UNPACKING THE CHALLENGES OF FINANCING WATER PROJECTS

The Development Bank of Southern Africa (DBSA) is focused on offering a centre of excellence for water-based projects, as well as blended funding options for financiers of new waterrelated projects in South Africa. Kirsten Kelly talks to two specialists at the DBSA about governance issues around the financing of water projects.

THE INTERVIEWEES

Johann Lübbe (JL) is a disruption specialist who investigates and develops new, innovative funding instruments, products and programmes for infrastructure investment.

Konstant Bruinette (KB) is a senior deal originator who assists municipalities and water utilities to conceptualise and prepare projects for funding.

Are water infrastructure projects difficult to finance?

JL Absolutely. There are a few reasons for this, with the most obvious being:

1) Water is a basic human right, and people expect to get it for free. This means that there are limited revenue streams associated with the provision of water, as opposed to energy, for example. Water is free, but people pay for it to be treated, stored and conveyed to them – and that is what people often do not understand. In order to finance water projects, a revenue stream is essential and there needs to be a willingness and ability to pay for water.

2) When structuring projects, advisors often tend to consider only the technical aspects, but it is much broader than that. The technical side is the easier part of creating a bankable project. The more difficult parts are tariff structures, revenue sources, lending structures, types of entities, as well as legal, social and environmental aspects.

3) There are limited municipalities with strong balance sheets and the country has seen very few public-private partnerships (PPPs) in the water sector. There is funding available to invest in water infrastructure, and there are a lot of possible water projects, but very few of them are bankable.

KB I would like to add affordability and political support to that list:

4) If one wants to provide and fund infrastructure, it needs to be affordable for the end user. When structuring a water project, there is a difficult balancing act between receiving returns on an investment and affordability for the end user. One also needs to consider how to use grants available in the system to gear private sector investment.

5) You need to separate political support from water projects. A municipal political term is five years, and it may take three to five years to prepare a water project to bankability – project preparation will only be completed right before there is a potential change in political governance and project support.

When funding a project, does one include costs relating to administrative overheads, operations, maintenance, routine repairs and periodic replacements of equipment?

KB We take a view of the entire project life cycle. The DBSA sometimes provides long-term funding up to 25 years, so it is important to ensure that the infrastructure that is financed is properly operated and maintained. When looking at the project life cycle, we evaluate how all of these costs may impact on the project’s revenue streams and affordability for the end user.

JL The operation and maintenance (O&M) costs are so important. South Africa cannot continuously build new infrastructure only to find that it is dysfunctional a few years later. If government wishes to attract private sector funding into this asset class, O&M must be adequately addressed so that those assets perform according to their design specifications.

Why are PPPs so scarce within the water sector?

JL The water sector is not alone in this; quite a few other sectors are also battling to attract PPPs. I think that there are systemic issues in the way PPPs are structured. National Treasury is revising its PPP framework and approach, which will address some of these challenges and make PPPs easier to structure and implement. One of the reasons why PPPs are not successful is timing – it takes an extremely long time to put a PPP project together and it is also costly. Also, focusing on the water sector specifically, water is a basic human right and people often do not wish to see the private sector making a profit from this basic service.

KB Looking at the broader South African context, outside of the metros and secondary cities, given the consumer profile in rural areas, one would struggle to develop a PPP. The traditional PPP in the water and sanitation space has its place, but there are clear limitations when looking at smaller, rural municipalities.

Alternative models need to be developed in order to crowd in private sector investment and participation.

Do tariff structure and subsidies within the water sector need to be reviewed? JL I am generalising here, because there are exceptions, but the tariff structures in the water sector are usually not cost reflective. A lot of municipalities do not know what it costs to provide water services. Without correctly priced tariffs, it is very difficult to finance a project. KB Also speaking in general, in many municipalities, water tariffs do not reflect the true economic cost of water, which includes all operating and maintenance costs, as well as a component for risk like cost recovery and demand risk. Also, in a lot of cases, there is no rising block tariff structure that will address the issue of ‘over consumption’.

Punitive tariffs need to be used to drive down water consumption, driving system efficiencies and protecting our natural resource. The average global consumption of water is approximately 170 litres/ person/day while the average consumption in South Africa, as a water-scarce country, is 240 litres/person/day. Pricing water at its economic cost and developing a rising block tariff is key to developing a bankable project.

With subsidies, the Water Services Act (No. 108 of 1997) allows indigents to use 6 kℓ/ day to 9 kℓ/day for free. But what happens if that indigent consumes more than that basic allocation? Is that household metered and is that balance billed to that person? It is an extremely sensitive and politicised topic. But these questions need to be answered and mitigated when creating a bankable project.

What about de-risking water projects?

JL When applying to a funder, it is important to demonstrate that you have