There are different procedures for enacting adjustments in tariffs. In some cases, there is agreement that the costs of certain inputs (energy, for instance, or bulk water) are to be immediately reflected, passed-through, in the tariff charged to and collected from consumers. In this way, the risk of the input price increase is immediately passed on to consumers. Other pass-throughs might include a change in tax rates, or a change in the quality standards imposed by government. The mechanism is appropriate when the service provider has no control over the input. The pass-through may reduce the service provider's incentive to use the input more efficiently, yet the provider is also wary of increasing tariffs beyond what consumers are willing and able to pay.
Tariff indexation. This mechanism is similar to a cost pass-through but uses a different tool to make the adjustment. Rather than the actual costs of the service, the tariffs are adjusted to reflect a change in an index of prices (such as the consumer price index), on a regular timetable. While indexation may protect the provider from price increases that are predictable and within normal limits, the provider is still vulnerable to changes outside the norm or outside the index. In some cases, the indexation formula is based on a basket of prices most relevant to the service being provided.
Tariff reset or periodic tariff adjustment. A more tailored mechanism for adjusting tariffs is the tariff reset. For a long-term PPP, an indexation or pass-through will likely be insufficient to accommodate all sector changes over the life of the contract. Therefore, the rules for tariff resets are defined before PPP is implemented and will be a topic of discussion among all parties relevant to the discussion of allocating risk.
The discussion of tariff resets has to cover:
• the objectives of the reset,
• the methodology for the reset, and
• triggers for a review and potential reset.
The objectives of the adjustment can include allowing a reasonable rate of return to the operator, encouraging efficiency through a rate of return, or restoring the financial position of the operator who has confronted an unanticipated (and uncontrollable) change in the operating environment such as an exchange rate change.
Depending on the objective of the reset, different methodologies may be used. For instance, there might be an attempt to determine what the most efficient operating costs would be through benchmarking or obtaining expert advice. If the reset is to restore financial standing to the operator, only key cost variables may require review.
Such a tariff adjustment might be triggered by a request for a review or by a specified event. Typically, these adjustments are allowed on a predetermined periodic basis, such as every 5 years.
In some cases, highly unusual circumstances such as strife or bankruptcy might trigger an extraordinary price review.