Tariff Reform in Municipal Water Supply System Second ...Second Seminar of Experts Tariff Regulation and Investments Attraction in Water Supply and Sanitation Sector Moscow, June 2002.

The document prepared for the Second Expert Workshop on the Tariff Reform in the Municipal Water Supply in the NIS(Moscow, June 2-3, 2002) sponsored by the EAP Task Force of OECD. Please contact Alexander Danilenko, projectmanager ([email protected]), for the information about the Project and its products.

Tariff Reform in Municipal Water Supply System

Second Seminar of Experts

Tariff Regulation and Investments Attraction in Water Supply and Sanitation Sector

Moscow, June 2002.

S.B. SivayevRussia,

«Institute of Urban Economics »Moscow

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Table of Contents:1. Preface........................................................................................................................32. Current situation with tariff regulation in water supply and sanitation sector...........33. Principal governmental objectives in water supply sector........................................64. Tariff regulation and investment attractiveness .........................................................85. What is a good tariff regulation .................................................................................96. Tariff regulation policy ............................................................................................13

6.1. What is an object of regulation? .......................................................................136.2. Metre-based inventory policy ...........................................................................156.3. Tariff regulation and tariff plans .......................................................................17

7. Concession-based plans of sourcing investments ....................................................188. Choice of measures of state support to attract investments in water supply sector .209. Conclusions..............................................................................................................22

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1. Preface

This paper has been prepared in furthering the findings of the report /1/ presented at the FirstSeminar of Experts dealing with drawing up an information document “Tariff reform inMunicipal Water Supply Sector”. In the first report, the attention was primarily focused onanalysing the situation with water tariffs formation in the NIS. The report will concentrate onwater supply and sanitation utilities operation regulation, tariff regulation techniques andpractice analysis, creation of investment attractiveness of the water sector companies,discussion of potential measures of the state support to attracting private investment in thewater sector. Approaches to attracting private business to managing water supply and sewagefacilities will be discussed separately.

The problem of tariff plans optimisation and instrument-based inventory introductionacceleration will be discussed in the context of putting in place an efficient system ofincentives and identification of potential entities interested in addressing these tasks.

Special attention will be attributed for a situation being specific for the NIS countries whenthe public dwelling in multi-flat residential buildings appears to be a prime consumer of watersupply and sanitation services. Noteworthy, this residential fund in terms of ownershipreplicates a condominium model where some elements of the buildings belong to owners(being, as a rule, both private individuals and municipalities/state), while others are a sharedownership. This situation is drastically different from that in the majority of Europeancountries, where citizens most commonly dwell in one-family houses. Therefore it requiresspecial legal and organisational solutions both from the contractual relations perspective, andfrom the technical support standpoint when it gets to organising an instrument-based waterconsumption inventory.

2. Current situation with tariff regulation in water supply and sanitation sector

The operation of water supplying and sewage companies is subject to the state regulationvirtually in all of the NIS. This situation appears to be perfectly grounded as this sector isessentially a natural local monopoly engaged in the public services provision.1,2 However, inpractically all cases that were examined the tariff regulation system does not orient watersupply companies to raising their performance efficacy. Furthermore, it objectively motivatesthem to increasing costs. This situation ensues from the inadequate attention attached by thelegislative and executive power to effective regulation of the water sector.

Power authorities in almost all NIS attribute priority attention to problems of transition to a100 percent collection of water bills, reduction and subsequently doing away with budgetsubventions and/or cross-subsidies to water utilities in connection therewith. As a result ofconsumers low payment discipline, financial constraints of water supply utilities, frequentlycritical condition of engineering systems authorities react to result rather to the cause.Networks poor condition requires additional budget expenditures or increase of consumerstariffs, while difficult financial situation of companies leads to think that management

1 It should be underscored that cases have been recorded when Vodokanals operation is not regulated. Inparticular, in Russia some of the municipality formations only regulate tariffs for the public, while tariffs forindustrial consumers are set by Vodokanals themselves.2 Notably, the legal definition of Vodokanals operation dealing with water supply and sewage as a monopoly canbe found not in all countries. This may bring about paradoxical situations: e.g. under the law of Russia, theoperation of municipal unitary utilities, including Vodokanals, is regulated on a municipal level. At the sametime, no legal definition of regulating Vodokanals in a different organisational and legal form is provided whileregulations and bylaws vest this responsibility in the regional level of the Russian Federation subjects.

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centralisation is a good idea, while low solvency level of the public hampers the completecoverage of costs. This brings about the enhancement of administrative impact on vodokanalsoperation and centralisation of water supply systems management at both regional andnational levels. This kind of situation is observed in Armenia, Georgia, Byelarus. In manyregions of Russia developments are similar. Against the background of declarations to theeffect of promoting economic autonomy of water sector companies the practical activity ofregional and municipal authorities is often times aimed at reinforcing the administrativecontrol over these utilities operation.

The irony of the situation is that it is Vodokanals that are most independent companies in themunicipal economy sector in the majority of NIS countries. The reason behind it is that sincethe Soviet era times they were least dependent on budget subventions and are therefore usedto live to their own budget limits. Furthermore, it is easy to prove that in the existingcircumstances water companies managers behave – in economic activity terms – perfectlyadequately to the situation.

Let us assume as a working hypothesis that a water supply company operation is pursuing theobjective of profit maximisation. How can it address this task? In the market conditions, acompany is expected to cut costs while in our case a company operates in a regulatedenvironment. The price to its product is set contingent on the company’s costs: the higher isthe costs the higher is the price and consequently – the higher is the profit. Losses means theincrease in costs and price. Resources saving means the reduction of the price and the costs.In this kind of an economic situation increasing costs is advantageous. That is reason whyvodokanals managers go for it telling at the same time how miserable they are. But it shouldbe stressed again that economically they behave perfectly right. However, neither theconsumers nor the society as a whole should accept this “rightness”. Unless this situation isrectified it will not really matter who pays water bills – the budget, the industry or the publicand poor pipes will be perpetually replaced with even poorer ones and no money will ever beenough. These are the rules of the game. It is quite likely that new rules will trigger a dramaticchange in the behaviour of managers of these companies.

Having said that, it is worthwhile to take a closer look at the existing tariff regulation practicein the NIS countries.

Some of the most general questions ought to be discussed:• tariff regulation decision making level;• principles incorporated in the tariff determination;• tariff approval procedure.

So, at what level are decisions pertaining to tariff regulation made? In most countries tariffsare approved at the municipal level – Armenia, Georgia, Moldova, Russia. In countries likeByelarus, Kazakhstan, Uzbekistan, Ukraine decisions on the tariff value are by and largemade at the regional level. The next important question to answer is who makes a decision onthe tariff value. Whenever this is a decision of local governments, it is often times approvedby local representative power bodies and consequently bears a clear indication of politicalcolouring. In Russia, the municipal water companies tariff regulation competence is legallyassigned to local self-governments. The direct competence of water tariff setting is defined incharters of municipalities and their agencies. In most cases (over 70 %) this is referred to thejurisdiction of local representative power authorities – deputies assemblies.

The world practice features a variety of options of approaches to the level of tariff regulationdecision making. They will be further discussed below. But in principle, no successful tariff

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regulation can be talked about inasmuch it is dealt with by the representative powerauthorities. This remains to be one of the key problems requiring immediate solution.

Let us review key principles underpinning tariffs formation.

In the vast majority of cases, the tariffs are formed by means of multiplying estimated costsby the a certain profitability level. To be more accurate, it is not even the costs that aredetermined but rather the prime cost which in the bookkeeping reporting of the majority ofcountries (e.g. Russia) is not an economic category and is only used for the taxation purposes.In particular, a series of costs which the companies have to suffer in their operation must besourced from their profits.

The costs calculation principle is essential. Traditionally, a normative technique of prime costcalculation was employed which makes use of certain approved standards for calculating bothlabour costs and materials costs. Obviously, these normative parameters in general fail to takeinto account the real structure of costs at a specific enterprise. It is really difficult to setnormative standards of real cost of labour, losses, electric power consumption at pumpingstations depending on the terrain and many other factors. While determining the prime cost,the value of the calculated tariff will have very little connection with the real structure ofcosts. As an alternative to the normative calculation, a calculation based on factual costs isused. This procedure allows to analyse the company’s performance especially wheninformation is available with reference not only to costs in one point but in a certain temporalsuccession. Regulatory documents approved in Moldova /2/ and Ukraine /3/ base on preciselythis approach to determining costs. This practice is increasingly becoming more widespreadin Russia though recommendation documents approved at the federal level /4/ speak of thenormative costs calculation. Of the above listed documents special attention should be givento ones approved in Ukraine where the costs calculation is tied up to the new nationalUkrainian accounting standards approximated to the International Accounting Standards. Onthe other hand, however, no real assessment of the practice of these documents enforcement isavailable at this stage.

We have considered the problem of costs calculation in the course of tariffs setting havingestablished that in most cases across the NIS costs are determined based on a normativemethod which fails to adequately account for the real situation at a specific enterprise.

The profitability percentage incorporated in the tariff appears to be an even more optionalvalue than the calculated costs. To a large degree it is only this parameter that is regulated –from 0 % to 25 %. Clearly, high costs and high cost-effectiveness margin secure high profitswhile the procedure of its use is not prescribed by a regulating authority.

Thus, the tariffs calculation is based on predominantly costs calculated subject to a normativemethod multiplied by a fairly optionally set profitability parameters.

Speaking about tariffs setting procedure one has to admit that the situation here is even moresombre. We have been unable to find at least one state-level regulation governing the tariffsetting procedure. Individual practices of formalising tariff approval procedure in severalRussian have been reported but it only highlights the general rule. Therefore, the process ofconsidering and approving tariffs occurs spontaneously. Apparently, it leaves little room forraising public confidence in tariffs in this situation.

This however does not exhaust the list of problems having to do with tariff regulation.

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New independent states feature one demerit in the existing system of tariff regulation beingcommon for water supply companies: local governments being, as a rule, owners ofcompanies’ assets do not assign to the latter any goals of their operation (virtually nocompany has either production or investment programs). Due to the absence of set targetswith public utilities, relations between water supply and sewage companies and localgovernments become of an administrative nature while boundaries of responsibility for thequality of utility services get blurred.

Tariffs are set for an unfixed period of time which breeds economic uncertainty for both thecompanies and for the consumers. In practice tariffs may be left unrevised for 3 and moreyears despite apparent leaps in inflation. As a result public utilities find themselveschronically underfunded which reverberates both on their current operation and on fixedassets restoration programs. Regulations of Moldova /2/ and Ukraine /3/ point out thenecessity in defining the tariff validity period though the implementation of these documentshas not as yet become a widespread practice.

Normally tariff regulation in water supply sector is not tightly related to regulation in energysector. The regulated fluctuations in the cost of electric power does not find an adequatereflection in alterations in water supply and sewage tariffs which brings about the growth incompanies’ losses. Another substantial bottleneck in the existing procedures is the fact thatthe tariff regulation process is not related to the budget formation process. Hence, changes intariffs during a budget year leads to the rise in receivables of budget-dependant organisationsencumbered with serious problems in paying their bills even without it.

The politicisation of tariffs setting reflects common deficiencies of the tariff regulationprocedures. International practice offers clear indications that one of the most acceptablemeans of relaxing social tension is a public hearing and putting in place a transparent andopen procedure of tariffs setting. A tariff for a certain utility service must at all times be atrade-off between the municipality’s needs (and its budget capabilities), utilities’ needs andsolvency of a consumer. It is fair to say that a tariff must be socially justified, i.e. a consumermust receive a clear and substantiated explanation of what quality service they are in aposition to have under the existing tariff values.

A general conclusion may be drawn from the above.

1. Water tariff regulation systems featured by the NIS countries are absolutely unfit for thenormal development of the sector. The importance of this challenge may only be comparedwith the task of raising the consumers’ payment discipline.

2. Addressing the problem of tariff regulation is hindered by the contradictory interested ofthe involved parties and is unpractical without an active stance taken by the government.

Attempting to outline possible solutions to the problem, it is deemed essential to pinpoint keyobjectives the achievement of which must be promoted by the water supply and sanitationservices pricing process.

3. Principal governmental objectives in water supply sector

In /1/ we have described, in a fairly fine detail, the most encumbering problems suffered bythe water sector of the NIS countries.

The following major ones may be singled out:

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• dramatic increase in the level of wear and tear of the capital assets, rise in accidentincidence and potential, drop in the degree of reliability;

• low payment discipline common with consumers and a grave financial situation ofthe sector’s companies.

As recently as 15 years ago this problem in the NIS would have been addressed by sourcingenormous budget resources into the sector. Today this solution appears unfit not only becauseof the limitations in the budget resources but also because of the utterly different economicpolicy pursued in our countries.

Virtually all post-Soviet countries have, to different extents, declared that the water sectorenterprises must operate based on economic principles with a limited state intervention. Thisin particular means that prices must cover all justified costs of the company ensuring the levelof revenues which would allow to maintain the network’s operability.

At the same time, water is a social good and the state is responsible for ensuring equal accessto it for everyone.

Proceeding from this assumption, the state policy in the water supply sector must seek toachieve the following objectives:

• improvement of quality and reliability of water supply and sewage systemsoperation by forming proper economic motivation with the sector’s companies andby attracting private investments;

• realisation of mechanisms of state social support to low-income strata to secure theaccessibility to the sector’s services.

It is important to mention that tariff regulation is key to the attainment of the aboveobjectives.

The water supply and sanitation tariff must be set at the level guaranteeing reasonablerevenues for a utility adequate for maintaining a normal operative regime of water suppliesand drainage at this point in time and in a conceivable future. In this context, a tariffformation system must stimulate private business’ interest in investing in the sector. Thisinvestment may be pursued in two avenues: sourcing borrowed and repayable investments byputting in place a crediting risk minimisation system following different models, or drawingup a variety of sector privatisation schemes and involving private management in the watersupply sector administration.

Social priorities may be addressed along two lines: formation of respective tariff plans at thetariff regulation stage with account for low-income groups, or by lowering the amounts ofpayment for low-income households under certain plans with a respective budgetcompensation. What is of principal importance is that the social policy pursued by the statemust not flashback on the financial standing of the sector’s enterprises. Downsizing paymentsfor one group of users must be balanced by either elevating payments for others, or byrespective governmental compensations. In many NIS countries (Russia, Ukraine,Kazakhstan) state programs of ad hoc social assistance to low income families in coveringtheir utility bills (housing subsidies programs) are pursued. Hence, the second approach toaddressing social protection problems seems to be implemented there. We tend to believe thatit is the right solution.

The following parts of this paper will concentrate on how tariff regulation may make a realdifference in the investment attractiveness of the sector’s companies.

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4. Tariff regulation and investment attractiveness

Tariff regulation of municipal water supply companies, as well as the regulation ofprivately owned utilities is one of key factors of the investment risk. Finding a solution to thetask of the municipal utilities fixed assets renovation brings about the necessity of attractingprivate investments (since the majority of municipal budgets are unable to finance companies’investment programs). Attracting private investments in turn necessitates the creation of thetariff regulation system which would minimise investor’s risks.

Before discussing approaches to attracting investments, attention must be given to the form ofownership of water supply and sanitation utilities. In the majority of countries under review,water supply and sewage companies are owned by the state or by municipalities in countrieswhere municipal ownership is severed from the state ownership (e.g. Russia). In practicalterms, no active work towards the sector privatisation is under way. To an extent, exceptionsare represented by Kazakhstan, Armenia and Moldova where primary experience in involvingWestern companies in managing water supply facilities yielded negative rather than positiveresults. One of the reasons behind it is an uncoordinated tariff policy leading to numerousconflict situations. It is commonly believed that in the conceivable future, communalinfrastructure facilities shall not be subject to privatisation. At the same time, increasinglymore countries seem to be supportive of the opinion that economic entities of any form ofownership may manage water facilities.

As was mentioned before, investments attraction into municipal water systems may be carriedout based on a variety of mechanisms. Under the existing organisational and legal form ofmanaging companies, sourcing extra-budgetary funding for their development is only possiblethrough different types of borrowings.

To what extent are borrowings for water sector enterprises feasible? And what restrains theirattraction? Investment risks are primarily dependant on two factors: markets stability andpricing situation. The water supply sector features guaranteed and basically stable marketswhich seems to be a good competitive edge versus other sectors of the economy. However,the pricing policy in the regulated sector is a perfectly foreseeable thing. Thus, insofar as thetariff regulation system allows to clearly project prices to water services it means thatinvestment risks may be minimised while the timeframes for the investment repayment maybe calculated and predicted. Water supply sector, sure enough, must not be a super-profitableinvestment target. A merit and point of attractiveness of this industry must be rooted in adifferent aspect – in low investment risks and in the guarantee that the invested funds willmost certainly be repaid as per the agreed terms and timeframes.

Two types of investment activity must be distinguished. The first one being a relativelytraditional approach is associated with an extensive development of water supply, drainageand treatment systems. It requires a single-time capital expenditures. Obviously, therepayability of the borrowing may be secured by incorporating a relevant componentforeseeing the repayment into the tariff. As a rule, a decision on such types of borrowings ismade by facilities owners and co-ordinated with the tariff regulation process. The other typeof investment activity has to do with investing in the raising of production efficiency,minimisation of losses and costs, systems modernisation. It is of a special importance thatsuch investment projects be initiated by water utilities themselves. In order to minimise risks,they must know for certain tariffs validity periods and the procedure of their revision.

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The other option for attracting investments needed for implementing investment projectsaimed at municipal water facilities upgrade implies the transfer to an investor of rights topossession and use of the municipal property being at the time in the economic control ofmunicipal utilities (concession) without transferring an ownership right to said property. Thismechanism has proved its effectiveness and is fairly commonly employed in the internationalpractice.

Evidently, a common feature of both approaches is the risk associated with setting tariffs.Notably, if in the concession agreement the municipality and the concessionaire are able tostipulate both the procedure of tariffs setting and the methodology of their calculation, andpenalties applying in the event of municipality’s violation of terms and conditions of theagreement, then, should the municipal utility have received a loan, a creditor appears to be leftwithout any real levers of affecting the municipal tariff policy.

Creation of a possibility to regulate tariffs in conformance with the agreement entered intobetween the utility and the municipality is one of the solutions of the latter problem. This sortof practice (contractual regulation) is used in a number of developed countries and has provedan effective tool for investment risks reduction.

5. What is a good tariff regulation

We would like to try to offer a formulation of key criteria of good tariff regulation of watersector companies’ operation.

From the outset, two criteria mentioned before should be repeated:• Tariffs must ensure the company’s revenue in the amount adequate to sustain and advance

the engineering infrastructure.• Tariffs must provide for the accessibility of the services in question to consumers.

Summarising the two first criteria one may fairly conclude that a tariff must be formed as atrade-off between the suppliers desire and consumer’s capabilities.

The next principally important criterion is the following:

• Tariff regulation must provide economic incentives for the company motivating it to raisethe efficacy of its operation and to cut non-operational costs and losses.

This criterion is not as simple as it may look and conceals a serious duality of approaches totariff regulation. In order to be able to explain it, theoretical principles of natural monopolistsregulation will have to be raised. Since it does not refer to the subject matter of this paper(see /5/), we will only touch upon the approaches illustrating contradictions of the saidcriterion.

There are several fundamental principles underpinning the tariff regulation. Two of them arecurrently being, to this or that extent, applied in the surveyed countries.

The first one is normally referred to as “cost +” and is based on the following approaches. Thetariff is formed as a totality of certain necessary costs plus a certain earning on the capital. Inthe Soviet era, and consequentially up till now in the post-Soviet countries, this approach kindof “mutated” into an approach “prime cost + prescribed profit”. Its essence implies that everytime at the regulation stage there is a sort of struggle for the substantiation of certain costs

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between a regulating authority and a regulated enterprise, whereafter the company remainsoperating to the set tariffs without any incentive to cut costs but dreaming to have them raisedby the next regulatory stage. The ideology behind this approach is that a regulating agency isfully capable of deciding what kind of expenditures the company needs to have and this issufficient for providing for its operation. The previously described analysis suggests that it isthis principle – plus in a considerably distorted form – which is predominantly employed inthe course of vodokanals operation regulation in the NIS.

The second principle referred to in documents /2/-/4/ and slowly paving its way in thepractical activity is called the price cap. Essentially it means that a tariff value and aprocedure of its revision is set for a company for a relatively durable time. Importantlyenough, if over the period of the tariff validity the company was able cut its costs versus theplanned figures, then such company may obtain additional revenues. Thus, during the periodof the tariff validity a company has additional economic motivation to cut costs to obtainadditional profits. At the stage of approving new tariffs meanings, a regulating authorityanalyses the new factual structure of the company’s costs and the detection of the costsreduction makes it possible to speak about real cuts in tariffs. Therefore, in the short term aregulated company benefits from cutting non-operational costs while in the medium term it isthe consumer who benefits. This principle however is not free of some internal deficienciesbut it is more than obvious that it is more advanced than the first one. Its major distinctionfrom the first principle is that it attempts to create a situation in which not only the regulatingauthority but the regulated company will be equally encouraged to reduce costs.

A conclusion therefore seems to be clear – a good tariff regulation system must turn down a“prime cost + prescribed profit” principle transferring to a “price cap” principle.

It is now essential to discuss what a price cap is about.

It was already indicated that a tariff formation concept must incorporate an idea of a balanceof interests between the supplier and the consumer. Reaching this balance requiresidentification of the company’s operation objectives and calculation of the costs associatedwith the attainment of these objectives, i.e. how much the tariff will be. The objectivesimplementation presupposes development of the company’s operational and investmentprograms. Their fulfilment requires defining company’s financial requirements and an abilityto meet them through respective tariffs. It may well happen that tariffs for fulfilling theprogram in question will be excessively high for consumers in which case iterativeadjustments to the objectives will have to be made and new, acceptable tariff values will haveto be calculated. Tariffs obtained through this procedure will be the ones to form the pricecap. The rules of their alterations may vary. In the UK, for instance, a minor real costreduction is planned /6/. For offering a maximum incentive for enterprises, we suggest thatthe tariff should be fixed for the period of its validity with account for the external inflationfactors. It is essential that the “price cap” principle implementation must be supported bysystem of monitoring of the company’s attainment of its objectives and it is this monitoringrather than the costs analysis that becomes the regulating authority’s prime task during thetariff validity period.

Below are attempts to formulate some of the fundamental principles on which a good tariffregulation in the water supply sector is based.

1. The tariffs setting must be preceded by the formulation of objectives of operation ofmunicipal utilities or other companies managing water supply and sewage facilities.

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2. Objectives must be formulated in the form of production and investment programsdesigned for the implementation over a certain period of time (regulation period).

3. Throughout the regulation period, tariffs must stay unchanged in real terms which impliestheir periodical indexation following a single pre-established rule and/or a list of causesfor their revision prior to the regulation period expiration.

4. Tariffs as set for the regulated company must be able to help it generate the amount offinancial resources necessary to safeguard the implementation of the approved productionand investment programs.

5. Tariffs approval procedures must provide for a possibility to achieve a balance of interestsof all interested parties (municipality, public, regulated company). One of the keyprerequisites of it is the transparency in the authorities activity in setting tariffs.

6. A regulating authority must possess an ability to monitor the progress of fulfilment by theregulated company of the objectives assigned to it (availability of regulated companiesperformance monitoring system).

The experience of the city of Cherepovets may serve a good example of the successfulregulation of vodokanals activity.Cherepovets is a relatively large industrial centre populated by 330 thousand citizens andlocated in Vologda region, in the North of the European part of Russia. The municipalvodokanal regulation is a responsibility of the executive branch of local government and iscarried out through the passage of relevant resolutions by the Mayor. 5 years ago a packageof documents was approved in the city providing for a comprehensive regulation of the tariffscontrol process. The following actions have been completed in the course of these documentsenforcement:• An inter-departmental commission on tariffs regulation was set up involving

representatives of a variety of administrative agencies reflecting interests of bothmunicipal companies and different groups of consumers. The Commission approachesthe tariffs formation precisely as a process of building a consensus between suppliersand consumers. Rules of the Commission’s activity are clearly defined. At the final run,the Commission prepares drafts of Mayor’s resolution.

• An adequate and exhaustive volume of information a regulated company is bound toprovide to the regulating authority has been identified and fixed. What makes thisinformation special is the fact that statistical data on the company’s operation cover thepast 5 years which allows to analyse the company’s development dynamics. Therefore, acalculated requirement in expenditures is determined based on the company’sperformance examination.

• Tariffs regulation involves reviewing a company’s investment program, whileexpenditures associated with investment activity are incorporated into the tariff.Inclusion of this component helped, in particular, to upgrade waste waters biologicaltreatment station.

• The tariff remains in effect for a definite period of time – now this period is set for 1 year.Extension of the tariff validity period due to the overall economic stabilisation iscurrently being considered.

The described steps have appeared quite successful. The company’s operation hasbecome much more transparent not only for the owner but also for the company’smanagement. Companies have obtained a set of incentives and motivations, their behaviourhas become the behaviour of a genuine business-oriented entity. This, by the way, entaileddubious outcomes: for instance, in Cherepovets almost all blocks of flats are equipped withcollective metres. But these instruments do not function as commercial tool due tovodokanals’ reluctance to use them for settling payments as companies are better-off selling

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their services based on normative consumption. Vodokanal uses these instruments only whenthey show a significant excess in the amount of actually consumed water over the normativestandard. This, as a rule, means big losses for in-building networks and serves grounds forfiling claims to housing authorities.

Implementation of these essential principles is not sufficient for addressing all tariffregulation-related problems however. It is deemed imperative that a tool could be foundallowing to fit vodokanals’ performance into the surrounding reality, to balance tariffregulation in this sector with budget constraints (budget sphere is one of the prime consumersof services being at the same time one of the major non-payers for them) and with regulationin the energy sector – primarily with regulation in the power supply industry as the electricpower cost accounts for a major proportion of the cost of water supply and drainage services(30 % and more).

The first problem is the regulation level. If we have agreed that the tariff regulation in thesector is essentially about the search for a balance of suppliers’ and consumers’ interestswhile water supply and sewage is a responsibility of a municipality level, it is only logical toassume that this balance of interests should be sought within the urban community and, in thefinal run, it is the urban community that is supposed to bear ultimate responsibility for themade decisions. This idea could be reworded: the level of regulation must be consistent withthe scope of a monopoly market.

Furthermore, it is obvious that a problem of tying up water tariffs regulation with fluctuationsin electric power tariffs typical for all NIS countries must be addressed without delay. This isan imperative prerequisite of ensuring financial stability in the sector as the electric energyprices in the most of the surveyed countries feature high dynamics of growth.

Conclusively, a good water tariff regulation system must fit into the entire mechanism of thestate regulation and must comply with the following principles:

1. Decisions concerning the amount of tariffs for the regulated enterprises must bemade at the level of an authority consistent with the scope of the given company’s operation.National scale companies (electric power supply, gas supply, railway transportation, etc.)must be regulated at the national level. Municipal regulation must apply to municipal utilities’tariffs (provided that these utilities are set up by municipalities for addressing local priorities),as well as to tariffs for companies managing municipality-owned facilities (irrespective of theform of the managing company’s ownership).

2. Regulation must follow a “top-down” principle and following a schedule.Apparently, the municipality controlled tariffs to water utility services must depend on theamount of tariffs set at the national level. For example, in the case of Russia, the price set forgas established for RAO Gazprom at the federal level will affect the cost of electric andthermal power generated by branches of RAO “EES” whose regulation is performed at thelevel of the federation subjects. Tariffs for electric and thermal power, in turn, will directlyaffect actual costs of municipal housing utilities.

Since the final value of the tariff to utility services for the public depends on decisionsconcerning the tariffs value made at regional and national levels, it is necessary that thesedecisions precede the approval of municipal tariffs. Thus, the tariffs approval must be pursuedalong the top-down lines while the schedule of tariffs revision at both national and regionaland local levels appears to be indispensable. In addition to that, tariffs at all regulation levelsmust be approved for fixed periods of time which must be inter-linked with each other.

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3. The budget process at all tiers must be related to setting tariffs. The tariffs valueimpacts the value of reimbursement of differences in the tariffs from the budget, expendituresfor benefits financing, provision of housing subsidies to citizens, as well as amounts ofappropriations to budget-dependent organisations. It is known that non-payment by budget-dependent organisations of their utility bills is one of the prime reasons for accretion ofreceivables with housing and utility companies.

Fixing these principles at the national level is deemed to be imperative.

6. Tariff regulation policy

The discussion of tariff regulation in the water sector, as well as in other localmonopoly sectors including heat supply or household waste processing has convincinglyproved that these are important issues of the state policy which up till now have not earneddue attention in the new independent states.

The previous chapter defined the criteria which a good tariff regulation system must meet. Itshould however be noted that very different tariff regulation policies may live up to thesecriteria. This chapter will concentrate on a variety of key questions pertaining to differenttariff regulation policies.

6.1. What is an object of regulation?

This by far is not as an easy question is it may appear at first sight. On the one handwe have to determine the cost of water supply service to be charged to the end-user. For theNIS countries this predominantly implies residents of blocks of flats. We have agreed (andthis is a prevailing posture in all of our countries) that the water rate must cover all of theexpenses associated with its supply to the final consumer. This means that the cost of watermust not only take account for expenditures incurred by water sector companies in connectionof delivering water to our home faucets, but also the cost of maintaining the in-buildingnetworks, the cost of maintenance and depreciation of the metres (if available), cost of billingservicing, etc.

Cases have been reported when local authorities charge all of these functions to watersupplying enterprises calculating a single tariff with account for all potential expenditures.

Is it the right thing to do? Absolutely certainly no.

First and foremost – from the legal standpoint. While making organisational decisions specialattention should be attributed to ownership issues. It then becomes more than obvious thatwhile municipal water networks refer as a rule to municipal or state ownership, the in-building networks including all of their elements is a property of a shared ownershipbelonging to such buildings (condominium) owners. And in the majority of cases, cityauthorities are legally incompetent to make decisions in lieu of owners concerning how, bywho and at what expense this shared ownership property should be maintained. One canaccept a situation when private owners owning privatised flats are passive in managementmatters though it is absolutely inadmissible to make decisions instead of housing ownersassociations and housing co-operatives.

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Second of all, it is important to comprehend an economic distinction between these two typesof works. We have already established that a key reason why vodokanals’ operations areregulated is their natural monopoly position in the given services market. However,maintaining in-building networks, metres, billing refer to the sector of real competitiverelations and going for regulating them is a big mistake. For instance, one housing ownersassociation invited certain contractors while another one chose to have a higher degree ofservice and replaced the in-building networks, installed most advanced remote controlledmetres minimising nevertheless maintenance costs, the third association decided to do themaintenance itself. Prices are different everywhere. And everyone has a right to that. Whereasfor the majority of countries this situation is not typical it however reflects the logic behindthe housing fund privatisation pursued – with different degree of speed – in all countries.

Several important conclusions may be made from the above arguments.

1. Prices to water supply and sanitation services in general consist not only of thecost of works performed by the water utility providing the supply to and drainagefrom the boundaries of a building, but also of cost of works associated withmaintaining in-building networks, metres and so on.

2. Regulation should only apply to activities of natural monopolies – water supplycompanies. The cost of other works must be established based on competitiveprinciples by housing owners.

These conclusions are especially meaningful for determining a pattern of contractual relationsand financial flows in the sphere of supplying water to multi-flat blocks.

The direct payment by citizens for water services has become particularly widespread in theNIS countries. This however is meant to imply that there are contractual relations between acitizen and a water supplying enterprise which more often than not is not the case. In additionto that, it remains utterly unclear how the relations between a citizen and vodokanal will beshaped up in case of failure in networks operation for which neither party seems to beresponsible. It is worthwhile mentioning that the Russian law (the Civil Code of the RussianFederation) explicitly prohibits such agreements. The chapter titled “Resources Saving” underwhich water supply falls has it that agreements may be entered into exclusively conditional onthe availability of connection network. It is perfectly clear that an individual citizen has noconnection network to get connected to vodokanal’s networks. Such connection network isonly available with the whole block of flats. Therefore, an agreement with the vodokanal onwater supplies to each specific building must be concluded by an organisation representinginterests of all owners.

We believe that a structure whereby owners hire a professional organisation to manage thehousing fund and charge it with responsibility for guaranteeing an appropriate level of livingcomfort and quality of utility services is the right option. As part of its responsibilitiesperformance, such a company enters into a water supply and drainage agreement with avodokanal. In addition to that, it could enter into an agreement with this or that contractor totake care of in-building networks, metres and other types of works. This company wouldreceive citizens’ payments for water the bulk which would be expended for vodokanal’sservices compensation. A good proportion of this water bill however must go to cover the costof work contractors participating in the process of delivering the water to flats.

It should be particularly highlighted that such an approach – conditional on the rightmotivation to the managing housing organisation – may foster the reduction of water losses

15

inside the building, speediest establishment of water metres and incorporating them in thecommercial settlements system.

6.2. Metre-based inventory policy

The metre-based inventory, rational water use and payment for water according to thefactually consumed amount make up most important avenues of water sector reform.

Two different policies in the metre-based inventory sphere are distinguished:• Administrative policy whereby metres are installed in accordance with relevant

administrative authorities’ decisions;• Economic policy whereby metres are, in the final account, installed to save

financial resources.

Noteworthy, both of these approaches are being practised in the world /7/. Even moreso, thereare countries (Ireland, the UK, New Zealand) where the perception of metre-based inventoryis very moderate. Nevertheless, if it gets to private one-family houses, metering is virtuallycompulsory in all countries of the globe. A different picture is observed in multi-flat blocks.An array of approaches here is very diverse. Water in blocks of flats is metered in practicallyall European countries. In the majority of cases an owner, a superintendent or anotherauthorised person receives water bills based on the water metre reading. These costs – as wellas wastewater-related services – are paid by tenants based on certain criteria (e.g. according tosquare metres covered by the flat, number of permanently residing inhabitants, number ofwater consuming devices, etc.). The story is all different with equipping flats with watermetres. In Germany, for instance, special governmental programs to install flat-mountedmetres are approved. In other countries (Switzerland) water bills are distributed amongtenants of a multi-flat block which is made a responsibility of a landlord, and further steps areplanned.

Serious success in equipping dwellings with water metres has been achieved in Chile /8/.

Across the new independent states, one of the most impressive experiences has beenaccumulated in Moldova /9/. Metre-based inventory was being introduced against thebackground of a relatively high growth in the cost of water supply which stipulated speedyrecoupment of the installed metres. However, even in this situation the experience hasunveiled quite a few technical and organisational problems which being unresolved disablethe mass installation of metres.

In Russia, there are cities where practically the entire housing fund has been equipped withmetres though they are not being used for commercial settlements purposes. Administrativedecisions to install metres preceded the formation of whoever’s interest in their reading. InRussia’s housing sector the water cost is still so low that metres recoupment exceeds allreasonable limits. At the same time, cities exist where the metre-based inventory has provedits highest efficiency. With account for the existing practice, we believe that it is of particularimportance that metres should be installed not through administrative pressure but rather inpursuance of economic feasibility.

In Murmansk region (Russia’s extreme North) an extensive effort is being pursued to the endof putting in place a metre-based water consumption system operative both at the level ofblocks of flats and at the level of individual flats. The majority of buildings in Murmansk areequipped with metres and dynamics of metres installation is really impressive:

16

1998 – 909 ;1999 – 1378;2000 – 2246; 2001 – 6027.Obviously, this has to do with water pricing policy pursued in the region. It should beparticularly highlighted that metres ARE used for commercial inventory purposes.The analysis of the metres reading presented in Figures31, 2 offers predictable yet amazingresults .

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Fig. 2. Comparative average monthly water consumption according to individual metres by the district ofMurmansk over 9 months of 2001

3 Source of Information: Committee for Housing and Utility Services of Murmansk region administration.

17

While readings of metres installed at blocks of flats indicate water consumption nearing thenormative standard, (at the average in Murmansk it is 324 litres per capita in 24 hours over 9month of 2001 against the normative standard of 330 litres per capita in 24 hours), the in-flatmetres indicate 111 litres per capita in 24 hours.

This work, most definitely, deserves more attention and a more detailed analysis andfurthering.

Given this situation it is interesting to look into a question of who is there that should initiatethe metres installation procedure? Many of the NIS countries are trying to have vodokanalsassume this initiative. Let’s see whether these expectations have grounds. We are proceedingfrom an assumption that a metre will be installed by those who may benefit from it. Todayvodokanals distribute water (cold and hot in aggregate) according to consumption normswithin the range of 250 to 340 litres per one person in 24 hours. The practice suggests thatinstalling metres even in blocks of flats may lead to a certain consumption reduction, whilethe family-level inventory proves that real consumption may be below these norms by two oreven more times. This means that a broad-based introduction of metres may cut theconsumption amounts and – consequentially – water companies revenues. The situation is assimple as that – water utilities are not incentivised economically to have metres installed inthe houses. The priority of metre-based inventory of resources consumption appears to be apriority for consumers.

6.3. Tariff regulation and tariff plans

Before discussing tariff plans it is worthwhile to highlight one of the above arguments.

A priority for tariff regulation is identification and satisfaction of financial needs of aregulated company for its efficient performance, in this case – water supply and sewageservices. These financial needs are met through tariff plans approved in the regulationprocess. These plans may pursue several objectives at a time: social protection of individualcategories of citizens, water consumption reduction, companies’ operation stabilisation.

Four major types of tariff plans are distinguished:- a single-rate tariff;- a double-rate tariff formed on the basis of differentiating fixed and variable costs;- progressive block-based tariff whereunder subsequent water amounts are charged

at a higher rate than the preceding amounts;- regressive block-based tariff whereunder subsequent water amounts are charged at

a lower rate than the preceding amounts.

Combinations of these tariff plans offer a good variety of tariff policies options.

In new independent states this is an almost unexplored subject as a single-rate tariff is appliedacross the board in these countries. Due to metres installation however water supplyingcompanies are getting increasingly more persistent in demanding a double-rate tariffintroduction in order to stabilise their financial performance in case that their sales deviatesubstantially. The practice of applying double-rate tariffs is reported in several cities of Russiathough this effort is being also pursued in Ukraine and Moldova. At the same time, against the

18

background of absence of advanced metre-based inventory systems, the question of block-based tariffs is not topical at present.

Hence, an important objective of tariff regulation improvement, of the enhancement of themetre-based inventory efficacy is the introduction of double-rate tariffs providing for theseparate payment of fixed and variable costs in the process of water supply and drainage.Importantly enough, introducing double-rate tariffs even before mass campaigns over metresinstallation is a good idea.

7. Concession-based plans of sourcing investments

A fundamental assumption for creating concession mechanisms stems from thefollowing.

The state and local governments must perform certain public responsibilities (public orderprotection, public transportation, water supply, etc.) which it can do using its assets andresources, or by attracting private capital (in this case, a state may have no assets). Relayingpublic functions onto the private sector is referred to as concession.

When we talk about using state-owned (municipal) property for the public functionsperformance, a question of managing this property arises. The regulatory framework existingin most of the NIS governs in fact only one possible approach to managing state property – bytransferring it into the economic control of unitary enterprises. This technique features quite afew deficiencies, whereas the fact that it is essentially the only approach deprives an owner ofany flexibility in managing this property. This entails the necessity of legal coverage of abroad spectrum of agreements on managing state-owned (municipal) property.

It is possible that the state (municipality) has a responsibility of performing a certain type ofpublic functions though it lacks its own resources for it. In this case options could be eithercreating new state-owned (municipal) assets and decide on managing them, or to involveprivate sector with its own assets for the same purposes.

Thus, the following may be regarded a concession:1. Transfer of state-owned (municipal) assets management responsibilities to a respective

private entity for the purpose of public functions of the property owner. The managementmay (or may not) include concessionaire’s investment commitments, an amount of theconcessionaire’s powers in respect of executive decision making may vary, by the sametoken a degree of risk that a concessionaire may assume may vary too, etc.

2. A private company’s creation of new property and such property management by thiscompany for the purpose of the state (municipality’s) public responsibilities performance.This option implies that the created property may be transferred to the state (municipal)ownership either from the time of its creation or upon the expiration of the concessionagreement period, or the property will stay in ownership of a private company. In thelatter case it will be necessary to determine the procedure of further use of the createdassets for the purpose of performing the state’s (municipality’s) public functions.

The experience of both developed and developing countries indicates that mechanisms ofdelegating management of municipal engineering infrastructure is an effective mechanism ofraising the quality of utility services and attracting into the industry of extra-budgetaryinvestments. These mechanisms are implemented by concluding agreements or contracts onthe right to engage in different business activities through the transfer into operation and

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management by a domestic or foreign business (managing company) of municipalinfrastructure facilities. The activities relevant to managing municipal infrastructure may betied up to certain investment commitments assumed by a concessionaire.

Given a broad range of possible types of relations between local self-governments andmanaging companies (concessionaires), it is worthwhile to talk not about concessionagreements (this term presupposes an arrangement with a fairly broad range of powersgranted to the managing company for a relatively long period of time – up to 30 years) , butrather about concession-type agreements. What makes these two types of agreements differentis the transfer of municipal property management powers to a specialised managementcompany. Distinctions between concession-type agreements will root in the scope of authorityto manage the municipal property which a local self-government may delegate to a specialisedmanagement company. Likewise, periods for which agreements are entered into, degree ofresponsibility and risk assumed by the managing company may vary. Legal constructions ofsuch agreements will be different as well.

The international experience makes it possible to offer the following classification ofconcession-type agreements:• Agreement containing terms and conditions of works performance (services provision)using the municipality-owned facility;• Agreements containing terms and conditions of municipality-owned facilitymanagement;• Agreements containing terms and conditions of leasehold of a municipality-ownedfacility;• Agreements based on a “construction – operation – transfer” model;• Agreements based on a “construction – possession – operation – transfer” model;• Agreements on concession of facilities owned by municipality.

The scope of powers assigned to a managing company, amount of risk assumed by themanaging company, period of the agreements grow according to their ranking in the abovelist. Similarly, concessionaire’s obligations with respect to making investment inmunicipality-owned facilities grow.

The use of concession mechanisms makes it possible to encourage the promotion ofcompetition in the natural monopolies’ activities domain. International practice proves thatcompetition among managing companies (competition for the market) leads to the servicequality elevation, new resource-saving technologies, and helps address the problem ofsourcing private investment in the utility sector.

Of no less importance is the fact that entering into a concession-type agreement implies arefusal from a legal construction of the right to economic control which is incompatible withmarket relation practice. A transition to using by municipalities and by engineeringinfrastructure managing companies of legal constructions provided for by the effective lawsand taking account for market relations criteria will promote managing companies’ riskreduction and will elevate municipalities flexibility in relations with concessionaires.

In the city of Syzran (population – 230 thousand persons) in Samara region (Russia),municipal water supply and sanitation have been transferred into the concession-basedmanagement by a private organisation founded by interested industrial companies of the city.An agreement is entered into between the administration and the private company providingfor the municipal property transfer into trusteeship.

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The challenge with attracting private business to managing the municipal vodokanalwas to attract, through a concession-type agreement, additional private investments intowater infrastructure development with the subsequent repayment of the sourced capitalthrough raising efficiency of the company’s operation and a balanced tariff policy.

The project implementation unveiled its strengths and weaknesses.A system of relations between the company and local authorities has been improved

and is now based on contractual terms. Real additional amounts of investment were sourced.A whole series of organisational and legal problems became apparent at the same

time.No mutual obligations in regard of the tariff policy had been formed in advance which

led to conflict situations. Furthermore, as long as it is not a municipal company but a privateentity that is managing the municipal infrastructure facilities, the responsibility for itsregulation is, under the Russian law, assigned from local governments to regional authoritieswhich largely complicates an agreement between the infrastructure owner and theorganisation concerning a concerted tariff policy.

This experience has revealed quite a few problems which must be addressed at thenational legislature level.

The Table presents different options for concession-type agreements used in theinternational practice.

Agreement typeOwnership

to assetsResponsibility formanagement and

operation

Capitalinvestments Commercial risk

Period ofeffect,years

Service contract State(municipality)

State and private State(municipality)

State (municipality) 1-2

Managementagreement

State(municipality)

Private State(municipality)

State (municipality) 3-5

Leasehold State(municipality)

Private State(municipality)

Shared between the stateand private sector

8-15

“Construction –management –control”

Private Private Private Private 20-30

Concession State(municipality)

Private Private Private 25-30

Apparently, the use of concession mechanisms for managing municipal infrastructure objectsand attraction of investments into them requires relevant legal formalisation. According to ourinformation, the work towards drafting a framework law On Concession Agreements withRussian and Foreign Investors is currently underway. This piece of legislation will definemain requirements to concession agreements irrespective of the sphere of their performance.

Municipal housing and utility sector is unique in many respects and it is therefore expectedthat the passage of this law will be followed by a submission to Russia’s LegislativeAssembly of a draft law talking about specifics of entering into concession agreements andtheir performance in the given sector. The text of this draft law has already been developed.

8. Choice of measures of state support to attracting investments in water supply sector

Attracting investments through entering into a concession type agreement containinginvestment terms and conditions is not the only way of funding the housing and utilitycomplex. One must take due account for possibilities of attracting borrowed capital for thesepurposes while retaining the existing legal and organisational forms of housing and utilitycompanies incorporation and the housing and utility sector (HUS) administration system.

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Furthermore, even in the case of involving private managers in controlling the housing andutility sector entities, topicality of sourcing borrowed capital will stay.

Nevertheless, the attempts to source private borrowings are hindered by a whole series ofunresolved problems and finding a solution to the situation requires a good deal of statesupport measures.

The development of measures of state support to attracting investments aimed at HUSupgrade must take into account the current financial standing of the companies in the sector.The majority of housing and utility companies including vodokanals meet the bankruptcycriteria. Clearly, expecting investments without the industry’s financial rehabilitation makesno sense.

HUS companies’ arrears were stockpiling in 10 years, since market reforms inception. Maincauses of these arrears included political decisions to the effect of restraining tariffs tohousing and utility services, as well as budgets’ failure to meet their obligations with respectto funding HUS companies. In fact, the receivables of HUS companies and their fixed assets’wear and tear are the price the industry paid for the decisions authorities at all levels hadmade. This is precisely why the problem of financial rehabilitation if HUS companies is apolitical matter.

Given an immense mass of HUS companies’ debt, regional and local administrations may beunable to address this problem on their own. In addition to that, the HUS companies’ debtsrestructuring may breed conspicuous macroeconomic effects that are impossible to takeaccount for at the municipal or regional levels. Developing a procedure for housing and utilitycompanies’ debts restructuring and elimination at the state level appears therefore to be animperative.

Measures towards housing and utility companies financial rehabilitation are an indispensableyet not sufficient precondition for ensuring the inflow of investments into the industry. Thesemeasures must be followed by others which may be divided into two categories:• Measures aimed at encouraging private investments inflow into the sector (withborrowings being a key tool for sourcing private investments);• Measures towards providing ad hoc financial assistance (targeted budget funding fromthe municipal and/or regional budgets) to the HUS modernisation projects that may not beimplemented solely at the expense of private investments being however of special socialmeaning.

It appears that the provision of non-repayable capital for utility infrastructure upgrade projectsimplementation will be unable to address all of the sector’s problems. That is why mainemphasis in the effort of the development of state support measures must be made on puttingin place a set of market-oriented mechanisms of investment projects financing in the watersector. AS a matter of fact, a real challenge is to create a crediting products market meetingthe needs of initiators of engineering systems retrofitting investment projects. This marketformation must be accompanied by the formation of demand for crediting products, i.e. theoffers of developed municipal projects in the water supply sector.

At present, the crediting of water supply modernisation projects is hampered by a series offactors including:

• The short-term resource base of NIS banks prevents them from issuing long-term loans required for the utility infrastructure modernisation projects;

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• No risk assessment methodology associated with the funding andimplementation of these projects has been developed. This results in banks’ inabilityto adequately appraise the magnitude of investment risks and, consequently, choose torefrain from financing such projects;• In most cases, projects initiators are unable to provide traditional securitiesrequired by banks;• Water supply systems modernisation projects may stay unrepayable if thesolvency of consumers of services provided by the project initiators4 does not make itpossible to increase tariffs to the necessary amount.

These problems must be approached in a package manner. In this regard, a key message in thedevelopment of measures of the state support to modernisation projects investment is that thisactivity must be excluded from the budget process context. This dictates the necessity ofputting in place a specialised entity (guarantee fund) able to perform one or more of the belowfunctions:

• To assume a share of risks associated with environmental projects financing;• Promote the solution of a problem of short-term resource base of Russia’s

commercial banks by refinancing long-term loans and provision of credits.

In addition to the above functions, a GF may take up a responsibility of developing andimplanting into the lending practice of crediting products standards and crediting procedures,methodology of projects and initiators assessment which will foster the minimisation of risksrelated to such projects capitalisation; a responsibility of developing special schemes ofsecuritising the loans issued to utility companies (offering as a collateral of householdspayments as the most liquid asset of HUS companies).

A successful experience of such funds operation has been recorded in CEE, in particular, inthe Czech Republic.

Seeking to activate the market of investment in the utility sector of the Czech Republic, aMunicipal Infrastructure Finance Company (MUFIS) was founded. MUFIS is a specialisedfinancial intermediary borrowing financial resources and offering lending to commercialbanks which, in turn, provide credits to municipalities for the infrastructure projectsfinancing. MUFIS’ role was launch the process of commercial banks’ crediting tomunicipalities and the Company did an excellent job in fulfilling this objective.

A similar approach to providing state support to sourcing investments in the utilityinfrastructure is expected to be implemented in Russia. /10/

9. Conclusions

Tariff regulation issues receive regrettably insufficient attention in new independentstates. Implementation of the following principles must become a key criterion of theeffective tariff regulation:

• Tariffs must ensure companies’ revenues sufficient for the maintenance anddevelopment of the engineering infrastructure.• Tariffs must ensure accessibility of the said services for all consumers.• Tariff regulation must provide an economic incentive for companies to raise theefficiency, cut losses and non-production costs.

4 It is understood that infrastructure modernisation projects are initiated by municipal water supply and sanitationutilities, heat supply and household wastes removal and disposal companies.

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In addition to that, an effective tariff regulation procedure must make possible the attainmentof the following objectives:

1. The tariffs setting must be preceded by the formulation of objectives of operation ofmunicipal utilities or other companies managing water supply and sewage facilities.

2. Objectives must be formulated in the form of production and investment programsdesigned for the implementation over a certain period of time (regulation period).

3. Throughout the regulation period, tariffs must stay unchanged in real terms whichimplies their periodical indexation following a single pre-established rule and/or a listof causes for their revision prior to the regulation period expiration.

4. Tariffs as set for the regulated company must be able to help it generate the amount offinancial resources necessary to safeguard the implementation of the approvedproduction and investment programs.

5. Tariffs approval procedures must provide for a possibility to achieve a balance ofinterests of all interested parties (municipality, public, regulated company). One of thekey prerequisites of it is the transparency in the authorities activity in setting tariffs.

6. A regulating authority must possess an ability to monitor the progress of fulfilment bythe regulated company of the objectives assigned to it (availability of regulatedcompanies performance monitoring system).

Addressing these tasks must rely on responsible legal and regulatory decisions made at thenational level.

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Bibliography

1. Problems of Tariff Regulation of Water Supply and Sanitation Companies in NewIndependent States. S. Sivayev.First Seminar of Experts: Tariff Reform in Municipal Water Supply System, Paris,February 2002.

2. Methodology of calculation and application of tariffs to water supply and sanitationservices. Resolution of the National Agency for Energy Sector Regulation #28 of 7December 2000, Republic of Moldova.

3. Regulation On Pricing for Centralised Water Supply and Sanitation Services. Approved inAugust 2001 by the State Committee for Construction, Architecture and Housing Policyof Ukraine.

4. Methodological recommendations concerning financial substantiation of prices to waterand waste drainage as approved by the Decree of Gosstroy of Russia on 28 December2000, #302.

5. Regulatory Schemes for Water Provision in Theory and Practice, Carlos A. Chavez,Second Meeting of Tariff Reform in Urban Water Sector Reform, Moscow, June, 2002.

6. Role of Ofwat in Consumer Protection. Public Involvement in Water Related DecisionMaking in the UK, Michail Saundlers, EAP Task Force, Kiev, Ukraine, September, 2001.

7. Prices to water services for population of OECD member-states, OECD, Report of theTask Force On Integration of Environmental and Nature Conservation Policies, 1999.

8. Water Metres Use in Chile: The Success Story, Carlos Chavez, First Seminar of Experts:Tariff Reform in Municipal Water Supply System, Paris, February 2002.

9. Metre-based Inventory as a Tariff Policy Instrument. Moldovan Experience. S. Drozdov,First Seminar of Experts: Tariff Reform in Municipal Water Supply System, Paris,February 2002.

10. Subprogram of reformation and modernisation of the Russian Federation’s Housing andUtility Complex of the “Housing” Federal Program as approved by the Resolution of theGovernment of the Russian Federation on 17 November 2001.