4.0 FINDINGS, CONCLUSIONS AND RECOMMENDED NEXT STEPS

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1 4.0 FINDINGS, CONCLUSIONS AND RECOMMENDED NEXT STEPS 4.1 FINDINGS 1. The primary obligation of a water and wastewater utility is to be effective in providing service to its customers, specifically, to deliver clean, safe drinking water and to collect and treat wastewater. In terms of this primary obligation, WSSC, a publicly-owned and operated utility, demonstrates superior performance. 2. Currently, the major factors which typically drive public utilities to privatize all or a part of their operations are not apparent at WSSC. Factors which typically drive privatization are: Need for large cash infusion to address capital needs (WSSC has no such need nor have the Counties indicated this is a driving force.) Failure to meet regulatory requirements or conditions of a consent order (WSSC has an excellent record of regulatory compliance and a demonstrated history of going beyond the minimum regulatory requirements.) Rapidly increasing rates during the past few years (Although WSSC rates are at the higher end of those in the region, WSSC is in its second year of no rate increase.) Reasons cited for studying potential privatization alternatives for WSSC include: dissatisfaction with governance structure and its inability to reach mutually agreeable decisions between the two Counties on certain important issues, and the resulting costs, delays and, at times, unwarranted expenditures high cost of service dissatisfaction by developers with recent imposition of a System Development Charge differences of opinion and difficulties in reaching consensus between Counties and WSSC on long-term planning issues and in general lack of responsiveness to County requests lack of internal WSSC leadership inefficiency of WSSC management, administration and operation 4-1

2 3. WSSC is unique in that it is a bi-county agency created by the State of Maryland to serve Prince George s and Montgomery Counties. This bi-county governance structure has resulted in issues related to (a) a currently strained bi-county decision making process that is cumbersome in solving problems when the Counties deadlock, and (b) a desire by each County to control certain decisions currently made by WSSC. 4. A wide spectrum of alternative ownership and operation scenarios are possible. This report evaluates the following five scenarios: Full Asset Sale Full Contract Operations County-owned and operated Systems, bifurcated along County lines County-ownership and operation of Retail aspects of the System bifurcated along County lines Restructured WSSC with CAP Plus At this time, no legal fatal flaws have been identified for moving forward with any of these alternatives. 5. Based on a limited review of the marketplace and informal discussions with private sector entities, there are a sufficient number of private sector companies (at least five) with an interest in and capacity to pursue any of the privatization options evaluated from full asset sale (or lease) to full contract operations - or any subset thereof. These private sector industry leaders have demonstrated experience in providing effective and efficient water and/or wastewater services. Although a due diligence analysis has not been performed, it appears likely that if asset sale were pursued, sufficient qualified participants would respond to have a competitive procurement. 6. The major advantages of private sector alternatives management expertise, capital for investment in new technologies, increased operational efficiencies, higher pay scale (although possibly accompanied with lower retirement benefits for future employees), are available to public utilities through any of the forms of private involvement evaluated asset sale, asset lease or contract operations. Therefore, the decision of whether or not it is reasonable to sell WSSC can be evaluated solely on the basis of the advantages and disadvantages of the sale of a system and separate from the issues of savings due to efficiencies since these are attainable through other means. 4-2

3 4.2 CONCLUSIONS Based on the evaluation and findings presented, the following conclusions have been developed: 1. WSSC is effective in providing its customers with adequate, safe and reliable water and environmentally-favorable wastewater treatment services in a manner that is in accordance with regulatory and environmental requirements. 2. In performing its water and wastewater services, WSSC=s current costs are high compared to costs charged by other regional utilities. There are several key factors related to WSSC=s current costs: A major factor in this higher cost is the current debt burden which, even after excluding debt to be funded by front foot benefit charges, represents a higher than desirable portion of the annual operating costs. A major contributor to the current debt levels is that the cost of expanding the water/sewer system to serve growth/growth projections was borne by the ratepayers, not the developers until the recent institution of a system development charge. Some expenditures which increase WSSC=s costs represent voluntary actions initiated by the Counties or the WSSC to offer additional protection of human health, to reduce environmental impact, to provide higher quality service, to enhance overall quality of life or provide some other perceived benefit to the public. Other expenditures impacting WSSC=s cost are the result of inefficiencies related to the governance, management, capital improvements planning and implementation, system operations and administration support services performed by WSSC. 3. Significant opportunity exists for increasing the efficiency with which water and wastewater services are provided to Montgomery and Prince George=s Counties. 4. Substantial barriers exist within WSSC and its governance structure which limit its ability to take full advantage of the opportunities for increased efficiency. We believe that WSSC is unlikely to overcome all of these barriers without some level of restructuring. 5. WSSC is in the process of implementing a Competitive Action Program (CAP) which is designed to reduce 1996 annual operating costs by $25 million by the year Reengineered processes have been identified by work teams that will save an additional $15 million beyond year CAP includes an attrition only policy for staff reductions. The CAP program recognizes that greater efficiencies are possible beyond the first phase of the program. 4-3

4 6. While all of the evaluation criteria are significant in considering the five Base Case Scenarios, the following seven criteria have been identified as key drivers in differentiating among the alternatives: Effectiveness Enhanced Environmental Protection Governance Issues Employee Issues Public/Community Needs Administrative/Management/Institutional Issues Economic Issues Effectiveness - All five scenarios are capable of providing effective service, which includes provision of adequate supply of clean water, returning clean water to the environment while complying with regulations, maintenance of the system/protection of the public investment, and being responsive to customers, developers, the Counties, and regulators. The major difference among the five Base Case Scenarios with regard to effectiveness is the nature in which each generates the rates and fees needed to maintain the effectiveness of the system, both in terms of annual operating and maintenance costs and long-term capital improvements. These differences can impact on the long-term delivery of effective service. Under the asset sale scenario, the private owner would submit a rate case to the PSC for approval, and the PSC would review the adequacy of available funds for not only system operation but long-term system maintenance and upgrade. Under three scenarios (contract operations, wholesale/retail, and restructured WSSC with CAP Plus), the current rate setting procedures would be maintained. All three scenarios may include a change in the structure of the WSSC Commission to reduce the opportunity for deadlock on rate setting and other decisions. The two County-operated system scenario would rely on each County government to assess rate increases that will be sufficient to cover both annual operating and long-term capital needs. Rate increase approvals are typically more difficult for municipalities than for private companies due to public pressures to maintain the lowest possible rates. Typically, the private sector is only required to furnish convincing evidence that an increase in rates is supported by essential capital needs, and to demonstrate efficient operations. 4-4

5 Enhanced Environmental Protection - Under all five scenarios, the system owner and operator is required to meet all federal and state regulatory and environmental protection requirements. In terms of enhanced environmental protection, under three of the scenarios (contract operations, wholesale/retail and restructured WSSC with CAP Plus), the WSSC is retained as owner of the major water and wastewater systems. Each of these three scenarios would continue WSSC s strong commitment to enhanced environmental protection. Under the remaining two scenarios (asset sale and two county operated system), the new owner s policies regarding enhanced environmental protection, their public image, national reputation, and its level of success at raising revenues to provide these services would likely determine the level of enhanced environmental protection which is maintained in the long term. A major issue related to evaluation of any change in ownership of the WSSC system is the final disposition of the water resource itself as well as sensitive environmental properties, including but not limited to: Little Seneca Lake All other reservoirs Watershed buffer properties Non-watershed buffer properties currently providing public and environmental benefit In general, the water asset is available for use by the WSSC through a water allocation permit regulated by the State. This same type of limited access to water use under the regulated protection of the State would apply to each Base Case Scenario. Without specific action to the contrary the Asset Sale or the Two County Operated System Base Case Scenarios would transfer ownership of these land assets. Discussions with the Task Force members, the public and private sector firms all indicate that consideration of any future transfer of WSSC assets should not include transfer of sensitive environmental properties which the Counties, the WSSC and the public would intend to be essentially permanently protected from other users. This protection would be provided by maintaining public ownership of these sensitive properties. Governance Issues - Two scenarios (asset sale and two county operated system) significantly change the governance of the water and wastewater utility. Under each of these two scenarios, the WSSC ceases to exist. Under the asset sale scenario, a new governance structure would exist with the private owner and the PSC (regulating system rates, etc.) as the major entities involved. Under the two county operated system scenario, each county would be responsible for the system within its borders, and the individual county governments would form the governance structure. 4-5

6 The remaining three scenarios (contract operations, wholesale/retail and restructured WSSC with CAP Plus) will continue to have the WSSC Commission and in general, its current governance structure, although consideration of modifying the existing governance structure consistent with items 1, 2, 3, or Section 3.3.5, or otherwise, is warranted. Employee Issues - Two types of employee issues were addressed: impact on current employees, and impact on future employees; i.e., salary, benefits, training, potential for advancement, etc., for staff retained long-term by the new owner of the system. In terms of the impact on current employees, all scenarios involve a change in the WSSC workforce. Two base case scenarios offer less change - wholesale/retail and restructured WSSC with CAP Plus. Under each of these base case scenarios, existing employees would be impacted by the implementation of WSSC s CAP or CAP Plus programs, each of which include a no layoff policy, but would reduce overall staffing levels. For example, reductions in staffing anticipated under the CAP Plus alternative represent 1/3 of 1996 staffing levels. Under these two scenarios, either all (restructured WSSC with CAP Plus) or most (wholesale/retail) of the employees will remain as WSSC staff. The asset sale and contract operations scenarios may also adopt a no layoff policy, but through use of (1) attrition, (2) staff voluntarily accepting a buy-out offer, (3) staff voluntarily accepting a position at another location within the private company s organization, or (4) failure to pass drug testing (a condition of the no layoff policy), are expected to further reduce the number of total staff. In terms of future employees, the core aspects (salary scale, retirement benefits, general leave policies, collective bargaining agreements) of WSSC employment would be retained by all staff under the restructured WSSC with CAP Plus scenario and by the retained WSSC staff under the wholesale/retail scenario. Under the other three scenarios (asset sale, contract operations and two county operated systems), as well as partially under the wholesale/retail scenario, staff would be transferred to a new employer, introducing some change for new county employees and potentially greater changes for contract operations and asset sale employees. Transfers to county or private company employers can offer staff a variety of new opportunities. Private sector firms typically offer staff options for continued employment at their current location, or voluntary resignation with a buyout bonus, or opportunity for relocation. Private companies are typically national or global in scale and can offer opportunities beyond the borders of the two counties which may include opportunities for career advancement. For existing employees, the retention of existing retirement packages is a key consideration. For new staff, employee compensation and employee bargaining rights appear to be relatively consistent among the alternatives, with 4-6

7 possibly somewhat higher compensation for Montgomery County and private company employees. Public/Community Needs - All scenarios are capable of protecting the public s infrastructure investment, subject to their ability to continue to raise revenues for long-term system maintenance and upgrade. The two county operated system, wholesale/retail and restructured WSSC with CAP Plus scenarios offer control of the number of local staff and local businesses to the local municipalities and/or WSSC. Under the asset sale scenario, the private owner would be the employer and ultimately determine the level of opportunities for employment of county residents and utilization of county businesses for all services. Under the contract operations scenario, the private operator would be the employer and ultimately determine the level of opportunities for employment of county residents and utilization of county businesses for out-sourced services under their contract. It is possible to dictate in any of these agreements the level of local business or resident utilization. Administrative/Management/Institutional Issues - The availability of service providers is not an issue for any of the five scenarios. The level of MBE participation is directly under the control of each county in the two county-operated system scenario and split between the Counties and WSSC in the wholesale/retail scenario. Under restructured WSSC with CAP Plus, the WSSC MBE goals would apply while WSSC/County MBE goals could be imposed through the private operator s contract under contract operations. Under the asset sale scenario, MBE participation would be at the discretion of the private owner. In terms of management complexity, asset sale offers less management complexity than the other four options. In terms of impacts on current WSSC contracts, rights and responsibilities, asset sale and two county operated systems require numerous legal, institutional and administrative changes to be implemented. In terms of technical feasibility, the major issue is the geographic interdependence of the system when addressing the two county-operated system scenario. The contract operations and restructured WSSC with CAP Plus alternatives are least complex to implement. All alternatives will take at least several years to implement, with asset sale and two county systems taking three to five years assuming no major obstacles are encountered. Economic Issues - The potential economic impacts vary for each of the scenarios. The asset sale scenario offers the advantages of private sector efficiencies, a large cash infusion (sale proceeds) and county property tax revenues. It also imposes additional costs - the increased cost of debt due to the loss of tax-exempt status, payment of taxes (federal, State and local) and the need to provide a rate of return (profit) to company shareholders. The combined impact of these factors can not be accurately assessed without issuance of a request for proposals and reviewing 4-7

8 submittals. The preliminary analyses presented herein, however, indicate that if the private sector were to purchase the system for approximately $ 3 billion and it sought to recover all of its costs through the rate base including a typical rate of return, it could result in a significant increase in rates. Lower purchase prices, lower rates of return, recovery of costs through means not involving the rate base and/or significantly lower rate of continued capital improvements could result in scenarios with no rate increases or much smaller rate increases. In any event, the added cost of asset sale offsets the potential for rate reductions due to increased private sector efficiencies. The contract operations scenario offers the advantage of private sector efficiencies without loss of tax-exempt debt capability. This scenario does not provide county property tax revenues. Under this scenario, private sector efficiencies are expected to be greater than the additional costs of return on investment to the private operator, resulting in lower rates for customers. Based on the analyses performed, an overall rate reduction of 10 to 25 percent in 1998 dollars is estimated. The two County operated system offers the advantages of public ownership - taxexempt debt, no taxes, no profits - as well as independent control of rates by each County. Some of the efficiencies assumed in this scenario are offset by the duplication of departments, staff and resources inherent in having two Counties operate the system. Based on the economic analyses performed, it is estimated that the Counties have the potential to obtain approximately 10 percent reduction in rates, with Montgomery County expected to have the potential for slightly lower rates than Prince George s County due to a difference in the Counties bond ratings. Insufficient information is available on a County by County basis to allow for a comparable evaluation of the wholesale/retail alternative, although it would be expected to offer most of the economic benefits of the restructured WSSC with CAP Plus alternative, while allowing for a change in governance and local community involvement in a portion of the system. The restructured WSSC with CAP Plus offers the advantages of public ownership (tax-exempt debt, no taxes, and no profits), while maintaining the bi-county budget and rate setting practices currently in place. Based on the economic analysis performed herein, and assuming that strong drivers are put in place to maintain and accelerate the pace of CAP to meet CAP Plus goals, it is estimated that a rate reduction of 10 to 25 percent can be achieved. When considering the economic impact of asset sale on the taxpayers of the Counties, it should be noted that: County residents/taxpayers would benefit from any net proceeds realized by the Counties resulting from an asset sale, either in additional services or otherwise through the one-time added County revenues. 4-8

9 An asset sale would also result in increased property tax revenues, another benefit to residents/taxpayers at the Counties. Any increase in water and sewer rates to WSSC customers to compensate a private owner for its property tax expenditures would offset these benefits for residents who are also rate payers. Therefore, County residents who are not WSSC customers would likely realize some net benefit from an asset sale, whereas residents who are customers would not. In fact, residents who are rate payers would likely be impacted negatively, since (a) a property tax is deductible from personal federal income taxes, but water/sewer rate payment is not and (b) any revenues from the private owner would typically be repaid through rates at a higher cost due to interest and/or profit. The impact of any of the Base Case Scenarios on large water users such as commercial or industrial customers could differ under the various scenarios. The current WSSC rate structure favors small water users since the unit rate applied to all water purchases increases with the amount of water used. Under the Contract Operations, and Restructured WSSC with CAP Plus Base Case Scenarios, the Counties and WSSC would continue to control budgeting and rate setting. Under the Asset Sale Base Case Scenario, the private owner would propose rates for PSC rate setting/approval. In general, private sector utilities are more accommodating to larger customers and may offer reduced rates for high volume use to attract large customers. Under the two County-Operated options, the Counties would take complete control of rate setting and could choose from among many alternative rate structures. 4.3 RECOMMENDED NEXT STEPS The process of moving forward with any of the options evaluated will involve many stakeholders and must address the full range of issues associated with the selected option. Based on review of WSSC and the options discussed in this report and HB 832, three sets of activities are recommended for initiation (or in some cases continuation) on a concurrent basis. An overview of these recommended activities is provided in Figure 4-1. The following summarizes these three sets of activities: I. Evaluate the Transfer of WSSC Ancillary Services - Regardless of the future privatization or restructuring of WSSC, the concerns raised by the Counties relative to the provision of several ancillary services by WSSC and the possible reassigning of these services to the Counties should be investigated to determine the advisability of providing a more localized one-stop approach to providing these services. These ancillary services include a variety of activities including plumbing/gasfitting permits/inspections; on-site water/sewer systems approvals/inspections; cross connection/backflow prevention inspections; the fat, oil and grease program inspections, examination/licensure of Master Plumbers and Gasfitters, and certain facility planning responsibilities. 4-9

10 Figure 4-1 identifies the major activities associated with investigating the transfer of responsibility for these services to the Counties. It is anticipated that the first step would be establishment of a bi-county committee with representation by the Master Plumbers and Gasfitters association, local gas companies and other involved parties to address the specific issues, consider transition options and then, if and as appropriate, develop a transition plan. II. Continue WSSC CAP and/or CAP Plus - Regardless of the future privatization or restructuring of WSSC, WSSC should continue to pursue the implementation of its CAP initiatives to further increase the efficiency of serving its customers, while providing healthy, safe water and wastewater service and supporting the economic growth of Montgomery and Prince George s Counties. These efforts will provide rate payer benefits while continued efforts are made to determine the most appropriate future privatization or restructuring alternative, and through the implementation of action on any of the alternatives. In addition, goals and objectives beyond CAP (i.e., CAP Plus) should be established to continue the process of making WSSC more efficient, while maintaining its strong history of being very effective. III. Continue to Evaluate Options for WSSC - The State Legislature, in concert with the Counties and WSSC, should proceed with the next steps of determining which of the five Base Case Scenarios (or variations thereof) should be implemented for the long term. As indicated in Figure 4-1, key steps in moving forward with this process include establishing a bi-county committee to address governance issues and the establishment of an implementation agency (see Decision Stage in Figure 4-1), which will be responsible for directing the implementation of the restructuring and/or privatization alternative, if any, selected for implementation. 4-10

11 Figure 4-1 Overview of Suggested Implementation Activities for Restructuring and/or Privatizing WSSC I. Evaluate the Transfer of WSSC Ancillary Services Establish Bi- County Committee to Examine Reassignment of WSSC Ancillary Services Investigate Reassignment of WSSC Ancillary Services Identify Key Issues Article 29 Management Needs Employee Issues Benefits/Pension Counties Needs Plumbing/Gas Fitting Permits/Inspections On-site Water/Sewer Systems Approvals/Inspections Cross Connection/Backflow Prevention Inspections Fats, Oil and Grease Program Inspections Examination/Licensure of Master Plumbers and Gasfitters Certain facility planning responsibilities Identify Transition Options Evaluate Transition Options Implement Transition Plan Initiate County Services II. Continue WSSC CAP and/or CAP Plus Execute Memorandum of Understanding between Counties and WSSC Continue Implementation of WSSC CAP Establish WSSC- County CAP Plus Partnership Complete Implementation of WSSC CAP Review CAP Assumptions for Additional Areas for Improvement Phase 2 Establish Work Teams Phase 3 Implement CAP Plus Continuous Improvement Program (review/modify/improve) Analysis Stage Further Evaluation Stage Decision Stage Development Stage Implementation Stage Contract Operations (see Figure 3-4); Estimated development stage period of 1.5 to 2 years III. Continue to Evaluate Options for WSSC WSSC Privatization Study State Legislature Review of Report & Identification of Next Steps Conduct More Detailed Investigations (if necessary) Establish Bi-County Committee to Examine Governance Issues Identify Options for Implementation & Entity to Lead Implementation Asset Sale (see Figure 3-3); Estimated development stage period of 3 to 5 years County-Operated Systems (see Figures 3-10 and 3-11); Estimated development stage period of 3 to 5 years Restructuring WSSC with CAP and/or CAP Plus; In progress with CAP goals by 2002; CAP Plus goals by 2005 Operations under New Arrangement Determine if Article 29 should be modified