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Key Issues in Water Services Privatization

Interest in an increased role for private sector participation in the U.S. water supply and wastewater industries expanded greatly during the 1990s. Although many U.S. water utilities were initially private undertakings, they have a long history of public ownership and operation. But despite this history of strong public sector involvement, views about the role of the private sector shifted during the 1990s because of a variety of economic, fiscal, regulatory, and environmental factors. City and water utility officials were increasingly subjected to pressures of limited financial and technical resources, stringent regulatory requirements, and inadequate infrastructure. In addition, private water companies saw profitable opportunities in the ownership and operation of water utilities and began to promote their services. These conditions led city officials across the United States to consider the pros and cons of privatizing some or all components of their water supply and wastewater utility systems.

The decision as to whether to transfer ownership or operations of a public water utility to a private firm is complex. Immediate economic questions such as “Will privatization reduce customers’ monthly water bills?” are accompanied by larger and longer-term questions relating to public health, employment, political control, environmental issues, and relations to other city services.

Given this broad and growing interest in the privatization potential of U.S. water services, the Water Science and Technology Board (WSTB) of the National Research Council discussed the prospects of conducting a study on the topic. The level of interest in the proposed study was high



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Privatization of Water Services in the United States: An Assessment of Issues and Experience 1 Key Issues in Water Services Privatization Interest in an increased role for private sector participation in the U.S. water supply and wastewater industries expanded greatly during the 1990s. Although many U.S. water utilities were initially private undertakings, they have a long history of public ownership and operation. But despite this history of strong public sector involvement, views about the role of the private sector shifted during the 1990s because of a variety of economic, fiscal, regulatory, and environmental factors. City and water utility officials were increasingly subjected to pressures of limited financial and technical resources, stringent regulatory requirements, and inadequate infrastructure. In addition, private water companies saw profitable opportunities in the ownership and operation of water utilities and began to promote their services. These conditions led city officials across the United States to consider the pros and cons of privatizing some or all components of their water supply and wastewater utility systems. The decision as to whether to transfer ownership or operations of a public water utility to a private firm is complex. Immediate economic questions such as “Will privatization reduce customers’ monthly water bills?” are accompanied by larger and longer-term questions relating to public health, employment, political control, environmental issues, and relations to other city services. Given this broad and growing interest in the privatization potential of U.S. water services, the Water Science and Technology Board (WSTB) of the National Research Council discussed the prospects of conducting a study on the topic. The level of interest in the proposed study was high

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Privatization of Water Services in the United States: An Assessment of Issues and Experience and in 1999 the WSTB appointed a committee of experts to examine the issue of water services privatization in the United States. The committee’s study was conducted with support from the following sponsors: American Water Works Company, Inc.; the University of California; the California Water Service Company; Severn-Trent Environmental Services; and the U.S. Environmental Protection Agency. The charge to the committee was as follows: This study will assess issues associated with various forms of ownership and operation of drinking water supply and wastewater systems in the United States, including strengths and weaknesses. Ownership and operation of water services ranges from fully public to fully private, with several possible public-private partnerships in between. This study will assess public, private, and public-private drinking water supply and wastewater systems in the United States in light of the following water management concerns: long-term water supply; stewardship of water resources; the ability to manage water from a regional or watershed perspective; the ability to implement conservation strategies; water quality (both at the tap and in the environment); reliability of services; economies of scale; efficiency of operation and management; political and financial incentives and disincentives for improving management and service; and fiscal and policy implications. FORMS OF WATER SERVICES PRIVATIZATION Four types of privatization considered representative of the range of privatization arrangements available in the United States are considered in this report. In order of private responsibility and risk assumption, they are (1) “outsourcing” of the performance of specific public utility support services to private companies; (2) full-service contract operation and management by private companies of publicly owned treatment works; (3) coupling design and construction services with comprehensive operating agreements for new, expanded, or upgraded facilities under design-build-operate (DBO) contracts; and (4) the sale of government-owned water/ wastewater assets to private water companies. Only the fourth option fully transfers risks and responsibilities of asset ownership, operation, maintenance, and replacement to the private sector. Private companies that operate as tax-paying corporate entities currently collect about 14 percent of the revenues and own about 11 percent of the assets providing drinking water in the United States (EPA, 1997). They typically operate under long-term franchises granted by local municipalities. State commissions regulate their rates and charges. The first three forms of privatization involve variously detailed contracts for private participation in publicly owned facilities where financ-

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Privatization of Water Services in the United States: An Assessment of Issues and Experience ing is usually provided by government agencies and ownership risks are retained by the government. These performance-based contracts for a fixed fee are the most common form of privatization in the U.S. water and wastewater industry. All three forms share similar goals in terms of assigning specific tasks and operating risks to financially sound and technically competent private companies or consortia under multiyear contracts. These agreements are frequently secured by insurance companies and by bank guarantees. Prices are fixed and schedules are set in these agreements, which usually seek to reward private operator-managers only for meeting efficiency and cost performance targets. Private companies working for government-run utilities under short-term contracts often provide design and construction services, technical consulting, biosolids disposal, laboratory analysis, and other special tasks. Some of the simpler privatization forms may evolve into longer-term, more complex agreements involving major operation and management responsibilities. A benefit of public ownership of water assets in the United States is the ability of governments to fund capital improvements with 100 percent debt financing. Investors in the large and highly liquid U.S. municipal bond market are exempt from federal and state income taxes on interest earnings, which substantially lowers the interest rate governments pay for borrowed capital as long as they retain full ownership control of the asset being financed. The advantage conferred on municipal governments in the form of lower borrowing costs greatly affects consideration of whether water/ wastewater capital assets should be publicly or privately owned. Water services are the most capital-intensive of all utilities, including electric power and natural gas (see Table 5-1 in Chapter 5), largely because of the high cost of building and repairing sewers and water pipelines. Capital expenditure needs for both types of conveyance systems are forecast to more than triple during the period from 2000 to 2030 (AWWA, 2001a). As capital needs grow, the borrowing cost advantage from lower interest rates on municipal debt will become even more important in discussions of asset ownership. Another barrier to change is the diversity in ownership, size, management characteristics, and capabilities within the U.S. water industry. As of 1999, nearly 54,000 community drinking water systems were in operation (the U.S. Environmental Protection Agency (EPA) defines a community water system as one serving more than 25 people, regardless of ownership; see Box 1-1). The vast majority of these systems serve small populations—85 percent of the water systems serve only 10 percent of the population served by community water systems (Table 1-1). In the wastewater sector, the EPA noted there were 16,024 publicly owned wastewater treat-

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Privatization of Water Services in the United States: An Assessment of Issues and Experience BOX 1-1 Forces of Change Affecting Water Utilities McGuire Environmental Consultants (2000) describes the forces affecting water utilities as follows: The majority of water utilities in the United States are owned by local municipal governments. The degree to which local governments embrace and/or react to change may well govern the pace at which the industry transforms. Broad societal, business and utility trends will shape the water utility future. These trends include the development of new technology, increasing stringency of water quality standards, aging infrastructure, globalization of the water business, population increases, demographic shifts, and the increasing litigiousness in the United States. Some of the trends affecting provision of water/wastewater services are not so obvious. For example, the free exchange of technological knowledge so common in the current collegial world of water may well become constrained if competitive pressures cause water utility managers to view such knowledge as a competitive advantage. Other, more discrete effects include the simplicity of advocacy group organization and mobilization in an era when electronic communication is in the hands of every water utility customer and the utility itself. The availability of water quality data on a real-time basis via the internet also could fundamentally change the manner in which consumers are made aware of water system issues. SOURCE: McGuire Environmental Consultants, Inc. (2000). TABLE 1-1 Community Water Systems (Public and Private) in the United States and Population Served, 1999 Population Served No. of Systems Percentage of Water Systems Population Served Percentage of Population Served 25–500 31,904 59.2 5.2 million 2.0 501–3,300 14,040 26.0 19.8 million 7.8 3,301–10,000 4,356 8.1 25.4 million 10.0 10,001–100,000 3,276 6.1 91.0 million 35.9 >100,000 347 0.6 112.4 million 44.3 Total 53,923 100.0 253.8 million 100.0 NOTE: Total systems based on U.S. Environmental Protection Agency, EPA Drinking Water Information System Factoids: FY1999 Inventory Data. Ownership percentages based on U.S. Environmental Protection Agency, 1995 Community Water System Survey, and applied to factoid data. SOURCES: EPA (1997, 1999a).

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Privatization of Water Services in the United States: An Assessment of Issues and Experience ment works (POTWs) serving 190 million persons, or about 73 percent of the U.S. population (Michael Cook, EPA Office of Wastewater Management, personal communication, 2000). Small communities in which fewer than 10,000 persons are served accounted for 71 percent of the total publicly owned wastewater treatment works. There is also diversity within ownership arrangements of U.S. water utilities. At one extreme is full private ownership and operation by investor-owned water companies, whose charges and rates are typically set by state public service commissions. More common are publicly owned systems that fund and manage their assets without economic regulation (except for accountability to local government) and that perform most of their operations with municipal employees. Nearly all medium- to large-sized cities in the United States follow this approach. Private ownership nonetheless plays an important role in the water industry. Table 1-2 shows that 14.3 percent of total revenues and 10.7 percent of assets are attributable to privately owned utilities. There are about 4,000 investor-owned water utilities in the United States, some of which serve large populations (e.g., Indianapolis Water Company). Other examples of U.S. cities and suburban areas served by investor-owned water systems include San Jose, California; Lexington, Kentucky; Baton Rouge, Louisiana; Chattanooga, Tennessee; Bridgeport, Connecticut; Hackensack, New Jersey; Charleston, West Virginia; St. Louis County, Missouri; and Peoria, Illinois. Table 1-3 shows there is private ownership in all of the size categories, but that it is more common in smaller systems. Public ownership is the rule for larger community water systems, but this has not always been the case in the United States. The early days of the U.S. water industry saw public and private operations growing side by side, and not until the twentieth century did municipal ownership become predominant (Baker, 1948). TABLE 1-2 Market Share of Publicly and Privately Owned Water Systems, 1995   1995 Revenues Assets Ownership Amount ($ bil.) Percentage Amount ($ bil.) Percentage Public 22.2 85.7 117.8 89.3 Private 3.7 14.3 14.1 10.7 Total 25.9 100.0 131.9 100.0

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Privatization of Water Services in the United States: An Assessment of Issues and Experience TABLE 1-3 Community Water Systems in the United States by System Size and Ownership (estimated for 1999)   System Size (in Terms of Number of Households Served) Total Number of Systems Percentage of Total Ownership <100 101- 500 501-3,300 3,300-10,000 >10,000 Public 7.7 34.8 68.6 78.1 87.7 23,187 43 Private 39.5 34.6 26.6 21.4 12.2 17,795 33 Ancillarya 52.8 30.6 4.8 0.5 0.1 12,942 24 Total systems   31,904 14,040 4,356 3,276 53,924 100 NOTE: Data are from EPA’s Drinking Water Information System Factoids: FY1999 Inventory Data. Ownership percentages are based on EPA’s 1995 Community Water System Survey. aAncillary systems deliver drinking water as an adjunct to their primary business (e.g., mobile home parks, retirement homes). SOURCES: Adapted from EPA (1997; 1999a). A March 2001 survey (PWF, 2001) reported results from the 17 largest firms seeking water/wastewater privatization contracts in the United States (Table 1-4). Collectively, these companies reported they were paid $917 million in calendar year 2000 for operating 2,273 publicly owned facilities (most often treatment plants but also solids handling, pump stations, and other components) with an aggregate design flow of about 7 billion gallons per day. These fees for contract services were paid by 1,882 different municipal, state, and federal government clients (PWF, 2001). Table 1-5 lists the values of a variety of investor-owned water companies, ranging from regional operators to multinational conglomerates. Any listing of water companies should be considered somewhat fluid, as the number of private water companies has changed significantly over the past five years through mergers and acquisitions (Table 1-6). TRENDS IN AND TYPES OF WATER PRIVATIZATION Deregulation and privatization trends in the airline, telecommunications, and energy industries have significantly influenced the water supply and wastewater treatment industry. However, based on data from the National Association of Water Companies (NAWC), the actual proportion of water services provided by private water companies, whether measured by customers served or by volume of water handled, has remained relatively steady in the United States since World War II, and currently stands at roughly 14 percent (EPA, 1997).

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Privatization of Water Services in the United States: An Assessment of Issues and Experience TABLE 1-4 Ownership of Major Contract Water Services Operations and Maintenance Firms Operating Company Parent Company Ultimate Ownership/Affiliation Acquisitions in 2000 Alliance Water Resources Privately held Privately held None American Water Services American Water Works Company Publicly traded NYSE None Americas’ Water Services Allete Water Services Allete Corp.,a publicly traded NYSE None CWS Utility Services California Water Service Group Publicly traded NYSE Dominguez Water (CA)b Earth Tech Total Water Management Earth Tech Inc. Tyco Int’l Ltd., publicly traded NYSE NA ECO Resources Southwest Water Company Publicly traded NASDAQ Master Tek Inc. (CO) Thames Water North America Thames Water Plc RWE E’town Corp. (NJ) Environmental Management Corporation Privately held Privately held None Covanta Water Covanta Energy Corp.c Publicly traded NYSE None Operations Management International CH2M Hill Cos. Ltd. Employee-owned None OPTECH Operations Technologies Inc. Privately held None Azurix North America Azurix Corp. Enron Corp., publicly traded NYSE Prism Res. Mgmt. (Ont.) H2O Utility Services. (FL) E. Craver Pumping Services (FL) Baker Hughes Indus. Services (TX) Severn Trent Environmental Services Group Severn Trent Services Severn Trent, PLC, publicly traded London exchange None United Water ONDEO Services Suez Lyonnaise des Eaux None U.S. Filter Services U.S. Filter Corp./Vivendi Water North America Vivendi Environment, publicly traded Paris Bourse None U.S. Water LLC UIC/United Utilities Bechtel/United Utilities None Woodard & Curran Privately held Privately held None aFormerly Minnesota Power Inc. bAcquisition included nine small industrial service contracts. cFormerly Ogden Energy. SOURCE: PWF (2001).

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Privatization of Water Services in the United States: An Assessment of Issues and Experience TABLE 1-5 Value of Investor-Owned Water Companies (in millions of currency units) Company Ticker Symbol Market Capitalization U.S. Companies   American Water Works Company, Inc. AWK $4,324 Philadelphia Suburban Corporation PSC $1,531 California Water Service Group CWT $359 American States Water Company AWR $367 Connecticut Water Services, Inc. CTWS $216 Southwest Water Company SWWC $133 International Water Utilities   Suez (ONDEO) SZE £33,502 RWE AG (Thames) RWE £22,992 Vivendi Environment VIE £13,227 United Utilities UU £3,300 Severn Trent SVT £2,517 Anglian Water Group AWG £1,502 Kelda KEL £1,391 NOTE: Bridge market data, January 23, 2002; 1.00 US$ = 1.16 Euros; 1.00 US$ = 0.71 British pounds (£) as of January 29, 2002. SOURCE: Schwab Capital Markets LP (2002). TABLE 1-6 Large U.S. Utility Acquisitions by Major Water Companies (EBIT and EBITDA figures in millions) Major Company-Company Acquired Date Announced Equity Value (million $) Trailing 12 Mos. P/E Book Value Premium $/Customer NiSource (NI)– Indianapolis Water Company 12/19/96 288 25.7 240 $1,719 Philadelphia Suburban (PSC)–Consumers Water 6/29/98 270 21.9 252 $2,045 Kelda Group PLC– Aquarion 6/1/99 444 25.5 281 $4,096 Suez Lyonnaise (SLEDF)– United Water (UWR) 8/23/99 1,360 30.3 292 $4,154 American Water Works (AWK)–Citizen’s water assetsa 10/17/99 NA 27.5 265 $2,738 Thames Water PLC– E’town (ETW) 11/22/99 607 26.7 256 $4,732 Median Multiples   26.7 265 $2,738 aAsset purchase, multiples as adjusted to reflect capitalization structure similar to other publicly traded water utilities. SOURCE: EPA (1997).

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Privatization of Water Services in the United States: An Assessment of Issues and Experience Responsibility for safe, reliable, and reasonably priced service ultimately rests with state and local agencies. Local and regional water supply and sanitation services may be provided by government agencies or private companies, either as asset owners or managers. Operating risks may be contractually assumed by private companies. But failures in services that affect health, fire safety, and other public goods will be attributed to political leaders. In most cases, privatization is driven by the desire of elected officials for greater accountability and improved service at lower cost. Ultimately, an important political goal is to reduce or avoid the blame for large increases in user fees that would eventually stem from the capital improvements needed to replace aging and failing infrastruc- BOX 1-2 Upgrading and Replacing the Water Services Infrastructure There is widespread agreement that current levels of investment must be increased substantially to replace old pipes and obsolete treatment systems, upgrade technology to comply with stricter quality standards, and meet the demands of a rapidly growing U.S. population. For example, a 2001 study on drinking water infrastructure in the United States found that spending on pipe replacement alone must triple over the next 30 years in order for the nation to maintain a reliable, high-quality drinking water infrastructure (AWWA, 2001a). This represents an additional $250 billion in capital spending over the next 30 years. Other estimates are of a similar magnitude. For example, in a needs survey conducted in 1996, the U.S. Environmental Protection Agency (EPA) estimated infrastructure investment requirements at $140 billion over 20 years (EPA, 1997). Other groups have provided similar estimates, nearly all of which reflect an aging water infrastructure. No matter which set of figures is chosen, substantial expenditures will be required to maintain and upgrade the nation’s water delivery and sewerage infrastructure in the ensuing decades. The AWWA study was conducted in 20 utilities nationwide and was the first comprehensive assessment of drinking water infrastructure needs ever performed, according to the AWWA. “The utilities in this study represent the best in the business;” said AWWA Executive Director Jack Hoffbuhr, who also stated, “They were chosen in part because they are so well-managed. By studying these best-case scenarios, we come to understand what we must do to maintain a reliable drinking water infrastructure for all of us” (AWWA, 2001b). The U.S. drinking water infrastructure network is primarily publicly owned and operated. It spans more than 700,000 miles, more than four times the length of the national highway system. Most utilities across the country will have to confront a convergence of replacement needs over the next few decades, as many of the pipes laid a century ago and many of the pipes laid in the post-World War II era will need to be replaced.

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Privatization of Water Services in the United States: An Assessment of Issues and Experience ture (Box 1-2) and to meet the mandates of the federal Clean Water Act and Safe Drinking Water Act. Other drivers are also at play. Even without a need for capital improvements, the economies achievable through private plant operations may allow long-term rate stabilization. Philosophically, some political leaders believe that subjecting public management monopolies to vigorous private competition is beneficial. Advances in treatment technology to meet increasingly stringent regulatory standards are also motivating some local governments to consider outsourcing the management of individual treatment plants, conveyance systems, and other services to private firms. How municipal governments fund these capital expenditures will play an important part in the scope and pace of private involvement in the water industry. The private investor-owned water industry and private operators of pubic utility systems generally oppose a major program of federal grants to fund municipal utility infrastructure. Their position was stated at a water investors conference in April 2001 by Peter Cook, executive director of the National Association of Water Companies: “The larger the federal role the more counter-productive it will be.” As replacement costs continue to rise, investor-owned utilities are forced to create operating efficiencies to help keep local rate increases within the realm of political acceptability. Costs of Needed Capital Improvements to Drinking Water Infrastructure for the Top 10 States by System Sizea,b State Large Systems State Medium Systems State Small Systems California 12,310.8 Texas 3,691.7 Texas 2,655.1 New York 9.305.0 Massachusetts 2,998.8 California 2,204.4 Texas 6,684.2 California 2,896.7 New York 1,739.0 Michigan 3,647.1 Illinois 2,738.6 Pennsylvania 1,375.0 Massachusetts 2,628.4 Ohio 2,096.7 Illinois 1,306.2 Florida 2,163.1 New York 2,015.4 Washington 1,256.5 Illinois 2,020.8 Pennsylvania 1,946.5 Ohio 957.5 Pennsylvania 1,722.1 Michigan 1,919.3 Florida 910.2 New Jersey 1,721.7 Iowa 1,800.3 North Carolina 908.5 Ohio 1,689.9 Minnesota 1,498.5 Missouri 881.4 aLarge systems: >50,000 customers; medium systems: 3,301-50,000 customers; small systems: <3,300 customers. bCosts reported in millions of dollars on January 1999 dollars. SOURCE: EPA (2001).

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Privatization of Water Services in the United States: An Assessment of Issues and Experience Private construction and management of new and replacement facilities thus are sometimes sought by governments seeking to transfer capital needs, the onus of rate increases, and operating risks to private design-build-operate (DBO) consortia. Outsourcing of operations and maintenance alone is often driven by a desire for cost savings through economies of scale and service efficiencies that may be possible through private enterprises. Few local governments want to sell their entire water system to a private water company and lose control of the community water supply and responsibilities like rate setting. Most municipal wastewater assets are encumbered by federal grants that must be paid back in any asset privatization. Further, any premium on the price paid by a private company for the purchase of the municipal water or wastewater utility will be recovered in the rates charged to the community by the private company, thus minimizing efforts to reduce rates to the residents and businesses. Finally, municipal utility valuations are difficult to establish because of variations in local governments’ bookkeeping and maintenance records. Of the major private U.S. water companies, Philadelphia Suburban Company (PSC) has been the most successful in expanding its rate base through acquisition of small public and private systems. Since 1992, it has purchased more than 40 public and private water utilities, including what PSC claims is the largest ever municipal water system asset sale in the United States, in Bensalem, Pennsylvania, in 1999. Most of PSC’s municipal acquisitions have been acquisitions of systems that are contiguous to its densely populated service area north of Philadelphia. The country’s largest publicly traded water company, American Water Works Company, Inc., bought municipal systems in Howell Township, New Jersey, in 1998, and Coatesville, Pennsylvania, in 2000. The type of privatization that involves the design, construction, and operation of new, upgraded, or expanded treatment plants, pipes, pumps, and storage facilities has become an accepted option for municipal owners during the past 10 years. Under these DBO contracts, municipalities set design criteria and their guidelines for long-term agreements. Private firms compete on the quality of their technical submissions and their prices for managing the detailed design/engineering/procurement/construction services and for operation and maintenance (in some cases with fixed prices for major maintenance and repairs). Municipal governments and their financial advisors usually arrange project financing for DBO projects. The cities of Atlanta, Seattle, Phoenix, Houston, and Tampa have completed or are building large new treatment plants or biosolids processing facilities procured as DBO projects. A substantial number of long-term management contracts for the private opera-

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Privatization of Water Services in the United States: An Assessment of Issues and Experience tion of existing municipal utility plants also include a capital upgrade or expansion component that is treated as a DBO project. The design-build-own-operate-transfer arrangement (DBOOT) is infrequently used but involves the private, taxable debt and equity financing of new or expanded water/wastewater systems for municipal governments. In DBOOT-transfer operations, private developers organize the project, obtain permits, arrange financing, and manage the capital and operational risks of new facilities under long-term contracts. In the past 15 years, only Cranston, Rhode Island, Franklin, Ohio, and Tampa, Florida, have awarded DBOOT contracts for new water/wastewater treatment plants. The cities of Chicago and Atlanta used a private DBOOT approach in 2001 for building and operating large wastewater biosolids treatment and disposal projects. Tampa Bay Water is a state-created regional water wholesaler that supplies water to municipally operated utilities in the Tampa Bay metropolitan area. In 1999, Tampa Bay Water signed a 30-year water supply contract under which Poseidon Resources is obligated to deliver 25 million gallons per day of drinking water from a large desalination plant set for operation by December 31, 2002. Although much attention has been given to new forms of contracting for facility construction, the most significant recent increase in private sector water activity has been in the operation and maintenance of both public and private water and wastewater facilities. This market, which now exceeds $2.5 billion per year, is projected to increase to $5.5 billion per year by the year 2004 (PWF, 2001). Table 1-7 summarizes recent activities. For example, the cities of Milwaukee and Indianapolis delegated management of their wastewater systems in 1999 and 1994, respectively, while Atlanta transferred its entire water system to private management in 1999. The largest number of privatization contracts is short-term service agreements of five years or less, signed with small and medium-sized municipalities. Water utilities, whether public, private, or some combination, have several goals. First and foremost is assuring public health and safety through the reliable provision of high-quality water supply and treatment facilities, and the provision of water for fighting fires. Water utilities seek to provide these services at reasonable prices. Water utilities also often aim to meet several related concerns, including environmental stewardship and providing jobs in the communities they serve. The challenges of meeting new regulations, especially drinking water quality standards and wastewater effluent standards, have put many water utilities, especially small- and medium-sized ones, under great pressure to continue to meet these goals. Many lack the expertise to upgrade or operate their

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Privatization of Water Services in the United States: An Assessment of Issues and Experience TABLE 1-7 Communities with Long-Term Water Contracts Municipality Description (System Type) Capacitya Contract Term (Years) Atlanta, Ga. Water 201.4 mgd 20 Augusta, Ga. Wastewater 46 mgd 10 Bessemer, Ala. DBO water 24 mgd 20 Boston, Mass. Wastewater sludge 125 dtpd 15 Brockton, Mass. Water/wastewater 24 mgd 20 Chicago, Ill. Wastewater sludge 150 dtpd 20 Cranston, R.I. DBO wastewater 23 mgd 25 Edmonton, Alb. Wastewater 24 mgd 8 Evansville, Ind. Water 60 mgd 10 Farmington, N.M. Water/wastewater 20 mgd 8 Franklin, Ohio BOT wastewater 4.5 mgd 20 Franklin, Ohio BOT water 5 mgd 20 Fulton Co., Ga. Wastewater 24 mgd 10 Hamilton, Ont. Water/wastewater 300/5 mgd 10 Indianapolis, Ind. Wastewater 250 mgd 14 Milwaukee, Wis. Wastewater 550 mgd 10 Moncton, N.B. DBO water 25 mgd 20 New Haven, Conn. Wastewater 45 mgd 15 Newport, R.I. Wastewater 10 mgd 20 Norwalk, Conn. Wastewater 20 mgd 20 Oak Ridge, Tenn. Utilities — 10+10 Plymouth, Mass. DBO wastewater 3 mgd 20 Rahway, N.J. Water 6 mgd 20 Seattle, Wash. DBO water 120 mgd 25 Springfield, Mass. Wastewater 67 mgd 20 Stonington, Conn. Wastewater 3 mgd 20 Tampa, Fla. DBO water 66 mgd 15+5 Tampa, Fla. BOT desalination 25 mgd 30 Taunton, Mass. Wastewater 8.3 mgd 20 Wash. Boro, N.J. DBO wastewater 1.2 mgd 15+5 West Haven, Conn. Wastewater 12.5 mgd 15 Wilmington, Del. Wastewater 105 mgd 20 Woonsocket, R.I. DBO wastewater 16 mgd 20 amgd = million gallons per day; dtpd = dry tons per day. SOURCE: PWF (2001). plants to meet often stringent regulations, as well as the capital to finance related investments. Private contractors may offer the expertise and the capital, plus they may assume the risks of complying with regulations. New management and communications technologies have made it possible for one company (private or public) to manage and operate several utilities from a central office. Provision of water services is based on access to information such as data on consumer demand, on quality levels

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Privatization of Water Services in the United States: An Assessment of Issues and Experience and water flows, effluent quality, as well as on financial flows. The ability to collect data and respond to changing conditions rapidly and appropriately is an important determinant of the scope and scale of water service systems. Technological advances in communications, monitoring, computing, and control systems have thus affected the water industry structure at the margins of change. Modern systems will accelerate the drive to larger units. Whether this technological shift will favor privatization or will be quickly adopted by efficient public systems remains to be seen. CONCERNS ABOUT PRIVATIZATION Unsuccessful Ventures In the preface of the Masons Water Yearbook 2000-2001, a British water publication, Owen (2001) stated the following about water utility privatization: Privatization, or private sector participation, has already enhanced economic growth worldwide, but in contrast with telecoms, power and transport, for example, its impact on the water sector has been much less marked, (because of its very different risk profile) despite demonstrable need. Only about six percent of the world’s population is currently served by private sector operators, and since more than one billion worldwide have inadequate water supplies, and some two billion no adequate sanitation, the potential market is truly very large-quite beyond the capacity, moreover, of the existing major players to service it. However, because water is a highly political issue, and existing infrastructure is often highly fragmented, market evolution has proved slower than earlier over-optimistic predictions suggested. Future development will be governed by creative solutions involving true partnerships of all the stakeholders in the sector, taking account of local political and social sensibilities. Several major cities around the world have availed themselves of private management under various arrangements, including all of the United Kingdom, Berlin, Buenos Aires, Johannesburg, Manila, and Mexico City. Many U.S. cities also have arrangements with private firms to provide water services, and these firms often reliably deliver high-quality water services at competitive prices, with high levels of consumer satisfaction. As noted earlier, private firms have held roughly a 15 percent share of the U.S. water market for the past 50 years. Contentious situations can stem from unrealistic contract conditions and strong competition in the process of bidding on water services contracts. And although improved system performance and cost savings have resulted from privatization in some instances, in some cases expected

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Privatization of Water Services in the United States: An Assessment of Issues and Experience benefits have not been fully realized. A recent case has been in Indianapolis, which repossessed its water utility from a private contractor (see Box 1-3). For one group’s evaluation of the problems with water services privatization, the reader is referred to a 2001 report from the Public Citizen group (Public Citizen, 2001). Inadequacies in performance can be resolved through negotiation between the contractor and the city. In Ohio, Clermont County’s water treatment plant suffered problems of discolored tap water shortly after the country awarded an operating contract to a prominent private firm. Although harmless, the brown water focused criticism on both the county and the company. It turned out that the problem would have occurred independently of who was managing the plant. Corrections were made, with the cost being shared by the operator and the county, while overall cost savings have resulted in a 5 percent rate reduction. The creation and failure of Azurix Corporation is an example of a market miscalculation in the water utility field (Box 1-4). Rapidly-evolving markets may exhibit instability and they raise questions of the reliability of member firms. BOX 1-3 Private Delivery of Water Services in Indianapolis The case of private sector water services in Indianapolis involves shifting the form of privatization from the ownership model to the contract operations model. The system was originally incorporated in 1869 and sold to the founders of the Indianapolis Water Company (IWC) in 1881. Indianapolis has long stood out as the largest U.S. city served by an investor-owned water company, although St. Louis County Water and San Jose Water are other important examples. The IWC also serves some nearby communities. In 1997, the local gas company purchased the water company, but was required under securities law to put the assets up for sale when it purchased another energy company in 2000. The city chose to purchase the system in order to try to maintain lower rates, take advantage of lower capital costs available to municipalities, and avoid a purchase by foreign interests. An eminent domain process was begun, despite some local dissention. However, although the purchase has not been consummated, the city has issued an RFP (request for proposal) for its operations. The city’s wastewater system is currently operated by a private consortium in which United Water Resources, owned by French Suez, plays a central role. The deal struck a blow to the U.S. investor-owned water industry, and water industry analysts will follow the case closely to see whether the shift affects performance.

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Privatization of Water Services in the United States: An Assessment of Issues and Experience BOX 1-4 Growth and Decline of Azurix The Azurix business plan presented to investors in 1999 was based on the expectation of fast revenue growth from radical change in the market structure of water supply and service delivery in the United States and abroad. The company was formed and then spun off (at $19 per share) in a public offering of stock by the energy marketing company, the Enron Corporation, in June 1999. Azurix lost over $1 billion in market value before it was deemed a failure by Enron and was reorganized late in 2000. Azurix eventually discovered it could not compete with the larger, well-established British and French firms and was unable to make a market by trading water. In 2001, Enron filed for bankruptcy in one of the spectacular crashes of a prominent U.S. corporation. Community Concerns Communities considering water services privatization options often have many concerns regarding new operations or ownership arrangements. They are concerned about privatization’s effects on their monthly water and sewerage bill: what does privatization imply for their short-and long-term bills? They are concerned about water quality: will they continue to receive consistently good-quality water in the long run? Citizens may also have concerns regarding new channels of communication and the airing of grievances: if they have questions regarding their water services under new privatization arrangements, do they voice their concerns with city officials or with a private firm? Communities may also have concerns regarding long-term protection of watersheds that convey raw water supplies, participation in and transparency of policy decisions, and competition after service contracts are awarded. Communities are nearly always concerned about the possible loss of control over a vital public service. The public and their elected representatives exhibit a natural caution when faced with surrendering control and/ or assets of essential municipal services. The reality of water services privatization is that the public official can never fully transfer accountability to a private operator for reliable delivery of water services, a function that communities believe is a vital public service. If the private operator fails to meet the public’s expectations, the public is more likely to protest to the public official than to the private operator. Privatization of water services will only be a net political gain for incumbent politicians if cost reductions and improved service deliveries more than compensate for the loss of control. This political calculus likely means that political control will be transferred only for those services that pose problems in

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Privatization of Water Services in the United States: An Assessment of Issues and Experience meeting minimum financial, regulatory, or management standards. That is, systems most likely to be offered for privatization are likely to have structural or managerial difficulties. A second concern is the recognition by administrators and citizen groups that privatization is not the same as competition. There is a tendency to equate the two, as the private economy is thought to work well because of the pressures of competition that force firms to operate efficiently and to produce what the public wants. However, by definition, when a contract is signed for the management, operation, design, etc., of a water system, only the monitoring and enforcement of the contract terms can guarantee the expected level of performance. Competition in urban water utilities is limited to the period when competitive bids are being accepted, and it is geographically limited to the system’s expanding margins. Bidding for the operation of complex organizations such as water and wastewater utilities is ripe for accusations of political favoritism. A review of the media coverage in competitive bid processes such as those in Birmingham, Atlanta, and New Orleans reveals charges that political favors were granted in connection with these bids. A third concern is the recourse that will be available if privatization does not work as intended. Terms of remediation must be carefully spelled out in legal and financial terms. Urban authorities must be sure that essential skills and equipment can be regained quickly if the terms of the contract are not fulfilled. A fourth concern is the possible loss of openness and transparency of utility policies and practices. Deliberations of public bodies are subject to numerous “sunshine” provisions that require open meetings and records. Once a private firm assumes operations, it is no longer clear that business practices and accounts will be open to the public. To ensure transparency, such agreements must be specified in the contract. A fifth concern is for the long-term protection of the water/wastewater infrastructure and the basic water supply itself. There are questions regarding whether private operators may take “shortcuts” by failing to maintain the system or allowing the degradation of watersheds and groundwater aquifers. Certainly, experience has not shown this to be a problem, but because relatively few long-term operations and maintenance contracts have run their course, little data regarding this concern are readily available. City administrations may be concerned with the possible loss of revenues to the general treasury and with loss of service functions to other departments. In many cities, the funds of utilities are comingled with general funds. Some cities have enjoyed profits from utilities that are used to support general government functions (although most cities impose a “no profit-no loss” constraint on their utilities). Free water and wastewa-

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Privatization of Water Services in the United States: An Assessment of Issues and Experience ter services to city parks and hospitals may have to be foregone, as well as disaster response services that have been rendered by the water utility. Concern for the welfare of the utility workforce and for the possible loss of local jobs is pervasive. Some fear that workers will be unfairly exploited or that jobs will be lost to nonresident personnel. Most privatization contracts have guaranteed no loss of jobs except through natural attrition. A frequent result has been the upgrading of skills, resulting in increased wages and increased promotion possibilities. Finally, experience has shown that the preparation of adequate contracts is expensive and time-consuming. Outside legal and engineering expertise is usually needed. The review of multiple bids can also be costly. Concerns of Private Contractors Preparation of detailed cost and technical proposals for contract operation of a major utility system is a costly exercise. If private financing is involved, lines of credit must be arranged. Some requests for proposals (RFPs) require parent companies to stand as guarantors of performance. Private contractors thus must consider the probability that the awarding process will be fair to all parties, that a contract will be signed, and that they will be permitted to earn a profit. Because of the high cost of preparing a proposal and to encourage well-qualified firms to bid on a request for proposals, some municipalities have offered to partially reimburse bid-related expenses for the short-listed firms. Although some public utilities, such as Seattle Public Utilities, have provided compensation to bidders, the amounts have been small compared to the total expense incurred by the bidders responding to the requests. In some instances, it is suspected that municipal requests for proposals have been issued with no intent of entering a contract, but rather as a means of gauging public managers’ performance or for winning concessions from unions on staffing. Another concern of private operators is gaining timely access to accurate condition assessments and maintenance records during their preparation of technical and cost proposals. Some private operators believe they operate on an “uneven playing field” because publicly owned utilities can issue tax-free bonds, thus raising capital at lower interest rates than the taxable debt available to a private company. A study done in 1999 for the city of Phoenix ruled out private financing for a new water treatment plant largely because city-issued tax-exempt water lease bonds could be issued at a 5.2 percent cost of capital, versus 8.2 percent for private financing using taxable debt and equity (PWF, 1999). Congress granted an interest-rate subsidy to municipal government

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Privatization of Water Services in the United States: An Assessment of Issues and Experience bonds soon after World War I. By exempting investors from having to pay income taxes on bond interest earnings, the federal government gave local borrowers a 250-300 basis points (a basis point is 1/100 of 1 percent; 100 basis points equals 1 percent) cost advantage over private issuers. The difference in borrowing costs accelerated the shift from private to public ownership of water and wastewater utilities during the infrastructure expansion period after World War I. To obtain and keep their federal interest subsidy, municipal borrowers must maintain public ownership and management control of the debt-financed asset until the bonds are retired. In an attempt to expand the market for privately managed capital projects, in June 2001 federal tax legislation that would exempt water and wastewater bonds from volume caps was proposed. This bill (H.R. 2207) was referred to the House Ways and Means Committee, where it is expected to be considered as part of a larger review of the federal tax code. Federal grants provided up to 85 percent of the capital cost of publicly owned wastewater treatment plants built during the 1970s and 1980s. In 1988, Congress voted to phase out these construction grants, but since 1989, Congress has provided seed funding for states to set up revolving loan funds for municipal wastewater projects. These revolving funds can be used only for municipally owned facilities. CONCLUDING OBSERVATIONS This report’s executive summary lists the study’s key findings. A few of those observations are nonetheless worth emphasizing in this introductory chapter. It is clear that no single model of water services privatization fits all situations. Indeed, continued public ownership and operation is the most likely outcome for the majority of water utilities. A major effect of the availability of private alternatives has been to increase the resolve of the publicly owned and operated water utilities to sharpen their operations, reduce costs, and upgrade the quality of services. Large municipal water utilities typically have the expertise and resources to address emerging challenges. Small to medium-sized water utilities generally have more difficulty in meeting higher quality and health standards and in responding to pressures of population growth. Small municipalities may thus be the most fertile ground for private participation in water utility operation and management.