HISTORICAL TRENDS IN WATER AND WASTEWATER FINANCING AND MANAGEMENT

By Alethea T. Abuyuan

About the Author...

Alethea T. Abuyuan recently joined IP3 as their Water and Sanitation Specialist. Prior to joining IP3, she was a consultant at the World Bank's Environment Department and Water and Sanitation Division. Her experience in the water sector also includes working for the Presidential Task Force on Water Resources Development and Management in the Philippines. Ms. Abuyuan holds a Master's degree in Environmental Policy and Management from Yale University and a Bachelor's degree in Sociology from the University of the Philippines.

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Current structures for water financing have evolved from historical patterns in water management. As such, reviewing how different countries have dealt with their water problems over time provides useful background for understanding today's financing options.

Governments have been managing water resources as a public good since ancient times. It was during the Industrial Revolution, however, that much of the foundation was laid for today's efforts to provide urban water supply and wastewater services by both public and private actors. The experiences of France, Great Britain, and the US provide examples of the roots of modern water financing and management techniques. Those techniques are now being adapted and new ones created for addressing the critical water issues facing urban areas in developing and transitional countries.

Historical patterns in water financing and management make it clear that both public and private actors have key roles to play. The challenge is allocating those responsibilities in ways that best address local needs, in the local context.

Ancient Civilizations

As early as the third millennium BC, the Indus, Egyptian and Mesopotamian civilizations had bathrooms in wealthy houses and sewers in the streets. Slave labor was employed for digging wells and cisterns, and laying interior plumbing for temples and palaces. Likewise, the Minoan civilization on the island of Crete enjoyed running water and flushed latrines. Qanats, tunnels, and aqueducts for gravity flow, plumbing for interior drainage, and open drains leading to the edges of citadel areas were built in Iran, Palestine and Greece. In Imperial Rome, revenues from North Africa were used to build monumental aqueducts, house connections, public baths, and latrines (Gunnerson 1991).

One important similarity among the large water systems of these early peoples was the fact that they were public works - planned and financed by the king or ruler of the land, for the welfare of his/her subjects. At the same time, private management of water resources was occurring in parallel. The basic principle of water supply seemed to be to use as many different sources of water as possible for the least effort. In a study on water management in ancient Greek cities, Crouch concluded that water management was balanced between elements that people could build, maintain, and use privately, and those that required communal effort and provided communal rewards (Crouch 1993).

Industrialized Countries -- 18th to the 20th Century

Among the industrialized countries, France, Great Britain and the US provide a useful range of examples for ways to finance and manage urban water resources. Their approaches are reflected around the world. France has been especially influential, as its business model of "delegated management" has been widely applied by its large, private water companies. Great Britain, also known for its large private water companies, has led the way on full privatization. Meanwhile, the US, which has see-sawed between private and public involvement in its water infrastructure, is opening up again to more private sector participation.

France -- delegated management

The operation of water systems in France has been considered a private sector activity from its earliest days - perhaps since Generale des Eaux won its first municipal contract in 1853 under the reign of Napoleon III (Financial Times 1999a), or in 1782 when the brothers Perrier founded a company that was granted a license to supply piped water in the Paris area for 15 years (Roth 1987).

The French approach to water operations anticipates a range of roles for public and private actors. The public authority, usually a municipality, can choose to build and operate the system with its own financial resources (regie direct system). It can be managed either by the public authority's own staff (regie simple) or by an autonomous board (regie autonome), which is a separate local entity owned by the public authority (Roth 1987).

In addition, under the popular private model developed by the French, called gestion deleguee or delegated management, municipalities retain ownership of infrastructure and the right to impose tariffs, while private sector companies bid for long-term contracts to provide the services (Financial Times 1999a). The three most common arrangements for private sector participation in the water sector are the management contract (gerance); the concession system; and the affermage (lease) system (Roth 1987).

The vast majority of the water systems in France are managed with private involvement (Dyk and Lynn 1999). However, only 12% of these water systems are both owned and operated by private utilities (Jacobson and Tarr 1993). Up to one-third of the waterworks in the central communes of urban areas in France (populations of 23,000 or more) are both owned and operated by the government (Jacobson and Tarr 1993).

France's experience with the private provision of water services clearly demonstrates the importance and difficulty of regulating providers of basic services (World Bank 1999). There have been downsides, as well as successes, to the decentralized public-private system of municipal contracts. Sharp increases in customer fees, reports of contamination of "post-privatization" drinking water, and corruption between company executives and elected officials have been reported (Barlow 1999). Moreover, legislative changes in the 1990s, weak monitoring and regulation, and inexperienced municipal negotiators have contributed to the sometimes shaky relations between the public sector and private concessionaires. Despite these problems, however, French water companies have remained a formidable force in the provision of domestic water supply and sanitation services.

Based on this experience in their home market, the large, private French water companies have expanded into markets all over the world. Vivendi SA (whose water division is Generale des Eaux) and Suez Lyonnaise des Eaux own, or have controlling interests in, water projects in approximately 120 countries on five continents. They distribute water to almost 100 million customers worldwide - Suez alone delivered drinking water to 77 million people around the globe last year (Barlow 1999). Between the two, they have won more than half of the big private sector water contracts awarded between 1993 and 1997, totaling $12.6 billion (Financial Times 1999a). Both companies are well over 100 hundred years old, giving them a depth of experience attractive to many governments seeking private involvement in water supply and waste water treatment. Another French water company, SAUR, which is owned by the construction company Bouygues, is also active in a number of countries.

Great Britain -- full privatization

By the early part of the 19th century, private water companies had already been serving London for over 200 years (Tynan and Cowen 1998). English private companies were also among the first to be granted concessions in other countries, such as Berlin in 1856 and Cannes in 1866 (Roth 1987).

At the same time, nineteenth century England faced massive urban sanitation issues. When revenues from the East India Company reverted to the Crown, government financing for sewers became feasible (Gunnerson 1991). The massive sewer construction programs were also funded by municipal bonds - allowing governments to borrow money from private investors to finance projects that promoted public welfare. The opportunity to float municipal bonds was created in response to the challenges posed by rapid urbanization in Britain and Europe in the late 19th century (O'Meara 1999). Over time, the provision of water and sewerage services in England came to be dominated by public sector water and sewerage providers.

In 1989, Britain privatized its regional water and sewerage authorities (OFWAT 1993). Before the introduction of the Water Act in 1989, which authorized the privatization of the water and sewerage sector in England and Wales, there were 10 government-owned regional water authorities supplying water and sewerage services and 29 statutory water companies supplying water only (OFWAT 1993). The assets and liabilities of the 10 water and sewerage authorities were transferred to 10 private companies in September 1989. In November of the same year, shares in the holding companies were sold in the stock exchange (OFWAT 1994).

Instead of the French model of delegated management, England opted for full privatization - placing all of the assets of the water networks into private companies and selling their shares. In order to protect the interests of consumers, an independent water regulatory body was established (the "Office of Water Services" or "OFWAT") to oversee prices and levels of service. Other regulatory bodies oversee the quality of drinking water (the Drinking Water Inspectorate) and wastewater discharges (the National Rivers Authority, now the Environment Agency).

To support its private market in water services, new forms of bond issues are being developed in the UK. For instance, in March 1999, the Stirling Water Consortium issued a 79 million pound (US$130.5 million) bond issue for a wastewater project (Project Finance 1999).

According to a 1996-1997 OFWAT report on the performance of the privatized water companies, the companies were more efficient than expected at the start of the privatization, and were able to improve services while reducing expenditure in real terms. Capital investment in 1996-1997 totaled 1.6 billion to 3.2 billion pounds on water and 1.6 billion on sewerage - an increase of 22% in real terms compared with 1995-1996 (OFWAT 1997). With regard to customer service, the Drinking Water Inspectorate concluded that the companies continued to improve drinking water quality through a scheduled completion of improvement programmes. Additionally, the Environment Agency was content with the performance of the companies on controlling wastewater discharges. However, it expressed concern that sewerage investments were not increasing as expected even though infrastructure renewals expenditure, which increased by 29% in 1996-1997 (in real terms) compared with 1995-1996, had reached its highest level since privatization. The 1996-1997 increase was focused on water service, unlike in the year before which focused on sewerage service expenditure (OFWAT 1997).

While water privatization has improved many aspects of water management in England and Wales, there have been problems. Complaints have been made that the water companies deceived the government by initially understating their ability to achieve efficiency savings, thereby eventually increasing their profits (Financial Times 1999b). Public Services International reports that between 1989 and 1995, there was a 106 percent increase in the rate charged to customers, while the profits of the companies increased by 692 percent (Barlow 1999). The British firms have been attacked by media and politicians alike for these price hikes and for running short on water during drought conditions (The Economist 1996). In addition, in 1998, OFWAT criticized 10 of the water and sewerage companies and 17 water-only companies for failing to promote water efficiency by persuading customers to use less water or by significantly reducing leakages (Evening Standard 1998).

Twelve Years' Experience with Full Privatization of Water Systems in England and Wales Since privatizing water systems in 1989, the quality of drinking water supply and wastewater treatment in England and Wales has improved dramatically. Over £30 billion has been invested. Simultaneously, the Office of Water Services (OFWAT) has been driving the industry towards greater efficiency through the use of comparative or yardstick competition (publicizing the different firms' performance on common metrics). These efforts have borne fruit. Improvements have been made in the quality of bathing water (91 percent of all beaches are now in compliance with U.K. standards) and of river water and drinking water (99.7 percent compliance). Sustained investment in total water resource planning has led to the reduction of leakage by about 1.8 million cubic meters a day, the equivalent of the daily requirements of 12 million people. It is anticipated that over the next five years alone, £7 billion of additional environmental improvements will be made. Current estimates suggest that between 1990 and 2005, water companies will have invested over £50 billion, much of it financed by customers, to improve water quality and to protect the environment. Nevertheless, concern about increases in user fees and the companies' use of the revenues persists. Partly because of public discontent over the payment of £10 billion in dividends to shareholders-much of it apparently at the expense of investment in the water system-OFWAT imposed an average annual reduction in water prices of approximately 2.1 percent over the period 2000-05 and a 12 percent one-time price reduction in customer water bills in 2000. The price reduction caused an outcry by the water companies and their shareholders. They argued that the additional investments needed to comply with EU standards, especially for improvements in drinking water quality, would be compromised and that OFWAT's expectation of a 16 percent efficiency saving across 100 percent of operating costs was simply not attainable, particularly on top of the efficiency gains that had already been realized in the first 10 years of private control. The impact of the price review was so dramatic that some companies even suggested that they be restructured to separate asset ownership from operation ("mutualization"). Recent initiatives such as the Competition Act of 1998 have focused on promoting competition by opening regions to new entrants ("inset appointments") and by developing methods for promoting the common carriage of water through different companies' networks. An important lesson from recent events is that comparative competition may be approaching its limits. The industry, and customers, might be better served by the introduction of legislation that clearly defines the scope for future competition in the water market and provides an unambiguous legal framework under which companies would be able to expand competition through market mechanisms. OFWAT's evolving role may be that of promoting competition by enabling the industry to reinvent itself, while keeping precautions in place to safeguard customer interests. Source: Kurukulasuriya 2001

Similar to those from France, large British water companies have also ventured into the global water market. Firms such as Thames Water, Anglian Water, United Utilities (a joint venture between two English water and electricity companies), and Biwater have interests all over the world. In North America, Thames Water has acquired the Elizabethtown, New Jersey water utility. This move is one of the latest in the British and French strategies of securing a stake in the US, believed to be the largest water market in the world (Project Finance 1999).

United States -- Fragmented Public and Private Systems

In 1790, Philadelphia was the largest city in the US with a population of 43,000. New York followed closely with 33,000 inhabitants. Neither had a central water supply. People pumped water from their own wells or from public wells placed at intervals along the street. In order to address the acute risks of disease and fire, 19th century engineers constructed vast water and wastewater systems, using private, not public, funds. The decision to work through private companies was influenced by the fact that London, the largest city in the world, was still being supplied by eight private companies, each serving a section of the city (Gunnerson 1991). Private companies supplied water to Boston from 1796 to 1848, and to Baltimore from 1807 to 1854. As late as 1860, 79 out of 156 water works in the US were privately owned. By 1890, private companies owned only 57 percent of waterworks in the country (World Bank 1999).

Eventually, most US cities turned to municipal ownership of water and sewerage utilities. The profit motive of private companies was thought to be ill-suited to the public supply of water. Businesses were reluctant to invest sufficient capital to cover entire cities, preferring to lay pipes through the wealthier sections and to hold back from supplying poorer areas. They also failed to provide water for public fountains and washing the streets, or to supply enough fire hydrants (Hanson 1991). Some private water utilities have remained, however, subject to stringent government regulation of prices and services.

With regard to wastewater treatment in the US, public funds have traditionally been used. Piped sewerage systems have typically been funded by a combination of user fees, assessments on abutting property holders, and general tax revenues (Jacobson and Tarr 1993). During the 1970s, laws such as the Water Pollution Control Act Amendments of 1972 provided municipalities with federal funds for up to 75% of the money needed to plan and build waste water treatment plants. By 1984, more than $40 billion had been spent by the federal government through the award of approximately 17,000 grants to municipalities (Jacobson and Tarr 1993). Because of this, the proportion of the population served by wastewater treatment facilities increased from about 67% to 75% (based on 1976 to 1986 figures).

However, increasing pressure to maintain wastewater systems and to meet minimum drinking water requirements has placed US municipalities in a bind. In 1995, the government estimated that $138.4 billion would be needed to improve drinking water treatment facilities by 2015, with an additional $332 billion required to upgrade wastewater plants (Project Finance 1999b). But since 1979, the level of federal funding has decreased considerably (Anderson 1999).

These pressures are leading many government officials to reconsider the involvement of the private sector in US water services. Until now, the US water sector has been controlled by small, municipal operators - only 10 to 15 percent of more than 55,000 water utilities are privately-owned (Financial Times 1999c). This trend may change for three main reasons:

• New US laws have paved the way for more private involvement in the water supply and wastewater treatment business
• Municipalities are finding it increasingly difficult to finance the improvements necessary to meet stringent environmental requirements
• With close to $90 billion in annual revenues from water services, the US is the largest water market in the world (Barlow 1999).

Fueling the interest in private participation has been the ability of private firms, through the use of fixed-price contracts and performance guarantees, to comply fully with environmental regulations, while at the same time achieving significant cost savings in municipal systems (Haarmeyer and Mody 1997). Large European water companies, such as Vivendi (which recently purchased U.S. Filter Corporation), are busy acquiring interests in the small, private water companies that dot the US. At the same time, large US firms from other sectors are looking to expand into the global water business - such as Azurix (a product of US energy giant Enron and Britain's Wessex Water PLC). As noted in the table below, they are finding it hard to compete against the French firms.

International Lead Contractors in Middle- and Low- Income Countries' Water Systems

Source: Franceys 2000

Developing countries and economies in transition: Emerging models for private investment

Much of the same debate over the roles of public and private actors in water services is occurring in developing and transitional countries - for many of the same reasons. Declining public funds, deteriorating and undersized government water systems, opportunities for attracting new private investment, technical knowledge, and management systems - all are part of the mix.

The key for governments is to understand and choose from the wide range of approaches for improving the performance of water and sanitation systems. Some options keep the operations in public hands, but change the operational incentives. For example, in "corporatization," the water utility remains in public ownership, but adopts a formal, corporate structure (Netherlands Ministry of Housing, Spatial Planning and the Environment 2000). The new structure puts it at arms length to the government, typically giving the corporation rights in setting tariffs, managing budgets, and financing new projects (Global Water Partnership 1999). Corporate structures may also enhance transparency and accountability compared with traditional government set-ups.

Other options involve private actors in a variety of ways and to a variety of degrees. Among the major approaches being used are the following:

• Private operation, public oversight, investment and ownership - various forms of service contracts
• Private operation and investment, public oversight and ownership - greenfield "Build, Operate, Transfer" arrangements, concession contracts
• Public-private operation and ownership, public oversight - joint ventures
• Unregulated private provision - small businesses, community organizations

Many of these approaches are derived from the experience in industrialized countries, particularly if international water companies are involved (as described above). Others - such as municipal bond financing and full privatization of water companies (following the British model) - are in the early stages of development.

Municipal Bonds: Expanding local markets In the United States and Canada, sub-national governments rely on the bond market. Bond debt issued by sub-national governments in the two countries now totals more than $7.4 trillion. Bond financing is possible because both countries have well-developed capital markets, and their history of macroeconomic stability has made private investors willing to make the long-term financial commitments infrastructure investment requires. Confidence in laws and procedures; public disclosure guidelines; and well-established financial track records for local governments are other prerequisites for a strong municipal bond market. Interest payments that are tax-free to the recipient are also a major plus, as they enable municipalities to borrow at lower cost than private firms. In many developing countries, few of these conditions exist. Many municipal governments are viewed - often incorrectly - as unattractive borrowers lacking the autonomy to raise revenues or reduce spending. However, municipal bond markets are emerging despite these concerns. In Latin America, 52 municipalities and provinces accessed capital markets between 1991 and 1998. Asia's local bond market is estimated at $477 billion. All Czech cities with more than 100,000 people have issued municipal bonds, enabling the investment share of Czech municipalities to remain at more than 38% of their budgets, despite deep cuts in central government capital transfers. Standard and Poor's has given Prague and Ostrava "A" ratings for foreign currency bonds. Poland, Russia, South Africa and Turkey also have nascent municipal bond markets.

Source: World Bank 1999

Today, with the increasing use of public-private partnerships in delivering water and wastewater services, there is a need to clearly define the roles of public and private actors. The matrix below summarizes the allocation of these roles across a range of structures. What stands out is that the government (indicated by the darkest squares) retains responsibility for setting and enforcing performance standards - regardless of the form of private involvement chosen.

ALLOCATION OF PUBLIC/PRIVATE RESPONSIBILITIES ACROSS DIFFERENT FORMS OF PRIVATE INVOLVEMENT IN WATER SERVICES

Key:

Dark grey = public responsibility

Light grey = shared public/private responsibility

White = private responsibility

Source: Yale-UNDP Partnerships Program 1998

For governments, NGOs and others interested in attracting more private involvement in their water systems, the critical questions are: (i) what lessons have been learned about private involvement in the water sector; and (ii) based on those lessons, what steps can be taken to attract more private involvement in water services.

This article draws heavily from "Global Trends in Urban Water and Wastewater Financing and Management: Changing Roles for the Public and Private Sectors", a technical paper prepared by Bradford Gentry and Alethea Abuyuan (Yale School of Forestry and Environmental Studies) for the Organization on Economic Cooperation and Development (OECD) in April, 1999.