China Water Risk recently spoke with Steve Clark, Executive Director of Sino French Water Development (SFWD), a partnership between Suez Environnement of France (SEV:FP) and NWS Holdings Limited of Hong Kong (659 HK). The company’s core business covers five areas: water production, full water services, industrial water treatment, sewage treatment and sludge treatment. SFWD has more than 20 water-related projects in China. Focusing on the water sector in China, Steve shared his thoughts on pricing.
CWR: Can you tell us about the history of Sino French in China?
Steve: Sino French was formed in 1985 as a 50/50 venture between New World (NWS) and Suez Environnement. Sino French first invested in Macau Water and Macau Electricity ( CEM). In 1992, we won the first contract in China just across the border in Tanzhou. This was a full concession contract to supply services to Tanzhou Township.
CWR: Since 1992 Sino French has won numerous contracts in water concession, sewage and sludge treatment all over China (25 contracts in 18 Chinese municipalities). As you are one of the few big foreign firms with experience in water concession/production in China, can you tell us a little bit about this market?
Steve: There are two different contracts on water. One is water production where you are supplying bulk supply to the city. That’s an agreement between the joint venture and the local water company that distributes to the end users. That tariff is contractually set. You have to get the financial balance, since the water company will need to sell water for more than they buy it from you.
The second type, which is the more difficult kind, is the concession contract. Under this contract we are allowed and obliged to supply water services in a defined geographical area. So that means we supply everybody in that area directly, and if that area grows we have to install the necessary assets to supply them. We are billing the end customer directly, whether it’s an industry or a family, and in addition the government needs to agree on the tariff. You cannot contractually set that tariff independently.
In an industrial park tariffs are set contractually because that is a private area. If you have local industry next to the houses within the city, then the tariff would also have to be agreed with the government. You generally have four categories of tariffs – residential, commercial, industrial, and special. Special is generally applied to really heavy users like carwashes, but it’s a really small category.
CWR: Is the price of water paid by industrial users in the municipality vs. an industrial park relatively the same?
Steve: Yes, generally the water tariffs are very similar.
CWR: What about prices paid by other users?
Steve: The lowest tariff is generally for municipal/domestic users, then commercial, followed by industrial users. Sometimes there is not a big difference between them, other times it could be double. In some cases industrial users pay double the tariff of domestic users within the same geographical area, but that is set by the government and not by us.
CWR: In the last few years, we have seen water tariffs increase steadily in China. We know the government has the final say in water tariff pricing, but do water companies have any influence over that decision and what is the process of determining the price?
Steve: In our contract there are certain clauses that allow us to apply for tariff increases. It probably would not be a regular annual increase and we would work on the application with our local partners. Our partners can be the local water company, the construction bureau or the PUB. The tariff increase would be based on a reasonable return as well as providing cash flow to finance ongoing infrastructure investments as some of the cities are growing dramatically like Chongqing. The process itself is totally transparent.
Sometimes when we ask for tariff increases, the government in charge would ask us to implement efficiency measures such as reducing non-revenue water. So managing our non-revenue water is important in any tariff application.
CWR: What are the rates of non-revenue water in China?
Steve: In Macau it is 9% which is extremely low, while in Changshu it is 16%. Outside of our JVs I suspect that the average in China would be above 25%. Non-revenue water is split into two segments, one is physical loss and the other is commercial loss.
Physical loss is caused by leaks in the system. Commercial loss results from a number of things, for instance the water meters. Water meters are inherently not as accurate as electricity meters. It is possible that poor meters monitor the water inefficiently. Another cause would be theft. Bad customer management is another problem. In this instance, customers are not billed correctly. In most parts of China, the non-revenue water split is 50% physical loss and 50% commercial loss.
CWR: Have the recent tariff increases made the water delivery/full service part of the industry more profitable and attractive?
Steve: Yes, most of the big cities in China and even some smaller ones are now financially viable without subsidies.
CWR: As a result, have you seen more competition, particularly from local companies?
Steve: Yes, we see a lot more. Chinese companies are entering this market, so there’s definitely more competition.
CWR: Are you anticipating this trend of increasing tariffs to continue?
Steve: Yes, because everything else is rising. Salaries are rising 10% each year; energy costs and construction costs are also going up. In most of the cities in which we operate, GDP is showing double-digit growth. I would anticipate continuing increases over the years though not necessarily uniformly.
CWR: What are the considerations that go into a pricing decision?
Steve: We would look at the impact of the water bill on the customer. For a domestic customer, we try to keep the water tariff within 2% of household income. There is less political pressure when people can afford to pay the rates and that is where you want to be.
In industrial parks, water is a relatively small amount of overall costs and therefore pressure from the authorities or industrialist is not too significant. However, when there is a downturn, as in 2008, it is made clear that costs need to be kept low. In cities like Changshu, approximately 60% of our water goes to industrial users, so the water demand depends on the economy. This year water demand has gone up 7%, but if there is a major recession water use would come down. We are linked to the general economic climate, but not as dramatically as other industries.
CWR: You have entered the industrial park and sewage treatment business in recent years. Are these activities more profitable and how does pricing work in these markets?
Steve: For domestic sewage, a uniform tariff is applied in the city for all customers.
For industrial parks, the tariff is based on the strength of the effluent. COD (Chemical Oxygen Demand) in the city would normally be approximately 300 parts per million, but some industrial users could discharge as much as 10,000 parts per million. Therefore, the tariff is not just based on volume, but includes the amount of COD, suspended solids, or any other elements that would have to be removed. The tariff varies per customer, and the average tariffs in industrial parks are significantly higher than municipal tariffs. In a big petrochemical industrial park, for example, it could be three to four times higher.
However industrial parks also face commercial realities, and they are our partners. The park’s intention is to attract more industry, so they want to ensure that tariffs aren’t too high.
CWR: Have there been increases in sewage or discharge treatment tariffs for industrial users?
Steve: Increases have been dramatic over the last few years, but tariffs started from a very low base. The tariff in most Chinese cities is still less than RMB 1/m3, and that’s too low.
CWR: What should the tariff be for sewage and sludge treatment?
Steve: The total rate should be approximately RMB 3/m3 with sludge treatment, which doesn’t just mean taking the sludge away to a landfill. This includes treating and drying the sludge. Each city may be slightly different, but RMB 3/m3 would be the average.
CWR: Do relatively low prices exclude technologies such as desalinated water or fully recycled water from becoming commercially viable?
Steve: Desalination is not commercially viable yet without government subsidies. It still has to be subsidized by governments in the North-East of China where it’s currently needed.
CWR: Will prices increase enough in the coming few years to make desalination more attractive?
Steve: I think pricing will go up and the government has to let it increase. North-East China won’t stop development due to lack of water, so they will have to start using desalination near the coastline. As the region becomes wealthier, they will be able to afford an increase.
CWR: Do you think water demand will be affected significantly if pricing goes up substantially for both industrial users and domestic users?
Steve: For the big industries, eventually there will be an impact, but probably not for domestic users. Currently, water tariffs are a small percentage of overall costs for industrial users, but if the cost becomes significant they will become more efficient. For example, many of the state-owned enterprises (SOEs) are probably inefficient in water use. Political and economic considerations will both play a role in determining the outcome.
For domestic users, we have found that unless it’s an incredibly high increase, a higher tariff will have no effect on long-term water use. If the government announces a doubling of the water tariff, water demand will probably drop significantly in the first two months. However, demand will eventually creep back up.