New forces are reshaping the responsibilities of water and wastewater
utilities. Although they come in different forms, water utilities conventionally
serve the public and industry supplying, treating, and distributing drinking
water; the collection and disposing of used water or “effluent;” and sometimes
draining storm water and other run-off. Competitive practices evolving
in telecommunications, electric power, and gas utilities are beginning
to emerge in public water. Many municipalities and regional authorities
are inadequately equipped to respond to the challenges of this newly competitive,
market-driven environment.

Water Privatization Becomes a Trend

Municipalities are increasingly considering privatization as a viable
option. Privatization could involve a private company purchasing a public
water system or a private company taking over the operations of a public
water system. Private sector firms supply the investment needed to improve
customer service, the global expertise to employ advanced technologies,
and the incentives required for more efficient practices. Particularly
in a setting where municipalities confront flat or diminishing budgets,
the involvement of private sector firms is appealing because they lower
expenses, improve cash flows, and add new funding sources. The U.S. private
water industry is ready and able to do both asset acquisitions of publicly-owned
properties or contract operations, but U.S. tax law and federal policies
have impeded sale transactions and made contract operations currently
the most used option for U.S. localities.

Until recently, federal grant repayment obligations and IRS policies
impeded the movement to privatize public water systems. In 1992, an executive
order (E.O. 12803) changed the allocation of proceeds from the sale or
lease of municipal facilities built with federal funds. Now, cities will
not be penalized for selling, leasing, or structuring contract operations
for facilities built with federal support. Moreover, in the past, IRS
rules held that municipal water utilities with outstanding tax-exempt
debt could not enter contract operations agreements for terms longer than
five years and still maintain the debt’s tax exempt status. Because private
operators need several years to begin recouping the high costs associated
with beginning contract operations, five-year contracts dramatically limited
the benefits of private sector participation. In 1997, however, the IRS
changed the policy to allow contracts with terms up to 20 years (Rev.
Proc. 97-13).

Now that these obstacles have been removed, incentives exist to create
attractive business opportunities for properly equipped companies, many
of which are poised for success in the emerging industry. The current
circumstances have led to a chance for the private sector to assist municipalities
with reducing operational expenses and improving service delivery quality.
With acquisitions or long-term operations and maintenance contracts, both
the public and private sector can succeed. The public sector can save
on operational costs and attract new funding sources for needed capital
improvements. Meanwhile, the private operator has an incentive to run
the plants more efficiently – profit.

Figure 1
Alternatives to private allocation of services and ownership to the public
sector

Privatization Comes in Different Forms

The French have been far ahead of others in utilizing a practice in which
municipalities continue to own their water utilities, but contract out
services to private operators. They started this in the nineteenth century,
but it is only now being employed in large cities in the United States.
The British, under the Thatcher administration, sold their state-owned
water operations to private investors. Those newly privatized companies
have become multinational players in privatization markets, including
the U.S. In some cases, like in Buenos Aires, governments have sold or
leased out their water facilities, allowing private operators to sell
services directly to the public, with government regulation. Of course,
the U.S. has always had successful privately-owned and publicly-regulated
water and wastewater utilities. Mexico City took yet another approach
to privatization, contracting the rights to operate parts of the city
water system to four operators, with the thought of stimulating competition
among them.

Privatization can be partial; it does not necessarily have to encompass
the entire system. Water utilities are increasingly contracting out specialized
parts of their systems, such as billing, payroll accounting, lab work,
or meter reading. It is now common for public water utilities to engage
an outside firm to operate a treatment plant or another major part of
the system. In cases where the rehabilitating or building of new system
elements is required, a variety of well-known arrangements are possible,
including Build Own Operate (BOO) and Build Own Operate Transfer (BOOT).
Figure 1 illustrates the major alternatives for providing for varying
degrees of private allocation of services and ownership to the public
sector:

What works for one public water supplier, both economically and politically,
may not be the best solution for another. Choosing the most suitable privatization
solution needs to be carefully analyzed for each situation. Following
is a recent example where contract operation of the entire water system
proved to be the solution that best met local objectives and conditions.

Atlanta: A Case Study

The City of Atlanta recently completed the largest water operations outsourcing
in North America, awarding a 20-year full operations and maintenance contract
to United Water Services (UWS) as a result of a competitive procurement
process. While the city will retain ownership, its operations costs will
be cut almost by half. UWS will manage the workforce and all operations
and will coordinate capital improvements to provide clean drinking water
to 1.5 million customers. In doing so over such a long period, UWS can
count on nearly half a billion dollars in service fees to be paid by the
City of Atlanta over the term of the contract.

Background

During a tough mayoral campaign in which both candidates and the major
newspaper favored privatization, incumbent Mayor Bill Campbell promised
to drastically scale back a scheduled water rate increase of 51 percent.
There was no question that a rate increase was imminent. The city faced
EPA fines of $100,000 a day for environmental violations by the wastewater
system and $900 million in necessary repairs and improvements, including
new underground pipe and facility construction and restoration. The question
facing Mayor Campbell was how he could pay for the needed capital facilities
and improve the performance of the city’s water system without a 51 percent
rate increase. This pending financial distress and the fear of an infrastructure
collapse caused Mayor Campbell and other political stakeholders to view
privatization as the right solution.

The First Step: Assess Cost-Effectiveness of Current Operations

As a first step, the city commissioned a detailed study to assess the
cost-effectiveness of its current water and wastewater operations and
identify operational alternatives. This involved analyzing approximately
40 functions and facilities, reviewing documents, interviewing key personnel,
benchmarking against similar systems, and identifying long-term goals
and strategy. The study identified and examined several operational alternatives,
determining their effect on future rates. These options included:

• Light re-engineering/outsourcing of non-core operations (such as
  grounds keeping)

• Heavy re-engineering/outsourcing

• Contract operations of various treatment facilities

• Contract operations of all system facilities

An outright sale of the assets was not considered because, in this particular
situation, it was not politically feasible. The city wanted the full support
of the council and wanted to act quickly. A sale would have opened public
discussion on a level that could have been too difficult for the council
to support within the timeframe that the city believed was acceptable.

The city then estimated the range of cost savings that could be derived
from each of the options after assembling them into the following savings
alternatives:

• Light Re-engineering/Outsourcing: Making the straightforward
  changes that can be accomplished within a single system/department.
  Also included in this alternative was the outsourcing of non-core
  functions to the private sector.

• Heavy Re-engineering/Outsourcing: Adding to the light re-engineering
  package those more difficult internal actions that involve the cooperation
  of two or more departments and/or a basic change in the way that the
  city conducts its business. Also included in this alternative was
  the outsourcing of non-core functions to the private sector.

• Contract Operations: Selecting through competition a qualified
  private firm or firms to operate one or more of the five treatment
  facilities in the system while implementing the heavy re-engineering
  package on the non-contracted facilities and functions that remain
  under the city’s management.

• System Management: Selecting through competition a qualified
  private firm to manage the water system, the wastewater/sewer system,
  or both, while implementing the heavy re-engineering scenario on the
  remaining system.

The city constructed a financial model to evaluate the impact of these
alternatives on the customers. The model simulated the flow of revenues
and costs through the systems, including operational costs, indirect costs,
capital spending, debt service on bonds, outside revenue sources, and
other factors, to demonstrate what future rates would look like under
the various alternatives. As Mayor Campbell stated in his campaign, the
city needed to generate cash under any alternative to avoid dramatic rate
increases. This analysis determined that a combination of the alternatives
would realize the greatest overall potential benefit to the city and its
utility customers, at acceptable levels of risk. The chosen combination
was contract management of all water system operations and one wastewater
plant, with re-engineering of the rest of the wastewater and sewer system.

Choosing a Contractor: A Three-Phase Process

The City of Atlanta followed a careful selection process with three phases
that took less than a full year to execute: (1) qualification of bidders;
(2) initial cost and technical proposals; and (3) best and final offers.

In the first stage, the city issued a widely advertised Request for Qualification/Request
for Proposals (RFQ/RFP), which incorporated a draft Operating Agreement.
Five statements of qualification were received. It should be noted that
at least one expected bidder declined to bid because of the form of privatization
that Atlanta selected. Of the five that did bid, three were from consortia
led by French concessionaires, and two were from teams led by U.S. firms.
Using pre-determined criteria, the city evaluated the financial strength
and technical ability of each proponent to fulfill the requirements of
the contract. The purpose of this stage was to narrow the field by eliminating
those contractors who were not substantial enough to meet minimum requirements.
All five contractors, however, met the qualification criteria required
to continue to the next phase.

At the completion of this qualification phase, all five bidders were
invited to submit separate technical and cost proposals. The RFQ/RFP for
these proposals provided such information as historical and current city
water utility operating statistics, staffing, budgetary, and other related
financial data, proposed capital improvement programs, and various policies
and procedures. In addition, the RFQ/RFP included various required levels
of service and performance measures to which the winning contractor would
be held during the contract term. In general, the proponents’ proposals
were to describe the detailed technical project approach, proposed key
personnel and staffing plans for the project team, the proposed annual
cost for the term of the contract, and the mechanism for the escalation
of costs over time. Some of the most important aspects of the entire process
for the city dealt with the requirement that bidders comply with the city’s
Equal Business Opportunity (EBO) policy and its proposed employee relations
and transition plans. (The city had required that no current water system
staff be laid off for the first three years of the contract.)

To ensure that the evaluation process was as democratic and unbiased
as possible, multiple evaluation teams of city staff members were assembled.
Each team was responsible for evaluating various specific aspects of the
proposals, rather than entire proposals, to further decentralize the evaluation
process. As part of the review of the technical and cost proposals, the
city held personal interviews with each of the bidders. Questions raised
by either side that could not be answered during the interview were submitted
and answered as a follow-up to the interview process.

After the interviews and subsequent requests for further information
were completed, the city moved into the “Best and Final Offer” phase.
In this phase, the city refined and standardized the final Operating Agreement
to include any additional information and requirements that resulted from
the entire evaluation process. The bidders then submitted their final
technical and cost proposals based on the revised Operating Agreement.
The city evaluated the final proposals and provided the final ranking
of the bidders and recommendations to the mayor and city council.

A Successful Conclusion

After nearly a year’s effort by the city team, Atlanta contracted with
United Water Services to operate the City of Atlanta’s water system. With
annual revenues of $120 million, United Water Services is a joint venture
of Suez Lyonnaise des Eaux and New Jersey-based United Water Resources,
bringing global expertise to the system. The company offered to operate
Atlanta’s system at a guaranteed annual cost of $21.4 million, almost
half of the city’s current operating budget.

Using Atlanta as an example, it is clear that privatization offers attractive
choices to public and commercial interests. In some cases, the best alternative
will be to sell the entire public water system to a private company. In
others, it may be to outsource only the operation of certain non-core
processes. Or the best solution may fall somewhere in between, as it did
for Atlanta. Each privatization opportunity is different and must be evaluated
on its own merits.

Current trends in water competition are rooted in rising consumer expectations.
As consumers have forced improved services in other utilities, so will
water owners and managers have to meet the demands in this sector. The
water utility of the future will be defined by its ability to deliver
better quality and service for lower rates.

PricewaterhouseCoopers, together with the engineering firm of Brown
and Caldwell, and the law firm of Long, Aldridge & Norman, assisted the
City of Atlanta with the operations assessment, developing the operations
alternatives, and implementing a successful privatization strategy.