Technical Note Sabesp's Tariff Revision First Phase

TECHNICAL NOTE

Nº RTS 01/2013

SABESP’S TARIFF REVISION FIRST PHASE OF THE SECOND TARIFF CYCLE

CALCULATION OF P0 AND X FACTOR

March 2013

TECHNICAL NOTE RTS 01/2013- SABESP’S TARIFF REVISION FIRST PHASE OF THE SECOND TARIFF CYCLE

CALCULATION OF P0 AND X FACTOR

1. INTRODUCTION ...... 2 2. OVERALL CONTEXT ...... 2 3. MARKET ANALYSIS ...... 4 3.1 Water Measured Volume Projection ...... 5 3.2 Sewage Volume Projection ...... 11 3.3 Water Losses ...... 14 3.4 Market: Adjustments made by ARSESP ...... 16 3.5 Conclusion: Consolidated Market ...... 20 4. CAPEX Analysis ...... 23 4.1 CAPEX of the Second Cycle Business Plan ...... 23 5. CALCULATION OF INITIAL BRRL ...... 31 5.1 Calculation of provisional initial BRRL ...... 32 5.2 Adjustment to initial BRRL by Contractual Investments not made ...... 33 6. OPERATING EXPENSES (OPEX) ...... 34 6.1 Business Plan OPEX ...... 35 6.2 OPEX: Adjustments Made ...... 38 7. REGULATION, CONTROL AND INSPECTION FEE ...... 42 8. TAXES AND CONTRIBUTIONS ...... 43 9. REVENUES ...... 43 9.1 Irrecoverable revenue (default) ...... 44 9.2 Indirect revenue ...... 44 9.3 Non-operating revenue ...... 46 10. CALCULATION OF P0 AND X FACTOR ...... 47 10.1 Calculation of P0 ...... 47 10.2 Calculation of X Factor ...... 48 11. SABESP TARIFF STRUCTURE ...... 49 12. ATTACHMENT I – CALCULATION OF EFFICIENCY IN OPEX ...... 50 12.1 The Benchmark Construction ...... 50 12.2 Results ...... 54 13. ATTACHMENT III: ANALIS OF INVESTMENTS PROPOSED IN SABESP’S BUSINESS PLAN FOR THE PERIOD BETWEEN 2013 AND 2016 ...... 60 4.3.Conclusion ...... 68 14. ATTACHMENT – IMPACT OF LAW N0 12,783 IN ELECTRIC POWER OPEX ...... 69 15. ATTACHMENT V: TARIFF LISTS ...... 73

1. INTRODUCTION

The purpose of this Technical Note is to present the final results obtained in the application of methodology defined in the Final Technical Note (NTF) N° RTS/01/2012 of April 2012 which contains a detailed methodology for the tariff revision process related to SABESP’s second tariff cycle in view of information provided by SABESP according to the Schedule established by ARSESP Resolution N° 373/2012 of November 2012.

On the one hand, due to delays in the delivery of information by concessionaire and on the other hand, the great delay seen in the process to hire an auditing firm, which will issue the Valuation Report on the Regulatory Remuneration Basis (BRL) that led ARSESP to unfold this tariff revision in two phases:

st • 1 Phase: Definition of new preliminary tariff level (P 0), with an initial BRL, X Factor and linear adjustment of tariffs currently practiced, maintaining the same tariff structure in force (Deadline: 12/29/2012). • 2nd Phase: Definition of final tariff level, with final BRL and new tariff structure to take effect as of September 2013.

Basic data applied to calculate concessionaire’s new tariffs derive from Business Plan delivered by SABESP in September 2012.

This Technical Note incorporates the results deriving from analysis of contributions received in the public consultation about the content in the Preliminary Technical Note (PTN) of November 2012 and public hearing held on 12/7/2012 and 1/15/2013.

2. GENERAL CONTEXT

As of December 2007, with the enactment of State Supplementary Law 1,025, it shall be incumbent upon ARSESP to regulate and oversee the basic sanitation services. In view of these duties, in April 2012, ARSESP issued the Final Technical Note N° RTS/01/2012 - NTF which aims at explaining and justifying the basis to define the methodology to be adopted in the calculation of tariffs and tariff structure for Sabesp’s Second Tariff Cycle. Therefore, this Preliminary Technical Note composes the Tariff Revision process in conformity with the process framework defined by the Final Technical Note (FNT) and the Schedule set forth by ARSESP Resolution N° 370/2012.

As indicated in the FTN, the Tariff Revision comprises the calculation of two basic parameters:

a) The initial value of maximum tariff “P0” of SABESP to be applied in the Second Tariff Cycle;

b) The efficiency factor (“X Factor”) to be applied to P0 in each of years 2 to 4 of the Second Tariff Cycle.

As indicated in the Final Technical Note (FTN), in order to set the value of P0 parameter, SABESP provided ARSESP with a Business Plan (BP) containing among others, the following information: (i) value of the company’s asset base; (ii) the CAPEX Plan (physical and financial), including investments in the replacement of assets and new facilities; (iii) operating, non-operating and financial revenues and expenses; and (iv) information about historical costs and volumes; (v) water and sewage volume projections.

The data contained in SABESP ’s BP were added by historical information deliveredeliveredd by SABESP and data collected by ARSESP of peer companies and comparable systems allowing to evaluate SABESP’s relative efficiency and define efficiency standards a nd targets to be achieved in the tariff cycle.

The methodology defines a maximum price mechanism (P 0) based on the company’s efficient costs projected for the tariff cycle, creating a st strongrong incentive for the company to reduce costs , since any reduction a utomatically results in higher profitability for ththee company . According to the FTN, the calculation of P0 is based on SABESP’s full economic and financial breakeven . This means that to calculate P0 , the efficient costs associated with all services rerenderendere d by SABESP in all concessions will be considered . Therefore, an average tariff is obtained (expressed in reais per cubic meter) which reflects the economic cost of water and sewagsewagee services for a tariff cyclecycle and every year will only be adjusted based on criteria presented in said FTN. In fact, according to these criteria, during the tariff cycle, the maximum average tariff (P 0) must be yearly adjusted through the following mechanism: (i) an adjustment factor based on the evolution of pricpricee index that avoi ds the inflationary erosion of the company’s revenue , (ii) an efficiency factor (the X Factor ) that partially transfers productivity gains for users through lowelowerr tariffs in real terms and (iii) an adjustment factor for variations in quality of services re ndered 1. This last factor seeks to prevent incentives to reduce costs to compromi se service quality levels .

Therefore, the calculation of P0 consist s of simulating SABESP’s economic and financial breakeven during the tariff cycle through the Discounted Ca sh Flow Methodology. The mechanism elected allows to ensuring SABESP’s economic sustainability . The Discounted Cash Flow technique to calculate P0 may be expressed according to the following formula:

• = Maximum average tariff that ensures SABESP’s economic and financial breakeven , • = Net Regulatory Remuneration Basis (i.e., net of depreciations), early in the cycle to be determined by a study established by ARSESP Resolution 156/2010. BRRL includes the working capital initial inventory . • = Ne t Regulatory Remu neration Basis (i.e., net of depreciations) at the end of tariff cycle.

1 According to the FTN, the implementation of quality regime foresees three phases over the Second Tariff Cycle. During the initial phase, the annual adjustment pe r quality shall not apply, therefore, P0 will not b e adjusted by this criterion. Accordingly, this document does not discuss this regulation component .

• = Duration in years of Tari ff Cycle. • • Total billable volume for year t (corresponds to the sum of water and sewage volumes ). These include the minimum consumption collection effects existing in current tariff structure. • = Operating, administrative and selling expenses in year t. • = Invest ment incorporated to operation in year t. • = Remunerable Working Capital Variation (CCR) in year t. • = income tax and social contribution (CSLL). • • Cost of Capital calculated according to ARSESP Resolution N° 227/20 11. • = Accounting depreciations .

The elements involved in previous formulas are estimated, in real terms, during the entire cycle . The evaluation in real terms calculates the appropriated amount of each component, allows to more appropriately estimate C apex expenses (the nominal approach usually overestimates capital expenditures) and, lastly, it is not necessary to project inflation and type of exchange (which eliminates the need of determining macroeconomic variables projections in order to maintain th e economic consistency).

It is worth mentioning that the parameter corresponding to the projected weighted average cost of capital ( WACC ) was already calculated by ARSESP through Resolution N° 227/2011. According to this Resolution, WACC for SABESP’s Seco nd Tariff Cycle is 8.06%.

As far as the initial Asset Base is concerned (Net Regulatory Remuneration Basis , BRRL 0), the process defined by ARSESP Resolution N° 156/2010 has not been concluded yet. When this document was issued, ARSESP was still validating the studies requested by SABESP to estimate BRRL 0. Therefore, ARSESP decided to work with a preliminary estimate of BRRL 0 whose calculation reasoning is explained thereafter .

In addition, the related historical information was evaluated and that one cont ained in SABESP’s Business Plan in the framework of Revision process, aiming at defining the regulatory parameters to be calculated when applying the Discounted Cash Flow equation previously described . In addition, only the elements strictly related to the efficient rendering of services regulated by ARSESP were considered to calculate P0.

Below, main considerations about the parameters required to calculate P 0 are analyzed and reported, namely: (i) Market ; (ii) Investments (C apital Expenditure – CAPEX ); (iii) Net Regulatory Remuneration Basis (BRRL) when Second Cycle begin s; (iv) Operational Expenditure - OPEX ); (v) treatment of taxes and charges ; (vi) other revenues; and (vii) X Factor estimate. SABESP’s proposal included in its BP and the viewpoint adop ted by ARSESP to calculate P 0 are presented for each of these parameters.

The attachments detail the calculations necessary to obtain said parameters, as well to calculate P0.

3. MARKET ANALYSIS

Now, the methodologies and projections adopted by SABESP a re outlined to calculate P0 in view of data and information presented in its BP . Thus, water and sewage markets are outlined separately .

In order to facilitate the analysis of each market, this will be divided into categories: residential, non-residential and permissionaires. In addition, each segment will detail the projection on units and connections estimated for the tariff cycle. ARSESP’s viewpoint is presented at the end of this chapter, pointing out the discrepancies, criteria and values adopted when calculating P0.

3.1 Water Measured Volume Projection

The FTN contains the guidelines that SABESP shall observe in these projections. Thus, the FTN points out that in order to correctly project water demand, since the environment of SABESP’s users differs in nature, the consideration of several types of users and their uses is required. Therefore, SABESP’s projection included in its BP, considers separately several consumption categories, given distinguished behavior associated with the nature of each activity. Therefore, the total measured water volume observes the following reasoning:

Figure 1: Consumption categories and overall reasoning to calculate total water measured volume

Water Measured Volumes

Residential Demand Non-Residential Demand Permissionaries Demand

Household Commercial Household

Industrial Commercial

Public IndustrialIndustrial

Public Public

Market projections were made from unit consumption estimates and expected increase in the number of units and connections through the projection of serviceable households and water supply coverage ratio for residential category. For other categories, demand was projected from the analysis of related time series. Details on these methodologies are shown below.

3.1.1 RESIDENTIAL WATER DEMAND

3.1.1.1 BRIEF DESCRIPTION OF THE METHODLOGY TO PROJECT WATER MARKET

According to the FTN, the water residential demand projection is estimated from units and average consumption. The estimate of unit evolution relies, on the one hand, the development of serviceable households and on the other hand, the coverage coefficient estimate. Below, a summary of the reasoning applied to estimate the water market for residential use:

Figure 2: Overall Reasoning to Calculate Residential Water Measured Volume Serviceable Households Water Supply Coverage Ratio

Residential Units Unit Consumption

Connections

Residential Water Measured Volume

Below, a summary of the amounts projected for each element shown in previous figure.

3.1.1.2 RESULTS OF SERVICEABLE HOUSEHOLDS PROJECTIONS

The Brazilian Institute of Geography and Statistics (IBGE) data were applied to project the serviceable households, referring to the Total Urban Householders item, published in the Census 2010 (August/2010 reference)2 and updated for 2011 base year. Thus, in order to estimate the number of urban households this year, the geometric average growth verified in the period through the last five Censuses (1970, 1980, 1991, 2000 and 2010) was applied. The growth rate results of Serviceable Households are shown in the table below:

Table 1: Growth Rate Results of Serviceable Households

2012 2013 2014 2015 2016 Growth rate of serviceable households reported in BP 1.93% 1.89% 1.86% 1.82% 1.80%

Absolute values of Serviceable Households were estimated from growth rates shown above:

Table 2: Results of Serviceable Household Projections

2012 2013 2014 2015 2016 Number of serviceable 9,165,427 9,338,729 9,512,032 9,685,334 9,859,436 households reported in BP

2 Except for RS and RN business units projection. In fact, due to the demographic characteristics of these two business units, the Serviceable Households were adjusted in order to meet the coast area peculiarities and taking into account the condominiums in the region with private treatment and supply.

3.1.1.3 RESULTS OF WATER SUPPLY SERVICE RATIO PROJECTIONS

According to the FTN guidelines, the Water Service Ratio (WSR) was calculated through the ratio between the number of Water Residential Units and Serviceable Households. In order to calculate the service ratio in 2011, data observed in Water Residential Units and the number of Serviceable Households in December 2011 were applied. The projections between 2012 and 2016 were made through the linear interpolation between the ratio recorded in 2011 and the year when the highest service ratio is expected, or the universalization, according to different sources of information (historical information, the statement of financial position and the Business Plan provided by SABESP) 3. Results are shown in the table below:

Chart 3: Results of Residential Water Service Ratio Projections

2012 2013 2014 2015 2016 Residential w ater service ratio projection reported in BP 95.6% 96.0% 96.4% 95.8% 97.2%

3.1.1.4 RESIDENTIAL WATER UNIT CONSUMPTION

According to the BP, ARSESP resolved to adopt a steady residential water unit consumption during the entire tariff cycle. This decision is justified in view of data that evidence a stability, which until 2011 no broken trend could be seen that could justify an alteration in future consumption. Figure 3 shows the average consumption per residential unit over the last 5 years. Note that values show a seasonal trend between 12 and 14 m³/month, i.e., no broken trend was seen that could justify an alteration in future consumption.

Therefore, SABESP decided to maintain unit consumption seen in 2010 which on average remained at 12.95 m3 per residential unit.

3 According to the BP, service ratio projections in the period referring to RN and RS business units were calculated based on the growth of Water Residential Units and Serviceable Households expected for the regions taking into account these regions’ peculiarities.

Figure 3: Residential Average Consumption by Unit

Translator’s note: Average Consumption by Unit/Average Consumption by unit in m3/Average Consumption (Measured Volume)

3.1.1.5 RESULTS OF WATER RESIDENTIAL DEMAND PROJECTIONS

SABESP also projected residential units and connections . Results of units’ projections are shown in the chart below:

Chart 4: Result s of Water Residential Unit s Projections

2011 2012 2013 2014 2015 2016 SABESP 8,563,349 8,766,289 8,969,215 9,172,277 9,377,238 9,582,773

Connections were projected taking into account the assumption of stable unit /connection ratio 4. Results can be seen the chart below :

Chart 5: Result s of Water Residential Connection Projections

2011 2012 2013 2014 2015 2016 SABESP 6,114 ,778 6,279 ,718 6,436 ,868 6,593 ,918 6,752 ,574 6,911 ,748

Residential Water Measured Volumes were updated from the number of units and related unit consumption. The chart below shows these projections results:

4 From the history , we saw that unit/connection ratio remained afloat.

Chart 6: Results of Residential Water Measured Volume Projections

2011 2012 2013 2014 2015 2016 SABESP 1,325,736 1,360,163 1,391,796 1,423,086 1,454,510 1,486,097

3.1.2 NON-RESIDENTIAL WATER DEMAND

The non-residential demand estimated by SABESP considered the following categories:

• Commercial, • Industrial and • Public Sector.

According to the FTN guidelines, unit consumption was not estimated for each category, but the following was estimated from econometric models:

• The number of users of each category, and

• Total demand in m 3 of each category

For projections, structural models were applied (or space-status) of Bayesian statistics proposed by Harvey (1989) 5 and they capture changes of parameters over time. These models modify the time series in non-observable components (structures) – trend, seasonality, cycle and irregular – and may be tested if there changes over time in their related standards. They also allow to including explanatory variables and lagged dependent variable. Then, model parameters were estimated by an interactive algorithm referred by Kalman Filter. The period adopted to estimate the models comprise monthly data for the period between January 2005 and December 2011.

For Commercial and Industrial categories, grouped water and sewage demands were projected due to high correlations of both services. In the public category, water and sewage were projected separately. All estimates were made by Business Unit. The historical series features applied in projections were the following:

5 Harvey, Andrew. Forecasting, Structural Time Series, Models and Kalman Filter. Cambridge University Press, 1989.

Chart 7: Methodology of non-residential water demand projection

COMMERCIAL

AND INDUSTRIAL RETAIL MEASURED VOLUME (WATER + SEWAGE) CATEGORIES

PUBLIC RETAIL MEASURED VOLUME (WATER ) VARIABLES CATEGORY RETAIL MEASURED VOLUME (SEWAGE)

COMMERCIAL AND INDUSTRIAL CONNECTIONS (WATER + SEWAGE) CATEGORIES PUBLIC CONNECTIONS (WATER) CATEGORY CONNECTIONS (SEWAGE ) WHOLESALE M EASURED VOLUME (WATER + SEWAGE ) FREQUENCY MONTHLY REGIONAL INLAND: BY BUSINESS UNIT AGGLOMERATION RMSP: TOTAL

Applying this methodology, connection projections for all non-residential categories were estimated.

Chart 8: Results of Non-Residential Water Connection Projections

2011 2012 2013 2014 2015 2016 SABESP 713,306 730,564 746,995 763,427 779,859 796,291

Below, the results of water measured volumes for the non-residential category.

Chart 9: Results of Non-Residential Water Measured Volumes Projections

2011 2012 2013 2014 2015 2016 SABESP 228,115 233,136 238,132 243,130 248,128 253,126

3.1.3 PERMISSIONAIRES WATER DEMAND

The permissionaires demand was estimated observing the same methodology applied to project the non-residential use demand. This methodology is justified in view of the lack of information about distribution, but only data about permissionaires’ units and connections. Projections are shown in the chart below.

Chart 10: Results of permissionaires’ water measured volume projections

2011 2012 2013 2014 2015 2016 SABESP 297,328 295,761 294,733 293,779 292,877 292,015

3.1.4 WATER TOTAL DEMAND PROJECTION

Total demand is the sum of previously estimated required amounts. Therefore, total water demand projection for the tariff period is presented from consumption projections of each category as mentioned above. 10

Chart 11: Results of total water measured volume projections

2011 2012 2013 2014 2015 2016 SABESP 1,851,179 1,889,060 1,924,661 1,959,995 1,995,515 2,031,238

3.2 Sewage Volume Projection

SABESP provides sewage services in the municipalities that compose its concession area , operating in the entire chain, as well as provides sewage treatment services for few municipalities whose water supply and sewage collection servi ces are operated by municipality . Hence, demand projections considered the volumes collected referring to municipalities of its concession area, divided into residential and non -residential and the volume by wholesale corresponding to the treatment service provided to municipalities out of its full concession area.

Collected volume projections were separated into users ’ categories as seen the figure below .

Figure 4: Overall Reasoning to Calculate Total Sewage Collected Volume

Residential Commercial Industrial Sewage Public Sewage Volume Sewage Volume Sewage Volume Volume

Sewage Collected Volume

Below, the explanation how the projection for each item above was calculated .

3.2.1 RESIDENTIAL SEWAGE COLLECTED VOLUME

3.2.1.1 BRIEF DESCRIPTION OF THE METHODOLOGY FOR THE SEWAGE RESIDENTIAL MARKET PROJECTION

The methodology for the residential sewage collected volume projection follows the same reasoning employed to project measured water volume, i.e., residential units and unit consumption must be estimated. Similarly to the residential water demand estimate, this estimate on the one hand, relies on the evolution of serviceable households and on the other hand on the coverage estimated coefficient.

The figure below shows in general terms the me thodology applied to estimate the evolution of residential sewage percentage:

Figure 5: Overall Reasoning to Calculate Residential Sewage Collected Volume

Serviceable Households Sewage Collection Coverage Ratio

Water Unit Residen tial Unit s Consumption

Connections

Residential Sewage Collected Volume

Serviceable household projections and water unit consumption were discussed in previous items 6. Belo w, we explain how other figure’s items projections were updated .

3.2.1.2 SEWAGE COLLECTION RATIO

From total urban households projection, we considered only those households that effectively contributed to the sewage volume, i.e., only the households that use Sab esp’s sewage collection service. In view of data availability, the simplification was elected where service ratio was treated as the ratio between the number of sewage units and Total Urban Households. Likewise water supply, the ratio applied corresponds t o a simplification, since the universe is not only restricted to total urban households, as there are covered households, but service is not used , thus, there are households also serviced out of urban area . The sewage collection ratio is calculated accordi ng to the following formula:

Translator’s note: Sewage Collection Ratio = Number of Sewage Residential Units Serviceable Households

Likewise water, collection ratio projections were made through the linear interpolation between the ratio in 2011 and the year where the highest service ratio is expected , or the universalization, according to different sources of information (historical information, the statement of financial position and the Business Plan provided by SABESP) 7.

6 Sewage collected volumes are projected according to the sewage amounts commercially obtained . 7 Service ratio projections of RN and RS business units took into account the peculiarities of the region and the ratio was calculated based on the growth of Sewage Residential Units and Serviceable Households expected for the regions including condominiums with own treatment .

The resulting ratio for each BU was calculated from data referring to Serviceable Households of each municipality and from collection ratio. Results are shown in the chart below:

Chart 12: Results of Service Ratio Projections in Residential Sewage Collection

2011 2012 2013 2014 2015 2016 SABESP 79.0% 80.4% 82.3% 84.1% 85.9% 87.7%

3.2.1.3 RESIDENTIAL SEWAGE UNIT CONTRIBUTION

Finally, once projected sewage units, total volume is calculated from the sum of unit contributions, i.e., the volume collected by household unit. The sewage unit contribution was considered as corresponding to the residential water consumption.

3.2.1.4 RESULTS OF SEWAGE RESIDENTIAL DEMAND PROJECTIONS

Sewage units were projected from sewage collection service ratio and serviceable household projections. Results can be seen in the chart below:

Chart 13: Results of Sewage Residential Unit Projections

2011 2012 2013 2014 2015 2016 SABESP 7,102,713 7,371,643 7,681,383 7,996,368 8,318,681 8,648,269

In view of unit projection shown above and sewage unit contributions, collected volumes were updated:

Chart 14: Results of Residential Sewage Collected Volume Projections

2011 2012 2013 2014 2015 2016 SABESP 1,097,569 1,115,633 1,162,703 1,210,585 1,260,216 1,311,594

Sewage residential connections were also updated, besides collected volume. In sewage service, it was not possible to observe a temporary stability between units/connection ratio. In view of higher sewage collection coverage, connection projections were calculated through the number of units taking into account current sewage coverage level. For those municipalities whose services are close to universalization, we took the assumption that connections would have growth similar to the number of units. Concerning municipalities whose services are still scarce, units/connection ratio was projected from the assumption of this amount convergence to the ratio seen in water services.

The ratio seen in 2011 was updated in 2012 base year and the convergence year was considered that one when sewage collection service universalization is obtained. Interim years were calculated by the linear interpolation. The chart below shows these projections’ results.

Chart 15: Results of Sewage Residential Connection Projections

2011 2012 2013 2014 2015 2016 SABESP 4,882,880 5,118,126 5,348,989 5,583,241 5,822,934 6,068,035

3.2.2 NON-RESIDENTIAL SEWAGE COLLECTED VOLUME

Likewise water service, for non-residential projections, we decided to project total collected volume (represented by water consumption) and the number of connections through a series of historical trend.

Thus, unit contribution was calculated from the ratio between total projected volume divided by the number of sewage collections where connections were also projected by historical trends.

The methodology to project sewage collected volume and non-residential connections was conducted through time series similarly to non-residential water projections (methodology details were previously reported in Non-Residential Water Demand).

Chart 16: Results of Non-Residential Collected Sewage Volume Projections

2011 2012 2013 2014 2015 2016 SABESP 211,459 216,043 220,553 225,066 229,578 234,090

3.2.3 PERMISSIONAIRES SEWAGE VOLUME

The sewage volume received from permissionaries for treatment at SABESP’s units was calculated similarly to water projections, i.e., through time series. Projections were calculated for tariff cycle and are shown in the chart below:

Chart 17: Results of Permissionaires Collected Sewage Projections

2011 2012 2013 2014 2015 2016 SABESP 35,197 29,002 28,902 28,808 28,720 28,635

3.3 Water losses

The tariff system adopted through FTN approved by ARSESP, defines a maximum price mechanism based on the company’s efficient costs projected for the tariff cycle. Within this regulatory framework, water loss control has a direct impact on production costs, as it reduces the electricity consumption, chemical products, among others with strong percentage in cost structure. The recognition of efficient costs, thus, implies the recognition of losses at efficient levels (or regulatory losses). Therefore, for each year, a maximum level of losses was verified compatible with efficient costs to be recognized in revenue requirements.

Overall, the difference between the water volume produced and water volume consumed generally represents both physical and non -physical water losses. Formally, the percentage of water losses represents the quotient defined as follows :

Where:

• is the water loss ratio • is the water total volume produced by SABESP • is the water total volume consumed (measured) • refers to v olumes concerned with social, operating and emergency use .

The estimates of annual regulatory losses level are defined as follows:

• Estimate of initial losses level

• Defini tion of regulatory losses level course during tariff cycle

Losses initial level is the value of losses recognized during the first year of tariff cycle . This value was calculated considering SABESP ’s loss amounts observed in the past and compared with values seen in other Brazilian water companies, in order to analyze the reasonableness of the value adopted.

The definition of regulatory losses level course during tariff cycle relied on related investments . Therefore, ARSESP verified the consistency between CAPEX plan provided by SABESP and losses reduction targets.

Based on the aforementioned paragraph, the production recognized represents the amount of water consumed, other water uses and losses recognized every year , according to SABESP’s data and ARSESP’s analysis. Formal ly :

The term “VolOut rosUsos”, consist s of water volume related to social, operating, emergency and own uses. In order to project this vol ume , we took the assumption that the value verified in base year would have a growth proportional to the sum of residential and non -residen tial measured volumes.

SABESP’s projections results and mentioned in its Business Plan are shown in the following charts:

Chart 18: Result s of Volume Projections for social, operating and emergency uses (1000 m 3/year)

2011 2012 2013 2014 2015 2016 Proje ctions for social, operating and emergency uses 176,847 181,100 184,812 188,170 191,546 194,953 according to BP

Chart 19: Result s of Total Losses Ratio Projections

2011 2012 2013 2014 2015 2016 Losses reported in BP (%) 30 .7% 30.6% 30.5% 30.3% 30.2% 30.1%

Chart 20: Results of Water Total Loss Volume Projection s (1000 m 3/year)

2011 2012 2013 2014 2015 2016 Losses reported in BP 896,916 911,459 923,787 935,495 947 ,049 958,517

Water produced volume projections were cal culated from losses volume and water measured volume projections. These projections’ results are show in the chart below :

Chart 21: Results of Water Produced Volume Projections (1000 m 3/year)

2011 2012 2013 2014 2015 2016 Water Produced Volume reported in PN 2,929,941 2,981,620 3,033,261 3,083,659 3,134 ,111 3,184,709

3.4 Market: ARSESP ’s adjustments

3.4.1 RESIDENTIAL WATER AND SEWAGE UNIT CONSUMPTION

ARSESP analyzed SABESP’s projections which are relatively adequate, however, they require an adjustm ent in three basic issues, namely : residential users’ unit consumption ; volume delivered to permissionaires and losses.

Sabesp projected the residential market evolution proposed in BP based on unit consumption (water measured volume per residential unit ). The residential measured volume projection in BP was obtained through the estimate of the number of residential units multiplied by corresponding unit consumption. On their turn, residential units were estimated in view of the projection of the number of Total Urban Households weighted by water supply service ratio . The figure below shows in general the methodology applied to estimate the evolution of residential water volume:

Figure 6 – Reasoning of Residential Water Volume Projection in BP

Translator’s note: Serviceable Households/Water Supply Coverage Ratio/Residential Units/Unit Consumption/Residential Water Measured Volume ARSESP agreed with the projection reasoning proposed by SABESP that applied two main elements. On the one hand, the projection of households to be serviced by SABESP’s network and on the other hand, related household unit consumption. The household projection was based on a population study carried out by SEADE (State System of Data Analysis Foundation) of excellent quality.

Nevertheless, the unit consumption amounts applied to project total consumption, despite the econometric analysis, were based on data observed over the past two years (see justification in Paragraph 3.1.14). ARSESP does not agree with this assumption and FIESP (Federation of Industries of the State of São Paulo) also pointed out this same problem in comments about its contribution to the public consultation held to define P0 value and X factor.

Thus, the agency decided to broaden the scope of study in order to project the consumed volume by connection. In this regard, initially, we verified that histograms contained in BP- SABESP- 2013/2016 only reported amounts between 2008 and 2012. Thus, it was necessary to add in such study data from a broader series available at the BRAZILIAN SYSTEM OF SANITATION INFORMATION (SNIS), at the website: www.snis.gov.br

For the purposes of establishing a projection model of monthly, residential water volume per unit consumed in the municipalities serviced by SABESP, data were selected to allow any type of statistical treatment, with acceptable meaning. In this regard, SABESP had to submit monthly data between 2005 and 2011, as per chart below.

Month\Year 2005 2006 2007 2008 2009 2010 2011 January 12.73 13.53 13.14 13.25 13.40 13.41 13.37 February 13.10 13.34 13.40 13.22 13.09 13.40 13.71 March 13.03 13.34 13.74 12.92 13.45 13.51 13.11 April 12.86 12.92 13.23 12.82 13.18 13.21 13.27 May 12.51 12.62 12.26 12.53 12.85 12.74 12.81 June 12.47 12.54 12.13 12.26 12.15 12.51 12.45 July 12.12 12.59 12.26 12.44 11.95 12.55 12.49 August 12.74 12.90 12.41 12.53 12.40 12.91 12.91 September 12.65 12.84 13.06 12.68 12.51 13.27 13.18 October 12.87 12.77 13.22 12.90 12.71 12.90 13.16 November 13.16 13.07 12.99 13.15 13.46 13.43 13.16 December 13.07 13.19 13.08 13.05 13.39 13.58 13.37 Average 12.78 12.97 12.91 12.81 12.88 13.12 13.08 Source: SABESP

A solid econometric methodology was applied over these data for estimate modeling. ARMAX model is ARIMA evolved, where ARIMA is applied by adding exogenous variables independent from endogenous variables, but dependent from each other. This dependency differentiates ARMAX from other estimate models and makes this model applicable to the economy reality given by the market that has been analyzed. Results are the following:

Model 1: ARMAX, applying 2005:01-2011:12 (T = 84) observations. Dependent variable: consumption

Coefficient Standard Error Z p-value Const 12.5898 0.29473 42.7164 <0.00001 *** phi_1 0.585821 0.117795 4.9732 <0.00001 *** theta_1 0.214653 0.128855 1.6659 0.09574 * Consumption_1 0.0257986 0.0224454 1.1494 0.25039

Average dependent var. 12.92699 D.P. dependent var. 0.412979 Average innovations -0.000769 D.P. of innovations 0.286026 Probability log -13.39894 Akaike criterion 36.79787 Schwarz criterion 48.58142 Hannan-Quinn criterion 41.51504

Data estimated by this model can be seen in the graph below compared with actual data.

Figure 7:

Translator’s note: Consumption/Estimate We can see that ARMAX model perfectly adheres to data observed. Based on this same model, water demand between 2012 and 2016 was projected, amounts varying between 12.896 and 12.975 m³/month/unit, as per chart 22.

Chart 22: Consumed Volume Projection by unit (m3/month)

Year 2012 2013 2014 2015 2016 Volume / unit 12 .8960 12 .9170 12 .9370 12 .9560 12 .9750

Residential total demand projections were recalculated from this unit consumption.

Chart 23a: Results of Residential Water Volume Projections with adjusted unit consumption (1000 m 3/year)

Criterion 2013 2014 2015 2016 Residential water demand projection 1,391,796 1,423,086 1,454,510 1,486,097 according to BP Residential water demand projection adjusted according to 1,390,264 1,423,941 1,457,898 1,492,038 ARSESP ’s criterion Difference -1,532 855 3,388 5,941

Chart 24: Results of Residential Sewage Volume Projections with unit consumption adjusted (1000 m3/year)

Criterion 2013 2014 2015 2016 Residential sewa ge demand 1,162,703 1,210,585 1,260,216 1,311,594 projection according to BP Residential sewage demand

projection adjusted according to 1,190,645 1,241,368 1,293,322 1,346,535 ARSESP ’s criterion Difference 27,942 30,783 33,106 34,941

3.4.2 PERMISSIONAIRES WATER DEMAND

Considering that total water volume at wholesale provided to permissionaires increased on average 2.35% in the period between 2005 and 2011 and this growth decreased to 1.39% over the last 2 years (2010-2011), ARSESP deemed reasonable to apply a moderate growth rate of 1% p.a. to project this volume for the period between 2013 and 2016. The chart below shows SABESP’s projection and ARSESP’s adjusted projection.

Chart 25: Projection of Adjusted Water Demand at Wholesale by Permissionaires (1000 m 3/year)

2013 2014 2015 2016 Permissionaires water demand 294,733 293,779 292,877 292,015 projection in BP

Permissionaires water demand projection adjusted according to 298,719 301,706 304,723 307,770 ARSESP ’s criterion Difference -3,985 -7,927 -11,846 -15,755 19

3.4.3 REGULATORY LOSSES

According to SABESP’s business plan, losses were down 1.7 percentage points between 2010 and 2011 (from 32.3 to 30.7). ARSESP deems insufficient the 0.1 percentage point annual reduction proposed by SABESP and adopts as target for 2016, a level of regulatory losses of 27%.

Therefore, the chart below shows the adjusted losses levels to be considered in the new tariff cycle.

Chart 26: Adjusted Losses Projection (% p.a.)

2013 2014 2015 2016 Losses p rojection in BP 30.46% 30.34% 30.22% 30.10% Regulatory losses projections adopted by 29.70% 28.80% 27.90% 27.00% ARSESP Di fference (in percentage 0.76 1.54 2.32 3.10 points )

3.5 Conclusion: Consolidated Market

Considering ARSESP’s adjustments to water and sewage service demand projections provided by SABESP, resulting amounts are shown in chart 26 below. Chart 27: Total historical and projected measured demand (including permissionaires) (1000 m3/year)

History Base Year Projected Criterion Services 2011 2012 2013 2014 2015 2016 Water 1,851,178 1,889,060 1,924,661 1,959,995 1,995,515 2,031,238

SABESP Sewage 1,344,225 1,360,678 1,412,158 1,464,459 1,518,514 1,574,319 Total 3,195,403 3,249,738 3,336,819 3,424,454 3,514,029 3,605,558

Water 1,889,060 1,927,115 1,968,777 2,010,749 2,052,934

ARSESP Sewage 1,360678 1,440,100 1,495,261 1,551,620 1,609,261

Total 3,249,738 3,367,215 3,464,038 3,562,369 3,662,195

Water -- 2,454 8,782 15,234 21,696

Differences Sewage -- 27,942 30,802 33,106 34,942

Total -- 30,396 39,854 48,340 56,638

Two following charts show, respectively, a summary of water and sewage services under the historical and projected perspective (according to ARSESP’s criterion).

Chart 28: Consolidated Historical Data History Base Year Segment Breakdown 2010 2011 2012 1000 Volume 1,293,021 1,325,736 1,360,163 m3/year Residential No. End of 8,319,489 8,563,349 8,766,289 Units the year 1000do Volume 227,616 228,115 233,136 m3/year WATER Non-residential o End of N of 696,124 713,306 730,564 connections the year 1000 Permissionaries Volume 293,261 297,328 295,761 m3/year 1000 TOTAL Volume 1,813,897 1,851,178 1,889,060 m3/year

1000 Volume 1,064,893 1,097,569 1,115,633 m3/year Residential No. End of 6,833,462 7,102,713 7,371,643 Units the year 1000 Volume 203,969 211,459 216,043 m3/year SEWAGE Non-residential o End of N . of 597,870 616,512 631,390 connections the year 1000 Permissionaries Volume 28,378 27,248 29,002 m3/year 1000 TOTAL Volume 1,297,240 1,336,276 1,360,678 m3/year

1000 TOTAL (W+S) Volume 3,111,138 3,187,454 3,249,738 m3/year 1000 Volume 956,056 907,110 911,459 Losses (*) m3/year (excluding Percentage % 32.32% 30.66% 30.57% OES) Water produced WATER Volume m3/year 2,958,186 2,924,941 2,981,620 Volume Service ratio Percentage % 95.2% 95.6% Number of urban Amount End of 8,992,125 9,165,427 households the year

SEWAGE Treatment ratio Percentage % 79.0% 80.4%

(*) excludes water volumes related to social, operating, emergency and own uses.

Chart 29: Consolidated Market: Estimate (ARSESP’s Criterion)

Segment Breakdown 2013 2014 2015 2016 Volume 1000 m 3/year 1,390,264 1,423,941 1,457,898 1,492,038 Residential No. End of the 8,969,215 9,172,277 9,377,238 9,582,773 Units year

WATER Volume 1000 m 3/year Non-residential 238,132 243,130 248,128 253,126 No. of End of the 746,995 763,427 779,859 796,291 connections year

Permissionaries Volume 1000 m 3/year 298,719 301,706 304,723 307,770

TOTAL Volume 1000 m 3/year 1,927,115 1,968,777 2,010,749 2,052,934

Volume 1000 m 3/year 1,190,645 1,241,388 1,293,322 1,346,536 Residential No. End of the 7,681,383 7,996,368 8,318,681 8,648,269 Units year

SEWAGE 1000 m 3/year Non-residential Volume 220,553 225,066 229,578 234,090 No. End of the 645,592 659,793 673,995 688,196 connections year

Permissionaries Volume 1000 m 3/year 28,902 28,808 28,720 28,635

TOTAL Volume 1000 m 3/year 1,440,100 1,495,262 1,551,620 1,609,261

Measured 1000 m 3/year TOTAL (water and sewage) (1) volume 3,367,215 3,464,038 3,562,368 3,662,195

Billed volume TOTAL (water and sewage) (2) 1000 m 3/year 3,727,507 3,834,691 3,943,542 4,054,050

Volume 1000 m 3/year 892,237 872,473 852,206 831,410 Losses (*) excluding OES Percentage % 29.70% 28.80% 27.90% 27.00%

Volume produced 3 WATER Volume 1000 m /year 3,004,164 3,029,419 3,054,501 3,079,297 Service ratio Percentage % 96.04% 96.43% 96.82% 97.19% Urban households Amount End of the 9,338,729 9,512,032 9,685,334 9,859,436 year

SEWAGE Collection ratio Percentage % 82.25% 84.07% 85.89% 87.72%

(*)excludes water volumes related to social, operating, emergency and own uses.

4. CAPEX ANALYSIS

4.1 CAPEX of Second Cycle Business Plan

Considering that FTN sets forth that “Capex included in Business Plan approved by ARSESP will be built into the Regulatory Remuneration Basis during the Tariff Cycle that complies with” common sense criterion (which comprises the following aspects: i) utility; ii) usage; and iii) reasonable costs), ARSESP verified if Capex projection provided by SABESP in its Business Plan is:

i) compatible with the trend of investments made during previous tariff cycle, and

ii) consistent with service targets set out in market projections.

4.1.1 ANALYSIS OF CONSISTENCY OF CAPEX PROPOSED IN BUSINESS PLAN

In order to analyze consistency, firstly ARSESP compared the information delivered by SABESP on investments made contained in its Business Plan. Concerning past investments, historical data provided by SABESP were applied as requested by ARSESP in Phase A6 of the schedule defined by ARSESP Resolution N° 210/2011 8. In the chart below we can see the amounts effectively invested and projected for CAPEX related to 2010. - 2016 by service, according to SABESP’s Business Plan.

8 Capex amounts in this section refer to currency of December 2012.

Chart 29: Investments made and projected between 2010 and 2016

(millions of R$ in December 2012)

Million R$ 2012 Percentage

Total Water Sewage Water Sewage

2010 2, 639 1, 267 1, 372 48% 52% Made 2011 2, 138 995 1, 143 47% 53%

Base year 2012 2, 721 1, 162 1, 560 43% 57%

2013 2, 664 977 1, 688 37% 63%

2014 2,522 851 1, 671 34% 66% Projected 2015 2, 339 892 1, 447 38% 62%

2016 2, 484 1, 121 1,3 63 45% 55%

Figure 8: Investments made and estimated between 2010 and 2016 (2012 currency)

Translator’s note: million R$ 2012 / History/Base year/Projected Sewage/Water

SABESP’s investments in real terms show a relatively stable trend. We can see a decline of investments in 2011, but they increased in the following year. We can see that in 2016 investments are up again. The amounts invested in water account for on average 42% of total investments, varying between 34% and 48%. The graph below shows investments divided into regions 9.

Figure 9: Investments made between 2011 and 2016 (2012 currency)

9 Given the lack of breakdown in 2010, related investment is omitted.

Translator’s note: Bragantina region/inland/north coast/ metropolitan region of São Paulo/Santos coast metropolitan region

We can see that the metropolitan region of São Paulo is the region with the highest level of projected investment, accounting for nearly 60% of total amount invested. Bragantina region and inland together account for 22% of investments in 2012.

We may conclude that investments proposed in Business Plan are consistent with the historical evolution of Sabesp’s Capex.

4.1.2 ANAL YSIS OF CONSISTENCY OF CAPEX PROPOSED IN BUSINESS PLAN

In order to analyze the Capex plan proposed by S ABESP in its Business Plan to be implemented in the next tariff cycle, from the viewpoint of its consiste ncy with physical targets proposed, ARSESP had to regroup several programs into three main components; (i) the first one related to the expansion and replacement of systems referred to as direct investment; (ii) the second one related to operational and institution al development aspects of companies ; and (iii) finally, a third one mainly related to the process to develop engineering works, thus, referring to studies, projects and project management. The chart below summarizes CAPEX according to this classification. Chart 30: CAPEX according to SABESP’s BP (R$ thousand)

CAPEX 2,721 ,292 2,664 ,422 2,522 ,190 2,339 ,455 2,483 ,865

WATER 1,161,563 976,683 850,760 892 ,109 1,120,756

Dire ct investment 835 ,323 677 ,291 575 ,728 639 ,665 897 ,047

Operatio nal and institutional development 64 ,533 47 ,011 35 ,211 36 ,283 38 ,530

Special and capitalizable services 261 ,707 252 ,381 239 ,821 216 ,161 185 ,179

SEWAGE 1,559,729 1,687,739 1,671,430 1,447,346 1,363,109

Direct investment 1,164,209 1,321,875 1,335,335 1,141,013 1,088,106

Operational and institutional development 75,655 57,398 42,980 42,136 48,672

Special and capitalizable services 319,865 308,466 293,115 264,197 226,331

TOTAL 2,721 ,292 2,664 ,422 2,522 ,190 2,339 ,455 2,483 ,865

Dire ct investment 1,999 ,532 1,999 ,166 1,911 ,063 1,780 ,678 1,985 ,153

Operational and institutional development 140,188 104,409 78,191 78,419 87,202

Special and capitalizable services 581,572 560,847 532, 936 480,358 411,510

Aiming at assessing the first component (direct investments) few estimates of unit cost were applied from a study developed by the Ministry of Cities when drafting the National Basic Sanitation Plan – PLANSAB and unit costs applied by SABESP in its estimates seeking to check consistency and common sense of investments fully proposed. The Attachment III shows the breakdown of these unit costs.

For the effects of this evaluation, initially the physical targets of SABESP’s Business Plan were explained for each type of service. Thereafter, unit costs provided by concessionaire were analyzed to check price list and contracts signed to support these average reference costs. The chart 31 shows average cost of investments on a summarized basis 10 for water supply services.

Chart 31- Summary of Average Cost of Water Direct Investments

UNITS Average Amounts (R$/ud) Water connections Unit 369.85 Water network meter 394.63 Water mains meter 3,259.03 Water treatment stations liters/seconds 18,685.46 Water reservoirs liters/seconds 507.03 Pumping stations liters/seconds 2,965.71

Chart 32 shows incremental physical quantities calculated based on Sabesp’s Business Plan targets, from which direct investments were estimated that would be necessary to meet estimated targets. The Chart 33 below shows a summary of direct investments based on Sabesp’s average costs.

10 A detailed presentation of unit costs applied in this analysis is included in the Attachment III hereof.

Chart 32– Physical expansion estimated for water supply systems

Units 2012 2013 2014 2015 2016 New connections Unit 182,198 173,581 173,482 175,088 175,606 Network expansion meters 1,152,279 924,202 923,674 932,225 934,983 Water mains expansion meters 87,917 70,515 70,475 71,128 71,338 Treatment capacity liters/second 1,797 1,638 1,598 1,600 1,604 Reservation capacity liters/second 1,797 1,638 1,598 1,600 1,604

Chart 33 – Estimate of Direct Investments in Water Systems

TOTAL ANNUAL COST (R$ 1.00)

2012 2013 2014 2015 2016 New connections 67,385,202 64,198,239 64,161,624 64,755,596 64,947,177 Network expansion 454,728,661 364,721,426 364,513,411 367,887,874 368,976,275 Water mains expansion 286,525,363 229,811,639 229,680,569 231,806,824 232,492,627 Treatment stations 33,582,988 30,597,913 29,861,420 29,893,416 29,979,923 Reservoirs 911,274 830,274 810,289 811,157 813,505 Pumping stations 5,330,202 4,856,419 4,739,525 4,744,603 4,758,333 TOTAL 848,463,689 695,015,909 693,766,837 699,899,470 701,967,839

For sewage collection and treatment services, the analysis followed the same methodology, applying the average cost of sewage direct investments, as seen in the Chart 34 below.

Chart 34 – Average Cost of Sewage Direct Investments

UNITS Average Amounts (R$/ud) New connections Unit 627,93 Network expansion Meters 342,66 Trunk collectors, interceptors, effluents Meters 4,527.62 Sewage treatment stations liters/seconds 30,285.17 Sewage pumping stations liters/seconds 8,888.23

Chart 35 shows the sewage systems physical expansion of Sabesp’s Business Plan from which by applying the average costs of Chart 34, it was possible to estimate the investments seen in Chart 36.

Chart 35 – Physical Expansion of Sewage Systems

Units 2012 2013 2014 2015 2016 New connections Unit 235,246 230,863 234,252 239,693 245,101 Network expansion meters 1,718,492 1,686,474 1,711,231 1,750,978 1,790,484 Trunk collectors, interceptors, meters 75,757 74,346 75,437 77,189 78,931 effluents Treatment stations (ETE) liters/second 2,164 2,067 1,907 2,160 3,440 Pumping stations (EE) liters/second 2,881 3,910 3,739 4,071 5,411

Chart 36 – Estimate of Sewage Systems Direct Investments

TOTAL ANNUAL COST (R$1.00)

The comparison of these investments according to this methodology with those proposed by concessionaire can be seen in Chart 37 below.

Chart 37 – Estimates of ARSESP’s Direct Investments and Sabesp’s Capex Plan

2013 2014 2015 2016 Total Water 695,02 693,77 699,90 701,97 2,790.65 ARSESP’s estimate (R$ million) Sabesp’s Sewage 1,156.83 1,166.01 1,201.58 1,277.08 4,801.50 unit costs Total 1,851.84 1,859.78 1,901.48 1,979.05 7,592.15 Water 677,29 575,73 639,66 897,04 2,789.72 Sabesp’s business Sewage 1,321.87 1,335.33 1,141.01 1,088.10 4,886.31 plan (R$ million) Total 1,999.16 1,911.06 1,780.67 1,985.14 7,676.03 Difference (%) 7.96% 2.76% -6.35% 0.31% 1.10%

As you can see, the differences verified are not relevant, so that we may consider SABESP’s direct investment estimates 11 through this methodology as valid.

In order to analyze the second component, estimated investments in operational and institutional development were compared with OPEX amount that ARSESP considers as acceptable on a regulatory basis, and resulting amounts are shown in the Chart 38 below.

11 In addition, Attachment III hereto includes another analysis on PLANSAB’s unit costs which in their entirety indicate that the concessionaire’s estimates are consistent with proposed targets.

Chart 38 – Operational and Institutional Development Investments - R$ thousand

2013 2014 2015 2016 Operational and institutional development 104 ,409 78 ,191 78 ,419 87 ,202

OPEX 4,034 ,208 4,139 ,922 4,249 ,480 4,371 ,294

(%) 2.6% 1.9% 1.8% 2.0%

We can see that proposed levels remain at 1.8% and 2.6%. These levels are extremely low confirming ARSESP’s assumption that actually the company is not earmarking sufficient resources to relevant operating activities, such as water loss prevention. ARSESP understands the concessionaire must allocate more resources to this component, however, from the tariff equation viewpoint, the agency will consider the amounts proposed in the Business Plan.

Referring to the third component, proposed amounts were compared with direct investment acceptable on a regulatory basis and the agency verified that yearly amounts have been set aside for this component above 20% of direct investments, as seen in the chart below.

Chart 39 – Investments in Special and Capitalizable Services - R$ thousand

2013 2014 2015 2016

Special and Capitalizable Services 560,847 532,936 480,358 411,510 Direct Investment 1,999,166 1,911,063 1,780,678 1,985,153 (%) 28.1% 27.9% 27.0% 20.7%

For this category of expenses, ARSESP, based on the international experience deems a level of 15% as acceptable on a regulatory basis on direct investment. Thus, for the tariff calculation effects, this threshold shall apply. Chart 40 below shows the reduction in this component.

Chart 40 – Investments in Special and Capitalizable Services- R$ thousand

2013 2014 2015 2016

SABESP 560,847 532,936 480,358 411,510 ARSESP 299,875 286,659 267,102 297,773 Difference -260,972 -246,277 -213,256 -113,737

After these adjustments, the new Capex plan to be considered in the tariff revision is mentioned in Chart 41 below.

Chart 41: CAPEX according to ARSESP’s adjustment criteria (R$ thousand)

2012 2013 2014 2015 2016

CAPEX

Direct investment 1,999 ,532 1,999 ,166 1,911 ,063 1,780 ,678 1,985 ,15 3

Operational and institutional development 140 ,188 104 ,409 78 ,191 78 ,419 87 ,202

Special and capitalizable services 581,572 299,875 286,659 267,102 297,773

TOTAL 2,721,291 2,403,450 2,275,913 2,126,199 2,370,128

The Chart 42 below summarizes ARSESP’s readjustment compared to SABESP’s proposal:

Chart 42: CAPEX comparison (R$ Thousand)

CAPEX Category Criterion 2012 2013 2014 2015 2016

SABESP 1,999,532 1,999,166 1,911,053 1,760,678 1,985,153 Direct investment ARSESP 1,161,563 1,999,166 1,911,053 1,760,678 1,985,153

Operational and SABESP 140 ,188 104 ,409 78 ,191 78 ,419 87 ,202 institutional development ARSESP 140 ,188 104 ,409 78 ,191 78 ,419 87 ,202

SABESP 581,572 560,847 532,936 480,538 411,510 Special and capitalizable ARSESP 581,572 299,875 286,659 257,102 297,773 services

SABESP 2,721,291 2,664,423 2,522,190 2,339,456 2,483,865 CAPEX ARSESP 2,721,291 2,403,450 2,275,913 2,126,199 2,370,128

R$ thousand - -260,973 -246,277 -213,257 -113,737 DIFFERENCE

% 0.00% -9.8% -9.8% -9.1% -4.6%

5. CALCULATION OF INITIAL BRRL

Overall, the Net Regulatory Remuneration Basis (BRRL) is the asset base available to the company’s services. P 0 value is determined so that BRRL is remunerated with cost of capital recognized by ARSESP.

In case of this tariff revision, SABESP’s first one, since the regulatory system was altered, the initial BRRL reflects past system’s conditions. From this viewpoint, the initial asset base is a monetary value that can be determined fully independent from new tariff methodology established by Final Technical Note N° RTS/01/2012.

Through Resolution 156 of July 30, 2010, ARSESP defined the methodology and general criteria to define SABESP’s asset regulatory remuneration basis, aiming the development of the concessionaire’s tariff revision process, as well as the definition of initial parameters for audits to be conducted by ARSESP.

5.1 Calculation of provisional initial BRRL

The Chart below shows a summary of the initial Regulatory Remuneration Basis provided by SABESP based on surveys conducted by independent auditors hired by concessionaire.

Chart 43: Assumptions to calculate initial BRRL proposed by SABESP (R$ thousand)

Item Assumption Amount (Dec/12 currency) Gross AIS according to SABESP’s report 53,763,830 BRRL AA Accumulated depreciation according to SABESP’s report 27,645,263 installments Net AIS according to SABESP’s report 26,118,567 Total investments made according to the Business Plan 2,807,390 CAPEX J Works in progress 6,402,963 installments Total investments disbursed 9,210,353 VarWK J Calculated as 5% of Required Revenue 559,993 Gross AIS + CAPEX depreciated at a 3% rate in the J 2,037,199 D J J period BRRL o Initial Net Regulatory Remuneration Basis 33,851,714 J From Sep/2011 to Dec/2012 15 months

We can see that for the purposes of calculating P0, SABESP proposed to use R$33.851x 10 6 as the value of its initial Net Regulatory Remuneration Basis. Considering that this regulatory basis shall be submitted to ARSESP’s auditing and validation process, and certainly few adjustments should occur in the values reported, ARSESP decided to adopt, for the purposes of calculating P0 a more conservative initial BRRL. Therefore, firstly, the amount of works in progress was removed from the basis estimate submitted by concessionaire. We understand that this item must not compose the basis directly, but only from the moment the work is incorporated into the operation. In addition, we considered that until Dec/2012, 40% of the balance of works in progress in Sep /2011 would be incorporated into the Fixed Asset in Service (FAIS). The chart below shows the calculation of BRRL 0 adopted to calculate P0.

Chart 44: Assumptions to calculate initial BRRL proposed by ARSESP

Breakdown R$1,000 Sources

Gross operating fixed assets 53,763,830 Report Sep 30, 2011

Accumulated depreciation 27,645,263 Report Sep 30, 2011

Net operating fixed assets 26,118,567 Report Sep 30, 2011

Incorporations to: 9/30/11 to 12/31/12 (15 months) 2,561,185 SABESP BP and Initial TN (Nov/2011)

Depreciation between 9/30/11 and 12/31/12 (15 months) -1,245,573 Calculation: includes base report and CAP

Adjustment by investments not made (contracts) -218,577 See calculation below

Initial Regulatory Remuneration Basis -BRRLo 27,215,602 /////////// Not es: 1) Remaining useful life of net basis on 12 /31 /2012 ( years) 27 years 2) Useful life for new water and sewage investments (years ) 44 years

Thus, the preliminary BRRL considered to calculate P0 in first revision phase was R$27,215,602 thousand.

5.2 Adjustment to initial BRRL by contractual investments not made.

As of 2007, SABESP’s concession contracts with the municipalities of the state of São Paulo start to expire and will be succeeded by the execution of Program Contracts, as provided for in the Brazilian Sanitation Law (Law Nº 11,445 of 1/5/2007) and Law 11,107/2005. Until December 2011, SABESP renewed the contracts with 223 municipalities.

Upon renewal of each contract, the tariff level to be practiced by the company in the municipality was defined, as well as the rules for annual adjustments, which have been fully complied with up to date.

With the tariff level defined, SABESP assumed the responsibility for the execution of a target and capex plan in each municipality, included in the attachments of related Program Contracts. This leads to the conclusion that these contractual investments were contemplated by agreed tariffs, even for municipalities whose projected cash flows for the contractual period record deficit . In these cases, deficits were supported by tariff plan based on crossed subsidies between municipalities and/or regions ensuring the concessionaire’s overall economic and financial breakeven.

Within this context, ARSESP understands the investments envisaged in these new contracts were supported by overall tariff level, resulting from the application of tariffs in force, yearly updated based on the Tariff Adjustment Index (TAI).

Therefore, the sub-execution of these contractual investments resulted in an extraordinary benefit, which was unduly appropriated by SABESP, therefore, must be refunded to users in the next tariff cycle.

In order to determine the amount of this benefit, ARSESP considered, from SABESP’s information and new contracts, total contractual investments not made between 2009 and 2011, assessed at Dec/2012 prices. These amounts were annualized at a discount rate of 7.75% (lower rate considered in contracts) and taking into account an average useful life of 44 years, which was that one applied to depreciate new investments scheduled for the tariff cycle.

The Chart below shows a statement of these investments not made, which in Dec/2011 currency amounted to R$773,157 thousand. Adjusted for Dec/2012, based on inflation of 5.42% applied in projections of SABESP’s BP, corresponds to R$815,062 thousand.

Chart 45: Analysis of committed investments compliance in program contracts

Estimated in the Program Contract ( 2011 cu rrency – R$ thousand ) Year Inland RMSP Total Municipality with Program Contract Until 2009 520,259 - 520,259 2010 316,106 1,314,446 1,630,552 2011 319,797 1,276,288 1,596,085 Effectively made (2011 currency – R$ thousand) Year Inland RMSP Total Municipality with Program Contract Until 2009 364,144 - 364,144 2010 196,060 999,661 1,195,720 2011 241,996 1,159,991 1,401,987 Investments not made (2011 currency – R$ thousand) Year Inland RMSP Investments not made Until 2009 156,115 - 156,115 2010 120,046 314,786 434,832 2011 73,036 109,174 182,210 TOTAL INVESTMENTS NOT MADE 773,157

The surplus revenue to be refunded was estimated by present value of annualized amounts corresponding the four years of the next tariff cycle (2013-2016). This resulted in R$218,577 thousand, which was deducted from initial BRRL for the purposes of calculating P0, as offset for contractual investments not made in previous cycle. The Chart below shows the statement of such amount.

Chart 46: Amount to offset by investments not made

Investments not made - R$ thousand Dec/2012 815,062 Discount rate 7.75% Useful life (years) 44 Annualized amount - R$1,000 Dec/2012 65,626 Tariff cycle present value (2013-2016) 218,577

6. OPERATIONAL EXPENDITURE (OPEX)

This chapter shows the analysis and assessment of operational expenditures (OPEX ) projected by SABESP to be considered in the Discounted Cash Flow equation to set the initial amount of maximum tariff (P 0) for the second tariff cycle.

The concept of Operational Expenditures includes all the expenditures related to the operation and systems maintenance, as well as administrative, financial and commercial management of water and sewage services provided by SABESP. PIS/COFINS (social contribution taxes) expenses and Regulation Fee, whose amounts rely on revenue, are not included in this analysis, and appropriately considered when applying the Discounted Cash Flow equation.

The analysis of projected Operational Expenditures was based on the sources of information described as follows.

• Historical data between 2010 and 2011, especially the last fiscal year;

• Expenses projection until December 2012 (base year);

• Regulatory expenses defined by ARSESP for the 2013-2016 cycle;

• Expenses projected by SABESP for the tariff cycle under analysis.

The information provided by SABESP was not consistent between historical data and data from different Business Plans provided (which not only contain the prospective but also historical information)12 . This inconsistency hampered the evolution analysis of several expenditures categories of the company. Within this context, the amounts proposed in SABESP’s business plan and ARSESP’s considerations are presented.

6.1 Business Plan OPEX

This item shows operational expenditures (O PEX ) included in the Business Plan informed by concessionaire in September 2012.

6.1.1 BUSINESS PLAN INFORMED

The chart below shows the evolution of users, networks and volumes traded informed by SABESP in its Business Plan between 2011-2016.

12 According to ARSESP’s tariff revision schedule, SABESP delivered regulatory information in several occasions. For instance, early in the process, historical data were requested (phase A6 of the schedule) and the Business Plan (phase A7 of the schedule). Then, this updated information was requested again (phase B1 of the schedule). SABESP’s information provided during this process lacked homogeneity and posed several inconsistencies.

Chart 47 – Evolution of units, networks and volumes informed by SABESP in its business plan

TOTAL AT THE END Description 2011 2012 2013 2014 2015 2016 OF TARIFF CYCLE Units Amount 17,014,579 Increase of Amount 19,736,191 504,463 543,734 549,114 558,343 566,191 units/year Networks* Km 111,785 Increase of Km 121,671 networks/ 1,599 2,115 1,826 2,065 2,281 year Volumes thousand measured m³ 3,195,403 3,249,738 3,336,819 3,424,454 3,514,029 3,605,558 (A+E)

*Added Km correspond to the following items: TREATED WATER INTAKE, TRUNK COLLECTORS, EFFLUENTS / INTERCEPTORS , TRUNK COLLECTORS, INTERCEPTORS, COLLECTION NETWORK (VEGETATIVE GROWTH + EXPANSION), DISTRIBUTION NETWORK (VEGETATIVE GROWTH + EXPANSION), DISTRIBUTION NETWORK REPLACEMENT, DISTRIBUTION NETWORK REPLACEMENT (losses), SEWAGE NETWORK REPLACEMENT.

SABESP projects for the next tariff cycle a growth of 2,217,149 units, which accounts for an increase of 12.7% in units compared to the cycle’s start and a growth of 8,287 km of networks, corresponding to an increment of 7.3%. The market, on its turn, grows 10.95%, increasing from 3,249,738.000 m 3, in early 2013 to 3,605,558,000 m 3, at the end of 2016.

The operational expenditures projection (OPEX) for the Second Tariff Cycle submitted by SABESP is shown in the following chart 13 .

13 Expenditures accounts are excluded which are not endogenous to the company’s sales (for instance, credit write-off, COFINS/PASEP, etc.).

Chart 48: Business plan informed by SABESP (R$ thousand- Dec/2012)

History Base Year Projected Category 2010 2011 2012 2013 2014 2015 2016

Personnel 1,618,579 1,962,933 2,012,522 2,066,068 2,117,823 2,171 ,354 2,230,422

General supplies 169,733 173,422 179,106 185,240 191,275 197 ,516 204,397

Treatment 157,258 167,438 170,908 175,620 180,289 185 ,153 190,716 supplies

Services 1,117,924 1,076,259 1,104,623 1,135,939 1,166,708 1,198 ,410 1,232,245

Electric power 612,005 631,083 646,179 663,148 679,952 697 ,436 717,987

Overall expenses 324,769 325,455 332,855 341,242 349,493 357 ,931 366,777

Total 4,000,268 4,336,590 4,446,193 4,567,256 4,685,540 4,807 ,800 4,942,544

This evolution can be seen graphically :

Figure 10: BP informed by SABESP (R$ thousand- Dec/2012)

Translator’s note: history/base year/projected

It is worth noting that SABESP’s total OPEX historical amounts (2010 and 2011) were compared with corresponding accounts and these were consistent 14 . Below, the percentage of each account in reported period.

Chart 49: OPEX percentage informed by SABESP (%)

Category 2010 2011 2012 2013 2014 2015 2016

Personnel 40.46% 45.26% 45.26% 45.24% 45.20% 45.16% 45.13%

General supplies 4.24% 4.00% 4.03% 4.06% 4.08% 4.11% 4.14%

Treatment supplies 3.93% 3.86% 3.84% 3.85% 3.85% 3.85% 3.86%

Services 27.95% 24.82% 24.84% 24.87% 24.90% 24.93% 24.93%

Electric power 15.30% 14.55% 14.53% 14.52% 14.51% 14.51% 14.53%

Overall expenses 8.12% 7.50% 7.49% 7.47% 7.46% 7.44% 7.42%

Total 100% 100% 100% 100% 100% 100% 100%

According to information provided in SABESP’s business plan between 2010 and 2011, OPEX were up 8.41% and the “personnel” account evidences more than proportional increase. We can see that the “personnel” account increases its percentage considerably, from 40% to 45%. Other accounts are slightly affected.

When analyzing the information submitted by concessionaire, we saw that the opening of costs of historical information and different Business Plans provided by SABESP were not consistent. Inconsistencies were mainly seen in the evolution projection of few accounts, unit prices and drivers applied in projections. Below, details on main inconsistencies found in each of these dimensions and ARSESP’s related adjustments.

6.2 OPEX: Adjustments made

ARSESP analyzed the information provided by SABESP during the tariff revision process and found that: 1) information provided was not consistent and 2) there were accounts that should not be recognized on a regulatory basis as they are not essential in basic sanitation services.

Firstly, ARSESP verified that the information provided by the company to project OPEX for the next tariff cycle was not consistent referring to unit prices and drivers applied.

14 However, differences were found between statements of financial position and the Business Plan in relation to the accounts composing these total amounts. For instance, in 2011, the personnel account is 20% higher in BP compared to the statement of financial position, but this difference is mitigated by a relevant difference in “overall expenses” account.

Specifically, if BP delivered early in current year (in compliance with phase B1 of schedule), we verify there are differences in OPEX compared to the amounts reported in previous versions of the BP (as requested, for instance, in phase A7 of the schedule). There are differences both for drivers applied to project and for unit prices established in each BP. The origin of these differences was not explained by SABESP.

Secondly, as previously mentioned, there are OPEX accounts that should not be considered in tariffs of the next cycle (or should be considered only partially), as they do not compose the water or sewage services.

In view of the aforementioned paragraph, ARSESP made two adjustments to OPEXs which are reported hereinafter.

6.2.1 ADJUSTMENTS BY NON-RECOGNIZED OPEX

ARSESP analyzed in detail over 120,000 OPEX categories delivered by SABESP in its Business Plan and after analysis of justifications included in SABESP’s contributions, the agency concluded that few accounts should not be recognized in tariffs as they are not essential for the adequate service rendering. After this analysis, ARSESP adjusted the Business Plan data submitted by SABESP. The chart below shows non-recognized OPEX categories to be considered when calculating P0.

Chart 50: Non-recognized OPEX categories

OPEX Item

GENERAL EXPENSES INSTITUTIONAL SUPPORT GENERAL EXPENSES DONATIONS PERSONNEL BOARD OF DIRECTORS BONUS PERSONNEL BOARD OF EXECUTIVE OFFICERS BONUS PERSONNEL SABBATICAL LEAVE PERSONNEL PROFIT SHARING PERSONNEL SUPPLEMENTARY PENSION - G0 PERSONNEL REWARD PROGRAM PERSONNEL SABESPREV MAIS – INCENTIVE SPONSOR PERSONNEL CONSENT DECREE – RETIREES

SERVICES CHANELLING OF STREAMS SERVICES PROVISION FOR SABESP/PMSP AGREEMENT SERVICES CREDIT RECOVERY

These expenses categories according to ARSESP ’s understanding should not compose the basis of calculation, besides others whose amounts submitted by SABESP were considered excessive, therefore, they were adjusted. Obviously there are few OPEXs that should have their structure and nature more detailed prior to their interpretation. For few OPEX categories, the lack of information about its structure and nature can be attributed to the company; however, in other cases, it also relies on the effective implementation of the regulatory accounting system.

The Chart shows the impact of this adjustment by non-recognized OPEX compared to the amounts mentioned in SABESP’s Business Plan 15 .

Chart 51: Non-recognized OPEX (R$ thousand in Dec/2012 currency)

Category Criterion 2013 2014 2015 2016

Personnel PN-SABESP 2,066,068 2,117,823 2,171,354 2,230,422

NTF-ARSESP 1,745,082 1,800,791 1,858,123 1,920,736 PN-SABESP 185,240 191,275 197,516 204,397 General supplies NTF-ARSESP 189,177 195,875 202,775 210,319

Treatment PN-SABESP 175,620 180,289 185,153 190,716 supplies NTF-ARSESP 178,305 182,908 187,690 193,153

PN-SABESP 1,135,939 1,166,708 1,198,410 1,232,245 Services

NTF-ARSESP 1,146,186 1,181,192 1,217,179 1,255,979 PN-SABESP 663,148 679,952 697,436 717,987 Electric power NTF-ARSESP 573,100 587,836 603,111 620,965

PN-SABESP 341,242 349,493 357,931 366,777 Overall expenses NTF-ARSESP 324,758 334,017 343,434 353,224

PN-SABESP 4,567,257 4,685,540 4,807,800 4,942,544 TOTAL

NTF-ARSESP 4,156,609 4,282,619 4,412,312 4,554,376 Total Difference -8.99% -8.60% -8.23% -7.85%

From this analysis, and considering the effects of demand adjustments reported in item 3 (it alters few drivers), the reduction deriving from ARSESP’s non-recognition of few OPEX items, compared to SABESP’s BP amounts, varied between 8.99% in 2013 and 7.85% in 2016.

6.2.2 OPEX ADJUSTMENTS DUE TO INCONSISTENCY IN BUSINESS PLAN

OPEX projections prepared by SABESP in different BPs delivered to ARSESP, within the scope of the tariff revision process, differ without an explanation by the company that allows to verifying the consistency between data. The origin of differences lies both on unit prices and drivers applied in projections of few OPEX accounts.

15 Based on accounts not relying on the company’s sales (Personnel, Treatment Supplies, General Supplies, Services, Electric Power and Overall Expenses).

In fact, the BP delivered by SABESP in August 2011 (in observance to Phase A7 of schedule) has 2010 as base year of projection; while the BP delivered in September 2012 projects the amounts corresponding to 2011. When observing the OPEX accounts projections, we could see that both methodologies and drivers and unit prices differ in both BPs, without any explanation. For instance, the difference in the personnel account with “commercial”16 purposes for unit costs of both BPs was on average 2.7%, i.e., the unit cost for OPEX “Personnel” account (with “commercial” purpose) of BP of August 2011 is 2.7% lower than the BP amount of 2012 (both in same currency).

In view of this situation, ARSESP then started to analyze main differences in all OPEX accounts aiming at identifying which projection methodology was more compatible with historical data.

From this analysis, ARSESP also adjusted OPEXs in view of these inconsistencies, the results of which are outlined in the chart of item 6.2.4.

6.2.3 ADJUSTMENT TO ELECTRIC POWER EXPENSES (LAW 12,783 – TARIFF REDUCTION )

On 1/25/2013, the Law Nº 12,783 was enacted which impacts the electric power tariffs paid by SABESP. In view of relevant percentage of electric power expenses over SABESP’s costs, ARSESP assessed the impact of such law, which is detailed in the Attachment IV of this Technical Note, and decided to apply a 15% discount over electric power unit costs adopted in the PTN.

6.2.4 SUMMARY OF OPEX AND ADJUSTMENTS MADE

OPEX were projected again by ARSESP for the tariff cycle, taking into account, besides referred adjustments, the effects deriving from demand projection adjustments previously mentioned, which altered few drivers.

The chart below shows the combined effect of these considerations, by comparing OPEX provided by SABESP in its Business Plan (delivered in September 2012) with those resulting from ARSESP’s adjustments, which were applied when calculating P0.

The chart below shows the combined effects of ARSESP’s adjustments and the OPEX recognized for tariff cycle which were considered when calculating P0.

16 The reason why this cost category is adopted as example is because in both BPs the driver is the same (water connections), avoiding the comparison of projected accounts with methodologies completely different. Therefore, a unit cost was estimated which removes the drivers difference effect that may exist between BPs.

Chart 52 OPEX adjusted by ARSESP

Projected (Dec/2012 currency– R$ thousand)

OPEX Adjustment 2013 2014 2015 2016

SABESP BP 4,567,257 4,685,540 4,807,800 4,942,544

ARSESP’s revision (non-recognized OPEX ) -410,648 -402,921 -395,488 -388,168

ARSESP’s revision (adjustment due to inconsistencies found in BP) -96,056 -116,350 -136,482 -156,731

ARSESP’s revision: OPEX adjusted to calculate P0 4,060,553 4,166,269 4,275,830 4,397,645

ARSESP’s revision: OPEX adjusted to calculate P0 (%) -11.09% -11.08% -11.06% -11.02%

As you can see, these regulatory adjustments imply a reduction of OPEX by approximately 11% p.a. in relation to the projections proposed by SABESP, already including the impacts on OPEX deriving from changes in demand parameters mentioned in previous section and the reduction of energy tariffs.

7. REGULATION, CONTROL AND INSPECTION FEE

The amount of Regulation, Control and Inspection Fee (RCIF) was set at 0.50% of annual sales directly earned with service rendering, less taxes 17 . According to current laws, “annual sales will correspond to the gross operating revenue of the last fiscal year, as verified in the financial statements, less the following taxes, pursuant to prevailing laws: (i) State VAT - ICMS; (ii) PIS/Pasep social contribution taxes; and (iii) Social Security Financing Contribution – COFINS.

The amount referring to this Regulation Fee will be levied only on municipalities with services regulated by ARSESP and were not considered in P0 calculation as they will be broken down in users’ accounts.

17 According to ARSESP Resolution 287 of 12/14/2011.

8. TAXES AND CONTRIBUTIONS

According to the FTN approved by ARSESP in April 2012, all taxes related to water and sewage services will be considered in P0 calculation, whether explicitly or as OPEX component. For other charges deriving from legal requirements of different jurisdictions, the FTN resolved considering them out of Maximum Average Tariff (P 0) and were included in users’ bills of specific jurisdiction that originated them.

In order to determine the costs under the PIS/COFINS concept, we should note that these contributions have tax rates of 7.60 and 1.65 percentage points, respectively, totaling 9.25 percentage points over operating revenue. Considering there are credits that can be deducted from these contributions, the tax rate to be considered when projecting these expenses must be net of these credits. The chart below shows the result of this net rate seen in the 2006-2011 period:

Chart 53 – History of PASEP/COFINS Expenses

Projected (Dec/2012 currency – R$ thousand) Description 2006 2007 2008 2009 2010 2011 Gross operating revenue 5,984,012 6,448,211 6,838,803 7,236,218 7,655,226 8,305,043

COFINS/PASEP (456,679) (477,369) (487,131) (505,671) (555,531) (602,231)

COFINS/PASEP rate 7.6% 7.4% 7.1% 7.0% 7.3% 7.3%

Therefore, ARSESP agrees with SABESP (as mentioned by the company in its BP) to apply an average rate of 7.3% to project PIS/COFINS expenses in the tariff cycle. Under this assumption, effective expenses related to this item for the tariff cycle will be those represented in the following Chart:

Chart 54: Projection of PASEP/COFINS Expenses

Projected (Dec/2012 currency – R$ thousand) Description 2013 2014 2015 2016

PASEP/COFINS Projection 703,246 723,416 743,900 764,695

9. REVENUES

Besides direct or tariff revenues, other forms of revenues were considered related to the rendering of water and sewage services affecting the calculation of P0 which are analyzed hereinafter.

9.1 Irrecoverable revenue (default)

The Irrecoverable Revenue means the amount of invoiced revenue but not received as a result of default from users’ invoices. Therefore, as it is treated as deferred payment, it is legitimate to recognize as cost to be refunded by tariff, a limit value for the accounts deemed as bad debt, as long as the commercial system complies with desirable efficiency standards, especially referring to sales and collection for services rendered to users.

This limit value of irrecoverable revenue to be envisaged in tariffs is referred to as Regulatory Irrecoverable Revenue. There are different approaches to estimate which should be the level allowed for irrecoverable revenue. The FTN approved by ARSESP in April 2012, establishes the utilization of aging methodology.

Therefore, ARSESP identified the "stable" percentage of default during a time period by applying the source of information provided by SABESP in its BP. It is worth noting that this “stable” amount of debt aging curve was adjusted to consider both additional cost to which the company must incur to activate debt collection additional policies (hiring of debit/credit recovery companies), and most of revenue generated by the impact of these policies (reduction of default rates).

As a result of this methodology, a default rate was estimated at 2.61% to be applied over invoiced revenue for the next tariff cycle as irrecoverable revenue. The chart below shows the amounts for the cycle.

Chart 55: Irrecoverable revenue

Projected (Dec/2012 currency – R$ thousand) Description 2013 2014 2015 2016

Irrecoverable revenue to calculate P0 245,862 252,931 260,111 267,400

9.2 Indirect Revenue

Indirect revenue foresees the company’s revenue as a result of sale of the following additional services:

• Connections: revenue deriving from water and/or sewage connections

• Expansions: revenue deriving from expansions (enlargements) of water and/or sewage networks

• Reconnections: revenue deriving from water and/or sewage reconnections

• HydroCons/Rep/Hydro box: revenue deriving from repair, replacement of hydrometer boxes

• Addition due to delay: revenue deriving from delayed payment of bills

• Repairs at networks: revenue deriving from repairs at networks

• Inspections, certificates and other (partnerships): revenue deriving from inspection services, certificates, etc.

According to the BP, indirect revenue was projected by SABESP taking into account the percentages of 2.3% and 0.6% over water and sewage direct revenue, respectively. Under this assumption, SABESP shows the following projections:

Chart 56: Indirect revenue projection according to SABESP’s BP

Projected (Dec/2012 currency– R$ thousand – Description excluding COFINS/PASEP) 2013 2014 2015 2016

Total indirect revenue reported by 153,289 156,670 160,083 163,528 SABESP

In this aspect, ARSESP does not agree with the parameters estimated in SABESP’s BP as far as sewage is concerned. After analyzing the historical evolution of sewage indirect revenue in relation to sewage direct revenue, ARSESP observed that the average of the last three years (2009, 2010 and 2011) was 1.5%. Therefore, ARSESP adopts this parameter as reasonable for regulatory purposes and accepts SABESP’s proposal for the parameter corresponding to water indirect revenue (namely, 2.3% of water direct revenue). The chart below shows the one-off effect of this change on indirect revenue projection parameter (caeteris paribus ) in relation to amounts projected in SABESP’s BP:

Chart 57: Indirect revenue projection according to SABESP’s BP adopting the 1.5% parameter for sewage

Projected (Dec/2012 currency – R$ thousand – Description excluding COFINS/PASEP) 2013 2014 2015 2016 Total indirect revenue reported in BP 153,289 156,670 160,083 163,528

Total indirect revenue and parameter adjusted (1.5% 180,743 185,429 190,182 194,990 of sewage direct revenue ) Difference (27,454) (28,759) (30,099) (31,462)

The chart below shows final indirect revenue, incorporated in the calculation of Maximum Tariff (P 0), considering, besides the alteration mentioned above, all the effects deriving from the adjustments to P0 calculation components.

Chart 58: Indirect revenue to calculate P0

Projected (Dec/2012 currency – R$ thousand – including Description COFINS/PASEP) 2013 2014 2015 2016

Total indirect revenue to calculate P0 184,725 189,728 194,802 199,944

9.3 Non-Operating Revenue

Company’s revenue was analyzed mainly related to the following events:

• Property, plant and equipment: revenue deriving from asset disposal;

• Scrap: revenue deriving from the sale of scrap;

• Invitation to bid: revenue deriving from invitations to bid

• Indemnities and Expenses Refund: revenue deriving from indemnities and refund of expenses caused by third parties

• Fines and pledges: revenue deriving from contractual fines due to contract default

• Technical services: revenue deriving from project services and technical assistance, technical and laboratory services.

• Property lease: revenue deriving from property lease (rental)

• Real properties: revenue deriving from sale of real properties;

• Pura: revenue deriving from PURA project (Water Rational Use Program)

• Time-barred amounts: revenue deriving from time-barred amounts to refund to clients

• Bank of New York: revenue deriving from the Bank of New York

• Sanebase: revenue deriving from SANEBASE program

• Aqualog: revenue deriving from Aqualog technology

• Donations: revenue deriving from donations (networks)

• Banco do Brasil exclusiveness agreement: revenue deriving from the adhesion to the agreement for the sale of exclusiveness right of Sabesp’s employees’ payroll deposits, in the period between March 2007 and March 2014, with Nossa Caixa and Banco do Brasil.

• Other metrological essays, attorney’s fees, etc.

In its BP, SABESP informs that “between 2010 and 2011, other operating revenue accounted for an additional R$13 million at Dec 2011 amounts”.

Initially, ARSESP planned to review the amounts projected for these revenues based on additional data collected. However, in view of new data and justifications mentioned in SABESP’s contribution (SABESP proposes R$11,487 thousand/year), ARSESP resolved to maintain projections mentioned in its Preliminary Technical Note, i.e., R$13,705 thousand/year .

10. CALCULATION OF P0 AND X FACTOR

10.1 Calculation of P0

In order to calculate P0 parameter, the following items were considered:

a) The calculated amounts, as explained in this Technical Note, for parameters:

• BRRL in December 2012

• OPEX for each year of the tariff second cycle (at Dec/2012 prices)

• CAPEX for each year of the tariff second cycle (at Dec/2012 prices)

b) Depreciations for each year of the Tariff Second Cycle

c) The cost of capital determined according to related procedure and calculations described in the Technical Note of WACC . ( WACC =8.06%)

The chart below shows a summary of components considered to calculate P0.

Chart 59: Components considered when calculating P0

Form ula 2012 Tariff Cycle - R$1000 Breakdown Components Present Value 2013 2014 2015 2016

Billed volume (A+E) - (1000m3) VF 12,831,992 3,727,507 3,834,691 3,943,542 4,054,050

+ Direct required revenue (tariff) RRD 32,480,365 9,435,073 9,706,377 9,981,901 10,261,619 + Indirect revenue RI 634,449 184,725 189,728 194,802 199,944 + Non-operating revenue RN 45,331 13,705 13,705 13,705 13,705 - COFINS/PASEP CP 2,420,691 703,246 723,416 743,900 764,695 - Operational expenditures (OPEX) OPEX 13,939,491 4,060,553 4,166,269 4,275,830 4,397,645 - OPEX – excluding losses OPEXsp 12,885,995 3,733,313 3,845,084 3,960,971 4,089,387 - Losses OPEX OPEXp 1,053,496 327,240 321,185 314,859 308,258 - Irrecoverable revenue (bad debt) INC 846,382 245,862 252,931 260,111 267,400 - ARSESP inspection fee TR - - - - - AUX: Depreciation/Amortization DC 2,559,488 703,508 749,826 801,190 860,869 (accounting) - Income tax/social contribution IRCS 4,553,992 1,332,914 1,365,905 1,397,188 1,422,784 - Investments CAPEX 7,596,528 2,403,450 2,275,913 2,126,199 2,370,128 - Working capital variation DWK 72,837 84,801 -974 -1,686 -4,729 - Initial base of capital BRL0 27,059,856 - - - - + Final base of capital BRLT 23,329,631 - - - 31,810,297

= Free cash flow + Bdk -27,059,856 802,678 1,126,349 1,388,867 33,067,642 = Free cash flow + Bdk (deducted) -27,059,856 742,808 964,591 1,100,692 24,251,766

Maximum Average Tariff - Po (R$ / m3) Net Present Value= 0,00000 Calculated Current Chg. Internal Rate of Return (IRR) = 8.06% 2.53120 2.47306 2.3509%

The result obtained by ARSESP for P0 value is R$2.5312/m 3, denominated in reais of December 2012. This new tariff level should correspond to a linear adjustment in tariffs of

2.3509% considering that SABESP ’s current average tariff is R$ 2.47306 18 and that SABESP decided in this phase to maintain its current tariff structure .

10.2 Calculation of X Factor

The tariff system approved by ARSESP in April 2012, foresees a regulation mecha nism by maximum prices with an efficiency factor (or X factor) aiming at transferring to the users the efficiency profits earned by the company. This efficiency factor is gradually transferred to users and the efficiency gains through reductions in tariffs in real terms within tariff cycle. In fact, according to referred FTN, P 0 reported herein must be adjusted yearly during the tariff cycle according to the following formula:

Where

• is the maximum average tariff to be applied during year t of tarif f cycle

• is the percentage variation of IBGE’s extended consumer price index for the reference period.

• is the efficiency percentage to be transferred to users at the end of each year t of tariff cycle.

• is the maximum average tariff of previous tariff year whose initial value will be P0

• is the adjustment factor by quality , expressed as billed R$/m3

According to the FTN, the annual index factor (AIF), will be calculated in view of IPCA variation seen in previous year. The annual adjustment factor by quality (AAFQ) will be implemented during the tariff cycle according to the rules set forth by FTN. Lastly, tariffs will be adjusted by X efficiency factor (observing the methodology laid down in FTN ) which are briefly pointed out below together with results of its calculation.

According to the FTN approved by ARSESP in April 2012, the calculation of X Factor must observe the following reasoning:

• Firstly, the P0 breakeven tariff is estimated assuming that the efficiency level remains afloat dur ing the entire revision period .

• Secondly, the “efficient P0 ” breakeven tariff is calculated again including in OPEX the efficiency levels defined for operating expenses (see section 10).

18 Determin ed from the application of current tariffs over 2011 Consumption Histogram , provided by SABESP.

Finally, the X Factor should be calculated from an interactive process, taking into account the following equation of present value equation and revenues linking P0 with “efficient P0”:

Where: • efficient maximum average tariff that ensures SABESP breakeven (and includes in OPEX the efficiency levels according to estimates deriving from previous item , “Calculation of Efficiency Applied to Operating Expenses ”) • maximum average tariff to ens ure SABESP breakeven, supposing that efficiency level remains sustained during entire period and corresponding to that level seen at the beginning of Tariff Cycle. • total billable v olume for year t ( corresponding to the sum of water and sewage volume) • is the WACC according to ARSESP estimate reflected in ARSESP Resolution N° 227/2011.

• is the X Factor to be calculated .

Therefore, considering that ARSESP concluded that OPEX should be reduced by 2.68196% (see details of estimate at the Attachmen t I) yearly during the tariff cycle, so that SABESP transfers the efficiency gains to the users, the agency determines through previous formula that the X Factor is 0.8593%. Accordingly , P 0 previously calculated will evolve during the tariff cycle as follows:

Chart 60: A pplication of X Factor under breakeven tariff

Year Period Tariff

1 from 2012 to 2.9295 2013

2 from 2013 to 2.9044 2014 3 from 2014 to 2.8794 2015 4 from 2015 to 2.8547 2016

11. SABESP ’s TARIFF STRUCTURE

According to the schedule es tablished for the tariff revision process, SABESP submitted its proposal for a new tariff structure to ARSESP in October 2012. However, in the document “Technical Note on SABESP ’s Tariff Structure ”, SABESP prop oses that given the short time period until th e conclusion of the Periodic Tariff Revision and the complexity of issues involved , that the proposition of a new tariff structure is discussed

49 with the regulatory agency and society in a Public Hearing not tied to the revision process (discussion of P0 and X Factor) dated November 9, 2012 .

ARSESP agrees with this SABESP’s proposal, deciding accordingly to postpone the discussion on tariff structure to the end of this revision’s second phase.

12. ATTACHMENT I – CALCULATION OF OPEX EFFICIENCY

The efficiency factor (or X Factor) seeks to transfer the company’s efficiency gains to users through lower tariffs in real terms. These efficiency gains may be divided into two main sources:

• Reduction of inefficiencies (catch-up)

• Technological change

The first component aims at reducing the distance that separates certain company from an efficient cost frontier. The second one tries to capture until which point the efficient frontier shifts over time as a result of technological change.

According to the FTN, in order to estimate the company’s productivity gains due to expected technological change, the Malmquist index through DEA was applied, which enabled to isolate part of the variation in productivity attributable to this technological change.

In order to estimate the second component related to catch-up, the company’s average distance was calculated until frontier in DEA cross section adopting the last period available (2009). Then the annual percentage that should be incorporated into X factor was calculated so that, during the tariff cycle, the company reduces by 75% its inefficiency inventory estimated in previous phase. Below, further details of the method applied to estimate OPEX efficiency.

12.1 The Construction of Benchmark

12.1.1 GUIDANCE

The efficiency models may be guided to (i) a proportional reduction of inputs – inputs guidance - or (ii) proportional increase of products – products guidance, or also may not be guided (in this case, the reduction of inputs and the increase of products are calculated jointly). The selection of type of guidance will rely on the sector’s peculiarities. In case of water and sewage companies, ARSESP deemed more appropriate to adopt the inputs guidance (in light of the sector’s characteristics), since the product is typically exogenous (or much less subject to the company’s control than its inputs).

12.1.2 COMPANIES INCLUDED IN THE SAMPLE

In all approaches of efficiency estimate there is an issue of level of freedom, worsened by the emphasis in relative efficiency of these approaches. The levels of freedom increase with the number of sample companies and decrease with the number of variables (inputs, products and environmental variables).

These choices are not independent, since the inclusion of a higher number of companies allows to include other inputs and products in the analysis, so that to have a more accurate identification of technological frontier.

12.1.3 TECHNOLOGICAL CHANGE

In order to calculate Malmquist indexes (see FTN approved by ARSESP), ARSESP applied the data of the Brazilian System of Sanitation Information (SNIS). Concerning service providers in a first approach, we analyzed a representative sample of 10% of SABESP’s target population, i.e., 2,000,000 of inhabitants to be serviced. The result was a panel of 18 companies observed in 2007- 2009 period. In case of SABESP, the information was divided into 11 business units, resulting in a total of 28 x 4 = 112 observations company-year for analysis. The following chart shows other details of companies and business units considered.

Chart 1: Companies in SNIS sample

Acronym Service Provider Municipality State Companhia de Saneamento Básico do Estado de São Paulo:

U.N. ALTO PARANAPANEMA U.N. BAIXADA SANTISTA U.N. BAIXO PARANAPANEMA U.N. BAIXO TIETE E GRANDE

U.N. CAPIVARI/JUNDIAI SABESP U.N. LITORAL NORTE São Paulo SP U.N. MEDIO TIETE U.N. PARDO E GRANDE U.N. VALE DO PARAIBA U.N. VALE DO RIBEIRA U.N. REGIAO METROPOLITANA COPASA Companhia de Saneamento de Mi nas Gerais Belo Horizonte MG CEDAE Companhia Estadual de Águas e Esgotos Rio de Janeiro RJ EMBASA Empresa Baiana de Águas e Saneamento Salvador BA SANEPAR Companhia de Saneamento do Paraná Curitiba PR COMPESA Companhia Pernambucana de Saneamento Recife PE CORSAN Companhia Rio -Grandense de Saneamento Porto Alegre RS CAGECE Companhia de Água e Esgoto do Ceará Fortaleza CE SANEAGO Saneamento de Goiás S/A Goiânia GO COSANPA Companhia de Saneamento do Pará Belém PA CAEMA Companhia de Águas e Esgotos do Maranhão São Luís MA CAGEPA Companhia de Águas e Esgotos da Paraíba João Pessoa PB CASAN Companhia Catarinense de Águas e Saneamento Florianópolis SC CAERN Companhia de Águas e Esgotos do Rio Grande do Norte Natal RN AGESPISA Águas e Esgotos do Piauí S /A Teresina PI CASAL Companhia de Saneamento de Alagoas Maceió AL CESAN Companhia Espírito -Santense de Saneamento Vitória ES CAESB Companhia de Saneamento Ambiental do Distrito Federal Brasília DF

12.1.4 REDUCTION OF INEFFICIENCIES (CATCH -UP )

The lack of adequate comparison (the counterpart of a restricted number of sample companies) may result in qualifying a company as efficient by standard: not because it is really efficient, but because there is no other company in the sample that could be compared. The search of peer companies for a substantiated exercise of relative efficiency estimate, in many circumstances, requires to resorting to companies of other countries for comparison.

In order to obtain a better discernment of relative efficiency in cross section, a group of 10 water and sanitation companies of the United Kingdom was added to 28 companies considered in previous item. All data correspond to the last year available: 2009. The Chart below shows a list of companies incorporated.

Chart 2: Water and sanitation companies of the United Kingdom

ANH = Anglian Water Services NES = South East Water Ltd NWT = United Utilities plc SRN = Southern Water Services Ltd SVT = Severn Trent Water Ltd SWT = South West Water Ltd TMS = Thames Water Utilities Ltd WSH = Dwr Cymru Cyfyngedig (Welsh Water) WSX = Wessex Water Services Ltd YKY = Yorkshire Water Services Ltd

12.1.5 ELECTION OF INPUT AND PRODUCT VARIABLES

Typically, inputs are defined as the resources applied by companies or as conditions that affect their performance, while products are the benefits generated as a result of the company’s operations. However, sometimes it is difficult to classify a factor in particular as input or product. In these cases, a way of classifying the factor is to verify if a company with higher registration in this factor is deemed more efficient or not. If answer is yes, usually the factor is classified as product; if not, it is classified as input.

Selection criteria usually are subjective, at least, partially. However, few general guidelines may be specified. Observing the usual practice in water and sanitation, the following variables are applied to this estimate:

• Inputs: operating expenses, AP losses. • Products: water and sewage connections, water units, sewage units, billed water volume, recollected sewage volume.

Operating expenses are reported in 2009 constant Reais in case of SNIS data. In order to facilitate comparison, when also applying United Kingdom data, all monetary amounts are converted into U.S. dollars (using the purchasing power parity exchange rate) and converted into constant U.S. dollars of 2009 applying the USA price index 19 .

The Chart 3 shows descriptive statistics for different variables applied in the last year available (2009).

Chart 3: Descriptive Statistics

SNIS BASIS

Standard Average Median Minimum Maximum Deviation AP connections 982,168 508,199 1,082,438 96,160 4,603,331 AR connections 417,541 206,698 652,466 11,220 3,053,027 AP units 1,236,126 707,257 1,381,012 96,972 5,728,931 AR units 621,658 241,345 984,704 29,063 4,739,470 Billed water volume (1000 m3/year) 226,527 112,577 294,307 16,514 1,371,547

Recollected sewage volume (1000 m3/year) 94,284 37,514 151,501 583 720,088

Operating expenses (constant US$) 312,068,068 165,742,828 356,800,827 35,704,870 1,648,990,342

AP losses (%) 36.1 33.7 12.2 18.5 58.9

OFWAT BASIS

Standard Average Median Minimum Maximum Deviation AP units 1,933,913 1,951,268 1,111,627 557,086 3,482,421 AR units 2,394,218 2,061,493 1,464,518 673,180 5,372,483 Billed water volume (1000 m3/year) 361,388 377,138 217,540 105,512 751,148

Recollected sewage volume (1000 379,477 320,138 278,326 86,640 1,025,226 m3/ year ) Operating expenses (constant US$) 932,572,663 836,500,763 447,032,474 356,030,534 1,587,175,573

AP losses (%) 26.8 27.7 5.6 18.0 33.9

19 Operating expenses of Ofwat basis correspond to the “current operating costs" variable (including CCD and IRC). Data referring to the type of exchange and price index of the USA were collected from the World Economic Outlook Database of the International Monetary Fund.

12.2 Results

12.2.1 TECHNOLOGICAL CHANGE

Different models were considered according to the selection of products. In compliance with the international practice and due to results obtained from different estimated models, ARSESP adopted a model to be estimated whose functional relation was determined by 20 :

• Products: AP units, AR units • Inputs: operating expenses, AP losses

According to the model elected by ARSESP, results establish that Brazil’s water and sanitation sector in the 2007-2009 period saw a lag of 2% p.a. of technological frontier (this percentage is obtained as geometric average, weighted by the number of AP connections in 2009 of changes related to each sample company).

12.2.2 REDUCTION OF INEFFICIENCIES (CATCH -UP )

The Chart shows the efficiency measurement of each business unit of SABESP, as well as the average (weighted by AP 2009 connections) for the company’s total. Under no assumption, a priori presupposition is imposed on the type of scale yields, i.e., we work on the variable yield assumption.

Chart 4: (In)efficiency measurements

Model U.N. ALTO PARANAPANEMA 0.843 U.N. BAIXADA SANTISTA 0.771 U.N. BAIXO PARANAPANEMA 0.853 U.N. BAIXO TIETE E GRANDE 1.000 U.N. CAPIVARI/JUNDIAI 0.829 U.N. LITORAL NORTE 0.941 U.N. MEDIO TIETE 0.697 U.N. PARDO E GRANDE 0.879 U.N. VALE DO PARAIBA 0.875 U.N. VALE DO RIBEIRA 1.000 U.N. REGIAO METROPOLITANA 1.000 SABESP 0.946

20 In addition, ARSESP preferred applying water and sewage units model as product to maintain the internal consistency (there are no connection data for the United Kingdom companies), since units data seem more accurate and reliable than volumes.

We obser ve that results indicate an efficiency level of nearly 95%, revealing an inefficiency inventory of 5%.

12.2.3 EFFICIENCY AND BREAKEVEN TARIFF

Establishing that the company should decrease by 75%, the lag separating it from efficient frontier (catch-up), the eff iciency that should be applied to operating expenses is 2. 68%.

Chart 5: E fficiency applied to operating expenses

Technological change 2.00%

Catch-up 0.68%

Expenses efficiency 2.68%

Therefore, in order to estimate the potential value of impact of X efficiency factor on tariff, we should consider a reduction of 2. 68% inter-annual in operating expenses.

ATTACHMENT II – SABESP ’S RESIDENTIAL WATER DEMAND PROJECTIONS

Sabesp projected the evolution of the residential market in BP based on unit consumpti on (water measured volume by residen tial unit). The projection of residential measure d volume of BP was obtained through an estimate of the number of residential units multiplied by related unit consumption. On their turn, residential units were estimated in view of projection of the number of Total Urban Households weighted by water supply service ratio. The figure below shows in general terms the methodology applied to estimate the evolution of residential water volume:

Figure 1 – Reasoning of Residenti al Water Volume Projection in BP

Translator’s note: serviceable households/water supply coverage ratio /residential units/unit consumption/residential water measured volume

The Agency agreed with the projection reasoning proposed by SABESP that adopts two main elements. On the one hand, the projection of households to be serviced by SABESP ’s network and on the other hand the related household unit consumption . The projection of households was based on excellent quality population study carried out by S EADE.

However, the unit consumption values applied to project total consumption were b ased on data observed over the p ast two years . ARSESP does not agree with this assumption, and FIESP also pointed out this same problem in its comments when contributed to the public hearing held to define P0 value and X factor.

Therefore, the agency decided to broaden the scope of study in order to project the volume consumed by connection. In this regard, initially we verified that histograms presented in BP - 55

SABESP-2013/2016 only reported amounts between 2008 and 2012. Thus, the agency deemed necessary to add to referred study data from a broader series available at the BRAZILIAN SYSTEM OF SANITATION INFORMATION (SNIS) at the website www.snis.gov.br

This system yearly receives municipal data provided by respective concessionaires which have been operating in Brazil since 1995. The correct completion of spreadsheets and the definition of variables have been improved over the years, making us to start the data analysis as from 2005.

CONSUMED WATER VOLUME AT RESIDENTIAL HOUSEHOLDS

For the purposes of establishing a projection model of monthly, residential water volume by unit consumed in the municipalities serviced by SABESP, data were selected that allowed any type of statistical treatment, with acceptable meaning. In this regard, data between 2005 and 2009 were collected at SNIS, which is the most recent series published. These data were added by data provided by SABESP in its Business Plan. Initially considering the units data, we can see that SNIS only makes available their figures on the last day of each year:

• AG013 – Number of water active residential units

In a preliminary analysis of collected data, we may affirm that there was a change of trend in the number of units as of 2006. Thus, the amounts between 2005 and 2009 of SNIS were applied and those of SABESP’s BP between 2010 and 2011. For the analysis of the historical series of residential units’ annual volumes, the following variable was applied:

• AG020 – Micro-measured water volume in residential units

Likewise unit values, volumes underwent a relevant change of trend as of 2006 advising to make a linear regression with amounts corresponding to the period between 2005 and 2009 of SNIS and between 2010 and 2011 of SABESP’s BP in order to obtain the amounts projected for the period between 2012 and 2016, maintaining the consistency of data and respective years.

The historical series of residential water average volume consumed by unit may be estimated from the amounts previously obtained of Units and Volumes, converting them into monthly average amounts. In Chart 1 below, we can see the monthly evolution of this variable between 2005 and 2011.

Chart 1- Evolution of Average Consumption by Unit.

A solid econometric methodology was applied to these data for estimate modeling. ARMAX model is an evolution of ARIMA, which applies ARIMA by adding exogenous variables independent from endogenous, but dependent from each other. This dependency differentiates ARMAX from other estimate models and makes the model applicable to the economic reality given by the market which has been analyzed. The results obtained are the following: Model 1: ARMAX, using observations 2005:01-2011:12 (T = 84) Dependent variable: consumption

Coefficient Standard Error z p-value

const 12.5898 0.29473 42.7164 <0.00001 *** phi_1 0.585821 0.117795 4.9732 <0.00001 *** theta_1 0.214653 0.128855 1.6659 0.09574 * Consumption_1 0.0257986 0.0224454 1.1494 0.25039

Average dependent var. 12.92699 D.P. dependent var. 0.412979

Average of innovations -0.000769 D.P. of innovations 0.286026

Probability Log -13.39894 Akaike criterion 36.79787

Schwarz criterion 48.58142 Hannan-Quinn criterion 41.51504

The data estimated by the model are presented in the following graph compared with actual data.

Translator’s note: Consumption/Estimate We can see that ARMAX model perfectly adheres to data observed. Thus, water demand was projected between 2012 and 2016, amounts varying between 12.896 and 12.975 m³/month/unit, as per chart 22.

Chart 30: Consumed Volume Projection by unit (m 3/month)

Year 2012 2013 2014 2015 2016 Volume/unit 12.8960 12.9170 12.9370 12.9560 12.9750

RESIDENTIAL WATER DEMAND ESTIMATE

When preparing SABESP’s business plan, Fundação SEADE demographic studies were contracted for projections of population to be serviced and corresponding number of residential households. When applying the household amounts provided in BP, the household amounts should reflect besides demographic values with corresponding vegetative growth percentages, the effects of concessionaire’s investments in pursuit of services universalization.

Based on reported figures, we can project water demand, as per the following chart:

Chart 2a: Water residential volume to be consumed

2011 2012 2013 2014 2015 2016 unit projections (SEADE- 8,563,349 8,766,289 8,969,215 9,172,277 9,377,238 9,582,773 Units SABESP) SABESP volume by unit 12,901 12,930 13,140 13,140 13,140 13,140 BP water volume 1,325,736 1,360,163 1,414,266 1,446,285 1,478,603 1,511,012 annual % variation 2.597% 3.978% 2.264% 2.235% 2.192% volume by unit 12,906 12,930 12,931 12,929 12,926 12,923 prelTN water volume 1,326,218 1,360,163 1,391,796 1,423,086 1,454,510 1,486,097 annual % variation 2.560% 2.326% 2.248% 2.208% 2.172% ARSESP volume by unit 12,879 12,902 12,926 12,950 12,973 12,997 finalTN water volume 1,323,424 1,357,272 1,391,232 1,425,329 1,459,836 1,494,549 annual % variation 2.558% 2.502% 2.451% 2.421% 2.378%

13. ATTACHMENT III: ANALYS OF INVESTMENTS PROPOSED IN SABESP’S BUSINESS PLAN FOR THE PERIOD BETWEEN 2013 AND 2016.

1. Introduction

ARSESP analyzed investments proposed by SABESP in its Business Plan (PN) aiming at verifying their common sense, as well as the consistency of their measurement in relation to the targets set out by concessionaire.

It is worth pointing out that the existence of a great number of restrictions did not allow this analysis to be made on a stricter basis. The first and basic analysis refers to the fact that most of municipalities still do not have a sanitation municipal plan. In addition, many municipal plans which were already prepared are precarious and do not fully comply with requirements of federal law n o. 11,445/07.

With a view to assessing the costs of investments made available by SABESP, few unit cost estimates were applied from a study developed by the Ministry of Cities when drafting the Basic Sanitation National Plan – PLANSAB.

Investments were analyzed in two phases. The first one sought to check the reasonableness of unit costs employed by SABESP in its estimates. In the second one, by applying the unit costs identified in the first phase, we verified the consistency and common sense of investments proposed.

2. Unit Cost of SABESP’s Works

SABESP’s unit costs were obtained from the “Study of Project Costs” prepared by Sabesp’s Project Management Oversight Board, based on data obtained from projects and contracts of works already concluded and in progress.

In order to quantify unit costs, nearly 1,000 contracts of works concluded were selected and data were compiled in virtual work spreadsheets, divided into: (i) water supply systems: distribution network, household connections, water mains, reservoirs, tubular deep well, pumping station and treatment station; and (ii) sewage systems: collection network, household connections, trunk collectors, interceptors, pumping station and treatment lagoon.

The contracts were selected, so that to have sufficient works to characterize each phase of Water Supply and Sewage Systems with the following characteristics:

I –WATER SUPPLY SYSTEM II – SEWAGE SYSTEM

A) CATCHMENT A) COLLECTION NETWORK

Deep Tubular Well = well with 206 mm diameter (8”) covered Networks and Connections = Virtual work composed of 20 by rigid PVC pipes, drilled in sedimentary rock, with depths of agreements concluded: (i) network executed at RMSP with 200m, 247 m and 293 m. extension of 271,848 m and 22,633 connections; (ii) network executed in inland with extension of 27,850 m and 2,105 connections; and (iii) network executed in the coastal region with extension of 21,404 m and 1,829 connections.

B) INTAKE B) TRUNK COLLECTOR

Steel Water Mains = linear 14,650 meter-water mains, with Trunk Collector = Virtual work composed of 7 work diameter varying between 36 and 100 inches, with 35% agreements concluded in RMSP and inland, executed in discontinued support and 65% of metallic/timber support. (4 ceramic pipes (diameters of 300 mm and 400 mm) and agreements concluded in RMSP). concrete pipes (diameters between 600 mm and 1,000 mm), with tota l extension of 17,443 m, 10% supporting timber pole, Cast Iron Water Mains = linear 32,919 meter-water mains , 10% of discontinued support, 15 % of continued support, with diameter varying between 200 and 1, 000 mm, 22% 25% of special support and 40% of metallic support. supporting timber pole, 30% of discontinued support, 25% of continued support, 20% of special support and 3% metallic or timber support. (11 agreements concluded in RMSP, coast al region and inland).

C) PUMPING STATION C) INTERCEPTOR

Pumping Station = 2 standard pumping stations with capacity Interceptor: = Virtual work composed of 6 work agreements concluded in RMSP and inland executed in concrete pipes of 120 l/s and 200 l/s. (diameters between 400 mm and 1,200 mm), with total extension of 17,443 m, 20% of discontinued supported, 15 % of continued support, 25% of special support and 40% of metallic support

D) TREATMENT D) PUMPING STATION

Water Treatment Station= 3 standard water treatment Pumping Station = Sewage pumping stations in successive stations with modules for water flow of 12 l/s; 25 l/s and 50 staves with underwater pumps and water flows of 5 l/s, 25 l/s, l/s. 30 l/s, 55 l/s and 85 l/s.

E) RESERVATION E) TREATMENT

Reservoir (up to 2,000 m3 capacity) = Semi-interred with Treatment Lagoons = lagoons with digging volume of 3,600 capacity of 100 m3, 500 m3, 1.000 m3 and 2,000 m3, built in m3 (Q = 8.0 l/s), 9,500 m 3 (Q= 14.0 l/s) and 245,000 m 3 reinforced concrete. (Q= 125.0 l/s). Reservoir (above 2,000 m3 capacity) = Semi-interred with capacity of 5,000 m3 and 10,000 m3, built in prestressed concrete.

F) DISTRIBUTION Networks and Connections = Virtual work composed of 8 agreements: (i) network executed at RMSP with extension of 109,617 m and 3,189 connections; and (ii) network executed in inland with extension of 95,139 m and 6,366 connections.

Unit costs correspond to the procurement costs plus cost of works and services necessary for their implementation. In order to quantify the supplies provision, Sabesp’s Input Price List was applied, with BDI rate of 20%. On the other hand, Sabesp’s Engineering Works and Services Price List was applied to compose the costs of works and services, observing the technical criteria adopted in the Manual of Technical Specifications, Regulation of Prices and Measurement Criteria. Prices adopted refer to works with moderate level of complexity (DD-415/99 of 12/15/99).

In case of linear works, virtual work spreadsheets were prepared according to the type of material, diameter, and support applied. We point out that the parameters adopted are merely referential, in view of several variables composing each type of work.

The Chart 1 below shows a summary of Sabesp’s unit costs, calculated by type of project.

Chart 1: Summary of SABESP’s unit costs

Water systems Sewage syst ems Item Unit Cost R$ Item Unit Cost R$ Network Network not paved linear meter 332.55 not paved linear meter 287.80 paved linear meter 410.79 paved linear meter 375.15 paving -stone linear meter 391.61 paving -stone linea r meter 353.73 cement pavement linear meter 381.51 cement pavement linear meter 353.96 Household connection unit 369.85 Household connection unit 627.93 Steel water mains Trunk collectors not paved linear meter 4,907.88 not pave d linear meter 969.36 paved linear meter 5,123.76 paved linear meter 1,114.51 paving -stone linear meter 5,070.83 paving -stone linear meter 1,078.98 cement pavement linear meter 5,081.64 cement pavement linear meter 1,083.91 Cast iron water mains Interceptor ITI -12 not paved linear meter 1,553.90 not paved linear meter 1,620.87 paved linear meter 1,673.39 paved linear meter 1,822.18 paving -stone linear meter 1,644.10 paving -stone linear meter 1,77 2.82 cement pavement linear meter 1,646.97 cement pavement linear meter 1,749.57 Jaguaré -Perus water mains 3,101.47 Interceptors ITI -12 linear meter 6,878.24 Treatment stations Treatment 12 liters/second 24,811.09 8 liters/second 38,467.26 25 liters/second 17,251.08 14 liters/second 41,298.45 50 liters/second 13,994.21 125 liters/second 43,128.65 Pumping stations 1.500 liters/second 23,363.55 120 liters/second 3,212.27 Pumping stations 200 liters/second 2,719.14 5 liters/second 19,537.72 Reservoirs 25 liters/second 7,402.91 100 liters/second 948.65 30 liters/second 7,378.19 500 liters/second 508.12 55 liters/second 5,494.65 1000 liters/second 412.58 85 liters/second 4,627.66 2000 liters/second 342.59 5000 lit ers/second 434.59 10000 liters/second 395.64

3. PLANSAB’s Unit Costs

PLANSAB – Basic Sanitation National Plan was an initiative developed in 2010 by the National Department of Environment Sanitation (SNSA) of Ministry of Cities, advised by the Federal University of Minas Gerais and University of Rio de Janeiro, in order to establish nationwide, a plan 62 that reflected the current status of basic sanitation in Brazil, from a plural view of the entire society on this issue. Therefore, it relied on current projects and Basic Sanitation Municipal Plans which were inferred to the municipalities that have not prepared yet their Basic Sanitation Municipal Plans, as provided for by Law 11,445/2007.

ARSESP’s unit costs applied in this analysis were obtained from a study developed by the Ministry of Cities, referred to as Overview of Basic Sanitation in Brazil. This study was one of the phases to draft the Basic Sanitation National Plan – PLANSAB and details the steps to build estimate models of the need of investment in Brazil’s sanitation.

It is worth mentioning that the amounts presented in referred study are at December 2003 and December 2009 prices. Thus, in order to update the amounts to November 2012 prices (last index published when this analysis was made), SINAPI – National System of Civil Construction Costs and Indexes Research was applied with costs referring to the state of São Paulo. The indexes verified were 16.8% for December 2009 prices and 76.6% for December 2003 prices.

In addition, few costs presented in the study were verified by household and others by inhabitant. Taking into account that the variable applied to verify demand was “the number of households to be serviced”, it was necessary to convert the amounts by inhabitant for households. Thus, the average of inhabitants was applied by household of the state of São Paulo, verified in the 2010 demographic census, which is 3.2.

Chart 2: PLANSAB’s unit costs for investments in expansion of water supply and sewage systems in the state of São Paulo

Sewage Water production Water distribution collection Sewage treatment

Average price 216.04 778.22 1,136.08 378.19

Reference date Dec/09 Dec/03 Dec/09 Dec/09

Average price 252.36 1,374.10 1,327.06 441.76 (Dec/12)

Measurement R$/inhab. R$/household R$/household R$/inhab. unit

4. Verification of consistency of proposed investments

For the purposes of checking the consistency and prudenceof proposed investments, the following variables were applied: (i) number of serviceable households; (ii) service targets for water supply, sewage collection and treatment; and (iii) unit costs for water and sewage systems expansion in the state of São Paulo according to Plansab’s and SABESP’s estimates.

The methodology adopted by ARSESP is outlined below.

4.1. Estimate according to PLANSAB’s unit costs a) Water systems

The general guidelines established in the Overview of Basic Sanitation in Brazil and service targets defined in Sabesp’s business plan were applied to calculate demand.

For production sub-system – expansion investments, demand is calculated based on the increment of households serviced yearly. Thus, the following was applied: (i) the projection of serviceable households/year; and (ii) Sabesp’s water supply service targets.

Other two factors are also considered when calculating water production demand: reduction of water loss ratio and lagged water supply of households currently serviced.

The target established by ARSESP in the Technical Note of 1 st Tariff Revision was considered for water loss ratio, which is 30.57% in 2012 until 27% at the end of cycle in 2016.

Referring to the factor applied to lagged water supply of households currently serviced, in initial year the number indicated by referred study for the state of São Paulo was considered, which is 0.9, gradually increasing to 1 until the end of tariff cycle (2016).

For water distribution sub-system – expansion investments, demand is calculated based on the increment of households yearly serviced.

b) Sewage system

The general guidelines established in Overview of Basic Sanitation in Brazil and service targets defined in Sabesp’s business plan were applied to calculate demand.

For sewage collection sub-system – expansion investments, demand is calculated based on the increment of households serviced yearly. Thus, the following was applied: (i) the projection of serviceable households/year; and (ii) Sabesp’s sewage collection service targets.

Concerning sewage treatment sub-system – expansion investments, the calculation of demand advised by study cannot be fully applied, as few variables were not available, such as network average extension, water loss percentage (in each household serviced) that reaches the sewage network, amongst others.

Therefore, we decided to adopt same demand applied to sewage collection sub-system, observing the sewage treatment targets provided for in Sabesp’s business plan.

c) Result

In this analysis, we reached an estimate of R$7,375.34 million of investments in water and sewage between 2013 and 2016, as shown in Chart 3.

Chart 3 – Estimate of direct investments according to PLANSAB’s unit costs

Water (R$ million) Sewage (R$ million) Total Year Production Distribution Total Collection Treatment Total (R$ million) 2013 694.81 278.84 973.65 411.04 599.16 1,010.20 1,983.85 2014 526.13 279.03 805.16 418.00 557.74 975.74 1,780.90 2015 350.69 281.64 632.33 427.73 640.54 1,068.27 1,700.60 2016 165.98 282.43 448.41 437.38 1,024.20 1,461.58 1,909.99 Total 1,737.61 1,121.94 2,859.55 1,694.15 2,821.64 4,515.79 7,375.34

Below, a comparison between the estimate based on PLANSAB’s unit costs and investments proposed by SABESP. We can see from Chart 4 below that Sabesp’s Capex plan for the period between 2013 and 2016 is 5.3% higher than the amount estimated with Plansab’s unit costs.

Chart 4 – ARSESP’s direct investments estimate and Sabesp’s Capex plan

2013 2014 2015 2016 Total Water 973.65 805.16 632.33 448.41 2,859.55 ARSESP’s estimate (R$ million) Plansab’s Sewage 1,010.21 975.74 1,068.26 1,461.58 4,515.79 unit costs Total 1,983.86 1,780.90 1,700.59 1,909.99 7,375.34 Water 677.29 575.73 639.66 897.04 2,789.72 Sabesp’s business Sewage 1,321.87 1,335.33 1,141.01 1,088.10 4,886.31 plan (R$ million) Total 1,999.16 1,911.06 1,780.67 1,985.14 7,676.03 Difference (%) 5.50% 13.5% 4.80% -1.10% 5.30%

4.2. Estimate according to SABESP’s unit costs

In this item, the Capex estimate is presented for the period between 2013 and 2016 calculated from the average cost of projects developed over the last years by Sabesp, and also the company’s works in progress. The Chart 5 below shows a summary of average costs of water investments applied to this estimate, based on the physical expansion of Sabesp’s business plan.

Chart 5 – Summary of average cost of water direct investments

UNITS Average Amounts (R$/ud) Water connections Unit 369.85 Water network meters 394.63 Water mains meters 3,259.03 Water treatment stations liters/seconds 18,685.46 Water reservoirs liters/seconds 507.03 Pumping stations liters/seconds 2,965.71 Chart 6 below shows the physical expansion of water supply systems, in terms of connections, networks, intake, treatment and reservation, calculated based on Sabesp’s business plan. From unit costs and systems physical expansion, direct investments in water systems was estimated, as shown in Chart 7 below.

Chart 6 – Physical expansion estimated for water supply systems

The chart below shows the investments estimated for water systems based on Sabesp’s unit costs.

Chart 7 – Estimate of direct investments in water systems

TOTAL ANNUAL COST (R$ 1.00)

The same methodology was adopted to estimate investments in sewage systems based on Sabesp’s unit costs. The Chart 8 below shows the average cost adopted for the purposes of this estimate .

Chart 8 – Average costs of sewage direct investment

UNITS Average Amounts (R$/ud) New connections Unit 627.93 Network expansion meters 342.66 Trunk collectors, interceptors, effluents Meters 4,527.63 Sewage treatment stations liters/seconds 30,285.17 Sewage pumping stations liters/seconds 8,888.23

Likewise, the systems physical expansion was obtained from Sabesp’s business plan, in terms of new sewage connections, network expansion, trunk collectors, interceptor, effluents, treatment and pumping stations, as shown in the Chart 9 below.

Chart 9 – Physical expansion of sewage systems

Units 2012 2013 2014 2015 2016 New connections Unit 235,246 230,863 234,252 239,693 245,101 Network expansion meters 1,718,492 1,686,474 1,711,231 1,750,978 1,790,484 Collectors, interceptors, meters 75,757 74,346 75,437 77,189 78,931 effluents Treatment stations (ETE) liters/second 2,164 2,067 1,907 2,160 3,440 Pumping stations (EE) liters/second 2,881 3,910 3,739 4,071 5,411

The Chart 10 shows the estimate of direct investments in sewage systems calculated based on average costs of Chart 8 and systems physical expansion of Chart 9.

Chart 10 – Estimate of sewage systems direct investments

TOTAL ANNUAL COST (R$1.00)

2012 2013 2014 2015 2016 New connections 147,717,629 144,965,419 147,093,468 150,510,026 153,905,862 Network expansion 588,861,679 577,890,267 586,373,524 599,993,294 613,530,459 Trunk collectors, 342,999,916 336,609,292 341,550,616 349,483,854 357,368,977 interceptors, effluents Treatment stations 65,537,206 62,609,140 57,760,401 65,410,442 104,179,227 Pumping stations 25,609,742 34,754,166 33,235,873 36,182,268 48,093,835 TOTAL 1,170,726,172 1,156,828,284 1,166,013,882 1,201,579,885 1,277,078,361 The Chart 11 below shows for comparison purposes, the investments estimated by ARSESP, based on Sabesp’s unit costs and investments presented by Sabesp’s business plan. Thus, we can verify that investments presented in Sabesp’s business plan for the total period between 2013 and 2016, only differs at 1.10% from ARSESP’s estimate.

Chart 11 –ARSESP’s estimate of direct investments and Sabesp’s Capex plan

4.3. Conclusion

The amounts verified were compared with Sabesp’s Capex plan, resulting in a maximum difference in 2014 of 13.5%, between Capex estimates and Plansab’s unit costs, as shown in Chart 4. Based on Sabesp’s unit costs, the maximum difference is verified in 2013 of 7.96%, as seen in Chart 11. In terms of total investment for the period between 2013 and 2016, the difference of investment estimated by Plansab is 5.3% and 1.1% when estimated by unit costs. These results can conclude that investments of Sabesp’s business plan comply with the principles of consistency and prudence , justifying their approval by ARSESP.

14. ATTACHMENT IV – IMPACT OF LAW N0 12,783 ON ELETRIC POWER OPEX

The studies guiding the Preliminary Technical Note of Sabesp’s First Tariff Revision – Second Tariff Cycle did not foresee the outcome of Provisional Measure nº 579 that resulted in smaller electric power expenses. As the provisional measure was converted into Law nº 12,783/2013, as of January 25, 2013 new electric power tariffs started to take effect with effects on energy costs considered in the tariff revision study, thus, it was necessary to readjust OPEX amounts referring to electric power expenses item.

Analysis of impact of Law nº 12,783 of 1/11/2013 on Sabesp’s electric power expenses

Expenses related to electric power, connection and use of electric power distribution system of Sabesp are detailed in the file INFO_reajuste_of57_Jan09_Jun12 – FCP Sabesp . The accounts analyzed are:

6.0 – ELETRIC POWER

6.1 – Electricity

This account accumulates the amounts deriving from the electric power consumption by maintenance, office equipment, and lighting of company’s properties.

6.2 – Electricity (operation)

This account accumulates the amounts deriving from electric power consumption by the Company’s operation equipment. Ex.: pumps of ETA’s (water treatment station), EEA’s (water pumping station), ETE’s (sewage treatment station), EEE’s (sewage pumping station), intake, boosters, wells and reservoirs.

6.4 – Electricity (free market)

This account accumulates the amounts deriving from electric power consumption, acquired by free market system to be used in the company’s operation equipment. Ex.: ETA’s, EEA’s, ETE’s, EEE’s, etc. Note: Free market – acquisition of electric power from other generation companies nationwide, pursuant to Law 10,848 of 3/15/2004.

6.5 – Connection and use of electric power distribution system

This account accumulates the amounts owed to electric power companies, due to connection and use of distribution system, together with the concessionaire liable for the service in the region. Note: Free market – acquisition of electric power from other generation companies nationwide, pursuant to Law 10,848 of 3/15/2004.

06.81 – Estimate of electric power expenses This account accumulates the amounts as estimate and the reversal of estimate.

Summary of impact of Law 12,783/2013 on the electric power market

ANEEL approved on 1/24/2013, new tariffs that will reduce the electric power bill. The average effect of reduction will be 20.2% . For residential consumers, the minimum reduction will be 18%. For high voltage consumers, discount may reach 32%. New tariffs started to take effect as of 1/25/2013.

The reduction is the result of Law nº 12,783/2013, which promoted the renewal of energy transmission and generation concession to expire until 2017 and the provisional measures 591/2012 and 605/2013. Main changes that allowed to reducing the bill were:

- Allocation of energy quotas, resulting from generation companies with concessions renewed; - Reduction of transmission costs; - Reduction of sector charges; - Withdrawal of tariff structure subsidies, with direct contribution from National Treasury

Reduction and adjustments. The effect of this reduction is structural, i.e., it will promote a permanent change in the level of tariffs, as it definitively withdraws costs which composed previous tariffs.

Different tariffs: ANEEL establishes a different tariff for each distribution company, in view of peculiarities of each concession. Clock reading dates are distributed during the month, thus, electric power price reduction only must be fully received by consumer after a full cycle of collection with new tariffs, i.e., in the first month of new tariffs effectiveness, depending on the bill maturity date, part of consumption will apply the old tariff and another part will apply the new reduced tariff. As new tariffs are effective as of January 24, for instance, a consumer who has his reading done on February 10 would have in February 50% of energy invoiced by old tariff and the other 50% by new tariff. As of February 25, all bills will enjoy full benefits of reduced tariff. Consolidated figures of electric power expenses will be available by the end of May 2013.

Consumption classes. Other factors that diversify energy bills are the supply contract characteristics. Residential captive consumers who only can be serviced by a distribution company have a single tariff in their concessionaire.

Variations also occur according to the voltage level where consumers are serviced, which is the voltage available at the concessionaire’s electric system and varies between amounts lower than 2.3 kV (such as voltages of 110 and 220 volts) and amounts exceeding 2.3 kV. This variation divides consumers into groups A (in excess of 2.3 kV, for instance, industries and large commerce) and B (lower than 2.3 kV which includes residential consumers).

Group A consumers have tariffs defined for energy and use of network for peak and out-of-peak hours. Free consumers have different characteristics, as they may contract energy from other suppliers, under special conditions.

Chart 1

Simulation of impact of Law nº 12,783 of 1/11/2013 on Sabesp’s electric power expenses

PREFIX PURPOSE ANAL DESCRIPTION 2009 2010 2011 JAN_JUN 2012 COST OF SERVICES 31100 0600 ELECTRIC POWER - - - - RENDERED COST OF SERVICES 31100 0601 ELECTRICITY 4,263,901.26 4,595,103.06 4,665,766.33 2,686,768.79 RENDERED COST OF S ERVICES 31100 0602 ELECTRICITY (OPERATION) 298,793,638.98 323,925,512.53 352,172,843.65 179,439,265.13 RENDERED COST OF SERVICES ELECTRICITY ( FREE 31100 0604 102,749,691.46 115,069,305.18 133,745,363.14 72,416,094.84 RENDERED MARKET)

COST OF SERVICES 31100 0605 CONNECTION AND USE OF 77,052,274.34 84,671,787.87 91,574,834.79 41,142,952.53 RENDERED TUSD SYSTEM COST OF SERVICES 31100 0681 EXPENSES ESTIMATE 815,345.79 1,090,581.75 250,996.25 1,285,441.70 RENDERED 32100 SELLING EXPENSES 0601 ELECTRICITY 739,068.56 775,158.92 621,955.69 327,131.29

32100 SELLING EXPENSES 0602 ELECTRICITY (OPERATION) - - 93.70 - ELECTRICITY ( FREE 32100 SELLING EXPENSES 0604 2,223.27 - - - MARKET)

32100 SELLING EXPENSES 0605 CONNECTION AND USE OF - - - - TUSD SYSTEM 32100 SELLING EXPENSES 0681 EXPENSES ESTIMATE (2156.73) - - - ADMINISTRATIVE 13200 0601 ELECTRICITY 1,042,461.94 1,219,158.80 1,046,458.85 659,178.37 EXPENSES

ELECTRIC POWER 485,456,448.87 531,346,608.11 584,078,314.40 297,956,832.65 ENERGY PURCHASED IN THE 382,704,534.14 416,277,302.93 45,032,951.26 225,540,737.81 75.70% REGULATED MARKET ENERGY PURCHASED IN THE 102,751,914.73 115,069,305.18 133,745,363.14 72,416,094.84 24.30% FREE MARKET PERCENTAGE 78.8% 78.3% 77.1% 75.7%

GENERAL EXPENSES 377,509,437.15 444,241,176.13 655,951,422.12 291,495,490.74

TAX EXPENSES 55,013,126.90 63,379,728.16 61,496,117.85 46,112,285.67

TOTAL OPEX (DEX) 3,680,398,471.89 5,773,686,286.32 6,590,147,920.89 3,287,602,544.11

PERCENTAGE 10.4% 7.2% 6.8% 6.9% 1.37%

Source: INFO_reajuste_of57_Jan09_Jun12-FCP Sabesp

Considering data referring to the period between 2009 and mid-2012, the amount of purchased energy (electric power, connection and use of TUSD system) in the regulated market is 75.7% while energy purchased in the free market is 24.3%.

Applying the average effect of 20% reduction in the percentage of 75.7% referring to the regulated market, a reduction combined effect of 15.14% is obtained. The chart below summarizes the impact of reducing electric power expenses in OPEX amount.

Chart 2

Estimate of Discount Impact of Law nº 12,783 of 1/11/2013 on Sabesp’s electric power OPEX

TOTAL in VP 2013 2014 2015 2016 Electric power in OPEX before discount 2,261,570,362.93 668,112,627 678,379,658 689,427,449 703,514,889

15.14% reduction of 339,235,554.12 100,216,894 101,756,949 103,414,117 105,527,233 energy expenses

Electric power in OPEX 1,922,334,808.81 567,895,733 576,622,709 586,013,332 597,987,656 after discount

Amounts in R$

Any differences in foreseen electric power expenses will be subsequently considered in the annual adjustment, when non-manageable expenses, pointing out electric power, will be quantified and actual reductions in expenses will be considered in the calculation of Sabesp’s tariffs readjustment.

15. ATTACHMENT V: TARIFF TABLES

Table 1

METROPOLITAN EXECUTIVE BOARD - GT-M MC, ML (includes the municipality of Guararema), MO, MN (except for the municipalities of: Bragança Paulista, Joanópolis, Nazaré Paulista, Pedra Bela, Pinhalzinho, Piracaia, Socorro and Vargem) and MS.

RESIDENTIAL COMMERCIAL / INDUSTRIAL / PUBLIC Social Tariff Commercial / Industrial / Public without contract Consumption levels (m³) Water Sewage Consumption levels (m³) Water Sewage 0 to 10 R$/month 5.53 5.53 0 to 10 R$/month 32.75 32.75 11 to 20 R$/m³ 0.96 0.96 11 to 20 R$/m³ 6.37 6.37 21 to 30 R$/m³ 3.37 3.37 21 to 50 R$/m³ 12.21 12.21 31 to 50 R$/m³ 4.82 4.82 Above 50 R$/m³ 12.72 12.72 Above 50 R$/m³ 5.32 5.32

Shantytown Tariff Commercial: social welfare entities Consumption levels (m³) Water Sewage Consumption levels (m³) Water Sewage 0 to 10 R$/month 4.22 4.22 0 to 10 R$/month 16.37 16.37 11 to 20 R$/m³ 0.48 0.48 11 to 20 R$/m³ 3.19 3.19 21 to 30 R$/m³ 1.59 1.59 21 to 50 R$/m³ 6.13 6.13 31 to 50 R$/m³ 4.82 4.82 Above 50 R$/m³ 6.36 6.36 Above 50 R$/m³ 5.32 5.32

Normal Tariff Public with contract Tariff Consumption levels (m³) Water Sewage Consumption levels (m³) Water Sewage 0 to 10 R$/month 16.31 16.31 0 to 10 R$/month 24.54 24.54 11 to 20 R$/m³ 2.55 2.55 11 to 20 R$/m³ 4.77 4.77 21 to 30 R$/m³ 6.37 6.37 21 to 50 R$/m³ 9.18 9.18 31 to 50 R$/m³ 6.37 6.37 Above 50 R$/m³ 9.54 9.54 Above 50 R$/m³ 7.02 7.02

Tariff 0.00 OTHER SERVICES Water Sewage OTHER SERVICES Water Sewage Tank Car: Third Parties R$/m³ 25.96 Tank Car: SABESP R$/m³ 63.73 Permissionaires R$/1000m³ 1,431.66 922.40

Table 2

METROPOLITAN EXECUTIVE BOARD: GT-MN MN – only for municipalities in the region of Bragança Paulista (Bragança Paulista, Joanópolis, Nazaré Paulista, Pedra Bela, Pinhalzinho, Piracaia, Socorro and Vargem) RESIDENTIAL COMMERCIAL / INDUSTRIAL / PUBLIC Social Tariff Commercial / Industrial / Public without contract Consumption levels (m³) Water Sewage Consumption levels (m³) Water Sewage 0 to 10 R$/month 5.53 4.42 0 to 10 R$/month 32.75 26.19 11 to 20 R$/m³ 0.86 0.69 11 to 20 R$/m³ 3.88 3.07 21 to 30 R$/m³ 1.87 1.48 21 to 50 R$/m³ 6.25 5.00 31 to 50 R$/m³ 2.66 2.14 Above 50 R$/m³ 7.35 5.87 Above 50 R$/m³ 3.17 2.54

Normal Tariff Commercial: social welfare entities Consumption levels (m³) Water Sewage Consumption levels (m³) Water Sewage 0 to 10 R$/month 16.31 13.07 0 to 10 R$/month 16.37 13.09 11 to 20 R$/m³ 2.28 1.80 11 to 20 R$/m³ 1.95 1.54 21 to 30 R$/m³ 3.50 2.78 21 to 50 R$/m³ 3.16 2.53 31 to 50 R$/m³ 3.50 2.78 Above 50 R$/m³ 3.68 2.94 Above 50 R$/m³ 4.18 3.33

Tariff Public with contract Tariff OTHER SERVICES Water Sewage Consumption levels (m³) Water Sewage Tank Car: Third Parties R$/m³ 25.96 0 to 10 R$/month 24.54 19.63 Tank Car: SABESP R$/m³ 63.73 11 to 20 R$/m³ 2.90 2.32 Permissionaires R$/1000m³ 1,431.66 922.40 21 to 50 R$/m³ 4.71 3.75 Above 50 R$/m³ 5.50 4.41

Table 3

REGIONAL SYSTEMS EXECUTIVE BOARD: GT-RS and RN

Municipalities of Santos Coast Region and North Coast

RESIDENTIAL COMMERCIAL / INDUSTRIAL / PUBLIC Social Tariff Commercial Normal/ Industrial / Public without contract Consumption levels (m³) Water Sewage Consumption levels (m³) Water Sewage 0 to 10 R$/month 5.53 5.53 0 to 10 R$/month 32.75 32.75 11 to 20 R$/m³ 0.86 0.86 11 to 20 R$/m³ 4.27 4.27 21 to 30 R$/m³ 1.60 1.60 21 to 50 R$/m³ 9.32 9.32 31 to 50 R$/m³ 2.30 2.30 Above 50 R$/m³ 10.06 10.06 Above 50 R$/m³ 3.09 3.09

Normal Tariff Commercial: social welfare entities Consumption levels (m³) Water Sewage Consumption levels (m³) Water Sewage 0 to 10 R$/month 16.31 16.31 0 to 10 R$/month 16.37 16.37 11 to 20 R$/m³ 2.28 2.28 11 to 20 R$/m³ 2.14 2.14 21 to 30 R$/m³ 3.02 3.02 21 to 50 R$/m³ 4.69 4.69 31 to 50 R$/m³ 3.02 3.02 Above 50 R$/m³ 5.04 5.04 Above 50 R$/m³ 4.08 4.08

Tariff Public with contract Tariff OTHER SERVICES Water Sewage Consumption levels (m³) Water Sewage Tank Car: Third Parties R$/m³ 25.96 0 to 10 R$/month 24.54 24.54 Tank Car: SABESP R$/m³ 63.73 11 to 20 R$/m³ 3.20 3.20 Boats and Ships 21 to 50 R$/m³ 6.99 6.99 Santos Coast Region-RS R$/m³ 11.42 Above 50 R$/m³ 7.55 7.55 North Coast-RN R$/m³ 17.51

Table 4

REGIONAL SYSTEMS EXECUTIVE BOARD: GT-Registro

RR (except for municipalities of Apiaí, Barra do Chapéu, Itaóca, Itapirapuã Paulista and Ribeira)

RESIDENTIAL COMMERCIAL/INDUSTRIAL/PUBLIC Social Tariff Commercial Normal/ Industrial / Public without contract Consumption levels (m³) Water Sewage Consumption levels (m³) Water Sewage 0 to 10 R$/month 5.53 5.53 0 to 10 R$/month 32.75 32.75 11 to 20 R$/m³ 0.86 0.86 11 to 20 R$/m³ 3.88 3.88 21 to 30 R$/m³ 1.87 1.87 21 to 50 R$/m³ 6.53 6.53 31 to 50 R$/m³ 2.66 2.66 Above 50 R$/m³ 8.29 8.29 Above 50 R$/m³ 3.17 3.17

Normal Tariff Commercial: social welfare entities Consumption levels (m³) Water Sewage Consumption levels (m³) Water Sewage 0 to 10 R$/month 16.31 16.31 0 to 10 R$/month 16.37 16.37 11 to 20 R$/m³ 2.28 2.28 11 to 20 R$/m³ 1.95 1.95 21 to 30 R$/m³ 3.50 3.50 21 to 50 R$/m³ 3.30 3.30 31 to 50 R$/m³ 3.50 3.50 Above 50 R$/m³ 4.17 4.17 Above 50 R$/m³ 4.18 4.18

Tariff Public with contract Tariff OTHER SERVICES Water Sewage Consumption levels (m³) Water Sewage Tank Car: Third Parties R$/m³ 25.96 0 to 10 R$/month 24.54 24.54 Tank Car: SABESP R$/m³ 63.73 11 to 20 R$/m³ 2.90 2.90 Boats and Ships 21 to 50 R$/m³ 4.92 4.92 Santos Coast Region-RS R$/m³ 11.42 Above 50 R$/m³ 6.23 6.23 North Coast-RN R$/m³ 17.51

Table 5

REGIONAL SYSTEMS EXECUTIVE BOARD: GT-Inland RA, RB, RG ( except for Itapira), RJJ, RM, RR ( for municipalities of : Apiaí, Barra do Chapéu, Itaóca, Itapirapuã Paulista and Ribeira) and RT (except for municipality of Lins) RESIDENTIAL COMMERCIAL/INDUSTRIAL/PUBLIC Social Tariff Commercial Normal/ Industrial / Public without contract Consumption levels (m³) Water Sewage Consumption levels (m³) Water Sewage 0 to 10 R$/month 5.53 4.42 0 to 10 R$/month 32.75 26.19 11 to 20 R$/m³ 0.86 0.69 11 to 20 R$/m³ 3.88 3.07 21 to 30 R$/m³ 1.87 1.48 21 to 50 R$/m³ 6.25 5.00 31 to 50 R$/m³ 2.66 2.14 Above 50 R$/m³ 7.35 5.87 Above 50 R$/m³ 3.17 2.54

Tariff Public with contract Tariff OTHER SERVICES Water Sewage Consumption levels (m³) Water Sewage Tank Car: Third Parties R$/m³ 25.96 0 to 10 R$/month 24.54 19.63 Tank Car: SABESP R$/m³ 63.73 11 to 20 R$/m³ 2.90 2.32 21 to 50 R$/m³ 4.71 3.75 Above 50 R$/m³ 5.50 4.41

Table 6

REGIONAL SYSTEMS EXECUTIVE BOARD: Vale Paraiba (RV)

RV (except for municipality of Guararema where tariff practiced comes from RMSP-ML)

RESIDENTIAL COMMERCIAL/INDUSTRIAL/PUBLIC Social Tariff Commercial Normal/ Industrial / Public without contract Consumption levels (m³) Water Sewage Consumption levels (m³) Water Sewage 0 to 10 R$/month 5.53 4.42 0 to 10 R$/month 32.75 26.19 11 to 20 R$/m³ 0.86 0.69 11 to 20 R$/m³ 3.88 3.07 21 to 30 R$/m³ 1.87 1.48 21 to 50 R$/m³ 6.47 5.17 31 to 50 R$/m³ 2.66 2.14 Above 50 R$/m³ 8.18 6.52 Above 50 R$/m³ 3.17 2.54

Normal Tariff Commercial: social welfare entities Consumption levels (m³) Water Sewage Consumption levels (m³) Water Sewage 0 to 10 R$/month 16.31 13.07 0 to 10 R$/month 16.37 13.09 11 to 20 R$/m³ 2.28 1.80 11 to 20 R$/m³ 1.95 1.54 21 to 30 R$/m³ 3.50 2.78 21 to 50 R$/m³ 3.25 2.59 31 to 50 R$/m³ 3.50 2.78 Above 50 R$/m³ 4.06 3.28 Above 50 R$/m³ 4.18 3.33

Tariff Public with contract Tariff OTHER SERVICES Water Sewage Consumption levels (m³) Water Sewage Tank Car: Third Parties R$/m³ 25.96 0 to 10 R$/month 24.54 19.63 Tank Car: SABESP R$/m³ 63.73 11 to 20 R$/m³ 2.90 2.32 21 to 50 R$/m³ 4.84 3.90 Above 50 R$/m³ 6.15 4.92