In 1997 the City of Atlanta privatized their waterworks system, entering into a 20-year contract with United Water. At the time, it was the largest and longest privatization of infrastructure in U.S. history. The deal garnered many awards including one from the National Council on Public-Private Partnerships and the U.S. Conference of Mayors.
However, in the past few months several issues have arisen in Atlanta regarding the performance of the water system, contractor payments or change orders, and the status of the system before the contract was entered into. Ultimately, while not perfect, the Atlanta water privatization presents a valuable opportunity from which to learnif nothing else, it teaches us what not to do.
In order to do this, we talked with many parties, including representatives from United Water, consultants, and city officials who were involved in the original privatization. Because of the continued contentiousness of the issue many people were not able to commentat least not on the record. This report does not place blame on either party, nor does it have "the answer" to fixing the problems. However, it does recognize that in order for the partnership to work, in the long run, both sides must be willing to make concessions.
The experience in Atlanta , while often cited as a failure of privatization, is not the death knell of water privatization. In fact, it is quite the contrary. The bottom line is that the drivers that originally pushed Atlanta toward privatization exist, worldwideand in many ways still do in Atlanta . Even more importantly the experience gives us valuable lessons to apply to future water privatizations.
II. The Push Toward Privatization The EPA and GAO Reports
In the last few years both President Clintons Environmental Protection Agency (EPA) and the U.S. General Accounting Office (GAO) have reported about the quality and environmental benefits associated with privatization of water and wastewater services.
The EPA endorsed privatization as a means by which local governments can meet environmental standards. Indeed the EPA wrote, "[Privatization case studies] provide concrete examples to local officials of how successful partnerships and other models can be used by communities to provide needed environmental services more efficiently. They also show how public-private partnerships can be used as a way to provide substantial benefits to both the public and private sectors, creating the classic "win-win" situation."
In August, the U.S. General Accounting Office (GAO) released a critical report on the status of U.S. water and wastewater infrastructure. The report noted that municipalities have been turning to privatization to address needed infrastructure improvements, rising costs, and more stringent regulatory requirements.
Using EPA estimates, communities will need an estimated $300 billion to $1 trillion over the next 20 years to repair, replace, or upgrade aging drinking water and wastewater facilities; accommodate a growing population; and meet new water quality standards.EPA projects a $650 billion shortfall between current spending levels and money that will be needed over the next 15 years. The Water Infrastructure Network claims spending will need to increase by $23 billion a year for the next 20 years in order to meet the growing water/wastewater treatment needs. Also, in May 2002, the Congressional Budget Office estimated that the cost of drinking water and wastewater infrastructure over the next 20 years would be $492 billion under a low-cost scenario and $820 billion under a high-cost scenario.
The GAO report also noted that the adequacy of user charges was a key indicator of sound management. However, the amount of funds obtained from user charges and other local sources of revenue was less than the full cost of providing serviceincluding operation and maintenance, debt service, depreciation, and taxesfor over a quarter of drinking water utilities and more than 4 out of 10 wastewater facilities. Fully 29 percent of utilities deferred maintenance because of insufficient funding! Even though 85 percent of drinking water and 82 percent of wastewater utilities covered at least operation and maintenance using user charges, capital costs are not fully captured.
In fact, while many utilities had plans for financing their future capital needs, nearly half believed that their projected funding over the next 5 to 10 years would not be sufficient to meet their needs. However, more than 25 percent of utilities lacked asset management plansand many more utilities did not include all of their assets or omitted key plan elements. Additionally, about 27 percent of water and 31 percent of wastewater utilities did not have plans for managing their existing capital assets.The report did note that "plans developed by privately owned utilities tend to be more comprehensive than those developed by publicly owned utilities."
Trouble is around the corner in many places. More than one-third of the utilities had 20 percent or more of their pipelines nearing the end of their useful life. In about 60 percent of water and 65 percent of wastewater utilities, pipeline rehabilitation and replacement was less than desired levels. Private utilities fared much better, in fact "public utilities were more likely than their privately owned counterparts to defer maintenance and major capital needs."
Ultimately, the GAO report signaled that privatization could improve the quality and operations of water and wastewater systems. Noting the despair that much of the U.S. infrastructure is in, there is a good opportunity for private market penetration and increased privatization as a result of the tremendous needs the U.S. systems have.
In addition, a 1999 survey found that privatizing water and wastewater services can improve compliance with environmental standards. Prior to privatization, 41 percent (12) of the facilities surveyed were not in full compliance with the federal Safe Drinking Water Act. One year after entering into a public-private partnership, all were in compliance with federal water standards. The same survey found that all of the privatizations resulted in lower rate increases than were planned prior to privatization, and at 17 percent (five) of the facilities, public-private partnering brought cost savings of between 10 percent and 40 percent, allowing local governments to avoid large increases in water rates.
III. How Does Atlanta Stack Up
Much of what the EPA and GAO report occurred in Atlanta . The system is one of the oldest and biggest in the U.S. serving over 142,000 accounts with over 2,400 miles of pipe in the distribution system, some of which was laid in 1875.
Over the last 40 years the Atlanta metropolitan area experienced rapid growth. In 1960 the population was a little over 1. 3 million people but that has ballooned to over 4. 1 million in 2000more than tripling the population. While Atlanta water works does not provide water services to the entire metro area the rapid growth is indicative of the climate and pressure that it has been under.
There was tremendous pressure and need to invest additional dollars to expand the capacity and reach of the system. It is evident that the necessary capital dollars were not invested by the current status of the system. Ultimately maintenance was deferred or never undertaken exasperating todays problems. While the water system does have its problems, they are not as dramatic as the wastewater systemas a result of being sued for violations of the U.S. Clean Water Act the City of Atlanta entered into a Consent Decree in September 1998. In the Consent Decree the City agreed to correct problems with its antiquated combined sewer operation. The initial deadline for correcting the identified problems with the combined sewers is September 2007.A year after this Consent Decree was signed another legal settlement was negotiated which is referred to as "The First Amended Consent Decree." The initial deadline for correcting identified problems with the sanitary sewers is 2014. City officials were planning on applying savings from the water privatization to pay for the much needed improvements in the sewer system.
IV. What (Exactly) Happened?
Before privatization operating costs ran about $50 million a year with poor service and a major need for modernization. Then Mayor Bill Campbell decided to privatize water operations as a way out, although he did not generally support privatization. In general, there was not much initial public support for the proposal. However, it went forward and United Water was eventually selected with a winning bid of $22 million.
Entering the contract negotiations phase the city had little idea of the exact location of water mains in the city, or their condition. The city did know that a high percentage of treated water was not billed, and probably leaked out between the treatment plant and meters. United Water (UW) insisted that the city make warranties on the system, but ultimately the city held firm and none were made.
United Water took over operations of the system on January 1, 1999 .
Fast forward to this summer, Mayor Shirley Franklin issued formal notice to contractor UW that they were not in full compliance with the terms of the 20-year contract reached in 1997. She noted that problems included: staffing levels, bill collection, and meter installation and repair. This came as UW was seeking an additional $80 million dollars for services they claim were provided outside of the contract.
However, city officials also say that they are saving less than $3 million a year, and there is no room for additional payments. UW officials dispute this claim, state that the city was paying $49 million for water services before privatization, and the contract only pays UW $21 millionan annual savings of $18 million. While there may be some monitoring and oversight costs associated with the contract, it should not be in the neighborhood of $15 million. If the city is only seeing a net decrease of $3 million, money must be flowing into other areas or swallowed by bureaucracy.
UW was given 90 days to "cure" complaints in four key areas: insufficient maintenance, poor bill collection, tardy meter installation, and an improper letter of credit. As of October 31, 2002 , the city reported that performance had improved but more improvement was needed. A scorecard will be used to evaluate the performance, which both sides agreed to, since it will be measuring actual outputs and outcomes rather than subjective measures.
In early October, another issue sprang up regarding the requested $80 million in change orders. UW produced letters that had been signed by then Mayor Bill Campbell authorizing the payments of nearly $80 million just before he left office. The letters would have reimbursed UW more than $10 million for work it claims to have done without compensation and increased the companys rates by more than $4 million for each of the next 17 years. Franklin has contested the validity of the letters and has called for an investigation. Ultimately, UW rejected the notion that the letters werent valid, but has since dropped its claim for the additional money rather than fight with the new mayor.
Still at issue in Atlanta is whether or not UW deserves more than the $21 million a year they are paid. UW is contending that the city grossly underestimated basic repairs and maintenance. Assumptions were built into UWs fee proposal. For example: that 1,171 water meters per year would break, requiring repairsbut in reality, 11,108 broke; another was that 101 main breaks would occur in a yearactual equaled 279; and yet another was that 734 fire hydrants would require repairwhen 1,633 needed it. Essentially UW assumed that the system would require one level of repair, when a different much higher level of repair was needed.
Ultimately the problem resulted from poor data, or in some cases no record keeping. The city did not have good records to establish a baselineeither data wasnt kept, wasnt kept accurately, or existed but was understated due to bureaucratic malfeasance. However, some of the blame must fall on UW. All of the bidders knew about the lack or quality of data ahead of time before they bid. Furthermore, UW has a lot of experience running old systems (older and larger than Atlanta s) and they should have built that expertise into their proposal.
V. Why Atlanta Is Different Trends and Experiences in Water Privatization
Atlanta s experience with water privatization is not typical. Satisfaction with water and wastewater privatization has been very high, with over 90 percent of communities choosing to continue privatization at renewal time.
Water privatization is not new, rather converting government-owned facilities to private ownership or management goes back at least three decades. Water and wastewater service privatization follows broader privatization trendsthat show a continued increase in privatization. More than 40 percent of drinking water systems nationwide are private, regulated utility systems. Of the 60 percent of systems owned by local governments, privatization by contracting for operations and management has grown rapidly in recent years. In 2001, nationwide privatization of water and wastewater services grew by 13 percent, after growing by 84 percent over the decade of the 1990s. At the end of 2001, nearly 1,300 local governments have privatized operation of wastewater systems, and over 1,100 have privatized operations of water systems.
Governments seek privatization for many reasons. However, the combined factors of growth, age, and regulations have led to a capital-funding crisis for water and wastewater facilities. Extending systems to cover more area or to handle increased demand is costly and complicated. Furthermore, many water and wastewater systems include water, sewer infrastructures that date back to the early 1900s.The most recent systems were built with federal funds during the 1970s, and even these now need upgrading or replacing. Also in order to meet increased standards through the Clean Water Ace and the Safe Drinking Water Act, many systems will require improved technologies and upgraded infrastructure. Despite the increase in mandates, over the years, the federal government has reduced its contributions to local water systems forcing local governments to rely on local funds to meet these regulations.
In the face of such a crisis, surveys show that privatization is a policy tool to which public officials often turn. Local government surveys have found that public officials turn to privatization in response to fiscal crisis and/or when privatization has been shown to work in other jurisdictions. According to the U.S. Conference of Mayors, four out of ten cities are actively considering privatization in order to reduce costs and attract private capital investment.
So how have other cities faired? The following two case studies are taken directly from the U.S. Environmental Protection Agency, Environmental Finance Program, A Guidebook of Financial Tools Section 4. B. Public-Private Partnerships and Optimization Case Studies.
Indianapolis , Indiana (Contract Operations, Maintenance, and Management)
Description: This partnership involves the contract management, maintenance and operations of two advanced wastewater treatment (AWT) facilities by a private operator. Prior to the contract, both facilities were sophisticated, state-of-the-art, and operated at a high level of efficiency. The facilities include preliminary treatment, primary clarification, biological treatment via bio-roughing and oxygen nitrification, followed by secondary clarification, effluent filtration, and ozone disinfections prior to effluent discharge into the river. Also included in the contract were the associated sludge handling facilities, laboratories, and pretreatment programs. Excluded from the contract were sewer collection, billing and collection, and customer service functions. Major capital improvements remain the responsibility of the City.
Demographics: The Indianapolis area has a very stable and diversified economy, with average growth of approximately 1. 5% annually. The two AWT facilities serve 850,000 to 900,000 people (400,000 accounts) in the greater Indianapolis area, which includes all of Marion County .Total average treatment capacity of the plants is 300 million gallons per day ("MGD") - 150 MGD each. The plants were 11 years old in 1993 when the procurement began.
Procurement/Competition: The City wanted to improve operation, maintenance, and management (OM&M) while cutting costs and generating revenue for system improvements. The City looked at many options and chose to compete the OM&M of the facilities. In selecting this option, the City retained the tax advantages of public ownership and gained savings via private sector efficiencies.
A task force was formed to evaluate proposals. It included members of the City-County Council, utility management and staff, regulatory officials, general citizens, and the union the American Federation of State, County, and Municipal Employees (AFSCME). Relations between the City and AFSCME were originally constrained, but they improved over the course of the procurement. The winning proposer honored the agreement between AFSCME and the City and guaranteed jobs. All employees were placed within two months. The entire process, including the preparation time for procurement, took 8 to 10 months. It cost $200,000 to $300,000 for advisors, consultants and engineers. This amount was recovered by the City through contract savings within a few weeks.
Proposer Selected: White River Environmental Partners (WREP), a group of private firms, was selected to operate, maintain, and manage the two AWT facilities. WREP's proposal guaranteed 38% savings over the previous year's budget, and the professional capabilities of the companies in the group were considered superior to the other proposers. WREP must meet NPDES requirements, is responsible for any penalties as a result of violations, and must maintain the same effluent level or better than under City operations. WREP is subject to selective audit by an overseeing "board" to ensure both compliance with the contract and the quality of private operations.
Benefits: WREP operations are projected to save about $60 million over five years. Between 1993 and 1994, the facilities' O&M budget was reduced from $30 million to $17 million and the number of employees reduced from 328 to 196.By June 1996, 168 WREP employees staffed the facilities.
The City has held rates constant due to savings, but they are expected to grow slowly in the future due to inflation. Instead of lowering rates, the City puts savings into a Sewer Sanitary Fund used to improve the City's system. These funds have been used to dry out interceptors and collector systems and to provide sewer service to new areas.
Effluent violations have been cut from seven under City operations to one even though rains have been heavier than usual. The facilities accident rate decreased by 80% in the first two years of the contract and the Indiana Water Pollution Control Association gave its 1995 safety award to WREP. Since the contract began, employee grievances have dropped from 38 in 1993 to 1 in 1994, and none in 1995.
Drawbacks: The contract is only for five years. At the end of the contract term, the contract will have to be renegotiated. Any changes desired by the City or the private operator at that time must be incorporated into a new contract, or the City will need to re-propose the operations.
Lessons Learned: Although Indianapolis approaches each competition individually, it has developed general principles which guide its efforts:
(The creativity of these competitions was recognized in 1995 by an American Government Award from the Ford Foundation, presented jointly to the union and the City.)
[Note: After the EPA created this case study, a late-1999 report by the City of
Indianapolis examined the success of the White River Environmental
Partnership (WREP) in running the city's sewer collection system and wastewater treatment
plants since 1994.The report measured performance in three crucial areas:
In 1997, after three years of contract performance that exceeded expectations, the city decided to replace the existing five-year contract with a new 10-year contract extending through 2007.Total savings from the contracts from 1994 to 2007 are expected to total $250 million. To date, the city has used most of the savings for capital improvements in the sewer system and treatment facilities and for rate reductions. ]
Jersey City , New Jersey (Contract Services)
Description: In the summer of 1995, the City of Jersey City (City) sought to privatize the operations of its Water Department through the efforts of a new Mayor elected on a pro-business and privatization platform. After investigating options, the City projected that large cost savings and the increased revenue could be achieved through a public-private partnership. After issuing a comprehensive Request For Proposals (RFP) and carefully evaluating the proposals, the City entered into a three-year operating contract (with two optional one-year renewals) with United Water Resources (UWR).
Demographics: Jersey City has a favorable cost of living and tax environment for attracting business. Wages are relatively low as are taxes and other city charges for utility services. Many New York City companies have offices in the City due to the lower cost of doing business. In recent years the City has had economic problems, and as a result, the Mayor has focused on the City's economic development and financial challenges. He has been instrumental in promoting privatization and desires the most cost-effective method for providing water services.
The Jersey City Water Department provides water service to about 32,000 retail customers located in the New Jersey metropolitan area across the Hudson River from New York City. Potable water is pumped via aqueduct to the Jersey City area, where it is distributed to retail customers. Wholesale customers in Hackensack, New Jersey and the municipalities of Hoboken, Lyndhurst, and West Caldwell are served along the aqueduct.
The City-owned system consists of two reservoirs, 5,700 acres of watershed property surrounding them, a treatment facility, and an extensive transmission and distribution system. The reservoirs have capacities of 3.3 and 8.0 billion gallons a day, respectively. The 80 million gallons per day (MGD) water treatment facility receives average daily flows of about 55 MGD. The water treatment plant is located adjacent to one of the reservoirs, 23 miles northwest of the City.
The City has had compliance problems with State and federal regulations in the past. In particular, the City had been stockpiling sludge from the water treatment plant and was forced to dispose of this stockpile, and further sludge generated, into a regulation disposal site.
Procurement/Competition: A steering committee was formed, consisting of members of the City Council and key staff personnel involved in providing water services. Labor unions were active in the process, as were water utility managers and the City's Business Manager. Raftelis Environmental Consulting Group managed the privatization feasibility and procurement process, assisted by W. R. Lazard on financial issues.
A detailed RFP was prepared and proposers were evaluated on technical merit, management, operations and maintenance approach, experience and responsiveness, ability to meet contract obligations, and price. New Jersey had recently passed a privatization procurement act for water utilities and the procurement required approval from several State agencies. The procurement took about one year, cost $300,000 to $350,000, and the contract was signed on April 1, 1996. Given projections for savings and increased revenues, gaining the City Council's support was straightforward. Labor unions were brought into the process early and were heavily involved in negotiating the contract. An innovative leasing of employees was the basis for agreement. The contract required the privatizer to use all employees for at least one year.
Proposer Selected: The City entered into a three-year operating contract with UWR. The contract privatized all water services including source of supply, treatment, distribution, meter reading, billing and collection, and laboratory services. UWR assumed liability for any fines due to regulatory violations. The City retained rate setting and policy making functions. A creative cost-sharing approach was negotiated to encourage a decrease in uncollectables, promote marketing of water services to new wholesale customers, and reduce the amount of unaccounted-for water.
Benefits: The City is projected to save about $38.5 million over the five-year contract period: a $2.5 million up-front concession payment to the City by UWR; $17.5 million in operational savings; and $18.5 million from increased revenues to the utility via improved collections and bulk water sales. The contract has incentive clauses which allow UWR to earn additional revenue if it increases the collection rate and successfully markets excess water. Instead of lowering rates, the City is using cost savings for capital improvements in the system. UWR has begun a comprehensive predictive and preventive maintenance program unavailable to the City. Privatization is expected to lead to improved customer service and expanded opportunities for employees via training and higher pay.
Drawbacks: Although unions were included from the beginning, the transition of labor to private operations was difficult. Since UWR chose to base its customer service operations in its Hackensack headquarters, concerns were raised about UWR's ability to be as responsive as City operations.
Lessons Learned: A comprehensive, detailed RFP and frank negotiations with all parties are essential. A Draft Service Agreement which gave proposers expected contractual requirements was invaluable at the time of actual contract negotiations as all parties were on the same page. Labor negotiations played a major role in the privatization process and cannot be downplayed.
VI. Whats Happened Since in Atlanta
This summer, Mayor Franklin sent a formal notice to UW that the city was dissatisfied with its performance under the contract. Franklin cited problems including the firms staffing levels, bill collection, and meter installation and repair.
Since Franklin issued her report and list of grievances there has been better communication between the two parties. UW had changed leadership, in an effort to salvage the strained relationship and start anew. The two parties are working through the contract settling ambiguities in the contract and setting acceptable service standards. Prior to the report, neither side was openly or effectively communicating.
According to Franklin, United Water went into default and entered into a 90-day cure period in August. UWs performance has improved since, but there continues to be room for improvementboth sides openly acknowledge this.
UW has been very responsive to Franklins concerns. For starters, they have dropped any claim on $80 million payment approved by the outgoing mayor, as well as committed an additional $9 million to catch up on backlogs in service.
VII. Whats Gotten Lost
Three things have gotten lost over the past few months during this debate. First, the notion of relative performance. Under public operation, Atlanta s water system always had its critics and complaints about performance, slow repairs, and erroneous water bills. While UW's service is far from perfect, they are completing more repairs and quickly rehabilitating various components of Atlantas infrastructure than was ever completed under municipal operation. For example, the contract calls for upwards of 4500 fire hydrant repairs annually; UW is completing about 4000 a year, which is better than the approximate 3,000 municipal operations completed before priva tization.
Second, on its face alone they are saving the city a significant amount of money. The city was paying $42 million a year, and now only pays $21 millionon its face a savings of $400 million over 20 years. There are some monitoring and contract administration costs associated so the savings probably are not that high, but the city should be realizing significant savings. Despite that it is now a moot issue; even if the $80 million change order were approved it would be saving the city nearly $320 million over the 20-year contract life. UW is also injecting a great deal of capitalresulting in even further savings.
Thirdly, Mayor Franklin is demanding performanceshe deserves it and is entitled to it. However, could the same demands be made of public operations? The advantage that privatization has is the contractit is the mechanism that allows more direct oversight, transparency, and more accountability. One thing is certain, under public management Franklin would not be able to enforce a cure period or withhold payment. The fact that Atlanta s system toiled for so many years is evidence of this. Simply put, under privatization the city now has additional powers to demand performance and improve the quality and level of service of their waterworks department.
When you couple relative performance (i.e., more work being completed) with the significant level of savings Atlanta is getting a great deal. Essentially Atlanta is getting more with less.
VIII. Lessons from the Atlanta Experience
What will ultimately happen remains to be seen and will play out in the coming months. The Atlanta deal will offer some valuable insight into how to structure and negotiate public-private partnerships.
IX. Recommendations for Atlanta
The city of Atlanta is at a crossroads. It can abandon the partnership with United Water and opt to bring operations back in-housepossibly a political popular move but not a fiscally sound one. Is there any indication that in-house operations will be any better than they were before when privatization was sought out to fix the system? Rather, city officials need to think long term. Atlanta's water and wastewater systems need dramatic infrastructure improvements; while the city remains fiscally strapped. Atlanta cannot afford not to keep the partnershipthe city cant afford to leave the great potential future benefits on the table. The contract and partnership need to be changed or fixed to make this a success from this point forward.
In order for this to happen, both sides will have to give a little. Specifically:
X. About the Author
Geoffrey F. Segal is director of Privatization and Government Reform Policy at Reason Foundation. He is also a research fellow at the Davenport Institute for Public Policy at Pepperdine University s School of Public Policy. Mr. Segal was a fellow at the 2002 general meeting of the Mont Pelerin Society in London.
Mr. Segal has authored numerous studies and articles on privatization, government performance, accountability, and efficiency. He is also editor of Reasons monthly newsletter Privatization Watch and the Annual Privatization Report. His articles have appeared in publications as diverse as Investors Business Daily, Intellectual Ammunition, L. A. Daily News, and Orange County Register.
Mr. Segal has presented his research at numerous conferences around the world. He has appeared in front of the cities of Phoenix, San Diego, and Stockton city councils as well as submitted testimony to the State of California. He is in demand as a consultant to numerous government officials on privatization, efficiency, transparency, and accountability .
Mr. Segal holds a Masters in Public Policy from Pepperdine University with specializations in Economics and Regional/Local Government. While at Pepperdine, Mr. Segal was named a Hansen Scholar. He graduated cum laude from Arizona State University with a Bachelor of Arts in Political Science.