PART I: Once Monopolistic Water Utilities Are Becoming Competitive; Is Yours?

Editor's note: The following is the first of a three-part series on competition and its impact on the once-monopolistic water utility industry. The first part explores the market drivers in the industry that are contributing to the trend toward increased competition and privatization. The second will look at the ways to assess your utility's competitiveness. And the third will provide ways for your utility to become more competitive.

By Neil V. Callahan, Senior Consultant, R. W. Beck, Inc.

Competitiveness is, very simply, how well you are doing compared to the competition. Most water utilities are monopolies; why should they care about being competitive? Because the marketplace for water services is undergoing some very dramatic changes!

Monopolistic utilities are generally averse to change. However, it seems they serve an increasingly aware and demanding group of stakeholders. The customer's expectations of the water service provider are constantly increasing, both in terms of performance and rates. The owners are concerned about costs and risks. This situation has created opportunity in the water industry that the privatization companies are capitalizing on.

This series of articles will explore some of the forces that are driving many water utilities to address their competitiveness. It will present some current trends and market drivers in the water industry that are forcing decision makers to explore if there are better alternatives. A discussion to determine if your utility has a need to improve its competitiveness is also presented. Part of this discussion is a survey to allow the audience to gauge if their utilities have a competitive strategy. Finally, the paper concludes with some measures to consider that may assist your utility in an effort to become competitive.

Market Drivers Shaping Direction of Water Market Today
There are several principal factors that are shaping the direction of the water market called market drivers. Four of the major market drivers are:

• the age of the existing facilities;
• the public policy of implementing stricter regulations;
• the water industry's globalization; and
• privatization.

These market drivers are the impetus that are causing many in the water industry to examine if the new paradigms for service delivery can offer more value for the utility's stakeholders.

Aging Facilities Need Major Capital Renewals and Replacements
Most water treatment systems are of an age that they need significant capital renewals and replacements. According to the U.S. Environmental Protection Agency, the cost of water infrastructure replacement in the U.S. over the next 20 years is estimated to be approximately $76.3 billion dollars. It has been my experience that these numbers tend to understate the need because these are EPA-qualified needs. Whatever the true number, this is undoubtedly a major undertaking. Building new or expanded facilities, or replacing outdated or inadequate facilities, will require investments by utilities and rate increases to pay for the debt.

Age and Method of Ownership Compound Capital Problem
Two issues that compound the problem of raising adequate capital for water systems: the age of much of the water infrastructure; and the method that the utility may have assumed ownership of some of its assets.

In most East Coast utilities a majority of the assets are in excess of 20 years old. The cost of construction for the renewal of these assets will have increased many-fold since they were paid for by the utility. Replacing them at the end of their useful life will be very expensive. Additionally, many utilities have had a significant percentage of their distribution network contributed. Consequently, water rates of today are based on the recovery of only a fraction of the current replacement cost of the utility's assets. This means that in the future rates will have to undergo significant increases just to keep pace with current service and new capital requirements.

New Stricter Legislation Tightens Requirements for Water Utilities

• Safe Drinking Water Act: The pending disinfectant and disinfectant by-product rule and the enhanced surface water treatment rule are setting new, lower standards for total trihalomethane, haleoacetic acids and lower turbidity limits. Additional filter monitoring requirements are likely and the necessity for monitoring and or meeting a Crytosporidium limit also is being considered.
• Consumer Confidence Reports: The 1996 amendments to the Safe Drinking Water Act required EPA to mandate that water utilities provide their customers with "Consumer Confidence Reports" including monitoring results, violations, water sources, health implications of violations, and the identification of susceptible populations. This initiative represents a watershed event in regulatory terms; one that EPA calls "the centerpiece of public right-to-know in SDWA." What this means is that the EPA will no longer have to play the heavy in the water industry. It no longer will issue orders to utility administrators that hit the local press as "EPA orders residents to fork over big bucks for new filtration plant." The customer will know what is in their water and what problems their utility is experiencing. In the near future, the customer, not the EPA, will drive the way the utility spends money. Are you ready to have your customers become your boss? Will they become your biggest critic or supporter?
• Contaminant Candidate List: The 1996 amendments to the SDWA require EPA to establish a list of contaminants to aid in priority setting for the agency's drinking water program. The Contaminant Candidate List is a list of contaminants, which are not currently subject to any national primary drinking water regulation. EPA selected these contaminants because they are either known or anticipated to occur in public water systems, and consequently may require regulations under SDWA. The criteria developed addressed the following questions: "Does the contaminant adversely affect public health?" or "Is the contaminant known or substantially likely to occur in public water systems with a frequency and at levels posing a threat to public health?" EPA will select five or more contaminants from the Regulatory Determination Priorities list and determine, by August 2001, whether to regulate them. Possible contaminants to be regulated include p-cymene, coxsackieviruses, microsporidia, sulfate, and aluminum.

Water Industry Globalization Has Grown
The provision of water to customers has historically been a local enterprise. Municipal utilities, regional water districts, and Investor-Owned Utilities (IOUs) were predominantly local companies. But water is becoming big business.

In the U.S., one of the biggest water companies is American Water Works, which serves 7 million people and had annual revenues of $954 million in 1997. USFilter has emerged in the last few years as a major equipment and service provider in the industry. But these companies pale in comparison to the size of some of the global water industry participants. The two larger ones from France, General des Eaux and Suez Lyonnaise des Eaux, each have revenues in excess of $30 billion a year. Companies this size have tremendous advantages over small utilities because of the economies of scale and available resources. These companies all have aggressive growth plans for their businesses in the U.S. market.

Privatizers Offer Certain Advantages:
The privatizers sell their products based on several features that distinguish them from other service providers. Several of the key features of there products are listed below.

• Multinational corporate R & D
• Concession fees
• Stabilized rate structure
• Access to private capital
• Off-balance sheet financing
• Higher competencies
• Performance guarantees

Benefits of Privatization Cited by Utility Owners:
The benefits cited translate into reasons that the owners of the pursued privatization.

• Cost reduction
• Technologies
• Guarantees
• Management expertise
• Capital

The privatization market shares some attributes with the high tech market. There is constant development of performance enhancement, financial and contractual products. The privatization contracts are for a myriad of different services and financial relationships that comprise the privatization product spectrum.

Predominance of Contracts To-Date Have Been for O&M
The predominance of these contracts to-date has been for operations and management services not involving private capital. O&M contracts present the lowest political and legal barriers to enter into privatized services. However, once a utility has been privatized, the general trend has been to continue operations and expand the relationships.

Some of the newer types of public/private/partnerships have stirred significant interest in the water industry. Following is a brief summary of three recent privatization agreements, two concessions and a design/build/operate project.

Facility: 23 MGD WWTP, 11 pump stations, collection system
Developer: Poseidon Resource Corp.
Subcontractors: Professional Services Group and Metcalf & Eddy

Agreement:


• City leases system to Triton Ocean State L.L.C., a Poseidon subsidiary.
• Triton secures project financing on lease payments.
• Triton pays Cranston a $48 million concession fee and agrees to construct capital improvements necessary to guarantee performance of facilities.
• PSG and M&E are subcontractors for O&M and design-build components of project.
• Parent Air & Water Technologies is guarantor.

Benefits:


• Risk mitigation
• Performance guarantees
• Rate stabilization
• Improved bond rating
• Off-balance sheet financing
• Deceased $26 million in municipal GO debt
• 11 million of capital system improvements
• Established $6 million general fund surplus

Savings anticipated: $76 million

Facility: 10 MGD WTP, two storage tanks/pump stations, water distribution and wastewater collection system.
Developer: U.S. Water L.L.C.
Subsidiaries: North Brunswick Water L.L.C.

Agreement:


• Township leases water treatment & distribution system, and wastewater collection system to No. Brunswick Water, L.L.C., a U.S. Water L.L.C. subsidiary.
• U.S. Water secures loan on lease payments.
• U.S. Water pays No. Brunswick Township a $6 million up-front concession fee with annual royalty payments of $23.9 million over the life of the concession.
• U.S. Water agrees to make capital improvements necessary to assure the installation of ARM water meters.
• Parent company guarantee on project.

Benefits:


• Risk mitigation
• Performance guarantees
• Rate stabilization
• Off-balance sheet financing
• Deceased $25 million in municipal GO debt
• $1 million of metering system improvements

Savings anticipated: $9.9 million

Facility: 120 MGD total water treatment facilities
Developer: CDM & Phillips Utilities Management Corp

Agreement:


• CDM-Phillips will design, build and operate a filtration/ozonation plant for $101 million.
• SPU retains ownership and liability for future capital requirements.
• City of Seattle provides the financing for the project.
• Company guarantees on project.

Benefits:


• Risk mitigation
• Performance guarantees
• Rate stabilization
• Exceeded 15% savings off of benchmarked construction costs
• Exceeded regulatory requirement

Savings Anticipated: $70 million

Privatization is a force that has and will continue to change the landscape of the water industry. There is little question that new industry wide expectations for service, performance and costs are emerging simply because privatization exists as an option for service delivery in the water utility marketplace.

Growing Political Support for Privatization
There is growing political support for privatization. This can be related to the fact that privatization has benefits to politicians that may not be available through other forms of service delivery. In its 1997 Survey, the Urban Water Council of the U.S. Conference of Mayors, found that the political interest in public/private/partnerships was expanding:

Survey Finds 40% Had Some Form of Privatization
Of 261 cities surveyed, 40% currently had some form of public/private/partnership. Another 14% of the cities without any public/private/partnerships are considering it.

The most common services that were privatized included:

The results suggest that politically there is significant dissatisfaction with nearly every aspect of service delivery. The results of this survey strongly suggest that political decision-makers increasingly see significant benefits by using privatization for the deliver of water services.

Part II will explore markers to look for when evaluating your utility's competitiveness, and will appear on Water Online next week.

For more information contact the author, Neil Callahan, a senior consultant in R.W. Beck's Boston office at 508-935-1837.

Edited by Joyce Jungclaus, Editor of Public Works Online, a sister site to Water Online within the VerticalNet family of online business communities.