ANNEX: Determining the Target Tariff
1. This annex provides a first attempt to estimate cost curves (total, average and marginal) for Sonangol and ENE, in order to propose methodological steps for setting optimal cost-recovery public utilities tariffs.
2. As suggested by the literature, for the enterprises such as public utilities a condition of natural monopoly may exist. Given the fixed costs, the size of the plant necessary to achieve efficiency may be so large relative to the market that a competitive situation could not exist. Moreover, if production is in the range where marginal and average costs are decreasing, demand could be such that the public enterprise is providing the service but losing money. In order to avoid the decapitalization of the firm and/or negatively affect its financial viability some space for subsidies or cost-recovery pricing might exist.
3. As the analysis suggest, the “cost-recovery target” may change with the level of production; and with the underlying price of inputs. When average costs are decreasing, a higher production level, implies, a lower cost-recovery target. Whenever the price of inputs increases, the costs tend to increase (cost curves shift to the right), implying higher cost-recovery targets for any level of production. In this sense, a “fixed” tariff may cause losses to the firm whenever the actual level of production is lower than the specific production level the fixed tariff is consistent with, or whenever there is a change in input prices.
4. The non-optimal setting of targets might produce: (i) firm losses, and therefore affect its viability; (ii) eventual pressures on the fiscal deficit (if subsidies are granted) and; (iii) pressures on inflation because of (ii).
5. The next subsections present the cases of Sonangol (for gasoline) and ENE.
Document prepared by Jorge Araujo (The World Bank), Jose Giancarlo Gasha, and Gonzalo Pastor (IMF).
Some privately owned public transportation companies are included amongst such providers.
These payments reportedly refer to: (i) in the case of TAAG, the costs of leasing one aircraft; (ii) in the case of ENDIAMA, the expenses associated with the hiring of a security company; and (iii) in the case of SOCIANG, which is said to be nearly bankrupt, the salaries and benefits due to its staff.
The extent to which poor households indeed benefit from such subsidies depend on their consumption patterns. In Angola, water, electricity, and fuel price subsidies are likely to be regressive, disproportionately benefiting the non-poor. Preliminary results from the 2000-01 Household Budget Survey (see APAP (2002)) indicate that kerosene and firewood account for 75 percent of energy consumption for extreme poor households, while electricity is the main source of lighting for 50 percent and 66 percent of moderately poor and non-poor households respectively. In addition, almost 35 percent of extreme poor households consume water from unprotected wells, rain and river water. These sources are insignificant to non-poor households, who consume water mostly from in-door and outside taps, and outside tanks. See Box 1 for a discussion of social safety nets to protect the poor in the event of a subsidy removal.
Differently from water tariffs, which are set by provincial governments, electricity tariffs are fixed by decrees by the Minister of Finance. Once a decree is issued by the Minister of Finance with the new tariff structure, tariffs will remain fixed in kwanza terms until a new decree is issued. EDEL and ENE cannot change tariff policy on their own.
It is worth mentioning that, so far, in the case of utilities, the cost-recovery targets do not include any investment needs. This might be an important issue given the quite limited access of the population to services, which raises the need for important investment.
In accordance with Resolution No. 22 (December 4, 2001) of the Standing Commission of the Council of Ministers.
As noted by Gupta et al, 2000, Equity and Efficiency in the Reform of Price Subsidies. A Guide for Policymakers, Washington, D.C., International Monetary Fund, “subsidies for kerosene have been defended because they tend to benefit the poor and they can reduce reliance on firewood and protect forests” (p. 17). The authors point out that this claim is not always supported by empirical evidence, as this kind of “commodity targeting” can lead to “errors of inclusion” proportional to the share of kerosene and LPG consumed by the nonpoor.
Known in Portuguese as the Sistema Integrado de Gestao Financeira, or SIGFE.
Data furnished by the authorities were provided in different units of account with their respective conversion factors into liters.
Sonangol acquires gasoline from two main sources: the domestic refinery and imports.
It is worth noting that in the estimation, it is assumed that the price of inputs are constant, which is not necessarily the case, in particular, for the oil price. Therefore, regular corrections for variations in the oil price are necessary for average and marginal cost estimates. An average price of US$24 per barrel was assumed in the estimation, while the price at December 2002 was US$26 per barrel.
It is important to note that average costs include billing and collection costs. Therefore, improvements in commercial practices may lower the cost curves and help smooth the tariff adjustment process, insofar as the cost-recovery level could be reached through lower target tariffs.