National Drinking Water Clearinghouse
West Virginia University
PO Box 6893
Morgantown, WV
26506-6893


Privatization
When Public Goes Private

by Jamie Knotts
On Tap Assistant Editor

jknotts@wvu.edu



Someone is knocking at your utility’s door, and it looks like representatives from a private water company. Maybe they want to strike a management agreement for billing and collection. Maybe they want you to contract out your operation and maintenance to them. Then again, maybe they want to buy out your utility entirely.

That’s unlikely, you say. Not in a million years would they want this water plant. Why would they want to talk to us? The answer is simple: money.

More and more, private, multi-national corporations are taking over public water systems because they see them as good investments. With a consistent customer base, private companies see a cash flow waiting to be tapped. Opponents say private companies seek out struggling water utilities that have problems meeting regulatory health standards, maintaining a consistent supply, or operating a
deteriorating infrastructure. With added pressure from Washington, the time looks ripe for the word “private” to replace the word “public” in identifying your water system.

A recent article in U.S. News & World Report says that Congress is considering increases for federal infrastructure funding. The Bush Administration, however, encourages privatization, saying that water systems cannot expect to get all the dollars they need from Washington. The article quotes G. Tracy Mehan, U.S. Environmental Protection Agency (EPA) assistant administrator for water, saying, “I think the needs are so great, especially when you see the demands of homeland security and the federal budget. Private capital is one of several options that are going to have to be considered much more than they have been.”

Why privatize?
Advocates cite numerous reasons why a utility should be privatized. In some cases, it’s a matter of a crumbling infrastructure. In other instances, newer systems need updates because of increases in stress due to growing populations.
A recent EPA report cites a $265 billion need over 20 years for both capital and operations and maintenance for the nation’s 54,000 drinking water systems. Where will these systems find the money?

EPA Administrator Christie Whitman says that for fiscal year 2003, the Bush Administration proposed the largest combined request for state drinking water and clean water revolving loan funds in history—$2.1 billion. Whitman said the country would need to use public and private sector financing to develop new technologies and innovations. Even if $2.1 billion is appropriated to aid ailing water systems, the industry needs billions more.

Water systems also face increasing federal mandates without the corresponding money to pay for them. A recent report from the Public Policy Institute says the federal government has reduced its contributions to local water systems over the past 30 years, while at the same time imposing stricter water quality and effluent standards. Opening the Floodgates: Why Water Privatization Will Continue says that unfunded mandates force municipal systems to meet federal regulations through local revenue sources or state revolving loan funds. Privatization is one strategy municipalities are choosing.

The report also says a lack of political will hampers upgrades and system repairs. “It’s often difficult for local officials to commit to making the necessary investments in community water systems,” the report states. “Water pipes and sewer mains are not visible and not perceived as immediately critical for adequate funding. It is easier for elected officials to ignore them in favor of expenditures for more visible services, such as police and fire. Additionally, water and sewer rates do not adequately cover the actual cost of providing services in many municipalities—but raising water and sewer rates to cover operations and maintenance as well as capital replacement is an unpopular move for elected officials.”

Trying Something New

In the last decade, hundreds of U.S. cities and counties have hired private companies to manage their waterworks. Currently, New Orleans; Stockton, California; and Laredo, Texas, are in the process of going private, although opposition has sprung up in all three cities. Indianapolis signed a $1.5 billion agreement with USFilter, the largest U.S. privatization to date, and San Jose, California, voted to consider privatizing.

Private firms have a history of supplying water to cities, dating to as early as 1796. Utilities also have long hired outside contractors to build, but not operate, plants and distribution systems. More firms now manage systems due to an Internal Revenue Service ruling that helps firms obtain longer-term, tax-free water contracts, combined with a political push for deregulation and municipal-system breakdowns.

Less than 15 percent of U.S. utilities are investor-owned, but in recent years, a handful of big water corporations, mostly foreign owned, have moved onto the U.S. scene. Those companies vying for U.S. systems include: Suez and the media-water conglomerate, Vivendi from France and the utility RWE from Germany. One domestic player with giant ambitions was Enron’s water subsidiary, Azurix.

But all is not well with corporate water companies. In Atlanta, the experience has not been positive for residents. Mayor Shirley Franklin notified United Water Resources (UWR), a Suez-owned company, that the city was dissatisfied with its performance under the 20-year contract signed by the city’s previous administration. Franklin said the firm reduced staffing levels, billed the city for work it didn’t do, and failed to perform adequate maintenance.

In Jacksonville, Florida, UWR’s ownership and operation was so poor that citizens bought the system back for $219 million. In its brief, five-year ownership, critics say the company’s chief efficiency was getting rate increases from the Florida Utility Commission. Monthly bills went up by $9.44 in 1997. The company asked for an additional 12.5 percent rate hike a year later. By taking control of the utility, residents are expected to pay nearly 25 percent less for water and sewer services.

In other areas of the country, residents have been fighting a proposed buyout of American Water Works Company by Thames Water, a British subsidiary of Germany’s RWE. Those fighting the sale fear the loss of local control of their water to a large, multi-national corporation that was more interested in the financial bottom line than quality water and service.

Opinions Strong on Both Sides
Many of those working in small and rural water utilities worry that private companies will try to take over their systems. The National Rural Water Association (NRWA), which works closely with small systems by providing them with technical assistance and training, strongly opposes small utility privatization. “Customers and utilities oppose privatization because it takes control from the public and gives it to a private company,” says Rob Johnson, NRWA chief operating officer. “People lose control of their own utility.” Johnson says that when a private company takes over a utility, they have to make a profit somehow, and if a state public service or utility commission doesn’t allow an increase in rates, something must give.

“It’s either costs going up or services going down,” Johnson says. “If water rates don’t move up, then it must be taken up somewhere and that’s probably going to be services.” Once a system is taken over, private companies often have asked for rate increases ranging from 10 to 25 percent. Johnson thinks it is odd that EPA activiely encourages public to private ventures in small or rural systems. “It greatly amuses me that EPA is pushing for privatization,” he says. “When you consider the water systems that serve customers in metropolitan areas, it is possible for these larger systems to privatize due to population density, but it's ludicrus for small or rural systems to do so because they are spread out.”

Johnson says he is seeing a trend emerging in the water industry. “The American public wants their water systems back,” he says. “That’s the story we’re hearing now. Back in the early ‘90s, we saw a number of systems go private, but now there seems to be a reverse trend with the public buying their systems back. “Why do you think Atlanta has regained control of their system? “The assumption that private systems will bring more investment into a utility is just humorous,” Johnson says. “There is no reason that a private company can do as well as a public utility.”

Louis Jenney, senior director of government relations for the National Association of Water Companies (NAWC), a trade association that serves the private- and investor-owned water-utility industry, disagrees with some who say public is good and private is bad. He says there are benefits for a public utility when it becomes privatized. “The simple answer is private industry offers financial options and experience for local utilities. There have been utilities all across the country who have worked in partnership with private industry to solve their financial problems.”

One of the biggest criticisms of public to private ventures is the issue of rising water rates. Jenney says you must look deeper to understand the issue.

“What the customers of municipalities pay for their water is often hidden,” he says. “There is often extensive cross-subsidization between city or town general accounts and the water industry. What you are paying in your water bill doesn’t necessarily reflect how much you are really paying for it because you may also be subsidizing the utility through your various taxes. “Private utility rates are much more open and obvious,” Jenney says. “The customer knows exactly what they are paying for their water, whereas with the public utility, the cost is much more hidden. It’s really an unfair comparison between the two.”

Jenney says customers who oppose privatization don’t understand all the issues. “I think local folks are often given misleading information. The industry has opponents who are trying to limit local utilities’ choices,” he says. “Opponents want to keep the utility business in a very old-fashioned model. They are very reticent about anything new coming along. When people are opposing privatization, they are being misled about the potential benefits, challenges, and the downsides.”

Arguments for and Against Privatization

For Privatization:
• Helps government save money in management and service delivery for the public.
• Is necessary for speed implementation of certain programs.
• Provides high-quality services in some areas.
• Is necessary when government lacks expertise or personnel to carry out certain programs.
• Is useful because private providers use more innovative approaches and technology.
• Helps dissolve unnecessary government monopolies.
• Allows private providers to offer services more effectively due to flexibility and less red tape.
• Slows the growth of government or downsizes government.
• Introduces competition between government employees and private providers.
• Is an alternative to traditional ways of improving government productivity.

Against Privatization:
• Does not save government and taxpayer money.
• Often leads to significant rate increases for customers.
• Does not guarantee market competition and can result in “private monopolies.”
• Leads to corruption, including political patronage, kickbacks, and bribes.
• Results in policy makers and managers loosing control over privatized services and functions.
• Diminishes accountability of government officials.
• Leaves some to think that private gain and public good do not always correspond.
• Is not necessary because other productivity improvement approaches are available.
• Leads to privatized services and functions being compromised because of private providers’
profit motives.
• Lowers employee morale and brings fear of displacement to affected workers.
• Destabilizes economically marginal communities and neighborhoods.
Types of Privatization
Privatization can take many forms. Only the most absolute form transfers full ownership of water systems to the private sector. What is much more common is to leave public ownership of water resources unaffected and only transfer some operational responsibilities for water supply or wastewater management from public to private. Privatization also does not, or should not, relieve public officials from their responsibility for environmental protection, public health and safety, or monopoly oversight.

There is also a difference between public and private ownership of water assets. Private ownership involves transferring assets to a private utility. Public ownership involves keeping the assets in the public domain, but integrating the private sector in various utility operations and activities through contract. Public or private-sector employees can perform various functions.

As an example, Table 1 lists several functions that could be assigned to employees, ranging from fully public to fully private operations. The functions can also be performed privately in one geographic area and publicly in another, such as northern and southern halves of an area.

Table 1 - Water System Functions That Can be Privatized


1. Capital improvement planning and budgeting (including water conservation and wastewater reclamation issues)
2. Capital improvement financing
3. Capital improvement design
4. Capital improvement construction
5. Operation of facilities
6. Maintenance of facilities
7. Pricing decisions
8. Billing and revenue collection management
9. Managing payments to employees or contractors
10. Financial and risk management
11. Establishing, monitoring, and enforcing water quality and other service standards

Split Ownership is An Option
In this model, water system ownership may be split between private and public shareholders in a corporate utility. The public sector usually maintains majority ownership, while private ownership is often legally restricted, for example, to 20 percent or less of total shares. Such organizations typically have a corporate structure, a managing director to guide operations, and a board of directors with overall responsibility.
A main benefit of this model is that it combines two potentially conflicting goals of water supply—profit versus cost and service. Private owners seek to recover costs and maximize profits. Public owners may also seek to recover costs, but they are more likely to worry about affordability, water quality, equity of access, and service expansion.

Mixed Management
In some cases, public water utilities may give private entities responsibility for operation and maintenance activities, general services contracts, or control over management of leased facilities. The public maintains ownership. Such models do not usually address new facility financing or create better access to private capital markets. They do, however, bring in managerial and operational expertise that may not be available locally.

Leasing contracts may include revenue collection responsibilities as well as operation and maintenance. Such contracts may last for
10 to 15 years or more and arrangements sometimes allow the private company to share in the revenue increases gained from better management and bill collection. Service contracts range from smaller, one-time arrangements, such as meter installation or pipeline construction to longer-term comprehensive arrangements. Service contracts tend to be effective for equipment maintenance and repair, water and sewerage networks, and pumping stations; meter installation and maintenance; service payment collection; and data processing.

Concession Models
The full-concession model transfers operation and management responsibility of the entire water-supply system, along with most of the risk and financing responsibility, to the private sector. To recoup heavy initial investments, concessions to private companies are usually long-term, as long as 25 to 50 years. Technical and managerial expertise may be transferred to the local municipality and community over time as local employees gain experience.
Variations on full concessions include:
• build-operate-transfer,
• build-operate-train-transfer,
• build-own-operate-transfer,
• rehabilitate-operate-transfer, and
• build-operate-own.

These arrangements are “partial concessions” that give responsibilities to private companies, but only for a portion of the water-supply system. Companies may transfer ownership to the government at the end of the contract.
For both full and partial concessions, governments and companies find that responsibilities and risks must be clearly defined because such contracts are for lengthy periods, and ultimately govern how the concession will perform. Case-by-case concession contract writing has led to vastly different outcomes. The public benefits most when the government serves as a skillful contract negotiator, but this can’t always be guaranteed.

The True Cost of Water
Critics say privatization leads to higher costs for customers, which may often be true. Advocates say that private companies charge the true cost of water as opposed to public utilities, which often price water artificially lower because of taxpayer subsidies. “One of the most basic problems of public water systems is their practice of charging prices that are less than the real unit costs of providing water service,” writes David Haarmeyer in Privatization Infrastructure: Options for Municipal Water-Supply Systems. “Underpricing of municipal water services explains the inability of these systems to provide reliable water supplies and to be able to finance the investment needed to meet environmental standards. Moreover, underpricing by public water systems may explain why there are so few privately owned water systems since their (full-cost) rates are often uncompetitive with those of publicly owned facilities.”

Haarmeyer suggests that prices reflecting the full costs of water are important because they inform consumers about the true value of water and thus encourage efficient use. Yet Haarmeyer says, water supply decisions have not historically linked water demand, costing, and pricing.

In addition to not pricing water services to recover cost, publicly owned water systems generally have less incentive to adopt complex rate structures that reflect demand conditions. Economist Steve Hanke notes in Privatization and Development, that “private firms do have more price schedules [than publicly owned water systems] and that these private rate schedules more closely reflect cost and demand conditions than do public schedules.” Advocates also say that not charging the full cost of providing water services creates a problem of not having enough capital to comply with water quality mandates.

Utility Workers Oppose Privatization
Just mentioning the word privatization is enough to raise some water professionals’ blood pressure. The topic is heated, with many employees and customers alike opposed to any notion of a private company taking over their public system. Utility workers who face the risk of losing their jobs under private ownership are often the loudest critics. The American Federation of State, County, and Municipal Employees, a union that represents public workers, is strongly opposed to privatization and encourages its membership to fight local privatization efforts. “Privatization is fueled by an unholy alliance of politicians, private companies, and publicity-conscious conservative think tanks,” the groups notes on its Web site. “In the ultra-competitive, global economy, many companies are driven by the search for new markets and higher profits.

For public officials and political candidates, privatization can be an attractive ‘quick fix.’ Government officials can take credit for ‘shrinking government’ by cutting public payrolls. Never mind that the cost to provide the service simply shifts to a different budget line—or the customers. “They (government officials) seek to cut costs in the short-term by selecting companies that drive out unions and drive down wages and benefits. In the long run, the quality of these services suffers from the loss of skilled employees and the failure to attract qualified new workers. They think they can escape accountability when the quality and accessibility of public services decline and when costs to the public, through taxes and user fees, increase. They can also raise campaign funds from the private companies that receive lucrative government contracts or that take over public assets.”

Workers and their advocates aren’t the only groups pushing for scrutiny of privatized utilities. Water utility customers are raising questions about proposed privatization plans due to rising rates and poor service. Munici-palities are also closely questioning the contract deals they’re being offered by private companies.

Where do we go from here?
A recent report titled The New Economy of Water: the Risks and Benefits of Globalization and Privatization of Fresh Water cautions against blindly accepting privatization as the best means of producing and supplying our country’s water. The report says that the public’s understanding and oversight of deals is lacking.

“Water privatization must be subject to much stronger public scrutiny,” writes Dr. Peter H. Gleick, lead author and director of the Pacific Institute. “Part of the problem is that there are few formal guidelines and, in most cases, inadequate public oversight.

“We do not think the trend toward globalization and privatization of fresh water can be stopped, nor do we think it has. In some places and in some circumstances, letting private companies take responsibility for some aspects of water provision or management may help millions of poor people receive access to basic water services.”

The report says that the rush toward private markets hasn’t addressed some of the most important issues and concerns about water. Some of the consequences of privatization may be irreversible; thus they deserve special scrutiny and control.

So is privatization on the rise or on the decline as some suggest? The reality is that both are occurring. Faced with growing public displeasure, some public utilities that had gone private faced problems and chose to revert to public ownership and operation. On the other hand, private corporations are working harder than ever to buy out systems or establish management contracts. Your system could be next.
Numerous groups—for and against privatization—offer information about the subject. Contact them directly to learn more.

American Federation of State, County and Municipal Employees, AFL-CIO
1625 L Street, N.W.
Washington, DC 20036-5687
(202) 429-1000
www.afscme.org

National Association of Water Companies
1725 K Street, N.S., Suite 1212
Washington, DC 20006
www.nawc.org

National Rural Water Association
P.O. Box 1428
2915 South 13th Street
Duncan, OK 73543
(580) 252-0629
www.nrwa.org

Public Citizen
1600 20th St. NW
Washington, DC. 20009
(202) 588-1000
www.citizen.org/

Reason Public Policy Institute
3415 S. Sepulveda Blvd.,
Suite 400
Los Angeles, CA 90034
(310) 391-2245
www.rppi.org/

References:
American Federation of State, County, and Municipal Employees, AFL-CIO.
www.afscme.org/

Brubaker, Elizabeth. 1998. “Privatizing Water Supply and Sewage Treatment: How Far Should We Go?” Journal des Economistes et des Etudes Humaines.

Chi, Keon S. and Cindy Jasper. 1998. Private Practices: A Review of Privatization in State Government. Council of State Governments.

Gleick, Peter H., Gary Wolff, Elizabeth L. Chalecki, and Rachel Reyes. 2002, The New Economy of Water:The Risks and Benefits of Globalization and Privatization of Fresh Water. Pacific Institute.

Haarmeyer, David. 1992. “Privatizing Infrastructure: Options for Municipal Water-Supply Systems.” Privatization Watch. Reason Public Policy Institute.

Hanke, Steve H. 1987. Privatization and Development. ICS Press.

Hightower, Jim. 2002. “Stop the Corporate Takeover of our Water” Hightower Lowdown.

Johnson, Robin and Adrian Moore. 2001. Opening the Floodgates: Why Water Privatization Will Continue. Reason Public Policy Institute.

Luoma, Jon R. 2002. “The Price of Water.” Mother Jones.

National Research Council. 2002. Privatization of Water Services in the United States: An assessment of Issues and Experience.

Public Citizen. 2002. “Water for All.” www.citizen.org/cmep/Water/

U.S. Environmental Protection Agency. 2002. “EPA Releases Water Infrastructure Gap Analysis, Calls for National Forum with Stakeholders.” www.epa.gov/