In this video, I will describe the seven main ways that private sector enterprises can be engage in the delivery of modern sanitation services. You can think of these seven alternatives as deal structures. They represent different contractual arrangements between the state in a private sector firm. The key message that I want you to take away from this video is that privatization in the water sector is not simply one type of contract. There are many different ways that a private sector firm can be engaged in the water sector. The single term privatization does not seem to be an accurate description of all these different contractual arrangements. This is why some people prefer to use the term public private partnerships or PPP rather than privatization. All these different deal structures require a conflict resolution mechanism. Typically, there's a regulator to educate or any disputes but disputes can also resolve in a legal system. A publicly own water untill may engage a private sector to conduct a study, such as a tariff review or the preparation of a master plan for capacity expansion. Someone might not object that this is not profitization. But it is a type of contract to engage a private sector firm. A consult contact might be small such as a single study or might be large, such as a contract for the design of a dam or desalinization plant. Even a large consulting or construction contract typical does not seem threatening. And rarely raises the public concerns about loss of control of a community's water supply. The contract simply provides a way for a publicly owned water utility to benefit from private sector expertise that does not exist in house. The second option is a build operate and transfer contract, or a BOT. Here the private firm plays a larger role. The firm designs and builds a project and then operates it for the state for a specified period of time, typically 20 to 30 years. In exchange, the state makes a series of periodic payments to the firm. At the end of the specified period, the firm transfers the ownership of the project to the state. The private firm then exits the scene. Typically examples of BOT projects might be a raw water supply facility or waste water treatment plant. BOT contracts offer several advantages to this state. First, they enable the state to take advantage of the private sector's design and construction expertise. Second, because the private sector firm also operates the facility for a number of years, the state can benefit from the firm's expertise in operations. Often a BOT contract will have a training component so that the staff of a publicly owned water utility can learn how to operate the facility. And then take over operations when the private firm transfers the facility to the public sector. Third and importantly, the private sector firm provides the financing for the project. The periodic payments made by the state to the private firm cover both the cost of capital, and the operational cost of the services provided. The state does take advantage of the private sector's access to capital markets. Although BOT contracts engage the private from for a longer period of time the consulting or construction contracts. They're typically not very controversial, in per because they focus on a single component of the overall world service delivery system. On the other hand, they cannot address any of the problems of overall management of the water supply system. Note here that I will use the term private sector firm or private company to distinguish it from a state owned enterprise. I do not mean that the firm is privately held, that is, a private firm may be listed on a stock exchange and have shareholders. A third type of deal structure is a service contract. A service contract begins to engage a private sector firm in a daily operations of a water utility. A service contract assigns specific tasks to a private sector firm for a relatively short period of time such as two years. For example, a service contract could involve engaging a private sector firm to handle a water utility's accounting and billing system. This might also involve the conversion of the utilities customer's accounts from paper to digital form. Or a service contract could engage a private firm to read and maintain customers' water meters. Another example would be a service contract with a private firm to conduct ongoing leak detection and reduction. All of these examples of a service contract hold out the promise to bring technical expertise to the water utilities operations that it may not have in house. Because service contracts are typically short and limited to specific operations, they also tend to be not so controversial. In some instances, customers may not even be aware that a private firm is providing ongoing services to the water utility. A fourth type of deal structure is a management contract. A management contract is similar to a service contract. But it is typically longer in duration, and involves turning over a wider set of municipal services to a private firm. Management contracts typically last 3 to 5 years. The management contract involves the water utility paying the private firm a fee to operate a set of services which could be the water supply distribution system. A management contract must thus specify service standards, or quality of services that the water utility expects of the private firm to provide. Bonuses may be built into the management contract for the private firm, if it exceeds its targets. The private firm has more decision making authority under a management contract to achieve operational efficiency, such as to reduce unaccounted for water. And the firm has an incentive to achieve efficiencies of these, because this will increase its profits. This will typically mean that the private firm will bring in more senior managers under a management contract than for service contract. With a management contract, the private sector operates the state's capital facilities. But the firm does not have any incent to invest its own capital in the water supply system. Because management contracts involved a greater involvement in the water utilities operations and last for a longer period of time. They may begin to make citizens uneasy about the prospect of losing control over the publicly owned water system. But the large controversies over water privatizations have not been over management contracts. The fifth type of deal structure is a lease. In this type of contract, the private firm pays the state for the right to use the water utility's capital assets and raw water supplies, and to keep the revenues from the utility's customers. You can think of this type of deal structure as the private firm renting the utility's capital assets and water supplies for a period of 10 to 15 years. If a lease contract is put out for bids, the private firm that wins the contract would be the one that offered the highest rental payment to the state. Subject to also meeting specified service standards. The advantage of a lease contract is that the private firm has wide authority to make the operations of the water utility more efficient. However, the private firm is still not responsible for capital investments. The leasee operates the capital facilities and new capital investments that the public sector commits to undertake over the period of the lease. The state still has the responsibility to design, build and finance capital investment. The hope is that the leasing will operate the capital facilities more efficiently than a publicly owned utility. A lease is a big step toward giving the private sector more decision making authority and control over the water utility's assets and raw water supplies. This deal structure can thus be threatening to the public. A private firm does not own the water utility, but it does collect the revenues from the customers. From the private sector perspective, a lease over the capital assets is of little use if there is no raw water in the distribution system that can sell. It does have a strong interest and the municipalities were all water supplies. But as we saw when we discussed ancient instinct about water, the public is likely to be highly sensitive to the notion that a private sector firm controls its raw water supply. A lease contractor is one of the first steel structure that necessitates the establishment of a water regulator. The sixth type of deal structure is a concession. This type of contract is similar to a lease in the sense that the water utility retains ownership of its assets, and the private firm receives the revenue stream from customers. However, concession differs from a lease in two main respects. First, the contract specifies that the private firm is responsible for investment. For example, the contract may require the private firm to expand service coverage or build waste water treatment facilities. Second, a concession contract lasts longer than a lease. A normal duration of a concession is 25 to 30 years assuming it is not cancelled. Most of the controversies over water privatization have involved concession contracts. Both the big failures of water privatization such as Jakarta and Buenos Aires as well as the big successes such as Manila have involved concessions. One of the big advantage of concessions was supposed to be that the product firm would mobilize private finance to make the needed investments to expand services. One of the big disadvantages was that the long duration of the contract required a sophisticated knowledgeable regulator. 30 years is a long time in any business. It's difficult to foresee how conditions will evolve, especially technological innovations in local water resource situations. The state must be able to adapt a concession contract changing conditions. This must be done in a way that is fair to all stakeholders. To learn more about this steel structure, I want to call your attention to your readings on the Manilla privatization case. The Manilla case is better documented than most other concessions, and is worth spending some time reading and reflecting on the Manilla story. Be sure to read the Manila water concession, a key government official's diary of the world's largest privatization, by Mark Dumol. It was published in 2000, but it's still one of the best things written on water privatization in developing countries. Also in one of the interviews this week, Professor Eduardo Araral discusses the Manila case. The seventh deal structure is divestiture. Here the state literally sells the assets of municipal water utility to a private firm. The term privatization is certainly an accurate description of these deal structure. The expectation is that this transfer of ownership is permanent although in practice the state can reverse its decision and reestablish public ownership. The hope is that private ownership of a water utility will provide even more incentives for efficient operations and capital investments. This is the most controversial deal structure of all. However, because this is so controversial, it is very rare. The only large scale example is here in the UK. And even within the UK, only the water utilities of England and Wales actually underwent full divestiture. To this day, Scotland and Northern Holland retain public ownership and operation of their systems. I'm not going to say too much about divestiture, because we're going to spend an entire session on the UK experience. But it is important to emphasize here that divestiture does not mean that the state exits the scene. If the private sector owns a municipal water utility, in fact the essential law of the state comes much more sharply in focus. This is because here state regulation of the private form is absolutely essential. The precise form of the deregulation should should take has been the focus of much policy debate and innovation in the UK. Not only as this states still engage in this deal's structure, but there is a new set of stakeholders involved, the shareholders of the firm. The shareholders bring an additional voice to ensure the capital deploys efficiently by the private firm. Because the water supply and sanitation sectors are so capital intensive. I consider this to be potentially a large advantage of this deal structure. This last slide compares seven different deal structures along four different dimensions. Duration, ownership of the assets, capital investment, and commercial risks. Various versions of this slide have been floating around the sector for several years. I believe the first person to do this comparison was Penelope Brook of the World Bank. And I'd like to acknowledge her contribution here, not only for this slide, but also to the literature on private sector participation. As shown, different types of contracts have very different durations. In general, as duration increases, the private firm assumes greater management responsibility, and greater commercial risk. By commercial risk I mean, uncertainty both in the revenue stream from customers and in the cost of operation and capital investments. As private operators takes on more risk they naturally expect the opportunity for more rewards. Similarly, if they assume that the ownership of the assets they expect to be paid for the use of their capital. However, only in the divestiture option does the private sector assume full ownership of the capital assets of the utility. Even here, the ownership typically does not extend to the water resource. Although in practice the private operator needs assurance that there will be a raw water supply for its system. My key message in this video is that there are many different ways that the private sector can engage with the state in the provision of water and sanitation services. Privatization is not a very acrid or helpful description of some forms of contracts. Some deal structures are much more controversial than others. In general, the likelihood of controversy increases with increases in the duration of the contract. The private firms control of customer revenues, the private firms responsibility for investments and the private firms control over water resources. Most of the global controversy over privatization is focused on concession contracts which have long durations. And in which the private firm has control of customers revenues and is responsible for investments. Note that political controversy over a particular deal structure makes an option much less attractive to both the public and the private parties to the deal. In the next video, we will look at the private sector participation from the perspective of the private operator. But before we do that, I want to encourage you to share your thoughts on these different deal structures and privatization in general on the discussion boards for this session. In the blogs associated with the first part of the MOOC in 2014, some participants thought that Duncan and I were actually advocates or promoters of privatization, even though we never discussed this topic explicitly. Let me just say that if you're against private sector participation of the water sector, there's good and bad news. The good news is that in most parts of the world, you don't need to worry, the multinational private firms are no longer interested in this business. They have found that the transaction costs associated with concessions are much too high. The bad news is that the public sector is going to have to address the challenges of providing improved water supply and sanitation services to the mega cities in low and middle income countries without much help from the private sector. And those individuals who have actually run world class water utilities.
