Implications of Private Ownership and Operations

Elizabeth Brubaker and Tom Adams
September 24, 2001

Energy Probe Research Foundation’ s Presentation to Justice O’ Connor
The Walkerton Inquiry, Public Hearings 7 & 8

(A list of EPRF’s recommendations regarding revenue, financing, and privatization appears at the end of this presentation.)

Elizabeth Brubaker:

During the oral arguments for Part One, you had exchanges with our lawyer, and with the lawyer for OPSEU, about the importance of concerning yourself with the quality of management. You suggested that there are arguably a number of vehicles to give us competent management. Good management, you said, might be provided by an accredited private firm, or OCWA, or a larger municipality, or a consolidation of small systems.

What we’re hoping to do in the course of this Inquiry is to persuade you that all of the items on that menu are not equally viable. We’re hoping to demonstrate that one of the options – privatization, combined with public regulation – is by its very nature better than the others. We’ll be arguing that privatization, when properly regulated, has inherent advantages – advantages that make private management superior to that found in the public sector.

I should mention at the outset that we’re defining privatization broadly. As you know, the term can encompass a whole range of private sector involvement. Most of what we will have to say about privatization’s benefits will apply primarily to long-term operations and maintenance contracts and to the sale of assets.

If we persuade you of privatization’s benefits, we ask you to endorse privatization in your report on this Inquiry. We’re asking you to put privatization forward not just as one of several mechanisms for achieving better quality management but as the superior choice.

We’re aware that you’ll be hearing a lot of opposition to privatization in tomorrow’s public hearing – especially from labour. You’ll doubtless get a demonstration of the political barriers to privatization. And while it may be appropriate for you to recognize those barriers in your report, we’re asking you not to let them interfere with your recommendations.

We don’t believe that the job of this Inquiry is to reach consensus on these issues. We don’t believe that the Inquiry should produce lowest-common-denominator recommendations. (By that I mean recommendations that are palatable to every party.) The Inquiry should discover and articulate the best solutions. We urge you to make principled recommendations and to leave compromise to the politicians.

That said, let me turn to the benefits of privatization.

You’ve already heard a good deal from us on this subject. You have the minutes from the expert meetings on public and private operations. You have our study entitled The Promise of Privatization, which documents the experiences in the US, the UK, and other jurisdictions. You also have our supplementary submission on privatization here in Ontario. That submission reviews a decade of interest in privatization and the reasons for that interest, or the anticipated benefits of privatization. I won’t try to cover everything in those studies today, but I’d certainly be happy to answer questions about any issues that arise in them.

As you know from our earlier submissions, we don’t believe that privatization is a magic solution to all of the problems plaguing our water systems. But we do believe that increased private sector involvement, with appropriate regulation, will greatly improve our odds of solving four major problems. 1) We need an injection of capital. The private sector is willing and able to provide it. 2) We need greater expertise. Private firms have it. 3) We need to be more efficient. The incentives are right in the private sector. And 4) We need stricter accountability. Privatization will bring it.

We’ll be addressing each of these issues in turn, but let me mention that even if our systems weren’t so badly broken, we would still be advocating privatization. We’re not recommending privatization because Ontario can’t avoid it. We’re urging municipalities to privatize not out of necessity but out of choice. And that’s because, regarding each of these different issues – investment, expertise, efficiency, and accountability – private utilities have inherent advantages over public utilities.

Let’s look at the issue of capital investment first. The need for investment in infrastructure has driven privatizations around the world. The public sector typically faces constraints on financing. And the private sector typically has access to enormous pools of capital. The need for capital investment was certainly a major reason behind the water privatization in England and Wales. There, water companies invested £33 billion in the first decade after privatization. As one official from the Department of the Environment said, “You just couldn’t contemplate that kind of expenditure in the absence of privatization.”

Here in Ontario, the need for capital investment has spurred arguments for privatization for a decade. Back in 1991, the MISA Advisory Committee recommended public-private partnerships as one way to finance water and sewage improvements. In 1993, the NDP government changed the Municipal Act in order to facilitate private investment. It did so because it was concerned about the gap between public outlays and capital needs. In 1995, provincial consultants again pointed to the substantial gap between government spending levels and capital requirements. They warned that it was a gap that the province would not, and could not, fill.

Today, that gap looms as large as ever – or perhaps even larger, given that our systems are aging and our population is growing. Nobody knows exactly how much capital is required, but virtually everyone agrees that we’re talking about many billions of dollars. A 1995 estimate put capital needs for water and wastewater at $2 billion a year. That figure is similar to one put forward by the Canadian Water and Wastewater Association in 1998. It estimated that Ontario would need to invest more than $32 billion over the course of 15 years – almost $13 billion in water and $19 billion in wastewater.

We haven’t seen any indication that the public sector will come forth with the amount of money needed. With recession in the wind, the likelihood is all the smaller. But what if the public sector could invest sufficiently? What if the province or the municipalities themselves were willing and able to borrow, or to raise taxes, or to otherwise obtain the money? Even if public money were available, we’d still advocate going with private money. There are a number of reasons for this. One has to do with opportunity costs. There are so many competing demands for our public funds. And those funds are limited. What we spend on water infrastructure we can’t spend on health, or education, or security. Why spend public money on water when the private sector is willing and able to foot the bill? Why not free up the money for other uses?

Another reason for using private rather than public money is that doing so transfers financial risks to the private sector. Moving risks away from the public purse comes up frequently in the government’s and its consultants arguments for privatization here in Ontario.

Tom Adams:

Yet another reason to go with private capital is that private investment is likely to be used more efficiently than public infrastructure spending. (Elizabeth will address operating efficiencies in a few minutes but for now I’m referring to capital efficiencies and not to operating efficiencies.) Public sector dollars are ultimately obtained from private individuals but those individuals have little reason or ability to influence how their dollars are used. The governance of the funds is instead in the hands of public officials who have no personal interest in the outcome of the expenditures. In Ontario’s water sector, one of the effects of relying on public financing has been that many water treatment facilities have been significantly overbuilt – which is tragically ironic considering the underfunding that persists throughout the sector generally.

This kind of gross inefficiency is less likely to happen with private capital, particularly if an appropriate regulatory regime is in place. Given the right institutional circumstances, private money comes with its own management. Lenders of private capital will want to ensure that the money is spent wisely. Lenders will apply their own due diligence to at-risk capital. As a result, overall capital costs to create needed facilities will be lower. That will free up capital for other important projects and minimize societal costs. Due diligence by at-risk lenders is also another safety device for our water system.

Elizabeth Brubaker:

The final reason to go with private money is to reduce the conflicts of interest that now hinder enforcement. When systems are financed publicly, the government understands that if it enforces the law and requires costly improvements, some level of government will have to foot the bill. Either taxes or the public debt will rise. That puts the government in a conflict. It makes it less likely to demand improvements.

So those are the four primary reasons to go with private capital: To meet investment needs. To offload risk. To increase efficiency. And to reduce regulatory conflicts.

Now, what about the operations side of things? Why do we favour private operations over public?

One argument for privatizing operations is that doing so will inject expertise into our systems. Of course, privatizing – especially if the contract is awarded to a new firm or a small firm – doesn’t guarantee this will happen. We believe that a system of accreditation is called for to ensure that those we entrust our water systems to are qualified for the job.

Tom Adams:

We have a modest amount of advice on accreditation. We think that there should be accreditation for both individuals and organizations to help ensure that acceptable performance qualifications have been achieved. There are accreditation models available that might be useful. Measurement Canada, the organization that administers meter verification for gas and electricity meters, has a regulatory process for the accreditation of meter verification shops. Through this process, direct oversight of verification is farmed out to others, and is not a hands-on responsibility of Measurement Canada. This process is part of a very successful, albeit slow to innovate, metering regime in Canada.

Another model that might be borrowed is the self-regulatory approach used in various sectors. An example of a self-regulating agency is the Ontario Energy Marketer Association (OEMA). OEMA is a federally incorporated non-profit organization. Previously operating under the name of the Direct Purchase Industry Committee, it has been operating since 1994. An organization formed by market stakeholders, its membership includes energy marketers, utility representatives, consultants, government agencies, and consumer groups. OEMA’s purpose is to advance the development of competitive energy marketing and to provide protection to energy consumers through the enforcement of codes on OEMA members. It will pursue the goal of becoming the licensor of all energy industry participants actively marketing in Ontario.

Elizabeth Brubaker:

It’s important to appreciate by how much some private water companies would exceed the demands of any accreditation program. It’s important to appreciate how much better qualified they are than their public counterparts. The larger private firms have far greater expertise than any Ontario municipality. Some of the large international firms have more than a century of experience. Some have more than a hundred million customers around the globe. These firms have thousands of employees whose expertise can be harnessed to solve local problems. They invest small fortunes in research and development. In 1999, the world’s two largest water companies invested almost 200 million US dollars between them on R&D in the water sector.

It was this kind of experience and expertise that persuaded Indianapolis to privatize the operation of its sewage system. The director of that city’s public works department said, “It’s just a different league. These guys have resources our guys could only dream of.” The mayor added that the company brought the city “some of the best technical experience in the world – the companies comprising the partnership employ more PhD civil engineers than the city of Indianapolis has employees. They literally wrote the book on water treatment.”

But let me ask the same question I asked a moment ago regarding capital. What if expertise weren’t an issue? What if public operators had, not necessarily the same level of expertise, but sufficient expertise? Even if that were the case, we would still advocate private operations. And that’s primarily because of the incentive structures that characterize them – at least in the right institutional environment.

Incentives to provide high quality service inhere in a competitive, regulated environment. The competition to obtain contracts rewards companies with good reputations – companies that have performed well in other communities. The drive to maintain and renew contracts keeps companies focussed on good performance. Contracts that are structured to reward improvements enhance these incentives. For example, the Milwaukee sewage contract includes bonuses if the contractor reduces the amount of BOD in plant effluent. This has given the contractor a powerful incentive to improve performance. In each of the three years since the contract was let, the contractor has earned $50,000 bonuses.

Competition for contracts also creates incentives to operate efficiently and thus to reduce the costs of providing service. In a non-competitive private environment – one in which assets are sold – incentives to operate efficiently are created through specific approaches to economic regulation. As long as the quality of service is regulated, efficiencies don’t come at the expense of good performance. Instead, they’re achieved through innovation and through the elimination of waste. Efficiencies also arise from the very structure of most private companies. They tend to be more flexible than public agencies, and capable of making faster decisions. They often link employees’ compensation with performance. Furthermore, the larger companies benefit from some economies of scale. And they have both the resources and the incentives to innovate. All of these factors translate into reduced construction times, improved service, and lower costs.

Indeed, the cost savings from privatization have been enormous. When Atlanta privatized its drinking water system, operating costs fell by 44 percent. The city will save US$400 million over the course of the 20-year contract. Atlanta is not unusual. In Houston, contracting out water plant operations brought savings of 43 percent. In Seattle, the contract to design, build, and operate a water filtration plant was priced at 40 percent below the city’s benchmark. In Indianapolis, privatizing sewage treatment reduced costs by 42 percent. In The Promise of Privatization, I reviewed a number of surveys of the cost savings from privatization. The numbers vary from study to study, but they’re generally in the range of 20 to 50 percent.

Cost savings of that magnitude would make a big difference to water systems here in Ontario. One company estimates that it could save Toronto between $95 million and $110 million every year if it managed the city’s water and wastewater systems. Other communities could realize proportional savings. Money that’s currently being used for operations would be freed up for capital expenditures. Because our capital needs are so great, consumers would probably still face rate increases, but they would be far more modest. That’s a persuasive argument for privatization.

But let me return to my “what if” line of questions. What if the public sector could become more efficient? To a limited extent, we’ve seen that happen at OCWA, where economic pressure has cut staff and competition has cut costs. What if that happened on a broader scale? What if we could devise incentives for public servants, municipal or provincial, to perform more efficiently? For the sake of argument, let’s lump all of my what-ifs together: What if the public sector could provide the capital, had the expertise, and could operate our systems effectively and efficiently?

That would certainly be an improvement. But it still wouldn’t address our final concern. And that’s our concern about accountability. We don’t believe that public owners and operators can be held fully accountable for their performance. We believe that a private owner or operator is inherently more accountable. It’s more accountable to municipal governments, to provincial regulators, to the public, and to the market.

We touched on some of the reasons for this at previous hearings. I want to expand on those comments now. First, let me address the matter of accountability to municipal governments. Privatization enhances accountability at the municipal level because it involves enforceable contracts. Contracts with specific performance criteria provide municipalities with powerful tools to compel compliance. Contracts can guarantee water quality, maintenance levels, and capital expenditures. They can require financial assurance. And they can include financial penalties for non-compliance.

Privatization also enhances accountability to the provincial government. By this I mean accountability through the setting and enforcement of regulations. Our research and our own experience lead us to believe that governments often demand better performance from private firms than from public operators.

Tom Adams:

Our foundation encountered this attitude in the Ministry of Environment when we tried to prosecute it for the discharge of arsenic and other toxins from the Deloro mine site. MOE didn’t create that mess, but it has controlled the site for more than 20 years. At the 1999 trial, the government’s main witness was Brian Ward, the regional director for the eastern region of MOE. Mr. Ward suggested that standards should be higher for the private sector than for the public sector. His reasoning was that the former profits from the activity whereas the latter doesn’t. Justice Dorval asked, “So the requirements of the Ministry of Environment depend on how much profit you gain from the site?” And Mr. Ward answered, “Well, if you’ve gained profit, you have a full responsibility to correct the problem in a timely fashion.” He added, “I think there’s a higher onus on the private sector who has benefited from it to, in a timely way, address the problems.”

There also seems to be a belief within MOE that compliance requirements are laxer for the public sector, and that public polluters who don’t comply with the law should be dealt with gently. Mr. Ward told the Deloro trial that MOE should not go after itself. He testified that when the ministry is remediating sites, it should not be subject to investigation or prosecution.

This summer, another MOE employee contended that the ministry should not have to meet discharge limits set out in Deloro’s Certificate of Approval. When arsenic levels exceeded those in the C of A, Jim Ritter, who’s in charge of the site cleanup project for the ministry, insisted that the limits in the C of A are “only objectives.” He told the Kingston Whig-Standard, “In low-flow years they can’t be met and in low-flow years they won’t be met…”

Elizabeth Brubaker:

We don’t know whether these are merely the opinions of one regional director and one project manager, or whether they’re endemic in MOE. But, more generally, we do know that people at the highest levels of the ministry think that it’s easier to prosecute the private sector. You’ll remember that Norm Sterling told Part One of the Inquiry that privatization would bring better enforcement of regulations. He said that it’s easier for the government to regulate the private sector. He said that there’s no potential conflict of interest. As a result, there’s less political interference, and less reluctance to prosecute.

Ontario’s limited experience with privatization suggests that that is indeed the case. In Hamilton, enforcement has gotten much tougher since privatization. Hamilton’s sewage treatment plants have a long history of violations. They made eight appearances on non-compliance lists between 1987 and 1994. They weren’t prosecuted once. Hamilton contracted out operations in 1995. The plants continued to experience problems. But there was a sea change in people’s attitudes towards those problems. The union became extremely critical, and pressured the ministry to enforce environmental laws. It took a while, but the ministry did act: It has laid 22 charges. It’s undeniable that both the union and the ministry are holding the private operator to higher standards than those to which they held its public predecessor.

The same thing has happened in other jurisdictions, most notably in England and Wales. Before privatization, the government understood that it was in a conflict of interest that prevented it from enforcing tough standards. In its words, it was both the poacher and the gamekeeper. Privatization changed that. It separated the operator from the regulator. One regulator identified this separation as the “most significant gain” of water privatization.

Since privatization, the system of water regulation in the UK has become one of the toughest in the world. In its report on the management and financing of drinking water systems, Pollution Probe praised the system, calling it “the most advanced system of regulatory supervision and enforcement.” As a result of this new system, drinking water quality has improved steadily under privatization. Pesticides have been virtually eliminated. There have been significant reductions in lead, faecal coliforms, aluminum, and iron. The Drinking Water Inspectorate reported in July that water quality continues to improve. It attributed the progress in part to its strict enforcement policy emphasizing investigations and prosecutions. That is a product of privatization.

Now, we shouldn’t fool ourselves into thinking that privatization will solve all regulatory problems. We know that successive governments have tolerated private pollution as well as public pollution. In eliminating the conflicts of interest that discourage regulation and enforcement, privatization will increase the odds of accountability to government. But it won’t guarantee anything. And that’s why it’s important to have another level of accountability: accountability to the public.

The public is able to hold private water providers more accountable than public water providers. Back in July, at the first public hearing, you asked me if legal accountability is different for those who work in private and municipal systems. At the time, I mentioned that municipalities and their employees enjoy certain liability limitations under the Municipal Act. I also mentioned that private boards of directors may be held to a higher standard of care than PUC commissioners.

However, I neglected to mention several other differences in the liability of public and private providers. One major difference is that governments are immune from tort liability for the consequences of their policy decisions. Under that umbrella, courts have ruled that governments shouldn’t be liable for the results of decisions based on economic expediency. Budgeting is thought to be a matter for the political process, and not for the courts. This doesn’t have any parallel in the private sector. A private water company can’t defend itself by arguing that it had a policy not to repair pipes or that it had decided not to budget for repairs that year.

Another difference between public and private providers may lie in the remedies available to those who sue them. The courts cannot grant injunctions against the crown or its servants. I don’t know whether this protection would or would not extend to OCWA. It would be worth looking into.

There’s one other important difference in the liability of public and private providers, and that’s a difference in the consequences of liability. The consequences of being found liable for a particular failure are often more serious in the private sector. The individuals who are responsible are more likely to lose their jobs. The companies are more likely to feel real financial heat. Damages levied against them will come out of their profits. If the damages are big enough, they could threaten the company’s very existence. Because private decision makers will bear the costs of their decisions, liability has a great deterrent value. That deterrent is diminished in the public sector. Liability doesn’t personally threaten public providers. Public decision makers don’t usually foot the bills for their mistakes. Municipalities offload financial responsibility to their taxpayers. And OCWA is backed by the province’s financial guarantee: The government will pay any judgment against it from the Consolidated Revenue Fund. Because the liability is less direct, the public sector’s accountability to the public through the courts is reduced.

I was intrigued by an article that appeared in the National Post in August. It was about the response to the cryptosporidium outbreak in North Battleford. It reported that only 460 residents had joined a lawsuit against the city, and attributed that low number to the pressure that citizens felt not to sue their own city. “Don’t sue yourself,” they were being urged. If that water system had been private, I can’t imagine that citizens would have felt the same reluctance to hold it accountable.

There is one other form of accountability that I want to discuss today. And that’s the accountability that inheres in the market. In a private system, the market provides a kind of enforcement. Last week, after MOE announced that Dofasco faced three charges related to an oil spill, shares in the company closed down 8 percent. Investors were punishing the company for poor performance. They were holding it accountable. That doesn’t happen in the public sector.

Market accountability works on a larger scale as well. Clients and potential clients hold irresponsible companies accountable by refusing to work with them. As the president of Azurix said, “If you are negligent, you are history.” Erv McIntyre confirmed this in Part One of the Inquiry. Private-sector suppliers, he said, “couldn’t stay … in the business of providing water if they were providing unsafe water. If you were a customer, would you buy their water from them?” If the owners of private water works made a mistake, he repeated, “they’d be put out of business.” That punishment doesn’t threaten municipal or provincial service providers. And that makes them less accountable.

Those, then, are the four primary reasons that we believe privatization is the superior choice for municipalities. It will provide capital investment, expertise, efficiency, and more complete accountability.

An obvious question arises: If privatization is so clearly beneficial, why haven’t we seen more of it? Of course, we’ve seen a huge amount of it elsewhere in the world in the last decade. And even here in Ontario, some municipalities are moving in the right direction. Just last week, London announced its choice of a private operator for its water systems. However, for a number of reasons, progress has been slower here than elsewhere.

One factor is that municipalities have been quite comfortable with the status quo. The province has allowed them to flout laws and regulations. It has protected them from liability when things go wrong. They haven’t had much of an incentive to seek private sector expertise. The same can be said of private capital. The province has been happy to pick up the tab for many capital improvements. If public money is readily available, why bother with private money?

At previous hearings, we’ve recommended that the province strictly enforce laws protecting public health and the environment. We’ve recommended that it remove liability limitations on municipalities, utilities, and their employees. And we’ve recommended that it stop subsidizing water and wastewater services. We believe that all of these things should happen regardless of privatization. But we also believe that implementing these changes will encourage municipalities to look to the private sector for assistance.

Another impediment to privatization has been the lack of information on privatization’s benefits and the lack of instruction on how to go about privatizing. In the US, the EPA has actively promoted privatization. We haven’t seen anything like that here. In fact, although the provincial Cabinet adopted a policy promoting privatization in 1996, the government kept the policy under wraps. It never informed municipalities of it. Last summer, Premier Harris even went so far as to say that nobody was considering any privatization of water or sewer systems.

It’s time for the government to demonstrate the courage of its convictions. It should publicly endorse privatization. It should issue a policy statement explaining the benefits of privatization. And it should distribute that statement to all municipalities.

The government should also facilitate privatization. It should prepare case studies to illustrate how different approaches to privatization have worked best in different circumstances. It should prepare model Requests for Expressions of Interest and Requests for Proposals, along with information to guide municipalities through the bidding process. And it should distribute model contracts. These kinds of tools would help municipalities, particularly the smaller ones.

In order to create a competitive environment in the province – in order to create the conditions in which privatization can thrive – the government should also disband OCWA. The agency is a serious impediment to competition. We have made a written submission on OCWA that draws on some of the documents that were made available through the Inquiry. In it we argue that OCWA embodies a conflict of interest for the government, that it is an unsuccessful business, both financially and in operations and management, that its policies and practices are often in opposition to the public interest, and that it enjoys unfair advantages over its competitors. We discussed these issues at the second public hearing, and presented our recommendations.

Tom Adams:

I want to address one issue you raised at that time. You asked, if OCWA operated efficiently, would consumers benefit, since they wouldn’t be paying for profit? There are two aspects of this question: How could OCWA be efficient, and does the absence of profit confer benefits on consumers? We see consumer benefits bestowed by OCWA to be a reflection of subsidies, not efficiencies. Elizabeth’s written review of OCWA looks at OCWA’s efficiency so I will leave that issue aside. We agree that looking narrowly at the question of consumer rate minimization, the fact that OCWA’s special status protects it from the normal costs of capital, of which profit is simply another cost, does confer benefits. But we do recommend a caveat in considering this consumer benefit. It may only be a short term benefit. Eliminating the profit motive is achieved by the provincial government subsidizing OCWA by giving it access to public capital and liability protection. Access to public capital and liability protection has the effect of making the element of risk apparently disappear from OCWA’s decision-making environment. Artificially eliminating the element of risk can stimulate blind risk taking that can result in higher long-term costs. A recent example of this unfortunate phenomenon is the recently disbanded Ontario Hydro. The Ontario Hydro experience should prove to us the necessity of containing risks created by Crown corporations. If OCWA is not disbanded as we have recommended, at minimum it must be required to make a reasonable profit on resources invested and to dividend surplus cash to its shareholder.

Another institutional barrier to the full privatization of municipal water facilities is the province’s requirement that municipalities return provincial grants received since 1978 if they sell facilities that benefitted from the grants. We recommend that the government remove this requirement.

The policy of requiring grant repayment contradicts government policies endorsing privatization. The repayment policy appears to have been introduced to deliberately thwart privatization in response to political pressure and has the appearance of being purely arbitrary. Minister Sterling provided an explanation of the policy in his presentation to the Inquiry on June 27th.

The market value of municipal water assets is a function of its going-forward stream of expected net benefits. The historical costs sunk in these assets may have nothing to do with their current value. The value of previously granted funds is not necessarily recoverable from existing assets. For municipal assets in this situation, the repayment policy is a virtual prohibition on their sale. Circumstances that might lead to previous grants being unrecoverable might include instances where the grants were used to construct oversized facilities with high operating costs or instances where performance requirements and the revenue outlook are such that the book value of the assets overstates their market value.

The government might be concerned that cashing in grants through privatization creates the potential for municipalities to divert funds to uses other than water service for consumers, the original purpose of the grants. Proper administration of rates, preferably through independent, arms-length, public regulation, provides a process to eliminate this concern. Rates can be lowered so that owners do not recover the capital costs of any grants. In an environment where rates are based on cost-of-service, which is Energy Probe Research Foundation’s proposal for water services, rates are set to recover the annualized impact of capital costs. The concept of the “rate base” is used to calculate this annual cost, where the rate base reflects the net current investment in assets. The interest, depreciation, preferred share costs, and dividends payable by the utility for this rate base are included in rates. Capital costs not included in the rate base are not recovered in the rate. If the cost of grants were not included in the rate base, any benefits from the grants would flow directly to consumers at no charge. If this rule is understood in advance, then potential buyers of municipal water assets would know that they must adjust their revenue expectations to reflect this fact.

Accounting and regulatory practices in Ontario’s natural gas sector include a close analogue for this proposed treatment. It is normal for some particular customers seeking access to some gas distribution systems to make capital contributions to the system called contributions-in-aid-of-construction (CIAC). The accounting treatment for CIAC excludes these from the definition of the distribution utility’s rate base.

Recommendations for Public Hearings 7 and 8

Revenue and Financing

The government should promote full cost pricing of water and wastewater services. Consumers should pay the full costs of constructing and operating water and wastewater systems. Full cost pricing and user pay encourage the efficient use and conservation of water resources, provide the means to support the provision of the service, rationalize investment, and encourage private sector investment.

Despite decades of broad support from governments, scholars, and NGOs, full-cost pricing has not been implemented. There has been no mechanism to implement it. Pricing has been in the hands of municipalities whose short-term priorities have been inconsistent with the long-term needs of the system. The implementation of full cost pricing will require that decisions be taken out of the hands of municipal politicians. Decisions on pricing should be made by an independent economic regulator. (See below.)

The government should phase out all direct and indirect subsidies to water and wastewater systems. Removing subsidies improves accountability, disciplines providers, reduces the existing dependence of municipalities, reduces perverse incentives (including the incentives to overbuild facilities and to allow facilities to run down), encourages conservation, and rationalizes decisions regarding where individuals and industries locate.

If particular users cannot afford to pay the full cost of water and wastewater services, the provincial government should provide these individual users with cash subsidies unrelated to their usage. This will encourage equity, efficiency, and conservation. Individuals will use their subsidies as they see fit.

Water systems should be financed privately. There is an acute need for replacement and upgrading of water and wastewater systems. Public sector financing is limited and is likely to be insufficient to meet infrastructure needs. Furthermore, public sector investment undermines the independence of public sector regulation. Reliance on private capital facilitates independent regulation.

The government should establish an independent, quasi-judicial economic regulator. The future safety of water supply in Ontario requires capable oversight of financing and revenue. Determining revenue requirements, allocating costs to customer classes, and designing rate structures is a demanding task and the expertise required to do so is not widely available to municipalities. The Ontario Energy Board’s oversight of the province’s natural gas distribution sector until 1998 provides a model of successful regulation.

The regulator should be charged with determining just and reasonable rates and with protecting the public interest. It should encourage public participation in the regulatory process. Due process should be available to all parties. The regulator’s decisions should be subject to judicial review. Regulators need adequate resources; regulatory costs should be recovered from users.

Just and reasonable rates should include reasonable returns on capital.

Utility assets should be financed through efficient capital structures. The balance between equity and debt should be overseen by the economic regulator.


The private sector should finance, operate, manage, and in many cases own water and wastewater systems. The benefits of the private provision of water and wastewater services may include: access to expertise; access to private capital; de-politicization of management decisions; staffing and operating efficiencies; willingness to charge prices that fully reflect costs; direct liability; and increased accountability.

The provincial government should not operate water and wastewater facilities. It should disband the Ontario Clean Water Agency (OCWA). If the government choses to maintain OCWA, it should level the playing field to avoid undermining competition and discouraging private-sector involvement in the industry. It should create an arms-length relationship with the agency, withdraw all subsidies to it, impose a dividend policy that requires it to turn over surplus cash to the public, and hold it accountable for its performance by strictly enforcing environmental and health standards at its facilities. If the government does not remove OCWA’s special privileges, and if it insists on maintaining the agency as an operator of last resort, it should allow it to accept contracts only if there is insufficient competition among other bidders.

The government should endorse privatization. It should issue a policy statement explaining the benefits of privatization. The government should distribute the policy statement to the media and to all municipalities.

The government should facilitate privatization. It should prepare case studies of privatization to illustrate how different approaches to privatization have worked best in different circumstances. It should prepare model Requests for Expressions of Interest and Requests for Proposals, along with information to guide municipalities through the bidding process. It should distribute model contracts. It should provide advice on how to make privatization work for labour, so as to reduce opposition to it from that sector.

The government should remove barriers to privatization. It should strictly enforce laws protecting public health and the environment. It should remove liability limitations on municipalities, municipal utilities, and their employees. It should stop subsidizing water and wastewater services. It should remove the requirement that municipalities that sell their facilities repay grants. It should disband OCWA. (See above.)

Privatization will be most effective when it occurs in a competitive environment. Municipalities that privatize should avoid the sole-sourcing of sales or contracts.

Corruption must be avoided – and be seen to be avoided – if privatization’s benefits are to be realized. Privatization processes should be open, transparent, fair, and free of opportunities for influence. Robust access to information laws will increase transparency and accountability. Prohibiting campaign contributions from corporations and trade unions will reduce opportunities for influence. Restrictions on municipal politicians’ and bureaucrats’ freedom to take contracts or employment with those they have assisted while in government will further enhance the integrity of the privatization process.

Water and wastewater utilities should be subject to thorough, routine disclosure requirements for economic and quality data.

Privatization will require effective economic and environmental regulation. (See recommendations made at previous hearings.)


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