Auctioning off water systems
It used to be just troubled governments that sold off water utilities to pay off debt. Now more places are doing it.
Happy Finance Friday! I’m diving back into Chester, Pennsylvania’s bankruptcy this week to look at one of the biggest pain points in the case: the city’s water system. The Chester Water Authority has been kinda-sorta on the auction block for years but it was only recently that a state court ruled on who even had the authority to sell it. This week, I’ll explain why so many Pennsylvania cities end up selling off their water assets and the ramifications for ratepayers.
Who owns the Chester Water Authority?
You’d think ownership of a public utility would be pretty clear-cut, but thanks to an act of the Pennsylvania legislature, this became a gray area in Chester. For most of the CWA’s more than 100 years of existence, only the city had the authority to appoint members of the governing board. Over time though, the CWA became one of the region’s largest public water systems, serving more than 200,000 people across 37 municipalities in Delaware and Chester counties.
In 2012, the state passed Senate Bill 375, which required that all ratepayers have representation on the board of any water or sewer authority—even ones incorporated by a single municipality. It was basically directed at the CWA and as a result, the water authority’s five-member board expanded to nine members and split appointees equally between the city and two surrounding counties.
A few years later, the legislature struck again and passed what’s called “fair market value” legislation. Consumer protection attorneys have called these bills “one of the biggest inducements for water deals” and “a potent lure for cities that need money for their ailing budgets.” They allow a city to sell its water system for an appraised value closer to what it would cost to replace the system, rather than the commonly used and much lower “book value,” which reflects the age and original purchase price of the assets.
That led to the private water utility Aqua America offering to buy the CWA in 2017 with an unsolicited bid. A years-long fight ensued between the CWA board and the city over who had the right to sell it. Meanwhile ratepayers and their very vocal attorneys were opposed to any sale for fear of their rates skyrocketing.
In the fall of 2022, the Pennsylvania Commonwealth Court ruled the city of Chester is the sole owner of the water authority and its assets. Chester City Council immediately and unanimously voted to approve a $410 million asset purchase agreement with Aqua. CWA has asked the state Supreme Court to hear its case and an answer is pending.
The takeaway: Easy money—too easy. Selling the water system would solve—on paper anyway—Chester’s overwhelming retiree liabilities which accounts for the bulk of its debt. That’s actually kind of a thing with Pennsylvania localities: sell off the water/sewer utility to wipe away debt and avoid expensive infrastructure improvements to the system. Scranton and York have done so in the last several years.
But, as I’ve written about before, there’s a lot more going on in Chester than just bad numbers. Offloading the water system to a private company may very well be the answer to fixing the city’s pension debt. But it won’t come close to addressing the short-sided governance and mismanagement that bankrupted the city in the first place. That’s true of any distressed city looking for an easy out to its debt.
The problem with ‘fair’ market value legislation
Pennsylvania isn’t the only place with a rash of localities selling their water utilities. A total of 12 states have now passed Fair Market Value (FMV) acquisition regulations: California, Iowa, Illinois, Indiana, Maryland, Missouri, New Jersey, North Carolina, Ohio, Pennsylvania, Texas and Virginia.
FMV legislation’s aim is to encourage larger utilities to purchase distressed, municipal, or smaller water systems and thus provide the scale of funding and expertise needed to upgrade and stabilize them. On the surface, the idea of upping the price seems like a good idea. After all, more money to spend on services, stabilize the budget, etc. is better for taxpayers.
But raising the price of the sale has ramifications: namely that the new owner will want to recoup those costs and that will most likely come through rate hikes. FMV often also allows the private utility to spread costs over its entire rate base. While that means the costs associated with upgrading an aging system in one county can be spread across many more people and thus reduce the per-customer rate hike, it also means that all customers will pay the cost of acquiring more water systems.
Those costs have been rising as private companies buy up larger systems. Pennsylvania American Water’s deal to buy York’s water system was for $235 million on top of an estimate $17.5 million needed for upgrades. Aqua Pennsylvania’s failed bid for Bucks County’s public sewer system was for an eye-popping $1.1 billion. (County commissioners decided not to sell after a public backlash.)
Bottom line, FMV works better financially for the purchaser in the long run. A Philadelphia Inquirer editorial opposing the Bucks County sale warned that other places that sold off municipal water and sewer systems, towns have come to rue it. In fact, Mooresville, Ind., tried to buy back its water system from American Water after residents grew frustrated with rate hikes, but couldn’t afford the ticket price. “Local governments should say no to the fast bucks being waved around for municipal water and sewer systems,” the Inquirer said. “Any cash taken in up-front will only result in rate hikes and regrets later on.”
Governments shed the burden but taxpayers don’t
It’s not that privatizing a water utility is always a bad idea. There’s a lot to be said for the capital these companies have to invest in the infrastructure backlog and keep water systems safe. And in many cases, bringing a smaller water system into the fold of a larger utility can cut down on operational costs.
However any claim that selling off an income-generating public asset will save taxpayers money should be met with a healthy dose of skepticism. Sure, in the short term that’s probably true—especially if the proceeds from the sale are used to pay off the debt. That frees up money in the budget to invest today in the services and amenities residents need for quality of life.
But let’s also consider that these water systems need big upgrades because elected officials don’t like raising taxes or rates to pay for the infrastructure investments and maintenance required to keep these systems in tip top shape. Selling them makes it someone else’s responsibility but it doesn’t change the fact that rates will go up to pay for it.
Some sales stipulate a grace period of several years before the new owner is allowed to raise rates, but they do, the difference is often dramatic. The Inquirer editorial noted that five towns where Aqua recently purchased municipal water systems were hit with percentage rate hikes ranging from 47% in East Bradford to 98% in Limerick Township. “By comparison,” the Inquirer said, “residential customers in Philadelphia, where the city owns the water department, pay about half as much as suburban customers of for-profit water companies.”
As fixing water infrastructure gets more expensive, the temptation to turn the burden over the the less-accountable private sector has only become greater. “After all,” the Washington Post pointed out a few years ago, “once a system has been sold, private operators, not public officials, take the blame for higher rates.”
And with rate differences that big, it makes you wonder. How much of that hike is private sector profiteering and how much of it was a necessary cost increase government officials were simply avoiding?
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