Gleanings on Water and Wastewater Privatization Summit

by: Daniel Kucera

The Third Annual Water Industry Summit presented a detailed focus on current issues in the privatization of water and wastewater systems. Sponsored by Strategic Research Institute and held April 30 and May 1, 1996 in Washington, DC, the conference offered the views and advice of leading industry, financial and legal professionals.

One of the overriding themes was that successful privatization requires positive attitude adjustments. Public ownership of water and wastewater systems is not an inherent governmental function. The current trend to privatization arises from a perception that investor-owned utility systems can provide efficient service at reasonable rates, and that privatization will enable local governments to increase tax revenues and free capital for other infrastructure projects. Both municipalities and privatizers must be open to the various alternative approaches to privatization, ranging from outright sale of assets through concessions, leases, management contracts, and special incremental projects. For example, privatization could involve a portion of a system, such as construction and operation of a new water supply treatment plant.

Similarly, privatizers must be cautious as well as flexible. For instance, one speaker discussed potential impacts of privatization on a municipal labor force and how adverse effects could be reduced. In particular, he reviewed different methods to alleviate worker concerns, ranging from hiring the city workers outright to such mechanisms as tax free earnings for new outside jobs or grants to start new businesses.

Attendees were apprised of recent privatization projects, such as Franklin, Ohio and Indianapolis, Indiana, and new legislative proposals under the Clean Water Act and Safe Drinking Water Act.

Several speakers discussed the potential restrictions or impediments to privatization which may arise from the interplay between outstanding public financings and federal tax law. In particular, attention was given to the possible "change of use" consequences which could render taxable outstanding municipal bond issues. - Such potential consequences generally limit privatization operations agreements to five-year terms unless "remedial" action can be taken to defease the bonds. Revised IRS regulations, pending for approval for some time, could relieve some of these consequences.

Along the same lines, if municipal facilities were constructed with grant funds, questions can arise as to whether those grants must be returned in the event of a sale. A 1992 Presidential Executive Order alleviates some concern, but the issue remains to cause either an obstacle to privatization which must be resolved in each case, or at least a source of delay.

Several speakers addressed opportunities in international privatization, as well as risks. The Department of Commerce has been active in promoting exports of U.S. environmental technologies and in generally assisting U.S. companies seeking foreign privatizations.

One speaker focused on the elements of negotiating an "optimal" privatization contract, providing a working model for such contracts. For example, he reviewed components of a service contract, such as performance guarantees, with damages or penalties for non-performance. However, he also pointed out that there may not be guarantees against changes in law and necessary future capital improvements.

Another speaker identified various legal issues which can arise in asset acquisition privatizations. For example, will the privatizer become a regulated public utility by purchasing a water or wastewater system?

He also pointed out the importance of valuation of a municipal system, creating an inventory and identifying the original cost, depreciation and contributions in aid of construction. This information is needed to not only establish the purchase price the privatizer will be willing to pay, but also to identify future ratemaking implications for the privatizer.

The speaker also touched on such issues as possible statutory limitations on the authority of a local government to sell a utility system, and legal responsibility for environmental non-compliance of a system.

The editor of Water Online discussed how this Internet service can be of assistance to firms interested in developments in the privatization area and in the ownership and operation of water and wastewater utilities generally.

One speaker presented a table of risk issues to be allocated, between the municipality and the privatizer. These risks include: 0 & M budget risk, environmental compliance and penalties, inflation, change-in-law, construction cost, financing rate, benefits and pension rights, technological innovation and capital availability.

Another speaker explained how "project finance" can be used for a "dual function" project such as a power generation, desalination facility. He pointed out salient features of the water sale agreement, such as "take-or-pay" for the fixed carrying costs and payment for delivered water linked to variable costs and price escalators. He also discussed features of the construction contract, such as performance guarantees. Finally, he reviewed project risk factors and how the financing package may be developed.

Another speaker discussed how a privatization arrangement may be monitored and evaluated through an asset management plan and performance benchmarking. Models for benchmarking have been developed in the United Kingdom, and studies currently are underway in the United States.

The conference concluded with a look forward to the year 2000 in the water industry. It was predicted that compliance costs and capital requirements will increase, but that opportunities for government assistance would not. Therefore, it can be expected that municipalities will need to continue to gain knowledge as to the benefits of privatization, and that privatization will itself significantly increase. Again, successful privatization will result from good attitude!

Dan Kucera is a partner with the Chicago law firm of Chapman and Cutler, specializing in public utilities, water and wastewater and environmental law. Tel: (312) 845-3757; Fax: (312) 701-2361; email: