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Annual Privatization Report 2005 - Water/Wastewater

January 1, 2005

Water/Wastewater


In early 2003 the city of Atlanta canceled its contract with United Water and took back water system operations. During the past year, many people have weighed in on the question of "What went wrong?" Although much can be learned from considering this question, we first must think clearly about two issues central to any privatization effort—performance and cost.

The city terminated United's contract for poor performance, but how did the firm's performance compare to the city's? While far from perfect, United's performance was significantly better—and much cheaper—than what the city had been providing for years. In just a short time, United was rehabilitating the water system and completing more repairs than were ever completed under city operation.

Critics also claimed United failed to save the city money. A city audit that found millions in savings claimed this wasn't really savings at all, since the money was "subsidizing other government functions." Before privatization the city spent approximately $40 million on municipal water operations. United received a service fee of approximately $21.5 million, amounting to a difference of $18.5 million. Only very creative accounting practices can overlook the cost savings. Moreover, United had no control over how the city manages its money and if it decides to divert savings elsewhere.


Learning from Atlanta

Public officials can improve future privatizations by examining what happened—or what failed to happen—in Atlanta:


Communication is essential.

A lack of understanding or agreement about performance expectations can lead to disputes and even termination. Establishing a trust relationship requires structuring the right risks, rewards, benefits and opportunities early in the contract negotiation stage. Also, the more that the expectations of the contract are based on measurable outcomes and outputs (costs, quality, reliability), rather than inputs (like work levels, hours, personnel, etc.), the less subjective everyone's assessment will be, and the less likely conflicts will arise.

Expectations and definitions need to be clearly established and understood by both parties. Open and consistent communication both before and during the contract period will help eliminate ambiguities. Both sides must commit to their due diligence, which should be agreed upon and confirmed with data. Additionally, both parties must have a realistic understanding of the condition of the infrastructure.

Communication during the contract period is just as crucial. The first half is really about management and oversight. Few would disagree that accountability is important. A contract is only as strong as the monitoring, reporting and direct oversight that are built into it. Periodic reporting and monitoring are standard in privatization contracts. The higher the risk and uncertainty, the stronger these requirements should be.

How the two parties speak about each other—especially in the media—is also important. Over the last few months of the contract, Atlanta Mayor Shirley Franklin painted herself into a corner leaving her with little room to maneuver even though performance was improving.


Contracts should develop appropriate long-term business models.

Atlanta was the first city to take advantage of new legislation that allowed for long-term contracts. This new territory provoked some missteps. The contractors attempted to take the existing operations and maintenance model (typically three to five-year contracts on individual plants) and simply extend them, both in terms of scope and length. The industry has since recognized that it isn't healthy to simply extend a boilerplate approach, and is now readjusting its approach to long-term contracting.


Contracts should be value-based.

Thus the contract criteria should not only address cost, but performance measures to ensure system integrity. Very low-bid contracts may be too cheap to ensure quality, and cost-plus contracts that don't specify the price up front but let the contractor add on as needed provide little incentive for contractors to hold down their costs.


Most privatizations succeed.

Over 90 percent of cities that have privatized do not de-privatize. With the dire status of our nation's water and wastewater infrastructure, privatization will continue to be an important policy tool. Both the Environmental Protection Agency and Government Accountability Office recognize privatization's ability to improve services, meet tougher environmental standards and lower costs.


Watering the West: The Status Quo Versus Water Pricing

It has often been said that the West faces a perpetual water crisis. But is it because water is always in short supply, or could it be because there is too much cheap water? Government-subsidized water and crops allow farmers to grow rice, cotton, alfalfa and other water-hungry crops that suck up 75 percent of raw water supplies. Contrary to popular opinion, water is priced so low that about 90 percent of it goes to irrigating urban greenscapes with only about 10 percent needed for the essentials of living—drinking, cooking, washing, and industrial uses. The water crisis in California is not a misfortune of nature or the failings of the market—it is a social and political creation.

A potential solution may have bubbled to the surface during California's recent electricity crisis. When policymakers ineptly tried to deregulate electricity, water agencies briefly followed suit—only to abandon such efforts when they saw what a mess politicians made of electricity deregulation (See How to Keep the Lights On, Oct. 2003). Politicians got cold feet at the notion of privatizing water, but maybe they should have at least considered "price-a-tizing" the system.

Because the cost of wholesale water is socialized and thus underpriced, consumers may exploit it for "wasteful" uses such as lawns, golf courses, gardens, and non-native vegetation. Newer command-and-control water conservation policies that seek to solve the problem by drought landscaping (xeriscaping) get more to the core of the ongoing urban water crisis. But without an economic structure, xeriscaping is bound to offer mere drops in the big regional water policy mud puddle. As with electric power, the most promising solution to the long-term water crisis in California is full-cost pricing.


How the System Operates

The government industrial water system at the wholesale level is comprised of a backbone of massive aqueducts, reservoirs, pipelines, and pumping and treatment plants that draw and filter water from snowpack-fed rivers, lakes, and deltas. Urbanization and corporate agriculture in the western United States depend on this huge water hydraulic system. Most of this water infrastructure was put into place under Works-Progress Administration Programs in the Depression Era. Water supply at the local level is comprised of ground water and/or water purchased from wholesale government water suppliers.

Water is handled by a dizzying array of both small and large agencies, districts, departments, private regulated companies, mutual water companies, and agricultural water-stock cooperatives. At the bottom of the cascade of water entities is the small mutual water company that may serve only a neighborhood (e.g. Rubio Canyon) or a small city (e.g., Sierra Madre) at a price of say $50 per acre-foot. This compares to government-supplied "manufactured" water that may be purchased for around $500 per acre-foot, a ten-fold price difference! (An acre-foot supplies about two families for one year.)

At the after-market level in Southern California, water is recaptured, retreated, and recharged into groundwater basins. Urban storm water is controlled in flood channels, catch basins, and settlement basins to avert floods and replenish local aquifers. Wastewater is recycled through sewer plants and reclamation facilities. In many cases all that municipal water departments do is serve as a mere distributor of water purchased from government wholesalers. In other cases, such as the city of Los Angeles, the water department may hold a monopoly as a wholesaler, retailer, and recycler.


Water is Free, But Getting It Isn't

Like air, water is a free natural good, but the cost to dam, pump, treat, and deliver it is what reflects its cost to the consumer. For example, the cost to pump water from Parker Dam on the Colorado River through the Colorado River Aqueduct mostly reflects the huge pumping costs needed to lift the water across the mountains of the Mojave Desert to a point east of Palm Springs where it can flow by gravity into Southern California.

Ironically, the Coachella and All American Canals also take water from the Colorado River at a spot south of Parker Dam for agricultural irrigation purposes and transport it by gravity flow to almost the same destination as the Colorado River Aqueduct east of Palm Springs, only without the huge pumping costs! Ideally, water conveyance systems should follow gravity flow engineering. Instead water is pumped over mountain chains at enormous cost mainly for political reasons. This proves the popular dictum in water economics that "water flows uphill toward money."


Transforming Water and Electricity

Water and electric power are reciprocals of one another. Hydroelectric plants generate power. In turn, power lifts water over mountain chains. Without huge pumping plants that run on electric power, the California Aqueduct could not pump water over the Tehachapi Mountains nor could the Colorado River Aqueduct transport water over the mountains of the Mojave Desert.

During the California Energy Crisis of 2000-01, the huge spike in electricity costs amounted to nearly $500,000 in pumping costs per peak hour extra for Southern California water wholesalers. However, this was entirely offset by the hydropower credits generated from shipping nearly double the annual allotment of water through the California Aqueduct to Southern California during that same period. If this had not occurred California would probably have suffered through an energy crisis of greater proportions. In other words, Northern California relies on sending raw water to Southern California in order to generate cheap wholesale hydroelectric power for its own needs. Both electricity and water may find the greatest hope for reform in the same concept—full-cost pricing.


Enter Pricing

Full-cost pricing, or congestion pricing, involves a host of measures including lifeline rate pricing and submetering apartments like electricity. Lifeline rates are where the charge for an amount of water service considered to support the essentials of living (sanitary drinking water) is kept low, but much higher charges are levied on "luxury" water consumption beyond that threshold amount (swimming pools). At the very least we know that when prices rise, quantity demanded falls and vice versa. The Federal Congressional Budget Office estimates that combined water and sewer bills only average a half percent of income in this nation. Curiously, however, submetering is deemed "selling" water and is subject to the full requirements of the Safe Drinking Water Act.

Some price discrimination already occurs in water policy, but it is not market-based. Urban users typically subsidize the cost of water for agricultural producers, which results in cheap retail prices of agricultural products subsidized through taxes. This blurs the line between public and private systems and thus hides the true price.


Enter Politics

But is full-cost water pricing too risky for public policymakers to consider? Or does the conventional subsidized system result in exploitation and waste of an under-priced natural asset?

The history of California is replete with water policy failures such as the voter rejection of the proposed Peripheral Canal to bring water from the Sacramento Delta to Southern California, the Arizona vs. California Supreme Court case diverting Colorado River Water from Southern California to Arizona, Colorado, and Nevada, and the more recent reclaiming of Owens Lake water from Los Angeles by environmental lawsuit. Recent Southern California water policy efforts to divert political water allocations from farmers, from the Bay Delta, and from the upstream urban users of the Colorado River in Denver, Phoenix, and Las Vegas are equally bound to fail in the long run because they externalize the problem and depend upon shifting political currents. The present supply of Southern California water is a diminishing asset as it is being politically "diced" by ever-growing urban populations in surrounding states and by growing jurisdictions within the state. California is projected to run out of "low-cost" water by 2030. What should policymakers do—wait until this tipping point arrives?

Continuing to depend on political solutions for water policies is like depending on luck—it will eventually run out. Successful privatization of retail water will depend not merely on privatizing municipal water agencies, but on full-cost demand pricing. If water were continuously priced at retail prices to reflect demand and, thus, peak and off-peak prices, then there would be no disparity, no losses and no ongoing crisis. For local water services that will mean more than new computerized meters. It will require the political will to price the commodities rationally. Full-cost pricing of water at the consumer level may even result in a ripple effect of creating more market rigor to the entire larger water pond of the government water system.

Unfortunately, many politicians prefer to tell people that somehow they don't have to pay the full cost of essential services and utilities. Politicians want the public to believe in such mythical things as free clean air, free clean water, free and clean renewable energy, cheap agricultural water, or that the public will conserve water without an economic incentive. If California resists reform the political precariousness of water resources may lead to more conflict. For example, in Santa Clarita, California environmentalists have taken over a local water board and have blocked large new tract home developments because they believe water is priced so low that it will result in the natural environment drying up in favor of urban gardens and swimming pools. The continued dependence on such demand-side policies as politicized Colorado river and state delta "water allocations," "agricultural fallowing contracts," and "water transfers" on one hand, and xeriscaping, environmental lawsuits and the political takeover of water boards on the other hand, will only cast the fortunes of politicians to the unpredictable currents and eddies of a political river that is ever drying up. Full-cost water pricing may not be too risky when compared to the long-term political fortunes of those who raft down the rivers of politics.

By:Wayne Lusvardi and Charles B. Warren


Milwaukee Water Contractor Scores Well on Audits

Speculation about quality oversights prompted the Milwaukee Metropolitan Sewerage District to carefully examine its contractor, United Water. MMSD Executive Director Kevin Shafer hired a Seattle sewerage district manager to head the audit.

The audit—which took nine months and cost $157,000—found generally high levels of quality: "The treatment performance levels place the system in the top rank of systems in the nation. The number and volumes of combined sewer and separated system overflows are much lower than in similar systems."

New Jersey-based United Water took over wastewater operations in 1998, when it entered into a 10-year agreement with MMSD. A service area population of 1.1 million made the Milwaukee contract the nation's largest wastewater public-private partnership, and other features made it the most complex. The Milwaukee facility has a biosolids program, two wastewater treatment plants, an inline storage system and a 30-megawatt power plant. Most facilities would not, for example, have their own power plant.

The audit gave especially strong marks to the two wastewater treatment plants, noting that special recognition by the Association of Metropolitan Sewerage Agencies demonstrates that "the treatment system in particular is being operated in a very good manner." Both treatment plants have received AMSA's Platinum Award, given to agencies that go five or more consecutive years with no discharge violations. Prior to the United Water contract, the wastewater system had never received the platinum distinction. The audit goes on to note that United Water has also "consistently been awarded the incentives for superior effluent quality" contained in the contract.

Systems often gauge quality on TSS (total suspended solids) and BOD (biochemical oxygen demand) levels, with TSS and BOD levels measured in milligrams per liter. A TSS/BOD standard of 30/30 is considered typical. However, United Water Project Manager Terry Tobel points out that the Milwaukee contract sets a more stringent 15/15 standard, and that his company's 9/9 performance has bettered even that.

Although the audit was mostly complimentary of United Water and described MMDS as "generally well run," the report did include some concerns, such as the maintenance of non-critical equipment and the contractor's relatively low staffing levels.

Tobel thinks such criticisms put too much faith in previous management models. "There are those who don't understand privatization and think that we don't have enough people, but that's just because we do our business so differently," he says. "We've downsized by about a third, and at the same time we've had an increase in water quality."

Since United Water guaranteed there would be no layoffs, the company has downsized through attrition. When an employee leaves, United Water reviews the position and decides whether or not to find a replacement.

A different approach to staffing and the implementation of other efficiencies have allowed United Water to stay on pace with the goal of saving 30 percent ($140 million) over the term of the contract. Customers have felt efficiency gains in the form of lighter water bills as rates have dropped 16 percent.

New maintenance strategies demonstrate how efficiency can serve quality. "Before there were three separate maintenance systems," says Tobel, "and we brought it down to one." A computerized maintenance system called MAXIMO has improved tracking and allowed for the development of a predictive maintenance program. Meanwhile, an internal program known as Performax evaluates factors such as water quality, maintenance, cost and energy use on a daily, weekly and monthly basis.

Because the right information allows employees in the field to perform more effectively, Tobel credits Performax with helping to foster continuous improvement. "They know how much energy or how much chemicals they should be using," notes Tobel. "We review so often because you don't wait a month and realize you've used too much chemicals."


Don't Believe the Hype: Successful Water Privatization is the Norm

If private involvement in water provision were the high-risk endeavor that critics claim, we would see disaster all around us. After all, water privatization is more common than most people realize.

Of course, we aren't sinking in disasters. In fact, when the anti-privatization group Public Citizen set out to report the most heinous examples of privatization gone bad they came up with only one substantiated case of a private operator running amok, buried in the midst of stories of such terrible things as the publicly appointed utilities commissions granting rate increases.

In a rich irony, the researcher for Public Citizen who wrote that report and other early attacks on privatization quit soon after. He came out publicly to explain that his work had taught him that privatization works when done right, and that critics have failed to show any problems with it beyond a few anecdotes (See: http://www.reason.org/pb22.pdf).


Widespread Support

Privatization has bipartisan support as a means of improving the environment and the health of citizens. In a 1999 study President Clinton's EPA endorsed privatization as a means by which local governments could meet environmental standards. Indeed the EPA wrote that privatization creates a classic "win-win" situation. The former Public Citizen researcher now says that his work to dig up dirt on private operators convinced him that "private operators have a respectable record of providing quality water and complying with environmental standards." Comparisons of compliance performance all find that privately operated utilities are less likely to violate safe drinking water standards.


Satisfied Customers

At renewal time, 91 percent of communities choose to continue privatization. And this is not because they are captive to the private firms—6 percent of communities switch to another private company when existing contracts are up, and each year about 10 communities bring services back in house. Ninety- four percent of communities say they would recommend their private water manager to other communities.


Common Concerns

Even after 1500 contracts, some people still misunderstand privatization's real record. They may worry about accountability for private operators: Will contractors put the bottom line before quality?

However, the market provides us food and medicine, child seats for our cars, and in fact, most of the things we put in our bodies or use to make us safer come from the private sector. And—as noted earlier—for many Americans that includes water. Just as with government-run facilities, private employees and managers and their families live in the community and drink the water. And companies that consistently fail to deliver expected service will soon find no more willing customers.

Others have different accountability concerns. They may, for example, raise the specter of foreign ownership. However, like the private sector in general, most of us already seem quite comfortable with foreign ownership. We trust foreign-made cars with our lives—and they are far more likely to be the cause of our death than our wateris. We ingest foreign-made pharmaceuticals, we eat imported foods, we strap our children into foreign-made car seats, all without really worrying about where they are made. Why? Because there is a system for ensuring they are safe products. Privatization of water and wastewater services does not change the system for ensuring the water is safe and reliable. Government remains responsible for establishing and enforcing quality and reliability standards, and with a good contract, contractors have every incentive to ensure the same.

The partnership in a privatization and the contract that binds it must be based on visible, measurable performance, and must reward private companies only if they meet the goals and performance they have promised. Community leaders have to apply the best practices and lessons learned from past privatizations to their own decisions. Communities may even turn to specialized consultants to help them negotiate new contracts with private operators.

Still, water privatization is neither inherently bad nor inherently good. It is not a White Knight that can ride in and rid a city council of all its water utility worries. Privatization does enjoy a solid track record of success, and research and experience shows that—in the right time and place—it is a viable option.




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