The Business of Water
Publication: Journal of Water Resources Planning and Management
Volume 133, Issue 3
Once nearly unnoticed public services, urban water supply and wastewater utilities have lately found themselves at the center of attention. Saddled with crumbling infrastructure and financial problems, they are called upon to meet ever stricter drinking water and environmental standards, and to do so in a public atmosphere of increasing vigilance and decreasing confidence. Questions are raised about the competence of many utilities and about their long-term sustainability.
One thread of the public debate concerns the role of the private sector in the provision of drinking water and the management of wastewater. Some argue that increased involvement by the private sector is the “magic bullet” that will solve most current and anticipated problems; others claim that private sector involvement can only lead to increased rates and lower quality service. After some twenty years of debate in the United States, it has became apparent that these divergent views are deeply held, emotional, and grounded in conflicting ideologies that have little to do with the water industry. Although the following paragraphs discuss U.S. controversies, a very similar debate rages with respect to developing countries. Unfortunately, the heat of the debate has obscured many real issues and has sometimes made it difficult for the industry to identify and adopt real solutions.
The Industry Today
Most people think of water and wastewater services as being delivered by local government. In the case of wastewater utilities, this is still largely true. On the other hand, a substantial number of drinking water utilities have always been privately owned. Indeed, over half of all community water systems in the United States are either privately owned or public/private partnerships. These include a large number of very small systems, often owned by consumer cooperatives, homeowners associations, or developers. A more informative sample would be limited to those large community water systems serving populations of 100,000 or more. U.S. EPA data from January 2006 identify 386 such systems, of which 61 (16%) are listed as privately owned. The privately owned systems account for almost 16% of the 126 million persons served by utilities in this size range.
By way of comparison, note that a national survey conducted in 1982 by Temple, Barker, and Sloane, Inc., concluded that 18% of all water utilities serving communities of 100,000 or more were privately owned at that time, and that these utilities served 16% of the population in this size range. There are at least two interesting things about these statistics. The first is that the private sector has long been a significant part of the water industry. In fact, the history stretches back into the 19th century, when most urban water systems were privately owned. Second, the level of participation by the private sector has hardly changed in recent decades. Of course, these data hide many changes and trends. During this time, there have been numerous consolidations, regionalizations, privatizations, deprivatizations, etc. It should also be noted that the 2006 data are of substantially better quality than data available previously. Nevertheless, someone looking for empirical evidence of strong movements toward or away from private sector participation in the water industry will not find it in such aggregate data.
On the other hand, anecdotal evidence suggests other changes. It appears that the range of possible private sector roles has expanded in recent years. These might be loosely categorized as follows:
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Contract operation of specific facilities (e.g., water treatment plants, wastewater treatment plants, including design-build-operate contracts);
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Outsourcing of other functions (e.g., laboratories, watershed maintenance, etc.);
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Contract operation of utility without rate-setting authority (government owner sets rates and retains financial control);
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Contract operation of utility including rate-setting authority (franchise bidding: government owner or other agency regulates rates; private partner handles all financing); and
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Ownership transfer (the entire utility is permanently transferred to the private sector firm, together with rate-setting authority and financing responsibility).
The term “privatization,” strictly speaking, refers only to the last of these: complete transfer of ownership. The other roles are generally described as “public/private partnerships.” They vary widely in significance and in potential for controversy.
Why the Private Sector?
Individual proposals to entertain some form of public/private partnership arise for many reasons. While each case is different, motivations for private sector participation may include, in no particular order, the following issues.
Operating Economies
The first thing to be said here is that there is no inherent reason for a private sector operator to be more efficient than a government owned utility. The incentive for efficiency can be great or small in either situation, depending on factors such as the quality of management or the degree of budgetary discipline. Much has been said about the role of competition in promoting private sector efficiency, but real price competition has been very difficult to inject into the public utility sector. In most cases, the private operator functions as a regulated monopolist, an activity not noted for great efficiency.
Though there is no reason to expect a private sector operator to be more efficient, there is no reason why it cannot be. Where utilities have chosen to outsource operations of specific facilities, such as treatment plants, it seems likely that many have done so to capture cost savings. Those cost savings may emerge in several ways. Where the utility has been unable, for political or other reasons, to efficiently deploy or reduce staff, a private operator may be able to implement significant staffing adjustments. Also, where the private firm operates a number of similar facilities in different locations, it may benefit from economies of scope (derived from the diversity of activities, rather than their sheer size), reducing the average cost at each location.
Improved Access to Capital
Water and wastewater utilities throughout the country are faced with daunting capital needs. Existing infrastructure may be deteriorated, facilities may be inadequate for present or future needs, and mandated treatment upgrades may create further investment requirements. Meeting these needs by simply issuing more debt is not always feasible for a government-owned utility. There may be statutory constraints on the kind of debt that can be issued and on the maximum amount that can be outstanding. One reason for seeking private sector participation might be to obtain improved access to the capital market, based on the credit worthiness of the private firm.
It must be noted, however, that capital obtained in this way will likely be more costly than government financing, especially where the private firm must issue taxable bonds. Private sector participation can improve access to capital, but at a price.
Technical Competence
The steady progression of drinking water and environmental standards that utilities must comply with, as well as the treatment challenges posed by deteriorating source waters, demand a higher level of technical competence on the part of water and wastewater utilities. Government-owned utilities, especially smaller ones, often report difficulty in attracting, hiring, and retaining employees with the skill levels needed. To some extent, the shortfall can be filled by consultants and by short-term contracts for specific services, but these are poor substitutes for full-time operators and technical support staff with the necessary competence. In such situations, contract operation of the treatment plants or other form of public-private partnership can provide the necessary skills. Large multi-site private operators generally find it easier to recruit and retain competent operators, engineers, and scientists.
Removal from Political Influence
Among the various possible ownership arrangements, municipally-owned utilities are uniquely susceptible to political influence and intervention. In some cases, close attention by engaged and well-informed elected politicians can prove to be of great benefit, creating a strong motivation for high performance and providing extra clout when external assistance is needed. On the other hand, there are many examples of harmful and destructive political interference. These cases may involve pressure to increase staffing above efficient levels, pressure to retain nonperforming employees, or the inability to secure commitments for long-range plans. A more insidious effect of political intervention is the difficult environment that it creates for utility management, making it problematic to attract competent managers.
Private sector participation can, depending on the degree to which it is implemented, reduce or eliminate damaging intervention by elected politicians. It can be argued that full privatization, where the ownership of the utility passes entirely into private hands, reduces political interference to a level no higher than that experienced by other large employers in the same city.
Long-Term Sustainability
One requirement for long-term sustainability of drinking water and wastewater systems is a consistent policy of full-cost pricing, where user charges are sufficient to cover operating, maintenance, and administration costs, as well as providing for the capital needs of the utility. It is sometimes tempting for a government-owned utility to avoid needed rate increases by deferring capital investment or maintenance. Once started, this practice can only lead to progressive deterioration of the utility. Private sector firms, on the other hand, have no option but to recover their full costs if they wish to remain in business. Therefore, the greater the degree of private sector participation, the smaller the ability to defer costs. A fully privatized utility is inherently a full-cost recovery utility, and is thus consistent with long-term sustainability.
Cash Windfall to Local Government
In the special case of an outright sale of a government-owned utility to a private firm (full privatization), one outcome of the sale may be a large cash payment to the government. The prospect of this cash infusion may be a major motivation for the government to consider such a sale. It was widely believed that this motivation was a major driver for the massive privatization of public services in England and Wales that took place in the 1980s (although the actual cash windfall was much smaller than predicted). This issue has little relevance to U.S. privatization efforts, which only rarely involve outright sales.
Why Not?
As described, there are a number of ways in which some type of public/private partnership might be advantageous. Similarly, there are other ways in which private sector participation may not be desirable.
Hidden Subsidies for Government Ownership
As noted above, private sector operation can lead to cost savings in certain situations. But a high level of private sector participation can produce some diseconomies as a consequence of the hidden subsidies provided to government-owned utilities. These are of three kinds: (1) government-owned utilities are not liable for local or state taxes on real or other property; (2) government-owned utilities are permitted to issue nontaxable debt at a lower interest rate than most private sector firms; and (3) government-owned utilities have no equity holders and are thus spared from paying dividends to shareholders. These issues do not all apply in every case; for example, some government-owned utilities, while not subject to tax, make payments in lieu of taxes. Also, as a result of State Revolving Loan Funds and other factors, there may be little difference in the cost of debt between some government-owned and some investor-owned utilities. But where all factors apply, the difference in total revenue requirement can be substantial, even for similarly efficient operations.
In particular, this concern applies to full privatizations, where the actual ownership of the utility changes. If such a change is considered on the basis of operational economies alone, the efficiency gain may have to be very large to compensate for the lost subsidies.
Cherry-Picking Service Areas
Again, this issue applies mostly to a fully privatized utility, or to contract operations where the private firm sets rates and handles financing. As a matter of public policy, water and wastewater utilities must provide universal service within the agreed upon service area. For a given rate level, some customers will provide revenue in excess of incremental costs while others will not, and a profit-seeking utility with the option of expanding its service area may have an incentive to avoid serving certain neighborhoods. Typically, operators will avoid low-income neighborhoods where use will be low and bill collection problems high. This problem can be addressed through careful regulation, but it illustrates a situation where public and private goals conflict.
Affordability
A related problem, which may also arise in the case of a private firm with rate-making authority, pertains to household-level affordability. It is in the public interest to insure that low-income households have access to reasonable amounts of water at an affordable cost. Following this policy relieves political pressure to hold rates down for other customers and facilitates the achievement of full-cost pricing. Since private sector operators are expected to experience less political pressure and to be able to price at full cost, they have correspondingly less interest in providing low rates to low-income users. Again, this must be addressed through regulation.
Integrated Water Management
Another principle of long-term sustainability is that water resources be managed in an integrated, coordinated way. This usually implies a watershed approach, where all water sources, water users, and pollutant sources are considered simultaneously, with water resources targeted toward their highest and best uses. Such coordination is difficult to achieve with fragmented government control of the various water agencies; it is even more difficult when one or more of the agencies is a private firm, which has no particular responsibility to cooperate with government agencies in this endeavor.
An Alternative
If the divide between public and private provision of water services seems too threatening, there is an intermediate strategy that can achieve many of the advantages of private sector operation with few of the disadvantages. This strategy, sometimes called “commercialization,” is a familiar one. It consists of the creation of a public body that is fiscally autonomous and organizationally independent of local government. Such bodies are known generically as government corporations and may be designated as water authorities, water management districts, water commissions, etc. These organizations are run by professional managers who report to a board of directors. The directors may be appointed by political bodies (in some cases they are themselves elected), but they serve fixed terms and are expected to perform their duties in an apolitical way.
Because a commercialized agency is expected to attract and retain better-quality managers than most government operations, there may be some operational efficiencies achieved in this way. Capital access may be improved, technical competence may be improved, political influence is reduced, and full-cost pricing is improved. Typically such organizations make payments in lieu of taxes, so the hidden subsidies are smaller, but still present. As a public sector organization, the commercialized utility should be expected to protect low-income users and to seek better management of the water resource. In each case, the promised advantages may fall a bit short of what public/private partnerships could deliver, but the negative aspects, including much of the public controversy, are largely missing.
Conclusions
Water and wastewater utilities face serious challenges of many kinds: fiscal, operational, managerial, infrastructural. There is some reason to believe that meeting these challenges successfully will be particularly difficult for the traditional government-owned municipal utility. These organizations often lack the ability to attract sufficient capital, skilled staff, quality management, and funding continuity needed to deal with issues as they arise. One response to these shortfalls may be restructuring.
Restructuring can take many forms. Among them are the different “flavors” of public/private participation: contract operation of facilities, contract operation of utilities, or full privatization with ownership transfer to the private firm. Each of these arrangements has specific advantages and disadvantages and is appropriate to specific circumstances. For example, operating economies may be gained by contract operation, but wiped out by the loss of subsidies in the case of full privatization. The private sector may provide increased access to capital, but sometimes at a higher cost. Public/private partnerships generally reduce political interference and bring increased technical competence. One often cited advantage of these arrangements is the guarantee of full-cost pricing, but this is only true for full privatization or contract operation with rate-making authority. However, full privatization combined with inadequate regulation may also fail to protect the public goods provided by water utilities, including universal access, affordable services for the poor, and integrated watershed-based water management.
An alternative form of restructuring is the commercialization of government-owned utilities, achieved through the creation of a fiscally autonomous, organizationally independent entity supervised by a professional manager who reports to a board of directors. These corporation-like structures can deliver many of the advantages of full privatization or contract operation with few of the disadvantages. In particular, some of the subsidies for government ownership are retained and the responsibility to protect public goods continues.
Are public/private partnerships a good thing? They may be in the appropriate circumstances, provided the form of partnership is chosen carefully, whether it be simple outsourcing or full privatization or any form in between.
Is commercialization of existing government-owned utilities a good thing? It may be in the appropriate circumstances.
All of these forms of restructuring should be viewed as alternative tools which may be used to improve the performance of a water or wastewater utility. There are no “magic bullets”; there are no intrinsically bad restructurings. None of these alternatives are solutions; they are merely tools. The business of water will always be conducted by public and private organizations, both separately and can jointly.
Information & Authors
Information
Published In
Journal of Water Resources Planning and Management
Volume 133 • Issue 3 • May 2007
Pages: 189 - 191
Copyright
© 2007 ASCE.
History
Published online: May 1, 2007
Published in print: May 2007
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