Designing a PBC for NRW reduction

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Liliana Jennings
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1 Designing a PBC for NRW reduction What to look for and pitfalls to avoid Philippe Marin, Sr. Water & Sanitation Specialist Global Water Practice, The World Bank Pristina, October 7 th,

2 PBCs have the potential to be more efficient contracts than the traditional, input-based contracts While the contractor is required to take more risks, it has also more incentives to deliver tangible results For the contracting utility, a well-designed PBC is less risky since it will pay the full price of the contract only if targeted performance improvements are achieved No staff layoff: private partner comes for limited time to carry out additional tasks not done by the utility A well-designed PBC is a win-win proposition for both the utility and its contractor 1

3 Successful PBC for NRW reduction have high financial return Typical cost Euros per m3 saved per day (physical losses) Project payback in years depending on O&M cost/tariff levels (physical vs. commercial losses). Approximate calculation based on cost of 600 Euros per m3 saved per day: Tariff / O&M cost In Euros per m3 1 Euro per m3 0.5 Euro per m Euro per m3 0.2 Euro per m3 Payback period in years 1.6 year 3.3 years 4.7 years 8 years 2

4 But PBCs tend also to be more complex to design and implement How much risk can be passed to the contractor depends on many factors, including inter alia: The country and the utility context Governance structures Specific performance improvement sought after Quality of available information 3

5 Designing the contract and incentives framework: the devil is in the details Achieving efficient incentives is dependent on many factors including: Striking a proper balance between fixed and variable payment How the contractual targets are determined Which NRW indicators are used Level of flexibility left to the contractor There is no blueprint: well designed PBCs are heavily customized contractual PPP instruments 4

6 Main requisites for contemplating a PBC in NRW 1) Availability of reliable baseline data Or baselining done at onset of contract 2) Possibility of ring fencing the private partner s activities Accountability for results 3) Do potential benefits outweigh the costs? (complexity) 4) Do public procurement rules allow for PBC? Bonus payment, flexibility to decide activities 5) Understanding the NRW dynamics (water balance) Very challenging with intermittent supply 5

7 Key issues for designing a NRW PBC Checklist based on past experiences around the world 6

8 Fixed vs. variable remuneration Most PBCs are hybrid schemes, combining fixed payment with variable payments While a 5-10% bonus provides some incentives for performance, a true PBC shall aim for at least 20 or 30% of the remuneration paid through variable fees so as to include not just profit but also part of contractor s costs The feasibility of having at least 20% paid through bonus depends on local conditions and contractual design: - Allocation of risks must be carefully thought about - Contractual enhancements to mitigate risks (e.g. donors support with partial risk guarantee) 7

9 Clarity of contract PBC are complex. Poorly drafted clauses can generate undue conflicts between the parties: Lawyers must work closely with sector experts Special care shall be taken to : Clearly define expected inputs tied to the fixed payment Choose simple and objective indicators Quantify the targets (be realistic) Spell out how the bonus formula shall be calculated Spell out the responsibilities of the contracting utility 8

10 Financing the NRW activities PBCs are typically by a mix of public funds (e.g. donors lending) and private funds The contractor must pre-finance at least some activities since part of the remuneration will be paid only after tangible results are shown The feasibility of accessing private funding depends on market conditions: It can be enhanced by careful design of the PBC, with instruments such as a partial risk guarantee (PRG) 9

11 Measuring results - Baselining Objective and reliable measurement of target indicators is key for being able to pay based on results If baseline not already available, upfront investments may be necessary to install or upgrade measurement systems (macro-metering) as first action of the PBC It is highly advisable to use the services of an independent, third-party to monitor and evaluate the contractor s performance on a consistent and transparent basis 10

12 Setting targets For incentives to work, performance targets need to strike a balance between being achievable (i.e. realistic) and sufficiently ambitious. They may also need some degree of flexibility, to adjust to unpredictable conditions A good understanding of the NRW situation is critical: Physical vs. commercial losses (IWA water balance) Choosing the right NRW indicator: m3 lost per day-connection instead of % losses 11

13 Flexibility left to the private partner The utility must carefully ponder which decisions are best left to the contractor: Complete flexibility is not usually desirable Introducing a Works Funds financed by public side, if prefinancing from private partner is not an option The installation of some infrastructure may need to be specified upfront (as inputs): Macro-metering for measurement and baselining Sectorization for measurement and ring fencing 12

14 Ring fencing The interface between the contractor and utility s operations needs to be carefully analyzed and appropriate step taken to separate them: Network sectorization: how many? Which size? Dividing the city network between the utility and the private partner (e.g. Ho Chi Minh, Vietnam) How the utility staff will operate in areas where the private partner is carrying out NRW activities? 13

15 Utility ownership Even with good ring-fencing, the outcome will still usually depend upon the collaboration of the utility s staff Capacity building is needed so that they fully understand the contractual approach: Include compulsory training and knowledge transfer into the PBC contract The management and staff must understand the benefits for them and be willing to cooperate with private partner Mutual commitment is essential for success 14

16 Sustainability The challenge for a successful PB : ensuring that the gains achieved can be made sustainable after the contractor leaves Including knowledge transfer activities should be included But this may not be sufficient, in the absence of additional institutional reforms NRW improvement is only the first step. Maintaining NRW level and even improving it is the next goal Second generation PBC may be an option e.g. Algiers 15

17 Typical situations where implementing a NRW PBC makes lot of sense (1) 1) Advanced emerging countries e.g. Brazil: continuous supply with NRW in 30% range (quite good), but tariff is high so reducing NRW further is financially profitable: PBC can largely be self-financed by private sector 2) Water scarce countries developing desalination plants (MENA): even with NRW at 20%, reducing NRW further is financially profitable regardless of actual tariff levels because of high production costs (e.g. Djerba Tunisia, Aqaba Jordan, Gulf countries) 16

18 Typical situations where implementing a NRW PBC makes lot of sense (2) 3) Moving from intermittent to 24/7 continuous supply by increasing water production capacity (building a new potable water treatment plant) (e.g. many developing countries) What will happen when the new treatment plant start operating? More water 24/7 continuous supply: population is happy But more hours of service and increased pressure in deteriorated network will means MORE LOSSES NRW will rise, new hydraulic functioning, financial situation will worsen this can get out of control To avoid this situation, the only solution is to implement a comprehensive NRW program in parallel with starting the new treatment plant Can be customized to local conditions (what is needed?) 17

19 THANK YOU

What is PBC and how it can help deal with the challenges of reducing NRW?

Joint DWP ARA Regional Workshop on Performance Based Contracting for Non-Revenue Water Reduction What is PBC and how it can help deal with the challenges of reducing NRW? Bambos Charalambous World Bank