manual for performance-based contracting by water utility companies in brazil

7/28/2019 Manual for Performance-Based Contracting by Water Utility Companies in Brazil

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Manual for Performance-BasedContracting by Water Utility

Companies in Brazil

IFC Advisory Services in Latin America and the Caribbean

IN PARTNERSHIP WITH:Government of Spain through the Fondo Espaol para Latinoamerica y el Caribe


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Manual for Performance-Based Contracting by Water Utility Companies

Manual forPerformance-BasedContracting by

Water UtilityCompanies in Brazi

Prepared by GO Associadosfor International Finance Corporation

June 2013

This manual was prepared for International Finance Corporation (IFC, World Bank Group) by GO Associados.

The content of this manual, including the images, is copyrighted.

Neither this report, not any component part, may be reproduced, copied, or distributed in any form without reference to the Manua

for Performance-Based Contracting by Water Utility Companies in Brazil. It may not be sold, re-sold, leased, or distributed by any

means on a commercial basis without the prior approval of IFC or the World Bank Group.

The findings, interpretations, and conclusions expressed in this manual are entirely those of the authors and the project team and

should not be attributed in any manner to the World Bank or IFC, to its affiliate organizations, or to members of its Board of Execut

Directors or the countries they represent. The material in this manual is owned by the World Bank Group and IFC. Dissemination of

manual is encouraged and the World Bank Group and IFC will normally grant permission promptly. This manual was issued in Englis

and in Portuguese. Questions regarding this manual, including permissions to reproduce any part, or information on ordering

additional copies, should be directed to the addresses below:

International Finance Corporation

IFC Advisory Services in Mexico

Montes Urales 715, Piso 5.

Lomas de Chapultepec, C.P. 11000

Mexico, D.F. Mexico

Phone: +52 (55) 3098-0130

E-mail: [email protected]

International Finance Corporation

IFC Advisory Services

Sustainable Business Advisory

2121 Pennsylvania Avenue, NW

Washington, D.C. 20433 USA

Phone: +1 (202) 458-2584

www.ifc.org


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AcknowledgmentsMany institutions and proessionals made signicant contributions to this manual, which was discussed in several sessions o theGroup or Savings in Water Utilities, Energy & Environmental Solutions rom the Getulio Vargas Foundation. We thank the hundreds

o experts who took part in those discussions. Additionally, some people contributed with comments, case studies, and more relevant

and timely approaches. We would especially like to mention: Marcos Abicalil, Julian Thornton, Carlos Rosito, Eduardo Moreno, CarlosHackerott, lvaro Costa, Carlos Berenhauser, Dante Pauli, Eduardo Duarte, Luiz Moura, Milene Aguiar, and Roberval Tavares.

Lastly, it would not have been possible to drat this manual without the valuable support o several qualied proessionals and experts

rom the IFC: Elizabeth Burden, Jeremy Levin, Rogrio Pilotto, Patrick Mullen, Luiz T. A. Maurer, Luis A. Salomon, Marco Giussani,

and Miguel Nieto.


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Acknowledgments

Abbreviations and Acronyms

1. Introduction

2. Brie Description o the Water Losses and Energy Eciency o Brazilian Water Utility

Companies

3. Advantages o Perormance Contracts or Water Utility Operators

3.1 Review o International Literature

3.1.1 Literature related to reduction o water losses

3.1.2 Literature related to energy eciency

3.2 Why Hold Perormance Contracts in Brazil?

3.2.1 Financing capacity

3.2.2 Technical knowledge to structure programs

3.2.3 Reduced transaction costs3.2.4 Increasing positive incentives or private contractors

4. Technical Aspects: Dening the Scope o the Intervention and the Baseline

4.1 Obtaining Data or the Baseline

4.2 Establishing the Intervention Area

4.3 What Data Should be Collected to Design the Project and Establish a Perormance Contract?

4.4 What Criteria Are Used to Dene the Baseline?

4.4.1 Factors that may impact the baselines accuracy

4.4.2 Alternatives to dening the baseline

4.5 Minimum Scope

5. Economic Aspects: Parameters or an Economic-Financial Feasibility Study

5.1 Review o Financial Concepts

5.1.1 Discounted cash fow model

5.1.2 Net present value

5.1.3 Internal rate o return

5.1.4 Payback term

5.1.5 Comparison among the three nancial indicators

5.2 Cash Flow Assessment Applied to Perormance Contracts

5.2.1 Costs and benets involved in water loss reduction and energy eciency

enhancement contracts

5.2.2 Example o a perormance contract or energy eciency enhancements

5.2.3 Example o a perormance contract or water loss reduction

5.2.4 Case study: SABESPs perormance contract to reduce real water losses in the Vila

do Encontro Sector Municipality o So Paulo

5.3 Perormance Contracts Versus Traditional Contracts

5.4 Economic-Financial Aspects o Setting Up Perormance Contracts

Contents2

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6. Legal Aspects: Contracts Within the Law or Tenders

6.1 Legal Framework or Perormance Contracts

6.2 Tenders and Judgment Criteria

6.2.1 Tender modality

6.2.2 Judgment criteria

6.2.3 Criteria to judge a proposal: a case study o Vila Cacilda, SABESP, Sao Bernardo

do Campo Sao Paulo State

6.3 Main Clauses and Conditions Relating to Perormance Contracts Within the Framework

o Law 8.666/93

6.3.1 Basic project

6.3.2 Term

6.3.3 Compensation

6.4 Public-Public Partnerships

6.4.1 History o the CASAL-SABESP project

6.4.2 Institutional modeling

6.4.3 Contract

6.5 Warranty Structures7. Conclusions

7.1 Reasons to Adopt Perormance Contracts

7.2 Technical Aspects

7.3 Economic Aspects

7.4 Legal Aspects

Reerences

List o Boxes

Box 2.1: Key Concepts and Discussion Points or Chapter 2


Box 4.1: Water Isolation




List o Figures

Figure 2.1: Water losses in Brazil, 2000-2009 (losses over billing, %)

Figure 2.2: Losses over billing o Brazils state-owned water utility companies (%)Figure 2.3: Losses over billing o Brazils municipal water utility companies (%)

Figure 2.4: kWh/m o water produced by Brazils state-owned water utility companies

Figure 2.5: kWh/m o water produced by Brazils municipal water utility companies

Figure 3.1: Water loss scenario among water utility operators

Figure 3.2: Guaranteed savings model

Figure 3.3: Shared savings model

Figure 3.4: Vicious cycle in the management o water utility companies

Figure 4.1: Isolation caused by a railroad

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Figure 5.1: Synergies between water loss reduction and energy eciency enhancement

Figure 5.2: Example o perormance contract or energy eciency enhancements

Figure 5.3: Cash fow o the projects costs, years 1-5

Figure 5.4: Implementation o DMCs and VRPs Vila do Encontro

Figure 5.5: Leaks repair SABESP Vila do Encontro

Figure 5.6: Results o the SABESP perormance contract Vila do Encontro

Figure 6.1: Possible structure o an escrow account

List o Tables

Table 2.1: Estimated gains associated with three water loss reduction scenarios

Table 2.2: Estimated gains associated with three energy eciency enhancement scenarios

Table 3.1: Distribution o real and apparent water losses as water fows through system

Table 3.2: Comparison between guaranteed savings and shared savings models

Table 5.1: Comparison o rules or decision making on investments

Table 5.2: Lie cycle o assets in water loss reduction projects

Table 5.3: Benets o loss reduction

Table 5.4: Gains o the water utility company and the ESCO in dierent energysaving scenarios

Table 5.5: Economic-nancial indicators or the water utility operator implementing

the project on its own

Table 5.6: Economic-nancial indicators or the private partner under

a perormance contract

Table 5.7: Summary o economic indicators achieved under a perormance contract

Table 5.8: Stages o the SABESP perormance contract Vila do Encontro

Table 5.9: Features o traditional contracts versus perormance contracts

Table 6.1: Technical proposal scores used in Vila Cacilda project

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Abbreviations and AcronymsADA - guas do Amazonas S.A.

AG - guas Guariroba S/A

AGESPISA - guas e Esgotos do Piau S/A

AI - guas do Imperador S/A

CAEMA - Companhia de guas e Esgotos do Maranho

CAER - Companhia de guas e Esgotos de Roraima

CAERD - Companhia de guas e Esgotos de Rondnia

CAERN - Companhia de guas e Esgotos do Rio Grande do Norte

CAESA - Companhia de gua e Esgoto do Amap

CAESB - Companhia de Saneamento Ambiental do Distrito Federal

CAGECE - Companhia de gua e Esgoto do Cear

CAGEPA - Companhia de guas e Esgotos da ParabaCAJ - Companhia guas de Joinville

CAN - guas de Niteri S/A

CAP - guas do Paraba S/A

CASAL - Companhia de Saneamento de Alagoas

CASAN - Companhia Catarinense de guas e Saneamento

CEDAE - Companhia Estadual de guas e Esgotos

CESAMA - Companhia de Saneamento Municipal

CESAN - Companhia Esprito-Santense de Saneamento

COMPESA - Companhia Pernambucana de Saneamento

COPASA - Companhia de Saneamento de Minas Gerais

CORSAN - Companhia Rio-Grandense de Saneamento

COSAMA Companhia de Saneamento do Amazonas

COSANPA - Companhia de Saneamento do Par

CVU Compensation Value Unit

DAE - Departamento de gua e Esgoto

DAEJUNDIAI - DAE S/A gua e Esgoto

DAERP - Departamento de gua e Esgotos de Ribeiro PretoDEAS - Departamento Estadual de gua e Saneamento

DESO - Companhia de Saneamento de Sergipe

DMAE-MG - Departamento Municipal de gua e Esgotos de Uberlndia

DMAE-RS - Departamento Municipal de gua e Esgoto de Porto Alegre

ECOSAMA - Empresa Concessionria de Saneamento de Mau

EEP Energy Eciency Program

EMBASA - Empresa Baiana de guas e Saneamento


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1. Introduction

The objective o this manual is to oer a practical and useul tool or both public and private managers o water utility and sanitationcompanies (hereinater called water utility companies) to develop contracts to reduce both apparent and physical water losses, with the ul-

timate aim o increased energy eciency in the water sector. Notwithstanding the technical rigor, the text is simple and the main points aregeared mainly to managers. Technical language and legal and economic jargon were deliberately avoided; specic points and technicalities

can be ound in the sources listed in the reerences section. It is important to highlight that this manual is applicable outside o Brazil. It

is hoped that this work will become a useul tool or managers in other countries, especially in developing ones.

The current situation regarding water loss and energy eciency or Brazils water utility sector is quite problematic. The average water loss

in water utility companies in Brazil is approximately 40 percent (including both physical and apparent losses), and in some companies,

losses exceed 60 percent1. Expenditures on electricity represent the main cost o water utility companies ater expenditures on labor. As

such, water utility companies can do a great deal to enhance their energy eciency.

The high level o water losses reduces companies revenues, and consequently, their ability to obtain nancing and invest in improvements.

Additional damages are generated to the environment when water utility companies are orced to seek out new springs or water sourcesto compensate.

The International Finance Corporation (IFC) is supporting the promotion o a perormance-based contract with the intention o helping

water utility companies improve their operational eciency levels, and consequently, the quality o the public services rendered.

The manual has seven sections. Section 2 oers a brie description o the current situation regarding Brazils water utility companies water

losses and energy use. Section 3 explains why it is advantageous to use perormance contracts as a means to reduce water losses and to

oster energy eciency in water utility companies. Section 4 demonstrates how to conduct a technical evaluation o the water losses and

use o energy by water utility operators.

Section 5 prescribes how to carry out an economic-nancial easibility study, enabling water utility operators to veriy i the benets oundertaking a water loss reduction program justiy the costs. Section 6 oers details on the legal aspects o a perormance contract. Finally,

Section 7 presents a brie summary and some conclusions.

1 According to Gomes (2009), it is not economically easible to invest in the urther reduction o losses when they reach 10 percent (the ideal level). Nevertheless, it should be noted that states such as Caliornia, some Nordiccities, and Singapore have losses as low as 2-6 percent.


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2. Brie Description o the Water Lossesand Energy Eciency o Brazilian WaterUtility CompaniesWater losses are quite steep in Brazil and have maintained levels close to 40 percent over the last ten years (Figure 2.1). The level o losses

dropped rom 39 percent in 2000 to 37 percent in 2009, a marginal reduction. It should be noted that a large number o water utility

companies do not measure their water losses in a consistent manner, so the gure should be interpreted with caution. Although there has

been a slight downward trend in the last ew years, these losses continue to be excessively high. More ecient production and distribution

would clearly help to reduce water losses in Brazil.

Compared to various developed countries, the room or improvement in Brazils water utilization is even more noteworthy. According to

Gomes (2009), cities in Germany and Japan have water losses o 11 percent, while Australias loss is about 16 percent. The expectation is

that Brazil will be able to reduce its losses and, at the very least, achieve the lower levels associated with developed countries.

Water loss and energy eciency indicators or water utility companies in Brazil show that there is still a great degree o ineciency in the

production o water and the use o energy. Figure 2.2 and Figure 2.3 demonstrate the levels o losses over billing or the 52 largest Bra-

zilian water utility companies in terms o the population serviced, using SNIS data rom 2009. Figure 2.2 shows the losses over billing o

a variety o state-owned2 water utility companies in Brazil. COSAMA (State o Amazonas) and SANEPAR (State o Paran) are the least

and the most ecient state-owned companies in terms o water losses in Brazil, with 80.7 percent and 21.2 percent o losses over billing,

respectively. The average loss o all state-owned companies is 43.7 percent.

2 In the group o state-owned companies, there is one private company called Saneatins (Iguau Falls in Brazil).

39.2

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

40.6 40.6 39.4 40.439.0

39.839.1

37.4 37.1

Figure 2.1: Water losses in Brazil, 2000-2009 (losses over billing, %)

90

80

70

60

50

40

30

SANEPAR

SANEATINS

CAGECE

CASAN

CAESB

CORSAN

CESAN

SABESP

COPASA

EMBASA

SANESUL

SANEAGO

CAGEPA

MDIA

COSANPA

DESO

CEDAE

AGESPISA

CAERN

CAERN

CASAL

COMPESA

DEAS

CAERD

CAEMA

CAESA

COSAMA

21,2

43,7

80,7

20

10

0

Figure 2.2: Losses over billing of Brazils state-owned water utility companies (%)

Source: SNIS 2009

Source: SNIS 2009


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Figure 2.3 shows comparable data or Brazils municipal3 water utility companies. O these, SAERB (Rio Branco) and SANASA (Campi-

nas) are the least and most ecient in terms o losses over billing, with losses o 76.5 percent and 18.0 percent, respectively. The average

loss or Brazilian municipal utilities is 39 percent.

Figure 2.4 and Figure 2.5 show the energy eciency o the same state-owned and municipal water utility companies. The indicator shown

is the kWh/m o water produced, or the amount o energy that a specic company uses to produce one cubic meter o water.

3 Autarchies and private companies are included in the group o municipal companies.

90

80

70

60

50

40

30

SANASA

CESAMA

SEMASA

DMAE-MG

CAN

DAEJUNDIAI

CAP

AI

SEMAE

DMAE-RS

AG

DAE

MDIA

SAMA

SAAE-SORO

SEMAE-PIRA

SAAEB

CAJ

SANECAP

SANED

DAERP

SAAE-GUARU

SAMAE

SEMAE-MOJI

ADA

SAERB

18.0

39.0

76.5

20

10

0

Figure 2.3: Losses over billing of Brazils municipal water utility companies (%)

COSAMA

CAER

CAERD

DEAS

CEDAE

CAGECE

CAERN

CESAN

CAEMA

AGESPISA

SANEATINS

CASAN

SABESP

SANESUL

MDIA

SANEAGO

SANEPAR

COMPESA

COPASA

CAGEPA

CAESB

EMBASA

COSANPA

CASAL

DESO

0.39

0.71

1.28

0

0.2

0.4

0.6

0.8

1

1.2

1.4

Figure 2.4: kWh/m of water produced by Brazils state-owned water utility companies

Source: SNIS 2009

Source: SNIS 2009


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Among the state-owned companies, the average energy expenditure to produce a cubic meter o water is 0.71 kWh. DESO (State o

Sergipe) and COSAMA (State o Amazonas) are the least and most ecient companies, using 1.28 kWh and 0.39 kWh, respectively, to

produce one cubic meter o water.

Among municipal companies, the average energy used to produce one cubic meter o water is 0.83 kWh. SAAE-GUARU (Guarulhos)and SAERB (Rio Branco) are the least and most ecient companies, using 2.74 kWh and 0.31 kWh, respectively, to produce one cubic

meter o water.

It is important to highlight that energy eciency is highly dependent on the topographic conditions o the site on which the water dis-

tribution installation o the operator is located; thereore, the comparison among water utility companies is subject to some distortion.

Because o this, to evaluate the energy eciency o a specic water utility company, a comparison o its perormance over the years should

be carried out, rather than comparing the companys perormance to that o other water utility companies.

Demand or water loss reduction and energy eciency enhancement servicesI Brazil were to undertake a nationwide eort to reduce water losses and enhance energy eciency or water utility companies, signicant

gains could be realized. The ollowing subsection describes the estimated potential gains due to water loss reduction and energy eciency

enhancements under three scenarios, assuming a time horizon to 2025.

The benets generated by a reduction in water losses in Brazil are estimated or a period o 17 years (2009 up to 2025) (Table 2.1). The

base scenario considers a 38 percent decrease in water losses, rom 37.4 percent to 23.2 percent. The optimistic and conservative scenarios

consider decreases o 50 percent and 25 percent, respectively.

Table 2.1: Estimated gains associated with three water loss reduction scenarios

Source: SNIS 2009 and Rosito 2012. Prepared by GO Associados.

Losses in 2009 Losses in 2025 Reduction (%)Potential Gains

(Billion R$)

Scenario 1 Optimistic 37.4% 18.7% 50% 37.27

Scenario 2 Base 37.4% 23.2% 38% 29.93

Scenario 3 Conservative 37.4% 27.9% 25% 20.91

SAERB

SAAE-SORO A

I

SAAEB

DMAE-MG

CAP

SANECAP

DMAE-RS

SANEP

SANASA

CAJ

CESAMA

ADA

SEMAE-MOJI

DAEJUNDIAI

SAMAE

MDIA

SEMAE-PIRA

DAE

SEMAE

AG

DAERP

SEMASA

SAAE-GUARU

0.31

0.83

2.74

0

0.50

1.00

1.50

2.00

2.50

3.00

Figure 2.5: kWh/m of water produced by Brazils municipal water utility companies

Source: SNIS 2009


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Under the base scenario, the gross potential gains are estimated to be R$29.93 billion. I it is assumed that 50 percent4 o that total is

reinvested in water loss reduction programs, the net estimated gains or a 38 percent decrease in water loss in Brazil are R$14.97 billion

over 17 years, or an average o R$880 million per year. This represents approximately 12 percent o the investment in Brazils water and

sewage system in 2011 (R$7 billion).

A similar exercise was carried out or energy eciency enhancements, again with an assumed horizon o 17 years (2009-2025) and three

alternative scenarios (Table 2.2). The base scenario considers a program that would achieve a 20 percent decrease in energy expenditures.

The optimistic and conservative scenarios consider decreases o 25 percent and 15 percent, respectively.

Under the base scenario, the gross potential gains are estimated to be R$4.90 billion. It is assumed that 30 percent o this total will be

reinvested to implement urther energy eciency programs. The net estimated gain or a 20 percent decrease in the energy expenditures

o Brazils water utility companies would then be R$3.43 billion over 17 years.

There is thereore a promising path to be tread by Brazilian water utility companies that take actions to increase their operational eciency.

The ollowing sections suggest practical ways to undertake this successully.

4 This percentage is based on the water loss reduction program o SABESP.

Box 2.1: Key Concepts and Discussion Points or Chapter 2Key concepts:

Water losses

Water losses over billing

Energy efciency

Savings obtained from the reduction of water losses and energy efciency enhancements

Points or discussion:

1. Can water losses in Brazil be deemed high? How is Brazil positioned in terms o water losses compared to moredeveloped countries such as Japan?

2. What are the potential savings associated with water loss reduction projects in Brazil?

3. What are the potential savings associated with energy eciency enhancement projects in Brazilian water utility companies?

Table 2.2: Estimated gains associated with three energy efciency enhancement scenarios

Source: SNIS 2009 and Rosito 2012. Prepared by GO Associados.

Expenditures in2009

(Billion R$)

Expenditures in2025

(Billion R$)Reduction (%)

Potential Gains(Billion R$)

Scenario 1 Optimistic 2.20 1.65 25% 6.25

Scenario 2 Base 2.20 1.76 20% 4.90

Scenario 3 Conservative 2.20 1.87 15% 3.67


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3. Advantages o Perormance Contractsor Water Utility Operators

3.1 Review o International Literature3.1.1 Literature related to reduction o water losses

The objective o this section is to provide theoretical and empirical reerences that will orm the basis o the selection o perormancecontracts by both public and private water utility company managers. Perormance contracts are established as a useul tool to manage

programs associated with water loss reduction and energy eciency enhancement. Section 3.1 presents a brie review o the international

literature on experiences with water loss reduction and energy eciency enhancement, presenting some models o perormance contracts

used in other countries. Section 3.2 provides some inormation on the basic eatures o traditional contracts versus perormance contracts.

Section 3.3 oers reasons why Brazilian water utility companies might want to develop perormance contracts to implement water loss

reduction and energy eciency enhancement programs.

One o the main challenges o water utility companies in developing countries is reducing water losses. The initial volume o water made

available in the distribution system by water utility operators is mostly wasted during the distribution process (called physical or real water

loss). Oten, even when water reaches nal consumers, water utility companies do not or cannot accurately bill consumers or the actual

water consumed. This is called commercial or apparent water loss, which can be due to technical measurement problems or to raud by

consumers (Kingdom, Liemberger and Marin 2006).

In the international literature, losses in revenues (or billing) due to either physical or apparent water losses are called non-revenue water

or non-invoiced water. Table 3.1 shows the various paths through which water can go as soon as it enters the system.

Table 3.1: Distribution of real and apparent water losses as water ows through system

Source: Public Private Infrastructure Advisory Facility (free translation).

Water enteringthe system (includes

imported water)

Authorizedconsumption

Authorized andbilled volume

Invoicedwater

Measured invoiced volume (includes exported water)

Unmeasured invoiced consumption (estimated)

Non-billed authorized consumption Non-billed measured consumption (uses per se, water tank trucks, etc.)

Non-measured non-billed consumption (reghting, slums, etc.)

Non-authorized use (fraud and registry failures)

Measurement errors (macro- and micro-measurement)

Real losses in raw water piping and in treatment (whenever applicable)

Leaks in pipelines and/or distribution networks

Leaks and spillovers in pipeline reservoirs and/or distribution

Leaks in branch lines (upstream from the point of measurement)

Non-billedauthorized

consumption

Non-invoicedwater or

Non-RevenueWater (NRW)

Apparent losses

Real losses

Water losses


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The World Banks database on International Benchmarking Network or Water and Sanitation Utilities(IBNET) estimated the perormance

o water utility operators globally. O the operators studied by IBNET, the average water loss was estimated to be 35 percent. As large

developing countries were not included in the IBNET study, and as the statistics o such countries are generally not reliable, 5 it is likely

that water losses in developing countries are closer to 40-50 percent.

It is not expected that all physical and commercial water losses will be eliminated, as this is neither economically nor nancially easible.

Nonetheless, due to the signicant water losses in developing countries, it is reasonable to expect that water losses in these countries could

be reduced by hal. Water loss reduction programs should always consider the tradeos between the value generated by the water volume

saved (the water not lost) and the value o the investment needed to achieve the loss reduction, not only in inrastructure but also in the

variable costs o commercial management and operations. At a certain point, when water losses are extremely low, the cost o additional

loss reduction becomes ever higher, while the savings generated through investments become progressively lower.6

Traditional approaches to reducing the physical loss o water in developing countries typically consist o awarding technical assistance

contracts and outsourcing various parts o the water loss reduction project. Such approaches are presented in more detail below.

Technical assistance contracts are used to hire specialized private consulting companies that develop strategic projects geared to reducing

water losses. These consulting companies merely structure a project that is carried out with the water utility companys budget earmarked

or this purpose, and work with the pre-existing personnel already hired by the water utility company.

This approach has some drawbacks. The main one is due to the act that the compensation o the consulting company is xed and not tied

to the success o the water loss reduction program. Additionally, many water utility companies lack the technical knowledge to implement

the water loss reduction programs designed, thus reducing the useulness o the contracted technical assistance.

The literature also points to water utility companies lack o budgetary fexibility to cover large costs associated with water loss reduction

programs. This is crucial, given the need to accurately estimate the cost o all actions required to identiy a specic problem and nance

the actions to achieve loss reduction.

Outsourcing some o the services in water loss reduction projects is appropriate or some eld activities, such as detecting leaks in the water

distribution system, changing water meters, updating registries o end consumers, and identiying raud. Outsourcing presents some ad-

vantages compared to technical assistance contracts, such as lower costs or rendering the service through a tender process, greater fexibility

or work at night, and greater fexibility in capturing additional resources.

5 The percentage o water losses among utility operators in developing countries cannot be estimated in a reliable ashion. Many operators do not have inormation systems and adequate control to iner this data, and even ithey are able to measure the percentage o water loss, they decide not to disseminate the gure because it is very high. Companies that do divulge this inormation generally are the ones that have lower water loss rates.

6 The literature nds that in the case o commercial losses, programs or the reduction o commercial water losses are nancially attractive, as they generate a speedy nancial return. However, programs or the reduction o phys-ical water losses are nancially attractive at the beginning o their execution, especially in developing countries that have high levels o water loss. Nevertheless, ater a signicant reduction in water loss, investments in programsgeared to the reduction o physical water loss cease to be attractive. This can be explained through the law o decreasing returns, which suggests that the more we invest, the lower the additional return on each unit o investmentcompared to the previous one. In the case o water loss, i a worker is sent to look or leaks in the distribution network, this person will nd, say, ten pipes with leaks per day. The law o decreasing returns implies that i veworkers are sent to look or leaks, they will not nd 50 leaky pipes, as might be expected, but will nd a number lower than 50. This happens because the workers will likely look or leaks in the same places as their colleagues,thus decreasing the eciency o the search.

0%

50%

5%

10%

15%

20%

25%

30%

35%

Percentageofoperatorsateachlevel

ofwaterlosses

Figure 3.1: Water loss scenario among water utility operators

Source: IBNET


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The traditional approaches are largely aimed at reducing physical water loss. Regarding commercial water loss, water operators tend to

reserve or themselves all stages o the water bill collection procedure, as well as the maintenance o hydrometers.

As a counterpoint to the traditional approach, the literature unanimously sets orth the model o the perormance contract or dealing

with physical and commercial water loss. As opposed to the traditional approach, all o the activities relating to the reduction o water

losses are transerred to a private partner under a perormance contract. The essence o perormance contracts is that the private agent is

not compensated merely or delivering services, as would happen in outsourcing, but also or complying with the water reduction goals

set orth in the contract.

The perormance contract is based on the idea o compensating the private sector or the delivery o results, not only or executing a series

o tasks. To compensate or the risks undertaken, the private agent is granted the necessary fexibility to carry out the tasks in accordance

with what the agent deems best, based on its experience in that eld.

The practical application o perormance contracts depends on the level o risk the private agent is willing to accept, which is linked

indirectly to the political-economic situation o the country, the specic conditions o the water utility company, and the peculiarities or

specicities o each contract.

3.1.2 Literature related to energy eciency

According to Geller (1991), actions to enhance energy eciency in water utility companies generate several benets. First, increasing

eciency decreases costs, as it is cheaper to save and redistribute energy than to invest in producing more. Normally, investments in

building generation plants and distribution and transmission lines are more expensive than simply investing in eciency improvements.

Second, greater energy eciency reduces demand and the risk o scarcity without hampering the development o economic activity.

Third, an increase in eciency in the energy sector can help industries and Brazilian products become more competitive. Products like

aluminum and steel alloys use a great deal o energy in their production; as such, greater eciency in the use o energy may signiy a

considerable cost reduction.

Finally, Geller (1991) argues that reducing energy consumption via energy eciency enhancement programs results in lower environmental

and social impacts relative to those incurred when energy production is expanded.

In water utility companies, the issue o energy use is not trivial. According to Gomes (2009):

Losses in energy are not less signicant and they take place principally in the pumping stations o the water distribution systems and those

o sanitary sewage. These are losses that happen, mainly because o the low eciency o electro-mechanic equipment, due to inadequate

operational procedures or due to a faw in the conception o projects.

Given this, Energy Service Companies known as ESCOs play an important role in the reduction o water utility companies costs.

ESCOs are private companies that render energy conservation services, receiving their compensation primarily through perormance

contracts.

According to Stoner (2003), there are benets to carrying out energy eciency enhancement projects based on perormance contracts.

Energy perormance contracts oer greater credibility to consumers and more comort to those who und the project.7

This is because theESCOs, specialized in this type o project, are motivated to honor the deadlines and the objectives o the perormance contract or they

will not be compensated.

According to the Manual or Development o Municipal Energy Eciency Projects (MDMEEP), developed or the Indian market, a

perormance contract should contain not only the legal provisions but also the regulatory specicities to which each o the parties are

subject, the conditions or the rescission o the contract, and the establishment o parameters or eventual indemnities, among other

provisions (IFC 2007).

7 This happens because the perormance contracts guarantees an adequate cash fow or the project; provides the necessary calculations to veriy the easibility o the project; and guarantees that investments will be geared tocomply with their true purpose and not to alternative ends.


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At present, energy eciency enhancement projects are largely unded bypublic benet charge (benet unds). These unds have been

used in several countries ater their institutional reorms, with the aim o ostering public-private partnerships, beginning in the 1990s. A

public benet charge collects resources to support energy eciency enhancement projects. In Brazil, the Energy Eciency Program (EEP)

coordinated by the National Agency on Electrical Energy operates like a public benet charge. Nevertheless, the literature nds that there

are several obstacles to the appropriation by independent ESCOs o the nancial resources granted by public benet charges. Considering

this, there is still a great deal to be done to ensure that adequate unding levels are maintained in commercial banks and that investors can

be reached.

According to the MDMEEP and Stoner (2003), there are two basic models or energy perormance contracts:

1. Guaranteed Savings Model the loan goes to the water utility companys balance sheet. In this model, the ESCO assembles and

implements the project or the water utility company, which pays the ESCO compensation. The water utility company pays this

compensation using the nancing obtained. Figure 3.2 presents a scheme o this model.

2. Shared Savings Model the nancing goes to the ESCOs balance sheet. The dierence rom the previous model is that the banks

interaction is with the ESCO, not the water utility company. The ESCO helps nance the project and receives compensation or theenergy saved; i.e., or the eectiveness o its services. Figure 3.3 shows how this model works.

Project rates

Design andImplementation

of Project

Payments

Debt

Figure 3.2: Guaranteed savings model

Bank ESCOWater Utility

Financing

EnergySaved

EnergySaved

Design andImplementation

of Project

Payments

Figure 3.3: Shared savings model

BankWaterUtility

OperatorESCO

Project

Debt

Source: Stoner 2003

Source: Stoner 2003


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Table 3.2 provides a comparison o the two models:

3.2 Why Hold Perormance Contracts in Brazil?

3.2.1 Financing capacity

Brazils water utility companies are not accustomed to using perormance contracts or water loss reduction or energy eciency

enhancement programs. However, while perormance contracts are not a panacea, they could be an eective tool or overcoming specic

barriers commonly aced by these companies.

Very generally, it is possible to group these barriers and solutions into our topics: (i) nancing capacity; (ii) technical knowledge o how

to structure programs; (iii) reduced transaction costs; and (iv) increased positive incentives or the private contracted party.

Water utility companies limited capacity to access nance is one o the main problems associated with the low investment in the Brazilian

sanitation sector. This limitation is due to the precarious economic-nancial conditions that characterize water utility companies, who sel-

report low operational and management eciency. High operational costs and limited capacity to generate revenues diminish water utility

companies ability to obtain the nancial resources necessary or investment and operational improvements (such as water loss reduction

programs). This vicious cycle is depicted in Figure 3.4.

Guaranteed savings model Shared savings model

ESCO takes on the risk or modeling and perormanceESCO takes on the leveraging, modeling,

and perormance risks

Operator takes on the leveraging risk Normally out o the operators balance

Perormance based on the energy saved Perormance based on the cost o the energy saved

Table 3.2: Comparison between guaranteed savings and shared savings models

Limitedoperational

capacity

Reducedinvestment

capacity

Low revenuegeneration and high

operational costs

Reducedfinancingcapacity

Figure 3.4: Vicious cycle in the management of water utility companies

Source: GO Associados


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A survey by the Investment Fund o the FGTS (Guarantee Fund or Time o Service) indicates that o the 26 state-operated water utility

companies in Brazil, only seven have the necessary conditions to obtain nancing.8

Perormance contracts could represent an important solution to the limited capacity o water utility companies to leverage resources. In a

perormance contract, the contracting party (i.e., the water utility company) can considerably reduce its contribution o nancial resources

(or even not invest at all) to a water loss reduction or energy eciency enhancement program.

As already noted, the contracted party (i.e., the ESCO) must make all o the investments and render the necessary services (or example,

change pumps and water meters, policy or water cuts) beore receiving any payment rom the contracting party. As opposed to a traditional

contract, with a perormance contract, there is an obligation or the contracting party to pay the contracted party or nishing the stages o

a specic previously established physical-nancial plan, the compliance o which is assessed by means o results measurements. Payments

are made with the additional resources generated through the reduction o water losses or through a decrease in energy expenditures (based

on the increase in billing achieved). Thus there is no need or indebtedness on the part o water utility operators to nance interventions

in water loss reduction.

Another diculty associated with the reduction o water loss and energy eciency enhancement is the technical capacity o water utility

companies to plan and structure a global and integrated water loss reduction project. That is, the reduction o physical and/or apparentwater losses entails a series o activities that need to be developed in an integrated manner, but these may not be known to water utility

companies. For example, it is common or water utility companies to implement hydrometer substitution programs (reducing commercial

losses), but not to invest in the renewal o the water distribution networks, which may have high physical losses. Energy eciency

enhancements oten suer the same problem: specic equipment is replaced, but structured and systematic actions or operational

improvement are not undertaken.

One reason or this is that specic sections or departments within a company are oten not responsible or the implementation o a water

loss reduction and or an energy eciency enhancement program. Actions to reduce losses involve a variety o departments within a water

utility company (e.g., procurement, works, maintenance, accounts, and marketing, among others). The absence o a unit ocused on

structuring and ollowing up the water loss reduction and energy eciency enhancement program scatters and disperses eorts and leads

to a lack o coordination.

This is also refected in the budgeting. I there is no budget specically dedicated to all o the actions needed to implement a water loss

reduction and energy eciency enhancement program, then due to lack o resources, not all o the actions needed or the success o

the program will be implemented. This lack o central coordination can be explained by the lack o technical training o water utility

companies in how to structure an adequate program or water loss reduction or energy eciency enhancement. There is a paucity o

technical knowledge regarding how to set up basic projects, structure calls or bids, price services, and dene the best technical and

technological solutions.

The perormance contract, through a single instrument, makes it possible to allocate the responsibility or planning and executing all

actions needed to enhance operational eciency to a private contracted party. The water utility operator does not need to speciy every

step o the intervention in the perormance contract; in act, doing so could actually reduce cost-eectiveness. The perormance contractprovides a built-in incentive or the private contracted party to use the most cost-eective technology by tying the providers compensation

to achievement o a specic result rather than simple ulllment o a series o tasks.

This transer o risks relating to the design and implementation o water loss reduction and energy eciency enhancement programs allows

operators with less capacity and knowledge to still implement such programs and, based on the interaction with the private contracted

party, to absorb the knowledge and know-how regarding the implementation.

8 Available at: http://www.gts.gov.br/trabalhador/_gts.asp

3.2.2 Technical knowledge to structure programs


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As mentioned in the previous subsection, perormance contracts are designed to cover a series o actions which many times are contracted

independently. Disaggregated or piecemeal contracting substantially increases transaction costs, especially or public companies or

autarchies.

Public agencies are obliged to conduct a request or bids beore contracting out works or services. This process is lengthy and oten more

costly than private procurement or hiring. Managers are orced to negotiate and monitor a diversity o contracts with dierent deadlines,commercial conditions, and players that need to be coordinated to attain the desired results. Thus, coordination o a series o contracts

with dierent validity dates and dierent service providers is highly complex, incurring signicant managerial costs and supervision.

In contrast, in perormance contracts, the private contracted party is responsible or all o the actions needed to ulll a specic goal or

water loss reduction or energy eciency enhancement. The water utility company interacts exclusively with a service provider, demanding

rom the latter that specic and measureable goals be attained.

The ourth advantage o perormance contracts reers to the positive incentives provided to the private contracted party to carry out

services in the most ecient and cost-eective manner. As the private contracted party is paid only upon the attainment o results romthe implementation o activities set orth in the contract, incentives are provided so that his interventions are ecient and generate the

best possible outcomes.

When a contracted party is paid based only on the execution o a number o works and services rather than on the results o these

interventions, there is little incentive or him to invest in more ecient operational solutions. In practice, the contracted party strictly

complies with specications provided by the water utility company; ater nishing his service and receiving his payment, he is no longer

interested in whether his interventions generated eective benets to the water utility company. In other words, the perormance contract

produces incentives or the contracted party to attain operational improvements because only then will he be paid.

3.2.3 Reduced transaction costs

3.2.4 Increasing positive incentives or private contractors


Performance contracts

Physical water loss

Commercial water loss

Financing capacities


1. What are the main advantages o using perormance contracts to reduce water losses over the traditional approach

o outsourcing and service contracts?

2. What are the benets o increased eciency o water utilities?

3. What are the main characteristics o the three models o perormance contracts to increase energy eciency?


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4


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4. Technical Aspects: Dening the Scopeo the Intervention and the Baseline

4.1 Obtaining Data or the Baseline

This section addresses the technical aspects o water loss reduction and energy eciency enhancement programs. Subsection 4.1outlines how to obtain data to carry out the baseline. Subsection 4.2 ocuses on dening the project area. Subsection 4.3 describes the

necessary inormation needed to create the project model. Subsection 4.4 presents criteria that can be used to dene the baseline. Finally,

subsection 4.5 identies the minimum scope o work that should be included in the perormance contract and conducted by the contract-

ed party.

To be successul, development o a water loss reduction or energy eciency enhancement program must be based on a reliable inormation

source. The availability and reliability o inormation is essential or perormance contracts, because the private contracted partys com-

pensation will be based on it. In Brazil, ew water utility companies currently have reliable inormation with which to create a baseline.

A company cannot determine i a cost reduction program has succeeded i its expenses beore the beginning o the program are unknown.Likewise, it is not possible to develop a water loss reduction or energy eciency enhancement program without inormation on the volume

o water loss (or the volume not billed) or the baseline amount o energy consumed.

Thus, beore implementing a water loss reduction or energy eciency enhancement program, it is essential to obtain data regarding:

the macro and micro measured water volume; the volume o water loss; the amount billed; the amount collected; the amount o energy

consumed; and the amount paid or energy, among others. The baseline should be calculated so as to enable measurement o the rates o

both apparent and physical losses, as well as the real cost o electric power. I these data are not available, an audit in the intervention area

should be conducted to calculate the ollowing: the volume o water lost or not billed, the actual billed volume, the actual collections, and

the amount paid or energy. The outcome o this diagnosis is called the water balance. (see also Figure 3.2).

A detailed water balance diagnosis may require a reasonable period o time to be carried out, as well as signicant investments. Operators

with low-quality controls will certainly need a very detailed water balance and verication o the inormation collected. Under those

circumstances, it is essential to choose between either initially investing in a more detailed water balance or dening the perormance

contracts baseline based upon the most reliable data available.

A detailed water balance diagnosis enables a company to dene its baseline on several criteria (e.g., macro or micro measured volume;

billing volume; or input consumption, among others). In certain situations, it may be convenient to develop a perormance contract (even

i it is or a smaller area) with the available inormation so as to be able to demonstrate the models advantages and to begin to eliminate

losses and ineciencies as quickly as possible. The rst perormance contract may even include an obligation by the contracted party to

provide a consistent water balance ater a certain period o time.


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4.2 Establishing the Intervention Area

The rst and likely most important stage in preparing a successul perormance contract is dening the project coverage area. Criteria that

may help to dene the intervention area include:

(a) High rates o losses: The rst and most obvious criterion is the level o losses (physical or commercial). Although accurate data are not

always available regarding the level o losses in a certain area, it is essential to prioritize those areas with the highest loss levels. It will be

more attractive or the private sector to contract work in areas with the greatest reduction potential; this will generate urther ecienciesand/or increase billing or the water utility company as well.

(b) Water isolation: One o the main objectives o a water loss reduction program is to increase the available water volume, so it is essential

to be able to measure this increase eectively. Areas with greater water isolation should be prioritized or selected over areas with less water

isolation (see Box 4.1).

(c) Socio-economic characteristics: It is essential that the chosen area has socioeconomic characteristics representing all other areas operated

by the contractor. This representativeness will enable a proper verication o the eectiveness o water loss reduction actions in the system

as a whole.

(d) Number o connections: An area with at least 10,000 connections is recommended. Water loss reduction programs require teamsand skilled labor, and the transaction costs associated with perormance-based projects do not justiy projects with less than 10,000

connections; the private sector will usually not mobilize teams and resources to undertake smaller projects. As the main private companies

that provide water loss reduction services are located in the Southeast o Brazil, training and displacement o teams to other regions are

only justied in larger projects o longer duration.

(e) High production costs, the system distribution or expansion: One o the major advantages o a water loss reduction program is the

possibility o postponing investments to expand water production. Thereore, it is advisable to develop water loss reduction programs in

systems that are already running at maximum water production capacity and have high levels o losses.

() High distribution cost: An aggressive loss reduction program may help to reduce high distribution costs, as well as enhance revenues to

oset these costs. Thus areas with high distribution costs should be selected over those with lower costs.

(g) Economies o scale: A water loss reduction program that covers a whole municipality (or more specically a ull supply system) is an

interesting alternative or a water loss reduction program because it implies economies o scale and lowers the risk o system isolation.

Thus, those areas with greater potential or economies o scale should be prioritized over those with less potential. Similarly, the possibility

o using the project as an example to be multiplied in other company departments should be considered. Thus, areas that have the

potential to infuence the companys water loss reduction as a whole should be preerred to those with more limited infuence.


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Dening the scope o an energy eciency enhancement projectperormance contract

It is usually less complex to determine the baseline or perormance contracts that involve only energy eciency enhancement in water util-

ity companies; the baseline is based on the average energy consumption o the acilities to be improved. Such acilities include: lit stations,

water treatment stations, sewerage treatment stations, administrative buildings, and other similar acilities. Normally, the average energyconsumption or the last 12 months is calculated in acilities that underwent improvements, and the contracted partys compensation is

calculated based on the savings obtained through energy consumption reduction in those acilities.

To prevent distortions, it is sometimes advisable that the baseline is bound to a rate improvement. For instance, i a water treatment station

undergoes an intervention that results in the station treating a higher water volume (resulting in higher energy consumption), this act

must be taken into account to prevent the private contracted party rom being penalized. That is, while the unit cost o treatment drops,

the absolute level o water treated increases, possibly masking the greater energy eciency achieved. In this scenario, the ideal baseline

would be measured, or instance, by the kilowatts used per cubic meter o water treated.

Box 4.1: Water IsolationSystem isolation can be created by rivers, streams, railways, highways, or long avenues which serve as barriers to connections (and

hence water transer) with other systems.

Consider a hypothetical scenario in which there is a water supply system that is supplied by only one reservoir and is totally isolated.

I the physical water loss is zero, the available water volume at the systems entrance (i.e., the reservoirs outlet) should be equal to the

volume available to consumers in that system.

I some o the water o the system is transerred or comes rom other systems not included in the water loss reduction program, it

would be more dicult to measure the programs outcomes. This is because each o the water entrances and outlets must be identied

and the water volume that is not or consumers o the system under intervention must be measured.

Figure 4.1 shows an example o a system isolated by a railway. In this scenario, Reservoir 2 initially supplied water to both City 1

and City 2; Reservoir 1 also supplied City 1. Ater the railway was built, Reservoir 2 could no longer supply City 1, resulting in the

isolation o both systems. This isolation renders a water loss reduction program more easible (or both Reservoir 1 and 2).

Figure 4.1: Isolation caused by a railroad

Railroad

Reservoir 2

City 1

City 2

Reservoir 1

Source: GO Associados


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4.3 What Data Should be Collected to Design the Project and Establish aPerormance Contract?

To properly model the technical and nancial aspects o a proposed project and to carry out an economic-nancial assessment (see Section

5 or more detail), it is essential to collect the basic inormation that will be used to estimate both the investment and operational costs o

the private contracted party, as well as to determine the best size or the project. As already mentioned, inormation quality and reliability

are more important than quantity.

The ollowing inormation on the selected project area must be available. Data should reer to the last 12 months at a minimum.

Inormation should be obtained directly rom the water utility company. Three types o data should be collected:

(i) Commercial system data:

Number of connections per category

Amount of savings per category

Number of active, inactive, and feasible connections and the associated amount of savings

Monthly billing volume

Monthly collection volume

Debt portfolio by category

Micro measured monthly water consumption per category, and if possible, stratication by consumption range

Debt portfolio by category, stratied by debt age, if possible

Number of connections with and without water meters

Water meter distribution prole by age and capacity, if possible

Commercial system used

Pricing rule and present tariffs

Procedures for reading meters and issuing bills

(ii) Operational data: Some operational data are indispensable or setting up a perormance contract. Other data, i available, may greatly

aid the project design while not being indispensable.

(a) Fundamental inormation:

System sketch with a topographical map

Delimitation of the geographic area covered by the project

List of the existing operational units in the area covered by the project, their location and technical information, and in particular their

capacities (water abstraction, lit stations, treatment stations, reservoirs, boosters, wells, fow meters and pressure reducing valves)

Electricity bills of each of these operational units from the last 12 months, if possible, and of the last three months at a minimum

Documentation of complaints of lack of water, and/or existence of areas with ashing or rotating supply

(b) Important inormation (not indispensable):

Cadastral plan with contour lines of the project area

Documentation of the history of leaks Network extension

A prole of the distribution of branches by type (PEAD, PVC, galvanized)

Macro measured volumes of the last 12 months

(iii) Energy eciency data: For energy eciency enhancements, the necessary data reers mainly to energy consumption by each acility

undergoing improvement, preerably rom the last 12 months.


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4.4 What Criteria Are Used to Dene the Baseline?

4.4.1 Factors that may impact the baselines accuracy

4.4.2 Alternatives to dening the baseline

Denition o the baseline is one o the major challenges or speciying and evaluating a projects perormance. The baseline is a parameter

or set o parameters that will be used to measure the results obtained under the perormance contract. I the baseline is not properly

determined, contract risks will increase: the contracting party may pay compensation but not obtain the expected outcomes, or the private

contracted company may not receive adequate compensation i the parameters used to determine the baseline are not reliable.

When setting the baseline, it is essential to take into consideration the several variables that can interere with the criteria used to establish

the contracted partys compensation. Certain goals and objectives can only be achieved i the initial technical assumptions are maintained.

In addition to setting the base to calculate compensation, it is undamental to identiy the actors that could eventually interere with this

base.

I the base or measuring perormance is the volume o additional water available, it is important to clariy in the perormance contract

that a specic target volume available will only be reached i the initial pressure conditions o the system do not experience large changes.

For instance, i a public notice announcing the commissioning o a new water production system will signicantly increase the distribution

system pressure, it is important that the baseline setting considers this change by taking into account any losses generated by this increasedpressure.

Likewise, in energy eciency enhancement projects, it is important that the baseline enables managers to take account o eventual energy

consumption increases related to, or instance, increased water pumped by a certain lit station or more sewerage treated by a sewerage

treatment station.

As there are dierent ways to measure the results o the services dened in a perormance contract, the compensation or services can

consequently be dened dierently as well. The criterion used should be easily audited by the contracting party, by the private contractedparty, or by third parties. Oten, the lack o data or inaccurate data prevent the adoption o certain criteria normally recommended by the

international literature (such as the available water volume). Given this, our alternatives are assessed:

(i) Volume saved baseline

Regarding contracts or water loss reduction, whose aim is to decrease physical losses, an alternative is to dene a compensation value unit

or every m3 eectively saved. Generically, compensation will be expressed as ollows:

Compensation value unit (CVU)= Volume saved (m3 )x Compensation per m3 (R$)

The volume saved can be calculated in two steps. First, the total volume o the systems physical loss is calculated as: (i) the macro measured

volume at the entrance o the area set orth in the perormance contract (or instance, water volume measured at the outlet o a certainreservoir) less (ii) the micro measured volume o each consumer. Second, volume saved is calculated as the dierence between the monthly

average volume lost over a certain period (or instance, 12 months) beore the beginning o the perormance contract and the monthly

volume lost ater the perormance contract begins.

Under this alternative method, it is essential that both the micro and macro measurements o the area under intervention are reliable,

that there is compatibility between the commercial and operational data, and that the system is guaranteed to be without leaks. I these

conditions are met, the volume saved baseline is a reliable criterion. This method can be used to handle seasonal eects (with enough data

over the long run).


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(ii) Operational cost reduction baseline

Operational cost reduction is the most commonly used baseline in energy eciency enhancement programs. Nevertheless, it can also be

used or physical water loss reduction programs, particularly when there is a lack o reliable data to calculate a baseline based on volume

saved.

Reduction o energy or chemical products consumption takes place when volume consumption drops, as volume production drops

consequently, too. This is clearly not the best alternative method or calculating the baseline; however, when there is a lack o reliable data,

energy and chemical products consumption may be an interesting substitute or establishing the baseline, as most companies keep reliable

records o these costs (e.g., energy bills and the volume o chemical products used).

(iii) Collection and billing baseline

In apparent water loss reduction programs, the use o collection and billing data is the most common method or establishing the baseline.

Unlike the volume saved method, collection and billing data are relatively reliable, as they are recorded by bank deposits and the issuance

o water bills.

Events that could distort the programs collection and billing outcomes should be identied early on. For instance, i an area is being

developed as a tourist site, an increase in water consumption in the tourist season should be expected. The revenue growth associated

with this must also be anticipated and taken into account. Likewise, eventual tari increases, mismatching o bills between a water utility

company and the state or municipal government, or collective mobilization to decrease delinquency must be identied and stipulated in

the perormance contract to ensure that the private company does not benet rom collection level changes associated with events outside

o its control.

(iv) A combination approach

Even i it is possible to allocate the total volume o losses between real and apparent losses, actions to reduce one component have a

direct impact on the other component, so it is recommended that both components be addressed. In those situations, billing growth in

connection with volume saved are two important criteria or establishing the baseline. However, when volume data are not reliable, billing

growth can be used along with operational cost reduction. The data or these two criteria are normally reliable; i they are applied together,

it is easible to assess both apparent and physical water loss reduction.

As or measuring the baseline or physical water losses, an interesting combination is to use both the volume saved and operational costreduction methods. This double baseline encourages the contracted party to use more ecient technical solutions to reduce losses rom an

operational standpoint, because in addition to reducing physical losses, the contracted party will be paid based on the reduction in energy

consumption. Use o the volume saved method exclusively can discourage the contracted party rom looking or ecient solutions in terms

o reduced energy and input consumption.

4.5 Minimum Scope

Finally, an important technical aspect to consider in the perormance contract is inclusion o a minimum scope o work to be carried out

by the contracted party. For instance, the perormance contract may represent an opportunity to modernize certain acilities that have an

impact on water loss levels.

The perormance contract may have a list o interventions that are mandatory or the contracted party to carry out, even i they will

not have an impact on water loss reduction. One example is to include an obligation to upgrade the billing and collection systems with

complete online access and the capacity to produce reports and process other data essential to monitoring the system. Other examples can

encompass reorms o reservoirs or other acilities linked to water loss reduction or energy eciency enhancement programs.


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Dening the baseline

Collection of data

Calculating the water balance

Water isolation

Socio-economic characteristics Number of connections


1. How important is it to have a well-dened baseline? What are the alternatives or dening the baseline?

2. Which criteria must be applied to dene the coverage area o a water loss reduction project?

3. What inormation is needed to be able to model the project and carry out an economic-nancial assessment?


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5


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5. Economic Aspects: Parameters or anEconomic-Financial Feasibility Study

5.1 Review o Financial Concepts5.1.1 Discounted cash fow model

5.1.2 Net present value

The objective o this section is to provide a simple script or an economic-nancial assessment o a water loss reduction or energyeciency enhancement project. The economic-nancial assessment can be done using a discounted cash fow model, as is done in other

similar analyses. Subsection 5.1 presents an overview o some requently used nancial concepts. Subsection 5.2 shows how a discounted

cash fow model can be used to inorm the design o a perormance contract. Subsection 5.3 compares the basic eatures o perormance

contracts to traditional contracts, while subsection 5.4 indicates the basic aspects o carrying out an economic-nancial assessment or a

perormance contract.

A discounted cash fow model is a method used to assess projects, companies, or assets. Cash fow reers to the projection o a companys:(i) revenues; (ii) operational costs; and (iii) investments. The cash fow comprises accounts receivable (positive amounts or cash infows)

and accounts payable (negative amounts or cash outfow). In a typical project, the rst years are characterized by larger cash outfows than

cash infows due to large upront investments. In the later years, cash infows are typically larger than cash outfows.

To conduct a discounted cash fow assessment, all o the uture cash fows both positive and negative are estimated and then updated

to present values based on the interest rates that represent the value o money over time. The ollowing variables are used in the subsequent

discussion:

FCt= net cash fow in period t

Rt

= gross revenue in period t

Ct= cost in period t

It= investment in period t

Tt= tax in period t

r= discount or required rate o return

T = period in which project ends

A projects net present value (NPV) is the sum o the present values o the cash fows rom each year o the projects lie, both positive and

negative (Damodaran 2004). NPV represents the sum o updated cash fows minus any initial investment.

The discount rate used should be compatible with the opportunity cost o capital. To be attractive to an investor, the NPV should be at

least zero. An NPV o zero is a necessary condition or minimum and proper compensation or the investors opportunity cost o capital.

NPV is calculated as ollows:

NPV =

FCt

(1+r)t

T

t = 0


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This ormula enables the comparison o values over dierent moments in time. When NPV = 0, r is called the internal rate o return (IRR).

NPV = 0 =

FCt

(1+IRR)t

T

t = 0

FCt

(1+r)t

Payback =Initial investment

T

t=1

5.1.3 Internal rate o return

5.1.4 Payback term

A projects IRR is the discount rate which makes the projects NPV equal to zero. (Damodaran 2004). Altogether, the IRR can be dened

as the interest rate that makes two sets o capital (cash infow and cash outfow) have the same NPV (Gittman 1997). Mathematically, the

IRR can be written as the rate that sets the cash fows NPV equation equal to zero.

The discounted cash fow assessment uses negative infows (investments, costs, and expenditures) and positive infows (revenues). The time

it takes or the sum o negative infows to equal the sum o positive infows is called payback (or the recovery period). Payback is expressed

in number o periods (usually months or years) and can be calculated based on nominal values or on cash fows discounted to the present

value.

A projects payback measures how ast cash fows generated by that project cover the initial investment. Projects that cover their investments

earlier can be considered more attractive, all else equal (Damodaran 2004). In principle, the lower the payback, the more attractive the

project.

Payback is expressed mathematically as ollows:

According to a study carried out by Kingdom, Liemberger and Marin (2006), most activities to reduce commercial water losses, such as

changing water meters and updating consumers cadastre, have a short payback. These activities require low investments and generate

prots quickly or water utility companies. However, conditions are more complex when it comes to activities to reduce physical water

losses, as the investments required are higher and involve, at least partly, investment in long-term assets.

The payback or physical water loss reduction depends directly on the unit cost o water that ceases to be lost per cubic meter a day and

the present water cost. Furthermore, according to Kingdom, Liemberger and Marin (2006), in developing countries, which have high

levels o losses and a low cost o water saved, payback takes approximately our to eight years, which makes investments on physical water

loss prevention less attractive.

IRR is the compounded, eective, and annualized return rate that indicates the projects protability. I two projects have the same initial

investment but two dierent IRRs, the project with the higher IRR is the more protable o the two.


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5.1.5 Comparison among the three nancial indicators

5.2 Cash Flow Assessment Applied to Perormance Contracts

5.2.1 Costs and benets involved in water loss reduction and energyeciency enhancement contracts

Deciding whether or not to invest in a certain project or whether to invest in project A or project B involves an assessment o the returns

o each project. The three economic indicators presented in this section NPV, IRR, and payback are tools that can be used to help

make this kind o decision. While decision making regarding investments also involves several other elements that transcend this manuals

scope, the concepts reviewed in this section can still help managers assess perormance contracts to reduce water losses and increase energy

eciency. But a careul look is necessary, because each indicator has both advantages and disadvantages.

By and large, the NPV is the most complete measurement or assessing investments. Table 5.1 compares the three indicators based on two

parameters: (i) whether the indicator works in all kinds o projects; and (ii) whether the indicator can be used to compare two projects

rom the standpoint o maximizing the companys value.

The discounted cash fow assessment can be used to inorm perormance contracts to reduce water losses or increase energy eciency.

Cash fow is the base, using estimates o: (i) revenues; (ii) operational costs; and (iii) investments. In this case, there is a peculiarity: the

contracted partys compensation is calculated based on gains obtained over the contract, measured by energy eciency gains (e.g., a

reduction o energy costs) or loss reduction (e.g., reduction o material costs, or a billing increase, among others).

Estimation o a projects cash fow depends on identiying all o the costs and revenues involved. These data will enable an economic

assessment o the project.

Economic and nancialindicators

NPV IRR Payback

Works in all kinds o projects Yes

No

It requires, at least, anindication o change o the

cash ow.

No

It only works with projectswhere there is an initial period

o investment, ollowed bypositive cash ows.

Maximizes the companysvalue

Yes

However, requires thatcompany has access to capital

to invest.

Yes, when comparing projects

Nevertheless, there areprojects which do not havean IRR or have more than

one IRR. In these cases,

comparison is not possible.

Not necessarily

By and large, it takes intoaccount the project periodonly, in which investments

are covered. Benets

can be greater i possiblepostponements o investmentsare considered.

Table 5.1: Comparison of rules for decision making on investments

Source: Damodaran 2004.


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Costs and benets o water loss reduction projects

Economic analysis o water loss reduction projects requires evaluating involved costs. Costs may be distinguished as xed costs, which

occur during the specic implementation period, and variable costs, which occur over the whole project.

The costs o water loss reduction projects can include:

Equipment and facilities (pipelines, valves, pumps, motors, accessories, connection parts, control and automation elements,

electric power equipment, and substations); Civil works (structuring of capture, pump houses, digging, and pipeline tting); and

Indirect costs (includes project expenditures, management and work inspection, and consultancy services, among others).

The lie cycle o the assets involved is another important aspect. Physical equipment usually has a lie cycle over which its eciency drops.

When a water loss reduction or energy eciency enhancement project is being prepared, it is essential to know the useul lie span o each

asset. For instance, consider a 10-year water loss reduction project, in which a change o water meters is one o the planned actions. As

water meters have a ve-year lie cycle, the project must plan on at least two complete changes o the water meters. Table 5.2 suggests the

lie cycles o some equipment typically used in water loss reduction projects.

A water loss reduction project may have various benets. By reducing physical water losses, the company can produce less water to supply

the same number o people. By producing less water, the water utility company reduces expenditures on several items, such as:

Chemical products

Electric power

Purchase of raw water (when they pay for the use of water)

Labor

Other inputs

By reducing apparent water losses resulting rom illegal connections, consumption not billed, lack o water meters, or measurement issues,

among others, the main outcome is increased billed consumption and consequently, revenue growth.

Additionally, the company can postpone investments. A hypothetical example shows how this can take place. In this example, assume the

ollowing parameters:

Population served: 100,000 inhabitants

Forecast of total population in the next 10 years: 120,000 inhabitants

Total water production: 200 liters per second

Real water losses:9 80 liters per second

9 This case assumes that there are no apparent losses, or simplicity.

Material and Equipment Average years o lie

Cleaning or coating o pipelines 3

Drive and inverters 5

Water meters 5

Motors 10

Pumps 10

Valves 10

Automation 10

Pipelines 30

Reservoirs 30

Table 5.2: Life cycle of assets in water loss reduction projects


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Costs and benets o energy eciency enhancements

Water utility companies are electricity intensive, such that electric power is one o their main inputs. According to the Programa Nacional

de Conservao de Energia Eltrica para o Saneamento(PROCEL SANEAR), over 2 percent o the total electric power consumption in

Brazil is consumed by water utility companies. The main actors that can lead to energy inecient consumption are: Incorrect contractual clauses

Inadequate operational procedures

Water waste

Wrong sizing of systems

Old equipment

Technologies used incorrectly

Conceptual design errors

Poor maintenance

As the city population is expected to grow 20 percent over the next ten years, it is assumed or simplicity that water consumption will also

grow by 20 percent in this period. The water utility company has two alternatives: (i) increase the water production capacity rom 200

liters per second to 240 liters per second; or (ii) reduce water losses.

The second alternative will, in many cases, be more appropriate rom an economic-nancial and environmental standpoint. By reducing

water loses, the same volume produced serves more people. In the example, the necessary volume to serve the entire population is 120

liters per second, which is the subtraction o total production (200 liters per second) rom lost production (80 liters per second). I the

population increases by 20 percent, the necessary volume to serve the entire population would be 144 liters per second (120 liters per

second x 1.2). I losses diminished rom 80 liters per second to 56 liters per second, a 30 percent drop, it would be easible to serve the

entire population without actually increasing water production.

Gains with water loss reduction

manual for performance-based contracting by water utility companies in brazil

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