Empowering Communities, Advocating Solutions
Campaigns:

CCE IN THE NEWS

Source: Knowledge @ Wharton

Making the Most of Public-private Partnerships

Posted: June 11, 2015
Originally Published: June 10, 2015

It may not be common knowledge, but private companies have been helping cities manage public water systems for some time. According to the National Environmental Services Center, a process known as design-bid-build is the traditional method employed by water utilities throughout the U.S. Under this process, a municipality hires an engineering firm to design a water project, puts the project out to bid and chooses a private contractor to build the plant. The local water authority may choose to run the plant itself or hire yet another private firm to operate and maintain it.

But what typically happens in all these cases, is that the city “fragments the work, controls all of it and takes all the risk,” said Patrick Cairo, senior vice president for corporate development at Suez Environnement. So if any aspect of the work is faulty, the city has to pay to fix it, he added. Cities have traditionally taken on the financial risk as well, often by issuing tax-exempt municipal bonds.

Over the past 25 years, however, a new kind of partnership has developed in which the public and private sectors share the risks and rewards involved in building, maintaining and operating public water systems.

A Handy Tool

Public-private partnerships (P3s) have grown increasingly common in several countries, especially Canada and the U.K. In the U.S., the federal government has helped P3s play an important role in the transportation sector. But according to Cairo, the use of P3s is relatively new for water and sewer projects in the U.S.

Tim Carden, managing director of PFM Group, said that although there was “a lot of activity before 2008, few large deals were closing.” Mayors and other local officials didn’t know enough about P3s at that point and state legislatures had not yet created the necessary statutory framework. During the Great Recession, P3 deals started losing ground, he said. But as financial markets have recovered, so has interest in P3s. Indeed, Cairo estimates that today close to 50% of all water construction projects are design-build, a process in which one entity under a single contract designs and builds the project.

Richard Anderson, a senior advisor at the U.S. Conference of Mayors and managing director of the Mayors Water Council, offers two reasons for the growing interest. The first is the ballooning debt burden many cities are now facing. With more than $1.7 trillion in long-term debt already on the books, and pension liabilities surging, cities are hard pressed to finance badly needed capital improvements for water systems. Private equity would not only help fund these projects, it could even help take existing debt off a city’s balance sheet, thereby strengthening the municipality’s credit rating and lowering its cost of capital for other vital services, he said. (For an example of this, see the accompanying case study of Bayonne, N.J.).

Regulatory compliance is the second driver, Anderson said. A private company or consortium can help a city complete the work demanded by a consent decree within the time specified, and it can also assume the risks involved by guaranteeing that the work will be successfully completed for a fixed price.

Even without financial or regulatory crises, advocates of P3s cite the positive role private companies can play in long-term planning. The enormous cost of making up for deferred maintenance suggests that neither residents nor local politicians are disposed to think much about the future of water infrastructure. Private companies, on the other hand, routinely develop long-range plans and are accustomed to profiting from long-term investments.

Private companies can also achieve far greater efficiencies than municipalities. According to Anderson, private companies can “get you savings of 15% to 30% on operation and maintenance overnight.” In Nassau Country, N.Y., the P3 contract required United Water to save the county a minimum of $10 million a year. In its first year, the company delivered $12 million in savings.

Many Models of P3s

The key distinctions of P3s are the duration of the partnership, the nature of the financing and the sources of revenue.

Design-Build (DB): A private entity can take full responsibility for the design and construction of a project based on the requirements of the public utility. In such design-build arrangements, the private sector assumes only the risks inherent in this first phase. Once the construction work is finished, the public sector assumes responsibility for operating and maintaining the system.

Operate and Maintain (O&M): A municipality may choose to handle the design-build part of a project itself, but have a private partner assume responsibility for operating and maintaining the system. Such O&M arrangements are typically long-term, often lasting decades.

Design-Build-Finance-Operate and Maintain (DBFOM): This is a far more inclusive deal, in which a private consortium takes responsibility for every phase of a project, including the financing. While one company takes the lead and assumes “wrap-around responsibility,” many private firms are involved.

A concession agreement: What distinguishes a concession agreement from other contractual arrangements is that the private sector partner collects revenue directly from those who use the system, usually in the form of fees paid by residents.

In practice, the permutations of these basic models is nearly endless. What is common to all of them is the sharing of risk and reward among private and public partners. Two large, groundbreaking DBFOM deals — in Bayonne, N.J. and Rialto, Calif. — are covered elsewhere in this report. But simpler P3s are also common.

In Nassau County, long-term neglect had left the Bay Park Sewage Treatment Plant needing $300 million simply to bring it up to code. That was before Hurricane Sandy hit and knocked the plant offline. The importance of a functioning plant became painfully evident very quickly. People were forced out of their homes, said Michael Martino, a county employee at the time and now manager of communications and community relations at United Water. “Two sections of street were literally blown open,” he explained, and 16 noisy generators had to be brought in to help get the plant back in service. The generators ended up running continuously for two years.

As a result of the devastation, the cost of rehabilitating the plant nearly tripled, growing from $300 million to more than $800 million. The Federal Emergency Management Agency (FEMA) agreed to provide most of the needed funds, with the state and county making up the difference.

The FEMA money enabled the county to bring the plant back on line, but it did not fund the ongoing operation and maintenance (O&M) that everyone now saw as critical. To that end, the county signed a 20-year P3 agreement with United Water to operate and maintain the Bay Park facility. The company will continue to make improvements over the two decades in return for a fixed fee that Martino said is significantly lower than the county would otherwise pay.

Elements Critical to Success of P3s

Public officials need to understand what P3s can accomplish and how to evaluate whether a partnership is appropriate in a given situation. Several groups are currently offering help to those who want it, including the Metropolitan Policy Program at the Brookings Institution, the Mayors Water Council at the U.S. Conference of Mayors, the National Governors Association and the West Coast Infrastructure Exchange.

1. P3 authorizing legislation, already enacted in 25 states, protects against last-minute legislative roadblocks. According to Patrick Sabol, a senior policy and research assistant with Brookings’ Metropolitan Policy Program, such legislation removes a major risk factor and is therefore key to attracting private partners.

2. A P3 that is nothing more than a stopgap measure is unlikely to succeed. A public-private partnership should not “just lengthen the fuse before a liability blows up,” said Sabol. It should enable local governments to reallocate resources in ways that improve the delivery of core services to the community, as in Bayonne, Rialto and Nassau County, among many others.

3. If local communities are not included in the development of P3s, they are likely to oppose them. Residents often fear that profit-motivated companies will shortchange the public by underperforming, overcharging and then drain the local economy by eliminating jobs.

The practical answers to these concerns can vary — the local workforce can be reduced over time by attrition, thus preserving current employees’ jobs, and solid contracts can guarantee that work will be accomplished and rates kept at reasonable levels. But unless residents feel that their concerns are being heard and satisfactorily addressed, few answers will soothe public opposition.

In Nassau County, United Water “sat down with some 17 environmental groups,” said Cairo. “We asked them, what do you want to accomplish?” The discussions lasted for two years and covered a range of problems, everything from foul odors and ground water contamination to job losses and inland bay nutrient pollution. He said possible solutions were presented and reviewed until all concerned agreed that a suitable plan had been developed.

Just before the final contract was to be voted on last July, Emily Wurth, director of the water program at Food & Water Watch, warned voters that no good would come from the P3 being proposed. But local environmental leaders spoke up. Adrienne Esposito, executive director of Citizens Campaign for the Environment, said, “we believe a professional contractor, with community and county oversight, is the best safeguard for protecting public health, our groundwater and our waterways.” In response to Food & Water Watch, she added, “they don’t live here. The county does not have the capability to treat wastewater.”

The contract was approved by the Nassau County Legislature, the Nassau County Interim Finance Authority (NIFA) and signed by County Executive Edward Mangano in September 2014.

The Future of P3s

While P3s have been growing judiciously in the U.S., the private sector’s appetite for these deals is not boundless. “In gross terms, P3s are just a drop in the bucket,” said Carden. “If P3s were meeting 10% of a given country’s infrastructure needs, that would be a lot.”

“These public-private partnerships are alternately framed as a panacea to all of America’s infrastructure challenges or a corporate takeover of critical public assets,” write Sabol and Robert Puentes in “Private Capital, Public Good: Drivers of Successful Infrastructure Public-Private Partnerships.”

“In reality, they are neither. A well-executed [P3] is simply another tool for procuring or managing public infrastructure — albeit a new and increasingly popular one.”