Water

You Said Private Sector Participation?
June 2008

By Hubert Jenny
Senior Urban Development Specialist, ADB

"Privatization is not for us! It will never happen here!" is an oft-repeated claim by many a public official. But the truth is private sector participation (PSP) comes in many shapes and forms and many implement it without clearly labeling it as such. Outsourcing an internal service such as janitorial, security or accounting services—a common practice these days—is now viewed as an emerging form of PSP. With so many forms and factors to consider, how can utilities take an easier plunge into PSP?

Water supply provision is a monopolistic and public sector activity by tradition. But water utilities require cash at levels that public funds cannot always meet. Involving private players can generate the financing, expertise, and innovation needed to improve services. In some cases, they can even promote or fast-track the implementation of more transparent and fair processes, regulation, and laws.

Clearly, PSP has its uses. But are the choices available just as clear?

PSP¹ in water comes in many shapes and forms, and they vary depending on the scope and the risk allocation between public and private sectors. What exactly are the different forms of PSP?:

Service Contract: The private sector takes over some part of the operation and maintenance (O&M) of the water company without any responsibility and say on the management. The contract is given for a fixed or variable fee for a specific task.

Management Contract: The private sector takes over the technical and administrative management of the water company and has responsibility for human resources and operation and maintenance, with some performance indicators defined and monitored.

Leasehold or Affermage: Similar to a management contract, but with added responsibility on collection of revenues and a long list of performance indicators to meet as part of the contract.

Concession: The two main forms of concession are the Build - Own - Operate (BOO) and the Build - Own - Operate - Transfer (BOOT) and its variations, Build - Operate – Transfer (BOT) and Build – Transfer – Operate (BTO). In the BOO, the private sector finances the assets plus operates and maintains them for as long as allowed by law. In the BOT, the private sector also finances the assets, operates and maintains them, and transfers them back to the public sector at the end of the contract for a pre-determined residual value.

Divestiture: The public sector sells to the private sector part or all of the assets of the water company, usually through sale of the company's shares.

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The rationale for private intervention in the public sector is always either or both of these:

• To provide alternative sources of financing to public funding; and
• To improve the level of service.

Before any public utility takes a decision on the form of PSP they can undertake, they need to ask these crucial questions:

• Who will own the assets?
• Who will finance the capital investment (CAPEX)?
• Who will finance the operation and maintenance (OPEX)?

The allocation of responsibilities and risks between public and private sectors in the different forms of PSPs are summarized as follows:

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The different forms of PSPs have been tried and tested through the years, with varying shades of successes and failures. To ensure a workable and sustainable partnership between the public and private sectors, what major factors should be put on the table whenever the prospect for a PSP in the water sector arises?

The need for Leadership: The different forms of PSPs are fraught with political and social obstacles. Stakeholders need to understand these obstacles, together with the benefits of, and the reasons for, the PSP. The leader needs to manage the expectations for changes and improvements, and this will likely take some time (some even spanning a few years).

The need for a Communication Plan: Often, the public and private partners have underlying suspicions about each other or questions about their partnership’s deliverables and mechanics. Stakeholders must

• clarify the responsibilities and the risk allocation between the public and the private sectors;
• identify measurable objectives, performance indicators and milestones, share them with the public, and update them every year;
• review the status of customer complains and their evolution on a year to year basis; and
• set a conflict resolution mechanism between the water company and the users.

The need for regulation: Regulation should be established even prior to the introduction of PSP. It can be done either by contract or by a regulatory agency. The former involves including in the contract key performance indicators that will be monitored against a pre-determined and agreed baseline.² As for the latter, experience shows that setting up a regulatory institution requires strong political that will to allow the regulation to be independent from political decision makers. The public sector capacity and service delivery can be defined and monitored through a benchmarking program.

The need for alternative financing model: These models will enable clients to maximize the financing instruments from the Asian Development Bank’s Innovation and Efficiency Initiatives. Among the possible avenues are:

• combining public and private sector loans;
• promoting lending in local currency, given that the revenues are also in local currency, partial credit guarantees (PCG) and political risk guarantees (PRG);
• conciliating the requirement for long term financing with the inherent short term maturity of private sector financing in local currency;
• developing Output-Based-Aid (OBA) or Small Scale Piped Network Providers to increase the number of consumers, and therefore the revenues, by pre-financing connection costs.

The need for a structured deal: A proper PSP deal cannot be improvised. In addition to the technical due diligence, financial and legal advisers should be retained to organize and set-up the competitive bidding process. The biggest shortcoming of a PSP deal is the failure to plan for the financing of future expansion and coverage of the system, with most of the focus on improving service delivery and financing the immediate component. A PSP deal can last for 20 over years and need to include plans to finance future investment. Furthermore, PSP should encompass the entire operation of the water and wastewater company in order to ensure an optimum service delivery; it does not make any sense to separate production of water supply and distribution as well as collection of wastewater and treatment.³

As best practice, it is good to have a separate company that owns the assets and another company for the O&M. Such a deal provides flexibility and protects the assets against any litigation. It also removes the issue of private ownership of the assets yet retains the advantage of a PSP arrangement, where the asset is publicly owned and its operations privately run. Should the operator be deficient in its service delivery, it can be replaced without having to renegotiate all the ownership and financing of the assets.

PSP should be seen as an opportunity rather than a threat. Under one of its many forms and shapes, PSP provides an improvement in the service delivery and access to service and financing, with the public sector remaining in the driving seat through planning and oversight from regulation.