Page 85 - Urban water supply handbook

IMPROVING URBAN WATER INFRASTRUCTURE THROUGH PUBLIC-PRIVATE PARTNERSHIPS

3.4 HISTORY, PLANNING, OUTSOURCING

Prior to 1997, contracts for water and wastewater O&M were limited to 5 years
and required a termination clause allowing cancellation after 3 years. With such a
narrow time frame, operators were restricted in their ability to secure new capital
improvements and increase operating efficiencies. Short-term contracts were
designed to keep vendors honest—rebidding contracts every 3 or 5 years kept con-
tinuous competitive pressures on vendors to reduce costs and improve operations.

3.2 LONG-TERM CONTRACTS

The market for water and wastewater public-private partnerships was transformed
in 1997 when the Internal Revenue Service (IRS) issued new regulations that
made possible long-term contracts for public utility operations while maintaining
the tax-exempt status of bonds used to finance the facility. Under Revenue
Procedure 97-13, private operators can enter into contracts for at least 15 years and
up to 20 years for public utility properties, which include water and wastewater
treatment systems.
The new IRS rules also imposed constraints on long-term contracts that are
designed to prevent the abuse of tax-exempt financing. Contractors can have no
interest in the net revenues of the system but may share in cost savings or revenue
enhancements. These measures have led to a wave of recent contracts with gain
sharing provisions that provide incentives for private operators to achieve addi-
tional cost savings.
Another incentive-based provision of the rule changes allows private operators
to have 20 percent of the total contract amount to be in the form of a variable pay-
ment from cost savings or revenue sharing. These provisions create a win-win out-
come for private operators and municipalities—contractors continually search for
further operating efficiencies and cities benefit from additional cost savings.
The net effect of the changes in IRS rules has been to give the private sector
more flexibility to meet local water and wastewater needs. Public-private partner-
ships can now run the gamut from a short-term O&M contract to a long-term con-
tract that includes design, build, and operate (DBO) features, all without private
ownership (Table 3.1). Long-term contracts have proven to be an effective method
for addressing municipal water and wastewater needs, especially for capital
improvements or in cases where new facilities are required.

3.3 EXTENT OF PRIVATIZATION

While the current extent of privatization of water and wastewater facilities is
somewhat limited, recent trends suggest that more cities will be examining private
sector alternatives in the future.

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