ISROb 獵 C。開∥try Oe&LI l日lin員meliC日日朋d lhe C日ri&he日朋“eg面。∥ EC○n○m 1 CN○中es !！珊  Country Dept. I Latin America and the Caribbean Region Economic Notes Reform Options for Uruguay's Water and Sanitation Sector Judy Chang Antonio Estache and Jean Martin June 1996 The World Bank This series presents the findings of work in progress. They are prepared or sponsored by LAl staff to address immediate policy concerns identified through the dialogue with governments and they reflect the views of the LAl Department. This note was prepared by Judy Chang (Consultant), Antonio Estache (LAlIU)\, and Jean Martin (Consultant) under the general direction of Antonio Estache (LA1lU). Questions and concerns should be addressed to Mr. Estache, telephone number (202) 458-1442, email address: aestache@worldbank.org.  REFORM OPTIONS FOR URUGUAY'S WATER AND SANITATION SECTOR Executive Summary Objectives. This note has three main about 8 and its total labor force has been cut by about purposes: 10% (from 6670 to 6092) during the same period. * it describes the current state of the sector in OSE has also dramatically improved its cost recovery Uruguay, focusing on the activities of its main in its 19 departments. In water, it increased from actor: Obras Sanitarias del Estado (OSE), the 64% in 1990 to 88% in 1993. It tripled with an public enterprise which is the primary water and increase from 8% to 24% in sanitation. sanitation services provider of Uruguay (the A Snapshot of the Main Issues. major exclusion is Montevideo's sanitation which Unfortunately, not every performance indicator is as is under the responsibility of the municipality); positive and OSE has slowly become a victim of its * it proposes a set of criteria to assess the current lack of commercial orientation. Indeed, while its performance of OSE; and concern for quality and for the poor are obvious in * it uses these criteria to identify the main issues many anecdotes and statistics, its overall performance and proposes reforms to improve and expand is still far from what many within and outside of OSE Uruguay's water and sanitation services. would expect from a company endowed with many very good professionals. Its main problems include: The Key Players. The sector counts five its weak responsiveness to users outside of main actors. Three are its key providers: OSE, the Montevideo; Municipality of Montevideo and private providers. t l The fourth is the Planning Office who monitors the cothe s the ae p nvsnt performances of all public enterprises and takes the initiative in the analysis of reform options. The fifth the poor service performance by international player is the National Environmental Directorate standards, (DINAMA) with still a minor role but with the its high and increasing costs, potential to have a much more significant role if environmental concerns start moving to the fore. The ot lte incete fo cos e ss role of private providers is still minor, but their inclusion in this list is not only a reflection of the the iefficient and inequitable interregional and progress made by users but also by OSE in interpersonal allocation of resources due to the recognizing the possibilities offered by alternatives to staff policy; and the current structure of service delivery. the lack of clarity in OSE's responsibilities in the The Achievements. By Latin American concessioning strategy arena. standards, . Uruguay's water and sanitation public utility (OSE) has achieved a lot as a public enterprise ow should The ote Imact of and until recently had enjoyed good rating by the Reform o the otcm e areform population for its services. Between 1988 and 1995, on h pefonof t sor cne a s the share of population with access to piped water services increased from 88.8% to 97.7% in Efficiency: a well managed and operated sector Montevideo and is over 75% in the rest of the should avoid distortions in production decisions. country. There are about 600 communities not Key indicators of operational efficiency are served by OSE and many isolated farmers who have percentage of unaccounted-for-water and their own sources of water. Its number of employees breakage rate. Key indicators of managerial has been cut from about 10 per 1000 connections to efficiency are employees per one thousand connections and level of maintenance expenses Managerial efficicncy: OSE's 8 employee/000 (assumed to be a management decision). Water connection is 3 to 4 times the intemational best quality reflects the quality of service provided. practice or about 2 times the developing country * Financial viability: this indicator is concerned with the fiscal impact of the sector; a reasonable would probably employ no more than 3,000 indicator of this source of financial risk is the people; to pay for this additional cost, every ratio of cost recovery expressing revenue as a Uruguayan is paying an implicit tax of about 30% share of total costs (including amortization); other on each water and sanitation bill. indicators include the cost of implicit cross- Equity: the major equity issue stems from the subsidies built in the design of tariffs. large differences in coverage between the Capital * Equity/redistributional considerations: equity and the Interior; the investment required to impact is defined as the distributional impact achieve full coverage represent between 7 and across income group or across regions. A key indicator of inter-regional equity is coverage: Financial viability: since tariffs are set to cover percent population receiving service. Inter- cost, there is no obvious financial viability personal equity is defined as the ability of problem in the short run; this is, however, different income groups to afford water services. achieved through some cross-subsidies: Affordability is measured as the share of income Montevideo subsidizes the rest of the country; spent on water. surface water subsidizes other water sources and * Administrative feasibility: any proposal has to sanitation subsidizes water. They amounts recognize the political and administrative involved in these cross subsidies are quite preferences and limitations of the country. This significant. In 1990, they added up to almost 10 is clearly a subjective criteria and the reformers million, decomposed as follows: US$4.9 for the will have to make the ultimate call on this matter; subsidy of Montevideo to the Interior, US$29 it may, however, be useful to point to some of the' million for the subsidy of surface water to other administrative costs and benefits of each option water sources and US$1.5 Million from sanitation to ease the final reform decision This is the main to water. The first two subsidies are important to purpose of the comments made here. consider in any attempt to decentralize sice someone will have to pick up their cost if tariff The Costs of OSE's Current are to reflect true regional cost. Performance. These criteria reveal the How to reduce these costs? Many of the following costs: folloing csts:problems, and some of these costs, were known to * Operational efficiency: OSE's almost 50% of OSE's managers five years ago and very little has unaccounted for water (UFW) is about 2 times improved since. The most likely explanation is that higher than what could be considered a under its current structure, OSE lacks incentive to reasonable international benchmark; it is not reform and the performance contract that has been in correlated (in a statistical sense) with the age of place for over five years has not achieved much. the pipes, suggesting that these losses are just as When new changes have taken place they represented likely to be commercial as they are to be short-term solutions to long-term problems technical; their financial cost is between US$5 (e.g., increase tariff to cover cost rather than trying to and 6 million a year, about 20% of what would minimize cost while improving efficiency). A have to be invested every year for the next sustainable improved performance can only be 10 years to achieve universal coverage in both achieved by restructuring Uruguay's water and water and satation. sanitation sector. Three main options are considered: * Decentralization; and private providers). It would reduce the efficiency * Corporatization, and and equity cost mentioned above and would appear to be administratively feasible since it does not imply * Combination of concessioned and corporatized any formal privatization. Though the ideal vision for public provision. the sector may be one of perfect competition, the Decentralization: even if more aggressive more practical opton may be: to concession those than the current administraive deconcentration beg areas that would readily benefit from private thanthecurentadmiistatie bing sector participation and to corporatize the implemented by OSE, decentralization is unlikely to remaining areas with or without decentralization. accomplish sufficient gains in efficiency to be T means: recommended at this point. Decentralization will not give OSE access to needed private capital for 1. Concession the Resorts (Balneaios): investment nor will it necessarily improve efficiency; 2. Try to concession Paysandu and Montevideo: it could, however, help introduce more competition 3 Corporatize (through private management (through a formalization of the comparison of each contracts) the "residual OSE" as a whole or as region's performance) in the sector if designed with its regional units, recognizing that investment and that purpose in mind. rehabilitation expenditures may have to be Corortziocolbease nte-gt subsidized or financed in these areas: some Coporatization could be a step in the right direction and it could be implemented whether OSE operations in the interior may still attract private deepens or not its decentralization; it would change investors if Uruguay is willing to subsidize their the legal status of OSE's workers; it would also earnings. The bidding process may be adjusted require a change in the treatment of its profits: for such that Uruguay can accept negative bids for now, whatever profit is made by a public enterprise service to higher risk areas or BOTs can be an has to be transferred to the Treasury; this reduces the option for specific projects such as building incentive to minimze costs and is not compatible treatment stations. Areas that cannot be with a commercialization of OSE. But even if this is franchised even with a negative bid should achieved, it will not necessarily provide access to remain a part of OSE and be corporatized. By private resources to finance the large investment increasing management accountability and requirements; this can only be achieved through moving closer to best practice targets, areas with concessions poor rates of return may be made more attractive for private sector involvement in the long term. Recommendation. The combined approach of But this of course only part of the many steps to concessioning and corporatization will bring the reform. Many issues have not been touched upon highest degree of competition into the sector (by here and should be addressed in the design of any allowing the comparison of the performance of public detailed implementation strategy.  Reform Options for Uruguay's Water and Sanitation Sector INTRODUCTION This note addresses the reform needs * it proposes a set of criteria to assess the and options of Uruguay's water and sanitation. It is motivated by the recognition that three recent developments could lead to major 0 it uses these criteria to identify the main changes in the organization of the sector. First, issues and proposes reform options to surveys conducted in various parts of the improve Uruguay's water services and country reveal the growing concerns with the expand its sanitation coverage. increasing number of incidents concerning the level and quality of water distribution and the s Road oaniztion 2 prviesd frustration with the very slow progress in the snapho of oation oflth sectordbasd expansion of waste water services in the ontin ation aaIalo pply,deand, interior.' Second, the recent emergence of institutio and fina stas pves ai demand driven small private initiatives in the overview o e psica serthesctorian sector suggests that the population is willing to dicusses various pofsice qalit try alternatives to OSE. This has been the most indiars Whenever ssibe the aper recent response to the frustration stemming compar ugay' statu tovthe st of from OSE's difficulties in meeting the demand for services in various parts of the country in a countries. Section 3 presents an assessment of timely and cost effective manner. Third, these the sector. It does so by relying on a more recent developments point to a need to look for conceptual framework, even though most of the somewhat bolder solutions than the simple assessment is based on 'back-of-the envelope" administrative decentralization contemplated for approaches. Section 4 then proposes 3 possible now by OSE. The debate, up to recently, has directions for reform. Section 5 concludes. indeed tended to be more concerned with 2. A SNAPSHOT OF THE CURRENT making the most of the current modest reform agenda rather than to try to assess the potentials cost and benefits of status quo against those of This current triapshot" of the sector more dramatic changes. provides a description of Objectives. The note has three main 9 the key players in the sector specific purposes: 0 status of the infrastructure; * it describes the current state of the sector in * supply and demand for water and sewerage; Uruguay, focusing on the activities of its * cost structure; and main actor: Obras Sanitarias del Estado e tariff rates for water services. (OSE), the public enterprise which is the primary water and sanitation services provider of Uruguay (the major exclusion is Montevideo's sanitation which is under the Three The se co ie main ts responsibility of the municipality); respnsiiliy o th muicialiy);Municipality of Montevideo and some private providers. The fourth is the Planning Office See for instance, Equipaje (1995), "Opiniones de Operadores Turisticos who monitors the performances of all public de Punta del Este" and ""Opinion de Veraneantes y Turistas en Punta del enterprises and takes the initiative in the analysis Estec, prepared for OSE. 2 Reform Options for Uruguay's Water and Sanitation Sector of options for reforms in the role of the state. persons. It is financed through its tariffs. The fifth player is the National Environmental OSE's administration is centralized in Directorate (Direcci6n Nacional de Medio Montevideo with II offices in the interior that Ambiente or DINAMA) with still a minor role operate the services and maintain local but with the potential to have a much more networks. The 11 offices are mainly responsible significant role if environmental concerns start for the implementation of central decisions and moving to the lime lights. The role of private for the maintenance of exiting infrastructure. It providers is still minor but their mere inclusion initiated earlier this year the regionalization of in this list is a reflection of the progress made by its services dividing the country into four users but also by OSE in recognizing the regions + Montevideo. Only some commercial possibilities offered by alternatives to the current activities have started to be 'decentralized" structure of service delivery. along those lines. A much deeper administrative decentralization is being aimed at through an Obras Sanitarias del Estado (OSE). ID project. OSE was established in 1952 by the government of Uruguay to supply water and sanitation for Montevideo Municipal Authority. the entire country, except for the department of IMM is a municipal government agency that Montevideo, where sanitation services are provides public services to Montevideo provided by the Montevideo Municipal residents. Its sanitation division is responsible Authority (IMM). As written in the National for the coordination of all activities related to Register of Law and Decrees2, OSE is the single the collection of waste water. 1MM does not entity responsible for providing potable water to report to OSE and hence any coordination effort all parts of the country and sewerage service to between these two actor of the sector are all parts of the country except Montevideo. essentially informal. There is very little Given this mandate by the central government of information on IMM's cost and revenue Uruguay, OSE is held accountable for meeting structure as the services are provided by various the people's demand for water and sanitation units of the Municipal government. The main services. One interpretation of this law is that source of revenue appears to be a ' anitation OSE's ability to delegate this authority to a sub- tax" which is very far from covering the contractor, public or private, is constrained by operational cost of the various services this law. Another critical feature of the law involved. The lack of specific information on creating OSE is that it makes it its own this is however a major impediment to any regulator, giving it 'hygienic control of all the serious analysis of the incentives and financing courses of water that are used in the delivery of capability of the municipality. services." A seven-member commission within OSE is responsible for quality assurance. One Private Providers. Two private firms, member reports that there are occasionally both Uruguayan, are currently providing water conflicts between Commission decisions and the services. Agua Corrientes, a small five- rest of OSE, but that the strong support of employee family-mn operation, serves 2,500 OSE's President bolsters the commission's families in El Pinar, a coastal community just authority. outside Montevideo. Aguas de la Costa, a larger operation run by a team of former OSE OSE is under the Ministry of Housing, employees, serves the communities of Josd Land-Use Management, and the Environment Ignacio and La Barra in Punta del Este where as (MVOTMA). As of 1994, OSE employed 6077 many as 20,000 people live in the summer. By agreement, Agua Corrientes operates Ley No. 11.907, Registro NacionTal de Leyesh D1cretos, etc. Reform Options for Uruguay's Water and Sanitation Sector 3 independently of OSE, although OSE monitors Ignacio is too expensive given the seasonality of the quality of its water (see Box 1). Aguas de the demand for water in these areas. Both are la Costa is OSE's first private concessionaire primarily tourist vacation spots with few and is contracted, monitored and regulated by permanent residents. The private providers are OSE. OSE permits private service delivery to permitted to set their own tariffs and to charge these communities because the cost of extending connection fees. OSE's service to El Pinar, La Barra and Josa Box 1: Agua Corriente: The Private Provider of El Pinar El Pinar is a high-income area about 30 minutes from Montevideo. There, a private water supply company, Agua Corriente, is currently servicing 2500 households with potable water. The operation is small, low investment, with a semi- automated monitoring system. It is a low cost distribution system because the area covered by its service is very sandy and the cost of the laying the network is relatively low. Its unaccounted-for water level is around 20 percent which is much more efficient than OSE's in Montevideo. All of Agua Corriente clients have meters to gauge usage and one dedicated person reads the meters on a monthly basis and collects the fees. Because Agua Corriente is small in scale, its staff is able to keep a tight inventory of client records and there is no bill collection problem. The drinking water in El Pinar has always been provided privately (it use to be done by the developer of the community). OSE does not extend its network to that area because the variability in demand between the winter and summer months would not provide OSE with a sufficient return. The only alternative to Agua Corriente is privately-owned wells. Agua Corriente was bought from its original owners in 1992 with special profit sharing arrangements'. The initial investments were completely funded by the owners plus revenue from service. In the past three year after the transition of ownership, the client base increased from 600 to 2500, and continues to grow at 30 new connections per month (with one household per connection.). The connection fee of rich consumers subsidizes the cost of providing the service to the poorer users. OSE monitors Agua Corrientes' quality of water with weekly samples in the same way OSE monitors its own regional sites. Agua Corrientes reports that its water is consistently cleaner than that of OSE. It sets its own prices, with no price control from OSE. It differentiates its consumers by high and low income groups and charges a unique price to each. The richer consumers pay a bit more per unit to subsidize the poor. As Agua Corrientes grows and extends its network outside El Pinar, its interaction with OSE becomes more and more complicated. Not having the experience in negotiating with the private sector, OSE finds it difficult to locate the proper administrative groups that can responsibly make decisions to allow Agua Corriente to enter certain areas not covered OSE. 4Agua Corriente also expressed frustration with current tax laws which allow OSE, as a public entity, to deduct 40 percent of its annual investment from its income before taxes while Agua Corriente, a private sector service provider, cannot. The Planning Office (OPP). OPP (Oficina de that makes its own decisions about its services. Planeamiento y Presupuesto) is the only actor But its more recent role is probably the most which is not a provider but it is entity closest to challenging one: it is supervising a detailed being an effective 'regulator" for the sector-- study of the reform of the sector. OPP is acting although it does not enjoy the independence as a catalyzer of reform in all public enterprises needed for a regulator to be effective and would and concerned with the new role of the thus not qualify as such. It has in fact a double government once private agents are providing role in the sector. To begin with, it is the public services. auditor of the sector. It monitors tariffs, investment requirements and financing options. OPP considers OSE to be an autonomous entity is responsible for the monitoring of water quality cThe profit shanng scheme gave the original owier 20 percent ofdtotal profit for first 20 years ofuthe life of Agua Colente. Interview with Aguas Coeentrs staff, December 5, 1995. 4 Reform Options for Uruguay's Water and Sanitation Sector and can be viewed as one of the main sources of that OSE would need to invest about US$10 independent information on the quality of water. million per year for the next ten years to reach As expected, OSE and DINAMA disagree on 100 percent coverage for water (see Box 2). the value of their respective laboratory work. This is probably an upper bound for the cost of DINAMA is still a young institution and should new investments, since direct connections are be able to be soon a key partner in the not necessarily the most cost effective solution monitoring of the sector. This independent of the interior and in addition, the estimates monitoring role is important because it could were based on relatively high construction costs offset the absolute power granted by the 1952 assumptions. law establishing OSE as its own regulator. For now, OSE tests its water weekly. As required Abou 94 perent of maEn water by the regulatory division within OSE, OSE's conutio isme tered. temin olem regional offices submit samples each week to a central laboratory where they are assessed for in some cases obsolete. On average, 47 percent level of contaminants and taste. OSE sets its of the water pipes network is more than 40 own quality standards and applies the same years old and only 42 percent less than 20 years standards to the private sector providers. OSE old. Water pipes are often not wide enough, too does not maintain an environmental impact close to the surface and water is of deteriorating study or a plan for the reduction of quality as discussed later. The average number environmental impact, nor do they require of breaks per thousand connections per year is private providers to maintain such studies or 18 percent and the percent unaccounted-for- plans. water (water produced but never billed) is 47 percent--although this is estimated since the 2.2 STATUS OF THE INFRASTRUCTURE instruments needed to measure losses are not available in Uruguay. While this may appear to The water network is composed of 665,000 connections nationwide. In 1995, drinking water service s were provided to about Box 2: A Back-of the-Envelope Methodology to Assess 84 percent of the population. The coverage for Investment Requirements drinking water in Montevideo (including areas 1. Assume population growth of 0.06 percent per year sered n Cnelnes isove 95perentwheeas 2. Assume coverage will increase at the same percentage served in Canelones) is over 95 percent whereas peyarfrtners the coverage for the Interior, outside of tourist 3. Assume 1994 coverage by OSE for drinking water to locations (beach resorts) is approximately be 84 percent and for sewerage to be 28 percent (in 5 the interior) 74.4 percent. Drinking water coverage 4. Multiply standard level for per capita investment increased at a rate of 2 percent per year from (USS200 for drinking water, USS350 for sewerage 1989 to 1991 and 0.5 percent per year from with treatment) by increase in number of people 1992 to 19946. As of 1994, OSE's rate of servedeachyear. coverage for drinking water was among the best This results in estimates of investment in LtinAmeica Butif he argt isto ave~ll requirements much lower than the figures presented in the in1990 Plan. While we did not have the detailed information coverage, it will have to invest more in the to explain the differences, the most likely explanation is interior. A 'back-of the envelope calculation that the estimates presented here are based on based on standard international levels of per international best practice, while the Plans' estimate are based on Uruguay's historical cost which were typically capita investment for drinking water suggest excessive. 5not No. ISAP-2, Five Year Plan, 1990solion 6o thri i Water Supply and Sewerage Project Supply and Demand forsi at Water and Sewerage" Attachment to World Bank Progress Repob deterioration over a five year period. In 1990, June 1, 1995. Reform Options for Uruguay's Water and Sanitation Sector 5 losses were estimated to be 42 percent. This is 2. 3 SUPPLY OF AND DEMAND FOR very similar to many Argentinean provincial WATER AND SEWERAGE water systems. The main lessons from their experience is that the cost of the rehabilitation Supply of water is not a problem. needs can be quite significant. It may in fact be Uruguay is a water-rich country, located on the much higher than the cost of achieving full coast of the Atlantic Ocean and bordered on the coverage in water. South by the River Plata and on the West by the River Uruguay. Most of the northern border Coverage for sanitation is much lower with Brazil follows small rivers. The large River than for water. 1DB estimates that about Negro crosses the country from northeast to 48 percent of the total population enjoys such a west and empties into the River Uruguay. There connection (including about 80 percent of the are numerous lakes and lagoons and a high residents of Montevideo). About half a million water table facilitates well-digging. In the people only have connection to the OSE's sewer Interior, at the center of the country, a dam at network through 137,575 connections (in 1994). Paso de los Toros on the Rio Negro has formed This represents only 28 percent on the interior's the largest potable water reservoir in South population. (About half of the population is America. Underground springs are numerous. concentrated in Montevideo and is hence the Because of its plentifu water sources, Uruguay responsibility of IMM). About 95 percent of the has no Irigation program requiring specialized 633 localities in the interior are not connected at water supply to the agricultural sector. In 1990, all and rely on septic tanks instead, about 89 percent of OSE's water was provided from 200,000 of them and this does not meet the surface water sources, 4 percent from drillings needs of many of the interior. Among the (underground sources) and 9 percent from a sanitation networks, most (about 30) have no mixture of the tWo.7 treatment or only primary treatment capacity; only 11 can deal with secondary treatment. Demand for drinking water and Most of them are however over 60 years old, sewerage is better documented than in many are obsolete and not capable of doing most of countries in the region thanks to IDB's efforts. what is expected from them. While this has not OSE services are separated by types of users: yet had a major environmental impact, it is only households, commercial and industrial, and a matter of time, in particular for some public (fire hydrants, street cleaning) users. In commercial users of water and in some urban 1993, sales percentages for drinking water were areas. A 'back of the envelope" estimate of 93 percent residential, 5 percent commercial and investment needs in sanitation suggests that industrial and 2 percent public. Sewerage OSE will have to invest in the area under its services were 88 percent residential, 11 percent responsibility around $20-25 million for the next commercial and industrial and 1 percent public. ten years to reach 100 percent coverage for A 1990 demand study completed by the IDB , sewerage and around $30-35 million if treatment based on a survey of five areas9, urban and rural has to be included. Again, these estimates are but excluding Montevideo, showed the probably high since they assume that consumers aggregate demand for water in Uruguay to be would best be served by OSE rather than by sensitive to price, income and number of individual septic tanks. But they provide an inhabitants per household. Of the three factors, order of magnitude that is quite significant. price has the largest effect, with a 1 percent Using the price ranges used in Brazil would cut these estimates in half of1990 Five iear Plan 8 cDB Study by Cancela December 1990. 9 Durazno, Minas, Pavsandu, Rivera e Tecuarembo 6 Reform Options for Uruguay's Water and Sanitation Sector increase in price resulting in a 0.34 percent dissatisfaction 36 percent of residents and decrease in quantity demanded. A 1 percent 21 percent of tourist services reported poor increase in income results in a 0. 15 percent water pressure and 17 percent of the hotels and increase in quantity demanded. A I percent II percent of the restaurants reported that the increase in number of inhabitants results in a tariff was too expensive. " Fifty-six percent of 0.24 percent increase in quantity demanded. responding residents in Punta del Este reported The elasticity of demand with respect to price, that their sewerage service was 'bad." 12 however, varies across departments. Table 1 Interruptions in service have also been a shows how five departments differ in their problem for Montevideo, where most recently in response to an increase in price. Thus, increases December 1995, the city was without water for in price affect demand most in the central several days due to excessive consumer demand southern regions of Minas and Durazno and in the summer months.'" Such shortages have least in the northwestern region of Rivera. Note increased public impatience with OSE's that this elasticity works both ways and is the services. reforms of the sector results in cost reductions which can be translated into lower tariffs, the Unmet demand is however a moving demand will increase in similar proportions. target because the relocation of population and business. An increasing share of the population Table 1 Price Elasticity of Demand by Department of Montevideo is opting for commuting and is How much does Demand for moving into the suburbs. In the zone of San Department Water Decrease With a 1% Jos6 de Carrasco and El Pinar for instance the Increase in Price? growth of population over the last few years has Durazno 0.39% been over 13 percent. The outcome is that Minas 0.41 % Paysandu 0.35 % 0,000 have been left without drinkable water. Rivera 0.24% In one case, in El Pinar about 25km from Tacuarembo 0.29% Montevideo, a private company has been Source: IDB (1994) created to provide water to 2500 families. But On the demand side, the major problem this is still an exception and the exclusion of is in sanitation. According to OSE's 1990 Five specific communities from access to the OSE Year Plan, clients have asked that OSE increase network represents only a relatively minor coverage and improve quality and continuity of concern for now. The major change that many-- service. Recent survey results monitoring the often outside of OSE--are discussing is that tourist season in the resort, Punta del Este, some degree of industrial relocation is likely to show that in 1995, 15 percent of responding result from changes brought by Mercosur. This consumers (residents, businesses and ot yet been analyzed but should be given restaurants) were dissatisfied with their running more consideration when deciding investment water service and 29 percent were dissatisfied plans and strategies at OSE. with sewerage. 10 Indicating the reason for 2.4 COST STRUTCTURE '0Equipos, Codultores Asociados, "Opinion de Operadores Turisticos de According to the 1990 OSE plan, on Punta del Este(1995)MonitordeTemporadaTuristica",O2E, average, about 2/3 of OSE's cost have tended to Montevideo, March 1995.p. w3. People were asked about their telephone service, electricity, security, streetcleanpng, traffic regulation, running water, sanitation and the state ofrthe beach. More people surveyed felt negatively about their sanitation setvice than any other service except for traffic regulation. More people felt negatively about running water than all ibid. p.22 other set-vices except public security, sanitation and traffic regulation. N= 12 ibid. p. 23 81 for running water and N=77 for sanitation. ""Montevideo Sin Agu: El Siste a Hizo Crisis A Raiz Dec Una Demanda Record," UUtmas Noticias, Thursday, December 7, 995.p.3 Reform Options for Uruguay's Water and Sanitation Sector 7 be fixed cost and 1/3 variable.14 From a 31 percent, sewerage appears to be just as functional perspective, the area of highest cost inefficient as drinking water services. The fact has tended to be production, with nearly that sewerage is only 5.5 percent of OSE's total 50 percent of total cost. The highest production cost should not be taken as an indicator of cost has tended to be energy which is needed to success. As discussed earlier sewerage pump the water. Since energy cost is directly coverage in Uruguay is only 24 percent. Before related to the amount of water produced, OSE can be considered effective in its provision reducing unaccounted-for-water would reduce of services, it will need to allocate substantially the necessary amount of water production more of its budget to expanding the sewerage thereby reducing energy cost. In recent years, network to areas with unmet demand for the highest cost appears to have been wages. In service. Thus, it may be expected that the cost 1995, the wage bill represented about of sewerage will grow significantly over the next 60 percent of OSE's total expenditure, reflecting decade and that cost containment in sewerage a very high employment level. In order to cut services will become increasingly important. administrative cost, employee productivity needs to be improved and this may require reducing employment but it is also very likely to require Tariff design is at the core of the an adjustment in the salary structure since many sustainability of any utility service. This is well highly qualified staff are significantly underpaid understood in Uruguay and is one of the major in comparison to not only the private sector but also other public entities. An organizational reorm Optionss ox 3 A s analysis might assist OSE in reducing the cost of rva aect ofthnass of taif isetati administration by dividing the organization by can alte ct of the a ces s tospriate cost categories and examining each division to prves the epec e ofte to small see if there is adequate financial responsibility and accountability."piaewtrcmaisipovntobque and ccontablit.15useful in showing the signaling value of tariffs Examining cost of drinking water and in allowing comparisons between private production by water source (Table 2) shows that and public suppliers. the unit cost of production is higher for OSE's Water Tariffs. Annual water operations that use ground water as a source. tariff rates are designed to ensure that revenues Moreover, the high share of personnel cost Morever th hig shre f pesonel ost cover cost for both water and sanitation. Water suggests that ground water sources are more tariffs are differentiated according to user types, labor-intensive. Based on this data and without (i) domestic; (ii) industrial and commercial, and considering engineering requirements, it appears (iii) Official and according to the region of that in formulating its plan for cost reduction, OSE should, where possible, redirect its (ii) eachvarea ando. It is operations to surface water sources. systematically about 25 percent more expensive While cost containment is of critical in the beach zones. Beach Resort Areas are importance to drinking water services, it is also charged a higher rate to cover the high costs of vital to OSE's expanding provision of sewerage production, distribution, and storage that results services. With an administrative cost of fr the large change in demand between the winter and summer months. " Five Year Plan, 1990. 1 OSE's 1992 report on "Costos Dinanicos de Generaci6n - Agua Potable Total de Pais" (a forecast report). 8 Reform Options for Uruguay's Water and Sanitation Sector Table 2: Unit Cost of Drinking Water: Comparison across Water Sources Type of water source Cost per m water sold Personnel cost / Total operations cost Surface Water 0.34 0.23 Ground Water 1.17 0.45 Mixed 0.60 0.36 Overall 0.40 0.28 Source: OSE s 5- Year Plan For all consumers that tariff is essentially * Utilities pay between US$5.39 (10.78) and a two-part tariff with a fixed charge and a US$57.11 (114.23 for their fixed charge; variable charge. As of January 1, 1996, the and US$2.04 for their variable part; and levels and the design of both parts varies, e Services without metering pay US$6.28 flat. however, across user types (the number provided below are for Montevideo and the These tariffs increase with inflation and Interior; the information for the resort areas is are adjusted incrementally every 3-4 months. given in parenthesis) as follows: The current tariff represents a significant * Domestic users pay a fixed charge that adjustment over past trends. In 1995, in real varies with the pipe diameter from 2.66terms, it was almost 40 percent higher than it vane wih te pie dameer fom .66 was 10 years earlier. The bulk of the adjustment US$/month (5.32) for 12mm to US$28.38 has taken place since 1992, about 10 percent over 25 mm (56.77); they also pay a variable increase each year. Occasionally, additional charge that increases in 8 blocks of 5 m3 up to consumption levels over 50 m3 16; ; this rate starts at US$2.09 (2.68); additional costs. There are a few exemptions for low income retire and fire services but there * For the first block, doubles for the next are m-nor. block, then starts at US$0.42 (0.54), going OSE's Tariff for Sewerage. up to US$1.32 in increments of about 30 percent for each 5 m3 of consumption; Consumers pay a fixed connection fee for " Inustialandcomercil uerspaya fxed sewerage service and then a monthly bill of 100 * Industrial and commercial users pay a fixedwater bill to a maximum number charge that varies with the pipe diameter of m' for domestic, industrial, and commercial from US$13.31 (26,63) to US$141.88 consumers and a higher maximum number of m' (283.75); they also pay a variable charge of for public agencies. More specifically, the $1.75/month ($2.5 in the beach region)for maximum variable charge for private consumers consumption up to 1000 cubic meters and it is US$306.29 as of January 1996. For public goes down to $1.44/month for larger users it is US$485.62. The fixed charge is consumption (2.08); US$1.56 for domestic users, US$3.04 for public Official users pay a fixed charge that varies users and US$44.39 to US$59.29 depending on with the pipe diameter from US$5.39 the type of industry. (10.78) to US$57.11 (114.23).; they also pay a variable charge of $1.064/month; The actual tariff structure is in fact somewhat mare complex; it increase for the first two blocks, jumps down for the third block and then continues to increase for the rest of the blocks. Reform Options for Uruguay's Water and Sanitation Sector 9 Box 3: Preliminary Conclusions from the Recent Study to Redesign Uruguay's Water and Sanitation Tariffs OPP has encouraged OSE to develop a more transparent and obiective formula for tariff pricing. A tariff study by Ernst & Young, commissioned by OSE, resulted in three proposals that will still allow OSE to fully cover its costs: * average cost pricing: a flat rate would be applied to all users (although the flat rate in the resort area would be about 40 percent higher in the resort areas) and a 42 percent (Montevideo and Interior) or 52 percent surcharge would be collected for sewerage; * increasing block pricing: starting with a fixed charge, it would recover cost for each user type according to the cost of providing a peak service; tariff decluie modestly with consumption, so that domestic users pay more to reflect the higher cost of serving them ; the tariff for the resort areas would be seasonally adjusted (cheaper in summer); the surcharge for sewerage would be around 50 percent- * marginal cost pricing with life line: domestic users would get a very low rate for the first 5 M3 of consumption (although this rate would not be available in the resort areas) and all the other consumption levels would be priced at marginal cost adjusted to ensure that the budget constraint is met and a surcharge would be levied on potentially polluting industries; The following table summarizes the implication on the water and sanitation bill per user category: Changes in total bill as a % of current bill Volume User type M3 Average Cost Increasing Blocks Life line and Marginal Cost Montevideo Montevideo Montevideo and Interior Resort and Interior Resort and Interior Resort Domestic 5 120% 102% 122% 103% 88% 102% 10 113% 127% 115% 133% 105% 126% 20 78% 93% 80% 95% 87% 92% Commercial 10 46% -48% -46% 48% -48% -48% 200 -50% -25% -52% -28% -53% -25% 4000 9% 22% 3% 14% 2% 22% Industrial 10 -46% -48% -41% -35% -44% -36% 200 -50% -25% -45% -2% -46% 2% 4000 9% 22% 18% 58% 17% 66% Government 100 -48% 4% 49% -8% -51% -5% 500 -34% 41% -37% 34% -38% 40% 3000 -8% 78% -13% 67% -7% 90% Utilities 500 -45% -40% -41% 4000 -23% -17% -18% 9000 -21% -15% -15% While it seems that domestic consumers will end up paying much more, it turns out that it should not be significant as a share of total income also this may reauire a much more detailed analysis than what is provided by the study. How do Private Tariffs Compare to charging connection fees consistent with their Public Tariffs? The smallest of the two private own cost. They do however have some operators, Agua Corriente, is essentially allowed distortions as their connection charges of low to set its own tariffs and is not subject to any income users are subsidized by the richer users systematic regulatory control so that there is not but the variable cost of water is the same for all much public information on how they function. users. The other private operator, Agua de la According to interviews with the owners and Costa, the largest of the two private operators, accountant, they are able to recover all cost by is a concessionaire regulated by OSE. They are 10 Reform Options for Uruguay's Water and Sanitation Sector regulated by price capping where the cap is variable cost of water Is less than that for Aguas defined by the public tariff The incentive to de la Costa, the company covers its investments continue improving efficiency is however minor (and makes substantial profit) by passing a large their is no periodic assessment of the cap portion of its fixed costs on to the consumer and scheduled formally. While the tariffs were charging very high connection fees. Most of initially set in the contract, they are ending up these connection fees would likely be paid by being negotiated tariffs as the consumers commercial users (hotels, restaurants, etc.). associations have been very vocal about the very A quick comparison of the tariffs shows high tariff that were resulting from the initial bills send by the private operator. This was thare is soe iffecembetween thEs never an option for OSE's clients. In other cared by th at coman diffes words, once the private operator will have been rate Fge 1 a the main differnc able to converge to an agreeable tariff for all twee the public and he privae pris users through a number of public hearings that tha the cscto n aerae triff continue to take place, any ulterior increase in incrs h c n hile t e private productivity will become a rent and will not poidr a nvea ge tariffsdeclin and havereflects a clear difference in goals between The main interest in the short run from a public and private providers. The declining look at their tariff structure comes from a average tariff for low levels of consumption comparison of their average tariff with that of reflect the government's concern for the poor. OSE. In fact, Figure I compares the evolution The need to make the most of economies of of the water bill for OSE's and Agua de la scale is the main concern of the private operator, Costa's client in the same region. Table 3 as expected since his ultimate objective is to summarizes that information for the private maximize profits. company. Agua de la Costa gives a 20 percent discount on connection fees and fixed cost It may be worth to note that in regions in charges to permanent year-round residents of La which the scarcity value of water is significant, Barra and Josv Ignacio. Though the firm's the strategy adopted by the private operator may Table 3: Agua de La Costa: Tariff Rates for Sewerage and Drinking Water: (August 1995) _____________WATER SANITATION DRINING WATER (US) with discount c With Discount Variable Costs (per month)connectionfees.Mos La Barra 0.22/ m3 0.52/ m3 Jose Itacio 0.37! m3 connecion 0.52/ m3 Fixed Costs chargd_byteprivtecomanyan OSE' La Barra 44.30 88.61 70.89 Jose Ignacio 79.74 63.80 103.37 Connection Fee (one time initial fee) betw n td t La Barra 1063.28 1020.15 2126.59 2040.31 Josetgnacio 1417.72 1 s360.00 1771.15 1700.31 Aguas de la Costa: Bimestre Septiembre - Oclubre 1995,i (Exchange Rate: 6.s$Um i SUS) Reform Options for Uruguai''s Water and Sanitation Sector Figure 1. Comparing Private and Public Tariffs in Uruguay Total W ater B ill 1 200 1 00 0 - --- 8 0 0-- - --- - - M P b F e m lF y GPub i fl ~C omn ml 0rcial 2EIPrével Jos. -- 400 · MPrIVate L a m 9Barra 200 10 15 20 30 40 0 60 Consumpion in cubic meter Total Sew er Bill 1.000 900 600 ØP.bl., 500 ... * P riv 1te Jos 2 400 - 300 100r = 0 15 20 30 4. 50 60 Consumplion in cubic meter Average Tariff 140.00 120.00 ffPublic Family 01 100 00 *Pubc Com mercial 80 00 EPrivate La Barra 60.00Prvate JOSe 4000 20.00 10 15 20 30 40 50 60 Consumption in cubic meter 12 Reform Options for Uruguay's Water and Sanitation Sector be somewhat problematic as it does not appear expressing revenue as a share of total costs to reflect the scarcity value of water: the more (including amortization), other indicators water you use, the less you pay In fact to some include the cost of implicit cross-subsidies extend there is an incentive to waste water. A built in the design of tariffs; and second difference between the public and the equiti-redistributional considerations: private approaches to tariff is that the equity impact is defined as the distributional differentiation in water bills is much more impact across income group or across significant under the public model, reflecting the regions. Inter-regional equity can be inter-personal cross subsidies that is resulting measured by the share of population from the design of the tariff they are adopting. receiving service in each region. Inter- Large commercial and industrial users would personal equity is defined as the ability of appear to be the winners of the adoption of the different income groups to afford water pricing strategy currently adopted by Agua de la services A key indicator of affordability is Costa since they end up paying a lower total percent income spent on water. Note that water and sanitation bill. Small domestic, some of the indicators of efficiency can also commercial and industrial users are the main I losers since they end up paying 2 to 5 times as repet o ribution cositions For much under the private model.repctodsrbinacnieain.Fr muchundr te prvat moel.instance, the design of the tariff can be quite 3. ASSESSING THE CURRENT effective in addressing the need of the poor. PERFORMANCE OF OSE Also, when the public enterprise is not efficient and neither workers nor managers The performance of any organization in are providing performances compatible with the sector can be assessed according to the best practice, the users end up paying the following three broad criteria: consequences as they pay much more than Sefficiency: an efficient organization of theIn the cases in which service avoids distortions in production and cost recovery is not effective, tax payers are servce void ditortonsin podutionand the main victims of these inefficiencies since consumption decisions; while this is not easy the government has to allocate tax revenue to measure, some useful conclusions can be to cover the gaps between revenue form drawn from a comparison with international water and sanitation tariffs and costs. best practice benchmarks indicating how the level of service can be achieved at the lowest A fourth criterion, adminstrative production cost. Key indicators of feasibility, is needed when drastic changes are operational efficiency are percentage of considered. Any proposal has to recognize the unaccounted-for-water and breakage rate. political and administrative preferences and For managerial efficiency, the indicators are limitations of the country. This is clearly a employees per one thousand connections subjective criteria and the reformers will have to and level of maintenance expenses (assumed make the ultimate call on this matter; it may, to be a management decision). Water however, be useful to point to some of the quality is used an indicator of quality of administrative costs and benefits of each option service provided. to ease the final reform decision This is the * financial viability: this indicator is main purpose of the comments made here. concerned with the fiscal impact of the Efficiency (in particular cost sector. A reasonable indicator of this source minimization) and financial viability are of financial risk is the ratio of cost recovery important criteria for Urguay since it is trying Reform Options for Uruguay's Water and Sanitation Sector 13 to maintain fiscal stability and the minimization the population does not seem to translate into a of costs is a necessity in that context. These very tariff by international standard. two criteria are also important because any misallocation of resources has a high opportunity cost in terms of Uruguay's ability to major concern for most citizens. Indeed, since finance the rehabilitation of its very old and large users subsidize small (including the poor) underperforming network and the increase in users, affordability does not appear to be a sanitation coverage: unaccounted for water is problem, even for the poorest income groups. around 50 percent--more than three times what Percent income spent on water is just over the best Latin American water utilities loose-- I percent for all nineteen departments. In all and only 20 percent of the users with water departments, the percent income spent on water connections enjoy waste water services. But is at least three percentage points less than the these cannot be the only criteria. Water and five percent which Is International best sanitation services are perceived by many practice.17 it is important to recognize, Uruguayans as a public service to which anyone, however, that this analysis is limited in that including the poorest, should be entitled information regarding the number of families regardless of the cost. This suggest that any whose income Is significantly below the median change to the current approach needs to be is not known. Those families toward the bottom assessed very carefully also from an equity point of the income range may face greater problems of view. Who will the changes hurt and how with affordability. much? But to be able to answer that question, In sum, under the current tariff structure, one needs to identify who benefits from the it does not appear that affordability is a major current approach and who is paying for any concern. However, as the tariff is increased to indirect or cross subsidy. Indeed, status quo in the sector does have its own equity implications percent of their income on OSE services, equity that cannot be ignored. may become more of an issue.'s Besides the Equity. Since the concern for the basic opportunity cost of inefficient services is often needs of the population is clearly at the core of much harder to track down but much higher many resistances to look into private alternatives than expected since money used to cover high to water services by OSE, this is the first criteria cost in water is money that cannot be used to to address. A common strategy in Latin improve roads, educate children or pay for America is to control the price of public utilities. retirees. Without having looked at the design of Cost increase but prices don't. This is why the tariff yet, the only serious inequity in the system subsidy requirements of many public utilities is stems from the large differences in coverage very large. This is not the case in Uruguay. between the Capital and the Inteor. This can Because OSE's tariff policy sets revenues equal only be addressed through an investment to cost, OSE has inflated its tariff and passed the program that requires significant resources. cost of its inefficiency, specifically the cost of its While these resources only represent a very unaccounted-for-water, on to the consumer. modest share of GDP, they could represent One of the outcomes is that in comparison with other public waterworks, OSE has the second highest tariff for water in a sample of 12 Latin International best practice for percent income spent on water is believed America (second only to Costa Rica). So the to be 5% according to a response from Paul Smoke, MIT Professor and effective impact of the concern for the needs of crt on decentralization, Feb. 6, 1996. s analysis is an upper bound on equity impact because we used 1995 prices and i994 income (likely to be higer in 1995). Therefore, the differences ma t be even more slight. 14 Reform Options for Uruguay's Water and Sanitation Sector between seven and ten percent of the public losses of 54 percent, in Soriano 52 percent of investment program. the pipes are over 40 years old while in Canelones, only 21 percent of the pipes are that Operational Efficiency. One of the old. Montevideo has the oldest pipes and has most striking problem areas for OSE is its high one of the lowest UFW. In sum, some new percentage of unaccounted -for-water. systems have high UFW and some old ones have Unaccounted for Water (UFW) is defined as the low UFW. The correlation between age of difference between quantity of water produced system and UFW appears weak at best. The and quantity of water sold. OSE's UFW main alternative explanation is that UFW percentage has increased by 10 percent over the represents commercial losses rather than past five years, increasing from 38.54 percent in technical losses. This reflects organizational 1984 to 42.12 percent in 1990 to 46.85 percent problems: such as response time to breaks, staff in 1995. OSE's UFW performance over time is allocation to maintenance, and technical capacity among the worse in a sample of 15 countries for repairs. But ultimately, this is about around the world where only Colombo (Sri incentives as discussed later. Lanka), Costa Rica (in 1988) and Manila (Philippines) water system were performing This problems needs to be addressed worse. quickly as there is a high economic and a financial loss associated with a high volume of Why is UFW so High? Interviews with unaccounted-for-water (see Box 4). The costs OSE administrators suggest that water loss is attributable to UFW are categorized as: due to leakage reflecting the old age of the infrastructure. This would imply that high UFW ( n)roper a tional co o eswth the would be expected to correlate with sources of ire p iea leaks such as old pipes and high breakage rates. This is not verified by the experience however. For instance, Canelones and Soofano both have Box 4: Financial Savings from Reducing Unaccounted for Water If the volume of unaccounted-for-water decreases, then the necessa,y amount of water produced would decrease. If we assume that production cost has a linear relationship with amount of water produced, then reducing UFW would reduce the total cost by the amount of production cost required to produce the regained UFW. The table below approximates the total financial savings resulting from reductions in UFW. This calculation holds all other costs constant, assuming that less water produced does not necessarily lower the overal distribution, commercial and administrative costs. in reality, more efficient delivery would also be likely to reduce maintenance and administrative costs. By decreasing UFW to approximately 25 percent, OSE could reduce its overall cost by US$5.2 million per year. If these savings are not passed on to the consumer in the form of a tariff decrease, this money can be used sa finance investment. These calculations assume that the marginal cost of producing water is US$1.01 (which is the results found by the Ernst and Young study mentioned earlier). Potential Savings from asFW Reduction Reduction of Potential Savings qcFW to... in USSmillion 50% 0 45% 0.7 40% 1.8 35% 2.9 30% 4.1 25% 5.2 Reform Options for Uruguay's Water and Sanitation Sector 15 (2) additional costs due to the need to advance through their water bill. But as already (2) dditonalmentioned, total cost is not the only problem, new production facilities to meet the individual incentive also matter and this may demand; and deman, andmean that the best employees are underpaid. (3) loss of revenue due to unbilled water. The evolution of drinking water quality OSE pays an extremely high economic is another indicator of efficiency. While OSE's cost for its high level of UFW. Measuring the track record in this area has traditionally been excess burden resulting from increased impressive, it is now also becoming a source of production to compensate for water loss9, it is concern. It is, however, well known by OSE evident that OSE incurs an annual average and actions are taken to ensure that this does economic loss of approximately over US$5 not get out of hand. Currently the percentage of million20 per year due to its failure to minimize unaccounted for water. This would finance 1000 Connections" about 50 percent of the investment requirements needed for the next 10 years to achieve full coverage of water services. Kathmandu 18.6 Manila (Metro) 12.8 Managerial Inefficiency: Look at Colombo 9.2 Overemployment. The main indicator of Delh 8.9 OSE's management difficulties is its OSE 8 Rio de Janeiro 5.7 overemployment. OSE employs 6077 people. Bangok 5.5 That is eight workers per thousand connections Rio Grande do Sul 4.3 at an average monthly salary of US varying from BogotA 3.6 Sao Paulo 3.4 US$2615.60, for managers, to US$1401 for Pana 3.3 professionals (engineers, accountants, ..) and to USA 2.9 US$595.42 for unskilled workers. For water Lima 2.74 providers in industrialized nations, such as the Santiago 2.1 US, the average employee/1000 connections ratio equals 2.9. For most departments, the violations of bacteriological standards in the number is more than twice the international best Interior has decreased from an average of 12 practice standard as seen in Table 4.21 This percent in 1993 to 10 percent in 1995. means that an efficient OSE could probably run However, the percentage of violations of with less than 3,000 employees. Although the chemical standards in the Interior began at total number of employees has decreased by ten 22 percent in 1993, increased to 31 percent in percent since 199022, the continuing high ratio 1994 and then decreased to 24 percent in of employees to 1000 connections is a sign of 1995.2' These relatively high rates of violation significant labor inefficiency. Overemployment and the unpredictable jump in chemical is damaging in its effect on cost. Currently, violations to nearly one-third of all classified OSE's second highest cost is personnel. Until suggest a significant need for tighter regulation the cost of personnel can be contained, costs and monitoring. will not be minimized and water users will continue subsidizing the costs of excess labor Financial Viability. OSE's 1990 business analysis showed that its net cash flow "Methodology for this calculation is found in Appendix. 20 Assumes 1993 value of 645,611 connections. 2' includes only those countries for which data was available. 23 Resumen Mensual de Amilisis Fisicos Quirnicos and Bacteriol6gicos, i OSE Five Year Plan, 1990. produced byiOSE, 1993-1995. 16 Reform Options for Uruguay's Water and Sanitation Sector had declined significantly between 1986 and system inefficiencies. In 1990, cost recovery 1990, culminating in a negative cash flow of was over 100 percent in Montevideo and in Las almost USS9.5 million in 1990.24 To date, Piedras. Cost recovery was less than 50 percent OSE's most obvious policy response to poor in Florida, Riviera and Cerro Largo. In fact its cost recovery has been to increase its tariff so was around 60 percent on average outside of that revenues will cover cost. A less exposed Montevideo. This means that any attempt to response has been a cut in maintenance and introduce marginal cost pricing in the interior is other repair expenditures. The high level of likely to: (i) increase tariff, (11) reduce demand-- water losses just discussed is a clear indicator of the detailed data is provided in the appendix. these maintenance problems. So while there is Similar distortions can be seen in the pricing of not serious financial viability problem for now, sanitation although in that case, some of the because OSE sets the tariffs to cover costs, it differences across each department depend on seems clear that if private alternative are allowed the cost allocated to sewage treatment. Only to OSE's services, they will reduce OSE's room larger localities (cities and counties) have for cross subsidies and also reduce the client treatment plants. Those that have treatment base of the company.25 While increased plants incur a higher cost and thus have a lower competition could benefit users, it would pose a cost recovery ratio. threat to the financial viability of a very expensive public enterprise. Btti sntteol itrini h expesivepublc enerprse.allocation of resources. The cost recovered for The Efficiency Costs of the Current sanitation appear to be subsidizing the water Approach to Financial Viability. As services. In 1990 for instance, cost recovery for explained above, OSE sets one tariff for the water was 93 percent. Cost recovery for entire country, with the exception of higher sanitation was 150 percent. But this is not the prices in the resort areas. The nationwide only distortion in the allocation of resources. potable water tariff is set such that the revenue The level of cost recovery for drinking water generated for the country covers the total cost. varies in other ways as well. The cost recovery However, at the departmental level, only rate for water from surface water sources is Montevideo covers its costs. Because greater than that from other sources. As approximately 50 percent of the country's Table 5 suggests, water from surface water population is concentrated in Montevideo. sources has a cost recovery of 1.07, whereas Montevideo has the lowest cost per unit of ground water sources and mixed sources have water produced and is thus, a perfect source for 0.36 and 0.62, respectively. cross-subsidy, especially if a flat nationwide tariff is adopted for equity reasons. As of 1990, Te amutsiin e In thes e Montevideo generated 68 percent of OSE's ubdes ar te sgnifiant. n 1990 , overall revenue and constituted 52 percent of its dedop to alost 10$millon dollars total cost. OSE uses revenue generated in oMoed as follows: US$ fidy Montevideo to subsidize the provision of of tesid o the Intero US$29 milio drinking water to the Interior, and. perhaps any forte sbd of surface wTo otater "24 ,FveYa lai 90 water. The first two subsidies are important "OSE, Five-Year Plan, 1990. 21 OSE has a problem with collection. Although no specific data was available on collection and metering, OSE administrators expressed confidence that the number ofmeters was sufficient and increasing and that billing and collection were not a problem. However, in the 1992 Balance Sheet for OSE, the Accounts Receivables is 22 million, the same size as Net Operating Income, suggesting that a collection problem may exist. Reform Options for Uruguay's Water and Sanitation Sector 17 Table 5: Proportion of Water by Source and their Cost Recovery Ratio Type of Water % of total water produced by OSE Cost Recoverv Ratio Surface Water 86.4% 1.07 Ground Water 4.4% 0.36 Mixed 9.2% 0.62 Country Overall 100% 0.93 Source: OSE's 5 Year Plan Volume 3, Cuadro PF5 to consider in any attempt to decentralize since nutshell, OSE has few incentives to behave someone will have to pick up their cost if tariff commercially without accountability for are to reflect cost on a region by region basis. mistakes and without payoffs for successes. Now, not everything can be blamed on The Long-run financial OSE's management problems. Some of the Unsustainability. Much of the discussion so rules to which public enterprises are subject too far reflects the short terms of the financing in Uruguay greatly contributes to the problem. strategy followed by OSE, i.e., cut cost where Whatever profit is made by a public enterprise nobody sees them (maintenance of a very old has to be transferred to the Treasury. This network), deal with emergency situation as they prevents them from accumulating reserves to come up and set tariff to cover costs whatever finance investment or rehabilitation needs. It they are. The recent developments in also reduces the incentive to minmuze costs. Montevideo show that this approach is not This lack of incentive is not compensated by the sustainable, as time goes by, emergencies are performance contracts initiated in 1989 as a BID likely to become the norm because the network requirement for one of its loans as there is no is decaying fast. The financial strategy will clear accountability for failures to meet the targets of the performance contract. In a CONCLUSIONS: EVALUATION OF OSE's CURRENT PERFORMANCE: Equity and 0 No problem with affordability. Affordability f Coverage for water is good although the interior is much worse off oa Montevideo. s Coverage for sanitation is low and again the interior is much worse off. Operational and t Significant overemployment Managerial n but poor incentive for staff to performt. Efficiency & Poor overall management reflected in high unaccounted for water resulting in Annual economic loss of over US $5 million per year. * multiple types of cross subsidies (interpersonal, interuser, interregional) which are likely to require explicit government transfers under any kind of real decentralization or in the event of pMvvate sector involvement Financial Viability 0 Hfigh costs in the areas of administration and production. Little incentive to cut cost since profits are returned to Treasury 0 not short run viability problem since strategy is not to minimize cost but to set tariff rate high enough to cover short run costs, whatever these are * Not financially self-sustaining over the long run as the tariff do not seem to cover the high cost of S maintenance and in the shorter run, the rehabilitation needs. have to deal with the probably very cost of to be done quickly, the total annual financing rehabilitation, in addition to dealing With the requirements for the sector could be as high as recovery of expansion costs. If everything had 15 to 20 percent of the public investment 18 Reform Options for Uruguay's Water and Sanitation Sector budget. Of course, these costs need to be criteria of Equity and Affordability, Operational assessed more careful than the back-of-the and Managerial Efficiency, and Financial envelope followed here, but once they have been Viability. An additional criterion of carefully assessed, the conclusion is unlikely to Administrative Feasibility is added to evaluate change: the main challenge of OSE will be to proposed changes. Administrative feasibility is come up with alternative sources of financing defined as ease of implementation and level of for all these costs because the government will political receptivity to the proposed change. not be able to do it. It is indeed unlikely that the government will be able to allocate a share of its 4.1 MODEL 1: DECENTRALIZATION annual resources that is high enough to allow a The government of Urguay and OSE quick solution to this problem. are now examining possible strategies for 4. OTION FORRESTUCTUINGdecentralization. The alternative currently under 4. OPTIONS FOR RESTRUCTURINGconsideration by OSE divides the country into THEfour operational regions plus Montevideo. The Many of the problems identified in the regional offices will be sited in the towns of previous section may be addressed under the Maldonado, Paysandu, Rivera and San Jos& current structure of OSE. But many of there Each region includes several departments as problems were known to OSE's managers five years ago and not much has changed. Region Maldonado: Cerro Largo, Moreover, when new changes have taken place Lavalleja, Maldonado, Rocha, Treinta Y they represented short-term solutions to long Tres; term problems (e.g., increase tariff to cover cost rather than trying to minimize cost while improving efficiency). The most likely Salto, Soriano; explanation is that under its current structure, Region Rivera: Artigas, Rivera, OSE lacks incentive to reform. Absence of Tacuarembo; competition, lack of staff accountability, insufficient financial incentives for the best performing cases, continued direct or indirect Durazno, Flores, Florida, San Jos6; and subsidies and an insufficient regulatory * Region Montevideo: Montevideo. environment allow OSE to continue operating As it is viewed for now, this is merely a inefficiently. Quality service, improved performance and financial sustainability can be econcentionof the cent ices to the achieved only by restructuring Uruguay's water regions.ant is n hangn incent iany and sanitation sector. In this section, three snca a d ence itho nt mk models are developed to simulate the following OSE. Decentralization is about accountability. sectoral reforms: Regional managers should be accountable to * Decentralization, their users and not only to the central office in * Corporatization, and Montevideo. To be accountable to their users, * Combining concessions to private operators they need to be able to match their expenditure where possible and corporatized public policies to the demand of these users. But they provision. also need to be able to match this with Likethe urrnt prforanc of SE, autonomy in the setting of a tariff that reflects Like the current performance o OSe the cost of this demand. All this means that theinistelsiveeeaevbluatydisccorddingetoluat Reform Options for Uruguay's Water and Sanitation Sector 19 OSE needs to devolve most powers and percent, equity is not an issue unless the tariff responsibilities to its regional units and created rises significantly. Even for those who receive autonomous 'baby-OSEs" if it wants to see any both water and sewerage services, sewerage significant benefit from the costs involved in contributes only an additional 07 percent, creating these regional centers. But autonomy is making the total percent income spent on water not enough, these regional units should also be and sewerage 2.5 percent. Affordability does more accountable and an effective way of not appear to be a problem in any regions. achieving this is to have each regional unit managed privately through some form of management contractor possibly a concession regionalization of cost and revenue. It shows bidded in such a way that the subsidy that none of the interior regions could recover requirements are minimized. If this effective costs on its own under the current tariff decentralization or devolution is accepted, here structure. All regions are currently subsidized are the implications in terms of the criteria by Montevideo. Any strategy aiming at introduced earlier. imposing full cost recovery at the regional level would reduce this interregional distortion. But Equity. In considering the impact of the it will affect different users groups in different creation of autonomous regions on equity, the ways. Since most consumers in the interior are main concern should be interregional equity domestic, the new tariff policies under rather than affordability. If the tariff structure consideration would also reduce the regional remains, there seems no reason to expect any room for cross subsidies from industrial users to impact on the ability to pay--although this domestic users. On the other hand, it is not should clearly be tested formally in any detailed unreasonable to assume that cost could be cut study of the issue. The problem could emerge if dramatically in each region and that tariff would every region is asked to aim at full cost not have to increase by as much as is suggested recovery, but this is unlikely if the preliminary by the Ernst and Young study since its estimates results of the Ernst and Young study are are based on historical cost which have tended confirmed: most of the new tariff proposals to be too high. The back up is, as always, to ask being circulated would probably make many the government to pick up the tab. As domestic users somewhat worse but none would mentioned earlier, this means an annual subsidy lead to any dramatic situation. For now, despite of about US$5 million/year to the regional OSEs the variance in median income across regions, all serving the interior. regions have an average of 1.8 percent of income spent on water. (Maldonado has the Operational Efficiency. In highest percent income spent on water at decentralizing along the lines proposed by the 3.4 percent, because of the special tariff for IDB project, OSE should be concerned with the beach resorts). The approximate international current levels of operational efficiency in each standard for percent income spent on water is region, including the age of each region's five percent. Since none of the regions approaches the standard level of expense of five 20 Reform Options for Uruguay's Water and Sanitation Sector Table 6: Regional distribution of costs and revenue (1990) OSE's "NEW" REGION Share of OSE cost Share of OSE revenue Revenue/Cost Montevideo 52.33% 67.5% 119% Pavsandu 9.64% 7.13% 68% Rivera 6.87% 4.22% 56% San Jose 12.88% 8.42% 60% Maldonado 18.28 12.74% 64% network and each region's frequency of breaks, care, recognizing the specificity of each so as to determine how resources will need to be subsystem. allocated. The age of the network by region, the Money spent on maintenance is UFW and the regional breakage rate is given in significantly higher in the Maldonado Region Table 7. because of extremely high expenses in the Cerro The information on the age of the system Largo and Maldonado departments. For the and the breakage rate are important to figure out Interior Regions, maintenance expenses are the regional distribution of the investment similar at US$10,000-US$11,000 per year per requirements. Montevideo and Paysandu have thousand connections. This similarity may the oldest system and are probably likely to suggest either that Regions receive a set required a large share of rehabilitation over time. maintenance allocation per year or that There breakage rate, however, is fairly good maintenance needs in the Interior regions are considering their age. The major problem is in similar. Again this kind of rule does not lead to the Rivera region were short-term needs are effective maintenance and should be better likely to be the largest. Rivera also happens to tailored to specific needs. This should be one of be the most subsidized region under the current the key outcomes of decentralization. But it will approach. If the devolution option is adopted only happen if regional managers are given an and autonomous regional OSEs are in place incentive to be accountable to their local users, Rivera is likely to have a substantially higher and if resources are consistent with expenditure tariff than the other regions to take on the cost requirements as discussed below. of rehabilitating. Financial Viability. The discussion so Managerial Efficiency. If regional far has shown that financial autonomy will be managers aim at more efficient employment key to an effective decentralization. Every levels, the reduction of staff will be a problem in regional manager will have to recover its own all regions. There is little variance in the cost. For now, only the Montevideo Region average number of employees allocated to each covers its costs. In fact, it runs a surplus and all region: Maldonado Region has the highest other regions benefit from that surplus. As average at 10 employees per 1000 connections discussed earlier, Montevideo represents and the Paysandu Region the least at 7. All 52 percent of the total cost but 68 percent of the regions should probably aim at reducing revenue of the OSE system. All of the other employment at levels no higher than Regions have less than full cost recovery and, international best practice levels of 5 employees without efforts at cost containment or revenue per 1000 connections. The specific numbers maximization, will require a subsidy. But however will clearly vary from region to region financial autonomy should be achieved in a way and will have to be assessed with much more that matches revenue with expenditure Reform Options for Uruguay's Water and Sanitation Sector 21 requirements. In some cases, the government regional cross-subsidies are very high and would may still want to subsidize some of the manager not be sustainable under an effective for specific types of services, but these subsidies decentralization policy as they run against the should be transparent and designed in such a desirable incentives for all regions. None will way that they do not reduce the regional' s have much incentive to improve cost recovery. manager incentive to minimize cost and recover Note that another adjustment to current policies the non-subsidized costs. The current levels of will be to force the regional Table 7: Comparini Efficiency cross Regions in 1990 Department % of network % of network UFW Breakage Rate Mtce Cost per # of Employees >40 Yrs. old <20 yrs. old % of conn 1000 conn (US$) per 1000 conn Montevideo 55 29 38 18 20.093 8 Maldonado Cerro Largo 28 30 43 23 52,363 11 Lavalleja 51 47 56 18 11,538 12 Maldonado 20 65 52 18 15,859 10 Rocha 36 56 47 18 11,453 10 Treinta y Tres 37 60 49 22 11,764 7 AVERAGE 34 52 49 20 20,595 10 Paysandu Paysandu 51 39 50 10 10,646 9 Rio Negro 45 42 44 16 10,649 9 Salto 43 55 53 18 9,088 5 Sorlano 52 41 54 34 10,888 8 AVERAGE 48 44 50 20 10,283 7 Rivera Artigas 33 58 55 25 11,404 8 Rivera 27 59 42 21 9,413 11 Tacuarembo 38 53 53 29 10,891 9 AVERAGE 33 56 50 25 10,569 9 San Josi Las Piedras 34 55 54 11 7.624 2 Pando 11 66 54 10 6,686 6 Colonia 45 88 44 10 8,353 8 Durazno 47 48 38 12 15,260 10 Flores 47 50 45 15 17,266 9 Florida 27 62 34 21 10,860 12 San Jose 32 56 51 11 11,268 8 AVERAGE 35 61 46 13 11,045 8 Grand Average 38 53 47 18 13,867 8 managers to return any surplus to the Treasury. How does Decentralization Actually Lead to This is inconsistent with a commercial financial Improvements? management of the regional units. But this is discussed later in the context of the The current maintenance problems in the Corporatization of the regional units of OSE. current system stem from: (1) budgeting that is not sensitive to need, and (2) centralized repair capacity. The low correlation between maintenance and breakage suggests that areas in 22 Reform Options for Uruguay's Water and Sanitation Sector the Interior receive a fixed allocation of region. Such a system facilitates managerial maintenance funds rather than an allocation accountability and improved operations. To be proportional to breakage rate or age of system. effective, this requires and effective regulatory Such budgeting may also reflect lack of system, which is not yet in place in Uruguay as information as to the status of the system in discussed later. these remote departments. Decentralization will facilitate regional reporting on infrastructure Administrative and Political status and thus allow for better allocation of Feasibility. The last criteria to assess this resources to those areas most in need. proposal Is administrative and political feasibility. As mentioned earlier, what is feasible Decentralization will also improve is clearly subjective and the government is proximity of service to more remote regions clearly much more capable than any one else to such as Rivera. According to staff at OSE, make this decision. But there are a few factors maintenance capability at the local level is than will have to addressed. To start with, there limited to basic repairs. For equipment is the cost of decentralization. It may seem that replacement and for more complicated repairs a all this is not cheap, and it will take time to staff is called in from the central office. To recover the cost of decentralization. IDB, in its service an area like Rivera, this may mean decentralization project documents, estimated at driving five hours or more. It is therefore not US$11.6 million per Region the total cost of an surprising that high maintenance expenses are administrative decentralization is US$46.4 seen in the areas immediately surrounding million. If the reduction in unaccounted for Montevideo where attention to repair is not water to international standards is the only gain limited by distance. Maintenance, if properly from decentralization, it will reimburse this cost managed, could be much more efficient when injust eight years. decentralized. When breaks occur, local technical staff can be notified and there is less This will not be an easy process. It will time between time of breaks and time of repair. also be politically difficult since one of the likely When operations staff can pay closer attention effects of an effective decentralization is a to the trend of breaks, preventative maintenance reduction in employment level. While many will procedures would reduce future maintenance benefit from lower tariff and possibly from costs. Similarly, by allowing for targeted service higher salaries within OSE, the losers of the and specific information regarding regional adjustment will be vocal. Another significant performance, the regional OSE can better design barrier to administrative feasibility may be: an investment plan to improve the system and attracting enough qualified employees to the reduce UFW and its associated economic loss. decentralized regional offices, especially to the most remote areas. This is another reason why A final and often underestimated OSE must review its salary scale. The cost of elements of the gains that decentralization can transition may also be extremely high. Keeping bring is that regions may be encouraged to the same total number of employees at higher compete against each other toward achieving salaries, long-run gains in labor efficiency may performance goals. Some form of yardstick not be realized. Moreover, the loss of the cross competition could be very effective at giving the regional subsidies will also be painful if it is not right incentives to regional managers. OPP or matched by a quick matching reduction in the sector regulator may wish to publicize the production costs. OPP may wish to consider best performing region each year and encourage changes in the design of voluntary retirement other regions to keep pace with the best practice Reform Options for Uruguay's Water and Sanitation Sector 23 policies, retraining in preparation for the and OSE is not one of them. The introduction implementation of an effective decentralization of a performance contracts initiated in 1989 as a BID requirement for one of its loans has not A second major concern that needs to be been very successful at increasing accountability. addressed to make sure that the regional entities Failures to meet the targets of the performance work in a fair competitive environment is the contract have been common and resulted in need for effective regulation. To facilitate changes. In a nutshell, OSE has few incentives monitoring and accountability, the regulatory to behave commercially without accountability entity must be prepared to perform the following for mistakes and without payoffs for successes functions: and there is a serious risk that regional OSEs * clearly define the area for which regional will enjoy the same privilege. One way of offices are responsible; minimizing this risk is to corporatize OSE. * assist regions in establishing efficient tariff Although Corporatization does not bring structure or spell out tariff guidelines; benefits as comprehensive as a full-scale " ovrseethe eveopmet ofstanard cornpetitive environment, if managed effectively * oversee the development of standard i practices regarding hook-up, disconnection may offer significant benefits in the areas of and maintenance, and consumer relations for equity, efficiency and financial viability. The each region to ensure that a minimum level central advantages of Corporatization are: of quality in all regions; 0 more flexible access to labor markets (less * set accounting requirements and a reporting restricted by civil service laws); schedule; and * independent access to capital markets * monitor to ensure compliance. (ability to issue bonds for specific projects); 0 less politicization in decisionmaking; and Summing up: Steps Towards an Effective Decentralization: fewer constraints based on political ...... ... .. ....boundaries. 1. Establish autonomous regions for service. 2. Reallocate staff. 3. Train regional staff and new regional Corporatization: coordination units within central office. 0 gives the public entity an independent status, 4. Create standards for regional performance. free of ministerial control, yet still subject to 5. Create mechanism to enforce standards. 6. Establish new information and accountability control by an independent regulatory system. agency; 0 establishes a Board of Directors to provide direction and advice to the enterprise; 4.2. Model 2 CORPORATIZATION (usually 9-11 members named for a fixed Decetraizig fnanial espnsiiliies tenure, independent of the political cycle) to Decentralizing financial responsibilitiesguidance. Its and management functions will not necessarily responsibilities include: (1) setting solve the challenges that currently face OSE if objectives, including for restructuring; (2) the changes in incentives of the regional managers are not dramatic enough. This change adoincentis for oo performance in incentive has traditionally been difficult to adsing ent ; (4) man dio achieve in public enterprises. Outside of East in eidso mcii; () daith poten Asia, there are few examples of public entities capable of sustaining the pressure of market test 24 Reform Options for Uruguay's Water and Sanitation Sector private investors, and (6) report to Equity and Affordability. As a government; corporatized entity, OSE will base its investment * subjects it to the same legal requirements offor other firms: standard commercial and ta payment. If an area is able to pay, service will law; be extended. Regional analysis of affordability law-,(see Model 1) confirms that all Departments * accounting criteria, competition rules, and have the capacity to pay for OSE water and labor law; sanitation service (even under OSE's inflated * creates performance objectives and tariff rate). Thus, under Corporatization, * crate perormncenetwork expansion will be determined by levels evaluation and monitoring systems to ensure that target goals are reached based on vfbiitanic Te unde Co oraia international best practice. These objectives should provide for a timetable; established should assist in financing expansions. Thus, quantitative objectives, growth figures and higher coverage rates for water and sewerage market share; closing of inefficient activities: should be achieved through Corporatization. extentLife lines may have to be imposed for some of potentia diversication;s ad asessmrentaof the poorest consumers, but this is typically not a potential diversification; andaeent o problem. The government would have to decide the 'performance of management through wehri at osbiieta ieln review of activities with respect for the whether it s to subsidi e tradeoff between rigidity and flexibility; and dir c ome degre oroubie * holds managers and workers accountable; strategize a process for achieving these Operational and Managerial targets having thoroughly examined OSE's Efficiency. Soon after corporatizing, existing management process.26 governmental oversight agencies, top management and the new Board of Directors In fact, whether or not it decentralizes, establish clear efficiency targets for the OSE may wish to consider applying these enterprise. A corporatized OSE's achievement commercial principles to its management. of these targets will be facilitated by: (1) Under Corporatization, the government retains transparent objectives (that may be formalized exclusive ownership over the enterprise but under performance contracts); (2) increases in releases it from Ministry control and establishes accountability in the management hierarchy, and the public enterprise as a wholly separate entity, (3) improved feedback systems and information similar to a Port Authority in the United States. flow that allow for more efficient resource Corporatized state-owned enterprises have allocation. Holding managers and workers shown success in achieving new levels of individually accountable to clear objectives will efficiency and particularly, in decreasing costs facilitate gains in worker productivity, improved and establishing more efficient and direct maintenance, higher quality and improved linkages to capital markets. The effect of customer service. In addition, once OSE is Corporatization on the criteria spelled out corporatized it will be free from civil service earlier is discussed next but before that Box 6 laws that might impede the dismissal of less summarizes what Corporatization entails. productive employees and allow the enterprise more freedom to offer salaries that will attract the best qualified staff. 26 Process mapping should be a key component of the strategizing; unfortunately, at the time of writing, data was insufficient to provide such maps within this study. Reform Options for Uruguay's Water and Sanitation Sector 25 Clearer goals and a better employee revenue base through expansion of service and, incentive structure should be supported by a most significantly, by reducing unaccounted for management information system that facilitates water. decisionmaking. As financial status improves, OSE may wish to improve service through Th ost unacout rat rocan installation of assertive technology, such as bon e unde crrt trogh: pressure gauges that will feed into a central (1 oabandon e the Ue trolicy computer system to notify employees of breaks which obfuste te to problem; and leakage. Such information systems will (2ampe instent atg ter t allow for more effective allocation of resources l to frequent 'trouble spots" in the network. accounting system that recognizes Better information systems will enable managers nonremunerat've activities. Although these to study areas with high breakage rates and changes may be accomplished without enable OSE to allocate more maintenance funds corporatizing, corporatization commits the to areas where breakage and leaks are highest. agency to being financially self-sustaining; thus, high-cost inefficiencies will no longer be Management of drinking water quality tolerated. The other significant area to be should also improve under corporatization. targeted for cost reduction is personnel and Implementing better information systems for administrative costs. Performance-based standards and testing and holding inspectors and management contracts, more rigorous employee quality managers more accountable may result in evaluations and increased manager and worker fewer violations. In addition, corporatization accountability should improve labor allows the government to continue to regulate productivity. the enterprise. The Governor may appoint the commissioners of the corporatized entity or Ministry representatives may sit on the Board of corporatization will allow the entity to have its Directors. Such arms-length regulation will own independent relationship with capital assist in ensuring quality service for the markets, making it possible to sell bonds to raise consumer. money for capital investment. Expecting that it would be well-received on the capital market, Financial Viability. From efficiency OSE should have sufficient access to additional gains, OSE should also realize significant gains funds for specific reinvestment projects targeted in financial viability. As discussed earlier, OSE toward improving service. This financial attempts to cover its cost by artificially inflating independence would also avoid the limits on its its tariff rate for an end-of-the-year adjustment. investment programs imposed by OPP and the If OSE adopts a new pricing strategy, it may not slow control of Tribunal de Cuentas that often cover its cost for the first several years until it results in delays in the implementation of reduces its Unaccounted for Water and other investment programs. inefficiencies. During this time, financing infrastructure improvement may require short- term loans, government transfers or bond change, this model also has costs. The issuance. As leakage is reduced, OSE should significant costs of corporatization will be in move to full cost recovery and at much lower staff retraining, implementation of a new overall cost. In this way, corporatization should information system and the cost of a allow for full cost recovery based on improved comprehensive assessment of existing capacity efficiency, decreasing overall costs, improving to deteinine needs for improvement. Specific 26 Reform Options for Uruguay's Water and Sanitation Sector costs of transition will depend on the particular degree of competition between the various performance improvement plan adopted by regional corporatized OSEs. This still leaves OSE's Board of Directors. OSE also faces the Uruguay with two concerns. The first is that decision of whether to remain fully corporatization is to some extent an extension of governmentally owned or to sell off shares to the performance contract it is currently subject private shareholders depends upon: (1) ease of to. Many of the players are the same and the accessing a private shareholder market; (2) ease incentive change but not that significantly. Yet of managing dividend distribution and interests OSE's own experience with performance contracts has been poor because users are only Box 5: Steps to Corporatization one of the agents to which the utility is accountable to. The second problem is that the 1. Make OSE an Independent Agency financing of the investment and rehabilitation 2. Elect Board of Directors requirements has to come from the government. 3. Set Objectives and Best Practice Targets 4. Evaluate and Assess Existing Capacity 5. Train Employees/ Establish Incentives and bonds and other sales of share could help, but is Sanctions unlikely to be significant as long as the company 6. Develop Investment Plan and spell out other targets 7. Sell Bonds to Fund Investment this last model is one in which the sector is 8. Ensure "Arms-Length" Governmental redesigned to maximize access to private sector Regulation Regultionfinancing and long-term investment decisions are of a private constituency; and (3) political separated from short-term political priorities feasibility of relinquishing governmental control. At this point in time, OSE may wish to spin off In considering how to involve the private OSE as a wholly governmentally owned entity sector in the management of Urguay's water and to consider sale to private shareholders after and sanitation system, a range of institutional this transition is complete. However, the early options exist that do not transfer ownership. involvement of private shareholders may be The most relevant to Uruguay's needs is a critical in creating incentives for efficiency concession contract. This is clearly accepted by improvements, as private shareholders will insist OSE since it recently initiated its first contract on a certain level of efficiency in order to with Aguas de la Costa. The main features of guarantee financial return. Box 5 summarizes the contract are reviewed in Box 6. But the use the major steps that could lead to an effective of this instrment as advocated here is corporatization under these constraints. somewhat different from the vision revealed by 4.3.MODL 3CONCSSIN W EREits first experience with Aguas de la Costa. The 4.3. MODLE key is for the government to design contract POSSIBLEterms with incentives for the private sector to Ifmeet the long-term goals for the sector but to If mnagd efectvely coporaizaion do so guaranteeing that the users are not paying offers significant advantages in the areas of a significant rent to the private operator. In equity, efficiency and financial viability at a other the design of regulation has to ensure that relatively low cost. It is flexible enough that it the financial ains from a more effective can be combined with a decentralization policy. g In fact, decentralization would reinforce some of oerano the erv i a b e the incentives for cost minimization of a corporatization strategy by allowing cross regional comparisons that introduce some Reform Options for Uruguay's Water and Sanitation Sector 27 Box 6: Uruguay's First Major Concession Contract: Aguas de la Costa in Punta del Este Aguas de la Costa is a concession of OSE to a private company to provide water and sanitation services to the coastal resort towns ofLa Barra and Jose de Ignacio in Punta del Este. In the winter, approxnately 300 families live in Punta del Este but in the summer, there are over 20,000 residents. The infrastructure required to serve these areas is very extensive and diflicult to construct. OSE had been servicing 1200 connections, but in 1992, the decision was made to offer a concession because OSE could no longer afford the high investment costs given the expected low rate of retum. The contract was drawn by OSE. It is for 25 year with an option to renew it for 10 more years after which time the operation would return to OSE. A minimum service level of 60 cubic meters of water per connection per month be provided. It also specifies levels of quality and requires the concession to maintain a book of all consumer complaints and to submit this book periodically to OSE. Three firms, two Argentinian and one Uruguayan, bid for the contract, but only the Uruguayan firm could make the investment that OSE had determined necessary for the required level of service. Four of the individuals in the Uruguayan firm are former OSE employees. The contract establishes that its regulator is a Commission within OSE. It is responsible for monitoring the quality of water and service under the concession and reviews and approves all business practices including the way the tariff should be set This commission counts seven people, al of whom have other jobs within OSE-the general manager, two lawyers, one notary, one engineer, one accountant; and one secretary. The Commission does not have a separate budget from OSE. Aguas de la Costa has 19 employees and no subcontracts. Aguas de la Costa operates two treatment plants for drinking water and two for sewage. The drinking water system extrects water from lakes. The sewage system uses septic tanks which are then collected and dumped. (OSE says that the cost of this system is more expensive than the traditional system where dirty water is collected directly). In La Barra, Aguas has expanded upon OSE's existing 1200 connection network and has constructed a sewage system In Jose Ignacio, Aguas constructed both drinking and sewage networks Aguas de las Costas has a rate of return of 16 percent Every customer has a meter which is read monthly and there are no problems with revenue collection. Thus far, the cost to OSE for monitoring is less than OSE had expected because compliance with the contract is very good and there have been very few consumer complaints. Since service began in March 1994, coverage is estimated at 100 percent for drinking water (1600 consumers) and 60 percent for sewage (900 consumers). Aguas' level of unaccounted for water is 30 percent due largely to leaks in old pipes left over from the original OSE infrastructure. Reduction in the UFW level is one of Aguas goals for the next several years. In considering the extent to which Aguas can serve as a model for other concessions, it is necessary to realize that Aguas' success may be attributed to several unique factors: (1) the ability to charge a very high tariff during the summer months due to the influx of very wealthy consumers with high willingness to pay, (2) the high level of technical skills within the firm; (3) the high level of financial capacity within the firm, the partners were able to fund 54 percent of the initial investment themselves; (4) OSE's previously existing infrastructure that lessened the immediate need for investment; and (5) the special friendly relationship between Aguas and OSE that facilitated the somewhat difficult regulatory role of the Commission. Combining Public and Private Department of Maldonado are likely to be good Provision. The key question for Uruguay is candidates, not too far behind Paysandu and how to allocate the water and sanitation market Colonia would follow in the short list. between the public and the private providers in order to cut costs dramatically and obtain Ani a e Costa o er the irs t o sufficient private financing for not only candidate h rs t areas w t blit to expansion but also rehabilitation. The key to i make that decision is to recognize that the two unreasonable to argue that a zone of about 100 types of providers are complements but that km around Punta del Este (--i.e., around the there is a sequence in which the allocation of existing concession) would have a significant responsibilities should be done. The private potential to attract private financing through a sector is not going to take just any concession. concession contract. The coastal Departments, The best chances of getting the private sector Paysandu, Rocha, Maldonado and Colonia are involved is where commercial risks are the expected to be high growth areas due to an lowest. This means in areas in which the increasing flow of tourists to their developing willingness and the ability to pay is the highest. resorts and beachfronts. Such growth will This means that Montevideo and the necessitate high levels of investment and improvement that may not be met by OSE, 28 Reform Options for Uruguay's Water and Sanitation Sector given its current problems. At the same time, differentiated across regions. This would in fact these areas would be expected to yield high allow some level of competition not only rates of return because of their increasing base between regional OSEs but between private and of consumers, many of which will be hotels and public providers. It could be envisaged that the other commercial users. This contract would be regional authorities decide to award concession in the service area of the Maldonado regional contracts at minimum subsidy levels if OSE is OSE. not interested in providing a service in any area. To date, OSE has not extended service Note that within areas to be maintained to large parts of these areas because under its under OSE's control there is no reason why current tariff, revenue will not cover the cost of some expansion could be organized as a BOT initial investment. This is due largely to the deal or any similar arrangement. In fact, these seasonality of demand in these regions: lack of types of deals could be very effective for year-round residents makes it difficult for OSE treatment stations. In some of the regions of to sustain itself financially in the winter months Rivera, it would not be inconceivable to have a under the existing tariff formula. For this BOT to cover service both in Brazil and in reason, many beachfront areas are without a Uruguay. Uruguay is already exporting water to network for water and sanitation. Such areas some of the Brazilian southern states. Most of are very well-suited for concession contracts the service remains public but the financing of under which private firms build a network and the expansion requirements is done privately. then operate it for a given number of years. This requires a strict coordination of tariff rule Aguas de la Costa is one example of a which is why the design or regulation is so successful concession in a beach resort area. important But these are not the only potential candidates. The five main cities along the Uruguay more market oriented approach would clearly river could be bundled in a single package. It is require regulation since every service provider is a longer shot because the population density is essentially a monopoly. Licenses for provision lower and so is the ability to pay. This of services should be granted in accordance with concession area would be in the area of the two schedules: (1) the water supply area for Paysandu regional office. which the concessionaire is responsible, and The final candidate is probably the most the conditions ma in ce obvious: Montevideo. Montevideo is the only region with a cost recovery ratio larger than one * restrictions on charges: uniform tariff, so that it appears to be the most attractive for maximum tariff, or prescribed tariff formula private investment. Here the situation is much and mechanism for formula adjustment;27 trickier because of the need to separate water 0 codes of practice and consumer relations; and sanitation and because of the potential tension that could emerge between a private * minimum investment requirement; concessionaire selected by the National o service targets, performance standards, and Government, on the one hand, and IMM. The accounting and reports and schedule for rest of the territory should be the responsibility of a decentralized OSE. Since regional cross oSE may opt to limit the weighted average ofthe franchisee's charges subsidies would have disappeared under thisthan some fao "K" above general ilation as subsdie woud hve isapeard uner his measured by the Retail Prices Index. A more complete discussion of this is scenario, the regional OSE would have to be contained in Oxford Economic Research Associates, Ltd. (OXERA) either subsidized and/or tariff would have to be "Guide o the Economic Regulation ofthe Water Industry," 1993/1994. Reform Options for Uruguay's Water and Sanitation Sector 29 submission to the central office and/or the contract between the regulated firm and the rest regulatory entity; of society. Within an effective regulatory * enurig tat he oncesioair ha an system, this contract is formally reviewed and * ensuring that the concessionaire has an incentive to continue maintaining the roniity. The tonship itn thi investment until the end of its tenure; and contract will differ substantially depending on * payments of administrative costs: franchise whether OSE decentralizes, corporatizes or may be asked to pay for a percentage of concessions. A check list of the specific oversight cost.28 structure of a regulatory agency is provided in Table 8. Create an Independent Regulator. This approach also requires a national regulator, In spite of the lack of specific data to completely independent of OSE. OSE cannot simulate the quantitative impact of these continue to serve as its own regulator if conflicts proposals was not available, it may be worth to of interest are to be avoided. OSE cannot quickly discuss how this proposal would cope in provide a service and be in charge of comparing contrast to others in terms of the criteria its own performance to that of alternative discussed earlier. providers such as Aguas de la Costa. But there is a much more immediate problem. OSE, as Equity and Affordability. the regulator, would have the power to use Affordability should not be a problem as long as regulatory restrictions to discourage the the public service obligations are spelled out entrance of competitors into this sector which correctly. However, Uruguay's low coverage may not be in the consumers' interest. Opp rate for sewerage and relatively low rate for should clearly consider the creation of a separate drinking water in the Interior suggest that regulatory entity to oversee consumer coverage may be more of an issue. A protection and environmental quality. There are concession contract can allow the private clearly many models available and in the short company make appropriate investment decisions run a sector specific agency may be the most based on their own assessment of potential politically realistic. But in the longer run, the return to investment. By opening the investment public utility commission approach seems to be opportunity to the private sector, we introduce the most appropriate when accounting for the competition to provide the best network and size of the consumer basis of Uruguay's utilities. service. By allowing the private sector to make Ideally, this regulator should be in place before expansion decisions based on expected return, the reforms are implemented. communities are more likely to receive better quality service. This is why regional subsidies to This water sector regulator would have finance expansion will probably have to be two duties: (1) economic: to protect the considered, but once more, this needs to be consumer against unfair prices and poor service assessed much more carefully than done here. and to preserve a competitive environment, and (2) environmental: to ensure the effective management and conservation of water resources. Regulation may be viewed as a 2c Oxford Economic Research Associates, Ltd. (OXERA) "Guide to the Economic Regulation of the Water Industry,o 1993/1994. 30 Reform Options for Uruguay's Water and Sanitation Sector Table 8: How Could a Water Regulatory Agency Work? Structure: Board of five directors appointed by Government, recruited through public job listing Financing: * Makes and publishes its own budget annually. * Budget to be approved by legislature (as part of national budget). * Keep a small staff of which a good chunk should deal with complaints by users. * Budget resources could be from: regulatory fee billed to users, inspection and control fees; subsidies and donations, fines; interest on its own resources investment. Functions and * Enforce the regulatory, contracts and public service obligations Obligations of the Entity * Issue rules and regulations on matters of safety, tech procedures and norms, measurement, as spelled out legally billing, control and use of meters, interruption and reconnection of servce, access and service quality * Prevent monopolistic and discriminatory behavior at each stage of the process * Define the basis for the calculation of tariffs set in contracts * Control tariff enforced * Publish the general principles to be respected by all providers to ensure free access to services * Determine the basis and criteria for assignment of concessions * Organize and implement the bidding, adjudication and signature of contracts * Organize public hearings * Monitor the respect of property rights, environments and public safety * Coordinate with other relevant agencies (DINANA for instance) * Take to court the relevant issues * Impose sanctions * Publish information * Issue an annual report and recommend actions to executive power * Do whatever is necessary to ensure respect for the law * Collect information from transmission enterprises Operational and Managerial government, it will never accept operating at a Efficiency. A good concession contract will deficit. Thus, while the effect of not need to specify an administrative or decentralization and corporatization on cost operational efficiency requirement because if recovery is uncertain, private sector efficiency gains are tied to financial gains for the participation guarantees full cost recovery. This company, the private sector Will automatically full cost recovery may be accomplished through strive to be efficient. As long as efficiency gains increases in tariff or through reductions in cost. are reflected in profit levels, the incentive to Because of the profit motive, the private sector improve efficiency will be considerable .29 The firms have a large incentive to operate at corporatization of the ' -esidual" OSE should minimum cost. Through reduction in UFW and achieve the same results with the assistance of reduction in number of employees per thousand an independent regulator monitoring the connections, the private firms will be able to performance of both public and private achieve higher levels of production at a cheaper providers, price. However, the private sector firms also Financial Viability. Private sector have an incentive to charge a very high price to participation will result in significant gains in consumers. Effective regulation or monitoring financial viability. If the private entity is given will be necessary to ensure that financial viability ownership of assets, and not subsidized by the is not achieved entirely at the expense of the consumer. 29GIynn et a], 1992 Reform Options for Uruguay's Water and Sanitation Sector 31 Administrative Feasibility. Even improving performance and quality. It could in under the current efforts to reform infrastructure fact cut water cost for many consumers. sector, the political environment remains precarious for this kind of proposal. The thecmpaison oe vou opis difficulty of carrying out reforms must not be underestimated. Labor unions may resist the sufficient gains in efficiency to be recommended transition from government to private provision at this point. Decentralization will not give OSE because they feel it puts job security in jeopardy access to needed private capital for investment in a company in which the average worker is 44 nor will it necessarily improve efficiency but its years old and the least qualified over 48. This is could help introduce more (benchmark or a choice Uruguay has to make. The trade-off is yardstick) competition in the sector if designed between: (i) maintaining an underperforming with that purpose in mind. The combined company unchanged because it provides jobs to approach of concessiomng and corporatization about 6,000 people, and (ii) adopting a new will bring the highest degree of competition into structure for the sector which could result in job the sector (by allowing the comparison of the losses probably over 50 percent but which could performance of public and private providers) lead to an average tariff reduction of 30 percent while at the same time ensuring that the public (i.e., everyone in Uruguay is paying the sector operates at maximum efficiency. equivalent of a 30 percent tax and hence higher Wherever possible, concessioning would water bills to pay for the salary of OSE's excess accomplish the most in the way of overall workers) and higher wages for many of the employees remaining in the sector.30 Early government (and without having to transfer negotiations with labor unions would allow property of the assets to anyone). The resort unions to participate in the decision process and areas appear to be very suited to concession planning for involving the private sector. contracts as they have a large number of Except for these political barriers, OSE's consumers willing to pay a high rate for problems of technical efficiency and service services. The combination of these factors quality may best be solved by private sector should result in a rate of return that is very participation. Proper preparation and provision attractive to the private sector. Moreover, the for private sector involvement must be involvement of the private sector in the considered as Uruguay plans for its development provision of water and sanitation services may not just in water and sanitation but in all sectors. go far toward increasing development 5. FINAL RECOMMENDATION: opportunities for all areas of the country. COMBINE PUBLIC AND PRIVATE Uruguay can use concession or BOTs contracts PROVISION to build necessary new parts of the network. Yet, the overall feasibility of pursuing a solely The ultimate goal for reform must be to private sector strategy may be limited. Rural improve efficiency without giving up the interior areas with high costs and a low density important social concerns that have always consumer base may be unable to generate driven Uruguay's policies. Only by inducing sufficient rates of return and therefore, may be competition into the water and sanitation sector unable to attract private investment. Thus, the will service providers lower their cost while more practical option may be to concession _____________________those areas that would readily benefit from 30 Considering that in 1995 ,the wage bill was about 60% of the total cost private sector participation and to corporatize and that this cost is used to set the tariff, a 50% reduction in staff, to get 4 workers per connection (and this is still high by international standards) would lead to a 30%i reduction in tariff(.50*a60) 32 Reform Options for Uruguay's Water and Sanitation Sector the remaining areas with or without These analysis require detailed quantitative decentralization. More specifically: simulations whih should be included in the report to be presented by the consultants (1) Concession the Resorts (Balnearios); working for OPP on the reform options for the (2) Try to concession Paysandu and sector since they are well within their time, Montevideo; and resource and coverage scope of their study. (3) Corporatize (with management contracts or minimum subsidy concessions) the ' esidual OSE" as a whole or as its regional units, recognizing that investment and rehabilitation expenditures may have to be subsidized or financed in these areas and that OSE cannot be the regulator of the sector: Some Interior operations may still attract private investors if Uruguay is willing to subsidize their earnings. The bidding process may be adjusted such that Uruguay can accept negative bids for service to higher risk areas or BOTs can be an option for specific projects such as building treatment stations. Areas that cannot be concessioned even with a negative bid should remain a part of OSE and be corporatized. By increasing management accountability and moving closer to best practice targets, areas with poor rates of return may be made more attractive for private sector involvement in the long term. In the meantime, since they will have to be operated by a 'torporatized OSE", it should be clear that OSE can no longer be the regulator of the sector if conflicts of interest are to be avoided. But this of course is only part of the many steps to reform. A final comment on the limitations of this study may help. Many issues have not been covered here because they were beyond the scope of the study. These omission cover the design of any detailed implementation strategy (what is the specific optimal level of decentralization of the sector, what kind of specific regulation is needed, what are the staffing reform needs, the level of subsidies, ...).