Problems with Private Water Concessions: a Review of Experience

Public Services International Research Unit (PSIRU) www.psiru.org

Problems with private water concessions: a review of experience

Emanuele Lobina [email protected] and David Hall [email protected]

June 2003

Fully revised to June 2003. An earlier version of this paper was presented at Third World Centre for Water Management/Inter-American Development Bank Workshop on “PPPs in the Water Sector”, Mexico City, 25-26 September 2002

ABSTRACT...... 3 INTRODUCTION...... 3

DYNAMIC INTEREST-SEEKING BEHAVIOUR...... 3 EMPIRICAL EVIDENCE...... 4 DEFINITIONS...... 4 PART I – PSP IN PRACTICE: INCENTIVES, RISK ALLOCATION AND GOVERNANCE...... 4 PSP AND RESTRICTED COMPETITION...... 5

RESTRICTED COMPETITION AT GLOBAL LEVEL...... 5 Difficulty at entry in the global water industry...... 5 RESTRICTED COMPETITION AT LOCAL LEVEL...... 6 Joint ventures in France and internationally...... 6 Single-bid concessions...... 6 Endless concessions in France and internationally...... 7 POLITICAL ECONOMY OF WATER CORRUPTION...... 8 PSP AND RISK ALLOCATION...... 8

PERFORMANCE RISK...... 9 Guarantees...... 9 Renegotiation and reduction of investments...... 10 Weakness of performance bonds...... 12 ALLOCATION OF CURRENCY RISK IN PRACTICE...... 12 POLITICAL RISK AND IMPLICATIONS OF DISTORTED RISK ALLOCATION...... 13

Public Services International Research Unit (PSIRU) Email: [email protected] Website: www.psiru.org School of Computing and Mathematics, University of Greenwich, Park Row, London SE10 9LS U.K. Tel: +44-(0)208-331-9933 Fax: +44 (0)208-331-8665 Director: David Hall Researchers: Kate Bayliss, Steve Davies, Robin de la Motte, Kirsty Drew, Jane Lethbridge, Emanuele Lobina, Steve Thomas, Sam Weinstein PSIRU’s research is published on its website, www.psiru.org . It is centred around the maintenance of an extensive database of information on the economic, political, financial, social and technical experience with privatisation and restructuring of public services worldwide, and the multinational companies involved in these processes. This core database is financed by Public Services International (PSI - www.world-psi.org), the worldwide confederation of public service trade unions. PSIRU University of Greenwich www.psiru.org

The Buenos Aires crisis...... 15 PSP AND GOVERNANCE...... 16

ACCESS TO AND ASYMMETRY OF INFORMATION...... 16 CAPACITY TO REGULATE...... 17 LACK OF TRANSPARENCY AND ACCOUNTABILITY...... 18 CORRUPTION, STATE-CAPTURE AND GOVERNANCE FAILURE...... 19 WEAK ACCOUNTABILITY AND LACK OF PUBLIC PARTICIPATION...... 20 PART II – PSP IN PRACTICE: COSTS AND OUTPUTS...... 21 PSP AND THE COSTS OF INVESTMENT FINANCE...... 21

PSP, RISK AND TRANSACTION COSTS...... 22 PSP, RISK, INCENTIVES AND THE COST OF FINANCE...... 22 INTERNAL SUBCONTRACTING...... 23 PSP AND THE DYNAMICS OF WATER PRICING...... 25

POST-AWARD DYNAMICS...... 25 MAKING PRIVATISATION MORE APPEALING...... 25 CURRENCY RISK ALLOCATION AND PRICING...... 26 RENEGOTIATION AND DYNAMIC PRICING...... 27 TACTICAL RESOURCES OF TNCS AND DYNAMICS OF PRICING...... 28 PSP AND DELIVERY TO THE POOR...... 29

LIMITATIONS OF PRIVATE SECTOR IN DELIVERING FOR THE POOR AND DEVELOPMENT...... 29 TNCS’ ATTEMPTS AT SOLVING PROBLEMS WITH SERVICE PROVISION TO THE POOR...... 31 Global selectivity...... 31 Ring-fencing profitable customers...... 31 Making the poor profitable: the case of Buenos Aires...... 32 FINANCING WATER FOR THE POOR AND SUBSIDIES FOR TNCS: THE CAMDESSUS REPORT...... 33 PART III – THE POLICY OF WATER REFORM: MULTILATERAL AGENCIES, PSP AND THE PUBLIC SECTOR OPTION...... 33 POLICY ISSUES...... 34

MULTILATERAL AGENCIES, PSP AND THE POLICY BOTTLENECK...... 34 THE PROBLEM OF CONDITIONALITY...... 34 NEED FOR STRENGTHENING THE PUBLIC SECTOR OPTION...... 34 TABLES AND FIGURES...... 41 Figure 1. Global private water business compared...... 41 Figure 2. Joint ventures between leading water multinationals, 2002...... 42 Table 1. Uncontested water concessions in central Europe involving TNCs...... 42 Table 2. Investment and under-performance by Aguas Argentinas S.A., 1993-1998...... 43 Total...... 43 Service expansion...... 44 NOTES...... 45

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ABSTRACT Based on empirical evidence, this chapter looks at experience with privatised water supply and sanitation concessions and operating contracts in transition and developing countries, with particular reference to Latin America. The essay is an attempt to address the complexity of issues affecting PSP in the water sector from a dynamic point of view, that is to say taking into account how the interests, objectives and resources of private sector operators continuously shape their relationships with local stakeholders, citizens and local governments alike, and how the interaction between multinational companies and other actors affect the developmental impact of PSP. We argue that the introduction of commercial considerations into the system and the profit seeking behaviour of private water operators are major determinants of the economic, social, political and environmental results of PPPs. Such factors may explain the discrepancy between the theory pointing at PSP as the way forward and the results of PSP in practice. In a first part, we look at the structural factors determining the performance of private water operations, such as competition, risk allocation and governance. In a second part, we observe how the outcomes of PPPs, in terms of investment costs and pricing, and service delivery for the poor, are affected by the dynamics of interest-seeking. Finally, we briefly discuss the “policy bottleneck” resulting of IFIs and the current emphasis on PSP, and we urge the international water community to promote and support public water operations as a credible solution to enhance sustainable development.

INTRODUCTION Since the early 1990s, private sector participation (PSP) in water supply and sanitation has been introduced into a number of transition and developing countries (Braadbaart, 2001: 5; Nickson, 1996: 2). The advocates of private sector involvement, ranging from international financial institutions (IFIs), bilateral agencies, OECD countries’ governments, transnational corporations (TNCs), professional associations and scholars, have argued that PSP will improve efficiency, enable the extension of water services, raise the necessary investment finance, and relieve governments from budget deficits. As summarised by Idelovitch & Ringskog (1995: 1), “The three primary objectives of the public sector with respect to private sector participation are to expand the water supply and sewerage systems in order to increase population coverage, to expand sewage treatment in order to reduce water pollution and public health hazards, and to provide better quality of service. The secondary objectives are to ensure higher operating efficiency and to finance the system without public subsidies or guarantees”i. According to the prevailing wisdom, the success of PSP in delivering the expected efficiencies and social benefits depends on the introduction of appropriate incentives and effective transfer of risk to the private sector, as well as adequate reform of governance. While incentives and risk allocation are expected to unleash the efficiency of the private sector the reform of governance, for example through the creation of an adequate regulatory framework, should safeguard the public interest and ensure a level playing field between the parties involved.

This chapter looks at the evidence on the results associated with PSP in water supply and sanitation, which increasingly indicates a failure to deliver the forecast benefits, while eliciting political resistance, and discusses the structural factors preventing PSP from delivering the efficiencies and social benefits expected in theory.

Dynamic interest-seeking behaviour Many commentators take the view that the crucial element in ensuring the success of PSP is the contract itself, which defines rules of subsequent behaviour. Such analysts then explain failure to deliver as deficiencies in the contract, for example in respect of incentives or regulation. Failure to deliver expected results is thus attributed to weakness in contract design, and to be avoided in future by better contractual provisions. As summarised by Braadbaart (2001: 6), “The idea was that PPPs would create competition for contracts, that is, competition for the market rather than in the market. Also, by writing elaborate penalty and reward systems into the contract, PPP supporters expected that these would mimic efficiency-driving rivalry in the market place”.

By contrast, we propose that this discrepancy between practice and theory is best understood by analysing PSP as a dynamic process, with interaction among different actors pursuing different objectives. The most

03/04/2018 Page 3 of 49 PSIRU University of Greenwich www.psiru.org important factor driving outcomes appears to be continual profit-seeking and risk-avoiding behaviour of international water companies, in interaction with local and national governments (pursuing mixed political and fiscal goals), political and community movements, and international donors and institutions pursuing their own goals. The results of this process are strongly affected by the unequal distribution of resources and skills between the parties and by the limited competition in this sector. It is these dynamics, we argue, which explain the actual (mis)allocation of risk, the (in)effectiveness of governance, and the content (and constant revision) of the contracts themselves, as well as the actual outcomes in terms of investment finance, extension of systems (or failure to extend), pricing policies, and transparency.

Empirical evidence The main body of this essay focuses on the empirical evidence as it relates to these issues. This evidence is drawn from transition and developing countries, with particular reference to Latin America. Cases from France are also treated, to introduce and illustrate relevant trends observed at global level, because the French model of delegated management is the prevailing form of PSP in any region of the world, and French-based companies are also dominating the global water industry.

The first main section examines the extent of competition in the sector, with a small number of companies dominating the local market, and sharing a number of close links; the evidence of risk allocation in practice; and the impact on governance, including regulatory processes, accountability mechanisms, and evidence of corruption.

We then consider the effects PSP has on the social and economic costs of the reform of urban water systems; on the costs of investment finance, in the light of transaction costs and the use of different techniques to leverage capital finance such as resort to the so-called project finance or corporate finance; and on water pricing, in relation to investments and seen into a dynamic perspective, and finally on delivery to the poor.

The last section of the chapter touches on policy issues revolving around the reform of water supply and sanitation in transition and developing countries. We first identify loan conditionality imposed by IFIs as a major distortion of policy and decision making processes at national and local levels. Finally, we call for the international water community to acknowledge the developmental potential of public sector water operations, to promote best practices under public ownership and management as guidelines on reform, and to support public sector water providers with sustainable finance.

Definitions For the purposes of this essay, we use the term ‘privatisation’ to mean the partial or total transfer of managerial control of a water undertaking from the public sector to a private operator, usually a TNC. This definition of privatisation encompasses a number of arrangements ranging from management contracts to leases/concessions and full divestiture. It broadly coincides with the concept of private sector participation (PSP).

This use of ‘privatisation’ better reflects general usage than the definition which restricts it to ‘full divestiture only’. It reflects our view that the important element in privatisation or PSP is the introduction of a profit- seeking company, whereas the formal variations in the route adopted are less significant in understanding and explaining the actual processes.

Other definitions based on formal distinctions can be even more misleading. For example, it has been suggested that Dutch public water PLCs (Public Limited Companies), wholly publicly-owned and managed water companies subject to company law, represent a form of PPPs (Franceys, 2000)ii. Yet these public water PLCs may operate a zero-dividend policy, as is also the case in Sweden (Westman, 2001), and no partnership takes place with privately-owned operators in the management and operation of water services.

PART I – PSP IN PRACTICE: INCENTIVES, RISK ALLOCATION AND GOVERNANCE

PSP AND RESTRICTED COMPETITION A substantial literature relies upon competition to unleash the efficiency of the private sector and ensure the success of PSP in water supply and sanitation, for example through tariff reductions following competitive tendering (Webb & Ehrhardt, 1998)iii. According to Franceys, “it is competition that draws the real benefits out of the private sector, just as it draws it from the regulators. Privatization, regulation and competition are the complementary strands of PPP” (Franceys, 2000). Similarly, Rees states that “The overwhelming presence of monopoly may mean that the efficiency savings, which private-sector involvement is supposed to achieve, will not arise, unless, that is, the form of privatisation, industry structure and regulatory arrangements provide competitive incentives”. The same author refers to competition as a potential alternative to regulation (Rees, 1998).

According to Lorrain, regulation by the markets in the French system of delegated management implies competition among urban services groups for entry to local markets: “Competition among urban services groups for major contracts does take place since the market is of a nature where entry opportunities are presented intermittently… (Firms) are not in a position to not compete, for their future growth depends dearly on it” (Lorrain, 1997).

As a matter of fact, empirical evidence suggests that competition for entry into the water market is restricted at both global and local level, with the same kind of restrictions observed in France being noticeable either in the global water industry or at local level. Outright lack of competition and restricted competition represent an impediment to the delivery of the expected benefits of PSP.

Restricted competition at global level The global water industry is characterised by a marked concentration, with two TNCs (Vivendi and Suez) dominating almost 70% of world private market; joint ventures between these few dominant companies; and difficulty of entry. A similar pattern of concentration, joint ventures and difficulty of entry is also characteristic of the water market in France, which is the home base of the dominant multinationals and of the system of privatisation by delegation which has been the core means of privatisation in this sector.

Figure 1 below compares the 2001 sales of these two and the next largest companies. There are one or two even smaller international operators, from Spain and Italy. The process of concentration continued in 2002, notably with a series of takeovers of US companies. Suez bought US Water, which was owned by Bechtel and United Utilitiesiv, and also a number of Azurix contracts in Mexicov. RWE-Thames purchased American Water Works, who had previously acquired full control of private water operations in the USA from Anglian Watervi. In December 2002, Vivendi was reportedly considering a bid for Anglian Water’s international division which had been put up for sale in October 2002vii.

Difficulty at entry in the global water industry The lack of contestability of the global water industry, that is to say the difficulty at entry in that market, contributes to explain the high level of concentration observed. The global water industry appears to be very resistant to new entrants, even in the case of TNCs well established in other sectors than water and irrespective of their financial resources.

Attempts by Azurix – owned by US-based energy company Enron – to break into the market proved a failure. One of the main reasons for this failure, were the poor results obtained when bidding against French- based water TNCs Vivendi and Suez-Lyonnaise des Eaux, which could count on superior financial clout and could accept initially lower profit ratios in order to win a tender. Tim Winter, a water analyst with St. Louis firm A.G. Edwards & Sons, summarised as follows: “The French aren't as driven by profits as the U.S. investors are, so they're more tolerant of longer time frames”. As a result, in January 2002 Azurix announced it would change strategy focussing on smaller projects which would appeal less to the French giants viii. In April 2001, Enron announced it had decided to break up Azurix and sell its assetsix.

In order to establish itself as a global player on the water market, German conglomerate RWE had to take over UK-based Thames Water. RWE had established a number of joint ventures with the major water TNCs: the acquisition of a 49.9% stake in Berlin’s water company Berliner Wasser Betriebe jointly with Vivendi;

03/04/2018 Page 5 of 49 PSIRU University of Greenwich www.psiru.org an indirect participation in Budapest Municipal Sewerage Company FCMS through Berliner Wasser Betriebe and jointly with Vivendi; the acquisition of a 25% stake in Budapest Waterworks Rt jointly with Suez-Lyonnaise des Eaux. It was only with the takeover of the already established UK-based water TNC Thames Water in September 2000 that RWE acquired a significant share of the world water market x. From the perspective of the contestability of the global water industry, the operation represented a zero-sum game.

Restricted competition at local level Restricted competition also takes the form of joint ventures between TNCs; b) anti-competitive practices including uncompetitive award of long-term concessions; c) endless concessions. All these characteristics are similar to what can be observed in France.

Joint ventures in France and internationally In France, where they control 85% of private water operations, Suez and Vivendi have created joint subsidiaries in a number of towns and regions, with the effect of restricting competition in the French private water market. In July 2002, the French competition council (“Conseil de la concurrence”) ruled that Suez (Lyonnaise des Eaux - SLDE) and Vivendi (Générale des Eaux - CGE) had been abusing their market dominance in France: a report by the Competition Council listed 12 joint ventures in France, including cities such as Marseilles and Lille – two of these joint ventures also involved SAUR, the third largest water company. The Competition Council recommended that the Ministry of Economy act to force CGE and SLDE to remedy the situation by dismantling their joint ventures (Conseil de la Concurrence, 2002) xi.

This forming of joint ventures is not restricted to France. Figure 2 below shows a number of these joint ventures. It is striking that even the nearest competitors to Suez and Vivendi - Thames, SAUR, and Anglian – have made partnerships with Suez and Vivendi to establish themselves in the market. RWE/Thames for example are partners to Vivendi on three of their major water operations – Berliner Wasserbetriebe, Budapest Sewerage (FCSM), and United Water in Adelaide, Australia, and its offshoots in New Zealand (Papakura) and Indonesia (Sidoarjo). RWE is also a partner to Suez in Budapest Water. SAUR has partnerships with Vivendi in both the UK and the Czech Republic. Anglian is a partner of both Suez and Vivendi in Aguas Argentinas, and separately of Vivendi and Suez in the Czech Republic

The collaborations extend beyond water into other sectors. For example, Suez’ energy subsidiary Tractebel and RWE’s energy division formed a joint venture at the end of 2001 to provide electricity to a large factory in Antwerp, although the electricity market in EU countries is now supposed to be competitive.xii

Single-bid concessions Although most contracts are awarded after tendering and competitive bids, there are a number of cases where water concessions have been awarded through one-bidder tenders, or competitive procedures to which only one company put forward a bid.

 Argentina: In 1999, an Aguas de Bilbao-led consortium, AGBA, was awarded a 30-year water concession covering 1/6 of the Buenos Aires province. Observers were surprised at the low amount of the bid, of US$ 1.26m, submitted by the successful consortium, which initially included the Argentine company Sideco. Other interested consortia, including Urbaser (Dragados group) and Dycasa failed to submit offers despite being pre-qualified. Accordingly, the Aguas de Bilbao/Impregilo/Sideco consortium submitted the only bid and won the concession in November 1999. Sideco then left AGBA "for strategic reasons", and was replaced by Dycasa and Urbaser before the concession agreement was finally signed in December 1999xiii.

 Bolivia: In September 1999, Aguas del Tunari, a consortium led by International Water Limited (IWL), was awarded a 40-year water supply and sanitation concession for the water and sanitation system of Cochabamba and a complex related infrastructure project called the Misicuni Project. Aguas del Tunari was the only bidder, and its tender was accepted despite serious omissions and irregularities. The Bolivian Times suggested that the generosity was most likely due to political connections - the local partner in Aguas del Tunari, ICE Ingenieros, was owned by one of the most affluent and influential men in Bolivia (Lobina, 2000)xiv.

 Chile: In November 2001, RWE's Thames Water won a 30-year concession for operating southern Chilean waterworks company Essam. Thames Water's bid of US$ 171m was the only one submitted despite 12 companies having pre-qualified. Thames Water described Region VII's Essam as being "strategically" located in between two other of the company’s Chilean subsidiaries - ESSEL in Region VI and ESSBIO in Region VIIIxv.

 Colombia: In December 1994, Suez subsidiary Aguas de Barcelona was awarded a 45.91% stake in ACUACAR (Aguas de Cartagena, S.A. E.S.P.), a public-private joint venture set up with the municipality of Cartagena. Aguas de Barcelona was the only bidder in an international tender for the acquisition of the equity stake. In June 1995, the municipality of Cartagena signed a 26-year contract covering operation and maintenance of the water supply and sanitation system (Nickson, 2001a: 15- 16).

 Ecuador: In January 2001, International Water was awarded a 30-year water supply and sanitation concession in Guayaquil after putting forward the only bid. International Water's local subsidiary, Guayaquil Interagua C. Ltda., would start operations in April 2002. The international tender failed to attract a satisfactory number of bidders and make the process competitive despite US$ 20.2m out of a US$ 40m loan issued by the Inter-American Development Bank (IDB) had been earmarked to "undertake technical, legal and financial studies and to prepare bid specifications for the concession award"xvi.

 Czech Republic, Hungary and Poland: As shown in Table 1 below, most of the water concessions awarded in the 1990s’ in Central and Eastern Europe were not subject to competition. By mid-1997, TNCs held equity shares and operated a total 12 water companies. In none of these cases, with the exception of Budapest, was there any competitive tender carried out to select a multinational partner. In all other cases the municipalities negotiated an arrangement without any competitive process (Hall, 1997).

 Romania: In November 2000, Suez-Lyonnaise des Eaux (then renamed Ondeo) was awarded a 25- year water and wastewater concession in Timisoara. Under "sponsorship" of the EBRD, Suez- Lyonnaise des Eaux was "selected" without the concession being put out to tender. The EBRD first provided a loan under the condition that Aquatim be privatised to a water multinational, was then "fully involved" in the negotiations on the privatised water company development programme and would provide investment finance (Lobina, 2001)xvii.

Endless concessions in France and internationally The sheer length of water concessions represents a significant obstacle to competition, which can be observed in developed countries with a longer history of PSP in the water sector, such as France and Spain, as well as in developing countries. Other implications related to competition and the long-term duration of concession agreements, include the issue of whether and how a private water concession can ever be terminated, re-tendered, or brought back into public ownership.

Water privatisation in France and Spain has existed long enough to allow observation of the factors affecting the choice of the conceding public authorities on ensuring service provision once a long-term agreement expires. In France, until recently, concessions were frequently renewed without tendering, according to the Cour des Comptes, France’s national audit body (Cour des Comptes, 1997: 95-97). It was only in 1993 that the so-called Loi Sapin, or anti-corruption law, provided for privatised concessions to be publicly and competitively tenderedxviii. In 1995, the Sapin Law was integrated by the so-called Barnier Law which limited the maximum duration of privatised water contracts at 20 years xix. Several contracts were renegotiated and extended a few weeks or months prior to entry into force of the new legislation, sometimes before the contract expiry date (Cour des Comptes, 1997: 105-106). Although in future more concessions can be expected to be re-tendered, in many cases this will not happen before 2020 as contracts concluded before the new legislation became applicable escaped those provisions (Druin, 2002). In Nice, Générale des Eaux has xx managed water supply and sanitation under a concession contract since 1864 . Even when contracts are re- tendered, due to its superior knowledge of the system, the incumbent remains at a competitive advantage in

03/04/2018 Page 7 of 49 PSIRU University of Greenwich www.psiru.org respect of competing companies and this strongly undermines the effectiveness of competition (Cour des Comptes, 1997: 98-99).

A clear example of the limitations to the effectiveness of competition when long-term concessions are re- tendered is provided by the case of Aguas de Valencia in Spain. In 1902, the city of Valencia awarded a water concession to a private company, AVSA. The contract specified that the monopoly would last for 99 years. And so in the late 1990s, for the first time since 1902, the city of Valencia began to draw up tender documents. At this point AVSA, now part of the SAUR-Bouygues multinational group, and advised by international accountancy firms Pricewaterhouse and Arthur Andersen, announced that if it lost the tender it would demand compensation of € 54m Euros for investments it had made in the systemxxi. The tender proceeded, with a clause stating that the winner would have to pay € 54m to AVSA. Not surprisingly, there was not a single competing bid. AVSA, now part of a joint venture with the council itself, will enjoy the concession for a further 50 years. In 2050, the city of Valencia will have had 150 years of private water monopoly with not a single competitive bidxxii.

Similar restrictions to competition apply to developing countries and are a cause of concern in the light of the limited experience available with managing long-term water concessions throughout the whole life-cycle of the contract. Few water concessions in developing countries have in fact lasted long enough yet to reach their appointed end. The most long-standing example, in the Côte d’Ivoire, was originally awarded without any public competitive tendering, and was later renewed and extended without any public or competitive tendering (Bayliss, 2001). There are already cases of Valencia-length concessions in Latin America. In 1998, a SAUR-led consortium also including Enron was awarded a 95-year water concession in Mendoza, Argentinaxxiii. In June 1999, a Suez-Lyonnaise des Eaux/Agbar consortium bought 42% of the shares of Santiago de Chile’s water company EMOS (then renamed Aguas Andinas) for US$ 957m. The private consortium was also awarded an unlimited duration concession to manage and develop the city’s water and sewerage (Suez Lyonnaise des Eaux, 1999: 25).

Political economy of water corruption The expected benefits of competition are made less likely because of the incidence of corruption associated with privatisation (for more details on cases, see section 4.4 Corruption, state capture and governance failure below). The economic function of a bribe is to provide a financial inducement for an official/politician/public authority to act in the interests of the company rather than the public interest which he/she/it is supposed to represent. Illegal payments are only one category of such inducements, (and illegal payments for which a company has been convicted are an even narrower sample).

Companies will offer such inducements as often as there is the chance of gaining profitable business by doing so. Construction contracts, which are frequently contracted to private operators, and so there is commonly experience of inducements being offered – for example, in the UK, Germany and France (Hall, 1999). If the public sector offers more business opportunities to the private sector, whether by selling assets, issuing concessions, or simple contracting-out, then the private sector will have more frequent reason for considering inducements. The value of the business to be won will influence the size of inducements that companies offer, and the risks that they are prepared to take. For a 30-year water concession worth $10m a year, companies will offer bigger, riskier payments than for a 2-year turnkey construction project worth $5m. The growth of long-term water concessions will therefore increase the potential gains.

Inducements are offered at the points in the process where there is economic gain for the company in doing so. In private water business, the key point is the award of the contract or concession. This usually results in a monopoly for up to 30 years or longer, and so is both potentially extremely valuable and a unique opportunity to gain. The process leading up to awards thus represents the crucial opportunity for using inducements.

PSP AND RISK ALLOCATION

Ranging from management contracts to outright concessions, PPPs rely on risk allocation to deliver the expected benefits in terms of improved efficiency and performance. PPPs are in theory expected to unleash the efficiencies of the private sector and deliver social and environmental benefits subject to the effective allocation of operating and political risks to the parties best placed to minimise and manage such risks (ADB, 2000: xvii). It is generally assumed that private operators are ablest at dealing with operating risks while public bodies should preferably retain the political risks involved with PPPs.

The World Bank has stressed that whether contractual options ranging from management contracts to full concessions “perform better than full provision by state-owned enterprises depends in particular on whether performance risk is effectively shifted from taxpayers to the private shareholders of the company that enters into a concession-type arrangement” (World Bank, 2002: 23-24).

Performance or operating risk may be identified as the variety of risks associated with the commercial provision of water supply and sanitation services, such as failing to meet the agreed service targets or facing declining revenues as a result of decreasing consumption. Furthermore, the real value of revenues from operations in a transition or developing country may be eroded by currency devaluation. Acceptance of such risks by the private operator seems to reflect the ancient French formula according to which the private concessionaire operates the service “à ses risques et périls”.

Political risk may be defined as the risk faced by a commercial water operator due to undue governmental interference, such as in the case of breach of contract, expropriation, restrictions to currency transfer, or war and civil disturbance. An array of technical instruments has been designed to transfer the political risk from the project operator to the public sector. Those instruments range from international arbitration to political risk insurance and guarantees, from multilateral agencies’ equity participation to political and regulatory risk “carve out” clauses. Such commercial instruments are expected to mitigate the occurrence of adverse governmental interference and allow the private operator to devote all its energies to deliver the expected benefits of PPPs.

Empirical evidence increasingly suggests that risk allocation in privatised water concessions departs in practice from what laid out in theory. As performance risk is shifted away from the private sector, local taxpayers and consumers are left to bear the full costs of distorted incentives. This has an obviously adverse impact on sustainable water development.

Performance risk

Guarantees Irrespective of the availability of technical instruments designed to shift performance risk on to the private operator, such as performance bonds, water PPPs often appear as virtually risk-free for international operators. Contractual agreements may directly or indirectly guarantee a steady rate of return, or may be renegotiated in case of failure to achieve the originally set investment objectives or service targets.

 Bolivia: The Cochabamba water supply and sanitation concession allowed the operating company Aguas del Tunari, a subsidiary to International Water Limited (IWL), to enjoy a guaranteed 15% real return for 40 years (Lobina, 2000).

 Chile: In June 1999, a Suez-Lyonnaise des Eaux/Aguas de Barcelona consortium acquired a 42% stake in Santiago water company EMOS. The consortium, which was awarded an unlimited duration concession to manage and develop water and sewerage, reportedly enjoyed a “constant level of profitability, of roughly one-third of total sales, … guaranteed by the state”xxiv.

 Argentina: According to parent company Suez, the Aguas Argentinas concession agreement guarantees a “fair remuneration on capital employed (U.S. Dollar equivalent)” (Suez, 2002: 143).

Concession arrangements often guarantee a steady rate of return by shielding the operator from a downfall in revenues due to variations in water consumption. This may take place in the form of clauses providing for

03/04/2018 Page 9 of 49 PSIRU University of Greenwich www.psiru.org automatic tariff adjustment in case of variations in demand or in the form of bulk water supply schemes, requiring the conceding authorities to buy fix volumes of water irrespective of future demand. Guarantees against demand risk thus shift the burden of operating risk on to taxpayers or consumers, depending on whether the guarantees require compensatory payment by local government or tariff adjustments.

 Peru: In January 2000, ACEA and Impregilo won a 27-year BOT contract to build and operate the Rio Chillon water treatment plant. The plant would supply drinking water to Lima’s state-owned water company SEDAPAL on a take-or-pay basis. SEDAPAL was locally rated AAA and its payment obligations were backed by a formal guarantee from the Peruvian government. A further element aiming to reduce operating risk was the use of simple, relatively low-risk and proven technology, and the fact that the concessionaire faced a relatively low capital expenditure requirementxxv.

 China: In September 1999, Vivendi and Marubeni obtained multilateral finance for a water supply BOT in Chengdu, China which would provide water to the local municipality on a take-or-pay basisxxvi.

 Vietnam: In December 1997, Suez subsidiary Lyonnaise Vietnam Water Company (LVWC) was awarded a 25-year BOT contract to build and operate the Thu Duc water treatment plant in Vietnam. LVWC would provide bulk supplies of drinking water to the Ho Chi Minh City Water Supply Company (WSC) on a take-or-pay basis. Bulk purchases were guaranteed by Ho Chi Minh city council, with the Vietnamese government on turn guaranteeing payment obligations assumed by the municipalityxxvii.

 Hungary/Czech Republic: Similarly, some water concessions in transition countries include clauses which protect the company from trading losses at the expenses of taxpayers. For example, in Pecs and Szeged, Hungary and Plzen, Czech Republic, the concession contracts include clauses stating that if the tariffs are not sufficiently high to provide an operating profit, the council must make good the loss for the company (Hall, 1998: 129).

Less than accurate or overoptimistic demand projections may trigger renegotiation and alter the originally agreed contractual balance. There are a number of cases where prices have been forced up within a year or two of a concession being started, where the assumption in the original contract about the level of demand turned out to be too high, and the real level of demand was then used as a justification for large price rises.

 East Germany: In Rostock, water prices rose by 24% in 1996, 22 months into a 25-year contract, because over-estimated consumption would have led to losses for Suez subsidiary Eurawasser, and so “The shortfall automatically activated price-adjustment clauses within the Eurawasser contract” (Hall, 1998: 129)xxviii.

 South Africa: In June 2001, Saur’s subsidiary Siza Water renegotiated its contract with the municipality of KwaDukuza in Dolphin Coast, only 2 years and 4 months after the award of the 30- year concession. Siza asked for relief under the contract, which allows for renegotiation if returns are either above or below a predetermined range, as a result of actual demand failing projections. As the expected development of middle-income and mass housing had not materialised, Siza's revenues were affected by a shortfall of some R12m a year. The renegotiated agreement provided for an immediate 15% price increase and a R15m reduction in projected investments, from R25m to R10m in 5 yearsxxix.

Renegotiation and reduction of investments Modest investment and service targets are instrumental in removing operating risk. Renegotiation in the light of changed operating conditions may either cancel original investment commitments or substantially postpone their realisation. There are a number of cases where, shortly after the award of a concession, private operators have revised downwards projected investments.

 Aguas Argentinas: In May 1993, a Suez-Lyonnaise des Eaux-led consortium started operating a 30- year water supply and sanitation concession in Buenos Aires, Argentina. It was only eight months later that the operating company Aguas Argentinas requested an "extraordinary review" of tariffs, due to unexpected operational losses. Despite tariff increases approved in June 1994, 45% of projected investments were not implemented in the first three years of the concession, for a total of some Peso/US$ 300m. The concession agreement was then renegotiated from February to September 1997 and substantially altered so that little remained of the initial covenant. Not only were new charges introduced and tariffs adjusted, but completion of the first 5-year plan was also delayed from April to December 1998, with the concessionaire enjoying 8 additional months to implement the projected investments, and "various investments originally agreed upon" were either cancelled or delayed (Azpiazu & Forcinito, 2002: 23-28). A recent study has estimated that from May 1993 to December 1998, Aguas Argentinas failed to realise 57.9% of the originally agreed investments for a total of US$ 746.39m (see Table 2 below) (Azpiazu & Forcinito, 2002: 44-45).

 Aguas Cordobesas: In April 1997, Suez-Lyonnaise des Eaux was awarded a 30-year water supply and sanitation concession in Cordoba, Argentina. Total investment required to increase water supply coverage from 83% to 97% in 30 years had been estimated at around US$ 500m. Although the contract required the operator, Aguas Cordobesas, to invest US$ 150m in the first two years, the concessionaire invested only US$ 84m from 1997 to 1999 (Nickson, 2001b: 1, 14-15). Accordingly, Aguas Cordobesas failed to realise US$ 66m or 44% of the originally agreed investments for the first two years.

 Aguas de Santa Fe: In September 1995, a Suez-Lyonnaise des Eaux-led consortium was awarded a 30-year concession for the provision of water supply and sanitation in the province of Santa Fe, Argentina. The concession agreement fixed the limit value of harmful substances to be found in the supplied drinking water much above what established by Argentine law. Also, local consumers’ association Union de Usuarios y Consumidores described how the concession had followed a very similar pattern to that of other Argentine privatised water concessions, characterised by immediate and persistent renegotiation, price increases and downward revision of projected investments and operational targets. The first renegotiation of the concession agreement started in May 1997, only 18 months after the beginning of operations, and provided for the postponement of projected investments by 6 to 7 years, in some cases from 1998 to 2004, in others from 2001 to 2007 and 2008. In December 2000, concessionaire Aguas Provinciales de Santa Fe (APSF) and the provincial government reached a preliminary agreement on the content of a second renegotiation. The proposed renegotiated agreement provided for the introduction of additional tariff increases and a substantial reduction in the amount of projected investments (see Table 3 below) which, for the period 1996- 2008, would total US$ 405m instead of the US$ 707m established by the original concession agreement (Muñoz, 2002). In 2002, APSF claimed it had invested US$ 250m in the first 6 years of the concession. As the original concession agreement required the concessionaire to invest US$ 356m, APSF failed to realise US$ 106m or 29.8% of the originally agreed investmentsxxx.

 Aguas Guariroba: In July 2000, a consortium led by Suez-Lyonnaise des Eaux subsidiary Aguas de Barcelona a US$ 217m, 30-year water supply and sewerage concession in Campo Grande, the capital of Brazil's Mato Grosso do Sul state. Although initial reports put the total amount of investments over the life-cycle of the concession at US$ 144m, the operating company Aguas Guariroba was reported in November 2001 as planning to invest US$ 105mxxxi. This would result in a 27.1% reduction in initially pledged investment.

 Belize: In March 2001, the Belizean government privatised the Belize Water and Sewerage Authority (WASA) through the sale of shares. The Biwater/Nuon joint venture CASCAL would operate water supply and sanitation as a strategic investor in the newly set up Belize Water Services Ltd. (BWSL). CASCAL had made a “binding commitment to improve the management of Belize Water Services Ltd. and to bring with it enhanced technology and investment to improve and expand the water and sewerage services in the urban areas of the country provided for in its Operations Licence”xxxii. As a matter of fact, within weeks of the deal the private operator announced that sewerage connection charges would increase from $80 to over $1,000 and that “it would not spend

the $140m which it had promised on new capital investment because the company had been 'tricked' in the fine print of the original purchase agreement”xxxiii.

Weakness of performance bonds Performance bonds, deposited by private concessionaires to guarantee achievement of agreed performance targets, are the normal way of providing protection against non-performance. However, governments may prove reluctant to call in these bonds, for a number of reasons, including unwillingness to engage a dispute with a powerful TNC – which may be withholding payment of lease or concession fees to add pressure, concerns for the continuity of service provision, and the costs of re-tendering or re-establishing a public service. This calls into question the effectiveness of performance bonds and general ability of local governments to force private operators to assume risk for poor performance.

 Philippines: Water supply and sanitation in Manila were privatised in January 1997 to two private groupings: a Lyonnaise des Eaux-led consortium to operate in the western zone of the city and a North West Water-led consortium to operate the eastern zone (Esguerra, 2002: 1). Suez ONDEO subsidiary Maynilad failed to tackle Unaccounted-For-Water (UFW) in west-Manila. Despite pledging to cut UFW from 57.4% to 42.0% between 1997 and 1999, Maynilad saw UFW rise from 63.3% in 1997 to 67.0% in 1999. IWL subsidiary Manila Water Company, operating in east-Manila, projected a reduction in UFW from 44% to 22% between 1997 and 1999. As a matter of fact, UFW decreased from 45.2% in 1997 to just 39.8% in 1999 (Esguerra, 2002: 31)xxxiv. Each of the two concessionaires deposited a US$200 million performance bond, which the government failed to recall. By contrast, in September 2001 the government agreed to renegotiate the terms of the two concession agreements and allow the companies recover the losses suffered for having submitted unrealistic bids and caused by currency devaluation. Maynilad had previously declared it was ready to return the concession to the government should the government not agree to renegotiate the concession and introduce an automatic mechanism to adjust water tariffs to currency devaluation. Apart from tariff adjustment to currency devaluation, the September 2001 renegotiation of Maynilad’s concession agreement established that Maynilad would resume payment of maturing concession fees and that “Maynilad shall withdraw its case filed against MWSS and in turn, MWSS shall suspend calling on the performance bond posted by Maynilad” (Esguerra, 2002: 5, 17, 33).

 South Africa: In February 1999, SAUR subsidiary Siza Water was awarded a 30-year contract to provide water supply and sanitation to the resort of Dolphin Coast, South Africa. In June 2001, Siza Water requested renegotiation of the contract after being hit by financial problems. Faced with a serious shortfall in revenues of about R12m a year, due to demand failing to reach projected levels, Siza Water refused to pay the scheduled R3,6m lease payment due to the municipality of KwaDukuza and obtained the renegotiation of the contract in its favour (see 3.1.1 Guarantees). According to KwaDukuza's acting municipal manager, the only alternative to renegotiation was "to go off to the contract guarantor (a bank) and take back the performance bond"xxxv.

Allocation of currency risk in practice In order to attract investment finance, PPPs have to meet the requirements of financial investors who have their reluctance to accept risk, especially currency risk. Water multinationals naturally seek to reduce currency risk, and do so by seeking provisions for indexing tariffs to the value of US dollar, in order to preserve the real value of profits generated by local operations and of payments in hard currency to subcontracted subsidiaries.

Whatever the provisions governing private water operations, the reality appears to be a contest between the parties: in Manila the original provisions implied recovery of currency losses in the future, but the operators were not prepared to accept this delay and sought to insist on earlier recovery. In Buenos Aires, where renegotiation introduced clauses apparently providing for 100% protection against currency risk, through the dollarisation of tariff indexing (see 6.3 Currency risk allocation and pricing), the collapse of the Argentine economy following the financial and political crisis of December 2001 effectively nullified these guarantees which became unsupportable so that the new government sought their cancellation (for details, see below 3.3.1 The Buenos Aires Crisis). In effect currency risk was not avoided, simply converted into political risk,

03/04/2018 Page 12 of 49 PSIRU University of Greenwich www.psiru.org or ‘whole economy risk’. (In May 2002, US rating agency Standard & Poor’s downgraded the credit rating of the contractually “dollarised” Aguas Argentinas from “CC” to “D”, for default in payment of interest on a US$ 140m IDB loan)xxxvi.

 Peru: Acea’s Rio Chillon subsidiary Agua Azul raised investment finance by issuing bonds on the Peruvian pension funds market. Bonds repayments were linked to the US$, as was the tariff offered by Agua Azul for the supply of treated water. Project Finance commented that: “the Peruvian authorities went out of their way to structure a concession that would be robust enough to create a project bond asset class” xxxvii.

 Manila: The original concession agreement in Manila partially relieved consumers from currency risk, in that it provided for the concessionaires to recover additional costs incurred in the previous operating year as a result of currency devaluation with interest and in instalments (Esguerra, 2002: 11-12). Following the Asian crisis in July 1997, the Philippine Peso (PHP) devaluated from PHP 26.00 = US$ 1.00 in December 1996 to PHP 50.00 = US$ 1.00 by end-2000 (Esguerra, 2002: 1, 8, 12). Currency devaluation hit the finances of the two concessionaires, which sought alleviation of currency risk. In October 2001, the concession agreement was renegotiated and a mechanism – the Foreign Currency Differential Adjustment (FCDA) - was introduced allowing the operators to automatically pass all the costs of currency devaluation on to consumers on a quarterly basis (Esguerra, 2002: 20). As of March 2002, prices charged by Maynilad reached PHP 15.46 pcm as opposed to PHP 4.96 pcm charged by Maynilad in 1997-1998 on the basis of its bid. As of March 2002, prices charged by Manila Water Company reached PHP 6.75 pcm as opposed to PHP 2.32 pcm charged by Manila Water Company in 1997-1998 on the basis of its bid (Esguerra, 2002: 34)xxxviii. As of November 2002, tariffs were being renegotiated and were expected to escalate further to PHP 30.92 pcm for Maynilad and PHP 15.00 to 16.00 pcm for Manila Water Company (Fajardo, 2002). For a comparison of prices with pre-privatisation levels, see below 6.2 Making privatisation more appealing. A recent study argues that currency devaluation could only explain part of the losses incurred by the two concessionaires, which were also due to inefficiency and, at least in the case of Maynilad, the submission of an over-optimistic bid (Esguerra, 2002: 2, 24, 32). Furthermore, the study argues that the FCDA would hardly enhance efficiency as the two concessionaires have no incentive to reduce the acquisition of foreign currency-denominated goods and services (Esguerra, 2002: 10, 21). See also 5.3 Internal subcontracting.

Political risk and implications of distorted risk allocation Facing little operating risk, private water operators have little incentive to deliver the expected efficiencies and performance achievements. Facing little currency risk, water multinationals have no incentive to achieve efficiencies through reducing the purchase of US$-denominated goods and services bought from their own subsidiaries, in favour of purchasing local inputs.

Distorted risk allocation not only alters incentives for the private operators, it may mean that PPPs turn into debt-like obligations for public authorities and, more broadly, local communities. The public’s financial obligations to pay charges for the private operation for 20 years or more remains constant, while the operator has an incentive to and often does negotiate away the original commitments in terms of service, investment and/or price levels. Resort to commercial and legal instruments to protect operators’ interests against political risks may then place additional costs on to local taxpayers. From a private operator’s point of view, this risk allocation is a satisfactory outcome for profit maximisation; but at the cost of undermining the social and political sustainability of PPPs. PPPs in which so favour private concessionaires might end up triggering political risk rather than taking advantage of risk mitigation and produce the expected developmental results.

This can be seen in a number of cases where poor performance or excessive prices have sparked political decisions to terminate privatised concessions and operating contracts. In most cases, those events were prompted by consumers’ resentment against what was perceived as an unsustainable situation. In most cases, water TNCs have in turn filed multi-million compensation claims in front of international arbitration panels. The exit from privately-run operations thus proves either difficult or costly for the local political authority and community – a prospect which decision makers need to bear in mind when considering the potentially

03/04/2018 Page 13 of 49 PSIRU University of Greenwich www.psiru.org adverse long-term implications for host countries and local communities resulting of entering PPPs in the water sector.

 Tucuman, Argentina: In May 1995, Aguas del Aconquija, a subsidiary to Générale des Eaux (now Vivendi) was granted a 30-year concession to supply the province of Tucuman. Although water tariffs doubled following the award, the company failed to accomplish the planned investment programme as it reportedly “failed to put up the financial guarantees it had promised and made good on few promised investments during its tenure” xxxix. When water became "inexplicably" brown, more than eight out of ten consumers stopped paying their bills and the concession was terminated in October 1998. The company filed a US$ 300m compensation suit with the World Bank’s ICSID (International Centre for Settlement of Investment Disputes), and in November 2000 the international arbitration court decided to dismiss Vivendi's claims (ICSID, 2000). The French multinational has appealed (Gaillard, 2003)xl.

 Cochabamba, Bolivia: The September 1999 water privatisation to IWL’s Aguas del Tunari led to price hikes of up to 200% in order to cover the costs of the Misicuni project, a massive engineering scheme causing water to cost “roughly six times that of alternative sources” and provide for a guaranteed 15% real return. The massive tariff hikes hit the people of Cochabamba where the minimum wage was less than US$100 per month. The average water bill was estimated to equal 22% of the monthly pay of a self-employed man and 27% of that of a woman. The concession was terminated in April 2000, following social unrest and military repression which left one person dead, two blinded and several injured (Lobina, 2000). In November 2001, Aguas del Tunari filed a US$ 25m compensation claim with ICSID. Aguas del Tunari sought damages due to foregone profits as a result of the Bolivian government's unilateral termination of the water concession. The concession was, in fact, terminated after less than 6 months since Aguas del Tunari started operations on 1st November 1999 - with little time to implement significant investments. The Bolivian Minister of Foreign Commerce and Investment stated that the amount of compensation demanded by Aguas del Tunari was "not in accordance with reality". The Bolivian government offered to pay the equivalent of what was actually invested in 6 months, less than US$ 1 million, but Aguas del Tunari did not accept that sum and resorted to ICSID instead. According to ATTAC-NL, the figures reported by International Water's Dutch holding company IWH in its 2000 Annual Report showed that the US$ 25m claimed were almost three times the total ‘carrying value’ of Aguas del Tunari, and almost four times the total value of the fixed assets of Aguas del Tunarixli.

 Buenos Aires Province, Argentina: Awarded in June 1999, Azurix’ concession covering two of the three Buenos Aires Province’s operating areas ran into trouble following allegations of poor service quality, and failure to honour contractual commitments as well as financial problems xlii. In October 2001, Azurix announced it would withdraw from the contract as of January 2002 accusing the regional government of “serious breaches”xliii and filed a US$ 600m compensation claim with ICSIDxliv. The provincial government maintained that it had complied with the concession arrangement and that it was rather Azurix to have breached the contract, adding that it had rejected the price increases requested by the operator as those were not linked to service provisionxlv. The concession was terminated in March 2002. In August 2002, the provincial government of Buenos Aires was to file a US$ 600m lawsuit against Azurix for wrongfully abandoning the concessionxlvi.

 Potsdam, Germany: In January 1998, Eurawasser – a joint subsidiary to Suez-Lyonnaise des Eaux and Thyssen – acquired a 49% equity stake in the local water company and signed a 20-year contract to manage and operate water and wastewater services. Potsdam city council terminated the contract in June 2000, “when the municipality found that prices were increasing in a way customers found untenable”xlvii. More precisely, Eurawasser projected tariff increases from DM 8.80 pcm in 2000 to DM 16.40 pcm in 2017 as opposed to the city council’s estimate of increases up to DM 10.21 pcm to DM 11.95 pcm in 2017xlviii. The termination led to a legal dispute between the parties to the contract over payment of compensation, which was settled in January 2001 with the agreement that the city council would pay Eurawasser an undisclosed sum and that in the future Potsdam Water Works would contract Eurawasser to carry out consultancy workxlix.

 Nkokobde, South Africa: In December 2001, the municipality of Nkonkobe in Eastern Cape won a court case effectively obtaining the cancellation of a 10-year operation contract entered into in 1995 with Suez-Lyonnaise des Eaux subsidiary WSSA (Water and Sanitation Services SA). The problems in the contract emerged because of the municipality's inability to pay the management fees to the company. This was also accompanied by high levels of dissatisfaction with service among the communities. According to the mayor of Nkonkobe, the cancellation of the contract meant that the Nkonkobe municipality would save R19million. The mayor said his council had inherited the previous government TLC's debts but was not prepared to honour invalid contracts. The Nkonkobe municipality comprised poverty-stricken rural areas where people were unable to pay for services, he said. Nkonkobe includes Alice, Fort Beaufort, Middledrift and Seymour. WSSA would appeal against the rulingl.

 Szeged, Hungary: International arbitration was a deterrent against the termination by Szeged city council of a flawed operating concession to Vivendi. The dispute arose from the determination of the local government not to allow further increases in the operation and maintenance costs. More precisely, exclusive subcontracting to a Vivendi subsidiary was a major determinant of inflated costs and allowed the French TNC to export a high share of the profits realised by the semi-privatised water operations (Lobina & Hall, 2000). For more details, see below 5.3 Internal subcontracting. As Générale des Eaux repeatedly refused to renegotiate the concession agreement, the municipality of Szeged established its own water company in July 1999 and decided to terminate the contract with Générale des Eaux. The dispute was amicably settled in February 2001 after Vivendi Water had resorted to international arbitrationli.

The Buenos Aires crisis The events in Argentina, following the collapse of the economy and the currency in 2001-2002, are an extreme illustration of how currency and performance risks might collapse into political conflicts of interest between public authorities and private companies.

In theory, the Buenos Aires water concession was protected from currency risk, as prices were indexed to the US dollar (see 6.3 Currency allocation and pricing). With the collapse of the Argentinean economy at the end of 2001, however, that indexation became practically unsustainable. In 2002, following Argentina's default on the external debt, a new law on "Public Emergency and Reform of the Exchange Regime" (Law Nº 25.561) abolished the parity between the Argentine Peso and the US$ and aimed to revise the regulatory and contractual framework applying to the privatised utilities. It specifically abolished the "dollarisation" of prices and the periodic adjustment of tariffs to foreign inflation and currencies. The law also provided for the renegotiation of the contracts with the privatised companies operating the utilities according to a number of criteria, to take into account "the impact of prices on the competitiveness of the economy and the distribution of income; the quality of the services and the investing plans, when they were considered in the leasing contracts; the consumers’ interests and the accessibility to the system; the security of the systems; and the profits of the firms" (Azpiazu & Forcinito, 2002: 53-59).

This has created a continuing conflict between the Argentinean consumers of water, and the multinationals like Suez and Aguas de Barcelona, represented by the French and Spanish governments. Aguas Argentinas (led by Suez), the largest and most prominent of the privatised water companies in Argentina, started an intensive lobbying campaign aiming to protect its shareholders' interests. In February 2002, the management of Aguas Argentinas and the French ambassador in Argentina, Paul Dijoud, had a private meeting with the vice Minister of Economy and a senior ministerial official. The management of Aguas Argentinas sent a note to the Sub-secretary of Hydric Resources, informing him of Suez’ unilateral suspension of a number of obligations of Aguas Argentinas, including the investment objectives in the contract renegotiated as recently as January 2001.

These unilaterally suspended obligations included the investment plans which the company had signed up to in 2001 with the regulator, and the regulator’s rulings that Suez had to repay customers whom they had overcharged. Suez also insisted that: “... the Central Bank of the Argentine Republic will sell

03/04/2018 Page 15 of 49 PSIRU University of Greenwich www.psiru.org dollars to Aguas Argentinas S.A. at the parity one peso = one dollar to guarantee the payment in time of short and long term debt services that were taken with National and International Banks, as well as with Multilateral Organisms”. Aguas Argentinas’ external debt was US$672m at the last count, and the Peso had already fallen to Peso 2.00 = US$1.00 by Easter 2002, so this demand was in effect that the Argentine government and people should shoulder half of Aguas Argentinas’ debt (Azpiazu & Forcinito, 2002: 59-65).

In June 2002, Suez stated in a note to its Consolidated Financial Statements that it would continue to pursue the Argentineans for money to pay the loans of Aguas Argentinas – implying that some of these were guaranteed by Suez – and also that it may sue the government of Argentina because the contract had a clause “guaranteeing a fair remuneration on capital employed (U.S. Dollar equivalent)” (Suez, 2002: 143).

PSP AND GOVERNANCE The theory of PPPs in the water sector does not only rely on competition and risk allocation for the private sector to unleash its efficiency and deliver the expected social and environmental benefits. It also relies on the reform of governance, for example through the introduction of regulation of prices and outputs or the monitoring by local government retaining a shareholding in the operating company. The rationale for regulation in water supply and sanitation is provided by the monopoly structure of the industry (Franceys, 2000), implying the risk that the private operator might otherwise abuse its monopoly power and cause the so-called “deadweight” loss in social welfare. Regulation is thus viewed as an imperfect substitute for competition aiming at safeguarding consumers’ interests while providing private companies with the incentives to invest and operate efficiently (Rees, 1998; Klein, 1996). Finally, a study by the Asian Development Bank (ADB), one of the main advocates of PSP in water supply and sanitation, stressed that “A key advantage of having the private sector provide public services is that it allows public administrators to concentrate on planning, policy and regulation” (ADB, 2000).

One of the constraints to regulation identified by the literature is the asymmetry of information between the regulator and the regulated operator, that is to say the fact that regulators “tend to be less well informed about costs and quality of water systems operations than the water company management” (Klein, 1996). Regulation is described as a bargaining process between the parties involved, whose outcome is expected to “depend on the resources (power) and needs of the various players. Government departments responsible for the water sector and private companies, including financial institutions, are not the only players. Other government agencies, political parties, current utility managers, labour unions and consumer organisations will all be among the stakeholders keen to ensure that private-sector involvement will serve, or at least not harm, their interests” (Rees, 1998).

The following empirical evidence confirms the view that asymmetry of information is a problem which reduces the effectiveness of regulation. There is also evidence that asymmetry of capacity is also a problem, as regulators may simply lack the resources of the private companies in addressing any areas of conflicting interests.

Beyond regulatory weaknesses, there is evidence that PPPs create problems of transparency and accountability, and also provide incentives for corruption. These questions are usually avoided in the literature on PSP, but have a significant effect in reality: the bargaining relationship is altered by the lack of public accountability mechanisms, which reduces the role of public political inputs, and the opportunities for corruption create obvious distortions in the goals sought by the different actors.

Access to and asymmetry of information The effectiveness of regulation and monitoring mechanisms is affected by the ability of local governments and communities to access vital information on the operations carried out by private operators, as well as by the asymmetry of information between regulators and regulated operators.

 Commercial confidentiality: Commercial operations invariably prefer confidentiality and secrecy, as it protects their ability to manage financial affairs to maximise the benefit to their owners. For example, Aguas del Tunari, the privatised water concession in Cochabamba, Bolivia, refused to disclose the financial model behind its price rises on the grounds that the model itself was a commercial secretlii. Furthermore, private operators frequently insist that the contract itself should be a secret document – even from the elected councillors of the authority which has given the contract. In Fort Beaufort, South Africa, the contract prevented any member of the public from seeing the contract without the explicit approval of the company WSSA (owned by multinational, Suez-Lyonnaise): “2.2.2: Confidentiality: the documentation contained herein has been developed exclusively by the operator (WSSA) and shall not be disclosed to third parties without the written approval of the operator." liii Documents relating to the privatised Budapest Sewerage Company, operated by Vivendi, are kept secret, even from council officials, and Budapest City Council debates related issues only in closed sessions.liv (Hall, 2002)

 The cost of asymmetry of information: In 1989, a consortium led by SAUR and Vivendi was awarded a lease contract to operate and manage urban water services in 17 urban centres in Guinea. The private consortium set up SEEG (Société d’Exploitation des Eaux de Guinée) as the operating company. A report had pointed to the fact that state water authority SONEG did not have access to information on SEEG’s finances. This meant that when SEEG put in a request for SONEG to increase tariffs, SONEG was not able to accurately assess the grounds on which this was based. A World Bank audit found that weak regulation meant that the formulas used to adjust prices in response to cost changes were misapplied and this meant that tariffs were overvalued. Because of this and because of the informal price negotiations between SEEG and the government, the private operator received far greater compensation than was anticipated – the lease contractor rate – i.e. the part of the tariff to be paid to SEEG was supposed to be 214 GF/m3 but in fact it was 448 GF/m3. This was due in part to a lack of administrative capacity at SONEG but also because SEEG had failed to provide the information to SONEG that was required under the contract (Bayliss, 2001; Ménard & Clarke, 2000: 45).

Capacity to regulate The asymmetry of capacity can be observed not only in developing countries but in France itself, the home of the PSP model and the dominant multinational companies. In 1997, a report by French audit body Cour des Comptes (1997) repeatedly emphasised the disparity between the local authorities and the three giant companies dominating the national water market, which resulted in inadequate monitoring of privatised operations. Le Monde commented that the French system of delegated management "left elected councillors on their own, without support, to deal with conglomerates wielding immense political, economic and financial power"lv. A clear example of the implications of PPPs not being partnerships of equals is provided by events in Grenoble, France from privatisation to remunicipalisation (Hall & Lobina, 2001), but the disparity of resources and capacity between water TNCs and governments appears to be a more destabilising factor in transition and developing countries.

 Newly Independent States (NIS): In October 2000, the NIS Ministerial Conference on Water Management and Investment acknowledged that state capacity represented a major impediment to effective regulation of private operators. “The capacity of most NIS governments to effectively regulate private sector participation, particularly the more extensive forms, is an important constraining factor [on developing public-private partnerships]”lvi.

 South Africa: A recent study of public-private-partnerships in South Africa concluded that “lack of public sector capacity is, as the BOTT experience demonstrates, an important reason not to privatise, rather than a justification for public-private sector partnerships” (Bakker & Hemson, 2000).

 Colombia: A recent study on the PPP set up in Cartagena by Suez concluded that: "The Municipality of Cartagena lacks the minimal technical support in its negotiations within the joint venture. To all intents and purpose it is a "sleeping" partner. However, by wilfully neglecting capacity building for its own organisation, the municipality is running the risk of very negative consequences for the long-term sustainability of the partnership" (Nickson, 2001a: 34).

Lack of transparency and accountability Lack of transparency and poor institutional development are key factors in determining the failure of regulation. As summarised by Nickson (1997): “In many countries, regulatory structures are still embryonic, in others they lack transparency, while in others they appear to be excessively complex in their organisational structure, laying them vulnerable to political interference. In particular, the study has identified questions concerning the limited accountability of the essentially 'political' nature of the regulatory process associated with the French-style concession contracts”. One element in this is the private companies’ insistence on commercial confidentiality being observed, which means that in many cases the contract itself is treated as a restricted secret document, and withheld even from elected representatives. For examples of commercial confidentiality, see 4.1 Access to and asymmetry of information.

 Argentina: The Argentine government has bypassed local water regulators during the renegotiation of the concessions held by Suez-Lyonnaise des Eaux subsidiaries. Ministerial Decree N. 1.369/99 provided for sidelining regulator ETOSS (Ente Tripartito de Obras y Servicios Sanitarios) in the renegotiation of the concession with Aguas Argentinas in Buenos Aires: “... given the technical complexity of the issues relating to the regulation of the supply of the water and sewerage services... it is convenient to delegate in the Secretary of Natural Resources and Sustainable Development dependent on the Nation’s Presidency, the faculty to enact the text of the regulatory framework and the licensing contract” (Azpiazu & Forcinito, 2002: 26). Similarly, during the renegotiations with Aguas Provinciales de Santa Fe, regulator ENRESS (Ente de Regulación de Servicios Sanitarios) was sidelined by the Sub-Secretary to Public Services (Muñoz, 2002).

 Manila, Philippines: In order to win favour for proposals to automatically adjust tariffs to currency devaluation and increase prices, in 2001 Suez-Lyonnaise des Eaux subsidiary Maynilad supported attempts to negotiate the reorganisation of regulatory agency MWSS-RO (Metro- Manila Waterworks and Sewerage System -Regulatory Office) and the removal of some of its members. The argument used was that, since the establishment of MWSS-RO was provided for by the concession agreement, the contracting parties were entitled to mutually agree and modify the regulatory set-up (Esguerra, 2002: 17-18). On the other hand, individual members of MWSS- RO decided to withdraw a case contesting the competence of an International Appeals Panel which had ruled in favour of a proposal for price increases put forward by IWL’s Manila Water Company. Although the case had been filed by MWSS-RO as an institution and by local authorities, “the withdrawal was made by individuals without the backing of formal consent of either the MWSS Board or the MWSS-RO. Key members of the MWSS-RO were not even informed of the decision to withdraw the case contesting the Appeals Panel decision” (Esguerra, 2002: 12-13, 17). It should be noted that MWSS-RO was made up of five individuals and that the adoption of recommendations on rate adjustments required the approval of the majority of regulators. As of November 2002, only two of five regulators had been appointed permanently to their posts, while the others occupied their posts in an acting capacity. As the three regulators temporarily appointed did not enjoy the same job protection as the permanent members, who could only be replaced through international arbitration, the regulatory framework seemed permeable to external pressureslvii.

 Financial dependency of regulators: The independence of water regulators may be further affected by their lack of autonomous financial resources. In many cases, in order to alleviate governmental budgets, regulatory agencies rely on a fix percentage of tariffs collected by private water operators. As a result, regulators might appear as permeable to the interests of water multinationals. As of December 2001, funding of Buenos Aires regulator ETOSS was secured by a 2.67% charge on tariffs collected by Aguas Argentinas (Azpiazu & Forcinito, 2002: 4, 22). As of October 1998, funding of regulator for the province of Santa Fe ENRESS came from a 4.92% charge on tariffs collected by Aguas Provinciales de Santa Fe (Muñoz, 2002). The same principle applies to the funding of MWSS-RO in Manilalviii.

 Renegotiation and regulation as bargaining in Manila: In September 2001, Maynilad’s concession agreement was renegotiated providing for the Suez subsidiary to “resume payment of maturing concession fees, at least MWSS’ current operating budget”, in exchange for tariff adjustment to currency devaluation. The renegotiated agreement also established that “Maynilad shall withdraw its case filed against MWSS and in turn, MWSS shall suspend calling on the performance bond posted by Maynilad” and paved the way for the postponement of water pressure obligations and of investments in sewerage (Esguerra, 2002: 33). In November 2002, regulator MWSS-RO was in the process of resetting tariffs after the first five years of operations as provided for by the concession agreements. After defining the new tariffs, the regulator would set performance targets in consultation with the two concessionaires “since these targets should be mutually agreed upon”lix.

Corruption, state-capture and governance failure For a private water company, the incentive to engage in corruption of public officials is not only to bypass competition (see 2.3 Political economy of water corruption) but also to seek more favourable contract terms, and laxer regulation or monitoring. The local community thus has to bear the costs not only of the bribe but of the distorted terms of contract and regulation.

 Grenoble: A clear example of the implications on local consumers and taxpayers arising of the economics of corruption is provided by Grenoble, France where a tribunal found that the corrupt award of a 25-year water concession to a Suez-Lyonnaise des Eaux subsidiary had damaged consumers. The court found that the water service had been privatised in exchange for contributions by Lyonnaise des Eaux to the mayor’s electoral campaign, and other gifts, totalling over FF19m. In 1995, the regional auditor found that over the lifecycle of the contract the costs borne in excess by local consumers and taxpayers would be more than FF 1bn (US$150m) (Hall & Lobina, 2001).

There have been a number of convictions for bribery to obtain water contracts, involving executives of subsidiaries of both Suez (formerly Lyonnaise des Eaux) and Vivendi (formerly Générale des Eaux). These convictions have happened in developed countries (see Table 4 below), where institutional strength and the available resources allow to tackle corporate corruption more effectively than in poorer countries.

In the USA, privatised water company PSG has been the object of investigations for corruption in New Orleans, Louisiana and Bridgeport, Connecticut. In May 2001, three former PSG executives and a former member of the New Orleans Sewerage and Water Board were indicted with respectively paying and receiving a $70,000 bribe in exchange for the recommendation that the city renew its wastewater treatment contract with PSG for five more years. “Aqua Alliance, PSG’s parent company, agreed earlier to plead guilty to the charge of bribery and pay a $3 million fine”. Although at the time the payments were made PSG was not a subsidiary to Vivendi, PSG was subsequently acquired by U.S. Filter, which in turn would be purchased by Vivendi in March 1999. In June 2001, two close associates of Bridgeport mayor Joseph P. Ganim pleaded guilty to charges of bribery, fraud and tax evasion in connection with bribes totalling US$ 700,000 allegedly paid by PSG “in order to obtain a contract to operate the city’s wastewater treatment plant” (Tsybine, 2001: 6-7).

Allegations of corruption have been made in many other cases of water privatisation (sometimes by unsuccessful bidders) especially in developing countries, but without criminal convictions of water TNCs’ executives. This is consistent with research by a division of the World Bank itself, which “found that transnational firms are just as likely to pay administrative bribes and to try to capture the state as other firms, and that transnational firms headquartered abroad are more likely than other firms to pay public procurement kickbacks.” (Hellman et al., 2000)

 Buenos Aires: These cases include Aguas Argentinas, where a recent academic paper reported that: “Many of the people interviewed for this research suggested that attempts to buy the support of both the regulator and the government were not uncommon. The fact that the minister in charge of the 1997 tariff renegotiation, Maria Julia Alsogaray, has been tried for accepting multi-million dollar bribes in the privatization of the Buenos Aires port system only raises suspicions further. Several interviewees suggested that the cost of the 1997 renegotiation was in the multi-million dollar range.

Others stated that the support of local councillors had been bought with free trips to World Cup football matches in France in 1998. Though no concrete evidence was provided to this effect, there would appear to be growing concern around the issue of corruption. And, as Alsogaray’s name becomes increasingly tarnished with other scandals, several interviewees stated that it is only a matter of time before the anti-corruption office links her to improper dealings with Aguas Argentinas.” (Loftus & McDonald, 2001).

 Lesotho Highlands Water Project: In Lesotho, a major corruption trial concerning a water supply project involves prosecution of companies which were at the time subsidiaries of Lyonnaise des Eaux (now Suez), RWE and Bouygues (Hall, 2002). In May 2002, Masupha Sole, the former Chief Executive of the Lesotho Highlands Water Authority was found guilty on 11 counts of bribery and two of fraud for accepting some GBP 3m in bribes from a dozen multinational and South African firms in return for contracts worth hundreds of millions of pounds lx. In September 2002, the Lesotho High Court convicted the first of the companies to face trial, Canadian engineering consulting firm Acres International, of paying bribes totalling nearly $266,000 to Mr. Solelxi.

 Tangará da Serra, Brazil: In July 2001, Daniel Lopes, city councillor of Tangará da Serra, state of Mato Grosso, was murdered as he left the city hall in the same day where a vote was held which approved water privatisation. First police investigations related the murder to Mr. Lopes’ opposition to the privatisation and led to the exposure of a major corruption scandal and the imprisonment of 14 people in March 2002, 8 of whom were city councillors. Detained city councillors confessed having received from R$10,000 to R$40,000 each in exchange for approving to put a 30-year concession out for tender (Hall & Lobina, 2002). Tangará mayor Jaime Luiz Muraro was indicted on five charges including bribery and fraudlxii and investigating authorities found out that municipal funds had been used to pay part of the bribeslxiii. Mr. Muraro revealed that expressions of interest in bidding for the privatised concession had come from firms based in France as well as in the Brazilian states of Mato Grosso and Paranálxiv.

 Accra, Ghana: In April 2000, Azurix was awarded a build own operate and transfer (BOOT) project situated in the north of Accra. Azurix denied press allegations that the company had paid a US$5m bribe to senior officials to secure the contractlxv. The World Bank, which had put up a US$100m loan, subsequently cancelled the project. In a letter to Ghana’s vice president John Atta-Mills, and published in the Ghana Tribune, the Bank's director in Accra, Peter Harrold, said the choice of Azurix had not been made in a transparent manner. Ghana has been called upon to pay $800,000 for the costs of preparing the defunct project. In turn, Britain's Department for International Development (DFID) cancelled a US$30m rural water project (Bayliss & Hall, 2001).

 Jakarta, Indonesia: In 1997, while the country was still under the control of President Suharto, Jakarta’s water supply was privatised, under the auspices of the World Bank. One concession went to a consortium led by Thames Water and another to a consortium led by Lyonnaise des Eaux. Both consortia included partners which were owned by friends of the president. After Suharto’s fall, these contracts were deemed to be corrupt and the two TNCs moved rapidly to negotiate new contracts with Jakarta City Council, to run from February 1999. However, these contracts were also the subject of bitter criticism on the grounds that they were never properly advertised, that the prices contained in them were excessive, and that Suharto’s son continued to hold a five per cent equity stake in the new Thames Water venture. Court action was taken to have the contracts declared void, and a trade union of water workers demanded that the contracts be rescinded (Hall, 1999).

Weak accountability and lack of public participation In a context of less than transparent decision making on the award of privatised water concessions and weak accountability, public participation would have a role to play in institutional development. As a matter of fact, despite the emphasis placed on community participation by the advocates of PSP, effective public participation in decision making on and monitoring of PSP is either non-existent or ineffective.

A review of community participation in water projects found that although the private sector may act with governments, donor agencies and NGOs to set up a variety of privatisation options - such as BOTs,

03/04/2018 Page 20 of 49 PSIRU University of Greenwich www.psiru.org concessions, leases, etc. - they do not in practice include any role for the community itself: “It is uncommon to find a project with a large private and community involvement component” (Miller, 1999).

The following examples show how PSP in the water sector is associated with weakened accountability and restricted opportunities for public participation in decision making.

 Nkokobde, South Africa: On the cancellation of the contract between the municipality of Nkonkobe and WSSA, and the economic and social costs of the contract, see above section 3.3 Political risk and implications of distorted risk allocation. The court who gave the ruling found the contract was invalid as it had not been published first for comment by members of the public. Secondly, approval from the local government MEC was never obtainedlxvi. On the secrecy clause preventing any member of the public from seeing the contract without the written approval of WSSA, see above 4.1 Access to and asymmetry of information.

 Casablanca, Morocco: In 1997, a Suez-led consortium was awarded a 30-year multiple concession for water and energy in Casablanca by King Hassan, which the city council was not even informed about until later (Hall, 2001).

 Budapest, Hungary: On the secrecy surrounding the documents relating to the privatised Budapest Sewerage Company and city council debates on its operations, see above 4.1 Access to and asymmetry of information.

PART II – PSP IN PRACTICE: COSTS AND OUTPUTS

PSP AND THE COSTS OF INVESTMENT FINANCE In a context of growing urbanisation, large-sized water operators and TNCs in particular are expected in theory to reduce the costs of investment finance. Lorrain (1997: 24-26) elaborates on the comparative advantages enjoyed by large water operators on the basis of economic and organisational arguments. The economic arguments relate to economies of scale and the corresponding increase in yield rates, and to economies of scope. The industrial organisation arguments relate to transaction costs and optimal technical systems.

As regards economies of scale, Lorrain (1997: 25) argues that “a group that manages water services in hundreds of cities should theoretically perform better than a firm operating one single network, due to the higher yields the group can attain. To reach this stage, firms implement strategies of concentration and vertical integration. … This “law” of increasing yields forms the basis of the organization of some monopolistically-run sectors”. As regards economies of scope, “The know-how required to enter into a particular sector carries with it an acquisition cost which can’t simply be measured in technical terms. Understanding contract law and financing techniques is essential; knowing how to handle an ongoing relationship with the user is also essential; gaining access to both local and national decision-making circles is likewise essential, and so forth. Firms are obliged to include this phase of investment”.

As regards transaction costs, “The organization of a large group that relies on a great number of subsidiaries and on networks of subcontractors can, by performing work in-house, avoid using the market, with its scheduling constraints, myriad of controls and associated extra costs. These internally-driven organizations, contractually flexible, constitute for some activities a viable alternative to the market outcomes (Coase 1937)”. As regards optimal technical systems, “The mechanism of concession and leasing, which constitutes the very heart of the expansion of the French urban services firms, implies the management of an entire technical system. … This global presence allows engineers to design optimal solutions at the system level as opposed to the level of each sub-component. These solutions offer an efficiency/cost compromise which can prove more effective than cutting up the system into a sequence of activities” (Lorrain, 1997: 25-26).

Empirical evidence suggests that these comparative advantages enjoyed by water TNCs in terms of scale, scope, transaction costs, and other size- and capacity-related aspects do not translate in lower costs for local consumers and taxpayers.

PSP, risk and transaction costs Transaction costs can be defined as the legal, consulting and financial costs of structuring an infrastructure project. To these costs, typically incurred by private project developers, it is also necessary to add transactions costs borne by host governments, for example the costs of setting up and running a regulatory agency. Although transaction costs vary to a great extent across countries and different sectors, a World Bank study has identified transactions costs in private infrastructure projects as possibly ranging between “some 5 to 10 percent of total project cost — or some US$2 billion to US$3 billion a year, assuming that investments worldwide exceed US$35 billion a year” (Klein et al., 1996). Interestingly, “Prominent developers are unable or unwilling to produce accounts showing detailed transaction costs by project” and “Transaction costs are dominated by staff and travel costs, primarily reflecting the legal and financial complexity of reaching contractual agreements between numerous parties in essentially new and unique environments”.

In relation to PSP in water supply and sanitation, transaction costs can be seen as the costs of identifying, allocating and mitigating the various risks involved. Transaction costs are clearly higher for PSP than for water operations under public ownership. One reason for this is that there is no need for such complex legal provisions, as the public authority is unavoidably responsible for ensuring water supply, whatever happens, and so the liabilities of each side do not need to be spelt out in advance. Some transaction costs only exist under PSP: for example, political risk, defined as “the probability of the occurrence of some political event that will change the prospects for the profitability of a given investment” (West, 1996: 6-7), only exists under PSP and therefore does not apply to public water operations.

Advocates of PSP argue that the higher transaction costs under private sector projects are due to the fact that risks perceived by private developers remain hidden under public provision and ultimately borne by consumers or taxpayers (Klein et al., 1996). For example, political risk might translate into political interference or inefficiency under public water operations. This argument however relies on an unsupported assumption that political decision-making in this area is always associated with dysfunctional results, which leads to a consistent relative inefficiency of public sector operators compared with private sector operators. However, the empirical evidence does not support this assumption about inefficiency: the results of most empirical studies, in water as in other sectors, are, overall, neutral on whether public or private ownership is more efficient (Hall 2002b, 1998; Lobina & Hall, 2000). The empirical evidence supports this position in all sectors, not only water, as well as a general case that political decision-making actually increases efficiency in monopoly sectors (Willner, 2001).

There is a further layer of transaction costs involved in PSP, which is the restructuring of the water sector to make it suitable for privatisation through a concession model, often through legislation. These and other transaction costs are often substantial enough to require specific development bank loans to cover these costs alone.

 Paraguay: In July 2000, the World Bank was to issue a US$ 12m loan to Paraguay aiming to finance the preparation costs of the privatisation of state water company Corposana and telecoms company Antelco. Would-be private operators were expected to refinance the loanlxvii. In June 2001, the Paraguay government and the World Bank awarded a US$ 2m contract to Spanish firm Sanchis & Asociados to provide an 18-month long public relations campaign supporting the privatisation of Corposana and Antelco. This was the largest PR contract ever awarded in Latin Americalxviii.

 Guayaquil, Ecuador: In July 1997, the IBD approved an US$ 40m loan aiming to improve water supply and sanitation services in Guayaquil. In preparation to privatisation of water operations, US$ 20.2m out of the US$ 40m lent – that is to say, 50.5% of the loan issued – were earmarked to "undertake technical, legal and financial studies and to prepare bid specifications for the concession award"lxix. For details, see above 2.2.2 Single-bid concessions.

PSP, risk, incentives and the cost of finance A number of structural factors contribute to inflating the costs of investment finance under PSP, including the profit motive as well as the typical reluctance of private shareholders to assume the financial risks related to a long-term project and secure loan repayment. In the water sector, project finance is the preferred method of structuring investment finance as loan repayment is secured entirely on the cash flow generated by the operation of the project. This means that, contrary to corporate finance where loan repayment is secured on the balance sheet of the operating company’s shareholders, under project finance most if not all of the financial risk is shifted on to local consumers or taxpayers. The implications of private sector's favour for project finance rather than corporate finance are visible in Manila where the two concessionaires adopted two different methods of securing loan repayment.

 Manila: Both concessionaires were subject to the pressures resulting of currency devaluation, but Maynilad experienced considerable difficulty in achieving financial closure of a US$ 350m loan to finance investments in the first five years of operations. While Manila Water Company resorted to corporate finance, Maynilad opted for project finance or limited recourse financing. Difficulties at reaching financial closure were due to the fact that “Other things being equal, the risk premium that creditors would assign to Maynilad would be higher and this raises the financing cost. Maynilad’s creditors would also be far more meticulous than Manila Water’s creditors when it comes to rights of third parties (e.g., creditors) to Maynilad’s assets and future income streams, especially in case of bankruptcy or default”. It should also be noted that in December 2000 Maynilad proposed to renegotiate the concession agreement and postpone some of its service obligations in terms of water pressure targets and investments in new sewerage networks. Maynilad argued that lenders - including the ADB, EIB (European Investment Bank), France’s export credit agency Coface and seven commercial banks led by Citibank N.A.lxx - would not release the US$ 350m loan unless Maynilad was allowed to defer such targets. The lenders were concerned that the creditworthiness of the Suez subsidiary could be affected by the company’s failure to meet its contractual obligations and the eventuality of forfeiting its performance bond. Furthermore, Maynilad proposed to alter the volume of water it was expected to invoice, meaning that “the company will not be able to meet its targets on billing and non-revenue water reduction, and will consequently have a smaller revenue intake” (Esguerra, 2002: 9-10). In October 2001, Maynilad’s concession agreement was renegotiated and the regulator agreed to address the concerns of lenders, including the postponement of sewerage investments beginning year 5 and the postponement of water pressure obligations (Esguerra, 2002: 33). In November 2002, it was reported that “Instead of requiring the water firms to expand their facilities in order to achieve higher water pressure of around 14 pounds per second inch (psi), pressure will be lowered to less than 10 psi”lxxi.

Overall, the profit motive has a major impact on the long term costs of PSP, especially in view of pressure from parent companies with double digit growth projections as is the case with Vivendi and Suez.

 Double digit growth projections: In October 2001, Suez CEO Gerard Mestrallet promised shareholders double digit growth in the water sector for fiscal year 2001-2002 by more than 10%lxxii. In May 2002, Mestrallet “confirmed his target of double-digit compound annual average growth in sales and earnings per share in its three global businesses (water, energy and waste) on the 2001- 2004 period”lxxiii. In August 2001, it was reported that Vivendi Environnement - active in the water sector as well as in energy, waste and transport - had announced targets of “10% a year growth in turnover, and 14% a year in operating profit”lxxiv.

Internal subcontracting Vertically-integrated water TNCs have a vested interest in purchasing equipment from and subcontracting services to their own subsidiaries in order to maximise profit from water and wastewater operations to the benefit of shareholders. Private operator’s ability to pass the entire costs of subcontracting on to local consumers or, as a last resort, taxpayers and to preserve the so-called economic and financial equation of the concession may give rise to such a vested interest. Similar practices affect competition in the acquisition of external services and goods, undermine the operator’s incentive to achieve efficiencies and may have a significant impact on operating and capital costs. The implications of privileged or exclusive access to

03/04/2018 Page 23 of 49 PSIRU University of Greenwich www.psiru.org subcontracting can be observed in France (Hall & Lobina, 2001), as well as in transition and developing countries.

 Subcontracting and competition: There is a striking coincidence between the award of a number of privatised water concessions and the subsequent subcontracting of major works contracts to subsidiaries of the same water TNCs. In July 2000, UK-based Anglian Water acquired a controlling interest in Chilean water and wastewater company Esval. In March 2001, Esval awarded three contracts valued a total US$ 29.7m for the design, construction and start-up of wastewater treatment plants, one of which went to a consortium led by Anglian Water’s subsidiary Puraclxxv. In June 1999, a Suez-Lyonnaise des Eaux/Agbar consortium bought a 42% equity stake in Santiago de Chile’s water company EMOS (Suez Lyonnaise des Eaux, 1999: 25). In March 2001, EMOS awarded a technology and management contract to Suez wholly-owned subsidiary Dégrémont for the US$315m La Farfana wastewater treatment plantlxxvi.

 Subcontracting and costs in Manila: The bid successfully submitted by Suez subsidiary Maynilad estimated aggregate operating expenses for 1997, 1998 and 1999 to be PHP 4.369bn. As a matter of fact, actual operating expenses for the corresponding period amounted to PHP 6.259bn, that is to say 43 percent more than projected. Internal trading might explain at least part of such extra costs. As has been reported in a comprehensive study on the Manila water privatisation, "there are also claims from disgruntled employees at Maynilad and from an MWSS source that the company had very expensive contracts with the affiliate companies of the French and Filipino corporate sponsors. This included a management consultancy contract with Lyonnaise des Eaux Philippine (LDEP), and interest bearing advances from Benpres Holding Company (BHC) as well as from LDEP for bidding and start-up costs. There also was a technical assistance and service agreement with both BHP and LDEP. Maynilad also paid charges for guarantee fees related to loans and standby letters of credit guaranteed by BHC and Suez Lyonnaise des Eaux (SLDE). Then, there was an Interim program management deal with Safage Consulting and Montgomery Watson, an affiliate of SLDE. Finally, there was a technical assistance agreement with Lyonnaise des Eaux Services Association (LYSA) for the revenue enhancement program of reducing the non-revenue water. All of these deals are denominated in foreign currency and thus became inflated as a result of the peso devaluation" (Esguerra, 2002: 10).

 Szeged, Hungary: Vivendi owned 49% of Szegedi Vizmu, the company which runs the water operating concession in Szeged. A separate works company, 70% owned by Générale des Eaux and 30% by the local municipality, had also been established. Szegedi Vizmu payd the works company a fixed annual fee, described as “very high”, for the execution of all the maintenance work. Moreover, the works company had exclusive rights to works contracts issued by Szegedi Vizmu. This arrangement allowed the French TNC to use its works subsidiary as a vehicle to export a high share of the profits realised by Szegedi Vizmu (Lobina & Hall, 2000).

 Łodz, Poland: In March 1995, Łodz city council terminated a construction contract awarded in 1993 to a joint venture between Vivendi’s engineering subsidiary OTV and the city council itself. The contract for the construction of a sewerage plant was affected by many problems in terms of costs and failures. The work was being done late and uneconomically - Lodz council brought constant economic cases against OTV for failures. When OTV bought equipment, it was always from GdE subsidiaries in France - tenders were apparently held, but French companies always won. The equipment sometimes did not work and was invariably late. In February 1995, the public prosecutor issued a report stating that OTV was in breach of contract because they were not keeping deadlines, construction work was not finished on time, and they were paying themselves for work – e.g. instead of buying Polish equipment were buying French equipment which did not fit (PSPRU, 1998).

 Cartagena, Colombia: In 1995, Acuacar was set up as a public-private joint venture between the city council and Aguas de Barcelona to provide water supply and sanitation to Cartagena. Immediately after being awarded the 26-year operating contract, ACUACAR signed a fee-based management with Aguas de Barcelona. So that Aguas de Barcelona was remunerated through the dividends paid to shareholders and the management fees, calculated as a percentage of Acuacar's

gross income. This arrangement has allowed Aguas de Barcelona to extract increasing revenues from its Cartagena operations, as management fees were calculated as a growing percentage of Acuacar's gross income. "In the first four years of operation, this management fee was fixed at 2.94%, 3.37%, 3.82% and 4.25% respectively of gross income. In 1999 AGUACAR declared profits of $1.96m. In the same year, AGBAR received a total of around $2,100,000 from its involvement in the Cartagena concession - $900,000 from its dividend share and $1,200,000 from its management fee" (Nickson, 2001a).

PSP AND THE DYNAMICS OF WATER PRICING

Post-award dynamics The advocates of PSP in water supply and sanitation argue that competition for the market, for example in the form of competitive bidding for long term concessions, delivers benefits to consumers as it would result in “spectacular” tariff reductions in respect of previous public water operations. Examples referred to in support of this view include the experience in countries such as Argentina and Guinea as well as in Manila, Philippines. It has been argued that “Competition forces the bidders to reveal the minimum cost of providing water and sanitation, allowing efficiency gains to be realized and passed on to consumers. Many major water sector reforms in recent years have used competition for the market as an efficient way of introducing private sector participation, and the approach has delivered benefits to consumers. For example, in Guinea competition resulted in a tariff 30 percent lower than a benchmark price estimated by consultants, and in Manila the winning consortium for one of the concession areas offered a tariff reduction of 74 percent” (Webb & Ehrhardt, 1998).

Empirical evidence seems to contradict the above static interpretation of water pricing under PSP as, particularly as a result of private operators’ interest-seeking, pricing proves to be a dynamic process. Once private operators are isolated from competition, that is to say immediately after the beginning of operations, the same factors observed as affecting the functioning of PPPs will also determine pricing and indeed the broader outcomes of PSP. In this sense, restricted competition, distorted risk allocation, contract renegotiation and regulation in a context of unequal distribution of resources and capacity, not to mention lack of transparency, often mean that the initial tariff reductions are only temporary and destined to be more than offset by successive increases.

Another aspect of pricing as a dynamic process is the relative impact of tariff increases, possibly exceeding the extent of price variations in nominal terms, which might result from concurrent reductions in the level of projected investments or in other outputs. Before presenting empirical evidence on the dynamic factors conditioning pricing, it should be noted that also constraints affecting policy and decision making on urban water systems reform have repercussions on the dynamics of water pricing. For example, tariff reductions following the award of privatised concessions may seem less spectacular when considered that, due to ideological or other political motivations, rates charged by public undertakings may be increased substantially to make forthcoming privatisations more appealing to potential investors. In the light of the complexity of privatisation as a political process, the dynamics of pricing under PSP might in fact stretch to the preparatory period preceding the competitive bidding.

Making privatisation more appealing It is often the case that local governments decide to increase water tariffs charged by public providers as a way of attracting greater interest from international operators and investors and facilitate the public perception of the privatisation as a political success. Successful bidders are thus in a position to substantially reduce tariffs, which may then start to increase again immediately after the beginning of privatised water operations. Tariff reductions resulting of international competitive bidding may also appear less impressive, if not illusory, when considering the favourable contractual conditions obtained by the private operator, in terms of either the expansion of the volume of water and wastewater on which the tariff is applied, or in terms of commitment to achieve quality standards.

 Buenos Aires, Argentina: Water tariffs in Buenos Aires were raised a number of times prior to the award of the 30-year concession to Aguas Argentinas in May 1993. In February 1991, tariffs were

augmented by 25%, followed by a 29% increase in April 1991. In April 1992, tariffs were marked up by an 18% VAT charge and a further 8% tariff increase was introduced just before May 1993. The Suez-Lyonnaise des Eaux-led consortium won the concession as it offered the highest reduction in tariffs, that is to say a 26.9% downwards adjustment (Azpiazu & Forcinito, 2002: 7, 12). However, the concessionaire immediately started to renegotiate the agreement in order to obtain price increases and the deferral of its investment plan. From May 1993 to January 2002, bills increased by 88.2% (see below for further details – 6.4 Renegotiation and dynamic pricing) (Azpiazu & Forcinito, 2002: 38-39).

 Province of Santa Fe, Argentina: In September 1995, Suez-Lyonnaise des Eaux-led consortium APSF was awarded a 30-year concession for the provision of water supply and sanitation services in the Santa Fe province. APSF succeeded in the bidding process as it offered the lowest tariff, that is to say Peso/US$lxxvii 0.2865 per cubic metre, starting from the tariff previously applied by the state water company DiPOS. According to consumers association Union de Usuarios y Consumidores, contrary to the method applied by DiPOS, the tariff formula applied by APSF meant that water supply was charged as much as sewerage. More precisely, the full tariff of US$ 0.2865 per cubic metre was applied to cover the costs of both water supply and sewerage, while 20% of the tariff was applied to compute the costs of rainwater drainage. The concession agreement fixed interests on arrears at levels two or three times the maximum allowed by Argentine law. More precisely, the contract fixed interests on arrears at 5% at 30 days, 10% starting from the 31 st day, plus an additional compensatory 2% each month. As a result, a consumer who settled his debts at the end of the second year of the privatised concession, paid twice for the first two months of APSF operations in 1996 than for the last two months under DiPOS in 1995. The contract also provided for a hike in the cost of connections, fixed at US$ 440 plus VAT for a connection to the water supply network and US$ 820 plus VAT for a connection to the sewerage network. This was very much above what had been previously charged by local municipalities and cooperatives and clearly unsustainable. As regards quality standards, the concession agreement fixed the limit value of harmful substances to be found in the supplied drinking water much above what established by Argentine law. For example, the contract fixed the maximum limit of arsenic at mg/l 0.10 instead of the mg/l 0.05 required by law and the mg/l 0.01 recommended by the WHO (World Health Organisation). In September 1997, water supplied by APSF in the town of Firmat was declared unfit for human consumption (Muñoz, 2002).

 Manila, Philippines: In August 1996, tariffs charged in Manila by publicly-owned MWSS were increased by 38%, from PHP 6.43 pcm to PHP 8.78 pcm. Following the January 1997 privatisation, tariffs charged by Maynilad in west Manila fell by 43.5%, down to PHP 4.96 pcm, while tariffs charged by Manila Water Company in east Manila fell by 74%, down to PHP 2.32 pcm (Esguerra, 2002: 4). It is not clear to what extent successive tariff increases agreed upon to compensate for the losses suffered by the two concessionaires reflected the scale of currency devaluation. As of March 2002, prices charged by Maynilad reached PHP 15.46 pcm, with a 211.7% increase on 1997-1998 levels; while prices charged by Manila Water Company reached PHP 6.75 pcm, with a 190.9% increase on 1997-1998 levels (Esguerra, 2002: 34). For details on the full scale of price increases following currency devaluation, see above 3.2 Allocation of currency risk in practice. Esguerra (2002: 2, 24, 32) argues that currency devaluation might only explain part of the losses incurred by the two concessionaires, which were also due to inefficiency and over-optimistic assumptions. For details on Maynilad’s underestimated operating expenses and costly subcontracting, see above 5.3 Internal subcontracting.

Currency risk allocation and pricing The most obvious examples of risk allocation affecting pricing relate to currency risk. Profit motive and the typical reluctance of private investors to assume currency risk also affects the costs of investment finance ultimately borne by local communities. Water TNCs appear to have no vested interest in seeking the removal of currency risk away from local consumers and taxpayers and often require the indexation of tariffs to the US$ and/or US inflation. In fact, profits from water operations are repatriated in US$ or other hard currency and failure to provide for tariff indexation would deteriorate commercial returns. Subsidiaries of water TNCs also tend to purchase goods and services from other subsidiaries of their own group, often at a high cost, and

03/04/2018 Page 26 of 49 PSIRU University of Greenwich www.psiru.org those goods and services are paid for in US$. Manila provides clear examples in this sense (see above 5.3 Internal subcontracting), but is not an isolated case as shown by the below empirical evidence.

 Buenos Aires, Argentina: The Aguas Argentinas concession agreement was renegotiated for the second time from February to September 1997 and, among other provisions, the new renegotiated contract provided for automatic tariff adjustment in case of currency devaluation. In July 1999, the regulatory and pricing framework was modified to adjust tariffs by the price index IPD minus the efficiency ratio X (IPD-X), in order to transfer part of the realised efficiency gains to consumers. However, instead of adopting a domestic price index, IPD was an average between the US Producer Price Index and Consumer Price Index, both of which would then increase more than domestic prices. The indexation to US price indexes allowed water tariffs to increase further, as US inflation in the following years had been higher of the X factor, fixed at a mere 0.5% (Azpiazu & Forcinito, 2002: 25-31). A further attempt to link local water tariffs to variations in US prices was made in January 2001, when Aguas Argentinas and ETOSS agreed on an aggregate 3.9% tariff increase for the years 2001 to 2003 "to finance the company's US$ 1.1bn 1999-2003 investment plan", together with a 1.5% adjustment to US inflation (1% applied to tariffs in 2001 and 0.5% in 2002). In January 2001, Buenos Aires consumers associations were to take legal action against the planned 1% tariff adjustment to US inflation, introduced although the Argentine economy was experiencing deflation. The agreement also provided that starting from 2003 water rates would be indexed to US inflationlxxviii.

 Cochabamba and La Paz, Bolivia: A recent study revealed that both the concession awarded in 1997 to Suez subsidiary Aguas de Illimani in La Paz and the concession awarded in 1999 to IWL’s Aguas del Tunari in Cochabamba provided for tariff indexation. The study also showed that, over the period 1997-1998, tariff adjustment to US$ would have resulted in an 11.5% tariff increase due to currency devaluation. Tariff indexation under the Cochabamba privatised concession was even more favourable to the private operator as tariffs were not only pegged to the US$ but also to US inflation (Laurie & Crespo, 2002).

This can be contrasted with an approach to currency risk in public water operations, as in the case of the Porto Alegre municipal water company in Brazil: "DMAE is now exploring the scope for tapping a blend of multilateral and federal source in order to finance construction of the R$ 270.3m Serraria wastewater treatment plant. The aim of the proposed co-financing scheme is to enjoy the favourable terms and conditions offered by multilateral lenders while cushioning the loan from currency risk. In fact, a loan entirely issued in US$ would expose DMAE to the volatility of the Brazilian R$ and the risk of spiralling repayment costs" (Hall et al., 2002b).

In January 2000, the EBRD decided to issue a PLN 108m (€ 21m) loan in favour of the Polish municipally- owned water company MWiK (Bydgoszcz). This was the first loan to be issued by the EBRD in Polish zloty, a scheme designed in order to remove currency risk from local consumers/taxpayers. Also, in December 2000, the EBRD decided to issue a € 20m, 12-year loan to Krakow municipally-owned water company MPWiK - the EBRD loan was to be provided in two currencies, respectively PLN 45.5m and € 10m (Lobina, 2001).

Renegotiation and dynamic pricing Continuous renegotiation of contractual arrangements in a context of unequal resources and capacity has a direct impact on water pricing, as tariffs may be raised and projected investments revised downwards. Water TNCs often start to renegotiate immediately after the beginning of operations in order to alter the legal and economic framework of operations. The disparity of resources and capacity between international private operators and local authorities almost systematically translates into a penalising outcome for local consumers and taxpayers, with a net increase in the cost of outputs.

 Buenos Aires, Argentina: Having started only eight months after the beginning of operations, continued renegotiation of the Aguas Argentinas concession (Azpiazu & Forcinito, 2002: 23-38) led to a far greater increase in the relative cost of outputs than suggested by nominal increases in tariffs and billing. Figure 3 below shows the development of average bills in Buenos Aires from May 1993

to January 2002, as opposed to the variation in Argentine inflation over the same period. Average household bills increased from Peso/US$ 14.56 to Peso/US$ 27.40, that is to say increased by 88.2% in nominal terms as opposed to a 7.3% increase in the Consumer Price Index (CPI). It should be noted that for most of the period considered the Argentine Peso maintained its parity with the US$, as the Argentine currency was devaluated on 6th January 2002 (Azpiazu & Forcinito, 2002: 38-39, 55). In order to evaluate the net increase in the cost of outputs under Aguas Argentinas, the reduction of projected investments resulting of renegotiation should also be taken into account. From May 1993 to December 1998, Aguas Argentinas failed to realise 57.9% of the originally agreed investments for a total of US$ 746.39m (see Table 2 below). Table 5 below shows that, from May 1993 to December 1998, Aguas Argentinas failed to realise 46.3% of originally agreed investments in the expansion of the water supply network and 56.8% of originally agreed investments in the expansion of the sewerage network. When considering investment targets as defined after renegotiation in 1997, Aguas Argentinas failed to realise 39% of projected expansions in the water supply network and 59.7% of projected investments in the expansion of the sewerage network (Azpiazu & Forcinito, 2002: 39-45).

 Manila, Philippines: The renegotiation of Maynilad’s concession, together with its implications on pricing and implementation of projected investments, has already been considered (in particular, see above – 5.2 PSP, risk, incentives and the cost of finance). If Maynilad opened the renegotiation process in December 2000, Manila Water Company started requesting revisions to the agreement in 1998 or less than a year since beginning operations. Manila Water Company sought the modification of originally agreed parameters which would result in an increase in prices above the levels projected by two of its competitors in the bidding process. This implies that, had Manila Water Company put forward its bid on the basis of the parameters it later sought to obtain through renegotiation, it would have failed to win any of the two Manila concessions. It should be noted that the regulator rejected the request of the concessionaire but its decision was overturned by the Appeals Panel. MWSS-RO subsequently appealed against the Appeals Panel decision to allow a 9.3% increase in the parameter, as opposed to the requested 18%, as the Appeals Panel was only competent to rule on procedural matters rather than on substance, so that the Appeals Panel had no power to rule and determine the revision of parameters used in tariff formulae (Esguerra, 2002: 12-14).

Tactical resources of TNCs and dynamics of pricing Water TNCs may resort to a variety of tactical resources in order to alter pricing and adapt it to their commercial objectives. Such tactics may range from the adjustment of indexation bases or other technical parameters determining tariff formulae to various forms of overcharging for investments - such as plain double charging and over-estimation of projected investments and demand forecasts, from the use of subcontracting (see above - 5.2 PSP, risk, incentives and the cost of finance) to non-payment of fees as a lever in bargaining (see above – 3.1 Allocation of performance risk in practice).

 Misapplication of tariff formulae and pricing in Guinea: A World Bank audit on the lease contract awarded in 1989 found that weak regulation meant that the formulas used to adjust prices in response to cost changes were misapplied and this meant that tariffs were overvalued. This helped explain why private operator SEEG received far greater compensation than was anticipated – the lease contractor rate – i.e. the part of the tariff to be paid to SEEG was supposed to be 214 GF/m 3 but in fact it was 448 GF/m3, a variation of +109.3% (Bayliss, 2001). By 1996, prices in real terms had increased faster than originally projected as the average tariff reached 880 GF/m3 as opposed to the expected tariff of 660 GF/m3. It has been noted that the observed 33.3% upward price adjustment was not related to inflation. The World Bank study noticed problems of affordability, especially in relation to costly connections and noted that improvement in performance had not been “as dramatic as was originally hoped” and that there was still “significant scope for future improvement” (Ménard & Clarke, 2000: 26). Acceptability of the high prices charged by SEEG was the reason for the government’s refusal to extend the 10-year lease by awarding SEEG a new 15-year agreement (Hall et al., 2002).

 Financial manipulations of water operations in Tallinn, Estonia: In January 2001, IWL together with United Utilities International acquired a 50.4% stake in AS Tallinna Vesi for € 80m. Tallinna

Vesi provides water services to the Estonian capital Tallinn. Financial manipulations of the water operations by the foreign operator affected water pricing, as was the case with a surcharge introduced for water drainage and the diversion of financial resources in the form of dividends lxxix. In May 2001, Tallinna Vesi demanded that the city council agree to pay a total of EEK 235m (US$ 12.8m) in five years for water drainage. The council had never paid the water company for this before, on the basis that the relative cost was included in the water tariffs. The tariffs already covered surface water drainage and so it would mean paying double for one and the same service. The company claimed extra payment, referring to a law introduced several years ago, according to which water tariffs shouldn't contain any sums not directly connected with the given service. In May 2001, the supervisory council of Tallinna Vesi recommended that the shareholders' annual meeting pay out EEK 182m (US$ 10.3m) in dividends out of the profit for the financial year (EEK 24m) and previous years' retained profit. The reason for payment of such high dividends was the “obvious” overcapitalization of the Tallinna Vesi balance sheet and the large amount of idle money on its bank account: "European water companies have on the average of 47 percent of borrowed or external capital and 53 percent of shareholders' capital. In Tallinna Vesi, that proportion was very much in favour of the shareholders' capital and payment of dividends was a good means to change it" (Lobina, 2001). In September 2002, Tallinna Vesi reduced its own stock capital by EEK 950m (€ 60.7m), down to EEK 200m, by buying back shares from its own owners and paying EEK 479m to IWL/UU and EEK 471m to Tallinn city councillxxx. By the end of 2002, two years after privatisation, International Water and United Utilities had together received a total of EEK 636m - partly in dividends and partly from the capital reduction - and this before the 50% above-inflation rise in water prices expected by 2010lxxxi. They had thus recouped 93% of the EEK 687m of new equity capital they injected into Tallinna Vesi in January 2001lxxxii, while still owning 50.4% of Tallinna Vesi (Hall et al., 2003).

PSP AND DELIVERY TO THE POOR

The proponents of PSP expect private water operators to deliver better quality services at lower costs in the light of their efficiency and benefit the totality of consumers, including the poor. As summarised by the World Bank quoted by Catley-Carlson (2002): “The reality is that the private sector has the capacity and the interest to serve the poor, is willing to experiment with low cost options, and different levels of service, and with greater efficiency can benefit all consumers”.

As a matter of fact, empirical evidence suggests that the profit motive may be extremely difficult to reconcile with service delivery to the poor without public subsidies or the alteration of the original contractual agreement. In this sense, it is the experience of the major water TNCs which is most illuminating.

Limitations of private sector in delivering for the poor and development In January 2002, in a presentation to the World Bank water division, J.F. Talbot, the chief executive of SAUR International, the fourth largest water company in the world, addressed the limitations of the private sector in delivering for the poor. Talbot (2002) referred to the huge scale of the investments required to meet the basic water needs of developing countries and thus enhance sustainable development, while questioning the commercial viability of operations subject to a number of market trends unfolding in the 1990s. After discussing the implications of such market trends on private water operators, he rejected common beliefs about the role of the private sector as an investor, about the compatibility between regulation and profitability, and the viability of introducing cost recovery – and concluded by insisting that subsidies and soft loans were essential to ensure the continuity of service provision.

Pointing to “An often premature or simply unrealistic emphasis on concession contracts and full divestiture” and to “A belief that any business must be good business and that the private sector has unlimited funds”, Talbot rejected the assumption that privatisation would automatically tap into private funds. Moreover, he acknowledged that the private sector simply did not have the financial capacity to deliver the required investment levels and achieve the expected developmental outcomes as “The scale of the need far out- reaches the financial and risk taking capacities of the private sector”. He then identified tighter contracts and

03/04/2018 Page 29 of 49 PSIRU University of Greenwich www.psiru.org regulation as possible deterrents from a business perspective in that the general increase in risk perceived in the water sector, in terms of country and financial risks, was exacerbated by “Unreasonable contractual constraints” and “Unreasonable Regulator power and involvement”. Further difficulties for private water operators were represented by “An emphasis on unrealistic service levels”, “Attempts to apply European standards in developing countries” and “The demand for "connections for all" in developing countries”. He finally rejected the sustainability of introducing full cost recovery from users in developing countries, arguing that “Water pays for water is no longer realistic in developing countries: Even Europe and the US subsidise services” and that “Service users can’t pay for the level of investments required, not for social projects” (Talbot, 2002).

A similar analysis appears supported by Biwater’s experience in Zimbabwe. As Biwater pulled out of a major water supply project, because the project could not deliver the rate of return now demanded by private investors, in December 1999 the company manager explained: "Investors need to be convinced that they will get reasonable returns. The issues we consider include who the end users are and whether they are able to afford the water tariffs. From a social point of view, these kinds of projects are viable but unfortunately from a private sector point of view they are not" (Hall, 2001)lxxxiii.

The above suggests that the fundamental problem faced by private operators in trying to provide water supply and sanitation to the poor is that the poor are not profitable, because they cannot afford to pay for the connection or to consume enough water to cover the costs of service provision. When it comes to serving the poor, water TNCs might be confronted with a dilemma originating out of the conflict between the objectives to maximise return for the private operator’s shareholders and to ensure universal access to basic water supply and sanitation services. As profit maximisation is the “raison d’être” of private enterprise, the dilemma is between withdrawing from serving areas where consumers cannot afford to provide the operator with the return demanded by its shareholders, or where commercial risk is perceived as excessive, and supplying all customers in the area of operation while sticking to commercial considerations, which in turn inform pricing policy and levels of service and investment. Different approaches to solving this dilemma have all significant implications in terms of access to service. In particular, the operator’s choice to stick to commercially desirable tariff levels might lead to what can be defined as “water poverty”, in the case of consumers who cannot afford to pay bills and have to resort to alternative sources of drinking water and face serious health hazards. The following are examples of “water poverty”.

 Paraná, Brazil: Poor users in the area served by Vivendi’s subsidiary Sanepar have been forced to resort to alternative sources of water to treated drinking water supplied by the semi-privatised operator. In November 2002, months after being disconnected for failure to pay water bills, poor families in Maringá were using rain water for cooking and drinking purposeslxxxiv. In January 2003, consumers in Vila Democracia, in the metropolitan region of Paraná’s capital city Curitiba, were using contaminated water as they could not afford paying for the bills issued by Saneparlxxxv.

 KwaZulu-Natal, South Africa: In August 2000, a cholera outbreak started outside Empangeni in Kwazulu-Natal, with later outbreaks elsewhere, which by February 2002 took the total death toll from cholera up to 260, the worst epidemic in the history of South Africa. lxxxvi The development of the epidemic was linked by many, including South African Water and Forestry Minister Ronnie Kasrils, to the operation of government policies of full cost recovery for water. lxxxvii According to a report by the South African Press Association: “A government committee has found that it would be feasible to provide water free of charge to poor communities, Water and Forestry Minister Ronnie Kasrils said on Friday [October 2000]. Kasrils said in a statement that the inter-ministerial group, comprising himself and the ministers of finance and provincial and local government was formed to investigate the provision of free basic water to the poor. A study by the committee found it would be "feasible and viable" to provide free water once schemes were established. Funding for free water would come from local government and by recovering costs from those who could pay. In many areas, particularly rural districts, the poor do not pay at present for water. "The problem is that when we try to implement cost recovery, many of the poor cannot pay". Kasrils said health problems, such as the current cholera outbreak in KwaZulu-Natal, arose when the poor were excluded from water supplies. He said his visits to rural areas had highlighted the fact that many people were so desperately poor that they could not afford what might seem to ordinary people a very small price for water. He said rural women complained that should they have to pay a R10 per month for water,

their families would have less to eat. They therefore chose to buy food instead and took their chances in searching for river or ground water, he said. "It is our moral duty to make a basic amount of safe water available to all South Africans, or at least to those who cannot afford to pay for it”. Kasrils said the cholera outbreak in KwaZulu-Natal would not have happened if all South Africans had access to safe drinking water”lxxxviii. This appeared to reverse the previous policy based on World Bank advice. World Bank economist John Roome advised then-water minister Kader Asmal in 1995 against cross-subsidisation, arguing that this could deter private companies (Hall et al. 2002).

The last example shows that when public sector water operators try and introduce commercial policies, such as full cost recovery in pricing, the impacts on the poor in terms of restricted access are not dissimilar to those caused by the commercialisation of service provision promoted by the advocates of PSP and adopted by water TNCs. The implications of pricing on access to water supply and sanitation have been addressed in December 2001 by the Bonn Recommendations for Action issued at the International Freshwater Conference, which urged that: “cost recovery objectives should not be a barrier to poor people’s access to water supply and sanitation” (Federal Government of Germany, 2001: 30)lxxxix.

TNCs’ attempts at solving problems with service provision to the poor In an attempt to escape the dilemma between withdrawing from potential markets and the risk of inducing “water poverty” in the served areas, water TNCs have developed different approaches aiming at reconciling commercial considerations and the objective of serving the poor. These approaches range from defining the contractual framework in a way to ring-fence profitable customers, to introducing cross-subsidisation of tariffs and requiring substantial public sector subsidies and other forms of financial support to private sector operations. So far, empirical evidence on experiences in this sense has highlighted persistent difficulties in resolving the conflicts between private water operators’ profit seeking and the pursuit of universal access, leading to question whether PSP can ever be made pro-poor.

Global selectivity The most basic strategy available to the private companies is avoiding cities and countries which are assessed as not profitable – a selective approach not available to public authorities, who have to address the needs of their territories. This negative selection process is clearly presented in the policy announced by Suez in January 2003xc, under which the company planned to adopt more demanding investment criteria for investments in developing countries. These criteria gave preference for “currency risk-exempt financing”, “the quickest free cash flow generating projects and contracts”, and projects which finance all their investments out of their own cash-flow – which will limit investments to populations which can afford prices based on full cost recovery, including the cost of investments.

This selectivity may be dangerous even for those selected for attention, especially when companies make unsolicited approaches to cities, when there is a risk of non-competitive, corruption and long-term inefficiency, according to a review published by the World Bank (Hodges, 2003).

Ring-fencing profitable customers In February 2001, a presentation by two Vivendi Water executives at a conference on the reform of the water sector in Africa emphasised the ring-fencing of profitable customers as a method to ensure the viability of PPPs in the region (Bourbigot & Picaud, 2001). More precisely, the presentation stressed that the requirements of low risk and profitability limited private investment to “big cities where the GDP/capita is not too low”. Also, the prospects of profit depended either on “Sufficient and assured revenues from the users of the service” – thus potentially excluding the poor and anyone who could not afford to pay for the required stream of revenues - or on government guarantees of payments for the service, in effect subsidies.

Water TNCs have developed a number of approaches complementary to the straightforward cherry-picking of relatively affluent urban areas. One approach is to redefine the boundaries of the service to be provided. So in Cartagena, Colombia, for example the shanty town areas are treated as not covered by the contract because they are not in the city area. In La Paz, Bolivia, where the contract said unequivocally that 100%, including the major shanty town of El Alto had to be connected, Suez subsidiary Aguas de Illimani argues

03/04/2018 Page 31 of 49 PSIRU University of Greenwich www.psiru.org that “connection” does not mean a piped connection but may just mean access to a standpipe or tanker (Hall, 2002).

An example of PPP neglecting the need to include shanty towns within the service area is represented by Cordoba, Argentina, where the 1997 concession agreement required Suez subsidiary Aguas Cordobesas to extend water supply coverage from 83% to 97% over the 30-year duration of operations. However, it remained unclear whether the projected 97% coverage ratio included low-income areas, for which the operator seemed to have no legal requirement to connect residents to the network. Also, the 1997 contract only provided for the operator's responsibility to build and extend the primary network and not residential connections, which remained the responsibility of the municipality or individual households. This was contested by many residents in low-income neighbourhoods (Nickson, 2001b: 21-22).

Making the poor profitable: the case of Buenos Aires The other approach developed by water TNCs is to make more of the poor profitable through the mechanisms of voluntary labour, collective provision of materials, and cross-subsidy from the richer to the poorer. These techniques were used in Buenos Aires, during the Aguas Argentinas concession, where water supply was extended to some of the poorest barrios: Suez offer this experience as a demonstration of a private sector ‘pro-poor’ approachxci. The economic and political details, however, suggests that political initiative and public sector economics were at the heart of these developments.

Firstly, the economics of the extensions to the barrios were simple, as laid down by Aguas Argentinas at a meeting with community representatives: “Aguas Argentinas presented a budget for the construction of the networks in each settlement, divided into three items: technical assistance, building materials, and labour. The utility could take responsibility for the first item, including training for specialised labour, and proposed that the community provide the labour and look for ways to obtain the materials (e.g. from the local government)” (Schusterman et al., 2002: 40-41).

Secondly, political initiatives were crucial: the company “responded to pressure from the local government and the community itself”, and the municipalities were also crucial to the extension of services to the barrios because their agreement removed from the company the risk associated with supplying illegal settlements. Aguas Argentinas did not have any division or policy for providing extensions to the barrios for 4 years, indeed it was “attempting to re-orient staff, most of whom had previously worked for the public utility, towards profit-maximising goals and behaviours” (Schusterman et al., 2002: 17). The original contract allowed Aguas Argentinas to finance new connections by charging $600 to the user, and also allowed the company to decide whether customers should be metered or not: so the company could, and did, provide meters which meant that the poor paid more rather than less (Alcázar et al., 2000: 28)xcii.

Thirdly, the investment required was predominantly raised by a solidarity tax on all consumers – the Universal Service and Environmental Improvement fee (SUMA). This delivered most of the financing required for all the extensions, with little contribution from the company or external finance - the SU element of the SUMA (i.e., the universal coverage) plus another special charge for sanitation was projected to raise $340m of a total investment programme of only $450m, leaving the company to find only $110m over 5 years – a level of investment that even its derided predecessor OSN could have provided (Azpiazu & Forcinito, 2002).

The four barrios involved in the main experiments did get water supply, which was a dramatic improvement of living conditions. However this can now be seen in a context of political initiatives from municipalities, with a private company which did not adjust its profit-maximisation policies, mobilising resources of free community labour, municipal goods, and public sector-style cross-subsidy.

This interpretation appears to be supported by other data on extensions and profits. Azpiazu & Forcinito (2002: 40-45) estimate that during the first five years of operations, without considering the regularisation of illegal users, Aguas Argentinas extended water supply to 53.7% of the population projected in the original bid and 61% of the population projected in the 1997 renegotiated agreement. Similarly, the private concessionaire provided connections to the sewerage network to 43.2% of the population projected in the original bid and 40.3% of the population projected in the 1997 renegotiated agreement (see Table 5 below).

By contrast, the achievement on profits was considerable (Azpiazu & Forcinito, 2002: 33-34), according to an analysis of the company’s reports between 1994 and 2000, when Aguas Argentinas recorded, on average, a 19% rate of return on net worth (see Table 6 below). This compared with an average rate of return of 4.5% over net worth of the two hundred biggest corporations in the Argentine economy.

Financing water for the poor and subsidies for TNCs: the Camdessus report The original arguments in favour of water privatisation included a criticism of the public sector for failing to charge enough for full cost recovery, leading to excessive and non-transparent subsidisation. Winpenny (1994: 5) stressed that “Water utilities, and their governmental sponsors, are in no position to bear the increasing capital, operating and maintenance costs of catering for the projected growth of water requirements. Their poor financial position is partly due to failures in pricing and cost-recovery”. Furthermore, in the introduction to this chapter we note how Idelovitch & Ringskog (1995: 1) indicate that, apart from the extension of service coverage and enhancement of service levels and quality, the objectives of PSP are “to ensure higher operating efficiency and to finance the system without public subsidies or guarantees”. Interestingly, subsidies through public finance are now seen as a key to sustain the presence of the private sector in developing countries.

According to SAUR’s CEO Talbot, the problems of scale, risk, excessive regulation, and impossibility of full cost recovery, which undermine the attractiveness of the water business for the private sector (see above 7.1 Limitations of private sector in delivering for the poor and development), can be solved by injections of public sector subsidies. He stated that “substantial grants and soft loans are unavoidable to meet required investment levels”, and argued that this entails “The considerable dependence of the growth of the water sector in the developing world on soft funding and subsidies”. The role of the World Bank would thus be to provide and coordinate the supply of soft loans and subsidies from other international funding agencies, advise developing and highly indebted countries on how to reform the water sector and create a favourable investment climate, and act as a partner to private companies rather than “a counterbalance to private sector interests”. He concluded by stating that, without financial support in the form of subsidies and soft loans under the coordination of the World Bank, water TNCs would pull out of developing countries: “If it does not happen the international water companies will end up being forced to stay at home” (Talbot, 2002).

The so-called Camdessus report on financing water for the poor, presented at the 3 rd World Water Forum at Kyoto in March 2003, can be seen as a response to this kind of demand from the water companies. Written by James Winpenny, the report is the contribution of the World Panel on Financing Water Infrastructure, chaired by former Managing Director of the International Monetary Fund (IMF) Michel Camdessus. The report addresses the question of how to finance water infrastructure stemming from the ambitious development goals adopted in recent years by the international community: to reduce by half the proportion of people, respectively without sustainable access to safe drinking water and without access to basic sanitation, by 2015 (Camdessus, 2003: ii).

The devices proposed by the Camdessus report include the use of aid and IFI money to help provide guarantees against political risks, finance private sector tendering costs, and reduce currency risk. All of these devices operate as risk-reducing subsidies to private sector involvement. The guarantees would come from export credit agencies, but most of all from the development banks: “one of the most important ways in which MFIs [multilateral finance institutions] can increase funding for water is through the much greater use of their guarantee programmes to leverage other kinds of finance” (Camdessus, 2003: 26). The tendering costs would be assisted through the use of aid money in “The creation of a Revolving Fund or funds consisting of grant money to finance the preparation and structuring costs of complex projects (including private sector participation and other innovative structures). The fund would be used to cover the legal, financial and technical advisory costs of the preparation and structuring of projects up to and including the tendering and negotiation phases. The Fund would be replenished, partly or totally, by the public partner on the award of the project to the successful bidder” (Camdessus, 2003: 22). The currency risks will be reduced through use of public sector funds to create a “devaluation liquidity backstopping facility” (Camdessus, 2003: 29). The report also recommends international expenditure as a matter of urgency on a study “for the preparation of best practice and model clauses in the legal agreements of public-private partnerships … The panel wishes to draw the attention of relevant institutions to the urgent need for this initiative” (Camdessus, 2003: 22).

PART III – THE POLICY OF WATER REFORM: MULTILATERAL AGENCIES, PSP AND THE PUBLIC SECTOR OPTION

Policy issues Previous sections of this chapter have focussed on the developmental impact of PSP in water supply and sanitation. This section discusses some key policy issues arising, focussing on three features in particular: - the “policy bottleneck” of IFIs, especially the World Bank; - the specific problem of conditionality; - the need to recognise and support the actual and potential role of the public sector.

Multilateral agencies, PSP and the policy bottleneck Multilateral development agencies are a major driver of water privatisation worldwide. Their clout in doing so is commensurate to the resources they can devote to influencing national policies in transition and developing countries through a range of promotion and advisory activities, but most importantly to the strategic role they play in channelling aid and investment finance to recipient countries. In promoting PSP in the water sector, multilateral agencies appear inspired by the theoretical benefits expected from PSP and have generally proved resistant to acknowledge the limitations of the private sector in fostering sustainable water development. Instead of opening up in favour of a wider range of policy options competing on the basis of their responsiveness to local developmental requirements, they have insisted on the promotion of a one-size-fits-all model, that of PSP. The literature promoted by the World Bank’s Rapid Response Unit is a good example of this.xciii This results in a “policy bottleneck”, whereby PSP is increasingly relied upon as the way forward irrespective of the adverse implications it has on sustainable water development and macro- economic policies.

The problem of conditionality In the water sector, privatisation conditionality has been rejected by the inter-governmental International Conference on Freshwater in Bonn in December 2001 where the delegates declared in their ‘Recommendations For Action’ that “Private sector participation should not be imposed on developing countries as a conditionality for funding” (Federal Government of Germany, 2001: 30)xciv.

The practice is widespread in poor countries: “In general, it is African countries and the smallest, poorest and most debt-ridden countries where loan documents reveal IMFxcv conditions on water privatization and cost recovery. Water privatization or cost recovery provisions are attached to loans to Angola, Benin, Guinea- Bissau, Honduras, Nicaragua, Niger, Panama, Rwanda, Sao Tome and Principe, Senegal, Tanzania and Yemen” (Grusky, 2001).

The World Bank’s reliance on the use of conditionality is clear in policy documents. For example, the Private Sector Development (PSD) Strategy that was approved in April 2002 (World Bank, 2002: 49-50; 55), makes it clear that the Bank will continue to force countries to privatise though the use of “policy- based lending”xcvi - a clear euphemism for conditionality. One clear example was in Tanzania, where a consortium of Biwater and German engineering firm Gauff was awarded a 10-year water supply and sanitation lease contract for Dar Es Salaam in January 2003. The operations, due to start in June 2003, would be financed by a total US$ 145m package coming from a number of multilateral and bilateral agencies: the African Development Bank (AfDB), the World Bank, EIB and the Agence Française de Développement (AFD). According to the Global Water Report: “All four bodies insisted on a private concession as a precondition for committing funds”xcvii.

Need for strengthening the public sector option Global policy urgently requires a reinstatement of public sector water operations at the heart of future strategies – especially given the political commitment to the ambitious Millennium Development Goals xcviii

03/04/2018 Page 34 of 49 PSIRU University of Greenwich www.psiru.org and the parallel retreat of water TNCs from developing markets perceived as excessively risky or unprofitable. The simple fact is that “over 90% of domestic water and wastewater services worldwide are provided by the public sector and this is likely to remain the case”.xcix

In this sense, there are three key areas where to converge the efforts of the international water community:

1. Analyse existing successes of public sector While the World Bank has repeatedly emphasised the problems experienced with public sector operations, very little effort has been made to examine successful public sector operations and the lessons that can be learnt. Case studies such as those of Porto Alegre’s municipal water company DMAE (Hall et al., 2002b) show the positive developmental impact produced by sound management practices together with transparency, accountability and the democratisation of management through meaningful public participation. Other case studies corroborate the potential for publicly-owned and managed water operations in transition and developing countries (Hall, 2001; Lobina & Hall, 2000).

2. Building capacity In many cases there may be a need for capacity-building to enable public operations deliver the required service. There are good established examples of public-public partnerships (PUPs) which have done this, especially in the Baltic region, which can be used as a basis for developing a more general policy (Hall & Lobina, 2003). International organisations of public sector water companies also have a key role to play.

3. Developing finance mechanisms for local public sector The financial focus needs to be switched from providing incentives and subsidies for multinational operators, to identifying the financial needs of local public sector water providers, and ways in which they can be supported. Extension of work on municipal bonds, and revolving funds for municipalities to draw on, is a key part of this.

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Tables and Figures

Figure 1. Global private water business compared

Water sales, 2001 (€m illions)

16000.00

13640 14000.00

12000.00 10088 10000.00

8000.00

6000.00

4000.00 2746 2494

2000.00 936 181 100 0.00 Ondeo Vivendi Tham es SAUR Anglian Cascal IWL Water

Source: PSIRU database, derived from companies’ annual reports as in Hall (2002).

Figure 2. Joint ventures between leading water multinationals, 2002

 Source: PSIRU database, 2002. Generated by Vladimir Popov, PSIRU using Social Network Analysis software.

Table 1. Uncontested water concessions in central Europe involving TNCs Country Location Company Multinational Czech republic Brno Brno VaK Suez Ostrava Ostravske VaK Suez Karlsbad Vodarny Karlovy Vary Suez North Bohemia Severoceske VaK Hyder (now Anglian) Southern Bohemia VaK JC Anglian Water Plzen Vodarna Plzen Vivendi South Moravia Severomoravske VaK Suez

Hungary Kaposvar Eaux de Kaspovar Suez Szeged Szegedi Vizmu Vivendi Pecs Pecsi Vizmu Suez Budapest Budapest Water Suez/RWE

Poland Gdansk SAUR Neptun Gdansk SAUR Source: PSIRU database; in Hall (1997)

Table 2. Investment and under-performance by Aguas Argentinas S.A., 1993-1998 (in millions of pesos/dollars at supply values)

1993 1994 1995 1996 1997 1998* Total

Investments committed in original bid 101.5 210.52 302.91 362.36 229.10 83.07 1289.46

Investments realised 40.93 144.55 132.17 100.49 109.52 15.41 543.07

Under-performance -60.57 -65.97 -170.74 -261.87 -119.58 -67.66 -746.39 * Corresponding period: May-December 1998. Source: Azpiazu & Forcinito (2002: 45); elaboration on the basis of data provided by the Users’ Committee of ETOSS.

Table 3. APSF (Santa Fe, Argentina), amount of investments provided for in original concession agreement and in second renegotiation (proposed renegotiation, not implemented) (in millions of pesos/dollars) Five-year period Investments provided for in Investments provided for in original contract second renegotiation

1996 –2000 290.00 245.00

2001 –2004 211.00 80.00

2005 –2008 206.00 80.00

707.00 405.00 Total Source: Muñoz (2002).

Table 4. Convictions of water TNCs’ executives on corruption charges

Date of Country Location and Parent conviction company 2001 Italy Milan (OTV) Vivendi 1996 France Grenoble Suez 1996 France Réunion Vivendi Source: PSIRU database.

Figure 3. Buenos Aires: Average bills under Aguas Argentinas in Pesos/US$ and inflation, 1993-2002

Chart Nº 1: Development of the average residential bill (in pesos/dollars) r) 30

28 27,40 26,25 26

23,73 24

21,65 22 20,55 20

18 16,53 16 14,56 14

10 May-93 Jun-94 Nov-97 May-98 Nov-98 Jan-01 Jan-02

Fsource: Economy and technology department at FLACSO, on Average bill CPI Lentini, op.cit. 2002 Source: Azpiazu & Forcinito (2002: 39)

Table 5. Water and sewerage services: connected population – projected and effective - during the first five-year period (extended, May 1993 to December 1998) (in thousands and percentage)

Water Sewerage

According to original bid 1,709 924 According to Resolution Etoss Nº 81/94 1,764 925 According to Decree Nº 1,167/97 1,504 809

Service expansion I. Works by AASA 631 112 II. OPCT* 286 287 III. Regularisation of illegal users 172 152 Real expansion of the network (I + II) 917 399 Degree of effective compliance (not considering regularisation of illegal users) With respect to the original bid 53.7% 43.2% With respect to Resolution Etoss Nº 52.0% 43.1% 81/94 With respect to Decree Nº 1,167/97 61.0% 40.3%

*OPCT: Works on account of a third party paid by the users. Source: Azpiazu & Forcinito (2002: 42-43); elaboration on the basis of the History and Balances of Aguas Argentinas S.A. and information from the Users’ Committee of ETOSS.

Table 6. Profitability rates for Aguas Argentinas S.A., 1994-2000 (post-tax profits as percentage of net worth) Years % 1994 20.0 1995 14.4 1996 25.4 1997 21.1 1998 12.5 1999 18.6 2000 21.4 1994-2000 19.1 Source: Azpiazu & Forcinito (2002: 34); elaboration on the basis of the History and Balances of Aguas Argentinas S.A.

03/04/2018 Page 45 of 49 i Similarly, according to the EBRD (1999: 13), PSP in water supply and sanitation is expected to enhance capital and operating efficiency, through enduring design, construction, financing and operating risks. ii “Considering first examples of long-running PPP’s, our host, the Netherlands, describes its water supply as a public private partnership – private companies operating under private company law with public (government) ownership of the shares (non-tradable). The Public Water PLC, developed to achieve economies of scale by serving up to ten local government areas, performs well with a high degree of technical effectiveness. The model has achieved full coverage of water, albeit at a fairly high cost, and does not have to make any returns to shareholders. In wastewater, traditionally managed by separate government boards, the country is now tentatively considering a large Design, Finance, Build and Operate (DBFO) contract for wastewater treatment” (Franceys, 2000). For a description of the organisational structure of Dutch public water PLCs, see Braadbaart et al. (1999). iii See also http://lnweb18.worldbank.org/eap/eap.nsf/Attachments/water3. iv “DISTRIBUTION D'EAU: Ondeo achète US Water”, Les Echos, 2nd August 2002, p. 15. v Source: PSIRU database; “Ondeo snaps up Azurix deals”, Global Water Report 150, 29th July 2002, pp. 8-9. vi Source: PSIRU database; Tara Tuckwiller, “West Virginia Governor Approves Takeover of Water Utility by German Firm”, The Charleston Gazette, 3rd January 2003; Claire Poole, “American Water holders OK $4.6B purchase by RWE”, Daily Deal (New York, NY), 18th January 2002; “American Water Works Company, Inc. Signs Agreement to Purchase Anglian Water Plc's Interest in American-Anglian Environmental Technologies, L.P.”, American Water Works Press Releases, 7th February 2000; “Anglian Water sells joint venture to American partner”, Anglian Water Press Releases, News Release Ref: NR99609, 1st October 1999. vii Source: PSIRU database; Tim Webb, “Vivendi weighs up AWG's £270m arm”, The Business, 15 December 2002, p. 4. viii Source: PSIRU database, News Item 3717 “Azurix and Wessex face problems of failing to capture water market” (http://www.psiru.org/newsitem.asp?newsid=3717); Jenalia Moreno, “Azurix testing the waters - Company competing against giant foes in Latin America market”, The Houston Chronicle, 9 January 2000. ix Source: PSIRU database, News Item 4481 “Azurix to be broken up” (www.psiru.org/newsitem.asp?newsid=4481) ; Sophie Barker, “Wessex Water parent plans major surgery”, The Daily Telegraph, 19 April 2001; Micheal Davis, “Water under the bridge; Enron will take Azurix private, sell its assets”, The Houston Chronicle, 16 December 2000. x Source: PSIRU database, News Item 4416 “RWE to take over Thames Water” (http://www.psiru.org/newsitem.asp? newsid=4116); Andrew Taylor & Uta Harnischfeger, “RWE acquires Thames Water in £4.3bn deal”, The Financial Times, 22 September 2000. xi See also Conseil de la concurrence, «Marché de l’eau: le Conseil de la concurrence demande au ministre de remettre en cause les filiales communes de la CGE et de la SLDE», Communiqué de Presse N. 22, 17th July 2002 (http://www.finances.gouv.fr/conseilconcurrence/communiques/comm22.htm); «Vivendi et Suez accuses de fausser le jeu de la concurrence», La Tribune, 18th July 2002. xii “RWE and ELECTRABEL invest on BASF Antwerp site”, Suez Press Releases, 21st November 2001. xiii Source: PSIRU database; IDB, “Aguas del Gran Buenos Aires Water and Sanitation Project”, Project Summary (http://www.iadb.org/exr/doc98/pro/aar0282.pdf); “OSBA receives 1 bid for 6th sub-region – Argentina”, Business News Americas, 8th July 1999. xiv Source: PSIRU database; Alvino-Mario Fantini, “Will Water Flow to Cochabamba?”, Bolivian Times, Internet Edition Thursday, April 22, 1999, Vol VI No. 16. xv Source: PSIRU database; “Thames wins ESSAM, no bids for ESSAR – Chile”, Business News Americas, 13 November 2001; Thames Water, “Thames Water announces new Chilean concession”, Press Releases, 13 November 2001 (http://www.thameswater.co.uk). xvi Source: PSIRU database; IDB, “IDB Approves $40 Million to Improve Water, Sanitation in Guayaquil - New resources for system through private sector concession”, Press Release 164/97, 16 July 1997 (http://www.iadb.org/exr/PRENSA/1997/cp16497e.htm); “International Briefs”, Global Water Report, 26 September 1997; “International Water Services' Guayaquil concession confirmed - Ecuador”, Business News Americas, 8 January 2001. See also Acosta (2002). xvii Source: PSIRU database; Suez-Lyonnaise des Eaux, “Timisoara selects Lyonnaise des Eaux to manage water and wastewater services”, Press Releases, 9 November 2000; EBRD, “EBRD supports first public-private partnership in Romania’s municipal sector”, Press Releases, 22 December 1999; “Lyonnaise agrees multi-project loan with EBRD”, Water Briefing FT Bus Rep: Energy, 9 August 1995. On EBRD’s MPF scheme, see EBRD (1999 : 29-30). xviii Art. 38, Loi no 93-122 du 29 janvier 1993 relative à la prévention de la corruption et à la transparence de la vie économique et des procédures publiques, Journal Officiel n° 25 du 30 janvier 1993 (http://www.legifrance.gouv.fr/WAspad/UnTexteDeJorf?numjo=PRMX9200148L). xix Art. 75, Loi no 95-101 du 2 février 1995 relative au renforcement de la protection de l'environnement, Journal Officiel n° 29 du 3 février 1995, p. 1840 (http://www.legifrance.gouv.fr/WAspad/UnTexteDeJorf? numjo=ENVX9400049L). xx “Nice work cuts costs”, Global Water Report 144, 19 April 2002, p. 3. xxi “Informe De Pricewaterhousecoopers Valencia Pagara A Avsa 54 Millones Si Rescata La Concesion”, Expansion, 17 January 2001. xxii Alfonso, J. (2001) “Aguas de Valencia gana el concurso de suministro local”, Cinco Dias, 3 October 2001, p. 6. xxiii “Enron preferred bidder for Mendoza: Argentina/Project”, Global Water Report FT Bus Rep: Energy, 26 May 1998. xxiv Source: PSIRU database; Iskandar, S. & A. Taylor, “Franco-Spanish group wins bid for Emos”, Financial Times, 15 June 1999, p. 36. xxv Source: PSIRU database; “Rio Chillon: Latin American water deal of the year 2001”, Project Finance, 01/03/2002, p. 36. xxvi Source: PSIRU database; “CHENGDU Generale des Eaux-Marubeni Waterworks Company Limited”, ADB Private Sector Project Profiles (www.adb.org/Work/Projects/Profiles). xxvii Source: PSIRU database; Lippens, G. & K. M. Dang, “Market maker; Asia Focus – Vietnam”, Project Finance, 1 December 2001, p. 41. xxviii Source: PSIRU database; “Demand shortfall triggers Eurawasser price rises in Rostock”, FT Energy Newsletters - Water Briefing, 22 February 1995, p. 11. xxix Source: PSIRU database; Bernard Simon, “Municipal partnership pioneer in a squeeze”, Business Day, 6 June 2001. xxx Source: Asamblea Provincial por el Derecho al Agua. xxxi Source: PSIRU database; “Interaguas Allocates US$ 144mn for Campo Grande - Brazil”, Business News Americas, 20 July 2000; “Guariroba to Invest US $ 7.6mn in 2002 – Brazil”, Business News Americas, 5 November 2001. xxxii Source: PSIRU database; Government of Belize, “Privatization of WASA – Joint Media Release”, Press Release, 23 March 2001 (http://www.belize.gov.bz/features/wasa/ministerstatement.html). xxxiii Source: PSIRU database; Cutlack, M., “When the dollars run out”, New Statesman, 4 March 2002. xxxiv NRW stands for Non-Revenue Water and is a synonym for UFW (Unaccounted-For-Water). xxxv Source: PSIRU database; Bernard Simon, “Municipal partnership pioneer in a squeeze”, Business Day, 6 June 2001. xxxvi “S&P lowers Aguas Argentinas’ IDB loan rating - Argentina”, Business News Americas, 17th May 2002. xxxvii Source: PSIRU database; “Rio Chillon: Latin American water deal of the year 2001”, Project Finance, 01/03/2002, p. 36. xxxviii Note: all prices are basic charges, excluding VAT and other taxes. xxxix Source: PSIRU database; Hudson, P. “Muddy waters – Overview of troubles with Argentina’s water infrastructure”, Latin Trade Business & Industry: 5 Mar 1999. xl See also “Argentina cos must settle dispute with govt locally before arbitration -report”, AFX European Focus, 5th July 2002. xli Source: PSIRU database; “Aguas del Tunari resorts to World Bank’s ICSID arbitration and claims US$ 25m compensation”, News Item 4983 (http://www.psiru.org/newsitem.asp?newsid=4983). xlii Source: PSIRU Database, “Buenos Aires government asks for Azurix pledge to improve water service”, News ID 4439; Azurix provides low pressure water in Buenos Aires”, News ID 3867. xliii “Buenos Aires Guarantees Water Supplies – Argentina”, Business News Americas, 5th November 2001. xliv Sources: http://www.worldbank.org/icsid/cases/pending.htm; SOSBA (Sindicato de Obras Sanitarias). xlv “Entonces, el gobernador Carlos Ruckauf habia denunciado que fue la empresa "la que incumplio con el contrato" y "en pedidos de aumentos tarifarios que no aceptamos, porque nos parece que no estan vinculados con el servicio que la empresa daba"”. Source: “Empresa estadounidense de agua Azurix continuara prestando servicio en Argentina”, Agence France Presse – Spanish, 1st January 2002. xlvi Source: PSIRU database; “BA to file US$600mn claim against Enron”, Business News Americas, 12 August 2002; “Argentine Province Sues Enron”, The Oil Daily, 13 August 2002. xlvii Source: PSIRU database; “Potsdam Management Award: Germany/Privatisation”, Global Water Report, 8 January 1998; “GERMANY/Companies - Vivendi spells out its strategy”, Global Water Report, 10 November 2000. xlviii Source: Berliner Morgenpost, 27 July 2000. xlix Source: Potsdam City Council, Press Release No. 42/01, 31 January 2001. l Source: PSIRU database; News Item 4777, “WSSA South African water contract nullified” (http://www.psiru.org/newsitem.asp?newsid=4777). li Source: PSIRU database; “Vivendi Water reaches agreement with Szeged council”, MTI Econews, 12 February 2001. lii Source: Democracy Centre, Cochabamba, Bolivia. liii Agreement for Management, Operation and Maintenance of the Water and Sewage Systems of Fort Beaufort and Associated Customer Management, 05/10/95, p. 6. liv NEPSZABADSAG: 7 Dec 1998. lv Source: Le Monde, 28 January 1997. lvi Issues paper, NIS Ministerial Conference on water management and Investment, Almaty 16th-17th October 2000 lvii Source: PSIRU database; Cecille S. Visto & Ruffy L. Villanueva, “Rate hike to boost water services”, BusinessWorld, 12 November 2002, p. 1. lviii Source: PSIRU database; “Philippines – More trouble in Manila”, Global Water Report, N. 145, 3 May 2002, p. 11; “Philippines/Legislation - Calls for independent regulator”, Global Water Report, N. 140, 22 February 2002, p. 12. lix Source: PSIRU database; Ruffy L. Villanueva, “MWSS-RO readying higher water tariffs”, BusinessWorld, 14 November 2002, p. 1. lx Source: PSIRU database; Chris McGreal, “UK firms named in Lesotho bribery verdict”, The Guardian, 21st May 2002. lxi Source: PSIRU database; Karen MacGregor, “Acres Int'l convicted in African bribery case”, Globe and Mail, 18th September 2002, p. B1. lxii Source: Observatório Social; “Tangará (MT): Polícia conclui o inquérito amanhã” - from Diário de Cuiabá (MT), 12/04/2002. lxiii Source: Observatório Social; “MP investiga privatização de água de Tangará da Serra (MT)”, Diário de Cuiabá (MT), 03/12/2002. lxiv Source: PSIRU database; Celso Bejarano Júnior, “Escândalos afugentaram os interessados na água”, Diário de Cuiabá (MT), 04/04/2002 (http://www.diariodecuiaba.com.br). lxv “Rocky Ride for Enron”, Africa Energy & Mining, 29th March 2000. lxvi Source: PSIRU database; News Item 4777, “WSSA South African water contract nullified” (http://www.psiru.org/newsitem.asp?newsid=4777). lxvii Source: PSIRU database; “Private operators to refinance sell-off costs – Paraguay”, Business News Americas, 28 July 2000; “WB delays clearance of Corposana rules – Paraguay”, Business News Americas, 13 November 2000. lxviii Source: PSIRU database; Holly Williams, “Sanchis scoops Paraguay privatisations”, PR Week, 15 June 2001; “Sanchis & Asociados informe sobre privatizaciones en Paraguay”, Expansion, 5 June 2001. lxix Source: PSIRU database; IDB, “IDB Approves $40 Million to Improve Water, Sanitation in Guayaquil - New resources for system through private sector concession”, Press Release 164/97, 16 July 1997 (http://www.iadb.org/exr/PRENSA/1997/cp16497e.htm); “International Briefs”, Global Water Report, 26 September 1997; “International Water Services' Guayaquil concession confirmed - Ecuador”, Business News Americas, 8 January 2001. See also Acosta (2002). lxx Source: PSIRU database; Ruffy L. Villanueva, “MWSS-RO readying higher water tariffs”, BusinessWorld, 14 November 2002, p. 1; “Philippines – Maynilad reprieve”, Global Water Report, No. 142, 22 March 2002, p. 13; “Philippines/Legislation - Calls for independent regulator”, Global Water Report, N. 140, 22 February 2002, p. 12. lxxi Source: PSIRU database; Melody M. Aguiba, “Hearings set today on water rebasing rate; Business”, Manila Bulletin, 21 November 2002. lxxii Source: PSIRU database; “France/Companies – Suez results”, Global Water Report, N. 130, 2 October 2001, p. 8. lxxiii Source: PSIRU database; “France/Companies – Suez AGM”, Global Water Report, N. 145, 3 May 2002, p. 8. lxxiv Source: PSIRU database; “France/Companies – Vivendi share doubts”, Global Water Report, N. 127, 3 August 2001, p. 5. lxxv Source: PSIRU database; “Anglian Water takes controlling interest in Chile water concession”, News Items, No. 3384, (http://www.psiru.org/newsitem.asp?newsid=3384); “Esval awards contract to Anglian Water’s Purac”, News Items, No. 4443 (http://www.psiru.org/newsitem.asp?newsid=4443). lxxvi Source: PSIRU database; “Degremont awarded major contract by EMOS”, News Items, No. 4427 (http://www.psiru.org/newsitem.asp?newsid=4427). lxxvii From 1995 to January 2002, the parity between the Argentine and the US currencies was maintained (Peso 1.00 = US$ 1.00). lxxviii Source: PSIRU database; “Aguas Argentinas, water pricing, contractual flexibility and the Argentine crisis”, News Items, No. 4995 (http://www.psiru.org/newsitem.asp?newsid=4995). lxxix Source: PSIRU database; “Financial manipulations of Tallinn water by International Water”, News ID 4495. lxxx Source: PSIRU database (Sources ID: 7693); “Estonia's Tallinn Water Co reduces stock capital by EUR 60.7 mln”, Baltic News Service, 13th September, 2002. lxxxi Source: PSIRU database (Source ID: 7694); “City of Tallinn, Water co to change service accord”, Baltic News Service, 6th September, 2002. lxxxii Source: PSIRU database (Source ID: 7695); “City issues 30 mln new stocks to buyer of Tallinn Water”, Baltic News Service, 17th January 2001. lxxxiii Zimbabwe Independent 10/12/99. lxxxiv Source: Observatório Social; “Famílias usam água de chuva”, Gazeta do Povo (PR), 19/11/2002. lxxxv Source: Observatório Social; “Consumidores da região metropolitana de Curitiba não contam com tarifa social de água”, Paraná Online (PR), 08/01/2003. lxxxvi Sources: No.5083:- Business Day 17/11/1999 'Will the World Bank halt corruption and cancel debt?' Patrick Bond and David Letsie . No.5084:- SAPA 26/09/2000 'KZN cholera outbreak spreads, death toll rises'. No.5085:- Mail and Guardian 13/10/2000 'More government confusion on privatisation?' . No.5086:- SAPA 13/10/2000 'FREE WATER IS FEASIBLE: KASRILS' . No.5087:- SAMWU 17/10/2000 'Cholera epidemic would not have happened if there was free water!' . No.5090:- Misanet/IPS 18/10/2000 'Govt promises free water to curb cholera epidemic' http://www.iclinic.co.za/oct00/cholera18b.htm/LS# . No.5111:- The Lancet 27/01/2001 'Prevention fails to halt South Africa's well-treated cholera epidemic' . No.5112:- Beeld 23/01/2001 '23/01/2001' . No.5113:- The Star 23/01/2001 'Squatters on 'cholera river' to be moved' . No.5114:- SAMWU press statement 23/01/2001 'Union highly concerned about events in Johannesburg, including cholera in Jukskei River' . No.5115:- Daily Dispatch 19/01/2001 'Cholera found in Alexandra's Jukskei River' . No.5116:- Sapa 15/01/2001 'GOVT RUNNING LOW ON FUNDS: PEOPLE MUST BUILD THEIR OWN TOILETS' . No.5117:- Business Day 11/01/2001 'Cholera cases now more than 17000' . No.5118:- BuaNews 06/11/2000 'Safe water and sanitation still elude cholera-plagued KZN' . No.5119:- Financial Mail 03/11/2000 'LEARNING TO PADDLE UPSTREAM' . No.5120:- SAMWU & RDSN 26/10/2000 'The Cholera Epidemic in South Africa and the Government's attack on the Working Class' . No.5121:- Beeld 25/10/2000 ' Supply cuts caused cholera' . No.5122:- Sapa 29/01/2001 'Cholera death toll hits 85' . lxxxvii Mail and Guardian 13/10/2000 lxxxviii ‘Free water is feasible’: 13 October 2000 Sapa lxxxix See also http://www.water-2001.de/outcome/BonnRecommendations/Bonn_Recommendations.pdf. xc “SUEZ introduces its 2003-2004 action plan: refocus, reduce debt, increase profitability”, Suez Press Releases, 9th January 2003 (http://www.suez.com/upload/up970.pdf). xci Ondeo Services (2000) Bridging the Water Divide: The “Water Truce” – An Open Letter (http://www.suez.com/documents/english/lettre-uk.pdf). xcii “Metering becomes profitable for Aguas Argentinas when the variable charge for metered water is more than half of the fixed charge (Abdala 1996). Since those with low fixed charges are likely to be poor, in effect the tariff regime provides Aguas Argentinas with a incentive to meter those households that are the least able to afford the higher water bill” (Alcázar et al., 2000: 28). xciii See http://rru.worldbank.org/ xciv See also http://www.water-2001.de/outcome/BonnRecommendations/Bonn_Recommendations.pdf. xcv “In the division of labor between the IMF and the World Bank, it is the Bank that has primary responsibility for “structural” issues such as the privatization of state-owned companies. In countries where IMF loan conditions include water privatization or cost recovery requirements, there are usually corresponding World Bank loan conditions and water projects that are implementing the financial, managerial and engineering details required for “restructuring” the water sector. But IMF structural adjustment documents are more often publicly available than those from the World Bank, making it easier to search IMF documents, despite the Bank’s lead role in this area” (Grusky, 2001). xcvi See the Implementation Matrix, Annex I, “Private Sector Development Strategy – Directions for the World Bank Group”, 9th April 2002 (http://rru.worldbank.org/documents/PSDStrategy-April%209.pdf). xcvii “Biwater wins Dar es Salaam concession”, Global Water Report 162, 15 January 2003, pp. 1-2. xcviii See Camdessus (2003: ii). xcix See Rogers and Hall (2003), p.32