the costs to be recoveredand the overall revenue requirements.The total revenue requirements to coverall expenditures should be determinedand the sources of those fundsidentified. The total costs for a waterand sanitation utility can be brokendown into the cost of capital (includingreplacement cost and the opportunitycost of capital), operations andmaintenance expenditure (to ensure theresulting fixed assets are professionallyrun and remain serviceable for theirprojected useful life). The process ofmoving towards cost reflective tariffs(where total user fees, and thereforerevenues, are matched with the totalcosts) should be commenced andaccelerated in order to enhancesustainability of services.

• Step Four: Determine the basis forlevying user fees. The basis for charging

user fees (tariffs) should be as simplifiedas possible. The key criterion is thattariffs should be adequate (cover costs),fair and enforceable. In addition, theyshould include an effective signalrelating to the increased costs, financial,economic and environmental, ofdemanding ever-greater amounts ofwater. The main approaches tocomputing user fees include: a fixed orvariable volumetric fee based upon themeasured amount of water taken(though recognizing the significantadditional cost of metering) and a fixedor variable fee based upon somehousing, household or pipecharacteristic.

A demand-responsive approach shouldbe used to balance service levels withaffordability and willingness to pay. Aservice and price differentiationapproach should be used to provideusers with service levels andtechnologies that they can afford andare willing to pay for, to ensuresustainability. After determining totalrevenue requirements, it may benecessary to reconsider service andcost recovery objectives (Step Two).

• Step Five: Implement the user feesand cost recovery system. Since userfees are only useful as a source ofrevenue if they can be collected, an

ix

effective, transparent and accountablerevenue collection system should beput in place. The selection and use ofappropriate mechanisms should be amatter of practical convenience: it is agood principle to use a system that isalready in place, and which either worksor can be made to work with minimuminvestment. Consideration of levels andstructures of user fees should includepayment mechanisms.

• Water and sanitation utilities should makethe payment process as easy aspossible to facilitate collection andpreclude evasion. For the lower-incomecustomers, a suitable system shouldprovide for payments that are “little andoften”, coupled with a lifeline subsidizedconsumption level to match capacity topay. Such flexible payment mechanismsincrease bill collection efficiency withoutundermining social equity and the public

goods attendant on universal access towater and sanitation.

An example is provided by pre-paidmeters that simplify the billing andcollection processes, working either ona time-limited or a volume-limited basis.Utilities should have a clear and effectivedisconnection policy to enforce userfees. Disconnection should always bea last resort. If used regularly, it indicatesa failure in revenue collectionprocedures. Existing and potentialcustomers should be involved in theprocess as outlined in the four keysteps. Where stakeholders have beeninvolved, implementation of user feesis usually more acceptable and muchsmoother.

Details of each of these five steps areexplained in the Guidelines and a summaryis presented in Table1.

1

Introduction

Background to the cost recovery guidelines

User fees have an important role in meetingsocial, economic and environmental policyobjectives. User fees, and their structure,provide signals to users about the cost of theservice, the scarcity of resources used to providethe service, and the priorities that governmentsplace on provision of services to particulargroups.

At a minimum, user fees for cost recoveryprovide the basis for financial sustainability:failure to provide for adequate funding leads tothe degradation of water and sanitation systems,deteriorating performance and services, andfurther unwillingness to pay – a commonlyobserved ‘vicious circle’.

In 2000, the Bank produced an IWRM Policystatement. The policy stated that getting theprices right is at the very core of improving waterresources management. These Guidelines havebeen developed to assist in the implementationof the Bank Group’s water policy, particularlywith regard to financial sustainability.

The Guidelines for user fees and cost recoveryfor urban water and sanitation projects apply tourban areas (including cities and towns) withpiped water and sewerage networks. In thecommon situation where urban water is

networked but for the majority of urbaninhabitants sanitation is non-networked, it isnecessary to refer also to the Guidelines forRural Water and Sanitation, for guidance on on-site sanitation issues.

Objectives of the guidelines

The main objective of these Guidelines is toprovide guidance to Bank Group Task Managersand other stakeholders as well as to enhance thedesign and implementation of financiallysustainable water sector projects andprogrammes. The ultimate goal of the Guidelinesis to improve water and sanitation serviceprovision, in order to accelerate growth ineconomic development as well as improving thehealth of all households, particularly the poor.The Guidelines recognize the economic andinstitutional environment in which RegionalMember Countries are operating.

A key objective of these guidelines is to enableservice providers to deliver better services to all,within the context of a protected environment,through accessing enhanced revenue andfinance flows whilst acknowledging that directfull cost recovery may not be achievable in allurban areas in the near term. In this context, it isrecognized that part of the process of movingtowards direct cost recovery has to be throughensuring that appropriate service levels andtechnologies are chosen so that users obtain theservices they desire and for which they arewilling to pay.

2

However, the multiplicity of objectives of watersector projects and programmes (such asviewing water as both an economic and asocial good) and the trade-offs involved oftenmake the subject of utility services pricingcontroversial.

Much of the controversy stems from the lack ofconsensus on the boundaries to be drawnbetween the role of utilities as instruments ofgovernment social and economic policies, andas commercial entities that need to effectivelyprovide quality services and also balance theirbooks. The implications of economic, financialand policy objectives may conflict in particularinstances, and pricing decisions may involvetrading off one objective against another.

These guidelines stress the iterative nature ofreflecting anticipated user fees against proposedservice levels and the need to reconsider theselevels when subsequent willingness and ability topay indications are that such services would notbe able to recover sufficient costs for sus-tainability. By matching service levels and techno-logy options (service differentiation), a serviceprovider can serve all customers at differentiatedprices that correspond to customers’ willingnessto pay, and thus achieve both social and financialobjectives.

The Bank’s Guidelines for Financial Gover-nance and Financial Analysis of Projectsprovide detailed information on standards and

procedures for financial accounting that arecomprehensive in scope and fully adequate toguide financial accounting aspects ofensuring overall revenue sufficiency once thescope of a cost recovery approach has beenidentified.

The main steps of the guidelines

There are five key steps to be followed indeveloping, setting and implementing user feesand cost recovery systems for urban water andsanitation projects :

1. Determining the economic, policy, andinstitutional context in the country, withrespect to water and sanitation services;

2. Setting cost recovery and serviceobjectives;

3. Undertaking investment planning, costingand appraisal, to determine costs to berecovered and overall revenuerequirements;

4. Determining the basis for charging userfees; and

5. Implementation of user fees and costrecovery system.

The five steps are summarized in Table 1 inthe annex.

3

1. Step one

1.1 Determining the economic, policy and institutional environment

1.1.1 Promoting cost recovery through user feesrequires an understanding of the country’seconomic conditions, including the institutionaland social environment. Useful economicindicators include average household wealth andGross Domestic Income per capita. The level ofeconomic wealth is already recognized in AFDB’sclassification of RMCs and is an importantpredictor of possible levels of cost recovery.

1.1.2 Another useful indicator is the ‘tax-to-GDI’(or GDP) ratio that not only illustrates thepotential for supporting water and sanitationservices through direct taxation (throughbudgetary support to the water and sanitationprovider) but most importantly the likelihood ofthe sustainability of this source of finance. Somecountries have achieved good water andsanitation services through a tax-based systemwith only limited user fees. However, suchsuccesses are unusual, particularly in low-income countries and this approach does notassist in the IWRM goal of appropriate sharing ofscarce resources based upon the principle of“water as an economic good.”

1.1.3 Analysis of the institutional frameworkgives an indication of any institutional

weaknesses which need to be addressed toensure viable organizations and the necessarysupporting framework for service delivery andcost recovery. Useful indicators can be obtainedfrom the Country Governance Profile (CGP),which identifies the strengths and weaknessesof governance arrangements in a country. TheCountry Policy and Institutional Assessment(CPIA) should also be considered as it gives anindication of the governance potential to deliversufficient autonomy to support a cost recoverysustainability policy.

2. Step two

2.1 Setting cost recovery and serviceobjectives

2.1.1 These Guidelines on user fees and costrecovery suggest a systematic approach toreconciling financial and policy objectives,particularly with regard to cross-subsidization,reflecting also the 2005 Guidelines on FinancialGovernance which refer to the Bank policy ontariffs in general and the 1985 policy on tariffs andcost recovery . This long-standing guidancerelating to tariffs and cost recovery continues tobe relevant with the emphasis primarily on thesufficiency of revenues to finance operations andservice debt. The policy requires theestablishment of a tariff agreement preferably inthe form of a rate of return covenant, i.e. apositive return on capital employed over andabove operations and capital maintenance costs.

4

2.1.2 However, the earlier policy also recalls thatsocial benefit must not be sacrificed for financialexpediency. Sound project design requires anequitable distribution of benefits, including theuse of cross-subsidies, where necessary, toprovide the largest volume of benefits to themost deprived sectors of the populationconcerned. User fees for cost recoverynecessarily reflect the cost of delivering aparticular level of service. Setting user feestherefore is an iterative process of consideringservice objectives, calculating cost-reflectivetariffs then, having taken into account potentialefficiency savings, judging those proposed tariffsagainst indicators of affordability and willingnessto pay.

2.1.3 Where the tariffs are deemed to be toohigh, for whatever reason, it is necessary toreconsider the objectives, investigating forexample whether there might be over-investment in certain levels of service, for bothwater and sanitation. It is necessary to lookclosely at proposed levels of service,subsequent investment needs and potentialefficiency gains before considering cross-subsidies.

2.1.4 Project design and appraisal necessarilytake as a starting point the RMC’s presentsystem for charging user fees. Agreements withRMCs may require an overall tariff increasebased upon the existing tariff structure as anachievable objective, recognizing that it requiressignificant inputs of professional time to facilitate

changes in tariff structures. These guidelines forurban/networked water and sanitation servicesincorporate two critical components of costrecovery: the need to accept differentiatedservice standards to ensure costs are minimizedto match potential affordability and apreparedness to accept that some specific usergroups may be unable to afford to pay desireduser fees even when supported by the maximumpossible cross-subsidy within the sub-sector.

2.1.5 One of the reasons for failure in the watersector has been the unwillingness of directproviders to segment customers to a sufficientdegree, both within and between countries andthen to target levels of services accordingly. Thiserror has been compounded by the presumptionthat subsidies to all will ensure affordableservices to the poor.

2.1.6 In general, subsidies (through low tariffs) inwater and sanitation are absorbed by customersoften living in planned areas, who are connectedto the existing network and more likely to be thehigher-income groups rather than the low-income groups described above. Higher-incomegroups should not normally need to receive anysubsidy for conventional services, beyond a costof capital subsidy for ADF countries if servicelevels and service delivery have been designedappropriately. Revenue from the higher-incomecustomers (note, not necessarily high-income) iscritical to ensure the viability of the utility. For thisreason, the use of ‘lifeline blocks’ can undermineor distort cross subsidy. Lifeline blocks should,

5

therefore, be discouraged for the averageconsumer or at the least proposals mustconsider very carefully whether any extension ofan incremental block tariff system is reallybeneficial.

2.1.7 There is need for support to the poor toenable them access clean water and sanitationfor health and convenience (time saving incollection, privacy for women for example). Thissupport should NOT be delivered through belowservice cost user fees, but through costreduction in the pattern of supply anddifferentiated services to meet the special needsof the poor. Service differentiation is what issustainable in the long term, and not below-service cost user fees.

2.1.8 For example, the poorest may well need toaccess water services, bathing and sanitationcommunally, through stand-posts and publictoilets, sanitary blocks and bathing houses.These services need to be well managed,perhaps through local private or community-based operators, to deliver an appropriate levelof service at least cost, whilst making allowancefor the destitute to be able to access at little orno cost.

2.1.9 The slightly better-off poor, usually ininformal slums and shanties can generally afford,and want, to pay for differentiated householdconnections (such as variations of low pressure,limited hours, group meters, volumetricallycontrolled, prepaid meters etc). Because of the

lower cost of connection, fees can be reduced(or removed altogether) and potentially someform of ‘lifeline’ block is appropriate for thisspecific consumer group. For households thathave been used to paying the necessarily highcosts for alternative services from, say, vendors,a water tariff that covers full operating andcapital maintenance expenditures is normallyaffordable as long as the payment facilities areaccessible for small and frequent payments.Designing flexible payment systems is thereforekey to effective revenue collection among thepoor customer segments.

2.1.10 The iterative process of determiningappropriate service levels necessarily starts fromconsideration of existing service levels, inparticular the extent of service coverage and theresulting costs and revenues. Costs can bebenchmarked against the metrics of internationalcomparators or the process benchmarks ofother national utilities to determine both validityand efficiency. Public involvement in the privategood of urban water supply is justified by thepublic health benefits it delivers to the entireurban population as well as the significantreduction in costs of water supply to the poorthrough a centralized system benefiting fromeconomies of scale, particularly in abstractionand treatment.

2.1.11 Setting service objectives, and thereforeuser fees, should focus upon ensuring thathealth and convenience benefits are achieved byall but particularly by the poor. That water supply

6

supports economic activities (which in turnimprove people’s lives) should also be taken intoaccount when setting service objectives.

2.1.12 Average weekly household payment towater vendors in informal housing areassuggests a level of potential revenue that can beaccessed by a cheaper, better-quality pipedservice with the expectation that householdpayments can be reduced through the formalservice. Such information, ideally verified bysimple customer surveys and focus groups inthe lowest-income housing areas, could includesome form of willingness to pay survey basedupon a menu or ‘ladder’ of alternative levels ofservice (service differentiation), at different prices(price differentiation). More sophisticatedmethodologies are available to investigatewillingness to pay, such as using contingentvaluation and conjoint analysis studies. It ishowever wasteful to over-invest in such studies.

2.1.13 Efficient water services at cost-reflectivetariffs are generally affordable for the majority ofcustomers, present and potential. This is notnecessarily true for networked sanitationservices (sewerage and wastewater treatment).Some low-income areas may initially have toaccess sanitation through non-networked on-plot and on-site systems. Condominial seweragemay be affordable where treatment costs are notincluded. Treatment costs can be reduced byusing appropriate treatment technologies thatare also more easily maintained to ensureprotection of the environment.

2.1.14 Desired levels of service (or standards)may be unaffordable, making cost recoveryimpossible. The extent to which the servicelevels or standards are deemed discretionarycan be adjusted to match affordability. Inaddition, the apparent costs might be higherthan necessary and can be reduced throughefficiency savings in service provision wherethere are sufficient drivers to do so. It should benoted that the choice of technology is asignificant factor in determining the costs ofservice provision.

2.1.15 One significant influence on tariff levels isthe extent of “non-revenue water”, which refers notonly to physical leakage but also commerciallosses (due to illegal connections, water soldthrough legal connections but not paid for and thewater distributed free through standpipes).Investment in reducing non-revenue water is likelyto be a component of cost-recovery programmes.

3. Step three

3.1 Determining revenue requirements

3.1.1 The first cost element usually considered indelivering water and sanitation is the capitalcost, the amount invested in constructing fixedassets. Networked water and sewerage has aparticularly high dependence upon fixed assets,sometimes described as “capital intensity”.Capital Intensity is the ratio of revenues to fixedassets (at current costs).

7

3.1.2 Investments in fixed assets are necessarilyoccasional and therefore “lumpy” in investmentterms, and are therefore best addressed throughconventional “accrual” or fixed asset accountingprocedures, a method of distributing these costsfairly (so as not to disadvantage any particularconsumer group) over the lifetime of the assets.Capital investment in fixed assets is normallyfinanced externally to the service provider andthere are, therefore, costs to be reimbursed tothe provider of finance. A relatively efficient directprovider serving a large number of customers inan urban area is able to share out the costs ofcapital investment through small charges tomany customers over many years.

3.1.3 Similarly, the cost of ensuring that theseassets are maintained in good and serviceablecondition over many years can also be sharedout, averaging occasional capital maintenancecosts over time so that they are affordable.Actual delivery of services to users andconsumers depends upon operating these fixedassets, i.e. employing staff to run the systems,providing power to run the pumps and motorsas well as procuring chemicals for use in watertreatment works etc.

3.1.4 The total costs for a water and sanitationutility can thus be usefully broken down into thecost of capital (to service the capital financeinvested), capital maintenance expenditure (toensure the resulting fixed assets remainserviceable) and operating and minormaintenance expenditure. The key to ensuring

adequate revenues for sustainability of urbannetworked services is to begin the process ofmoving towards “cost-reflective tariffs”, whichindicates the aim to match total user fees, andtherefore revenues, to the total of these threecost categories as closely as possible.

3.1.5 Operating costs are often referred to asoperation and minor maintenance (O & M) costsand for many water providers the initial goal is toachieve tariffs that will at least recover thoseO&M costs. This might be a significant first stepfor under-performing utilities and particularlysignificant for politicians who have to “sell” anyresulting tariff increase but this limited approachautomatically builds in subsidies for (or failure todeliver) capital maintenance costs and costs ofcapital. For the majority of consumers thesesubsidies cannot be justified in the long-term.

3.1.6 The capital maintenance costs, alsodescribed as renewal, replacement or“rehabilitation” costs (though the latter termindicates a failure in asset management planningif assets have to be rehabilitated from a non-adequately performing condition), are the criticalcosts to ensure that services continue to deliverthe required benefits in the long-term. There is adifficulty in networked water supply andsewerage in that once some elements of thesystem have been built, they are able to operatefor a substantial period without any apparentfailure in service and therefore apparently notrequiring any maintenance. However, once a(difficult to determine) level has been reached,

8

failure to invest in capital maintenance leads to asteady degradation in service quality as well asan increase in costs of provision.

3.1.7 Where customers have not been paying fortheir fair share of these capital maintenancecosts on a regular basis, the result is thatsystems tend, over time, to produce ever poorerquality water increasingly intermittently (with thepoorest always at the end of the servicereceiving line), with eventually a very highadditional cost to finance rehabilitation.

3.1.8 These guidelines, recognizing the difficultyof achieving full cost recovery in low-incomeeconomies at the beginning, neverthelessrequire calculations of user fees to concentrateon achieving a reasonable level of collection ofcapital maintenance costs (in addition tooperation and minor maintenance costs). This isto ensure the ability of the direct service providerto be able to undertake the necessarymaintenance works in a timely manner.

3.1.9 Waiting on governments for budgetaryallowances to service providers to pay for capitalmaintenance has failed in nearly all levels ofeconomies worldwide. Recovery of capitalmaintenance costs also signals to customers abetter approximation of the cost of water andtherefore the value allowing demand to beadjusted accordingly. To ensure sustainability ofwater and sanitation services in the long term,capital maintenance charges should berecovered.

3.1.10 The mechanism by which capitalmaintenance charges are recovered is known inaccounting terms as “depreciation”. For aconventional business this is the measure of theusing up of the value of the fixed assets neededto produce products for sale such that a reallevel of profitability can be understood. Withchanging technologies and products thoseassets might never be directly replaced.However, in the networked water and sewerageindustries, particularly the underground assetscomprising pipes and fittings, it can be assumedthat those assets will always be needed andtherefore the depreciation charge, over the long-term, represents the best estimate of the costsof keeping those assets in good, serviceablecondition.

3.1.11 Traditionally, depreciation charges arebased upon dividing the cost of the asset by theassumed life of that asset. Asset ManagementPlanning is now the standard and expected toolto refine that process to ensure that the realcosts of long-term asset maintenance forserviceability are charged for. The Bank expectsto support utilities in setting up appropriate assetmanagement plans as part of the move towardscost recovery, to ensure financial sustainability.

3.1.12 The third component of revenuerequirement for water and sanitation services isthe Cost of Capital, which is the cost ofaccessing the finance that has paid for thecapital investments. The finance has to be paidfor, “serviced”, either through interest payments

9

on the debt element or through “dividend”returns to the owners, i.e. the providers of theequity capital. Where governments haveprovided the equity through budgetary grants,they may not require any “dividend” or“financing” payments. The costs for this should,however, be established so as to know theactual costs of the services provided.

3.1.13 The two returns on capital, i.e. anydividend required and interest payments, aretogether referred to as the weighted averagecost of capital (WACC), weighted according tothe relative levels of debt and equity (gearing).For further information on WACC, users of theseGuidelines are referred to African DevelopmentBank Guidelines on Financial Governance andFinancial Analysis of Projects (2006).

3.1.14 There is a number of situations wheregovernment provision of the cost of capital is anefficient direct subsidy to the utility, and thereforeits customers, without affecting the performancelevel of the utility. However, the cost of capitalshould be included in all tariff calculations so thatthe level of subsidy is transparent to allstakeholders (users, civil society, etc) andtherefore the value of water appropriatelyrecognized.

3.1.15 This explanation of quantifying revenuerequirements makes no mention of amortization,in other words paying back the capital amount ofdebt or loans. Repaying capital is a componentof financing rather than revenue requirement.

There should be sufficient cash flow fromoperations to pay for actual capital maintenancecosts (not necessarily directly comparable todepreciation charges in any particular year) andto meet debt repayment requirements. Wherethese numbers do not balance conveniently,issues of financing or cash flow have to beaddressed in addition to the three maincomponents of revenue requirements.

3.1.16 For smaller water and sanitation systemswhere investment is supported by a single loan,the total revenue requirements may berecognized as the sum of operating expenditureand loan amortization (interest and principalrepayment). This functions conveniently wherethe repayment period of the loan principal islikely to be concluded before the need forsignificant capital maintenance – which is thennecessarily financed by a further loan.

3.2 Calculating average user fees

3.2.1 The discussion above relates toaccounting costs which are by nature“historical”, i.e. recording costs that have alreadybeen incurred. It is of course possible andnormal to project these costs into the future toensure adequate tariff levels for cost recovery,taking into account future needs to ensurecontinued sustainability of services.

3.2.2 The projection will be able to indicate areasonable rate of “catch-up” from existing tariffsto what is needed in order to be reasonably cost

10

reflective. Depending on the existing level of userfees, it may not be desirable to expectcustomers to bridge the gap between them andcost reflective fees in one adjustment.Depending upon the size of the gap, and theeconomic conditions, it might well beappropriate to plan for a transition periodthrough implementation of several adjustmentsto achieve cost reflective user fees.

3.2.3 It is now normal practice to make theseprojections using present day costs on theunderstanding, or rather the requirement, thattariffs will be increased by the level of inflationeach year before taking account of any possiblesavings from efficiency or increases fromimprovements to the service. Indexation oftariffs, maintaining the value of the user fees overtime, is critical for long-term sustainability ofcapital-intensive networked services.

3.2.4 Having determined total revenuerequirements for water and sanitation services,specific user charges can be calculatedaccording to the “Basis for charging” in Step 4.Some regulatory systems have found it helpful tosummarize the necessary elements of an annualtariff increase as “Inflation” plus “K”, measured asa percentage increase on the existing user fees.“Inflation” (measured by an appropriate priceindex) is independent of any water activities,whilst the “K” factor describes those elementsunder the control of the direct service provider. Inthe context of Bank lending, “K” is defined asbeing equal to ”Pc”, representing a “catch-up”

factor, minus “X”, a value representing anestimation of future efficiency gains by the utility,plus “C” to pay for extending Coverage,particularly to the poor, plus “Q” for anyenvironmental Quality enhancement, watersupply and particularly waste water treatment,plus “V” for any security of supply (representingenhanced storage & leakage reduction), plus “S”for any improvements to customer Service levels.

Future Revenue Requirement = ExistingRevenue x (1 + (Inflation + K))

Where K = Pc – X + C + Q + V + S (all as percentages)

3.2.5 The purpose of this formula is to assist utilitymanagers and governments explain the reasonfor tariff increases. Unless customers and theirrepresentatives, politicians and civil society candecipher, understand and argue about thecomponents of tariff increases in a transparentmanner, there is likely to be little acceptance of theneed for the increases and even less willingnessto pay those increases. Experience shows thatwhere stakeholders understand the reasons forcharging given levels of user fees, then there isgreater acceptance of such user fees.

3.2.6 In this context, governments find it usefulto have a semi-autonomous body to determineappropriate tariffs. Economic regulators havegenerally been introduced in the context ofcommercialization and/or private sectorparticipation in the water sector, where it is clear

11

that a monopolistic service provider might haveincentive to raise prices higher than costs. Somelevel of “independent” or objective economicregulation of public providers is also beneficial.

3.2.7 One of the key tasks of a regulator, in theabsence of whom it remains the duty of utilitysenior management, is to move towardsreducing costs thereby ensuring continualefficiency gains. This may be difficult in asituation where there are no incentives to rewardefficiency and where there may be a tendency bygovernment as owner to require ever more staffto be employed. However, users can only beexpected to pay cost-reflective charges whenthose costs are reasonably fair and efficient. On-going reforms in many water and sanitationinstitutions provide a good basis for improvingservices and simultaneously implementing cost-reflective user fees.

3.2.8 Overall, the most effective driver forefficiency, where monetary rewards are notappropriate, is through some form ofcomparative competition. Comparing theperformance of one utility or section of a utilitywith another, and bringing out strengths andweaknesses in each often acts as a powerfuldriver for improvement amongst professionalsand good staff who want to demonstrate thatthey are equally competent.

3.3 Future costs for sustainability

3.3.1 There is an additional approach toensuring sustainable cost recovery whichfocuses upon the future costs of supply. It is inthe nature of water supply that each new sourceto meet increased demand tends to be moreexpensive than the existing source. Costs offuture water consumed are therefore nearlyalways higher than present costs. There is anargument therefore that some (large) usersshould pay more at present to signal the likelyadditional costs of delivering those levels ofservice in the future if they continue to accesswater resources at a similar rate as total waterdemand rises. These “long-run marginal costs”are nearly always higher than “average historicalcosts” and are a key component in achievingIWRM goals.

3.3.2 Long run marginal costs are best estimatedthrough a process known as average incrementalcosting whereby the capital costs and theoperating costs of the next major source of water(including the necessary additional treatment &transmission costs, etc) are calculated in “presentvalue terms” relative to additional water delivered.For further information please see the “Toolkitsand Knowledge Resources for User Fees andCost Recovery for Water, Sanitation and IrrigationProjects”.

12

3.4 Support to revenue through societalcontributions (subsidies)

3.4.1 Subsidies play an important role inensuring adequate revenue for effectiveoperation of utilities in low-income economies.Particularly for the lowest-income urbancommunities, smaller secondary towns and ruralareas, subsidies are often a necessary elementof ensuring sustainability until economic growthis sufficient to enable greater dependence uponlocal resources.

3.4.2 Subsidies, which are societal contributionsto ensuring adequate services for all, maycontribute towards revenue needs from withinthe water sector (cross-subsidies), from anational tax base or from internationalcontributions. However subsidies, particularlysubsidies for capital investment, can make itdifficult for governments and utility managers todetermine the true cost of maintaining capital-intensive infrastructure, usually leading to agradual rundown in service quality.

3.4.3 Within the context of ensuring overallrevenue adequacy, subsidies should be clearlyspecified, targeted and limited, either by time orby an acceptable indicator of the likelihood offully cost-reflective tariffs. Subsidies should alsobe transparent, ideally with each billcommunicating the extent to which actual waterand sanitation costs are being subsidized inorder to signal the true cost, and therefore value,of water and sanitation service.

4. Step four

4.1 The basis for charging user fees

4.1.1 The determination of total revenuerequirements, and an understanding of long-runmarginal costs, is the starting point fordetermining the actual user fees (prices/tariffs)that customers should pay for sustainableservices. There are then four main approachesto computing domestic user fees: a fixed orvariable volumetric fee based upon themeasured amount of water taken (thoughrecognizing the significant additional cost ofmeasuring water used i.e. metering) and a fixedor variable fee based upon some housing,household or pipe characteristic.

4.1.2 Many tariff systems use differentcombinations of these four approaches. Theseguidelines anticipate only limited changes to thebasis for charging in any particular RMC in theshort-term. The first priority is to ensure anadequate overall increase in existing user feelevels to achieve the desired movement towardsadequate revenues. Subsequently, the guidanceis to work with RMCs to simplify their basis forcharging wherever possible.

4.1.3 User fees are required not only to ensurerevenue adequacy but also to reflect socialissues, such as service to the poor, as well as toreflect environmental issues related to economicvalues of water. It is at this stage that the basisfor charging becomes more complex with most

13

utilities using some combination of fixed andvariable tariffs and some utilities using ever morecomplex variations between groups ofcustomers to meet these, sometimes conflicting,requirements for charging: revenue adequacy,affordable service to the poor and water demandmanagement.

4.1.4 The “meeting all requirements approach” isgenerally attempted through some form of“block tariffs” system whereby users whoconsume different amounts per period of time(usually per month but also bi-monthly, quarterlyetc) pay a different amount for each cubic meterconsumed within any particular consumptionband. There is no universal consensus as towhat amount of water per month might fairlyconstitute a reasonable “lifeline” amount ofwater. If it is too small then large families (who areoften the poorest) and multiple householdssharing one connection cannot access theamount of water they need without moving intothe higher tariff bracket. However, if it is toolarge, then the majority of households will beable to access their water needs within theamount allowed for the subsidized “lifeline” tariff,and the total revenue may be insufficient toensure sustainability.

4.1.5 Although metering is essential forpurposes of measuring amounts consumed andmonitoring incremental blocks, it should benoted that metering can add upwards of 25% tothe cost of water supply. Metering is, however,extremely essential for demand management

purposes. Large users, who coincidentally areusually cheaper to supply, may be imposing anunfair burden on the supply system (and thewater resources environment) by assuming thatthey can take ever-increasing quantities of waterat a given charge.

4.1.6 The integrated water resourcesmanagement approach requires that tariffsinclude a “signal” relating to the increased costs,financial, economic and environmental, ofdemanding ever greater amounts of water. Largeusers should therefore pay more at present, at ahigher tariff block representing the long-runmarginal cost of water, to indicate the likelyadditional costs of extending the service in thefuture.

4.1.7 The approach in some countries has beento take this latter point as a reason to increasecharges on large users to such an extent thatthey not only pay the long run marginal cost butalso they are in effect subsidizing all domesticconsumers (not just the poor). This thenbecomes a tax on industry and commerce,which may hinder economic development andemployment. It can also reduce thecompetitiveness of developing countries in aglobalized world.

4.1.8 An alternative (or additional) approach isto introduce ‘seasonal tariffs’. Again, becausemost water supply costs are fixed, it isunreasonable to size (and pay for) plant andequipment and pipe networks to meet demand

14

in only a small fraction of the year. Seasonalcharges may be used with higher charges forlarge users during, for example, the hottestperiod of the year. Utilities also address thisissue through the use of ‘interruptible tariffs’whereby large users can choose to pay a loweraverage tariff but the utility can cut their supply(with due notice) at times of peak demand onthe system. Similarly some utilities reduce thesize of any incremental blocks during periodsof drought.

4.1.9 Where incremental block pricing cannotbe avoided it is recommended that, in additionto specific connection size fixed charges:

• Large users are charged the incrementalcost of water;

• Average domestic (and institutional)consumers are charged the averagehistorical accounting cost of water, alwaysupdated by inflation; and

• There is a limited lifeline block (5 or 6 m3per connection per month) for the poorestonly with, ideally, some provision to reflecthousehold size and/or numbers ofhouseholds per connection.

4.1.10 The level of the lifeline block is not judgedonly by affordability but also by the amount ofsurplus revenue raised through the excess oflarge user incremental tariffs above the averagecost of providing water. This is to ensure the

imperative of adequate revenue collection toensure capital maintenance. It is recommendedthat the charge for the lifeline block not be lessthan the operation and minor maintenance(O&M) costs so as to limit the potential fordistorting customers’ understanding of the valueof water.

4.1.11 Infrastructure development charges andconnection charges, payable as new customersconnect, are an apparently useful means ofraising capital funds to pay for extensions ofdistribution systems to service new customersand to pay for the tapping of the main waterpipeline and the pipeline to the house. However,they assume that existing customers have paidthe full cost of connecting, which is not alwaysthe case.

4.1.12 A difference has to be recognized betweencommercial, industrial and housing developers,individual, middle-income household connectorsand low-income, tenement, slum and shanty,room-renting households wanting to connect. Forthe latter group the infrastructure developmentcharge and the connection charge is simply anunaffordable barrier to entry which needs to beremoved. Initially this might be achieved throughspecial arrangements where the charges areinitially absorbed by the utility and an additionalmonthly fixed payment is made by the householdto pay back the costs of connection over one, twoor more years. Alternatively those costs areabsorbed into the average tariff paid by allconsumers.

15

4.1.13 As for water supply, the operatingexpenditure, capital maintenance expenditureand cost of capital is determined for thesewerage network and for whatever wastewatertreatment is undertaken. Where the water supplyis metered, it is appropriate to apportion the totalwastewater costs relative to metered waterconsumption, though possibly with an allowancefor non-returned (to sewer) water ofapproximately 20%. The total revenue collectednecessarily remains the same, but it may becharged on 80% of the water consumed in orderto help the customer understand that thecharges are fair.

4.1.14 Where wastewater is treated tosecondary level and sludge appropriatelydisposed of, the cost of the sewerage systemmay be in the region of 100-120% of the realwater cost. Where water services are notmetered, the costs can be similarly apportionedby the number of households receiving theservice (not all households as in some systems)though for social reasons this can be made more‘progressive’ with charges weighted accordingto property characteristics.

4.1.15 Households with non-networkedsanitation, septic tanks and pit latrines of varioustypes, need to have the tank or pit emptiedoccasionally and the resulting sludge disposedof safely. Where the accepted discharge pointsare to the public sewers (or direct to the wastewater treatment plant), then the user fees fordischarging the effluent should be similar to the

charges for disposal of industrial waste water.Industrial waste water disposal, also known as“trade effluent”, and defined as “any wastederived from trade premises other than“domestic” sewage’’ should follow the PolluterPays Principle. This means that tariffs shouldreflect the costs of treatment, which will dependupon the volumes and strengths of thewastewater that is taken away and/or treated.For details of industrial waste charging, pleaserefer to the “Toolkits and Knowledge Resourcesfor User Fees”.

5. Step five

5.1 Implementation of user fees and cost recovery system

5.1.1 Establishing appropriate water user feesand full financial cost recovery for urban and/ornetworked water and sanitation services is along-term process. The selection and use ofappropriate mechanisms should be a matter ofpractical convenience, e.g. it is a good principleto use a system that is already in place andwhich either works or can be made to work withminimum investment. These guidelinesemphasize the practical approach, looking forways to balance IWRM principles with the needsof the utility to be financially sustainable whilstsignificantly expanding and improving services tothe poor.

5.1.2 User fees are only accessible as revenue ifthey can be collected. Consideration of levels

16

and structures of user fees must thereforeinclude proposals for payment mechanisms. Theoverall guidance is that utilities should make thepayment process as easy as possible. Forlowest-income customers, allowance must bemade for payments to be ‘little and often.’ Pre-paid meters simplify both the billing andcollection process, working either on a time-limited or a volume-limited basis. Manycustomers prefer the security of knowing thatthey are not liable to run up an unaffordable bill.Utilities need to have a clear disconnectionpolicy if they are to enforce water user fees.Disconnection should always be a last resort,and if used regularly, indicates a failure inrevenue collection procedures.

5.1.3 Depending on the policy environment inthe country, each of these elements may requirechange in government policy and practice.Implementation of cost-reflective user fees istherefore often a reform issue or a “changemanagement” process which is likely to requirethe setting-up, or strengthening, of some form ofeconomic regulation, or even an economicregulator.

5.1.4 Customers, present and potential, shouldbe involved, both formally through some level of‘customer committees’ and informally throughsurveys and focus groups, particularly among

the poor. Where stakeholders have beeninvolved in the process as outlined in the four keysteps, implementation of user fees is usuallymore acceptable and much smoother.

Conclusion

Cost-reflective user fees for urban (andnetworked) water and sanitation services arevitally important for achieving financialsustainability. In the urban sector, user fees arecritical to ensure maintenance as well asextension and improvement of services.

Although user fees are important for all customercategories, well designed and appropriatelyimplemented tariffs are especially important forthe low-income customers. When appropriatelydesigned, cost recovery facilitates access to lowcost, clean and convenient drinking water andsanitation for all.

The key approach recommended in theseguidelines is for service providers (utilities) tooffer a menu of desired service levels (servicedifferentiation) to different segments of thecustomer base, at different prices (pricedifferentiation) that the various segments ofcustomers require and are willing to pay.

17

Table 1: Summary of the five steps comprising guidelines for user fees and cost recovery forurban water & sanitation services

STEP 1

The Economic,

Policy and

Institutional

Context

Economic condition, growth and average income levels (GDP pc and Gini index);Trends in urban population growth rates, including peri-urban and informal/slum growth;Policy and institutional environment, laws and formal statements of cost recovery policy byrelevant authorities;Country Policy and Institutional Assessment – likelihood of political support for accelerated movetowards cost recovery for sustainability;Stakeholder analysis – likelihood of support/opposition to enhanced cost recovery;Relative objectivity of price-setting responsibilities; is there a semi-autonomous economicregulator? What level of independence? If none, are there plans to introduce appropriateobjective capacity?Is there any system of comparative competition between service direct (service) providers in thecountry to promote efficiency?

STEP 2

Setting Cost

Recovery and

Service

Objectives

Existing RMC & AFDB policy on setting cost recovery targets from user feesWhat are the primary objectives of service delivery in this context – social, economic, financial,environmental? To what extent should attainment of desired cost recovery target be time-extended?What is the existing financial situation, levels of efficiency, levels of service provision of the directservice provider? What is the existing level of subsidies to average customers of water? And sewerage?How costly is access to bulk water?What levels of service are being accessed by the poorest? What quality and quantity of services are desired by users and consumers, both present andpotential? Can services be delivered through alternative, differentiated, modes of provision?Does the service provider need to be introduced to concepts of service and price differentiation?What, if any, are the restrictions on serving ‘illegal slums’?What is the affordability and willingness to pay for services at various levels of provision,particularly in the slums?Is there a need for detailed user surveys and focus groups in the slums?

Co

un

try P

rog

ram

me A

ssessm

en

tS

ecto

r R

evie

w,

Pro

ject

Iden

tificati

on

& F

easib

ility

18

STEP 3

Investment

Planning,

Costing &

Appraisal:

Determining

Revenue

Requirements

Investment Planning, Costing & Appraisal; understanding total revenue requirements;What are present operating expenditures, capital maintenance expenditures, costs of capital?What should they be at present service levels? What should they be at proposed service levels?Have these costs incorporated direct support costs? What is the average inflation rate? Is thedirect service provider/regulator/ government prepared to accept indexation of user fees?Future Revenue Requirement = Existing Revenue x (1 + (Inflation +K))

Where K = Pc – X + C + Q + V + S

‘Pc’, catch-up percentage necessary to achieve cost recovery at existing service levels; ‘X’potential utility efficiency; ‘C’ to achieve MDG service coverage to the poor; ‘Q’ to achieve desiredenvironmental quality enhancement; ‘V’ to achieve acceptable security of supply (and/or possiblemove towards 24/7 supply); ‘S’ to achieve any desired improvements in customer service levels.What are the future costs (LRMC) required to ensure water resources sustainability? Is the countryinvesting sufficiently in indirect support costs? Is there a justifiable need for extra-sectoralsubsidies, particularly related to the time-spread of achieving cost recovery?

STEP 4

The Basis

for Charging

User Fees

What is the basis for charging user fees? Volumetric fixed or variable; Flat-rate fixed or variable?To what extent do the user fees reflect the principle of revenue adequacy, social fairness, waterconservation and polluter pays, simplicity and enforceability?If incremental block pricing is used, are the sizing and pricing of the blocks appropriate?Is there a lifeline block that is being accessed by too many users to the detriment of the utility’s(service provider’s) revenue stream? Can the charges be simplified to aid customer’s understandingand responsiveness? Is it an appropriate time to re-consider the basis for charging? Is there anappropriate balance in sharing the total revenue burden between different consumer segments? Do consumers accessing water at kiosks pay a proportionate share of the costs?Do the new connection fees allow/encourage access to the piped network by the poor?To what extent are sewerage (and any wastewater treatment) costs being recovered?Are industrial/commercial users being charged according to «polluter pays» principle? Is theresufficient enforcement to limit «polluter pays» avoidance?Is there sufficient willingness and ability to pay these user fees?Have women, the poorest and the most disadvantaged been consulted separately?If not, reconsider service objectives and modes of provision Step 2.

STEP 5

Implementation

Are any additional sources of finance required to ensure coverage for all, especially to the poor?

Is there an adequate strategy to communicate to customers the reasons for moving towards full

cost recovery?

What customer involvement mechanisms are planned?

Are there appropriate user payment collection procedures (flexible payment systems) in place? Can

lower-income customers pay little and often?

Are there appropriate but enabling processes in place/planned for non-payment?

Are public institutions paying their water fees?

Is there any need for adaptation of local bye-laws to enforce compliance?

Is there a system of financial control, monitoring and evaluation of the development of user fees?

Pro

ject

Pre

para

tio

n a

nd

Ap

pra

isal

19

gives a resulting tariff of 0,29 CUs / m3 as shown in the calculations

below

Tariff Calculations

% Volume, m3 Currency Units (CUs)

1

Operating CostsEnergyChemicalsLabour

900,000400,000100,000400,000

2Depreciation (average Capital MaintenanceExpenditure)Value of current Capital Employed

400,00010,000,000

3

Required Return on Capital Employed(ROCE) Debt / (Debt + Equity) RatioAverage Cost of DebtAverage Cost of EquityWeighted Average Cost of Capital (toservice debt & equity)

50 %7,5 %2,5 %5,0 % 500,000

4 TOTAL ANNUAL COST, CUs 1,800,000

Guidelines for User Tariffs in Urban Networked Water and Sanitation

Sample Water Tariff Calculations for Urban Utilities

Scenario A: Government subsidy for Capital Maintenance and Cost of Capital, typically poor Non Revenue Water and limited Bill Collection Efficiency


5Government Subsidy 1 - any cost ofcapital (debt or equity) not charged toutility

5 % 500,000

6Government Subsidy 2 -any directbudgetary subvention, usually for(deferred) capital maintenance

400,000

7

Required Total Revenue from customers,CUsWater produced in year, m3 Non revenue water, % => m3Billed water, m3Bill Collection efficiency Water bills paid, m3

35%

75%

4,800,0001,680,0003,120,000

2,340,000

900,000

8Average TariffRequired total revenue divided by waterbilled, CUs/m3

20

0,29

21


below

Tariff Calculations


1


900,000400,000100,000400,000


400,00010,000,000

3


50 %7,5 %2,5 %5,0 % 500,000

4 TOTAL ANNUAL COST, CUs 1,800,000



Scenario B: Government subsidy only for Return on Equity Capital - full Debt Servicing,reasonable Non Revenue Water and Bill Collection Efficiency

22



1,3 % 125,000


0

7


25%

85%

4,800,0001,200,0003,600,000

3,060,000

1 675,000


0,47

23


below

Tariff Calculations


1


900,000400,000100,000400,000


400,00010,000,000

3


50 %7,5 %10 %8,8 % 875,000

4 TOTAL ANNUAL COST, CUs 2 175,000



Scenario C: No subsidy for private equity return, full Debt Servicing, good Non Revenue

Water and Bill Collection Efficiency

24



0 %


0

7


15%

95%

4 800,000720,000

4 080,000

3 876,000

2 175,000


0,53

25

www.afdb.org

The Water Partnership Program and its mission

The Water Partnership Program (WPP) promotes effective water management policies and practices at regional and countrylevels. It operationalizes the African Development Bank’s Integrated Water Resources Management policy in the Bank’s regionalmember countries.

WPP pursues its goal through the generation and dissemination of a range of knowledge products, fostering dialogue on keysector issues and promoting partnerships that enhance knowledge sharing.

The Guidelines presented here touch upon a very critical issue for all rural water sector investments: how to build rural water and

sanitation infrastructure that is, first and foremost, financially sustainable, in addition to being environmentally and socially sustainable?

Water Partnership Program WPP

The African Development Bank,

Temporary Relocation Agency (TRA),

13 Avenue du Ghana, BP 323,

1002 Tunis Belvédère, Tunisia

Tel. (216) 71 333 511 / 7110 3450

www.afdb.org

Agencecanadienne dedéveloppementinternational

CanadianInternationalDevelopment Agency

Documents

Guidelines for User Fees - African Development Bank · Please refer to the long version of this publication, “Guidelines for User Fees and Cost Recovery for Urban, Networked Water