F. Minutes from the Question & Answer Session

Acuacar And The Cartagena Water Supply And Sanitation Joint Venture

Question: At the beginning of the water supply joint venture in Cartagena, capital investments were split up in the following manner: 50% public sector ownership, 4% private investor ownership, and 46% Aguas de Barcelona ownership. As the size of the area covered and the services expand, Acuacar will have to make additional investments. How can the company increase equity in that process? What kind of revenue system is being applied and how is the revenue on capital regulated? What are the prices?

Discussion:

• Participation in investment started out on a 50-50 basis, but over the course of developing the system, there were numerous changes in planning and conception. Changing the original plan in the middle of the process means that you have to give the private operator time to adjust to new conditions. This means that the investment process requires flexibility. The Cartagena approach has been flexible vis-a-vis production targets and indicators.
• Efficiencies in service, productivity and management also lead to resource gains. There is a re-investment control that requires putting 12% to 15% of the profits of the company into an investment programme. The private sector may not be willing to finance investment at first, but during operation some cash flow is generated. It is also possible to borrow from multilateral institutions and commercial banks. It is important to do finance analysis that is reasonable.
• With regard to tariff levels, there has been some uncertainty. Acuacar had to be open-minded to see what would happen with new regulation. Under new regulations imposed in 1996, prices will gradually be increased until the year 2001 by a total of 15% (50 cents on the dollar per cubic meter for water). For sewage, prices are about 60% of the price of potable water or 30 cents to the dollar per cubic meter.
• Another question that arises in cases like the Cartegena water supply system revolves around the new role of the municipal government. Is it to become an arms length regulator trying to guess what cash the flow is or is likely to be? Or is it to assume an investor role that would provide a better perspective on revenue streams?

Small Scale Independent Providers (SSIP) Model

Question: What are the comparative costs to consumers of services provided by SSIPs as opposed to a centralised network?

Discussion:

• Studies by the British Government have indicated that SSIPs are characteristically much more expensive for consumers than a larger scale centralised system. DfID's experience suggests that SSIPs can cost as much as 30 times more. The British government is therefore very cautious about pursuing the SSIP alternative unless there is a way to tap into the central supply network.
• Studies conducted by the IRC Water and Sanitation Centre indicate that the high prices associated with SSIPs may be the result of a) distortions resulting from subsidised water tariffs that do not reflect the true costs of providing the service, and b) the capital expenditures required by some private informal providers who have to transport water long distances from the source. Overall, however, IRC's data does not support the conventional wisdom that says SSIPs cost consumers 20 to 30 times more than the central utility.

Procurement Issues And Contract Negotiations

Question: Given the frequency of contract revisions and the importance of post-award negotiations for small and medium-sized investments in water supply and sanitation projects, how can you ensure the most fair and competitive selection process during procurement? Is the key to fair and competitive bidding in an environment of uncertainty and post facto modifications based on standards and levels of service?

Discussion: This is one of the most important questions when negotiating a contract, and the answer depends on the kind of contract and price formula being applied. According to Dr. Rudolph, there are four alternatives from which to choose:

1. The investment-driven price formula: The higher the investment costs, the higher the end-user service fees. In Dr. Rudolph's experience, this approach can be counter-productive, and there are often difficulties avoiding surplus costs in this kind of price formula.
2. Cost index-driven price formula: Here, the winner in the procurement process has the most price efficient solution and delivers unit cost prices on a percentage basis. For instance, a contract may stipulate that 18% of the service fee is related to the cost of energy, which is publicly available information. When energy costs rise or fall, the service fees will rise or fall proportionally.
3. Market development index. This approach is viewed favorably by Dr. Rudolph. It involves referring to the prices of the same services in neighboring cities - an approach that allows benchmarking as has happened in the British Ofwat system. Under this approach, the provider is again permitted to raise - or be forced to lower - prices.
4. Level-of-Service (LOS) driven price formula. In many cases, this involves declaring certain standards of quality (for example, water quality) and establishing a time frame. There are no objections to surpassing the standards by more than 100%, but regulators will pay close attention to whether or not they are fulfilled within 2, 5 or 10 years.

The "take home" message is that you have to find an optimal composition of these elements in the price formula. This will form case-specific, individual contract regulations with regard to indexing and adjustments. In spite of these formulas and the wisdom of all the consultants and lawyers involved in the procurement process, governments, private operators and the public have to be prepared for unforeseen changes to occur over the course of long time periods. This is especially the case if there are changes in the national laws that will affect costs. In such a situation, the costs for maintaining a plant, building up a management system, annual effluent fees, analyzing existing chemical parameters or having to analyze new additional chemical parameters can all change unexpectedly. If enough of these factors require a regulatory report, the price formula may be rendered obsolete. At this point, it will be very beneficial to have a contract with a built-in philosophy that will allow regulators and operators to find the correct price.

1. Although there are significant challenges in the procurement of private sector services, the alternative is a non-regulated public entity that will have to recover costs without any incentive for achieving efficiencies or the kind of profits that would allow for the substantial re-investments required by just about every municipality in the developing world.
2. Different approaches to procurement can anticipate some of the changes that are bound to arise. But there is also the need for creating a set of partnership tools in those cases where the services are user-driven, when traditional forms of procurement are not applicable. What kinds of problems will this create? In Madeleen Wegelin-Schuringa's work with communities, for instance, the operators are responding directly to user demands so there is no initial competitive bidding procedure. In another example, the discussions in the waste water treatment project in Windhoek were conducted between the municipality and the breweries and focused on figuring out how to develop an operator, rather than on how to select one.
3. PPPs, therefore, require that Governments think through the procurement procedures where they are not just buying pencils, but are trying to optimize a system that will evolve over time in a way that no one fully understands from the outset.
4. If one argues that the high transaction costs associated with feasibility studies and the competitive bidding process inevitably drives prices up, would there be a feasible and lower cost alternative in identifying a trustworthy partner and building a contractual arrangement around them over time?
5. One of the problems with high transaction costs may indicate that the World Bank and the international finance institutions do not have the right approach. They bring in a lot of bureaucracy, as well as their own procurement rules, and are linked to the high- priced consulting world. All of this leads to expensive procedures, and results in projects with transaction costs of under US $1 million being neglected or overlooked. Just looking at small-scale examples in Germany demonstrates that there are much cheaper alternatives. But for these, competition is very important.
6. However, it might be possible to negotiate with a single partner from the beginning, but over time there will always be a need for hard incentives to find the lowest cost approach for all of the elements (for example, personnel). Or else there is an alternative that lies somewhere in between open competitive bidding and unsolicited bids. For instance, the government identifies four or five companies with an optimal investment plan and then chooses the one that it most trusts.
7. The Poznan example. The Municipal Board of the City of Poznan decided to pursue an ambitious and highly individualised approach for their water system involving a three-stage procurement process:
   1. Based on fixed maximum tariff level and fixed level of service, seven pre-selected companies submit their own optimum investment plans. The best four plans pass onto the second stage.
   2. Based on the optimized investment plans (for example, result of 1st stage), and the maximum water tariff the companies propose their level of service (for example, how long before the system reaches the European standard?). The best two are selected.
   3. Award and final price negotiations (based on the water tariff criterion).

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