Experiences of Budapest Waterworks with state, municipal ownership structures and with the involvement of private funding: case study of Budapest Waterworks

Between 1991 and 2000, the population served by private operators in developing and transition countries grew steadily from 6 million to 94 million. The number of developing and transition countries with active water PPP projects increased from 4 to 38. However, problems started to appear in the late 1990s and the number of new PPP contracts began to decrease.

Although general perception is that water PPPs in developing countries are on the decline, the situation is more nuanced. The populations served by private water operators in developing and emerging countries has continued to increase steadily, from 94 million in 2000 to more than 160 million by the end of 2007. Large countries such as Algeria, China, Malaysia and the Russian Federation have started to rely on private water operators on a large scale. Out of more than 260 contracts awarded since 1990, 84 percent were still active at the end of 2007 and only 9 percent had terminated early (Sub-Saharan Africa and Latin America). Overall, it is estimated that water PPP projects have provided access to piped water for more than 24 million people in developing countries since 1990 (Meriem Ait 2016).

The issue of public-private partnership is always complex, and this is even more true in the case of municipal water supply. In my paper I would like to provide a review of benefits and disadvantages of private funding in utilities with a particular emphasis on lessons learnt from and for the Hungarian context, more particularly for Budapest Waterworks.

PPP involves a contract between a public sector authority and a private party, in which the private party provides a public service or project and assumes substantial financial, technical and operational risk in the project. Public Private Partnership projects must be economically efficient and socially responsible. The basic elements of PPP concept are clear allocation of responsibilities, risk sharing and long lifetime partnerships. The concept of PP relieves the public partner from a good part of the costs that the partner otherwise have to bear. It also reduces the problems of fiscal pressure and at the same time allows to public partner to use managerial, technical, financial and innovative capacity of the private partner (Akintoye et. al 2003).

In Central Eastern Europe private funding had a significant role, since due to the compliance with the Maastricht criteria set by the European Union, according to which member states are obliged to keep their budget deficit which shall not reach 3% of the GDP. In Hungary PPP constructions got in focus in 2003 when Hungary set an ambitious target to meet the Maastricht criteria by 2007. Between 2003- and 2010 more than 100 pp projects was implemented in Hungary, mostly in sectors of construction, energy and telecommunication. Similar to the global trends, water supply and waste water related privatization projects lagged behind partly due to the specificities of water supply, waste water collection and treatment services such as:

• Since water supply is a main public activity, sensibility of consumers and politicians towards participation of private sector is much higher than other public activities.

• Provision of regular water supply and collection of waste water is conditioned significantly by external factors regarding environment and public health and implies ‘natural monopoly.’ This is also justification for rigorous regulation imposed by the state, when participation of private partner is introduced in public service delivery.

• Prices are often below economic level, what further complicates structuring of financially sustainable arrangements with private sector.

A government opting for private funding can gain the following benefits and face the following concerns (Virginia Tan, 2012):

• PPPs tend to take a long term view rather than short term concerns.

• PPPs provide additional capital to be allocated on reconstruction of assets vs tight municipal or state sources.

• Risk and works are transferred to a party which is best able to manage utility services at the least cost, achieving best value.

• The timings and costing tend to be more certain and therefore deliver better value for money.

• The cross transfer of public and private sector skills and knowledge and expertise can create innovation and efficiency. PPPs provide value added to the consumer and public at large.

• The private sector often brings in with greater construction capacity, labour capacity and resources than would be available to the public sector.

• Payments to the private sector in PPP projects are usually linked to how they perform, which leads to efficiency improvements.

• PPP projects are not subject to political interference and deferred payments for the government.

• Due to tight control from either side, the number of potential frauds or corruption can be significantly reduced.

Disadvantages (Baietti et. al 2005)

• Due to the characteristics of PPP, long term commitment is required, and interest of all stakeholders might change over the long contractual period.

• The number of parties involved and the long term nature of the relationships often result in complicated contracts and complex negotiations, and therefore high transaction and legal costs.

• There is a risk that the private sector party will become insolvent or make large profits during the course of the project, this can cause political problems for the public entity.

• The long term nature of a PPP project means that debt is incurred long before benefits appear.

• Sometimes a public sector entity could borrow more cheaply alone than it could via the private sector.

In Central and Eastern Europe privatization happened in the era of general political and economic transformation and was itself an important element of this transformation. The importance attached to privatisation is understandable given the specificity of the formerly planned economies where all almost all productive assets were in the possession or under tight control of the state. Privatisation in CEE countries is unique in many respects; the number of assets that changed owners is huge and touched upon almost all sectors of economy. The speed of the process compared to Western European cases was extremely fast especially in countries leading the reforms like Hungary.

Laws and institutions regulating the privatisation process itself as well as the functioning of a market economy had to be created. Privatisation promised to increase efficiency through the creation of real ownership. In other words, privatisation was considered the key factor in creating a healthy economy with competitive companies that provide jobs for people and pay taxes, rather than dependent upon state policies and subsidies, which was the case for many of the old socialist state owned firms. Looking back of the history of fifteen years of transition, it can be concluded that privatisation should not be the only factor and measure of economic success. Privatisation in itself proved to be an effective but not a sufficient condition for creating efficient corporate governance in formerly communist countries.

In 1996 the Municipality of Budapest published an international tendering process as a result of which in 1997 they concluded a public private partnership contract with two professional investors, the French SUEZ Lyonnaise des Eaux and the German RWE to operate the water utility of the City. After having considered several different versions of contracting a mixed delegated management contract a so called Affermage model was chosen by the municipality of Budapest. The contracting authority preferred an affermage model to a management contract because affermage transfers the commercial risk to the operators which is believed to create incentives to perform and assets are better maintained. However, we have to note that the Municipality of Budapest was also driven by short term goals, since a long term contract brought in more revenues, which were needed for the realisation of the then development plans of the city.

Imperatives for choosing a PPP model:

• The over aged network needed further investment, and the low water tariffs of the past decades did not allow a proper yearly reconstruction budget.

• No resources were available from the Municipality to support reconstruction.

• The Municipality's direct supervision and control over the company and its assets had to be maintained.

• Strategic investors were needed for the support of technology transfers, safe operations and customer orientation.

• Organisational and technical inefficiencies/processes needed to be reengineered and improved.

• The amount of overdue payments had to be radically reduced.

The private and public partnership structure encouraged Budapest Waterworks to develop its expertise and contributed to enhancing the quality of service and to operational efficiency thorough the successful realisation of the following programmes:

• Technical Development Programme

• Implementation of Geographic Information System (GIS) system, Digital utility registry

• Implementation of Systeme, Anwendungen und Produkte, integrated enterprise management software (SAP)

• Supervisory Control and Data Acquisition (SCADA)

• Work Force Management System

• Asset management

• Active Leakage Control, Water Loss Management

• Long term Development Programme

• Water Quality Improvement Programme

• Reorganisation of Customer Service Activities

• implementation of customer information system,

• centralised customer contacts

• set-up of contact centre (back office, call centre, front office, e-services)

A key objective for incorporating private investors is to improve efficiency. In practice the overall efficiency of Budapest Waterworks can be broadly captured by three main indicators: water losses, bill collection and labour productivity. As it is well seen from the below graphs, as a result of all the delivered actions, the efficiency improved significantly during these years.

In June 2012, the shares of Budapest Waterworks was repurchased by the Municipality of Budapest after lengthy negotiations with the investors at 15,1 M HUF.

One of the main reasons of the early termination of the contract was that the duration of the contract proved to be too long. As in case of Budapest Waterworks the management rights were purchased for 25 years, which in such a transitional period of time that Hungary was going through seemed to be unnecessary. The added value of the investors drastically decreased after 15 years. However, the return on investment on the investors’ side is calculated for the complete duration of the contract, which caused continuous tension between the city management and the operators.

Consumers have to pay the management fees or profits of the investors; while the private owners may only be interested in reducing costs, that only the local government may be sensitive to socials issues, especially as it happened after the municipal elections in 2010. In 2010 a new political party came into power, which considered the ownership of natural resources such as water of strategic importance and decided to return key assets to community ownership.

Furthermore, the mechanism of the contract did not regulate well the continuous revision of the provisions of the agreement. The lack of proper contract management was one of the underlying reasons for the change.

There is an almost desperate need for new investments in traditionally neglected sectors such as public transport, water and waste water management, natural gas supply and solid waste management, for which PPP can offer one solution.

Successful implementation of Public Private Partnership is a challenge for all, especially in the water sector. Each case shall be adapted to local conditions having considered pros and cons of each type of private funding. Moreover, it is crucial for the contracting authority to understand the drivers that attract private funding.