Paying for water - urban water tariffs

by Richard Franceys

Cost recovery is an essentialcomponent of a sustainable watersupply. Richard Franceys outlines theprinciples for setting tariff rates andshows the methods used by the BornoState Water Board in Nigeria.PEOPLE NEED WATER for life.Water utilities need money toconstruct, operate and maintainabstraction, treatment and distributionfacilities. These two statementssuggest that although on one handwater is a basic need for which nobodyshould have to pay and which shouldbe available by right, on the other thewater utility has to do a job which issimilar to a bottled-soft-drink producerbut on a much larger scale- andnobody suggests that the soft- drinksproducer should give their productsaway free of charge. Some peoplebelieve that water is a free gift for allin the same way that air is free; othersfeel that the cost of providing cleanwater for the benefit of poor peopleshould be subsidized by the richer

people through the government - butthat the poorest should pay somethingtowards the cost in order to understandthe value of clean water.

Introduction to tariffsIn the past, governments have tendedto subsidize water supply to the rich aswell as to the poor by creating semi-autonomous water utilities with noclear financial mandate, and thencovering the subsequent annual losses.This has led to the rich receivingmore by way of subsidy than the pooras Cairncross (1988) noted when hefound that the poorest people inKhartoum had to pay 120 times morefor the water they purchased throughvendors than the rich paid for their

piped connections. The objective oftariffs (Laugeri, 1982) is to ensurethat optimum use is made of scarcewater resources whilst notcompromising the financial situationof the water utility.

Current thinking on helping thepoorest is summed up by Briscoe(1988):An integral and essential part of an effectivestrategy is to mobilize the community's ownresources, both fmancial and non·fmancial. Thisis necessary to ensure that the community istruly in control, that systems remain operating,and that the limited funds available togovernments are directed to wherever they areneeded most.

A goal of every improvement effort shouldbe to bring closer the day when !he communitycan cover all of the costs of its water servicefrom its own resources. Many communitiescould and should contribute more now tomeeting their costs !han they could have beenexpected to in the past. The primary role ofgovernment agencies and donoI1lmust changefrom !hat of direct provideI1l and financiers ofservices to !hat of facilitatoI1l.

To meet the apparently conflictingdemands of consumer' and waterutility, four principal objectives oftariffs may be described (IWES,1983). Tariffs should be:

Water tariffs may allow the water utilities to bring supplies closer to homes, eliminating transportation problems.

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o Adequate A level of resourcesmust be produced which will meetthe financial commitments of theutility and provide somecontribution towards futureinvestment

o Fair This level of revenue mustbe allocated between consumergroups in a fair and equitablemanner, giving particularconsideration to the needs of thepoorer members of the community.

o Simple and enforceable Thetariff should be simple toadminister and easy for consumersto understand. For tariffs to beeffective there has to be a politicalwillingness to accept the need fordisconnections when bills are notpaid. This remains true even wherethe worst offenders are othergovernment institutions.

o Water conserving The structureof the tariff should influenceconsumption to the extent thatconsumers will purchase enoughwater to satisfy their needs withoutbeing wasteful.

Ability to pay vs.willingness to payIn trying to reconcile these criteria, itis commonly assumed that as long aswater tariffs do not exceed the 'abilityto pay, level of three to five per cent ofhousehold income, low-incomecommunities will choose to abandontheir existing water supply in favour ofa new 'improved' system. Severalreviews have shown that this simplemodel of behavioural response isusually proved incorrect (Briscoe,1988). In many communities either thelevel of service is too low (that is, thecommunity does not value theimproved service and therefore willnot pay for it) or the level of service istoo high (that is, the community wantsthe service but not at the price that hasto be charged).

Willingness, rather than ability topay, therefore becomes the crucialfactor in determining service levels.Factors influencing willingness arebelieved to be: perceived healthbenefits; convenience; amenity; timesavings and economic benefits; levelof service; existence of alternativesources; income; price; different uses;different determinants; value ofwomen's time; and family size(Whittington, 1987).

Meters or flat ratesTo meet the criteria of simplicity andwater conservation there is a choice

between using a flat rate charge or ametered charge. For household orindividual connections tariffs havebeen charged according to:

o size of the connection pipe, withdifferent flat rate charges fordomestic, institutional, commercialand industrial users;

o property values;o property characteristics, that is the

number of taps, basins, showers orbaths;

o the amount of water used,measured by household meters.

It is believed by many that the use ofmeters best fits the four objectives oftariffs. In the United Kingdom thenewly privatized water utilities have tofind an alternative to the old flat ratesystem of tariffs based on propertyvalues. First indications from theirextensive studies suggest that theinstallation, reading and maintenanceof meters is a very expensive exercisewith few benefits gained fromreduced water usage. Countries suchas Indonesia have used flat rates withflow restrictors in the connection linesin order to limit water wastage.

StandpostsThere are different problemsassociated with standposts wheretariffs have been based upon:

o a flat rate charged on allsurrounding households;

o a water rate charged as an additionto local council taxation or as apercentage of ground/property rent;

o an agreed water rate paid bygovernment to the water utility as asocial service;

o a meter on the standpost with thecost shared out in the communityper family, per person, or byproperty value - but withconsiderable difficulties decidingwho organizes the share out;

o an individual or communitycouncil concession or water kioskwhere access to the standpost iscontrolled and water is sold atfixed rates, usually determined bygovernment.

Ideas fIrst developed as elements ofcommunity participation programmesin rural areas and later adopted inurban areas are described by Maheri(1990). A community associationtakes up full responsibility for the

distribution of water in a defined area,making its own arrangements forcollecting a suitable tariff fromhouseholders and paying the localcouncil for bulk delivery of water tothe distribution system. By thismethod the utility gains by not havingto manage the many leaks andconnection problems or a distributionsystem whilst only having to collectmoney from a single customer. Thecommunity gains by having muchgreater control over their own watersupply and its extension to universalhousehold connections.

Setting tariff ratesWhatever the method of charging, thefixing of tariff rates has considerablepolitical implications, particularlywhere a high rate of inflation has, overa number of years, reduced the valueof existing rates. There are variousapproaches to setting rates that can beconsidered:

o Increase the tariffs modestly in linewith inflation - the resultingrevenue may not be sufficient toenable the utility to do its job but atleast it is more or less acceptablepolitically.

o Aim for full recovery of operationand maintenance costs, assumingthat the capital costs were a donorgift to the people.

o Set tariffs to recover operation andmaintenance costs plus fullamortization of the capital costs,that is, paying back any loans,including interest.

o Aim for a target rate of return onfixed assets employed in additionto operation, maintenance andamortization costs - it is desirablefor a surplus over and above theimmediate cash requirements to begenerated to provide a contributionto future investment; this will thengive a measure of independenceand reduces reliance on outsidesources. It is also the method anycommercial enterprise would use.

o Use long run marginal costing, alsoknown as Average IncrementalCost (AIC); this is a method ofcharging the full life-cycle costs ofextending the water-supply systemto meet increased demand.

This last method is attractingincreased attention from the fundingagencies, who believe that it isbeneficial if the rates charged signal to

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the consumer the value of theresources used in providing theservices. Rather than setting rates byreference to existing and historicalcosts, rates should reflect the cost ofproviding additional (incremental)services. Thus consumers are informedof the true costs of providingadditional services, and throughadjustments to their consumption canindicate their willingness to consumeat that rate.

The marginal cost is the additionaloperating cost for an additional unit ofoutput. Where extensions of capacityare required to allow for increasedconsumption, marginal cost includesthe necessary investment costs overthe long run. Strict application ofmarginal costing can cause large andsudden fluctuations in price - thedonor agencies therefore favour AICwhich sets the price equal to theaverage or long-run marginal cost

As the cheapest nearby watersources are the first to be used, themarginal cost price will normally behigher than the price based onhistorical costs.

Variable block pricingIn order to meet the four objectives oftariffs it is not necessary to have asingle rate, as determined by any ofthe methods described above. Inparticular it may be politicallyunacceptable to use the preferredAverage Incremental Cost method forall consumers because it appears tolead to very high tariffs.

A compromise solution is toincorporate the marginal rate as thesecond or third block in' a block ratestructure. Initial consumptionproviding for basic needs at ahousehold level of about 10m3 permonth would be charged at a lowerrate, estimated according toaffordability. Higher or discretionaryconsumption could be chargedaccording to consumers' willingness topay at full historical costs or even atthe long-run marginal rate.

Average tariffsTariffs from nine water utilities inAfrica were investigated (Saquee1986) finding an average tariff formetered domestic consumers of$0.22/m3

• However, for low-incomehouseholds where water is deliveredthrough standposts, the charge is likelyto be zero; where delivered by vendorsthe charge may be many times higherthan the piped tariff. This compareswith an average for fifteen Europeancountries (Stadtfeld, 1988) of

The cost of providing a piped water supply is often less than the cost of waterboughtfrom vendors by the bucket.

$0.53/m3• representing between 1 and the state government, in addition to

0.3 per cent of household income. water rates and charges.Since 1982 the state subsidies and

grants have been reduced, reflectingBarno State Water Board the decline in federal and statutoryIn practice, social and political allocation. The income derived fromconsiderations mean that a tariff charges is small compared to the coststructure has to be adapted to suit the of operating and maintaining theparticular situation. The example existing water systems. The existinggiven here investigates an updating of tariffs are low and difficult to collecttariffs for the Borno State Water Board (The average collection period forin Nigeria. The Board was created in tariffs has improved from a low of 7241977, charged with the responsibility days to its present 202 days.)of development, operation, distribution Furthermore the present tariffs are notand maintenance of drinking-water related to the economic cost ofsupplies in the state. The Board's producing the water. This financialincome comes from monthly recurrent situation has led to intermittent supplysubsidies and capital subventions from of water throughout the state.

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The present tariff structure chargesmost domestic consumers a flat rate of$0.86 per month (7 Naira=$I) with ametered rate of $0.06/m3

, rising to$0.09/m3 above 68m3 per month onlyfor high volume domestic users.Connection fees are approximately$17.50. Industrial and commercialmetered tariffs are O.14/m3 and$0.15Im3 for monthly consumption upto and over 2272m3

•

Calculated tariffsAs the price of water varies theamount used is also likely to vary(above the level of the most basicneed). This price elasticity is definedas the percentage change in quantity,divided by the percentage change inprice. Katko (1988) reports ratios ofbetween -0.2 to -0.4 which suggeststhat as the price is doubled,consumption drops by between 20 percent and 40 per cent. This informationis important in the setting of proposedtariffs to ensure that the desired totalrevenue is achieved.

It has been determined (Usman1988), that with a 6 per cent rate ofreturn on fixed assets employed, theaverage water charge for Maiduguri,assuming 30 per cent wastage in thedistribution system, should be in theregion of $O.086Im3

• This represents a40 per cent increase on the existingtariff. Using a price elasticity of -0.3this would lead to a 13 per centreduction in water usage.

In the case of Borno, however,because of considerable unfulfilleddemand for water it may be assumedthat the subsequent shortfall in totalrevenue does not have to be made upby an additional increase in tariffs.

The growing demand for water hasled the Board to initiate a new surface-water project. This is expected to becommissioned in 1991, and initialcapacity of lO,274m3 per day and a 15per cent annual increase in productionup to 1977. With a total capital cost of$24.5m. and annual operating costs of$0.8m. in 1997, the Ale method ofcalculation suggests a tariff for waterfrom the new works of $0. 181m3 at an11 per cent discount rate. Thisrepresents a 28.5 per cent increaseover the existing initial industrial andcommercial rates.

These computed tariffs may be seenas two blocks of an increasing-blockpricing system. Low-incomeconsumers would receive their waterthrough standposts, paid for in BornoState by local government (at a rateequivalent to the historical cost with a6 per cent return on assets) for reasonsof social equity. Low-volume

consumers with yard taps are assumedto use an average of 16m3 per monththereby paying a flat rate of $1.40 permonth. Medium- to high-volumedomestic users, including all thosewith underground storage tanks, aremetered, with the option of using AlCrates for the highest consumers.Industrial and commercial consumersshould pay the long-run marginal costof producing the extra water theydemand.

RecommendationsBased on Usman's study it wasrecommended that:

o tariffs should be based onincreasing block rates;

o connection charges payable bylow-income households should belevied as a standing charge spreadover many years;

o tariffs must be levied on all usersof water;

o the system of charging should bewidely comprehensible, fair andwater conserving;

o metering can be a useful approachto meet these requirements and theBoard should aim to m.eter allservices to medium- and high-volume consumers in Maiduguri.These meters should be checkedand consumption recordedmonthly;

o charges for stand posts should bepaid by local government,deducting it from the monthlyallocation they receive from theState Government;

o strict penalties should be imposedon the illegal resale of water andon the construction of privateunderground tanks;

o the Board should organize healtheducation workshops with theassistance of the Ministry of Healthin all towns so that the need forimproved water supplies and itsrelated costs can be understood byall.Subsequently, Usman reports that

the proposed tariffs have beenaccepted by the Board and approvedby the state government.

A water utility has to receive anadequate level of funding if it is toprovide the services that consumersdesire and need. Where thegovernment tax base cannot supportthe utility in the long term thenfinance has to be obtained throughuser-tariffs. Modern managementideas reject the concept ofsubsidization from other sectors of the

economy because of the lack ofcontrol of income on the part of thewater utility.

The poorest consumers can besupported effectively throughdifferential pricing structures withinthe water sector, but long-termreliance on local authorities to pay forwater delivered through standpostsmay not produce the desired benefits.The wastage that is apparent at moststandposts devalues that water andlessens the potential for resultinghealth benefits. The process ofextending utility management over thefinancial aspects of water supply willhave to cover standpost users inaddition to other consumers, eitherthrough community-associationcontrol or through vendor kiosks. •

ReferencesBriscoe, J. de Ferranti, D., Water forrural communities, World Bank, 1988.Cairncross, S., Kinnear J.,Measurement of the elasticity ofdomestic water demand, LondonSchool of Hygiene and TropicalMedicine, 1988.Gilling, J. 'World Bank Water TariffPolicies', Aqua, Vol. 2, 1980.!WES, Water supply and sanitationfor developing countries, Institution ofWater Engineers and Scientists, 1983.Laugeri, L., Tariff structures in watersupply, WHO, ETS/82.2, 1986.Maheri, C.M.W., personalcommunication, 1990.Saquee, G., Water tariff for provincialwater supply, Sierra Leone',unpublished Msc thesis,Loughborough University ofTechnology, 1986.Stadtfeld, O.R., Schlaweck, K.I.,'International comparison of waterprices', Aqua, Vol. 4, 1988.Usman, B., 'Tariff structure for BornoState Water Board', unpublished MScThesis, Loughborough University ofTechnology, 1988.Whittington, D., Briscoe, J., Mu .. X.,'Willingness to pay for water in ruralareas', WASH Field Report 213,1987.

Richard Franceys is a lecturer at WEDe,Loughborough University of Technology,Leics., LEll 3TU, UK.

AcknowledgementThis paper in its original form was presentedat the Fifteenth WEDC Conference in Kanoby Bukar Usman and Richard Franceys whogratefully acknowledge the information givenby the Borno State Water Board; the ideasexpressed do not necessarily reflect thepolicies of the Water Board.

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