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Private SectorParticipation inWater Supplyand Sanitationin Latin AmericaEMANUEL IDELOVITCH

KLAS RINGSKOG

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Private Sector Participationin Water Supply and Sanitation

in Latin America

Emanuel IdelovitchKlas Ringskog

The World BankWashington, D.C.

o 1995 The International Bank for Reconstructionand Development/THE WORLD BANK

1818 H Street, N.W.Washington, D.C. 20433

All rights reservedManufactured in the United States of AmericaFirst printing May 1995

This report is a study by the World Bank's staff, and the judgments madeherein do not necessarily reflect the views of the Board of Executive Directorsof the governments they represent. The boundaries, colors, denominations,and other information shown on any map in this volume do not imply on thepart of the World Bank Group any judgment on the legal status of anyterritory or the endorsement or acceptance of such boundaries.

Cover photograph courtesy of the Inter-American Development Bank.

Emanuel Idelovitch is a consultant; he was previously a staff member of theWorld Bank's Latin America and the Caribbean Regional Office. KlasRingskog is the principal water specialist in the World Bank's TechnicalDepartment of the Latin America and the Caribbean Regional Office.

Library of Congress Cataloging-in-Pziblication Data

Idelovitch, Emanuel.Private sector participation in water supply and sanitation

in Latin America / Emanuel Idelovitch and Klas Ringskog.p. cm.-(Directions in development)

ISBN 0-8213-3219-81. Water utilities-Latin America. 2. Sewage disposal-Latin

America. 3. Water utilifies-Argentina-Buenos Aires MetropolitanArea. 4. Sewage disposal-Argentina-Buenos Aires MetropolitanArea. 5. Privatization-Latin America. 6. Privatization-Argentina-Buenos Aires Metropolitan Area. 1. Ringskog, Klas,1945- . II. Title. Ill. Series: Directions in development(Washington, D.C.)HD4465.L29134 1995363.6'1'098-dc20 95-13904

CIP

Contents

Foreword v

Abbreviations vii

Summary I

1. Options for Private Sector Participation 7The Main Problems of the Public Water Company 8Rationale for Private Sector Participation 10Options of Private Sector Participation 13Main Elements of Success and Obstacles to PSP 21Regulatory System 24Psp in Latin America and the World 25

2. Case Study: The Buenos Aires Concession 27Background 28Rationale for Private Sector Participation 29Main Stages of Transition from Public to Private

Operation 30Sharing Out of Tasks among Main Entities 42Timetable 44First-year Results 45

Conclusions and Lessons from Experience 48

Notes 51

iii

iV CONTENTS

Tables1-1. Main Features of PSP Options with Public

Ownership 221-2. Comparison of PSP Options 232-1. Performance Targets of the Buenos Aires

Concession 392-2. Division of Tasks among Main Entities in the Buenos

Aires Concession 432-3. Intended and Actual Timetable of the Buenos Aires

Concession 44

Foreword

The water and sanitation sector in Latin America and the Caribbean isfacing a crisis of confidence. The return of cholera to the region in 1991was a symptom of deep-seated problems and exposed the fragility andinadequacy of publicly operated water supplies and sanitation sys-tems. Despite substantial efforts to improve the quality and coverageof service, one-quarter of the urban population is not connected to apublic water system, half lacks public sewerage, and the sewage isvirtually untreated. The results are a constant threat to the health of theentire population, a perpetuation of unmet basic needs of the poor, anda steady deterioration of the environment.

The failure of the public sector to provide reliable service is largelyexplained by its inability to operate efficiently and maintain ade-quately existing water and sanitation systems. In addition, the invest-ments for rehabilitation and expansion are very large. It is estimatedthat the region's countries need to invest an annual $5 billion in watersupply and $7 billion in sewerage and sewage treatment over the nextten years.1 These requirements are well beyond the public sector'sfinancial capacity and have prompted a reexamination of its role as themain financier and provider of services. Instead, the notion is spread-ing that the public sector should establish the legal and regulatoryframework, while remaining the owner of the assets, and then allowpublic and private companies to compete for the mandate to provideservice.

As a result, the public water and sanitation agencies in Latin Amer-ica and the Caribbean are entering a crucial phase. They have to decidewhether they can sharply improve their performance while remainingin the public sector or whether they should seek to increase privatesector participation in both operations and financing.

Although a few public water companies demonstrate a good per-formance record, the majority of them perform poorly, partly becauseof excessive outside interference in their daily operations and mis-guided financial policies. Wider private sector participation is likely to

f1

Vi FOREWORD

improve operational efficiency, while at the same time attracting pri-vate finance and improving the efficiency of investment.

In recent years, private sector participation in water and sanitationhas been a topic of discussion among various countries in Latin Amer-ica, as evidenced by the large attendance at a number of regional semi-nars organized by the Technical Department of the World Bank's LatinAmerica and the Caribbean Regional Office. These seminars haveshown that virtually all public water companies are interested in coop-erating with the private sector. Some have advanced further and havealready involved the private sector in their operations in one way oranother. The seminars have catalyzed the pursuit of greater privatesector participation and the evolution of privatization models adaptedto the institutional realities of Latin America and the Caribbean. Thispublication incorporates some of the insights gained at these seminarsand is aimed at assisting the decisionmaking process that many coun-tries face.

The publication consists of two chapters. In the first-Options forPrivate Sector Participation-the main problems of the public sectorare analyzed, the rationale for private sector participation (PSP) is ex-plained, and the array of options for PSP is reviewed. In the secondchapter-Case Study: The Buenos Aires Concession-the large conces-sion for the Greater Buenos Aires water supply and sewerage servicesawarded by the government of Argentina to a private consortium offoreign operators and local investors is presented and analyzed, be-cause it provides an excellent example of the planning and implemen-tation stages that are needed to ensure a successful transition frompublic to private management.

Sri-Ram AiyerDirector, Technical Department

Latin America and the Caribbean Regional OfficeWorld Bank

Abbreviations

AA Aguas ArgentinasBOO Build-Own-OperateBOOT Build-Own-Operate-TransferBOT Build-Operate-TransferETOSS Ente Tripartito de Obras y Servicios SanitariosIDB Inter-American Development BankOSN Obras Sanitarias de la Naci6nPSP Private sector participation

vii

Summary

The services provided by public water companies in developing coun-tries have traditionally been plagued by a series of problems that areresponsible for the poor performance and low productivity of mostpublic companies. These problems may be classified into four catego-ries: technical and operational, commercial and financial, human andinstitutional, and environmental. Because of the generally poor per-formance of public sector companies, many authorities have looked foralternative ways of providing water and sanitation services more effi-ciently. Currently, there is a growing consensus that at least some func-tions, and in many cases all functions, related to the management ofwater and sanitation services should be entrusted to the private sector.

The three primary objectives of the public sector with respect toprivate sector participation are to expand the water supply and sewer-age systems in order to increase population coverage, to expand sew-age treatment in order to reduce water pollution and public healthhazards, and to provide better quality of service. The secondary objec-tives are to ensure higher operating efficiency and to finance the sys-tem without public subsidies or guarantees.

Options for Private Sector Participation

Private participation in the water sector ranges from the fulfillment oflimited attributions to overall responsibility. PSP has eight main op-tions, which vary in the degree of involvement of the private sector,the risk for both the public and private sector, the private operator'sautonomy and responsibility, the required capital investment, the du-ration of the contract, and the contractual relationship with the con-sumer. These options may be grouped into two distinct categories.In the first group, the ownership of the assets remains with the gov-ernment or the public sector, whereas in the second group, partial orfull ownership is transferred (permanently or temporarily) to the pri-vate sector. Each group includes four options. The first group-public

1

2 PRIVATE SECTOR PARTICIPATION

ownership-includes service contracts, management contracts, leasearrangements, and concessions. The second group-private owner-ship-includes BOOT (Build-Own-Operate-Transfer), reverse BOOT,

joint ownership or mixed companies, and outright sale.To varying degrees, all these options promote the operational effi-

ciency and commercial viability of water and sanitation utilities. At thesame time, they introduce competition, improved cost recovery, and, inmost cases, performance-based compensation. They feature flexibilityand the potential to progress from less risky arrangements with noprivate investment to more risky arrangements with private invest-ment as the two parties gain credibility and confidence. A combinationof options is also possible, for example, a lease for distribution systemsand a concession or BOOT for a new treatment plant. In concessions, theprivate operator has an incentive to invest efficiently, because it isresponsible for recovering both current and capital costs.

Some type of regulatory framework is necessary to monitor andcontrol the private sector operations. Lack of regulatory systems andfailure to enforce existing regulations are two of the main causes ofunreliable service provided by public water utilities. In all PSP options,the central or local government retains its important regulatory roleand can thus oversee the sector and provide the guidance it may need.Private sector participation does not mean that the public sector losescontrol, but rather that it adopts a new division of tasks between pub-lic and private partners, based on the comparative advantage of each.The main objectives of the regulatory system are to ensure compliancewith standards of acceptable service, protect the rate payer from mo-nopolistic behavior, and create a business environment that promotescommercial viability and attracts the private sector. In the absence of aformal regulatory body, contract regulation becomes necessary. Thecompliance of such contracts is monitored by the public partner. Con-tract disputes can be referred to civil courts for decisions.

Inevitably there are obstacles to PSP, such as lack of adequate legisla-tion, the public sector's resistance to losing control, a reluctance to facelabor problems, and simply the fear of trying the unknown. As a re-sult, successful PSP requires public education and the consensus of allstakeholders. In most Psp options, many obstacles can be overcome byprocuring the services required through a transparent bidding andaward process. The bidding procedures should include, at a minimum,the establishment of sound qualification criteria and procedures, aclear definition of the evaluation methodology, and preparation of thedocuments well enough in advance to permit open and universalbidding.

SUMMARY 3

A Case Study: The Buenos Aires Concession

The government of Argentina, with the World Bank's support andassistance, embarked in 1990 on a massive and ambitious privatizationprogram, encompassing virtually all the public services and federallyowned enterprises. As part of this effort, the operation of the watersupply and sewerage systems of the large Buenos Aires metropolitanarea was transferred in May 1993 from an inefficient public companyto a competent consortium of private foreign operators and local in-vestors, after a thorough and successful process of preparation andbidding. The model adopted was a thirty-year full concession,whereby the government remained the owner of the assets, but theconcessionaire was responsible for operating, maintaining, and man-aging the system, investing in rehabilitation and expansion works, andalleviating contamination of water resources caused by the disposal ofdomestic sewage. Regulation and control of the concession were ac-complished through a regulatory agency established specifically forthis purpose.

Four main stages are necessary for achieving a successful transitionfrom a public company to a private concession. These stages should beapplicable, with minor adjustments or modifications, to other types ofPSP as well. They are as follows:

* Stage I. The initial activities, which are undertaken prior to thedecision on how to privatize

* Stage II. The preparation of bidding documents and background mate-rials required for selecting a qualified operator

• Stage III. The bidding and contracting process, which culminateswith the signing of the respective contract

* Stage IV. The actual transfer of services to the private operator andthe setting up of the regulatory agency.

Numerous conclusions may be drawn from the successful privati-zation of the water supply and sewerage systems in Buenos Aires.Nineteen of the most relevant conclusions are briefly presentedbelow.

1. Political commitment to privatization at the highest level shouldbe ensured.

2. Privatization should preferably be part of a comprehensive pro-gram of economic reforms.

3. Consensus building among all stakeholders is important.


4. Risks of all types (political, economic, commercial, technical,and legal) should be assessed, and appropriate mechanisms to allevi-ate them should be adopted.

5. Participation of multilateral agencies, such as the World Bank,enhances the transparency and credibility of the process.

6. All PSP options must be analyzed prior to selecting the preferredprivatization mode, but ownership of the system may remain with thepublic sector; the assets do not necessarily have to be privatized topromote efficiency and attract private capital.

7. Successful privatization cannot be accomplished overnight, evenif the political decision is taken; careful preparation and reasonabletime are required.

8. Although a concession contract provides self-contained regula-tion, a full regulatory framework and the regulatory institutional set-up should be clearly established, before starting the actual biddingprocess.

9. The technical and financial feasibility of the concession shouldbe carefully studied prior to bidding.

10. Specialized, experienced consultants should be contracted to as-sist in various aspects of the preparation process; hiring a single, mul-tidisciplinary consulting firm is preferable to contracting two or morefirms.

11. Adequacy of water rates should be examined, and, if necessary,rate increases should be adopted prior to bidding.

12. Prequalification of potential bidders should be conducted to en-sure that only qualified bidders eventually submit bids and to simplifythe process of bid evaluation, but it requires extra effort and time.

13. Reduction of staff-probably the most sensitive of all privatiza-tion issues-is achievable, with the help of aggressive promotion ofattractive early retirement packages to be financed by the government,the concessionaire, or both.

14. The regulatory entity should be strong enough to be able toconfront an experienced international operator and should be assistedby specialized institutional consultants, if needed.

15. A residual public company must continue to function in par-allel with the private operator for at least a year, until the orderlytransfer of all services is accomplished and the nonconcession serv-ices are liquidated.

16. A clear understanding of the reasons for any extraordinary in-crease in rates, beyond that stipulated by the concession contract, isimportant to minimize the danger of reducing the credibility of therate offered in the bid and used as main criterion of award.

SUMMARY 5

17. Political pressure to impose priorities, although considerably di-minished compared to that exerted on the public water company, canstill be exerted on the private operator, through the regulatory agency,which is a public entity

18. At least at the beginning of the operation, the private sector maynot be willing to finance investments with its own resources, but it iswilling to invest cash generated by the operation and to borrow moneyfrom multilateral agencies or commercial banks.

19. The concession contract must be realistic and as specific as pos-sible to avoid disappointment and minimize conflicts and debate be-tween the concessionaire and the regulatory authority. At the sametime, it should be flexible, because it is expected that the targets, indi-cators, and other aspects of the contract can be more realistically deter-mined after the first year of operation.

The Buenos Aires concession provides a valuable model of PSP inwater supply and sanitation that is being adopted in other provinces inArgentina and can be useful to other countries. Nevertheless, privati-zation cannot be regarded as a universal panacea to problematic watercompanies. Its applicability and probability of success must be ana-lyzed in the specific context of each country, in conjunction with otherrelevant measures and reforms that must accompany it.

1. Options for Private SectorParticipation

There is growing awareness in many countries that government provi-sion of water supply and sanitation services, as well as other infra-structure services such as power, telephone, gas, and transportation,has been inadequate. Inefficient public sector monopolies are widelyblamed for the failure to provide access to safe water and adequatesanitation to the entire population, particularly the poor. The magni-tude of the needs in the sector-more than 1 billion people worldwidelack a source of potable water near their homes, almost 2 billion arewithout adequate sanitation, and more than 4 billion discharge theirwastes without treatment-has led to an increasing acceptance thatwider participation of the private sector is needed in the provision ofwater and sanitation services.

In the 1980s, privatization of government-owned enterprises beganto be recognized in some countries in Latin America as a tool foreconomic change. The objective was to sell state-owned or parastatalcompanies to the private sector as a way for governments to generaterevenue in the case of profitable companies or to eliminate or at leastreduce public subsidies as part of restructuring the public sector in thecase of money-losing companies. In an effort to shrink the size of thepublic sector and to focus on providing those services that only thepublic sector can provide, the conviction grew that the public servicemonopolies should be opened up to competition and impartial regula-tion. Major and ambitious privatization programs were announced byseveral Latin American countries, such as Argentina, Chile, and Mex-ico, as well as by such diverse economies as Malaysia and Nigeria inother parts of the world. A number of additional countries embarkedon major privatization studies in preparation for reforms.

In the early 1990s, it appeared that progress, though slower thananticipated, had been made in some countries, mostly in the powerand telecommunications sectors. However, private sector participation

7


was slow in the water and sanitation sector, with the exception ofChile, where limited private sector participation took place in the forrnof service contracts, which will be discussed later in this study.

Since the early 1990s, however, a renewed interest in private sectorparticipation in the provision of water and sanitation services, hasbeen sweeping Latin America. Argentina has embarked on a majorprivatization program in all sectors including water and sanitation andis now in the forefront of this end-of-the-century privatization effort.Additional countries in Latin America that have privatized or are inthe process of privatizing some of their water and sanitation servicesare Chile, Colombia, Mexico, and Peru. Other countries in Latin Amer-ica and the Caribbean, such as Trinidad and Tobago, Uruguay, andVenezuela, have attempted to privatize their water companies on amore limited scale.

The Main Problems of the Public Water Company

Traditionally, the services provided by public water companies in de-veloping countries have been plagued by a series of problems, whichhelp to explain the poor performance and low productivity of mostpublic companies. These problems may be classified into four catego-ries: technical and operational, commercial and financial, human andinstitutional, and environmental. They are briefly described below.

Technical and Operational Problems

Operational practices are inefficient, regular maintenance is inade-quate, and preventive maintenance does not exist. Unaccounted-forwater is high-40-50 percent of the water produced compared with10-20 percent in well-managed systems in industrial countries. This ispartly due to physical losses through old pipes, which are neitherproperly maintained nor replaced in a timely manner. Under such cir-cumstances, service expansion is rather limited and cannot cope withpopulation growth.

Commercial and Financial Problems

Consumption metering is limited or does not exist at all. Even when itdoes, regular meter reading and billings based on actual consumptionare rarely practiced. In many cases, water charges are based on lotsize and property value, regardless of the amount of water consumed.The unmetered system creates distortions in consumer charges, which

OPTIONS FOR PRIVATE SECTOR PARTICIPATION 9

result in legitimate consumer protests. The amount of water producedis usually estimated and not metered. The paucity of reliable datamakes planning difficult. Under these circumstances, any attempt tomanage demand becomes futile. Water demand may reach very highvalues of 500400 liters per capita a day-double the norm for meteredand well-managed water supply systems.

Poor consumer records, combined with inefficient billing and collec-tion practices, create commercial losses-the main reason for the highlevels of unaccounted-for water. The low collection rates reflect to agreat extent the laws prohibiting cutting off water service because ofnonpayment, which are based on the traditional idea that water is abasic human need and not a commodity that must be bought. Underthese conditions, revenues are generally not sufficient to generate thefunds needed to expand service or to protect the aquatic environmentagainst contamination by untreated sewage discharges.

Tariff policies add to the financial problems. Invariably, the level oftariffs does not adequately reflect the true economic cost of futurewater supplies, let alone the costs of collecting and treating wastewaterso that it will not create an environmental hazard. In an effort toreduce the costs of water consumed by low-income groups, tariffstructures with large cross-subsidies are the rule. The unfortunateresult has been the opposite of what was intended: in unmeteredsystems with underpriced water, the wealthy who consume morewater enjoy the largest subsidies. The poor are rarely connected be-cause utilities view them as commercially unattractive at the low pre-vailing tariffs. Chile represents an exception because water chargesreflect full economic costs and subsidies are provided for the low-income population directly from the central budget rather thanthrough cross-subsidies.

Human and Institutional Problems

Excess staff explains the low productivity of public water companies.Ratios of 5-10 employees per 1,000 water connections are common,compared with a ratio of 2-3 employees per 1,000 water connectionsfor an efficient water company.

Public companies are also plagued by political appointments, exces-sive political intervention, and inability, due to lack of adequate incen-tives, to attract sufficient managerial talent and qualified technicalstaff. Political appointments and noncompetitive wages result in fre-quent turnover of high-level staff, low productivity, and lack of disci-pline of the labor force.


Another institutional problem, typical of public water companies, isthe lack of clear regulatory responsibility. Many large, national watercompanies run the risk of a potential conflict of interest by being bothoperator and regulator. Consequently, in many cases, when the waterquality obtained at a treatment plant, for example, is below the ex-pected standard, the easiest regulatory measure is adopted, loweringthe standard, rather than improving the operation of the treatmentplant.

Environmental Problems

Public water companies have traditionally favored connecting thepopulation to the water system and been slow in connecting them tothe public sewerage system. Consequently, sewerage coverage is, ingeneral, much lower than water coverage. When this occurs, the rela-tively large numbers of households not connected to the public sewer-age system dispose of their sewage through cesspools and septic tanks,which may contaminate shallow groundwater aquifers from whichsome cities withdraw their potable water supply. At the same time,central sewerage systems usually discharge large quantities of un-treated sewage into rivers or lakes located in the proximity of the city,sometimes endangering the main source of potable water for the cityor of irrigation water for adjacent agricultural lands and creating aes-thetic pollution in the city. The health hazards involved in such prac-tices escalated considerably after the recent cholera outbreak in anumber of Latin American countries.

The combination of all these problems-technical, financial, institu-tional, and environmental-ultimately results in unreliable service andunsatisfied consumers and exposes the urban population to unneces-sary and unacceptable health hazards.

Rationale for Private Sector Participation

Under the circumstances, it is easy to explain why many authoritieshave looked for ways of providing water and sanitation services moreefficiently There is a growing consensus that at least some functions,and in many cases all functions, related to the management of waterand sanitation services can be entrusted to the private sector. In thiscontext, it is important to remember some of the main characteristics ofthe water sector.

OPTIONS FOR PRIVATE SECTOR PARTICIPATION 1i

Water supply is a natural monopoly. In simple words, it is uneco-nomic to duplicate the water and sewerage network in the city streets.As a consequence, one service provider has such a dominant positionthat competition is difficult to achieve. In order to protect consumersagainst abuses of monopoly powers, regulation becomes necessaryand important.

The water and sanitation sector is capital intensive. Studies from theUnited States indicate that the ratio of investments in fixed assets toannual tariff revenue is on the order of 10:1 as compared with 3:1 fortelecommunications and 4:1 for the electric power. The higher ratio forwater supply and sanitation makes it more difficult to attract privatesector participation with responsibility for financing investments be-cause the payback period is long.

The sector has important externalities, mostly related to publichealth and environmental effects. As a result, there is a need to pro-mote sector investments over and above what a private operator maywish to do because the socioeconomic benefits are larger than the ap-parent financial benefits. In particular, the importance of achieving fullcoverage of both water supply and sanitation must be emphasized.

Experience in industrial countries and in some developing countriesthat have delegated some water and sanitation services to the privatesector has shown that private sector participation can result in benefitssuch as stable management, higher efficiency, and improved access toprivate capital. The access to long-term private capital is particularlycrucial, because water supply and sewerage investments are large andbulky, and the costs can be recovered only over many years. Privatefinancing will generally depend on the perceived risks and the re-wards in compensation. The availability of long-term funding will de-pend on whether a long-term capital market exists. Some countriessuch as Chile have been successful in creating private pension fundsthat have invested in infrastructure development. The incentives forinternational capital to finance the investments are contingent on theguarantees and rewards offered.

Experience has shown that the main catalyst for the interest in pri-vate sector participation is the proven record of poor performance andmismanagement characterizing most publicly owned and operatedutilities in the region. The few well-managed publicly owned utilitiesseem to be the exception that confirms the general rule. A second im-portant consideration is the insufficiency of public funds alone to meetthe increasing investment needs of both the water and sanitation sectorand other sectors.


Two important objectives of private sector participation are, then, toensure improved management and higher efficiency and to acquire thecapital needed for investments. These objectives are closely related.Efficiency gains result in cost savings that can generate investmentfunds, whereas improved management may ensure easier access toprivate capital. The incorporation of large amounts of private capitalfor investment also creates an additional incentive for improving op-erational efficiency.

Risks Involved in Private Sector Participation

There are risks involved in PSP for both the public and the privatesector. There are two primary risks for the public agency: the risk thatservices supplied by the private sector will not be in accordance withthe desired standards and the risk that the cost of such services will bemuch higher than that currently charged by the public entity.

The risks for the private investor include commercial, financial,technical, legal, and political risks. The commercial risks are that hewill not be paid for his services at all times, he will not be able torecover costs in the long term, if the rates are too low and cannot beincreased according to needs, and he will not make a reasonable profit.Another commercial risk is related to the market, and that is the riskthat the demand for services will be lower than that planned for orassumed. The financial risks are related to currency devaluationsand convertibility of local to foreign currency The issue of convert-ibility is an important risk, because revenues will be in local cur-rency and part of the investments and borrowings will be in foreigncurrency.

The technical risks are related to the lack of sufficient knowledgeabout the state of the installations, the need for replacement, reha-bilitation, and expansion, and the resulting operational risk that theinstallation will not perform as expected. An additional risk is thatconstruction costs will escalate beyond what is planned because ofunit price escalation beyond expectations and delays in the con-struction timetable. As a rule, the construction risk is better borneby the private sector, because experience has shown that privatecompanies are better qualified to execute investments within thebudget and timetable envisaged.

The legal risks are related to the ways in which contractual disputeswill be resolved, and the main political risk is that the government willexpropriate the assets or change its policy toward privatization in the


future. Another political risk is the reluctance of governments to raisetariffs, particularly before elections.

Successful PSP will be conditioned to a great extent on how wellthese risks can be quantified and mitigated. Careful analysis of therisks involved is required at an early stage of the process, and thesharing of risks between the private and public sector should followthe guiding principle that whoever can control the risk best shouldassume it and should receive adequate compensation for doing so.Some measures that can reduce the risks will be discussed later in thisstudy, with examples from the Buenos Aires case study.

Options of Private Sector Participation

Private participation in the water sector varies from the fulfillmentof limited attributions to overall responsibility. PSP has eight mainoptions, which vary in the degree of involvement of the privatesector, the risk for both the public and private sector, the privateoperator's autonomy and responsibility, the required capital invest-ment, the duration of the contract, and the contractual relationshipwith the consumer. These PSP options may be grouped into twodistinct categories. In the first group, the ownership of the assetsremains with the government or the public sector, whereas in thesecond group, partial or full ownership is transferred (permanentlyor temporarily) to the private sector. Each group includes four op-tions, which will be reviewed in the order of increasing private sec-tor involvement.

The first group-public ownership-includes:

- Service contracts- Management contracts* Lease arrangementsi Concessions.

The second group-at least partial private ownership-includes:

* BOOT (Build-Own-Operate-Transfer) and its variationssuch as BOT (Build-Operate-Transfer) and BOO

(Build-Own-Operate)* Reverse BOOT

* Joint ownership or mixed companies* Outright sale.


Service Contracts

Service contracts are the simplest form of private sector participation,whereby the public authority retains overall responsibility for opera-tion and maintenance of the system, except for the specific, limited-scope services that are contracted out or outsourced. The publicauthority also bears all the commercial risk and must finance fixedassets as well as working capital. The responsibility of the privatecontractor is limited to managing its own personnel and services effi-ciently. Service contracts can cover a wide range of activities. Typically,service contracts are used for maintenance, emergency repairs, meterreading, billing and collection, upgrading of existing or construction ofnew facilities, and equipment rental.

Public authorities that plan to use service contracts extensively mayneed to undergo some changes to fulfill their new role, which shiftsfrom execution to supervision. For example, institutional reforms maybe required to decentralize control, to provide technical assistance atthe local level, to enforce standards for quality and control, and tomanage staffing changes.

Service contracts are usually set for periods of one to two years andare usually renewable. These contracts require little or no fixed invest-ment on the part of the private firm. Because the contract period isshort, contractors are subjected to frequent competition, which encour-ages efficient performance. In large urban areas, different firms can becontracted in separate geographical areas to deliver the same services.Multiple contracts ensure adequate competition and enable the waterauthority to compare costs and performance on an ongoing basis.

A major benefit of service contracts is that payments to the contractorare linked to the work performed, instead of guaranteed wages paid toa public utility's workers. For example, a contract for meter readingwould stipulate that the operator be paid a set amount for each meterread.

Management Contracts

Management contracts are a more comprehensive arrangement, wherethe public authority transfers to a private company responsibility forthe entire operation and maintenance of a system. This gives the privatecompany the freedom to make day-to-day management decisions with-out assuming any commercial risks. Under this arrangement, the con-tractor has no direct legal relationship with the consumer. The privatecontractor acts at all times on behalf of the public authority, and yet it

OPTIONS FOR PRIVATE SECTOR PARTICII'ATION 15

will not get paid unless rates are collected from the consumers. Thegovernment or public authority retains financial responsibility for theservice and has to provide funds for working and investment capital.

Payments to a management contractor are usually proportional tosome physical parameters, such as improved efficiency, volume ofwater produced, improved collection rates, or reduction of unac-counted-for water. Such a payment system creates an incentive forincreasing productivity. In case the management contractor does notcontrol the functions affecting productivity or quality, it is often com-pensated on the basis of a fixed fee.

Because management contracts do not require the contractor tomake large investments with long payback periods, their duration isgenerally from three to five years. They can also feature an option toconvert to more intensive, longer-term PSP arrangements. In manycases, management contracts precede leasing or concession contracts.In this case, their main purpose is to put the utility in order when thequality of service is poor or when accounting, consumer records, andinformation on the physical facilities are not reliable or available.

Lease Contracts

Lease contracts, also known as affermage, are arrangements whereby aprivate operator rents the facilities from the public authority for acertain period and is responsible for operation, maintenance, and man-agement of the system. The public authority, which remains the soleowner of the assets, is responsible for capital expenditures for newprojects, replacement of major works, debt service, and tariffs and cost-recovery policies.

Leaseholders are responsible for all operation and maintenancefunctions, including offices, vehicles and spare parts, renewals, andreplacements as well as for billing, collection, and financing workingcapital. In many cases, leaseholders pay the owners a rental fee suffi-cient to service the debt and finance part of the investment program.

Lease contracts can be medium or long-term in duration. They usu-ally last five to ten years but can be extended for as long as twentyyears.

Payments to leaseholders are contingent on the difference betweenthe tariff revenues collected and the operating costs. The contractorshould be ensured a reasonable return on investment and have incen-tives for maintaining efficient operations. The fact that the contractordepends on collections for revenue is an incentive to provide goodservice and establish good billing and collection practices.


The risks involved in a lease arrangement tend to be limited,making them a low-risk PSP option, which allows a private firm tobecome acquainted with the system and may pave the way for moreextensive involvement in the future. When risks are limited, there ismore competition from potential private partners, which benefitsthe public authority. In most cases, the public authority assumes thecapital investment risk, and the leaseholder assumes the commer-cial risk.

The lease contract usually provides for automatic periodic revisionsof the contractor rate using price index formulas. It is also common tohave periodic renegotiations of the rates and cost index formulas onthe basis of results achieved. In this way, savings that the leaseholderhas been able to achieve during past years can be passed on to con-sumers, if the public negotiators are knowledgeable about the poten-tial for reducing costs.

The lease contract also states the penalties that will apply in the caseof poor performance. Lease contractors usually put up a security de-posit that can be called in by the public authority if performance isunacceptable. If, for example, a major goal of involving the privatesector is to reduce pollution, penalties for not meeting quality stand-ards can serve as a contractually backed incentive. A common per-formance indicator is the level of unaccounted-for water.

Concessions

In a concession, the private contractor, or concessionaire, has overallresponsibility for the services, including operation, maintenance, andmanagement, as well as capital investments for the expansion of serv-ices. The fixed assets, however, remain the property of the governmentor public authority, but they are entrusted to the concessionaire for theduration of the concession contract and must be returned in the samecondition at the end of the concession period.

The advantage of combining responsibility for operations and in-vestments in the same entity is that it provides an incentive to theoperator to make efficient investment decisions, because their conse-quences will affect it directly It also provides an incentive for techno-logical innovations, because the operator will benefit directly from anyefficiency improvements.

Concession contracts usually run for twenty to thirty years, depend-ing on the level of investments and the payback period needed for theconcessionaire to recover investment costs. The concessionaire retainsexclusive rights for the duration of the contract. When the contract


expires, all works and equipment are tumed over to the governmentor public authority. If some capital expenditures have not been fullyamortized by the end of the contract, the contract usually allows thecontractor to be compensated accordingly.

Under concession contracts, the contractor is paid for its servicesdirectly by the consumer, based on the contractually set price. Thecontractor retains the balance of revenues after paying back any taxesand charges levied on consumers by the public authority If expensesexceed revenues, the private company suffers losses, which is the larg-est risk it assumes.

Penalties in concession contracts are levied if the concessionaire failsto meet either the targets for service coverage or the quality of servicespecified in the contract. The penalty fines should be explicitly linked toeach cause and should ascend as the breach of contract becomes moreserious. The penalties are generally paid to the regulatory agency.

The second part of this study will discuss in detail numerous aspectsof the concession arrangement, based on the case study of the BuenosAires concession.

BOOT Contracts

Under a BOOT contract, a firm or a consortium of firms finances, builds,owns, and operates a specific new facility or system. After a predeter-mined period of time, ownership of the facility is transferred to thepublic authority. BOOT contracts have not been used extensively in thewater and sanitation sector but are becoming increasingly common inthe power and transportation sectors. BOOT arrangements are attractivemostly for new plants that require large amounts of financing-forexample, large water treatment plants or wastewater treatmentplants-but they are not suitable for water distribution or wastewatercollection systems.

Under a BOOT contract, the public authority is often responsible fordetermining the demand for the service being contracted and, there-fore, for the size of the facility. Demand is often guaranteed by thecontracting agency, and problems may arise if there are differencesbetween real and estimated demand.

The duration of BOOT contracts is almost always the period of timeneeded to retire the debt incurred and to provide a return to equityinvestors. At the end of this period, the contractor transfers the facilityto the public authority In some cases, provisions may be made forholding new negotiations to determine possible ongoing private inter-est in ownership or participation in operations.


A BOOT contract can represent a substantial risk for the private firm,if there are no assurances that the output of the investment will bepaid for by the public authority or that the quality of services will beuniform and according to design standards. The enforcing capacity ofthe public authority to ensure that only legal discharges into the sourcewill be allowed is a special risk for the private operator.

Experience with BOOTs has shown that four issues require carefulconsideration. First, the legal basis for private sector involvement inareas often reserved for the public sector has to be established. Thesecond issue pertains to the effect on financing caused by the size andlength of time of these contracts. The time taken to implement a BOOT

transaction is usually longest for the first one undertaken by a country.Subsequent projects may be expedited due to previous experience.Many BOOT projects tend to be large and can cost millions of dollars.The large size and the long maturities required raise the complexity ofthe financing package and, often, the number of financiers needed tocomplete the package.

The third issue pertains to pricing and contractual arrangements.The risks are unique because of the normally regulated structure of thewater industry. Pricing and contractual arrangements in some caseshave to cover the project's foreign exchange risk because infrastructu-ral BOOTs rarely have foreign exchange revenues, but dividends toforeign equity investors as well as debt service of extemnal loans needto be in foreign currency. Pricing is also difficult because it is oftenpredetermined, and the private investor does not have the opportunityto recoup early losses by realizing higher profits when industry condi-tions improve. These pricing arrangements are often based on precon-struction estimates of capital costs and project implementation times.

And, fourth, the level of tariffs and the quality of service providedcan become particularly sensitive because, in most cases, the privatecompany is providing a service directly to consumers.

A slight variation of the BOOT system is known as BOT, wherebyownership is transferred to the public sector as soon as the facility iscompleted, and the function of the private firm is only to build andoperate it. Another variation is BOO, whereby ownership is not trans-ferred to the public sector but remains with the private firm that buildsand operates the facility.

Reverse BOOT Conltracts

In countries where economic or political risks are high, private sectorfirms either may not be interested in participating in a BooT-bidding


process or may request very high risk premiums in return for theirparticipation. In these cases, it may be preferable for the public sectorto finance and build the plant itself and then to contract a private firmto operate the plant over a long period of time. To acquire the plantgradually, the private firm pays an annual fee to the public authority,which usually covers the full debt service of the entire investment cost.

The lower risk of reverse BOOT, as compared to BOOT, may encour-age more private sector firms to participate. Reverse BOOT offers theadvantages of efficient private sector operations and encourages theprivate operator to maintain the facility well because it expects to be-come the owner at some point in the future.

Joint Ownership

In some cases, it may not be feasible to pass full responsibility forinvestment and operations to the private sector, particularly during theinitial stages of a sector reform program. If the country environment isrisky, capital investments may have to be separated from operations inorder to attract private involvement in operations. In such cases, whereit is desirable to maintain a higher degree of private sector participa-tion than service or lease contracts allow, joint ownership may be agood solution. Under joint ownership, a private sector firm and thepublic authority incorporate a firm under the normal commercial code.Initially, they have equal or almost equal shares, then later, the publicauthority may sell off its shares. Although both own shares, the publicauthority may keep a golden share, which entitles it to special powersthat may be used only in specific situations.

The private partner typically has majority representation on theboard of directors of the new firm, even though the public and privateequity shares are equal. In this case, the private sector partner prevailsin the day-to-day management of the new firm. More substantial deci-sions are made by a qualified majority, as required by law.

Joint ownership companies require a corporate agreement that spellsout in detail the objectives of joint ownership, the duties and obliga-tions of the two partners, and their rights. In particular, the corporateagreement should spell out how profits will be shared between thepublic and private partners. Successful jointly owned companies canbe expected to establish creditworthiness and to raise capital by float-ing bonds or issuing notes. This has the advantage of limiting publicsector debt, an important sector objective.

In countries with a weak regulatory tradition, joint ownership maysatisfy regulatory requirements because the public sector is repre-


sented by a board of directors and will have broad insights into thefirm's operations.

Outright Sale

The sale and private ownership of water supply and sewerage systemsmay be prompted by the desire to completely separate ownership fromoperations and maintenance. It is also a way for the public sector toraise revenues. The attraction to private buyers depends mainly on therates they are permitted to charge, because the installations themselveshave virtually no alternative value. Even when water supply and sew-erage systems are privately owned, it does not follow automaticallythat the water resources are also private.

Recent experience with full privatization of the water sector is lim-ited, but shares of the company are usually sold on the stock market toprivate investors. Pressure to operate efficiently is exerted through theoperation of the stock market.

Comparison of PSP Options

The eight Psp options reviewed vary in the private and public entity'sroles in ownership, financing, and management. To varying degrees,all these options promote the operational efficiency and commercialviability of water and sanitation utilities. At the same time, theyintroduce competition, improved cost recovery, and, in most cases,performance-based compensation.

They feature flexibility and the potential to progress from less riskyarrangements with no private investment to more risky arrangementsthat involve private investnent as the two parties gain credibility andconfidence. A combination of options is also possible, for example alease for distribution systems and a concession or BOOT for a newtreatment plant.

Service and management contracts are designed to improve opera-tions within specific activities, usually in the short term. The publicauthority retains ownership and responsibility for the system. Ar-rangements in which the contractor assumes commercial risks offer theadvantage of motivating the contractor to improve the efficiency of thesystem. Thus, lease contracts and concessions are more likely to lead tothe least-cost output than are service contracts in which compensationis not linked to revenues. Concessions may be preferable to lease con-tracts if there are advantages to assigning responsibility for invest-ment, in addition to operations, or if large amounts of private capital


are required. The operator is well placed to forecast demand and makeinvestment decisions that will satisfy demand in a commercially viableway.

Only in concessions does the private operator have an incentive toinvest efficiently, because it is responsible for recovering both currentand capital costs. In contrast, in lease contracts, the lessee who is re-sponsible only for current costs may influence the public owner of theassets to make excessive investments in order to reduce the operatingcosts. The potential conflict is greater if the lessee/operator belongs toan integrated group that manufactures equipment, while at the sametime providing advice to the public owner on investment decisions.

Recent efforts to attract large-scale private investment in water sup-ply assets through BOOT contracts have been successful in a few cases.Because BOOT contracts involve gradual transfer to the public authorityor the private contractor at some future time, they can be a usefultransitional approach in countries where the private sector has pre-viously not had any role in providing water services.

Joint ownership or mixed companies can reduce risks and attractprivate sector involvement more readily Full privatization by sellingassets or floating shares on the stock market is the most advancedoption, but it is rarely used in the water sector.

Table 1-1 provides a summary comparison of the four PSP optionsin which ownership remains with the public sector: service, man-agement, lease, and concession contracts. It shows the sharing ofresponsibilities between the public and private sectors, with respectto the financing of investments and working capital, as well as thecontractual relation with the consumers and the setting of rates. Theprivate capital needed, the private sector responsibility and auton-omy, as well as the financial risk involved grow from low to high inthe options compared.

Table 1-2 summarizes the eight options for PSP with emphasis on theownership and financing of fixed assets and on the management of thesystem.

Main Elements of Success and Obstacles to PSP

A successful PsP should be viewed as a partnership between thepublic and private sectors aimed at maximizing the benefits for theconsumers.

The three objectives of the public sector with respect to private sec-tor participation are to expand the water supply and sewerage systemsin order to increase population coverage, to expand sewage treatment

Table 1-1. Main Features of PSP Options with Public Ownership

PSP option Service contract Management contract Lease contract Concession contract

Financing of invest- Public sector Public sector Public sector Private sectorments

Financing of working Public sector Public sector Private sector Private sectorcapital

Contractual relation Public sector Private sector on behalf Private sector Private sectorwith customers of public sector

Private sector respon- Low ................ ......... ....... Highsibility and autonomy

Need for private capital Low ................ ......... ....... High

s Financial risk Low ................ ......... ....... High

Duration (years) 1-2 3-5 5-10 20-30

Responsibility for Public sector Public sector Contract Contractsetting rates

Method of payment Work done-unit price, Cost-plus and produc- Basic rates Rateslump sum tivity bonus

Method of recovering Rates Rates User overcharge Not applicablepublic expenditures

Main objective of PSP Improve operating Improve operating Improve operating Mobilize private capitalefficiency efficiency efficiency


Table 1-2. Comparison of PSP Options

Option Ownership Financing Management

Service contract Public Public Public, someprivate

Management Public Public PrivateLease Public Public PrivateConcession Public Private Private

BOOT Private, then Private Privatepublic

Reverse BOOT Public, then Public Privateprivate

Joint ownership Private and public Private and public Private and publicOutright sale Private Private Private

in order to reduce water pollution and public health hazards, and toprovide better quality of service. The secondary objectives are to en-sure higher operating efficiency and to finance the system withoutpublic subsidies or guarantees.

The cooperation between the public and private sectors must be ofmutual benefit, and the public must be informed and educated aboutthe reasons for involving the private sector in what is perceived as anatural, public sector monopoly.

The most adequate PSP option should be selected in each case, andthe consensus of the main stakeholders must be obtained to ensure itsadoption. The selection of the most suitable PSP option must take intoaccount the political, legal, and cultural circumstances of the countryinvolved as well as the institutional, financial, and technical charac-teristics of the water and sewerage system or project involved.

The contracts with the private sector must be robust to resist timeand public scrutiny, and the public sector must be capable of supervis-ing these contracts. The targets set in the contracts must be realistic sothat they translate into reasonable and affordable rates.

In order to achieve these objectives, experienced advisors (technical,financial, and legal) must be retained by the public sector agency, ifnecessary.

Some of the main obstacles to private sector participation are:

* Resistance to what is perceived as loss of control* Lack of adequate legislation


* Bureaucratic inertia. Lack of confidence in the private sector, based on the sometimes

prevailing misconception that it "just wants to make money"* Lack of knowledge about private sector methods* Reluctance to face labor problems* Lack of interest on the part of the private sector* Unfavorable public opinion* Fear of foreign operation.

In most PSP options, some of these obstacles can be overcome byprocuring the services required through a transparent bidding andaward process. The bidding procedures should include, at a minimum,establishment of sound prequalification criteria and procedures, cleardefinition of evaluation criteria, and preparation of the documentswell enough in advance to permit open and universal bidding.

The most important factor that can determine the success or failureof a concession is a clear contract that defines the relationship betweenthe concessionaire and the regulatory body An effective agreementshould clearly define the geographical area of the concession; the spe-cific services to be provided; the standards to be met for quality, serv-ice coverage, or effluent standards; the financial, accounting, andmanagement objectives; the employer's obligations that the conces-sionaire must follow; the conditions for terminating the contract andapplicable penalties; the recourse the concessionaire has if new laws orregulations affect original conditions; and the right to arbitration.

Regulatory System

Some type of regulatory framework is necessary to monitor and con-trol the private sector operations. In this context, lack of regulatorysystems or failure to enforce existing regulations are two of the maincauses of unreliable service provided by public water utilities.

In all PSP options, the central or local government retains its impor-tant regulatory role and can thus oversee the sector and provide theguidance it may need. Private sector participation does not mean thatthe public sector loses control, but rather that it adopts a new divisionof tasks between public and private partners, based on the compara-tive advantage of each. The main objectives of the regulatory systemare to: ensure compliance with standards of acceptable service, protectthe rate payer from monopolistic behavior, and create a business envi-ronment that promotes commercial viability and attracts the privatesector.


One of the main elements that affects the success of a PsP arrange-ment such as a concession is the establishment of an adequate regula-tory body that oversees the compliance of the concessionaire with theterms of the concession contract. The regulatory body should havepolitical independence-members should be appointed for a fixed pe-riod of time and only be removed for abuse of authority or illegalactivities-and transparency-all the proceedings of the body shouldbe a matter of public record. The concession agreement should be fol-lowed in such a way that the rights and obligations of all parties areguaranteed. The regulatory body should have access to legal recourseto ensure a reasonable degree of predictability. In most cases, thenewly established regulatory agency will have to be strengthened sothat it is able to confront an experienced private operator.

In the absence of a formal regulatory body, contract regulation be-comes necessary. The compliance of such contracts is monitored by thepublic partner. Contract disputes can be referred to civil courts fordecisions.

PsP in Latin America and the World

Service contracts have been used successfully in Chile. Since 1977,EMoS-the public water utility in Santiago-has encouraged its em-ployees to leave the company and form private firms that can bid forservice contracts. Contracts for meter reading, billing, maintenance,and vehicle leasing are awarded by competitive bidding for periods ofone to two years. As a result of this policy, EMOS has one of the lowestrates of staff per water connections (2.2 company employees per 1,000water connections, or 3.5 per 1,000 water connections considering theequivalent cost of the service contracts).

Management contracts, which have been traditionally used inFrance and Spain, have been recently introduced in Guinea-Bissau andMexico.

Lease contracts have been used extensively in France and Spainfor some time and are presently used in Bolivia, C6te d'Ivoire, theGambia, and Guinea. Concession contracts have been used extensivelyin France and Spain and, more recently, in Argentina, Chile, and Coted'lvoire.

In Latin America, examples of BOTs or BOOTs in the water sector canbe found mostly in Mexico for upgrading and expanding wastewatertreatment plants in various cities. Chile has plans for to use BOT ar-rangements to contract the construction and operation of major waste-water treatment plants for Greater Santiago. In Australia and Malaysia,


BOOT arrangements are used for the construction of large water treat-ment plants.

Examples of joint ownership or mixed companies can be found inFrance, Guinea, and Spain. In Latin America, the mixed-companymodel was recently adopted in Colombia. The best example of fullprivatization of water supply and sewerage is that of the United King-dom, where the ten major water companies were privatized in 1989through the sale of shares to private investors on the stock market. Aspecial regulatory body (OFwAT) was created to protect consumersfrom the excessive charges that might result from such privatization.In the United States, a large number of small privately owned systemsare in operation.

As experience with these types of operational and investment op-tions grows, it is expected that more governments will develop theinstitutional capabilities to enable a more permanent private sectorpresence in the water sector, while at the same time ensuring the pro-tection of public interests.

2. Case Study-The Buenos Aires Concession

The government of Argentina, with the World Bank's support andassistance, embarked in 1990 on a massive and ambitious privatiza-tion program, encompassing virtually all the public services andfederally owned enterprises such as electricity, natural gas, oil, tele-phone, water supply and sewerage, airlines, railways, subways,roads, and ports. Privatization was part of a comprehensive statereform, which consisted of a series of macroeconomic measuresadopted by the government with the ultimate objective of promot-ing economic stability. The most notable of these reforms was theconvertibility plan establishing parity between the Argentine pesoand the U.S. dollar. Privatization in Argentina was basically aimedat reducing the fiscal deficit by collecting more revenues from eitherthe direct sale of assets or the elimination of subsidized, inefficientpublic services, while at the same time improving the quality of theinfrastructure services provided to the population.

By the end of 1992, the shares of at least thirty companies had beenpartially or totally sold to the private sector, and more than twentyservices had been transferred to the private sector in the form of con-cessions. By the end of 1994, more than 90 percent of the federal priva-tization program was completed, and various provincial privatizationprograms had gotten under way.

In the water sector, the concession for the water supply and sew-erage services of Greater Buenos Aires, which started operating inMay 1993, was preceded by a smaller concession in the province ofCorrientes. By the end of 1994, several other provincial water com-panies, which were following the Buenos Aires concession model,were in advanced stages of contract negotiations, bidding, or bidpreparation.

27


Background

At the beginning of the century (1912), a national public company-Obras Sanitarias de la Nacion (OSN)-was established to be in chargeof water supply and sewerage for the entire country. Many decadeslater (1980), a major reform to decentralize the sector took place,whereby the provincial governments took over from the federal gov-ernment the responsibility for local water supply and sewerage serv-ices, and OSN remained in charge of Buenos Aires only.

The Greater Buenos Aires area is comprised of the city of BuenosAires-the federal capital-plus thirteen municipalities surroundingthe capital and belonging to the province of Buenos Aires (first-beltmunicipalities), which are connected to the same water supply andsewerage systems. The total population of Greater Buenos Aires was8.6 million in 1991, of which only some 6 million (70 percent) and 5million (58 percent) were connected to the public water supply andsewerage systems, respectively

The magnitude of the Greater Buenos Aires system is indicated bythe huge extension of its water distribution network (some 11,000 kilo-meters) and sewage collection network (more than 7,000 kilometers) aswell as by the large daily water production capacity-more than 3.6million cubic meters a day, of which more than 70 percent are pro-duced at the San Martin water treatment plant, which is one of thelargest of its kind in the world (a capacity of almost 30 cubic meters asecond). The main source of water supply is the River Plate, whichfeeds both the San Martin plant and a second smaller and newer plant(Belgrano), which has a capacity of 1.0 million cubic meters a day Theriver water is conveyed to the consumption areas by means of severalgravity tunnels referred to as underground rivers (rios subterrdneos),from which it is pumped to the distribution network and storage reser-voirs. The remainder is supplied by groundwater wells (about 250 arepresently in operation), which have been contaminated, mostly by ni-trates as a result of the direct disposal of untreated sewage, and arebeing gradually phased out.

Most of the sewage collected by the network-some 2.2 millioncubic meters a day-is returned without any prior treatment to theRiver Plate, downstream of the two main water intakes, by means ofan outfall 2.5 kilometers long. Untreated domestic and industrial sew-age also flows into several rivers and creeks crossing the metropolitanarea and eventually discharging into the River Plate, in some casesupstream of the water intake. Only one wastewater treatment plant(the Southwestern plant, with a capacity of 120,000 cubic meters a day)

CASE STUDY-THE BUENOS AIRES CONCESSION 29

treats a small percentage (5 percent) of the total sewage flow beforedischarging its effluent into the nearby river.

Prior to privatization, OSN administered about 1.2 million water con-nections and almost 1 million sewage connections. Its yearly billingamounted to some $300 million.

Rationale for Private Sector Participation

The operation of the Greater Buenos Aires system by OSN was charac-terized through the years by a series of problems, most of which areexperienced by many water companies in Latin America and aroundthe world. Most of these problems were described in chapter 1 of thisstudy.

Unaccounted-for water was high-about 45 percent of the waterproduced. OSN was famous for constructing monumental waterworks,some of which were only partially used, while at the same time devot-ing little attention to the rehabilitation of existing installations.

Water meters were installed at only 20 percent of the connections,but regular meter reading and billing based on actual consumptionwere virtually absent. Water demand was estimated in the high rangeof 400-500 liters per capita a day-double the norm for metered andwell-managed water supply systems.

With a staff of some 8,000, OSN had a serious problem of excesspersonnel-a ratio of 8-9 employees per 1,000 connections, comparedwith a ratio of 2-3 for an efficient water company. This problem wasexacerbated after the 1980 decentralization reform, when almost thesame number of employees who had previously operated the watersystems of the entire country remained in charge of Greater BuenosAires only, that is, about one-third of the total number of connections.In addition, the company was plagued by a series of political appoint-ments and excessive political intervention.

The decision of the central government, supported by the WorldBank, to include OSN in the first package of state-operated enter-prises where private sector participation would be sought, wasbased on the recognition that huge investments were required forrehabilitating and expanding the water and sewerage systems, onthe one hand, and that the performance of OSN as a public companycontinued to be poor, despite various attempts to improve it, on theother hand.

In addition to a series of substantial loans provided to OSN by theInter-American Development Bank (IDB), one attempt to improve itsoperation was the inclusion of OSN (together with the provincial water


companies of C6rdoba and Santa Fe) in the World Bank's first watersupply loan to Argentina, which was granted in 1986. This loanprovided funds for a technical assistance ("twinning" type) contractbetween OSN and a consortium composed of an international opera-tor of a well-managed water system and an international consultingfirm. After a lengthy selection process, OSN hired twinning consult-ants in 1988 to assist in increasing its operational and institutionalefficiency. The work was to be carried out in three phases: first,preparation of a detailed diagnosis of the situation; second, identifi-cation and evaluation of possible solutions; and third, help in im-plementing the recommended solutions. The consultants managedto complete successfully only the first and part of the second phaseof their work. Although some of their recommendations could havebeen carried out to provide rapid improvements, OSN never imple-mented them.

In 1991, the government's decision to privatize OSN, and OSN's deci-sion not to contract the twinning consultants to assist in this task, dealtthe final blow to the twinning contract and provided OSN with a legiti-mate excuse not to implement any of the consultants' recommenda-tions. It was decided to let the future private operator make all thenecessary improvements. The twinning contract, which had sufferedall along from a lack of cooperation between the consultants and OSN,was terminated after lengthy negotiations of the consultants' claims;the twinning consultants were phased out. Nevertheless, a major effortwas undertaken at the World Bank's initiative to rescue at least thelarge amount of information accumulated by the twinning consultantsduring their work.

The main reasons that led to the decision to privatize OSN are in linewith experience elsewhere, which has shown that either one of thefollowing two considerations, or a combination of both, are the maincatalysts of private sector participation: (1) the record of poor perform-ance and mismanagement characterizing public utilities in general and(2) the insufficiency of public funds alone to meet the increasing in-vestment needs of the water and sewerage sector.

Main Stages of Transition from Public to Private Operation

The transition from a problematic, inefficient public operation to acompetent private operation cannot be accomplished instantane-ously-it is a process encompassing many activities that must be car-ried out sequentially within a certain period of time in order to ensurethe successful completion of the whole process.


Four stages can be distinguished in the case of Buenos Aires thatshould be applicable, with minor adjustments or modifications, to anyoperation involving private sector participation:

. Stage I. The initial activities, which are undertaken prior to thedecision on how to privatize

* Stage II. The preparation of bidding documents anid background mate-rials required for selecting a qualified operator

* Stage III. The bidding and contracting process, which culminateswith the signing of the respective contract

* Stage IV. The actual transfer of services to the private operator andthe setting up of the regulatory agency

The main activities involved in each of these stages, together withsome observations resulting from the Buenos Aires case, are presentedbelow.

Stage I: Initial Activities

This stage includes all the activities undertaken from the moment priva-tization is considered until the decision is made to issue the call for bidsfor a specific form of private sector participation. It is the most complexand often the most time-consuming of all stages, because it involves aseries of important high-level decisions that have to be made.

COMMITTEE FOR PRIVATIZATION. To manage the privatization proc-ess without interfering with the daily operation of the company, thegovernment appointed an eleven-member special Privatization Com-mittee, whose main task was to overview and coordinate all the activi-ties involved in preparing the private concession. The committeeincluded representatives from the relevant institutions: OSN, munici-pality of Buenos Aires, province of Buenos Aires, Ministry of Economy(Public Works and Privatization Secretariats), Congress, and the laborunions. Concern was expressed about whether a committee repre-senting such a broad range of interests and opinions was capable ofmaking timely decisions. Nevertheless, the committee, which chose tomake its decisions by consensus building, worked intensively andmanaged to fulfill its tasks satisfactorily and more or less within thetimetable established.

SELECTION OF PSP OPTION. As soon as the decision was made toconsider privatization of OSN, the relevant government officials briefly


considered the possible options of private sector participation, such asservice contracts, management contracts, leases, concessions, and thesale of assets. It was determined that a long-term concession was themost appropriate option to pursue. Because of the need for large in-vestments in water supply and, especially, in sewerage and control ofwater pollution, all of the options that exclude the obligation of theconcessionaire to invest in the system (service contracts, management,lease) were considered unsuitable in this case. The concept adoptedwas the French concession model, whereby a private or mixed enter-prise assumes responsibility for operating, maintaining, and investingin the system during a long period of time (twenty to thirty years), butthe assets remain the property of the public sector.

EVALUATION OF RISK. The risks involved in PSP for both the publicsector and the private operator were evaluated with the objective ofidentifying the main factors that could mitigate such risks and thusincrease the likelihood of private sector participation. The main risksfor the public agency and the private investor were reviewed in chap-ter 1. To reduce the risk for the public sector that services supplied bythe private sector would not be in accordance with the desired stand-ards, it was decided to prequalify all interested participants to ensurethat only capable, qualified firms would eventually participate in thebidding process. To reduce the risk for the public sector that the cost ofsuch services would be much higher than that currently charged bythe public entity, it was decided to carry out a careful evaluation of thetechnical and economic feasibility of the venture prior to issuing thebids and to ensure maximum transparency of the bidding process.

As for the private participants, the technical and commercial riskswere mitigated by providing potential bidders with all the availableinformation on the system and by changing existing legislation andpolicies, if necessary, to ensure payment for services provided and topermit cutting off the service in case of nonpayment. The financialrisks were reduced by ensuring free convertibility of foreign currency.And, finally, the legal risks were reduced by introducing in the conces-sion contract clear clauses on arbitration or other modalities of resolv-ing disputes.

SCOPE OF OPERATION. A decision had to be made on the scope of theconcession, because OSN, in addition to its main task of providingwater supply and sewerage services to Greater Buenos Aires, had de-veloped a series of other activities, some related and some not relatedto the main services provided. It was decided that the concession


would include operation and management of the water supply andsewerage systems in the service area of OSN, rehabilitation of existingfacilities, and gradual expansion and upgrading of service in the samearea. In future, the concession could also be extended to areas pres-ently serviced by others, by mutual agreement of the concessionaireand the regulatory authority. It was also decided that complementaryactivities carried out by OSN, which were related to its main task, suchas production of water treatment chemicals, repair shops, transport,and laboratory services, could continue as they were modified or dis-continued by the concessionaire.

Some of the activities previously under the responsibility of OSN butnot related to the provision of water supply and sewerage serviceswere excluded from the concession. These included rainstorm drain-age (which was transferred to the municipalities), control of industrialwater pollution (for which a new Secretariat for Environment had beenestablished), certification of sanitary devices, as well as a series of es-tablishments used for the employees' benefit such as a kindergarten, aschool, a hospital, and a club.

CONCESSION SIZE. Because of the huge size of the proposed conces-sion, consideration was given to the possibility of dividing the servicearea into two or more concessions. The advantages of such a division,which was favored by the World Bank, would be to avoid a monopo-listic approach, to spur competition, and to enable comparisons be-tween the performance of at least two operators. The division ofBuenos Aires was conceivable, because the city is supplied by twoproduction and treatment plants. Nevertheless, because the two sys-tems are connected, it would have been necessary to separate themphysically and to meter the amount of water transferred from onesystem to the other (similar to the situation in Paris, France). The con-struction of such separation required certain investments and time.Another disadvantage was that the division of the area into two con-cessions would have granted one concessionaire a more affluent area,leaving the other with a lower-income population having less capacityto pay for the service. Because such division would have delayed thewhole process of privatization, it was eventually rejected.

Stage II: Preparation of Bidding Documents

After the important aspects mentioned above had been analyzed andthe relevant decisions taken, it was necessary to prepare the biddingdocuments and the background material required for bidding. To do


this, the Privatization Committee decided to hire specialized privatiza-tion consultants. In this particular case, two consulting firms were con-tracted: a technical engineering firm for preparing the technical andlegal documentation required and a financial engineering firm for car-rying out the financial analysis required and promoting the concessionamong potential investors. Funds for the privatization consultants, aswell as technical advice, were provided by the World Bank through theongoing loan to OSN.

The Privatization Committee, with the assistance of the World Bank,prepared the terms of reference and the short list for the privatizationconsultants, evaluated and compared the proposals received, andawarded the consultant contracts, in accordance with the guidelinesfor contracting consulting services financed by World Bank funds.

REGULATORY FRAMEWORK. The first major task of the technical priva-tization consultants was to prepare the draft regulatory frameworkunder which the concession would operate, which, after it was re-viewed and completed by the Privatization Committee, was submittedto Congress for approval. At the same time, the representatives of themunicipality of Buenos Aires, the province of Buenos Aires, and thefederal government (via OSN) started laying the ground for the newregulatory agency (Ente Tripartito de Obras y Servicios Sanitarios-ETOSS), where these three organisms would be equally represented: thecentral government as the owner of the assets and the municipalityand the province of Buenos Aires as the representatives of the geo-graphical areas served by the concession.

PROMOTION AND DISSEMINATION. A brochure was prepared for thepurpose of promoting the future concession among potential investorsworldwide. The brochure contained a general description of the exist-ing system, the objectives and legal background of the privatization,the general terms of the bidding process to be used, some essentialaspects of the concession, the regulatory framework, and the expectedtimetable. The brochure was widely distributed to potential investorsand operators, both nationally and at a series of international seminarsorganized in the world's main financial centers.

TECHNICAL AND FINANCIAL FEASIBILITY. The technical and financialfeasibility of the concession had to be carefully evaluated before start-ing the bidding process, to avoid setting up unrealistic levels of expec-tations and creating the embarrassing situation whereby potentialbidders would be initially interested only to discover later that the


"business" was not attractive. Because enormous investments were re-quired to rehabilitate and expand both the water supply system and thesewage collection and treatment system, it was necessary to identifyand compare various possible scenarios for expansion of these systems,in order to select the recommended scenario-a set of achievable targetsresulting in reasonable water rates. These targets would be presented inthe bidding documents as the basis for the offers submitted.

LEGAL ASPECTS. In order to provide the potential bidders with clearand unequivocal information on the legal environment with whichthey might not have been familiar, a review and analysis were under-taken of all current laws, decrees, and policies relevant to the conces-sion. This kind of information, which was eventually incorporated asan annex to the bidding documents, included, for example, details onthe rather elaborate current system of water rates for unmetered andmetered consumption and on the variety of federal, provincial, andmunicipal taxes, duties, and contributions currently applicable in Ar-gentina for local and foreign operations.

FINANCIAL MODEL. The privatization consultants developed a finan-cial model designed to help in the evaluation of the different pro-grams proposed by bidders. This model included the proposedprogram's sensitivity to operational improvements such as billingand collection efficacy, the cost recovery at various water rates thatwould be charged, and the requirements for self-financing by the pri-vate investor.

WATER QUALIrY STANDARDS. A set of water quality parameters wasdefined for the purpose of serving as standards for the potable waterto be produced under the concession. Similarly, two sets of effluentquality parameters were determined for wastewater undergoing pri-mary and secondary treatment. All these figures were based on na-tional and intemational standards as well as on historic data collectedby OSN.

PREQUALIFCATION DOCUMENT. Because of the interest expressed bymany national and foreign companies, it was decided early in theprocess to incorporate a prequalification stage to ensure that onlyqualified bidders would submit bids. This decision resulted in an addi-tional task for the privatization consultants-the definition of pre-qualification criteria and the preparation of a brief prequalificationdocument.


BIDDING DOCUMENTS. The ultimate and most important task of theprivatization consultants was to prepare the complete bidding docu-ments to be used for inviting bids from the prequalified participants.The multivolume document included a detailed description of the ex-isting situation, the essential aspects of the concession, the variousperformance targets that should be met at various stages of the conces-sion, a model contract, as well as the evaluation and award methodol-ogy to be employed.

The numerous annexes to the bidding documents included addi-tional material such as the regulatory framework; the current waterrate system; the current tax system; consumer regulations; the waterand wastewater quality standards expected; water test results; invento-ries of fixed and mobile assets; lists of ongoing construction and serv-ice contracts, projects prepared or in execution, and materials in stock;details on existing OSN loans from IDB and the World Bank; and lists ofOSN personnel with their qualifications and experience.

In addition to the material prepared by the privatization consultantsspecifically for the bidding documents, the large amount of informa-tion generated previously by the twinning consultants was also con-sidered useful and incorporated as an annex to the biddingdocuments. This annex included a description of the condition of exist-ing installations and, in some cases, recommendations on the low-costoperational improvements that could be carried out to produce rapidgains in operational efficiency and to raise revenues.

Before the publication of the bidding documents, the PrivatizationCommittee organized a meeting with the bidders-all representingcompanies of recognized experience and prestige-in order to testtheir reaction to some controversial aspects of the concession and thebidding process. The privatization consultants took into account someof the comments made during this meeting when they prepared thefinal version of the bidding documents.

Stage III: Bidding and Contracting Process

This stage includes all the activities from the moment bids are calledfor until the contract with the winning consortium is signed. If a pre-qualification step is included, it starts with the call for prequalification.

THE PREQUALIFICATION PROCESS. The main objective of the pre-qualification was to ensure that participation was restricted only tobidders having the technical expertise and financial capability to un-dertake a concession of such magnitude and to minimize the effort and


time eventually needed to evaluate the proposals submitted. As aresult of the high prequalification standards and possibly of therelatively high cost for the prequalification document ($30,000,which included the cost of the bidding documents for the prequalifiedfirms), some companies that had expressed interest withdrew, andothers formed consortia among themselves or with newly recruitedpartners.

The technical requirement for prequalification stipulated the mini-mum population of the largest city served by the bidder and the mini-mum aggregate population served by its entire operation. Thefinancial requirements were minimum figures for the total annual bill-ing and the net share capital. An additional requirement that had tobe fulfilled was related to the shareholding distribution regime ofa consortium. At least 25 percent of the shares had to be owned bythe operator, 10 percent had to be allocated to the employees, 3 andat least 51 percent had to be owned at any time by the concession-aire, that is, only a minority of up of 49 percent of the shares couldbe sold.

Five strong international consortia, incorporating French, British,Spanish, and local partners, were prequalified. The operators leadingthese consortia were the two largest French private firms (Lyonnaisedes Eaux-Dumez and Compagnie G6nerale des Eaux), two of the larg-est British private firms (Thames Water and Northwest Water), and thelargest Spanish public firm (Canal Isabel II).

THE BIDDING PROCESS. All the prequalified participants were in-vited to submit bids. At this stage, the World Bank's assistance anddirect involvement in the procurement process came to an end, be-cause the Bank was not going to be involved in financing the operationof the concession. The privatization consultants, however, continuedto assist the Privatization Committee at all stages of evaluating thebids and awarding and contracting the concession. The participantsreacted positively to the bidding documents. Because of the magnitudeof the operation and the high risks involved, all the bidders spent alarge amount of resources to send their own engineering and financialteams to carry out an independent evaluation of the system and pre-pare the detailed proposal. All bidders were satisfied with the clarityof the documents, the technical requirements, and the evaluation crite-ria. This confirmed that the intensive work invested in preparing thebidding documents by all parties involved (the Privatization Commit-tee, privatization consultants, and the World Bank) had been worth-while and the extra time taken well spent. It eventually allowed timely


and straightforward evaluation of the proposals and award of the con-tract, which did not cause any dispute or polemic.

All five prequalified firms participated in the bidding process, al-though only four bids were submitted (rather than compete with oneanother, the two French operators agreed on a joint venture for thislarge operation). Bid evaluation was a two-envelope process. The en-velopes with the technical proposals were opened and evaluated first.One consortium proposed an innovative and original wastewatertreatment solution, consisting of chemically aided primary sedimenta-tion followed by aerated lagoons, constructed on two artificial islandsto be built in the River Plate, at a distance of several kilometers fromthe shore. The Privatization Committee, with the assistance of inde-pendent engineering consultants, evaluated the proposed technologyand concluded that its technical and economic feasibility were notfully proved. Because of the unknown geotechnical conditions of theriverbed, such a solution could result in high cost overruns and con-struction delays. That bid was considered technically unresponsive.The other three bids were considered technically responsive, and theircorresponding price envelopes were opened.

As stipulated in the bid evaluation and award methodology, theconcession was awarded to the bidder who offered to charge the low-est water rate, while meeting the required service levels and perform-ance targets. The proposed water rate was expressed by means of a Kfactor (similar to the one used in the British privatization)-a decimalfraction applied to the current water rate, which could be less than,equal to, or more than 1.

Two aspects of the price offers were particularly interesting. First,the winning bidder offered a rate almost 27 percent lower than thecurrent water rate at the time of bidding.4 Second, the difference betweenthe rate of the winner (k = 0.731) and of the runner-up (k = 0.739) wasminimal, whereas the rate of the third bidder was higher (k = 0.885).The first aspect-the considerable reduction of the water rate-provedbeyond any doubt that the private concession was feasible and that theoperation of the Greater Buenos Aires system could be an attractivebusiness, if carried out efficiently. In this context, it should be men-tioned that the government had decided to implement a long-due raisein water rates by approximately 8 percent just prior to the call for bids.The second aspect-the closeness of the price offers-demonstratedthat the bidding documents were clear and unambiguous.

THE CONCESSION CONTRACT. After final negotiations with the win-ning bidder, a thirty-year concession contract was signed, and a take-


over date was set to coincide with the beginning of a bimonthly billingperiod. On May 1, 1993, the private concessionaire-an internationalconsortium named Aguas Argentinas (AA), led by Lyonnaise des Eaux-Dumez and comprised of four French, Spanish, and British operatorsas well as three Argentine investors,5 started operating the GreaterBuenos Aires system-the largest private water and sewerage conces-sion in the world to date. On the same date, ETOSS started to functionformally as the regulatory agency in charge of administering the con-cession contract. Some important aspects of the concession contract arebriefly described below.

* Performnance targets. The concession contract did not specify theinvestments that must be made. Instead, gradual performancetargets were set for such parameters as water and sewerage cover-age (percentage of population served), percentage of wastewater toreceive primary and secondary treatment, percentage of water andsewerage network to be renovated, and maximum percentage ofunaccounted-for water (see table 2-1).

* Quality of service. The contract also stipulated the quality of serv-ice required (water pressure, continuity of supply, and waterquality) as well as the maximum acceptable levels of various con-taminants allowed in the sewage discharged to collectors and inthe sewage disposed of into receiving water bodies without treat-ment, with primary treatment, and with secondary treatment. Thefrequency of sampling and analysis was also stipulated. The qual-ity requirements for both potable water and sewage effluentswere set to tighten gradually every five years (1993, 1998, and

Table 2-1. Performance Targets of the Buenos Aires Concession(percent)

NetworkPopldation Sewage renovation

Year of coverage treatment (cumulative)the conces- Water Sewage Prim- Secon- Water Sewer- Unacounted-sion supply collection ary dary supply age for water

0 70 58 4 4 0 0 455 81 64 64 7 9 2 37

10 90 73 73 14 12 3 3420 97 82 88 88 28 4 2830 100 90 93 93 45 5 25


2003). These requirements, together with many others, are en-forced by a government decree issued in 1992, which set up theregulatory framework of the concession.

* Metering. Metering of consumption and the application of the corre-sponding rates based on consumption were compulsory for nonresi-dential (large) consumers and for bulk water sales, within a periodof two years. To motivate the concessionaire to accelerate theinstallation of meters for large consumers, the contract stipulatedthat if after two years the concessionaire had not installed metersto such consumers, the rate applied would be the fixed charge inthe formula for metered consumption, that is, assuming zeroconsumption. For residential consumers, metering was optional,at the discretion of either the consumer or the concessionaire.

* Water rates. Under the contract provisions, the water rates wouldbe reassessed every five years, based on the next five-year up-dated investment plan and updated estimates of expenditures.An inflation index formula agreed upon in the contract enabledETOSS to monitor cost increases. The contract stipulated that therates could be revised only if cost increases due to inflation wereabove 7 percent.

* Procurernent. The contract stipulated that major works and equip-ment amounting to more than $10 million must be procured byinternational competitive bidding.

INVESTMENT PROGRAM. The challenging coverage targets foreseenfor the first fifteen years of the concession signify the connection ofapproximately 1 million inhabitants every five years to both the watersupply and the sewerage systems. Compliance with all the perform-ance targets stipulated in the concession contract implies an averageinvestment on the order of $130 million a year, or a total of $4.0 billionover the thirty-year period of the concession. These investments willeventually permit 100 percent coverage in water supply and 93 percentin sewerage, representing an additional population of 4.0 million to 4.5million that would be connected to water and sewerage services. In thefirst five years of the concession (1993-98), for which specific develop-ment plans are available, total investments would reach some $1.2billion or $240 million a year. This impressive five-year investmentprogram is one order of magnitude higher than the average historicinvestment made by OSN in the last decade ($20 million a year).

FINANCING. This investment program will be financed by a recentlynegotiated loan from the International Finance Corporation ($250 mil-


lion), which as a result, will become the owner of 5 percent of AA shares,an IDB loan to OSN ($98 million) that is being transferred to AA, and fundsgenerated internally from cash flow. If needed, long-term bonds andshort-term loans from local commercial banks are also envisaged. It ap-pears that, at least at the beginning of the operation, the private sectorwas not eager to finance investments with its own resources but waswilling to invest the cash generated by the operation and to borrowmoney from multilateral agencies and commercial banks.

Stage IV: Transfer of Services

The final stage includes all the activities from the moment the conces-sion contract is signed until the operation is fully transferred to theprivate concessionaire. The major activities taking place during thisperiod are analyzed below.

REDUCTION IN WORKFORCE. OSN, like many other public water com-panies in Latin America and other parts of the world, was grosslyoverstaffed (some 8-9 employees per 1,000 connections). Initially,7,600 employees were to be transferred to the concessionaire, whereasin accordance with the privatization consultants and the World Bank'sestimates, half that number would have been sufficient to operate thesystem efficiently. Of these, about 1,600 employees accepted a volun-tary early retirement program, whereby the central government fi-nanced $40 million for severance payments. Another 2,000 employeeswere separated through a similar voluntary retirement programlaunched and financed ($50 million) by the concessionaire soon aftertaking over the operation. As a result of these changes, the number ofemployees of Aguas Argentinas was reduced to approximately 4,000(50 percent) in less than six months-a remarkable achievement con-sidering the complexity and sensitivity of the issue.

The present ratio of approximately 3.5 employees per 1,000 waterconnections is acceptable and is expected to remain more or less con-stant in the future. On one hand, the number of connections willgradually increase as a result of the expansion of the water supplysystem, and, on the other hand, the number of employees should alsoslightly increase as a result of the additional qualified staff that will beneeded to fulfill the future goals of the concession contract.

PHASING OUT OF THE PUBLIC COMPANY. A residual OSN organizationremained in charge of some services until the concessionaire becamefully established and capable of taking over as well as of the services


not transferred to the concession. A liquidator of the residual companywas appointed by the government to terminate within one year thenonconcession facilities and close all other pending business (such ascollecting the large amount of past debt accumulated from unpaidwater bills). At the end of 1994, a year and a half after the concessionstarted operating, the residual OSN organization was still in the processof liquidation.

THE REGULATORY AGENCY. In accordance with the central govern-ment's regulatory decree, the regulatory agency (ETOSS) was created asan autonomous, self-sustaining entity "to ensure the quality of theservice and protect the consumers as well as to monitor the compli-ance with the existing norms and the provisions of the concessioncontract." Its board of directors consists of six members-two repre-senting each of the three entities involved: the central government, theprovince of Buenos Aires, and the municipality of Buenos Aires. ETOSS

is financed by the consumers. Its annual budget of about $8 million iscollected by the concessionaire through billing and represents a usersurcharge of 2.7 percent of the water and sewerage bill.

During the initial period, it became clear that ETOSS had to focus oncapacity building to fulfill its role at the level required to confront theexperienced concessionaire. Consultants for institutional strengtheningwere contracted by ETOSS for the first year of operation with funds andassistance provided by the World Bank. The consultants' contract gen-erally produced the anticipated results and was extended for a secondyear to help ETOSS consolidate its position. The personnel of theagency-some seventy professionals-first were drawn from formerOSN employees and later were hired through a comprehensive processof job description and competitive recruitment, carried out in accord-ance with the consultants' recommendations.

Sharing Out of Tasks among Main Entities

Considering the variety of activities that must be undertaken for thepreparation and operation of a private concession, it is important tosummarize, based on the experience of Buenos Aires, the division oftask responsibilities among the various parties involved (see table 2-2).A distinction is made between preparatory activities and privatizationactivities. The parties considered are the government, the PrivatizationCommittee, and the consultants.

The World Bank's involvement in preparing the Buenos Aires con-cession included a dialogue with the government during the initial,


Table 2-2. Division of Tasks among Main Entities in the Buenos AiresConcession

Task Responsible party

Preparatory activitiesAppoint Privatization Committee or similar

forum GovernmentSet up legal framework for regulatory agency GovernmentPrepare terms of reference for consultants Privatization CommitteePrepare short list of consultants or hire sole-

source consultants Privatization CommitteeEvaluate proposals, recommend award, and

contact consultants Privatization CommitteePrepare timetable Privatization CommitteeReview work of consultants Privatization CommitteeSet up regulatory agency GovernmentReach consensus on major controversial issues Government/Privatiza-

tion Committee

Privatization activitiesPrepare draft regulatory legislation ConsultantsPrepare promotion plan ConsultantsReview existing water and sewerage systems ConsultantsDefine possible scenarios ConsultantsCarry out feasibility study ConsultantsDetermine investment needs or performance

targets ConsultantsSelect recommended scenario Government/Privatiza-

tion CommitteePrepare prequalification process (if adopted) Privatization

Committee/ConsultantsPrepare bidding documents ConsultantsAward contract Privatization CommitteeTransfer service Government/Privatiza-

tion Committee

preparatory stages; assistance to the Privatization Committee in pre-paring the terms of reference and selecting the privatization consult-ants; assistance to the Privatization Committee in guiding andreviewing the work done by the privatization consultants at variousstages, up to the call for concession bids; a dialogue with the Privatiza-tion Committee and the privatization consultants on major controver-sial issues; and assistance to ETOSS on institutional strengthening.


World Bank funds from an ongoing loan were used to finance thetwinning consultants, the technical and the financial privatization con-sultants, and the institutional consultants as well as to acquire com-puter systems for the regulatory agency.

Timetable

The Privatization Committee set up an ambitious timetable for theconcession and took all possible measures to ensure that the privati-zation process was completed with minimum possible delays. Inaccordance with the original timetable envisaged (see table 2-3), thebidding process was planned for December 1991, when it was as-sumed that the regulatory framework would have been approved.An eight-month interval was foreseen for preparing and evaluatingthe bids and awarding and signing the contract, so that the conces-sion was expected to start operating in August 1992. Nevertheless,

Table 2-3. Intended and Actual Timetable of the Buenos AiresConcession

Activity and timetable Intended Actual

Activity (date)Commencement June 1991 June 1991Regulatory framework December 1991 June 1992Prequalification Not envisaged January 1992Call for bids December 1991 June 1992Bid opening April 1992 September 1992Award June 1992 December 1992Contract August 1992 March 1993Transfer September 1, 1992 May 1, 1993

Duration (monttls)

Preparatory activities 6 12Bidding process 9 11Total 15 23

Delay (months)Regulatory frame-work/prequalification n.a. 6Bidding n.a. 2Total n.a. 8

n.a. Not applicable.


two parallel events caused delays: the regulatory framework was ap-proved only in June 1992 (a six-month delay) and the decision to in-clude a prequalification process delayed the bidding of the concessionby six months, too. In addition to these unavoidable delays, there wasan additional minor delay of two months in the process of award andcontracting, so that the concession started operating on May 1, 1993,eight months after the originally planned date.

In spite of these delays, the timetable for the Buenos Aires conces-sion, like many other aspects of this undertaking, should be regardedas a success, considering its magnitude and its pioneering nature forLatin America at the time. The whole privatization process took abouttwo years, with one year dedicated to preparatory activities (prior tothe actual bidding) and another year dedicated to privatization activi-ties (from bidding to concession).

First-Year Results

It is too early to carry out a systematic evaluation of the concessionresults. For such purpose, operational data and reliable quantitativeindicators must be available for at least three years of operation. Nev-ertheless, some preliminary comments on the results of the first year ofthe concession can be made. They are based on first-hand impressionscollected during a visit to Buenos Aires in August 1994, informal con-versations held with representatives of the concessionaire and theregulatory agency, as well as data presented by the concessionaire inits first, audited annual report.

- More than a year after the concession started operating, somenoticeable improvements in the Greater Buenos Aires water supplyand sewerage system took place:

* For the first time in many years, the city did not experi-ence water shortages during the summer months of peakdemand; this was achieved by operating the San Martinplant at almost 20 percent capacity higher than before (2.7million cubic meters a day in March 1994) and by improv-ing the operating efficiency of some pumping stations.

• The water quality achieved at the San Martin plant wasgenerally better than before, due to improvements in thequality of chemical products used and in the performanceof the treatment process, in spite of the higher hydraulicload; the improved performance appears to be the result


of a series of low-cost, rapid improvements carried out atthe plant, some of which are still in progress.

• At the Southwest wastewater treatment plant, which con-sists of primary and secondary treatment units, the secon-dary units (very large circular trickling filters), which hadnever been operated by OSN because of mechanical prob-lems, were operated successfully, as a result of simple me-chanical modifications; consequently, the effluent qualityobtained was much higher than before.

* The relation with the consumers appears to have im-proved as a result of faster and better response to com-plaints. The reported number of complaints for brokenpipes received by the concessionaire was still high (some5,000 a month for water and 10,000 a month for sewage),but the time required for repair was reduced to some 48hours (compared to 180 hours previously), and the num-ber of pending complaints at the end of the month wasreduced from several thousand to several hundred. 6

* During the first year, some 40,000 water meters were installed forlarge, nonresidential consumers, some 125 kilometers of waterdistribution pipes and 2,600 valves were rehabilitated or reno-vated, 7 and about 1,000 kilometers of sewage collection pipeswere cleaned.

* Nevertheless, interruptions in service continued to occur, either asa result of unexpected power breaks or as a result of plannedrepair works carried out by the concessionaire. An effort wasmade to minimize such interruptions by attempting to coordinatethe power interruptions with the power company and informingthe affected consumers about repair works involving interrup-tions of service.

. A major achievement was the drastic reduction of staff and in-creased staff efficiency.

= No less important than these operational achievements was thecomprehensive collection of field data, planning, and design ef-forts that were initiated. For this purpose, the concessionaire con-tracted the services of a reputable consortium of French and U.S.consulting engineering companies, which began working at fullsteam to prepare for the major challenges that will face the opera-tor in the next few years. Most notable in this context are thefieldwork carried out to measure the flow in the water and sewagepipes, the campaign to monitor water quality and river water pol-lution, and the consumer census to detect illegal consumers.


* The cash deficit of some $25 million reported by the concession-aire at the end of the first year is understandable, considering thatan amount of $50 million was spent for the early retirement plan.Financial projections indicate a positive cash flow for the secondand third year of the concession.

* So far the operator has made only minor investments in urgent,high-return operational improvements. Future financing seems tobe assured by loans from the International Finance Corporationand IDB, together with funds generated from cash surpluses in thenext years of operation and possibly additional loans from com-mercial banks.

* A major task of the concessionaire is related to the high nitrateconcentrations in some of the wells supplying potable water. Al-most half of the operating wells exceed the allowable nitrate con-centration of 45 milligrams per liter, while a small percentage ofwells exceeds 100 milligrams per liter. The concessionaire andETOSS agreed that the latter will be given priority in the first stage,by replacing such wells with either wells of low nitrate concentra-tion or new surface water supply systems.

* The single most important event related to the concession was anextraordinary rate increase of 13.5 percent granted by ETOSS to theconcessionaire in July 1994, that is, at the beginning of the secondyear of the concession. This was due in part to the advancementof investments to increase coverage targets and replace nitrate-contaminated wells, as a result of pressure by various municipali-ties to solve urgent water and sewerage problems, and in part bythe recognition of higher labor costs incurred by the concession-aire, beyond the inflation formula included in the contract. Evenafter this increase, the water rates were still 17 percent lower thanthe OSN rates before the concession.As a result of its activity during the first year of operation and thebetter knowledge of the system gained, the concessionaire raiseda series of interesting points and issues and suggested changes inthe provisions of the bid and the contract, mostly with respect tosewage treatment. All of this will require review and decisions bythe regulatory agency.The relationship between the concessionaire and the regulatoryagency at the end of the first year of the concession seemed to besomewhat tense, due to controversial approaches to issues such asthe degree of independence of the operator vis-a-vis the regulator,the frequency and quality of reporting, and the reliability of someof the available information. The main problem seems to be that the


regulatory entity had high expectations from the very beginning ofthe operation, while the operator thought that it was being exces-sively controlled and at times had a different view on priorities thanthe regulator.

In general, the overall achievements of the concession seem reason-able, considering that in the first six to twelve months of the newconcession, as indeed was anticipated in the proposal of the winningconsortium, a great amount of time and resources had to be spent onbecoming familiar with the system, setting up new offices, corroborat-ing existing and collecting additional information, restructuring staff,mobilizing short- and medium-term financial resources, and so forth.

Conclusions and Lessons from Experience

Numerous conclusions may be drawn and lessons of various typesmay be learned from the successful contracting of a large water supplyand sewerage concession in Buenos Aires. The most relevant arebriefly presented below.

* Political commitment to privatization at the highest level should beensured.

* Privatization should preferably be part of a comprehensive pro-gram of economic reforms.

* Consensus building among all stakeholders is important.* Risks of all types (political, economic, commercial, technical, and

legal) should be assessed, and appropriate mechanisms to allevi-ate them should be adopted.

* Participation of multilateral agencies, such as the World Bank,enhances the transparency and credibility of the process.

* All PSP options must be analyzed prior to selecting the preferredprivatization mode, but ownership of the system may remainwith the public sector; the assets do not necessarily have to beprivatized to promote efficiency and attract private capital.

• Successful privatization cannot be accomplished overnight, evenif the political decision is taken; careful preparation and reason-able time are required.

* Although a concession contract provides self-contained regula-tion, a full regulatory framework and the regulatory institutionalsetup should be clearly established, before starting the actual bid-ding process.


. The technical and financial feasibility of the concession should becarefully studied prior to bidding.

. Specialized, experienced consultants should be contracted to as-sist in various aspects of the preparation process; hiring a single,multidisciplinary consulting firm is preferable to contracting twoor more firms.

* Adequacy of water rates should be examined, and, if necessary,rate increases should be adopted prior to bidding.

* Prequalification of potential bidders should be conducted to en-sure that only qualified bidders eventually submit bids and tosimplify the process of bid evaluation, but it requires extra effortand time.

* Reduction of staff-probably the most sensitive of all privatiza-tion issues-is achievable, with the help of aggressive promotionof attractive early retirement packages to be financed by the gov-ernment, the concessionaire, or both.

* The regulatory entity should be strong enough to be able to con-front an experienced international operator and should be as-sisted by specialized institutional consultants, if needed.

• A residual public company must continue to function in parallelwith the private operator for at least a year, until the orderlytransfer of all services is accomplished and the nonconcessionservices are liquidated.

e A clear understanding of the reasons for any extraordinary in-crease in rates, beyond that stipulated by the concession contract,is important to minimize the danger of reducing the credibility ofthe rate offered in the bid and used as main criterion of award.

* Political pressure to impose priorities, although considerably di-minished compared to that exerted on the public water company,can still be exerted on the private operator, through the regulatoryagency, which is a public entity.

* At least at the beginning of the operation, the private sector maynot be willing to finance investments with its own resources, butit may be willing to invest cash generated by the operation and toborrow money from multilateral agencies or commercial banks.

* The concession contract must be realistic and as specific as possibleto avoid disappointment and minimize conflicts and debate be-tween the concessionaire and the regulatory authority. At the sametime, it should be flexible, because it is expected that the targets,indicators, and other aspects of the contract can be more realisticallydetermined after the first year of operation.


The success of the Buenos Aires water and sewerage concession hasawakened great interest in the last couple of years and provided a PSP

model that is being adopted by other provinces in Argentina as well asby other countries. A word of caution is required, though. Privatiza-tion, no matter how successful it is proven in one circumstance oranother, cannot be regarded as a universal panacea to problematicwater companies. Its applicability and probability of success must beanalyzed in the context of the specific country where it is to beadopted, in conjunction with existing laws and policies and other rele-vant measures and reforms that must accompany it.

Notes

1. All dollars are in U.S. dollars; a billion is 1,000 million.2. This document establishes guidelines for the relationship be-

tween the concessionaire and the consumers.3. This is in accordance with a law stipulating workers' partici-

pation in the ownership of privatized companies (Ley de PropiedadParticipada).

4. The water rate at the time of bidding was $0.66 per cubic meterfor households with both water and sewerage connection and $0.33per cubic meter for households with water connection only. Thesevariable rates were applicable to metered residential connections-inaddition to a fixed charge equivalent to half the rate for unrmeteredconnections-for consumption over a free consumption allowed,which varies according to the property size.

5. The share distribution was 50.4 percent foreign operators (ofwhich Lyonnaise des Eaux-Dumez holds 25.3 percent), 39.6 percentlocal investors, and 10.0 percent company employees through the Pro-grama de Propiedad Participada.

6. In this context, it should be remembered that an additional entity(ETOSs) also receives consumer complaints but in general only dealswith problems not dealt with or resolved by the concessionaire.

7. The target for renovation of the water distribution network at theend of the fifth year was 900 kilometers.

51

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