Shake-out time for contract operators
- From: Vol 9, Issue 4 (April 2008)
- Category: General
- Region: Americas
- Related Companies: American Water, CH2M Hill, Severn Trent Services, Southwest Water, United Water and Veolia Water
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The US contract ops market seems to have settled into a kind of rhythm. The major players have accepted that achieving growth can be a frustratingly slow process.
When big public-private partnership (PPP) contracts came of age in the US during the 1990s, the market appeared promising – the private sector had very low penetration, and everyone expected a big leap forward.
But after a short period of growth, contract operators struggled to fulfil contracts, and the stream of sizeable new contracts tailed off. Why? Contractors found themselves in a cycle where intra-specific competition was so fierce that no winner emerged. “We fell into a trap,” says David Stanton of Southwest Water Company. “The market stalled for four or five years because of a bidding war amongst the privatisers,” he says, “and we suffered bad contracts which did not give us the opportunity to add the value we wanted. But we are all shaking out now.”
The contracts signed in the late 1990s suffered another weakness. “When the US Internal Revenue Service allowed tax-exempt bond emissions [in 1997], both parties looked for longer contracts,” says Gary Miller, senior vice president of business development and planning with CH2M Hill OMI. He notes, however, that “the contracts’ conditions did not evolve consequently, and that created problems.”
In 2001, the “big six” operating in the municipal sector of the US contract ops market (American Water, CH2M Hill OMI, Severn Trent Services, Southwest Water, United Water, and Veolia Water North America) set up an industry association in order to promote public- private partnerships in the US and to lobby the federal government. One of the results of the so-called Water Partnership Council (WPC) is that it was able to convince the other side – the municipalities – that privatisation is not against the public.
With better contracts, more organisation and collaboration, outsourcing started to produce tangible results: “You can see that the number of complaints decreased significantly with the introduction of PPPs,” says Patrice Fonlladosa, Veolia Water’s executive vice president for the US. “And Americans are quite pragmatic – if you do something, and you show good records, they will trust you.”
At present, market growth is driven by two forces. The first is that there is still space for the market to expand: “With only 2,000 PPP contracts out of 50,000 possible, the potential is huge,” says Patrick Cairo, EVP with United Water. “Even if we will never see a boom, the growth will be steady – once a municipality starts a PPP, it hardly [ever] goes back.”
The second driver is that water scarcity in the US is assuming biblical dimensions, meaning that pretty much every municipality has to do something to address it. Involving the private sector brings the necessary expertise to address water-related problems which many municipalities may find they are facing for the very first time.
Big cities have, in most cases, run their water systems for centuries. They have the expertise, and their budgets are big enough to employ experts. Rumours that New York wants to privatise one of its 13 wastewater plants and use it as a benchmark are now 30 years old. On the west coast, Los Angeles and San Francisco are also adamant that they will not open their systems up to private operators.
Nevertheless, water scarcity issues, combined with the current economic downturn, may generate new opportunities in America’s big cities. If no water comes from the sky, and the natural reservoirs are empty, desalination and water reuse are going to have to gain rapid acceptance as the only viable alternatives. In the present situation, with a federal deficit of more than $300 billion, no municipality wants to face the capital cost associated with designing, building and operating something it has never had to deal with before. Enter the private sector.
In terms of funding, tax exemption is for the time being restricted to municipal bonds, and as such, it is hard for the private sector to compete. Tax exemption is one of the biggest obstacles to private capital being employed in new projects, and although the EPA is pushing hard for tax exemption on private activity bonds, nothing is likely to change for the next five years at least.
Another obstacle more manifest in big cities than in small ones is local opposition to privatisation. The citizen’s view goes something like this: “We can always vote in a new public administration if we don’t like the political atmosphere. A private company with a long-term contract is much harder to get rid of.” Private contractors try to fight public opposition by showing deep involvement in community life. CH2M Hill OMI, for instance, organises local Olympiads and sets up computer centres in schools. Opposition from public workers, on the other hand, is harder to tilt, particularly in the North, where labour unions wield more power. Again, operators must find original ways to be accepted. In Jersey City, for example, United Water employees are classified as public employees, retaining their current wages, benefits and public retirement plans.
For small and medium-sized municipalities, the market is quite different. Local opposition tends to be weaker, and the advantages of bringing a private water or wastewater operator on board are clear to everybody – thanks to economies of scale which the larger operators can offer, the cost to the municipality decreases. But there are two other difficulties. Firstly, the competition is bigger, as small contractors can compete perfectly well with big ones at the local level. That is also why many people think there is still potential for consolidation in the contract ops market – big operators may try to acquire smaller ones to enhance their local footprint in certain areas.
There are obstacles, too. The first is the number. Big municipalities scarcely number more than 100, whereas there are tens of thousands of smaller ones, and these are so fragmented that they are much harder to cover. The solution is either a widespread network of sellers, or a centralised database of all the possible outsourcing contracts – something which simply does not exist [although we’re working on it – Ed.]
A further obstacle is the lack of uniformity in US regulation. The very fact that they are spread all over the country means that small municipalities have to follow different regulation rules. Although US Environmental Protection Agency (EPA) is a federal body, and sets national standards, every state can add its own local rules to the mix. That clearly poses a limit to the rapid geographic expansion of water operators.
As if that were not enough, the operators in charge of water and wastewater plants must be certified in the state in which they operate – and the certification is not valid in a different state. That poses a limit to the advantage of the economy of scale, and it is exacerbated by the chronic shortage of technical skills suffered by every company in the sector.
Apparently, many operators have a dream – an American Margaret Thatcher privatising the market from above. But every operator knows that in the US that would be not possible. E pluribus unum is a motto which recognises the authority of single communities, as does the US constitution. A federal imposition would simply not be accepted by the states. Each municipality has then to decide if it wants to outsource a service, and this process is necessarily slow. Nobody can help the private operators but themselves, through better relationships with each municipality and the highest level of internal collaboration to foster fair competition.