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May / June 2003

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OPINION - Confusing Cause and Effect


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Founder : Len Abrams
Water Policy International

 

  Private-Public Partnership Page  

 

PPP In Water & Sanitation Projects

Regional trends in project types

 

The previous section looked at the various contract types which private companies enter into with public authorities. These contracts have varying amounts of private and public control over assets and management. Linked with this are the different project types which private companies get involved in. These include:

• Management only - the infrastructure is already in place and the private company takes over the operation and management of it for a set period of time. Most common form of contracts - Management, Lease, Service.

• Concessions, with investment - operation and management contract for existing infrastructure accompanied by major investments from the private company. Most common form of contracts - BOT, BOO, BOOT, Concession.

• Greenfield projects - the private company builds new infrastructure from scratch. Contracts are usually one of the BOT variations.

• Divestiture - the private company invests in an equity stake of the utility, either owning it outright or in partnership with other companies or the state.

 

One striking feature of the water and sewerage sector is the dominance of concessions compared with other forms of private participation. Concessions are attractive to governments because they place full operational and investment responsibilities, and associated commercial and investment risk, with the private sector, maximizing potential benefits from efficiency gains and access to private sector financing.

DEVELOPING COUNTRIES, BY TYPE OF CONTRACT, 1990–97

Source: PPI Database, 1998

But they also require significant government commitment, and efforts to create a credible regulatory environment for private investment. Of ninety-seven contracts with the private sector in developing countries, forty-eight are concession contracts, accounting for 50 percent of all water and sewerage projects and 80 percent of all private capital investment (see chart alongside).

Developed countries vary in the type of projects and contracts they entered into with private companies to supply water and sanitation services. France typically operates on the system of handing out management contracts to private companies. All the assets and infrastructure are built and owned by the local municipality. Increasingly, concession projects are being entered into, where the private company is responsible for some portion of capital investment in the infrastructure. Germany has started getting more private involvement in water and sanitation through divestitures in state utilities. One of the largest so far is in the Berliner WasserBetriebe, with Vivendi holding 49.9% of the shares and the local government the rest. In this way ultimate control is, theoretically, kept public. Britain is the only country which has gone for 100% divestiture of water and sanitation companies to the private sector. These companies were formed in 1989 and floated on the stock exchange. The USA has public utility corporations which are privately managed but publicly owned. All the assets remain in the public sector. Often private finance, in the form of bonds, is relied upon. There is a trend towards increased private sector involvement and control such as through BOT contracts. The Netherlands also has publicly owned but privately managed water utilities.

By contrast, in the energy sector most private projects are greenfield projects or divestitures. Differences in government objectives help explain differences in the contracts preferred in each sector. In the energy sector private involvement has been driven largely by an increasing demand for new capacity, requiring significant private sector investment. In the water sector
most developing countries not only need to expand capacity and distribution networks, but also face high levels of unaccounted-for water and inefficient services. The creation of new capacity detached from the management of
distribution networks can exacerbate system inefficiencies. In effect this means that the construction of new infrastructure can increase the pressure on existing infrastructure. For example, a new water treatment plant coming on line will place more pressure on the distribution network, increasing leaks. Greenfield projects don't give the private contractor the incentive to take these issues into account. Whereas concessions can encourage the improved management and maintenance of the whole network.


Privatisation Vs Corporatisation

 

The debate between proponents of the two models has become increasingly polarized. As discussed above, PPP can take many forms, with varying levels of private sector involvement. Corporatisation, the creation of a publicly owned company which is managed along 'corporate' principles, offers a way to retain control of the service as well as the assets in the public sector.

Municipal Bonds -- expanding local markets


In the United States and Canada, subnational governments rely on the bond market. Bond debt issued by subnational
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: OECD Report, 2000

In this model the government is still responsible for the provision of water services, but can raise money on commercial capital markets to do so. Frequently this money is raised through bond issues. This allows members of the public to invest in the utility in order for it to finance capital as well as O&M costs. The problem for developing countries is that, frequently, their local capital markets are not well developed. This makes it difficult for them to raise money through issuing bonds (see box alongside). The result is that governments are forced to either borrow internationally or invite private companies to invest in the utility.

Once this happens the situation moves into the realm of PPP of one sort or another. Development assistance from the World Bank is often tied to the condition that services will be privatised. Frequently the result is that countries have little choice, other than to call in private companies. As the private company will be taking on a portion of risk when it makes a capital investment in the water sector, it will want some form of control as security. Depending on the level of investment to be made the company will be granted control over water and sanitation for anything from 2 to 30 years. The extent and duration of the control will be dependent on the contract and project type, as discussed above.

Full-scale PPP is the joint ownership of water assets and co-responsibility for the provision of water services. The public and private sector investors can either form a new company or share ownership of an existing one. Under PPP joint ventures, the government remains the ultimate regulator, but it also is an active shareholder in the operating company. From this position, it may share in the operating company’s profits and help ensure the wider political acceptability of its efforts. The private sector partner often has the primary responsibility for performing daily management operations.

Joint ventures require that both parties accept the idea of shared risk and shared reward. Each must be willing to make quantifiable contributions throughout the project development and implementation process. Different approaches to financing can be used depending on the nature of the services to be performed – varying from those under service contracts to those resembling concessions.

 

Potential Strengths of PPP Joint Ventures

Joint ventures combine the advantages of the private sector – dynamism, access to finance, knowledge of technologies, managerial efficiency, and entrepreneurial sprit –with the social responsibility, environmental awareness, local knowledge, and job generation concerns of the public sector. Under a joint venture, both the public and private sector partners have invested in the company and therefore both have a strong interest in seeing the venture work. This can allow for better conflict management.

Full responsibility for investments and operations gives the public and private sector partners a large incentive to make efficient investment decisions and to develop innovative technological solutions, since any gains in efficiency will directly increase their joint returns. Early participation by the public and private sector partners allows for greater innovation and flexibility in project planning and helps ensure that both the public and private partners are able to optimize their goals. Early dialogue between the public and private sector partners can help reduce the transaction costs associated with more traditional tendering processes.

 

Potential Weaknesses

Kelantan, Malaysia: State Government Buys Back Privatized Water Supply

Thames Water has agreed to sell its entire 70% equity in Kelantan Water for MYR 50 million (EUR 12.4 million) to the Kelantan State Government. Kelantan Water was set up as a joint venture between state agency Yayasan Kelantan Darulnaim (30% equity) and Thames Water (UK) in 1995.

Burdened with debts of over MYR 100 million, the company was unable to implement any pipe infrastructure works, bringing housing and commercial projects in the state to a standstill. The people in the state also had to endure low pressure, disruptions and unhygienic water supply. The Prime Minister has offered a MYR 600 million (EUR 149 million) soft loan to the Kelantan government to solve the current water crisis.

Source: OECD Report, 2000

The government's continuing regulatory responsibilities may lead to a conflict of interest in maintaining both public accountability and an eye on maximizing returns to the venture. This can increase the risk of political interference and reduce potential gains from private sector management. Private sector organizations tend to focus on the “bottom line” – governments on the process. These differences are often manifested in the timetables each sector considers reasonable and can create barriers during project development.

The early dialogue between the public and private parties involved in some joint ventures may lead to alternative public tender procedures such as direct negotiation. This can raise concerns about transparency and corruption in the selection of partners, which can affect political acceptability and additional private sector investment. Local economic conditions can also have an effect on the profitability of a joint venture. International private companies might not get their expected rates of return from the investment and this can potentially delay further investment in infrastructure (see box alongside).

 


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