Media
09/1/02

The Road Less Traveled, Until Now

A Look at the Benefits of Water Partnerships and How They're Shaping the Future of the American City

Public-private partnerships for water services in the United States began in 1972 in California. Embraced by local and national political leaders, such partnerships have developed into valued economic and customer service tools that cities are adopting with increasing frequency. This paper outlines the most frequently raised issues related to using private-sector companies in managing municipal water and wastewater systems, and it discusses the benefits of enlisting some of America's leading environmental services companies as allies in the fight to keep water sources and waterways safe for today's users and tomorrow's generations.
 

Table of Contents

  • History of Public-Private Partnerships
  • Benefits of Public-Private Partnerships
  • Concerns about Public-Private Partnerships
  • Financial 
    Are savings overstated?
    Municipalities' cost of borrowing
    Private companies' incentives to perform
    How savings are realized
    The profit motive versus public interest
    The role of managed competition
    The issue of corporate longevity and stability
  • Technical Service 
    Facility condition guarantees in contracts
    Municipal employee knowledge and experience
    Outside contractor dependency
  • Emotional 
    Lack of long record by public-private partnerships
    Monopoly and foreign ownership concerns
    Water is a public trust protected by government
    Municipal union tension with private sector
    Government accountability for public health
  • Environmental 
    Privatization and public health
    Impact of changes in regulatory framework
  • Conclusion
  • Works Cited
 

History of Public-Private Partnerships

America's move toward a more environmentally responsible water policy began with the passage of the Federal Water Pollution Control Act Amendments of 1972. Faced with incidents of polluted waterways, including images of fire on the polluted Cuyahoga River in Ohio, the nation's leaders resolved to address water system safety and protection. The Safe Drinking Water Act of 1974 and the Clean Water Act of 1977 strengthened the power of the then-newly created U.S. Environmental Protection Agency to ensure that the United States had the cleanest, safest water resources in the world. These EPA regulations and mandates fueled construction of new water and wastewater treatment plants in the 1970s. Funded largely by federal grants, new plants were constructed with the close cooperation of federal, state and local governments in conjunction with private-sector firms.

The year 1972 marked the country's first entrée into public-private partnerships. While communities previously engaged private firms to construct water and wastewater treatment plants or provide equipment or chemicals, a new relationship was pioneered by a small city near San Francisco.

Faced with odor problems, effluent discharges and bad publicity, the City of Burlingame joined with Veolia Water North America (then named Envirotech Operating Services) to provide full operations services for its 5.5-MGD (million gallons per day) wastewater treatment facility. The agreement marked the first time in U.S. history that the operational management of a publicly owned wastewater facility was transferred from a municipal government to a private company. After more than 30 years of operation and repeated contract renewals, the Burlingame partnership today represents the nation's longest-running water services partnership between the public and private sectors.

The environment governing public-private partnerships has changed considerably since 1972. After the Burlingame contract, cities began to enter into short-term management contracts. Fearing the loss of their tax-exempt status for their bonds, municipal officials limited contracts with private-sector firms to no longer than three years with two one-year extensions. Presidential Executive Orders issued in the 1990s by the Bush and Clinton administrations removed regulatory and legal barriers to public-private partnerships and, in fact, encouraged agencies to seek partnerships for water management. In addition, IRS Revenue Procedure 97-13 on qualified tax-exempt bonds remedied municipal officials' concerns over their tax-exempt status and allowed for 20-year contracts, which made practical and facilitated private investment in public infrastructure.

These regulations paved the way for greater private-sector involvement. Today, by most estimates, approximately five percent of U.S. municipal facilities are managed by public-private partnerships.

These partnerships are most easily described as a contractual partnering arrangement in which a public entity — a town, city, county, governmental board or related municipal entity — selects a private-sector company to operate, manage and support various water treatment facilities and systems. These agreements can also include meter reading, maintenance and replacement of distribution systems, customer service, billings and collections. While hundreds of companies provide equipment, engineering and specialty chemical services to municipalities, facility management has evolved into a broad and artful tool that includes the provision of Design-Build-Operate (DBO) agreements in which one company, or a team of companies, design, construct and then operate new water or wastewater assets at guaranteed performance levels and costs on behalf of a municipal entity.

Including both public-private partnerships (non-regulated markets) and investor-owned water utilities (regulated utility markets), it is commonly estimated that approximately 10 percent of the entire U.S. municipal water market is managed by private companies.

Public-private partnerships functioning within this "non-regulated" market are governed by a contract between the municipal entity and the private-sector firm, as well as by federal, state and local laws. Long-term public-private partnerships have been met by overwhelming approval in the United States and typically have been marked by improved compliance and financial savings ranging between 10 and 40 percent. In most cases, municipalities retain ownership of the water treatment assets and the private firm manages those assets.

Another small portion of the market is managed through investor-owned utilities in the "regulated" market in which a company actually owns assets and functions as a utility company. Two disadvantages are commonly cited with respect to the regulated investor-owned model including the high-capital intensity required by public companies that have to raise capital to actually purchase the public water infrastructure assets, and secondly, the resulting geographical monopoly that can be created by this form of asset ownership.

The third and more common municipal model is one in which the city operates and manages a community's water and wastewater system. Employees and professional managers alike are on a municipal payroll and, through various bureaucratic structures, report directly to a mayor or to a municipal supervisory board. To date, this model represents the more traditional approach.

With only a limited portion of the U.S. municipal market now under private-sector management, the United States has lagged far behind Europe. It is easily argued that public-private partnerships today represent what poet Robert Frost called a road "less traveled." Time is demonstrating this management mechanism as the best of both worlds with the public sector establishing policy, i.e., governing, and the private sector using core competencies in water technology and management methodologies to provide solutions. Meanwhile, leading companies worldwide continue to establish a track record for improving their clients' facilities, systems and services. They include CH2MHill's OMI, RWE's Thames Water, Suez's United Water, Tyco's Earth Tech and Veolia Water, to name a few.
 

Benefits of Public-Private Partnerships

Population growth, aging facilities, erratic weather patterns and increasingly stringent environmental regulations coupled with the federal initiatives previously cited have stimulated communities' interest in public-private partnerships. According to many public officials, water partnerships provide numerous benefits and innovative solutions that can meet a community's unique needs:
  • Cost savings in both infrastructure improvements and day-to-day operations.
  • Rate stability over the life of the contract that reduces the financial burden on ratepayers.
  • Guaranteed environmental compliance for increasingly stringent and continuously changing regulations.
  • Guaranteed services and costs through contractual performance measures.
  • Clean and safe water resources for the community, protecting health and stimulating economic growth because so much of the U.S. economy depends on water for its manufacturing processes.
  • The transfer of financial, operational and quality risks to the private operator.
  • Customized solutions, latest technologies and best water management practices from private-sector company experts.
  • Greater opportunities for professional growth and development for employees, as well as advanced technical training.
  • Innovative financing solutions offering more flexibility to the municipal customer.
  • Corporate partners for community programs and initiatives.
 

Concerns about Public-Private Partnerships

A small but vocal countercurrent flies in the face of these benefits, arguing that public-private partnerships over-promise and under-deliver. Certain camps — to date, special interests groups, select unions (many unions are engaged in partnership contracts), and a handful of academicians — argue that water partnerships can create more harm than good. Their arguments can primarily be broken down into four categories: financial, technical service, emotional and environmental issues. What follows is an examination of the major arguments put forth by such groups under each of these four spheres.


Financial Issues

Argument: Promised savings are overstated — there is no proof that anticipated savings are actually realized.
 
Response: Numerous public-private partnerships have consistently proven that rate stability and substantial savings are possible when the private sector manages municipal water and wastewater assets. Typical savings range from 10 to 40 percent.
 
Many municipalities offer examples of savings. The Tampa Bay Water Authority in Florida expects to save $85 million on a 15-year agreement to design, build and operate a new water treatment facility. Veolia Water North America has guaranteed these savings. Oklahoma City has saved an estimated $150 million to date on the private-sector management of its wastewater facilities. Honolulu's Board of Water Supply is saving millions (in the words of the city's director of environmental services, "tens of millions of dollars") on a high-technology water-reuse project. Examples of savings are numerous, regardless of size. Burlingame, Calif., is another excellent example of the possibilities.

Knowing figures for past and present operating budgets, as well as savings achieved to date, Burlingame city officials have repeatedly renewed that contract.
In some cases, municipalities select private-sector companies simply for the sake of ensuring their community's water quality, regardless of whether savings are achieved.

Argument: Municipalities can borrow money at cheaper rates. This is proof that the public sector can do the job at lower costs.
 
Response: It is true that municipalities can often secure financing at lower rates than corporations. However, any such borrowing typically impacts a municipality's bonding capacity, which is limited. Secondly, savings in financing to the city do not equate to savings in overall operations and infrastructure costs, which are typically far greater than the interest payment portion of a project. In addition, municipal entities can and do issue tax-exempt debt on capital improvements made by the private sector. In other words, the best of both worlds can be achieved with tax-exempt bonds and the efficiencies and savings created by companies on water projects.
 
Argument: Private-sector firms have no incentive to perform after winning the contract.
 
Response: Public-private contracts are written with strict performance criteria for cost, quality, compliance and customer service. They often have termination clauses that motivate private contractors to meet or exceed their obligations. In this regard, monitoring and oversight of contractual obligations is a de facto requirement. In addition, most companies argue that protecting their national reputations is far too important to allow performance to lapse. Veolia Water North America President Mike Stark writes, "Any company investing in its own long-term viability has greater and greater reason to impress its value upon the municipal customer as the company seeks to renew its operations management relationship at the end of the contract." Stark has argued that private firms have an economic incentive to perform at their best to prevent equipment failure or emergency repairs due to neglect because emergency repairs are always more expensive than preventive maintenance work. In addition, because the standards set forth in partnership contracts are demanding, any suggestion to the contrary implies that municipal managers are somehow incapable of negotiating agreements beneficial to their own community. Nothing could be further from the truth. By and large, today's contracts are well written and clearly define the obligations of both parties.
 
Argument: Companies only reduce costs through lay-offs and cutting corners to pad the bottom line.
 
Response: The loss of local jobs is often a concern foremost on the minds of city leaders considering a public-private
partnership for their water and wastewater assets. Companies typically retain the existing workforce, especially in order to take advantage of valuable local knowledge obtained by years of experience serving the community. Partnerships have opened up a wealth of opportunities for many workers in the form of technical training and prospects for advancement based on merit. It is ultimately up to a city's procurement rules to guide employee-related issues.
Cost savings are commonly achieved through the efficient maximization of a water company's core competencies, such as technical acumen or operations experience. A company's performance and efficiency gained from diverse operating and geological environments across the country can be shared with the new municipal customer to support the partnership. The private contractor's large client base allows it to make volume purchases at a lower cost that can be passed on to the city through an overall reduced operating expense. Investments in research and development, continuous process improvement and a host of other tools allow a firm to provide a complete solution and best value proposition to the city. During the life of these agreements, newly identified savings can be shared with the customer. For example, Veolia Water spends millions of dollars on research and development dedicated to water resource management. In short, the profit motive of the private-sector firm (how to get more with less) drives savings for the municipal client.

Argument: Private enterprise is based on principles of profit. Therefore, only governmental entities, which are not driven by profit, should manage water resources. Public money should stay in public hands.
 
Response: This argument implies that government should manage any profit-oriented enterprise. Such a political philosophy undermines the very foundation of our economy. The argument also slyly positions profit as wrong-minded and unnecessary while implying that profit derived from a public project is done so at the public's expense. Nothing could be further from the truth. First, profit would not exist without private-sector ingenuity and sweat equity. Second, and most important, the public is saving money through the private sector's participation. Simply put, without private-sector profit there are no public savings.
 
Are water services companies profiting by providing their services? Yes. Are consumers paying less under such a market structure? Yes! How then are consumers disadvantaged by private-sector profit when it is private-sector efficiency that is driving a lower price that would otherwise be impossible to achieve?

Most community's cost for water services and infrastructure projects are typically 10 to 40 percent less through a public-private partnership than through straight public-sector management.

Argument: When given the opportunity to compete, the government workforce often proves the most efficient because there is no profit.
 
Response: This argument raises two issues — motives over profit and the issue of managed competition, the idea that the public-sector workforce is more capable than the private sector when competing.
 
Occasionally when governments test the market for competitive bids, in-house employee groups also are given the opportunity to bid for the contract and compete against private firms. This model of public-private competition is sometimes referred to as "managed competition." Managed competition is typically stifled by the fact that employee groups cannot offer the same financial guarantees required of private firms, cannot assume operations and performance liabilities, cannot boast a strong balance sheet, nor finance the significant capital investments required by many projects. Employee groups often do not have the same depth of expertise and knowledge of private firms, which are more able to invest in personnel training and professional development programs.

A classic attack on water privatization typically points out how a particular municipality's experience was unsatisfactory. This is a "bad apples" analogy. Among the myriad U.S. and international facilities run by private-sector firms, there will always be a handful of municipalities unsatisfied with the results. The same criticism applies to municipally run facilities. When one compares the track record of both the public and private sectors, it is readily apparent the private sector drives savings, rate stability and efficiency while working to maintain compliance.

Private-sector employees are no smarter or more capable than public-sector employees. They simply operate within a different financial framework that offers a more comprehensive and flexible resource base. The secret to a successful partnership is in the clear definition of responsibilities and the framing of well conceived and executed contracts.

Argument: Corporations do not have the stability and longevity of municipalities.
 
Response: This is a common misperception. The world's two leading environmental service companies, Veolia Environment and Suez, have more than three centuries of experience between them. At $28.5 billion in annual revenues, Veolia Environment is in fact one of the world's largest corporations, on par with such companies as Microsoft and Dow Chemical.
 

Technical Service Issues

Argument: The government is left with a "bucket of bolts" at the end of the contract. Corporations will wash their hands of responsibility, leaving the government to pick up the pieces when a venture fails.
 
Response: Designing, operating and/or improving a municipal water or wastewater facility or system is a major investment for any community. As with any investment, municipalities want to ensure a fair return and long-term benefits. Consequently, public-private partnership contracts can be written so that municipal customers receive a guarantee that ensures a facility is in the same or better condition (less normal wear and tear) at the end of the contract as when the partnership began. Periodical client "check-ups" help ensure the proper functioning of these assets. Maintaining assets is in the best interest for the private contractor, since the company is interested in renewing the contract and protecting its reputation. Finally, a public-sector client can always contractually control and/or increase capital spending levels to ensure a plant's operational condition.
 
Argument: A new company won't understand "our" system like we do. Only the employees have the necessary knowledge to make things work.
 
Response: As a standard practice, municipal employees are readily welcomed into private-sector companies. Water companies collectively believe that a community is best served when local employees are involved both in the management transition and ongoing operations of a facility. Companies typically seek to preserve the workforce and its knowledge because of its inherent value.
 
While acknowledging the value of local experience, one should also note that technological innovation typically stems from companies specializing in water management. Because of their diverse experience and research capabilities, companies are often already equipped and well versed in situations a municipality may experience for the first time.

Actually, debate over technical issues is rarely witnessed and often avoided by critics of public-private partnerships because companies (engineering firms, operations companies and specialty manufacturers) are the innovators and drivers of technology and operations improvements.

Argument: There is an increased dependency on outside contractors as in-house expertise is reduced.
 
Response : This argument can be easily turned on its head. New management practices and treatment techniques actually increase in-house expertise. It is the private-sector firm that can dedicate highly skilled personnel to ensure efficient operation and compliance. A private firm also brings with it a wealth of expertise gained from managing numerous facilities over many years, as well as continuous investments in research and employee training. The formerly public employees, now part of the private company, have access to the latest training programs that will enable them to provide the highest quality service to the community in which they live and serve.
 

Environmental Issues

Argument: Privatization raises public health and environmental concerns.
 
Response: The private sector often assumes full responsibility for compliance and agrees to pay fines in the event of negligence. In cases where a city is facing a consent decree, administrative order, or other compliance issues, private-sector water experts can offer solutions to bring a facility into compliance with environmental requirements. If the city is experiencing violations because of needed capital improvements and maintenance costs that exceed budgetary allocations, private firms can step in and make capital investments under the conditions of the service contract. To underscore private-sector competency, EPA pilot studies are often conducted in conjunction with water companies.
 
Private-sector companies regularly win national, regional and state awards for environmental compliance and operational excellence. Competition for these awards has become part of the private-sector pedigree.

Argument: Over time, there may be an entirely different regulatory and economic environment than when a long-term contract was initially signed.
 
Response: Environmental regulations and standards are constantly changing and creating new challenges for local governments. Private partners can help the municipality stay up-to-date on all applicable regulations. The private sector invests heavily in research and development to provide technical solutions that are cost-effective and meet continually changing and increasingly stringent environmental regulations. Language specifying the attainment of environmental compliance standards and/or changes in environmental law during the contract term is always stated in public-private agreements.
 
Conclusion
Legitimate, well-intentioned concerns are raised by various groups about the potential issues that may arise in public-private partnerships. However, clearly spelled-out contractual obligations for both parties will ensure that a public-private partnership be a resounding success. Former EPA Administrator Christine Todd Whitman acknowledged in congressional testimony in 2002 that meeting the nation's water investment needs will require strong political commitment as well as public-private partnerships.

Like the path taken in the Robert Frost poem, "The Road Not Taken," public-private partnerships offer tremendous promise.
Two roads diverged in a wood, and I — 
I took the one less traveled by, 
And that has made all the difference.
 
Many hundreds of cities, towns and municipal water authorities have already taken that road and benefited from service gains, compliance improvements and financial savings. Given the successful transition and experiences of these communities, the public-private partnership path is being taken by many new communities each day. 

This paper was written by Scott Edwards, VP communications of Veolia Water North America, scott.edwards@veoliawaterna.com.
 

Works Cited