Water Privatization Can Help Detroit Avoid Drowning in Debt

Table 1

Water may be essential to human life, but is it essential that municipal governments own and operate water distribution systems and departments?

There is little question that a centralized source of water distribution is an efficient and effective way for people to obtain this life-sustaining resource. It need not, however, be a full-time job for the city of Detroit.

Detroit's water system services approximately 4.2 million people in 122 Michigan communities, pumping as much as 700 million gallons of water per day through 3,400 miles of transmission and distribution mains, all over a service area of 981 square miles. There are 15 pumping stations and five booster stations in the system, according to the Detroit Water and Sewerage Department's Web site.

Contracting out the city's water supply operations — even selling them to a private utility provider — could result in lower water bill rates and improved, more efficient services that save the city much-needed dollars. Detroit could best serve its many customers by either contracting out for operation and management of the water system or by selling the system to an investor-owned utility and relinquishing the role of water provider altogether.

Privatization of water systems is nothing new. Nationwide, the practice of involving the private sector in municipal management has grown substantially. Indeed, a series of surveys conducted by the International City/County Management Association between 1988 and 1997 showed that the service of water distribution by private companies (operating under contract or as an investor-owned utility) increased 84 percent.

There are even government-owned water utilities that are paying themselves "profits" out of the equity earned by the utility. That is, they operate very much like a private company. Cities with such an arrangement include Cincinnati, Ohio; Lancaster and Bethlehem, Pa.; Baltimore, Md.; and Edmonton, Alberta.

By several measures, Detroit's water distribution system is operating inefficiently. Consider how Detroit compares with Chicago, according to several commonly used standards of efficiency. Detroit produces an average of 673 million gallons of water per day. That works out to approximately 3.5 water department employees per million gallons daily (MGD). By contrast, Chicago produces 1 billion gallons of water per day. Its number of employees per million gallons daily is a mere two. Economies of scale probably account for some of Chicago's superior efficiency, but Philadelphia's water system is half the size of Detroit's and still outperforms Detroit's department.

The National Association of Water Companies reverses the above ratio to measure efficiency. That is, it divides the number of employees into the millions of gallons per day figure (see Table 1.)

Some observers note that Detroit charges less money per gallon of water than other major cities, such as Philadelphia or Boston, which charge $15 and $20 per 7,500 gallons, respectively. But utility expert and consultant Hank Mulle of H.G. Mulle and Associates doesn't believe this necessarily indicates greater efficiency. He notes that every system treats its water differently, depending upon local environmental factors. Philadelphia, for instance, has severe purification problems and Boston's well fields suffer from saltwater intrusion. The costs for treating these unique geographical distinctions are passed along to consumers in the form of higher rates.

One way for Detroit to operate a more efficient, money-saving water distribution system would be to retain ownership of the system but contract out for the various services it involves. There is no shortage of examples of how this might be done. As of 1997, there were over 400 privately operated but publicly owned water utilities in America. There are 10 in Michigan. These are based on contractual arrangements between municipalities and private companies for operations and management services such as maintenance and billing. The Los Angeles-based Reason Foundation reports that savings from such contracts average between 10 and 25 percent. Shaving just 20 percent from Detroit's $236 million water budget could save $47.2 million annually, assuming water rates and fees remain the same.

Earth Tech, Michigan's largest private water and wastewater management firm, might be a good place to start. It holds seven water distribution contracts in the state. Typically, Earth Tech has saved its Michigan clients between 10 and 30 percent on water distribution. The company's largest Michigan client, the city of Portage, contracts for water and wastewater operations. The firm operates the entire system with only 22 employees. This works out to an employee-to-millions of gallons per day ratio of 1.1, far below Detroit's 3.5. Earth Tech also handles 13 wastewater contracts in Michigan and performs billing for three clients.

Another option for Detroit officials would be to sell off the water system to private investors in the form of a utility. As of 1997, 15 percent of the American population got its water from investor-owned utilities. The nearest examples are the water distribution systems in Indianapolis, Ind., and Calumet, Mich. In France and Britain, a respective 75 and 100 percent of citizens get their water from investor-owned companies. Firms in both countries have been trying to get a foothold in the giant $300 billion American water distribution industry, and currently own water utilities in New Jersey, Connecticut, and portions of utilities in other locales.

Detroit's water efficiency does not stack up well against other municipalities. How does it fare against investor-owned utilities? The first two columns in Table 2 represent data from a 1996 Reason Foundation study entitled, Restructuring America's Water Industry: Comparing Investor-Owned and Government- Owned Water Systems. The third column reports Detroit's water expenses per connection, and employees per connection. As the data suggests, Detroit could may be able to improve its efficiency dramatically if it would sell the system to a private concern.

Using industry norms for calculating value and subtracting liabilities, the Mackinac Center for Public Policy calculates that Detroit's water system would sell for a price ranging anywhere from $1.775 billion and $2.285 billion. The size of such a sale would probably limit potential bidders to America's Earth Tech and several European companies.

There are many advantages to selling Detroit's water system. First, it would result in substantial savings for the city. Second, it would create a new source of revenue, since its owners would pay substantial property and income taxes into the municipal treasury. Third, it would mitigate the city's need to borrow money for any kind to support repairs and upkeep, much of which is mandated by the federal government.

The latter reason is all the more important to Detroit because the city will soon be forced to upgrade its water operations in order to comply with new environmental legislation. At a Sept. 12 federal court hearing on water compliance, Jim Murray, director of Wayne County's Department of Environment, said it would cost $3 billion to bring the city's water system into compliance with federal mandates emanating from the Clean Water Act.

Mayor Archer reported in a speech earlier this year that Detroit's water system would need an annual investment of $1 billion per year for the next 10 years to comply with these mandates and to maintain or improve infrastructure not covered by federal mandates.

Detroit is not the only city suffering from the burden of these new federal mandates. The Environmental Protection Agency and other organizations estimate that municipalities nationwide will have to spend over $500 billion to $1 trillion in compliance costs by 2005.

However, a tax increase on Detroit citizens to pay for environmental mandates is unlikely because the city does not fund its water operations from property taxes and because two-thirds of those using the city water system live outside the city limits. Therefore, the most likely source of funds will come from a rate hike. But this would be tantamount to forcing nonresidents to subsidize city residents because suburban water-supply systems require much less work.

These factors make water privatization far more than just an option for the city of Detroit. To deal with the costs that loom on the horizon, the Motor City will have to do everything in its power to save money. Privatization offers not only a way to do this, but opens up possibilities for more efficient and better water service for the city and its suburbs.

Brennan Brown is pursuing his master's degree in business administration from Central Michigan University.