When Does Privatization of Municipal-Owned Water Systems Make Sense?

by: Daniel Kucera Much has been written and discussed about the benefits and mechanics of privatization of municipal-owned water systems. And, much of this verbiage has been from the perspective of a privatizer.

From the view of a municipality, however, when does privatization-particularly a sale-make sense? What circumstances should cause a municipal-owned system to consider privatization?

• When there is a need for capital funds. A municipality's equity interest in its water system may be a valuable asset. If sold, it can provide a source of capital funds much needed for improvements to other infrastructure assets. Incurring debt or obtaining grants may not be feasible. A sale of the water system may be the only practicable source of needed capital funds.

• When the water system is not really making money. Many municipal systems fail to accurately determine their cost of providing water service. If they did so, they may discover that full costs of service are not being recovered in rates. This means that the municipality is subsidizing, one way or another, its water operations. An adequate rate increase may not be feasible. If an alternate provider is willing to satisfy the need for public water service, it may not make sense to continue to operate a municipal-owned system below cost.

• When the water system infrastructure requirements are overbearing. Safe Drinking Water Act requirements may require upgrades. Deteriorating mains, storage tanks and other facilities may require replacement. In particular, facilities previously contributed by developers at no cost to the city now must be replaced by new municipal investment. The funds simply may be unavailable for the huge capital costs involved.

• When continued municipal ownership denies customers the benefits of economies of scale and modern technology. A privatizer likely will be a regional or national utility, whose corporate business is water and which can offer efficiencies not available to a smaller system. It may be unnecessarily selfish and shortsighted to preclude customers of a municipal water system from lower rates or more reliable service that can be offered by a privatizer.

• When municipal utility management no longer is sufficiently sophisticated. The scope of environmental regulation, as well as developments in water treatment, have advanced greatly in recent years. Municipal management may no longer have the skills and resources to "keep up" with all the changes and requirements.

• When the source of water supply is perceived no longer satisfactory. The Safe Drinking Water Act, as well as changing customer attitudes, have diminished tolerance for inadequate water supplies or water which is not aesthetically acceptable. A privatizer may be able to offer an alternate water supply of higher quality or reliability.

• When risks exceed benefits. Operation of a water system is not without risk, as recent incidents involving water-borne disease illustrate. In many states, courts have held that municipalities operate water systems in their proprietary capacity; i.e., with characteristics as a business. A municipality may decide that the risks of its water system exceed the benefits of municipal ownership, and that it just does not want to be in the water business any more.

Dan Kucera is a partner with the Chicago law firm of Chapman and Cutler, specializing in public utilities, water and wastewater and environmental law. Tel: (312) 845-3757; Fax: (312) 701-2361; email: wimbush@chapman.com.