In a concession contract, the municipality turns over full responsibility for the delivery of services in a specified area to the partnership concessionaire, including all related construction, operation, maintenance, collection and management activities. The concessionaire is responsible for any capital investments required to build, upgrade or expand the system and for financing those investments. The public sector is responsible for establishing performance standards and ensuring that the concessionaire meets them. The additional responsibility to fund capital investments distinguishes it from a lease.
In a concession, the public sector must take on responsibility for the regulation of price and quantity. Such regulation is particularly critical in the water sector, given the argument that water has the qualities of a public good and piped delivery systems are natural monopolies. The fixed infrastructure assets are entrusted to the concessionaire for the duration of the contract but they remain government property. Concessions are usually awarded for time periods of over 25 years. The duration depends on the contract requirements and the time needed for the private concessionaire to recover its costs and profit.
Over the life of a concession contract, the private sector manager is responsible for all capital and operating costs, including infrastructure, energy, raw materials and repairs. In return, the private operator collects the tariff directly from the system users. The tariff level is typically established by the concession contract, which also includes provisions on how it may be changed over time. Tariffs may also be set under national, provincial or local legislation and regulation (see discussion in Chapter 10).
Structuring the tariff and the accompanying regulatory system is often the most complicated part of any concession arrangement. Tariffs need to be high enough to allow the operator to make a profit if it performs well, but not so high that the profits are excessive, causing a political backlash. The two most widely used approaches are the price cap and rate of return models. Under a price cap approach (the basis for the British regulatory structure), water prices are set for a number of years.11 If the water operator achieves higher than expected efficiencies, and lower costs, it can keep the savings as profit until the next periodic price review. Under the rate of return approach (widely applied in the US), an allowable level of profit (in the range of 6 to 12 per cent) is determined, and the operator is allowed to charge rates that result in that level of profit over its costs.12
In both approaches to setting tariffs, the key battles are over information. Does the regulator have enough information to make informed judgements as to the actual state of the concessionaire's finances during the concession period? Is the private operator meeting the performance standards and are the customers well served? Managing information flow among the concessionaire, the users and the regulators is one of the key challenges facing concession arrangements.
The financing for concession investments typically involves a combination of money from the private partners and international commercial banks (see Box 7.11 describing the financing arrangements for the Buenos Aires concession). Moving from guaranteed payments by governments to anticipated revenues from users increases the commercial risks to the private sector partner. This is particularly true for currency risks, as the revenues are in local currencies, while the debt payments for capital investments often need to be made in foreign currencies.
Like the application of the affermage/lease model, in practice municipalities can opt for, and operators accept, a range of variations on the basic elements of the concession. In particular, a municipality may wish to delegate the business, but may not wish to delegate the customer interface immediately, leading to a phased arrangement in which the municipality continues with the revenue collection function. Municipalities must understand the ramifications of these decisions, especially in terms of the changed incentive structure and overall efficiency that the operator can achieve.
Box 8.9 A Small Concession Queenstown in South Africa (population 200,000) first adopted a partnership arrangement for the delivery of water and sanitation services in 1992 prior to the democratic elections. In the apartheid context, the obligation of the Queenstown council at that time was limited to distribution functions in the 'white' town and bulk water supply in the outlying townships. A 25-year concession contract was established with a consortium (now WSSA - a consortium including Ondeo-Lyonnaise des Eaux and the South African national construction company Group 5). The operator services include water purification and distribution and sewerage services, but notably excluded consumer management. After its election in 1995, the Queenstown Transitional Local Council was faced not only with a town split along ethnic lines, but also a public/private division in the delivery of water and sanitation services. The incoming council was not enamoured with the private arrangement it had inherited, but the duration of the contract, the perceived penalties for withdrawing, and the case made by the administrative officials and the operator, swayed the decision and, after a six-month interim agreement, and following a public consultation process, the council agreed to an amendment to the concession to extend coverage to include the three township areas. A universal service standard was applied across the city. The contract obligations were changed both in terms of area and scope, to include: • the operation and management of the bulk water and sewerage treatment facilities, water and sewerage distribution and collection from the pump stations to each house; • the water and sewer network including connections and water meters; • the repair and replacement of the system assets on a regular basis; • funding and constructing an expanded sewage treatment plant; • an accelerated programme of rehabilitation and upgrade of existing supply services to the underserviced areas; and • a 24-hour standby emergency service and a 24-hour complaints line. Meter reading, billing and revenue collection, however, remained the responsibility of the council. Under South African law in 1992, the billing and collection function was a municipal obligation and there was thus no provision for its delegation. While this legislation is no longer in place, the Queenstown council has stalled the transfer of this function for political and institutional reasons (and fears over its marginalisation from the service delivery process), and thus retains responsibility for customer management. Customers receive one amalgamated service bill covering water, sanitation and solid waste. WSSA has provided support to computerise the accounts. The council is responsible for setting the tariff, which covers operating and capital costs, and is reviewed on an annual basis. The level of cost recovery is poor. Between 1997-99, R34 million (US$5 million) was accrued. The current estimated cost recovery in low-income areas is approximately 55%. WSSA are paid a composite fee based on: 1. a fixed charge to cover the costs of the service (approximately 60%); 2. a performance-related fee measured against performance indicators; 3. a variable charge based on the water sold at the meter at R2.13/kl (US$0.30/kl); and 4. a supplementary charge for drawing water from a different source. The compensation system provides WSSA with some incentives to reduce unaccounted-for water (which was 45%, and is now 21%). However, due to the fee arrangement, the municipality has also benefited substantially. Real costs have declined by approximately 20%. Over the concession period it is expected that WSSA will invest R30 million (US$4.2 million). To date, capital investment has totalled R10 million (US$1.32 million). The capital investment is for the annual replacement of an agreed number of water meters and water-pipe networks, and routine replacement of electromechanical equipment. It also included the expansion of the wastewater treatment works at the commencement of the contract. All assets remain in the ownership of the municipality. A number of reasons seem to explain the poor cost recovery. Due to the awkward agreement whereby the municipality carries out the customer management function - and does so inadequately - the increases in efficiency achieved by the operator are not being passed on to the consumer but are being accumulated by the municipality. The relatively high tariff in the province is a result of the poor cost recovery. The municipality must pay the operator fees from the tariffs collected from a minority of users. This is a vicious circle. High tariffs and poor customer management lead to higher tariffs and less cost recovery.
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