Jerson Kelman CEO, SABESP 2017 Finance Ministers’ Meeting Making more EFFICIENT and EFFECTIVE use of existing financial resources  The previous speaker made it clear that it is necessary to allocate more financial resources to water and sanitation. However, this is a necessary but not sufficient condition to achieve service universalization. Just pouring more money into inefficient utilities would result in a waste of scarce resources. In addition to money, it is in general necessary to ensure higher efficiency of the utilities and better governance. Jerson Kelman CEO, SABESP 2017 Finance Ministers’ Meeting

* Not including irregular areas SABESP in numbers 27.8 million clients 14,000 employees Responsible for about 25% of total investments annually made in Brazil Fourth largest in the world in terms of population served Investments in 2016 $1.25 billion Net profit $930 million $4.5 billion EBITDA $6.3 billion market value 237 water treatment plants 548 sewage treatment plants In the mid nineties, Sabesp, the water and sanitation company of São Paulo, was a mess, just like most other utilities in developing countries. Nowadays, it is technically very capable and adopts high governance standards. As a result, the company has free access to both equity and finance from private capital. It remains as a state controlled company, but half of its shares are traded in the New York and Sao Paulo stock exchanges. In the remaining of this talk we will discuss, based on Sabesp´s experience, which are the key points to improve the efficiency of the utilities in developing countries. 50,000 km of sewage collection pipes 73,000 km of water distribution pipes 87% sewage collection 79% treatment of collected sewage * Not including irregular areas

The water sector has only two sources of PREDICTABLE revenue Direct user payments Paid by consumers and users Taxes/public finance Paid by taxpayers Unpredictable: International transfers and loans Tariffs are the most common form of direct user payment. Ideally, the revenues from the water bills should cover operation and maintenance costs plus new investments to expand the service However, in many circumstances the taxpayer money needs to be used to bridge the gap between the ability to pay of groups of consumers and the cost of service In principle, the water and sanitation service should be sustained by local resources coming from the consumers or from the taxpayers. International transfers - such as grants and low interest loans - may help. But are unpredictable and will likely be insufficient to fill the gap. It is necessary to teach how to fish, rather than just give the fish.

Two sources of predictable income Why use public finance? Reluctance to charge the full operational costs to users Two sources of predictable income Direct user payments Public finance Public finance is a form of subsidy and is often necessary. Obviously, low direct user payments need to be matched by high public finance. And vice-versa. Denying tariff increases, without addressing budget shortfalls, results inevitably on bad services.

Direct user payments Tariffs | Investments in self-provision Consumers are, in general, WILLING TO PAY for reasonable and efficient services Households, on average, pay less than 1% of their income on water tariffs. Therefore, a higher percentage of the typical family budget could potentially be spent on better water and sanitation. However, low-income populations can pay a much higher percentage of their income for water and sanitation. Furthermore, there are situations where the poorest stay without services because they are not capable of paying the connection charges. Therefore, it is very important when setting the tariff structure – that is, when deciding who pays more and who pays less for the same service –to take into account the diversity of the ability to pay from the different strata of society. It is also important when defining the service geographical bounds to include rich and poor areas. Willingness to pay is much greater for WATER SUPPLY (individual benefit) than for sanitation (collective benefit)

Public finance should be TRANSPARENT and TARGETED to… … pay for services with HIGH EXTERNALITIES (for example, sanitation services) … help COVER THE DIFFERENCE between what users can afford and the full efficient cost of providing water supply and sanitation services Governments should target the fiscal resources in order to avoid its use to subsidize services for those that can pay. Fiscal resources should in principle be used to provide sewage collection and treatment for all. They could also be used to help the poorest pay their water bill. The rational is that, first, the willingness to pay for individual gains is higher than for collective gains, and, second, the beneficiary of water supply is the individual whereas the beneficiary of sewage collection and treatment is the community.

Independent and technically capable REGULATORY AGENCY Incentives for managers and staff to improve efficiency Managers chosen based on professional capability Internal and external auditing Administrative autonomy Governance is key Independent and technically capable REGULATORY AGENCY Good governance is key for increasing the availability and quality of services. Business should be conducted within proper environments, meaning professional staff, lines of accountability, and administrative autonomy, within and outside the utility. Internally, it is necessary to provide incentives for managers, who should be chosen based on their professional capability, not on their political connections, and allow them to take their own decisions. Externally it is necessary to have an independent and technically capable regulatory entity to control the quality of the service, to decide about the tariff level and how the service cost should be allocated among the users. Quality of the service Tariff level Tariff structure

Crisis, huge rehabilitation costs Consumers use water less efficiently Customers are less willing to pay Low tariffs, low collection Service levels deteriorate Infrastructure deteriorates Most utilities in developing countries are on a DOWNWARD SPIRAL Most utilities in developing countries are on a vicious path. In general it starts with governmental constraint to tariff increase for political reasons and/or the control of inflation. Because the price of water is low, consumers tend to waste it. This increases the cost of service, enlarging the gap between operating costs and revenues. Which leads to insufficient money for O&M and new investments. Service deteriorates, which decreases willingness to pay for lousy services. System assets go “down the drain”. At same point down the road, some huge cost rehabilitation plan needs to be implemented. Crisis, huge rehabilitation costs

Sustainable water sector Investments in new infrastructure expand revenue base More satisfied customers are more willing to pay Service levels and quality improve Staff and managers rewarded for improved performance A VIRTUOUS PATH is possible Service providers fully cover operating costs There isn´t a one size fits all solution to improving the management of utilities. But there are some basic concepts. Usually the recovery starts with the introduction of meritocratic rewards to managers and operational personnel. This leads to better services. More satisfied customers are more willing to pay. Tariffs can be increased Assets are properly maintained and new investments expand revenue base The utility reaches the last stage of the virtuous path, which is access to commercial finance

Reaching financial viability is possible Step 4 Increase revenues by 10% Step 3 Reduce non-revenue water to 25% Step 2 Reduce non-labor cost by 15% Step 1 Increase collection rate to 100% This graph was drawn based on a sample of 605 utilities, all around the world It shows that currently only 15% of them are viable, meaning that they cover O&M costs and create a 20% surplus. As the delinquency rate is in general high, a good first move for performance improvement is to get tougher with those that do not pay their bills. Assuming that all 605 utilities would be 100% successful in this effort, this would raise the percentage of viable utilities to 29%. Assuming further that it would be possible to reduce non-labor cost by 15%, mainly through the more efficient use of electrical energy, this would rise the percentage of viable utilities to 41%. As the non-revenue water is in general also high, assuming a 25% reduction would make the percentage of viable utilities to jump to 65%. This of course would demand a serious effort to combat fraud and/or inaccuracy of the meters, direct theft of water, as well as leakages. If meters are no installed, this would be the first thing to do. Finally, if it would be possible to increase revenues by 10% through tariff raise, the percentage of viable utilities would reach 77%. Reaching viability in the majority of the utilities is a daunting task. But it is possible. Currently viable

Smarter capital investments RECONFIRM appropriateness of design standards PAY for results, not for construction works PRIORITIZE solutions to meet the most urgent challenges So far I have talked about operational improvements. But it is also necessary to enhance the approach to capital investments in new infrastructure. First, it is necessary to eliminate high standards conceived for developed countries. Second, concentrate the scarce resources to solve the most urgent problems. Avoid, for example, constructing a sophisticated sewage treatment plant before building the pipes to collect the sewage. Third, and more importantly, pay for results, not for construction works. This is perhaps the most crucial message. In the traditional construction contracts, the profits of contractor are proportional to the construction cost. For him, the objective function is to maximize the cost. However, when the utilities pay for results, for example, for the delivery of water at the city gate at an agreed unit cost, there is an alignment between the interests of the utility and of the contractor. The new objective function turns to be to minimize costs, rather than to maximize the cost.

Maximize value from every dollar of public finance Making more EFFICIENT and EFFECTIVE use of existing financial resources  Maximize value from every dollar of public finance Facilitate and support appropriate sector regulation and planning Support managers and staff by giving them incentives to increase efficiency Summing up… In order to improve efficiency and effectiveness on the use of financial resources, it is necessary: To target the subsidies To ensure capable sector regulation and planning To give incentives to managers and staff for good results This is all I had to say, thank you very much.