WATER P-NOTES ISSUE 4 JUNE 2008 44722 Reducing Water Loss in Developing Countries Using Performance-Based Service Contracting A major challenge facing water utilities in the oping countries. A sizeable portion of the loss is developing world is reducing water loss caused by fraudulent activities and corruption--such caused by leakage, theft, and improper bill- as illegal connections, fraudulent meter reading, or ing. The difference between the amount of water meter tampering. put into the distribution system and that billed to consumers is known as "non-revenue water" Reducing NRW to just half the current level in (NRW). the developing world--a realistic target if both com- mercial and physical losses were tackled--would The worldwide cost of NRW is conservatively deliver important benefits. Every year an additional 8 estimated at $15 billion/year. More than a third of billion m3 of treated water would be available to ser- losses occur in the developing world, where some 45 million m3/day are lost through leakage-- enough to serve nearly 200 million people--and close to 30 million m3/day are delivered but not in- Three components voiced.1 These challenges seriously affect the finan- of non-revenue water cial viability of water utilities and limit their capacity to expand services, especially for the poor. Commercial losses are caused by under-registration on customers' meters, errors in data handling, and A high level of NRW normally indicates a poor- water theft. ly run utility that lacks technical and managerial Physical losses are leakage from the system and over- skills. Experienced operators, through well-managed flows from storage tanks. performance-based contracting, can provide the Unbilled authorized consumption includes water used missing skills. by the utility for operational purposes, water used for firefighting, and water provided free to certain groups. The case for reducing NRW Each year in the developing world, utilities' com- 1In the developing world, the utilities covered by mercial losses of water are equal in value to a the International Benchmarking Network for Water quarter of the total annual investment in water sup- and Sanitation Utilities www.ib-net.org lose an aver- ply. They also exceed the amount that the World age of 35 percent of their water each year through Bank lends every year for water projects in devel- NRW losses, an amount valued at US$5.8 billion. This note reports key messages and findings from "The Challenge of Reducing Non-Revenue Water (NRW) in Developing Countries--How the Private Sector Can Help: A Look at Performance-Based Service Contracting," by William D. Kingdom, Roland Liemberger, and Philippe Marin, published by the World Bank in 2006 (WSS Sector Board Discussion Paper 8). The complete paper can be down- loaded from www.worldbank.org/water. WATER P-NOTES vice customers, and 90 million more people could Case studies: reducing lost water gain access to water supply, without increasing pres- and increasing revenue sure on scarce water resources. Water utilities would gain access to an additional US$2.9 billion in self- We studied four PBSC projects and evaluated them generated cash flow, allowing them to become more on six dimensions: efficient and sustainable. Fairness among users would be promoted by acting against illegal con- · Scope. What is the role of the private contrac- nections and those who engage in corrupt meter- tor? What are the NRW reduction targets? reading practices. And thousands of jobs would be · Incentives. How is the performance-based ele- created to support labor-intensive leakage-reduction ment of the contract structured? activities. · Flexibility. To what extent can the private sector influence design and implementation? Why utilities struggle with NRW-- · Performance indicators and measurement. How and how the private sector is NRW reduction measured? can help · Procurement/selection. How is the contractor selected? The weaknesses of water utilities in developing countries are many: weak governance and poor · Sustainability. What happens upon PBSC com- financial management; political and economic pletion? Does the contract ensure transfer of constraints on managers; shortages of manage- knowledge to the utility? ment and technical expertise; and deteriorated infrastructure. Selangor, Malaysia: the largest The private sector can help in many ways, through public-private partnerships (PPP), service NRW reduction contract to date contracts, and subcontracting. Benefits can in- clude: In 1997, the Malaysian state of Selangor (and the federal territory of Kuala Lumpur) faced a water cri- · New technology and training to use it sis. An estimated 40 percent of the water produced · Better incentives for performance was not invoiced, and leakage was estimated at 25 percent, or around 500,000 m3/day--enough to · Creative solutions for program design and serve three million people. implementation Selangor's water utility accepted an unsolicited · Qualified human resources offer to reduce NRW. The contract specified a target · Flexibility in performing field work for NRW reduction within a given time, in return for a lump-sum payment. The contractor had full re- · Investment. sponsibility for design and implementation. Performance-based service contracting (PBSC) Incentives for achieving targets included penal- is a relatively new approach under which a private ties for noncompliance and a performance guar- firm contracts to implement an NRW reduction antee. The contract included establishing district program. The firm is paid for services and of- metered areas (DMAs), pressure management, leak fered incentives to meet targets. The applicability detection and repair, identification of illegal con- of PBSC depends on local circumstances, and nections, and customer meter replacement, as well contracts have to be adapted to how much risk as the supply of all equipment and materials. The the private sector will take in a given country. With contractor was free to choose where to conduct re- proper government oversight, PBSC can gener- duction activities. ate immediate operational and financial benefits. However, it is not a substitute for instituting the Phase 1 of the contract showed how a private broader reforms necessary to promote sector sus- firm operating under a performance-based service tainability. contract can efficiently reduce NRW losses. Perfor- mance actually exceeded targets: Twenty-nine DMAs ISSUE 4 · JUNE 2008 were established, with average savings of 400m3/d m3/day of loss reduction. And it appears that the in each; around 15,000 meters were replaced. The contractors failed to put some systems in place for cost was US$215 per m3/d. later use by the MWA. MWA has tendered a project A second, larger contract was awarded to for advanced network monitoring, DMA establish- the same company, with an ambitious target of ment, and other key tasks to redress this failure. 200,000 m3/d in NRW reduction--never before at- tempted under a PPP arrangement. São Paulo: payments The long-term sustainability of the approach and collections taken is not clear. Phase 1 included staff training, but the water utility failed to maintain improvements, SABESP, the utility that serves the São Paulo Metro- and phase 1 zones reverted to contractor control in politan Region, is one of the largest public water phase 2. Clearly, any NRW strategy must address utilities in the world, supplying 25 million people. the issue of what to do once the contract ends. By 2004, it was incurring daily revenue losses of 1 million m3/day because the metering system was under-registering true levels of consumption. SABE- Bangkok: plugging leaks SP chose to address the problem by replacing the meters used by 27,000 large accounts. Five meter- Bangkok's Metropolitan Waterworks Author- replacement contracts were awarded. The contrac- ity (MWA) struggles to cope with demand from a tors were responsible for analysis, engineering and fast-growing population. During the 1990s, as the design, and supply and installation of new meters. system's supply swelled from 3.0 to 4.5 million There was no upfront payment; contractors were m3/day, NRW rose dramatically, reaching a peak in to be paid based on the increase in billed volume. 1997 (1.9 million m3/day, or 42 percent). System The contractor financed the entire investment. input was reduced to below 4 million m3/day. NRW then decreased and stabilized in 1999, although at Performance payments were chosen because a high level of 1.5 million m3/day. the tasks of resizing and "flow profiling" the me- ters were the most critical activities in the contract. Subsequent efforts decreased NRW by 30 per- Given the high consumption of the customers cent to 1.3 million m3/day, even as system input concerned, proper calibration could significantly increased to 4.2 million m3/day. The reduction can increase metered flows. By linking payments to the be traced to performance contracts that began in improved billed volumes, SABESP ensured that the 2000 in three of Bangkok's 14 service branches. contractor would focus on these critical issues. Contract design for the three contracts differed The results were remarkable. The volume of significantly from the Selangor model. There was no metered consumption increased by some 45 mil- leakage-reduction target, and payment was based lion m3 over the contract's three years; revenues in part on true water savings. Each contractor was increased by US$72 million. Of this, US$18 million free to undertake activities as it saw fit. Instead of a was paid to the contractors. The net benefit to SA- lump-sum payment, as in Selangor, remuneration BESP was US$54 million. consisted of: (a) a performance-based manage- ment fee to cover overhead, profits, and foreign specialists, (b) a fixed fee covering local labor, and Dublin: upgrading (c) reimbursables for outsourced services, work, and materials--the largest part of the project's cost. This a very old system high proportion of reimbursables transferred a sub- stantial amount of risk from the private to the public In January 1994, the City of Dublin faced a severe partner. water shortage caused by decades of underinvest- ment in the distribution network and inadequate The contracts were a technical success: physical leakage control. Some 175 million m3--more than losses were reduced by 165,000 m3/day--enough 40 percent of treatment capacity--were estimated to to serve 500,000 residents. Cost efficiency, howev- be leaking from the system every day. Several areas er, varied widely between US$246 and US$518 per of Dublin had only an intermittent supply of water. WATER P-NOTES The Dublin Region Water Conservation Project, Training and capacity building led to substantial co-financed by the European Commission, was transfer of technology. The Dublin water utility now charged with reducing physical water losses. To regularly controls leakage. meet the ambitious target--reducing leaks from 40 percent to 20 percent (from 175,000 to 87,000 m3/day) over two years--an experienced contractor Lessons learned was required. In November 1996, eight consortia were invited It is possible to cut NRW losses by half in develop- to bid on the leak-reduction contracts. The contrac- ing countries through well-designed reduction pro- tor to be responsible for establishing DMAs, locat- grams. That possibility should capture the attention ing and repairing leaks, installing pressure-reducing of donors and developing-country governments. valves, rehabilitating parts of the network, and Performance-based service contracts appear training utility staff. Essentially a target cost contract a viable way to reduce NRW losses, provided two expressed in monetary terms, the arrangement in- essential elements are present: good contracts cluded bonus and penalty incentives. and realistic baselines. Contracts must clearly state A private UK water utility won the contract. all expectations and success metrics and should Remuneration included a management fee, techni- include guidelines concerning risk transfer, an indi- cal labor, and all leak-detection equipment, but cator for leakage, and provisions for oversight by excluded the cost of leak repairs, repair materials, utility managers. Contracts should set viable targets and network rehabilitation, which were carried out and allow flexible responses to challenges and op- through local subcontractors as reimbursables. portunities. The accomplishments were significant. Five Good preparation is required, starting with hundred small DMAs were created, covering the a strategy to address the sources and magnitude entire distribution network. Some 15,000 leaks of NRW over both the short and long terms. Op- were repaired, and about 20 km of mains replaced. portunities for private sector participation can Leakage dropped from 175,000 m3/day to about be identified during this stage. Once these are 125,000 m3/day--not the 20 percent target but known, incentives should encourage the private sufficient to end the crisis. The cost of the contract sector to deliver reductions in the most cost-effec- was US$750 for each cubic meter per day of water tive manner, allocating risk appropriately between saved. the parties. The Water Sector Board Practitioner Notes (P-Notes) series is published by the Water Sector Board of the Sustainable Development Network of the World Bank Group. P-Notes are available online at www.worldbank.org/water. P-Notes are a synopsis of larger World Bank documents in the water sector. THE WORLD BANK | 1818 H Street, NW | Washington, DC 20433 www.worldbank.org/water | whelpdesk@worldbank.org