Japan edges towards PSP

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Private participation in Japan’s water industry has been limited to date. However, the considerable financial strain on the sector has led to a series of reforms paving the way for municipal reorganisation and likely future PFI work for international private water companies.

While potable water connections cover 96.6% of the Japanese population, many of the existing WTPs and delivery networks were built after the Second World War, with a number constructed during the 1960s.

Not only does the country’s ageing infrastructure require significant capital expenditure, but there is also a need for a higher standard of treatment – typically by membranes – due to the steady degradation of water resources. Such a step up in the level of treatment also requires increased capital expenditure. According to an estimate by the Japan Water Works Association (JWWA), the total replacement cost for infrastructure built before 1975 is ¥15 trillion ($120 billion) for WTPs and ¥39 trillion ($312 billion) for distribution networks.

As for wastewater, 30% of Japan’s population is still not connected to a sewerage system. In towns with a population of less than 50,000, this proportion increases to around three-quarters.

Large combined sewerage systems in around 50 of Japan’s major cities date from before the Second World War and are in need of major renovation. Furthermore, increasing urban run-off in these cities adds to the pollution discharged by combined sewer overflows (CSOs). Annual capital expenditure on sewerage during the last seven years has averaged ¥3.4 trillion ($27 billion), of which 60% has been spent on sewers and 30% on treatment plants.

Such enormous investment needs have put a great strain on the public sector’s financial capacity. Since the Japanese economic boom came to a halt in the early 1990s, the economy has struggled to recover. Public works programmes designed to stimulate economic growth have simply resulted in the construction of roads and bridges in the countryside that nobody uses, together with a huge volume of public sector debt. At the end of 2001, the latter amounted to ¥458 trillion ($3.7 trillion) at the central government level and ¥187 trillion ($1.5 trillion) for local authorities, totalling ¥645 trillion ($5.2 trillion), or 130% of the country’s GDP.

An even more frightening prospect is the anticipated mass exodus of Japan’s ageing labour force from local government positions by 2010, requiring a one-off payment of retirement allowances. A peak in government bond renewals is also expected towards 2010, yet government debt is fast approaching junk bond status. If the prime minister succeeds in privatising the Japanese Postal Service, which currently buys most of the bonds, it will be very difficult to actually renew the debt.

Sector organisation
The dire financial situation is compounded by the highly fragmented nature of the Japanese water industry. The confusion starts at government level where the Ministry of Health, Labour and Welfare (MHLW) regulates potable water supply, and the Ministry of Land, Infrastructure and Transport (MLIT) controls urban sewage and flood protection. The Ministry of Agriculture, Forestry and Fisheries (MAFF) has responsibility for rural sewage, the Ministry of Environment for water quality and ‘non-collective sanitation systems’, and the Ministry of Economy, Trade and Industry (METI) for industrial water supply.

Potable water supply is also a highly confusing affair, as shown in Table 1. From a legal perspective, water undertakers fall into one of two categories – water suppliers serving more than 5000 people, and summary water suppliers which serve less than 5000.

Alternatively, a water undertaker can fall into one of the four categories shown above in Table 2 according to the type of service it provides. The sector is wholly publicly owned and operated, save for only a dozen exceptions which cover residential or resort development.

Japan’s sewage networks and treatment plants are administered in an equally confusing way. As is the case for potable water, there are numerous categories of undertaker and different ministries are responsible for different parts of the system. Table 3 attempts to summarise these. Again, it is a highly fragmented sector with over 4500 systems.

To counter the shortage of skilled personnel which results from this level of separation, a semi governmental agency under MLIT – the Japan Sewage Works Agency (JSWA) – pools and supplies technical and project management expertise for small municipal sewage undertakers.

Annual turnover in the Japanese water and wastewater sector amounted to ¥5.6 trillion ($45 billion) in the financial year ending March 2000. Capital expenditure was ¥6.5 trillion ($52 billion) in the same period. In terms of municipal water management, Japan therefore represents around 10% of the $400 billion global market, according to a recent estimate by Vivendi Environnement.

However, 23% of water supply undertakers are losing money. Similarly, wastewater charges – which amount to an average ¥3000/month ($25/month) for a consumption of 20m3 – cover only 60% of operating expenditure.

To date, private participation in water supply has been limited to metering and tariff collection under service contract arrangements. However, there is also an element of PSP in the operation and maintenance of STPs. The most notable player in this field is Nihon HELS Industry. Started by a Buddhist monk to operate small STPs near Tokyo in 1953, the company now operates more than 300 plants all over Japan with a total capacity of 17 million p.e.

Inspired by the early success of Nihon HELS, several private operators entered the plant operations market in the 1970s. These companies included subsidiaries of water treatment engineering companies, electrical system suppliers and some facilities management companies. However, apart from a dozen or so large firms, the market is quite disjointed with over 300 companies involved. The market for operating STPs and associated pumping stations was worth ¥520 billion ($4 billion) in 1997, of which ¥120 billion ($1 billion) was privately operated. The market is expected to grow by around 50% over the next ten years.

The impetus for change
In the last few years, the Japanese government has implemented a series of reforms which will eventually pave the way for reorganisation of the country’s water sector.

The first of these is a PFI Promotion Law passed in 1999. The law outlines general government policy for PFI schemes and pledges support where appropriate. Currently, over 50 PFI projects are underway, including a power generation facility for three WTPs and an STP in the Tokyo metropolitan region. However, the benefit of these schemes has so far been limited because of restrictions on PFI coverage. PFI projects have also tended to be driven by the need for design-build skills rather than the private finance itself.

The second major change is the decision taken in December 2000 to boost incentives for the consolidation of municipal governments. Measures include special subsidies for feasibility studies and project preparation work, as well as tax breaks during the first few years following consolidation. Currently, more than 2200 councils (70% of the overall total) are negotiating mergers with their neighbours. This move towards greater regional unity should bring about much-needed consolidation in the water supply and sewage sector by 2005.

The third aspect is a series of guidelines for the outsourcing of O&M work at STPs, issued by MLIT in April 2001. These guidelines recommend that municipal governments abandon their traditional method of contracting out operations – often a single-year contract – and opt for multi-year, output driven contracts in order to benefit from private sector expertise and efficiency.

In April 2001, with the arrival of Junichiro Koizumi at the head of the government, most Japanese believed they finally had a prime minister capable of carrying out far-reaching market reforms. Although the results so far have been rather disappointing, privatisation and liberalisation are still on the agenda, most notably for the postal service, as well as for roads and water.

However, the most significant reform of all was the introduction of a new water law in April of this year. The law simplifies the procedure for consolidation in the water supply sector, permits further management consolidation and authorises outsourcing and the transfer of WTP operations to a third party. MHLW, which drafted the law, envisages a period of consolidation led by Japan’s larger cities which would undertake to supply water services to other, smaller cities. However, the law doesn’t exclude the possibility of involvement by a private water company.

Private sector interest
A number of private companies have shown interest in recent market developments and have established strategic alliances (see Table 4). Vivendi Environnement was the first foreign operator to show interest, working with its long-time partner Marubeni.

Ondeo has a representative office for its engineering arm (Ondeo Degrémont) in Tokyo, but is not quite clear about its future strategy at this stage. RWE/Thames Water recently reactivated its joint venture with
Mitsui. The JV was initially set up in the early 1990s to transfer water treatment technology from Thames, but further to the two companies’ cooperation on the Izmit water supply BOT in Turkey, it evolved into a
consulting arm for water services management.

Mitsubishi, which is part of the Ayala/United Utilities consortium for the Manila East concessions and AWG’s partner for the Beijing No. 10 BOT, has stated that it is unlikely to partner with a foreign company,
preferring instead to be involved in a 100% Japanese venture to exploit PSP opportunities.

These international players, together with TOPS Water which is led by Kubota, a large industrial group involved in water treatment, are clearly betting on market evolution to a French-style system of concessions. Other Japanese consortia are more focused on smaller, plant operation type contracts.

It is still too early to speculate on the future development of the Japanese water market, but the die would appear to be cast. A number of municipal water service providers seem to be seriously considering letting concessions for their loss-making operations, or expanding their profitable businesses into other areas. Amongst others, Tokyo Metropolitan Water Services (which serves 11 million people) is reported to have submitted a privatisation proposal to Bangkok’s Metropolitan Water Authority (MWA) in 1999 and 2001.

Since the passage of the new water law in April, the municipal government of Geihokucho in Hiroshima Prefecture has contracted out the running of a WTP to the J-Team consortium, Saitama Prefecture is considering contracting out part of its water services, and the Marubeni/VE team is reported to be in discussions with Nagano Prefecture, again about contracting out water services.