Economic Situation

5.3. Economic Situation

The MWTP infrastructure is in poor condition, especially given that little investment in upgrading equipment over the last decade, and requires immediate modernization. Though creative, given the plant’s financial situation, a number of tradition mechanized processes are extremely labour intensive.  With the last major renovations/upgrades over fifteen years ago, and traditional approaches for management and upkeep of public utilities of this magnitude dictate constant investment, the priority of modernizing this key civic asset is critical.  The following outlines a range of key concerns.

Based on preliminary screening of Hot Spots on economic criteria for Phase 1, among candidate sites, the Smolensk Vodokanal (SVK) was determined to (scores indicate relative severity of problem based on qualitative data and professional judgement):

1. Have a negative impact on the downstream water supply. (Score 40 out of 100)

2. Have an adverse impact on water consumption downstream (where addition treatment efforts are required). (Score 30 out of 100)

3. Require a high level investment to meet EU water standards. (Score 30 out of 100)

4. Due to serving Smolensk’s working population, makes a substantial contribution to regional industrial employment. (Score 50 out of 100)

Beyond this preliminary assessment, almost all of treatment elements at the MWTP, from intake to sludge management, require upgrading.  Beyond the country’s existing economic position, much of the problem lies in former accounting systems and business practices that did not allocate funds for capital maintenance, upgrades and re-investment.  Facility managers had to become exceptionally creative in managing and maintaining the treatment facilities.  As such, with Russia’s move to a market economy the MWTP has inherited a challenging financial position.

Based on cost data provided by SVK^[1] the unit cost of supplied water was 3.49 roubles/m³ ($0.12 USD/m³), while for treated wastewater it was 2.67 roubles/m³ ($0.092 USD/m³). Thus, based on this cost data, to break even, SVK has to charge at least 6.16 roubles/m³ ($0.212 USD/m³) for water services to local residents, industries and institutions. However, this is not the case.  As the Municipality is the owner of the water utility, they are responsible for overseeing its operation^[2]. At present, the current average tariff on wastewater treatment is 1.4 roubles/m³ ($0.048 USD/m³). Based on feedback from plant management, to ensure that costs are covered, the tariff should be set at a minimum of 4.5 roubles/m³ ($0.155 USD/m³) for treatment. Though less than the estimated 6.16/m³ (the total minimum for supply and treatment) it would serve to improve the financial situation of the facility.

However, there is much resistance from industries and the residents.  If water tariffs are raised, there will be a negative reaction as incomes and industry earnings are low.  These groups, as well as institutions, also faced steep increases in electricity rates earlier (this is discussed in further detail below), and in absorbing higher power tariffs are unwilling to pay higher prices for other utilities.  Despite the establishment of a Commission whose recommendations were to increase water tariffs, the financial plight of industry and the public will likely result in the status quo (i.e. sustained operational loss for SVK.)  While the electrical utility (RAO) has the ability to set its prices and disrupt service due to non-payment, water utilities will likely continue to lack such powers. 

This tariff issue is particularly complex.  While SVK management seeks to fulfill its objective of greater revenue generation, there are impediments at higher orders of government.  Even though tariffs are approved municipalities, prices are set by Federal Law for each river basin.  The price set for water withdrawal has been set in the range of 1.2 roubles/m³ to 1.5 roubles/m³, while similar rates have been set for discharges.  Within its Federal Region, Smolensk has the lowest tariffs among all cities in the 18 oblasts, and one of the lowest rates within the Russian Federation.

Costs requirements and transfer payment issues confound this tariff issue.  Even though the VK is a municipal entity, it pays property taxes to the City.  Other fees paid are discharge fees (discussed below) and extraction from underground and other water bodies (i.e. a water tax).  Another is a fee that is intended to cover the cost of rehabilitation and protection of water bodies (i.e., a water protection fee).  Depending on the water use category, the following fees are set: for water extraction within a specified limit; and for non-extractable use of water bodies according to the conditions specified in the water permit.  These different types of water fees are identified in Annex 1 to this section. 

The Russian Federation (RF) is solely responsible for defining the procedures for the setting and collection of water use fees, as well as setting the fee limit values (for both the water use and protection fees).  Regional authorities can, upon submission to the regional office of the RF Ministry of National Resources, set a differentiated fee tariffs.  Specific fee rates are set for the following categories:

1. Water extraction within the specific limits;

2. Water extraction above the specified limit;

3. Use of water bodies without water extraction according to the conditions specified in a water use permit;

4. Discharge of wastewater compliant with existing effluent quality standards, within the mandatory limits; and

5. Discharge of wastewater compliant with existing effluent quality standards, above the specified effluent discharge limits.

The water use fee is applied to the following water use categories:

a)      Water uses that involve water extraction or wastewater discharge; the fee is charged on users that directly abstract from and/or discharge to a water body;

b)      Water uses that do not involve water extraction (including transport, hydropower, timber rafting, land excavation/drilling operations, organized recreational activities, construction activities and other uses of water bodies and water-related estate).

The legal basis for fee charging is (key reasons):

1. License (permit) granting the right to use a water body for a specified purpose;

2. Contract (between the executive authority of an RF constituent member and a water use), setting out the term, purpose, method, and physical parameters of water utilization; type, size and schedule of payment for use of a water body; and sanctions imposed in case of failure to comply with the contract provisions.

Water use fee charged for extraction of water resources (water extraction) and discharge of wastewater is set in Roubles per 1 m³ of abstracted (discharged) water for industries, municipal utilities, construction companies, transport companies and other customers that use water for domestic/drinking and technological purposes.

The Water use fee charged for non-extractable water uses is set for the following categories:

1. Hydropower sector; hydropower stations that have a legal entity status (HPS);

2. Water transport: shipping companies and fleet operators;

3. Timber rafting/floating;

4. Recreation;

5. Land excavation/drilling and timber-carrying operations;

6. Land drainage (wetland reclamation); and

7. Use of surface water bodies.

As indicated by the Russian National Economics Expert, fees paid by water users (including the water use and protection fees) should be included in an entity’s production cost (i.e. operational costs).  The RF Budget Law stipulates that 100% of the use and discharge fees be allocated toward the Oblast budget, of which half is to be redirected towards projects protecting water bodies.  However, due to economic challenges and other priorities, this has not occurred – of the 11 billion Roubles received, only 2.5 billion have been allocated towards water protection measures.  An identified, the designated approach for usage fees is to distribute them between the RF constituent member budget (60%) and the federal budget (40%).  Thus the entire amount of this 60% share is supposed to be redirected back to water protection measures.  This has resulted in a severe reduction in transfer payments to SVK that would have been used to upgrade and modernize treatment infrastructure.  At present, the Ministry of the Economy are working with the Ministry of National Resources to develop new legislation for the payment of water.  Current thought is not to consider it a tax, but allocate fees raised from resource extraction towards a water fund.   Industrial discharges also present a problem but needs to be considered as a separate issue. Industrial enterprises are required to have local waste treatment facilities on-site to prevent any discharges above normative levels.  Even though they are regulated to abide by these regulations, this has not been the case.  In particular, the local food industry has contributed to poor treatment efficiencies at the MWTP. The dairy industry has high concentrations of phosphate and surface-active substances in its discharges, which are also rich in nutrients.  These nutrients present problems in biological treatment – they provide too much food for microorganisms rendering them inactive.  Those industries who do have treatment facilities on-site, the technology is archaic and inefficient. 

Industries not meeting their MPC (Maximum Permissible Discharge), are supposed to pay up to five (5) times the initial tariff.  However, they can apply to the City for a permit to discharge untreated wastewater to SVK.  The fee structure established by the Regulators are set according to the level of MPC – (i) if within limits of MPC, SVK pays a flat fee; (ii) Temporary Agreed Discharge is five (5) times the rate of the flat fee; and (iii) Excess discharges – non-observance of the MPC – is twenty-five (25) times the original tariff.  In the case of SVK, they indicate that thy have been paying for Temporary Agreed Discharges at five times the original tariff rate.  Plant Staff have indicated that this has affected their operation and financial position in two ways: (1) It has reduced their ability to work directly with industries to seek solutions to improve on-site wastewater treatment; and (2) SVK is now subject to paying a discharge fee for exceeding their MPC.  As indicated by plant staff, many industries receive concessions from State authorities. State authorities are supposed to assume the responsibility of paying a subsidy of the difference between the concession and charge. However, no penalties have been levied against industry and no obligations related to subsidies have been met by the State. For SVK, it is considered a vital service and will continue operation, and will continue to be subject to scrutiny by the authorities.

This financial position has forced the MWTP to prioritize its key investments.  It has led the utility to review all aspects of its operation to determine strategically where emphasis should be placed to improve the solvency of the entire operation.  Please note the planned projects as identified by SVK, (Even though “planned”, no budget has been allocated for these projects).

Table 5.4 : Planned Actions on Renovation and Upgrade of Water Supply and Sewage Collection System in the City of Smolensk for 2004-2006

Due to public pressures, authorities have restricted the utility’s ability to raise water tariffs.  With electricity rates that have grown substantially over the last ten years, it is anticipated that such restrictions will remain for the immediate future.  In fact, one of the main costs facing SVK is energy – thus, while subject to higher electricity costs, they are unable to pass these higher costs back to industrial, residential and institutional users.

Based on “Full Cost of Wastewater collection and Treatment Service Provided by Smolensk Water Utility, Jan – Sept. 2003,” Electricity charges were 15.81 million Roubles ($545,100 USD), which accounted for 26.5% of operating expenses before taxes.  Plant Staff claim that overall monthly energy consumption is 5.5 million kWh, and 55% of revenues are for paying for electricity.  Hence, in proposed actions and projects, energy efficiency is the primary focus of any upgrade activities. 

Particularly worrying are the number of persons who are unserviced as well as losses in mains.  At present 27% of the population live in areas that are not covered by centralized sewage collection.  Raw sewage is collected in cesspools or septic tanks, and then collected and trucked for treatment at the MWTP.  

Smolensk’s population is also declining and currently the mortality rate exceeds the birth rate.  Traditional and recent economic theory of industry location indicates that firms prefer to locate their business where there is a thriving population and pool of talented workers.  Through depopulation, Smolensk is becoming uncompetitive in growing business and, thus its economic potential. This results in less local income and less property tax revenues.  This will ultimately present more challenges to The City, and in turn SVK in their respective revenue generating capacity.

While the overall economic situation for overall Smolensk water utility is particularly challenging, and the status of the MWTP is critical.  Due to the plant being the primary city facility for treating residential, industrial and institutional wastewater, its inefficient operation will continue to discharge contaminated water in to the Dnieper River.  As noted, the plant presently operates at a loss because of a lack of revenue, substantial energy and treatment costs, and a lack of funding due to the state authorities not meeting budget commitments (in terms of providing requires subsidies to the plant).  Due to regulation by the municipality, it is anticipated that the existing operation situation be maintained, thus losses will increase substantially for years regardless of Smolensk’s population and industrial growth. 

Thus, beyond programs such as encouraging industrial water users to reduce their discharges, given the focus of reducing pollution into the Dnieper River, the primary objective for the MWTP, is to adopt energy efficient sustainable processes. Such processes should focus on reducing operating costs, and whose savings could be redirected to improved maintenance and cover the cost investment, independent of other actions undertaken by the rest of SVK and regulating authorities.

Table 5.5 : Annex 1

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1. Cost data provided by A.E. Kupreev, Director of Smolensk Vodokanal Company, and E.N. Kozharskaya, Head of Economic Planning Department; Actual expenditures for the first nine (9) months of 2003

2. The enterprise has been given an order to undertake the management of SVK property.  This is further legislated by the Federal Law on State Unitary and Municipal Enterprises.

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