Just over two years after the water crisis in Southeast Brazil, its effects still have repercussions on the concession instruments or programs in effect within the public sanitation services. Even with the normalization of the droughts, the level of concessionaire indebtedness is inversely resilient to the volume of the reservoirs, which leads to further discussions in the tariff review processes conducted by the state regulatory agencies.
In general, the water crisis created a substantial change in the material circumstances in which utilities provided sanitation services due to both the forced reduction of demand (less availability of water) and the increase in water production costs and the need for new investments in more complex capture and adduction processes.
Conformity of the cycle was achieved through emblematic projects. In Minas Gerais, for example, Copasa carried out catchments in the main aquifer supply system of the Metropolitan Region of Belo Horizonte, Paraopeba, in addition to new artesian well drillings. In São Paulo, Sabesp interconnected some of the Cantareira System dams (such as the Jaguari with the Atibainha) and implemented a new schedule for the São Lourenço Project, one of the most successful public-private partnerships in terms of financing. The implementation of dams in the PCJ basin, with funding from multilateral agencies, is in the final phase of environmental licensing and about to be finalized.
This framework reveals not only an increase in current service expenses, but also, and above all, a significant change in the remuneration assumptions (pay back/amortization, risk, and opportunity cost) of the concessionaires' investors and creditors, since new investments (capital expenditures) had to be anticipated or conducted beyond the parameters originally designed and approved by the state regulatory agencies. These entities generally define a Regulatory Remuneration Rate in establishing the methodology for calculating cost recovery and capturing capital opportunities used in the expansion of services.
In the sanitation sector, the Regulatory Remuneration Rate must consider, by virtue of law, factors that, in general, are not mandatory in other regulated industries. As a financial discount rate for the calculation of the net present value of the concession contract (or, as the case may be, the project), the Regulatory Remuneration Rate is a necessary parameter in promoting tariff revision, not a mere readjustment. It is bound by article 46 of Law No. 11,445/07, which states that "in a critical situation of scarcity or contamination of water resources that requires the adoption of rationing, declared by the water resources management authority, the regulator may adopt contingency tariff mechanisms, with the objective of covering additional costs incurred, thereby ensuring a financial balance between service delivery and demand management."
The regulatory decree (No. 7,217/2010) further determines that the regulations should contemplate a tariff model that ensures not only the tariff modality, but also the economic-financial balance of the contracts, it being the responsibility of the agencies to define “system, structure, and tariff levels, as well as procedures and deadlines for setting, readjusting, and revising them." It is also incumbent on the agencies to ensure the participation of owners, users, and service providers, as well as to create mechanisms to induce efficiency, including productivity factors in the new tariff models.
In the tariff revision procedures, after the initial stage of establishing criteria and methods by which the concessionaire's current costs are calculated, one proceeds to an analysis of the elements that should compose the tariff structure and the respective risk matrix, which establishes as parameters remuneration and any events linked to obtaining financial return by the respective shareholders and creditors.
As the cost of capital for each source of financing is differentiated, most of the tariff revisions in the sanitation sector use WACC (Weighted Average Cost of Capital) as the average cost of owned and third-party equity. By this methodology, the financing costs are weighted according to the company’s capital structure, that is, according to the sources of financial resources employed, not considering their tax effects. The following aspects are principally considered in this analysis: (i) remuneration of the investment made by the service provider with its own funds, arising from both the generation of cash and the contribution of new resources by the shareholders (equity); and (ii) funds obtained from sources outside the company, for example, loans from financial institutions, issuance of debentures, promissory notes, and other credit rights (third-party capital). Therefore, more than one Regulatory Remuneration Rate, specific to each source of funding, is allowed.
The main controversies are concentrated, as a rule, in the measurement of the cost of equity. This is due to the fact that third-party capital still comes mainly from the domestic market, in which interest rates (Selic, TJLP, TR, and preferential rate) are directly or indirectly regulated by the monetary authorities, especially the Central Bank. Thus, quantification of the cost of capital is subject to even more objective metrics. Regarding equity, on the other hand, the Regulatory Remuneration Rate, according to some precedents in the sanitation sector, within the purview of the state regulatory agencies, has been following the Capital Asset Pricing Model (CAPM), by which one tries to establish a balancing relationship between the expected return and the risk factor, assuming as parameters of the latter the profitability of an unencumbered asset, the profitability of the market portfolio, and the sensitivity of the company's assets to market returns.
Risk free assets are devoid of volatility in the returns, that is, uncertainties with respect to future gain. Similarly, profitability of the market portfolio relates to the expected return capable of encouraging investors to invest in the stock market. Finally, the sensitivity of the company's assets to market returns is measured by the beta coefficient. This unit of measure symbolizes a systematic risk of an asset (market risk), which reflects possible and future fluctuations in the behavior of macroeconomic variables (inflation, economic growth, external crises, foreign exchange, etc.) that affect the concessionaire.
The CAPM does not automatically introduce, however, a sectorial or microeconomic risk premium, taking into account the specificities of the sanitation sector in a given country or region. In addition to the variables pertaining to the aggregates, captured by the beta coefficient, regulatory risk and now, above all, the risk of water unavailability in Brazil and especially in the Southeast Region, are no longer adequately considered in the calculation of the Regulatory Remuneration Rate.
The lack of attention given by some regulators to these last points has led, even if only for a certain period of time, to an undesirable loss of market value of publicly-held, publicly-traded companies and publicly-traded shares. These market "penalties" have an additional negative factor of increasing the cost of equity of concessionaires, since the perception of regulatory risk increases in direct proportion to the insensitivity of considering and pricing, for the future, further chances of water scarcity. In this sense, the concessionaire's cash flow contingency ends up being the only mechanism to mitigate the financial consequences of the actual occurrence of these risks, which also brings in an implicit loading cost in the business strategy.
There is no other way to deal with this result but to go back and admit that the tariff review procedures must effectively compensate for variation in the cost of executing the contract, including capital costs, taking place in the event of an unpredictable event or, as now, unavailability of water, for the Southeast, a predictable event, but with incalculable consequences.
If the public choice is to preserve moderate tariffs, maintenance of the economic-financial balance of the current concession and project contracts will have no solution except through the institution of state subsidies, which can be contributed through numerous alternatives for structuring or renegotiating the existing arrangements, such as the common concession subsidized pursuant to article 17 of Law No. 8,987/95 or the public-private partnerships governed by Law No. 11,079/04.
The revision procedure symbolizes mutual commitment in the field of responsibilities shared between public and private sectors in an effort for greater transparency and realism with respect to the challenges and perspectives in defining tariffs. In this procedure, the primary and reciprocal commitment should always be to reduce the cost of capital of concessionaires and, as a consequence, at a minimum, preserve their market value, in accordance with the requirements of financeability and bankability of new or ongoing projects.
