NT.F-0006-2018 FINAL TECHNICAL NOTE RESULT OF SABESP'S 2nd ORDINARY TARIFF REVIEW - FINAL STAGE: CALCULATION OF THE MAXIMUM AVERAGE TARIFF (P0) May 2018 - 1 - NT.F-0006-2018 FINAL TECHNICAL NOTE RESULTS OF SABESP'S 2nd ORDINARY TARIFF REVIEW: FINAL STAGE SUMMARY 1. INTRODUCTION ................................................................................................................................... 4 2. REGULATORY MODEL FOR THE SECOND ORDINARY TARIFF REVIEW ............................... 6 3. MARKET PROJECTION ........................................................................................................................ 8 3.1. Residential Demand .............................................................................................................................. 8 3.2. Non-residential demand ...................................................................................................................... 10 3.3. Demand of the permissionaires ........................................................................................................... 14 3.4. Projection of Total Demand ................................................................................................................ 15 4. PROJECTION OF WATER SUPPLY AND SEWAGE TREATMENT .............................................. 18 4.1. Water Losses ....................................................................................................................................... 18 4.2. Special Usage ...................................................................................................................................... 21 4.3. Projection of total volume of water produced ..................................................................................... 22 4.4. Projection of volume of sewage treated .............................................................................................. 22 5. OPERATING COSTS AND EXPENSES (OPEX) ............................................................................... 24 5.1. Adjustments for OPEX not recognized ............................................................................................... 24 5.2. Projection of operating costs ............................................................................................................... 24 5.3. Consideration from Public-Private Partnerships and Asset Lease ...................................................... 27 6. OTHER OPERATING COSTS ............................................................................................................. 29 6.1. Costs of Default: Irrecoverable Revenues .......................................................................................... 29 6.2. Fund for Expenditure on Municipal Sanitation Obligations ............................................................... 30 6.3. Fund for Research, Development and Innovation (PDI) ..................................................................... 31 7. INVESTMENTS (CAPEX) ................................................................................................................... 33 7.1. Investment Plan ................................................................................................................................... 33 7.2. Interest on Construction Projects in Progress - JOA ........................................................................... 35 8. WEIGHTED AVERAGE COST OF CAPITAL - WACC .................................................................... 38 9. DETERMINATION OF THE BASIS FOR REGULATORY REMUNERATION .............................. 39 9.1. Shielded Base ...................................................................................................................................... 39 9.2. Incremental Base ................................................................................................................................. 39 9.3. Summary of the Basis for Regulatory Remuneration .......................................................................... 40 9.4. Average Depreciation .......................................................................................................................... 41 9.5. Assets incorporated and depreciation following the asset report up to December/2016 ..................... 42 - 2 - NT.F-0006-2018 9.6. Regulatory Working Capital ............................................................................................................... 43 9.7. Annual updating mechanism for the BRRL (basis for net regulatory remuneration) ......................... 44 10. TAXES AND CONTRIBUTIONS ........................................................................................................ 45 10.1. Cofins/Pasep........................................................................................................................................ 45 10.2. Corporate Income Tax and Social Contribution on Net Income – IRPJ/CSLL ................................... 45 10.3. Regulation, Control and Inspection Fee ................................................................................................. 46 11. INDIRECT REVENUES AND OTHER REVENUES .......................................................................... 47 12. GENERAL QUALITY INDEX – FACTOR Q...................................................................................... 49 13. COMPENSATORY ADJUSTMENT OF THE LATEST CYCLE ....................................................... 50 14. DETERMINATION OF THE TARIFF REPOSITIONING INDEX..................................................... 53 14.1. Annual Tariff Adjustment – April/2018 .............................................................................................. 54 14.2. Retroactive Compensatory Adjustment for the period from April/2017 to April/2018 ....................... 55 EXHIBIT I –TARIFF RETROSPECT ................................................................................................................. 56 EXHIBIT II – CONTRACTUAL LOSS TARGETS OF THE MUNICIPALITIES REGULATED BY ARSESP .. 60 EXHIBIT III – ANALYSIS OF THE PROGRAMS COMPRISING SABESP'S INVESTMENT PLAN ……..67 EXHIBIT IV – CALCULATION METHODOLOGY OF SABESP'S PRELIMINARY WEIGHTED AVERAGE COST OF CAPITAL (WACC) .......................................................................................... 77 EXHIBIT V – BASIS FOR REGULATORY REMUNERATION .................................................................... 95 EXHIBIT VI – EFFICIENCY SHARING FACTOR – FACTOR X ................................................................ 133 EXHIBIT VII – CONSUMPTION HISTOGRAM ........................................................................................... 141 - 3 - NT.F-0006-2018 1. INTRODUCTION The purpose of this Technical Note is to present the final results of the calculation of the Maximum Average Tariff (P0) produced by Arsesp in the Final Stage of the 2nd Ordinary Tariff Review (2nd RTO) for Companhia de Saneamento Básico do Estado de São Paulo - Sabesp. Law no. 11445/2007, which establishes the national guidelines for basic sanitation, in article 38 determines that tariff reviews should include a reassessment of the conditions of the provision of services and of the tariffs practiced, which can be either ordinary periodic reviews or extraordinary reviews. The purpose of the ordinary periodic reviews is to share the productivity gains with the users and to reassess the market conditions (sub-section I, article 38). It is up to the regulatory body to issue rules regarding the regime, structure, and tariff levels, as well as the procedures and deadlines for their determination, adjustment and review (article 23, sub-section IV). The regulatory body defines the ordinary review schedule, after having heard the owners, users and providers of the services (article 38, §1). State Complementary Law 1025/2007, in article 10, sub-section IV, and article 11 allocates to Arsesp the authority for regulation and inspection, including in connection with tariff issues, basic sanitation services which are state owned and in the municipalities which were delegated to the State, in accordance with municipal competencies and prerogatives. In Arsesp Resolution no. 484/2014, which approved the conclusion of Sabesp's 1st Ordinary Tariff Review, it was established that the 2nd RTO would be concluded by April 11, 2017. The delay caused by the temporary suspension of the process of hiring a consulting company to help Arsesp with the tariff review, was due to a judicial decision in relation to an appeal filed by a bidder, which prevented the Agency from completing the tariff review process within the previously stipulated deadline. In view of the Agency's duty to ensure the affordability of the tariffs and guarantee the economic and financial balance of the provision of services, Arsesp then opted to carry out the 2nd RTO in two stages: Initial Stage and Final Stage. Arsesp began the Initial Stage of the 2nd RTO in January/2017. During this stage, the Agency continued with the methodology used for the 1st Ordinary Tariff Review process and used the historical data (2013-2016) and the Business Plan for the period 2017-2021 that was delivered by Sabesp in January/2017, the supplementary information requested by Arsesp over the course of the analysis phase of the data and, at the end, the revised Business Plan which was delivered in June/2017, which includes all of the adjustments made by Sabesp during the process. The final results