Co-written by Aleksandar D. Jovovic, Helen Mou and Alexander Greenberg
As world economies fret over energy supply and price shocks, developing countries increasingly anticipate the shortage of an equally critical resource — water.
Despite the United Nations General Assembly’s recognition of the human right to clean water and sanitation, almost 1 billion people do not have access to safe drinking water. By 2030, global water requirements are expected to grow to 6.9 trillion cubic meters, which is 40 percent above the current accessible, reliable supply. An estimated one-third of the global population, concentrated in developing countries, will live in basins where the demand-supply deficit is larger than 50 percent, according to the 2030 Water Resources Group.
Deutsche Bank estimates that an annual global investment of approximately $600 billion is needed to meet the needs of the water market. However, tight public budgets combined with the low or absent price for water continue to drive this investment gap wider. The impending shortages will impact individuals, communities, agriculture, industry and governments alike.
In response, the private sector has begun to apply commercial practices to fund water investment through innovative partnerships. Infrastructure firms can leverage technical knowledge, managerial strength, and access to private capital in order to drive growth, though they must come to the table armed with a deep understanding of the interplay between water demand, policy drivers, and economic resources available to fund projects.
Development organizations, building on their understanding of local capacity and international aid frameworks, can implement projects to strengthen urban and agricultural water practices. For its part, the nonprofit sector can enable these efforts by empowering host government capacity in program funding and finance, project management, and acquisition skills.
Working hand in hand, both the for- and nonprofit sectors can realize significant improvements in this increasingly demanding marketplace.
An investment solution
Despite fast-growing global water needs and the inability of current infrastructure systems to serve them, host governments — especially in developing countries — are often unable to organize and finance water infrastructure development. Politically and fiscally constrained, governments cannot meet the prohibitive startup costs of building and operating irrigation and water delivery networks. Economic, social and political instability, as well as the threat of drought in countries with arid climates generate risks too high for governments to bear single-handedly.
In the last two decades, public-private partnerships have emerged as mechanisms to share the risks, funding and operations costs of water infrastructure projects with the private sector. In water projects, PPPs vary in scope from short-term operation and maintenance agreements to 30-year concessions where a private company designs, builds and operates the utility.
In developing countries, wider-scope projects are beginning to gain favor with host governments as thePPP model is increasingly refined.
In Morocco in 2004, a unique PPP for an irrigation system was instituted after a depleted aquifer and skyrocketing pumping costs plagued farmers in the Guerdane perimeter, a region responsible for 50 percent of Morocco’s profitable citrus farming industry. The Moroccan government sought a private partner to finance and build an irrigation system, and competitively awarded a 30-year concession to a Moroccan industrial conglomerate, Omnium Nord-Africain.
In this arrangement, the government provided 47 percent of the financing with public funding, Omnium provided 43 percent with private investment, and the remaining 10 percent was supplied by the end users in the form of a connectivity fee that paid for installation costs at each farm. Omnium would build and operate the irrigation system for the duration of the contract and earn revenue by collecting tariffs from the end users. The PPP also contained contractual safeguards to mitigate the risks facing Omnium: The government agreed to reimburse the firm if a drought caused a 15 percent or greater revenue loss.
Governments often opt for firms with a local presence to administer water infrastructure efforts, and multinational water firms have adapted to this requirement by entering the localized and fragmented water PPP market through partnerships.
In 2011, Veolia, a leading French-based environmental solutions company, won a 25-year contract to overhaul and expand water infrastructure in Nagpur, India’s 10th largest city. Veolia India, in a joint venture with Nagpur-based engineering firm Vishvaraj Environment, is responsible for all facets of managing the city’s water supply, from treatment plants to delivery to Nagpur’s 2.7 million inhabitants, in addition to billing and collection of tariffs. This contract is considered the first Indian public-private partnership to operate at the scale of an entire city on a continuous basis. To carry out this project, Veolia and Vishvaraj established a special purpose entity, Orange City Water, to operate the water system.
In PPPs, such special purpose entities enable a project’s shareholders, typically the financiers, integrators, operators and advisors to legally “ring-fence” the project’s assets and risks. This practice centralizes both project management in a local context and enables contractors to isolate and concentrate liability.
In the above example, the city-owned water utility, Nagpur Municipal Corp. retains ownership and decision-making capacity over the water system, while Orange City Water is responsible for its upgrades and operations over the life of the contract. Orange City will spend five years upgrading the city’s water pipeline network and home connections at an investment cost of €60 million ($73.5 million) — 70 percent of this cost will be funded by the Indian government while 30 percent will come from the operator’s private funds. After paying its partners and subcontractors, Veolia is expected to earn close to €400 million over the life of the contract.
Best practices and lessons learned
The Nagpur example showcases opportunity for multinational water companies to win PPPs in developing countries. Nevertheless, local operators are also gradually achieving the requisite technological capacity and scale to challenge larger competitors.
A recent study by the Public-Private Infrastructure Advisory Facility, a multilateral technical assistance organization, explored this changing dynamic and found that in 2000, five multinational water companies composed 80 percent of the market for water PPPs in low- or middle-income countries as classified by theWorld Bank. By 2009, this share had shrunk to 60 percent, with 28 local firms serving at least 400,000 people.
Facing this competitive pressure, as well as the challenges of managing a resource-intensive project in another country, multinational firms must forge partnerships with local entities. Local partnership is also essential to gaining visibility and developing a presence in countries with opaque business and political processes.
No single defined template for designing PPP arrangements exists due to the unique constraints, risks and regulatory environments surrounding water infrastructure. PPP models tend to vary across regions due to variance in economics, climate, culture and precedents. Results may vary over time, and development stakeholders are beginning to identify best practices for PPPs.
Private firms have developed sophisticated mechanisms for financing their share of PPPs, such as leveraging or establishing their own capital arm to take on debt instead of borrowing from the open market. Still, some schemes have failed because private operators were forced to shoulder too much of the capital investment; for large projects, government subsidy is essential.
Public sector support must often continue in the implementation phase, through purchase agreements that assure a degree of predictable demand for the PPP. The Guerdane and Nagpur examples demonstrate hybrid funding models for water systems that both mitigate risk for the private operators and reduce the cost burden for the government.
Contractual challenges, political considerations, exchange rate fluctuations and other typical international business challenges are also to be expected. Host governments will also require greater sophistication in designing optimal legal agreements, financing and payback mechanisms to support water infrastructure development in their countries. Sharing the insights and experiences of the private sector with public counterparts will facilitate the successful expansion of PPPs and ensure efficient allocation of project risk.
Opportunities amid a growing crisis
Despite bleak statistics, innovative policy and business solutions are more readily apparent, signaling to governments to right-size policy, to development organizations to support change, and to business to seek solid, long-term investment opportunities.
Indeed, the water resource challenge in the developing world is a harbinger of problems in developed countries rather than an isolated problem only poor countries face. Disputes over scarce water resources and shale gas extraction in the United States or water supply for hydroelectric power versus agricultural use in China all fall squarely into this arena.
The business community may require the most assurances and support. Sometimes unaccustomed to working in uncertain business environments, concerned about the political and social stability of developing countries and unwilling to embark on less-than-well-trodden paths, engineering, infrastructure and utility firms as well as their financial backers will require solid operational guidance and advice. Yet at a time when infrastructure spending is ebbing in the developed world and traditional opportunities among the BRICs have stalled, firms may have little choice other than to embark on a thoughtful and guarded review of opportunities in the PPP water sector.
As they mull these options, they will need to develop clear answers to the following questions:
Do shareholders and other stakeholders have an appetite for long-term investments?
What are the true financial, legal and political risks of establishing PPPs in developing countries?
How can the firm’s offering better mitigate these and other challenges?
Successful firms have found ways to leverage in-house financing. Is this a possibility for the opportunity at hand?
What is the minimum government and nonprofit involvement required to move forward?
Who are the ideal partners and how best to evaluate them?
Can the business case and technical offerings developed now be applied to future opportunities?
The writers work with Avascent – Aleksandar D. Jovovic as senior associate, Helen Mou as senior analyst, and Alexander Greenberg as analyst.