Reinventing Water and Wastewater Systems: Global Lessons for Improving Water Management / Edition 1 available in Hardcover
Reinventing Water and Wastewater Systems: Global Lessons for Improving Water Management / Edition 1
- ISBN-10:
- 047106422X
- ISBN-13:
- 9780471064220
- Pub. Date:
- 07/25/2002
- Publisher:
- Wiley
Reinventing Water and Wastewater Systems: Global Lessons for Improving Water Management / Edition 1
Hardcover
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Product Details
| ISBN-13: | 9780471064220 |
|---|---|
| Publisher: | Wiley |
| Publication date: | 07/25/2002 |
| Pages: | 496 |
| Product dimensions: | 6.28(w) x 9.41(h) x 1.10(d) |
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Reinventing Water and Wastewater Systems
Global Lessons for Improving Water ManagementJohn Wiley & Sons
Copyright © 2002 John Wiley & Sons, Inc.All right reserved.
ISBN: 0-471-06422-X
Chapter One
An Overview of Private Sector Participation in the Global and US Water and Wastewater SectorDavid Haarmeyer and Debra G. Coy
1. INTRODUCTION: RISKS OVERSHADOW COMMERCIAL OPPORTUNITIES
The global water and wastewater sector has the distinction of being the infrastructure sector with greatest promise-steady long-term cash flows from what many describe as the "last monopoly utility business"-and the sector that has shown the least amount of progress in terms of attracting private investment. Year after year, figures are released indicating that both developing and developed countries require tremendous capital investment to meet the basic needs of their populations. Estimates from the World Bank put the capital "needs" for developing countries at $60 billion over the next ten years. In the United States, the Environmental Protection Agency (EPA) estimates that $275 billion is "needed" for investment in water and wastewater services over the next 20 years. And in the European Community, the figure is $220 billion.
Yet despite the tremendous needs, the amount of private capital flowing to the sector has been limited, especially when compared to other infrastructure sectors. As indicated in Figure 1.1,investment in water and sanitation has trailed transport, energy, and telecom investment throughout the 1990s during the emerging markets infrastructure revolution. Of the nearly $580 billion in total infrastructure investment directed to these sectors during this time, water and wastewater represented only $30 billion, or about 5%. Also noteworthy is the water industry's slow metamorpohsis to introduce competition and deregulate potential competitive segments of the sector's value chain, changes already made in the gas, electric, and telecom industries. As a result of this restructuring, consumers in these industries are experiencing significant benefits in terms of lower prices, a broader array of services, and greater innovation.
Why does the flow of private capital to the water and wastewater sector worldwide appear constrained relative to the tremendous needs for investment in new facilities, rehabilitation of leaking pipes, and system upgrades? The following five characteristics of the sector and their associated risks are a helpful starting place to answering this question:
Significant Interaction with Government. Health, environmental, and monopoly concerns have meant that governments, often at multiple levels, have tended to be heavily involved in regulating water and wastewater services. This level of interaction with the government exposes the sector to significant regulatory and political uncertainty and risk.
Local and Small Project Size. Water supply and wastewater systems tend to be small and local, given the relatively low value of the service and high capital cost required for long-distance transmission. Consequently, financiers are relatively less attracted to the sector's fragmented structure, which, compared to gas, electric, and telecom, severely limits its ability to generate efficiencies from regional integration.
Political Risks. As sunk, highly specific, and non-redeployable investments, private investors, especially in developing countries with limited independent regulatory and judicial frameworks, are often exposed to government opportunism and expropriation. These forms of political as well as regulatory risks are costly and difficult to cover.
Currency Risk. Water and wastewater projects in countries with less developed capital markets depend on foreign capital for investment. The mismatch between the foreign currency and the domestic currency that consumers use to pay their bills means that international lenders are exposed to the risk that they may not receive back the full value of their investment because of fluctuations in the domestic currency.
Inadequate Tariffs. Given the high level of capital investment and the history of government-subsidized services, full-cost pricing of water and wastewater service has yet to take hold fully in many markets, even in the United States. The public perception in many countries is that water is "free," which means that it remains broadly underpriced, which discourages private investment, or forces investors to rely on subsidies to obtain sufficiently attractive rates of return on invested capital.
Taken together, these unique features of the water industry indicate that, despite its potentially attractive cash profile in terms of offering investors steady long-term revenue streams, the sector as it is presently structured and regulated has a relatively unattractive risk profile. Indeed, to adequately address these risks-especially political and regulatory risks-most privately financed water and wastewater projects in developing countries have tended to require some form of political risk insurance or guarantee, and/or the participation of multilateral organizations, (such as the World Bank and the Inter-American Development Bank (Haarmeyer and Mody, 1997). Absent fundamental restructuring to better separate risks and open up the sector to more competition and more accurate market pricing, the monopoly integrated structure of the industry is likely to continue to discourage private capital flows, and thus restrict the improvements and innovations that it tends to bring.
As indicated in the following summaries on international and US developments, over the past several years there have been a number of noteworthy advances, as well as setbacks, in the water and wastewater sector's ability to attract private capital and initiative. In some cases, it is clear that the accumulated experience that the public and private sector has in designing workable contracts and organizing competition can successfully overcome noncommercial risks. In the case of the United Kingdom, the combination of significant regulatory pressures, high capital investment needs, and highly transparent capital market participation is encouraging the industry to go beyond its present organizational and financial structure to consider alternatives such as splitting asset ownership from operations and injecting competition into the sector. Taken together, there are substantial lessons to be learned by governments and private participants in how to better mitigate risks and structure new organizations that properly reward investors and, at the same time, provide the incentive to increase the efficiency and affordability of water and wastewater services.
2. MAJOR INTERNATIONAL DEVELOPMENTS: THE TREND IN PRIVATE PARTICIPATION EXPANDS TO NEW COUNTRIES
2.1 England and Wales
More than a decade after the United Kingdom privatized its water sector by floating 10 English and Welsh water and sewerage companies, its experiment remains controversial as ever. In response to tight price controls and a push to inject competition into the sector, water companies and regulators are fundamentally rethinking the organization of their industry.
In the early years postprivatization, the high returns available through a combination of pricing and efficiencies enabled a number of UK private water companies to build up substantial nonregulated international businesses that today are successfully competing and spreading technology and management practices around the world. The international water business is attractive, both from the perspective of the size of the business opportunities it represents and from the fact that it allows for more growth than the domestic market.
By nearly every measure, there have been substantial improvements in water and wastewater quality, making the United Kingdom one of the leaders in meeting the European Union (EU) Directives. These improvements have been the result of significant capital investment within the allowed price-cap structure. Since then, however, the Office of Water Services (Ofwat), the industry regulator, has dramatically squeezed prices and returns. In its third price review, which determined prices for 2000-2005, Ofwat stipulated average cuts to consumer bills of 12.4%, driving projected returns down to about cost-of-capital levels. In response, water companies announced cuts in dividends and workforce, and equity investors fled the sector.
A more far-reaching response to regulatory pressures has been for water companies to fundamentally rethink their company's financial and organizational structure. In 2000, Kelda, the renamed holding company for Yorkshire Water, proposed the most novel approach, which involves spinning the water and wastewater assets into a nonprofit mutual company financed completely by debt. Equity investors would be left with Kelda's unregulated business, which would be transformed into a contract operation service company, and thus no longer exposed to undue regulatory risk. Ofwat objected to the scheme on the grounds that a customer-owned company with a nonprofit structure would provide weak investment incentives and make it difficult for Ofwat to take enforcement actions.
In 2001, Ofwat did give the go-ahead to a similarly structured deal involving Glas Cymru, the renamed Welsh Water. The acquisition of the regulated water company is funded through a $2.7 billion securitization and, as a result of the new capital structure, the utility's cost of capital fell to just over 4%, compared with 6.5% industry threshold set by the regulator (Metcalfe, 2001). Two key differences in the deals are: 1) there was strong political support in the Welsh Assembly for community ownership of the water business, which serves all of Wales, and 2) Glas Cymru created a company that is legally liable for the nonprofit company's debt, rather than customers holding this obligation. To reduce risks for lenders and provide discipline for efficient operations, two four-year contracts were put out to competition: one for operations and the other for customer billing. While it is not clear that this model can be replicated, it does offer an attractive way of financing assets with heavily regulated revenue streams and fairly predictable capital expenditures, while at the same time injecting competition into operations.
Another innovative approach to restructuring the UK water industry has involved the promotion of cross-boundary competition and common carriage. With an Ofwat-approved "inset appointment," water and sewerage companies are able to compete to supply large customers in each other's territory. Similar to the gas industry practice, common carriage in the water sector requires water companies to make their pipes available to competitors. Although proposed many years earlier, in March 2000, the UK Competition Act 1998 was implemented, which gives Ofwat and the Office of Fair Trading legal powers to remove barriers to competition in the water sector and to promote common carriage. In addition to cost savings and better service to customers, the success of these approaches to advancing competition may also serve to minimize the need for regulation.
2.2 Europe
The integration of the European Union (EU), the significant capital demands to meet EU environmental directives, and liberalization are together increasing the attractiveness of private sector participation in the water and wastewater sector. A recent Standard & Poors (S&P) report expects that more than 250 billion Euros (about US $220 billion) will be required to meet EU environmental standards across Europe by 2005 (Standard & Poors, 2001). While the United Kingdom is the only country to privatize its water industry fully, the French and Spanish governments are relatively supportive of private sector participation compared to other European governments.
In France, under long-term contract, about 75% of water distribution, and 45% of wastewater treatment is provided by private companies. In Spain, almost 45% of the water supply is provided by private companies under long-term concession contracts. In Italy, the 1994 Galli Law is the main driver for making the sector more attractive to private investment by facilitating consolidation of the thousands of water utilities. As a result, international private companies, such as Severn Trent of the United Kingdom, have entered the market. In 1999, Portugal awarded its first major water and wastewater concession with a project financing structure. The Santa Maria da Feira Municipality granted Indaqua Feira a 35-year concession to operate and extend the town and outlying districts' water and wastewater systems (Swann, 2000).
The Netherlands and Germany have been less open to private sector participation, claiming, without substantiation, that involvement of private sector will compromise water quality. However, Nuon NV, the Netherlands' largest utility, is pushing for at least partial privatization within the next two years, in order to help fund its global expansion plans in the water and energy sectors. Germany, with a more mixed system than the Netherlands, has made some modest progress in opening up its industry to private investment. In 2000, Berlin sold a 49% stake in Berlin Water to a consortium that included the German energy and industrial conglomerate RWE and Vivendi.
In Eastern Europe, capital needs are significantly greater, as infrastructure is both less developed and less well maintained. An important obstacle for attracting investment is the absence of supportive and comprehensive legal and regulatory frameworks. Nevertheless, the goal of joining the EU is driving countries to raise their environmental standards in line with the EU, and thus look for near-term solutions to modernize their infrastructure. One of the strategies for making the greatest progress has been privatization.
In 1999, the municipality of Sofia in Bulgaria signed a 25-year concession for water and wastewater services with International Water. The concession serves 1.2 million customers and includes investment of $150 million for upgrade and expansion over 15 years, which is expected to enable the municipality to meet EU standards. The concession is noteworthy not only in that it is Bulgaria's first major municipal infrastructure project that is privately financed, but that the project includes no municipal subsidies or state guarantees (Temple, 2000). The European Bank for Reconstruction and Development (EBRD) is providing about $42 million in debt and equity to the project.
The concession generated substantial competition, with eight international water companies seeking prequalification.
Continues...
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