Law for Regulation of Public Water

The Law for the Regulation
of Public
Water-Related Utilities

Miguel Solanes
TAC Member

Regional Advisor Water Law and Related Public Utilities
United Nations Economic Commission for Latin America and the Caribbean
PO. Box 179-D, Santiago - Chile
Tel. 56-2- 2102271; Fax 56-2-2081946

Summary and Overview

Latin America has kept in step with the worldwide trend towards the privatization of public utilities. Motivation for doing so stems from a number of factors including: economic philosophy, quest for greater efficiency, macroeconomic situations, debt-equity swaps, and need to bring private capital and management into public utilities at a time of fiscal limitations, and others. The report analyses the characteristics and components of public utilities. It also examines some regulatory concepts, such as administrative controls, the notion of reasonable charges,holding companies, monitoring , and terms and conditions of service, including water use and public utilities. Among specific cases of reviewed, particular attention is devoted to the case of the United States and the United Kingdom.

The author suggests that the countries in Latin America should take comparative legislation and the experience of other nations into account, to set up suitable regulatory and monitoring systems prior to privatization.

Much of the ongoing political and legal debate in the Region is related to the privatization and regulation process and the conditions, quality of service and level of returns under which public utilities currently operate. Argentina, Chile, and, although to a lesser extent, Perú, are presently discussing the conditions under which public utilities perform and the need for improved regulation.

A global economy can be expected to expand well-being under certain commonly accepted rules. The analogy with the Roman "ius gentium" is tempting. The ius gentium was a liberal and progressive element in Roman Law, which was believed to be of universal application, its principles being regarded as so simple and reasonable that it was assumed they must be recognized everywhere and by everyone. Later, the concept was reinforced by the concept of "ius naturale", incorporated into the teachings of Thomas Aquinas.

The intent of this paper is to bring some concepts of comparative law, particularly American and English Law, into the discussion of public utilities, with a view to provide information to practitioners and governments.


The privatization process in South America, has been undertaken not only with a view to increasing the efficiency of public services but also as a means of bringing about structural changes in the economy ( Gerchunoff and Cánovas, 1993, p. 2).

In some countries, therefore, privatization operations have been, at least initially, a "macroeconomic tool" for stabilizing the economy, which has meant that the increased efficiency of production resulting from privatization has not necessarily been passed on to society in the form of lower rates and charges (as has occurred in the privatization of monopolies in various regions and countries of the world). Gains in efficiency have not necessarily resulted in lower rates for users. In some cases privatization has been accompanied by light regulation under limited competition. This triggered demands for a fine-tuning of the regulatory system (Gerchunoff and Cánovas, 1993, p. 2).

There is a trend to the internationalization of utility concerns.

Public utilities are a structural feature of modern societies. Without them, today's cities and forms of production would simply be inconceivable. In a number of cases they entail monopolistic elements and have a bearing on the public interest, since they are connected to public health and economic development (Tieman and others, 1995).

Historically, public utilities have involved significant economies of scale and scope, and called for fixed non-liquid investments and production capacities designed to meet peak demands. Regulatory systems primarily focused on service quality and rates, with the latter being pegged, in some systems, to reasonable profit levels for the purveyor. Traditional regulation has expanded to include environmental concerns.

Legal instruments governing the provision of essential services entail elements of public interest which set them apart from civil-law contracts. Governments and users take an active part in their implementation, regulation, monitoring and follow-up. Institutional structures for the regulation of public utilities consist of commissions and agencies in respect of which a special effort is usually made to ensure their technical and financial capabilities and independence.

In terms of water, service providers are large institutional users which are normally required to obtain water use permits, to comply with regulations concerning water discharge and pollution, and to respect general obligations regarding the efficient and beneficial use of the resource.

Utility companies often tend to become internationalized, to diversify and to integrate. Consequently, evolved systems devote particular attention to monitoring the composition, integration, and ownership of stock and shares of utility-related firms and also their contractual arrangements and trading practices.

Countries that are now turning to systems of privately-owned (or operated) public utilities need to develop relevant regulatory mechanisms and institutions. An institution-building process is essential for a proper understanding of utility-related activities. Institutions created for this purpose, which perform a role of fundamental importance, require constant updating.

Familiarity with comparative legislation and management systems is highly valuable in this area. The creation of systems, programs and projects for transferring relevant knowledge from countries with mature and long standing private-public arrangements would be useful capacity building exercises for the countries in the Region. These exercises are particularly valuable in the discussion of a subject which does not only represent a considerable portion of the wealth of the Region, but is also intrinsically related to the well being of its population.


Public utilities perform a structural role. They are outstanding elements in social and economic organization, similar in importance to monetary, credit and educational systems. Existing systems for organizing production and population centers would be inconceivable without efficiently run, mass scale, public utilities.


Public utilities have a number of characteristics which have made them a highly important area of the law:

i) They are activities in which competition is not always present, and are usually subject to government regulation designed to protect the public interest (Phillips Jr., 1993, p. 3).

ii) Some utility industries seem to operate more efficiently when they are monopolies; (such as water and sewerage) however, in such cases public utilities often must be compelled (by means of regulations) to contribute to the general welfare rather than doing so voluntarily (Kaysen and Turner, 1959, pp. 48-49, as cited in Phillips Jr., 1993, p. 4).

iii) The regulation of public utilities is a result of the public interest associated to their activities; and is mainly expressed in the control of rates and services (Phillips Jr., 1993, p.4).

iv) Conflicts often arise between public and private interests as they relate to public utilities. They stem from the difference between private firms' main objective (profit maximization) and the public interest (adequate service at the lowest possible price). Some countries have created institutions specifically devoted to research on public utilities, since the regulatory process is not only controversial but also analytically demanding.

v) At present, there are clear differences in the openness to technological change of the various types of public utilities; this gives rise to differing regulatory needs and, in some cases, even to a reformulation of the concept of natural monopolies in certain activities.

vi) Although regulation is certainly a characteristic of public-utilities, its content and scope is not fixed, but instead tends to undergo adjustments as time passes and as circumstances and needs change (Phillips Jr., 1993, p. 7).

vii) At the same time, some authors contend that regulation has not served its purpose and that, in practice, it has become "the haven of refuge for all aspiring monopolists who found it too difficult, too costly or too precarious to secure and maintain a monopoly" under a deregulated system (Gray, 1940, pp. 8-20, as cited in Phillips Jr., 1993, pp. 8 and 31). However, the result of competition will be accelerated consolidation and aggregation. Therefore, governments may want to assure that companies compete fairly. If deregulated markets do not produce the results expected, governments may have to re-introduce regulation.


The main economic characteristics of public utilities have traditionally included:

1. Economies of scale and of scope

Part of the justification for having public utilities lied in the notion of natural monopolies, i.e., activities involving economies of scale (the greater the scale of production, the lower the unit cost) and of scope (certain types of services are less expensive when provided by one, rather than two firms).

Drinking water and sanitation services provide ready examples of such situations. It has been determined that the investment required to supply water and sanitation services via a small-scale system for an average three-person household is US$ 1,600, whereas with a larger system, the figure is only US$ 200 (economies of scale).

The concept of economies of scope, for its part, has been advanced as an explanation for the tendency to integrate water and sanitation services.

Small-scale systems experience financial problems which give rise to difficulties in technical areas, in management and in the general adaptation or improvement of services (Lawton and Davis, 1983, as cited in Phillips Jr., 1993, pp. 851 and 836-839).

Economies of scale are thus a factor in the establishment of monopolies (Phillips Jr., 1993, p. 56), whose existence, in turn, partially justifies the regulation of prices (rates) and products (services).

In the electricity sector the notion of economies of scale is undergoing accelerated revision. New technologies are challenging traditional concepts.

Yet, a recent decision of the Chilean Antimonopoly Commission has concluded that the disintegration and disaggregation of generation, transmission and distribution activities in the electricity industry in Chile was not called for, therefore rejecting a request to effectively order the disintegration of the sector, both at horizontal and vertical level. Rather than radical restructuring the Commission recommended a mix of measures to regulate conduct and to incrementally improve the present structure of the sector. Some expert witnesses estimated the economic losses resulting from disintegration in 21%. (Larrain, Quiroz, Chumacero). Others stressed the prudence of utilizing conduct regulations [as opposed to structural regulation] (Paredes).

The decision may have been influenced by studies suggesting that the electric power industry have classical properties favoring vertical integration.

Environmentalists have noticed that disintegration and competition at generation level are the result of utilizing gas fueled generation plants. In Chile, this type of technology would affect the ozone layer in the central part of the country, particularly in the boundaries of the metropolitan region. However, the Commission did not consider environmental arguments.

2. Fixed non-liquid investment

The attainment of economies of scale frequently requires heavy non-liquid investments in large-scale infrastructure. Fixed investment usually represents a sizeable portion of total costs, and this means that organizations providing public services are often capital-intensive. This trait, too, is particularly marked in the case of drinking water and sanitation utilities, in which the revenue/capital ratio is low (Phillips Jr., 1993, p. 15).

Demand for these essential services, for which there is no substitute, is continually growing. There have been no major technological advances in recent years in the field, and this, coupled with inflation, environmental requirements, the cost of compliance with established standards and the need to secure and protect new sources of finance, has led to a constant increase in costs, with the resulting capital/revenue ratio ranging from 6:1 to 10:1 or, according to some authors, even as much as 12:1 (Wade Miller Associates, Inc., as cited in Haarmeyer, 1994, p. 43).

In fact, drinking water and sanitation services have been described as the most capital-intensive of all the public utilities (Environmental Protection Agency, 1977). This trait influences the legal conditions under which the private sector invests in drinking water supply and sanitation services, as well as these utilities' financing systems and the regulation of private activity in this sector.

It should be noted that not all public utilities have the same capital/revenue ratio. For telephone services, the ratio is 3:1, for electricity it is from 3:1 to 4:1. and for airlines it is 1:1. This clearly influences private sector's propensity to invest, the existence of real competition, the likelihood of monopolies and, in consequence, the various activities' differing needs in terms of regulation. In this connection it is interesting to notice that in 1991 out of 1.200 millions of capital expenditures in France (in british pounds) for water and sewage, 160 came from river authorities, 10 from regions, 150 from departments, 65 from national funds, 400 from water companies and 415 from local communities.

3. Idle capacity

Fixed investment in public utilities is carried out in order to meet peak projected demand and to cover increases expected in that demand over time. Some factors of production cannot be divided up, and for technical reasons must therefore be structured in a single bloc. Idle capacity can be regarded as a result of the diversity of demand levels, which prompts service providers to try to attract that demand through the use of consumer incentives. Since this may lead to undue discrimination, it becomes a factor in the adoption of controls for preventing such an eventuality.

4. Operational limitations

In some cases, the possibility of competition among service providers is limited by the nature of the service itself and by the carrying capacity of the facilities in question (e.g., pipes and available areas for installing and laying them), which normally do not have enough physical space available to support a large number of suppliers and thus set the stage for competition.

5. Market structure

In the case of the water supply and sanitation industry there are experiences indicating that often the structure of the sector is at best oligopolist, with opportunities for competition fairly limited.

6. Legal implications

Owing to the above characteristics, entry into the public-utility market is usually subject to government control and to regulatory measures aimed at forestalling transfers of income from consumers to investors. This is accomplished through consumer-complaint mechanisms and controls that have been expressly designed to keep the social, economic and political power of public utilities in check.


Some activities have the potential to affect general welfare, public health, collective security and other social concerns.

They are subject to government control in order to safeguard the general welfare (Spota, 1941, p. 917, note 189; Phillips Jr., 1993, p. 87). Regulation is justified by the monopolistic nature of many such activities, by their importance as essential consumer services, by their relevance to socioeconomic organization and by the absence of other alternatives.

Regulation, as well as the philosophical grounds for its existence, is nothing new. Some precedents in this area were laid down in the doctrine of the early Church Fathers --"just price" (justum pretium) and "natural price" (verum pretium)-- and in the regulation of the guilds of medieval times and of activities regarded as being of common interest (Glaesser, 1957, pp. 196-201, as cited in Phillips Jr., 1993, p. 122). Regulation included prices, quality and type of services provided, discrimination and other elements.

Although American authorities acknowledge that "public utility" is a term of popular usage, rather than a precise definition, they also indicate that it refers to services, more or less essential to the economy, which are public in nature.

Companies providing public services are a substitute for the State in the performance of public services, thus becoming a public servant, in the performance of a function of the state. Therefore, they are subject to regulation.

Within certain limits such regulation can be imposed ex post as exemplified by the historical development of regulation in the United States.

Corporate concentration resulted in competition being not as perfect as indicated by economic theory. As a result private corporations contracting essential services were able to take advantage of their economic predominance in conducting business so pervasive and varied as to require detailed supervision and a very high degree of regulation.

The legal concepts involved in regulation are not static, allowing broad range of measures within "ends of the spectrum standards" resulting from the interpretation of constitutional guarantees. Business subject to regulation are deemed to be "affected with a public interest".

Following English common law American courts have ruled that such business are not juris privati only and that "it matters not that....[ the activities] were established before the regulations were adopted" " if plaintiffs did not want to be subjected to regulations they should not have had clothed the public with an interest in their concerns". (Munn Vs. Illinois, US Supreme Court)

The public interest of the activity and its importance were such as to create a common burden upon the citizens. That justified regulation, even ex-post regulation, within certain constitutional limitations. Monopolistic elements justified regulation, even when in the commented case, two judges, Field and Stone, argued that public regulation required a franchise.

Later in the development of American regulations monopoly was no longer required, reasonability and public interest being the foundation of regulation, always within the limits of constitutional guarantees. Imperfect competition became also part of the legal cosmogony justifying regulation including not just monopoly, but also excessive competition.

An important methodological question is how should regulations be instrumented. Mature regulatory systems do not favor the instrumentation of regulations through contracts or franchises. Experience, according to American authorities is that "franchises proved to be defective instruments...little regard was paid to public interest...they were often exclusive...poorly drafted...due to was common for the utilities lawyers to draft the franchise and then present it to the city council for approval.

Moreover, in Cedar Rapids Justice Holmes explained "...if the franchise is interpreted to mean that the most profitable return that could be got free from competition is protected by Constitutional property guarantees, then the power to regulate is null. If the power to regulate altogether withdraws [the Constitutional guarantees] then the property is nought. This is not a matter of economic theory, but of fair interpretation of a bargain. Neither extreme can be meant. A midway must be hit".

A recent decision of the Argentinean Supreme Court remarked that public utilities have a right to rates allowing cost recovery, including investment, plus a just and reasonable profit, for it would not be acceptable to maintain that they have a right to profits objectively unlimited.

Accordingly, administrative contracts under which a private person is granted the right to operate a public utility usually contain special clauses regarding the provision of guarantees, the administrative authority to interpret the contract, modifications for the purpose of serving the public interest, dispute settlement, determination of effects and the clarification of any doubts that may arise.

Broadly stated, regulations may address a wide variety of issues, including the quality of the service provided, its scope and coverage, frequency or consistency, price and, in the case of drinking water services, environmental impact and conditionalities of water use. Moreover they can address market structures, such as the Public Utilities Holding Act of the United States (1935), or the legislation requiring disintegration of the electricity sector; contracting practices; ownership and transfer of stock; access to infrastructure and related conditionalities and procedures; separation or prohibition of activities; transfer pricing, information, accounting, disclosure of profits, etc.

1. Licensees' earnings

This section will make no attempt to delve into the technical complexities of different rate systems but will simply describe some of the legal criteria used to set the parameters which determine the profits realized by public utility licensees and their connection with the rates charged. Existing legislation offers examples that set precedents in this area. The laws of the State of New York, for example, require that water use rates shall be fair and reasonable and may not exceed the limits authorized by law or by order of the relevant regulatory commission. This question is clearly linked to the issue of reasonable profits for the licensee.

An important point is to determine what constitutes a reasonable profit. Providers of public services cannot be forced to operate at a loss, but this does not mean that they are everywhere guaranteed an actual return on their investment. The rate should be such as to cover operating costs and provide a reasonable return on the investment. It should also be enough to attract resources in the capital market. Legal experts in the United States have discussed the idea that the returns on such an investment should be comparable to those realized in activities involving similar levels of risk and uncertainty, in similar areas, at the time the activity is being conducted. They have also said that such returns cannot be set at a specific level or according to a pre-determined formula, since they are subject to changes in economic conditions stemming from the state of the general economy and the positions of the specific companies concerned. Indeed, in some cases rates have been lowered as a means of punishing companies deemed to be inefficient (Phillips Jr., 1993, p. 427).

Not all systems regulate the return on investments. Haarmeyer claims that since French water companies have not been subject to profit controls that hinder the innovation process, they have led the field in technological and managerial innovations (Haarmeyer, 1994, p. 48).

In the United Kingdom, drinking water and sanitation utilities were privatized in 1989. Rates have been regulated through the establishment of price caps. The system functions on the basis of the wholesale price index plus an adjustment factor ("K"). In the water industry, this factor is positive owing to the characteristics of the subsector, which include capital-intensiveness, high investment needs and low productivity (Haarmeyer, 1994, p. 49).

The United Kingdom's experience merits analysis because it has sparked a widespread public debate on the subject which is in some ways unique in its conceptual richness, ideological seriousness and transparency. The English system is based on the idea that earnings should not be limited but that caps should be placed on the rates charged. In so doing, the Government "slanted the playing field in the investors' favor at the expense of consumers" (Stelzer, 1995). By 1992-1993, water company earnings had climbed by an average of 23%. Operating profits were up by 34.3%, on average. These returns were felt to be excessive (Tieman and others, 1995). As of March 1994, water rates were absorbing a sizeable portion of the income of the poorest sectors of the population, and these sectors' ability to pay became the primary consideration in the determination of prices for 1994 (Booker, 1994, p. 61).

The British system was overhauled in July 1994. The Office of Water Services lowered the adjustment factor in the midst of a climate of consumer discontent, with users charging that the directors of water companies were doubling their salaries by doubling the cost of water to consumers (The Times, 1994), that the water companies' costs were not rising as fast as inflation, that capital expenditures were not as big as planned, that money had been lost on sideline businesses that had nothing to do with the main activity, and other problems. All this has prompted some commentators to forecast that regulatory provisions which are more closely tied to profit levels may be implemented in the future (Helm, 1994). Others do not so much predict but rather recommend that some means of controlling earnings and profits should be introduced into the regulatory system (Stelzer, 1995). In addition, in view of how much the stock in these companies is worth, the possibility of taxing windfall profits has been mentioned (Tieman and others, 1995) and a bill to such effect was submitted in July 1997.

The relevant regulatory decree in Buenos Aires includes references to the rationality and efficiency of the system, to a balance between supply and demand, to health and social objectives, to the need to reflect economic costs as well as the licensee's profits, and to transfers between different sectors of users. Rates are subject to review in the event of any significant change in operating costs, in the quality or level of service, in the taxes to be paid by the utility company, in the exchange rate for the dollar or in environmental or other laws.

It is interesting to compare the above Act with Spain's Public Administration Contracts bill, which calls for a set price in local currency and stipulates that the price should be geared to the market (article 13). Readjustments must reflect actual market fluctuations (the markets in question may be regional ones), including changes in the cost of labor and of basic factors affecting the contract (articles 100 and 101 of the Public Administration Contracts bill).

2. The provision of public services

Entry of service providers into the public utility system has normally been subject to State authorization. The fact that some of these utilities are monopolies has another legal implication as well: the conditions under which such services are provided are (or should be) monitored in order to ensure that utility licensees are not obtaining monopoly rents at the expense of users.

Spain's Public Administration Contracts bill permits the private management of public utilities when they have an economic content and the services provided are of a sort that can be delegated. Concession contracts cannot be implemented until a legal framework for the utility has been formed, areas of administrative responsibility have been defined, the benefits to be provided to the persons subject to that administrative jurisdiction have been specified, and it has been established that the activity corresponds to the administrative authority in question and is subject to the police powers necessary to ensure the satisfactory operation of the utility in question (article 151).

Consequently, the legal instruments by which authorization is given for the operation of public utilities have certain features which differentiate them from other contracts. One important feature of this sort, is that rate guidelines are subject to periodic review to ensure that the rate is reasonable and that it is performing its assigned functions of attracting investment and covering costs while not representing a monopolistic levy on users.

Under Argentine law, whose legal doctrines and jurisprudence have been strongly influenced by European experiences, "the licensing agreement is not a civil -law contract ... between equal parties ... but rather the delegation to a company of the responsibility for duly providing a public service ..."; following along the lines laid down by Mayer, it is stated that "the licensing arrangement is an administrative act that cannot be covered satisfactorily by private-law contracts"; therefore, "in the event of disputes, the application of civil law is suppletory" and is applicable only in so far as it does not contravene the general interest; "the rights which arise are public civil rights". United States law applies similar concepts, since the possibility of providing a public service is contingent upon the issuance of licenses, franchises or administrative permits, all of which imply the existence of special terms and conditions. This circumstance has important implications, since the legal act is subject to police power, and the licensee is obligated to comply with regulations and provisions even if they are subsequent to the issuance of the license.

A decision handed down in the United Kingdom holds that drinking water and sanitation utilities operate under the control of the State. In the case of South West Water, the court found that, despite its private character, South West Water derives from the State, since it operates a public utility which is controlled by a State-designated regulator. The legal character of the organization providing the service is irrelevant because the public utility is under the control of the State (Financial Times, 1994).

The activities of the State may not cause the licensee to operate at a loss or to suffer confiscation. Nevertheless, the methodology and concept of "reasonable" profits, both in regard to public utilities and as they relate to their conceptualization (in line with the Penn Station case mentioned earlier), are a legal tool with financial, economic and technical underpinnings which should be properly understood, analyzed and applied in countries that have privatization processes under way.

3. Licensees as institutional water users

The management of water-related utilities has an impact on both the quantity and quality of the resource. For this reason, licensees are regarded as large-scale users and are subject to water-use controls and requirements. The proliferation of water uses, their reciprocal effects and their aggregate impact on the environment have made it necessary to establish organizational and legal structures to monitor, plan and reconcile those uses.

There is also a trend to separate water demands for specific uses from national water policy and management. Responsibility for water policy and planning in general is being handed over to ministries responsible for the environment, natural resources or water resources. The idea here is that this is a suitable way to ensure impartiality and objectivity in the management of a resource subject to both environmental degradation and multiple demands. A report by the Secretary-General of the United Nations to the Committee on Natural Resources (United Nations, 1994) cites examples of this tendency in a number of countries, including Canada, France, Guatemala, Israel (with some differing characteristics), Oman, the United States and other nations.

In addition, some countries have modified their integrated water monitoring and management systems along with the system under which their drinking water and sanitation utilities operate.

Thus, in 1992 Mexico reformed its water-resource legislation with the introduction of a package that includes the adoption of a system of tradeable water rights, the creation of watershed authorities as a means of reducing the fragmentation of the water sector, the imposition of fines for polluting, and the possibility of privatizing the country's drinking water and sanitation utilities (Casasús, 1994).

One of the merits of the United Kingdom's reform of its drinking water supply and management system is that it separates water companies from the water-resource monitoring and management system; in other words, the regulator has been separated from the object of regulation. Today, the English system applies a series of controls on water companies. They include controls on the system as such, and environmental and water-use controls which are administered by different public authorities (Jeffrey, 1994, p. 64).

England's water companies have certain environmental obligations they must fulfil (see the Water Industry Act, 1991, articles 3-5). The prospectus describing the terms of sale of water-company stock sets out certain conditions regarding corporate water use. It notes that, pursuant to the Water Act, water utility licensees must obtain permits in order to divert watercourses or to create certain types of reservoirs. The regulation of discharges or dumping and the conditions under which dumping may be performed, as well as the issuance of watercourse diversion permits, are the responsibility of the Authority responsible for water resources (see the prospectus The Water Share Offers, 1989, pp. 29 and 30).

Under the system of privatization used in Greater Buenos Aires, the decree establishing the regulatory regime stipulates that the management of pollution control functions shall conform to the regulatory provisions of the Secretariat for Natural Resources and the Human Environment and to the annexes setting forth the regulatory framework for use in this area; that water pollution shall be monitored by the Regulatory Agency for the utility concerned (which sets it apart from the English system, in which the regulation and control of pollution is the responsibility of a different body from that which oversees the management of the utility as such); and, finally, that the utility licensee has the right to make use of groundwater and effect diversions of surface water.

The system for granting water rights may hinder competition in the provision of public services. To remedy this type of situation, water laws usually contain requirements regarding the effective use of water resources, within given time periods, for purposes which the legal system deems beneficial. The purpose of these principles is to prevent individuals from establishing absolute monopolies on the resource (Beck, 1991, p. 106 et seq.).

In connection with this point it has been noted that, in the case of hydropower generation, the issuance of use permits that are not subject to any conditionalities of effective use may actually result in the establishment of monopolies. This has also been seen to have a distortionary effect on power generation --a segment of the generation-transmission-distribution chain which may, by virtue of its particular characteristics, be regarded as non-regulable (according to some modern bodies of law) and open to competition. The issuance of unconditioned water rights opens up opportunities for monopolization (De Andrade, 1995, p. 10; Sánchez Albavera, 1994, p. 22).

Two decisions of the antimonopoly authorities of Chile have acknowledged the relationship between monopolization of public utility services and structure of water rights. Moreover, a recent ruling by the Constitutional Court has rejected claims that amendments to current water legislation would violate constitutional rights to acquire private property.

Another question relating utilities to water resources is if they should pay fees for their utilization of the resource. In some places, such as Mendoza in Argentina, there is no argument that there is a legal duty to pay for water use. In Switzerland, on the contrary, the Water Service of the Industrial Services of Geneva resisted a government attempt to introduce a water tax to pay for restoration of cantonal rivers.

4. Determination of the service area

The delimitation of drinking water and sanitation service areas should be based on two objectives: ensuring that no areas are left without service or that the different zones within a political district are gradually incorporated into the service area; and ensuring that the areas created are such as to permit economies of scale.

This was one of the aims of the reform of the drinking water supply and sanitation system in Mexico City, where the fragmentation of the service among various municipalities has been held to have weakened the sector (Casasús, 1994).

Figures have already been presented which attest to the differences between the relative costs of supplying a typical family in small and large service areas. The concept of economies of scale, where applicable, should be a fundamental consideration in the regulation of public utilities (whether they have been privatized or not). This means that the content of recommendations regarding such steps as the decentralization of services at the lowest suitable level need to be made more specific. This principle could be complemented by the concept of economies of scale. In some countries it has been suggested that regional enterprises should be created which would group together a number of smaller systems or that the larger companies should absorb the smaller ones.

Although these considerations may seem somewhat obvious, some countries are still working to decentralize their utilities on the basis of political levels, despite the fact the basic political units may not always be the best choice from a technical and/or economic standpoint.

5. Generic obligations and rights of licensees

According to a very useful summary prepared by Phillips, utility licensees have four basic obligations: i) They must serve any customer within their service area who is willing to pay for the service. This general duty may include the obligation to serve areas that are unprofitable and are therefore being subsidized by other services offered by the licensee. It may also entail the construction of infrastructure to meet future demand; ii) They must provide safe and adequate service which instantaneously meets demand; iii) They must serve all their clients without engaging in arbitrary, unfair or undue discrimination; and iv) Licensees must charge no more than a just and reasonable price for the services they render.

The generic rights of licensees include: i) Legal protection of their property; ii) The right to charge a reasonable price for their services, since they cannot be forced to operate at a loss, although the State does not always guarantee that they will actually realize a reasonable profit; iii) The rates and regulations to which their service is subject must be reasonable in nature and include the right to disconnect a customer under certain circumstances; iv) The right, in some cases, to protection from competition within their service area; v) In general, the right of eminent domain, which includes the right to expropriate private property, impose mandatory easements, gain entry, require information and other measures having to do with their ability to discharge their responsibilities (Phillips, Jr., 1993, p. 121).

Spain's Public Administration Contracts bill requires that licensees be in good technical, financial, economic and professional standing.

6. Some elements specific to water utilities

Water utilities have certain duties involving specific aspects of the generic rights and obligations listed in the preceding section.

They are obligated to provide water service within their area and to maintain, upgrade and expand the corresponding infrastructure, as well as to meet certain operating standards. In accordance with the financial terms and conditions of the licensing arrangement, they must provide services and infrastructure to users on demand (this is complemented by the right to require compulsory hook-ups). The financial terms of such arrangements may include payments, deposits, the installation of meters and other conditions.

In some systems, the licensee can be held liable under civil law if he fails to fulfil his obligations to users. This liability can be discharged by proof of due diligence.

A licensee's obligations include the provision of a sufficient amount of water of suitable quality, the maintenance of the continuity of such service at an adequate level of water pressure, and the upkeep of hook-ups to ensure that they remain in working condition. Under certain circumstances, this obligation may extend to non-domestic uses. Water quality requirements are particularly important, and licensees are obligated to abide by any guidelines established as to the purposes for which water may be used, the substances which the water may or may not contain, the concentrations of specific substances, sampling systems, monitoring of and information on the quality of the water sources used, etc.

The licensee's obligations may also extend to technical aspects of the methods used to provide service, the construction and design of infrastructure, and the quality and features of equipment and facilities. These obligations are complemented by a number of rights or authorities, such as the power to require the installation of meters in some cases, to monitor users, to prevent activities that pollute the resource, and to control dumping or discharges in the drainage system. For their part, the licensees themselves are also subject to increasingly strict standards concerning the level of pollution occasioned by their activities.

One particularly important obligation is that the licensee must supply adequate and timely information to the public and to government authorities. To this end, he must keep certain records and have available surveys, blueprints and maps of service networks, publications, reports and information on the status of the sector, etc.

Hydropower companies are subject to standards or regulations concerning, inter alia, public safety, environmental monitoring, environmental impacts, water resource use, and the operation of power plants affecting water resources (coordination with other uses).


The traditional dividing lines between governments, utility operators and the user public are undergoing major changes as a result of the transfer of utility operations to the private sector, the integration of users and their interests into water management structures, the monitoring of services (as a basis for legitimation) and the establishment of management and planning structures at watershed or regional levels (Barraqué, 1993, p. 46).

The term "privatization" is understood to refer to the introduction of market forces into the economy and, in a narrower sense, the transfer of public enterprises, activities or assets to private hands, whether wholly or as a majority or minority interest therein. The objectives of privatization may include the rationalization of public enterprises, increased efficiency, a broader distribution of ownership, the reduction of public-sector expenses, the conversion of external debt into equity and the generation of a public demonstration effect regarding a government's economic policy (Vuylsteke, 1988, vol. 1, p. 1; Gerchunoff and Cánovas, 1993).

In addition to the above reasons, and with specific reference to the water and sanitation sector, some authors also cite the professional interests of some groups connected with water resources which regard privatization as a means of avoiding financial constraints and carrying forward the professionalization of the water industry (Barraqué, 1993, p. 51). Another trend which has been observed is the concentration of services in a smaller number of companies and the diversification of these firms, many of which offer utility service proper, consulting services and construction capabilities, thereby availing themselves of the economies of scale and of scope associated with certain activities. Barraqué, for example, notes that the firms Générale des Eaux and Lyonnaise des Eaux have diversified both vertically and horizontally, offering drinking water service, sanitation services, solid waste disposal, transport services, heating, etc. Lyonnaise des Eaux merged with Dumez, which carried out construction activities and provides consulting services (Barraqué, 1993, pp. 47, 51 and 67).

The possibility of forming integrated holding companies, which may not benefit consumers, given the triangular practices and transfer pricing facilitated by such corporate structures, has prompted the passage of laws and the creation of special mechanisms to control such activities. The study of this subject and empirical research in connection with privatized public utilities in Latin America are still in their early stages.

The most common methods of privatization are private or public stock offerings, the incorporation of private investments in existing firms, sell-offs of the assets of public enterprises or of the government, the reorganization of firms into component parts, the purchase of a block of stock by a firm's management or staff, leases or management contracts, construction/ownership/operating contracts, payments based on usage rates, etc. (Vuylsteke, 1988, pp. 7-9).

Exogenous and endogenous factors influence corporate privatization processes. Exogenous factors include public opinion, situation of capital markets, overall state of the economy, employment regulations in the public and private sectors, area of activity in which a firm is engaged, etc. Endogenous factors include the original legal character of the activity in question (is it a public utility or not?), its organizational structure (is it an arm of the central government, a decentralized unit, a public stock corporation?), its financial standing, its market, its economic viability, its regulatory framework, possible price levels, type of ownership (public or national), etc.

In the United Kingdom, the privatization of firms in the water industry took the form of stock offerings. The terms of such sales were studied so as to ensure some degree of dissemination among the public of stock ownership. Limitations were also imposed to prevent excessive concentration of the stock being offered. Furthermore, the Government initially reserved for itself a special type of share which conferred no stockholder equity but gave it a say in certain sorts of decisions that it felt to be of fundamental importance (see The Water Share Offers prospectus, 1989).

Some authors have indicated that ownership concentration in the purchase of various State enterprises in Argentina resulted in an excessive amount of control over key activities to a small group of shareholders whose horizontal involvement in a sizeable number of public enterprises could have an impact from the standpoint of the power of the holding companies involved.

The provision of the service in question takes the form of an operating license under which the licensee promises to make the investments needed to upgrade, expand and maintain the utilities, while the State awards it the service and certain guarantees. The granting of monopoly rights has been regarded as an important element in the privatization of public utilities (Vuylsteke, 1988, p. 63).

It is interesting to compare this arrangement with Spain's Public Administration Contracts bill, which provides that, for all public utilities, contracts will be awarded on the tender-basis and which limits negotiated procedures to well-founded grounds of exception (article 155).

The privatization process usually requires a number of preparatory steps, including the preparation of public opinion, the creation of privatizable companies, the prior development of frameworks that will ensure the transparency and credibility of the process, financial reorganization aimed at putting the relevant firms on a sound financial footing, the taking of decisions regarding contracts being performed at the time and concerning the future of existing employees, the establishment of the regulatory structure for the relevant utilities, the creation of appropriate regulatory agencies, the establishment of a system of civil liability coverage (this is particularly important when the State continues to be the owner of record), the institution of safeguards and guarantees, and the definition of insurance and civil liability systems.

When water-related infrastructure is being privatized, plant safety systems (particularly in the case of dams) and methods for checking on the condition of the systems that are to be privatized take on great importance. These verification procedures play a crucial role in assessing the physical condition of corporate assets and illustrate the importance of undertaking baseline studies prior to privatization (Vuylsteke, 1988, p. 98). If a suitable baseline analysis of the relevant infrastructure is not undertaken before privatization in order to determine its condition, the State will not know what is being privatized and the licensee will be able to bring claims alleging the existence of undisclosed defects after the license has been granted. This type of situation can call the transparency of the process into question and eventually lead to rate increases that were not explicitly provided for in the original negotiations.

The various modalities of privatization that have been used in connection with water utilities in particular include the leasing of infrastructure, management contracts, franchises and licenses, property transfers and built-operate [own] and transfer arrangements.

In some of these arrangements, the equity investment remains in public hands, and what is actually being transferred is the operation of the systems. This type of arrangement has been used for drinking water and sanitation utilities, a sector which, owing to its high costs and low rates of return, has traditionally received some sort of preferential treatment, including special tax provisions. Thus, in the past local water companies in England used long-term reimbursable, rate-based loans to cover these costs. This system has fallen into disfavor because it does not promote efficiency, since it is presumed to be more efficient for capital costs to be covered by users' payments. This means, it has been said, that today's water users are paying a tax for the benefit of future generations (Tieman and others, 1995).

The method of dividing up systems into their component parts (generation, distribution and transmission) has been used in the hydropower industry. This represents a departure from the more traditional form of organization in which such enterprises (especially public power companies) were vertically integrated (Vuylsteke, 1988, p. 23).

As noted earlier, among these three activities, power generation is regarded as the one that lends itself the most to deregulation, since there would presumably be no limitations on corporate entry into the system. This idea of unlimited access is subject to certain conditions, however: for example, the relevant markets must be large enough, there must not be agreements among generating companies, the institutional system must not have monopolistic leanings (Sánchez Albavera, 1994; De Andrade, 1995), there must not be environmental or input-related constraints, and the State must not set aside certain markets for a particular generating company. Under such circumstances, an interesting quandary may arise if, following the State's award of licenses under which markets are set aside for certain generators, new sources emerge that can supply power more cheaply than those generators. Could users argue that such agreements are res inter alios acta and lodge legal demands that these new sources be given market access? The question is a complicated one, but failure to make allowance for this element of free enterprise in respect of market entry undermines the argument that generating activities should not be regulated and paves the way for the repetition, on a socially inequitable basis, of the inefficiencies in the public systems which prompted their privatization in the first place.

Under leasing arrangements, the contractor leases facilities from the State for the execution of the activities which have been transferred to him. The lessee assumes the full risk associated with the activity in question. The State needs to ensure that, upon termination of the contract, these facilities will be returned to it in good condition. The lessee, rather than the State, bears legal liability for the utility, but the government retains certain supervisory rights. This model has frequently been applied in France, where the municipalities employing it take responsibility for the financing and construction of the facilities, while the lessee runs, manages and charges for the service. Rates reflect the costs involved plus earnings and include a surcharge to cover capital costs, which is transferred to the public authority (Haarmeyer, 1994, p. 47). This system has also been used in Africa.

When management contracts are used, the State pays a third party to operate the systems in question. Under this arrangement the State does not save on investment costs, and in addition it has to pay a fee for management services. If the arrangement works as it should, the utility's efficiency and profitability will increase. Under this system, as applied in France, the municipality charges users for the service and then covers the contractor's expenses. The budget for drinking water and sanitation utilities is separate from the rest of the municipal budget (Haarmeyer, 1994, p. 47).

In both cases --leases and management contracts-- the payment of debts and other commitments continues to be the obligation of the State. And under both these systems, clear-cut and precise definitions are required regarding each party's obligations in respect of maintenance, operations, renewal of elements of the system, and the payment of other costs. The technical capabilities and financial standing of the contractors are of fundamental importance in such situations.

The granting of concessions has been widely used for drinking water and sanitation utilities and for power utilities. Typically, some sort of investment on the part of the licensee is required; the term of the concession is fairly long (20-30 years), and upon its expiration the utility reverts to the State. One important element in this kind of arrangement is the inclusion of precautionary provisions to ensure that, as the expiration date of the concession approaches, the concessionaire will still maintain a suitable rate of investment and will continue to operate and maintain the facilities properly.

Systems of concessions, leases and management contracts are all widely used in France and Spain.

Australia's experiences in this regard are interesting as well, especially because the contracts used in that country have been quite rigorous and detailed as to the obligations of the parties. The concessionaires finance the venture; the Government makes a commitment to buy the water; construction work and loans are covered by tied contracts in order to ensure that such projects are completed on time and within their budgets; and the works are covered in great detail in the concession contracts (Haarmeyer, 1994, p. 50).


The privatization of public utilities is a worldwide phenomenon.

The process is global, inasmuch as global investment funds exist in the sector and corporations providing the services operate on a worldwide scale. Within this context, a comparative study of relevant legislation, especially in economies that have a great deal of experience in this field, may be useful for countries that have only recently begun to return to a system of privately-run public utilities. Such an examination brings out a number of important points that warrant special consideration.

i) The drafting techniques required to draw up contracts that specify what is expected of each party, the costs, time periods (including deadlines for the completion of projects for the development of water resources), the features of the services to be rendered, the areas in which they are to be rendered, and the environmental controls to which they will be subject.

ii) The concept of a reasonable profit or return for the utility provider, bearing in mind that a number of services are monopolies with secured financial flows.

iii) The need to set up independent commissions or regulatory bodies and ensure that they have adequate funding, capacity and technical expertise. Countries that are now embarking upon the privatization process would be well advised to develop institutional and technical capabilities in this sector, since otherwise it will be almost impossible for them to know what to regulate or whether the profits of utility companies are reasonable or not.

iv) Given the concentration of many services in a limited number of companies and the presence of the same economic groups or conglomerates in various types of public and private utilities, it will be useful to establish precise, transparent rules governing public utilities' assets and their valuation, investment and operating costs and expenditures, accounting practices, loans, ownership and transfers of blocks of stock, contracts for the provision of services, consultancy and materials, holdings and monopolies.

v) There must be suitable participation by users, along with ready access to administrative and judicial fora. The provision of ready access should not be confined to cases in which an individual problem can be identified simply and quickly (e.g., inappropriate rates) but should also apply in instances where users as a group are affected by practices that unreasonably restrict competition in the provision of the service in question.

vi) Powers in respect of national water management policy should be given to non-sectoral bodies. In cases of privatization, the need for this type of management and harmonization of uses is especially crucial.

vii) A suitable regulatory structure and regulation should be established before privatization is undertaken.

viii) Agreements establishing conflict adjudication procedures other than national courts should carefully consider the choice of applicable law and competent fora.

(Original: Spanish)


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