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Public-private partnerships (PPP)

Inviting the participation of the private sector has recently been recognised as a means of making water supply and sanitation services more efficient and cost-effective, while raising revenue to improve long-term sustainability and generate investment for new infrastructure. Privatisation of public water companies can release funds for other development activities and reduce administrative burdens. Developing countries can also benefit from the know-how of commercial companies specialised in public services management. The involvement of the commercial private sector can help to underline the value of the natural resource and - given appropriate incentives - can also encourage measures to protect and conserve freshwater supplies.

A balanced partnership between public authorities and the private sector requires that their respective roles be clearly defined within a legal framework. The level of development in the country including the level of skills and capacities within the commercial sector, and the nature of institutions in water-related sectors will strongly influence the form of public-private partnerships. There are opportunities for the involvement of small-scale manufacturing industries and entrepreneurs in all water, irrigation and sanitation-related activities, but the involvement of the private commercial sector as a major partner in construction and administration of services is particularly important for the MWWS Focus Area. This was recognised in the Capetown Declaration, adopted by 20 African Ministers at the UNHCS International Consultation on Partnerships in Water for African Cities.

The two main objectives of private sector participation are:

  • (1) to ensure improved management and higher efficiency for service delivery;
  • (2) to promote long-term viability; and
  • (3) to acquire the capital neededfor investments. These two objectives interact. Improvements in efficiency result in cost savings that can generate investment funds, and the incorporation of private capital creates an additional incentive for improving operational efficiency. However, introducing marketplace economics into public health engineering has implications which have provoked considerable controversy, especially after a long period in which provision of water and sanitation infrastructure have been primarily regarded throughout the world as a public service to be provided from the public purse, or at least be heavily subsidised.

The key issue is how to set up institutional arrangements which allow the commercial sector freedom to introduce marketplace efficiencies while guaranteeing access to services to those communities - by definition the poorest and least able to exercise influence politcally or in the marketplace - who are already underserved and most at risk from public health hazard. In many poor urban areas, the poor already pay relatively high rates for water supplies to informal vendors and for waste removal to nightsoil removers. However, they are likely to remain outside the reach of any adequate form of engineered water or sanitation system unless there is affirmative action on their behalf. It is unrealistic to entrust the task of meeting their requirements to the commercial private sector, at least within the foreseeable future. The risk of private sector exploitation of their survival needs is very real. Thus, any set of institutional arrangements between the public and private sectors needs to address this reality as a priority.

Models of public-private partnerships The following discussion of models mainly relates to activities within the MWWS Focus Area, but the responsibilities of municipal authorities and government to address the needs of all citizens within a comprehensive framework should not be ignored. Thus, even where a project or programme is not intended for a low-income area for which a BWSS scheme is more appropriate, the need to generate funds for such schemes by tariff structures which take into account the need for subsidies elsewhere, should not be ignored. The form of public-private partnership should, in other words, recognise the totality of needs and requirements even if what follows mainly relates to commercial private sector participation in medium- or high-technology schemes.

There are many models of public-private partnerships including those employed by other utilities, for example electricity. The models range from contracting out the management of certain major installations, to full divestiture to autonomous water companies of responsibility for capital investment, operations, and commercial risk. When considering which model to use, a decision is required about the ownership of existing and future fixed assets: i.e. public ownership or private ownership. Under public ownership, public assets will be leased or rented to the private sector for a periodic fee. For private ownership, public assets are sold to a private sector utility company for a lump sum. The model of private sector involvement will vary according to infrastructure and institutional capacity. However, full privatisation of all assets is not suitable for most developing countries since an extremely rigorous legal and regulatory framework, with enforcement, is needed to make it workable in the public interest.

Various models of public-private partnerships are outlined below; these can be divided into models in which assets are retained in public ownership (1-4) and those in which assets are privately owned (5-7). Appropriate models should be selected to suit local conditions.

1 Concession
A private contractor or ‘concessionaire’ is responsible for the realisation of all new capital works including their operation, maintenance and management, as well as capital investments for expansion of services. Fixed assets remain the property of the government or public authority, and must be transferred to the public authority at the end of the concession, subject to exceptions specified in the contract. The concessionaire is fully responsible for maintaining and operating all fixed assets and other equipment. Concessions are long term (10-30 years) and tariffs are set by the concessionaire based on full cost recovery and may include a contribution to government (e.g. to cover historic debt). Financing and implementation of capital works are undertaken at the concessionaire’s risk.
2 Lease (Affermage)
The assets are placed at the disposal of the operator for a fixed period of time through a leasing or rental contract with the public authority owner. The operator is not responsible for capital investment for new or replacement works, which remain the responsibility of the public authority, who also retains responsibility for debt service, water rates and cost recovery policies. The operator is fully responsible for maintaining and operating all fixed assets and other equipment. Leases are for a medium- to long-term period of at least seven years. Tariffs are fixed by the operator and normally include remuneration to the operator to cover management costs and a contribution to the public authority towards asset depreciation. Commercial risks associated with the operation of the water system are carried by the operator and capital risks by the public authority.
3 Performance Management Contract
The assets are placed at the disposal of the operator but the operator is not responsible for capital works and carries no equity risk. The management company is paid a fee to manage the operation and for routine maintenance of equipment. The effectiveness of arrangements can be enhanced if funding and subsidy guarantees are provided to implement recommendations of the manager or technical consultant. Contract duration is usually for two to five years. The management fee contains a performance-based incentive element and tariffs are agreed between the operator and public authority. A variation of this type of arrangement is the Management Contract which is for a shorter term (one to three years) without a performance-based incentive and with no involvement by the operator in setting tariffs.
4 Service (Technical Assistance)
The assets and responsibilities remain with the public authority with technical assistance contracted from the private sector to provide advice on asset and capital programme management, metering, maintenance, emergency repairs, upgrading or construction of new facilities. The contractee provides technical or managerial advice to existing public sector management, but has no management responsibility and no equity. The effectiveness of arrangements is enhanced if funding and subsidy guarantees are provided to implement recommendations of the manager or technical consultant. Contracts are usually short term (one to three years).

The following are models in which assets are privately owned:

5 Joint ownership
With joint ownership a private sector company and public authority incorporate a firm in accordance with the normal commercial code of the country. A corporate agreement is required that spells out the objectives of joint ownership, the rights and obligations of each partner, and how profits will be shared between partners. The private partner typically has majority representation on the board of directors of the joint firm and prevails in its day-to-day management. Public and private expertise is brought together to the benefit of all.
6 Full privatisation
In this model the government sells all assets to a private sector utility company. The proceeds of the sale help the public sector to raise revenues. The attractiveness to private buyers depends mainly on the rates that they would be permitted to charge since the installations themselves have virtually no alternative value. Good communications and a very strong legal framework and regulation is required. This is the model that has been adopted by the UK.
7 BOOT (Build-Own-Operate-Transfer)
Under a BOOT contract, the private partner finances, builds, operates and owns a specific new facility or system. After a predetermined period of time, ownership of the facility is transferred to the public authority. There are many variations on this system, for example the reverse BOOT, where the public sector finances the new facility and then contracts a private firm to operate it over a long period of time with eventual transfer of ownership. This system encourages the private operator to maintain the facility well because it will become the owner at some point in the future. Other variations are the BOT (Build-Operate-Transfer) in which the ownership is transferred to the public sector as soon as the facility is completed.

The table below is a summary of the various options outlined above.

Option Ownership Financing Management

Concession

Public

Private

Private

Lease (Affermage)

Public

Public

Private

Management contract

Public

Public

Private

Service

 

 

 

(Technical Assistance)

Public

Public

Public & private

Joint ownership

Private & public

Private & public

Private & public

Full privatisation

Private

Private

Private

BOOT

Private then public

Private

Private

Risks implicit in all models
Private sector involvement in public utilities in developing countries offers constraints from the point of view of both the government and the private sector company related to the political, economic and regulatory environment. These combine to make any long-term programme uncertain. In any private sector activity, investors have to be prepared to take risks; but there are also risks to the government and to users that are multiplied in countries with weak or under-developed institutional structures. Some of these have already been outlined above, and relate to access by the poor; there are also questions surrounding the capacity of the private sector to meet quality standards, safeguard public health and support long-term environmental protection of the resource.

 

Some of the common risks to investors are outlined below:

Monopoly risk

Water supply is a natural monopoly and it is uneconomic to duplicate a water and sewerage network. As a consequence, competition is difficult to achieve. Thus regulation is necessary in order to protect the consumers from possible monopolistic behaviour of the private contractor.

Commercial risks

Companies/contractees may not be paid for services at all times, nor be able to recover costs in the long term, or unable to make a reasonable profit. Financial risks such as currency devaluation or convertibility of local to foreign currency need to be taken into consideration. Revenues are usually in local currency and some of the investments are in foreign currency.

Technical risks

There may be lack of sufficient knowledge about the state of existing installations, the need for replacement or rehabilitation, and the expansion needs and priorities. These may result in operational risks that the installations will not perform as expected.

Political risks

These are associated with the reliability of payment by the government of its water bills or subsidy payments; they could also relate to public expectation that services be provided at low cost and therefore company activities may provoke resistance and even sabotage.

Policy risks

These relate to the adverse conditions that may arise due to arbitrary or ad hoc changes in the regulatory, legal and economic policy framework.

It is important that all risks are evaluated and mitigated. Risks should be shared between the private and public sector and whoever can control the risk best should assume it and receive adequate compensation for doing so.

Measures to protect vulnerable groups

Measures to protect vulnerable groups must be clearly set out in any contract between government and private operators. Tariff structures to cover subsidies for low-income areas from low-value uses of water by well-off groups may be involved; or government may provide subsidies for coverage to low-income areas. There may also be opportunities to link basic services provided and/or run by NGOs and community groups with commercial operators.

Contracts and regulatory activity

One of the most important factors to determine the success or failure of privatisation is a well-defined contract. This should state the relationship between, for example, the concessionaire and the regulatory body and define the roles, functions and responsibilities of all the actors including consumers. A successful public-private partnership will maximise benefits to consumers. It is important that consumers are informed and educated about the reasons for involving private operators in what is generally perceived as a natural, public monopoly.

An effective regulatory system is necessary to facilitate financial viability of projects and services and to oversee compliance with the contract. The regulatory body should be transparent and independent and should have access to legal recourse, whenever this becomes necessary. In some cases a newly established regulatory agency will need to be strengthened institutionally in order to be able to deal with experienced private operators.

The main objectives of the regulatory body are to:

  1. (1) ensure compliance with standards of acceptable service as established in the contract;
  2. (2) protect the customer from possible monopolistic behaviour of the private contractor; and
  3. (3) create a business environment which promotes commercial viability and is attractive to the private sector.

It is also important that there are institutional incentives that include performance evaluation systems under the contractual arrangement. These arrangements should enforce a more effective use of investments. The main characteristics of a regulatory regime would be: to ensure a clear separation of operating and regulatory functions, establish investment and maintenance responsibilities, establish a tariff structure based on efficiency criteria, incorporate a system of direct subsidies for low-income consumers and to implement a long-term capital cost recovery concept.


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