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Country Water Action: Philippines
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How do you privatize a water and sanitation service, then make it difficult to succeed?
The short and simple answer: Avoid any kind of regulation. That way, contractual expectations by either the government or the private operator can more easily go unmet.
That’s the story of Subic Bay, a growing commercial port area and former U.S. naval base about 120 kilometers northwest of Manila, Philippines. It was the first build-operate-and-transfer (BOT) scheme for a water and sewerage system in the Philippines and Southeast Asia.
But any public run system struggling with low revenues, failing infrastructure and a frustrated public can easily relate to the Subic Bay story.
One of the private operator there—the British water utility specialists Cascal—and the fairly-new regulatory board believes the area has lost vital time, money and growth opportunities because of problems stemming from a lack of regulation in the first 5 years of the contract.
As with a private or public system, real troubles begin with shortfalls in revenues from user charges or reduced demand. Eventually, operators find themselves spinning their wheels in sinking profit margins, if there are any profits at all, which are needed for capital improvement projects.
Recently, Graham Fairclough, head of the Cascal office in Subic, and chairman of the Subic Water Regulator Board Antonio de Vera had a friendly face-off during a session at a subregional water financing conference hosted by the Philippine Water Partnership, the Global Water Partnership and the Asian Development Bank.
Here are both sides of the Subic Bay story—a lesson in why regulation matters.The Subic Bay story begins in 1992, when the United States vacated its naval base there, one of the largest U.S. foreign bases, turning over the water systems and services. Two years later, the World Bank developed a terms of reference and the local government advertised for a 25-year lease of the water systems covering the areas of the formal base and the neighboring city, Olongapo.
De Vera says three major issues caused the local governments involved to turn to the private sector:
In 1995, the BOT project was awarded to the Filipino construction firm DM Consuji Inc. (DMCI) in partnership with Cascal (formerly Biwater). The following year, Subicwater was formed by a joint venture agreement between the two private companies and two local government entities: the Subic Bay Metropolitain Authority (SBMA), which oversees both the city and the port area, and the Olongapo City Government. The SBMA granted the franchise for Subicwater to operate.
Through the joint venture, the two government agencies retain ownership of the system’s assets, earn from lease payments on the infrastructure over a 25-year period and receive profit dividends of 20% and 10% respectively from Subicwater.
By April 1997, Subicwater officially took over service provision for the area.Shortly after operations commenced, Cascal’s Fairclough said Subicwater started lobbying the local government to set up the regulatory board, which is a contractual obligation. What followed was five years of wrangling between the operator and the local government.
Fairclough’s timeline of events reads of frustrations: Changes in local government; consultants hired in place of a formal regulatory board; and a constant battle over tariff increases.
Eventually, the two sides found themselves in court. An agreement was reached in early 2000 and by the end of that year a regulatory board was nominated and appointed. 
Finally, the day had come and the Subic Bay Water Regulatory Board was operational in January 2001. Subicwater did not waste any time, and that same month, petitioned for a tariff increase, which was partially granted in October that year.
The new water regulatory board is made up of five board members:
Despite de Vera’s years of experience in national regulation, dealing with Subicwater and Fairclough does not necessarily come easy for him. Originally, he refused the offer to chair the regulatory board, which he now jokes about. “I had studied the concession contract with Subicwater,” which he says is skewed to favor the operator than the government, “I knew the water problems the area was facing and I knew of the performance history of Subicwater’s first several years of operation. I also knew a bit about the local politics. And I said, ‘No way. I’d be crazy to take that job.’”
Call him crazy then, because de Vera did take the job. And the fact that he is entirely independent of the operator, the local government and politics in general, has made him a tough match for Fairclough, but just the kind of watchdog any government and customer group would want.
Subic Bay may be on its way to the kind of progress envisioned for the area back in 1994, when the local government first began courting the private sector for solutions. But the struggle to get to today’s progress came at a steep price for both parties.
Subicwater clawed its way through five dismal years of performance levels before the regulatory board was established and tariffs began to finally increase to more financially viable levels. The company posted negative net income by as much as 29%. It made no gains in cutting system water losses or expanding the system with new connections and capital expenditures fell from 97 million pesos in its first year to just 4 million pesos by its fifth year as operator—a result of unsubstantial revenues and tariff levels.
The establishment of the regulatory board began a dramatic turnaround for both the company and the government. Revenues are up, system losses are down, staff per connection is leveling and capital expenditures are up again, around 55 million pesos in 2005.
Nine years into Subicwater operations, de Vera says the system and service levels are visibly improving. There is abundant supply and high pressure, although still few new connections.Still, Fairclough calls the current regulatory situation “a best compromise.” He says, “Despite political pressures, all appointees have acted very fairly, but pressures remain.” What he really prefers is to be regulated by a national water regulator, which he believes would protect Subicwater from local political interests getting in the way.
De Vera says a national regulator could make matters worse for Subicwater. The national board would have a limited capacity to understand local problems and would be overseeing thousands of utilities across the country, creating more bureaucratic delays.
Fairclough also says the board has a difficult time auditing Cascal’s operations of Subicwater and reviewing their requests. The regulatory board needs comparable benchmarking data, but there are few similar operations like Subicwater to offer that picture. As a result, Fairclough said the company has had to open its books entirely to the regulatory board and offer “extremely detailed” operational reports. This exposes Subicwater to risks of micro-management by the regulatory board, Faircough said.
Fairclough said he expects more progressive action by the regulatory board, particularly with tariff levels and giving more attention to future investment plans. Currently, the regulatory board holds annual reviews of Subicwater and is now working with Subicwater on a 3-year plan.
“A funding issue has been finding long-term financing when the government is only interested in 1-year reviews … yet there is a 30-year-plan in the contract,” Fairclough says.
De Vera says Fairclough may not be entirely satisfied with the regulatory situation, but a “best compromise” is exactly what he is after as chairman of the regulatory board. “On one side you’ve got the public, another side the government and another side the operator. You balance and are fair with great difficulty,” de Vera said. “You try to do what’s best for everybody, although everybody is never going to be happy with you at the same time. That’s regulating.”
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