# **2. The Goal of Cost Recovery**

The discussion begins by evaluating to what extent Latin American electricity and water utilities succeeded in advancing towards the cost recovery goal enshrined in the new regulatory frameworks of the 1990s. In order to put the achievements in perspective, benchmark comparisons against other regions will be performed wherever data permits.

The ideal methodology for measuring cost recovery would be to take the average tariff for each utility and compare it against the full average cost of production for that particular utility. Unfortunately, there is very little public information available about the full average cost of service provision, making this approach almost impossible to apply on a regional scale. Instead a simpler approach is taken, establishing indicative ranges within which tariffs would need to fall in order to have a high probability of recovering either operation and maintenance costs or full capital costs. These ranges are based on expert estimates.

It is important to acknowledge that this methodology does not enable us to say with precision when a particular utility is achieving full cost recovery. However, it does enable us to identify utilities that are _not_ achieving full cost recovery. Moreover, it allows us to classify utilities into three broad groups. In the first group are utilities whose tariffs are so low that they are extremely unlikely to be meeting even operation and maintenance costs. In the second group are utilities whose tariffs are at a level that is likely to be commensurate with operation and maintenance costs, but is extremely unlikely to leave over any significant contribution towards capital costs. In the third group are utilities whose tariffs are high enough to be making a significant contribution towards capital costs. Exact details of how this approach is applied to the water and electricity sectors are given below.

# **_Water_**

The water sector in Latin America has become highly decentralized during the last two decades and information on tariffs in smaller cities is very limited. The analysis is therefore based on tariff data from around 15 utilities serving the region’s larger cities for the period 1997 to 2003 (ADERASA, forthcoming). The group also includes one or two national level utilities serving smaller countries, such as Costa Rica and Uruguay. Given that tariff levels in larger cities tend to be higher than those in smaller cities, the true status of cost recovery is likely to be significantly worse than what can be portrayed through this analysis.

Local currency tariff trends provide a good indication of the degree of ‘effort’ that different utilities made to raise their tariffs towards cost recovery levels. The results show that 13 Latin American water utilities raised their residential tariffs in nominal terms at an average annual rate of 8% over the period 1997/03 (Figure 1). Nevertheless, these gains were largely wiped out by inflation, with real residential tariffs rising by less than 1% per year on average over the same period. In the case of industrial customers, water tariffs rose in nominal terms at an average annual rate of 4% over the period 1997/03. However, 3