7. Ensuring sustainable finance, investment and pricing for water and water services

The Recommendation calls on Adherents to “set up measures for the sustainable financing of water services, water infrastructures, water resources management and protection of water-related ecosystems”. The 2019 OECD Implementation Water Survey reveals that 63% of respondents (Figure 7.1) have developed a funding strategy alongside their water management plans.

Country-level projections provide estimates of the level of financing needed to meet future water infrastructure and service demands. Financing needs are driven by factors such as urban population growth, the need to adapt to climate change, or changes in the appropriate levels of water security (which translates into more stringent regulations). For example, in Europe, investment needs in all EU member states are projected to increase by more than 25% by 2030, to comply with the Drinking Water Directive and Urban Wastewater Treatment Directives (Figure 7.2) (OECD, 2020[1]).

Issues related to the sustainability of financing strategies for water-related infrastructure are not limited to water supply and sanitations services. As regards agriculture water, renewal of existing assets require additional expenditure. For instance, Japan has invested heavily in its irrigation infrastructure over the last 50 years, but more than 20% of the core irrigation facilities have now exceeded their expected lifespan (OECD, 2019[2]). In light of these challenges, the Recommendation suggests Adherents consider a set of principles for financing water-related infrastructure and water resources management, while aiming for the greatest social returns to investment and diversifying revenue streams.

Adherents to the Recommendation should “Consider four principles for financing water resources management: Polluter Pays, Beneficiary Pays, Equity and Coherence between policies that affect water resources.” These principles can usefully guide policy decisions for financing water management, notably when designing instruments, and help guide the allocation of scarce public resources (OECD, 2012[3]).Figure 7.3 shows that nearly all Adherents responding to the survey have adopted the Polluter Pays Principle and 17 out of 26 Adherents the Beneficiary Pays Principle. Considerably less, namely only 9 and 10 out of 26 responding Adherents state that equity and policy coherence principles were considered in the context of financing of their water resources management. More detailed reviews would help understand if and how the Principles are taken into account, and implemented on the ground.

The Polluter Pays principle is considered by over 90% of respondents, based on the 2019 OECD Implementation Survey. It serves the following purposes: either influence behaviour to reduce pollution, or generate revenues to alleviate pollution and compensate for social costs. Framework legislations, such as the EU Water Framework Directive (WFD) or the EU Waste Water Framework Directive have further encouraged Adherents part of the European Union to embrace this principle (Box 7.1). This principle is reflected in economic instruments, such as taxes and charges (e.g. abstraction or pollution charges) that many Adherents have put in place (see below or further details). Some Adherents, such as Belgium, Canada, France or Spain, also require industry to pay for managing water pollution, through extended producer responsibility schemes (OECD, 2019[4]). Such schemes transfer some of the costs of treatment to the polluters, and are therefore in alignment with the Polluter Pays Principle. They provide a financial incentive for polluters to invest in less polluting production processes or more sustainable substances/products (Box 7.2).

There are different approaches to the use of revenue of such policy instruments. In Mexico for instance, the resources collected in line with this principle are integrated into the general budget for its allocation according to national priorities and not earmarked for water expenditures, thus contributing to higher efficiency of budgetary expenditures.

The Beneficiary Pays principle aims at sharing the costs of water management between different water users such as industry, households and agriculture. The use of payment for ecosystem services illustrates this principle well, whereby beneficiaries pay directly (or indirectly) for the service providers. The city of Paris (France), or Munich (Germany) run voluntary payment schemes to encourage local farmers to adopt more sustainable organic farming practices, hence paying for improving water quality upstream (OECD, 2015[5]). In the United Kingdom, the water regulating agency has encouraged water companies to adopt catchment approaches in which they support improved agriculture practices in upstream farms to reduce downstream pollution (Gruère, Ashley and Cadilhon, 2018[6]). An empirical challenge is to identify beneficiaries (e.g. property developers or tourism industry managing recreational areas) to further implement the Principle and diversify revenue streams. Ultimately, authorities define the appropriate policy instruments (e.g. a tax on land use or property value) to harness identified beneficiaries.

The Equity principle focuses on who, within a group of users, bares the costs and benefits of water management. It aims to ensure equity in the access to water services and protection against water-related risks. It is considered in water management only in a limited number of Adherents, including Costa Rica, Korea, or Lithuania (OECD survey, 2019). When risks are disproportionate for some users, some countries promote solidarity across users. In the Netherlands, despite regional disparities regarding water-related risks (e.g. floods, sea-level rise) and regardless of the level of risk exposure, every Dutch citizen takes on a share of the burden by paying taxes to manage these water-related risks (OECD, 2014[7]). The same principle lies behind the French Natural Catastrophe (CatNat) compensation scheme, which levies a flat-rate premium on all household and car insurance contracts, independent of their exposure to natural hazards; the revenue is used to pay for damages incurred by disasters as well as to invest in public risk reduction measures (OECD, 2018[8]). While this scheme strongly enforces solidarity, the flat rate contributions have reduced incentives for at-risk communities and households to reduce their exposure and vulnerability to flood risks.

The Policy Coherence principle seeks to ensure that different policy areas (agriculture, energy, land use, urban development or trade) do not have negative impacts on water availability, quality and freshwater ecosystems, or increase the cost of water management. At the institutional level, this can be supported by merging responsibilities of water quantity and quality management under one ministry, as did Korea in June 2018 (OECD, 2018[9]). It can also be accomplished by combining units focusing on related but different water policies within ministries; in Denmark’s Ministry of the Environment and Food, officers working on payment schemes for farmers under the Common Agriculture Policy work on a daily basis with those in charge of regulating water pollution. Only a limited number of Adherents have reported to use this principle in water management planning, including Chile, Israel and Portugal (OECD, 2019[10]).

Although Adherents often consider these principles for policy-making, the extent to which they are implemented in financing strategies and instruments varies in practice (OECD, 2019[10]). Often, Adherents face difficulties in identifying and targeting polluters, in determining reliable estimates of pollution costs and in enforcing existing regulations. They also face strong political opposition to adequately reflect the policy coherence and polluter pays principles (OECD, 2017[11]). In particular, most OECD governments still employ agriculture support policies that can encourage water pollution (Henderson and Lankoski, 2019[12]), and they do not apply the polluter pays principle consistently in this sector (Gruère and Le Boëdec, 2019[13]) (OECD, 2012[14]).

To ensure sustainable water financing, the Recommendation calls on Adherents to “aim for the greatest social returns to investment”.

There is a compelling case for strengthening the financial sustainability of water services, water infrastructures, water resources management and protection of water-related ecosystems to ensure they bring wider social, economic and environmental benefits. However, this can be challenging in a context where Adherents are concerned by the lack of finance and under pressure from constant and growing need to modernise their infrastructure and address environmental concerns and regulatory obligations (OECD, 2009[15]) (OECD, 2012[16]).

To maximise the social returns on investments, Adherents should explore “options that can minimise current or future financing needs while addressing trade-offs and exploiting synergies between policy objectives and between short and long term challenges.” This helps governments, development finance institutions and other stakeholders take informed decisions (OECD, 2018[17]).

Investment decisions are best supported by robust data, methodologies and analytical tools. Cost-benefit analyses are an effective tool to assess how to minimise financing needs and evaluate trade-offs in water investment decisions at project level. Other tools and methods can be more appropriate to explore synergies from interrelated projects at basin scale, and their impact on water resources (OECD, 2018[17]). The city of Auckland (New Zealand) uses innovative data sources and methods for advanced asset management. It uses Geographic Information System (GIS) to overlay actions and investments with a direct or indirect effect on freshwater quality (including storm water asset maintenance, renewal and development; cycleway and road construction; network infrastructure development). This helped find synergies between different policy objectives (OECD, 2015[5]).

Another way to minimise financing needs while exploiting synergies between policy objectives is through the use of ecosystem-based approaches (or nature-based solutions, NBS) to manage water quantity or quality (e.g. treatment of contaminated urban runoff). Under specific conditions, and when implementation challenges are overcome, they can provide such co-benefits as opportunities for improved ecosystem services and biodiversity; reducing ambient air pollution; and mitigation of urban heat island effects (OECD, 2020[18]). Investment in these approaches is also generally less capital intensive, has lower operation, maintenance and replacement costs, avoids lock-in associated with capital intensive grey infrastructure, and appreciates in value over time with the regeneration of nature and its associated ecosystem services (OECD, 2020[1]).

The 2019 Survey of the OECD on the Implementation of the Council Recommendation on Water revealed that 90% of Adherents have included ecosystem-based approaches in their national water management plan. They are applied almost equally across the areas of flood risk, water quantity and water quality management (Figure 7.4).

The environmental and economic value of employing ecosystem-based approaches has been demonstrated in some key interventions of Adherents. In Australia, for example, a pilot project found that rather than upgrading a sewage treatment plant, repairing eroded riparian corridors close to it could achieve the same level of environmental performance at a lower cost (OECD, 2015[5]). In Philadelphia (United States), nature-based solutions are used to manage urban floods from heavy rains. These storm water enhancements, managing combined sewer overflows, are bringing about USD 2.6 billion of added benefits and cost less than a conventional upgrade of the current system of pipes and basins (OECD, 2015[5]).

To further enhance the social returns of water investments, the Recommendation states Adherents should “take stock of existing assets, to maintain them and to look for efficiency gains”. Better knowledge of the state of the assets for water supply and sanitation services supports more accurate planning and decisions for operation, maintenance and renewal.

In France, the National Observatory of Water and Sanitation Services estimated that close to 160 years would be needed to fully replace the water supply networks and 140 years for replacing the wastewater collection and treatment network at the current pace of renewal. This average hides urban-rural disparities with high-density areas having a significantly faster renewal rate (OECD, 2012[16]). France has required local authorities to do an inventory of public networks for water supply and sanitation; however compliance with this requirement is still low (OECD, 2020[1]). The Japanese Ministry of Health, Labour and Welfare estimated in 2012 that the replacement cost of water supply facilities in 2009 would be about approximately USD 14 billion per year to 2050 to meet the need to renew ageing water infrastructure (most of which in the next 20 years) and to strengthen infrastructure to meet earthquake standards in Japan (OECD, 2012[16]). In Portugal, the regulator for water and waste services ERSAR has developed and is pilot-testing a set of indicators on infrastructure value and infrastructure management (OECD, 2020[1]).

Artificial Intelligence (AI) technologies have been also used in water utilities to enable a more strategic and cost-effective operation, including better planning and execution of projects and infrastructure, better monitoring and understanding of resource-loss in real time, more efficient collection and distribution networks, and maximum revenue capture and customer satisfaction. These improvements have considerably reduced energy costs, chemical inputs, and water use, as well as enabled better allocation of staff time. Other AI services include chat bots which can be used to answer customer inquiries on demand, ensuring reliable, 24/7 service and enhancing customer satisfaction (OECD, FAO, IIASA, 2020[19]).

The Recommendation asks Adherents to develop “strategic financial plans that match financial resources with policy objectives, and ensure affordability for vulnerable segments of society, including through ad hoc targeted measures”.

Already a decade ago, most Adherents practiced some form of strategic financial planning for water supply and sanitation (OECD, 2009[15]). Driven by the EU WFD, EU member states are required to submit such plans to attract EU funding from the Cohesion and Regional Development budgets. The Czech Republic, for example, requires owners of water supply and sewerage systems to draw up and implement financial plans for the replacement of their infrastructure networks. The United Kingdom developed a high level strategy and framework for the long term planning of water resources for Public Water Supply in England and Wales. The strategy and framework are updated every five years with the aim of ensuring that there is enough supply of water to meet the anticipated demands of its customers of different water companies, over a minimum 25-year planning period, even under dry conditions.1

Ad hoc measures for ensuring the affordability for vulnerable segments of society are taken by a number of Adherents (see below for further details).

As a final recommendation to maximise social returns to investments Adherents should set up “an independent review of efficiency and cost-effectiveness of investments”.

Independent reviews can be undertaken by an independent regulator or a designed authority to ensure that investment decisions, that can have wide ranging impacts, are as efficient and cost-effective. Australia’s Water Act establishes the independent Murray-Darling Basin Authority to ensure sustainable management of water resources in the country’s largest basin and gives the Productivity Commission responsibility for assessing the effectiveness of Basin Plan implementation every five years (OECD, 2019[20]). In England and Wales (UK), the Water Services Regulation Authority (OFWAT) reviews company plans on a five-year cycle, using incentive-based regulation to encourage efficiencies and drive down costs. In Scotland (UK), the Water Industry Commission for Scotland (WICS) assesses the water-related investment plan every six years with a rolling review every three years to ensure that Scottish Water has visibility for future improvements while having enough flexibility to make the most pressing improvements according to priorities. Similarly in Portugal, the Water and Waste Services Regulation Authority (ERSAR) evaluates investments of the state-owned bulk water operators in the beginning of each new regulatory period (OECD, 2015[21]).

One final recommendation regarding the sustainable financing of water, proposes that Adherents diversify revenue streams and tap into new sources of capital in line with policy objectives. As a first step it is recommended “to combine revenues from water tariffs, transfers from public budgets and transfers from the international community (i.e. the 3Ts) to recover the costs of investment, operation and maintenance of water infrastructure as much as possible and where efficient”.

Adherents use a combination of different financing sources to fund water management (Figure 7.5), most frequently these sources are government budget allocations and revenues from water supply and sanitation tariffs.

In the EU member states revenues from water tariffs and public budgets are shared quite differently, as Figure 7.6 shows. In some Adherents such as Denmark tariffs dominate the combined total funding of these two sources, whereas in other Adherents such as the Netherlands and France they take up a much lower share.

Some Adherents, such as Denmark, rely almost exclusively on tariffs to finance water supply and sanitation-related upfront capital expenditures and operational expenses. Others, such as Finland, Italy and France rely on a combination of public and private sources of finance, with an emphasis on household expenditures to cover water supply and sanitation costs. In contrast to that, Ireland relies almost exclusively on public expenditures to cover water supply and sanitation-related expenditures. In Estonia, Slovenia and Greece the sources of funding are more evenly distributed between public and household (OECD, 2020[1]).

In addition to general budget transfers, several governments are also levying taxes on actors who benefit from increased water security (including land and property developers) or who generate higher costs and externalities (e.g. owners of large impervious surfaces, such as roads or car parks) (OECD, 2015[5]). Pollution and abstraction charges or taxes exist in a number of Adherents to recover costs and to internalise negative externalities (see chapter 8). The proceeds from these taxes are usually earmarked for water-related expenditures.

In Europe, transfers from the EU is an important source of financing for several member states’ investments in water supply and sanitation (Figure 7.7). They account for an average of 13% of total water supply and sanitation expenditures across EU member states. Baltic States (Estonia, Latvia, Lithuania) and Greece particularly relied on such sources of transfer.

Outside Europe, international transfers take the form of development assistance. While such transfers are less important in most Adherents, they still account for a significant share of water management funding in some Adherents. In Cabo Verde, for example, official development aid pays for 85% of its water production. Japan is one of the donors that has provided development funding for strengthening the country’s water supply systems and desalination plants (OECD, 2019[22]).

To bridge any remaining financial gaps for water investments, the recommendation encourages Adherents to consider “tapping into new sources of capital, where needed and in line with policy objectives”. Commercial sources of finance (loans, bonds, equity) are used, particularly for covering water supply and sanitation capital expenses, and are repaid from any combination of the 3Ts mentioned above.

Blended finance can play a critical role in mobilising commercial finance and strengthening the financing systems upon which water–related investments rely. The OECD defines blended finance as the strategic use of development finance for the mobilisation of additional finance towards sustainable development in developing countries. Its related principle and range of instruments are relevant for advanced and emerging economies as well (OECD, 2019[22]). Blended finance can add value by shifting funds that are currently not directed to sustainable development in developing countries and sectors that have significant investment needs in order to deliver on the Sustainable Development Goals (SDGs). A recent review of experience with blended finance for water-related investments indicates that blended finance models are emerging but have not reached scale. The success of blended finance is dependent on the ability to mobilise local commercial investment: blended finance for water-related investments reinforces the need for, and benefits from, tailoring blended finance to the local context. In general, blended finance should aim to build local capital markets by working with and mobilising local financiers, as highlighted in the OECD DAC Blended Finance Principles (OECD, 2019[22]).

To effectively tailor blended finance models for water-related investments, an understanding of the underlying business models and value chains is needed. Blended finance models can enter the sector at different points, for example at the water provision or treatment level, downstream at the end-user level or at the investor level. Effective blended finance approaches take into account the business models and respective revenue streams, and incorporate different stakeholder perspectives (OECD, 2019[22]).

Similar reasoning applies to the use of public funding and risk-management instruments to mobilise commercial finance in advance and emerging economies. Notably this applies to the cohesion policy in the European Union, or of public finance more generally. The United States has significant experience with water financing models, including State Revolving Funds and more recently, a loan facility to mobilise finance for large-scale water infrastructure established by the Water Infrastructure Financing and Innovation Act (the WIFIA loan programme). France uses co-financing mechanisms for drinking water and sanitation services as well as flood protection infrastructure and nature-based solutions: domestic financial institutions such as Caisse des Dépôts et Consignations partner with local authorities and water agencies. Note that fiscal regulations in some countries (e.g. Mexico) do not allow such arrangements.


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