Water Business Is Hot as Cities Decide to Tap Private Sector

Wall Street Journal, Interactive Ediltion, 9 November 1998

SOFIA, Bulgaria—Josef Schneider is digging trenches for the next battle in the world's water wars. As giant utilities from the U.S. and Western Europe line up to bid for Sofia's multimillion-dollar water-delivery concession, the Austrian engineer has been tearing up the Bulgarian capital's streets to determine how bad its water system is. It's bad. For one thing, there are no reliable maps, so he often can’t find pipes. The pipes he can find leak like sieves. “Pipes like these lose 60% of their water,” says Mr. Schneider, who is helping the city prepare to privatize its water system. For the city and its inhabitants, leaky pipes mean brown water and money down the drain. But for potential bidders—including such heavyweights as Bechtel Group Inc. of the U.S. and France's Suez Lyonnaise des Eaux and Vivendi SA—the chance to fix those leaks and collect water bills means money in the bank. Another U.S. giant, Enron Corp., has emerged as a new player in the field, aggressively courting similar business. After telephones, power and gas, water is the next utility to be shaken up by international competition. Already worth $300 billion a year, by Enron's estimate, a slew of new water-supply and waste-water treatment contracts is about to hit the market.

A ‘Political’ Business

“Water is the last infrastructure frontier for private investors,” says Johan Bastin, head of the municipal and environmental infrastructure team at the European Bank for Reconstruction and Development in London, which is advising Sofia on its water auction, set for later this year. And perhaps it also is the most politically sensitive. “Water is a very political business, because people tend to see it as their birthright. Many expect to pay little or nothing for it,” said Bill Alexander, chief executive of British utility Thames Water PLC, speaking at a conference in Washington last month. Birthright or not, leaky pipes need fixing. And that requires hefty investments. So, like Sofia, budget-conscious cities around the world are putting their water systems up for auction. In Europe, Berlin, Brussels, Bucharest and Prague are gearing up to privatize all or part of their systems. In Brazil, the state of Rio de Janeiro has put its system up for bid. In the U.S., Atlanta recently awarded a 20-year contract valued at $400 million to a consortium led by Suez Lyonnaise.

A French Province

What is attracting companies to the water market is the prospect of a long lease on a monopoly. Put simply, the business involves plugging the leaks, fixing the meters, improving the billing system, and then watching the regular flow of water turn into a steady cash flow for the next 20 to 25 years.Until recently, the water industry was dominated by Suez Lyonnaise and Vivendi. Both companies had built a powerful home base thanks to France's longstanding system of leaving it to each municipality to find a water-supply operator. Since Britain privatized its water companies in the 1980s, a handful of companies there, led by Thames Water, have also started competing in international tenders. Now, some big U.S. companies want a piece of the action. The most prominent new entrant is Enron, based in Houston, which in July spent $2.2 billion to acquire Wessex Water PLC of Britain. Enron Chairman and Chief Executive Officer Kenneth Lay predicts that water soon will be as important to Enron as its core natural-gas and electricity businesses. Already, Enron is vying for water privatizations in Rio de Janeiro, Berlin and Panama, posing a serious threat to the French. “Enron is the great unknown for us,” says Daniel Caille, chairman of Generale des Eaux, Vivendi's water division. “The electrical utilities are invading the market, and they have the cash. We’re small players compared to them.”

‘In Their Face’

“We're going to be in their face,” says Rebecca Mark, chairman and CEO of Enron's new water division. Ms. Mark, 44 years old, won a formidable reputation in the international energy market, where she developed about $20 billion worth of projects for Enron. The industry is watching closely to see if Ms. Mark can make a similar splash in water. Electric utility GPU Inc., Morristown, N.J., harbors similar ambitions. It is looking to expand internationally in both water and natural gas. GPU CEO Fred Hafer says his company's new strategy is to focus on “the regulated business of poles, pipes and conduits” world-wide. Meanwhile, the French aren’t sitting by. Suez Lyonnaise, with the Atlanta contract in hand, announced last month that it is teaming with some U.S. corporate investors to create a vehicle to compete in coming Latin American privatizations. And Vivendi, gaining what it considers a beachhead in the U.S. market, recently acquired a $125 million-a-year contract to manage Puerto Rico's water supply.

For cities such as Sofia, this competition holds the promise of a better deal. Atlanta, for example, used to spend $43 million annually to run its own water supply. Suez Lyonnaise has contracted to do the job for 20 years — and upgrade the system—for about half the price: $23 million a year.

The brisk rivalry also is encouraging municipalities to call for open competitive bidding, rather than pursue negotiated contracts. Sofia's own decision to enlist the private sector to fix its water woes stems from a lack of capital: It can’t afford the $200 million the EBRD estimates is needed to upgrade its water system. The city already was negotiating with two French water companies in 1995 when a brush with thirst highlighted its system's shortcomings and underscored the need to press ahead. Sofia's taps frequently ran dry that year, the second of two consecutive years of drought. Water levels in the two reservoirs in the mountains behind the city sank, prompting authorities to resort to water rationing. However, the city's talks with Saur SA, a unit of Bouygues SA, and Generale des Eaux bogged down as allegations of corruption circulated in the local press. When he took office in November 1995, Sofia's current mayor, Stefan Sofianski, called the negotiations off. Representatives of both French companies called on Mr. Sofianski, each demanding the concession and blaming its French rival for the corruption allegations. Shortly thereafter, he asked the EBRD to organize a call for bids, this time open to all comers. “Our idea was to use the EBRD as an umbrella to protect us against the French methods,” says Deputy Mayor Ivan Gechev. Jean-Patrice Poirier, Generale des Eaux's director for Central and Eastern Europe, concedes that the company was “clumsy” in its earlier approach to Sofia. “That team is no longer with us,” he says. Jules Chautemps, who runs Saur's Eastern European team, declines to discuss any specific meeting but says his company always maintained excellent relations with the Sofia authorities.

Lining Up at City Hall

Sofia is far from the largest concession coming up for bid, but utilities and engineering companies are already lining up at its city hall to express interest. “We can’t afford not to look at it,” says Thierry Bourbier, international director of Suez Lyonnaise, who has already sent his regional director, Jean-Pierre Lambert, twice to Bulgaria on courtesy calls in recent months. “We’re a bidder,” says Jack Kerr, chief executive of Bechtel's International Water Ltd. Representatives from Vivendi, Berliner Wasserbetriebe of Germany and Mitsubishi Corp. of Japan have also stopped by, says municipal project manager Andrei Delchev. No one is keener to see the improvement such lively competition might bring than consumers like Lubomir Markov, a lawyer who lives with his wife and two young children in an apartment block on the city's edge. “We stopped drinking the water two years ago because it doesn’t taste good,” he says. Instead, once a week he heads across town to fill up a couple of 10-liter plastic containers with fresh mineral water that he gets for free at one of the many nearby springs. Mr. Markov says much of the money he is shelling out for water bills is wasted. “That's what we’re paying for,” he says scornfully as he steps across a stream, apparently from a leaking main, that is flowing down the street outside his building. Mr. Sofianki, too, acknowledges the waste. “At the moment, water is God's gift, and we can afford to lose some. But without investment, problems like 1995 will come again,” he says.

Financial Flaps

To be sure, handing a precious local resource over to the private sector is controversial. But so far, it has been financial issues, not philosophical ones, that have provoked the controversy. “It's not ideology or water as a God-given right that makes for problems. It's always a question of access and pricing,” says Nancy Birdsall, a senior associate at the Carnegie Endowment for International Peace in Washington. Take the case of Rio de Janeiro. Last month, the auction of the state's water system — set at a starting price of $4.2 billion—was abruptly canceled by the Federal Supreme Court because of a fierce battle that erupted between state and city authorities over ownership of existing assets. “There's no ideological opposition to the auction, but there is an economic struggle between the state and the municipalities over who has the right to sell the system and who will get the revenues,” says Rodrigo Andrade, a partner in Brazilian investment firm CVC Opportunity, which already has a stake in another, smaller water privatization in Brazil. Even after a contract has been awarded, water companies remain vulnerable to backlash. Last month Vivendi rescinded a 30-year contract it won in 1994 to run the water system of Argentina's Tucuman province. The company also says it will seek a settlement in a Washington-based arbitration court for its losses—which it estimates at between $2 million and $3 million a month—plus damages. The French company, which had doubled water rates to pay for an ambitious upgrade of Tucuman's system, acted after certain politicians in the province seized on the issue, urging local consumers not to pay their water bills. “Our contract was taken hostage by the political authorities,” says Charles-Louis Maud’huy, an adviser to Vivendi's water unit. Certainly, the water business isn’t for the faint-hearted. Most water executives reckon that they are aiming for a 10% to 15% internal rate of return over the duration of a contract. But taking on a crumbling municipal network requires huge upfront investment. Political and economic uncertainty can run high, and the payback time is extremely long. “It's all about who can stand the most pain in the early years,” says Michele Positano, investment officer at the International Finance Corp. in Washington, the private financing arm of the World Bank. Mr. Positano is organizing a water-system auction that is larger than, but otherwise similar to, Sofia's, in Bucharest, the capital of neighboring Romania. But despite the efforts of consultants like Mr. Schneider—whose findings are to be provided to the bidders—no one can be quite sure what they will find underground. Ask Mr. Schneider what advice he would offer the successful bidder on the Sofia contract, and he is quick with his reply. He points to a hopelessly inaccurate map of the city's water pipeswhich he has been trying to update with his findings. The map is stiff with dried correction fluid. “They’ll need 50 liters” of the fluid, he says.