Asset Depreciation in Water Tariff Calculations: A Case Study from Albania

The reform in the water sector aims to improve the financial sustainability of utilities, as well as the quality of service to consumers. One of the main reasons for the problematic financial sustainability of utilities is the tariffs which are not aligned with operational and maintenance (O&M) costs. On the other hand, there always exists the risk that utilities may apply unjustifiably high tariffs for the customers.

It remains one of the main priorities of the Water Regulatory Authority (WRA) to carry out an accurate and in-depth analysis of the new tariff proposal from the utilities, so that the final approved tariffs by WRA should be based on justified costs. A consistent analysis to highlight the real justified costs of the utility’s operation is a difficult process that requires a serious commitment and close cooperation with utilities. Within this framework WRA requires additional information from utilities to justify proposed costs.

Currently, in the focus of WRA are the main items of the O&M costs, first monitoring the energy costs through the energy efficiency indicator, continuing with the depreciation and labor costs, which constitute the main components of OPEX and Total Costs.

In the current tariff approval methodology, WRA is using the “Cost Plus” and “Price Cap” methods, where the last one foresees the coverage of Total Costs based in a 5-Year Business Plan. The basic criteria of the methodology are, as follows:

• Coverage of justified O&M Costs (OPEX), or Total Costs
• Evaluation of the Utility’s Performance of KPI-s
• Affordability of the monthly customer bill.
• Environment protection on preservation of water resources from over usage.

Regarding depreciation costs, it is well known that the assets of WS and WW systems often are aging beyond their useful lifespan due to inadequate planning for their replacement. This leads to the deterioration of the performance indicators, an increase of Non-Revenue Water (losses), and increasing potential risks to public health.

The argument of the Depreciation Costs is in focus of this article.

Regional utilities established under the current sector reform in Albania aim to cover Total Costs either fully or partially by the proposed new tariff.

Depreciation costs of tangible assets in the utility’s asset inventory registers should account for investments needed to replace over-aged assets, particularly pipelines, and should be included in the total costs of new tariffs proposed to WRA.

In fact, the total costs should also include the depreciation of the past projects assets, those currently in the implementation process, and those planned to start within the 5-year period of the Business Plan.

The planning for replacement of the depreciated assets should be guided by an Asset Management Plan (AMP), which includes an inventory, the age (time of purchase or construction) of the asset, and using the depreciation rates approved by WRA in the current tariff methodology.

The AMP is a plan for managing the infrastructure and other assets to provide a certain standard of service that is required for financial reporting, maintenance and asset replacement.

The AMP is based on an asset inventory maintained through software programs. Generally, the inventory is conducted using GIS, where data is recorded, managed, and analyzed geographically in the field and linked to relevant data tables for attributes like size, material, installation time, and price.

The AMP facilitates rational planning and financing for future asset replacement and enables more efficient utility operations with tariffs based on accurate O&M information. The current tariff methodology is using the “Price Cap” method, where coverage of Total Costs is also projected in a 5-Year Business Plan.

Tariffs are calculated based on the required income (NA) according to the formula:

NA = OPEX + CAPEX + RAB * WACC

OPEX or O&M costs (justified) primarily encompass materials, chemicals, electricity, fuels, third-party services, taxes, wages, and social security, and other costs. The CAPEX or Capital Costs (justified) taking into account the depreciation of the tangible assets by their useful lifespan, including the assets in process of implementation and planned in the future (both non-inventoried) within the 5-year period of the Business Plan. Another item to consider in CAPEX costs is the principal payments of past investment loans.

The RAB x WACC costs comprises the cost of a reasonable profit or return on capital for the eventual needs of unforeseen capital investments by the utility during the 5-years activity of the Business Plan.

Based on the financial data reported by the utilities for 2021 and 2022, it comes out that many utilities claim to have very high depreciation costs that amount up to around 50% of the Total Costs, as is shown in Table 1.

Table 1 – Depreciation Costs (years 2021 and 2022)

As it can be seen from the table above, the Depreciation Costs represent significant value, clearly having an influence in the tariffs of the customers.

The calculation of the depreciation costs of physical assets is done taking into account the Asset Depreciation Rates (useful lifespan), approved at the end of 2021 by WRA in the new tariff methodology. They have been corrected in accordance with reality and international experience, as shown in Table 2.

Table 2 – Depreciation Rates of Assets (materials) of Water and Wastewater Systems (2022).

Referring to the above, WRA during the process of analysis of utilities proposals for new tariffs, in view of protection of the customer interests, takes into consideration only justified costs of the depreciation items. During this process WRA double checks the reported depreciation costs, as following:

• Are they planned (calculated) correctly based on the asset inventory and the annual depreciation rates of assets approved by WRA?
• Were the priorities of asset replacement followed, as scheduled on the Asset Management Plan the utility should have?
• Have the depreciation funds in the past been used for the dedicated destination, i.e. for replacement of assets?

During the tariff approval process, when the utility does not have an Asset Management Plan, WRA will take into account as justified costs only partially the costs of the asset depreciation proposed in the application. In the next application for tariffs for this utility, WRA will take into consideration only the part of the depreciation costs which are supported by the relevant documents that those funds are dedicated.

The above arguments have to be kept in consideration by the utilities when they draft the proposals for new tariffs near to WRA.

As it was emphasized above, WRA in the future will deepen in more detail the analysis for all the particular elements of the O&M costs, whereas a further step it is assumed to improve the analysis of the justified costs to be in particular the Labor Costs, as well as the efficiency of the investments as part of the CAPEX Costs.

Conclusion

WRA has the essential function in safeguarding both the financial stability of utilities and the protection of customer’s interests. Having the authority and responsibility of approving tariffs, the WRA is committed to a meticulous review process that aims to strike a balance between operational costs and fair consumer pricing.

A crucial aspect of this process is the consideration of depreciation costs, which can account as a significant portion total costs for the utility. The WRA’s emphasis on justified costs is not merely an academic exercise but a commitment to financial transparency and accountability. By adopting a “Price Cap” methodology based on a 5-Year Business Plan, the WRA ensures that tariffs are based on operational realities rather than inflated or false figures.

Moreover, the introduction of the Asset Management Plan (AMP) as a planning tool demonstrates a forward-thinking approach. The AMP is more than just an inventory; it is an essential planning tool for future infrastructure investment and operational efficiency. Proper asset management ensures not just the financial health of utilities but also the quality and safety of services delivered to the end-user.

The WRA’s evolving role in scrutinizing not only depreciation but also other cost’s elements such as labor costs and investment efficiency underlines its increasingly multifaceted function. While it might be tempting to view the role of the WRA as merely regulatory, it is clear that the authority serves as a cornerstone for a stable and sustainable water and sewerage sector.

The careful and systematic approach adopted by the WRA is not just an example of good governance, but it represents an imperative for the long-term sustainability and integrity of water supply and wastewater services in Albania.

Note: This article is authored by Ndriçim Shani, Chairman of Albanian Water Regulatory Authority (WRA)