guide2008_en

4.4Case Study: investment in a waste water treatment plant

4.4.1Project definition

The project is an investment in the field of waste water treatment, and for the reuse of well purified waste water for multiple purposes after an intensive tertiary treatment. It takes place in a Convergence region in a country eligible for the Cohesion Fund.

This project includes the construction of a new water purifier, in keeping with current regulations, to serve a medium-sized city (725,000 residents in the initial year, with the population growing an annual rate of 0.15%). Currently wastewater is discharged untreated into the river crossing the city.

The project includes the realisation of four modules of intensive treatment for water re-use, which will treat on average, about 70% of the flow of purified waste. Below this plant, two pumping stations and a pipe system will be erected to carry the treated water to the existing header tank in the irrigated area and the existing reservoir serving the industrial network79. Both the irrigation network and the water distribution network for the industrial plants already exist.

The wastewater and nearby tertiary treatment plants will take up a total area of 7,000 square meters.

The industrial area is already well developed. There are more than one hundred small and medium-size factories and many craft workshops. At present, the water supply is obtained through wells, subjecting the groundwater to an over-abstraction. For this reason, the local aquifer has been depleted, and its hydrogeological level has been considerably lowered in recent years. The territory with irrigated agriculture, not far from the city, is a new irrigated area and has a surface of 3,500 hectares, some of which are foreseen to be equipped with greenhouses in the next future.

The overall investment is realised by the Municipality, which will choose a private partner by means of a build operate transfer (BOT) tender (a form of Public Private Partnership, PPP). See Annex G for this type of PPP. The BOT horizon is fixed at 30 years and includes the time for design, erection, start-up and operation of the system.

The Municipality receives the revenues paid by the users for drainage water collection80 and the wastewater collection and treatment services. It pays, at a stated price per unit, the operating service charge to the PPP private partner. The drainage collection and sewerage system is directly managed by the municipal staff.

The private partner receives the revenue coming from the water tariff paid by industrial and agricultural users and sustains the ‘private’ part of the project investment and the operation and maintenance costs.

The Municipality receives the European and national (or regional) grants and transfers them to the private operator81, along with its own capital contribution (taken from the municipal budget). The private partner will provide the finance to cover the remaining part of the investment cost.

In the household sector, the demand for purification comes from the users of the existing urban sewer network. The industrial demand for water for process uses, or for other industrial purposes, comes from factories and craft laboratories. The water is used to irrigate the various seasonal and multi-seasonal crops and in greenhouses. The box below deals with the identification and the quantification of the water demand in the project.

In the feasibility study the BAU alternative was rejected because it involves further exploitation of groundwater, which, as previously stated, was being depleted mainly by the existing industrial use of the water.

79The recycled water is supplied to the factories for process and other industrial uses, but not for the human consumption.

80The sewage treatment plant is designed to treat rainwater up to a scale equal to 5 times the design flow of the wastewater.

81Proportionately for progress of the system construction.

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4.4.2Financial analysis

Although in this project the owner of the infrastructure (the Municipality) is different from the operator (the private partner of BOT assignment), a consolidated financial analysis is carried out. The time horizon for the analysis is assumed to be 30 years, the same as for the BOT.

In the analysis constant prices are used and corrections are entered for changes in the relative prices. Such adjustments are undertaken by assuming an average annual inflation rate of 1.5% and also by taking into account growth factors, marginal decreases in the prices of some services and some operating costs (see below for details). Thus, only relative price changes are considered. The financial rate of discount is 5%, expressed in real terms.

The cost of the investment includes the construction of the effluent and discharge mains, of the waste water treatment plant, the water refining treatment plant and the aqueducts (including the pumping houses) to supply water resources to the industrial and irrigated areas. The cost of such an investment, excluding VAT, is set at €100,831,000 (at constant price)83 and has been subdivided into homogeneous categories, whose values have been attributed to the first three periods, on the basis of the time programme for the implementation of the project.

Table 4.39 Distribution of investment cost in the time horizon

The start-up phase, lasting 5 months, will commence in the fourth year, in which the production is assumed to be at 70% of the regime production. The components of short lifetime84 (60% of the equipment costs) will be replaced once during the investment horizon, at the end of their economic life (16 years85). For the sake of simplicity, the calculation is made by introducing the whole cost of the aforementioned components in the twentieth year86.

Keeping in mind the aforementioned PPP arrangement scheme, the investment is financed87 by grant (ERDF and national or regional funds), by the fund provided by Municipality and by funds provided by the private partner. The requested co-financing EU grant is €22,129,000 (21.9% of total investment costs at current prices without VAT). An amount of €19,029,000 (18.9% of investment costs) is provided by a national or regional fund. The Municipal fund is €10,263,000 (10.2% of investment costs). The private financing (€49,410,000, the 49.0% of investment costs) is given by equity for 50% of the amount (€24,705,000) and by loan for the other 50% (€24,705,000). The loan has a 5.00% interest rate with an amortization period of 10 years.

The financing for the replacement of the short life-time components is provided by the private partner (50% equity, 50% loan) in the 20th year (€22,652,000).

83The cost of the investment at current prices is € 100,831,451.

84These are, basically, machines and other electromechanical equipment for the treatment and pumping plants.

85In accordance with the technical data from literature.

86The twentieth year has been determined taking into account 3 years of plant construction plus 16 years of life.

87The sum to be financed is the cost of investment net of VAT.

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THE CALCULATION OF REVENUES

Referring to a base years, the revenue predicted has been calculated as follows:

-civil purification service (in the current situation ‘without the intervention’ no purification charge is applied): 50.3 Mm3/year

*€0.283 per m3 * 0.950 = 13,523,000€/y90;

-industrial supply in the reservoir: 12.1 Mm3/year * €0.480 per m3 * 0.995= 5,779,000€/y;

-irrigation supply: 15.75 Mm3/year * €0.030 per m3 * 0.87 = 411,000€/y;

-to take into account the certain expected level of evasion of the payment of service bills the following ‘dispersion factors’ have been applied cautiously before revenue calculating: municipal services: 5%, industrial water supply service: 0.5%, irrigating water supply service: 13%.

-at the end, in calculating the performance indices, the values of the revenues in each year are obtained starting from the above baseline values and taking into account the growth in the water demands (see above) and the dynamics of current prices.

In addition to the above mentioned revenues, the residual value, over the 27 years of life of the infrastructures91, is set to be 4.0% of the initial costs of the long life parts of the investment plus 3.8% of the costs of the replaced components (short life parts). The total residual value (€6,030,000, expressed at constant prices and not discounted) is allocated in the last year (30th) of the investment period.

As for the financial sustainability of the project, the cumulative cash flow of the project is always positive with a minimum value of about €788,000, occurring in the fifth year.

Moreover, if the service fee is set at €0.02 per cubic metre of treated water, the separate analysis of the financial profitability of the local public capital (Municipal funds, i.e.: FNPV(Kg) and FRR(Kg)) and the financial profitability of the private capital (equity and loan to finance the investment and replacement costs and the cash deficit in the early years of operation, i.e.: FNPV(Kp) and FRR(Kp)) – net of EU grant

– gives the following results:

For this project, the maximum amount to which the co-financing rate of the priority axis applies is €32,467,727. This is determined by multiplying the project eligible cost (in this case €100,831,451 at current price) by the funding-gap rate (32.2%). Assuming the co-financing rate for the priority axis is equal to 80%, then the maximum EU contribution is €25,974,182.

90Note that the rate of the purification service is applied to the volume of water delivered to users, as measured by the water meters.

91At the end of the horizon time, the operative life of the plants and other equipments is equal to the analysis horizon minus the construction time: 30 – 3 = 27 years.

92In the table 3.32, the functioning financial costs are financed by short-term loans with an average interest of 8%.

93The sum of FNPV(Kg) and FNPV(Kp) is not equal to FNPV(K), because the amount of capital expenditures incurred separately by the partners does not include the national contribution, that instead is considered, in addition to above mentioned contributions, in the calculation of FNPV(K). A similar reasoning applies to the values of FRR(K).

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0.15 m3/m2 a depreciation of 20% of a yearly rent96 of about 63.6 €/m2 (corrected) leads to an hedonic price of 980 thousands of Euros per year.

For the evaluation of the economic benefits, the revenues collected by the Municipality and the operator from the services, even if corrected by means of appropriate CFs, do not, in this case, adequately represent the social benefits from the project97. So, in the present analysis, the financial inflows have not been included at all, in order to avoid any double-counting.

Generally, for the evaluation of the positive externalities or the benefits due to water supply services, the willingness-to-pay method could be used in order to establish accounting prices for the services that may have an alternative market. Since the accounting prices thus obtained refer to the service to the end-user, then in order to obtain the prices required for the analysis, appropriate breakdown coefficients derived from literature and experience have to be taken into account98.

In the present case study a direct valuation approach was preferred, differentiated for various services, as follows.

-The major benefit of the new system, that will supply the water to the industrial area, is the saving of the groundwater resources, with the consequent restoration of the hydro-geological balance over time and the generation of many positive environmental effects. A possible conservative approximation of the value of this positive externality can be obtained by putting a value on the volumes of water saved. Water is no longer extracted from groundwater, but supplied by the new project system re-using the intensively treated wastewater. In this case, the volumes of industrial supplied water (equivalent to the amount of resource yearly saved from the groundwater), reduced by a coefficient of dispersion99 (0.80), are equal to roughly 9.7 Mm3/year, assuming a potential irrigation re-use, at an accounting price100 of €0.81 per m3.

-The main benefits of the new irrigation service are the significant improvements in quantity and quality and the greater diversification of products, which increases the income of farms in the area. In the situation without intervention, agricultural production was limited by the scarcity of water, almost all taken from the local groundwater (oasis-like irrigation). Conservatively, an increase of 25% of added value generated in the irrigation area (estimated to be €52,000 per hectare; see above) has been taken. To the value obtained a breakdown factor (0.65)101 was applied in order to take account of the irrigation distribution network which is not part of the project. The method described above should be generally applied with caution. First, we must be careful not to double count the social benefit. This risk was avoided here by not taking into consideration the financial revenues from the irrigation service. Secondly, the accounting price for the supply of irrigation water, mentioned above, is not really suitable in this particular case. This price refers, in fact, to the economic benefit from new irrigated areas (practically not cultivated before). So, the accounting price might overstate the benefit due, as is the case under examination, to the replacement of a local irrigation system with a new system that is more stable and efficient. Not having a more appropriate value of the accounting price, the relative increase of the added value of the yearly crop production has been taken as the best proxy of the benefit.

96The figure adopted derives from a study on similar cases in the same state carried out with various methods (including: revealed preference and stated preference methods). See also: European Commission, Common Implementation Strategy for the Water Framework Directive, Guidance Document No 1 ‘Economics and the Environment – The Implementation Challenge of the Water Framework Directive’ produced by Working Group 2.6 – WATECO, 2003.

97The water service is a classic case of natural monopoly. Market prices generally suffer considerable distortions. As an example, the prices in the sector are based almost always on administered tariffs, which are, for many reasons, far from the equilibrium values.

98Accounting price for the supply of industrial water: € 1.00 per m3 x 0.70 (breakdown coefficient only for bulk water supply) = € 0.70 per m3. Accounting price for the supply of irrigation water: € 0.24 per m3 x 0.65 (breakdown coefficient only for bulk water supply) = € 0.16 per m3.

99Due to the leakage and other reasons.

100This accounting price was applied to evaluate the benefit due to the saving in resources abstracted from natural sources and substituted, as stated, by treated waste water. For the additional volumes of water the greater added value of the additional (or improved) agricultural production due to the greater availability of water was evaluated. In this way one obtains a value of € 0.81 per m3, used in the calculation. This last accounting price could be used to evaluate the benefits of the additional supply of resources for irrigation purposes, too.

101Values of the breakdown factors between the adduction and distribution or between other parts of the water nets can be derived from the analysis of the data reported in the technical literature on water services.

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As result, the probability distributions for the financial and economic performance indicators are calculated, utilizing the Monte Carlo method.

Table 4.44 Risk analysis: variable probability distributions

Note: MV = Mean value; SD = Standard deviation.

Figure 4.14 shows, as an example, the probability distribution obtained for the ENPV and in the following table other characteristic probability parameters are given (in thousands of Euros and %) for economic performance parameters.

Table 4.45 Probability distribution for ENPV and ERR

The following table shows the comparison of the Community contribution determined in the base case (see the previous section ‘Financial analysis’) with that calculated assuming the expected values (mean values) of the parameters (Investment cost, Residual value Revenues, Operating costs), derived from the risk analysis. Given the expected values, the maximum Community contribution is higher (+5.3%) than that in the base case.

Table 4.46 Results of risk analysis on Community contribution

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