Canadian Consulting Engineer

To Privatize or Not?

THE CASE FOR...

January 1, 2005  Canadian Consulting Engineer

THE CASE FOR

Public-private partnerships deliver value

By Mark Hodgson, P.Eng., Price WaterhouseCoopers

Canada, the dominant service provision model has water and wastewater systems owned and operated primarily by municipalities. In many other developed countries, the private sector is involved to a much greater extent. Several large multi-national private water companies have served the worldwide market for decades, the three largest being Veolia Water, United Water, and RWE Thames Water.

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Many private sector water services companies invested in Canada in the 1990s after pioneering municipalities such as Moncton, Dartmouth, Hamilton, and a handful of other communities initiated public-private partnership (“P3”) projects. With few exceptions, these projects are still under contract with the private sector and delivering value to ratepayers.

Despite the successes, and strong media attention to the challenges facing our water sector infrastructure post Walkerton and North Battleford, adoption of the P3 model has not been widespread. Current activity in water sector P3s is confined to western Canada, the largest project being the Britannia mine water treatment project in B.C.

There appear to be several inhibiting factors, a primary one being the current “anti-privatization” campaign led by public sector labour unions such as CUPE, which attempts to raise fear and cast doubt on the private sector’s ability and motivation to deliver safe and affordable water and wastewater services. A recent addition to the campaign is a CUPE-funded Ipsos-Reid survey of Canadians’ views on public-private partnerships referred to in Ms. Corrigan’s article.

In reality many municipalities worldwide have found that involvement of the private sector better meets their obligations to operate highly efficient and technically sound water and wastewater systems. The city of Moncton in New Brunswick estimated cost savings of over $12 million in its P3 contract with Veolia to deliver and operate a 25 MGD (million gallons per day) water treatment facility for 20 years.

A few key differences between a private water company and a public sector operator lie at the root of the financial and other benefits being found.

Non-performers fail to thrive

The first difference relates broadly to the nature of private enterprise but also specifically to private water companies. Non-performing water companies fail to thrive. There is no second chance when a water company fails to deliver safe drinking water — they go out of business. There is no tolerance for error, either internally within the company or externally from clients. Everything within the company is designed to ensure continued survival, starting with their governance structures.

Municipally run water and wastewater facilities are commonly overseen by a body consisting of political appointees or the political representatives of the municipality — people elected to oversee the activities being performed by their municipal organizations or boards, but not necessarily expert in any individual area. Typically, those serving on oversight bodies have no technical background in water systems.

Standing in sharp contrast, management boards of private water companies typically have expertise from both the technical and management side of the water business. Charged with the responsibility of ensuring that the company thrives and its clients enjoy a superior level of service, these boards are professionally able to judge the quality of the service being delivered in their company’s contracts.

Generally speaking, the private model carries a higher degree of professional competence than the government model. It is positioned, from a governance perspective, to achieve a higher quality operation and greater assurance of water quality provision. To support this objective, a well-crafted service contract spells out the performance standards, the extent and manner of risk the company assumes, and penalties it will suffer for non-performance. No similar document exists for monitoring the performance of the government model.

The benefits of the private model were not lost on EPCOR, Edmonton’s power and water utility, which delivers water and wastewater services under a P3 model to a number of municipalities in western Canada. Epcor’s board of directors operates independently, at arm’s length from its sole shareholder, the city of Edmonton. The board is comprised of business leaders from Vancouver, Calgary, Edmonton and Toronto, who have no affiliation to the shareholder or interest in Epcor. As stipulated in a Unanimous Shareholder Agreement, neither city councillors nor city officials sit on the board. Epcor was named the overall winner of the 2004 National Award in Governance from the Conference Board of Canada and Spencer Stuart.

The nature of enterprise and the management of risk

A second difference is how the private sector evaluates and manages risk compared to the public sector provider. Anything jeopardizing a company’s ability to perform is considered a risk. Inadequately trained staff, malfunctioning equipment, faulty infrastructure, etc. are unacceptable risks. Operations and standards are monitored continuously to ensure that top performance is being achieved and that the potential for failure is minimized or eliminated.

Risks in the public sector are often not given the same consideration. There is an inherent cost to any organization that assumes risk — be it public or private. When the public sector delivers a service, either directly or indirectly through an agency of the government, risk is being assumed and should be valued and treated as an expense of operation. Were the risks of total operational failure understood or calculated by the town of Walkerton or the province of Ontario? More than two years after Walkerton, 61% of Ontario’s municipal water treatment plants received failing grades in training, sampling, disinfection or water quality. There is a real cost associated with these risks that is currently not being accounted for.

Consistent with the objective to reduce and minimize risks while at the same time building efficiencies, many private water companies invest heavily in research and development activities, bringing improvements on a technical and operational level to all operations throughout the network of contracts worldwide.

These two sets of factors — the nature of enterprise and the management of risk through all factors including governance, research and technology and training of staff — in combination compel private sector operations to act somewhat differently than public sector operations and bring benefits to municipalities that have selected private sector partners.

As a professional engineer and a taxpayer, I look forward to the day the debate on P3 moves beyond rebuttals to the current rhetoric and misinformation campaigns of CUPE. The debate will eventually focus on getting the most out of P3 arrangements because they will have an essential role in restoring and sustaining our water infrastructure nation-wide.

Mark Hodgson, P.Eng. is senior vice-president and director with Pricewaterhouse Coopers LLP in Vancouver. This article includes extracts from a submission made to the Walkerton Inquiry by the Canadian Council for Public-Private Partnerships to which Hodgson contributed.

***

THE CASE AGAINST

Governments must retain control

By Kathy Corrigan, CUPE

rivate corporations have always worked with the public sector to build water and wastewater infrastructure, bringing the skills of private sector engineers to the public arena. Increasingly, however, the private sector is lobbying for access to a much larger market — the management, operation, financing and even full ownership of traditionally public services.

Proponents of public-private partnerships (known in Canada as P3
s) often cite Britain’s experience with its Private Finance Initiative projects (PFIs) as evidence of their workability. However, there are substantial concerns with P3s that need more investigation and debate.

Public accountability

In the past, polling has shown that Canadians want to see public services delivered publicly. They are concerned about loss of accountability and transparency. They feel very strongly that water, in particular, should be protected by public policy. According to a recent Ipsos-Reid survey, virtually all Canadians (97%) agree with the statement, “Canada should adopt a comprehensive national water policy that recognizes clean drinking water as a basic human right.”1

To ensure those human rights, it follows that government must retain control over the price of water to reflect public policy goals of universal access and conservation. Achieving those goals is difficult when price becomes a political war between those representing the interests of consumers and those representing industry. An article last year in Britain’s Guardian newspaper noted: “A fierce cabinet row over higher environmental standards and hefty increases in household bills has derailed the process for setting price limits for water and sewerage over the next five years…. City analysts and company executives are already warning that the political uncertainty surrounding Ofwat’s [the British water regulatory body] ‘periodic review’ is damaging the industry’s ability to raise new borrowings for investment.”2

And, in regard to freedom of information, the public was unable to access the requested increases because: “The companies refused to disclose the increases they are seeking on the grounds of commercial confidentiality.”3

Public sector comparators

The mechanism to evaluate whether a project should be a P3, as opposed to a design-build or traditional model, is the public sector comparator (PSC). Partnerships BC describes the PSC as: “A hypothetical costing of outputs that represents the lowest, risk-adjusted life-cycle cost to achieve a desired service output — if the public sector was to finance and deliver the project.”4

This comparison is meant to provide comfort to the politicians and the public by showing they are getting good value for the tax dollars spent on a P3. However, as even leading privatization advocates sometimes admit, the public sector comparator can be easily manipulated. Answering questions after a meeting of B.C’s Municipal Finance Authority in March 26, 2003, Larry Blain, president of Partnerships BC, said: “Us letting you see the public sector comparators won’t do you much good. I could make the public sector comparators as bad as I want to, in order to make the private sector look good.”

The primary criticism of the public sector comparator is the subjective nature of the assumptions. For example, the discount rate applied to the public sector comparator in the U.K. was set at 7% for several years. Under pressure, that discount rate was reduced to 6%, then to its present 3.5%. An inflated discount rate gives a tremendous advantage to private sector operators. In Canada, discount rates of 6-7% are still routinely used.

Risk transfer

Public-private partnerships are also justified as a means for the public to transfer risks associated with a project, at little cost. However, even P3 advocates have pointed out that this is an unreasonable expectation since contractors and private corporations are very good at assessing risk.

It is arguable that risk is often transferred not to the party best able to manage it, but to the party best able to afford it. Whether the risk is putatively transferred or not, at the end of the day, the public sector body will likely be liable in the event of the collapse of the private sector partner.

As Michael Meacher, British MP and that country’s past Environment Minister, recently pointed out: “Transfer of risk to the private sector is a mirage. If a major PFI contractor went bankrupt, the Government would have little alternative but to bail it out. That has already been demonstrated in the case of Railtrack, the Channel Tunnel consortium, the Criminal Records Bureau, air traffic control, and the Benefits Agency.”5

Risk is a highly subjective assessment, which is also capable of manipulation. An article in the British Medical Journal evaluated PFIs in the national health service. The writers found, “In all schemes risk transfer is the critical element in proving the value for money case. There is considerable variation between schemes in the absolute and relative value of risk transferred. What is striking, however, is that in all cases risk transfer almost equals the amount required to bridge the gap between the public sector comparator and the PFI. This suggests that the function of risk transfer is to disguise the true costs of PFI and to close the difference between private finance and the much lower costs of conventional public procurement and private finance.”6

Timeliness and innovation

One of the arguments consistently offered in support of PFIs or P3s is that projects come on stream quicker. This is refuted by the U.K. Treasury Board’s own guidelines. “A PFI transaction is one of the most complex commercial and financial arrangements which a procurer is likely to face. It involves negotiations with a range of commercial practitioners and financial institutions, all of whom are likely to have their own legal and financial advisers. Consequently, procurement timetables and transaction costs will be significantly in excess of those normally incurred with other procurement options.”7

Another claim by proponents is that PFI’s or P3s offer greater opportunity for innovation. However, no evidence has been produced supporting this proposition. Unfortunately, what have often been called innovations, leading to cost savings, are scope changes and service reductions.

Trade agreements

Perhaps one of the least understood, but most troubling issues, is that once a system is privately operated, it may be very difficult to return the service to the public sector.

A growing number of organizations, including the Federation of Canadian Municipalities, have expressed grave concerns about the implications of the international trade agreements, particularly Chapter 11 of NAFTA which subjects “investments” to the terms of that treaty. Similar protection of multi-national corporate interests is provided in the General Agreement on Trade and Services (GATS).

Concern about the loss of control of water systems due to the provisions of the trade agreements was key to the 2001 Greater Vancouver Regional District’s rejection of a public/private partnership for the $600-million Seymour filtration plant project.

Financial issues

The real seduction of P3s or PFIs is the claim that they will save money for cash-strapped governments. This is not true with respect to the financing of projects — governments can borrow money at significantly lower interest rates, do not pay the same level of taxes as the private sector, and do not have to produce a profit. Wages are slightly higher in the public sector.

Further, limited private contributions often come with the cost of long-term, hidden liabilities. In Britain, PFI’s are creating a significant amount of future debt (up to 100 billion pounds) resulting in a high-profile clash between the government and the International Monetary Fund (IMF).8

Ballooning budgets for P3 and PFI projects are common. Another worrying trend is the sell-off of PFI’s. According to the website of Henderson Global Investors: “Once the contract has been won and the construction work has been completed, the construction contractor may seek to ‘recycle’ the capital. There have been a growing number of sales of PFI portfolios and individual assets (secondary transactions) over the last two to three years and this trend is expected to accelerate and continue.
“9

Finally, one of the most damaging criticisms of the PFI experiment can be found in a recent U.K. Association of Chartered Certified Accountants report on British road and hospital PFIs. The two major findings of this in-depth report were lack of accountability, and that “PFI is an expensive way of financing and delivering public services that may, where public expenditure is constrained, lead to cuts in public services and/or tax rises. In contrast, we suggest that the chief beneficiaries are the providers of finance and some, but not necessarily all, of the private sector service providers rather than the public sector.”10

As Canadians, we must consider whether this is really the future we want for the delivery of public services.

The advance of public-private partnerships and the privatization of public services require careful study and thorough consideration by our engineering community. As advisors to government and by implication to our citizens, engineers must take a critical and independent role in assessing the benefits against the risks and liabilities.

Kathy Corrigan is a research representative for the Canadian Union of Public Employees (CUPE) in B.C. She specializes in privatization, international trade and municipal issues.

1 www.ipsos-reid.com. “Canadians Agree Canada Should Adopt a Comprehensive National Water Policy that Recognizes Clean Drinking Water as a Basic Human Right.” April 29, 2004.

2 Gow, David, “Ofwat Steams as Cabinet Row Holds Up Price-setting,” The Guardian, March 4, 2004.

3 The Guardian, October 4, 2003.

4 Govt. of B.C. Capital Asset Management Framework Guidelines, May 2002, p. 145.

5 Michael Meacher, “Picking up the tabs for the PFI,” TimesOnLine, December 14, 2004, www.timesonline.co.uk

6 Pollock, Shaoul and Vickers, “Private Finance and Value for Money in NHS Hospitals: a policy in search of a rationale?” British Medical Journal, May 18, 2002, http://bmj.bmjjournals.com

7 Value for Money Assessment Guidance, February 10, 2004, www.hm-treasury.gov.uk, p. 30.

8 See “UK Chancellor Brown Faces IMF Clash over Funding Scheme,” Knight-Ridder Tribune, Banking, Economy, Personal Finance, Stocks. April 25, 2004.

9 “What is PFI and Why is it an Attractive Investment?” Henderson Global Investments, www.henderson.com, p.3.

10 Edwards, Shaoul, Stafford, Arblaster, “Evaluating the operation of PFI in roads and hospitals,” ACCA Research Report 84, 2004, www.accaglobal.com/research/summaries RR84, executive summary, p. 8.

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