Presentation 1 - Water Research Commission

Setting Municipal Water Service
Tariffs for Cost Recovery in SA
Theoretical Observations
Stephen Hosking
Professor, Economics Department
Nelson Mandela Metropolitan University
Purpose of today’s seminar
Interface/discussion between Theorists (and
researchers), Practitioners and Policy designers and
implementers – thank the WRC for facilitating + others.
Presenters, we allow 15 minutes presentation and 5
minutes for discussion, plus some at the end of session.
Participants, please accept my apologies up front - I will
not have the time available to allow everyone to
question/comment who wants to.
Feedback – copies of the presentations can be obtained
from Charmaine of the WRC
Last but not least – indiv researcher share their thought
Terms we use - please be patient
when others use different terms
Example of the different terms of value, often
used interchangeably with respect to water service
• Price – an exchange/trade value negotiated.
• Charge/fee – levied by seller for the service, or
another party to a trade on the trade
• Tariff is a money value set, usually by a public
entity or government, with the aim of recovering
the cost of production, or the aim of discouraging
purchase of the good/service (import tariffs).
Tariff setting process may involve some
negotiation, but not necessarily with buyer.
Tariff setting involves, at least..
(A) The cost needing to be recovered and estimated (required
(B) Revenue collection options and principles
- Revenue (QR)/ Non-revenue (QNR) divide
- public education, water service package determination,
tariff structure and revenue (marketing)
- demand analysis – tariff elasticities
- opportunity cost revenue raised
(C) Assessing practice against goals
- ethical goals/principles
- policy self-interested voters support
- ethics and political interest compared with
practice/delivery – and the adequacy/instruments of monitoring and
Collective (social) Policy and Goals
determine water service tariff setting
Water Input Prices
Selecting WSP
Pvt Firm Pub Utility Municipality (Self)
Tech Choice/Cost calculation
Revenue Requirement
Revenue collecting method
Central Govt Other Property Tax
Tariff Structure/ Demand analysis/Opport cost
One Part
Two Part Tariffs
Economic rationale to recover cost
through usage tariffs?
1. Case of potable water
Potable water is a rival good, so once appropriated by a
household, is unavailable for another, so can be priced
like a private rival good.
2. Case of waste water
Waste water is mostly generated as a by-product of the
potable water service, and generates substantial external
costs, if not properly managed.
One way to internalise the waste water external cost into
users decision making is to incorporate the waste water
cost into the potable water service tariff (price).
Storm water management cost is unrelated to
potable water service
Storm water is
- partly a public good, in so far as it drains public
property, like roads and pavements, and the cost for
this part is best collected through property taxes
- partly an externality of roofing and paving construction
on privately owned land and also of illegal private
storm water diversion into the waste water
management system – this part can efficiently be
recovered through a separate storm water tariff – is
justification to feed back this revenue into the water
balance accounts
In which costs measures are we most
interested for tariff setting?
Efficiency requirement of setting the tariff level = P = SMC - for both
quantity of water sold (QR) and connections added to supply network
But the information available typically only allows SAC to be calculated
Which is not a problem because optimal exploitation of implemented
water supply schemes will bring about
So that Tariff = P= SMC = SAC
Note that SMC is expected to decline up until the capacity of the
storage and transport system is exceeded.
Costing/Pricing the investment in supply infrastructure – three water
supply schemes - implemented ones are (0) and (1) , planned one is (2)
Cost in
Rand per
Water per cubic metre
When is the Long-run marginal cost
(LMC) relevant - where scarcity cost
SAC1 is not the right reference to use when there is a scarcity cost (SC), that
is, increased real total cost of an increase in water supply due to
increased scarcity or decreased quality of raw water available
For planning purposes a planning cost structure should be used - the relevant
long-run cost measures
LMC2 = LAC2 + SC2
SC2= increased real total cost between water schemes 1 and 2
= LAC2 + Q2. (LAC2 – LAC1)
LAC2 = long-run average cost after scheme 2 implemented
Q2 = quantity of water supplied by all three schemes: 0, 1 and 2
A water account balance approach to
determining the Req Rev (RR)
RR =
(DCp + DCw + RC + OFC) + VC + (BD + CS) – (KG + OS)
TC = Total cost = FC + VC ;
FC/TC ≈ 80%
DCp + DCw = depreciated cost infrastructure for potable water + depreciated cost
infrastructure for waste water management
RC = rehabilitation, new investment and maintenance cost
OFC = Other Fixed Costs (interest on loans, wages, and so on)
VC = variable cost = c(QR + QNR); where c = average variable cost multiplied by the
revenue attracting quant of potable water supplied (QR) plus the non-rev quant (QNR)
TRANS = transfer requirement = BD + CS = bad debts + collectively ‘agreed’ implicit
tariff cross-subsidisation between users
GS = government grant/subsidy = KG + OS = capital grant + operational subsidy
A checklist on the components of the
water account balance
(DCp + DCw + RC + OFC) + VC + (BD + CS) – (KG + OS)
• Is depreciation cost properly calculated for replacement?
• Is rehabilitation cost adequate to maintain the assets?
• Are Capital Expenditure Grants timeously applied for and
• Is the Government Operational Subsidy (= Equitable
Share/ATTP) grant correctly applied for and allocated?
• Is the transfer burden bearable?
[Local Transfer Burden = (BD + CS)/TC]
• Does variable cost include all components it should?
Going through the VC cost checklist
• VC (of QR and QNR) - chemical treatment,
electricity (pumping) monitoring and testing, cost
of raw water and damage through waste water
disposal, etc.
• Two components of VC were not included in any
municipality’s water accounts that we
investigated, were
Opportunity cost (estimated at about 1-3% of TC)
Damage costs ‘externally’ borne (estimated at
about 3-7% of TC)
What are the consequences of omitting from
VC the opportunity and damage costs?
Failure to include opportunity and external costs does
• put at risk the sustainability of water services
• nor does it cause imbalances in the financial flows
underlying the water accounts ,
BUT may cause
• greater demand for the provision of potable water
services than would be efficient
• less waste water management service provision being
supplied than would be efficient - Siyathemba
Are there ‘new’ trends emerging in cost
calculation in SA municipal tariff setting?
(1) Containing VC and reducing the RC required by
increasing tariff levels
Q = f(Demand; Political Pressure)
Demand = g(P); inverse relation
P = tariff (price)
(2) Introduction of increased variety/flexibility in
quality of service package - with the aim of
improving efficiency, e.g., cheaper lower water
pressure options – Ethekwini, but we also predict
others and new supply technologies introduced Jessica Hosking.
Theoretical observations about costs
needed to be recovered
Advantages of market processes and private sector competition/particpation need
to be considered
SAC is an appropriate reference for tariff calculation
The waste water charge should be internalised into the potable water charge
A case for a storm water tariff can be built
There may be a need for greater advice to be given to politicians on the social
sacrifices required to balance the water service accounts
The local transfer burden needs careful management
The minimum required maintenance and rehabilitation expenditure needs to be
Investment in new infrastructure must keep pace with expectations of the
population and economy
Increasing use is being made of demand management to contain variable costs
and avoid making new investments
Adding households into a supply network where marginal connection costs are
obviously higher than the expected marginal revenues raises the question of
sustainability, and the spectre of idle/neglected infrastructure
Thank you
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