Chapter 4 Restructuring

Summary

The U.S., the UK,¹ and French water systems are discussed below, with a view to the possibility of the U.S. adopting some sort of similar water system. It is, however, unlikely that the U.S. will fully privatize along UK lines. The U.S. already has taken a step toward outsourcing operating and maintenance functions. It is unlikely that there will be a major sale of publicly owned water and wastewater assets in the U.S. Rather, greater reliance will be placed on public-private sector cooperation, with ownership remaining with the public. The French use of competitive leasing does suggest a possible direction for U.S. privatization. However, the solution will be uniquely American, because of the highly fragmented nature of the U.S. water and wastewater industry. In the U.S. there is no centralized oversight body, such as in England, Wales and France, that sets national water standards for rate-making and asset transfers.

USA

Tax Structure

The Tax Reform Act (TRA) of 1986 discouraged privatization of water and wastewater facilities. The 1986 TRA required that an investor owned utility, which acquired a utility property from a developer, pass the tax advantages back to the developer. This disadvantage was erased by the Small Business Job Protection Act of 1996. However, in the interim, investor owned utilities, saw this TRA as giving non-tax-paying municipalities an additional comparative advantage in production costs, in that municipalities do not pay taxes.²

Moreover, in 1993, the IRS started to require that issuers of tax-exempt bonds comply with the private activity bond restrictions for the full term of the bonds. This measure meant that a municipality, in entering a long-term private operation contract for a public facility funded by tax exempt bonds, could endanger the “safe harbor” of the bondholders. Thereby the bondholders’ tax-exempt income status might be revoked and the revocation could be imposed back to the date the bonds were first issued.³

However, on January 10, 1997, the IRS released final private activity bond regulations and revenue procedures that will permit local governments to sign long-term contracts with private operators and not have to give up benefits of tax-exempt financing. With the tax rules more amenable to privatization, it is believed that the cost of privatizing will be reduced. The new rules for privatizing now permit:

• 10-year management contracts if at least 80 percent of the compensation is a period fixed fee.

• 15-year contracts if at least 95 percent of the compensation is a is a periodic fixed fee.⁴

Michael Rapaport remarks on this new scheme: “Further, while the IRS did not go as far as some commentators suggested, in the case of ‘public utility property,’ the rules permit contracts with terms of up to 20 years if at least 80% of the annual compensation is a periodic fixed fee (and if 20 years does not exceed 80% of the expected useful life of the property).”⁵

California

Proposition 218

A wild card has appeared on the U.S. water scene regarding potential privatization. In November 1996, Proposition 218 was approved as a constitutional initiative by the California electorate. Proposition 218 restricts rates which are imposed “as an incident of property ownership.” There is no consensus as to what “as an incident of property ownership” means. This issue is important and will probably be decided by the legislature or courts. However, the drafters of Proposition 218 assert that the term refers to most fees commonly collected on monthly bills to property owners, such as water, garbage services, sewer service, and storm water management. In effect, if implemented as many understand it, municipal rate increases for such services would be subject to voter approvalnot on a one person-one vote system, but rather with the number of votes based on the extent of property ownership.⁶

A fuller understanding of Proposition 218 is available from a December 18, 1996 Legislative Analysts Office (LAO) report entitled “Understanding Proposition 218.” The assessment is that new taxes are most at risk. The report may be summarized as follows:

• “Local governments could suffer as much as a five percent annual decrease in the $50 billion that they collect annually from taxes, assessments, and fees. This could mean a potential loss of $2.5 billion annually.

• “Jurisdictions that are highly dependent on fees and/or assessments, such as some special districts, may lose more than the estimated 5 percent.

• “Proposition 218 requires the immediate reduction or elimination of certain existing fees and assessments. The assessments most likely to be eliminated are for fire protection, ambulance service, lighting and landscaping, and parks and recreation. These actions may cause a reduction of at least $100 million in 1997-98.

• “Proposition 218 requires governments to place certain existing assessments and taxes before the voters. Depending on the outcome of these elections, local governments may lose additional revenue, potentially exceeding $100 million.

• “Many local governments, especially counties, have limited ability to reduce costs because many of the services they provide are mandated by state law. Consequently, even small revenue losses associated with Proposition 218 could trigger large reductions in discretionary programs.

• “Many local governments will have to pay assessments imposed by other governmental entities, further reducing their revenue base.

• “Local governments will probably seek assistance from state and federal governments in order to mitigate the impact of Proposition 218. These attempts will produce few results given the fiscal and political landscapes in Sacramento and Washington, DC.

• “Limitations on property-based taxes, assessments, and fees will cause local governments to turn to ‘non-property’ sources of revenues. Local governments’ ability to rely on this type of revenue will depend on how broadly the legislature or the courts define the term ‘non-property.’”⁷

The current law requires that most new taxes levied by local governments in California must receive voter approval. The state Constitution requires that special taxes, defined as those levied by local governments to fund particular activities or programs, be approved by a two-thirds vote of the electorate. In 1986, voters approved Proposition 62, a statutory initiative requiring a majority vote by voters regarding new general taxes. A number of legal battles followed. In 1995, the state Supreme Court affirmed Proposition 62. However, it remains unclear if this proposition applies to the state’s 89 charter cities, since the California Constitution grants charter authority over municipal affairs. However, Proposition 218, as a Constitutional initiative, may extend the arm of Proposition 62 to all California cities.

The nationwide ramifications recall California’s landmark Proposition 13 (a so- called “tax payer revolt” measure), which significantly constrained the property tax base. Similar approaches were adopted in many other parts of the U.S. Some analysts have written that other states with self-regulating municipalities could again follow California’s lead and that such an electoral constraint on rate increases could provide the impetus for additional privatization.

Two-Thirds Electoral Approval Required for Asset Transfer⁸

Another constraint on privatization in California is that the law requires a two-thirds vote of approval by the electorate for an asset transfer. California Water discovered this obstacle when they tried to acquire the City of Hawthorne’s water system. Hawthorne wished to sell its water system to raise funds capital to fund police and fire services. California Water leased the facility for 15 years for a one-time payment of $6.5 million dollars to the city. During this period, California water will not have to pay Hawthorne for capital improvements. It is estimated that California Water will receive annual revenues of $4 million from operating this facility. The City of Hawthorne will receive an annual payment of $100,000 from California Water during the term of the contract.⁹

Current Trends in the U.S.

The U.S. water and wastewater systems remain largely public. However, increasingly water and wastewater utilities are turning toward contract operations. Currently, according to a Special Report issued in the January 1997 issue of PWFinancing, over 1,000 U.S. water and wastewater facilities employ some form of contract operations and maintenance management services. The article identifies the types of contract operations available:¹⁰

• Design, building, and operation of new facility upgrades.

• Design, building, operation, and financing the facility with private capital.

• Sale or lease of public plants, pipes, pumps and other facilities to an operator who then provides contract O&M and capital replacement under a long-term contract.

• Expanded contract O&M, including management functions such as billing and collection, meter installation and reading, customer services, monitoring and sampling for pre-treatment programs, site engineering and pipeline maintenance.

Adrian Moore¹¹ of The Reason Foundation, notes there are some critical difference between BOT (build-operate-transfer), BOOT (build-own-operate-transfer), and BOO (build-own-operate) schemes. Moore delineates these differences:

BOT is Build-Operate-Transfer. Meaning the private firm will build the facility, ownership transfers to the public sector on completion (though technically, ownership lays in the public hands from the start), and then the firm operates the privately built and publicly owned facility. BOOT is a build-own-operate-transfer. The private firm builds the facility, then at some point specified by law or contract, transfers ownership of the facility to the government. Usually various degrees of regulatory control remain in place while the private firm owns and operates the facility (e.g. rate controls, etc.). BOO is pure private sector.¹²

In Competition for City Services: Has the Time Arrived? Privatization in Illinois Municipalities (December 1996), Robin A. Johnson and Norman Walzer note that 18.3 percent of Illinois municipalities stated that they planned to increase privatization and few noted any decrease in this activity. These authors also note that 40 percent of Illinois larger cities (5000 inhabitants or more) plan to increase contracting in the future because such cities offer more services than smaller communities.

In their survey of Illinois municipalities, Johnson and Walzer note: “Most municipalities compare costs between public and private services. Larger cities are more likely to compare costs than smaller towns. While approximately one-fourth of respondents said privatization did not result in cost savings, 54.6 percent reported cost savings in some instances and 17.9 percent achieved savings in most cases.”

The authors report on the impact on the labor force by stating: “Employees were not adversely affected by privatization to the degree many opponents claim. Nearly two-thirds of reporting cities say there was no effect on employees due to contracting and only 3.0 percent say employees were laid off. Implementing strategies designed to ease employee concerns is the key to privatization.¹³

Forms of Privatization

Privatization can be in the form of asset acquisition or contract operations. As noted by Greg Orrill in Washington Analysis, a publication of Hong Kong Shanghai Bank, “[f]or decades private companies—notably American Water— have been buying the assets of existing systems. But increasingly, private companies—notably United Water—are simply contracting to take over management of municipally owned water systems. Both industry leaders have used both methods.”¹⁴ Donald L. Correll, CEO and president of United Water, according to The New York Times article of August 26, notes “[t]here are many municipalities that have well run water systems that may not need the assistance of the private sector, and have adequate access to capital and an efficient work force.” Economic theory suggests that if all factors minimize shirking, encourage production so that marginal cost equals marginal value, and are paid according to their marginal value in use, then the ownership construct is unimportant.

U.S. Foreign Business Relationships

The transatlantic links between U.S. and European water companies are summarized in Table 4-1.

Table 4-1. Transatlantic Links

The Competitors in the U.S. Water/Wastewater Markets

HKSB Washington Analysis, cited above, identifies the key players in the emerging field of U.S. competitive water. Table 4-2 is reproduced from the BSBC Analysis report of December 1996.

Table 4-2. Key Players in the U.S. Competitive Water Industry

Restructuring—the Electricity Analogue

In a 1993 report to EPRI, Brian Browne raised the possibility that U.S. water companies could benefit from an economic alliance with electric utilities. Browne suggested that U.S. electric utilities with large depreciation accounts, declining core market, similar business operations, correlative data base management, and experience with regulatory authorities could benefit from acquisition of water and wastewater companies. This had already occurred when Minnesota Power and Northern Indiana Public Service Company (NIPSCO) acquired, respectively, Southern States Utilities (Florida Water Systems) and Indianapolis Water. More and more analysts (Barons, Hart’s Energy Markets, etc.) are now coming to a similar conclusion.

Steve Hall of the 420-member Association of California Water Agencies (ACWA) does not see a parallel between the restructuring of the electric industry and of the water industry. The California electricity industry will be effectively restructured as of January 1, 1998. What Hall and others see is the opportunity for water companies, which are high consumers of electricity, to acquire power from competitive marginal suppliers. Lower power costs, if realized, should mitigate public budgetary constraints and defer rate increases. In California, this deferral of rate increases might not be inconsequential, with the specter of Proposition 218.

The deregulation of infrastructure around the world has challenged the concept underpinning of rate and monopoly regulation—the concept of the natural monopoly. Browne believes that such a challenge was inevitable in a period of fast technological growth, which has resulted in lower information and transaction costs.¹⁵

Restructuring of the water industry might take a completely different form than that of electricity. For one thing, there will probably be a movement away from master metering toward full implantation of individual metering. For another thing, not all water sold need be of the same quality. A qualitative difference could lead to a market for individual incoming water filtration and outgoing sewerage purification. In essence, private users would be charged for the type water they consume and the level of pollution that they discharge. For yet another thing, increasing industry consolidation—of functions and supply—will appear. As Richard Nemee notes in Hart’s Energy: “Already the [water] industry has consolidated to the point that about 3,000 water systems serve 75 percent of the U.S. population and 600 of those serve more than 50 percent of the population.”¹⁶

The National Competition Policy (NCP) of Australia (discussed in more detail in Chapter 5) provides interesting insights into the pros and cons associated with privatization. Privatization advocates in Australia point with enthusiasm to the A$ 1,550 million received for sale of Victoria’s united energy system. This amount, they point out, was well in excess of prior sale projections. The Australian Labor Party notes that most of this sale was financed with borrowed money. They believe that this high debt/equity ratio could impact the stability of the industry.

Further, they believe it could negatively impact the financial markets and generate a long-term need for electricity providers to set higher rates in order to cover their initial capital investment. Parenthetically, as of this writing, electric rates have decreased in Victoria. Additionally, much of the debt burden is carried by non-Australian financial institutions and there have been no business failures.

Another fear of the Australian Labor Party is that the various buyers of Victoria’s electric system will consolidate into large monopolies with power to set monopolistic prices. With open entry and interstate electric trading, this fear, however, may provide groundless.

The Australian Labor Party of New South Wales, fearing the sale of the state’s electricity system for an estimated $22 billion, believe that one debt is being retired for the loss of a significant revenue earner in terms of the power system. They also believe that sufficient concern will not be paid to the environmental trade-offs between profitability and the ambient quality of the state’s ecological system. They cite the Sacramento Municipal Utility District as presenting a viable government alternative. “A model for aggressive investment in solar energy is SMUD, the Sacramento Municipal Utility district, a publicly owned U.S. utility.” ¹⁷

United Kingdom (UK)

In 1989, the public water companies of Wales and England privatized. Scottish water companies remain in the public sector. However, other ownership forms for Scotland are currently being considered, including privatization and the formation of cooperatives. The 1989 privatization in the UK was analogous to the fall of communism—it happened quickly. Many water analysts feel the jury is still out as to the efficacy of the UK system. In 1996, in the House of Commons, it was estimated,¹⁸ that the investment on retrofitting all UK water systems (including customers) from lead piping to less environmentally hazardous systems was $20 billion.

Background

Environment

The UK rivers are generally in good shape.¹⁹ Most of the serious pollution in the UK comes from farm runoff. Seventeen percent of UK sewerage is dumped into the ocean. Twenty-four percent of UK beaches report water contamination below EC standards. The aggregate Water and Waste Pollution statistics are:

Table 4-3. UK Water and Wastewater Statistics

History of the Water Industry in England and Wales

Prior to 1974, local water boards and local authorities provided wastewater services. In 1974, ten regional water authorities were created and an effort was made to integrate water supply with river basin management. The same water authorities also took on wastewater responsibilities. In 1989, privatization of the UK water industry occurred. 10 regional water/wastewater companies were established, as well as 21 smaller, water-only companies. The pollution control function of the prior water authorities was transferred to a new government agency: the National Rivers Authority. The New South Wales (Australia) Socialists critically characterizes this process of privatization as follows:

Privatization of the water industry in the UK in 1989 was the culmination of a period of internal restructuring which focused on cost cutting. The result was the deterioration of the infrastructure, an increase in pollution incidents and a drastic deterioration in water quality and service standards. The government’s method of dealing with the problems it had created was privatization. Investment targets were agreed to but have not been met, while prices have risen and service quality has fallen.²⁰

The following financing mechanism was used to transfer ownership of water/wastewater facilities from public to private control. The UK government took over all district debts and created companies. Shares in these companies were sold to institutions and individuals for the U.S. (equivalent) $3.66/ share.²¹ Licenses were granted to these private companies for 25 years. Company failure to comply with established criteria, as delineated in the privatization provisions, however, might result in a government appointed administrator being appointed to run the organization. Such a prospect would supposedly negatively impact shareholder value and theoretically act as an incentive for effective privatization.

The license is an instrument of appointment by the UK Secretary of State and specifies conditions relating to charges, codes of practice for customers, preparation of asset management plans and provision of information for Director General of Water Services (DG). The Secretary of State must give a company 10 years’ notice prior to terminating their license.

The UK legal structure calls for the license to be held by a core operating service company with clearly defined customer responsibilities. This core company is owned by a Public Limited Company (Plc), the British equivalent of an American corporation whose shares are all publicly traded. This structure allows the holding company to expand into other commercial enterprises, without any effect on the core utility business. Provisions are made, at the time of privatization, to prevent cross subsidization between the core business and non-core activities. Apparently, at the time of privatization, the legislators envisioned this type of commercial expansion by the newly privatized UK water companies.

Regulatory Structure

In contrast to the highly centralized British regulatory system, the U.S. has a highly complex state-by-state system. In the U.S., federal (EPA), state (EPA), and local authorities (ordinances) administer environmental controls. However, municipal/district water companies generally have full authority to set their own prices.²² Private water companies in the U.S. generally must seek regulatory approval for price (rate) changes. The U.S. water distribution system is dominated by municipal/local water companies. Only 15 percent of U.S. water is supplied by private investor owned companies.²³

The UK regulatory system has a rate-making oversight body called OFWAT (Office of Water Services). The responsibilities of OFWAT are:

Primary Functions

• To ensure that water and wastewater functions are effectively carried out throughout England and Wales.

• To ensure that UK companies can properly finance their functions.

Secondary Functions

• To promote economic efficiency by water and wastewater companies.

• To facilitate competition.

The allowable rate increases are a function²⁴ of capital charges, operating and maintaining new and existing plants, and dividends paid to investors as related to capital invested. This formula is supposed to balance investor risks with consumer needs. However, there is a price ceiling in place. This ceiling is set at inflation plus an additional factor allowed by OFWAT, as averaged over a ten year period. ²⁵

Regulatory Tools (OFWAT)

• The license (control over entry and exit)

• Monitoring reports

• Interim determinations—Cost pass-through

• Periodic review of price limits²⁶

Statistics of Main UK Water Systems²⁷

Companies

Table 4-4 summarizes the major UK water sector companies by name, area served, water customers, and wastewater customer.

Table 4-4. Statistics of Main UK Water Systems²⁸

Finances

Table 4-5 delineates sales, operating costs, operating profits, and profits after taxes for the entire UK water sector. These data may be compared with individual U.S. companies, but not the entire U.S. water industry because of the mixture of public-private ownership formats in the U.S.

Table 4-5. Financial Performance UK Water Companies ($million)²⁹

Performance Attributes

The Water Services Company (trade association) of England and Wales has identified the following key environmental and qualitative attributes of UK water:

• 99.5% of drinking water samples meet the stringent European and British quality standards.

• 96% of all wastewater treatment works in England and Wales meet discharge consents set by the Environmental Agency (EA).

• 89% of 433 designated bathing waters in England and Wales meet European bathing quality standards.

• 91% of rivers and canals in England and Wales are designated by EA as of good or fair quality.

• 992,000 dry tonnes³⁰ of sewerage sludge are processed every year: 52 percent is recycled to land, 10 percent is disposed of as landfill, 17 percent to sea (which will cease in 1998), 8 percent is incinerated and 13 percent goes to other outlets.

• Since 1989, the new water service companies have invested £17 billion. A further £12 billion is planned for investment up to the end of the century, and another £10 billion for the five years thereafter. In total, £39 billion of capital investment will be spent in the first 15 years after privatization. This compares with £16 billion in the 15 years before privatization.

According to this industry group, the money spent in recent years has been spread across every part of the industry:

• 33% on wastewater treatment—improving the quality of discharges from treatment works to rivers, estuaries and the sea.

• 16% on sewerage—mains, sewers, storm overflows and sea outfalls.

• 23% on water distribution—mains, water towers and pumping stations.

• 25% on water quality—to comply with stringent health requirements as well as improving the aspects that every customer appreciates: color, taste and smell.

• 3% on water resources—reservoirs, boreholes etc.

As a result of this investment:

• 166 new service reservoirs have been commissioned.

• Nearly 900,000 communications pipes connecting water mains to customers'¹ pipes have been replaced. 700,000 of those replaced were made of lead.

• 18,000 km of water mains have been relined or renewed, with another 9,000 km added to the system.

• 34 new outfalls have been commissioned and 127 old ones have been abandoned.

• More than 400 new wastewater treatment works have been commissioned and nearly 400 old ones have been taken out of service.

However, in contrast to the rosy statistics set forth above, the Australian socialists (left members of New South Wales Labor Party) note:

The basic statistics of the water companies since privatization are not pleasant: disconnection because customers cannot pay their bills are up 50%, charges up 65%, profits up 125%, chairmen’s pay up 130%. Also up are river pollution and the water companies’ contributions to Tory party funds.³¹

Household Bills

The average UK household bills are delineated below for the period 1996-1997. As noted below, unmetered bills are higher than metered bills.

(Note: weighted industry average)

Customer Service

According to industry commentators, today the UK water industry is characterized by:

• Codes of practice.

• Guaranteed standards of service providing compensation for customers experiencing below-standard service.

• Special needs registers for elderly and disabled customers.

• A range of payment options to help customers budget.

• Free or low-cost phone services for customers.

• Customer service committees associated with the regulator rather than the companies.

Major Assets

Reservoirs 311
Boreholes 958
River abstractions 229
Service reservoirs/water towers 3,776
Water treatment works 1,124
Total length of water mains (km) 244,578
Sewage treatment works 6,065
Total length of sewers (km) 280,493
Storm overflows 15,464
Outfalls 610

Statistical Facts

• A person uses an average of 160 liters per day.

• Only 3% of domestic water use is for drinking and cooking.

• Toilet flushing accounts for around a third of domestic consumption.

• A shower uses 35 liters but a power shower can use as much as 80 liters.

• A washing machine can use up 80 liters per cycle; a dishwasher can use 22 liters.

• A sprinkler can use over 1,000 liters per hour—enough to fill 12 baths.

• The average cost of a liter of tap water is only 0.07p.

• The average household bill is less than 60p per day for both water and sewerage services.

• Customers use significantly more water today than they did 30 years ago. In some areas, demand has doubled.

• For every £ the customer pays, twice as much investment is required as was needed 10 years ago.

Case Study—Anglian Water, United Kingdom³²

Overview

Anglian Water Services (AWS) is one of ten privatized water companies serving Wales and England. AWS is part of the Anglian Water Group (AW), valued at $2.3 billion³³ on the UK Stock Exchange. AWS is geographically the largest water service company in the UK, providing drinking water to over 4 million people and wastewater services to 5 million. It operates in the southeast part of the UK, which is considered the driest part of England. AWS supplies 303,000,000 gallons of water daily, operates 155 water treatment plants, maintains 20,000 miles of water and sewer pipes, and maintains over 1,000 wastewater treatment facilities. The total investments since 1989 by AWS have amounted to $2.44 billion.

Anglian Water International (AWI) is also part of AW and generated $0.1 billion revenues in 1994. AWI specializes in:

• Concession services to water and wastewater utilities.

• Operation and maintenance of water and wastewater systems.

• The design, manufacture and installation of a wide range of water industry and proprietary products.

• Technological and process solution.

Anglian Water Service, the core operating company of Anglian Water, invested $1.8 billion from April 1990 through March 1994. In 1989, the annual per residence charge was $238. By 1994, it was $378. This increase in charges amounted to an annual upswing of approximately 10 percent.³⁴

Subsidiaries

Anglian Water divides its subsidiary companies into three “types”:

1. Operations Companies

2. Process Companies

3. Product Companies

The names of their subsidiaries are:

(1) Operations Companies

• Anglian Water International Ltd.—UK

• Anglian Water International—Lund, Sweden

• Anglian Water (Far East) SDN BHD—Kuala Lumpur, Malaysia

• American-Anglian Environmental Technologies—NJ, USA

• Anglian Water Pacific Pty. Ltd.—NSW, Australia

• AWI—Wellington, New Zealand

(2) Process Companies

• Purac AB—Lund, Sweden

• Purac GMBH—Merseburg, Germany

• Purac/Armton—Bronby, Denmark

• Purac Water—Poland

• Purac China—Beijing, China

• Purac Rosewater—UK

• Purac Engineering, Inc.—NJ, USA

(3) Product Companies

• Nordic Water Products AB—Sweden

• ARS (Aquafine Engineering Services) Ltd.—UK

• Fluid Systems Corporation Inc.—San Diego, USA

Rate Structure of Anglian Water

Anglian Water’s domestic rate structure is compared with the U.S. rate structure in Table 4-6. These are aggregate figures and illustrate that a slightly higher water rate is in effect in the UK, at least in the Anglian service area. The rate structure used for the U.S. was the “average” rate structure for all U.S. water districts. The U.S. water data were divided into high, average, and low.

Table 4-6. Rate Comparison of Anglian and U.S. Average³⁵

Revenue Sources for Anglian Water

Table 4-7 summarizes in pounds sterling and USD the sources by class and geographic location the revenue centers for Anglian.

Table 4-7. Anglian Revenues Millions of Pounds Sterling per Year

International Currency Fluctuations

Figure 4-1 summarizes the currency fluctuations associated with international trading with specific regard to four currencies: USD, Australian dollar, New Zealand dollar, and the French franc. This table does not include all market exchanges that Anglian is involved in, as noted in the section above. It does, however, indicate the complexities associated with international business. Hedging contracts are used to shield expected profits, but a downside of such an approach is the possibility of profit appreciation associated with favorable currency appreciation.

Figure 4-1. Annual Exchange Rate Variations 1985-Present

AWI—A Case Study of a Subsidiary (Moa Point—Wellington, New Zealand)

In March 1995, AWI contracted to design, build, and operate an extensive new wastewater treatment system to serve 300,000 people in Wellington, New Zealand’s capital city.

The contract involves two elements:

(1) Designing and building two sewage treatment plants, a sludge de-watering plant, and a 1.125-mile sea outfall.

(2) Agreeing to operate the plant for 21 years following completion of construction.

The construction will cost $78.7 million. Anglian Water will receive $3.93 million a year, at constant 1995 prices, for operating the plant.³⁶

France

Economic and Environmental Statistics³⁷

Table 4-8 presents a summary of the French environmental system. This section of Chapter 4 presents a review of the French water and wastewater system and an analysis of some of the major private companies involved in this field.

Table 4-8. French Environmental System

Water Services Structure

In France, approximately 78 percent of water services are provided by the private sector. Private companies in France operate under four basic types of arrangements, which depend on the individual district or municipal contract.

• Concession—A private company builds and finances a distribution network, which it then operates. The rates are negotiated with the relevant public authority. Escalation or indexation clauses are written into most contracts. The distribution company is responsible for O&M and specified construction extensions during the contract tenure. Concessions run from twenty to thirty years. At the end of the contract, the water facility reverts back to the public authority.

• Franchise (“Affermage”)—In this case, the facility is initially financed by the private operator who in turn is paid by the local authority to run the plant. O&M costs and agreed-on capital improvements are made by the private company.

• Management (“Gerance”)—Under this arrangement, the public authority appoints the private company to operate and maintain the network. The public authority maintains ownership of the facility. Payment to the private operator is based on volume, number of hook-ups, and work performed.

• Operating Contract (“Regie interessé”)—The private operator makes no financial contribution to construction, extension or renovation. Payment from the relevant authority varies according to volume and plant productivity.

The theoretical differences blur in practice. For example, with the two main methods of concessions and leasing (affermage), the private contractor is in charge of the day-to-day functions of the facility. In France the private operator is rarely the owner of the water system, in contrast to the UK and the U.S.

Market Share

Current domestic market share for water distribution in France is:

• Municipalities 25%

• Sault Cise 7%

• Suez Lyonnaise des Eaux 25%

• Generale des Eaux 43%

Current domestic market share for wastewater treatment in France is:

• Municipalities 59%

• Sault Cise 5%

• Suez Lyonnaise des Eaux 11%

• Generale des Eaux 25%

Flag Fall—Initiation Fee

Concessionaire rights are obtained in France by payment to the local authority for a right-to-operate permit. The initiation fees paid by General des Eaux and Suez Lyonnaise des Eaux for new acquisitions, were, at 5.5 Francs/Dollar:

Table 4-9. Initiation Fees

In 1995, this practice was abolished by statute (the “Loi Bernier”), in order to decrease the incentive for additional privatization without competitive bidding. It was thought that the “flag fall” scheme grandfathered in existing relationships and was anti-competitive.³⁸ Public tender offers are now obligatory for all increases over 5 percent and the duration of contracts has been reduced to twenty years. The French system is decentralized, unlike the OFWAT in the United Kingdom. The U.S. water/wastewater system, as noted above is decentralized and is mainly concerned with rate-making. U.S. investor-owned utilities are not subject to renegotiation of contract terms, but under certain egregious conditions an investor-owned utility may be condemned (de-privatized).

The Hong Kong Shanghai Bank/James Capel Europe’s Utilities Report notes, in regard to rate changes:

Private operators have lost popularity as public perception has become swayed by the seemingly incontrovertible evidence that customers supplied via private operators pay more than those supplied directly by municipalities. 17 out of the 20 most expensively-charged towns in France are supplied by private companies while the two large towns still paying less francs per liter and are supplied by municipality-owned utilities…

Global Rankings—Water and Wastewater Companies

The two major French companies—Generale Des Eaux and Lynonnaise des Eaux rank one and two in the world in terms of (1) market capitalization and (2) water services revenues. However, the UK has the two largest wastewater companies.

France and the UK dominate the international market because of their extensive domestic privatization of water and wastewater facilities. The global ranking of water and wastewater companies by national origin is shown below. The two largest French companies generate global revenues in excess of seven times the aggregate of the top 100 U.S. investor owned water companies.

Table 4-10. Global Rankings of Water and Wastewater Companies³⁹

Table 4-11 indicates the percent of national populations with wastewater treatment services. Approximately 95 percent of Western Europe has access to piped water.

Table 4-11. EC and USA Percent of Populations with Wastewater Treatment

Tables 4-12 and 4-13, expressed in French francs, quantify the past, present, and projected external revenue streams by Generale des Eaux and Suez Lyonnaise des Eaux from 1994 to 2000.⁴⁰

Table 4-12. General des Eaux and Suez Lyonnaise des Eaux.
Water Distribution Worldwide Earnings Estimates 1994-2000 (outside of France)

Table 4-13 quantifies the earnings of the two largest French water companies that are from domestic sales of water. All numbers are expressed in French francs.

Table 4-13. Water Distribution Domestic French Earnings Estimates 1994-2000
(inside of France)

Table 4-14 summarizes the total revenues, foreign and domestic, by both General des Eaux and Suez Lyonnaise des Eaux. These numbers are expressed in $USD at a 5.5 franc per USD exchange rate. However, the average exchange rate for each year is shown on this table along with the exchange rate dispersion factor emanating from the static 5.5FF/USD$1 used in the calculations. Exchange rate movements are important in conducting international business, but their exact impact, on the margin, in comparing world wide and domestic sales is not known explicitly.

Table 4-14. Total Revenues ($USD)

Table 4-15 aggregates total sales for both major French water companies and compares them with the combined sales of the largest 96 U.S. investor-owned water utilities. Many of the U.S. water companies are subsidiaries of larger holding companies. However, only 15-20 percent of U.S. water services are supplied by investor-owned utilities. On this table, a ratio of total revenues of the two largest French companies to total revenues of the combined 96 largest U.S. investor-owned utilities is presented. This ratio would be lower, however, if non-domestic French sales were excluded. Again, a constant FF/$USD ratio is assumed. However, the annual exchange rates—past and forecast—are presented.

U.S. sales were forecast by extrapolating, from historical observation, U.S. investor owned sales. With increasing privatization, the margin of error in these sales figures could be off by a large factor. Exchange rate variations were assumed based on current economic conditions. However, to guard against error, the 5.5 factor was used for all calculations, with the exchange rate dispersion shown to impute analytical variations.

Table 4-15. Total Revenues Two Largest French Companies to Total Revenues of Largest U.S. Investor-owned Water Utilities

Forecast Assumption: France—James Capel Europe: Utilities, Jan. 1996—U.S. Extrapolated Historical
Exchange Ratios—DSC—Annual

Table 4-16. International Customer Base Generale des Eaux and Suez Lyonnaise des Eaux

James Capel Report January 1996

Table 4-17. General des Eaux and Suez Lyonnaise des Eaux UK Involvement

($USD 5.5FF/USD)

James Capel Report January 1996

Table 4-18. French Subsidiaries in the U.S.

(FF5.5/$USD1)

Rate Increase—Rate Tax

Approximately half of all rates collected in France are forwarded to an environmental entity, Fonds National d’Adduction d’Eau, for the preservation of French rivers. In 1994, Generale des Eaux paid 54.2 percent of its collected revenues, while Suez Lyonnaise des Eaux paid 61.4 percent. The EU directive toward higher wastewater standards has significantly impacted the overall rate structure for French water services. Wastewater costs have risen on average over 12 percent a year, while water costs have risen approximately 5 percent a year. “Rate rebellion” surfaces from time to time. The imposition of higher qualitative standards in conjunction with a tax have a dual impact on the rate structure.

Foreign Investments by French Water Companies

The argument could be made that these taxes and higher environmental standards act as an inducement for French companies to seek overseas profit relief. For example, in 1935, when Texas passed the Connally Hot Oil Act on state oil production, U.S. firms did intensify their search for foreign oil, especially in the Arabian Peninsula.

Case Study—Suez Lyonnaise des Eaux Group

Suez Lyonnaise is involved in numerous commercial activities in France and around the world. They include:

• Water Services, Holding Company

• Water Treatment (see Case Study—Degremont)

• Waste Management

• Energy Technologies

• Mortuary Services

• Construction—Public Works

• Road Building

• Property Development

• Concessionary Operations

• Offshore

• Engineering

• Industrial Installation and Maintenance

• Electrical Contracting

• Groupe Dumez

Case Study—Sydney Water, Lyonnaise—Public Private Partnerships—Australian Water Services⁴¹

In 1993, Sydney Water⁴² and Australian Water Services (AWS) signed a contract to build-own-operate (BOO) the Prospect Water filtration plant. This plant, with an initial capacity of 780 mgd (3,000 ml/d),⁴³ will be one of the largest in the world. The $200 million capital expenditure contract makes AWS responsible for building, owning and operating the Prospect Filtration Plant for 25 years.

The consortium making up AWS comprises P&O Australia and Lend-Lease Corporation of Australia. P&O Australia specializes in maritime transportation and various industrial service activities. Lend-Lease Corporation of Australia performs construction and project management through its subsidiary, Civil and Civic. Also, Lend-Lease is active in the financial services industry via its relationship with MLC Insurance Company and Westpac. Eighty percent of the capital was raised through financial intermediaries and twenty percent was provided by the partners.

Seventeen international groups expressed interest in the project. Seven actually made presentations to Sydney Water. Only five companies were short-listed. Compagnie Generale des Eaux of France and Bechtel/American Water Works Company of the USA were serious contenders.

Case Study—Degremont (“The Group”)—Subsidiary of Suez Lyonnaise des Eaux Group⁴⁴

Degremont is an international engineering group specializing in the design, construction and operation of water treatment plants.

Degremont is a subsidiary of the Suez Lyonnaise des Eaux Group. Degremont employs approximately 3,300 people, more than 60 percent of whom work outside of France. Since it was established in 1939, Degremont has had a strong international presence. Today, it has a global network comprising 33 subsidiaries and 17 offices or representatives in over seventy countries. To date, the Group has equipped more than 25,000 facilities in some 65 capital cities. Locations of the most recent projects include Paris, Budapest, Bucharest, Beijing and Buenos Aires. Degremont Group is the world ‘s largest water treatment group.

Municipal Water

Degremont designs and builds production plants and facilities to treat the wastewater produced by local communities of any size, from the smallest town to the largest city, e.g., Bordeaux in France, Rostock in Germany, Grafham in Britain and Lima in Peru.

Industrial Water

Degremont designs and builds plants to produce process water or to treat the wastewater produced by a wide variety of industrial sectors: petrochemicals, food, pharmaceuticals, paper, etc.

Post-development Services

The Degremont Group also supplies a range of service activities, such as plant operation and an after-sales service covering assistance in plant operation and the sale of spare parts. Degremont is currently operating 40 facilities in France.

Water Conditioning—Chemical

Degremont is among the top European leaders in water conditioning, i.e., the sale and manufacture of chemicals to treat water. Through specialized subsidiaries, Degremont has developed a strong European network and is expanding its business around the world. Degremont has an expertise covering boiler and cooling systems, wastewater, paper indating and process industries.

Research and Development

For more than 55 years research and development studies have been the focus of constant effort. The Group generates 90 percent of sales from its own processes and techniques, a situation that makes it unique in this sector. Maximizing the Group’s potential for developing processes and products requires a multi-disciplinary approach to research. This is the function of the Degremont Research Center, which also works in liaison with the Suez Lyonnaise des Eaux Group (the International Center of Water and the Environmental Research) and with several universities in France and other countries.

Sales

In 1994, Degremont sales were $920 million. Sixty percent of sales were generated outside of France. Fifteen percent of sales occurred in Asia, which is Degremont’s fastest growing market. Degremont’s net profits in 1974 were $27.8 million, up 14.2 percent from the previous year.